diff --git a/parsed_sections/legal_matters/2002/CIK0000006260_anacomp_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000006260_anacomp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8a84d05a789f3f0b81822d923b1afdb692fc9909 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000006260_anacomp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the Class A Common Stock offered by this prospectus will be passed upon for Anacomp by Leagre Chandler & Millard LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000020232_chyronhego_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000020232_chyronhego_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..edc36f6df4b3c110ba852beccf75698b2abb8924 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000020232_chyronhego_legal_matters.txt @@ -0,0 +1,836 @@ +legal matters incidental to our business. In the opinions of management, the ultimate resolution of such matters will not have a material adverse effect on our financial position, results of operations or liquidity. + +Properties + + The executive offices and principal office of our company and our graphics business are located in Melville, New York pursuant to a lease that expires on June 30, 2004. This facility consists of approximately 47,000 square feet and is used for manufacturing, research and development, marketing and the executive offices. We closed down sales offices in Dunwoody, GA, of 2,700 square feet, and in Cupertino, CA, of 4,000 square feet, but we remain liable pursuant to leases, which both expire on November 30, 2002. + + In the United Kingdom, our executive office is located in Reading, U.K. where we own a facility of approximately 19,000 square feet. This facility is also used for research and development and marketing and sales. We occupy additional facilities in Reading U.K., used primarily for manufacturing, assembly and test, which total approximately 28,000 square feet pursuant to leases that expire from December 25, 2012 through September 29, 2020. We currently utilize 90% to 100% of the space of all of our facilities. Management believes that each facility is suitable for our existing operations and does not foresee the need for any significant expansion of our current U.K. facilities. Finally, we have a sales office in Paris, France of approximately 3,000 square feet from which we cover the French market and support adjacent territories. + +Management + +Executive Officers and Directors + + Our executive officers and directors, and their ages and positions as of October 1, 2002 are as follows: + + Name + +Age + + Position + +Charles M. Diker + +67 + +Director, Member of the Audit Committee, Member of the Compensation and Stock Option Committee + +Donald P. Greenberg + +68 + +Director + +Roger Henderson + +46 + +President and Chief Executive Officer, Director + + + + + +Christopher R. Kelly + +43 + +Director + +Wesley W. Lang, Jr. + +45 + +Chairman of the Board of Directors, Chairman of the Compensation and Stock Option Committee + +Eugene M. Weber + +51 + +Director, Member of the Audit Committee + +Michael I. Wellesley-Wesley + +50 + +Director, Chairman of the Executive Committee of the Board of Directors, Member of the Office of the Chairman, Member of the Compensation and Stock Option Committee + +Jerry Kieliszak + +50 + +Senior Vice President and Chief Financial Officer + +James M. Paul + +59 + +Executive Vice President + +Graham Pitman + +52 + +Senior Vice President and Managing Director of Chyron Pro-Bel + + Charles M. Diker has been a director of our company since September, 1995. He was a non-managing principal with the investment management company of Weiss, Peck & Greer, L.L.C. from April 1995 through October 2001, and had previously been associated with such company since 1976. Mr. Diker has been the Chairman of the board of directors of Cantel Medical Corporation, a manufacturer of infection control equipment and distributor of diagnostic devices, since 1986. Mr. Diker is also a member of the board of directors of International Specialty Products Inc., a manufacturer of specialty chemicals. Mr. Diker was a member of the board of directors of AMF Bowling Inc., an operator of bowling centers, from April 1996 through March 2002. + + Donald P. Greenberg has been a director of our company since September, 1996. He is the Jacob Gould Schurman Professor of Computer Graphics and Founding Director, Program of Computer Graphics, at Cornell University. He has been a professor at Cornell University since 1968. He is also a member of the board of directors of Interactive Data Corporation, a provider of various financial data and proprietary information, and PCA International, an operator of portrait studios. + + Roger Henderson is our President and Chief Executive Officer and has held such positions since June 1999. He has been a director of our company since February 1999. Prior to his current positions, he served as the Managing Director of Chyron Pro-Bel since April 1996. From 1987 to March 1996, he was Software Director of Pro-Bel and Managing Director of Pro-Bel Software Ltd. + + Christopher R. Kelly has been a director of our company since August 1999. He has been the owner of Fortuna Investments since 1997, where he specializes in private investments and venture capital. From 1985 through 1997, he held various positions, including partner and director, at Kelly Television. During his last four years at Kelly Television, he was also Partner and Director of Kelly Broadcasting Company. + + Wesley W. Lang, Jr. has been a director of our company since July 1995 and has served as Chairman of our board of directors since February 2002. He continues to serve as a Managing Director with the investment management company of Weiss, Peck & Greer, and has been associated with such company since 1985. Weiss, Peck & Greer manages, directly or indirectly, the following funds: WPG Corporate Development Associates IV, L.L.C.; WPG Enterprise Fund II, L.L.C., WPG Corporate Development Associates IV (Overseas), L.P., and Weiss, Peck & Greer Venture Associates III, L.L.C. (collectively, the "WPG Funds"). These funds are shareholders of our company. + + Eugene M. Weber has been a director of our company since July 1995. He is the Managing Partner of Weber Capital Management, L.L.C., an investment management firm that is the successor to Bluewater Capital Management, Inc., which Mr. Weber founded in 1995. From 1994 to 1995, Mr. Weber was an independent consultant to Westpool Investment Trust plc, a shareholder of our company, and from 1983 to 1994 he was with Weiss, Peck & Greer, L.L.C., becoming a partner in 1987. + + Michael I. Wellesley-Wesley is Chairman of the Executive Committee of the board of directors as of February 2002 and a Member of the Office of the Chairman. He formerly held the position of Executive Chairman of the board of directors from July 1995 through February 2002 and previously served as our Chief Executive Officer from July 1995 through June 1997. He is currently a Managing Director of WIT Soundview Ventures. From 1992 until 1995, he was a Director and Executive Vice President of DBC and from 1990 until 1992 he was a consultant to that corporation's predecessor. Mr. Wellesley-Wesley was an executive director of Stephen Rose & Partners Ltd., a London-based investment banking firm, from 1980 to 1990. + +Executive Officers + + In addition to Mr. Henderson, our executive officers are as follows: + + Jerry Kieliszak joined us in March 2002 as Senior Vice President and Chief Financial Officer. From 2000 to 2001 he served as Executive Vice President and Chief Financial Officer of CoreCommerce, a business-to-business e-commerce software developer. From 1989 to 2000, Mr. Kieliszak was Vice President and Chief Financial Officer of ABT Corporation, an international enterprise project management software development company. From 1977 to 1989 he was with Price Waterhouse where he was a Senior Audit Manager. + + James M. Paul is General Manager of the Graphics Division and is a corporate Executive Vice President. Mr. Paul joined us as Senior Vice President, Human Resources in October 1997 and was promoted to General Manager, Graphics Division, in January 2001 and named a corporate Executive Vice President in mid-2001. From February 1995 through September 1997 he held the position of Senior Vice President, Human Resources with TELE-TV. From 1993 to 1995, Mr. Paul was Human Resource Director for Bell Atlantic Information and Video Services. From 1975 to 1993 he held several management positions at PRC Inc., a subsidiary of Black and Decker Corporation, including Vice President, Human Resource Policy and Programs and Vice President of Human Resources for the Commercial and International Group. + + Graham Pitman is Senior Vice President, Worldwide Sales & Marketing. Mr. Pitman was appointed Senior Vice President, Worldwide Sales & Marketing in April 2001. From 1999 to 2001 he served as Senior Vice President and Managing Director of the Pro-Bel Division. He joined Pro-Bel Ltd. in 1977 as a Founding Director and, upon our acquisition of it in 1996, served as Operations Director and later General Manager of the Pro-Bel Hardware Division until 1999. + +Board of Directors + + Our directors are elected annually to serve until the next annual meeting of shareholders or until their successors are duly elected and qualified. + +General + + Our board of directors has created a Compensation and Stock Option Committee (the "Compensation Committee") and an Audit Committee. In addition, from time to time our board has created other sub-committees in order to address specific needs of our company. Recently, our board created an Office of the Chairman that consists of Messrs. Henderson, Lang and Wellesley-Wesley. This office is charged with enhancing shareholder value. + + The Compensation Committee is authorized to review and make recommendations to the board of directors on all matters regarding the remuneration of our executive officers, including the administration of our compensation plans. The current members of the Compensation Committee are Messrs. Diker, Lang and Wellesley-Wesley. + + The Audit Committee is responsible for making recommendations to the board of directors as to the selection of our independent auditor, maintaining communication between the board of directors and the independent auditor, reviewing the annual audit report submitted by the independent auditor and determining the nature and extent of problems, if any, presented by such audit warranting consideration by our board of directors. The current members of the Audit Committee are Messrs. Diker and Weber. Membership on the Audit Committee is restricted to directors who are independent of management and free from any relationship that, in the opinion of the board of directors, would interfere with the exercise of independent judgment as a committee member. + +Compensation Committee Interlocks and Insider Participation + + Messrs. Diker, Lang and Wellesley-Wesley served as members of our Compensation Committee during 2001. No executive officer served as a director of another entity or as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served as a member of our board of directors or on our Compensation Committee. + + Mr. Wellesley-Wesley, a member of the Office of the Chairman, the Compensation Committee and Chairman of the Executive Committee of our board of directors, served as our Chief Executive Officer from July 1995 through June 1997. During 2001, Mr. Wellesley-Wesley was paid $15,000 on a monthly basis for a period of six months and an additional $26,000 in other forms of compensation for consulting and other services rendered in respect of transactions and potential transactions involving our company. Mr. Wellesley-Wesley will continue to receive the $15,000 monthly payment during fiscal 2002 for consulting and other services related to future transactions involving our company. Mr. Wellesley-Wesley may also receive a bonus upon the consummation of certain transactions constituting a sale of our company on or before December 31, 2002. The amount of the bonus varies between one-quarter of one percent (0.25%) and one-half of one percent (0.50%) of the gross sales price obtained in such transaction. + +Director Compensation + + Our directors who are also salaried officers or employees of our company do not receive special or additional compensation for serving on our board of directors or any of its committees. Each director who is not a salaried officer or employee of our company receives an annual fee of $5,000 (except for the Chairman who receives an annual fee of $10,000), plus $1,000 for attending each meeting of the board of directors and $500 for attending each committee meeting. In addition, each non-employee director receives options to purchase 5,000 shares of Common Stock at an exercise price equal to the market value on the last trading day of each July. + +Executive Compensation + + The following table sets forth certain information with respect to compensation for the year ended December 31, 2001 earned by our Chief Executive Officer and our two other most highly compensated executive officers serving as such at December 31, 2001, whose compensation exceeded $100,000 for the years indicated. No other executive officer of our company earned a salary and bonus for the fiscal year ended December 31, 2001, in excess of $100,000. In this prospectus, we refer to these individuals as our named executive officers. + +Summary Compensation Table + + + + +Annual Compensation(1) + +Long Term Compensation + + + + + + + +Restricted + +Securities + +All Other + +Name and Principal + + + + +Stock + +Underlying + +Compensation + +Position + +Year + +Salary + +Bonus(2) + +Awards(2) + +Options + + (3) + + + + + + + + + +Roger Henderson + +2001 + +$293,089 + +$ 0 + +$ 0 + +150,000 + + +President, CEO and + +2000 + +297,139 + +37,500 + +37,500 + +90,000 + + +Director + +1999 + +228,773 + +83,000 + +0 + +300,000 + + + + + + + + + + +James M. Paul + +2001 + +192,000 + +0 + +0 + +60,000 + +12,300 + +Executive Vice President + +2000 + + 164,904 + +15,050 + +15,050 + +45,000 + + 10,400 + +and General Manager, + +1999 + +157,672 + +32,500 + +0 + +30,000 + + 10,400 + +Graphics Division + + + + + + + + + + + + + + + +Graham Pitman + +2001 + +156,832 + +0 + +0 + +60,000 + + +Senior Vice President, + +2000 + +152,661 + +4,875 + +4,651 + +35,000 + + +Worldwide Sales + +1999 + +137,819 + +21,000 + +0 + +55,000 + + +& Marketing + + + + + + + +(1) Other Annual Compensation has been excluded since such amounts do not exceed the lesser of $50,000 or 10% of the total annual base salary and bonus disclosed in this table for any of the named executive officers. + +(2) The 2000 bonus amount was payable partly in cash and partly in restricted stock which cannot be sold for a period of one year from May 2001, when the shares were issued. Messrs. Henderson, Paul and Pitman were awarded 32,895, 13,202 and 4,079 shares, worth $37,500, $15,050 and $4,651, respectively, based on the closing price of our common stock on the OTC Bulletin Board on the date of issuance of $1.14 per share. At December 31, 2001, these shares were valued at $8,882, $3,565, and $1,101, respectively, based on the closing price of our common stock $0.27 per share on the OTC Bulletin Board. + +(3) All other compensation for James Paul includes company contributions under the U.S. 401(k) plan of $2,100, $2,000 and $2,000 and automobile allowance of $10,200, $8,400 and $8.400 for 2001, 2000 and 1999, respectively. + +Stock Option Grants + + The following table sets forth the stock options we granted during the fiscal year ended December 31, 2001 under our 1999 Incentive Compensation Plan to each of the named executive officers. + + + +Option Grants in Last Fiscal Year + + + + + +Individual Grants + + + + + +Number of + +Percent of + + + + + + +Securities + +Total Options + + + + + + +Underlying + +Granted to + +Exercise + + +Grant Date + +Present Value + + + +Options + +Employees in + +Price + +Expiration + + + +Granted + +Fiscal Year + +Per Share + +Date + + + + + + + + +Roger Henderson + +150,000 + +8.8% + +$0.55 + +7/25/11 + +$61,500 + + + + + + + + +James M. Paul + +60,000 + +3.5% + +$0.55 + +7/25/11 + +$24,600 + + + + + + + + +Graham Pitman + +60,000 + +3.5% + +$0.55 + +7/25/11 + +$24,600 + + + + + + + + + All options reported above were awarded under the 1999 Incentive Compensation Plan. We have not granted any stock appreciation rights. Pursuant to the terms of the Plan, the exercise price per share for all options is the closing price of the Common Stock as quoted on the OTC Bulletin Board on the date of grant. The options reported above for Roger Henderson vested as follows: 25,000 became exercisable on the 25th day of each of the months August 2001 through January 2002. The options reported above for James M. Paul and Graham Pitman became exercisable on January 25, 2002. + + "Grant Date Present Value" is determined under the Black-Scholes pricing model, a widely recognized method of determining the present value of options. The factors used in this model are as follows: dividend yield = 0.0%, volatility =110.9%, risk-free rate of return = 4.25% and option terms of 4 years. The actual value, if any, an executive officer may realize will depend on the extent to which conditions as to exercisability of the option are satisfied and the excess of the stock price over the exercise price on the date the option is exercised. There is no assurance that the value realized by an executive officer will be consistent with the value estimated by the Black-Scholes model. The estimated values under the model are based on assumptions regarding interest rates, stock price volatility and future dividend yield. The model is used for valuing market traded options and is not directly applicable to valuing stock options granted under our 1999 Incentive Compensation Plan that cannot be transferred. + +Fiscal Year End Option Values + + Our named executive officers did not exercise any options during the fiscal year ended December 31, 2001. The following table sets forth information concerning the number of options owned by the named executive officers and the value of any in-the-money unexercised options held by the named executive officers at December 31, 2001. + +Aggregated Option Exercises in Last Fiscal Year + +and Fiscal Year-End Option Values + +Name + +Shares + +Acquired + +On + +Exercise + +Value + +Realized + +Number of + +Securities Underlying + +Unexercised Options At + + Fiscal Year-End + +Value of + +Unexercised + +In-the-Money Options + + at Fiscal Year-End + +Exercisable + +Unexercisable + +Exercisable(1) + +Unexercisable(1) + + + + + + + + + +Roger Henderson + +- + +- + +527,499 + +122,501 + +$0 + +$0 + + + + + + + + + +James M. Paul + +- + +- + +77,499 + +107,501 + +$0 + +$0 + + + + + + + + + +Graham Pitman + +- + +- + +80,332 + +119,668 + +$0 + +$0 + + + + + + + + + +(1) As of December 31, 2001, none of the unexercised options held by the named executive officers were in-the-money. + + + +Employment Agreements and Change-in-Control Arrangements + + We have an employment agreement with Mr. Henderson, our President and Chief Executive Officer, which is in effect until June 30, 2003 and can be renewed on an annual basis thereafter. Under the agreement, Mr. Henderson is entitled to receive a base salary of $325,000, subject to adjustment based on the Consumer Price Index. In addition, Mr. Henderson is eligible to receive an annual bonus of up to 50% of his base salary based upon the achievement of performance goals determined by the Compensation Committee. If the agreement is terminated for cause, Mr. Henderson is entitled only to receive that portion of his base salary owed through date of termination. If the agreement is terminated without cause, Mr. Henderson is entitled to receive the greater of his base salary for a twelve-month period or the remainder of his employment term. In addition, all options which have not vested at the date of termination shall immediately vest. The agreement also contains certain restrictions on competition. Mr. Henderson voluntarily reduced his base salary to $280,000 per annum for the period commencing April 1, 2001 through December 31, 2002. In addition, we have entered into an agreement with Mr. Henderson whereby he may receive a bonus upon the consummation, on or before December 31, 2002, of certain transactions constituting a sale of our company. The amount of the bonus varies between one-quarter of one percent (0.25%) and one-half of one percent (0.50%) of the gross sales price obtained in such transaction. + + We have an employment agreement with Mr. Paul, Executive Vice President, which is in effect until October 30, 2003. Mr. Paul is entitled to receive an annual base salary of $215,000 and is eligible for a bonus of up to 30% of his base salary, subject to the achievement of certain annual performance criteria set by the Compensation Committee. If the agreement is terminated for cause, Mr. Paul is entitled only to receive that portion of his base salary owed through the date of termination. If the agreement is terminated without cause, Mr. Paul will be entitled to his base salary and bonus for the lesser of eighteen months or the balance of his employment term. In addition, all options granted which have not vested at the date of termination shall immediately vest. The agreement also contains certain restrictions on competition. Mr. Paul voluntarily reduced his base salary to $185,000 per annum for the period commencing April 1, 2001 and continuing through October 30, 2003. + + We have an employment agreement with Mr. Pitman, Senior Vice President and Managing Director of Chyron Pro-Bel. The agreement is indefinite until Mr. Pitman is provided written notification by our company. The required notice period is one year. Under the agreement, Mr. Pitman is entitled to receive a base salary of 100,000 British pounds sterling ($145,000 at March 1, 2002). Mr. Pitman shall be entitled to additional remuneration and bonuses as determined by the Compensation Committee. The agreement also contains restrictions on competition. + + Mr. Paul and Mr. Pitman are participants in our Executive Retention Program implemented in July 2001, and in effect through December 31, 2003. The program is intended to encourage executives to actively support the sales process in the event of a sale of our company. Under the program, each of Messrs. Paul and Pitman were granted 60,000 loyalty options in July 2001, which vested 6 months from the date of grant, and is eligible to receive a loyalty bonus equal to 3 months' base salary ($53,750 and $40,560, respectively) upon a sale of our company. Although the program contemplates payment of a prorated annual bonus, based upon the participant's bonus received in the prior year, to participants who transfer to a successor company or who are involuntarily terminated upon a sale of our company, no such bonus would be payable under the program because neither Mr. Paul nor Mr. Pitman received a bonus for 2001. The program recognizes Mr. Pitman's right to receive severance payments for a period of one year under his employment agreement. In addition, Mr. Paul is eligible to receive payment of COBRA premiums and a minimum of 9 months' severance payments under his employment contract. + +Pension Plans + + We maintain a domestic, qualified non-contributory defined benefit pension plan (the "U.S. Pension Plan") for all of our employees. Under the U.S. Pension Plan, a participant retiring at normal retirement age receives a pension benefit equal to the sum of: (i) 25% of his or her average monthly total compensation up to the level of social security covered compensation plus 38% of such earnings in excess of social security covered earnings for years of service prior to July 1, 1998 and (ii) 32% of his or her average monthly base compensation up to the level of social security covered compensation plus 48% of such earnings in excess of social security covered earnings for years of service subsequent to July 1, 1998. A participant's average monthly compensation is his or her monthly compensation averaged during the five consecutive years during the ten-year period prior to his or her termination that produces the highest average monthly compensation. + + Participants in the U.S. Pension Plan vest according to the following schedule: + +Employees Hired Prior to July 1, 1998 + + +Employees Hired on or After July 1, 1998 + + + + + + + + + +Years of Service + + +Amount Vested + + +Years of Service + + +Amount Vested + + + + + + + + + +Less than 2 + + +0% + + +Less than 5 + + +0% + +2 + + +20% + + +5 or more + + +100% + +3 + + +40% + + + + + +4 + + +60% + + + + + +5 or more + + +100% + + + + + + As of December 31, 2001, the number of years of service for the named executive officers is as follows: Mr. Paul, 4 years, entitling him to 60% vesting. + + The following table shows the aggregate annual benefits under the U.S. Pension Plan as now in effect that would be currently payable to participants retiring at age sixty-five on a single-life basis under various assumptions as to salary and years of service. Benefits under the U.S. Pension Plan are payable in the form of a monthly, lifetime annuity commencing on the later of normal retirement age or the participant's date of retirement, or, at the participant's election, in a lump sum or installment payments. The amounts shown reflect the level of social security covered compensation for a participant reaching age 65 in 2001. In addition, the participant is entitled to receive social security benefits. The Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986, as amended, limit the annual retirement benefit that may be paid out of funds accumulated under a qualified pension plan. The current maximum annual benefit payable under the U.S. Pension Plan is $130,000. This maximum is proportionately reduced for years of plan participation less than ten. Compensation in excess of $200,000 may not be taken into account in the determination of benefits under the U.S. Pension Plan. + +U.S. Pension Plan Table + + + +Highest Consecutive Five-Year Average + +Years of Credited Service at Retirement at Age 65 + +Compensation During the Last Ten Years + + + + + +of Employment + +10 + +20 + +30 + +35 + + + + + + + + + + +$ 50,000 + +$ 5,200 + +$10,300 + +$15,500 + +$18,000 + + + +100,000 + +12,000 + +24,000 + +36,000 + +42,000 + + + +150,000 + +18,900 + +37,700 + +56,600 + +66,000 + + + +160,000 + +20,200 + +40,500 + +60,700 + +70,800 + + + +170,000 + +21,600 + +43,200 + +64,800 + +75,600 + + + +200,000 + +25,700 + +51,500 + +77,200 + +90,000 + + Our U.K. subsidiary, Pro-Bel, has a non-contributory defined benefit pension plan (the "U.K. Pension Plan") covering all permanent employees of Pro-Bel who were hired prior to 1999. Under the U.K. Pension Plan, a participant retiring after working 40 years with Pro-Bel will receive 66.66% of his or her basic earnings averaged over the last 36 months of employment in addition to the U.K.'s basic and earnings related pension. Under U.K. legislation, benefits vest on a pro rata basis following completion of 2 years of membership. Spouses' pension of 50% of the members pension are payable on the death of the plan member whether in service or following retirement. As of December 31, 2001, Mr. Henderson and Mr. Pitman, participants in the U.K. Pension Plan, have 17 years and 22 years of credited service, respectively. + +401(k) Plan + + We adopted a 401(k) Plan exclusively for the benefit of participants and their beneficiaries. All of our U.S. employees are eligible to participate in the 401(k) Plan. Effective July 1, 1998, we amended our 401(k) Plan by increasing our matching contribution to one-fifth of up to the first 10% of the compensation contributed by a participant and changing our matching contributions from cash to our common stock and the vesting period for the matching contribution to three years. An employee may elect to contribute a percentage of his or her current compensation to the 401(k) Plan, subject to a maximum of 20% of compensation or the Internal Revenue Service annual contribution limit ($10,500 in 2001 and 2000), whichever is less. Total compensation that can be considered for contribution purposes is limited to $170,000. + + We can elect to make a contribution to the 401(k) Plan on behalf of those participants who have made salary deferral contributions. During 2001, 2000 and 1999, we contributed $0.09 million, $0.06 million and $0.1 million, respectively, to the 401(k) Plan. + +Stock Option and Other Employee Incentive Plans + + On May 12, 1999 our shareholders adopted our 1999 Incentive Compensation Plan (the "1999 Plan"). On February 28, 2002, our board of directors unanimously adopted, subject to approval by our shareholders, an amendment to the 1999 Plan to increase the maximum number of shares available for grant thereunder by 1,000,000 shares. The amendment to the 1999 Plan was approved by our shareholders on May 23, 2002. The following general summary of our 1999 Plan is qualified in its entirety by reference to the text of the 1999 Plan, a copy of which is on file with the SEC. See "Where You Can Find More Information" for a description of the documents incorporated by reference. + + The purpose of the 1999 Plan is to assist us in attracting, retaining and rewarding high-quality executives, employees, directors and other persons who provide services to us, enabling these persons to acquire or increase a proprietary interest in us and to strengthen the mutuality of interests between us and such persons, and to provide annual and long-term incentives to expend their maximum efforts in the creation of shareholder value. The 1999 Plan is administered by the Compensation Committee, consisting of two or more members of the board of directors appointed by the board. The 1999 Plan does not limit the availability of awards to any particular class or classes of eligible employees. If an award were to lapse or rights to an award otherwise were to terminate, the shares subject to the award would be available for future awards to the extent permitted by applicable federal securities laws. Awards granted under the 1999 Plan are not transferable, except in the event of the participant's death. In the event of a change in control, a right to exercise that was not previously exercisable and vested shall become fully exercisable and vested at the time of change in control. + + The total number of shares authorized for issuance in connection with awards under the 1999 Plan is 2,500,000 plus the number of shares remaining available under our 1995 Long-Term Incentive Plan (the "1995 Plan") immediately prior to the date on which our shareholders approved adoption of the 1999 Plan, plus the number of shares of our common stock subject to awards under the 1995 Plan which become available in accordance with the 1999 Plan, for an aggregate of 5,500,000 shares authorized for issuance under the 1999 Plan. As of October 1, 2002, 375,614 options granted under the 1999 Plan had been exercised and 3,875,610 options granted under the 1999 Plan were outstanding, leaving 1,248,776 shares remaining available for future option grants. + + Awards to Eligible Employees under the 1999 Plan are made in the form of stock options, stock appreciation rights ("SARs"), restricted stock, restricted stock units ("RSUs") and annual incentive and performance awards. A non-employee director will automatically be granted options at the close of business on the last trading day of each July. The Compensation Committee, in its sole discretion, designates whom is eligible to receive awards, determines the form of each award, determines the number of shares of stock subject to each award, establishes the exercise price of each award and such other terms and conditions applicable to the award as the Compensation Committee deems appropriate. + + Stock option awards can be either incentive or non-incentive. In either case, the exercise price of the option would not be less than the fair market value of the underlying shares as of the date the award is granted. Options would become exercisable at such times as may be established by the Compensation Committee when granting the award. No stock option could be exercised more than ten years after the date the option is granted. + + A SAR allows the holder, upon exercise, to receive the excess of the fair market value of one share of our common stock on the date of exercise over the grant price of the SAR. The Compensation Committee determines the circumstances under which a SAR may be exercised, the month of exercise and method of settlement. SARs may be awarded independently or in tandem with other awards. + + Restricted stock awards are awards of shares subject to such restrictions as to transferability and risk of forfeiture as imposed by the Compensation Committee, which restrictions may lapse separately under such circumstances such as achievement of performance goals and/or future service requirements. Except to the extent restricted under the terms of the 1999 Plan, any employee granted restricted stock shall have all the rights of a shareholder including the right to vote and receive dividends. + + The Compensation Committee is authorized to grant RSUs to participants which are rights to receive stock, cash, or a combination thereof at the end of a specified deferral period. The Compensation Committee is also authorized to grant stock as a bonus or to grant stock in lieu of obligations to pay cash under the 1999 Plan or under other compensatory arrangements. + + Our board of directors may amend or terminate the 1999 Plan at any time without the consent of shareholders, except that any amendment or alteration to the 1999 Plan shall be subject to the approval of our shareholders not later than the annual meeting next following such board action if shareholder approval is required by any federal or state law or regulation or the rules of any stock exchange or automated quotation system on which the common stock may then be listed or quoted, provided that, without the consent of an affected participant, no such board action may materially and adversely affect the rights of such participant under any previously granted and outstanding award. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000021239_coastal_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000021239_coastal_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4580d78447a80fa6ee4cabb91647a486dd6a53c2 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000021239_coastal_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Murtha Cullina LLP, Hartford, Connecticut, has passed upon legal matters relating to U. S. law in connection with this offering. Mr. Timothy L. Largay, a director and officer of the Company, is a partner of Murtha Cullina LLP. Mr. Largay owns shares of our common stock, has options to purchase shares of our common stock (See Security Ownership of Management) and Murtha Cullina has a contingency fee in the Florida Litigation (See Legal Proceedings). All matters relating to Bermuda law affecting Coastal Caribbean and its common stock have been passed upon by the firm of Conyers Dill & Pearman, Hamilton, Bermuda, of which firm Mr. Collis, a director and Secretary of Coastal Caribbean, is a partner. Mr. Dill, a director, is a consultant to the firm of Conyers Dill & Pearman. Both Messrs. Dill and Collis own shares of our common stock and have options to purchase shares of our common stock (See Security Ownership of Management). The firm of Angerer & Angerer, Tallahassee, Florida, has passed upon all matters relating to litigation in which Coastal Petroleum has been involved until December 31, 2000. Mr. Angerer has a contingency fee in the Florida Litigation (See Legal Proceedings). The firm of Gaylord Merlin Ludovici Diaz & Bain, Tampa, Florida, has passed upon all matters relating to litigation filed in Florida Circuit Court pertaining to the taking case in which Coastal Petroleum has been involved since January 1, 2001. Gaylord Merlin Ludovici Diaz & Bain has a contingency fee in the Florida Litigation (See Legal Proceedings). Murtha Cullina LLP may rely, insofar as Bermuda law is concerned, on the opinion of Bermuda counsel, and insofar as litigation is involved, on the opinions of Angerer & Angerer and Gaylord Merlin Ludovici Diaz & Bain. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000029806_constar_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000029806_constar_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f729c98b754818f2446b57447ed7bc04542cc84e --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000029806_constar_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered hereby will be passed upon for us and for Crown by Dechert, Philadelphia, Pennsylvania and for the underwriters by Cleary, Gottlieb, Steen & Hamilton, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000353827_pharmaceut_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000353827_pharmaceut_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4ac96dbd2534bfb61c94954b489ff872ff287d80 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000353827_pharmaceut_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Stroock & Stroock & Lavan LLP, New York, New York, our counsel, will issue an opinion with respect to the validity of the shares of common stock offered in this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000704328_somanetics_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000704328_somanetics_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4957fc4680e1d718882529796133bca9dc519ea2 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000704328_somanetics_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the common shares offered by this Prospectus will be passed upon for Somanetics by Honigman Miller Schwartz and Cohn LLP, Detroit, Michigan. Certain legal matters will be passed upon for the Placement Agent by Piper Marbury Rudnick & Wolfe LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000797313_chell_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000797313_chell_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..72889dbf0d193970ce4cd1235606d940c512c661 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000797313_chell_legal_matters.txt @@ -0,0 +1 @@ +Legal matters Certain legal matters with respect to the validity of the shares of common stock offered hereby are being passed upon for us by Mintz & Fraade, P.C., 488 Madison Avenue, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000880285_enbridge_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000880285_enbridge_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..65f8a7f493ed1dca8f6f283268b0e9ad5cae133a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000880285_enbridge_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares and the i-units offered by this prospectus will be passed upon for us by Vinson & Elkins L.L.P., Houston, Texas. Various legal matters relating to the offering will be passed upon for the underwriters by Andrews & Kurth L.L.P., Houston, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000886239_graphic_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000886239_graphic_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b17d36cc7406237c848fd6170d2a6c741220c6d5 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000886239_graphic_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of common stock offered by this prospectus will be passed upon for us by Debevoise & Plimpton, New York, New York, and for the underwriters by Cravath, Swaine & Moore, New York, New York. Franci J. Blassberg, Esq., a member of Debevoise & Plimpton, is married to Joseph L. Rice, III, who is a shareholder of the general partner of the general partner of Clayton, Dubilier & Rice Fund V Limited Partnership. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000890924_data-race_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000890924_data-race_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3b5cefe4c7ea772852924e6103b8210253aed1ff --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000890924_data-race_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Feldman Weinstein LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000891456_plains_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000891456_plains_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f1b39cf76e21696af9508f7222946575a02d1345 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000891456_plains_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Akin Gump Strauss Hauer & Feld LLP will pass on certain legal matters with respect to the validity of the common stock offered hereby. Certain legal matters in connection with this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000891533_arg_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000891533_arg_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4d36976b6bec296b7a86e12ac0db941117673834 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000891533_arg_legal_matters.txt @@ -0,0 +1,5087 @@ +LEGAL MATTERS + + + The validity of the Notes and certain legal matters in connection with this offering will be passed upon for the Company by Milbank, Tweed, Hadley & McCloy +LLP, Los Angeles, California. + + + + +EXPERTS + + + The financial statements included in this Prospectus and elsewhere in the Registration Statement to the extent and for the periods indicated in their report have +been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report with respect thereto, and are included herein in reliance upon the authority of said firm as experts +in accounting in giving said report. + +65 + + + + + + +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS + + + + + +Page + +Report of Independent Public Accountants + +F-2 + +Consolidated Balance Sheets as of December 27, 1999, December 25, 2000, and September 24, 2001 + + + +F-3 + +Consolidated Statements of Operations for the Years Ended December 28, 1998, December 27, 1999, and December 25, 2000, and the Thirty-nine Weeks Ended September 25, 2000 and September 24, 2001 + + + +F-4 + +Consolidated Statements of Common Stockholders' Equity (Deficit) for the Years Ended December 28, 1998, December 27, 1999 and December 25, 2000 + + + +F-5 + +Consolidated Statements of Cash Flows for the Years Ended December 28, 1998, December 27, 1999, and December 25, 2000, and the Thirty-nine Weeks Ended September 25, 2000 and September 24, 2001 + + + +F-6 + +Notes to Consolidated Financial Statements + + + +F-7 + +F-1 + + + + + + +REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS + + +To +the Board of Directors of + +American Restaurant Group, Inc.: + + We +have audited the accompanying consolidated balance sheets of AMERICAN RESTAURANT GROUP, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 27, 1999 and +December 25, 2000, and the related consolidated statements of operations, common stockholders' equity (deficit), and cash flows for the years ended December 28, 1998, December 27, +1999, and December 25, 2000. 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. + + We +conducted our audits in accordance with auditing standards generally accepted in the United States. 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. + + In +our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Restaurant Group, Inc. and subsidiaries as +of December 27, 1999 and December 25, 2000, and the results of their operations and their cash flows for the years ended December 28, 1998, December 27, 1999, and +December 25, 2000, in conformity with accounting principles generally accepted in the United States. + +/s/ +ARTHUR ANDERSEN LLP + +San +Francisco, California + +March 2, 2001 + +F-2 + + + + + + +AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + CONSOLIDATED BALANCE SHEETS + DECEMBER 27, 1999, DECEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + + +December 27, + +1999 + +December 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + +(unaudited) + + + + +ASSETS + + + + + + + + + + + +CURRENT ASSETS: + + + + + + + + + + + + +Cash + +$ +8,316 + +$ +8,532 + +$ +3,850 + + + +Accounts receivable + + +2,655 + + +2,938 + + +3,690 + + + +Inventories + + +2,755 + + +2,853 + + +2,916 + + + +Prepaid expenses + + +2,873 + + +2,803 + + +4,521 + + + + +Net current assets of discontinued operations + + +6,068 + + + + + + + + + + + + + + + + + + + + +Total current assets + + +22,667 + + +17,126 + + +14,977 + + + + + + + + + + + +PROPERTY AND EQUIPMENT: + + + + + + + + + + + + +Land and land improvements + + +2,629 + + +2,629 + + +2,598 + + + +Buildings and leasehold improvements + + +65,418 + + +67,631 + + +69,409 + + + +Fixtures and equipment + + +48,977 + + +48,629 + + +48,953 + + + +Property held under capital leases + + +7,480 + + +7,480 + + +7,293 + + + +Construction in progress + + +521 + + +2,816 + + +1,345 + + + + + + + + + + + + + + +125,025 + + +129,185 + + +129,598 + + + +Less Accumulated depreciation + + +73,557 + + +75,815 + + +78,851 + + + + + + + + + + + + + + +51,468 + + +53,370 + + +50,747 + + + + +Net property and equipment of discontinued operations + + +36,032 + + + + + + + + + + + +Net Property and equipment + + +87,500 + + +53,370 + + +50,747 + + + + + + + + + + + +OTHER ASSETS: + + + + + + + + + + + + +Intangible assets + + +7,668 + + +7,445 + + +7,445 + + + +Deferred debt costs + + +11,061 + + +9,970 + + +9,970 + + + +Leasehold interests + + +6,577 + + +6,577 + + +6,577 + + + +Liquor licenses and other + + +4,758 + + +4,156 + + +4,136 + + + +Cost in excess of net assets acquired + + +7,537 + + +7,536 + + +7,536 + + + + + + + + + + + + + + +37,601 + + +35,684 + + +35,664 + + + +Less Accumulated amortization + + +14,083 + + +16,605 + + +18,603 + + + + + + + + + + + + + +Net other assets from discontinued operations + + +9,044 + + + + + + + + + + + + + + + + + + + + +Net other assets + + +32,562 + + +19,079 + + +17,061 + + + + + + + + + + + + + + +Total assets + +$ +142,729 + +$ +89,575 + +$ +82,785 + + + + + + + + + + + +LIABILITIES AND COMMON STOCKHOLDERS' (DEFICIT) + + + + + + + + + + + +CURRENT LIABILITIES: + + + + + + + + + + + + +Accounts payable + +$ +13,627 + +$ +15,193 + +$ +13,615 + + + +Accrued liabilities + + +9,486 + + +11,521 + + +6,320 + + + +Accrued insurance + + +2,509 + + +2,373 + + +2,695 + + + +Accrued interest + + +7,010 + + +6,251 + + +2,116 + + + +Accrued payroll costs + + +4,148 + + +7,069 + + +4,115 + + + +Current portion of obligations under capital leases + + +638 + + +713 + + +776 + + + +Current portion of long-term debt + + +477 + + +432 + + +4,416 + + + + +Current liabilities of discontinued operations + + +22,586 + + +2,945 + + +1,059 + + + + + + + + + + + + + + +Total current liabilities + + +60,481 + + +46,497 + + +35,112 + + + + + + + + + + + +LONG-TERM LIABILITIES, net of current portion: + + + + + + + + + + + + +Obligations under capital leases + + +3,300 + + +2,588 + + +2,005 + + + +Long-term debt + + +160,297 + + +144,066 + + +143,787 + + + + +Long-term debt from discontinued operations + + +2,299 + + + + + + + + + + + + + + + + + + + + +Total long-term liabilities + + +165,896 + + +146,654 + + +145,792 + + + + + + + + + + + +DEFERRED GAIN + + +4,395 + + +4,192 + + +4,037 + + + + + + + + + + + +COMMITMENTS AND CONTINGENCIES + + + + + + + + + + + + +CUMULATIVE PREFERRED STOCK, MANDATORILY REDEEMABLE + + + + + + + + + + + +Senior pay-in-kind exchangeable preferred stock, $0.01 par value; 160,000 shares authorized; 41,584 shares accrued and outstanding at December 27, 1999, 50,953 shares accrued and outstanding at December 25, 2000, +and 56,792 shares accrued and outstanding at September 24, 2001 + + +41,914 + + +49,891 + + +56,029 + + + + + + + + + + + +COMMON STOCKHOLDERS' (DEFICIT): + + + + + + + + + + + +Common stock, $0.01 par value; 1,000,000 shares authorized; 128,081 shares issued and outstanding at December 27, 1999, December 25, 2000, and September 24, 2001 + + +1 + + +1 + + +1 + + + +Paid-in capital + + +50,552 + + +15,788 + + +9,469 + + + +Accumulated (deficit) + + +(180,510 +) + +(173,448 +) + +(167,655 +) + + + + + + + + + + + + + +Total common stockholders' (deficit) + + +(129,957 +) + +(157,659 +) + +(158,185 +) + + + + + + + + + + + + + +Total liabilities and common stockholders' (deficit) + +$ +142,729 + +$ +89,575 + +$ +82,785 + + + + + + + + + + + +The accompanying notes are an integral part of these consolidated statements. + +F-3 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF OPERATIONS + FOR THE YEARS ENDED DECEMBER 28, 1998, DECEMBER 27, 1999, + DECEMBER 25, 2000, +AND THE THIRTY-NINE + WEEKS ENDED SEPTEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + +Year ended + +Nine Months Ended + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + +September 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + + + +(unaudited) + + +REVENUES + +$ +265,536 + +$ +263,561 + +$ +299,822 + +$ +226,567 + +$ +226,808 + + + + + + + + + + + + +RESTAURANT COSTS: + + + + + + + + + + + + + + + + + +Food and beverage + + +89,521 + + +88,110 + + +103,339 + + +77,675 + + +75,602 + + +Payroll + + +74,912 + + +75,114 + + +82,818 + + +60,715 + + +64,923 + + +Direct operating + + +63,260 + + +63,033 + + +69,721 + + +52,852 + + +53,830 + + +Depreciation and amortization + + +10,115 + + +9,396 + + +9,554 + + +7,352 + + +6,478 + +GENERAL AND ADMINISTRATIVE EXPENSES + + +11,780 + + +11,975 + + +11,108 + + +7,660 + + +7,198 + +NON-CASH CHARGE FOR IMPAIRMENT OF LONG-LIVED ASSETS + + +149 + + +459 + + + + + + + + + + + + + + + + + + + + + + +Operating profit from continuing operations + + +15,799 + + +15,474 + + +23,282 + + +20,313 + + +18,777 + +INTEREST EXPENSE, net + + +20,269 + + +19,450 + + +19,036 + + +14,322 + + +12,801 + + + + + + + + + + + + + +Net income /(loss) before provision for income taxes + + +(4,470 +) + +(3,976 +) + +4,246 + + +5,991 + + +5,976 + +PROVISION FOR INCOME TAXES + + +67 + + +70 + + +185 + + +211 + + +183 + + + + + + + + + + + + + +Income/(Loss) from continuing operations + + +(4,537 +) + +(4,046 +) + +4,061 + + +5,780 + + +5,793 + + +Income (Loss) from discontinued operations + + +(4,879 +) + +(1,622 +) + +3,474 + + +3,474 + + + + +EXTRAORDINARY GAIN/(LOSS) ON EXTINGUISHMENT OF DEBT FROM CONTINUING OPERATIONS + + +9,559 + + + + + +(473 +) + + + + + + + + + + + + + + + + + + +Net Income/(Loss) + +$ +143 + +$ +(5,668 +) +$ +7,062 + +$ +9,254 + +$ +5,793 + + + + + + + + + + + + +The +accompanying notes are an integral part of these consolidated statements. + +F-4 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (DEFICIT) + FOR THE YEARS ENDED DECEMBER 28, 1998, + DECEMBER 27, + 1999 AND DECEMBER 25, 2000 + (dollars in thousands) + + + + + +Common + +Stock + +Paid-in + +Capital + +Accumulated + +Debt + +Total + + +BALANCE, December 29, 1997 + +$ +1 + +$ +63,246 + +$ +(174,985 +) +$ +(111,738 +) + + +Net Income + + + + + + + + +143 + + +143 + + + + +Amortization of cost related to the issuance of preferred stock + + + + + +(332 +) + + + + +(332 +) + + + +Dividends payable, preferred stock + + + + + +(3,648 +) + + + + +(3,648 +) + + + +Non-cash distribution to parent + + + + + +(3,600 +) + + + + +(3,600 +) + + + + + + + + + + + + +BALANCE, December 28, 1998 + +$ +1 + +$ +55,666 + +$ +(174,842 +) +$ +(119,175 +) + + + + + + + + + + + + + +Net (Loss) + + + + + + + + +(5,668 +) + +(5,668 +) + + + +Amortization of cost related to the issuance of preferred stock + + + + + +(399 +) + + + + +(399 +) + + + +Dividends payable, preferred stock + + + + + +(4,715 +) + + + + +(4,715 +) + + + + + + + + + + + + +BALANCE, December 27, 1999 + +$ +1 + +$ +50,552 + +$ +(180,510 +) +$ +(129,957 +) + + + + + + + + + + + + + +Net Income + + + + + + + + +7,062 + + +7,062 + + + +Net book value of assets and liabilities transferred in conjunction with Stock Sale + + + + + +(26,788 +) + + + + +(26,788 +) + + +Amortization of cost related to the issuance of preferred stock + + + + + +(399 +) + + + + +(399 +) + + +Dividends payable, preferred stock + + + + + +(7,577 +) + + + + +(7,577 +) + + + + + + + + + + + + +BALANCE, December 25, 2000 + +$ +1 + +$ +15,788 + +$ +(173,448 +) +$ +(157,659 +) + + + + + + + + + + + + +The +accompanying notes are an integral part of these consolidated statements. + +F-5 + + + + + + +AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED + DECEMBER 28, 1998, DECEMBER 27, 1999, DECEMBER 25, 2000, + AND THE THIRTY-NINE WEEKS ENDED +SEPTEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + + +Year Ended + +Nine Months Ended + + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + +September 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + + + + +(unaudited) + + + + +CASH FLOWS FROM OPERATING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Cash received from customers + +$ +264,195 + +$ +263,562 + +$ +299,539 + +$ +226,054 + +$ +226,056 + + + +Cash paid to suppliers and employees + + +(271,512 +) + +(229,650 +) + +(260,096 +) + +(204,032 +) + +(212,900 +) + + +Interest paid, net + + +(20,729 +) + +(19,473 +) + +(19,823 +) + +(19,020 +) + +(16,936 +) + + +Income taxes, net + + +(67 +) + +(71 +) + +(312 +) + +(211 +) + +(183 +) + + + + + + + + + + + + + + + + +Net cash provided by/(used in) continuing operating activities + + +(28,113 +) + +14,368 + + +19,308 + + +2,791 + + +(3,963 +) + + + + + + + + + + + + + + +CASH FLOWS FROM INVESTING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Capital expenditures + + +(7,896 +) + +(6,248 +) + +(7,872 +) + +(6,438 +) + +(1,876 +) + + +Net (increase) decrease in other assets + + +3,734 + + +(2,619 +) + +(1,221 +) + +(606 +) + +14 + + + +Proceeds(Loss) from disposition of assets + + +9 + + +471 + + +12 + + +(12 +) + +25 + + + + + + + + + + + + + + + + + +Net cash (used in) investing activities + + +(4,153 +) + +(8,396 +) + +(9,081 +) + +(7,056 +) + +(1,837 +) + + + + + + + + + + + + + + +CASH FLOWS FROM FINANCING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Proceeds received from Stock Sale + + + + + + + + +17,000 + + +17,000 + + + + + + +Payments on indebtedness + + +(163,116 +) + +(15,376 +) + +(16,275 +) + +(264 +) + + + + + +Borrowings on indebtedness + + +163,226 + + +16,229 + + + + + +119 + + +3,705 + + + +Net increase in deferred debt costs + + +(10,818 +) + +(243 +) + + + + + + + + + + + +Cost included in extraordinary gain on extinguishment of debt + + +(1,686 +) + + + + + + + + + + + + + + +Issuance of cumulative preferred stock + + +35,000 + + + + + + + + + + + + + + + +Cost related to issuance of cumulative preferred stock + + +(2,179 +) + + + + + + + + + + + + + + +Payment on insurance related financing + + +(7,450 +) + + + + + + + + + + + + + + +Payments on capital lease obligations + + +(682 +) + +(637 +) + +(637 +) + +(472 +) + +(520 +) + + + + + + + + + + + + + + + + +Net cash provided by/(used in) financing activities + + +12,295 + + +(27 +) + +88 + + +16,383 + + +3,185 + + + + + + + + + + + + + + + +NET INCREASE/(DECREASE) IN CASH FROM CONTINUING OPERATIONS + + +(19,971 +) + +5,945 + + +10,315 + + +12,118 + + +(2,615 +) + +NET INCREASE/(DECREASE) IN CASH FROM DISCONTINUED OPERATIONS + + +23,163 + + +(5,617 +) + +(10,099 +) + +(6,167 +) + +(2,067 +) + + + + + + + + + + + + + + +CASH, at beginning of period + + +4,796 + + +7,988 + + +8,316 + + +8,316 + + +8,532 + + + + + + + + + + + + + + + +CASH, at end of period + +$ +7,988 + +$ +8,316 + +$ +8,532 + +$ +14,267 + +$ +3,850 + + + + + + + + + + + + + + + +RECONCILIATION OF NET INCOME (LOSS) TO NET CASH PROVIDED BY OPERATING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Net income (loss)from continuing operations after extraordinary items + +$ +5,022 + +$ +(4,046 +) +$ +3,588 + +$ +5,780 + +$ +5,793 + + + +Adjustments to reconcile net income (loss) to net cash provided by operating activities: + + + + + + + + + + + + + + + + + + + +Extraordinary (gain) loss on extinguishment of debt + + +(9,559 +) + + + + +473 + + + + + + + + + + + +Depreciation and amortization + + +10,115 + + +9,396 + + +9,554 + + +7,352 + + +6,478 + + + + + +Loss on disposition of assets + + +1,529 + + +3,317 + + +581 + + +581 + + + + + + + + +Impairment of assets + + +149 + + +459 + + + + + + + + + + + + + + +Amortization of deferred gain + + +(599 +) + +(289 +) + +(203 +) + +(152 +) + +(155 +) + + + + +Accretion on indebtedness + + +21 + + + + + + + + + + + + + + + + +(Increase) decrease in current assets: + + + + + + + + + + + + + + + + + + + + +Accounts receivable, net + + +1,341 + + +1 + + +(283 +) + +(173 +) + +(752 +) + + + + +Inventories + + +25 + + +89 + + +(98 +) + +(310 +) + +(63 +) + + + + +Prepaid expenses + + +102 + + +(834 +) + +70 + + +1,244 + + +(1,718 +) + + + +Increase (decrease) in current liabilities: + + + + + + + + + + + + + + + + + + + + +Accounts payable + + +(10,764 +) + +2,193 + + +1,566 + + +(3,697 +) + +(1,578 +) + + + + +Accrued liabilities + + +(16,929 +) + +2,479 + + +2,034 + + +(2,783 +) + +(5,201 +) + + + + +Accrued insurance + + +(1,528 +) + +(513 +) + +(136 +) + +323 + + +322 + + + + + +Accrued interest + + +(481 +) + +(23 +) + +(759 +) + +(4,698 +) + +(4,135 +) + + + + +Accrued payroll costs + + +(6,557 +) + +2,139 + + +2,921 + + +(676 +) + +(2,954 +) + + + + + + + + + + + + + + + + + + +Net cash provided by/(used in) continuing operating activities + +$ +(28,113 +) +$ +14,368 + +$ +19,308 + +$ +2,791 + +$ +(3,963 +) + + + + + + + + + + + + + + +The accompanying notes are an integral part of these consolidated statements. + +F-6 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + + DECEMBER 28, 1998, DECEMBER 27, 1999, AND DECEMBER 25, 2000 + + + +1. Background and Summary of Significant Accounting Policies + +a.Company + + American Restaurant Group, Inc. (the "Company"), a Delaware corporation, through its subsidiaries, operates middle-price full-service +restaurants, primarily in California, the Pacific Northwest, and Arizona. The Company is a subsidiary of American Restaurant Group Holdings, Inc. ("Holdings"), also a Delaware corporation. At +year-end 1998, 1999, and 2000, the Company and its subsidiaries, collectively referred to herein as the Company, operated 101, 102, and 105 restaurants, respectively, in its continuing +segment. + +b.Operations + + The Company's operations are affected by local and regional economic conditions, including competition in the restaurant industry. Prior to the year ended +December 25, 2000, the Company experienced recurring operating losses (before extraordinary gain (loss) on extinguishment of debt) after debt service. A recapitalization plan was consummated +during 1998 (see Note 3, "Long-Term Debt"). This plan substantially eliminated debt principal payments until the year 2003. + + Management +believes the recapitalization will also allow it to effect changes in its operations and has already implemented measures to reduce overhead costs. However, the Company does +not expect to generate sufficient cash flows from operations in the future to fully pay the principal on long-term debt upon maturity in the year 2003 and, accordingly, it expects to +refinance all or a portion of such debt, obtain new financing, or possibly sell assets. + +c.Sale of Stock to Spectrum Restaurant Group, Inc. + + The Company sold all of the outstanding stock of four wholly owned subsidiaries (Non-Black Angus Subsidiaries) to Spectrum Restaurant +Group, Inc. (formerly known as NBACo, Inc.). There was no gain or loss recorded because of the related-party nature of the Stock Sale. The Company received $17.0 million in cash +on June 28, 2000, and transferred certain assets and liabilities to Spectrum Restaurant Group, Inc. Concurrent with the sale, advances between the Company and the Non-Black +Angus Subsidiaries were eliminated. Paid-in capital of $26.8 million was charged as a result of the sale. The Company retained the assets and liabilities associated with certain +closed restaurants as well as certain liabilities, estimated on June 26, 2000 at $12.6 million, associated with the operating restaurants that were sold. The amount of estimated +liabilities remaining at December 25, 2000 was approximately $2.9 million. + + The +Company is currently working to settle these liabilities. Any adjustments to the recorded balance will be recognized when the amount becomes known, however management does not +believe that such amounts, is any, will be material to the Company's financial position or results of operations. + +d.Principles of Consolidation + + The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and +transactions have been eliminated. + +e.Use of Estimates in the Preparation of Financial Statements + + The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and +assumptions which affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results could +differ from those estimates. + +F-7 + + + +f.Inventories and Prepaid Expenses + + Inventories consist primarily of food, beverages, and supplies and are valued at the lower of cost (first-in, first-out method) or market +value. + +g.Advertising Costs + + Advertising costs are accrued as a percentage of sales and expensed during the year. At year end, production costs for advertisements, which have not been aired, +are included in prepaid expenses. Prepaid advertising costs of $1,196,000 and $1,022,000 were included in prepaid expenses at December 27, 1999 and December 25, 2000, respectively. +Advertising expenses included in net income (loss) were $13,983,000, $13,515,000, and $16,134,000 in fiscal years 1998, 1999, and 2000, respectively. + +h.Property and Equipment + + Property and equipment is carried at the lower of cost or, if impaired, at the estimated fair value of the assets. The Company provides for depreciation and +amortization based upon the estimated useful lives of depreciable assets using the straight-line method. Estimated useful lives are as follows: + +Land improvements + +20 years + +Buildings + +30 to 35 years + +Leasehold improvements + +Life of lease + +Fixtures and equipment + +3 to 10 years + +Property held under capital leases + +Life of lease + + When +a restaurant is opened, the initial purchase of expendable equipment, such as china, glassware, and silverware, is recorded as an asset and is not depreciated; +however, all replacements are expensed. + + Substantially +all of the Company's assets, including property and equipment, are pledged as collateral on the senior debt of the Company. + +i.Interest Costs + + Interest costs incurred during the construction period of restaurants are capitalized. The Company capitalized approximately $68,000 and $44,000 for the years +ended 1998 and 1999, respectively. There were no interest costs capitalized in 2000. + +j.Other Assets + + Other assets include intangible assets, leasehold interests, franchise rights, liquor licenses, and cost in excess of net assets acquired. These costs are +amortized using the straight-line method over the periods estimated to be benefited, not greater than 40 years. + + Deferred +debt costs are amortized using the effective interest method over the related debt term. + +F-8 + + + + Estimated +useful lives are as follows: + +Intangible assets + +3 to 40 years + +Deferred debt costs + +Term of debt + +Leasehold interests + +Life of lease + +Franchise rights + +35 years + +Liquor licenses + +40 years + +Cost in excess of net assets acquired + +40 years + + The +following table details the components of intangible assets included in the accompanying consolidated balance sheets (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Assembled workforce + +$ +2,986 + +$ +2,986 + +Going Concern + + +1,928 + + +1,928 + +Trademarks/service marks + + +1,794 + + +1,794 + +Acquisition costs + + +696 + + +696 + +Other + + +264 + + +41 + + + + + + +Total + +$ +7,668 + +$ +7,445 + + + + + + + As +of December 27, 1999 and December 25, 2000, no indicators of impairment exist. + +k.Insurance + + The Company self-insures certain risks up to varying limits including medical, workers' compensation, property and general liability. Deductible and +self-insured limits have varied historically, ranging from $0 to $350,000 per incident depending on the type of risk. The policy deductibles are $100,000 for its annual medical and dental +benefits per person. Reserves for losses are established based upon currently estimated obligations for the claim over time and the deductible or self-insured retention in place at the +time of the loss. + +l.Fair Value of Financial Instruments + + The Company's financial instruments consist primarily of cash, accounts receivable and payable, and debt instruments. The carrying values of all financial +instruments, other than debt instruments, are representative of their fair value due to their short-term maturity. The fair value of the Company's long-term debt instruments is +estimated based on the current rates offered to the Company. + +m.Accounting Period + + The Company's fiscal year ends on the last Monday in December. + +n.Earnings per Share + + Earnings per share information has not been presented because there is no market for the Company's common stock. + +o.Reclassifications + + Certain prior year accounts have been reclassified to conform with the current year presentation. + +F-9 + + + +p.New Accounting Pronouncements + + In June, 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS +No. 142, Goodwill and Other Intangible Assets. These new standards are effective for fiscal years beginning after December 15, 2001. Under the new standards, goodwill will no longer be +amortized, but will be subject to an annual impairment test. The standards also promulgate, among other things, new requirements for accounting for other intangible assets. The impact of these new +standards on the Company's financial position and results of operations has not yet been determined, but is not believed to be material. + + In +August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or +Disposal of Long-Lived Assets. FASB Statement No. 144 retains FASB Statement No. 121's Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of, fundamental provisions for the: (1) recognition and measurement of impairment of long-lived assets to be held and used; and (2) +measurement of long-lived assets to be disposed of by sale. The Company does not believe that FASB Statement No. 144 will have a material impact on its financial position or results of +operations. Statement No. 144 is effective for fiscal years beginning after December 15, 2001. + +2. Lease Obligations + + The Company leases certain of its operating facilities under terms ranging up to 40 years. These leases are classified as both operating and capital +leases. Certain of the leases contain provisions calling for rentals based on sales or other provisions obligating the Company to pay related property taxes and certain other expenses. + + The +following is a summary of property held under capital leases and included in the accompanying consolidated balance sheets (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Property + +$ +7,480 + +$ +7,480 + +Less Accumulated depreciation + + +5,720 + + +6,071 + + + + + + + + +$ +1,760 + +$ +1,409 + + + + + + +F-10 + + + + The +following represents the minimum lease payments remaining under noncancelable operating leases and capitalized leases as of December 25, 2000 (in thousands): + +Fiscal Years Ending + + +Operating + +Leases + +Capitalized + +Leases + +2001 + +$ +16,504 + +$ +1,070 + +2002 + + +15,107 + + +1,070 + +2003 + + +14,757 + + +830 + +2004 + + +13,778 + + +263 + +2005 + + +12,168 + + +232 + +Thereafter + + +168,018 + + +1,347 + + + + + + +Total minimum lease payments + +$ +240,332 + + +4,812 + + + + + + +Less Imputed interest (8.75% to 15.5%) + + + + + +1,511 + +Present value of minimum lease payments + + + + + +3,301 + + + + + + + +Less Current portion + + + + + +713 + + + + + + + +Long-term portion + + + + +$ +2,588 + + + + + + + + Rental +expense was $15,216,000, $15,460,000, and $16,650,000 during 1998, 1999, and 2000, respectively. + +3. Long-Term Debt + + Long-term debt is summarized as follows (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Senior secured notes, interest only due semi-annually beginning August 15, 1998 at 11.5%, principal due February 15, 2003 + +$ +158,600 + +$ +142,600 + +Other + + +2,174 + + +1,898 + + + + + + + + + +160,774 + + +144,498 + +Less Current portion + + +477 + + +432 + + + + + + +Long-term portion + +$ +160,297 + +$ +144,066 + + + + + + + Maturities +of the remaining long-term debt during each of the five fiscal years subsequent to year end 2000 are $432,000, $335,000, $142,627,000, $30,000, and +$1,074,000 thereafter. + + In +February 1998, the Company completed a recapitalization plan (the "Recapitalization Plan") that included, among other things, the issuance by the Company of $155,000,000 of +Notes due 2003. + + In +conjunction with the Recapitalization Plan, the Company issued an additional $3,600,000 principal amount of Notes to holders of certain Holdings debt and recorded such issuance as a +non-cash distribution. There was an extraordinary gain recorded in 1998 of 9,559,000 as a result of this transaction. + + As +part of the Recapitalization Plan, the Company concurrently (a) redeemed at par senior secured notes of $126,381,000 together with interest thereon and repaid certain other +interest-bearing + +F-11 + + + +short-term liabilities, (b) repurchased its existing 10.25% subordinated notes at 65% of the par amount of $45,000,000 together with interest thereon, and canceled the related +warrants to purchase common stock of Holdings, and (c) established a $15,000,000 revolving credit facility to include letters of credit. A quarterly fee of 0.5% per annum is payable on the +unused portion of the letter of credit facility and a quarterly fee of 2.5% per annum is payable on outstanding letters of credit. + + On +June 28, 2000, the Company amended the terms of the Credit Facility to reduce the aggregate commitment of the lenders from $15,000,000 to $12,000,000, to reduce the amount +available for issuance of letters of credit from $10,000,000 to $7,000,000, and to extend the maturity date from February 25, 2001 to June 30, 2002. + + At +year end 1999 and 2000, the Company had outstanding letters of credit primarily related to its self-insurance programs of approximately $3,597,000 and $5,500,000, +respectively. + + The +revolving credit facility contains certain covenants, the most restrictive of which requires the Company to maintain a certain ratio of cash flows to total debt. As of +December 25, 2000, the Company was in compliance with all financial covenants. The Company made a prepayment of principal of $16 million in December 2000, and recorded an +extraordinary loss of $473,000 to write-off the related unamortized deferred financing costs. + + Substantially +all assets of the Company are pledged to its senior lenders. In addition, the direct subsidiaries guaranteed the indebtedness owed by the Company and such guarantees are +secured by substantially all of the assets of the subsidiaries. In connection with such indebtedness, contingent and mandatory prepayments may be required under certain specified conditions and +events. There are no compensating balance requirements. + + Management +believes the fair value of the debt approximates its carrying value. + +F-12 + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + DECEMBER 28, 1998, DECEMBER 27, 1999, AND DECEMBER 25, 2000 + +4. Income Taxes + + The Company's state income-tax provision, all of which was current, was $67,000, $70,000, and $185,000 in 1998, 1999, and 2000, respectively. No +provision for federal income taxes was required in any year. + + The +income tax effects of temporary differences that give rise to significant portions of the Company's deferred income tax assets and liabilities are as follows (in thousands): + + + + +Year Ended + + + + + +December 27, + +1999 + +December 25, + +2000 + + +Deferred income tax asset: + + + + + + + + + +Reserves and other accrued expenses not currently deductible for tax purposes + +$ +4,221 + +$ +3,358 + + + +Long-lived asset impairment not recognized on tax return + + +2,813 + + +2,813 + + + +Tax gain on sale/leaseback transactions, net + + +3,097 + + +2,978 + + +Discontinued Operations + + +2,514 + + + + + +Net operating loss carryforward + + + + + + + + + +From continuing operations + + +38,756 + + +39,043 + + + +From discontinued operations + + +14,991 + + +0 + + + + + + + + + + + +Deferred income-tax asset + + +66,392 + + +48,192 + + + + + + + + + +Deferred income tax liability: + + + + + + + + + +Tax depreciation greater than depreciation for financial reporting purposes + + +(6,927 +) + +(6,789 +) + + +Costs capitalized for financial reporting purposes and expensed on tax return + + +(4,172 +) + +(4,087 +) + + +Other, net + + + + + + + + + + +From continuing operations + + +(597 +) + +(350 +) + + + + + + + + + + +Deferred income-tax liability + + +(11,696 +) + +(11,226 +) + + + + + + + + +Deferred asset, net of deferred liability + + +54,696 + + +36,966 + + +Valuation allowance + + +(54,696 +) + +(36,966 +) + + + + + + + + +Net deferred income-tax asset + +$ + + +$ + + + + + + + + + + + The +Company fully reserves its net deferred tax assets because of its history of operating losses. + +F-13 + + + + The +effective tax rate differs from the federal statutory rate of 34 percent as a result of the following items (in thousands): + + + + +Year Ended + + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + + +Federal income-tax provision (benefit) at statutory rates + +$ +49 + +$ +(1,903 +) +$ +2,655 + + +State income-tax provision for which no federal benefit was recorded + + +44 + + +1 + + +464 + + +Losses for which no federal benefit was recorded + + +3,792 + + +1,195 + + + + + +Nondeductible items, principally intangible amortization + + +964 + + +777 + + +159 + + +Benefit of net operating loss carryforward + + + + + + + + +(3,093 +) + +Cancellation of debt income + + +(4,782 +) + + + + + + + + + + + + + + + + +Provision for income taxes + +$ +67 + +$ +70 + +$ +185 + + + + + + + + + + + +Provision for income taxes attributable to discontinued operations + +$ +21 + +$ +20 + +$ +59 + + + At +December 25, 2000, the Company had available net operating loss carryforwards for federal income-tax purposes of $96,619,000 expiring in 2003 to 2020, and federal +general business credit carryforwards of $6,192,000, expiring in 2009 to 2019. + +5. Commitments and Contingencies + + The Company is obligated under an employment agreement with an officer. The obligation under the agreement is $500,000, provides for periodic increases, and +expires in 2001 unless extended. + + The +Company has been named as defendant in various lawsuits. Management's opinion is that the outcome of such litigation will not materially affect the Company's financial position or +results of operations. + +6. Cumulative Preferred Stock, Mandatorily Redeemable + + As part of the Recapitalization Plan in February, 1998, the Company issued 35,000 preferred stock units (the "Units") of the Company. Each Unit consists of $1,000 +initial liquidation preference of 12% senior pay-in-kind exchangeable preferred stock and one common-stock purchase warrant initially to purchase 2.66143 shares of the common +stock at an initial exercise price of one cent per share. The Company's cumulative preferred stock is mandatorily redeemable on August 15, 2003, for cash at a price per share equal to 110% of +the then applicable liquidation preference. + + A +stock dividend of 2,499 shares was paid on February 15, 2000. In the second quarter of 2000, the Company agreed to an interpretation of the financial covenants used to determine +the dividend rate. The result was an increase in the dividend rate from 12% to 15% and additional dividends issued on August 15th of 2,503 shares (relating to holders at August 1999 and +February 2000). Stock dividends of 5,872 (including the adjustment) and 3,618 shares were made on August 15, 2000 and February 15, 2001, respectively. There were 50,953 shares +outstanding at December 25, 2000. + +F-14 + + + +7. Common Stock + + As of December 29, 1997, all of the Company's common stock was owned by American Restaurant Group Holdings, Inc., Anwar S. Soliman, and Management +Shareholders. They also own all outstanding shares of Holdings common stock other than shares of Holdings common stock issued to holders of the debenture units and rights to acquire shares of Holdings +common stock issuable upon exercise of options and warrants. + + In +conjunction with the Recapitalization Plan, the Company issued shares of common stock to certain members of the Company's management (the "Management Stockholders") in an aggregate +amount equal to 15% of the common stock on a fully diluted basis. Such Management Stockholders have entered into a voting trust agreement with Anwar Soliman to exercise all voting and substantially +all other rights to which such Management Shareholders would otherwise be entitled until August 15, 2005, or the earlier termination of the agreement. The Management Shareholders also entered +into a shareholders' agreement with the remaining Company shareholders, which provides that the parties will agree to vote all of their shares of the Company's equity securities so that the Board of +Directors of the Company consists of five directors, with two directors designated by TCW Investors, two by the Management Shareholders, with the remaining director being an independent director +initially designated by the initial purchaser of the Notes. + +8. Savings Plan + + The American Restaurant Group Savings and Investment Plan (the "Savings Plan") is a 401(k) plan established for the benefit of employees who satisfy certain +requirements. These requirements include completion of one year of service with a minimum of 1,000 hours worked. Subject to applicable limits imposed on tax-qualified plans, +eligible employees may elect pre-tax contributions up to 20.0% of a participant's total earnings for a calendar year (but not in excess of $10,500 for 2000). The Company makes matching +contributions to the Savings Plan equal to 25% of the participant's contributions up to 6% of the participant's earnings. During fiscal 1998, 1999, and 2000, the Company contributed approximately +$174,000, $225,000, and $206,000 to the Savings Plan, respectively. At December 25, 2000, there were approximately 3,900 employees eligible, 1,100 participants, and 600 contributors to the +plan. + +9. Subsequent Event (unaudited) + + The Company will recognize a charge of approximately $5.5 million in its results of operations for the fourteen weeks ended December 31, 2001. Under +GAAP the Company must immediately expense a portion of its transaction costs deemed to be associated with an exchange of debt instruments that are substantially the same. The exchange of +Series B Notes for Series C Notes is deemed to be such a transaction. The Company incurred additional costs associated with the issuance of the New Notes which have been capitalized and +will be amortized over the term of the New Notes. + +F-15 + +AMERICAN RESTAURANT GROUP, INC. + + + +PROSPECTUS January 24, 2002 + + + + + + + + +PART II + + INFORMATION NOT REQUIRED IN PROSPECTUS + + +ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. + + The estimated expenses payable by the Company in connection with the issuance and distribution of the Notes and in connection with the offering described in this +Registration Statement are as follows: + +Registration Fee + +$ +8,100 + +Legal fees and expenses + + +111,161 + +Accounting fees and expenses + + +35,571 + +Printing and duplicating expenses + + +57,140 + +Miscellaneous expenses + + +1,824,595 + + + + + +Total + +$ +2,036,567 + + + + +ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS + + Section 145 of the General Corporation Law of the State of Delaware (the "GCL") provides in relevant part that a Delaware corporation may +indemnify any persons, including officers and directors, who are, or are threatened to be made, parties to any threatened, pending or completed legal action, suit or proceeding, whether civil, +criminal, administrative or investigative (other than an action by or in the right of such corporation), by reason of the fact that such person is or was an officer or director of such corporation, or +is or was serving at the request of such corporation as a director, officer, employee or agent of another corporation or enterprise. The indemnity may include expenses (including attorneys' fees), +judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding, provided such officer or director acted in good +faith and in a manner he reasonably believed to be in or not opposed to the corporation's best interests and, for criminal proceedings, had no reasonable cause to believe that his conduct was illegal. +A Delaware corporation may indemnify officers and directors in an action by or in the right of the corporation under the same conditions, except that no indemnification is permitted without judicial +approval if the officer or director is adjudged to be liable to the corporation in the performance of his duty. Where an officer or director is successful on the merits or otherwise in the defense of +any action referred to above, the corporation must indemnify him against the expenses which such officer or director actually and reasonably incurred. + + Article IV +of the by-laws of the Company provides for indemnification of its officers and directors to the fullest extent permitted by Section 145 of the GCL. + + Section 102(b)(7) +of the GCL provides that a Delaware corporation may eliminate or limit the personal liability of a director to a Delaware corporation or its stockholders for +monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director (i) for any breach of the director's duty of +loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under +Section 174 of the GCL relating to the unlawful payment of a dividend or an unlawful stock purchase or redemption or (iv) for any transaction from which the director derived an improper +personal benefit. + + Article 7 +of the Certificate of Incorporation of the Company provides for the elimination of personal liability of its directors for monetary damages for breach of fiduciary duty +as a director, except as otherwise provided by the GCL. + +II-1 + + + +ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES + + On October 31, 2001, we privately placed, under Rule 144A and Regulation S of the Securities Act, $30 million aggregate principal +amount of 111/2% Senior Secured Notes due 2006, yielding net proceeds to the Company of approximately $3.1 million, after deducting estimated expenses and commissions. The +proceeds were used to refinance existing indebtedness, to pay the accrued and unpaid interest with respect to the Existing Notes and for general corporate purposes. Jefferies & +Company, Inc. was the initial purchaser of these securities. On October 1, 2001, we commenced an offer to exchange all of our outstanding Old Notes for up to $131.7 million +aggregate principal amount of 111/2% Senior Secured Notes due 2006. The notes include registration rights such that the registrant is required to exchange the notes for a new issue of +notes registered under the Securities Act of 1933 and are to be declared effective no later than 150 days after the issue date. + +ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES + +Exhibit No. + + +Description + + +1.1 + +Purchase Agreement dated as of September 28, 2001 by and between the Company and Jefferies & Company, Inc.******* + +2.1 + + + +Purchase Agreement dated as of September 11, 1996 by and between ARG Property Management Corporation and ARG Enterprises, Inc. and ARG Properties I, LLC.*** + +2.2 + + + +Master lease dated September 11, 1996 between ARG Properties I, LLC, as Landlord and ARG Enterprises, Inc. as Tenant.*** + +2.3 + + + +Lease #06152 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Bloomington, Minnesota.*** + +2.4 + + + +Lease #06153 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Fridley, Minnesota.*** + +2.5 + + + +Lease #06154 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Minnetonka, Minnesota.*** + +2.6 + + + +Lease #06155 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Roseville, Minnesota.*** + +2.7 + + + +Not Applicable. + +2.8 + + + +Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to ARG Properties I, LLC as Landlord.*** + +2.9 + + + +A Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to Captec Net Lease Realty, Inc. as Landlord for each of four Minnesota restaurants.*** + +2.10 + + + +Not Applicable. + +2.11 + + + +Stock Purchase Agreement, dated as of May 9, 2000 between the Company and NBACo, Inc.****** + +2.12 + + + +Amendment No. 1, dated as of June 26, 2000, to Stock Purchase Agreement, dated as of May 9, 2000, between the Company and NBACo, Inc.****** + +3.1 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on July 23, 1991.* + +3.2 + + + +Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on March 21, 1992.* + +II-2 + + + +3.3 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on February 23, 1998.**** + +3.3A + + + +Amendment to Certificate of the Designation of the Powers, Preferences and relative, Participating, Optional and Other Special Rights of the 12% Series A Senior Pay-In-Kind Exchangeable Preferred stock and the 12% Series B Senior Pay-In-Kind +Exchangeable Preferred Stock and Qualifications, Limitations or Restrictions Thereof of the Company filed with the Secretary of State of Delaware on October 31, 2001.******* + +3.4 + + + +By-Laws of the Company.* + +3.5 + + + +Restated Articles of Incorporation of ARG Enterprises, Inc. filed with the Secretary of State of California on May 3, 1988.******* + +3.6 + + + +Bylaws of ARG Enterprises, Inc.******* + +3.7 + + + +Restated Articles of Incorporation of ARG Property Management Corporation filed with the Secretary of State of California on May 3, 1988.******* + +3.8 + + + +Bylaws of ARG Property Management Corporation.******* + +3.9 + + + +Certificate of Incorporation of ARG Terra, Inc. filed with the Secretary of State of Delaware on June 20, 2000.******* + +3.10 + + + +Bylaws of ARG Terra, Inc.******* + +4.1 + + + +Indenture dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as Trustee (including specimen certificate of 11.5% Senior Secured Note due 2003).**** + +4.2 + + + +Warrant Agreement dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as warrant agent (including specimen certificate of warrant).**** + +4.3 + + + +Registration Rights Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc.**** + +4.4 + + + +Securityholders' and Registration Right Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc., as purchaser.**** + +4.5 + + + +Management Registration Right Agreement dated as of February 28, 1998 between the Company and the Management Stockholders.**** + +4.6 + + + +Certificate of Designation filed with the Secretary of State of Delaware on February 24, 1998.**** + +4.7 + + + +Certificate of Correction to the Certificate of Designation filed with the Secretary of State of Delaware on February 25, 1998.**** + +4.8 + + + +Not Applicable. + +4.9 + + + +First Supplemental Indenture, dated as June 28, 2000, to Indenture, dated as of February 25, 1998, between the Company and U.S. Trust Company, National Association (formerly known as U.S. Trust Company of California, +N.A.).****** + +4.10 + + + +Second Supplemental Indenture, dated as of October 31, 2001, to Indenture, dated as of February 25, 1998, between the Company and BNY Western Trust Company (successor in interest to U.S. Trust Company, National Association, formerly known as +U.S. Trust Company of California, N.A.).******* + +II-3 + + + +4.11 + + + +Registration Rights Agreement dated as of October 31, 2001 between the Company and Jefferies & Company, Inc.******* + +5 + + + +Opinion of Milbank, Tweed, Hadley & McCloy LLP.******** + +10.1 + + + +Amended and Restated Employment Agreement dated as of December 14, 1993 between the Company and Ralph S. Roberts.** + +10.2 + + + +Loan Agreement dated as of December 17, 2001 between Foothill Capital Corporation, as lender and the Company, ARG Enterprises, Inc., ARG Property Management Corporation and ARG Terra, Inc., as borrowers.******* + +10.3 + + + +Second Amended and Restated Intercreditor and Collateral Agency Agreement dated as of December 17, 2001 between BNY Western Trust Company, as collateral agent and as trustee, the Company, ARG Enterprises, Inc., ARG Property Management +Corporation and ARG Terra, Inc., as borrowers, and Foothill Capital Corporation, as lender.******* + +12 + + + +Statement setting forth Computation of Ratio of Earnings to Fixed Charges.******* + +21 + + + +Subsidiaries of the Company.** + +23.1 + + + +Consent of Milbank, Tweed, Hadley & McCloy LLP (included in Exhibit 5 hereto). + +23.2 + + + +Consent of Independent Public Accountants.******** + +24.1 + + + +Power of Attorney (American Restaurant Group, Inc.)******* + +24.2 + + + +Power of Attorney (ARG Enterprises, Inc., ARG Property Management Corporation, ARG Terra, Inc.) (contained on the signature page to this registration statement). + +25 + + + +Statement of Eligibility and Qualification (Form T-1) under the Trust Indenture Act of 1939 of United States Trust Company of New York.******* + + + + + + +* + +Incorporated by reference to the Registrant's Registration Statement No. 33-48183 on Form S-4 filed with the Securities and Exchange Commission on May 28, 1992 as amended with Amendment No. 1 filed on +September 11, 1992. + +** + +Incorporated by reference to the Registrant's Registration Statement No. 33-74010 on Form S-4 filed with the Securities and Exchange Commission on January 12, 1994. + +*** + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated September 13, 1996 filed with the Securities and Exchange Commission on September 30, 1996. + +**** + +Incorporated by reference to the Registrant's Annual Report on Form 10-K dated December 29, 1997 filed with the Securities and Exchange Commission on March 30, 1998. + +***** + +Incorporated by reference to the Registrant's Registration Statement No. 333-55861 on Amendment No. 1 to Form S-4 filed with the Securities and Exchange Commission on July 29, 1998. + +****** + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated June 28, 2000 and filed with the Securities and Exchange Commission on July 12, 2000. + +******* + +Incorporated by reference to the Registrant's Registration Statement No. 333-76442 to Form S-4 filed with the Securities and Exchange Commission on January , 2002. + +******** + +Incorporated by reference to the Registrant's Registration Statement No. 333-76434 to Form S-1 filed with the Securities and Exchange Commission on January 8, 2002. + +II-4 + + + +ITEM 17. UNDERTAKINGS + + A. Insofar +as indemnification for liabilities arising under the Act 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 Act +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. + +B.The +undersigned registrant hereby undertakes: + + (1) To +file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: + + (i) To +include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; + + (ii) To +reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement. Notwithstanding the foregoing, any increase or decrease in +volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering +range may be reflected in the form of prospectus filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change +in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. + + (iii) To +include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such +information in the registration statement. + + (2) That, +for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new +registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona +fide offering thereof. + + (3) To +remove from registration by means of a post-effective amendment any of the securities being registered that remain unsold at the termination of the +offering. + +II-5 + + + + + + +SIGNATURES + + + Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the +requirements to file Amendment No. 1 to Form S-1 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in +the City of Los Altos, State of California on the 17th day of January 2002. + + + + + + + +AMERICAN RESTAURANT GROUP, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer, Secretary and + +General Counsel + + + + + +ARG ENTERPRISES, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + + + + +ARG PROPERTY MANAGEMENT CORPORATION + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + + + + +ARG TERRA, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed below by the following persons in the +capacities and on the dates indicated. + + + +AMERICAN RESTAURANT GROUP, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ GEORGE G. GOLLEHER* George G. Golleher + +Chairman of the Board and Director + +January 17, 2002 + +/s/ RALPH S. ROBERTS* Ralph S. Roberts + + + +Chief Executive Officer, President and Director (principal executive officer and director) + + + +January 17, 2002 + +II-6 + + + +/s/ PATRICK J. KELVIE* Patrick J. Kelvie + + + +Vice President, Treasurer, Secretary and General Counsel (principal financial officer) + + + +January 17, 2002 + +/s/ SHERRI A. CARROLL* Sherri A. Carroll + + + +Controller + + + +January 17, 2002 + +/s/ ANWAR S. SOLIMAN* Anwar S. Soliman + + + +Director + + + +January 17, 2002 + +/s/ ROBERT D. BEYER* Robert D. Beyer + + + +Director + + + +January 17, 2002 + +/s/ M. BRENT STEVENS* M. Brent Stevens + + + +Director + + + +January 17, 2002 + +*By:/s/ PATRICK J. KELVIE Patrick J. Kelvie + Attorney-in-fact + + + + + + + + + + + + +POWER OF ATTORNEY + + + Each person whose signature appears below constitutes and appoints Patrick J. Kelvie his or her true and lawful +attorney-in-fact and agent, with full power of substitution and resubstitution for him or her and in his or her name, place and stead, in any and all capacities to sign any and +all amendments (including post-effective amendments) to this Registration Statement, and any registration statement of the Company to be filed after the date hereof pursuant to +Rule 462(b) under the Securities Act of 1933, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, and to +take such actions in, and file with the appropriate authorities in, whatever states said attorneys-in-fact and agents, and each of them, shall determine, such applications, +statements, consents, and other documents, as may be necessary or expedient to register securities of the Company for sale, granting unto said attorneys-in-fact and agents full +power and authority to do so and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in +person, hereby ratifying and confirming all that said attorney-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done +by virtue hereof and the registrant hereby confers like authority on its behalf. + + This Registration Statement and Power of Attorney, pursuant to the requirement of the Securities Act of 1933, as amended, have been signed below by the following +persons in the capacities and on the dates indicated. + + Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed below by the following persons in the +capacities and on the dates indicated. + +II-7 + + + +ARG ENTERPRISES, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +ARG PROPERTY MANAGEMENT CORPORATION + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +ARG TERRA, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +II-8 + + + + +EXHIBIT INDEX + + +Exhibit No. + + +Description + + + 1.1 + +Purchase Agreement dated as of September 28, 2001 by and between the Company and Jefferies & Company, Inc.******* + + 2.1 + + + +Purchase Agreement dated as of September 11, 1996 by and between ARG Property Management Corporation and ARG Enterprises, Inc. and ARG Properties I, LLC.*** + + 2.2 + + + +Master lease dated September 11, 1996 between ARG Properties I, LLC, as Landlord and ARG Enterprises, Inc. as Tenant.*** + + 2.3 + + + +Lease #06152 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Bloomington, Minnesota.*** + + 2.4 + + + +Lease #06153 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Fridley, Minnesota.*** + + 2.5 + + + +Lease #06154 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Minnetonka, Minnesota.*** + + 2.6 + + + +Lease #06155 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Roseville, Minnesota.*** + + 2.7 + + + +Not Applicable. + + 2.8 + + + +Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to ARG Properties I, LLC as Landlord.*** + + 2.9 + + + +A Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to Captec Net Lease Realty, Inc. as Landlord for each of four Minnesota restaurants.*** + + 2.10 + + + +Not Applicable. + + 2.11 + + + +Stock Purchase Agreement, dated as of May 9, 2000 between the Company and NBACo, Inc.****** + + 2.12 + + + +Amendment No. 1, dated as of June 26, 2000, to Stock Purchase Agreement, dated as of May 9, 2000, between the Company and NBACo, Inc.****** + + 3.1 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on July 23, 1991.* + + 3.2 + + + +Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on March 21, 1992.* + + 3.3 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on February 23, 1998.**** + + 3.3A + + + +Amendment to Certificate of the Designation of the Powers, Preferences and relative, Participating, Optional and Other Special Rights of the 12% Series A Senior Pay-In-Kind Exchangeable Preferred stock and the 12% Series B Senior Pay-In-Kind +Exchangeable Preferred Stock and Qualifications, Limitations or Restrictions Thereof of the Company filed with the Secretary of State of Delaware on October 31, 2001.******* + + 3.4 + + + +By-Laws of the Company.* + + 3.5 + + + +Restated Articles of Incorporation of ARG Enterprises, Inc. filed with the Secretary of State of California on May 3, 1988.******* + + 3.6 + + + +Bylaws of ARG Enterprises, Inc.******* + + 3.7 + + + +Restated Articles of Incorporation of ARG Property Management Corporation filed with the Secretary of State of California on May 3, 1988.******* + + 3.8 + + + +Bylaws of ARG Property Management Corporation.******* + + 3.9 + + + +Certificate of Incorporation of ARG Terra, Inc. filed with the Secretary of State of Delaware on June 20, 2000.******* + + 3.10 + + + +Bylaws of ARG Terra, Inc.******* + + 4.1 + + + +Indenture dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as Trustee (including specimen certificate of 11.5% Senior Secured Note due 2003).**** + + 4.2 + + + +Warrant Agreement dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as warrant agent (including specimen certificate of warrant).**** + + 4.3 + + + +Registration Rights Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc.**** + + 4.4 + + + +Securityholders' and Registration Right Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc., as purchaser.**** + + 4.5 + + + +Management Registration Right Agreement dated as of February 28, 1998 between the Company and the Management Stockholders.**** + + 4.6 + + + +Certificate of Designation filed with the Secretary of State of Delaware on February 24, 1998.**** + + 4.7 + + + +Certificate of Correction to the Certificate of Designation filed with the Secretary of State of Delaware on February 25, 1998.**** + + 4.8 + + + +Not Applicable. + + 4.9 + + + +First Supplemental Indenture, dated as June 28, 2000, to Indenture, dated as of February 25, 1998, between the Company and U.S. Trust Company, National Association (formerly known as U.S. Trust Company of California, + N.A.).****** + + 4.10 + + + +Second Supplemental Indenture, dated as of October 31, 2001, to Indenture, dated as of February 25, 1998, between the Company and BNY Western Trust Company (successor in interest to U.S. Trust Company, National Association, formerly known as +U.S. Trust Company of California, N.A.).******* + + 4.11 + + + +Registration Rights Agreement dated as of October 31, 2001 between the Company and Jefferies & Company, Inc.******* + + 5 + + + +Opinion of Milbank, Tweed, Hadley & McCloy LLP.******** + +10.1 + + + +Amended and Restated Employment Agreement dated as of December 14, 1993 between the Company and Ralph S. Roberts.** + +10.2 + + + +Loan Agreement dated as of December 17, 2001 between Foothill Capital Corporation, as lender and the Company, ARG Enterprises, Inc., ARG Property Management Corporation and ARG Terra, Inc., as borrowers.******* + +10.3 + + + +Second Amended and Restated Intercreditor and Collateral Agency Agreement dated as of December 17, 2001 between BNY Western Trust Company, as collateral agent and as trustee, the Company, ARG Enterprises, Inc., ARG Property Management +Corporation and ARG Terra, Inc., as borrowers, and Foothill Capital Corporation, as lender.******* + +12 + + + +Statement setting forth Computation of Ratio of Earnings to Fixed Charges.******* + +21 + + + +Subsidiaries of the Company.** + +23.1 + + + +Consent of Milbank, Tweed, Hadley & McCloy LLP (included in Exhibit 5 hereto). + +23.2 + + + +Consent of Independent Public Accountants.******** + +24.1 + + + +Power of Attorney (American Restaurant Group, Inc.)******* + +24.2 + + + +Power of Attorney (ARG Enterprises, Inc., ARG Property Management Corporation, ARG Terra, Inc.) (contained on the signature page to this registration statement). + +25 + + + +Statement of Eligibility and Qualification (Form T-1) under the Trust Indenture Act of 1939 of United States Trust Company of New York.******* + + + + + + +* + +Incorporated by reference to the Registrant's Registration Statement No. 33-48183 on Form S-4 filed with the Securities and Exchange Commission on May 28, 1992 as amended with Amendment No. 1 filed on +September 11, 1992. + +** + + + +Incorporated by reference to the Registrant's Registration Statement No. 33-74010 on Form S-4 filed with the Securities and Exchange Commission on January 12, 1994. + +*** + + + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated September 13, 1996 filed with the Securities and Exchange Commission on September 30, 1996. + +**** + + + +Incorporated by reference to the Registrant's Annual Report on Form 10-K dated December 29, 1997 filed with the Securities and Exchange Commission on March 30, 1998. + +***** + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-55861 on Amendment No. 1 to Form S-4 filed with the Securities and Exchange Commission on July 29, 1998. + +****** + + + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated June 28, 2000 and filed with the Securities and Exchange Commission on July 12, 2000. + +******* + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-76442 to Form S-4 filed with the Securities and Exchange Commission on January 8, 2002. + +******** + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-76434 to Form S-1 filed with the Securities and Exchange Commission on January 8, 2002. + +QuickLinks + +TABLE OF CONTENTS \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000891537_arg_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000891537_arg_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4d36976b6bec296b7a86e12ac0db941117673834 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000891537_arg_legal_matters.txt @@ -0,0 +1,5087 @@ +LEGAL MATTERS + + + The validity of the Notes and certain legal matters in connection with this offering will be passed upon for the Company by Milbank, Tweed, Hadley & McCloy +LLP, Los Angeles, California. + + + + +EXPERTS + + + The financial statements included in this Prospectus and elsewhere in the Registration Statement to the extent and for the periods indicated in their report have +been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report with respect thereto, and are included herein in reliance upon the authority of said firm as experts +in accounting in giving said report. + +65 + + + + + + +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS + + + + + +Page + +Report of Independent Public Accountants + +F-2 + +Consolidated Balance Sheets as of December 27, 1999, December 25, 2000, and September 24, 2001 + + + +F-3 + +Consolidated Statements of Operations for the Years Ended December 28, 1998, December 27, 1999, and December 25, 2000, and the Thirty-nine Weeks Ended September 25, 2000 and September 24, 2001 + + + +F-4 + +Consolidated Statements of Common Stockholders' Equity (Deficit) for the Years Ended December 28, 1998, December 27, 1999 and December 25, 2000 + + + +F-5 + +Consolidated Statements of Cash Flows for the Years Ended December 28, 1998, December 27, 1999, and December 25, 2000, and the Thirty-nine Weeks Ended September 25, 2000 and September 24, 2001 + + + +F-6 + +Notes to Consolidated Financial Statements + + + +F-7 + +F-1 + + + + + + +REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS + + +To +the Board of Directors of + +American Restaurant Group, Inc.: + + We +have audited the accompanying consolidated balance sheets of AMERICAN RESTAURANT GROUP, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 27, 1999 and +December 25, 2000, and the related consolidated statements of operations, common stockholders' equity (deficit), and cash flows for the years ended December 28, 1998, December 27, +1999, and December 25, 2000. 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. + + We +conducted our audits in accordance with auditing standards generally accepted in the United States. 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. + + In +our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Restaurant Group, Inc. and subsidiaries as +of December 27, 1999 and December 25, 2000, and the results of their operations and their cash flows for the years ended December 28, 1998, December 27, 1999, and +December 25, 2000, in conformity with accounting principles generally accepted in the United States. + +/s/ +ARTHUR ANDERSEN LLP + +San +Francisco, California + +March 2, 2001 + +F-2 + + + + + + +AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + CONSOLIDATED BALANCE SHEETS + DECEMBER 27, 1999, DECEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + + +December 27, + +1999 + +December 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + +(unaudited) + + + + +ASSETS + + + + + + + + + + + +CURRENT ASSETS: + + + + + + + + + + + + +Cash + +$ +8,316 + +$ +8,532 + +$ +3,850 + + + +Accounts receivable + + +2,655 + + +2,938 + + +3,690 + + + +Inventories + + +2,755 + + +2,853 + + +2,916 + + + +Prepaid expenses + + +2,873 + + +2,803 + + +4,521 + + + + +Net current assets of discontinued operations + + +6,068 + + + + + + + + + + + + + + + + + + + + +Total current assets + + +22,667 + + +17,126 + + +14,977 + + + + + + + + + + + +PROPERTY AND EQUIPMENT: + + + + + + + + + + + + +Land and land improvements + + +2,629 + + +2,629 + + +2,598 + + + +Buildings and leasehold improvements + + +65,418 + + +67,631 + + +69,409 + + + +Fixtures and equipment + + +48,977 + + +48,629 + + +48,953 + + + +Property held under capital leases + + +7,480 + + +7,480 + + +7,293 + + + +Construction in progress + + +521 + + +2,816 + + +1,345 + + + + + + + + + + + + + + +125,025 + + +129,185 + + +129,598 + + + +Less Accumulated depreciation + + +73,557 + + +75,815 + + +78,851 + + + + + + + + + + + + + + +51,468 + + +53,370 + + +50,747 + + + + +Net property and equipment of discontinued operations + + +36,032 + + + + + + + + + + + +Net Property and equipment + + +87,500 + + +53,370 + + +50,747 + + + + + + + + + + + +OTHER ASSETS: + + + + + + + + + + + + +Intangible assets + + +7,668 + + +7,445 + + +7,445 + + + +Deferred debt costs + + +11,061 + + +9,970 + + +9,970 + + + +Leasehold interests + + +6,577 + + +6,577 + + +6,577 + + + +Liquor licenses and other + + +4,758 + + +4,156 + + +4,136 + + + +Cost in excess of net assets acquired + + +7,537 + + +7,536 + + +7,536 + + + + + + + + + + + + + + +37,601 + + +35,684 + + +35,664 + + + +Less Accumulated amortization + + +14,083 + + +16,605 + + +18,603 + + + + + + + + + + + + + +Net other assets from discontinued operations + + +9,044 + + + + + + + + + + + + + + + + + + + + +Net other assets + + +32,562 + + +19,079 + + +17,061 + + + + + + + + + + + + + + +Total assets + +$ +142,729 + +$ +89,575 + +$ +82,785 + + + + + + + + + + + +LIABILITIES AND COMMON STOCKHOLDERS' (DEFICIT) + + + + + + + + + + + +CURRENT LIABILITIES: + + + + + + + + + + + + +Accounts payable + +$ +13,627 + +$ +15,193 + +$ +13,615 + + + +Accrued liabilities + + +9,486 + + +11,521 + + +6,320 + + + +Accrued insurance + + +2,509 + + +2,373 + + +2,695 + + + +Accrued interest + + +7,010 + + +6,251 + + +2,116 + + + +Accrued payroll costs + + +4,148 + + +7,069 + + +4,115 + + + +Current portion of obligations under capital leases + + +638 + + +713 + + +776 + + + +Current portion of long-term debt + + +477 + + +432 + + +4,416 + + + + +Current liabilities of discontinued operations + + +22,586 + + +2,945 + + +1,059 + + + + + + + + + + + + + + +Total current liabilities + + +60,481 + + +46,497 + + +35,112 + + + + + + + + + + + +LONG-TERM LIABILITIES, net of current portion: + + + + + + + + + + + + +Obligations under capital leases + + +3,300 + + +2,588 + + +2,005 + + + +Long-term debt + + +160,297 + + +144,066 + + +143,787 + + + + +Long-term debt from discontinued operations + + +2,299 + + + + + + + + + + + + + + + + + + + + +Total long-term liabilities + + +165,896 + + +146,654 + + +145,792 + + + + + + + + + + + +DEFERRED GAIN + + +4,395 + + +4,192 + + +4,037 + + + + + + + + + + + +COMMITMENTS AND CONTINGENCIES + + + + + + + + + + + + +CUMULATIVE PREFERRED STOCK, MANDATORILY REDEEMABLE + + + + + + + + + + + +Senior pay-in-kind exchangeable preferred stock, $0.01 par value; 160,000 shares authorized; 41,584 shares accrued and outstanding at December 27, 1999, 50,953 shares accrued and outstanding at December 25, 2000, +and 56,792 shares accrued and outstanding at September 24, 2001 + + +41,914 + + +49,891 + + +56,029 + + + + + + + + + + + +COMMON STOCKHOLDERS' (DEFICIT): + + + + + + + + + + + +Common stock, $0.01 par value; 1,000,000 shares authorized; 128,081 shares issued and outstanding at December 27, 1999, December 25, 2000, and September 24, 2001 + + +1 + + +1 + + +1 + + + +Paid-in capital + + +50,552 + + +15,788 + + +9,469 + + + +Accumulated (deficit) + + +(180,510 +) + +(173,448 +) + +(167,655 +) + + + + + + + + + + + + + +Total common stockholders' (deficit) + + +(129,957 +) + +(157,659 +) + +(158,185 +) + + + + + + + + + + + + + +Total liabilities and common stockholders' (deficit) + +$ +142,729 + +$ +89,575 + +$ +82,785 + + + + + + + + + + + +The accompanying notes are an integral part of these consolidated statements. + +F-3 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF OPERATIONS + FOR THE YEARS ENDED DECEMBER 28, 1998, DECEMBER 27, 1999, + DECEMBER 25, 2000, +AND THE THIRTY-NINE + WEEKS ENDED SEPTEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + +Year ended + +Nine Months Ended + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + +September 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + + + +(unaudited) + + +REVENUES + +$ +265,536 + +$ +263,561 + +$ +299,822 + +$ +226,567 + +$ +226,808 + + + + + + + + + + + + +RESTAURANT COSTS: + + + + + + + + + + + + + + + + + +Food and beverage + + +89,521 + + +88,110 + + +103,339 + + +77,675 + + +75,602 + + +Payroll + + +74,912 + + +75,114 + + +82,818 + + +60,715 + + +64,923 + + +Direct operating + + +63,260 + + +63,033 + + +69,721 + + +52,852 + + +53,830 + + +Depreciation and amortization + + +10,115 + + +9,396 + + +9,554 + + +7,352 + + +6,478 + +GENERAL AND ADMINISTRATIVE EXPENSES + + +11,780 + + +11,975 + + +11,108 + + +7,660 + + +7,198 + +NON-CASH CHARGE FOR IMPAIRMENT OF LONG-LIVED ASSETS + + +149 + + +459 + + + + + + + + + + + + + + + + + + + + + + +Operating profit from continuing operations + + +15,799 + + +15,474 + + +23,282 + + +20,313 + + +18,777 + +INTEREST EXPENSE, net + + +20,269 + + +19,450 + + +19,036 + + +14,322 + + +12,801 + + + + + + + + + + + + + +Net income /(loss) before provision for income taxes + + +(4,470 +) + +(3,976 +) + +4,246 + + +5,991 + + +5,976 + +PROVISION FOR INCOME TAXES + + +67 + + +70 + + +185 + + +211 + + +183 + + + + + + + + + + + + + +Income/(Loss) from continuing operations + + +(4,537 +) + +(4,046 +) + +4,061 + + +5,780 + + +5,793 + + +Income (Loss) from discontinued operations + + +(4,879 +) + +(1,622 +) + +3,474 + + +3,474 + + + + +EXTRAORDINARY GAIN/(LOSS) ON EXTINGUISHMENT OF DEBT FROM CONTINUING OPERATIONS + + +9,559 + + + + + +(473 +) + + + + + + + + + + + + + + + + + + +Net Income/(Loss) + +$ +143 + +$ +(5,668 +) +$ +7,062 + +$ +9,254 + +$ +5,793 + + + + + + + + + + + + +The +accompanying notes are an integral part of these consolidated statements. + +F-4 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (DEFICIT) + FOR THE YEARS ENDED DECEMBER 28, 1998, + DECEMBER 27, + 1999 AND DECEMBER 25, 2000 + (dollars in thousands) + + + + + +Common + +Stock + +Paid-in + +Capital + +Accumulated + +Debt + +Total + + +BALANCE, December 29, 1997 + +$ +1 + +$ +63,246 + +$ +(174,985 +) +$ +(111,738 +) + + +Net Income + + + + + + + + +143 + + +143 + + + + +Amortization of cost related to the issuance of preferred stock + + + + + +(332 +) + + + + +(332 +) + + + +Dividends payable, preferred stock + + + + + +(3,648 +) + + + + +(3,648 +) + + + +Non-cash distribution to parent + + + + + +(3,600 +) + + + + +(3,600 +) + + + + + + + + + + + + +BALANCE, December 28, 1998 + +$ +1 + +$ +55,666 + +$ +(174,842 +) +$ +(119,175 +) + + + + + + + + + + + + + +Net (Loss) + + + + + + + + +(5,668 +) + +(5,668 +) + + + +Amortization of cost related to the issuance of preferred stock + + + + + +(399 +) + + + + +(399 +) + + + +Dividends payable, preferred stock + + + + + +(4,715 +) + + + + +(4,715 +) + + + + + + + + + + + + +BALANCE, December 27, 1999 + +$ +1 + +$ +50,552 + +$ +(180,510 +) +$ +(129,957 +) + + + + + + + + + + + + + +Net Income + + + + + + + + +7,062 + + +7,062 + + + +Net book value of assets and liabilities transferred in conjunction with Stock Sale + + + + + +(26,788 +) + + + + +(26,788 +) + + +Amortization of cost related to the issuance of preferred stock + + + + + +(399 +) + + + + +(399 +) + + +Dividends payable, preferred stock + + + + + +(7,577 +) + + + + +(7,577 +) + + + + + + + + + + + + +BALANCE, December 25, 2000 + +$ +1 + +$ +15,788 + +$ +(173,448 +) +$ +(157,659 +) + + + + + + + + + + + + +The +accompanying notes are an integral part of these consolidated statements. + +F-5 + + + + + + +AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED + DECEMBER 28, 1998, DECEMBER 27, 1999, DECEMBER 25, 2000, + AND THE THIRTY-NINE WEEKS ENDED +SEPTEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + + +Year Ended + +Nine Months Ended + + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + +September 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + + + + +(unaudited) + + + + +CASH FLOWS FROM OPERATING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Cash received from customers + +$ +264,195 + +$ +263,562 + +$ +299,539 + +$ +226,054 + +$ +226,056 + + + +Cash paid to suppliers and employees + + +(271,512 +) + +(229,650 +) + +(260,096 +) + +(204,032 +) + +(212,900 +) + + +Interest paid, net + + +(20,729 +) + +(19,473 +) + +(19,823 +) + +(19,020 +) + +(16,936 +) + + +Income taxes, net + + +(67 +) + +(71 +) + +(312 +) + +(211 +) + +(183 +) + + + + + + + + + + + + + + + + +Net cash provided by/(used in) continuing operating activities + + +(28,113 +) + +14,368 + + +19,308 + + +2,791 + + +(3,963 +) + + + + + + + + + + + + + + +CASH FLOWS FROM INVESTING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Capital expenditures + + +(7,896 +) + +(6,248 +) + +(7,872 +) + +(6,438 +) + +(1,876 +) + + +Net (increase) decrease in other assets + + +3,734 + + +(2,619 +) + +(1,221 +) + +(606 +) + +14 + + + +Proceeds(Loss) from disposition of assets + + +9 + + +471 + + +12 + + +(12 +) + +25 + + + + + + + + + + + + + + + + + +Net cash (used in) investing activities + + +(4,153 +) + +(8,396 +) + +(9,081 +) + +(7,056 +) + +(1,837 +) + + + + + + + + + + + + + + +CASH FLOWS FROM FINANCING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Proceeds received from Stock Sale + + + + + + + + +17,000 + + +17,000 + + + + + + +Payments on indebtedness + + +(163,116 +) + +(15,376 +) + +(16,275 +) + +(264 +) + + + + + +Borrowings on indebtedness + + +163,226 + + +16,229 + + + + + +119 + + +3,705 + + + +Net increase in deferred debt costs + + +(10,818 +) + +(243 +) + + + + + + + + + + + +Cost included in extraordinary gain on extinguishment of debt + + +(1,686 +) + + + + + + + + + + + + + + +Issuance of cumulative preferred stock + + +35,000 + + + + + + + + + + + + + + + +Cost related to issuance of cumulative preferred stock + + +(2,179 +) + + + + + + + + + + + + + + +Payment on insurance related financing + + +(7,450 +) + + + + + + + + + + + + + + +Payments on capital lease obligations + + +(682 +) + +(637 +) + +(637 +) + +(472 +) + +(520 +) + + + + + + + + + + + + + + + + +Net cash provided by/(used in) financing activities + + +12,295 + + +(27 +) + +88 + + +16,383 + + +3,185 + + + + + + + + + + + + + + + +NET INCREASE/(DECREASE) IN CASH FROM CONTINUING OPERATIONS + + +(19,971 +) + +5,945 + + +10,315 + + +12,118 + + +(2,615 +) + +NET INCREASE/(DECREASE) IN CASH FROM DISCONTINUED OPERATIONS + + +23,163 + + +(5,617 +) + +(10,099 +) + +(6,167 +) + +(2,067 +) + + + + + + + + + + + + + + +CASH, at beginning of period + + +4,796 + + +7,988 + + +8,316 + + +8,316 + + +8,532 + + + + + + + + + + + + + + + +CASH, at end of period + +$ +7,988 + +$ +8,316 + +$ +8,532 + +$ +14,267 + +$ +3,850 + + + + + + + + + + + + + + + +RECONCILIATION OF NET INCOME (LOSS) TO NET CASH PROVIDED BY OPERATING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Net income (loss)from continuing operations after extraordinary items + +$ +5,022 + +$ +(4,046 +) +$ +3,588 + +$ +5,780 + +$ +5,793 + + + +Adjustments to reconcile net income (loss) to net cash provided by operating activities: + + + + + + + + + + + + + + + + + + + +Extraordinary (gain) loss on extinguishment of debt + + +(9,559 +) + + + + +473 + + + + + + + + + + + +Depreciation and amortization + + +10,115 + + +9,396 + + +9,554 + + +7,352 + + +6,478 + + + + + +Loss on disposition of assets + + +1,529 + + +3,317 + + +581 + + +581 + + + + + + + + +Impairment of assets + + +149 + + +459 + + + + + + + + + + + + + + +Amortization of deferred gain + + +(599 +) + +(289 +) + +(203 +) + +(152 +) + +(155 +) + + + + +Accretion on indebtedness + + +21 + + + + + + + + + + + + + + + + +(Increase) decrease in current assets: + + + + + + + + + + + + + + + + + + + + +Accounts receivable, net + + +1,341 + + +1 + + +(283 +) + +(173 +) + +(752 +) + + + + +Inventories + + +25 + + +89 + + +(98 +) + +(310 +) + +(63 +) + + + + +Prepaid expenses + + +102 + + +(834 +) + +70 + + +1,244 + + +(1,718 +) + + + +Increase (decrease) in current liabilities: + + + + + + + + + + + + + + + + + + + + +Accounts payable + + +(10,764 +) + +2,193 + + +1,566 + + +(3,697 +) + +(1,578 +) + + + + +Accrued liabilities + + +(16,929 +) + +2,479 + + +2,034 + + +(2,783 +) + +(5,201 +) + + + + +Accrued insurance + + +(1,528 +) + +(513 +) + +(136 +) + +323 + + +322 + + + + + +Accrued interest + + +(481 +) + +(23 +) + +(759 +) + +(4,698 +) + +(4,135 +) + + + + +Accrued payroll costs + + +(6,557 +) + +2,139 + + +2,921 + + +(676 +) + +(2,954 +) + + + + + + + + + + + + + + + + + + +Net cash provided by/(used in) continuing operating activities + +$ +(28,113 +) +$ +14,368 + +$ +19,308 + +$ +2,791 + +$ +(3,963 +) + + + + + + + + + + + + + + +The accompanying notes are an integral part of these consolidated statements. + +F-6 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + + DECEMBER 28, 1998, DECEMBER 27, 1999, AND DECEMBER 25, 2000 + + + +1. Background and Summary of Significant Accounting Policies + +a.Company + + American Restaurant Group, Inc. (the "Company"), a Delaware corporation, through its subsidiaries, operates middle-price full-service +restaurants, primarily in California, the Pacific Northwest, and Arizona. The Company is a subsidiary of American Restaurant Group Holdings, Inc. ("Holdings"), also a Delaware corporation. At +year-end 1998, 1999, and 2000, the Company and its subsidiaries, collectively referred to herein as the Company, operated 101, 102, and 105 restaurants, respectively, in its continuing +segment. + +b.Operations + + The Company's operations are affected by local and regional economic conditions, including competition in the restaurant industry. Prior to the year ended +December 25, 2000, the Company experienced recurring operating losses (before extraordinary gain (loss) on extinguishment of debt) after debt service. A recapitalization plan was consummated +during 1998 (see Note 3, "Long-Term Debt"). This plan substantially eliminated debt principal payments until the year 2003. + + Management +believes the recapitalization will also allow it to effect changes in its operations and has already implemented measures to reduce overhead costs. However, the Company does +not expect to generate sufficient cash flows from operations in the future to fully pay the principal on long-term debt upon maturity in the year 2003 and, accordingly, it expects to +refinance all or a portion of such debt, obtain new financing, or possibly sell assets. + +c.Sale of Stock to Spectrum Restaurant Group, Inc. + + The Company sold all of the outstanding stock of four wholly owned subsidiaries (Non-Black Angus Subsidiaries) to Spectrum Restaurant +Group, Inc. (formerly known as NBACo, Inc.). There was no gain or loss recorded because of the related-party nature of the Stock Sale. The Company received $17.0 million in cash +on June 28, 2000, and transferred certain assets and liabilities to Spectrum Restaurant Group, Inc. Concurrent with the sale, advances between the Company and the Non-Black +Angus Subsidiaries were eliminated. Paid-in capital of $26.8 million was charged as a result of the sale. The Company retained the assets and liabilities associated with certain +closed restaurants as well as certain liabilities, estimated on June 26, 2000 at $12.6 million, associated with the operating restaurants that were sold. The amount of estimated +liabilities remaining at December 25, 2000 was approximately $2.9 million. + + The +Company is currently working to settle these liabilities. Any adjustments to the recorded balance will be recognized when the amount becomes known, however management does not +believe that such amounts, is any, will be material to the Company's financial position or results of operations. + +d.Principles of Consolidation + + The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and +transactions have been eliminated. + +e.Use of Estimates in the Preparation of Financial Statements + + The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and +assumptions which affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results could +differ from those estimates. + +F-7 + + + +f.Inventories and Prepaid Expenses + + Inventories consist primarily of food, beverages, and supplies and are valued at the lower of cost (first-in, first-out method) or market +value. + +g.Advertising Costs + + Advertising costs are accrued as a percentage of sales and expensed during the year. At year end, production costs for advertisements, which have not been aired, +are included in prepaid expenses. Prepaid advertising costs of $1,196,000 and $1,022,000 were included in prepaid expenses at December 27, 1999 and December 25, 2000, respectively. +Advertising expenses included in net income (loss) were $13,983,000, $13,515,000, and $16,134,000 in fiscal years 1998, 1999, and 2000, respectively. + +h.Property and Equipment + + Property and equipment is carried at the lower of cost or, if impaired, at the estimated fair value of the assets. The Company provides for depreciation and +amortization based upon the estimated useful lives of depreciable assets using the straight-line method. Estimated useful lives are as follows: + +Land improvements + +20 years + +Buildings + +30 to 35 years + +Leasehold improvements + +Life of lease + +Fixtures and equipment + +3 to 10 years + +Property held under capital leases + +Life of lease + + When +a restaurant is opened, the initial purchase of expendable equipment, such as china, glassware, and silverware, is recorded as an asset and is not depreciated; +however, all replacements are expensed. + + Substantially +all of the Company's assets, including property and equipment, are pledged as collateral on the senior debt of the Company. + +i.Interest Costs + + Interest costs incurred during the construction period of restaurants are capitalized. The Company capitalized approximately $68,000 and $44,000 for the years +ended 1998 and 1999, respectively. There were no interest costs capitalized in 2000. + +j.Other Assets + + Other assets include intangible assets, leasehold interests, franchise rights, liquor licenses, and cost in excess of net assets acquired. These costs are +amortized using the straight-line method over the periods estimated to be benefited, not greater than 40 years. + + Deferred +debt costs are amortized using the effective interest method over the related debt term. + +F-8 + + + + Estimated +useful lives are as follows: + +Intangible assets + +3 to 40 years + +Deferred debt costs + +Term of debt + +Leasehold interests + +Life of lease + +Franchise rights + +35 years + +Liquor licenses + +40 years + +Cost in excess of net assets acquired + +40 years + + The +following table details the components of intangible assets included in the accompanying consolidated balance sheets (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Assembled workforce + +$ +2,986 + +$ +2,986 + +Going Concern + + +1,928 + + +1,928 + +Trademarks/service marks + + +1,794 + + +1,794 + +Acquisition costs + + +696 + + +696 + +Other + + +264 + + +41 + + + + + + +Total + +$ +7,668 + +$ +7,445 + + + + + + + As +of December 27, 1999 and December 25, 2000, no indicators of impairment exist. + +k.Insurance + + The Company self-insures certain risks up to varying limits including medical, workers' compensation, property and general liability. Deductible and +self-insured limits have varied historically, ranging from $0 to $350,000 per incident depending on the type of risk. The policy deductibles are $100,000 for its annual medical and dental +benefits per person. Reserves for losses are established based upon currently estimated obligations for the claim over time and the deductible or self-insured retention in place at the +time of the loss. + +l.Fair Value of Financial Instruments + + The Company's financial instruments consist primarily of cash, accounts receivable and payable, and debt instruments. The carrying values of all financial +instruments, other than debt instruments, are representative of their fair value due to their short-term maturity. The fair value of the Company's long-term debt instruments is +estimated based on the current rates offered to the Company. + +m.Accounting Period + + The Company's fiscal year ends on the last Monday in December. + +n.Earnings per Share + + Earnings per share information has not been presented because there is no market for the Company's common stock. + +o.Reclassifications + + Certain prior year accounts have been reclassified to conform with the current year presentation. + +F-9 + + + +p.New Accounting Pronouncements + + In June, 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS +No. 142, Goodwill and Other Intangible Assets. These new standards are effective for fiscal years beginning after December 15, 2001. Under the new standards, goodwill will no longer be +amortized, but will be subject to an annual impairment test. The standards also promulgate, among other things, new requirements for accounting for other intangible assets. The impact of these new +standards on the Company's financial position and results of operations has not yet been determined, but is not believed to be material. + + In +August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or +Disposal of Long-Lived Assets. FASB Statement No. 144 retains FASB Statement No. 121's Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of, fundamental provisions for the: (1) recognition and measurement of impairment of long-lived assets to be held and used; and (2) +measurement of long-lived assets to be disposed of by sale. The Company does not believe that FASB Statement No. 144 will have a material impact on its financial position or results of +operations. Statement No. 144 is effective for fiscal years beginning after December 15, 2001. + +2. Lease Obligations + + The Company leases certain of its operating facilities under terms ranging up to 40 years. These leases are classified as both operating and capital +leases. Certain of the leases contain provisions calling for rentals based on sales or other provisions obligating the Company to pay related property taxes and certain other expenses. + + The +following is a summary of property held under capital leases and included in the accompanying consolidated balance sheets (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Property + +$ +7,480 + +$ +7,480 + +Less Accumulated depreciation + + +5,720 + + +6,071 + + + + + + + + +$ +1,760 + +$ +1,409 + + + + + + +F-10 + + + + The +following represents the minimum lease payments remaining under noncancelable operating leases and capitalized leases as of December 25, 2000 (in thousands): + +Fiscal Years Ending + + +Operating + +Leases + +Capitalized + +Leases + +2001 + +$ +16,504 + +$ +1,070 + +2002 + + +15,107 + + +1,070 + +2003 + + +14,757 + + +830 + +2004 + + +13,778 + + +263 + +2005 + + +12,168 + + +232 + +Thereafter + + +168,018 + + +1,347 + + + + + + +Total minimum lease payments + +$ +240,332 + + +4,812 + + + + + + +Less Imputed interest (8.75% to 15.5%) + + + + + +1,511 + +Present value of minimum lease payments + + + + + +3,301 + + + + + + + +Less Current portion + + + + + +713 + + + + + + + +Long-term portion + + + + +$ +2,588 + + + + + + + + Rental +expense was $15,216,000, $15,460,000, and $16,650,000 during 1998, 1999, and 2000, respectively. + +3. Long-Term Debt + + Long-term debt is summarized as follows (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Senior secured notes, interest only due semi-annually beginning August 15, 1998 at 11.5%, principal due February 15, 2003 + +$ +158,600 + +$ +142,600 + +Other + + +2,174 + + +1,898 + + + + + + + + + +160,774 + + +144,498 + +Less Current portion + + +477 + + +432 + + + + + + +Long-term portion + +$ +160,297 + +$ +144,066 + + + + + + + Maturities +of the remaining long-term debt during each of the five fiscal years subsequent to year end 2000 are $432,000, $335,000, $142,627,000, $30,000, and +$1,074,000 thereafter. + + In +February 1998, the Company completed a recapitalization plan (the "Recapitalization Plan") that included, among other things, the issuance by the Company of $155,000,000 of +Notes due 2003. + + In +conjunction with the Recapitalization Plan, the Company issued an additional $3,600,000 principal amount of Notes to holders of certain Holdings debt and recorded such issuance as a +non-cash distribution. There was an extraordinary gain recorded in 1998 of 9,559,000 as a result of this transaction. + + As +part of the Recapitalization Plan, the Company concurrently (a) redeemed at par senior secured notes of $126,381,000 together with interest thereon and repaid certain other +interest-bearing + +F-11 + + + +short-term liabilities, (b) repurchased its existing 10.25% subordinated notes at 65% of the par amount of $45,000,000 together with interest thereon, and canceled the related +warrants to purchase common stock of Holdings, and (c) established a $15,000,000 revolving credit facility to include letters of credit. A quarterly fee of 0.5% per annum is payable on the +unused portion of the letter of credit facility and a quarterly fee of 2.5% per annum is payable on outstanding letters of credit. + + On +June 28, 2000, the Company amended the terms of the Credit Facility to reduce the aggregate commitment of the lenders from $15,000,000 to $12,000,000, to reduce the amount +available for issuance of letters of credit from $10,000,000 to $7,000,000, and to extend the maturity date from February 25, 2001 to June 30, 2002. + + At +year end 1999 and 2000, the Company had outstanding letters of credit primarily related to its self-insurance programs of approximately $3,597,000 and $5,500,000, +respectively. + + The +revolving credit facility contains certain covenants, the most restrictive of which requires the Company to maintain a certain ratio of cash flows to total debt. As of +December 25, 2000, the Company was in compliance with all financial covenants. The Company made a prepayment of principal of $16 million in December 2000, and recorded an +extraordinary loss of $473,000 to write-off the related unamortized deferred financing costs. + + Substantially +all assets of the Company are pledged to its senior lenders. In addition, the direct subsidiaries guaranteed the indebtedness owed by the Company and such guarantees are +secured by substantially all of the assets of the subsidiaries. In connection with such indebtedness, contingent and mandatory prepayments may be required under certain specified conditions and +events. There are no compensating balance requirements. + + Management +believes the fair value of the debt approximates its carrying value. + +F-12 + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + DECEMBER 28, 1998, DECEMBER 27, 1999, AND DECEMBER 25, 2000 + +4. Income Taxes + + The Company's state income-tax provision, all of which was current, was $67,000, $70,000, and $185,000 in 1998, 1999, and 2000, respectively. No +provision for federal income taxes was required in any year. + + The +income tax effects of temporary differences that give rise to significant portions of the Company's deferred income tax assets and liabilities are as follows (in thousands): + + + + +Year Ended + + + + + +December 27, + +1999 + +December 25, + +2000 + + +Deferred income tax asset: + + + + + + + + + +Reserves and other accrued expenses not currently deductible for tax purposes + +$ +4,221 + +$ +3,358 + + + +Long-lived asset impairment not recognized on tax return + + +2,813 + + +2,813 + + + +Tax gain on sale/leaseback transactions, net + + +3,097 + + +2,978 + + +Discontinued Operations + + +2,514 + + + + + +Net operating loss carryforward + + + + + + + + + +From continuing operations + + +38,756 + + +39,043 + + + +From discontinued operations + + +14,991 + + +0 + + + + + + + + + + + +Deferred income-tax asset + + +66,392 + + +48,192 + + + + + + + + + +Deferred income tax liability: + + + + + + + + + +Tax depreciation greater than depreciation for financial reporting purposes + + +(6,927 +) + +(6,789 +) + + +Costs capitalized for financial reporting purposes and expensed on tax return + + +(4,172 +) + +(4,087 +) + + +Other, net + + + + + + + + + + +From continuing operations + + +(597 +) + +(350 +) + + + + + + + + + + +Deferred income-tax liability + + +(11,696 +) + +(11,226 +) + + + + + + + + +Deferred asset, net of deferred liability + + +54,696 + + +36,966 + + +Valuation allowance + + +(54,696 +) + +(36,966 +) + + + + + + + + +Net deferred income-tax asset + +$ + + +$ + + + + + + + + + + + The +Company fully reserves its net deferred tax assets because of its history of operating losses. + +F-13 + + + + The +effective tax rate differs from the federal statutory rate of 34 percent as a result of the following items (in thousands): + + + + +Year Ended + + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + + +Federal income-tax provision (benefit) at statutory rates + +$ +49 + +$ +(1,903 +) +$ +2,655 + + +State income-tax provision for which no federal benefit was recorded + + +44 + + +1 + + +464 + + +Losses for which no federal benefit was recorded + + +3,792 + + +1,195 + + + + + +Nondeductible items, principally intangible amortization + + +964 + + +777 + + +159 + + +Benefit of net operating loss carryforward + + + + + + + + +(3,093 +) + +Cancellation of debt income + + +(4,782 +) + + + + + + + + + + + + + + + + +Provision for income taxes + +$ +67 + +$ +70 + +$ +185 + + + + + + + + + + + +Provision for income taxes attributable to discontinued operations + +$ +21 + +$ +20 + +$ +59 + + + At +December 25, 2000, the Company had available net operating loss carryforwards for federal income-tax purposes of $96,619,000 expiring in 2003 to 2020, and federal +general business credit carryforwards of $6,192,000, expiring in 2009 to 2019. + +5. Commitments and Contingencies + + The Company is obligated under an employment agreement with an officer. The obligation under the agreement is $500,000, provides for periodic increases, and +expires in 2001 unless extended. + + The +Company has been named as defendant in various lawsuits. Management's opinion is that the outcome of such litigation will not materially affect the Company's financial position or +results of operations. + +6. Cumulative Preferred Stock, Mandatorily Redeemable + + As part of the Recapitalization Plan in February, 1998, the Company issued 35,000 preferred stock units (the "Units") of the Company. Each Unit consists of $1,000 +initial liquidation preference of 12% senior pay-in-kind exchangeable preferred stock and one common-stock purchase warrant initially to purchase 2.66143 shares of the common +stock at an initial exercise price of one cent per share. The Company's cumulative preferred stock is mandatorily redeemable on August 15, 2003, for cash at a price per share equal to 110% of +the then applicable liquidation preference. + + A +stock dividend of 2,499 shares was paid on February 15, 2000. In the second quarter of 2000, the Company agreed to an interpretation of the financial covenants used to determine +the dividend rate. The result was an increase in the dividend rate from 12% to 15% and additional dividends issued on August 15th of 2,503 shares (relating to holders at August 1999 and +February 2000). Stock dividends of 5,872 (including the adjustment) and 3,618 shares were made on August 15, 2000 and February 15, 2001, respectively. There were 50,953 shares +outstanding at December 25, 2000. + +F-14 + + + +7. Common Stock + + As of December 29, 1997, all of the Company's common stock was owned by American Restaurant Group Holdings, Inc., Anwar S. Soliman, and Management +Shareholders. They also own all outstanding shares of Holdings common stock other than shares of Holdings common stock issued to holders of the debenture units and rights to acquire shares of Holdings +common stock issuable upon exercise of options and warrants. + + In +conjunction with the Recapitalization Plan, the Company issued shares of common stock to certain members of the Company's management (the "Management Stockholders") in an aggregate +amount equal to 15% of the common stock on a fully diluted basis. Such Management Stockholders have entered into a voting trust agreement with Anwar Soliman to exercise all voting and substantially +all other rights to which such Management Shareholders would otherwise be entitled until August 15, 2005, or the earlier termination of the agreement. The Management Shareholders also entered +into a shareholders' agreement with the remaining Company shareholders, which provides that the parties will agree to vote all of their shares of the Company's equity securities so that the Board of +Directors of the Company consists of five directors, with two directors designated by TCW Investors, two by the Management Shareholders, with the remaining director being an independent director +initially designated by the initial purchaser of the Notes. + +8. Savings Plan + + The American Restaurant Group Savings and Investment Plan (the "Savings Plan") is a 401(k) plan established for the benefit of employees who satisfy certain +requirements. These requirements include completion of one year of service with a minimum of 1,000 hours worked. Subject to applicable limits imposed on tax-qualified plans, +eligible employees may elect pre-tax contributions up to 20.0% of a participant's total earnings for a calendar year (but not in excess of $10,500 for 2000). The Company makes matching +contributions to the Savings Plan equal to 25% of the participant's contributions up to 6% of the participant's earnings. During fiscal 1998, 1999, and 2000, the Company contributed approximately +$174,000, $225,000, and $206,000 to the Savings Plan, respectively. At December 25, 2000, there were approximately 3,900 employees eligible, 1,100 participants, and 600 contributors to the +plan. + +9. Subsequent Event (unaudited) + + The Company will recognize a charge of approximately $5.5 million in its results of operations for the fourteen weeks ended December 31, 2001. Under +GAAP the Company must immediately expense a portion of its transaction costs deemed to be associated with an exchange of debt instruments that are substantially the same. The exchange of +Series B Notes for Series C Notes is deemed to be such a transaction. The Company incurred additional costs associated with the issuance of the New Notes which have been capitalized and +will be amortized over the term of the New Notes. + +F-15 + +AMERICAN RESTAURANT GROUP, INC. + + + +PROSPECTUS January 24, 2002 + + + + + + + + +PART II + + INFORMATION NOT REQUIRED IN PROSPECTUS + + +ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. + + The estimated expenses payable by the Company in connection with the issuance and distribution of the Notes and in connection with the offering described in this +Registration Statement are as follows: + +Registration Fee + +$ +8,100 + +Legal fees and expenses + + +111,161 + +Accounting fees and expenses + + +35,571 + +Printing and duplicating expenses + + +57,140 + +Miscellaneous expenses + + +1,824,595 + + + + + +Total + +$ +2,036,567 + + + + +ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS + + Section 145 of the General Corporation Law of the State of Delaware (the "GCL") provides in relevant part that a Delaware corporation may +indemnify any persons, including officers and directors, who are, or are threatened to be made, parties to any threatened, pending or completed legal action, suit or proceeding, whether civil, +criminal, administrative or investigative (other than an action by or in the right of such corporation), by reason of the fact that such person is or was an officer or director of such corporation, or +is or was serving at the request of such corporation as a director, officer, employee or agent of another corporation or enterprise. The indemnity may include expenses (including attorneys' fees), +judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding, provided such officer or director acted in good +faith and in a manner he reasonably believed to be in or not opposed to the corporation's best interests and, for criminal proceedings, had no reasonable cause to believe that his conduct was illegal. +A Delaware corporation may indemnify officers and directors in an action by or in the right of the corporation under the same conditions, except that no indemnification is permitted without judicial +approval if the officer or director is adjudged to be liable to the corporation in the performance of his duty. Where an officer or director is successful on the merits or otherwise in the defense of +any action referred to above, the corporation must indemnify him against the expenses which such officer or director actually and reasonably incurred. + + Article IV +of the by-laws of the Company provides for indemnification of its officers and directors to the fullest extent permitted by Section 145 of the GCL. + + Section 102(b)(7) +of the GCL provides that a Delaware corporation may eliminate or limit the personal liability of a director to a Delaware corporation or its stockholders for +monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director (i) for any breach of the director's duty of +loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under +Section 174 of the GCL relating to the unlawful payment of a dividend or an unlawful stock purchase or redemption or (iv) for any transaction from which the director derived an improper +personal benefit. + + Article 7 +of the Certificate of Incorporation of the Company provides for the elimination of personal liability of its directors for monetary damages for breach of fiduciary duty +as a director, except as otherwise provided by the GCL. + +II-1 + + + +ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES + + On October 31, 2001, we privately placed, under Rule 144A and Regulation S of the Securities Act, $30 million aggregate principal +amount of 111/2% Senior Secured Notes due 2006, yielding net proceeds to the Company of approximately $3.1 million, after deducting estimated expenses and commissions. The +proceeds were used to refinance existing indebtedness, to pay the accrued and unpaid interest with respect to the Existing Notes and for general corporate purposes. Jefferies & +Company, Inc. was the initial purchaser of these securities. On October 1, 2001, we commenced an offer to exchange all of our outstanding Old Notes for up to $131.7 million +aggregate principal amount of 111/2% Senior Secured Notes due 2006. The notes include registration rights such that the registrant is required to exchange the notes for a new issue of +notes registered under the Securities Act of 1933 and are to be declared effective no later than 150 days after the issue date. + +ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES + +Exhibit No. + + +Description + + +1.1 + +Purchase Agreement dated as of September 28, 2001 by and between the Company and Jefferies & Company, Inc.******* + +2.1 + + + +Purchase Agreement dated as of September 11, 1996 by and between ARG Property Management Corporation and ARG Enterprises, Inc. and ARG Properties I, LLC.*** + +2.2 + + + +Master lease dated September 11, 1996 between ARG Properties I, LLC, as Landlord and ARG Enterprises, Inc. as Tenant.*** + +2.3 + + + +Lease #06152 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Bloomington, Minnesota.*** + +2.4 + + + +Lease #06153 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Fridley, Minnesota.*** + +2.5 + + + +Lease #06154 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Minnetonka, Minnesota.*** + +2.6 + + + +Lease #06155 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Roseville, Minnesota.*** + +2.7 + + + +Not Applicable. + +2.8 + + + +Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to ARG Properties I, LLC as Landlord.*** + +2.9 + + + +A Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to Captec Net Lease Realty, Inc. as Landlord for each of four Minnesota restaurants.*** + +2.10 + + + +Not Applicable. + +2.11 + + + +Stock Purchase Agreement, dated as of May 9, 2000 between the Company and NBACo, Inc.****** + +2.12 + + + +Amendment No. 1, dated as of June 26, 2000, to Stock Purchase Agreement, dated as of May 9, 2000, between the Company and NBACo, Inc.****** + +3.1 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on July 23, 1991.* + +3.2 + + + +Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on March 21, 1992.* + +II-2 + + + +3.3 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on February 23, 1998.**** + +3.3A + + + +Amendment to Certificate of the Designation of the Powers, Preferences and relative, Participating, Optional and Other Special Rights of the 12% Series A Senior Pay-In-Kind Exchangeable Preferred stock and the 12% Series B Senior Pay-In-Kind +Exchangeable Preferred Stock and Qualifications, Limitations or Restrictions Thereof of the Company filed with the Secretary of State of Delaware on October 31, 2001.******* + +3.4 + + + +By-Laws of the Company.* + +3.5 + + + +Restated Articles of Incorporation of ARG Enterprises, Inc. filed with the Secretary of State of California on May 3, 1988.******* + +3.6 + + + +Bylaws of ARG Enterprises, Inc.******* + +3.7 + + + +Restated Articles of Incorporation of ARG Property Management Corporation filed with the Secretary of State of California on May 3, 1988.******* + +3.8 + + + +Bylaws of ARG Property Management Corporation.******* + +3.9 + + + +Certificate of Incorporation of ARG Terra, Inc. filed with the Secretary of State of Delaware on June 20, 2000.******* + +3.10 + + + +Bylaws of ARG Terra, Inc.******* + +4.1 + + + +Indenture dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as Trustee (including specimen certificate of 11.5% Senior Secured Note due 2003).**** + +4.2 + + + +Warrant Agreement dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as warrant agent (including specimen certificate of warrant).**** + +4.3 + + + +Registration Rights Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc.**** + +4.4 + + + +Securityholders' and Registration Right Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc., as purchaser.**** + +4.5 + + + +Management Registration Right Agreement dated as of February 28, 1998 between the Company and the Management Stockholders.**** + +4.6 + + + +Certificate of Designation filed with the Secretary of State of Delaware on February 24, 1998.**** + +4.7 + + + +Certificate of Correction to the Certificate of Designation filed with the Secretary of State of Delaware on February 25, 1998.**** + +4.8 + + + +Not Applicable. + +4.9 + + + +First Supplemental Indenture, dated as June 28, 2000, to Indenture, dated as of February 25, 1998, between the Company and U.S. Trust Company, National Association (formerly known as U.S. Trust Company of California, +N.A.).****** + +4.10 + + + +Second Supplemental Indenture, dated as of October 31, 2001, to Indenture, dated as of February 25, 1998, between the Company and BNY Western Trust Company (successor in interest to U.S. Trust Company, National Association, formerly known as +U.S. Trust Company of California, N.A.).******* + +II-3 + + + +4.11 + + + +Registration Rights Agreement dated as of October 31, 2001 between the Company and Jefferies & Company, Inc.******* + +5 + + + +Opinion of Milbank, Tweed, Hadley & McCloy LLP.******** + +10.1 + + + +Amended and Restated Employment Agreement dated as of December 14, 1993 between the Company and Ralph S. Roberts.** + +10.2 + + + +Loan Agreement dated as of December 17, 2001 between Foothill Capital Corporation, as lender and the Company, ARG Enterprises, Inc., ARG Property Management Corporation and ARG Terra, Inc., as borrowers.******* + +10.3 + + + +Second Amended and Restated Intercreditor and Collateral Agency Agreement dated as of December 17, 2001 between BNY Western Trust Company, as collateral agent and as trustee, the Company, ARG Enterprises, Inc., ARG Property Management +Corporation and ARG Terra, Inc., as borrowers, and Foothill Capital Corporation, as lender.******* + +12 + + + +Statement setting forth Computation of Ratio of Earnings to Fixed Charges.******* + +21 + + + +Subsidiaries of the Company.** + +23.1 + + + +Consent of Milbank, Tweed, Hadley & McCloy LLP (included in Exhibit 5 hereto). + +23.2 + + + +Consent of Independent Public Accountants.******** + +24.1 + + + +Power of Attorney (American Restaurant Group, Inc.)******* + +24.2 + + + +Power of Attorney (ARG Enterprises, Inc., ARG Property Management Corporation, ARG Terra, Inc.) (contained on the signature page to this registration statement). + +25 + + + +Statement of Eligibility and Qualification (Form T-1) under the Trust Indenture Act of 1939 of United States Trust Company of New York.******* + + + + + + +* + +Incorporated by reference to the Registrant's Registration Statement No. 33-48183 on Form S-4 filed with the Securities and Exchange Commission on May 28, 1992 as amended with Amendment No. 1 filed on +September 11, 1992. + +** + +Incorporated by reference to the Registrant's Registration Statement No. 33-74010 on Form S-4 filed with the Securities and Exchange Commission on January 12, 1994. + +*** + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated September 13, 1996 filed with the Securities and Exchange Commission on September 30, 1996. + +**** + +Incorporated by reference to the Registrant's Annual Report on Form 10-K dated December 29, 1997 filed with the Securities and Exchange Commission on March 30, 1998. + +***** + +Incorporated by reference to the Registrant's Registration Statement No. 333-55861 on Amendment No. 1 to Form S-4 filed with the Securities and Exchange Commission on July 29, 1998. + +****** + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated June 28, 2000 and filed with the Securities and Exchange Commission on July 12, 2000. + +******* + +Incorporated by reference to the Registrant's Registration Statement No. 333-76442 to Form S-4 filed with the Securities and Exchange Commission on January , 2002. + +******** + +Incorporated by reference to the Registrant's Registration Statement No. 333-76434 to Form S-1 filed with the Securities and Exchange Commission on January 8, 2002. + +II-4 + + + +ITEM 17. UNDERTAKINGS + + A. Insofar +as indemnification for liabilities arising under the Act 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 Act +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. + +B.The +undersigned registrant hereby undertakes: + + (1) To +file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: + + (i) To +include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; + + (ii) To +reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement. Notwithstanding the foregoing, any increase or decrease in +volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering +range may be reflected in the form of prospectus filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change +in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. + + (iii) To +include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such +information in the registration statement. + + (2) That, +for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new +registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona +fide offering thereof. + + (3) To +remove from registration by means of a post-effective amendment any of the securities being registered that remain unsold at the termination of the +offering. + +II-5 + + + + + + +SIGNATURES + + + Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the +requirements to file Amendment No. 1 to Form S-1 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in +the City of Los Altos, State of California on the 17th day of January 2002. + + + + + + + +AMERICAN RESTAURANT GROUP, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer, Secretary and + +General Counsel + + + + + +ARG ENTERPRISES, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + + + + +ARG PROPERTY MANAGEMENT CORPORATION + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + + + + +ARG TERRA, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed below by the following persons in the +capacities and on the dates indicated. + + + +AMERICAN RESTAURANT GROUP, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ GEORGE G. GOLLEHER* George G. Golleher + +Chairman of the Board and Director + +January 17, 2002 + +/s/ RALPH S. ROBERTS* Ralph S. Roberts + + + +Chief Executive Officer, President and Director (principal executive officer and director) + + + +January 17, 2002 + +II-6 + + + +/s/ PATRICK J. KELVIE* Patrick J. Kelvie + + + +Vice President, Treasurer, Secretary and General Counsel (principal financial officer) + + + +January 17, 2002 + +/s/ SHERRI A. CARROLL* Sherri A. Carroll + + + +Controller + + + +January 17, 2002 + +/s/ ANWAR S. SOLIMAN* Anwar S. Soliman + + + +Director + + + +January 17, 2002 + +/s/ ROBERT D. BEYER* Robert D. Beyer + + + +Director + + + +January 17, 2002 + +/s/ M. BRENT STEVENS* M. Brent Stevens + + + +Director + + + +January 17, 2002 + +*By:/s/ PATRICK J. KELVIE Patrick J. Kelvie + Attorney-in-fact + + + + + + + + + + + + +POWER OF ATTORNEY + + + Each person whose signature appears below constitutes and appoints Patrick J. Kelvie his or her true and lawful +attorney-in-fact and agent, with full power of substitution and resubstitution for him or her and in his or her name, place and stead, in any and all capacities to sign any and +all amendments (including post-effective amendments) to this Registration Statement, and any registration statement of the Company to be filed after the date hereof pursuant to +Rule 462(b) under the Securities Act of 1933, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, and to +take such actions in, and file with the appropriate authorities in, whatever states said attorneys-in-fact and agents, and each of them, shall determine, such applications, +statements, consents, and other documents, as may be necessary or expedient to register securities of the Company for sale, granting unto said attorneys-in-fact and agents full +power and authority to do so and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in +person, hereby ratifying and confirming all that said attorney-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done +by virtue hereof and the registrant hereby confers like authority on its behalf. + + This Registration Statement and Power of Attorney, pursuant to the requirement of the Securities Act of 1933, as amended, have been signed below by the following +persons in the capacities and on the dates indicated. + + Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed below by the following persons in the +capacities and on the dates indicated. + +II-7 + + + +ARG ENTERPRISES, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +ARG PROPERTY MANAGEMENT CORPORATION + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +ARG TERRA, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +II-8 + + + + +EXHIBIT INDEX + + +Exhibit No. + + +Description + + + 1.1 + +Purchase Agreement dated as of September 28, 2001 by and between the Company and Jefferies & Company, Inc.******* + + 2.1 + + + +Purchase Agreement dated as of September 11, 1996 by and between ARG Property Management Corporation and ARG Enterprises, Inc. and ARG Properties I, LLC.*** + + 2.2 + + + +Master lease dated September 11, 1996 between ARG Properties I, LLC, as Landlord and ARG Enterprises, Inc. as Tenant.*** + + 2.3 + + + +Lease #06152 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Bloomington, Minnesota.*** + + 2.4 + + + +Lease #06153 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Fridley, Minnesota.*** + + 2.5 + + + +Lease #06154 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Minnetonka, Minnesota.*** + + 2.6 + + + +Lease #06155 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Roseville, Minnesota.*** + + 2.7 + + + +Not Applicable. + + 2.8 + + + +Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to ARG Properties I, LLC as Landlord.*** + + 2.9 + + + +A Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to Captec Net Lease Realty, Inc. as Landlord for each of four Minnesota restaurants.*** + + 2.10 + + + +Not Applicable. + + 2.11 + + + +Stock Purchase Agreement, dated as of May 9, 2000 between the Company and NBACo, Inc.****** + + 2.12 + + + +Amendment No. 1, dated as of June 26, 2000, to Stock Purchase Agreement, dated as of May 9, 2000, between the Company and NBACo, Inc.****** + + 3.1 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on July 23, 1991.* + + 3.2 + + + +Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on March 21, 1992.* + + 3.3 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on February 23, 1998.**** + + 3.3A + + + +Amendment to Certificate of the Designation of the Powers, Preferences and relative, Participating, Optional and Other Special Rights of the 12% Series A Senior Pay-In-Kind Exchangeable Preferred stock and the 12% Series B Senior Pay-In-Kind +Exchangeable Preferred Stock and Qualifications, Limitations or Restrictions Thereof of the Company filed with the Secretary of State of Delaware on October 31, 2001.******* + + 3.4 + + + +By-Laws of the Company.* + + 3.5 + + + +Restated Articles of Incorporation of ARG Enterprises, Inc. filed with the Secretary of State of California on May 3, 1988.******* + + 3.6 + + + +Bylaws of ARG Enterprises, Inc.******* + + 3.7 + + + +Restated Articles of Incorporation of ARG Property Management Corporation filed with the Secretary of State of California on May 3, 1988.******* + + 3.8 + + + +Bylaws of ARG Property Management Corporation.******* + + 3.9 + + + +Certificate of Incorporation of ARG Terra, Inc. filed with the Secretary of State of Delaware on June 20, 2000.******* + + 3.10 + + + +Bylaws of ARG Terra, Inc.******* + + 4.1 + + + +Indenture dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as Trustee (including specimen certificate of 11.5% Senior Secured Note due 2003).**** + + 4.2 + + + +Warrant Agreement dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as warrant agent (including specimen certificate of warrant).**** + + 4.3 + + + +Registration Rights Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc.**** + + 4.4 + + + +Securityholders' and Registration Right Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc., as purchaser.**** + + 4.5 + + + +Management Registration Right Agreement dated as of February 28, 1998 between the Company and the Management Stockholders.**** + + 4.6 + + + +Certificate of Designation filed with the Secretary of State of Delaware on February 24, 1998.**** + + 4.7 + + + +Certificate of Correction to the Certificate of Designation filed with the Secretary of State of Delaware on February 25, 1998.**** + + 4.8 + + + +Not Applicable. + + 4.9 + + + +First Supplemental Indenture, dated as June 28, 2000, to Indenture, dated as of February 25, 1998, between the Company and U.S. Trust Company, National Association (formerly known as U.S. Trust Company of California, + N.A.).****** + + 4.10 + + + +Second Supplemental Indenture, dated as of October 31, 2001, to Indenture, dated as of February 25, 1998, between the Company and BNY Western Trust Company (successor in interest to U.S. Trust Company, National Association, formerly known as +U.S. Trust Company of California, N.A.).******* + + 4.11 + + + +Registration Rights Agreement dated as of October 31, 2001 between the Company and Jefferies & Company, Inc.******* + + 5 + + + +Opinion of Milbank, Tweed, Hadley & McCloy LLP.******** + +10.1 + + + +Amended and Restated Employment Agreement dated as of December 14, 1993 between the Company and Ralph S. Roberts.** + +10.2 + + + +Loan Agreement dated as of December 17, 2001 between Foothill Capital Corporation, as lender and the Company, ARG Enterprises, Inc., ARG Property Management Corporation and ARG Terra, Inc., as borrowers.******* + +10.3 + + + +Second Amended and Restated Intercreditor and Collateral Agency Agreement dated as of December 17, 2001 between BNY Western Trust Company, as collateral agent and as trustee, the Company, ARG Enterprises, Inc., ARG Property Management +Corporation and ARG Terra, Inc., as borrowers, and Foothill Capital Corporation, as lender.******* + +12 + + + +Statement setting forth Computation of Ratio of Earnings to Fixed Charges.******* + +21 + + + +Subsidiaries of the Company.** + +23.1 + + + +Consent of Milbank, Tweed, Hadley & McCloy LLP (included in Exhibit 5 hereto). + +23.2 + + + +Consent of Independent Public Accountants.******** + +24.1 + + + +Power of Attorney (American Restaurant Group, Inc.)******* + +24.2 + + + +Power of Attorney (ARG Enterprises, Inc., ARG Property Management Corporation, ARG Terra, Inc.) (contained on the signature page to this registration statement). + +25 + + + +Statement of Eligibility and Qualification (Form T-1) under the Trust Indenture Act of 1939 of United States Trust Company of New York.******* + + + + + + +* + +Incorporated by reference to the Registrant's Registration Statement No. 33-48183 on Form S-4 filed with the Securities and Exchange Commission on May 28, 1992 as amended with Amendment No. 1 filed on +September 11, 1992. + +** + + + +Incorporated by reference to the Registrant's Registration Statement No. 33-74010 on Form S-4 filed with the Securities and Exchange Commission on January 12, 1994. + +*** + + + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated September 13, 1996 filed with the Securities and Exchange Commission on September 30, 1996. + +**** + + + +Incorporated by reference to the Registrant's Annual Report on Form 10-K dated December 29, 1997 filed with the Securities and Exchange Commission on March 30, 1998. + +***** + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-55861 on Amendment No. 1 to Form S-4 filed with the Securities and Exchange Commission on July 29, 1998. + +****** + + + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated June 28, 2000 and filed with the Securities and Exchange Commission on July 12, 2000. + +******* + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-76442 to Form S-4 filed with the Securities and Exchange Commission on January 8, 2002. + +******** + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-76434 to Form S-1 filed with the Securities and Exchange Commission on January 8, 2002. + +QuickLinks + +TABLE OF CONTENTS \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000895040_gulfterra_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000895040_gulfterra_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9be909025169c27b01a5adc4b6eebfe252c79313 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000895040_gulfterra_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares and i-units offered by this prospectus will be passed upon for us by Akin, Gump, Strauss, Hauer & Feld, L.L.P., Houston, Texas. Various legal matters relating to the offering will be passed upon for the underwriters by Vinson & Elkins L.L.P., Houston, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000925942_zeigler_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000925942_zeigler_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000925942_zeigler_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0000927914_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0000927914_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..13ce2218a35d0639a79733761d672ecf1dd554d7 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0000927914_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus were passed upon for us by Jones, Day, Reavis & Pogue. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001001865_coast_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001001865_coast_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a1848e2ccc14d34846ea7282bc8ab08c34f68d3c --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001001865_coast_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Gibson, Dunn & Crutcher LLP, Los Angeles, California, and by McDonald Carano Wilson McCune Bergin Frankovich & Hicks LLP, Reno, Nevada. Certain legal matters will be passed upon for the underwriters by Latham & Watkins, Los Angeles, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001003264_aps_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001003264_aps_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..dc4290309d16f0453d2ed5bea78f52541aea2084 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001003264_aps_legal_matters.txt @@ -0,0 +1 @@ +Legal matters The validity of the shares of common stock offered hereby will be passed upon for us by Epstein Becker & Green, P.C., New York, New York. Steven B. Epstein, one of our directors, is a member of Epstein Becker & Green, P.C. and holds 125,000 shares of our common stock and options to purchase 150,000 shares of our common stock. Dewey Ballantine LLP, New York, New York, is acting as counsel for the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001013243_aaipharma_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001013243_aaipharma_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4c79049b7f651b0a07ddea1f1374dcf272475db6 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001013243_aaipharma_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered for sale by this prospectus will be passed upon for us by Robinson, Bradshaw & Hinson, P.A., Charlotte, North Carolina. Certain legal matters in connection with this offering will be passed upon for the underwriters by Shearman & Sterling, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001040736_mmi_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001040736_mmi_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7f318fe24ced3875ad082ad519079d2872b759cf --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001040736_mmi_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the resale notes will be passed upon by Weil, Gotshal & Manges LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001049782_brookline_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001049782_brookline_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..51ff5b46f7c52ef6456495b595ceda7c24612659 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001049782_brookline_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the common stock has been opined upon for Brookline Bancorp, Inc. by Luse Gorman Pomerenk & Schick, P.C., Washington, D.C., special counsel to Brookline Bancorp, Inc. Certain legal matters will be passed upon for Ryan, Beck & Co., LLC by Foley, Hoag & Eliot LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001050959_viacell_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001050959_viacell_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..76273976f8422286142411b776e5ab646ddc36c3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001050959_viacell_legal_matters.txt @@ -0,0 +1 @@ +Legal matters Our counsel, Palmer & Dodge LLP, Boston, Massachusetts, will pass on the validity of the shares of common stock offered by this prospectus. Paul Kinsella, a partner of Palmer & Dodge LLP, is our Secretary. Dewey Ballantine LLP, New York, is counsel to the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001053827_highland_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001053827_highland_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001053827_highland_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001053828_mountain_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001053828_mountain_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001053828_mountain_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001053829_aceco-inc_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001053829_aceco-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001053829_aceco-inc_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001053850_mining_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001053850_mining_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001053850_mining_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001053853_addington_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001053853_addington_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001053853_addington_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001053882_river_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001053882_river_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001053882_river_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001053908_leslie_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001053908_leslie_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001053908_leslie_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001061505_gpc_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001061505_gpc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..fd9cc8f59472083a1d60b33ae6895c1972597ed7 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001061505_gpc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby and other legal matters relating to this offering will be passed upon for us by Simpson Thacher & Bartlett, New York, New York. The validity of the notes offered hereby and other legal matters relating to this offering will be passed upon for the underwriters by Cahill Gordon & Reindel, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001061506_graham_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001061506_graham_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..fd9cc8f59472083a1d60b33ae6895c1972597ed7 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001061506_graham_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby and other legal matters relating to this offering will be passed upon for us by Simpson Thacher & Bartlett, New York, New York. The validity of the notes offered hereby and other legal matters relating to this offering will be passed upon for the underwriters by Cahill Gordon & Reindel, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001067356_horizon_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001067356_horizon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001067356_horizon_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001068084_private_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001068084_private_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e3612e2cac50f6b85f4488cf2d5ee16303f80853 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001068084_private_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered by this prospectus will be passed upon for Private Media Group, Inc. by Guzik & Associates, Los Angeles, California. Shearman & Sterling, Frankfurt, Germany, and London, England, will pass upon certain legal matters for the underwriters. Samuel S. Guzik, a principal of Guzik & Associates, beneficially owns 43,955 shares of common stock and holds options to acquire an additional 21,045 shares of common stock at $ 4.17 per share. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001070110_pharmacy_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001070110_pharmacy_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..eb2be8ccbc66d49889bc89595c1d175ed119b90e --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001070110_pharmacy_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Kutak Rock LLP, Kansas City, Missouri, will render an opinion regarding the validity of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078453_wyoming_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078453_wyoming_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078453_wyoming_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078458_bentley_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078458_bentley_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078458_bentley_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078459_bluegrass_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078459_bluegrass_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078459_bluegrass_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078462_cannelton_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078462_cannelton_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078462_cannelton_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078467_kentucky_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078467_kentucky_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078467_kentucky_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078477_meadowlark_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078477_meadowlark_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078477_meadowlark_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078478_grassy_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078478_grassy_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078478_grassy_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078479_mega_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078479_mega_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078479_mega_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078481_hayman_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078481_hayman_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078481_hayman_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078497_cc-coal-co_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078497_cc-coal-co_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078497_cc-coal-co_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078499_roaring_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078499_roaring_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078499_roaring_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078517_horizon_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078517_horizon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078517_horizon_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078521_west_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078521_west_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078521_west_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001078931_appalachia_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001078931_appalachia_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001078931_appalachia_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001089558_completel_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001089558_completel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d002cb31e0f6aef5b62ad75ad01c90b0b5d85ffd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001089558_completel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Ordinary shares underlying the Warrants will be passed upon for us by Stibbe, Amsterdam. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001089848_mccoy_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001089848_mccoy_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001089848_mccoy_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001089849_red-ridge_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001089849_red-ridge_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001089849_red-ridge_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001089851_sunny_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001089851_sunny_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68fce24f16a19b772bb5519e8df807e15a593fb3 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001089851_sunny_legal_matters.txt @@ -0,0 +1,4461 @@ +LEGAL MATTERS + + The +validity of the senior secured notes offered hereby will be passed on for us by +Stroock & Stroock &Lavan LLP, New York, New York. Certain legal matters +relating to the offering will be passed upon for us by Frost Brown Todd LLC, +Lexington and Louisville, Kentucky. + +EXPERTS + + +Horizon's consolidated financial statements as of December 31, 2000 and 2001 and +for each of the years in the three-year period ended December 31, 2000 included +in the registration statement of which this prospectus forms a part have been +audited by Arthur Andersen LLP, independent public accountants ("Andersen"), as +stated in their audit report including going concern modification appearing +herein. Pursuant to rules recently promulgated by the SEC, the audit report of +Andersen is included herein, although we have been unable to obtain Andersen's +consent to such inclusion. + + On +May 23, 2002, Horizon's board of directors approved the dismissal of Andersen as +our independent public accountants and engaged Deloitte & Touche LLP to serve as +its independent accountants for fiscal 2002. The board made this decision at its +first meeting after the effective date of our reorganization, at which the board +also appointed its audit committee. + + +Andersen's reports on Horizon's consolidated financial statements for each of +the two most recent fiscal years were qualified as to its ability to continue as +a going concern, but did not contain otherwise an adverse opinion or disclaimer +of opinion, nor were they otherwise qualified or modified as to uncertainty, +audit scope or accounting principles. + + In +connection with its audits for our two prior fiscal years and during the +subsequent period through May 23, 2002, there have been no disagreements between +Andersen and us on any matter of accounting principles and practices, financial +statement disclosure or auditing scope or procedure, which disagreements, if not +resolved to Andersen's satisfaction, would have caused Andersen to make +reference to the subject matter of the disagreement in connection with its +report on Horizon's consolidated financial statements for such years. + + +During our two prior fiscal years and through May 23, 2002, Andersen has not +advised us of any of the following: + + + +that the internal controls necessary for us to develop reliable +financial statements do not exist. + + + +that information has come to Andersen's attention that has led Andersen to +no longer be able to rely on management's representations, or that has made +it unwilling to be associated with the financial statements prepared by +management. + + + +the need to expand significantly the scope of its audit, or that information has +come to Andersen's during our two prior fiscal years and through May 23, +2002, that if further investigated may materially impact the fairness or +reliability of either a previously issued audit report or the underlying +financial statements or the financial statements issued or to be issued covering +periods after 2001 (including information that may prevent it from rendering an +unqualified audit report on those financial statements), or cause Andersen to be +unwilling to rely on management's representations or be associated with our +financial statements, and due to its dismissal or any other reason, Andersen did +not so expand the scope of its audit or conduct such further investigation. + + + +that information has come to Andersen's attention that it has concluded +materially impacts the fairness or reliability of either a previously issued +audit report or the underlying financial statements, or the financial statements +issued or to be issued covering periods after 2001 (including information that, +unless resolved to Andersen's satisfaction, would prevent it from rendering +an unqualified audit report on those financial statements), and due to +Andersen's dismissal or any other reason, the issue has not been resolved +to Andersen's satisfaction before its dismissal. + + We +requested Andersen to furnish us with a letter addressed to the Securities and +Exchange Commission stating whether it agrees with the above statements made by +us. We have been unable to obtain such a letter from Andersen. + + +During our two prior fiscal years and through May 23, 2002, we did not consult +Deloitte & Touche, LLP with respect to the application of accounting principles +to a specified transaction, either completed or proposed, or the type of audit +opinion that might be rendered on our consolidated financial statements, or any +other matters that were subject to a disagreement with our prior auditor or +events listed above. + + The +information appearing in this prospectus concerning estimates of our proven and +probable coal reserves was prepared by Marshall Miller & Associates and has been +included herein upon the authority of this firm as an expert. + +WHERE YOU CAN FIND MORE INFORMATION + + We +have filed with the Securities and Exchange Commission, a registration statement +on Form S-1 under the Securities Act with respect to the securities to be sold +in this offering. As permitted by the rules and regulations of the Commission, +this prospectus omits certain information contained in the registration +statement. For further information with respect to us and the securities to be +sold in this offering, you should refer to the registration statement and to its +exhibits and schedules. Statements contained in this prospectus regarding the +contents of any agreement or other document are not necessarily complete. You +should refer in each instance to the copy of the agreement filed or incorporated +by reference as an exhibit to the registration statement, each such statement +being qualified in all respects by the document to which it refers. We are also +required to file annual, quarterly and special reports, proxy statements and +other information with the SEC. + + You +can read the registration statement and the exhibits and schedules filed with +the registration statement or any reports, statements or other information we +have filed or file, at the public reference facilities maintained by the SEC at +Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and +at its regional office located at 500 West Madison Street, Suite 1400, Chicago, +Illinois 60661. You may also obtain copies of the documents from such offices +upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for +further information on the operation of the public reference rooms. You may also +request copies of the documents upon payment of a duplicating fee, by writing to +the SEC. In addition, the SEC maintains a web site that contains reports, proxy +and information statement and other information regarding registrants (including +us) that file electronically with the SEC, which you can access at +http://www.sec.gov. + +INDEX TO FINANCIAL STATEMENTS + + +Page + +Report of Arthur Andersen LLP, Independent Public Accountants +F-2 + +Consolidated Balance Sheets as of December 31, 2000 and 2001 +F-3 + +Consolidated Statements of Operations for the years ended December 31, 1999, 2000 and 2001 +F-4 + +Consolidated Statements of Stockholders' Equity (Deficit) for the +years ended December 31, 1999, 2000 and 2001 +F-5 + +Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001 +F-6 + +Notes to Consolidated Financial Statements +F-7 + +Consolidated Balance Sheets as of December 31, 2001 and March 31, 2002 (unaudited) +F-35 + +Consolidated Statements of Operations for the three months ended +March 31, 2001 and 2002 (unaudited) +F-36 + +Consolidated Statements of Cash Flows for the three months ended +March 31, 2001 and 2002 (unaudited) +F-37 + +Notes to Consolidated Financial Statements for the three months +ended March 31, 2002 (unaudited) +F-38 + +Report of Independent Public Accountants + +To the Stockholders of + + AEI Resources Holding, Inc.: + +We have audited the accompanying consolidated balance sheets of +AEI Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, +and the related consolidated statements of operations, stockholders' equity +(deficit) and cash flows for each of the three years in the period ended +December 31, 2001. 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. + +We conducted our audits in accordance with auditing standards +generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above +present fairly, in all material respects, the financial position of AEI +Resources Holding, Inc. and subsidiaries as of December 31, 2000 and 2001, and +the results of their operations and their cash flows for each of the three years +in the period ended December 31, 2001, in conformity with accounting principles +generally accepted in the United States. + +The accompanying financial statements have been prepared +assuming that the Company will continue as a going concern. As discussed in Note +2 to the financial statements, the Company has filed voluntary petitions for +reorganization under Chapter 11 of the United States Bankruptcy Code, +accompanied by a prepackaged plan of reorganization. In addition, as also +described in Note 2, the Company is in default of various covenants and +provisions, including debt service payments, of its principal debt instruments +which makes such obligations currently due. These matters raise substantial +doubt about the Company's ability to continue as a going concern. Management's +plans in regard to these matters are also described in Note 2. The financial +statements do not include any adjustments relating to the recoverability and +classification of asset carrying amounts or the amount and classification of +liabilities that might result should the Company be unable to continue as a +going concern. + +/s/ Arthur Andersen, LLP + +Louisville, Kentucky + + March 7, 2002 + +AEI Resources Holding, Inc. + +Consolidated Balance Sheets + +As of December 31, 2000 and 2001 + + 2000 2001 + ----------------- ----------------- + (Dollar amounts in thousands) +ASSETS +Current Assets: + Cash and cash equivalents $ 54,763 $ 62,215 + Accounts receivable (including amounts due from related parties + of $2,948 and $10,191, respectively, net of allowance for + doubtful accounts of $7,282 and $4,612, respectively) 123,571 121,859 + Inventories 84,693 91,044 + Deferred tax asset 12,750 13,010 + Prepaid expenses and other 19,886 23,138 + ------------- -------------- + Total current assets 295,663 311,266 + ------------- -------------- +Property, Plant and Equipment, at cost, including mineral reserves + and mine development and contract costs 2,282,816 2,305,633 + + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ------------- -------------- + 1,793,625 1,587,330 + ------------- -------------- +Debt issuance costs, net 82,287 68,105 +Other non-current assets, net 31,599 93,469 + ------------- -------------- + Total assets $ 2,203,174 $ 2,060,170 + ============= ============== + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current Liabilities: + Accounts payable (including amounts due to related parties of + $10,700 and $13,431, respectively) $ 99,838 $ 84,306 + Current portion of long-term debt and capital leases 1,333,477 1,329,651 + Accrued interest 54,288 216,443 + Current portion of reclamation and mine closure costs 35,242 32,882 + Current portion of employee benefits 33,494 39,663 + Income taxes payable 2,528 1,154 + Accrued expenses and other 126,500 121,193 + ------------ --------------- + Total current liabilities 1,685,367 1,825,292 + ------------ --------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases 17,398 5,232 + Employee benefits 557,096 585,430 + Reclamation and mine closure costs 328,396 301,510 + Deferred income taxes 12,750 13,010 + Other non-current liabilities 90,720 66,720 + ------------- --------------- + Total non-current liabilities 1,006,360 971,902 + ------------- --------------- + Total liabilities 2,691,727 2,797,194 + ------------- --------------- + +Commitments and Contingencies (see notes) + +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized; + 91,445 shares issued and outstanding, respectively) 1 1 + Additional capital 220 220 +Accumulated other comprehensive loss - (22,345) +Retained deficit (488,774) (714,900) + ------------- -------------- + Total stockholders' deficit (488,553) (737,024) + ------------- -------------- + Total liabilities and stockholders' deficit $ 2,203,174 $ 2,060,170 + ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these balance sheets. + +AEI Resources Holding, Inc. + +Consolidated Statements of Operations + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- ------------- -------------- + (In Thousands) + +Revenues (including amounts from related parties of + $126, $42 and $22,797, respectively) $ 1,330,822 $ 1,338,640 $ 1,412,523 +Costs and expenses: + Cost of operations (including amounts to related + parties of $66,434, $74,079 and $96,239, respectively) 1,040,912 1,123,217 1,146,414 + Depreciation, depletion and amortization 208,348 253,490 266,639 + Selling, general and administrative (including amounts + to related parties of $1,185, $1,774 and $2,197, + respectively) 48,907 41,747 41,394 + Writedowns and special items 87,656 11,679 13,928 + --------------- ------------- -------------- + Total costs and expenses 1,385,823 1,430,133 1,468,375 + --------------- ------------- -------------- + Loss from operations (55,001) (91,493) (55,852) + --------------- ------------- -------------- + +Interest and other income (expense): + Interest expense (140,238) (167,605) (194,099) + Gain (loss) on sale of assets (101,352) (251) 8,253 + Other, net 3,662 9,547 16,948 + --------------- ------------- -------------- + (237,928) (158,309) (168,898) + --------------- ------------- -------------- + Loss before income taxes (292,929) (249,802) (224,750) +Income tax provision (benefit) (93,510) (53,098) 1,376 + --------------- ------------- -------------- + Net loss $ (199,419) $ (196,704) $ (226,126) + =============== ============= ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Stockholders' Equity (Deficit) + +For the Years Ended December 31, 1999, 2000 and 2001 + + Accumulated + Common Stock Other + ---------------------- Additional Retained Comprehensive + Shares Amount Capital Deficit Loss Total + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at January 1, 1999 52,804 $ 1 $ - $ (92,651) $ - $ (92,650) + Issued 3,100 shares of $.01 + par value common stock + on February 1, 1999 3,100 - 220 - - 220 + 1999 Net loss - - - (199,419) - (199,419) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 1999 55,904 1 220 (292,070) - (291,849) + Issued 35,541 shares of $.01 + par value common stock on + June 13, 2000 35,541 - - - - - + 2000 Net loss - - - (196,704) - (196,704) + ---------- ----------- ----------- ------------ ---------- -------------- + +Balance at December 31, 2000 91,445 $ 1 $ 220 (488,774) - (488,553) + Minimum pension liability + adjustment (net of $- in tax) - - - - (22,345) (22,345) + 2001 Net loss - - - (226,126) - (226,126) + ---------------- + ---------- ----------- ----------- ------------ ---------- -------------- + 2001 Comprehensive loss (248,471) + -------------- +Balance at December 31, 2001 91,445 $ 1 $ 220 $ (714,900) $ (22,345) $ (737,024) + ========== =========== =========== ============ ========== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +AEI Resources Holding, Inc. + +Consolidated Statements of Cash Flows + +For the Years Ended December 31, 1999, 2000 and 2001 + + 1999 2000 2001 + --------------- -------------- -------------- + (In Thousands) + +Cash Flows From Operating Activities: + Net loss $ (199,419) $ (196,704) $ (226,126) + Adjustments to reconcile net loss to net cash provided + by operating activities + Depreciation, depletion and amortization 208,348 253,490 266,639 + Amortization of finance costs included in interest + expense 7,875 12,329 15,026 + Provision for deferred income taxes (95,701) (54,167) - + Provision for writedowns and special items 87,656 1,209 - + Provision for doubtful accounts 531 2,647 13 + Non-cash equipment sales (9,622) - - + Loss (gain) on sale of assets 101,352 251 (8,253) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables 3,632 22,568 196 + Inventories 4,628 18,364 (6,351) + Prepaid expenses and other non-current assets 2,353 7,800 4,666 + Increase (decrease) in: + Accounts payable 12,071 (40,746) (18,765) + Other accrued expenses and other non-current liabilities (52,311) 15,473 135,651 + --------------- -------------- -------------- + Total adjustments 270,812 239,218 388,822 + --------------- -------------- -------------- + Net cash provided by operating activities 71,393 42,514 162,696 + --------------- -------------- -------------- + +Cash Flows From Investing Activities: + Net proceeds from sale of assets 16,022 27,064 14,309 + Disposition of acquired assets resold 5,167 - - + Additions to property, plant and equipment and mine + development and contract costs (93,555) (69,870) (85,033) + Acquisition of coal-mining companies including debt + retirement, net of cash received (68,430) - - + Increase in restricted investments - - (55,113) + --------------- -------------- -------------- + Net cash used in investing activities (140,796) (42,806) (125,837) + --------------- -------------- -------------- + +Cash Flows From Financing Activities: + Borrowings on long-term debt 135,782 75,569 14,994 + Repayments on long-term debt (66,261) (37,563) (41,301) + Repayments on capital leases (4,788) (2,187) (2,256) + Payments for debt issuance and financing costs (14,922) (1,741) (844) + Payments for financing costs related to terminated transactions (2,265) - - + Proceeds from issuance of common stock 220 - - + --------------- -------------- -------------- + Net cash provided by (used in) financing + activities 47,766 34,078 (29,407) + --------------- -------------- -------------- + +Net increase (decrease) in cash and cash equivalents (21,637) 33,786 7,452 + +Cash and Cash Equivalents, beginning of year 42,614 20,977 54,763 + --------------- -------------- -------------- + +Cash and Cash Equivalents, end of year $ 20,977 $ 54,763 $ 62,215 + =============== ============== ============== + +The accompanying notes to consolidated financial statements are +an integral part of these statements. + +(1) Organization and Basis of Presentation: + +(a) Organization--AEI Resources Holding, Inc., a Delaware +company, (the Company) operates a coal mining business in the United States. The +Company owns AEI Resources, Inc. (Resources) which itself owns numerous direct +and indirect subsidiaries. The Company has no other activities other than the +ownership of Resources and the maintenance of a stock option plan. As of +December 31, 2001, the Company is majority-owned and controlled by Larry +Addington. As discussed in Note 2, on February 28, 2002, the Company filed a +voluntary petition for reorganization under Chapter 11 of the United States +Bankruptcy Code (Bankruptcy Code) accompanied by a prepackaged plan of +reorganization. + +(b) Basis of Presentation and Principles of Consolidation--The +accompanying financial statements include the historical accounts of the Company +and its majority-owned subsidiaries. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. Investments in 20-50 percent +owned entities are accounted for under the equity method and are not +significant. The accompanying financial statements also include the purchase +accounting and post-acquisition operations of the following significant +acquisitions since their date of acquisition: Princess Beverly (February 1999) +and Sunny Ridge (April 1999). + + +The Company operates in one reportable segment: the +production of steam and metallurgical coal from surface and deep mines in +Kentucky, West Virginia, Indiana, Illinois and Colorado. + +(2) Liquidity and Bankruptcy Proceedings- + + +The Company's consolidated financial statements have +been presented on the basis that it is a going concern, which contemplates the +realization of assets and the satisfaction of liabilities in the normal course +of business. The financial statements do not include any adjustments relating to +the recoverability and classification of asset carrying amounts or the amount +and classification of liabilities that might result should the Company be unable +to continue as a going concern. The Company suffered losses and has a negative +equity and working capital position at December 31, 2001. The Company has also +been unable to meet its debt service obligations during the fourth quarter of +2000 and continuing through February 2002. In addition, as discussed in Note 20, +the Company was directed by certain states it does business in to replace its +Frontier Insurance Company (Frontier) surety bonds or risk a cessation of +operations. The Company has replaced the Frontier bonds that governmental +authorities have demanded be replaced. Management's plans to remedy the +Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the +commencement of the Company's Chapter 11 cases, the Company solicited votes for +the acceptance or rejection of the Prepackaged Plan of Reorganization +(Prepackaged Plan) from the holders of their 10.5% Senior Notes due 2005; the +holders of their 6.95% Industrial Revenue Refunding Bonds, Series 1997, due +2028; the holders of their 6.90% Port Facility Revenue Refunding Bonds, Series +1997, due 2022; the holders of their 11.5% Senior Subordinated Notes due 2006 +and the holders of claims under the Company's Secured Bank Credit Agreement. Of +those voting, the holders of such claims voted unanimously in favor of the +Prepackaged Plan. + + +On February 28, 2002, the Company, together with +certain of its direct and indirect debtor subsidiaries, commenced in the United +States Bankruptcy Court for the Eastern District of Kentucky (Bankruptcy Court) +voluntary cases under chapter 11 of title 11 of the Bankruptcy Code and filed +concurrently therewith, as debtors and debtors-in-possession, the Joint Plan of +Reorganization of the Debtors dated February 28, 2002 (Plan) and a Solicitation +and Disclosure Statement dated January 28, 2002 (Disclosure Statement) relating +to the Plan. + + +The Company received approval from the Bankruptcy +Court to pay or otherwise honor its prepetition obligations, including employee +wages and benefits. The court also approved the Company's $150,000 +debtor-in-possession financing (DIP). The DIP allows the Company to resolve +bonding issues and should provide reassurance to employees, suppliers and +customers that the Company can continue to operate and meet its commitments +without interruption. + + +The Company has received a commitment from Bankers +Trust for a secured credit facility (Exit Facility), to be entered into on the +date the Plan becomes effective (Effective Date). The Exit Facility will consist +of a $250,000 revolving credit facility, under which revolving loans may be made +and letters of credit may be issued up to a sublimit of $200,000 for such +letters of credit. The Exit Facility will mature five years after the Effective +Date. The Company will use the funds borrowed under the Exit Facility to repay +all amounts outstanding under the DIP Facility, to fund certain cash needs on +the Effective Date and for working capital needs after emergence. The Exit +Facility contains various financial covenants which, among other things, limit +additional indebtedness, dividend and other restricted payments, affiliate +transactions, mergers and capital expenditures and require the Company to meet +certain financial ratios including, but not limited to, interest coverage and +maximum leverage ratio, all as defined in the Exit Facility. + + +The Company is currently in default on its Credit +Facility (Note 8b), Senior Notes (Note 8c), Senior Subordinated Notes (Note 8c), +Zeigler IRBs (Note 8d) and Kentucky Bank and Trust Loan (Note 8f). Accordingly, +this debt has been reflected as a current liability in the accompanying +financial statements. Since September 30, 2000, the Company has not made any +scheduled principal or interest payments on the Credit Facility, Zeigler IRBs, +Senior Notes and the Subordinated Notes and, as a result, has violated various +provisions and covenants under these debt instruments, including financial +covenants. As of February 28, 2002, the Company has missed scheduled principal +and interest payments of $77,500 and $210,723 (excluding penalty interest of +$16,907), respectively. The Senior Notes, Senior Subordinated Notes and Zeigler +IRBs (New Equity) will be cancelled, and the holders of such notes and bonds +will be issued equity in the reorganized company . According to the Plan, +current equity will be cancelled and no distributions will be made respect +thereof. + + +Pursuant to the Plan, each lender under the Credit +Facility (which had outstanding principal plus fees and accrued interest of +$985,777 at February 28, 2002) as of the Effective Date will be converted into +(A) such lender's pro rata portion of: (i) the New Senior Secured Term Notes +evidencing a senior secured term loan in an aggregate principal amount equal to +$475,000, minus Available Cash (as defined in the Disclosure Statement) as of +the Effective Date; (ii) $450,000 in aggregate principal amount of New Senior +Notes and (iii) Cash in the amount equal to the Bank Claims Cash Distribution +Amount (as defined in the Disclosure Statement). The $450,000 New Senior Notes +mature in 2009 with a stated interest rate of 11.75%. The New Senior Secured +Term Notes mature pursuant to an amortization schedule that requires quarterly +installment payments of $5,000 with the sixth anniversary date requiring payment +of the outstanding balance. Interest is calculated at LIBOR plus the Applicable +Margin, as defined in Exhibit 3 of the Plan. The New Senior Secured Term Notes +and New Senior Notes contain various financial covenants which are similar to +those in the Exit Facility. + + +A hearing to consider confirmation of the Plan, +including approval of the Disclosure Statement and the solicitation procedures +used in connection therewith, and any objections to the Plan is scheduled for +April 12, 2002. If the Plan is confirmed, the Company could emerge from +bankruptcy shortly thereafter, assuming certain conditions set forth in the Plan +are met. + + +Under Chapter 11, certain claims against a debtor in +existence prior to the filing of the petitions for relief under the federal +bankruptcy laws are stayed while the debtor continues business operations as +debtor-in-possession. Claims secured against the debtor's assets (secured +claims) also are stayed, although the holders of such claims have the right to +move the court for relief from the stay. Secured claims are secured primarily by +liens on the debtor's property, plant and equipment. During the pendancy of the +Company's bankruptcy proceedings, virtually all actions against it are stayed +pursuant to section 362 of the Bankruptcy Code. Upon emergence from bankruptcy +proceedings, the automatic stay would no longer apply. + + +Pursuant to SOP 90-7 "Financial Reporting by Entities +in Reorganization under the Bankruptcy Code", the Company plans on adopting +fresh-start reporting upon emergence from bankruptcy. Entities that adopt +fresh-start reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". See Note 3p for a +discussion of these statements. + + + +Each liability existing at the plan confirmation date, other than deferred +taxes, should be stated at present values of amounts to be paid determined at +appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally accepted +accounting principles. Benefits realized from preconfirmation net operating loss +carryforwards should first reduce reorganization value in excess of amounts +allocable to identifiable assets and other intangibles until exhausted and +thereafter be reported as a direct addition to paid-in capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +The Company's on-going financial viability is +dependent on Plan confirmation and its ability to improve operations and cash +flows. The Company's operating plan includes measures it believes will improve +operating profits and cash flows. These measures include, but are not limited to +the following: (1) enhancing mine productivity by replacing old, inefficient +production equipment, (2) consolidating operations to reduce mine level overhead +costs, (3) focusing on high margin properties to achieve the best possible sales +and production balance both in terms of coal quality and transportation factors, +(4) acquiring strategic, low cost reserves to replace existing operations, (5) +utilizing the restructured balance sheet and improved liquidity to establish new +relationships with first tier vendors and improve access to new vendors, +including improved pricing and payment terms. There can be no assurances that +the Plan will be confirmed or that operating profits and cash flows will be +realized in an amount sufficient to fund obligations or other liquidity +needs. + + +Bankruptcy proceedings have many variables and are +extremely difficult to predict. While not anticipated, the Plan may not be +confirmed or the conditions thereto satisfied. This would result in the Company +remaining in bankruptcy and possibly a liquidation of the Company. It is also +possible that an alternative, third-party plan of reorganization could be +proposed and approved by the Bankruptcy Court. Accordingly, we are unable to +assess the likelihood of an unfavorable outcome to the Company or estimate the +amount or range of potential loss it might sustain should the Plan not be +confirmed or not become effective. + +(3) Summary of Significant Accounting Policies and General- + +(a) Company Environment and Risk Factors--The Company, in the +course of its business activities, is exposed to a number of risks including: +the possibility of the termination or alteration of coal sales contracts, +fluctuating market conditions of coal (often impacted by the weather) and +transportation/fuel costs, competitive industry and overcapacity, changing +government regulations, unexpected maintenance and equipment failure, employee +benefits cost control, misestimates of proven and probable coal reserves, +satisfactory labor relations, loss of key employees, satisfactory resolution of +technology issues as well as the ability of the Company to obtain financing, +necessary mining permits and control of adequate recoverable mineral reserves. +In addition, adverse uncontrollable (wet) weather and geological conditions tend +to increase mining costs, sometimes substantially. + + +The Company is exposed to risks associated with a +highly leveraged organization. Such risks include: increased vulnerability to +adverse economic and industry conditions, limited ability to fund future working +capital, capital expenditures, business acquisitions or other corporate +requirements, possible liquidity problems as well as financing and credit +constraints (see Note 2). + +(b) Inventories--Inventories are stated at average cost, which +approximates first-in, first-out (FIFO) cost and does not exceed market. +Components of inventories consist of coal, deferred overburden and parts and +supplies (Note 5). Coal inventories represent coal contained in stockpiles and +exposed in the pit. Deferred overburden represents the costs to remove the +earthen matter (i.e., overburden) covering the coal seam in surface mining. +Costs to remove overburden are accumulated and deferred on a pro-rata basis as +overburden is removed and eventually charged to cost of operations when the coal +is extracted and sold. The calculation of deferred overburden requires +significant estimates and assumptions, principally involving engineering +estimates of overburden removal and coal seam characteristics. + +(c) Advance Royalty Payments--The Company is required, under +certain royalty lease agreements, to make minimum royalty payments whether or +not mining activity is being performed on the leased property. These minimum +payments may be recoupable once mining begins on the leased property. The +Company capitalizes the recoupable minimum royalty payments and amortizes the +deferred costs once mining activities begin or expenses the deferred costs when +the Company has ceased mining or has made a decision not to mine on such +property. The Company has recorded advance royalties of $22,705 (including +$7,670 included in prepaid expense and other and $15,035 included in other +non-current assets) in 2000 and $20,723 (including $5,658 included in prepaid +expenses and other and $15,065 included in other non-current assets) in 2001. + +(d) Depreciation, Depletion and Amortization--Property, plant +and equipment are recorded at cost, including construction overhead and +interest, where applicable. Expenditures for major renewals and betterments are +capitalized while expenditures for maintenance and repairs are expensed as +incurred. Fixed asset depreciation is provided using the straight-line method +with estimated useful lives comprising substantially the following ranges: + + Years + ----------- + + Buildings 10 to 45 + Mining and other equipment and related facilities 1 to 20 + Land improvements 15 + Transportation equipment 2 to 7 + Furniture and fixtures 3 to 10 + + +Depreciation expense for property, plant and +equipment for the years ended December 31, 1999, 2000 and 2001 was $90,802, +$104,189 and $108,105, respectively. + + +Mineral reserves are depleted using the +units-of-production method, based on estimated recoverable reserves. + + +Mine development costs are amortized using the +units-of-production method, based on estimated recoverable reserves. Costs +related to coal sales contracts are amortized as tons are delivered, based on +contracted tonnage requirements. + + +Debt issuance costs are being amortized (included in +interest expense) using the effective interest method, over the life of the +related debt. + +(e) Restricted Cash--Included in other non-current assets is +$1,807 and $57,120 for 2000 and 2001, respectively, relating to restricted cash. +The increase in restricted cash is directly related to cash held by third +parties for bonding (Note 20). The Company also pays amounts as required by +various royalty agreements. Certain of these agreements have been disputed by +third parties, requiring that cash be paid into an escrow account until the +rightful recipient is determined. Additionally, some agreements require amounts +be set aside until the completion of reclamation work. + +(f) Coal Mine Reclamation and Mine Closure Costs--The Company +estimates its future cost requirements for reclamation of land where it has +conducted surface and deep mining operations, based on its interpretation of the +technical standards of regulations enacted by the U.S. Office of Surface Mining, +as well as state regulations. + + +The Company accrues for the cost of final mine +closure and related exit costs over the estimated useful mining life of the +developed property or, if purchased, at the date of acquisition. These costs +relate to reclaiming the pit and support acreage at surface mines and sealing +portals at deep mines. Other costs common to both types of mining are related to +reclaiming refuse and slurry ponds as well as holding and related +termination/exit costs. The Company expenses the reclamation of current mine +disturbance which is performed prior to final mine closure. The establishment of +the end of mine reclamation and closure liability is based upon permit +requirements and requires various significant estimates and assumptions, +principally associated with regulatory requirements, costs and recoverable coal +reserves. Annually, the Company reviews its end of mine reclamation and closure +liability and makes necessary adjustments, including mine plan and permit +changes and revisions to cost and production levels to optimize mining and +reclamation efficiency. The economic impact of such adjustments is generally +recorded to cost of operations prospectively as remaining tons are mined. Also, +as described in Note 3j, when a mine life is shortened due to change in mine +plan, mine closing obligations are accelerated and the related accrual is +increased accordingly. Although the Company's management believes it is making +adequate provisions for all expected reclamation and other costs associated with +mine closures, future operating results would be adversely affected if such +accruals were later determined to be insufficient. End of mine reclamation and +closure expense for 1999, 2000 and 2001 was $16,192, $6,512 and $6,994, +respectively, and charges to the accrual for 1999, 2000 and 2001 were $58,834, +$38,175 and $36,220, respectively. See Note 3p for discussion of future changes +in reclamation accounting (SFAS No. 143). + +(g) Income Tax Provision--The provision for income taxes +includes federal, state and local income taxes currently payable and those +deferred because of temporary differences between the financial statement and +tax basis of assets and liabilities. The Company records income taxes under the +liability method. Under this method, deferred income taxes are recognized for +the estimated future tax effects of differences between the tax basis of assets +and liabilities and their financial reporting amounts as well as net operating +loss carryforwards and tax credits based on enacted tax laws. Valuation +allowances are established when necessary to reduce deferred tax assets to the +amount expected to be realized. + +(h) Revenue Recognition--Most of the Company's revenues have +been generated under long-term coal sales contracts with electric utilities, +industrial companies or other coal-related organizations, primarily in the +eastern United States. Revenues are recognized on coal sales in accordance with +the sales agreement, which is usually when the coal is shipped to the customer +and title has passed. The Company also rents and sells equipment and provides +repair and contract mining services, and the revenue from such rental, sale and +service is recognized when earned. Advance payments received are deferred and +recognized in revenue as coal is shipped or rentals are earned. + + +The Company grants credit to its customers based on +their creditworthiness and generally does not secure collateral for its +receivables. + +(i) Shipping and Handling Fees and Costs--Consistent with +Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and +Handling Fees and Costs" (EITF 00-10), the Company classifies shipping and +handling costs billed to customers as sales. Shipping and handling fees and +costs are included in Cost of Operations. + +(j) Asset Impairments and Accelerated Mine Closing Accruals--In +certain situations, expected mine lives are shortened because of changes to +planned operations. When that occurs and it is determined that the mine's +underlying costs are not recoverable in the future, reclamation and mine closing +obligations are accelerated and the mine closing accrual is increased +accordingly. Also, to the extent that it is determined that asset carrying +values will not be recoverable during a shorter mine life, a provision for such +impairment is recognized. The Company follows Statement of Financial Accounting +Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of," which requires that projected +future cash flows from use and disposition of the Company's assets be compared +with the carrying amounts of those assets. When the sum of projected cash flows +is less than the carrying amount, impairment losses are recognized. In +determining such impairment losses, the Company generally utilizes discounted +cash flows to determine the fair value of the assets being evaluated. + +(k) Employee Benefits--Postretirement Benefits Other Than +Pensions As prescribed by SFAS No. 106, "Employers' Accounting for +Postretirement Benefits Other Than Pension," the Company accrues, based on +annual outside actuarial valuations, for the expected costs of providing +postretirement benefits other than pensions, which are primarily medical +benefits, during an employee's actual working career. + + +Workers' Compensation and Black Lung Benefits +Certain of the Company's subsidiaries are liable under federal and state laws to +pay workers' compensation and pneumoconiosis (black lung) benefits to eligible +employees, former employees and their dependents. The Company is self-insured +for significant federal and state workers' compensation and black lung benefits. +The Company utilizes a combination of loss-sensitive insurance, self-insurance +and state workers' compensation fund participation to secure its on-going +obligations depending on the operation. The Company accrues for its workers' +compensation and black lung obligations on a present value basis determined by +outside actuarial valuations. + + +Postemployment Benefits As prescribed by SFAS +No. 112, "Employers' Accounting for Postemployment Benefits," the Company +provides certain postemployment benefits, primarily medical benefits, to certain +former and inactive employees and their dependents during a time period +following employment. The Company accrues the present value of expected future +benefits, based on outside actuarial valuations, during an employee's actual +working career. + +(l) Stock-Based Compensation--These financial statements +include the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based +Compensation". With respect to accounting for its stock options, as permitted +under SFAS No. 123, the Company has retained the intrinsic value method +prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock +Issued to Employees" (APB 25), and related interpretations. + +(m) Management's Use of Estimates--The preparation of financial +statements in conformity with accounting principles generally accepted in the +United States requires management to make estimates and assumptions that affect +the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported +amounts of revenues and expenses during the reporting period. Actual results +could differ from those estimates. + +(n) Reclassifications--Certain reclassifications of prior year +amounts were made to conform with the current year presentation with no effect +on previously reported net loss or stockholders' equity (deficit). + +(o) Statements of Cash Flows--For purposes of the statements of +cash flows, the Company considers investments having maturities of three months +or less at the time of the purchase to be cash equivalents. + + Supplemental disclosure: + + 1999 2000 2001 + --------------- ------------- --------------- + + Cash paid for interest $ 119,239 $ 95,865 $ 4,311 + Income taxes paid (refunded) 2,385 (200) 5 + + +No interest has been capitalized in 1999, 2000 or +2001. The 1999 statement of cash flows is exclusive of non-cash property sale +proceeds of $17,437 of which $7,066 is included in accounts receivable, $9,566 +in prepaid expenses and other and $805 in other non-current assets, non-cash +property additions of $2,525 and non-cash insurance premium financing of $9,461 +included in prepaid expenses and other. + + +The 2000 statement of cash flows is exclusive of +non-cash property sale proceeds of $1,060 included in accounts receivable, +non-cash property additions of $9,923, non-cash insurance premium financing of +$9,126 included in prepaid expenses and other and a non-cash accrual of $10,076 +with a corresponding increase to other non-current assets. + + +The 2001 statement of cash flows is exclusive of +non-cash property sale proceeds of $788 included in accounts receivable, +non-cash property additions of $4,364, non-cash insurance premium financing of +$14,951 included in prepaid expenses and other and discharge of a note payable +of $2,403 through a release of advance royalties. + +(p) Accounting Pronouncements--In September 2001, the staff of +the Financial Accounting Standards Board (FASB) cleared SFAS No. 133 +Implementation Issue Number C16 (C16), which relates to scope exceptions in +applying the normal purchases and sales exception for commodity contracts that +contain volumetric variability or optionality under paragraph 10b of SFAS No. +133. C16 is effective for the Company on April 1, 2002. The Company does not +believe adoption of C16 will have an effect on the Company. The Company believes +its coal contracts with volumetric variability or optionality are exempted out +of SFAS No. 133, because they fail to meet the net settlement criteria of SFAS +No. 133, which would preclude such contracts from being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations"; SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. +143, "Accounting for Asset Retirement Obligation". SFAS No. 141 eliminates the +pooling-of-interests method and requires all business combinations initiated +after June 30, 2001 to be accounted for using the purchase method. It also +requires intangible assets acquired in a business combination to be recognized +separately from goodwill. SFAS No. 141 is expected to have no future impact on +the Company's financial position or results of operations with respect to +business combination transactions that have occurred prior to June 30, 2001. The +primary impact to the Company will be in the allocation of the purchase price of +any future business combinations to the fair value of net assets acquired, +including goodwill and other intangible assets. The Company will apply SFAS No. +141 in fresh start accounting (Note 2) pursuant to SOP 90-7 upon emerging from +bankruptcy. SFAS No. 142 addresses how goodwill and other intangible assets +should be accounted for upon their acquisition and afterwards. The Company is +currently analyzing the impact of SFAS No. 142, which is required to be adopted +January 1, 2002. The primary impact of SFAS No. 142 is that future goodwill and +intangible assets with indefinite lives will no longer be amortized beginning in +2002. Instead of amortization, goodwill will be subject to an assessment for +impairment by applying a fair-value-based test annually and more frequently if +circumstances indicate a possible impairment. If the carrying amount of goodwill +exceeds the fair value of that goodwill, an impairment loss is recognized in an +amount equal to the excess. The Company does not have recorded significant +goodwill or intangible assets. Accordingly, these new accounting rules will not +presently have a significant impact on the Company but will have a significant +effect upon fresh start accounting. + + +SFAS No. 143 addresses asset retirement obligations +that result from the acquisition, construction or normal operation of long-lived +assets. It requires companies to recognize asset retirement obligations as a +liability when the liability is incurred at its fair value. The adoption of SFAS +No. 143 will affect the Company's recording of reclamation and closure +obligations and disclosure requirements. Currently, the Company records the full +(undiscounted) liability for end-of-mine reclamation obligations of all acquired +mines in current dollars. Developed mines accrue at a rate per ton over its +active life to the end-of-mine obligation. SFAS No. 143 will require the Company +to cease the per-ton accrual approach and to discount all end-of-mine +obligations to their fair values. The future accretion of the discounted +obligation will be recorded to cost of operations. The Company is currently +analyzing the impact of this Statement, which is required to be adopted January +1, 2003. + + +In August 2001, the FASB issued SFAS No. 144, +"Accounting for the Impairment or Disposal of Long-Lived Assets", which is +required to be adopted January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, +"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to +be Disposed of" and APB Opinion No. 30, "Reporting the Effects of Disposal of a +Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring +Events and Transactions" and combines the two accounting models into a single +model based on the framework established in SFAS No. 121. Effects of adopting +SFAS No. 144 on January 1, 2002 have had no material impact on the earnings and +financial position of the Company. + +(q) Comprehensive Loss--The Company complies with SFAS No. 130, +"Reporting on Comprehensive Income", by establishing standards for reporting and +presentation of comprehensive income (loss) and its components in a full set of +financial statements. Other comprehensive income can include, among other items, +foreign currency items, minimum pension liability adjustments and unrealized +gains and losses on certain investments in debt and equity securities. In 2001, +the Company recorded as comprehensive loss in stockholders' equity (deficit) a +minimum pension liability increase of $22,345 to properly record the pension +liability in accordance with the actuary calculations. The Company has no other +items of other comprehensive income or loss. + +(4) Acquisitions- + + +The following acquisitions have each been accounted +for as a purchase, and their results of operations have been included with that +of the Company since the date of acquisition. + +(a) Princess Beverly--In February 1999, the Company acquired all +the capital stock of Princess Beverly Coal Company, a coal mining business with +operations in West Virginia, for the purchase price of approximately $11,500. +The Company also acquired approximately a 1% interest in Hanna Land Company LLC, +a limited liability company established to develop a coal mining property in +West Virginia owned by the Company. The Company also has an option to purchase +(and the owner has the right to put) the remaining 99% in Hanna Land Company LLC +for $12,000 upon the successful permitting of the mining property. + +(b) Sunny Ridge--In April 1999, the Company acquired all of the +common stock of Sunny Ridge Enterprises, Inc., a coal mining business with +operations in Kentucky, for the purchase price of $50,000, plus a working +capital adjustment, as defined in the stock purchase agreement. + + +The following unaudited pro forma information for the +periods shown below gives effect to the aforementioned acquisitions as if they +had occurred on January 1, 1999: + + 1999 + ---------------- + Unaudited + + Revenues $ 1,352,200 + Net loss (199,200) + + +The unaudited pro forma information assumes that the +Company owned the aforementioned acquisitions at January 1, 1999 and includes +adjustments for depreciation, depletion and amortization and interest expense. +The unaudited pro forma financial data is presented for information purposes +only and is not necessarily indicative of the results of operations that +actually would have been achieved had such acquisitions been consummated at the +beginning of these periods and is not intended to be a projection of future +results. Certain purchase accounting adjustments related to the acquisitions +have been recorded in the accompanying financial statements. + +(5) Inventories- + +As of December 31, 2000 and 2001, inventories consisted of the following: + + 2000 2001 + ----------------- --------------- + + Coal $ 27,648 $ 27,438 + Deferred overburden 34,360 39,019 + Parts and supplies 22,685 24,587 + ----------------- --------------- + $ 84,693 $ 91,044 + ================= =============== + +(6) Property, Plant and Equipment- + +Property, plant and equipment, including mineral reserves and mine development +and contract costs at December 31, 2000 and 2001 are summarized by major +classification as follows: + + 2000 2001 + ----------------- ----------------- + + Land and land improvements $ 75,402 $ 78,475 + Mining and other equipment and related facilities 506,880 527,500 + Mine development and contract costs 166,534 178,839 + Mineral reserves 1,520,609 1,501,611 + Mine development in process 7,975 6,792 + Construction work in process 5,416 12,416 + ----------------- ----------------- + 2,282,816 2,305,633 + Less - accumulated depreciation, depletion and amortization (489,191) (718,303) + ----------------- ----------------- + Net property, plant and equipment $ 1,793,625 $ 1,587,330 + ================= ================= + + +Included in property, plant and equipment is $13,391 +for 2000 and $19,208 for 2001 related to development and construction projects +for which depreciation, depletion and amortization have not yet commenced. The +Company reviews realization of these projects on a periodic basis. + + +Accumulated amortization for intangible assets which +include debt issuance costs and contract costs as of December 31, 2000 and 2001 +was $50,618 and $101,500, respectively. + +(7) Accrued Expenses and Other- + +Accrued expenses and other as of December 31, 2000 and 2001 consisted of the +following: + + 2000 2001 + --------------- --------------- + + Payroll, bonus and vacation 37,857 42,082 + Non-income taxes 28,297 24,202 + Exit fee - Credit Facility (Note 8b) 15,793 15,793 + Deferred revenues 11,777 6,669 + Debt service reserve - Zeigler IRB (Note 8d) 10,076 10,076 + Royalties 7,110 7,563 + Other 15,590 14,808 + --------------- --------------- + $ 126,500 $ 121,193 + =============== =============== + +(8) Debt- + +(a) Long-Term Debt and Capital Leases--Long-term debt and capital leases as of +December 31, 2000 and 2001 consisted of the following: + + 2000 2001 + ----------------- ----------------- + + Credit Facility (Note 8b): + Term Loan A - Original $ 225,000 $ 223,021 + Term Loan A - Amended 75,000 74,340 + Term Loan B 332,500 329,576 + Revolving Credit Facility 177,719 182,163 + 10.5% Senior Notes (Note 8c) 200,000 200,000 + 11.5% Senior Subordinated Notes (Note 8c) 150,000 150,000 + Zeigler Industrial Revenue Bonds (Note 8d) 145,800 145,800 + Notes payable to sellers of Cyprus Subsidiaries ($10,386 and $3,462), + Mid-Vol ($9,000 and $6,000), Leslie Resources ($2,784 and $-) and + Ikerd-Bandy ($3,023 and $2,159) (Note 8e) 25,193 11,621 + Kentucky Bank & Trust Loan (Note 8f) 8,132 8,132 + Capital leases (Note 12b) 5,202 2,969 + Other 6,329 7,261 + ----------------- ----------------- + Total 1,350,875 1,334,883 + Less - current portion 1,333,477 1,329,651 + ----------------- ----------------- + Long-term debt $ 17,398 $ 5,232 + ================= ================= + + +Accrued interest at December 31, 2000 and 2001 is +$54,288 and $216,443, respectively. As discussed in Note 2, the Company has not +made various interest payments due in October 2000 through December 2001; +however, the Company has continued to accrue such amounts due in the +accompanying financial statements. + +Principal maturities of long-term debt and capital leases as of December 31, +2001 are as follows: + + Year Ended December 31: + 2002 1,329,651 + 2003 4,980 + 2004 252 + ---------------- + $ 1,334,883 + ================ + +(b) Credit Facility--The Credit Facility consists of Term Loan A +Facilities (Original Tranche A maturing in 2003 and Amended Tranche A maturing +in 2004), a Term Loan B Facility (maturing in 2004) and a $182,163 senior +secured revolving credit facility (Revolver), maturing in 2003. Interest is +calculated on the ABR (alternative base rate) plus the Applicable Margin, as +defined in the Credit Facility. The Applicable Margin is determined pursuant to +a formula based on the Company's financial performance. The ABR is the higher of +the Federal Funds Rate plus 0.5% and the Prime Rate. The interest rates as of +December 31, 2001 and average interest rates for 2001 were as follows: Original +Tranche Term Loan A (9.0% and 11.18%), Amended Tranche Term Loan A (10.0% and +12.18%), Term Loan B (9.5% and 11.68%) and Revolver (9.0% and 11.18%). The +Credit Facility is collateralized primarily by capital stock of most of the +Company's subsidiaries, along with substantially all accounts receivable; +inventory; property, plant and equipment; intangibles; contract rights and other +personal and real property of the Company and most of its subsidiaries. The +Company and most of its subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and +restated its Credit Facility to modify the payment terms and covenant +requirements. The changes included, among others, deferred principal payments, +increased interest rates and amended financial covenant ratios. Term Loan A +under the Credit Facility was separated into an Original Tranche and Amended +Tranche. The Amended Tranche aggregates $75,000 in principal with final maturity +on December 14, 2004. The Original Tranche aggregates $225,000 in principal with +final maturity on December 31, 2003. Both Original and Amended Tranches contain +new repayment terms. The Company incurred an exit fee equal to 2% of Credit +Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on the +earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +events, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations, (iii) debt issuances all net available proceeds from any +debt issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at prices of 102% in 2002 +and 101% in 2003. + + +The Credit Facility contains various financial +covenants which, among other things, limit additional indebtedness, dividend and +other restricted payments, affiliate transactions, mergers and capital +expenditures and require the Company to meet certain financial ratios, including +but not limited to interest coverage and maximum leverage ratio, all as defined +in the Credit Facility. In addition, the Credit Facility is generally required +to be prepaid with 50% of annual Excess Cash Flow, as defined in the Credit +Facility, 100% of proceeds from the incurrence of additional debt, 100% of +proceeds from asset sales or dispositions above certain defined thresholds or +50% of the net proceeds from the issuance of equity securities. As of December +31, 2000 and 2001, the Company was in violation of various financial and other +covenants including the non-payment of principal and interest payments due +giving rise to an Event of Default. During the default period, the Company must +pay a higher interest rate to its lenders. As a result of the Event of Default, +the entire Credit Facility is classified as a current liability in the +accompanying balance sheets. + + +As of December 31, 2001, the Company has $182,163 in +outstanding borrowings under the Revolver. In addition, the Company has letters +of credit in the amount of $20,431 issued under the Revolver. These letters of +credit cover the following: + + Insurance/Workers' compensation/Reclamation bonds $ 18,931 + Mineral leases/Royalties 1,500 + ------------- + $ 20,431 + ============= + + +As of December 31, 2001, due to default status, the +Company was restricted from making additional borrowings under the +Revolver. + +See Note 2 for changes related to the Credit Facility under the Plan. + +(c) 10.5% Senior Notes and 11.5% Senior Subordinated Notes--On +December 14, 1998, Resources and AEI Holding Company, Inc. (a subsidiary) +co-issued $200,000 of 10.5% Senior Notes due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 +of 11.5% Senior Subordinated Notes due 2006 (Subordinated Notes). + + +The Senior Notes mature in their entirety on December +15, 2005, and the Subordinated Notes mature in their entirety on December 15, +2006. The Senior Notes and Subordinated Notes are general, unsecured obligations +of the issuers. Interest is payable on June 15 and December 15 of each year. The +Company has the option to redeem the Senior Notes and Subordinated Notes on or +after December 15, 2002, at redemption prices ranging from 105.25% in 2002 to +100% in 2005. Before December 15, 2002, the Company may redeem the Senior Notes +and Subordinated Notes at the face amount plus accrued and unpaid interest, +liquidated damages, if any, and an applicable "make whole premium" of up to +$11,500 and $8,625, respectively. + + +Upon a change in control (as defined in the documents +governing the Senior Notes and the Subordinated Notes), the Company will be +required to make an offer to purchase all outstanding Senior Notes and +Subordinated Notes at 101% of the principal amount. The Senior Notes and +Subordinated Notes are jointly and severally guaranteed on a senior unsecured +basis by the Company and each of the Company's current and future domestic +majority-owned subsidiaries, other than Yankeetown Dock Corporation. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of December 31, 2000 and 2001, the +Company had not paid interest when due thereby giving rise to an Event of +Default. As such, the entire balance of the Senior Notes and Subordinated Notes +are classified as a current liability in the accompanying balance +sheets. + + +The Company filed an initial registration statement +for the Senior Notes with the Securities and Exchange Commission on February 12, +2000 and filed an amendment to the initial registration statement on April 29, +2000. Subsequently, the Company had planned to file a registration statement for +the Subordinated Notes; however, the Company withdrew the Senior Notes' +registration statement on May 31, 2001. Because the registration statements were +not filed or declared effective within the time periods allotted in the +documents governing the Senior Notes and the Senior Subordinated Notes, the +Company has been required to pay liquidated damages to the holders of the Senior +Notes and Subordinated Notes. For the Senior Notes, the Company is accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $100 per week) per week until the registration statement is +declared effective. For the Subordinated Notes, the Company is also accruing the +maximum liquidated damages of 50 per one thousand dollars principal amount +(aggregating to $75 per week) per week until the registration statement is +declared effective. + + +During 1999, 2000 and 2001, the Company incurred +liquidated damages pursuant to the Senior Note and Subordinated Note indentures, +exclusive of penalty interest (Note 2), of $3,803, $7,177 and $8,846, +respectively. If the registration statements do not become effective during 2002 +and no reorganizaton occurs, the Company will incur aggregate liquidated damages +of $9,125 during 2002. Accrued but unpaid liquidated damages are included in +accrued interest in the accompanying balance sheets. + +See Note 2 for changes related to the Senior Notes and Subordinated Notes under the Plan. + +(d) Industrial Revenue Bonds--In connection with the Zeigler +acquisition, the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, 2028. + + +The Zeigler IRBs contain redemption features which +allow the issuers, at the direction of the Company, the option to redeem the +Zeigler IRBs on or after April 1, 2009 at redemption prices ranging from 102% in +2009 to 100% in 2013. In addition, unless the bonds are Investment Grade rated, +as defined, as of April 1, 2009, the Zeigler IRBs will be subject to mandatory +sinking fund requirements of $9,200 per year through 2022 and $1,500 per year +thereafter through 2028. + + +Upon a change in control, as defined in the documents +governing the Zeigler IRBs, the Company, at the direction of the then current +bondholders, will be required to make an offer to purchase all outstanding bonds +at 103%. The Zeigler IRBs are unsecured but are guaranteed by substantially the +same entities that guarantee the Senior Notes and Subordinated Notes described +in Note 8c above. The documents also contain default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which results in the acceleration of any indebtedness prior to its +express maturity causes an event of default. An event of default also occurs +when the Company is in default under certain of its indebtedness. As of December +31, 2000 and 2001, an Event of Default had occurred under the terms of the +Zeigler IRBs as the Company had not paid interest due nor had it made the +required funding under the debt service reserve fund (discussed below). As such, +the Zeigler IRBs are classified as a current liability in the accompanying +balance sheets. + + +Beginning with the four quarters ended June 30, 2000, +the Company's guarantee under the Zeigler IRBs requires the establishment of a +debt service reserve fund in an amount equal to one year's interest +(approximately $10,076) in the event the Company's fixed charge ratio, as +defined, is less than 2 to 1. Amounts in the debt service reserve fund may +thereafter be returned to the Company if the ratio is later achieved for a +period of six consecutive quarters. The Company's fixed charge ratio, as defined +for the four quarters ended June 30, 2000 and for the year ended December 31, +2001, was below the 2 to 1 requirement. The Company has accrued, but not paid, +the required debt service reserve fund amount due. + +See Note 2 for changes related to the Zeigler IRBs under the Plan. + +(e) Seller Notes Payable--In connection with the acquisitions of +Ikerd-Bandy, Leslie Resources, Cyprus Subsidiaries and Mid-Vol, the Company +entered into notes payable to the sellers of these businesses (Seller Notes). +The Cyprus Subsidiaries Seller Notes are secured and the other Seller Notes are +unsecured and bear interest (or have been discounted) at rates ranging from 5% +to 10%. During 2001, the Leslie Resources note was retired early (via a non-cash +exchange) while the remaining Seller Notes mature from 2002 to 2004. + +(f) Kentucky Bank and Trust Loan--The Company has an unsecured +note payable to Kentucky Bank and Trust (KB&T Note) in the amount of $8,132. +The note bears interest at a rate equal to the daily floating prime rate as +published in the The Wall Street Journal (4.75% at December 31, 2001) with a +maturity date of September 3, 2007. This note carries covenants similar to those +of the Credit Facility described in Note 8b above. In addition, the agreement +contains default provisions whereby the failure to pay principal or interest on +certain indebtedness of the Company or a default which permits the acceleration +of certain indebtedness prior to its express maturity or an increase in the +interest rate on certain indebtedness causes an event of default under the +KB&T Note. Because events of default have occurred, the entire balance is +classified as a current liability in the accompanying balance sheets. The +KB&T Note is guaranteed by substantially the same entities that guarantee +the Credit Facility and by Larry Addington and an affiliate has pledged assets +as additional security for the loan. The Company is prohibited from making +principal payments on the KB&T Note prior to the earlier of June 30, 2005 or +91 business days after the satisfaction in full of all obligations under the +Credit Facility. + +(9) Income Taxes- + +The provision (benefit) for income taxes is comprised of the following: + + 1999 2000 2001 + --------------- --------------- --------------- + + Tax provision (benefit): + Current $ 2,191 $ 1,069 $ 1,376 + Deferred (95,701) (54,167) - + --------------- --------------- --------------- + $ (93,510) $ (53,098) $ 1,376 + =============== =============== =============== + + +The following table presents the difference between +the actual tax provision (benefit) and the amounts obtained by applying the +statutory U.S. federal income tax rate of 35% to the 1999, 2000 and 2001 loss +before income taxes. + + 1999 2000 2001 + ---------------- ----------------- ---------------- + + Federal provision computed at statutory rate $ (102,536) $ (87,805) $ (78,419) + State income tax (net of federal tax benefits and + apportionment factors) computed at statutory rate (7,330) (10,737) (7,613) + Valuation allowance 5,115 36,269 82,510 + Percentage depletion in excess of cost (3,500) - - + Mineral reserves amortization 14,741 7,223 4,898 + Other - 1,952 - + ---------------- ----------------- ---------------- + $ (93,510) $ (53,098) $ 1,376 + ================ ================= ================ + +Significant components of the Company's deferred tax assets and liabilities as +of December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + ----------------- ----------------- + + Deferred Tax Assets: + Accrued employee benefits $ 230,286 $ 236,280 + Accrued reclamation and closure 145,121 159,242 + AMT credits 28,547 33,315 + Net operating loss carryovers 48,173 138,263 + Patents and technology 11,537 11,795 + Additional minimum pension liability - 8,776 + Other 43,572 14,064 + ----------------- ----------------- + 507,236 601,735 + Valuation allowance (49,399) (177,142) + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Deferred Tax Liabilities: + Property, plant and equipment 186,564 15,255 + Mineral reserves and mine development costs 239,169 378,402 + Other 32,104 30,936 + ----------------- ----------------- + 457,837 424,593 + ----------------- ----------------- + Net deferred tax liability $ - $ - + ================= ================= + + Classified in balance sheets: + Other current assets $ 12,750 $ 13,010 + Noncurrent liabilities 12,750 13,010 + + +The Company has alternative minimum tax (AMT) credits +of $33,315 with no expiration date. Certain subsidiaries have carryforwards for +net operating losses (NOL) and AMT NOLs of approximately $16,000 and $4,800, +respectively, which may only be used by these subsidiaries and, if not used, +will expire between 2012 and 2018. NOL carryforwards may also be limited under +certain ownership changes. Other NOL and AMT NOL carryforwards aggregating +approximately $335,994 and $176,827, respectively, if not used, will expire +between 2011 and 2021 and 2020 and 2021, respectively. + + +A deferred tax asset valuation allowance was recorded +in 2000 and 2001 due to uncertainties in realization using the more likely than +not methodology. After completion of the 2000 income tax returns, deferred tax +assets and liabilities were adjusted. The net effect of these adjustments was to +increase net deferred tax assets, which were offset by an increase of $36,457 in +the valuation allowance. The adjustments had no impact on 2000 income or balance +sheet classification. + + +Included in the valuation allowance at December 31, +2001 is $8,776 to cover the deferred tax asset recognized by the recording of +the additional minimum pension liability in other comprehensive loss (OCL). +Pursuant to SFAS No. 109, if the tax asset that results from recording pension +liability through equity is fully reserved with a valuation allowance, there is +no net income tax expense or benefit to be allocated to equity OCL. + + +Certain preacquisition contingencies exist relating +to income tax matters which, when ultimately resolved, may adjust the purchase +accounting of the respective acquisition. In 2001, the Company decreased its tax +contingency account (included in other non-current liabilities) by $15,000 due +to updates made in its state and federal tax exposures. The offsetting credit +was recorded to mineral reserves pursuant to purchase accounting +rules. + + +The Plan (Note 2) will cause a variety of tax +implications. Because the cancellation of the Company's indebtedness will occur +in a case brought under the Bankruptcy Code, the Company will not be required to +recognize any cancellation of indebtedness (COI) income realized as a result of +the implementation of the Plan of Reorganization. However, the Company will be +required to reduce certain tax attributes, including its net operating losses +and loss carryforwards and its tax basis in its assets, in an amount generally +equal to the amount of COI income excluded from income. + + +The Company believes that some of its NOLs (including +AMT NOLs) may be eliminated after consummation of the Plan, but whether any such +elimination will actually occur and the extent of any such elimination is +uncertain because among other things, it will depend on the fair market value of +the new common stock and the issue price of the New Senior Secured Term Notes +and New Senior Notes on the effective date. It is possible that a substantial +portion of the Company's AMT NOLs could be eliminated and thus the Company's AMT +liability after the effective date of the Plan could be significantly +increased. + + +The Plan is also expected to trigger an ownership +change of the Company's consolidated group on the effective date. As a result, +the use of pre-ownership change NOLs (and certain other tax attributes) will +generally be subject to an annual limitation. Except as otherwise allowed, the +annual limitation will generally be the product of the long-term tax-exempt rate +(as published by the Internal Revenue Service for the month in which the +ownership change occurs) and the value of the Company's stock immediately before +the ownership change. Because the Company is in a case under the Bankruptcy +Code, there are two exceptions to the general limitation above. The first +exception applies where qualified creditors receive at least 50% of the vote and +value of the stock of the reorganized Company. Under this exception, the +pre-change NOLs are not subject to an annual limit but are instead reduced by +the amount of any interest deductions allowed during the three taxable years +preceding the taxable year in which the ownership change occurs, and during the +part of the taxable year prior to and including the effective date of the Plan. +The second exception requires no reduction of pre-change NOLs but provides +relief in the form of a relaxed computation of the annual limit. The value of +the Company's outstanding stock will be increased to reflect the cancellation of +indebtedness (but the value of such stock as adjusted may not exceed the value +of the Company's gross assets immediately before the ownership change (subject +to certain adjustments)). + +(10) Employee Benefits- + +Employee benefits at December 31, 2000 and 2001 are summarized as follows: + + 2000 2001 + --------------- --------------- + + Postretirement benefits $ 417,441 $ 427,363 + Workers' compensation and black lung benefits 114,162 120,091 + Coal Act benefits 51,150 50,373 + Pension benefits 5,005 2,729 + Additional minimum pension liability - 22,345 + Postemployment benefits 2,832 2,192 + --------------- --------------- + Total 590,590 625,093 + Less - current portion 33,494 39,663 + --------------- --------------- + Long-term portion $ 557,096 $ 585,430 + =============== =============== + +(a) Pension and Other Postretirement Benefits--Prior to the +Cyprus Subsidiaries acquisition on June 29, 1998, the Company did not have any +defined benefit pension plans, postretirement or postemployment benefits or +United Mine Workers of America (UMWA) Combined Benefit Fund (Coal Act) +obligations. In conjunction with certain of the 1998 and 1999 acquisitions, the +Company acquired or agreed to put in place benefit plans providing pension +benefits to certain employees and postretirement healthcare and life insurance +to eligible union employees. + + +Effective September 2, 1998, the Company acquired a +non-contributory defined benefit pension plan covering all salaried and +non-union employees of Zeigler and its subsidiaries. Effective January 1, 1999, +the Company amended and restated this plan to cover all salaried and non-union +employees of the Company. Effective August 1, 1999, this plan was divided into +two plans, one to be maintained by the Company and the other to be maintained by +West Virginia-Indiana Coal Holding Company, Inc., a subsidiary of the Company. +The union employees at one of the Company's acquired mines are covered by a +separate defined benefit pension plan. Benefits are generally based on the +employee's years of service and compensation during each year of employment. The +Company's funding policy is to make the minimum payment required by the Employee +Retirement Income Security Act of 1974. + + +Summaries of the changes in the benefit obligations, +plan assets (consisting principally of common stocks and U.S. government and +corporate obligations) and funded status of the plans are as +follows: + + Pension Benefits Other Postretirement + Benefits + ------------------------- ---------------------------- + 2000 2001 2000 2001 + ----------- ----------- ------------- ------------- + + Change in Benefit Obligations: + + Benefit obligations at January 1 $ 88,141 $ 94,324 $ 384,740 $ 402,711 + Adjustment for R&F Coal - - (5,789) - + Service cost 3,017 3,026 3,748 4,125 + Interest cost 6,537 6,623 27,467 29,196 + Actuarial (gain) loss 5,574 891 11,159 15,686 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Benefit obligation at December 31 $ 94,324 $ 94,917 $ 402,711 $ 429,460 + =========== =========== ============= ============= + Change in Plan Assets: + + Fair value of plan assets at January 1 $ 90,863 $ 77,330 $ - $ - + Actual return on plan assets (4,588) (4,216) - - + Employer contributions - 3,973 18,614 22,258 + Benefits paid (8,945) (9,947) (18,614) (22,258) + ----------- ----------- ------------- ------------- + Fair value of plan assets at December 31 $ 77,330 $ 67,140 $ - $ - + =========== =========== ============= ============= + + Funded Status of the Plans: + + Accumulated obligations less Plan assets $ (16,994) $ (27,777) $ (402,711) $ (429,460) + Unrecognized actuarial (gain) loss 12,716 25,702 (14,730) 2,097 + Unrecognized prior service cost (727) (654) - - + Additional minimum pension liability - (22,345) - - + ----------- ----------- ------------- ------------- + ----------- ----------- ------------- ------------- + Net liability recognized $ (5,005) $ (25,074) $ (417,441) $ (427,363) + =========== =========== ============= ============= + + Pension Benefits Other Postretirement Benefits + ---------------------------------- ----------------------------------- + 1999 2000 2001 1999 2000 2001 + ---------- ---------- ---------- ---------- ---------- ----------- + + Net Periodic Benefit Cost: + + Service cost $ 2,907 $ 3,017 $ 3,026 $ 1,506 $ 3,748 $ 4,125 + Interest cost 6,362 6,537 6,623 27,067 27,467 29,196 + Expected return on assets (8,150) (8,194) (7,886) - - - + Amortization of: + Prior service cost (73) (73) (73) - - - + Actuarial gain (3) (5) (4) (93) (635) (1,141) + Settlement charge 224 - - - - - + ---------- ---------- ---------- ---------- ---------- ----------- + Benefit cost $ 1,267 $ 1,282 $ 1,686 $ 28,480 $ 30,580 $ 32,180 + ========== ========== ========== ========== ========== =========== + + Weighted Average Assumptions: + + Discount rate 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% + Expected return on plan assets 9.50% 9.50% 9.50% NA NA NA + Rate of compensation increase 4.00% 4.00% 4.00% NA NA NA + + +For measurement purposes in 2000 and 2001, a 10% +annual rate of increase in the per capita cost of covered health care benefits +was assumed, gradually decreasing to 5% in 2010 and remaining level +thereafter. + + +Net periodic benefit cost is determined using the +assumptions as of the beginning of the year, and the funded status is determined +using the assumptions as of the end of the year. + + +The projected benefit obligation, accumulated benefit +obligation and fair value of plan assets for the pension plans with accumulated +benefit obligations in excess of plan assets were $94,242, $90,798 and $77,189, +respectively, as of December 31, 2000 and $94,917, $92,202 and $67,140, +respectively, as of December 31, 2001. + + +The expense and liability estimates can fluctuate by +significant amounts based upon the assumptions used by the actuaries. A +one-percentage-point change in assumed health care cost trend rates would have +the following effects: + + 1-Percentage-Point 1-Percentage-Point + Increase Decrease + ----------------- ------------------ + + Effect on total of service and interest cost components $ 4,900 $ (3,800) + Effect on postretirement benefit obligation 59,000 (45,000) + +(b) Multi-Employer Pension and Benefits Plans (UMWA Pension +Plan)--Certain of the Company's subsidiaries are required under their respective +contracts with the UMWA to pay amounts based on hours worked to the UMWA Pension +Plan and Trust, a multi-employer pension plan covering all employees who are +members of the UMWA. The accompanying consolidated statements of operations +include $532, $476 and $377 of expense in 1999, 2000 and 2001, respectively, +applicable to the plan. The Employee Retirement Income Security Act of 1974 +(ERISA), as amended in 1980, imposes certain liabilities on contributors to +multi-employer pension plans in the event of a contributor's complete or partial +withdrawal from the plan. The withdrawal liability would be calculated based on +the contributor's proportionate share of the plan's unfunded vested liabilities. + +(c) UMWA Combined Benefit Fund (Coal Act)--The Company provides +healthcare benefits to eligible retirees and their dependents. Retirees who were +members of the UMWA and who retired on or before December 31, 1975 received +these benefits from multi-employer benefit plans. The Company contributed to +these funds based on the number of its retirees in one of the funds and based on +hours worked by current UMWA members for the other fund. Current and projected +operating deficits of these trusts led to the passage of the Coal Industry +Retiree Health Benefit Act of 1992 (the Coal Act). The Coal Act established a +new multi-employer benefit trust that will provide healthcare and life insurance +benefits to all beneficiaries of the earlier trusts who were receiving benefits +as of July 20, 1992. The Coal Act provides for the assignment of beneficiaries +to their former employers and any unassigned beneficiaries to employers based on +a formula. Based upon an independent actuarial valuation, the Company estimates +the amount of its obligation (discounted at 7.25%) under the Coal Act to be +approximately $51,150 and $50,373 as of December 31, 2000 and 2001, +respectively. The unrecognized projected Coal Act obligation/(asset) (difference +between recorded accrual and projected obligations) at December 31, 2000 and +2001 was $(8,170) and $6,355, respectively, and are being provided for over the +average remaining life of the recipients. The projected Coal Act obligations may +vary in a given year based on changes in actuarial assumptions. The Company +recorded expenses related to the Coal Act of $3,869, $4,305 and $3,069 for 1999, +2000 and 2001, respectively. + +(d) Workers' Compensation and Black Lung--The operations of the +Company are subject to the federal and state workers' compensation laws. These +laws provide for the payment of benefits to disabled workers and their +dependents, including lifetime benefits for black lung. The Company's subsidiary +operations are either fully insured or self-insured for their workers' +compensation and black lung obligations. + + +The actuarially determined liability for self-insured +workers' compensation and black lung benefits is based on a 7.25% discount rate +and various other assumptions including incidence of claims, benefits +escalation, terminations and life expectancy. The annual black lung expense +consists of actuarially determined amounts for self-insured obligations. The +estimated amount of discounted obligations for self-insured workers' +compensation and black lung claims plus an estimate for incurred but not +reported claims is $114,162 and $120,091 as of December 31, 2000 and 2001, +respectively. The unrecognized projected black lung benefit obligations +(difference between recorded accrual and projected obligations) at December 31, +2000 and 2001 is approximately $24,374 and $17,401, respectively, and is being +provided for over the future service period of current employees. The projected +black lung obligations may vary in a given year based on the timing of claims +filed and changes in actuarial assumptions. The Company recorded expenses +related to self-insured workers' compensation and black lung of $11,428, $22,885 +and $19,603 for 1999, 2000 and 2001, respectively. + +(e) Post Employment Benefits Other than Pensions--The Company +has a long-term disability plan, which provides for up to three years of +disability benefits and for up to three years of continuation in the medical +plan for non-represented employees. Continuation of medical plan benefits for +disabled represented employees is also covered under the plan. Non-represented +claimants on disability at January 1, 1999 received three additional years of +indemnity and medical benefits. The actuarially determined liability for +long-term disability benefits is based on a 7.25% discount rate and various +other assumptions including life expectancy. The present value of the long-term +disability claimants is $2,832 and $2,192 at December 31, 2000 and 2001, +respectively. The Company recorded expenses related to long-term disability +benefits of $208, $269 and $205 for 1999, 2000 and 2001, respectively. + +(f) 401(k) Plans--The Company and certain subsidiaries sponsor +savings and retirement plans for substantially all employees other than +employees covered by the contracts with the UMWA. During 1999 and 2000, the +Company consolidated and merged its numerous 401(k) plans into two plans. The +two remaining plans matched the voluntary contributions of participants up to a +maximum contribution based upon a percentage of a participant's salary with an +additional matching contribution possible at the Company's discretion. The +expenses for 1999, 2000 and 2001 under these plans were $3,515, $3,325 and +$3,346, respectively. + +(11) Other Income- + +Other income consists of the following items: + + 1999 2000 2001 + --------------- --------------- ---------------- + + Black Lung Excise Refund Claim $ - $ - $ 6,099 + Lynch Trust Distribution - 5,100 2,729 + Interest Income 1,031 656 2,407 + Contingency Accrual Reversals - - 3,118 + Other (net) 2,631 3,791 2,595 + --------------- --------------- ---------------- + Total $ 3,662 $ 9,547 $ 16,948 + =============== =============== ================ + + +In 2001, the Company filed a claim with the Internal +Revenue Service (IRS) to recover past black lung excise taxes paid on exported +coal. These claims cover the years 1996 to 2000. The courts have determined that +certain excise taxes paid on export sales of coal are unconstitutional. The IRS +is expected to begin an audit in 2002 to confirm the validity of the claims. For +the period ending December 31, 2001, the Company recognized $6,099 in income +relating to these claims and recorded a long-term receivable of $6,099 (included +in other long term assets). This amount includes $938 of interest income on the +filed claims. + + +The Lynch Trust income relates to a distribution to +Old Ben Coal Company (Old Ben), a subsidiary of the Company. The trust consists +of surplus funds previously contributed by various coal companies to a workers' +compensation pool. The surplus represents premiums paid in excess of the +actuarially determined liability. Old Ben has the right to 50% of all +distributions made. The distributions are pursuant to an agreement whereby +vested parties may receive distributions based on a five-year payout schedule. +Payments are contingent on the trust's return. The Company expects to enter into +a new distribution agreement in 2002. + + +Most of the Company's interest income relates to +interest bearing cash deposits. In 1999, 2000 and 2001, the Company earned $963, +$544 and $2,021 on its operating cash deposits. + + +As part of past acquisitions, the Company reserved +for potential severance tax and related exposures of approximately $3,100. In +2001, the Company reversed each of these accruals to other income based on +current exposure assessments, including in the case of the severance tax +exposure, the clearance of state severance tax audits over the past three +years. + +(12) Commitments and Contingencies- + +(a) Coal Sales Contracts and Contingency--As of December 31, +2001, the Company had commitments under 42 sales contracts that extend past 2002 +to deliver scheduled base quantities of coal annually to 29 customers. The +contracts expire from 2003 through 2009 with the Company contracted to supply a +minimum of approximately 156 million tons of coal over the remaining lives of +the contracts. The Company also has commitments to purchase certain amounts of +coal to meet its sales commitments. These purchase amounts are insignificant to +sales commitments. Certain of the contracts have sales price adjustment +provisions, subject to certain limitations and adjustments, based on a variety +of factors and indices. + +(b) Leases--The Company has various operating and capital leases +for mining, transportation and other equipment. Lease expense for the years +ended December 31, 1999, 2000 and 2001 was approximately $48,300, $47,300 and +$53,000 (net of amount capitalized in mine development cost of $1,500, $140 and +$212 in 1999, 2000 and 2001, respectively). Property under capital leases +included in property, plant and equipment in the accompanying balance sheets at +December 31, 2000 and 2001 was approximately $10,104 and $7,203, respectively, +less accumulated depreciation of approximately $3,163 and $4,304, respectively. +Depreciation of assets under capital leases is included in depreciation expense. + + +The Company also leases coal reserves under +agreements that call for royalties to be paid as the coal is mined. Total +royalty expense for the years ended December 31, 1999, 2000 and 2001 was +approximately $57,500, $66,300 and $62,400, respectively. Certain agreements +require minimum annual royalties to be paid regardless of the amount of coal +mined during the year. However, certain agreements may be cancelable at the +Company's discretion. The assets of the Bowie mine are held as collateral for +one of these agreements. + +Approximate non-cancelable future minimum lease and royalty payments are as +follows: + + Royalties Operating Capital Leases + Leases + --------------- --------------- --------------- + + Year ended December 31, + 2002 $ 9,523 $ 48,870 $ 2,153 + 2003 11,905 30,935 1,056 + 2004 11,376 15,422 7 + 2005 10,147 11,567 - + 2006 9,895 8,036 - + Thereafter 74,082 8,025 - + --------------- + Total minimum lease payments 3,216 + Less - amount representing interest 247 + --------------- + Present value of minimum lease payments (Note 8a) 2,969 + Less - current portion 1,950 + --------------- + $ 1,019 + =============== + + +Included in operating leases above are aggregate +commitments of $62,396 to a related party for equipment rental and $12,939 to a +related party for office space. + +(c) Legal Matters--The Company is named as defendant in various +actions in the ordinary course of its business. These actions generally involve +disputes related to contract performance, property boundaries, mining rights, +blasting damages, personal injuries and royalty payments, as well as other civil +actions that could result in additional litigation or other adversary +proceedings. Certain actions are described as follows: + + +In connection with the acquisition of the Cyprus +subsidiaries, the Company became potentially liable under a suit filed in the +Circuit Court of Perry County, Kentucky in 1996 by Joseph D. Weddington and +Kentucky Land & Exploration Company (Kentucky Land). Weddington and Kentucky +Land each has asserted claims to approximately 1,425 acres of property upon +which the Company mines coal and is claiming substantial damages. On August 30, +2001, a third-party, Ezra C. Adair doing business as A.C.E. Development Company +and Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny +Ridge), which was purchased by a wholly-owned subsidiary of Resources in 1999, +was sued in the Circuit Court of Boyd County, Kentucky by Kentucky Electric +Steel, Inc. (Kentucky Electric), which alleged that it suffered a shut down at +its steel production facility in Boyd County as a result of the accidental +smeltering of a device containing radioactive material. Kentucky Electric +alleges that the device was contained in a shipment of scrap delivered to it by +Raleigh Junk and Cremer Iron & Metal ("Raleigh Junk"), which was also named +in the suit. Kentucky Electric further alleges that the device originated from a +coal prep plant owned by Sunny Ridge, which was demolished pursuant to a +contract between it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge +had a duty to ensure that the scrap produced by the demolition of the prep plant +was safe for reuse, and that Sunny Ridge breached that duty by allowing a device +containing radioactive material to become commingled with the scrap. Based on +Kentucky Electric's answers to the Company's interrogatories, Kentucky Electric +seeks damages of approximately $8 million, which with accrued interest could +result in damages in excess of $10 million. The Company answered the complaint +and denied any liability. The Company also filed a cross claim against Raleigh +Junk. The Company believes that if the damages alleged by Kentucky Electric were +caused by the smelting of a device containing radioactive material, there is +evidence that the device containing radioactive material could have come from a +source other than the prep plant. The Company intends to defend this claim +vigorously, and at this time it is not possible to predict the outcome of the +claim. + + +The Company is involved in three actions relating to +claims asserted by and against American Electric Power and its affiliates +(together AEP). On September 21, 2001, AEP filed suit against the Company in the +U.S. District Court for the Southern District of Ohio. On September 24, 2001, +AEP filed suit against the Company in the Court of Common Pleas of Franklin +County, Ohio. On September 26, 2001, the Company filed a related action against +AEP in Boyd Circuit Court in Boyd County, Kentucky. In each action, AEP alleges +similar claims that the Company breached certain coal supply agreements by +refusing to ship coal as required under those agreements. The Company believes +that any such failures are excused as a result of force majeure, failure of a +mutual assumption of the contract, duress, commercial impracticability and, in +some cases, fraud in the inducement of the agreements involved. Moreover, the +Company has alleged that AEP and its affiliates materially breached the +agreements by systemically under-reporting the weights and quality of shipments +received from the Company, and by paying substantially less than the amount due +under the terms of the various agreements. The actions filed by AEP seek to +recover the value to AEP of the agreements at issue, which value is subject to +fluctuations in coal prices but could be in excess of tens of millions of +dollars. The Company's action seeks a declaration that its obligations were +excused on the various grounds discussed above and seeks damages in a comparable +amount for the underpayments by AEP of those contracts and based upon tort law +theories. This litigation is at the initial stage and no discovery has yet taken +place. Therefore, it is impossible to anticipate the eventual outcome of the AEP +litigation. For the years 2001 through 2011, the minimum and maximum aggregate +amounts of coal to be delivered under the AEP contracts are approximately 5.1 +million tons and 7.4 million tons, respectively. The average base price of the +coal to be delivered under the AEP contracts is $24.75 per ton in 2001 and +$25.40 in 2002. The Company plans to vigorously defend against AEP's claims +against it and to vigorously pursue its claims against AEP. The ultimate outcome +of this matter is uncertain; however, the Company may experience a material +adverse effect in the event of an unfavorable outcome. + + +One of the Company's customers has claimed, in a +letter to the Company, that it has suffered damages in excess of $10,000 +resulting from the Company's failure to fulfill its tonnage obligations under +the customer's coal supply agreement. No legal proceedings have been instigated +by the customer at this time. The Company does not believe it is in default +under the coal supply agreement and intends to vigorously defend this claim. At +this time, it is not possible to predict the outcome of the claim. + + +The Company temporarily halted surface mining +operations at certain sites in West Virginia after a ruling by U.S. District +Judge Charles Haden on October 20, 1999. Haden's ruling restricted placement of +valley fills near intermittent and perennial streams via a reinterpretation of +the Surface Mining Control and Reclamation Act and the Clean Water Act. The West +Virginia Division of Environmental Protection (DEP) began denying new permits as +well as forbidding further advance under existing permits affected by Haden's +ruling. Haden stayed his ruling on October 29, 2000, and the DEP rescinded its +orders on November 1, 1999 pending a decision from the Court of Appeals or +congressional override. The Company resumed its operations at these sites, +pending a decision from the Court of Appeals. On April 24, 2001, the Fourth +Circuit Court of Appeals set aside Judge Haden's injunction on sovereign +immunity grounds and remanded the case of the District Court with instructions +to dismiss the action without prejudice to the plaintiffs' ability to pursue +their claims in state court. On July 13, 2001, the Fourth Circuit denied a +petition for rehearing en banc. The plaintiffs filed a petition for certiorari +with the U.S. Supreme Court, which was denied. + + +On August 21, 2001, a Kentucky-based environmental +interest group filed suit in U.S. District Court in West Virginia seeking, among +other things, an injunction prohibiting the issuance of permits by the U.S. Army +Corps of Engineers (Corps) for valley fills affecting "waters of the United +States" under Section 404 of the Clean Water Act. The case was assigned to Judge +Charles Haden. The Company filed a Motion to Intervene as Defendant in that +action on November 21, 2001, in order to defend the Company's interest in the +continuation of valley fill permitting by the Corps. The + + +Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. A Motion and Cross-Motions for Summary Judgment are +currently pending before the Court on the first count of Plaintiff's complaint, +which would prohibit all Corps permitting for valley fills. The Company has +continued its operations pending the outcome of this action. The ultimate +outcome of this matter is uncertain; however, the Company may experience a +material adverse effect in the event of an unfavorable outcome. + + +While the final resolution of any matter may have an +impact on the Company's financial results for a particular reporting period, +management believes that the ultimate disposition of these matters will not have +a materially adverse effect upon the financial position or results of operations +of the Company. However, the final resolution of a legal contingency may have an +adverse effect on the Company's liquidity. + +(d) Commissions--The Company has various sales and agency +agreements with third parties, whereby the Company pays a $.10 - $.65 per ton +commission on various coal sales agreements. The costs are expensed as the coal +is delivered, and the Company had approximately $7,375, $4,769 and $4,519 in +commission (selling) expense in 1999, 2000 and 2001, respectively. + +(e) Environmental Matters--Based upon current knowledge, the +Company believes that it is in material compliance with environmental laws and +regulations as currently promulgated (also see Note 3f). However, the exact +nature of environmental control problems, if any, which the Company may +encounter in the future cannot be predicted, primarily because of the increasing +number, complexity and changing character of environmental requirements that may +be enacted by federal and state authorities. + +(f) Performance Bonds--The Company has outstanding performance +bonds of approximately $648,781 as of December 31, 2001 to secure reclamation, +workers' compensation and other performance commitments (see Note 20). + +(g) Employment Agreements--The Company has entered into +employment agreements with individuals for various officer positions. These +agreements expire through September 2004 and contain termination benefits and +other matters. + +(h) Collective Bargaining Agreements--Approximately 34% of the +Company's coal employees are affiliated with unions. The Company has several +collective bargaining agreements with the UMWA. These agreements expire in 2006. + +(i) Indemnifications and Other--Pursuant to various stock and +asset purchase and sale agreements with counterparties, the Company has granted +indemnification for performance guarantees and other matters made by such +parties relating to mineral lease obligations, income taxes and employee +benefits. The Company believes no significant obligation will result relating to +such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus +Subsidiaries, the Company has committed to pay Cyprus up to $25,000 in +satisfaction of its royalty obligations in the event the Company receives an +equity investment of $75,000 or more. + +(j) Contract Mining Agreements--The Company performs contract +mining services for various third parties and utilizes contract miners on some +of its operations. Terms of the agreements generally allow either party to +terminate the agreements on a short-term basis. + +(k) Black Lung Legislation--New regulations proposed by the U.S. +Department of Labor (DOL) and amending the existing regulations of the Federal +Black Lung program in place since 1982 went into effect briefly on January 19, +2001. Implementation of the new regulations were quickly stayed by an agreement +with DOL before the Federal District Court for the District of Columbia, pending +the Court's response to an application by the coal and insurance industries for +a permanent injunction against the use of the new regulations. The Federal +District Court issued a decision on August 9, 2001 which granted no relief on +any of the multiple requests made to stay specific parts of the regulations. The +new regulations thus went into effect and claims are currently being +administered under them, pending the outcome of an appeal to the U.S. Court of +Appeals for the D.C. Circuit. A decision on the appeal is expected sometime +after the oral arguments scheduled for April of 2002. + + +The new regulations, among other things, establish a +presumption in favor of a claimant's treating physician and limit a coal +operator's ability to introduce medical evidence regarding the claimant's +medical condition. DOL, in testimony and in various pleadings, maintains that +the approval rate under the new regulations will not exceed the historic +approval rate of claims not assigned to individual coal operations (Trust Fund +Claims), which is approximately 13%. The Company and its predecessor companies +experienced less than a 3% approval rate during the period 1982 - 2000 under the +old regulations. The Company believes that it will experience a lower approval +rate under the new regulations than the national average. Although the DOL has +not processed a sufficient number of claims to a high enough level of +adjudication to measure the actual activity under the new regulations +meaningfully, the new regulations could result in the Company incurring +significantly increased costs associated with contesting and paying Black Lung +claims. + +(l) Stock Warrants--In connection with amending its Credit +Facility (discussed in Note 8b), on June 15, 2000, the Company issued warrants +to lenders enabling them to purchase 10% of its common stock for $.01 per share. +The warrants contain anti-dilution provisions, piggyback registration rights and +tag-along sale rights and are freely transferable. The warrants contain holder +put rights (Put) commencing June 15, 2001 and expiring June 15, 2010. The +purchase price for such Put is the fair market value of such warrant, determined +by formula or appraisal. The warrants also contain company call rights (Call) +commencing three years after any payment, maturity, acceleration, refinancing or +restructuring of all the Credit Facility and expiring June 15, 2010. The +purchase price for a Call is 110% for that of a Put. + + +In addition, if within one year after the exercise of +a Call, the Company is sold or has a "liquidating transaction", as defined, then +the Company shall pay to the warrant holder any additional amount they would +have received if the purchase price of the Call had been determined in +connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Plan (Note 2) will cause the +warrants to be relinquished. + +(m) Coal Settlement Agreement--Through December 31, 2001, the +Company is in arrears in delivering coal under a certain coal supply contract +with a customer. Pursuant to a settlement agreement with the customer, the +Company will prospectively ship the tons in arrears and is subject to damage +payments up to $3,400 in the event of non-shipment. + +(13) Stock Option Plan- + + +During 1998, the Company's Board of Directors adopted +a Stock Option Plan (the Option Plan) for Company stock. A total of 75,000 +shares of common stock are reserved for issuance upon exercise of options +granted under the Option Plan. The Option Plan is administered by the Board of +Directors which determines the terms of the options granted including the +exercise price, number of shares subject to the option and +exercisability. + +The Company applies APB Opinion No. 25, "Accounting for Stock Issued to +Employees" and related Interpretations in accounting for its plan. The Company +has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for +Stock-Based Compensation". Accordingly, no compensation cost related to the +option instrument has been recognized for the Option Plan. + +During 1999, stock options were exercised for 3,100 shares of common stock +issued for approximately $220. + + +On June 13, 2000, the Company issued 35,541 shares of +common stock to certain management and employees in consideration of canceling +their respective stock options. No value has been assigned to the shares issued +as it is considered negligible. + + +The following summarizes the stock option +transactions under the Option Plan for the years ended 1999, 2000 and +2001: + + 1999 2000 2001 + ------------------------- ------------------------ ------------------------ + Weighted Weighted Weighted + Average Average Average + Number Exercise Number Exercise Number Exercise + of Shares Price of Shares Price of Shares Price + ---------- -------------- ---------- ------------- --------- -------------- + + Options outstanding at January 1 67,676 $ 159.79 57,976 $ 175.40 34,500 $ 171.20 + Granted - - - - - - + Exercised 3,100 70.84 - - - - + Canceled 6,600 64.40 23,476 181.58 - - + ---------- -------------- ---------- ------------- --------- -------------- + Options outstanding at December 31 57,976 $ 175.40 34,500 $ 171.20 34,500 $ 171.20 + + Options exercisable at December 31 38,367 $ 169.50 19,741 $ 138.00 19,741 $ 138.00 + + A summary of stock options outstanding at December 31, 2001 follows: + + Outstanding Exercisable + -------------------------------------------------- ------------------------------ + Weighted + Average Weighted + Exercise Average Weighted + Number of Price Per Contractual Number of Average + Exercise Price Per Share Shares Share Life Shares Exercise Price + -------------------------- ---------------- -------------- ---------------- ------------- --------------- + + $64.40-$70.84 26,866 $ 69.44 6.1 16,566 $ 68.57 + $500-$550 7,634 529.31 6.6 3,175 500.25 + +As previously discussed, the Company accounts for the Option Plan in accordance +with APB No. 25 under which no compensation expense has been recognized for +stock option awards. Had compensation cost for the stock option plan been +determined on the fair value at the grant date for awards for the years ended +December 31, 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123 +and recorded by the Company, its net loss would have been increased to the pro +forma amounts indicated below: + + 1999 2000 2001 + ---------------- ----------------- ----------------- + + Net loss - as reported $ (199,419) $ (196,704) $ (226,126) + Net loss - pro forma (199,976) (197,261) (226,683) + + +During 1999, the Company acquired for cash an +employee's stock options for $2,500, of which $1,500 has been recorded in +expense in 1999. In January 2002, all shares of common stock, except those +already held by Addington Enterprises, Inc. (Enterprises), Robert Addington or +Larry Addington, were transferred to Larry Addington. No consideration was given +for the shares. Additionally, all outstanding stock options have been canceled +with no consideration to the option holders. No accounting entries were recorded +as the value for the shares and options was considered negligible. + +(14) Other Subsidiary Matters- + +(a) Employee Benefits Management, Inc.--Employee Benefits +Management, Inc. (EBMI), a subsidiary of the Company, has outstanding 1,000 +shares of Class A stock (999 shares owned indirectly by Fairview Land Company (a +subsidiary of the Company), one share owned by Enterprises (an affiliate)) and +176 shares of redeemable Class B common stock. The Class B common stock was +repurchased from a third-party by the Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from +Enterprises the one outstanding share of Class A common stock it did not already +hold, thereby making EBMI a wholly-owned indirect subsidiary. + +(b) Employee Claims Administration, LLC--Employee Claims +Administration, LLC (ECA), an indirect subsidiary of the Company, has +outstanding Class A and Class B membership units, representing 1,000 Class A and +205 Class B membership units. In January 2002, Resources purchased the 50 Class +A membership units not already owned by subsidiaries of the Company. The Class A +and Class B membership units are owned by several subsidiaries of the Company. +As a result of the Class A repurchase, ECA is a wholly-owned subsidiary. + +(15) Major Customers- + + +The Company had coal mining sales to the following +major customers that in any period equaled or exceeded 10% of +revenues: + + 1999 2000 2001 + ------------------------------ ------------------------------- ------------------------------ + Percentage of Percentage of Percentage of + Total Percentage Total Percentage Total + Percentage of Receivable of Total Receivable of Total Receivable + Total Revenues Balance Revenues Balance Revenues Balance + ------------------------------ -------------- ---------------- ------------------------------ + + Customer A 13% 8% 13% 10% 12% 10% + Customer B 13% 6% 13% 6% 12% 5% + Customer C - - 10% 10% 13% 11% + +(16) Writedowns and Special Items- + +During 2000 and 2001, the Company incurred legal, accounting and consulting +costs associated with restructuring its major debt obligations (Notes 2 and 8). +In addition, in connection with integrating operations, the Company has closed +certain of its mines and is considering others for disposal. Accordingly, +estimated non-recoverable assets were written off and estimated reclamation and +closure costs were recorded. Such mine closure costs, as well as other unusual +items, were as follows: + + 1999 2000 2001 + -------------- ------------- ------------- + Mine Closure: + Asset impairment charge $ 59,912 $ 527 $ - + Reclamation and closure charge 10,000 - - + Other: + Charge for reduction to estimated disposal proceeds 15,000 - - + Terminated financing project costs 2,744 - - + Debt restructuring costs (primarily professional fees) - 11,152 13,928 + -------------- ------------- ------------- + Total $ 87,656 $ 11,679 $ 13,928 + +(17) Fair Value of Financial Instruments- + +The book values of cash and cash equivalents, accounts receivable and accounts +payable are considered to be representative of their respective fair values +because of the immediate short-term maturity of these financial instruments. +Given the Company's current liquidity status (see Notes 2 and 8), the fair value +of the Company's Senior Notes, Subordinated Notes, Zeigler IRBs and Credit +Facility could not be determined or estimated. The book value of the Company's +other debt instruments approximates fair value. + +(18) Related-Party Transactions and Balances- + +The Company has dealt with certain companies or individuals which are related +parties either by having stockholders in common or because they are controlled +by stockholders/officers of the Company or by relatives of stockholders/officers +of the Company. In addition to related-party transactions and balances described +elsewhere, the following related-party transactions and balances are summarized +and approximated as follows below: + + 1999 2000 2001 + --------------- --------------- --------------- + + Revenues, costs and expenses: + Coal sales $ - $ - $ 19,960 + Royalty income - - 326 + Equipment rental and repair income - - 1,840 + Flight fee income 126 12 278 + Administrative and miscellaneous income - 30 393 + Purchased coal - - 622 + Trucking expense 23,734 24,926 19,452 + Repair, maintenance & other mining costs 30,798 37,802 57,984 + Equipment rental cost 11,902 11,351 18,181 + Administrative and miscellaneous expense 1,185 1,774 2,197 + + +The Company leases mining equipment, coal reserves +and aircraft as well as constructs, repairs and sells equipment as well as coal +to related parties. The Company has employed related parties for trucking, +consulting, equipment rental and repair and other administrative services. The +Company also purchases coal and leases office space from related parties. These +related-party transactions are generally carried out pursuant to written +agreements, some of which extend beyond one year. The related-party agreements +are subject to review and revision pursuant to the Plan. + +(19) Disposals- + + +In the ordinary course of business, the Company +disposes of excess assets (equipment, land, mineral reserves, etc.) that are not +needed in its business plans. The gain or loss on such disposals has generally +and historically been insignificant. In connection with the purchase accounting +for the acquisitions described in Note 1b, the mineral reserve balance increased +significantly to reflect the allocation of the fair value of net assets +acquired. Consistent with industry practice (pre 2000), the Company has not +recorded goodwill in its purchase accounting for these acquisitions but included +any such excess allocation amount in mineral reserves basis. Accordingly, the +Company's basis in its mineral reserves ranges in amounts up to four dollars per +ton. + + +During 1999, the Company entered into mineral +reserves disposal transactions which resulted in a loss on disposal of +$100,858. + + +Through March 7, 2002, the Company has not committed +to dispose of any assets at amounts less than book values. However, such +disposal losses may occur in the future. + +(20) Bonding Resolutions- + + +Frontier Insurance Company (Frontier), the Company's +prior principal bonding company, provided over $533,000 of surety bonds to the +Company as of the period ended December 31, 2001, approximately $360,000 of +which were surety bonds for reclamation obligations and $66,000 of which were +for workers compensation obligations. Frontier began experiencing financial +problems in 1999, and as a result, its financial rating was delisted by the U.S. +Department of Treasury. Frontier instituted rehabilitation proceedings in New +York in August 2001. In 2000, in response to Frontier's financial problems, the +states in which the Company has mining operations began requiring the Company to +obtain costly replacement bonds and to post 100% cash collateral to back those +bonds. As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by +Frontier. + + +The $150,000 DIP financing (Note 2) allowed the +Company to resolve bonding issues and continue operating without interruption. +New bonds were issued in March 2002 from other sureties pursuant to agreements +with them which included DIP financing cash and letter of credit support. As +these new bonds are accepted, the Company will receive releases of the old +Frontier bonds from the states. Some Frontier reclamation bonds securing (a) +permits pending transfer to unrelated parties, and permits pending final release +from the state will remain outstanding and (b) the remaining Frontier bonds +securing workers' compensation obligations of approximately $18,000, which have +not been required to be replaced, will remain outstanding. In addition to the +Frontier bonds, the Company has approximately $42,000 in letters of credit +securing workers' compensation obligations. In addition to the reclamation and +workers' compensation bonds issued by Frontier, described above, the Company has +approximately $107,000 of other bonds issued by Frontier securing miscellaneous +obligations. The Company has not been required to replace these bonds and they +remain outstanding. If the Plan is approved, management believes it will have +the resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +(21) Parent and Subsidiary Guarantees- + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 8c) as of December 31, 2000 and 2001 and for +each of the three years in the period ended December 31, 2001. Each of the +guarantor subsidiaries (except EBMI and ECA) is a wholly-owned subsidiary of +Resources and each has fully and unconditionally guaranteed the Senior Notes and +Subordinated Notes on a joint and several basis. Separate financial statements +and other disclosures concerning Resources and the guarantor subsidiaries are +not presented, because the Company has determined that they are not material to +investors. Yankeetown Dock Corporation (60% owned by the Company until sold June +29, 2001) was the only non-guarantor subsidiary. + + Non + Wholly- Non-Wholly + AEI Owned Owned + Resources AEI Guarantor Guarantor + Holding Resources Subsidiaries Subsidiaries + ------------- ------------ ------------- ------------ + +Operating Results + (1999): +Revenues $ -- $ -- $ 1,329,042 $ -- +Costs and expenses -- 106,707 1,249,768 27,822 + ---------- ----------- ----------- ----------- +Income (loss) from + operations -- (106,707) 79,274 (27,822) +Interest and other + income (expense) -- (220,108) (68,914) 25,372 + ---------- ----------- ----------- ----------- +Income (loss) before + income taxes -- (326,815) 10,360 (2,450) +Income tax provision + (benefit) -- (76,047) (16,685) (858) + ---------- ----------- ----------- -------------- + Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) + =========== =========== =========== ============= +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (250,768) $ 27,045 $ (1,592) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 249,388 20,993 1,595 + ----------- ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities -- (1,380) 48,038 3 +Net cash used in + investing activities -- (75,864) (64,932) -- +Net cash provided by + financing activities 220 66,672 (20,812) -- + ---------- ----------- ----------- ----------- + +Net increase (decrease) 220 (10,572) (37,706) 3 + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year -- 10,472 27,548 -- + ---------- ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 220 $ (100) $ (10,158) $ 3 + =========== =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ -- $ 236,024 $ 56,383 $ 14,179 +Properties, net -- 21,491 1,772,067 -- +Other assets (488,553) 613,712 1,172,975 644,398 + ----------- ----------- ----------- ----------- + Total assets $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Total current $ -- $ 1,260,678 $ 626,455 $ 26,627 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- 38,806 (21,408) -- +Other liabilities -- 60,516 929,390 640,968 + + Total + liabilities -- 1,360,000 1,534,437 667,595 + +Total shareholders' +equity + (deficit) (488,553) (488,773) (488,773) (9,018) + =========== =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ (488,553) $ 871,227 $ 3,001,425 $ 658,577 + =========== =========== =========== =========== + +Operating Results +(2000): +Revenues $ -- $ -- $ 1,337,967 $ -- +Costs and expenses -- 37,944 1,353,315 38,061 + ----------- ----------- ----------- ----------- +Income (loss) from +operations -- (37,944) (15,348) (38,061) +Interest and other +income (expense) -- (156,197) (57,781) 26,765 + ----------- ----------- ----------- ----------- +Income (loss) before -- (194,141) (73,129) (11,296) +income taxes +Income tax provision +(benefit) -- (34,980) (14,123) (3,953) + ----------- ----------- ----------- ----------- + Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) + =========== =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (159,161) $ (59,006) $ (7,343) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 169,178 78,867 7,344 + =========== =========== =========== =========== +Net cash provided by -- 10,017 19,861 1 + (used in) operating + activities +Net cash used in + investing + activities -- (1,152) (41,654) -- +Net cash provided by + financing activities -- 47,977 (13,920) -- + ----------- ----------- ----------- ----------- +Net increase (decrease) -- 56,842 (35,713) 1 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 (100) (10,158) 3 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 56,742 $ (45,871) $ 4 + =========== =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ 136,446 $ 334,044 $ 14,464 +Properties, net -- 15,841 1,571,489 -- +Other assets (737,024) 655,741 2,084,719 669,749 + ----------- ----------- ----------- ----------- + Total assets $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ 1,400,301 $ 718,951 $ 35,750 + +Long-term debt and + capital leases, + less current + portion -- 55,284 517,054 -- +Other liabilities -- 89,687 1,046,822 663,021 + ----------- ----------- ----------- ----------- + Total + liabilities -- 1,545,272 2,282,827 698,771 +Total shareholders' +equity + (deficit) (737,024) (737,244) 1 (14,558) + ----------- ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) (737,024) $ 808,028 $ 3,990,252 $ 684,213 + =========== =========== =========== =========== + +Operating Results (2001): +Revenues $ -- $ 996 $ 1,411,252 $ -- +Costs and expenses -- 53,824 1,371,907 42,274 + ----------- ----------- ----------- ----------- + +Income (loss) from +operations -- (52,828) 39,345 (42,274) +Interest and other +income +(expense) -- (165,951) (65,669) 33,913 + ----------- ----------- ----------- ----------- + +Income (loss) before +income taxes -- (218,779) (26,324) (8,361) + +Income tax provision + (benefit) -- 1,159 3,177 (2,926) + Net income (loss) $ -- $ (219,938) $ (29,501) $ (5,435) + =========== =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ -- $ (219,938) (29,501) $ (5,435) + ----------- ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities -- 300,466 115,267 5,435 + ----------- ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities -- 80,528 85,766 -- + +Net cash used in + investing + activities -- (56,432) (69,405) -- +Net cash provided by + financing activities -- (18,381) (11,026) -- + ----------- ----------- ----------- ----------- + +Net increase (decrease) -- 5,715 5,335 -- + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 220 56,742 (45,871) 4 + ----------- ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 220 $ 62,457 $ (40,536) $ 4 + =========== =========== =========== =========== + + Non- + Guarantor Combining + Subsidiary Adjustments Total + ----------- ----------- ------- + +Operating Results + (1999): +Revenues $ 1,780 $ -- $ 1,330,822 +Costs and expenses 1,526 -- 1,385,823 + ----------- ----------- ----------- +Income (loss) from + operations 254 -- (55,001) +Interest and other + income (expense) (20) 25,742 (237,928) + ----------- ----------- ----------- +Income (loss) before + income taxes 234 25,742 (292,929) +Income tax provision + (benefit) 80 -- (93,510) + ----------- ----------- ----------- + Net income (loss) $ 154 $ 25,742 $ (199,419) + =========== =========== =========== +Cash Flows (1999): +Cash flows from + operating + activities: +Net income (loss) $ 154 $ 25,742 $ (199,419) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities 639 (1,803) 270,812 + ----------- ----------- ----------- +Net cash provided by + (used in) operating + activities 793 23,939 71,393 +Net cash used in + investing activities -- -- (140,796) +Net cash provided by + financing activities (190) 1,876 47,766 + ----------- ----------- ----------- + +Net increase (decrease) 603 25,815 (21,637) + in cash and cash + equivalents +Cash and cash + equivalents, + beginning of year 3,123 1,471 42,614 + ----------- ----------- ----------- + +Cash and cash + equivalents, end + of year $ 3,726 $ 27,286 $ 20,977 + =========== =========== =========== + +December 31, 2000: + +Balance Sheet: +Total current assets $ 3,252 $ (14,175) $ 295,663 +Properties, net 67 -- 1,793,625 +Other assets 151 (1,828,797) 113,886 + ----------- ----------- ----------- + Total assets $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Total current $ -- $ (228,393) $ 1,685,367 + liabilities, + including current + portion of + long-term debt + and capital + leases + +Long-term debt and + capital leases, + less current portion -- -- 17,398 +Other liabilities 2,486 (644,398) 988,962 + + Total + liabilities 2,486 (872,791) 2,691,727 + +Total shareholders' +equity + (deficit) 984 (970,181) (488,553) + =========== =========== =========== +Total liabilities and + shareholders' + equity + (deficit) $ 3,470 $(1,842,972) $ 2,203,174 + =========== =========== =========== + +Operating Results +(2000): +Revenues $ 673 $ -- $ 1,338,640 +Costs and expenses 813 -- 1,430,133 + ----------- ----------- ----------- +Income (loss) from +operations (140) -- (91,493) +Interest and other +income (expense) (2) 28,906 (158,309) + ----------- ----------- ----------- +Income (loss) before (142) 28,906 (249,802) +income taxes +Income tax provision +(benefit) (42) -- (53,098) + ----------- ----------- ----------- + Net income (loss) $ (100) $ 28,906 $ (196,704) + =========== =========== =========== + +Cash Flows (2000): +Cash flows from + operating + activities: +Net income (loss) $ (100) $ 28,906 $ (196,704) +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (28) (16,143) 239,218 + =========== =========== =========== +Net cash provided by (128) 12,763 42,514 + (used in) operating + activities +Net cash used in + investing + activities -- -- (42,806) +Net cash provided by + financing activities -- 21 34,078 + ----------- ----------- ----------- +Net increase (decrease) (128) 12,784 33,786 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,726 27,286 20,977 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ 3,598 $ 40,070 $ 54,763 + =========== =========== =========== + +December 31, 2001: +Balance Sheet: +Total current assets $ -- $ (173,688) $ 311,266 +Properties, net -- -- 1,587,330 +Other assets -- (2,511,611) 161,574 + ----------- ----------- ----------- + Total assets $ -- $(2,685,299) $ 2,060,170 + =========== =========== =========== + +Total current + liabilities, + including + current portion + of long-term debt and + capital leases $ -- $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, + less current + portion -- (567,106) 5,232 +Other liabilities -- (832,860) 966,670 + ----------- ----------- ----------- + Total + liabilities -- (1,729,676) 2,797,194 +Total shareholders' +equity + (deficit) -- (955,623) (737,024) + ----------- ----------- ----------- +Total liabilities and + shareholders' equity + (deficit) $ -- $(2,685,299) $ 2 + =========== =========== =========== + +Operating Results (2001): +Revenues $ 275 $ -- $ 1,412,523 +Costs and expenses 370 -- 1,468,375 + ----------- ----------- ----------- + +Income (loss) from +operations (95) -- (55,852) +Interest and other +income +(expense) (13) 28,822 (168,898) + ----------- ----------- ----------- + +Income (loss) before +income taxes (108) 28,822 (224,750) + +Income tax provision + (benefit) (34) -- 1,376 + Net income (loss) $ (74) $ 28,822 $ (226,126) + =========== =========== =========== + +Cash Flows (2001): +Cash flows from + operating + activities: +Net income (loss) $ (74) $ 28,822 $ (226,126) + ----------- ----------- ----------- +Total adjustments to + reconcile net income + (loss) to net cash + used in operating + activities (3,524) (28,822) 388,822 + ----------- ----------- ----------- + +Net cash provided by + (used in) operating + activities (3,598) -- 162,696 + +Net cash used in + investing + activities -- -- (125,837) +Net cash provided by + financing activities -- -- (29,407) + ----------- ----------- ----------- + +Net increase (decrease) (3,598) -- 7,452 + in cash and cash + equivalents + +Cash and cash + equivalents, + beginning of year 3,598 40,070 54,763 + ----------- ----------- ----------- + +Cash and cash + equivalents, + end of year $ -- $ 40,070 $ 62,215 + =========== =========== =========== + + AEI Resources Holding, Inc. + (Debtor-in-Possession) + Consolidated Balance Sheets + As of March 31, 2002 and December 31, 2001 + + (Dollars In Thousands) + + March 31, December 31, + 2002 + (Unaudited) 2001 + ------------- ---------------- +ASSETS +Current Assets: + Cash and cash equivalents.................................................. $ 19,927 $ 62,215 + Accounts receivable (including amounts due from related parties of $9,895 + and $10,191, respectively, net of allowance for doubtful accounts of 117,101 121,859 + $6,135 and $4,612, respectively)........................................ + Inventories................................................................ 117,300 91,044 + Deferred tax asset......................................................... 11,600 13,010 + Prepaid expenses and other................................................. 26,138 23,138 + ------------- ---------------- + Total current assets................................................. 292,066 311,266 + ------------- ---------------- +Property, Plant and Equipment, at cost, including mineral reserves and mine + development and contract costs............................................. 2,313,189 2,305,633 + Less--accumulated depreciation, depletion and amortization.................. (774,801) (718,303) + ------------- ---------------- + 1,538,388 1,587,330 + ------------- ---------------- +Debt issuance costs, net....................................................... 69,541 68,105 +Restricted cash................................................................ 132,676 57,120 +Other non-current assets, net.................................................. 35,323 36,349 + ------------- ---------------- + Total assets......................................................... $ 2,067,994 $ 2,060,170 + ============= ================ + +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) + +Liabilities Not Subject to Compromise: + Current Liabilities: + Accounts payable (including amounts due to related parties of $12,218 and + $13,431, respectively).................................................. $ 65,085 $ 84,306 + Current portion of long-term debt and capital leases....................... 888,055 1,329,651 + Accrued interest........................................................... 141,745 216,443 + Current portion of reclamation and mine closure costs...................... 30,815 32,882 + Current portion of employee benefits....................................... 39,593 39,663 + Income taxes payable ...................................................... 1,576 1,154 + Accrued expenses and other................................................. 123,636 121,193 + ------------- ---------------- + Total current liabilities............................................ 1,290,505 1,825,292 + ------------- ---------------- +Non-Current Liabilities, less current portion: + Long-term debt and capital leases.......................................... 4,668 5,232 + Employee benefits.......................................................... 588,933 585,430 + Reclamation and mine closure costs......................................... 300,189 301,510 + Deferred income taxes...................................................... 11,600 13,010 + Other non-current liabilities.............................................. 62,569 66,720 + ------------- ---------------- + Total non-current liabilities........................................ 967,959 971,902 + ------------- ---------------- + Total liabilities not subject to compromise.......................... 2,258,464 2,797,194 + ------------- ---------------- + Liabilities Subject to Compromise.......................................... 596,848 - + ------------- ---------------- + ------------- ---------------- + Total liabilities.................................................... 2,855,312 2,797,194 + ------------- ---------------- +Commitments and Contingencies (see notes) +Stockholders' Equity (Deficit): + Common stock ($.01 par value, 150,000 shares authorized and 91,445 shares + issued and 1 1 + outstanding, respectively).............................................. + Additional capital......................................................... 220 220 + Accumulated other comprehensive loss....................................... (22,345) (22,345) + Retained deficit........................................................... (765,194) (714,900) + ------------- ---------------- + Total stockholders' deficit.......................................... (787,318) (737,024) + ------------- ---------------- + Total liabilities and stockholders' deficit.......................... $ 2,067,994 $ 2,060,170 + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF OPERATIONS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months Ended March 31, + ----------------------------- + 2002 2001 + -------------- -------------- + +Revenues (including amounts from related parties of $3,952 and $32, respectively)........ $ 316,496 $ 356,045 + +Costs and expenses: + Cost of operations (including amounts to related parties of $22,701 and $20,826, + respectively)........................................................................ 247,160 297,813 + Depreciation, depletion and amortization............................................... 68,292 62,131 + Selling, general and administrative (including amounts to related parties of $358 and + $525, respectively).................................................................. 9,310 9,329 + Writedowns and special items........................................................... 4,129 4,489 + -------------- -------------- + Total costs and expenses......................................................... 328,891 373,762 + -------------- -------------- + Loss from operations............................................................. (12,395) (17,717) + +Interest and other income (expense): + Interest expense (contractual interest of ($46,810) for the March 31, 2002 period)..... (38,658) (49,654) + Gain on sale of assets................................................................. 9 6,006 + Other, net............................................................................. 4,488 833 + -------------- -------------- + (34,161) (42,815) + -------------- -------------- + Loss before reorganization items and income taxes ............................... (46,556) (60,532) +Professional fees related to reorganization............................................... 2,084 - + -------------- -------------- + Loss before income taxes......................................................... (48,640) (60,532) +Income tax provision (benefit)............................................................ 1,654 (141) + -------------- -------------- + + Net loss......................................................................... $ (50,294) $ (60,391) + ============== ============== + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + AEI RESOURCES HOLDING, INC. + (Debtor-in-Possession) + CONSOLIDATED STATEMENTS OF CASH FLOWS + For the Three Months Ended March 31, 2002 and 2001 + (Unaudited) + (Dollars In Thousands) + + Three Months + Ended March 31, + ------------------------------- + 2002 2001 + -------------- ---------------- + +Cash Flows From Operating Activities: + Net loss ............................................................................ $ (50,294) $ (60,391) + Adjustments to reconcile net loss to net cash provided by operating activities: + Depreciation, depletion and amortization........................................... 68,292 62,131 + Amortization of finance costs included in interest expense......................... 3,949 3,661 + Provision for doubtful accounts.................................................... 1,523 - + Provision for write downs and special items........................................ 322 - + Gain on sale of assets............................................................. (9) (6,006) + Changes in assets and liabilities: + (Increase) decrease in: + Receivables.................................................................... 3,103 (16,444) + Inventories.................................................................... (26,256) 2,976 + Prepaid expenses and other..................................................... (3,019) (281) + Other non-current assets....................................................... 3,634 173 + Increase (decrease) in: + Accounts payable............................................................... (14,719) (15,270) + Accrued expenses and other and other non-current liabilities................... 26,100 40,530 + -------------- ---------------- + Total adjustments............................................................ 62,920 71,470 + -------------- ---------------- + Net cash provided by operating activities.................................... 12,626 11,079 + -------------- ---------------- +Cash Flows From Investing Activities: + Net proceeds from sale of assets..................................................... 199 7,328 + Additions to property, plant and equipment and mine development and contract costs... (23,925) (11,523) + Increase in restricted investments................................................... (79,444) (11,403) + -------------- ---------------- + Net cash used in investing activities........................................ (103,170) (15,598) + -------------- ---------------- +Cash Flows From Financing Activities: + Repayments on long-term debt......................................................... (6,834) (20,638) + Borrowings on long-term debt......................................................... 6,000 - + Borrowings under debtor-in-possession (DIP) Facility (post petition)................. 55,000 - + Repayments on capital leases......................................................... (525) (575) + Payments for financing costs related to DIP Facility................................. (5,385) - + -------------- ---------------- + Net cash provided by (used in) financing activities.......................... 48,256 (21,213) + -------------- ---------------- + Net decrease in cash and cash equivalents.................................... (42,288) (25,732) + -------------- ---------------- +Cash and Cash Equivalents, beginning of period.......................................... 62,215 54,763 + -------------- ---------------- +Cash and Cash Equivalents, end of period................................................ $ 19,927 $ 29,031 + ============== ================ + + The accompanying notes to consolidated financial statements are an integral part of these balance sheets. + +AEI RESOURCES HOLDING, INC. + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +March 31, 2002 + +(Unaudited - Dollars in thousands) + +1. +BASIS OF PRESENTATION + + +The accompanying interim unaudited financial statements of AEI Resources +Holding, Inc. (the "Company" or "ARHI") includes all adjustments, which are, in +the opinion of management, necessary for a fair presentation. Results for any +interim period are not necessarily indicative of the results that may be +achieved in future periods. The financial information as of this interim date +should be read in conjunction with the Company's annual audited financial +statements and notes thereto as of December 31, 2001. The Company's auditors +issued a going concern opinion in association with these annual statements. + + +Since filing for protection under the Bankruptcy Code on February 28, 2002 (Note +2), the Company has operated its businesses as a debtor-in-possession subject to +the jurisdiction of the Bankruptcy Court. Accordingly, the unaudited interim +financial statements of the Company have been prepared in accordance with the +American Institute of Certified Public Accountants Statement of Position 90-7, +"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" +(SOP 90-7) and generally accepted accounting principles applicable to a going +concern, which assume that assets will be realized and liabilities will be +discharged in the normal course of business. + + +The Company operates one segment: the production of steam and +metallurgical coal from surface and deep mines in Kentucky, West Virginia, +Indiana, Illinois and Colorado. Significant intercompany transactions and +balances have been eliminated in consolidation. Minority interests have not been +recorded due to insignificance or deficit equity. + + +Certain reclassifications of prior year amounts were made to +conform with the current year presentation with no effect on previously reported +net income (loss) or stockholder's equity (deficit). + +2. +LIQUIDITY AND BANKRUPTCY PROCEEDINGS + + +a. Bankruptcy Commencement and Emergence + + +The Company has suffered losses and has a negative equity and working capital +position at March 31, 2002. The Company has also been unable to meet its debt +service obligations during the fourth quarter of 2001 and continuing through the +bankruptcy period. In addition, the Company was directed by certain states to +replace its Frontier Insurance Company (Frontier) surety bonds or risk a +cessation of operations. The Company has replaced the Frontier bonds that +governmental authorities have demanded be replaced (Note 8). Management's plans +to remedy the Company's debt defaults are included in a plan of reorganization. + + +Beginning on January 28, 2002, prior to the commencement of the Company's +Chapter 11 cases, the Company solicited votes for the acceptance or rejection of +the Joint Plan of Reorganization (Prepackaged Plan) from the holders of their +10.5% Senior Notes due 2005; the holders of their 6.95% Industrial Revenue +Refunding Bonds, Series 1997, due 2028; the holders of their 6.90% Port Facility +Revenue Refunding Bonds, Series 1997, due 2022; the holders of their 11.5% +Senior Subordinated Notes due 2006 and the holders of claims under the Company's +Secured Bank Credit Agreement. Of those voting, the holders of such claims voted +unanimously in favor of the Prepackaged Plan. + + +On February 28, 2002, the Company, together with certain of its direct and +indirect debtor subsidiaries, commenced in the United States Bankruptcy Court +for the Eastern District of Kentucky (Bankruptcy Court) voluntary cases under +Chapter 11 of Title 11 of the Bankruptcy Code and filed concurrently therewith +the Prepackaged Plan and a Solicitation and Disclosure Statement dated January +28, 2002 (Disclosure Statement) relating to the Prepackaged Plan. + + +A hearing to consider confirmation of the Prepackaged Plan, including approval +of the Disclosure Statement and the solicitation procedures used in connection +therewith, and any objections to the Prepackaged Plan occurred on April 12, +2002. The order confirming the Prepackaged Plan was entered on April 17, 2002 +and the Company emerged from bankruptcy on May 9, 2002 under the name Horizon +Natural Resources Company. + + +b. Liabilities Subject to Compromise + + +Under Chapter 11, certain claims against the Company in existence prior to the +filing of the petitions for relief under federal bankruptcy laws are stayed +while the Company continues business operations as debtor-in-possession. These +claims are reflected in the March 31, 2002, balance sheet as "liabilities +subject to compromise." These claims consist of the following debt instruments: + + Accrued + Debt Interest Total + --------------- --------------- -------------- + 10.5% Senior Notes (Note 5b) $ 200,000 $ 48,177 $ 248,177 + 11.5% Senior Subordinated Notes (Note 5b) 150,000 38,078 188,078 + Zeigler Industrial Revenue Bonds (Note 5d) 145,800 14,793 160,593 + --- ----------- -- ------------ -- ----------- + Liabilities Subject to Compromise $ 495,800 $ 101,048 $ 596,848 + === =========== == ============ == =========== + + +Contractual interest on the above debt instruments amounted to $16,782 through +March 31, 2002, which is $5,651 in excess of reported interest expense; +therefore, the Company has discontinued accruing interest on these obligations. +Additionally, through March 31, 2002 the Company has not recorded $2,501 of +contractual interest related to the default status of the Credit Facility (Note +5b). + + +Claims secured against the debtor's assets (secured claims) also are stayed, +although the holders of such claims have the right to move the court for relief +from the stay. Secured claims are secured primarily by liens on the debtor's +property, plant and equipment. During the pendancy of the Company's bankruptcy +proceedings, virtually all actions against it are stayed pursuant to section 362 +of the Bankruptcy Code. As a result of the Company's emergence from bankruptcy, +the automatic stay no longer applies. + + +c. DIP and Exit Facilities + + +The Company received approval from the Bankruptcy Court to pay or otherwise +honor its prepetition obligations, including employee wages and benefits. The +Bankruptcy Court also approved the Company's $150,000 debtor-in-possession +financing (DIP, Note 5e). The DIP allows the Company to resolve bonding issues +and should provide reassurance to employees, suppliers and customers that the +Company can continue to operate and meet its commitments without interruption. + + +The Company received a commitment from Bankers Trust for a secured credit +facility (Exit Facility), that was entered into on the date the Prepackaged Plan +became effective (Effective Date). The Exit Facility will consist of a $250,000 +revolving credit facility, under which revolving loans may be made and letters +of credit may be issued up to a sublimit of $200,000 for such letters of credit. +The Exit Facility will mature five years after the Effective Date. The Company +has used the funds borrowed under the Exit Facility to repay all amounts +outstanding under the DIP Facility, to fund certain cash needs on the Effective +Date and for working capital needs after emergence. The Exit Facility contains +various financial covenants which, among other things, limit additional +indebtedness, dividend and other restricted payments, affiliate transactions, +mergers and capital expenditures and require the Company to meet certain +financial ratios including, but not limited to, interest coverage and maximum +leverage ratio, all as defined in the Exit Facility. + + +d. Debt Defaults and Plan Restructured Debt + + +As of March 31, 2002, the Company was in default on its Credit Facility (Note +5b), Senior Notes (Note 5c), Senior Subordinated Notes (Note 5c), Zeigler IRBs +(Note 5d) and Kentucky Bank and Trust Loan (Note 5f). Accordingly, this debt has +been reflected as a current liability in the accompanying interim financial +statements. Since September 30, 2000, the Company has not made any scheduled +principal or interest payments on the Credit Facility, Zeigler IRBs, Senior +Notes and the Subordinated Notes and, as a result, violated various provisions +and covenants under these debt instruments, including financial covenants. As of +February 28, 2002, the Company had missed scheduled principal and interest +payments of $77,500 and $210,723 (excluding penalty interest of $16,907), +respectively. Pursuant to the Prepackaged Plan, the Senior Notes, Senior +Subordinated Notes and Zeigler IRBs (New Equity) were cancelled, and the holders +of such notes and bonds issued equity in the reorganized company. According to +the Prepackaged Plan, current equity was cancelled and no distributions were +made in respect thereof. Pursuant to the Prepackaged + + +Plan, each lender under the Credit Facility (which had outstanding principal +plus fees and accrued interest of $985,777 at February 28, 2002) as of the +Effective Date will be converted into (A) such lender's pro rata portion of: (i) +the New Senior Secured Term Notes evidencing a senior secured term loan in an +aggregate principal amount equal to $475,000, minus Available Cash (as defined +in the Disclosure Statement) as of the Effective Date; (ii) $450,000 in +aggregate principal amount of New Senior Notes (iii) cash in the amount equal to +the Bank Claims Cash Distribution Amount (as defined in the Disclosure +Statement), and (B) the releases described in Section 11.7 of the Prepackaged +Plan. The $450,000 New Senior Notes mature in 2009 with a stated interest rate +of 11.75%. The New Senior Secured Term Notes mature pursuant to an amortization +schedule that requires quarterly installment payments of $5,000 with the sixth +anniversary date requiring payment of the outstanding balance. Interest is +calculated at LIBOR plus the Applicable Margin, as defined in Exhibit 3 of the +Prepackaged Plan. The New Senior Secured Term Notes and New Senior Notes contain +various financial covenants which are similar to those in the Exit Facility. + + +e. SOP 90-7 + + +Pursuant to SOP 90-7, the Company plans on adopting fresh-start +reporting upon emergence from bankruptcy. Entities that adopt fresh-start +reporting apply the following principles: + + + +The reorganization value of the entity should be allocated to the entity's +assets in conformity with the procedures specified by SFAS No. 141, "Business +Combinations." The reorganization value should be amortized in conformity with +SFAS No. 142, "Goodwill and Other Intangible Assets". + + + +Each liability existing at the plan confirmation date, other than +deferred taxes, should be stated at present values of amounts to be paid +determined at appropriate current interest rates. + + + +Deferred taxes should be reported in conformity with generally +accepted accounting principles. Benefits realized from preconfirmation net +operating loss carryforwards should first reduce reorganization value in excess +of amounts allocable to identifiable assets and other intangibles until +exhausted and thereafter be reported as a direct addition to paid-in +capital. + + + +Changes in accounting principles that will be required in the financial +statements of the emerging entity within the 12 months following the adoption of +fresh-start reporting should be adopted at the time fresh-start reporting is +adopted. + + +In connection with the implementation of fresh-start accounting, the Company +expects to record an extraordinary gain of approximately $112,000 from the +restructuring of its debt in accordance with the provisions of the Prepackaged +Plan. Other significant adjustments are expected as well to reflect the +provisions of the Prepackaged Plan and the fair values of the assets and +liabilities of the reorganized company as of May 1, 2002. For accounting +purposes, these transactions will be reflected in the operating results prior to +emergence. + + +The expected extraordinary gain on the debt restructuring is +calculated as follows: + + Liabilities Subject to Compromise $ 596,848 + Less unamortized financing costs (35,057) + Less assumed exchanged equity value (450,000) + ------------ + Extraordinary gain on restructuring $ 111,791 + + +f. Ongoing Financial Viability + + +The Company's on-going financial viability is dependent on its ability to +improve operations and cash flows. The Company's operating plan includes +measures it believes will improve operating profits and cash flows. These +measures include, but are not limited to the following: (1) enhancing mine +productivity by replacing old, inefficient production equipment, (2) +consolidating operations to reduce mine level overhead costs, (3) focusing on +high margin properties to achieve the best possible sales and production balance +both in terms of coal quality and transportation factors, (4) acquiring +strategic, low cost reserves to replace existing operations, (5) utilizing the +restructured balance sheet and improved liquidity to establish new relationships +with first tier vendors and improve access to new vendors, including improved +pricing and payment terms. There can be no assurances that operating profits and +cash flows will be realized in an amount sufficient to fund obligations or other +liquidity needs. + +3. +INVENTORIES + + +As of March 31, 2002 and December 31, 2001, inventories consisted +of the following: + + 2002 2001 + --------------- --------------- + + Coal................................. $ 53,445 $ 27,438 + Deferred overburden.................. 39,019 39,019 + Parts and supplies................... 24,836 24,587 + --------------- ------------- + $ 117,300 $ 91,044 + =============== ============= + +4. +SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION + + +For purposes of the statements of cash flows, the Company +considers investments having maturities of three months or less at the time of +the purchase to be cash equivalents. + + +Supplemental disclosure: + + Three Months Ended + March 31, + ------------------------- + 2002 2001 + ------------ ------------ + + Cash paid for interest............................ $ 4,987 $ 887 + Income taxes paid................................. 1,241 81 + + +The March 31, 2002 and 2001 Statement of Cash Flows is exclusive of non-cash +property additions of $94 and $749, respectively, included in accounts payable. + + +In conjunction with the bankruptcy, the Company paid professional +fees of $350 in March 2002. + +5. +DEBT + + +a. Long-term Debt and Capital Leases + + +Long-term debt and capital leases as of March 31, 2002 and December 31, 2001 +consisted of the following: + + March 31, December 31, 2001 + 2002 + ---------------- ------------------ + Credit Facility (Note 5b): + Term Loan A - Original $ 223,021 $ 223,021 + Term Loan A - Amended 74,340 74,340 + Term Loan B 329,576 329,576 + Revolving Credit Facility 188,163 182,163 + 10.5% Senior Notes (Notes 2 and 5c) - 200,000 + 11.5% Senior Subordinated Notes (Notes 2 and 5c) - 150,000 + Zeigler Industrial Revenue Bonds (Notes 2 and 5d) - 145,800 + Bankers Trust DIP Facility (Note 5e) 55,000 - + Notes payable to sellers of Cyprus Subsidiaries ($- and + $3,462), Mid-Vol ($6,000 and $6,000) and Ikerd- + Bandy ($1,932 and $2,159) 7,932 11,621 + Kentucky Bank & Trust Loan (Note 5f) 8,132 8,132 + Capital leases 2,441 2,969 + Other 4,118 7,261 + ---------------- ------------------ + Total 892,723 1,334,883 + Less - current portion 888,055 1,329,651 + ---------------- ------------------ + Long-term debt $ 4,668 $ 5,232 + ================ ================== + + +b. Credit Facility + + +The Credit Facility consists of Term Loan A Facilities (Original Tranche A +maturing in 2003 and Amended Tranche A maturing in 2004), a Term Loan B Facility +(maturing in 2004) (the term loan facilities) and a $188,163 senior secured +revolving credit facility (Revolver), maturing in 2003. Interest is calculated +on the ABR (alternative base rate) plus the Applicable Margin, as defined in the +Credit Facility. The Applicable Margin is determined pursuant to a formula based +on the Company's financial performance. The ABR is the higher of the Federal +Funds Rate plus 0.5% and the Prime Rate. As of March 31, 2002, the interest +rates and average interest rates for the period were as follows: Original +Tranche Term Loan A (7.00% and 8.31%), Amended Tranche Term Loan A (8.00% and +9.31%), Term Loan B (7.50% and 8.81%) and Revolver (7.50% and 8.81%). The Credit +Facility is collateralized primarily by capital stock of most of the Company's +subsidiaries, along with all accounts receivable; inventory; property, plant and +equipment; intangibles; contract rights and other personal and real property of +the Company and most of its subsidiaries. The Company and most of its +subsidiaries have guaranteed the Credit Facility. + + +Effective June 15, 2000, the Company amended and restated its Credit Facility to +modify the payment terms and covenant requirements. The changes included, among +others, deferred principal payments, increased interest rates and amended +financial covenant ratios. Term Loan A under the Credit Facility was separated +into an Original Tranche and Amended Tranche each with new repayment terms. The +Amended Tranche aggregates $75,000 in principal with final maturity on December +14, 2004. The Original Tranche aggregates $225,000 in principal with final +maturity on December 31, 2003. The Company incurred an exit fee equal to 2% of +Credit Facility borrowings at June 15, 2000 ($15,793) payable to the lenders on +the earlier of (i) the maturity date of each respective Tranche or (ii) the date +such Tranche is accelerated, refinanced, restructured or replaced. The exit fee +has been recorded as an increase in debt issuance costs and accrued expenses and +other. Mandatory prepayments are required based on the following: (i) casualty +event, as defined and based on specified calculations and limitations, (ii) +disposition events, as defined and based on specified calculations and +limitations (iii) debt issuances all net available proceeds from any debt +issuance, (iv) excess cash flow, as defined and calculated and (v) equity +issuances, as defined and based on specified calculations and limitations. The +Company has the option to prepay the Amended Tranche at 102% in 2002 and 101% in +2003. The Credit Facility contains various financial covenants which, among +other things, limits additional indebtedness, dividend and other restricted +payments, affiliate transactions, mergers and capital expenditures and requires +the Company to meet certain financial ratios including, but not limited to, +interest coverage and maximum leverage ratio, all as defined in the Credit +Facility. In addition, the Credit Facility is required to be prepaid with 50% of +annual Excess Cash Flow as defined in the Credit Facility, 100% of proceeds from +the incurrence of additional debt, 100% of proceeds from asset sales or +dispositions above certain defined thresholds or 50% of the net proceeds from +the issuance of equity securities. As of March 31, 2002, the Company is in +violation of various financial and other covenants including the non-payment of +principal and interest payments due giving rise to an Event of Default. Prior to +the default period, the Company had the option of choosing the LIBOR or ABR +method to calculate interest. As such the entire Credit Facility is classified +as a current liability in the accompanying interim balance sheets. + + +As of March 31, 2002, the Company has $188,163 in outstanding +borrowings under the Revolver. In addition, the Company has letters of credit in +the amount of $14,431 issued under the Revolver. + + +See Note 2 for changes related to the Credit Facility under the Prepackaged +Plan. + + +c. 10.5% Senior Notes and 11.5% Senior Subordinated Notes + + +On December 14, 1998, AEI Resources, Inc. (Resources) and AEI +Holding Company, Inc. (a subsidiary) co-issued $200,000 of 10.5% Senior Notes +due 2005 (Senior Notes). + + +Also on December 14, 1998, Resources issued $150,000 of 11.5% +Senior Subordinated Notes due 2006 (Subordinated Notes). + + +Upon a change in control (as defined in the documents governing the Senior Notes +and the Subordinated Notes), the Company will be required to make an offer to +purchase all outstanding Senior Notes and Subordinated Notes at 101% of the +principal amount. The Senior Notes and Subordinated Notes are jointly and +severally guaranteed on a senior unsecured basis by ARHI and each of the +Company's current and future domestic majority-owned subsidiaries. In addition +to containing various restrictive financial covenants, the Senior Notes and +Subordinated Notes restrict, among other things, additional indebtedness, +issuance of preferred stock, dividend payments, mergers, sale of subsidiaries +and assets and affiliate transactions. In addition, the Senior Notes and +Subordinated Notes contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of certain indebtedness prior to its express +maturity causes an event of default. As of March 31, 2002, the Company had not +paid interest when due thereby giving rise to an Event of Default. As such the +entire balance of the Senior and Subordinated Notes are classified as a current +liability in the accompanying interim balance sheets. + + +The Company filed an initial registration statement for the Senior Notes with +the Securities and Exchange Commission on February 12, 2000 and filed an +amendment to the initial registration statement on April 29, 2000. Subsequently, +the Company had planned to file a registration statement for the Subordinated +Notes; however, the Company withdrew the Senior Notes' registration statement on +May 31, 2001. Because the registration statements were not filed or declared +effective within the time periods allotted in the documents governing the Senior +Notes and the Senior Subordinated Notes, the Company has been required to pay +liquidated damages to the holders of the Senior Notes and Subordinated Notes. +For the Senior Notes, the Company is accruing the maximum liquidated damages of +50 per one thousand dollars principal amount (aggregating to $100 per +week) per week until the registration statement is declared effective. For the +Subordinated Notes, the Company is also accruing the maximum liquidated damages +of 50 per one thousand dollars principal amount (aggregating to $75 per +week) per week until the registration statement is declared effective. For the +three months ended March 31, 2002 and 2001, the Company incurred liquidated +damages pursuant to the Senior Note and Subordinated Note indentures of $1,741 +and $2,243, respectively. If the registration statements do not become effective +during 2002, the Company will incur liquidated damages aggregating $6,875 from +April 1, 2002 through December 31, 2002. + + +See Note 2 for changes related to the Senior Notes and +Subordinated Notes under the Prepackaged Plan. + + +d. Industrial Revenue Bonds + + +In connection with the 1998 acquisition of Zeigler Coal Holding Company +(Zeigler), the Company assumed floating rate industrial revenue bonds (IRBs) +issued by the Peninsula Ports Authority of Virginia ($115,000) and Charleston +County, South Carolina ($30,800) (collectively, the Zeigler IRBs). On April 1, +1999, the Company refinanced the Zeigler IRBs. The interest on the Peninsula +Ports Authority of Virginia bonds is currently fixed at 6.90%, and the interest +on the Charleston County, South Carolina bonds is currently fixed at 6.95%. +Interest is payable semi-annually on both bonds. The principal amount owed to +the Peninsula Ports Authority of Virginia is due in two equal lump-sum payments +on April 30, 2022 and May 2, 2022, and the principal amount owed to Charleston +County, South Carolina is due in one lump-sum payment on August 10, +2028. + + +The Zeigler IRBs contain redemption features which allow the issuers, at the +direction of the Company, the option to redeem the Zeigler IRBs on or after +April 1, 2009 at redemption prices ranging from 102% in 2009 to 100% in 2013. In +addition, unless the bonds are Investment Grade rated, as defined, as of April +1, 2009, the Zeigler IRBs will be subject to mandatory sinking fund requirements +of $9,200 per year through 2022 and $1,500 per year thereafter through 2028. + + +Upon a change in control, as defined in the documents governing the Zeigler +IRBs, the Company, at the direction of the then current Zeigler IRB bondholders, +will be required to make an offer to purchase all outstanding bonds at 103%. The +Zeigler IRBs are unsecured but are guaranteed by substantially the same entities +that guarantee the Senior Notes and Subordinated Notes described in Note 5c +above. The documents also contain default provisions whereby the failure to pay +principal or interest on certain indebtedness of the Company or a default which +results in the acceleration of any indebtedness prior to its express maturity +causes an event of default. An event of default also occurs when the Company is +in default under certain of its indebtedness. As of March 31, 2002, an Event of +Default had occurred under the terms of the Zeigler IRBs as the Company had not +paid principal or interest due nor had it made the required funding under the +debt service reserve fund (discussed below). As such, the Industrial Revenue +Bonds are classified as a current liability in the accompanying interim balance +sheets. Beginning with the four quarters ended June 30, 2000, the Company's +guarantee under the Zeigler IRBs requires the establishment of a debt service +reserve fund in an amount equal to one year's interest (approximately $10,076) +in the event the Company's fixed charge ratio, as defined, is less than 2 to 1. +Amounts in the debt service reserve fund may thereafter be returned to the +Company if the ratio is later achieved for a period of six consecutive quarters. +The Company's fixed charge ratio, as defined for the four quarters ended March +31, 2002, was below the 2 to 1 requirement. The Company has accrued, but not +paid, the required debt service reserve fund amount due. + + +See Note 2 for changes related to the Zeigler IRBs under the +Prepackaged Plan. + + +e. DIP Facility + + +The Company has a secured, super-priority credit facility from Bankers Trust +Company (Bankers Trust) with Deutsche Bank Alex. Brown (DBAB), as arranger, for +debtor-in-possession financing for an aggregate of up to $150,000. Amounts +outstanding under the DIP Facility bear interest at the Company's choice at +either a market base rate plus 2% per annum or at a market reserved adjusted +Euro-dollar rate plus 3% per annum. Fees for letters of credit issued under the +DIP Facility shall be 3.25% of the amount available for drawing under such +letters of credit. As of March 31, 2002, the interest rates and average interest +rates for the period were 4.94% and 6.57%. Additionally, the DIP Facility +provides for payment of various fees, including (i) a "commitment fee" equal to +.5% per annum of the daily average unused portion of the DIP Facility (with an +increase in such fee to .75% or 1.00% in the event that utilization of the DIP +Facility falls below certain levels): (ii) a "financing fee" of 2% of the DIP +Facility which is earned upon execution of the commitment letter and payable in +part upon the approval of the DIP Facility by the bankruptcy court and in +remaining part upon the closing of the DIP Facility; (iii) a monthly +administrative expense of $12,500. The commitment letter also permits Bankers +Trust to alter the interest rate on amounts outstanding under the DIP Facility +(subject to limitations) in aid of syndication of the DIP Facility. This loan +carries covenants similar to those of the Credit Facility described in Note 5b +above. In addition, the agreement contains default provisions whereby the +failure to pay principal or interest on certain indebtedness of the Company or a +default which permits the acceleration of certain indebtedness prior to its +express maturity or an increase in the interest rate on certain indebtedness +causes an event of default under the DIP Facility. The DIP Facility is +collateralized primarily by capital stock of most of the Company's subsidiaries, +along with all accounts receivable; inventory; property, plant and equipment; +intangibles; contract rights and other personal and real property of the Company +and most of its subsidiaries. The Company and most of its subsidiaries have +guaranteed the DIP Facility. + + +See Note 2 for additional discussion of the DIP Facility. + + +f. Kentucky Bank and Trust Loan + + +The Company has an unsecured note payable to Kentucky Bank and Trust (KB&T +Note) in the amount of $8,132. The note bears interest equal to the daily +floating prime rate as published in The Wall Street Journal (4.75% at March 31, +2002) with a maturity date of September 3, 2007. This note carries covenants +similar to those of the Credit Facility described in Note 5b above. In addition, +the agreement contains default provisions whereby the failure to pay principal +or interest on certain indebtedness of the Company or a default which permits +the acceleration of certain indebtedness prior to its express maturity or an +increase in the interest rate on certain indebtedness causes an event of default +under the KB&T Note. Because events of default have occurred, the entire +balance is classified as a current liability in the accompanying March 31, 2001 +and 2002 interim balance sheets. The KB&T Note is guaranteed by +substantially the same entities that guarantee the Credit Facility and by Larry +Addington (the majority owner of the Company) and an affiliate has pledged +assets as additional security for the note. The Company is prohibited from +making principal payments on the KB&T note prior to the earlier of June 30, +2005 or 91 business days after the satisfaction in full of all obligations under +the Credit Facility. + +6. +COMMITMENTS AND CONTINGENCIES + + +a. Legal and Regulatory Matters + + +The Company is named as defendant in various actions in the ordinary course of +its business. These actions generally involve disputes related to contract +performance, property boundaries, mining rights, blasting damages, personal +injuries and royalty payments, as well as other civil actions that could result +in additional litigation or other adversary proceedings. + + +In connection with the acquisition of the Cyprus subsidiaries, the Company +became potentially liable under a suit filed in the Circuit Court of Perry +County, Kentucky in 1996 by Joseph D. Weddington and Kentucky Land & +Exploration Company (Kentucky Land). Weddington and Kentucky Land each has +asserted claims to approximately 1,425 acres of property upon which the Company +mines coal and is claiming substantial damages. On August 30, 2001, a +third-party, Ezra C. Adair doing business as A.C.E. Development Company and +Klondike Mining, Inc., asserted claims to this property. Based on a prior +federal appellate court decision related to a similar claim, the Company +believes that it should prevail; however, the ultimate outcome remains +uncertain. + + +In April 1998, Sunny Ridge Enterprises, Inc. (Sunny Ridge), which +was purchased by a wholly-owned subsidiary of Resources in 1999, was sued in the +Circuit Court of Boyd County, Kentucky by Kentucky Electric Steel, Inc. +(Kentucky Electric), which alleged that it suffered a shut down at its steel +production facility in Boyd County as a result of the accidental smeltering of a +device containing radioactive material. Kentucky Electric alleges that the +device was contained in a shipment of scrap delivered to it by Raleigh Junk and +Cremer Iron & Metal (Raleigh Junk), which was also named in the suit. +Kentucky Electric further alleges that the device originated from a coal prep +plant owned by Sunny Ridge, which was demolished pursuant to a contract between +it and Raleigh Junk. Kentucky Electric claims that Sunny Ridge had a duty to +ensure that the scrap produced by the demolition of the prep plant was safe for +reuse, and that Sunny Ridge breached that duty by allowing a device containing +radioactive material to become commingled with the scrap. Based on Kentucky +Electric's answers to the Company's interrogatories, Kentucky Electric seeks +damages of approximately $8,000, which with accrued interest could result in +damages in excess of $10,000. The Company answered the complaint and denied any +liability. The Company also filed a cross claim against Raleigh Junk. The +Company believes that if the damages alleged by Kentucky Electric were caused by +the smelting of a device containing radioactive material, there is evidence that +the device containing radioactive material could have come from a source other +than the prep plant. The Company intends to defend this claim vigorously, and at +this time it is not possible to predict the outcome of the claim. + + +The Company is involved in three actions relating to claims asserted by and +against American Electric Power and its affiliates (together AEP). On September +21, 2001, AEP filed suit against the Company in the U.S. District Court for the +Southern District of Ohio. On September 24, 2001, AEP filed suit against the +Company in the Court of Common Pleas of Franklin County, Ohio. On September 26, +2001, the Company filed a related action against AEP in Boyd Circuit Court in +Boyd County, Kentucky. In each action, AEP alleges similar claims that the +Company breached certain coal supply agreements by refusing to ship coal as +required under those agreements. The Company believes that any such failures are +excused as a result of force majeure, failure of a mutual assumption of the +contract, duress, commercial impracticability and, in some cases, fraud in the +inducement of the agreements involved. Moreover, the Company has alleged that +AEP and its affiliates materially breached the agreements by systemically +under-reporting the weights and quality of shipments received from the Company, +and by paying substantially less than the amount due under the terms of the +various agreements. The actions filed by AEP seek to recover the value to AEP of +the agreements at issue, which value is subject to fluctuations in coal prices +but could be in excess of tens of millions of dollars. The Company's action +seeks a declaration that its obligations were excused on the various grounds +discussed above and seeks damages in a comparable amount for the underpayments +by AEP of those contracts and based upon tort law theories. For the years 2001 +through 2011, the minimum and maximum aggregate amounts of coal to be delivered +under the AEP contracts are approximately 5.1 million tons and 7.4 million tons, +respectively. The average base price of the coal to be delivered under the AEP +contracts is $24.75 per ton in 2001 and $25.40 in 2002. The Company plans to +vigorously defend against AEP's claims against it and to vigorously pursue its +claims against AEP. The ultimate outcome of this matter is uncertain; however, +the Company may experience a material adverse effect in the event of an +unfavorable outcome. + + +One of the Company's customers has claimed, in a letter to the Company, that it +has suffered damages in excess of $10,000 resulting from the Company's failure +to fulfill its tonnage obligations under the customer's coal supply agreement. +No legal proceedings have been instigated by the customer at this time. The +Company does not believe it is in default under the coal supply agreement and +intends to vigorously defend this claim. At this time, it is not possible to +predict the outcome of the claim. + + +The Company temporarily halted surface mining operations at certain sites in +West Virginia after a ruling by U.S. District Judge Charles Haden on October 20, +1999. Haden's ruling restricted placement of valley fills near intermittent and +perennial streams via a reinterpretation of the Surface Mining Control and +Reclamation Act and the Clean Water Act. The West Virginia Division of +Environmental Protection (DEP) began denying new permits as well as forbidding +further advance under existing permits affected by Haden's ruling. Haden stayed +his ruling on October 29, 1999, and the DEP rescinded its orders on November 1, +1999 pending a decision from the Court of Appeals or congressional override. The +Company resumed its operations at these sites, pending a decision from the Court +of Appeals. On April 24, 2001, the Fourth Circuit Court of Appeals set aside +Judge Haden's injunction on sovereign immunity grounds and remanded the case to +the District Court with instructions to dismiss the action without prejudice to +the plaintiffs' ability to pursue their claims in state court. On July 13, 2001, +the Fourth Circuit denied a petition for rehearing en banc. The plaintiffs filed +a petition for certiorari with the U.S. Supreme Court, which was +denied. + + +On August 21, 2001, a Kentucky-based environmental interest group filed suit in +U.S. District Court in West Virginia seeking, among other things, an injunction +prohibiting the issuance of permits by the U.S. Army Corps of Engineers (Corps) +for valley fills affecting "waters of the United States" under Section 404 of +the Clean Water Act. The case was assigned to Judge Charles Haden. The Company +filed a Motion to Intervene as Defendant in that action on November 21, 2001, in +order to defend the Company's interest in the continuation of valley fill +permitting by the Corps. The Company's Motion to Intervene was granted by Judge +Haden on December 4, 2001. On May 8, 2002, the Court granted the Plaintiff's +motion for summary judgment on the first count of Plaintiff's complaint. The +Court enjoined the Corps from "issuing any further Section 404 permits that have +no primary purpose or use but the disposal of waste," and in particular, +enjoined the issuance of "mountaintop removal overburden valley fill permits +solely for waste disposal under Section 404." The geographic jurisdiction of the +Corps' Huntington (WV) District, which is subject to the Court's injunction, +includes more than half of West Virginia, portions of eastern Kentucky and +western Virginia, roughly half of Ohio, and a small area of North Carolina. The +Company has substantial operations in this area. The ultimate outcome of this +matter is uncertain; however, if Judge Haden's ruling is not stayed or +overturned on appeal, the Company may experience a material adverse effect in +the event of an unfavorable outcome. While the final resolution of any matter +may have an impact on the Company's financial results for a particular reporting +period, management believes that the ultimate disposition of these matters will +not have a materially adverse effect upon the financial position or results of +operations of the Company. However, the final resolution of a legal contingency +may have an adverse effect on the Company's liquidity. + + +b. Commissions + + +The Company has various sales and agency agreements with third +parties, whereby the Company pays a $.10 - $.65 per ton commission on various +coal sales agreements. The costs are expensed as the coal is delivered. + + +c. Environmental Matters + + +Based upon current knowledge, the Company believes that it is in material +compliance with environmental laws and regulations as currently promulgated. +However, the exact nature of environmental control problems, if any, which the +Company may encounter in the future cannot be predicted, primarily because of +the increasing number, complexity and changing character of environmental +requirements that may be enacted by federal and state authorities. + + +d. Performance Bonds + + +The Company has outstanding performance bonds of approximately +$713,378 as of March 31, 2002, to secure reclamation, workers compensation +and other performance commitments. + + +e. Employment Agreements + + +The Company has entered into employment agreements with +individuals for various officer positions. These agreements expire through +February 2005 and contain termination benefits and other matters. + + +f. Collective Bargaining Agreements + + +Approximately 35% of the Company's coal employees are affiliated +with unions. The Company has several collective bargaining agreements with the +United Mine Workers of America (UMWA). These agreements expire through +2006. + + +g. Indemnifications and Other + + +Pursuant to various stock and asset purchase and sales agreements +with counterparties, the Company has granted indemnification for performance +guarantees and other matters made by such parties relating to mineral lease +obligations, income taxes, and employee benefits. The Company believes no +significant obligation will result relating to such indemnifications. + + +Pursuant to the purchase agreement for the Cyprus Subsidiaries, +the Company has committed to pay Cyprus up to $25,000 in satisfaction of its +royalty obligations in the event the Company receives an equity investment of +$75,000 or more. + + +h. Contract Mining Agreements + + +The Company performs contract mining services for various third parties and +utilizes contract miners on some of its operations. Terms of the agreements +generally allow either party to terminate the agreements with sufficient written +notification on a short-term basis. + + +i. Black Lung Legislation + + +New regulations proposed by the U.S. Department of Labor (DOL) and amending the +existing regulations of the Federal Black Lung program in place since 1982 went +into effect briefly on January 19, 2001. Implementation of the new regulations +were quickly stayed by an agreement with DOL before the Federal District Court +for the District of Columbia, pending the Court's response to an application by +the coal and insurance industries for a permanent injunction against the use of +the new regulations. The Federal District Court issued a decision on August 9, +2001 which granted no relief on any of the multiple requests made to stay +specific parts of the regulations. The new regulations thus went into effect and +claims are currently being administered under them, pending the outcome of an +appeal to the U.S. Court of Appeals for the D.C. Circuit. A decision on the +appeal is expected sometime after the oral arguments scheduled for April of +2002. The new regulations, among other things, establish a presumption in favor +of a claimant's treating physician and limit a coal operator's ability to +introduce medical evidence regarding the claimant's medical condition. DOL, in +testimony and in various pleadings, maintains that the approval rate under the +new regulations will not exceed the historic approval rate of claims not +assigned to individual coal operations (Trust Fund Claims), which is +approximately 13%. The Company and its predecessor companies experienced less +than a 3% approval rate during the period 1982 - 2000 under the old regulations. +The Company believes that it will experience a lower approval rate under the new +regulations than the national average. Although the DOL has not processed a +sufficient number of claims to a high enough level of adjudication to measure +the actual activity under the new regulations meaningfully, the new regulations +could result in the Company incurring significantly increased costs associated +with contesting and paying Black Lung claims. + + +j. Stock Warrants and Options + + +In connection with amending its Credit Facility (discussed in Note +5b), on June 15, 2000, the Company issued warrants to lenders enabling them to +purchase 10% of its common stock for $.01 per share. The warrants contain +anti-dilution provisions, piggyback registration rights and tag-along sale +rights and are freely transferable. The warrants contain holder put rights (Put) +commencing June 15, 2001 and expiring June 15, 2010. The purchase price for such +Put is the fair market value of such warrant, determined by formula or +appraisal. The warrants also contain Company call rights (Call) commencing three +years after any payment, maturity, acceleration, refinancing or restructuring of +all the Credit Facility and expiring June 15, 2010. The purchase price for a +Call is 110% for that of a Put. In addition, if within one year after the +exercise of a Call, the Company is sold or has a "liquidating transaction", as +defined, then the Company shall pay to the warrant holder any additional amount +they would have received if the purchase price of the Call had been determined +in connection with such liquidating transaction. No value has been assigned to +these warrants as it is considered negligible. The Prepackaged Plan (Note 2) +will cause the warrants to be relinquished. + + +In January 2002, all shares of common stock, except those already held by +Addington Enterprises, Inc., Robert Addington or Larry Addington, were +transferred to Larry Addington. No consideration was given for the shares. +Additionally, all outstanding stock options have been canceled with no +consideration to the option holders. No accounting entries were recorded as the +value for the shares and options was considered negligible. + + +k. Coal Settlement Agreement + + +Through March 31, 2002, the Company is in arrears in delivering +coal under a certain coal supply contract with a customer. Pursuant to a +settlement agreement with the customer, the Company will prospectively ship the +tons in arrears and is subject to damage payments up to $3,200 in the event of +non-shipment. + +7. +NEW ACCOUNTING STANDARDS + + +In September 2001, the staff of the Financial Accounting Standards Board (FASB) +cleared SFAS No. 133 Implementation Issue Number C16 (C16), which relates to +scope exceptions in applying the normal purchases and sales exception for +commodity contracts that contain volumetric variability or optionality under +paragraph 10b of SFAS No. 133. C16 is effective for the Company on April 1, +2002. The Company does not believe adoption of C16 will have an effect on the +Company. The Company believes its coal contracts with volumetric variability or +optionality are exempted out of SFAS No. 133, because they fail to meet the net +settlement criteria of SFAS No. 133, which would preclude such contracts from +being considered derivatives. + + +In June 2001, the FASB issued SFAS No. 141, "Business +Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. +141 eliminates the pooling-of-interests method and requires all business +combinations initiated after June 30, 2001 to be accounted for using the +purchase method. It also requires intangible assets acquired in a business +combination to be recognized separately from goodwill. SFAS No. 141 has had no +impact on the Company's financial position or results as the Company has not +entered into any business combination transactions since June 30, 2001. + + +The Company adopted SFAS No. 142, which addresses how goodwill and other +intangible assets should be accounted for upon their acquisition and afterwards, +on January 1, 2002. The adoption of SFAS No. 142 has had no impact on the +Company's financial position or results because the Company does not have +recorded goodwill or intangible assets. Premiums paid in prior acquisitions have +been allocated to mineral reserves and are amortized as the coal is mined. The +primary impact on the Company of SFAS No. 141 and SFAS No. 142 will be their +applications under fresh start accounting pursuant to SOP 90-7 upon emerging +from bankruptcy (Note 2). Upon emergence, SFAS No. 141 will require the +allocation of the Company's value (as well as purchase price of any future +business combinations) to the fair value of net assets (or net assets acquired), +including reorganization value (goodwill) and other identified intangible +assets. SFAS No. 142 will require that future goodwill (reorganization value) +and intangible assets with indefinite lives not be amortized. Instead of +amortization, goodwill will be subject to an assessment for impairment by +applying a fair-value-based test annually and more frequently if circumstances +indicate a possible impairment. If the carrying amount of goodwill exceeds the +fair value of that goodwill, an impairment loss is recognized in an amount equal +to the excess. + + +In +June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement +Obligation" which addresses asset retirement obligations that result from +the acquisition, construction or normal operation of long-lived assets. It +requires companies to recognize asset retirement obligations as a liability when +the liability is incurred at its fair value. The adoption of SFAS No. 143 will +affect the Company's recording of reclamation and closure obligations and +disclosure requirements. Currently, the Company records the full (undiscounted) +liability for end-of-mine reclamation obligations of all acquired mines in +current dollars. Developed mines accrue at a rate per ton over its active life +to the end-of-mine obligation. SFAS No. 143 will require the Company to cease +the per-ton accrual approach and to discount all end-of-mine obligations to +their fair values. The future accretion of the discounted obligation will be +recorded to cost of operations. The Company is currently analyzing the impact of +this Statement, which is required to be adopted January 1, 2003; however, +pursuant to SOP 90-7, the Company will early adopt SFAS No. 143 upon fresh start +accounting. + + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the +Impairment or Disposal of Long-Lived Assets", which is required to be adopted +January 1, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the +Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and +APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a +Business, and Extraordinary, Unusual and Infrequently Occurring Events and +Transactions" and combines the two accounting models into a single model based +on the framework established in SFAS No. 121. Effects of adopting SFAS No. 144 +on January 1, 2002 have had no material impact on the earnings and financial +position of the Company. + +8. +BONDING RESOLUTION + + +Frontier Insurance Company (Frontier), the Company's prior +principal bonding company, provided over $533,000 of surety bonds to the Company +as of the period ended December 31, 2001, approximately $360,000 of which were +surety bonds for reclamation obligations and $66,000 of which were for workers +compensation obligations. Frontier began experiencing financial problems in +1999, and as a result, its financial rating was delisted by the U.S. Department +of Treasury. Frontier instituted rehabilitation proceedings in New York in +August 2001. In 2000, in response to Frontier's financial problems, the states +in which the Company has mining operations began requiring the Company to obtain +costly replacement bonds and to post 100% cash collateral to back those bonds. +As a result, the Company was required to provide cash collateral of +approximately $8,400 during 2000 and $55,600 during 2001. In March 2002, as part +of its pre-packaged bankruptcy process, the Company obtained funding to replace +its reclamation and workers compensation bonds previously provided by Frontier. + + +The $150,000 DIP financing (Note 2) allowed the Company to resolve +bonding issues and continue operating without interruption. New bonds were +issued in March 2002 from other sureties pursuant to agreements with them which +included DIP financing cash and letter of credit support. As these new bonds are +accepted, the Company has received and will continue to receive releases of the +old Frontier bonds from the states. Some Frontier reclamation bonds securing +(a) permits pending transfer to unrelated parties, and permits pending +final release from the state will remain outstanding and (b) the remaining +Frontier bonds securing workers' compensation obligations of approximately +$18,000, which have not been required to be replaced, will remain outstanding. +In addition to the Frontier bonds, the Company has approximately $42,000 in +letters of credit securing workers' compensation obligations. In addition to the +reclamation and workers' compensation bonds issued by Frontier, described above, +the Company has approximately $107,000 of other bonds issued by Frontier +securing miscellaneous obligations. The Company has not been required to replace +these bonds and they remain outstanding. Management believes it will have the +resources necessary to obtain or replace, as necessary, surety bonds through +2002. + +9. +OTHER SUBSIDIARY MATTERS + + +a. Employee Benefits Management, Inc. + + +Employee +Benefits Management, Inc. (EBMI), a subsidiary of the Company, has outstanding +1,000 shares of Class A common stock (999 shares owned indirectly by +Fairview Land Company (a subsidiary of the Company), one share owned by +Enterprises (an affiliate)) and 176 shares of redeemable Class B common +stock. The Class B common stock was repurchased from a third-party by the +Company for $525 in October 2001. + + +In January 2002, Fairview Land Company acquired from Enterprises +the one outstanding share of Class A common stock it did not already hold, +thereby making EBMI a wholly-owned indirect subsidiary. + + +b. Employee Claims Administration, LLC + + +Employee Claims Administration, LLC (ECA), an indirect subsidiary of the +Company, has outstanding Class A and Class B membership units, representing +1,000 Class A and 205 Class B membership units. In January 2002, Resources +purchased the 50 Class A membership units not already owned by subsidiaries of +the Company. The Class A and Class B membership units are owned by several +subsidiaries of the Company. As a result of the Class A repurchase, ECA is a +wholly-owned subsidiary. + +10. +PARENT AND SUBSIDIARY GUARANTEES + + +The following tables summarize the financial +position, operating results and cash flows for AEI Resources Holding, Inc., +Resources and its guarantor, and non-guarantor subsidiaries regarding the Senior +Notes and Subordinated Notes (Note 5c) as of March 31, 2002 and December +31, 2001 and for the three months in the period ended March 31, 2002 and 2001. +Each of the guarantor subsidiaries (except EBMI and ECA until January 2002 + Note 9) is a wholly-owned subsidiary of Resources and each has fully and +unconditionally guaranteed the Senior Notes and Subordinated Notes on a joint +and several basis. Separate financial statements and other disclosures +concerning Resources and the guarantor subsidiaries are not presented because +the Company has determined that they are not material to investors. Yankeetown +Dock Corporation (60% owned by the Company until sold June 29, 2001) was the +only domestic, majority-owned, non-guarantor subsidiary. + + AEI Wholly-Owned + Resources AEI Guarantor Combining + Holding Resources Subsidiaries Adjustments Total + -------------- ------------- ------------- -------------- -------------- + +March 31, 2002 +Balance Sheet: +Total current assets.............. $ - $ 197,730 $ 132,420 $ (38,084) $ 292,066 +Properties, net................... - 14,238 1,524,150 - 1,538,388 +Other assets...................... (787,318) 623,209 1,632,267 (1,230,618) 237,540 + -------------- ------------- ------------- -------------- -------------- + Total assets.................. $ (787,318) $ 835,177 $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Liabilities Not Subject to + Compromise +Total current liabilities + including current portion of + long-term debt and capital + leases.......................... $ - $ 1,040,828 $ 162,158 $ 87,519 $ 1,290,505 +Long-Term debt and capital + leases, less current Portion... - 60,685 81,846 4,668 + (137,863) +Other liabilities................. - 84,947 878,344 - 963,291 + -------------- ------------- ------------- -------------- -------------- + Total liabilities not subject + to compromise............... - 1,186,460 1,122,348 (50,344) 2,258,464 + -------------- ------------- ------------- -------------- -------------- +Liabilities Subject to Compromise. - 436,255 408,770 (248,177) 596,848 + -------------- ------------- ------------- -------------- -------------- + Total liabilities............. - 1,622,715 1,531,118 (298,521) 2,855,312 + -------------- ------------- ------------- -------------- -------------- +Total Stockholders' equity +(deficit)......................... (787,318) (787,538) 1,757,719 (970,181) (787,318) + -------------- ------------- ------------- -------------- -------------- +Total liabilities and + stockholders' equity (deficit). $ (787,318) $ (835,177) $ 3,288,837 $ (1,268,702) $ 2,067,994 + ============== ============= ============= ============== ============== +Operating Results: +Revenues.......................... $ - $ 246 $ 316,250 $ - $ 316,496 +Costs and expenses................ - 4,237 324,654 - 328,891 + -------------- ------------- ------------- -------------- -------------- + Income (loss) from operations. - (3,991) (8,404) - (12,395) +Interest and other income +(expense)......................... - (38,875) (423) 5,137 (34,161) + -------------- ------------- ------------- -------------- -------------- + Income (loss) before + reorganization items and + income taxes ............... - (42,866) (8,827) 5,137 (46,556) +Professional fees related to + reorganization.................. - 2,084 - - 2,084 + -------------- ------------- ------------- -------------- -------------- + Income (loss) before income + taxes ...................... - (44,950) (8,827) 5,137 (48,640) + -------------- ------------- ------------- -------------- -------------- +Income tax provision.............. - 1,310 344 - 1,654 + -------------- ------------- ------------- -------------- -------------- + Net income (loss)............. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) + ============== ============= ============= ============== ============== + +Cash Flows: +Cash flows from operating +activities: +Net income (loss)................. $ - $ (46,260) $ (9,171) $ 5,137 $ (50,294) +Total adjustments to reconcile + net income (loss) to net cash + provided by (used in) + operating activities........... - 38,498 29,559 (5,137) 62,920 + -------------- ------------- ------------- -------------- -------------- +Net cash provided from (used in) + operating activities........... - (7,762) 20,388 - 12,626 +Net cash used in investing +activities........................ - (79,516) (23,654) - (103,170) +Net cash provided by (used in) +financing activities.............. - 50,065 (1,809) - 48,256 + -------------- ------------- ------------- -------------- -------------- +Net increase (decrease) in cash + and cash equivalents........... - (37,213) (5,075) - (42,288) +Cash and cash equivalents, + beginning of period............ 220 62,457 (40,532) 40,070 62,215 + -------------- ------------- ------------- -------------- -------------- +Cash and cash equivalents, end of +period............................ $ 220 $ 25,244 $ (45,607) $ 40,070 $ 19,927 + ============== ============= ============= ============== ============== + + Non-Wholly + AEI Wholly-Owned Owned + Resources AEI Guarantor Guarantor Non-Guarantor Combining + Holding Resources Subsidiaries Subsidiaries Subsidiary Adjustments Total + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + +December 31, 2001: +Balance Sheet: +Total current assets..... $ - $ 136,446 $ 334,044 $ 14,464 $ - $ (173,688) $ 311,266 +Properties, net.......... - 15,841 1,571,489 - - - 1,587,330 +Other assets............. (737,024) 655,741 2,084,719 669,749 - (2,511,611) 161,574 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total assets........... $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +Total current + liabilities, including + current portion of + long-term debt and + capital leases......... $ - $ 1,400,301 $ 718,951 $ 35,750 $ - $ (329,710) $ 1,825,292 + +Long-term debt and + capital leases, less + current portion........ - 55,284 517,054 - - (567,106) 5,232 +Other liabilities........ - 89,687 1,046,822 663,021 - (832,860) 966,670 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Total liabilities...... - 1,545,272 2,282,827 698,771 - (1,729,676) 2,797,194 + +Total shareholders' + equity (deficit)....... (737,024) (737,244) 1,707,425 (14,558) - (955,623) (737,024) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Total liabilities and + shareholders' equity + (deficit).............. $ (737,024) $ 808,028 $ 3,990,252 $ 684,213 $ - $ (2,685,299) $ 2,060,170 + ============ ============ ============== ============ =========== ============= ============ +March 31, 2001 +Operating Results: +Revenues................. $ - $ 245 $ 355,658 $ - $ 142 $ - $ 356,045 +Costs and expenses....... - 13,164 350,375 10,059 164 - 373,762 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Income (loss) from + operations............. - (12,919) 5,283 (10,059) (22) - (17,717) +Interest and other + income (expense)....... - (43,057) (15,008) 8,233 - 7,017 (42,815) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Income (loss) before + income taxes......... - (55,976) (9,725) (1,826) (22) 7,017 (60,532) +Income tax provision + (benefit).............. - (113) 611 (633) (6) - (141) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ + Net Income (loss)...... $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) + ============ ============ ============== ============ =========== ============= ============ + +Cash Flows: +Cash flows from +operating activities: +Net income (loss)........ $ - $ (55,863) $ (10,336) $ (1,193) $ (16) $ 7,017 $ (60,391) +Total adjustments to + reconcile net income + (loss) to net cash + provided by (used in) + operating activities... - 47,695 30,044 1,191 (443) (7,017) 71,470 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net cash provided by + (used in) operating + activities............. - (8,168) 19,708 (2) (459) - 11,079 +Net cash used in + investing activities... - (146) (15,452) - - - (15,598) +Net cash provided by + financing activities... - (19,272) (1,941) - - - (21,213) + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Net increase (decrease) + in cash and cash + equivalents............ - (27,586) 2,315 (2) (459) - (25,732) +Cash and cash + equivalents, beginning + of period.............. 220 56,742 (45,871) 4 3,598 40,070 54,763 + ------------ ------------ -------------- ------------ ----------- ------------- ------------ +Cash and cash + equivalents, end of + period................. $ 220 $ 29,156 $ (43,556) $ 2 $ 3,139 $ 40,070 $ 29,031 + ============ ============ ============== ============ =========== ============= ============ + +======================================================= ================================================ + No dealer, salesperson or other person is +authorized to give any information or to represent +anything not contained in this prospectus. You must +not rely on any unauthorized information or +representations. This prospectus does not offer to +sell or ask for offers to buy any securities other +than those to which this prospectus relates and it +does not constitute an offer to sell or ask for offers +to buy any of the securities in any jurisdiction where +it is unlawful, where the person making the offer is +not qualified to do so, or to any person who cannot +legally be offered the securities. The information $450,000,000 +contained in this prospectus is current only as of its +date. + + TABLE OF CONTENTS Horizon NR, LLC and + Horizon Finance Corp. +Prospectus Summary.................................. +Risk Factors........................................ wholly owned subsidiaries of +Forward-Looking Statements.......................... Horizon Natural Resources Company +Use of Proceeds..................................... +Other Offerings..................................... +Capitalization...................................... 11.75% Senior Secured Notes due 2009 +Selected Consolidated Financial Data................ +Pro Form Financial Data............................. +Chapter 11 Reorganization........................... +Management's Discussion and Analysis of Financial + Condition and Results of Operations.............. _____________ +The Coal Industry................................... +Business............................................ +Government Regulation............................... [Logo] +Management.......................................... +Executive Compensation.............................. +Selling Securityholders............................. _____________ +Transactions with Former Controlling Stockholder + and Related Persons.............................. +Description of Senior Secured Notes................. +Description of Other Indebtedness................... +Description of Capital Stock........................ +Principal Equityholders............................. Prospectus +Plan of Distribution................................ +Legal Matters....................................... __________, 2002 +Experts............................................. +Where You Can Find More Information................. +Index to Financial Statements....................F-1 +======================================================= ================================================ + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the expenses payable by Horizon Natural Resources +Company in connection with this registration statement. All of such expenses are +estimates, other than the filing and quotation fees payable to the Securities +and Exchange Commission. + +Filing fee - Securities and Exchange Commission.......................$41,400.00 +Fees and expenses of legal counsel....................................$* +Printing expenses.....................................................$* +Fees and expenses of accountants......................................$* +Miscellaneous expenses................................................$* + Total............................................................$* + +_________________________ + +* To be filed by amendment. + + +All of the amounts shown are estimates except for the filing fee payable to the +Securities and Exchange Commission. + +Item 14. Indemnification of Directors and +Officers + + +Section 145 of the General Corporation Law of Delaware, or GCL, empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action, suit or proceeding, +whether civil, criminal, administrative or investigative (other than an action +by or in the right of the corporation) by reason of the fact that he or she was +or is a director, officer, employee or agent of the corporation, or was or is +serving at the request of the corporation as a director, officer, employee or +agent of another corporation or other enterprise against expenses (including +attorneys' fees), judgments, fines and amounts paid in settlement actually and +reasonably incurred in connection with such action, suit or proceeding if the +person identified acted in good faith and in a manner he or she reasonably +believed to be in or not opposed to the best interests of the corporation, and, +with respect to any criminal action or proceeding, had no reasonable cause to +believe his or her conduct was unlawful. Section 145 further empowers a +corporation to indemnify any person who was or is a party or is threatened to be +made a party to any threatened, pending or completed action or suit by or in the +right of the corporation to procure a judgment in its favor by reason of the +fact that he or she was or is a director, officer, employee or agent of the +corporation, or was or is serving at the request of the corporation as a +director, officer, employee or agent of another corporation or other enterprise +against expenses (including attorneys' fees) actually and reasonably incurred in +connection with the defense or settlement of such action or suit if the person +identified acted in good faith and in a manner he or she reasonably believed to +be in or not opposed to the best interests of the corporation, except that no +indemnification may be made in respect of any claim, issue or matter as to which +such person shall have been adjudged to be liable to the corporation unless and +only to the extent that the court in which such action or suit was brought shall +determine that despite the adjudication of liability such person is fairly and +reasonably entitled to indemnity for such expenses that the court shall deem +proper. Section 145 further provides that to the extent a director or officer of +a corporation has been successful in the defense of any action, suit or +proceeding referred to above or in the defense of any claim, issue or matter +therein, he or she shall be indemnified against expenses (including attorneys' +fees) actually and reasonably incurred by him or her in connection therewith. +The statute provides that indemnification pursuant to its provisions is not +exclusive of other rights of indemnification to which a person may be entitled +under any bylaw, agreement, vote of stockholders or disinterested directors or +otherwise. + + +Our Amended and Restated Certificate of Incorporation and Amended and Restated +Bylaws, provide, in effect, that to the full extent and under the circumstances +permitted by Section 145 of the GCL, we shall indemnify any person who was or is +a party or is threatened to be made a party to any action, suit or proceeding of +the type described above by reason of the fact that he or she was or is a +director, officer, employee or agent of our company. + + +Our Certificate of Incorporation relieves our directors from monetary damages to +our company or our stockholders for breach of such director's fiduciary duty as +a director to the fullest extent permitted by the GCL. Under Section 102(b)(7) +of the GCL, a corporation may relieve its directors from personal liability to +such corporation or its stockholders for monetary damages for any breach of +their fiduciary duty as directors except (i) for any breach of the director's +duty of loyalty to our company or our stockholders, (ii) for acts or omissions +not in good faith or which involve intentional misconduct or knowing violation +of law, (iii) under Section 174 of the GCL or (iv) for any transaction from +which the director derived an improper personal benefit. + + +In addition, we carry an insurance policy for the protection of our directors +and executive officers against any liability asserted against them in their +official capacities. + +Item 15. Recent Sales of Unregistered +Securities + + +Effective May 9, 2002, all of our issued securities were cancelled by order of +the U.S. Bankruptcy Court and our company, in furtherance of our bankruptcy plan +of reorganization, issued new securities as follows: (i) 20,000,000 shares of +our common stock in consideration for the cancellation of approximately $597 +million in claims; and (ii) $450 million in new 11.75% senior notes in +consideration for the cancellation of approximately $450 million in claims. The +foregoing issuances and sales were conducted without registration of the +securities under the Securities Act of 1933, as amended, in reliance upon the +exemption from registration afforded by Section 1145(a)(2) of the Bankruptcy +Code. Section 1145(a)(1) of the U.S. Bankruptcy Code exempts the offer and sale +of securities under a plan of reorganization from registration under the +Securities Act and state laws if: (i) the securities are offered and sold under +a plan of reorganization; (ii) the securities are of a debtor, of an affiliate +participating in a joint plan with the debtor, or of a successor to the debtor +under the plan; and (iii) the recipients of the securities are issued such +securities entirely in exchange for the recipient's claim against or interest in +the debtor or principally in such exchange and partly for cash or +property. + +Item 16. Exhibits and Financial Statement +Schedules + + +(a) Exhibits + + +The exhibits to the Registration Statement are listed in the Exhibit Index which +precedes the exhibits to this Registration Statement and is hereby incorporated +herein by reference. + + +(b) Financial Statement Schedules + + +All schedules are omitted because the information required to be set forth +therein is not applicable or is contained in the Financial Statements or +Notes. + +Item 17. Undertakings + + +Insofar as indemnification for liabilities arising under the Securities Act 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 Commission, such indemnification is against +public policy as expressed in the Securities Act 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 Securities Act and will be governed by the final +adjudication of such issue. + + +The undersigned Registrant hereby undertakes: + + +(1) To file, during any period in which offers or sales are being made, a +post-effective amendment to this Registration Statement: + + +(i) +to include any prospectus required by Section 10(a)(3) of the Securities Act of +1933; + + +(ii) +to reflect in the prospectus any facts or events arising after the effective +date of the Registration Statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change +in the information in the Registration Statement. To reflect in the prospectus +any facts or events arising after the effective date of the Registration +Statement (or the most recent post-effective amendment thereof) which, +individually or in the aggregate, represent a fundamental change in the +information set forth in the Registration Statement. Notwithstanding the +foregoing, any increase or decrease in volume of securities offered (if the +total dollar value of securities offered would not exceed that which was +registered) and any deviation from the low or high end of the estimated maximum +offering range may be reflected in the form of prospectus filed with the +Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume +and price represent no more than a 20% change in the maximum aggregate offering +price set forth in the " \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001095901_veridian_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001095901_veridian_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a13765e6764bc7676bfd1f2f94b083a7378774e7 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001095901_veridian_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS" --> LEGAL MATTERS The validity of the shares of common stock issued in this offering will be passed upon for us by the law firm of Andrews Kurth L.L.P., Houston, Texas. Cravath, Swaine Moore, New York, New York has represented the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001103415_paypal-inc_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001103415_paypal-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3e324ffee136b67b1352495f651b06cf8bcb7eb --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001103415_paypal-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Latham & Watkins, Menlo Park, California. Various legal matters relating to the offering will be passed upon for the underwriters by Davis Polk & Wardwell, Menlo Park, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001106737_intacta_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001106737_intacta_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..dac152937f7f60896543f45e0de392a665979458 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001106737_intacta_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the common stock offered in the prospectus has been passed upon for Intacta by McDonald Carano Wilson McCune Bergin Frankovich & Hicks, LLP, Reno, Nevada. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001126424_innovative_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001126424_innovative_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f4e1fb6835cfe931a89cae8127b3d9877ea5941d --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001126424_innovative_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered will be passed upon for us by Brobeck, Phleger & Harrison LLP, New York, New York. The validity of the common stock offered will be passed upon for the underwriters by Pillsbury Winthrop LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001128441_partners_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001128441_partners_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2a7b4024231384540067b68711e6c0f7796113c4 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001128441_partners_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby has been passed upon for us by Greenbaum, Rowe, Smith, Ravin, Davis & Himmel LLP, Woodbridge, New Jersey. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001129425_zymogeneti_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001129425_zymogeneti_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9040f820fd740a45cc7f98211a0e2c8fe79ee347 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001129425_zymogeneti_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS ZymoGenetics is being represented by Perkins Coie LLP, Seattle, Washington. The underwriters are being represented by Latham & Watkins, Menlo Park, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001129446_agere_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001129446_agere_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4c62da0b00df3e5a991a071d8663f60eaeeeb54d --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001129446_agere_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes and put rights offered hereby will be passed upon for us by Cravath, Swaine & Moore, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001129623_odyssey_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001129623_odyssey_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a32117569c6390002d25702a5aa8c1853fcc5431 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001129623_odyssey_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Vinson & Elkins L.L.P., Dallas, Texas. Debevoise & Plimpton, New York, New York, has acted as counsel for the underwriters with regard to certain legal matters in connection with the offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001132327_instinet_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001132327_instinet_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..92bb9d67acb0190a4c9744acff5070ec8cd7b488 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001132327_instinet_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock being offered by us will be passed upon for us by Cleary, Gottlieb, Steen & Hamilton, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001134538_accenture_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001134538_accenture_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e83de51cec5cc1862649711a5e5ae5476c672f31 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001134538_accenture_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Appleby Spurling & Kempe, Bermuda, will pass upon the validity of the Class A common shares offered by this prospectus. Mello Jones & Martin, Bermuda, will pass upon the validity of the Class A common shares for the underwriters. Certain legal matters will be passed upon for us by Simpson Thacher & Bartlett as to matters of United States and New York law. The underwriters are being represented as to United States legal matters by Latham & Watkins. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001137861_wright_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001137861_wright_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1083ad416bf1cefdfa9ded7c1e355e32a2fd1f82 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001137861_wright_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters Willkie Farr & Gallagher, New York, New York will pass on the validity of the common stock offered by this prospectus for us and the Selling Stockholders. Milbank, Tweed, Hadley & McCloy LLP, New York, New York will pass on legal matters relating to the offering for the underwriters. Willkie Farr & Gallagher has in the past performed, and may continue to perform, legal services for us and Warburg Pincus, our principal stockholder. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001138951_leapfrog_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001138951_leapfrog_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..55c1e08a3f9f232aa655398be316fa44854a4524 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001138951_leapfrog_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Cooley Godward LLP, San Francisco, California, will pass upon the validity of the shares of Class A common stock being offered hereby for us. Shearman & Sterling, San Francisco, California, will pass upon certain legal matters in connection with this offering for the underwriters. Certain partners and employees of Cooley Godward are members of FrogPond, LLC, which holds 5,487,805 shares of our Class B common stock and a warrant to purchase an additional 1,800,000 shares of our Class B common stock. As of the date of this prospectus, such partners' and employees' interest in FrogPond, including shares that may be purchased under the warrant, corresponds to fewer than 225,000 shares of our Class B common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001143363_serco_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001143363_serco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a899f0d340fd9260ac689d09cb4652e6d05222a6 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001143363_serco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock we are offering by this prospectus will be passed upon for us by Shaw Pittman LLP, a limited liability partnership including professional corporations, McLean, Virginia. Sidley Austin Brown & Wood LLP, San Francisco, California will act as counsel to the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001144331_expressjet_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001144331_expressjet_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..bd988df6f2c5b03a6dff071c4e02a4e926090c9d --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001144331_expressjet_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered by this prospectus will be passed on for us by Vinson & Elkins L.L.P., Houston, Texas. Certain legal matters relating to our common stock offered by this prospectus will be passed on for the underwriters by Cleary, Gottlieb, Steen & Hamilton, New York, New York. From time to time, each of these firms has performed and continues to perform legal services unrelated to this offering for Continental Airlines, and Vinson & Elkins L.L.P. has represented Continental Airlines in connection with the negotiation of the agreements described under the heading "Our Agreements with Continental Airlines" and other matters related to this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001157644_gamestop_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001157644_gamestop_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..bf2ad7e250dc9f8fb2da2f8df11b71738f0b58b5 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001157644_gamestop_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of Class A common stock offered hereby will be passed upon for us by Robinson Silverman Pearce Aronsohn & Berman LLP, 1290 Avenue of the Americas, New York, New York 10104, and for the underwriters by Mayer, Brown, Rowe & Maw, 190 South LaSalle Street, Chicago, Illinois 60603. Michael N. Rosen, the Chairman of Robinson Silverman Pearce Aronsohn & Berman LLP, is our Secretary and a director. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001158833_life_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001158833_life_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3ca8747ff475f89610b24b8509dadad3d29d5429 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001158833_life_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the LSR Voting Common Stock offered by this document will be passed on by Ballard Spahr Andrew & Ingersoll, LLP, 300 East Lombard Street, Baltimore, Maryland 21202, special counsel to LSR. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161080_vhs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161080_vhs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161080_vhs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161082_vhs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161082_vhs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161082_vhs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161083_vhs-of_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161083_vhs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161083_vhs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161088_vhs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161088_vhs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161088_vhs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161093_anaheim_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161093_anaheim_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161093_anaheim_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161094_huntington_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161094_huntington_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161094_huntington_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161095_vhs-of_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161095_vhs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161095_vhs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161097_macneal_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161097_macneal_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161097_macneal_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161098_midwest_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161098_midwest_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161098_midwest_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161100_watermark_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161100_watermark_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161100_watermark_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161101_vhs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161101_vhs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161101_vhs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161107_healthcare_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161107_healthcare_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161107_healthcare_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161111_vhs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161111_vhs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161111_vhs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161113_vhs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161113_vhs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161113_vhs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161117_vhs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161117_vhs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161117_vhs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161119_vhs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161119_vhs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161119_vhs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001161122_hospital_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001161122_hospital_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41185a9b7717add1fcbff45e850d8161cc8e8d6a --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001161122_hospital_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davis Polk & Wardwell, New York, New York will opine for us on whether the new notes are valid and binding obligations of Vanguard. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001164060_arg-terra_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001164060_arg-terra_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4d36976b6bec296b7a86e12ac0db941117673834 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001164060_arg-terra_legal_matters.txt @@ -0,0 +1,5087 @@ +LEGAL MATTERS + + + The validity of the Notes and certain legal matters in connection with this offering will be passed upon for the Company by Milbank, Tweed, Hadley & McCloy +LLP, Los Angeles, California. + + + + +EXPERTS + + + The financial statements included in this Prospectus and elsewhere in the Registration Statement to the extent and for the periods indicated in their report have +been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report with respect thereto, and are included herein in reliance upon the authority of said firm as experts +in accounting in giving said report. + +65 + + + + + + +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS + + + + + +Page + +Report of Independent Public Accountants + +F-2 + +Consolidated Balance Sheets as of December 27, 1999, December 25, 2000, and September 24, 2001 + + + +F-3 + +Consolidated Statements of Operations for the Years Ended December 28, 1998, December 27, 1999, and December 25, 2000, and the Thirty-nine Weeks Ended September 25, 2000 and September 24, 2001 + + + +F-4 + +Consolidated Statements of Common Stockholders' Equity (Deficit) for the Years Ended December 28, 1998, December 27, 1999 and December 25, 2000 + + + +F-5 + +Consolidated Statements of Cash Flows for the Years Ended December 28, 1998, December 27, 1999, and December 25, 2000, and the Thirty-nine Weeks Ended September 25, 2000 and September 24, 2001 + + + +F-6 + +Notes to Consolidated Financial Statements + + + +F-7 + +F-1 + + + + + + +REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS + + +To +the Board of Directors of + +American Restaurant Group, Inc.: + + We +have audited the accompanying consolidated balance sheets of AMERICAN RESTAURANT GROUP, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 27, 1999 and +December 25, 2000, and the related consolidated statements of operations, common stockholders' equity (deficit), and cash flows for the years ended December 28, 1998, December 27, +1999, and December 25, 2000. 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. + + We +conducted our audits in accordance with auditing standards generally accepted in the United States. 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. + + In +our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Restaurant Group, Inc. and subsidiaries as +of December 27, 1999 and December 25, 2000, and the results of their operations and their cash flows for the years ended December 28, 1998, December 27, 1999, and +December 25, 2000, in conformity with accounting principles generally accepted in the United States. + +/s/ +ARTHUR ANDERSEN LLP + +San +Francisco, California + +March 2, 2001 + +F-2 + + + + + + +AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + CONSOLIDATED BALANCE SHEETS + DECEMBER 27, 1999, DECEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + + +December 27, + +1999 + +December 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + +(unaudited) + + + + +ASSETS + + + + + + + + + + + +CURRENT ASSETS: + + + + + + + + + + + + +Cash + +$ +8,316 + +$ +8,532 + +$ +3,850 + + + +Accounts receivable + + +2,655 + + +2,938 + + +3,690 + + + +Inventories + + +2,755 + + +2,853 + + +2,916 + + + +Prepaid expenses + + +2,873 + + +2,803 + + +4,521 + + + + +Net current assets of discontinued operations + + +6,068 + + + + + + + + + + + + + + + + + + + + +Total current assets + + +22,667 + + +17,126 + + +14,977 + + + + + + + + + + + +PROPERTY AND EQUIPMENT: + + + + + + + + + + + + +Land and land improvements + + +2,629 + + +2,629 + + +2,598 + + + +Buildings and leasehold improvements + + +65,418 + + +67,631 + + +69,409 + + + +Fixtures and equipment + + +48,977 + + +48,629 + + +48,953 + + + +Property held under capital leases + + +7,480 + + +7,480 + + +7,293 + + + +Construction in progress + + +521 + + +2,816 + + +1,345 + + + + + + + + + + + + + + +125,025 + + +129,185 + + +129,598 + + + +Less Accumulated depreciation + + +73,557 + + +75,815 + + +78,851 + + + + + + + + + + + + + + +51,468 + + +53,370 + + +50,747 + + + + +Net property and equipment of discontinued operations + + +36,032 + + + + + + + + + + + +Net Property and equipment + + +87,500 + + +53,370 + + +50,747 + + + + + + + + + + + +OTHER ASSETS: + + + + + + + + + + + + +Intangible assets + + +7,668 + + +7,445 + + +7,445 + + + +Deferred debt costs + + +11,061 + + +9,970 + + +9,970 + + + +Leasehold interests + + +6,577 + + +6,577 + + +6,577 + + + +Liquor licenses and other + + +4,758 + + +4,156 + + +4,136 + + + +Cost in excess of net assets acquired + + +7,537 + + +7,536 + + +7,536 + + + + + + + + + + + + + + +37,601 + + +35,684 + + +35,664 + + + +Less Accumulated amortization + + +14,083 + + +16,605 + + +18,603 + + + + + + + + + + + + + +Net other assets from discontinued operations + + +9,044 + + + + + + + + + + + + + + + + + + + + +Net other assets + + +32,562 + + +19,079 + + +17,061 + + + + + + + + + + + + + + +Total assets + +$ +142,729 + +$ +89,575 + +$ +82,785 + + + + + + + + + + + +LIABILITIES AND COMMON STOCKHOLDERS' (DEFICIT) + + + + + + + + + + + +CURRENT LIABILITIES: + + + + + + + + + + + + +Accounts payable + +$ +13,627 + +$ +15,193 + +$ +13,615 + + + +Accrued liabilities + + +9,486 + + +11,521 + + +6,320 + + + +Accrued insurance + + +2,509 + + +2,373 + + +2,695 + + + +Accrued interest + + +7,010 + + +6,251 + + +2,116 + + + +Accrued payroll costs + + +4,148 + + +7,069 + + +4,115 + + + +Current portion of obligations under capital leases + + +638 + + +713 + + +776 + + + +Current portion of long-term debt + + +477 + + +432 + + +4,416 + + + + +Current liabilities of discontinued operations + + +22,586 + + +2,945 + + +1,059 + + + + + + + + + + + + + + +Total current liabilities + + +60,481 + + +46,497 + + +35,112 + + + + + + + + + + + +LONG-TERM LIABILITIES, net of current portion: + + + + + + + + + + + + +Obligations under capital leases + + +3,300 + + +2,588 + + +2,005 + + + +Long-term debt + + +160,297 + + +144,066 + + +143,787 + + + + +Long-term debt from discontinued operations + + +2,299 + + + + + + + + + + + + + + + + + + + + +Total long-term liabilities + + +165,896 + + +146,654 + + +145,792 + + + + + + + + + + + +DEFERRED GAIN + + +4,395 + + +4,192 + + +4,037 + + + + + + + + + + + +COMMITMENTS AND CONTINGENCIES + + + + + + + + + + + + +CUMULATIVE PREFERRED STOCK, MANDATORILY REDEEMABLE + + + + + + + + + + + +Senior pay-in-kind exchangeable preferred stock, $0.01 par value; 160,000 shares authorized; 41,584 shares accrued and outstanding at December 27, 1999, 50,953 shares accrued and outstanding at December 25, 2000, +and 56,792 shares accrued and outstanding at September 24, 2001 + + +41,914 + + +49,891 + + +56,029 + + + + + + + + + + + +COMMON STOCKHOLDERS' (DEFICIT): + + + + + + + + + + + +Common stock, $0.01 par value; 1,000,000 shares authorized; 128,081 shares issued and outstanding at December 27, 1999, December 25, 2000, and September 24, 2001 + + +1 + + +1 + + +1 + + + +Paid-in capital + + +50,552 + + +15,788 + + +9,469 + + + +Accumulated (deficit) + + +(180,510 +) + +(173,448 +) + +(167,655 +) + + + + + + + + + + + + + +Total common stockholders' (deficit) + + +(129,957 +) + +(157,659 +) + +(158,185 +) + + + + + + + + + + + + + +Total liabilities and common stockholders' (deficit) + +$ +142,729 + +$ +89,575 + +$ +82,785 + + + + + + + + + + + +The accompanying notes are an integral part of these consolidated statements. + +F-3 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF OPERATIONS + FOR THE YEARS ENDED DECEMBER 28, 1998, DECEMBER 27, 1999, + DECEMBER 25, 2000, +AND THE THIRTY-NINE + WEEKS ENDED SEPTEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + +Year ended + +Nine Months Ended + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + +September 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + + + +(unaudited) + + +REVENUES + +$ +265,536 + +$ +263,561 + +$ +299,822 + +$ +226,567 + +$ +226,808 + + + + + + + + + + + + +RESTAURANT COSTS: + + + + + + + + + + + + + + + + + +Food and beverage + + +89,521 + + +88,110 + + +103,339 + + +77,675 + + +75,602 + + +Payroll + + +74,912 + + +75,114 + + +82,818 + + +60,715 + + +64,923 + + +Direct operating + + +63,260 + + +63,033 + + +69,721 + + +52,852 + + +53,830 + + +Depreciation and amortization + + +10,115 + + +9,396 + + +9,554 + + +7,352 + + +6,478 + +GENERAL AND ADMINISTRATIVE EXPENSES + + +11,780 + + +11,975 + + +11,108 + + +7,660 + + +7,198 + +NON-CASH CHARGE FOR IMPAIRMENT OF LONG-LIVED ASSETS + + +149 + + +459 + + + + + + + + + + + + + + + + + + + + + + +Operating profit from continuing operations + + +15,799 + + +15,474 + + +23,282 + + +20,313 + + +18,777 + +INTEREST EXPENSE, net + + +20,269 + + +19,450 + + +19,036 + + +14,322 + + +12,801 + + + + + + + + + + + + + +Net income /(loss) before provision for income taxes + + +(4,470 +) + +(3,976 +) + +4,246 + + +5,991 + + +5,976 + +PROVISION FOR INCOME TAXES + + +67 + + +70 + + +185 + + +211 + + +183 + + + + + + + + + + + + + +Income/(Loss) from continuing operations + + +(4,537 +) + +(4,046 +) + +4,061 + + +5,780 + + +5,793 + + +Income (Loss) from discontinued operations + + +(4,879 +) + +(1,622 +) + +3,474 + + +3,474 + + + + +EXTRAORDINARY GAIN/(LOSS) ON EXTINGUISHMENT OF DEBT FROM CONTINUING OPERATIONS + + +9,559 + + + + + +(473 +) + + + + + + + + + + + + + + + + + + +Net Income/(Loss) + +$ +143 + +$ +(5,668 +) +$ +7,062 + +$ +9,254 + +$ +5,793 + + + + + + + + + + + + +The +accompanying notes are an integral part of these consolidated statements. + +F-4 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (DEFICIT) + FOR THE YEARS ENDED DECEMBER 28, 1998, + DECEMBER 27, + 1999 AND DECEMBER 25, 2000 + (dollars in thousands) + + + + + +Common + +Stock + +Paid-in + +Capital + +Accumulated + +Debt + +Total + + +BALANCE, December 29, 1997 + +$ +1 + +$ +63,246 + +$ +(174,985 +) +$ +(111,738 +) + + +Net Income + + + + + + + + +143 + + +143 + + + + +Amortization of cost related to the issuance of preferred stock + + + + + +(332 +) + + + + +(332 +) + + + +Dividends payable, preferred stock + + + + + +(3,648 +) + + + + +(3,648 +) + + + +Non-cash distribution to parent + + + + + +(3,600 +) + + + + +(3,600 +) + + + + + + + + + + + + +BALANCE, December 28, 1998 + +$ +1 + +$ +55,666 + +$ +(174,842 +) +$ +(119,175 +) + + + + + + + + + + + + + +Net (Loss) + + + + + + + + +(5,668 +) + +(5,668 +) + + + +Amortization of cost related to the issuance of preferred stock + + + + + +(399 +) + + + + +(399 +) + + + +Dividends payable, preferred stock + + + + + +(4,715 +) + + + + +(4,715 +) + + + + + + + + + + + + +BALANCE, December 27, 1999 + +$ +1 + +$ +50,552 + +$ +(180,510 +) +$ +(129,957 +) + + + + + + + + + + + + + +Net Income + + + + + + + + +7,062 + + +7,062 + + + +Net book value of assets and liabilities transferred in conjunction with Stock Sale + + + + + +(26,788 +) + + + + +(26,788 +) + + +Amortization of cost related to the issuance of preferred stock + + + + + +(399 +) + + + + +(399 +) + + +Dividends payable, preferred stock + + + + + +(7,577 +) + + + + +(7,577 +) + + + + + + + + + + + + +BALANCE, December 25, 2000 + +$ +1 + +$ +15,788 + +$ +(173,448 +) +$ +(157,659 +) + + + + + + + + + + + + +The +accompanying notes are an integral part of these consolidated statements. + +F-5 + + + + + + +AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED + DECEMBER 28, 1998, DECEMBER 27, 1999, DECEMBER 25, 2000, + AND THE THIRTY-NINE WEEKS ENDED +SEPTEMBER 25, 2000 AND SEPTEMBER 24, 2001 + (dollars in thousands) + + + + + +Year Ended + +Nine Months Ended + + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + +September 25, + +2000 + +September 24, + +2001 + + + + + + + + + + + + + + +(unaudited) + + + + +CASH FLOWS FROM OPERATING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Cash received from customers + +$ +264,195 + +$ +263,562 + +$ +299,539 + +$ +226,054 + +$ +226,056 + + + +Cash paid to suppliers and employees + + +(271,512 +) + +(229,650 +) + +(260,096 +) + +(204,032 +) + +(212,900 +) + + +Interest paid, net + + +(20,729 +) + +(19,473 +) + +(19,823 +) + +(19,020 +) + +(16,936 +) + + +Income taxes, net + + +(67 +) + +(71 +) + +(312 +) + +(211 +) + +(183 +) + + + + + + + + + + + + + + + + +Net cash provided by/(used in) continuing operating activities + + +(28,113 +) + +14,368 + + +19,308 + + +2,791 + + +(3,963 +) + + + + + + + + + + + + + + +CASH FLOWS FROM INVESTING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Capital expenditures + + +(7,896 +) + +(6,248 +) + +(7,872 +) + +(6,438 +) + +(1,876 +) + + +Net (increase) decrease in other assets + + +3,734 + + +(2,619 +) + +(1,221 +) + +(606 +) + +14 + + + +Proceeds(Loss) from disposition of assets + + +9 + + +471 + + +12 + + +(12 +) + +25 + + + + + + + + + + + + + + + + + +Net cash (used in) investing activities + + +(4,153 +) + +(8,396 +) + +(9,081 +) + +(7,056 +) + +(1,837 +) + + + + + + + + + + + + + + +CASH FLOWS FROM FINANCING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Proceeds received from Stock Sale + + + + + + + + +17,000 + + +17,000 + + + + + + +Payments on indebtedness + + +(163,116 +) + +(15,376 +) + +(16,275 +) + +(264 +) + + + + + +Borrowings on indebtedness + + +163,226 + + +16,229 + + + + + +119 + + +3,705 + + + +Net increase in deferred debt costs + + +(10,818 +) + +(243 +) + + + + + + + + + + + +Cost included in extraordinary gain on extinguishment of debt + + +(1,686 +) + + + + + + + + + + + + + + +Issuance of cumulative preferred stock + + +35,000 + + + + + + + + + + + + + + + +Cost related to issuance of cumulative preferred stock + + +(2,179 +) + + + + + + + + + + + + + + +Payment on insurance related financing + + +(7,450 +) + + + + + + + + + + + + + + +Payments on capital lease obligations + + +(682 +) + +(637 +) + +(637 +) + +(472 +) + +(520 +) + + + + + + + + + + + + + + + + +Net cash provided by/(used in) financing activities + + +12,295 + + +(27 +) + +88 + + +16,383 + + +3,185 + + + + + + + + + + + + + + + +NET INCREASE/(DECREASE) IN CASH FROM CONTINUING OPERATIONS + + +(19,971 +) + +5,945 + + +10,315 + + +12,118 + + +(2,615 +) + +NET INCREASE/(DECREASE) IN CASH FROM DISCONTINUED OPERATIONS + + +23,163 + + +(5,617 +) + +(10,099 +) + +(6,167 +) + +(2,067 +) + + + + + + + + + + + + + + +CASH, at beginning of period + + +4,796 + + +7,988 + + +8,316 + + +8,316 + + +8,532 + + + + + + + + + + + + + + + +CASH, at end of period + +$ +7,988 + +$ +8,316 + +$ +8,532 + +$ +14,267 + +$ +3,850 + + + + + + + + + + + + + + + +RECONCILIATION OF NET INCOME (LOSS) TO NET CASH PROVIDED BY OPERATING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Net income (loss)from continuing operations after extraordinary items + +$ +5,022 + +$ +(4,046 +) +$ +3,588 + +$ +5,780 + +$ +5,793 + + + +Adjustments to reconcile net income (loss) to net cash provided by operating activities: + + + + + + + + + + + + + + + + + + + +Extraordinary (gain) loss on extinguishment of debt + + +(9,559 +) + + + + +473 + + + + + + + + + + + +Depreciation and amortization + + +10,115 + + +9,396 + + +9,554 + + +7,352 + + +6,478 + + + + + +Loss on disposition of assets + + +1,529 + + +3,317 + + +581 + + +581 + + + + + + + + +Impairment of assets + + +149 + + +459 + + + + + + + + + + + + + + +Amortization of deferred gain + + +(599 +) + +(289 +) + +(203 +) + +(152 +) + +(155 +) + + + + +Accretion on indebtedness + + +21 + + + + + + + + + + + + + + + + +(Increase) decrease in current assets: + + + + + + + + + + + + + + + + + + + + +Accounts receivable, net + + +1,341 + + +1 + + +(283 +) + +(173 +) + +(752 +) + + + + +Inventories + + +25 + + +89 + + +(98 +) + +(310 +) + +(63 +) + + + + +Prepaid expenses + + +102 + + +(834 +) + +70 + + +1,244 + + +(1,718 +) + + + +Increase (decrease) in current liabilities: + + + + + + + + + + + + + + + + + + + + +Accounts payable + + +(10,764 +) + +2,193 + + +1,566 + + +(3,697 +) + +(1,578 +) + + + + +Accrued liabilities + + +(16,929 +) + +2,479 + + +2,034 + + +(2,783 +) + +(5,201 +) + + + + +Accrued insurance + + +(1,528 +) + +(513 +) + +(136 +) + +323 + + +322 + + + + + +Accrued interest + + +(481 +) + +(23 +) + +(759 +) + +(4,698 +) + +(4,135 +) + + + + +Accrued payroll costs + + +(6,557 +) + +2,139 + + +2,921 + + +(676 +) + +(2,954 +) + + + + + + + + + + + + + + + + + + +Net cash provided by/(used in) continuing operating activities + +$ +(28,113 +) +$ +14,368 + +$ +19,308 + +$ +2,791 + +$ +(3,963 +) + + + + + + + + + + + + + + +The accompanying notes are an integral part of these consolidated statements. + +F-6 + + + + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + + DECEMBER 28, 1998, DECEMBER 27, 1999, AND DECEMBER 25, 2000 + + + +1. Background and Summary of Significant Accounting Policies + +a.Company + + American Restaurant Group, Inc. (the "Company"), a Delaware corporation, through its subsidiaries, operates middle-price full-service +restaurants, primarily in California, the Pacific Northwest, and Arizona. The Company is a subsidiary of American Restaurant Group Holdings, Inc. ("Holdings"), also a Delaware corporation. At +year-end 1998, 1999, and 2000, the Company and its subsidiaries, collectively referred to herein as the Company, operated 101, 102, and 105 restaurants, respectively, in its continuing +segment. + +b.Operations + + The Company's operations are affected by local and regional economic conditions, including competition in the restaurant industry. Prior to the year ended +December 25, 2000, the Company experienced recurring operating losses (before extraordinary gain (loss) on extinguishment of debt) after debt service. A recapitalization plan was consummated +during 1998 (see Note 3, "Long-Term Debt"). This plan substantially eliminated debt principal payments until the year 2003. + + Management +believes the recapitalization will also allow it to effect changes in its operations and has already implemented measures to reduce overhead costs. However, the Company does +not expect to generate sufficient cash flows from operations in the future to fully pay the principal on long-term debt upon maturity in the year 2003 and, accordingly, it expects to +refinance all or a portion of such debt, obtain new financing, or possibly sell assets. + +c.Sale of Stock to Spectrum Restaurant Group, Inc. + + The Company sold all of the outstanding stock of four wholly owned subsidiaries (Non-Black Angus Subsidiaries) to Spectrum Restaurant +Group, Inc. (formerly known as NBACo, Inc.). There was no gain or loss recorded because of the related-party nature of the Stock Sale. The Company received $17.0 million in cash +on June 28, 2000, and transferred certain assets and liabilities to Spectrum Restaurant Group, Inc. Concurrent with the sale, advances between the Company and the Non-Black +Angus Subsidiaries were eliminated. Paid-in capital of $26.8 million was charged as a result of the sale. The Company retained the assets and liabilities associated with certain +closed restaurants as well as certain liabilities, estimated on June 26, 2000 at $12.6 million, associated with the operating restaurants that were sold. The amount of estimated +liabilities remaining at December 25, 2000 was approximately $2.9 million. + + The +Company is currently working to settle these liabilities. Any adjustments to the recorded balance will be recognized when the amount becomes known, however management does not +believe that such amounts, is any, will be material to the Company's financial position or results of operations. + +d.Principles of Consolidation + + The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and +transactions have been eliminated. + +e.Use of Estimates in the Preparation of Financial Statements + + The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and +assumptions which affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results could +differ from those estimates. + +F-7 + + + +f.Inventories and Prepaid Expenses + + Inventories consist primarily of food, beverages, and supplies and are valued at the lower of cost (first-in, first-out method) or market +value. + +g.Advertising Costs + + Advertising costs are accrued as a percentage of sales and expensed during the year. At year end, production costs for advertisements, which have not been aired, +are included in prepaid expenses. Prepaid advertising costs of $1,196,000 and $1,022,000 were included in prepaid expenses at December 27, 1999 and December 25, 2000, respectively. +Advertising expenses included in net income (loss) were $13,983,000, $13,515,000, and $16,134,000 in fiscal years 1998, 1999, and 2000, respectively. + +h.Property and Equipment + + Property and equipment is carried at the lower of cost or, if impaired, at the estimated fair value of the assets. The Company provides for depreciation and +amortization based upon the estimated useful lives of depreciable assets using the straight-line method. Estimated useful lives are as follows: + +Land improvements + +20 years + +Buildings + +30 to 35 years + +Leasehold improvements + +Life of lease + +Fixtures and equipment + +3 to 10 years + +Property held under capital leases + +Life of lease + + When +a restaurant is opened, the initial purchase of expendable equipment, such as china, glassware, and silverware, is recorded as an asset and is not depreciated; +however, all replacements are expensed. + + Substantially +all of the Company's assets, including property and equipment, are pledged as collateral on the senior debt of the Company. + +i.Interest Costs + + Interest costs incurred during the construction period of restaurants are capitalized. The Company capitalized approximately $68,000 and $44,000 for the years +ended 1998 and 1999, respectively. There were no interest costs capitalized in 2000. + +j.Other Assets + + Other assets include intangible assets, leasehold interests, franchise rights, liquor licenses, and cost in excess of net assets acquired. These costs are +amortized using the straight-line method over the periods estimated to be benefited, not greater than 40 years. + + Deferred +debt costs are amortized using the effective interest method over the related debt term. + +F-8 + + + + Estimated +useful lives are as follows: + +Intangible assets + +3 to 40 years + +Deferred debt costs + +Term of debt + +Leasehold interests + +Life of lease + +Franchise rights + +35 years + +Liquor licenses + +40 years + +Cost in excess of net assets acquired + +40 years + + The +following table details the components of intangible assets included in the accompanying consolidated balance sheets (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Assembled workforce + +$ +2,986 + +$ +2,986 + +Going Concern + + +1,928 + + +1,928 + +Trademarks/service marks + + +1,794 + + +1,794 + +Acquisition costs + + +696 + + +696 + +Other + + +264 + + +41 + + + + + + +Total + +$ +7,668 + +$ +7,445 + + + + + + + As +of December 27, 1999 and December 25, 2000, no indicators of impairment exist. + +k.Insurance + + The Company self-insures certain risks up to varying limits including medical, workers' compensation, property and general liability. Deductible and +self-insured limits have varied historically, ranging from $0 to $350,000 per incident depending on the type of risk. The policy deductibles are $100,000 for its annual medical and dental +benefits per person. Reserves for losses are established based upon currently estimated obligations for the claim over time and the deductible or self-insured retention in place at the +time of the loss. + +l.Fair Value of Financial Instruments + + The Company's financial instruments consist primarily of cash, accounts receivable and payable, and debt instruments. The carrying values of all financial +instruments, other than debt instruments, are representative of their fair value due to their short-term maturity. The fair value of the Company's long-term debt instruments is +estimated based on the current rates offered to the Company. + +m.Accounting Period + + The Company's fiscal year ends on the last Monday in December. + +n.Earnings per Share + + Earnings per share information has not been presented because there is no market for the Company's common stock. + +o.Reclassifications + + Certain prior year accounts have been reclassified to conform with the current year presentation. + +F-9 + + + +p.New Accounting Pronouncements + + In June, 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS +No. 142, Goodwill and Other Intangible Assets. These new standards are effective for fiscal years beginning after December 15, 2001. Under the new standards, goodwill will no longer be +amortized, but will be subject to an annual impairment test. The standards also promulgate, among other things, new requirements for accounting for other intangible assets. The impact of these new +standards on the Company's financial position and results of operations has not yet been determined, but is not believed to be material. + + In +August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or +Disposal of Long-Lived Assets. FASB Statement No. 144 retains FASB Statement No. 121's Accounting for the Impairment of Long-Lived Assets +and for Long-Lived Assets to Be Disposed Of, fundamental provisions for the: (1) recognition and measurement of impairment of long-lived assets to be held and used; and (2) +measurement of long-lived assets to be disposed of by sale. The Company does not believe that FASB Statement No. 144 will have a material impact on its financial position or results of +operations. Statement No. 144 is effective for fiscal years beginning after December 15, 2001. + +2. Lease Obligations + + The Company leases certain of its operating facilities under terms ranging up to 40 years. These leases are classified as both operating and capital +leases. Certain of the leases contain provisions calling for rentals based on sales or other provisions obligating the Company to pay related property taxes and certain other expenses. + + The +following is a summary of property held under capital leases and included in the accompanying consolidated balance sheets (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Property + +$ +7,480 + +$ +7,480 + +Less Accumulated depreciation + + +5,720 + + +6,071 + + + + + + + + +$ +1,760 + +$ +1,409 + + + + + + +F-10 + + + + The +following represents the minimum lease payments remaining under noncancelable operating leases and capitalized leases as of December 25, 2000 (in thousands): + +Fiscal Years Ending + + +Operating + +Leases + +Capitalized + +Leases + +2001 + +$ +16,504 + +$ +1,070 + +2002 + + +15,107 + + +1,070 + +2003 + + +14,757 + + +830 + +2004 + + +13,778 + + +263 + +2005 + + +12,168 + + +232 + +Thereafter + + +168,018 + + +1,347 + + + + + + +Total minimum lease payments + +$ +240,332 + + +4,812 + + + + + + +Less Imputed interest (8.75% to 15.5%) + + + + + +1,511 + +Present value of minimum lease payments + + + + + +3,301 + + + + + + + +Less Current portion + + + + + +713 + + + + + + + +Long-term portion + + + + +$ +2,588 + + + + + + + + Rental +expense was $15,216,000, $15,460,000, and $16,650,000 during 1998, 1999, and 2000, respectively. + +3. Long-Term Debt + + Long-term debt is summarized as follows (in thousands): + + + + +December 27, + +1999 + +December 25, + +2000 + +Senior secured notes, interest only due semi-annually beginning August 15, 1998 at 11.5%, principal due February 15, 2003 + +$ +158,600 + +$ +142,600 + +Other + + +2,174 + + +1,898 + + + + + + + + + +160,774 + + +144,498 + +Less Current portion + + +477 + + +432 + + + + + + +Long-term portion + +$ +160,297 + +$ +144,066 + + + + + + + Maturities +of the remaining long-term debt during each of the five fiscal years subsequent to year end 2000 are $432,000, $335,000, $142,627,000, $30,000, and +$1,074,000 thereafter. + + In +February 1998, the Company completed a recapitalization plan (the "Recapitalization Plan") that included, among other things, the issuance by the Company of $155,000,000 of +Notes due 2003. + + In +conjunction with the Recapitalization Plan, the Company issued an additional $3,600,000 principal amount of Notes to holders of certain Holdings debt and recorded such issuance as a +non-cash distribution. There was an extraordinary gain recorded in 1998 of 9,559,000 as a result of this transaction. + + As +part of the Recapitalization Plan, the Company concurrently (a) redeemed at par senior secured notes of $126,381,000 together with interest thereon and repaid certain other +interest-bearing + +F-11 + + + +short-term liabilities, (b) repurchased its existing 10.25% subordinated notes at 65% of the par amount of $45,000,000 together with interest thereon, and canceled the related +warrants to purchase common stock of Holdings, and (c) established a $15,000,000 revolving credit facility to include letters of credit. A quarterly fee of 0.5% per annum is payable on the +unused portion of the letter of credit facility and a quarterly fee of 2.5% per annum is payable on outstanding letters of credit. + + On +June 28, 2000, the Company amended the terms of the Credit Facility to reduce the aggregate commitment of the lenders from $15,000,000 to $12,000,000, to reduce the amount +available for issuance of letters of credit from $10,000,000 to $7,000,000, and to extend the maturity date from February 25, 2001 to June 30, 2002. + + At +year end 1999 and 2000, the Company had outstanding letters of credit primarily related to its self-insurance programs of approximately $3,597,000 and $5,500,000, +respectively. + + The +revolving credit facility contains certain covenants, the most restrictive of which requires the Company to maintain a certain ratio of cash flows to total debt. As of +December 25, 2000, the Company was in compliance with all financial covenants. The Company made a prepayment of principal of $16 million in December 2000, and recorded an +extraordinary loss of $473,000 to write-off the related unamortized deferred financing costs. + + Substantially +all assets of the Company are pledged to its senior lenders. In addition, the direct subsidiaries guaranteed the indebtedness owed by the Company and such guarantees are +secured by substantially all of the assets of the subsidiaries. In connection with such indebtedness, contingent and mandatory prepayments may be required under certain specified conditions and +events. There are no compensating balance requirements. + + Management +believes the fair value of the debt approximates its carrying value. + +F-12 + + AMERICAN RESTAURANT GROUP, INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + DECEMBER 28, 1998, DECEMBER 27, 1999, AND DECEMBER 25, 2000 + +4. Income Taxes + + The Company's state income-tax provision, all of which was current, was $67,000, $70,000, and $185,000 in 1998, 1999, and 2000, respectively. No +provision for federal income taxes was required in any year. + + The +income tax effects of temporary differences that give rise to significant portions of the Company's deferred income tax assets and liabilities are as follows (in thousands): + + + + +Year Ended + + + + + +December 27, + +1999 + +December 25, + +2000 + + +Deferred income tax asset: + + + + + + + + + +Reserves and other accrued expenses not currently deductible for tax purposes + +$ +4,221 + +$ +3,358 + + + +Long-lived asset impairment not recognized on tax return + + +2,813 + + +2,813 + + + +Tax gain on sale/leaseback transactions, net + + +3,097 + + +2,978 + + +Discontinued Operations + + +2,514 + + + + + +Net operating loss carryforward + + + + + + + + + +From continuing operations + + +38,756 + + +39,043 + + + +From discontinued operations + + +14,991 + + +0 + + + + + + + + + + + +Deferred income-tax asset + + +66,392 + + +48,192 + + + + + + + + + +Deferred income tax liability: + + + + + + + + + +Tax depreciation greater than depreciation for financial reporting purposes + + +(6,927 +) + +(6,789 +) + + +Costs capitalized for financial reporting purposes and expensed on tax return + + +(4,172 +) + +(4,087 +) + + +Other, net + + + + + + + + + + +From continuing operations + + +(597 +) + +(350 +) + + + + + + + + + + +Deferred income-tax liability + + +(11,696 +) + +(11,226 +) + + + + + + + + +Deferred asset, net of deferred liability + + +54,696 + + +36,966 + + +Valuation allowance + + +(54,696 +) + +(36,966 +) + + + + + + + + +Net deferred income-tax asset + +$ + + +$ + + + + + + + + + + + The +Company fully reserves its net deferred tax assets because of its history of operating losses. + +F-13 + + + + The +effective tax rate differs from the federal statutory rate of 34 percent as a result of the following items (in thousands): + + + + +Year Ended + + + + + +December 28, + +1998 + +December 27, + +1999 + +December 25, + +2000 + + +Federal income-tax provision (benefit) at statutory rates + +$ +49 + +$ +(1,903 +) +$ +2,655 + + +State income-tax provision for which no federal benefit was recorded + + +44 + + +1 + + +464 + + +Losses for which no federal benefit was recorded + + +3,792 + + +1,195 + + + + + +Nondeductible items, principally intangible amortization + + +964 + + +777 + + +159 + + +Benefit of net operating loss carryforward + + + + + + + + +(3,093 +) + +Cancellation of debt income + + +(4,782 +) + + + + + + + + + + + + + + + + +Provision for income taxes + +$ +67 + +$ +70 + +$ +185 + + + + + + + + + + + +Provision for income taxes attributable to discontinued operations + +$ +21 + +$ +20 + +$ +59 + + + At +December 25, 2000, the Company had available net operating loss carryforwards for federal income-tax purposes of $96,619,000 expiring in 2003 to 2020, and federal +general business credit carryforwards of $6,192,000, expiring in 2009 to 2019. + +5. Commitments and Contingencies + + The Company is obligated under an employment agreement with an officer. The obligation under the agreement is $500,000, provides for periodic increases, and +expires in 2001 unless extended. + + The +Company has been named as defendant in various lawsuits. Management's opinion is that the outcome of such litigation will not materially affect the Company's financial position or +results of operations. + +6. Cumulative Preferred Stock, Mandatorily Redeemable + + As part of the Recapitalization Plan in February, 1998, the Company issued 35,000 preferred stock units (the "Units") of the Company. Each Unit consists of $1,000 +initial liquidation preference of 12% senior pay-in-kind exchangeable preferred stock and one common-stock purchase warrant initially to purchase 2.66143 shares of the common +stock at an initial exercise price of one cent per share. The Company's cumulative preferred stock is mandatorily redeemable on August 15, 2003, for cash at a price per share equal to 110% of +the then applicable liquidation preference. + + A +stock dividend of 2,499 shares was paid on February 15, 2000. In the second quarter of 2000, the Company agreed to an interpretation of the financial covenants used to determine +the dividend rate. The result was an increase in the dividend rate from 12% to 15% and additional dividends issued on August 15th of 2,503 shares (relating to holders at August 1999 and +February 2000). Stock dividends of 5,872 (including the adjustment) and 3,618 shares were made on August 15, 2000 and February 15, 2001, respectively. There were 50,953 shares +outstanding at December 25, 2000. + +F-14 + + + +7. Common Stock + + As of December 29, 1997, all of the Company's common stock was owned by American Restaurant Group Holdings, Inc., Anwar S. Soliman, and Management +Shareholders. They also own all outstanding shares of Holdings common stock other than shares of Holdings common stock issued to holders of the debenture units and rights to acquire shares of Holdings +common stock issuable upon exercise of options and warrants. + + In +conjunction with the Recapitalization Plan, the Company issued shares of common stock to certain members of the Company's management (the "Management Stockholders") in an aggregate +amount equal to 15% of the common stock on a fully diluted basis. Such Management Stockholders have entered into a voting trust agreement with Anwar Soliman to exercise all voting and substantially +all other rights to which such Management Shareholders would otherwise be entitled until August 15, 2005, or the earlier termination of the agreement. The Management Shareholders also entered +into a shareholders' agreement with the remaining Company shareholders, which provides that the parties will agree to vote all of their shares of the Company's equity securities so that the Board of +Directors of the Company consists of five directors, with two directors designated by TCW Investors, two by the Management Shareholders, with the remaining director being an independent director +initially designated by the initial purchaser of the Notes. + +8. Savings Plan + + The American Restaurant Group Savings and Investment Plan (the "Savings Plan") is a 401(k) plan established for the benefit of employees who satisfy certain +requirements. These requirements include completion of one year of service with a minimum of 1,000 hours worked. Subject to applicable limits imposed on tax-qualified plans, +eligible employees may elect pre-tax contributions up to 20.0% of a participant's total earnings for a calendar year (but not in excess of $10,500 for 2000). The Company makes matching +contributions to the Savings Plan equal to 25% of the participant's contributions up to 6% of the participant's earnings. During fiscal 1998, 1999, and 2000, the Company contributed approximately +$174,000, $225,000, and $206,000 to the Savings Plan, respectively. At December 25, 2000, there were approximately 3,900 employees eligible, 1,100 participants, and 600 contributors to the +plan. + +9. Subsequent Event (unaudited) + + The Company will recognize a charge of approximately $5.5 million in its results of operations for the fourteen weeks ended December 31, 2001. Under +GAAP the Company must immediately expense a portion of its transaction costs deemed to be associated with an exchange of debt instruments that are substantially the same. The exchange of +Series B Notes for Series C Notes is deemed to be such a transaction. The Company incurred additional costs associated with the issuance of the New Notes which have been capitalized and +will be amortized over the term of the New Notes. + +F-15 + +AMERICAN RESTAURANT GROUP, INC. + + + +PROSPECTUS January 24, 2002 + + + + + + + + +PART II + + INFORMATION NOT REQUIRED IN PROSPECTUS + + +ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. + + The estimated expenses payable by the Company in connection with the issuance and distribution of the Notes and in connection with the offering described in this +Registration Statement are as follows: + +Registration Fee + +$ +8,100 + +Legal fees and expenses + + +111,161 + +Accounting fees and expenses + + +35,571 + +Printing and duplicating expenses + + +57,140 + +Miscellaneous expenses + + +1,824,595 + + + + + +Total + +$ +2,036,567 + + + + +ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS + + Section 145 of the General Corporation Law of the State of Delaware (the "GCL") provides in relevant part that a Delaware corporation may +indemnify any persons, including officers and directors, who are, or are threatened to be made, parties to any threatened, pending or completed legal action, suit or proceeding, whether civil, +criminal, administrative or investigative (other than an action by or in the right of such corporation), by reason of the fact that such person is or was an officer or director of such corporation, or +is or was serving at the request of such corporation as a director, officer, employee or agent of another corporation or enterprise. The indemnity may include expenses (including attorneys' fees), +judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding, provided such officer or director acted in good +faith and in a manner he reasonably believed to be in or not opposed to the corporation's best interests and, for criminal proceedings, had no reasonable cause to believe that his conduct was illegal. +A Delaware corporation may indemnify officers and directors in an action by or in the right of the corporation under the same conditions, except that no indemnification is permitted without judicial +approval if the officer or director is adjudged to be liable to the corporation in the performance of his duty. Where an officer or director is successful on the merits or otherwise in the defense of +any action referred to above, the corporation must indemnify him against the expenses which such officer or director actually and reasonably incurred. + + Article IV +of the by-laws of the Company provides for indemnification of its officers and directors to the fullest extent permitted by Section 145 of the GCL. + + Section 102(b)(7) +of the GCL provides that a Delaware corporation may eliminate or limit the personal liability of a director to a Delaware corporation or its stockholders for +monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director (i) for any breach of the director's duty of +loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under +Section 174 of the GCL relating to the unlawful payment of a dividend or an unlawful stock purchase or redemption or (iv) for any transaction from which the director derived an improper +personal benefit. + + Article 7 +of the Certificate of Incorporation of the Company provides for the elimination of personal liability of its directors for monetary damages for breach of fiduciary duty +as a director, except as otherwise provided by the GCL. + +II-1 + + + +ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES + + On October 31, 2001, we privately placed, under Rule 144A and Regulation S of the Securities Act, $30 million aggregate principal +amount of 111/2% Senior Secured Notes due 2006, yielding net proceeds to the Company of approximately $3.1 million, after deducting estimated expenses and commissions. The +proceeds were used to refinance existing indebtedness, to pay the accrued and unpaid interest with respect to the Existing Notes and for general corporate purposes. Jefferies & +Company, Inc. was the initial purchaser of these securities. On October 1, 2001, we commenced an offer to exchange all of our outstanding Old Notes for up to $131.7 million +aggregate principal amount of 111/2% Senior Secured Notes due 2006. The notes include registration rights such that the registrant is required to exchange the notes for a new issue of +notes registered under the Securities Act of 1933 and are to be declared effective no later than 150 days after the issue date. + +ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES + +Exhibit No. + + +Description + + +1.1 + +Purchase Agreement dated as of September 28, 2001 by and between the Company and Jefferies & Company, Inc.******* + +2.1 + + + +Purchase Agreement dated as of September 11, 1996 by and between ARG Property Management Corporation and ARG Enterprises, Inc. and ARG Properties I, LLC.*** + +2.2 + + + +Master lease dated September 11, 1996 between ARG Properties I, LLC, as Landlord and ARG Enterprises, Inc. as Tenant.*** + +2.3 + + + +Lease #06152 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Bloomington, Minnesota.*** + +2.4 + + + +Lease #06153 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Fridley, Minnesota.*** + +2.5 + + + +Lease #06154 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Minnetonka, Minnesota.*** + +2.6 + + + +Lease #06155 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Roseville, Minnesota.*** + +2.7 + + + +Not Applicable. + +2.8 + + + +Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to ARG Properties I, LLC as Landlord.*** + +2.9 + + + +A Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to Captec Net Lease Realty, Inc. as Landlord for each of four Minnesota restaurants.*** + +2.10 + + + +Not Applicable. + +2.11 + + + +Stock Purchase Agreement, dated as of May 9, 2000 between the Company and NBACo, Inc.****** + +2.12 + + + +Amendment No. 1, dated as of June 26, 2000, to Stock Purchase Agreement, dated as of May 9, 2000, between the Company and NBACo, Inc.****** + +3.1 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on July 23, 1991.* + +3.2 + + + +Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on March 21, 1992.* + +II-2 + + + +3.3 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on February 23, 1998.**** + +3.3A + + + +Amendment to Certificate of the Designation of the Powers, Preferences and relative, Participating, Optional and Other Special Rights of the 12% Series A Senior Pay-In-Kind Exchangeable Preferred stock and the 12% Series B Senior Pay-In-Kind +Exchangeable Preferred Stock and Qualifications, Limitations or Restrictions Thereof of the Company filed with the Secretary of State of Delaware on October 31, 2001.******* + +3.4 + + + +By-Laws of the Company.* + +3.5 + + + +Restated Articles of Incorporation of ARG Enterprises, Inc. filed with the Secretary of State of California on May 3, 1988.******* + +3.6 + + + +Bylaws of ARG Enterprises, Inc.******* + +3.7 + + + +Restated Articles of Incorporation of ARG Property Management Corporation filed with the Secretary of State of California on May 3, 1988.******* + +3.8 + + + +Bylaws of ARG Property Management Corporation.******* + +3.9 + + + +Certificate of Incorporation of ARG Terra, Inc. filed with the Secretary of State of Delaware on June 20, 2000.******* + +3.10 + + + +Bylaws of ARG Terra, Inc.******* + +4.1 + + + +Indenture dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as Trustee (including specimen certificate of 11.5% Senior Secured Note due 2003).**** + +4.2 + + + +Warrant Agreement dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as warrant agent (including specimen certificate of warrant).**** + +4.3 + + + +Registration Rights Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc.**** + +4.4 + + + +Securityholders' and Registration Right Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc., as purchaser.**** + +4.5 + + + +Management Registration Right Agreement dated as of February 28, 1998 between the Company and the Management Stockholders.**** + +4.6 + + + +Certificate of Designation filed with the Secretary of State of Delaware on February 24, 1998.**** + +4.7 + + + +Certificate of Correction to the Certificate of Designation filed with the Secretary of State of Delaware on February 25, 1998.**** + +4.8 + + + +Not Applicable. + +4.9 + + + +First Supplemental Indenture, dated as June 28, 2000, to Indenture, dated as of February 25, 1998, between the Company and U.S. Trust Company, National Association (formerly known as U.S. Trust Company of California, +N.A.).****** + +4.10 + + + +Second Supplemental Indenture, dated as of October 31, 2001, to Indenture, dated as of February 25, 1998, between the Company and BNY Western Trust Company (successor in interest to U.S. Trust Company, National Association, formerly known as +U.S. Trust Company of California, N.A.).******* + +II-3 + + + +4.11 + + + +Registration Rights Agreement dated as of October 31, 2001 between the Company and Jefferies & Company, Inc.******* + +5 + + + +Opinion of Milbank, Tweed, Hadley & McCloy LLP.******** + +10.1 + + + +Amended and Restated Employment Agreement dated as of December 14, 1993 between the Company and Ralph S. Roberts.** + +10.2 + + + +Loan Agreement dated as of December 17, 2001 between Foothill Capital Corporation, as lender and the Company, ARG Enterprises, Inc., ARG Property Management Corporation and ARG Terra, Inc., as borrowers.******* + +10.3 + + + +Second Amended and Restated Intercreditor and Collateral Agency Agreement dated as of December 17, 2001 between BNY Western Trust Company, as collateral agent and as trustee, the Company, ARG Enterprises, Inc., ARG Property Management +Corporation and ARG Terra, Inc., as borrowers, and Foothill Capital Corporation, as lender.******* + +12 + + + +Statement setting forth Computation of Ratio of Earnings to Fixed Charges.******* + +21 + + + +Subsidiaries of the Company.** + +23.1 + + + +Consent of Milbank, Tweed, Hadley & McCloy LLP (included in Exhibit 5 hereto). + +23.2 + + + +Consent of Independent Public Accountants.******** + +24.1 + + + +Power of Attorney (American Restaurant Group, Inc.)******* + +24.2 + + + +Power of Attorney (ARG Enterprises, Inc., ARG Property Management Corporation, ARG Terra, Inc.) (contained on the signature page to this registration statement). + +25 + + + +Statement of Eligibility and Qualification (Form T-1) under the Trust Indenture Act of 1939 of United States Trust Company of New York.******* + + + + + + +* + +Incorporated by reference to the Registrant's Registration Statement No. 33-48183 on Form S-4 filed with the Securities and Exchange Commission on May 28, 1992 as amended with Amendment No. 1 filed on +September 11, 1992. + +** + +Incorporated by reference to the Registrant's Registration Statement No. 33-74010 on Form S-4 filed with the Securities and Exchange Commission on January 12, 1994. + +*** + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated September 13, 1996 filed with the Securities and Exchange Commission on September 30, 1996. + +**** + +Incorporated by reference to the Registrant's Annual Report on Form 10-K dated December 29, 1997 filed with the Securities and Exchange Commission on March 30, 1998. + +***** + +Incorporated by reference to the Registrant's Registration Statement No. 333-55861 on Amendment No. 1 to Form S-4 filed with the Securities and Exchange Commission on July 29, 1998. + +****** + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated June 28, 2000 and filed with the Securities and Exchange Commission on July 12, 2000. + +******* + +Incorporated by reference to the Registrant's Registration Statement No. 333-76442 to Form S-4 filed with the Securities and Exchange Commission on January , 2002. + +******** + +Incorporated by reference to the Registrant's Registration Statement No. 333-76434 to Form S-1 filed with the Securities and Exchange Commission on January 8, 2002. + +II-4 + + + +ITEM 17. UNDERTAKINGS + + A. Insofar +as indemnification for liabilities arising under the Act 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 Act +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. + +B.The +undersigned registrant hereby undertakes: + + (1) To +file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: + + (i) To +include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; + + (ii) To +reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment +thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement. Notwithstanding the foregoing, any increase or decrease in +volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering +range may be reflected in the form of prospectus filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change +in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. + + (iii) To +include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such +information in the registration statement. + + (2) That, +for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new +registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona +fide offering thereof. + + (3) To +remove from registration by means of a post-effective amendment any of the securities being registered that remain unsold at the termination of the +offering. + +II-5 + + + + + + +SIGNATURES + + + Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the +requirements to file Amendment No. 1 to Form S-1 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in +the City of Los Altos, State of California on the 17th day of January 2002. + + + + + + + +AMERICAN RESTAURANT GROUP, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer, Secretary and + +General Counsel + + + + + +ARG ENTERPRISES, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + + + + +ARG PROPERTY MANAGEMENT CORPORATION + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + + + + +ARG TERRA, INC. + + + + + +By: + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + Vice President, Treasurer and Secretary + + Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed below by the following persons in the +capacities and on the dates indicated. + + + +AMERICAN RESTAURANT GROUP, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ GEORGE G. GOLLEHER* George G. Golleher + +Chairman of the Board and Director + +January 17, 2002 + +/s/ RALPH S. ROBERTS* Ralph S. Roberts + + + +Chief Executive Officer, President and Director (principal executive officer and director) + + + +January 17, 2002 + +II-6 + + + +/s/ PATRICK J. KELVIE* Patrick J. Kelvie + + + +Vice President, Treasurer, Secretary and General Counsel (principal financial officer) + + + +January 17, 2002 + +/s/ SHERRI A. CARROLL* Sherri A. Carroll + + + +Controller + + + +January 17, 2002 + +/s/ ANWAR S. SOLIMAN* Anwar S. Soliman + + + +Director + + + +January 17, 2002 + +/s/ ROBERT D. BEYER* Robert D. Beyer + + + +Director + + + +January 17, 2002 + +/s/ M. BRENT STEVENS* M. Brent Stevens + + + +Director + + + +January 17, 2002 + +*By:/s/ PATRICK J. KELVIE Patrick J. Kelvie + Attorney-in-fact + + + + + + + + + + + + +POWER OF ATTORNEY + + + Each person whose signature appears below constitutes and appoints Patrick J. Kelvie his or her true and lawful +attorney-in-fact and agent, with full power of substitution and resubstitution for him or her and in his or her name, place and stead, in any and all capacities to sign any and +all amendments (including post-effective amendments) to this Registration Statement, and any registration statement of the Company to be filed after the date hereof pursuant to +Rule 462(b) under the Securities Act of 1933, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, and to +take such actions in, and file with the appropriate authorities in, whatever states said attorneys-in-fact and agents, and each of them, shall determine, such applications, +statements, consents, and other documents, as may be necessary or expedient to register securities of the Company for sale, granting unto said attorneys-in-fact and agents full +power and authority to do so and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in +person, hereby ratifying and confirming all that said attorney-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done +by virtue hereof and the registrant hereby confers like authority on its behalf. + + This Registration Statement and Power of Attorney, pursuant to the requirement of the Securities Act of 1933, as amended, have been signed below by the following +persons in the capacities and on the dates indicated. + + Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed below by the following persons in the +capacities and on the dates indicated. + +II-7 + + + +ARG ENTERPRISES, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +ARG PROPERTY MANAGEMENT CORPORATION + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +ARG TERRA, INC. + + + +Signature + +Title + +Date + + + + + + + + + + + +/s/ RALPH S. ROBERTS Ralph S. Roberts + +Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer (principal executive officer and director) + +January 17, 2002 + +/s/ PATRICK J. KELVIE Patrick J. Kelvie + + + +Vice President, Treasurer and Secretary (principal financial officer and director) + + + +January 17, 2002 + +II-8 + + + + +EXHIBIT INDEX + + +Exhibit No. + + +Description + + + 1.1 + +Purchase Agreement dated as of September 28, 2001 by and between the Company and Jefferies & Company, Inc.******* + + 2.1 + + + +Purchase Agreement dated as of September 11, 1996 by and between ARG Property Management Corporation and ARG Enterprises, Inc. and ARG Properties I, LLC.*** + + 2.2 + + + +Master lease dated September 11, 1996 between ARG Properties I, LLC, as Landlord and ARG Enterprises, Inc. as Tenant.*** + + 2.3 + + + +Lease #06152 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Bloomington, Minnesota.*** + + 2.4 + + + +Lease #06153 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Fridley, Minnesota.*** + + 2.5 + + + +Lease #06154 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Minnetonka, Minnesota.*** + + 2.6 + + + +Lease #06155 dated September 11, 1996 between Captec Net Lease Realty, Inc. and ARG Enterprises, Inc. as Tenant for Roseville, Minnesota.*** + + 2.7 + + + +Not Applicable. + + 2.8 + + + +Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to ARG Properties I, LLC as Landlord.*** + + 2.9 + + + +A Guaranty of Lease dated September 11, 1996 by ARG Enterprises, Inc. as Tenant to Captec Net Lease Realty, Inc. as Landlord for each of four Minnesota restaurants.*** + + 2.10 + + + +Not Applicable. + + 2.11 + + + +Stock Purchase Agreement, dated as of May 9, 2000 between the Company and NBACo, Inc.****** + + 2.12 + + + +Amendment No. 1, dated as of June 26, 2000, to Stock Purchase Agreement, dated as of May 9, 2000, between the Company and NBACo, Inc.****** + + 3.1 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on July 23, 1991.* + + 3.2 + + + +Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on March 21, 1992.* + + 3.3 + + + +Amended and Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on February 23, 1998.**** + + 3.3A + + + +Amendment to Certificate of the Designation of the Powers, Preferences and relative, Participating, Optional and Other Special Rights of the 12% Series A Senior Pay-In-Kind Exchangeable Preferred stock and the 12% Series B Senior Pay-In-Kind +Exchangeable Preferred Stock and Qualifications, Limitations or Restrictions Thereof of the Company filed with the Secretary of State of Delaware on October 31, 2001.******* + + 3.4 + + + +By-Laws of the Company.* + + 3.5 + + + +Restated Articles of Incorporation of ARG Enterprises, Inc. filed with the Secretary of State of California on May 3, 1988.******* + + 3.6 + + + +Bylaws of ARG Enterprises, Inc.******* + + 3.7 + + + +Restated Articles of Incorporation of ARG Property Management Corporation filed with the Secretary of State of California on May 3, 1988.******* + + 3.8 + + + +Bylaws of ARG Property Management Corporation.******* + + 3.9 + + + +Certificate of Incorporation of ARG Terra, Inc. filed with the Secretary of State of Delaware on June 20, 2000.******* + + 3.10 + + + +Bylaws of ARG Terra, Inc.******* + + 4.1 + + + +Indenture dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as Trustee (including specimen certificate of 11.5% Senior Secured Note due 2003).**** + + 4.2 + + + +Warrant Agreement dated as of February 25, 1998 between the Company and U.S. Trust Company of California, N.A., as warrant agent (including specimen certificate of warrant).**** + + 4.3 + + + +Registration Rights Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc.**** + + 4.4 + + + +Securityholders' and Registration Right Agreement dated as of February 25, 1998 between the Company and Jefferies & Company, Inc., as purchaser.**** + + 4.5 + + + +Management Registration Right Agreement dated as of February 28, 1998 between the Company and the Management Stockholders.**** + + 4.6 + + + +Certificate of Designation filed with the Secretary of State of Delaware on February 24, 1998.**** + + 4.7 + + + +Certificate of Correction to the Certificate of Designation filed with the Secretary of State of Delaware on February 25, 1998.**** + + 4.8 + + + +Not Applicable. + + 4.9 + + + +First Supplemental Indenture, dated as June 28, 2000, to Indenture, dated as of February 25, 1998, between the Company and U.S. Trust Company, National Association (formerly known as U.S. Trust Company of California, + N.A.).****** + + 4.10 + + + +Second Supplemental Indenture, dated as of October 31, 2001, to Indenture, dated as of February 25, 1998, between the Company and BNY Western Trust Company (successor in interest to U.S. Trust Company, National Association, formerly known as +U.S. Trust Company of California, N.A.).******* + + 4.11 + + + +Registration Rights Agreement dated as of October 31, 2001 between the Company and Jefferies & Company, Inc.******* + + 5 + + + +Opinion of Milbank, Tweed, Hadley & McCloy LLP.******** + +10.1 + + + +Amended and Restated Employment Agreement dated as of December 14, 1993 between the Company and Ralph S. Roberts.** + +10.2 + + + +Loan Agreement dated as of December 17, 2001 between Foothill Capital Corporation, as lender and the Company, ARG Enterprises, Inc., ARG Property Management Corporation and ARG Terra, Inc., as borrowers.******* + +10.3 + + + +Second Amended and Restated Intercreditor and Collateral Agency Agreement dated as of December 17, 2001 between BNY Western Trust Company, as collateral agent and as trustee, the Company, ARG Enterprises, Inc., ARG Property Management +Corporation and ARG Terra, Inc., as borrowers, and Foothill Capital Corporation, as lender.******* + +12 + + + +Statement setting forth Computation of Ratio of Earnings to Fixed Charges.******* + +21 + + + +Subsidiaries of the Company.** + +23.1 + + + +Consent of Milbank, Tweed, Hadley & McCloy LLP (included in Exhibit 5 hereto). + +23.2 + + + +Consent of Independent Public Accountants.******** + +24.1 + + + +Power of Attorney (American Restaurant Group, Inc.)******* + +24.2 + + + +Power of Attorney (ARG Enterprises, Inc., ARG Property Management Corporation, ARG Terra, Inc.) (contained on the signature page to this registration statement). + +25 + + + +Statement of Eligibility and Qualification (Form T-1) under the Trust Indenture Act of 1939 of United States Trust Company of New York.******* + + + + + + +* + +Incorporated by reference to the Registrant's Registration Statement No. 33-48183 on Form S-4 filed with the Securities and Exchange Commission on May 28, 1992 as amended with Amendment No. 1 filed on +September 11, 1992. + +** + + + +Incorporated by reference to the Registrant's Registration Statement No. 33-74010 on Form S-4 filed with the Securities and Exchange Commission on January 12, 1994. + +*** + + + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated September 13, 1996 filed with the Securities and Exchange Commission on September 30, 1996. + +**** + + + +Incorporated by reference to the Registrant's Annual Report on Form 10-K dated December 29, 1997 filed with the Securities and Exchange Commission on March 30, 1998. + +***** + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-55861 on Amendment No. 1 to Form S-4 filed with the Securities and Exchange Commission on July 29, 1998. + +****** + + + +Incorporated by reference to the Registrant's Current Report on Form 8-K dated June 28, 2000 and filed with the Securities and Exchange Commission on July 12, 2000. + +******* + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-76442 to Form S-4 filed with the Securities and Exchange Commission on January 8, 2002. + +******** + + + +Incorporated by reference to the Registrant's Registration Statement No. 333-76434 to Form S-1 filed with the Securities and Exchange Commission on January 8, 2002. + +QuickLinks + +TABLE OF CONTENTS \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001165532_atx_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001165532_atx_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..db8ea9f30ec0590f35fdc37dc1a669a8442eeee4 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001165532_atx_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the common stock offered by this prospectus will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001168311_united_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001168311_united_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b5dcf3b4ff25e6c760338135927f3c392334bc69 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001168311_united_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS" --> LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by our counsel, Katten Muchin Zavis Rosenman, 525 West Monroe Street, Chicago, IL 60661. Legal matters relating to the sale of common stock in this offering will be passed upon for the underwriters by Latham Watkins, 555 Eleventh Street, N.W. Suite 1000, Washington, D.C. 20004. Latham Watkins has from time to time provided legal services to us and they may continue to do so. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001168338_crum_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001168338_crum_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7d9b5171e1d9f56e018daed108778c5e8e0c5959 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001168338_crum_legal_matters.txt @@ -0,0 +1 @@ +legal matters and to specified conditions precedent. The underwriters are committed to purchase all of the shares, other than those shares covered by the over-allotment option described below, if any are purchased. The underwriters propose to initially offer some of the shares of common stock directly to the public at the public offering price on the cover page of this prospectus and some of the shares to dealers at the public offering price less a concession not in excess of $ per share. The underwriters may allow, and these dealers may re-allow, a concession not in excess of $ per share on sales to other dealers. After the initial offering of the shares to the public, the representatives of the underwriters may change the public offering price and such concessions. The underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. The following table shows the public offering price, underwriting discount and proceeds before expenses to us and to Fairfax. The information assumes either no exercise or full exercise by the underwriters of the over-allotment option granted to them by Fairfax. Total Total Without With Per Share Option Option \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001168463_advantage_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001168463_advantage_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e5238a4a6e2f5144e45d8a11e6b149ccfccb3ab --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001168463_advantage_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for Advantage Payroll Services, Inc. by Kirkland & Ellis (a partnership that includes professional corporations), Chicago, Illinois. Some legal matters in connection with this offering will be passed upon for the underwriters by Latham & Watkins, Chicago, Illinois. Kirkland & Ellis and Latham & Watkins have, from time to time, represented, and may continue to represent, some of the underwriters in connection with various legal matters and Willis Stein & Partners, L.P. and some of their affiliates, including Advantage Payroll Services, Inc., in connection with legal matters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001170218_carriage_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001170218_carriage_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a2b2d953c55b31fbc20b142d1e810b81e67ad2e4 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001170218_carriage_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Latham & Watkins, Los Angeles, California and New York, New York and Schreck Brignone Godfrey, Las Vegas, Nevada have passed upon certain legal matters with respect to the New Notes and the New Common Stock being offered. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001171825_cit-group_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001171825_cit-group_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4aaa4b32aef7e95fe4ab7006ac47dd5f2e40dd6b --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001171825_cit-group_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the common stock offered in this prospectus will be passed upon for CIT by Wilmer, Cutler & Pickering, Washington, D.C. Legal matters related to the offering will be passed upon for the underwriters by Milbank, Tweed, Hadley & McCloy LLP, New York, New York. Milbank, Tweed, Hadley & McCloy LLP acts as counsel from time to time in matters for Tyco and CIT. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001173276_sparkling_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001173276_sparkling_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2d6f5fe96c8a39ef14acdcad4c8358b44a061e16 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001173276_sparkling_legal_matters.txt @@ -0,0 +1 @@ +We purchase water coolers and bottles from various suppliers. We attempt to maintain relationships with two or three main water cooler suppliers and five to ten water bottle suppliers in order to preserve quality and consistency. However, from time to time we will switch suppliers for price, quality or other reasons. There are numerous suppliers of water coolers and water bottles. We maintain a stock of spare parts and new and returned water coolers at delivery depots, and we have not experienced any shortage of water coolers. Although we believe that we have quality water bottle suppliers, we have experienced instances where shipments of water bottles were delayed because a supplier could not meet demand. Because we maintain a supply of bottles and our bottles are returned by customers seeking to receive their deposits back, we have been able to ensure an adequate number of bottles to meet our customers needs. We estimate that the average life of a water cooler is ten years. The typical payback period for our water cooler investment (assuming only rental revenue and standard maintenance and redeployment costs) has been approximately 20 months. In the event of termination of the rental agreement, we have been able to redeploy water coolers at a relatively low cost to us. Prior to installing a returned water cooler, we strip down the cooler and then clean it. In addition, in some markets we charge a water cooler collection fee when a customer cancels the rental agreement. Other Products and Services. The remaining 10.3% of our 2001 revenue was generated through the sale of cups, coffee, water filtration devices, water through vending machines and cooler sanitization and maintenance services. Sales of accessory water products, such as cups and sanitization and maintenance services, grow at approximately the same rate as sales of our bottled water. Growth in this area is largely dependent on our ability to cross-sell to our existing customers. Sales of other products and services, such as coffee and water through vending machines, occur in a highly competitive environment and have grown at rates significantly below those for our home and office delivery business. (1) For purposes of this chart, we based the currency conversion rates on the average exchange rates prevailing during the given year. We market our products principally through telephone directory yellow page advertisements, newspaper advertisements, mall shows, coupons, product sponsorship programs, direct mail, radio and television commercials, and various referral programs. Our marketing activities were supported by the efforts of approximately 180 sales and customer service personnel as of May 31, 2002. Almost half of our new customers are derived from incoming telephone calls resulting from yellow page advertisements, our key advertising vehicle. To supplement this effort, our marketing team solicits potential new customers in specific geographical areas in which we desire to increase the density of existing routes or in which we desire to establish new routes. A potential new customer may be offered various introductory promotions, including a free trial offer. Our marketing activity emphasizes the benefits of bottled water and the convenience of a water cooler, including the associated regular delivery of bottled water, and, to a lesser extent, the opportunity to receive ancillary products or services in the form of cups, coffee, water filtration devices and water cooler sanitization and maintenance services. We focus our marketing and customer service strategy on retaining customers. We calculate our retention rate by subtracting from 100% the quotient of our total losses of water cooler rental locations during the year divided by our average monthly cooler rental locations base for the year. We deem a loss of a water cooler rental location to occur when we pick up the water cooler. During our last five fiscal years, we have experienced an average annual retention rate of approximately 70% of our water cooler rental locations. To improve our customer retention rate, we have implemented customer care groups and loyalty programs and we are focusing on increasing customer awareness about the benefits of drinking bottled water. Our primary strategy for increasing our retention rate is to focus on outstanding customer service. We compensate customer service representatives for the customers they help retain. Water Supply We own natural water sources that supply water for our Maritime Provinces, Scotland and British Columbia operations. We currently lease or have established similar rights to natural water sources in all of our other geographic markets. Our rights to these natural water supplies expire in 2004 for our Alberta source and 2011 for our England source. We do not have long-term agreements for our Oregon and Washington natural water supplies. For our British Columbia, Alberta and United States operations, we draw water for our premium and steam-distilled products from public sources pursuant to standard terms for the municipality or from local sources pursuant to non-exclusive, short-term contracts. These contracts generally provide us the right but not the obligation to draw water. We believe that there are alternative sources of water in each region in which we operate and we are not dependent on any one source of water. Table of Contents The Bottling Process We draw water for our premium and steam-distilled drinking water products at our bottling facilities, saving the cost of transportation. In all of our markets where we offer spring water, we currently transport the spring water to one of our bottling facilities by dedicated stainless steel tankers, except in the Maritime Provinces of Canada, where we bottle spring water at the source. In most instances, we hire a third party to transport the spring water. We operate 12 bottling facilities located in British Columbia, Alberta and the Maritime Provinces of Canada, the states of Oregon and Washington in the United States, and England and Scotland in the United Kingdom. Each facility contains purification and related equipment to appropriately process the water and an automated bottling line with various bottling capacities that bottles and seals the water for delivery to one of our distribution centers. Our bottling plants operate at our high-quality standards through constant review and monitoring of Good Manufacturing Practices under relevant regulations governing such plants. See Facilities for a more detailed description of our bottling facilities. Distribution As of May 31, 2002, we owned or leased approximately 340 beverage trucks and employed 440 people in our distribution operations. We generally deliver our products to neighborhoods within a 90 minute drive from one of our 31 distribution centers. Each truck has a useful life of between 7 to 12 years and can hold 120 to 300 five-gallon bottles. Since our drivers are generally paid on a per delivered bottle basis, we promote higher utilization of our delivery trucks by encouraging our drivers to assist us in enhancing delivery efficiency. On average, a delivery driver services between 500 and 1,100 water cooler rental and other customer locations. The average customer typically receives delivery once every two weeks. In addition, our drivers actively generate sales and are compensated for each new customer contract they originate. We believe that one of the most important success factors in the delivered bottled water business is delivery route efficiency, as the average cost of local delivery per bottle is over five times the cost of preparing and filling one bottle for distribution. However, the marginal distribution cost of delivering an additional bottle on an existing route is relatively low. Facilities Our various businesses operate through a total of 33 offices, 31 distribution facilities and 12 bottling sites, aggregating over 500,000 square feet. Generally, our policy is to maintain technologically-advanced and modern facilities. Our facilities are either leased or owned. We own all of our bottling lines and purification and related equipment. All our owned facilities are subject to a security interest granted to secure indebtedness under our senior credit facility. See Management s Discussion and Analysis of Financial Condition and Results of Operations . Our Scotland facilities are subject to a separate mortgage. We believe that our production plants and distribution facilities are well maintained and generally adequate to meet our needs in our existing markets for the foreseeable future. (1) Our Victoria plant is scheduled to be relocated to a larger, modern facility in January 2003. We are negotiating construction costs and lease terms. Competition We compete in the bottled water market directly with other home and office delivery companies in our geographic markets. We compete with these companies in both the sale and delivery of bottled water and the rental of water coolers. The home and office delivery market is highly fragmented, with the vast majority of the companies being operated as small entrepreneurial and family-owned businesses. In 2001, we believe the five largest home and office delivery companies accounted for approximately 60% of the total market in terms of sales in the United States, Canada and the United Kingdom. We believe we are the fifth such largest company. The other four are Nestl , Suntory, Danone/ McKesson and Culligan. Each of those companies possesses greater financial, personnel, marketing and other resources than us, and may possess greater name recognition. We believe we are the bottled water home and office delivery market share leader in Western Canada and the Maritime Provinces of Canada, in the states of Oregon and Washington in the United States and in Scotland based on our estimates of water cooler rental and customer locations. We also believe we have the third-largest market share in England (behind A.S. Watson and Nestl ). Table of Contents Quality of service and reliability of delivery are the primary competitive factors in the bottled water home and office delivery market and we believe we compete favorably in both of those areas. In addition to other bottled water home and office delivery companies, we also compete with warehouse and retail stores for the sale of water coolers, particularly in Canada. We compete indirectly for water sales with tap water producers and companies that distribute water through retail stores and vending machines and with other beverage companies. Some of the companies in the retail bottled water market are large and well-capitalized and have well-recognized brand names. These companies include PepsiCo., selling Aquafina, Coca-Cola, selling Dasani, Danone/ McKesson, selling Evian, and Nestl , selling Perrier. We believe any of these or other companies could choose to enter our markets and compete with us or expand their presence in our markets. We also compete with providers of on-premises water filtration systems, including systems distributed through retail outlets. In certain markets, we market and provide on-premises water filtration systems. Customers We have grown from a base of approximately 107,000 water cooler rental and customer locations at December 31, 1997 to a base of approximately 248,000 water cooler rental and customer locations as of May 31, 2002, consisting of approximately 198,000 water coolers rented from us and approximately 50,000 customers who do not rent our water coolers but purchase our bottled water or other products or services. We believe that the diversity of our customer base protects us from reliance on any one customer or customers in a particular industry. Organizational Structure and Company History Sparkling Spring Water Limited, or SSWL, was founded in 1971 in Halifax, Nova Scotia to operate in the bottled water industry. In 1988, SSWL was acquired by Maritime Beverages Limited, a Pepsi-Cola bottler, which was managed by G. John Krediet, Stewart E. Allen and K. Dillon Schickli. When Maritime Beverages Limited sold its soft drink bottling holdings to Pepsi-Cola Canada Limited in 1992, Mr. Krediet retained his interest in SSWL and he and Mr. Allen focussed their efforts on growing and improving its bottled water business. Sparkling Spring Water Holdings Limited was formed under the laws of Nova Scotia, Canada on October 20, 1997. Sparkling Spring Water Group Limited, or SSWGL, was formed on October 22, 1997 and it acquired all of the shares of SSWL. In the fourth quarter of 1998, SSWGL was reorganized through (1) the exchange of certain shares, and options to acquire shares, of SSWGL on a one-for-one basis for shares, and options to acquire shares, of Sparkling Spring Water Holdings Limited and (2) the acquisition by Sparkling Spring Water Holdings Limited of all remaining shares and options of SSWGL. The reorganization resulted in Sparkling Spring Water Holdings Limited owning 100% of the issued and outstanding shares of SSWGL as of December 31, 1998. At the end of 2000, SSWL was amalgamated with SSWGL. The new amalgamated company continues under the name Sparkling Spring Water Group Limited and continues to operate and own a number of our subsidiaries. Table of Contents Three Months Ended Year Ended December 31, March 31, Sparkling Spring Water Group Limited Nova Scotia Canadian Springs Water Company AB Limited Nova Scotia Polaris Water Company Inc. Nova Scotia PSW Acquisition, Inc. Nova Scotia 639540 B.C. Ltd. British Columbia Whistler Water Inc. Nova Scotia Crystal Spring Acquisition, Inc. Delaware Cullyspring Water Co., Inc. Washington Pure Water Corporation Washington Spring Water Incorporated Delaware Nature Springs Water Company Limited England Water at Work Limited Scotland Legal Proceedings In 2000, a company we acquired in May 2001 entered into a packaging agreement with Life O2 International, a distributor, to manufacture and package spring water in small packaged bottles. From 2000 to early 2002, our predecessor and we sold over 12,000,000 bottles of spring water to Life O2 International and its successor, BEVSystems International, Ltd. A Japanese customer of Life O2 and BEVSystems in turn sold the water to consumers and retailers. In February 2002, the customer claimed to have found a non-toxic mold growth in some of the bottles produced in April 2001 and unilaterally and voluntarily recalled all of the bottles it distributed. On April 17, 2002, we received a letter from counsel to BEVSystems threatening to bring legal action to pursue its legal remedies based on our alleged breach of contract and negligence. The letter states that BEVSystems currently estimates its losses to be in excess of $3.0 million, and that its customer is seeking significant compensation for lost profits and damage to its reputation. The letter also states that the Japanese government has informed the Canadian government and Canadian Food Inspection agency of the matter and that they are currently conducting their own investigation. We believe we have meritorious defenses to BEVSystems claims. We believe that we manufactured and packaged the bottled water we sold to BEVSystems in compliance with the specifications in our agreement. We also believe that the mold growth, which does not pose a health hazard, was not related to our bottling procedures or distribution of the bottles. If BEVSystems or its customer brings legal action against us, we intend to defend vigorously against their claims and do not anticipate that any such action would have a material adverse effect upon us or our assets. We are not a party to any other litigation other than routine legal proceedings incidental to our business. We do not expect that these proceedings will individually, or in the aggregate, have a material adverse effect on us. Regulations Our operations and properties are subject to regulation by various governmental entities and agencies. As a beverage producer, we are subject to production, packaging, quality, label and distribution standards in each of the countries where we operate. These standards are principally We have approximately 180 unionized employees in British Columbia who work in the areas of production and distribution. Most of these employees are parties to a collective bargaining agreement that expires in October 2002. We have not experienced any material slow downs or work stoppages in recent years, and we consider our employee relations to be good. From time to time, our employees engage in unionizing activities that may or may not result in collective bargaining agreements. G. John Krediet 51 Chairman of the Board of Directors and Chief Executive Officer Stewart E. Allen 43 Vice Chairman and Director K. Dillon Schickli 49 President, Chief Operating Officer, Chief Financial Officer and Director C. Sean Day 53 Director Joseph J. Heffernan 56 Director Jan Niessen 38 Director Kenneth B. Rotman 35 Director Joost E. Tjaden 52 Director Certain biographical information about each of these individuals is set forth below: G. John Krediet has been our Chairman of the Board of Directors and Chief Executive Officer since 1993. From 1987 to 1993 he served as Chairman of the Board of Maritime Beverages Limited, a Pepsi-Cola franchisee and former parent company of Sparkling Spring Water Limited. From 1987 through 1993, Mr. Krediet also served as Chairman of the Board of Eastcan Beverages Ltd., the Pepsi-Cola franchise for the territory in and around Ottawa, Ontario, Canada. In 1987, Mr. Krediet founded C.F. Capital Corporation, a consulting and management company. Prior to 1987, Mr. Krediet worked for Citibank from 1976 to 1980, AMRO Bank from 1980 to 1983 and General Electric Credit Corporation from 1983 to 1986. Mr. Krediet received his graduate degree in economics from Erasmus University in Rotterdam. Stewart E. Allen has been our Vice Chairman of the Board of Directors since January 2002, and has served as a member of the Board of Directors since 1992. Mr. Allen was our President and Chief Operating Officer from 1992 through 2001. Mr. Allen was a director of the Canadian Bottled Water Association from 1993 to 1997 and was President of that association in 1997. He has been a member of the Board of Directors of the International Bottled Water Association since 1998 and a director of the International Council of Bottled Water Association since 1996 and was Chairman of the Council from 1999 to 2000. He served as Vice President of Sales and Marketing for Maritime Beverages Limited from 1988 to 1992. K. Dillon Schickli has been our President and Chief Operating Officer since January 2002 and our Chief Financial Officer since 1998. Mr. Schickli has been a member of the Board of Directors since March 2000. Since 1998, Mr. Schickli has been the President of C.F. Capital Corporation, a position he previously held from 1987 to 1992. Mr. Schickli has over 15 years of beverage industry experience, including service as a member of the Board of Directors and the Executive Committee of Maritime Beverages Limited from 1987 to 1992, and Chief Financial Officer from 1981 to 1986 of Mid-South Bottling Company, a Pepsi-Cola franchise bottler. From 1993 to 1995, Mr. Schickli was Chief Operating Officer and a member of the Board of Directors of Affinity Group, Inc., a database marketing and membership management company. In 1996, Mr. Schickli served as President and a member of the Board of Directors of Ivid Communications, Inc., a leading multimedia training company. From 1997 to 1998, Mr. Schickli was Chairman, Chief Executive Officer and a co-owner of Affinity Development Group, Inc., a consulting firm. Mr. Schickli earned an MBA in Accounting from the University of Chicago, a BA from Carleton College and has a Certificate of Public Accountancy from the University of Illinois. C. Sean Day has served as a member of our Board of Directors since 1997. Since 1999, Mr. Day has been Chairman of the Board of Directors of Teekay Shipping Corporation 10. Obligations Under Capital Leases and Other Debt The obligations under capital leases are recorded net of the related imputed interest calculated at an average rate of 10%. Total minimum annual lease commitments are as follows (thousands of dollars): 2002 $ 1,091 2003 909 2004 551 2005 518 2006 214 thereafter Table of Contents (NYSE: TK), a world leader in the marine oil transportation industry, and has served on Teekay s Board of Directors since 1998. Mr. Day has also been Chairman of the Board of Directors of Seagin International LLC since 1999. From 1989 until 1999, Mr. Day was President and Chief Executive Officer of Navios Corporation, a company engaged in the worldwide operation of ocean-going bulkships. Mr. Day is also a member of the Board of Directors of Kirby Corporation (NYSE: KEX), Genesee Wyoming, Inc. (NASDAQ: GNWR), CBS Personnel, California Pellett Mills and Transmarine Navigation Corp. Mr. Day received a B.B.S. in finance from the University of Cape Town and an MA in jurisprudence from Oxford University. Joseph J. Heffernan has served on our Board of Directors since June 2001. Mr. Heffernan has been the Chairman of the Board of Directors of Rothmans Inc., Canada s second-largest tobacco company, since 1999, and he served as Rothmans Inc. s President and Chief Executive Officer from 1990 to 1999. Mr. Heffernan also held positions with Rothmans International B.V. as Deputy Chief Executive (Americas, Asia and Pacific regions) from 1998 to 1999, and as Chief Executive (Americas region) from 1995 to 1998. From 1990 to 1998, he was also the President and Chief Executive Officer for Rothmans, Benson Hedges Inc. Mr. Heffernan is also currently a member of the Boards of Directors of Rothmans, Benson Hedges Inc., Co-Steel Inc. and Clairvest Group Inc. Mr. Heffernan received a Master of Science in Management from MIT and his BSc in Chemical Engineering from the University of Alberta. Jan Niessen has served on our Board of Directors since 2000. Since 1999, Mr. Niessen has been the Managing Director of Egeria B.V., an Amsterdam (NL) based private equity fund. Before joining Egeria, Mr. Niessen was Director of CVC Capital Partners B.V. from 1996 to 1999. Mr. Niessen is Chairman of the Board of Directors of World View Investment Management and a Member of the Board of Directors of Koninklijke Ahrend. Mr. Niessen received his graduate degree in economics at the Erasmus University of Rotterdam. He also holds an MBA from New York University. Kenneth B. Rotman has served as a member of our Board of Directors since 1996. Since 1995, Mr. Rotman has been Managing Director of Clairvest, a Toronto-based merchant bank. Mr. Rotman also served as Clairvest s Co-President from 1999 to 2000, and has served as Clairvest s Co-Chief Executive Officer since 2000. Mr. Rotman also serves on the Board of Directors of Allied Global Holdings, Inc., NRI Industries, Voxcom Inc., Signature Security Group Inc. and Clairvest. Mr. Rotman received a BA in Economics from Tufts University, a M.Sc. from the London School of Economics, and an MBA from New York University. Joost E. Tjaden has served on our Board of Directors since March 2002. Mr. Tjaden has been the Managing Director of Janivo Holding B.V. since 1993. Mr. Tjaden serves on the boards of several companies in the Netherlands and the United States, including Tele Atlas N.V., Rhein Biotech NV (Neuer Markt Frankfurt), Atex Media Solutions, Inc. (Norway Stock Exchange), and Fidelio Properties. Mr. Tjaden received an MBA in Business Administration from the University of Delft. The business address of our directors and executive officers is care of 19 Fielding Avenue, Dartmouth, Nova Scotia, Canada B3B 1C9. Board Composition Our Board of Directors consists of eight members. Immediately prior to the closing of this offering, our board will be divided into three classes that will be, as nearly as possible, of equal size. Each class of directors will be elected for a three-year term of office, and the terms will be staggered so that the term of only one class of directors will expire at each annual general meeting. Messrs. Krediet and Schickli will be our Class I directors, and their term will expire in 2003. Messrs. Day, Heffernan and Tjaden will be our Class II directors and their term will expire in 2004. Messrs. Allen, Niessen and Rotman will be our Class III directors and their term will expire in 2005. Prior to the expiration of a director s term, a director may only be removed by the Table of Contents affirmative vote of 75% of the shares present in person or by proxy at a meeting called for that purpose. The foregoing classification and removal provisions of the Board of Directors may have the effect of delaying or preventing changes in our control or management. There is no requirement in our Memorandum and Articles of Association or Nova Scotia law that our directors must retire at a certain age. Pursuant to a Shareholder Agreement among us and our shareholders, specified shareholders have the right to appoint members to the Board of Directors. In accordance with the Shareholder Agreement, Clairvest Group Inc. has appointed Messrs. Heffernan and Rotman to our Board of Directors; Egeria B.V. has appointed Messrs. Niessen and Schickli; Janivo Holding B.V. has appointed Mr. Tjaden; and G. John Krediet has appointed himself and Messrs. Allen and Day. The Shareholder Agreement will terminate concurrently with this offering. See Related Party Transactions Shareholder Agreement . Board Committees The Board of Directors has standing Compensation and Finance and Audit Committees, but no standing nominating committee. Each Board committee has a written charter outlining its duties and responsibilities, and a chair for each committee is elected by the Board. The Compensation Committee is comprised of three to five directors, and reviews and approves our compensation policies and programs, including share option programs and other incentive-based compensation. It is responsible for reviewing and approving the compensation paid to selected key executives and reviewing the performance of the Chairman and Chief Executive Officer. The Compensation Committee from time to time seeks outside advice to support recommendations and decisions. Current members of the Compensation Committee are Messrs. Day, Niessen and Rotman, who are all outside directors. The Finance and Audit Committee is comprised of three to five directors who are required to have sufficient financial experience and ability to enable them to capably discharge their responsibilities. The Finance and Audit Committee oversees and monitors our audit procedures and results, accounting and internal audit procedures, and banking and treasury activities. Current members of the Finance and Audit Committee are Messrs. Niessen, Rotman and Tjaden, who are all outside directors. Compensation of Directors Prior to January 1, 2002, members of our Board of Directors were not compensated for their services as directors other than for serving on Board committees. Committee members received $1,000 per committee meeting. Beginning on January 1, 2002, each year directors will receive options to purchase 1,000 of our common shares plus an additional 1,000 options to purchase our common shares for each Board committee on which they serve. The exercise price of the options will be equal to the fair market value of our common shares on the grant date. Directors are reimbursed for travel and other related expenses associated with the performance of their duties. There are no service contracts between us and any of our directors providing benefits to a director upon termination of service as a director. (1) Prior to 2002, Messrs. Krediet and Schickli were paid indirectly by us through C.F. Capital Corporation pursuant to the terms of a Management Agreement. According to the Management Agreement, C.F. Capital Corporation received a management fee from us in exchange for providing executive management and other services. The amount of the fee that we paid C.F. Capital Corporation in any year was based, in part, on our earnings performance. The Management Agreement also provided for us to pay up to $100,000 annually of the reasonable out-of-pocket disbursements and office expenses incurred by C.F. Capital Corporation in performing under the Management Agreement and to pay fees to C.F. Capital Corporation for investment banking services rendered by C.F. Capital Corporation. Pursuant to the Management Agreement, we paid C.F. Capital Corporation an aggregate of $1.3 million in 2001. Effective as of January 1, 2002, we terminated the Management Agreement that was in effect during 2001 and replaced it with a new one-year Management Agreement that provides for an aggregate payment of $1.0 million per year plus an annual bonus of up to $500,000 based on our financial performance. The new Management Agreement provides for Messrs. Krediet and Schickli to render management services to us. Our Compensation Committee intends to review the new Management Agreement annually. The new Management Agreement provides for expense reimbursement up to $100,000 annually but does not provide for C.F. Capital Corporation to receive consideration for investment banking advisory services. C.F. Capital Corporation is a consulting and management company owned by Mr. Krediet and its sole activity is to provide management services to us. See Related Party Transactions Management Agreement . (2) Contribution to defined contribution plan. The following table provides information relating to options to purchase our common shares granted to each of our three executive officers during the fiscal year ended December 31, 2001. In 2001, no stock appreciation rights were granted to the executive officers and none of our executive officers exercised options to purchase our common shares. The potential realizable value of the options presented below is calculated by assuming that the price of our common shares increases from the initial public offering price of $18.50 per share at assumed rates of share appreciation of 5% and 10%, compounded annually over the remaining term of the option, and subtracting from that result the total option exercise price. (a) Includes 30,000 options that expire March 2, 2006. In addition, in March 2002, Messrs. Krediet, Allen and Schickli received options to purchase 25,000, 25,000 and 50,000 common shares, which together represented 51% of the total options granted during the first four months of 2002. These options have an exercise price of $15.00 and expire in March 2012. Stock Option Plan Our Board of Directors adopted the Stock Option Plan in 1998. The Stock Option Plan permits us to grant options to purchase our common shares to our directors, officers, employees and consultants. The Stock Option Plan allows for the issuance of up to 1,837,464 common shares. As of May 31, 2002, options to purchase 1,032,464 common shares are outstanding under the Stock Option Plan and options to purchase 805,000 common shares remain available for grant. The Stock Option Plan is interpreted and administered by the Board of Directors or the Compensation Committee. Subject to the provisions of the Plan, our Board of Directors or the Compensation Committee selects the individuals eligible to receive awards, determines the terms and conditions of the awards granted, including the number of common shares covered by each option and the time or times when options will be granted and exercisable. An optionee s rights under the Stock Option Plan are not transferable or assignable. The exercise price of options granted under the Stock Option Plan is determined by the Board of Directors or the Compensation Committee. Options may not be granted with an exercise price less than the fair market value of the underlying common shares on the date of grant. Options typically are subject to vesting schedules and terminate 10 years from the date of grant unless otherwise stipulated by the Board of Directors or the Compensation Committee. Upon the exercise of options, the option exercise price must be paid in full in cash or in an alternative manner approved by our Board of Directors or Compensation Committee. The Stock Option Plan provides that in the event of any capital reorganization, amalgamation or transfer of all or substantially all of our assets, all outstanding options will accelerate and become fully vested. The Board of Directors may at any time amend or discontinue the Stock Option Plan and, in some circumstances, make adjustments to the number of shares subject to the Plan and to outstanding options. (1) Market value per share as of May 31, 2002 is based on the assumed initial public offering price of our common shares in this offering of $18.50 per share and, for Canadian dollar options, at an exchange rate of Cdn$1.5275 per U.S. dollar. (2) Includes 14,000 and 4,000 options expiring in September and November 2003. (3) Includes 4,000 and 10,000 options expiring in February and March 2006. (unaudited) (unaudited) (U.S. dollars in thousands, except per share amounts and location data) Consolidated Balance Sheet Data: Cash and cash equivalents $ 27,507 $ 9,774 $ 710 $ 9,882 $ 9,416 $ 7,475 $ 4,032 Total assets 106,999 106,571 102,600 115,427 138,756 110,392 133,189 Total debt(10) 104,799 112,316 107,426 115,191 116,259 112,851 108,461 Common shareholder s equity (deficiency) (8,960 ) (20,907 ) (20,473 ) (15,215 ) (1,696 ) (19,276 ) (1,566 ) Number of common shares outstanding 5,533,312 5,576,752 5,684,208 6,663,416 8,644,028 6,663,416 8,644,028 Egeria B.V. 2,926,757 33.86% 20.84% Nieuwe Herengracht 51 1018 VN Amsterdam The Netherlands G. John Krediet(1) 2,493,408 77,852 29.48% 18.21% Clairvest Group Inc. 1,377,507 26,920 16.20% 9.98% 1700 22 St. Clair Avenue East Toronto, Ontario M4T 253 Janivo Holding B.V. 677,430 7.84% 4.82% Post Box 544 3700 AM Zeist The Netherlands * Less than one percent (1) Excludes 25,000 common shares issuable upon exercise of options first exercisable more than 60 days after May 31, 2002. See Management Stock Option Plan for details regarding options. Also excludes 480,356 shares owned by Mr. Larson which are subject to a voting agreement which may give Mr. Krediet the right to vote the shares on all matters but with respect to which Mr. Krediet disclaims beneficial ownership. The voting agreement will terminate upon the closing of this offering. (2) Includes 480,356 shares owned by Mr. Larson which are subject to a voting agreement which may give Mr. Krediet the right to vote the shares on all matters but with respect to which Mr. Krediet disclaims beneficial ownership. The voting agreement will terminate upon the closing of this offering. (3) Excludes 45,000 common shares issuable upon exercise of options first exercisable more than 60 days after May 31, 2002. See Management Stock Option Plan for details regarding options. (4) Excludes 182,800 common shares issuable upon exercise of options first exercisable more than 60 days after May 31, 2002. See Management Stock Option Plan for details regarding options. (5) Excludes 7,000 common shares issuable upon exercise of option first exercisable more than 60 days after May 31, 2002. See Management Stock Option Plan for details regarding options. (6) Excludes 1,404,427 common shares and warrants for common shares held by Clairvest Group Inc., a public company of which Mr. Heffernan is a Director and beneficial owner. Also excludes 1,000 common shares issuable upon exercise of options first exercisable more than 60 days after May 31, 2002. See Management Stock Option Plan for details regarding options. (7) Excludes 2,926,757 common shares held by Egeria B.V., of which Mr. Niessen is Managing Director. Mr. Niessen, along with Peter Visser, another Managing Director of Egeria B.V., hold the power to vote or dispose of the shares, for which they disclaim beneficial ownership. Also excludes 3,000 common shares issuable upon exercise of options first exercisable more than 60 days after May 31, 2002, the proceeds of which Mr. Niessen intends to transfer to Egeria B.V. See Management Stock Option Plan for details regarding options. Table of Contents (8) Excludes 1,404,427 common shares and warrants for common shares held by Clairvest Group Inc., a public company of which Mr. Rotman is Co-Chief Executive Officer, Managing Director and beneficial owner. Also excludes 3,000 common shares issuable upon exercise of options first exercisable more than 60 days after May 31, 2002. See Management Stock Option Plan for details regarding options. (9) Excludes 677,430 common shares and warrants for common shares held by Janivo Holding B.V., of which Mr. Tjaden is a Director who holds the power to vote or dispose of the shares and with respect to which Mr. Tjaden disclaims beneficial ownership. Also excludes 2,000 common shares issuable upon exercise of options first exercisable more than 60 days after May 31, 2002. See Management Stock Option Plan for details regarding options. (10) Excludes: 1,404,427 common shares and warrants for common shares held by Clairvest Group Inc., a public company of which Mr. Rotman is Co-Chief Executive Officer, Managing Director and beneficial owner and Mr. Heffernan is a Director and beneficial owner; 2,926,757 common shares held by Egeria B.V., of which Mr. Niessen is Managing Director, and with respect to which Mr. Niessen disclaims beneficial ownership; and 677,430 common shares and warrants for common shares held by Janivo Holding B.V., of which Mr. Tjaden is a Director, and with respect to which Mr. Tjaden disclaims beneficial ownership. As of May 31, 2002, we believe there were four U.S. holders of our common shares holding an aggregate of 12.7% of our then outstanding common shares. Warrants In May 1999, we issued warrants to purchase an aggregate of 88,000 of our common shares at a purchase price of $7.73 per share. The warrants are exercisable at any time prior to the earliest of May 26, 2004, 60 days following the death of the holder and 30 days following the occurrence of the approval by our Board of Directors of a takeover bid for at least 90% of our company. The warrants were issued to G. John Krediet, Stewart E. Allen, C. Sean Day, Clairvest Group, Inc. and certain other investors in connection with a financing used to repurchase options to purchase our common shares held by a financial institution. Selling Shareholders If the underwriters exercise their option to purchase additional shares in this offering, the following holders of our common shares will sell their common shares through the exercise of the option as set forth in the table below. The percentage of beneficial ownership before the offering is based on 8,644,028 common shares outstanding as of May 31, 2002. The percentage of beneficial ownership after the offering reflects the 6,210,000 common shares offered by this Stephen Larson 24,000 $ 5.00 Option exercise Egeria B.V. 1,283,148 11.69 Investment in common shares Janivo Holding B.V. 674,764 14.82 Investment in common shares Table of Contents RELATED PARTY TRANSACTIONS Management Agreements Prior Management Agreement. Effective January 1, 2002, we terminated a Management Agreement between us, C.F. Capital Corporation, G. John Krediet (our Chairman of the Board and Chief Executive Officer and Director) and Stephen L. Larson. C.F. Capital Corporation is a consulting and management business owned by Mr. Krediet. The Management Agreement, which was entered into in 1993 and subsequently amended, provided that C.F. Capital Corporation would perform certain management services for us, including managing our operations, negotiating contracts and managing our financial arrangements. Extraordinary actions, such as material acquisitions, capital expenditures in excess of 10% of our annual budget, issuances of securities, the sale or disposition of a material portion of our business or assets, mergers, liquidations, the declaration of dividends, and the determination of our annual budget required approval from our Board of Directors. In consideration for these services, including Messrs. Krediet and K. Dillon Schickli (our President, Chief Operating Officer, Chief Financial Officer and Director) acting as our officers, we paid an annual fee to C.F. Capital Corporation plus additional bonuses based on our financial performance. We also paid up to $100,000 annually of the reasonable out-of-pocket disbursements and office expenses incurred by C.F. Capital Corporation in performing services under the Management Agreement and paid fees to C.F. Capital Corporation in consideration of investment banking advisory services rendered in connection with our acquisitions of other businesses. Pursuant to the Management Agreement, we paid C.F. Capital Corporation an aggregate of $1.0 million in 1999, $1.4 million in 2000 and $1.3 million in 2001. In addition, the Management Agreement provided that we could compensate Messrs. Krediet and Schickli with stock options, incentives or other remuneration in accordance with industry standards. See Management Stock Plans and Management Compensation of Executive Officers . New Management Agreement. Effective January 1, 2002, we entered into a new Management Agreement with C.F. Capital Corporation, G. John Krediet and K. Dillon Schickli. Pursuant to the new Management Agreement, C.F. Capital Corporation has agreed to perform services for us similar to the services performed under the prior Management Agreement, including the provision of management services of Messrs. Krediet and Schickli. C.F. Capital Corporation s sole activity is to provide management services to us. The new Management Agreement provides for a payment to C.F. Capital Corporation of $1.0 million per year plus an annual bonus of up to $500,000 based on our financial performance. The Management Agreement has a term of one year that automatically renews for subsequent one-year terms unless terminated by either party 30 days prior to its renewal. Our Compensation Committee intends to review the new Management Agreement annually. The new Management Agreement provides for expense reimbursement up to $100,000 annually but does not provide for C.F. Capital Corporation to receive consideration for investment banking advisory services. Shareholder Agreement On July 31, 2000, we entered into a Shareholder Agreement with G. John Krediet, Clairvest Group, Inc., Egeria B.V., Stephen L. Larson, Lucy Stitzer, Stewart E. Allen, K. Dillon Schickli and other of our shareholders. We supplemented the Shareholder Agreement in March 2001 with a Supplemental Shareholder Agreement. The Shareholder Agreement provides registration rights, preemptive rights, rights of first refusal, voting and other rights in connection with specified matters of corporate governance and other rights and obligations of the shareholders and us. Effective as of the closing of this offering, the Shareholder Agreement will terminate by its terms, other than certain registration rights, which will be replaced as described below. Table of Contents Registration Rights Agreement Prior to the closing of this offering, we intend to enter into a Registration Rights Agreement between us and Clairvest Group, Inc., Egeria B.V. and G. John Krediet that will become effective on the closing of this offering and replace the registration rights of these parties under the Shareholder Agreement. The Registration Rights Agreement will provide that each of Clairvest Group Inc., Egeria B.V. and Mr. Krediet will have the right, subject to qualifications, to demand that we register with the SEC common shares held by them. In addition, in the event that we voluntarily register our common shares with the SEC, each such shareholder may require, subject to qualifications, that we register some of their common shares at the same time. We will agree to bear the expenses for any such registrations. See Shares Eligible for Future Sale . Share Transactions with Executive Officers In December 1996, we received a promissory note from Stewart E. Allen, our Vice Chairman, in the amount of $108,000, in connection with his purchase of common shares of Sparkling Springs Water Group Limited, which shares were subsequently exchanged for our common shares. This promissory note bore interest at a rate of 7% and was scheduled to mature on January 31, 1998, with principal and interest due on that date. The promissory note was cancelled by us and replaced with a promissory note from Mr. Allen in the principal amount of $116,300, which bore interest at a rate of 6% and was due to mature on January 31, 1999. On January 31, 1999, Mr. Allen paid interest due of $6,978. On January 31, 2000, 2001 and 2002, Mr. Allen paid interest on his note, and on each such date the promissory note of the preceding year was either extended or cancelled by us and replaced with a new promissory note in the same amount and due one year after that date. The principal and interest on Mr. Allen s presently outstanding promissory note are due January 31, 2003. Mr. Allen repaid the note in May 2002. In May of 1999, we issued common shares and warrants or options to purchase common shares to our shareholders, including our officers, directors and employees, at a price of $7.7325 per common share. In connection with these sales, we issued 6,000, 6,360 and 44,852 of our common shares and a like amount of warrants or options to purchase our common shares to K. Dillon Schickli, Stewart E. Allen, and Gaspar Limited, a company owned by a trust established for the benefit of Mr. Krediet and his children. The common shares and warrants purchased by Gaspar Limited were acquired by G. John Krediet in 1999. See Principal and Selling Shareholders Warrants . In July 2000, K. Dillon Schickli purchased 4,000 of our common shares from us for $11.69 per share. Share and Option Exchange Agreements In connection with our reorganization in 1998, we exchanged equity interests of Sparkling Spring Water Group Limited for our common shares and options to purchase our common shares pursuant to share and option exchange agreements. See Business Organizational Structure and Company History . Some of our directors, officers and other employees were parties to the share and option exchange agreements. Some of these agreements, among other things, provide us rights of first refusal with respect to the sale of the shares and provide us the right to purchase, and the holders the right to sell, the shares at fair market value. We intend to terminate the share and option exchange agreements effective upon the closing of this offering. Table of Contents DESCRIPTION OF CAPITAL STOCK The following description of our capital stock summarizes the material provisions of our Memorandum and Articles of Association that will become effective as of the closing of this offering, and applicable laws. Prospective investors are urged to read our Memorandum and Articles of Association, copies of which have been filed as exhibits to the registration statement filed in the United States of which this prospectus forms a part. General We are a company organized under the laws of the Province of Nova Scotia, Canada, with an indefinite duration. We were formed on October 20, 1997, under the Companies Act (Nova Scotia) with registration number 0311657. Our Memorandum of Association provides that there are no restrictions on our objects and powers and that we have the express powers to (a) sell or dispose of our undertaking, or a substantial part thereof; (b) distribute any of our property in specie among our members; and (c) amalgamate with any company or other body of persons. Capital Stock Upon completion of this offering, our authorized share capital will consist of 100,000,000 common shares, without par value, and 50,000,000 special preferred shares, Cdn$1.00 par value per share. Pursuant to our Memorandum and Articles of Association, and subject to the rules of any stock exchange on which our shares are listed, our board of directors is authorized to issue any of our authorized but unissued shares. Common Shares Holders of common shares are entitled to one vote for each share held on all matters submitted to a vote of the shareholders, including the election of directors. Accordingly, holders of the majority of the common shares entitled to vote in any election of directors may elect all of the directors standing for election. Our Memorandum and Articles of Association do not provide for cumulative voting in the election of directors. There are no limitations on the rights of non-resident or foreign owners to hold or vote common shares. Subject to preferences that may be applicable to any of our special preferred shares outstanding at the time, holders of common shares are entitled to receive ratably such dividends, if any, as may be declared from time to time by our Board of Directors out of funds legally available therefor. See Dividend Policy . In the event of a liquidation, dissolution or winding up of Sparkling Spring, holders of common shares are entitled to share ratably in all assets remaining after payment of our liabilities and the liquidation preferences, if any, of any outstanding special preferred shares. Holders of common shares have no preemptive rights and no rights to convert their common shares into any other securities and there are no redemption provisions with respect to our common shares. The rights, preferences and privileges of holders of common shares are subject to, and may be adversely affected by, the rights of the holders of any series of special preferred shares which we may designate and issue in the future. Special Preferred Shares Our Memorandum and Articles of Association provide that our Board of Directors, without further action by the shareholders, may issue special preferred shares in one or more series and may fix the relative, participating, optional or other rights, preferences, privileges and restrictions, including the voting rights, redemption provisions (including sinking fund provisions), dividend rights, dividend rates, liquidation preferences and conversion rights, and the rights of shares constituting any wholly unissued series of special preferred shares. Our Board of Directors, without further shareholder approval, can issue special preferred shares with voting and conversion rights that could adversely affect the voting power of the holders of common shares. Table of Contents No special preferred shares were outstanding as of the date of this prospectus and we currently have no plans to issue special preferred shares. The issuance of special preferred shares in some circumstances may have the effect of delaying or preventing a change of control of us without further action by the shareholders, may discourage bids for the common shares at a premium over the market price of the common shares, and may adversely affect the market price and the voting and other rights of the holders of common shares. Modifications, Subdivisions and Consolidations In accordance with the Companies Act (Nova Scotia), the amendment of some rights of holders of a class of shares, including common shares, requires the approval of not less than two-thirds of the votes cast by the holders of such shares voting separately as a class at a special meeting of such holders. In circumstances where the rights of the class of shares may be amended, the shareholders have the right under the Companies Act (Nova Scotia) to dissent from such amendment and require us to pay them the then fair value of their shares. In addition, the rights of common shareholders may only be changed by altering our Articles, which requires a special resolution of all of our shareholders. A special resolution must be passed by not less than three-fourths of the shares of a company entitled to vote as are present in person or by proxy at any meeting called for that purpose and, unless approved by all of the shareholders of the company, must also be confirmed by a majority of shares entitled to vote as are present in person or by proxy at a subsequent confirmatory meeting not less than fourteen days, nor more than one month, from the date of the first meeting. Changes to the conditions attaching to special preferred shares of Sparkling Spring require the approval of the holders of special preferred shares in accordance with the special preferred share conditions. Dividend Rights The Companies Act (Nova Scotia) does not address the payment of dividends and it is generally understood that the common law of Nova Scotia permits the payment of dividends out of profits and in any case where payment would not impair the capital of the company. The Memorandum and Articles of Association permit the directors to declare such dividend as they deem proper out of the profits, retained earnings or contributed surplus of the company upon shares of the company so long as such dividends are declared in accordance with the respective rights thereto of common shares and special preferred shares as set forth in the Memorandum of Association. The conditions attaching to the special preferred shares provide that the special preferred shares shall rank in priority to common shareholders with respect to priority to, and payment of, dividends. However, we have never declared or paid any dividends on our capital stock and we intend to retain earnings, if any, to fund the operation and growth of our business and do not anticipate paying any cash dividends in the foreseeable future. See Dividend Policy . Change of Control Under the Companies Act (Nova Scotia), a statutory amalgamation requires the approval of a three-quarters majority of the votes cast by the holders of shares entitled to vote, and if any class or series is entitled to vote thereon as a class, the affirmative vote of two-thirds of the shares within each class or series entitled to vote separately. The amalgamation must also be approved by the Supreme Court of Nova Scotia before it becomes effective. The Companies Act (Nova Scotia) provides for class voting in order to approve certain matters including sales of substantially all of our assets, whether or not the shares otherwise carry the right to vote. Such matters shall be deemed to be adopted by the shareholders when, among other things, approved by the holders of each class and series by a majority of not less than two-thirds of the votes cast. Table of Contents Appraisal Rights Under the Companies Act (Nova Scotia), a shareholder of a company participating in certain major corporate transactions may be entitled to dissenters rights or to appraisal rights. Major corporate transactions include changing or removing any restriction upon the business or businesses that the company may carry on, amalgamating with another company, other than any wholly-owned subsidiary of the company, continuing under the laws of another jurisdiction, or selling, leasing or exchanging all or substantially all its property other than in the ordinary course of business of the company. Pursuant to these rights, such shareholder may receive cash in the amount of the fair market value of the shares held by such shareholder (as determined by a court or by agreement of Sparkling Spring and the shareholder) in lieu of the consideration such shareholder would otherwise receive in the transaction. Ownership Restrictions There is no law or governmental decree or regulation in Canada that restricts the export or import of capital, or affects the remittance of dividends, interest or other payments to non-resident holders of our common shares, other than withholding tax requirements. There is no limitation imposed by Canadian law or by our Memorandum and Articles of Association on the right of a non-resident to hold or vote common shares, other than as provided by the Investment Canada Act, the North American Free Trade Agreement Implementation Act (Canada) and the World Trade Organization Agreement Implementation Act. The Investment Canada Act requires notification and, in specified cases, advance review and approval by the Government of Canada of the acquisition by a non-Canadian of control of a Canadian business , all as defined in the Investment Canada Act. Generally, the threshold for review will be higher in monetary terms for a member of the World Trade Organization or North American Free Trade Agreement. Election and Removal of Directors Our Board of Directors consists of eight members divided into three classes that will be, as nearly as possible, of equal size. Each class of directors is elected for a three-year term of office, and the terms are staggered so that the term of only one class of directors expires at each annual general meeting. In addition, we have 90 days advance notice requirements for nomination of directors for election. Prior to the expiration of a director s term, a director will only be removed by the affirmative vote of the shareholders attending a meeting for that person and who hold at least 75% of the common shares present in person or by proxy at a meeting called for that purpose. Interested Transactions Our Articles of Association provide that a director must declare the nature of any direct or indirect interest in a proposed contract at the first meeting of the Board of Directors at which the proposed contract is considered. A general notice to the Board of Directors to the effect that a director is a member of another company and may be regarded as interested in any contract entered into between us and that company is deemed a sufficient declaration of the interest in the contract. Our Articles of Association do not prevent directors from voting on interested transactions or as to their compensation. In addition, our Articles of Association do not limit a director s ability to borrow from us. Meetings of Shareholders Our ordinary general meetings are held at least once every calendar year, at such time and place as may be determined by the directors, and not later than 15 months after the preceding ordinary general meeting. All of our other shareholders meetings are called special general Table of Contents meetings. Ordinary or special general meetings may be held either within or outside the Province of Nova Scotia. Under the Companies Act (Nova Scotia) special meetings of shareholders may be called as provided in the Articles of Association or on the requisition of the holders of not less than five percent of the shares of the company carrying the right to vote at the meeting sought to be held. Our Articles of Association provide that special meetings of the shareholders may be called upon seven days prior written notice by the President, a Vice President or the directors. The accidental omission to give notice to a shareholder or non-receipt of a notice by a shareholder does not invalidate any resolution passed at any general meeting. There are no provisions in our Articles of Association with respect to the conditions of admission to our shareholders meetings. We have 90 day advance notice requirements for proposing matters that can be acted on by shareholders at meetings. Table of Contents UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS In the opinion of Perkins Coie LLP, U.S. tax counsel to Sparkling Spring, the summary below of U.S. federal income tax considerations describes the material U.S. federal income tax matters expected to be relevant to U.S. Holders (as defined below) who hold our common shares as a capital asset. This discussion is based upon, as of the date hereof, the applicable provisions of the U.S. Internal Revenue Code of 1986, as amended (the Code ), Treasury Regulations promulgated or proposed thereunder, and administrative and judicial interpretation thereof, all of which are subject to change either prospectively or retroactively, or are subject to different interpretations. Sparkling Spring has not obtained, nor does it intend to obtain, a ruling from the Internal Revenue Service as to any United States federal income tax consequences discussed below and there can be no assurances that the Internal Revenue Service will not take contrary positions. As used herein, the term U.S. Holder means a beneficial owner of common shares that is for United States federal income tax purposes: a citizen or resident of the United States; a corporation, or other entity taxed as a corporation for United States federal income tax purposes, created or organized in or under the laws of the United States or any political subdivision thereof; an estate, the income of which is subject to United States federal income taxation regardless of its source; or a trust, if both (a) a United States court is able to exercise primary supervision over the administration of the trust, and (b) one or more United States persons have the authority to control all substantial decisions of the trust. The discussion below does not address all of the United States federal income tax consequences that may be relevant to U.S. Holders in light of their particular circumstances, nor does it address the tax consequences to U.S. Holders subject to special treatment under the United States federal income tax laws, such as: certain financial institutions; insurance companies; traders in securities that elect to mark-to-market; securities dealers; partnerships or other entities classified as partnerships for United States federal income tax purposes; tax-exempt organizations; persons that hold the common shares as part of an integrated investment (including a straddle); persons owning, directly, indirectly or constructively, 10% or more of voting stock of Sparkling Spring; and persons whose functional currency is not the U.S. dollar. The discussion also does not address the tax consequences arising under the laws of any foreign, state or local jurisdiction. Prospective investors are urged to consult their own tax advisors as to the federal, state and other tax consequences of acquiring, holding and disposing of Sparkling Spring common shares. Table of Contents General Distributions Subject to the discussion under Special Tax Provisions below, distributions of cash or property made by Sparkling Spring with respect to the common shares will constitute dividends to U.S. Holders, to the extent that the distributions are made out of current or accumulated earnings and profits of Sparkling Spring (as determined for United States federal income tax purposes). Dividends paid by Sparkling Spring are includible in a U.S. Holder s gross income and are taxable as ordinary income. If a portion of a distribution made by Sparkling Spring with respect to the common shares exceeds its current and accumulated earnings and profits, that portion will be treated as a nontaxable return of capital, which will reduce the U.S. Holder s adjusted basis in the common shares (but not below zero). To the extent a distribution exceeds the U.S. Holder s adjusted basis in the common shares, the distribution will constitute capital gain. Dividends received by a corporate U.S. Holder from Sparkling Spring generally will not be eligible for the dividends received deduction. For United States foreign tax credit purposes, a distribution treated as a dividend for United States federal income tax purposes will constitute income from sources outside the United States. In the case of U.S. Holders who are not residents of Canada, the Canada-United States Income Tax Convention (1980), as amended (the Convention ), provides that dividends received in respect of the common shares generally will be subject to a 15% Canadian withholding tax. Subject to limitations set forth in the Code, as modified by the Convention, including certain minimal holding periods, U.S. Holders may elect to claim a foreign tax credit against their U.S. federal income tax liability for Canadian tax withheld from dividends paid in respect of common shares. The limitation on foreign taxes eligible for the foreign tax credit is calculated separately with respect to specific classes of income. For this purpose, dividends paid by Sparkling Spring generally will constitute passive income , or in the case of certain U.S. Holders, financial services income . The rules relating to the United States foreign tax credit are extremely complex and the availability of the foreign tax credit depends on numerous factors. Prospective investors are urged to consult their own tax advisors concerning the application of the United States foreign tax credit rules in light of their particular circumstances. If a dividend is paid in a currency other than the U.S. dollar, the amount includible in a U.S. Holder s gross income will be the U.S. dollar value of the dividend, calculated by reference to the exchange rate in effect on the date the U.S. Holder receives the dividend, regardless of whether the payment actually is converted into U.S. dollars. Gain or loss, if any, that a U.S. Holder realizes as a result of currency exchange fluctuations during the period from the date the U.S. Holder includes the dividend in gross income to the date the U.S. Holder converts the payment into U.S. dollars will be treated as ordinary income or loss for United States federal income tax purposes. This gain or loss generally will be from sources within the United States for United States foreign tax credit purposes. Prospective investors are urged to consult their own tax advisors regarding any potential foreign currency gain or loss, in the event that a dividend is paid by Sparkling Spring in a currency other than the U.S. dollar and is not converted into U.S. dollars on the date of receipt. Dispositions Generally, subject to the discussion of Special Tax Provisions immediately below, upon a sale or other taxable disposition of the common shares, a U.S. Holder will recognize taxable gain or loss in an amount equal to the difference between the amount of cash and the fair market value of other property that the U.S. Holder receives in the sale or other taxable disposition (the amount realized ) and the U.S. Holder s adjusted tax basis in the common shares. Subject to the passive foreign investment company rules discussed below, the U.S. Holder s gain or loss will be capital gain or loss. The gain or loss will be long-term capital gain or loss if the common Table of Contents shares were held by the U.S. Holder for more than one year. Long-term capital gains recognized by certain non-corporate U.S. Holders (including individuals) are eligible for preferential United States federal income taxation rates. Any gain or loss recognized by U.S. Holders on a sale or other taxable disposition of the common shares generally will be treated as derived from U.S. sources for United States foreign tax credit purposes. The deduction of capital losses is subject to certain limitations under the Code. A capital loss realized by a non-corporate U.S. Holder is allowable as an offset against capital gain and up to $3,000 of ordinary income. Any capital loss not utilized in any taxable year by a non-corporate U.S. Holder may be carried forward indefinitely and used to offset capital gain and up to $3,000 of ordinary income in any future taxable year of the non-corporate U.S. Holder. A capital loss realized by a corporate U.S. Holder is allowable as an offset only against capital gain. Any capital loss not utilized by a corporate U.S. Holder first must be carried back and applied against capital gain in the three years preceding the year of the sale or other taxable disposition giving rise to the capital loss, and then may be carried forward to the five taxable years subsequent to the year of the sale or other taxable disposition. The amount that a corporate U.S. Holder generally may carry back is limited, however, to an amount that does not increase or produce a net operating loss in the carryback year. Backup Withholding and Information Reporting Backup withholding and information reporting requirements may apply to distributions made by Sparkling Spring to a U.S. Holder with respect to the common shares, or to the proceeds of a sale, redemption or other disposition of the common shares. Under the backup withholding rules, a paying agent may be required to withhold tax from a U.S. Holder s distributions or proceeds, if the U.S. Holder fails to furnish a correct taxpayer identification number and comply with certain certification procedures, or otherwise fails to comply with the applicable requirements of the backup withholding rules. Some U.S. Holders (including, among others, corporations) are exempt from the backup withholding requirements. Any amounts withheld under the backup withholding rules generally may be claimed by a U.S. Holder as a credit against the U.S. Holder s United States federal income tax liability and the U.S. Holder may be entitled to receive a refund, provided that the required information is furnished to the Internal Revenue Service. Special Tax Provisions Some provisions of the Code specifically deal with the United States federal income tax treatment of investments by U.S. persons in foreign corporations and may alter the United States federal income tax consequences described above or propose special rules for United States foreign tax credit purposes. Passive Foreign Investment Company U.S. persons owning shares of a passive foreign investment company ( PFIC ) are subject to a special United States federal income tax regime with respect to specified distributions received from the PFIC and gain from the sale or disposition of PFIC stock. A foreign corporation generally will be classified as a PFIC for United States federal income tax purposes in any taxable year in which, after applying relevant look-through rules with respect to the income and assets of subsidiaries, either: at least 75% of its gross income is passive income ; or on average at least 50% of the gross value of its assets is attributable to assets that produce passive income or are held for the production of passive income. For this purpose, passive income generally includes, among other things, dividends, interest, rents, royalties, gains from the disposition of passive assets and gains from commodities Table of Contents transactions, other than gains derived from qualified active sales of commodities and qualified hedging transactions involving commodities, within the meaning of applicable Treasury Regulations. Based on certain estimates of the gross income and gross assets of Sparkling Spring, Sparkling Spring does not believe that it currently is a PFIC, nor does Sparkling Spring anticipate becoming a PFIC in the foreseeable future. However, since PFIC status will be determined by Sparkling Spring on an annual basis and PFIC status depends upon the composition of Sparkling Spring s income and assets (including, among others, less than 25% owned equity investments), and the nature of its activities, from time to time, there can be no assurance that Sparkling Spring will not be considered a PFIC for any taxable year. In addition, Sparkling Spring will not obtain an opinion of counsel, and no ruling will be sought from the Internal Revenue Service, regarding the characterization of Sparkling Spring as a PFIC for United States federal income tax purposes. If Sparkling Spring is treated as a PFIC for any taxable year during which a U.S. Holder held common shares, some adverse consequences could apply to the U.S. Holder (see discussion below). For this reason, if Sparkling Spring is treated as a PFIC for any taxable year, a U.S. Holder may desire to make an election to treat Sparkling Spring as a qualified electing fund (a QEF ) with respect to the electing U.S. Holder. Generally, a QEF election should be made on or before the due date for filing the electing U.S. Holder s United States federal income tax return for the first taxable year in which the common shares are held by the U.S. Holder and Sparkling Spring is treated as a PFIC. If a timely QEF election is made, whether or not distributed by Sparkling Spring, the electing U.S. Holder will be required to annually include in gross income (a) as ordinary income, a pro-rata share of the ordinary earnings of Sparkling Spring, and (b) as long-term capital gain, a pro-rata share of the net capital gain of Sparkling Spring. An electing corporate U.S. Holder will not be eligible for the dividends received deduction with respect to the income or gain included in gross income under this rule. In addition, in the event that Sparkling Spring incurs a net loss for a taxable year, the loss will not be available as a deduction to an electing U.S. Holder, and may not be carried forward or back in computing the ordinary earnings and net capital gain of Sparkling Spring in other taxable years. In some cases in which a QEF does not distribute all of its earnings in a taxable year, electing U.S. Holders may be permitted to elect to defer the payment of some or all of their United States federal income taxes on the QEF s undistributed earnings, subject to an interest charge on the deferred tax amount. If Sparkling Spring is treated as a PFIC for any taxable year during which a U.S. Holder held common shares, Sparkling Spring will provide to a U.S. Holder, upon written request, all information and documentation that the U.S. Holder is required to obtain in connection with making a QEF election for United States federal income tax purposes. In general, if a U.S. Holder fails to make a timely QEF election (or mark-to-market election, see discussion below) for any taxable year that Sparkling Spring is treated as a PFIC, the United States federal income tax consequences to the U.S. Holder will be determined under the so-called interest charge method. Under the interest charge regime: any gain derived from the disposition of PFIC stock (possibly including a gift, an exchange in a corporate reorganization, or a grant as security for a loan), as well as any excess distribution that is received from the PFIC (i.e., a distribution that exceeds 125% of the average distributions from the shorter of the prior three years, or the U.S. Holder s holding period for the stock), will be treated as ordinary income that was earned ratably over each day in the U.S. Holder s holding period for the PFIC stock; the portion of the gain or distribution that is allocable to prior taxable years, other than any year before Sparkling Spring became a PFIC, will be subject to United States federal income tax at the highest rate applicable to ordinary income for the relevant taxable years, regardless of the tax rate otherwise applicable to the U.S. Holder; and Table of Contents an interest charge will be imposed on the resulting United States federal income tax liability as if such liability represented a tax deficiency for the past taxable years, other than any year before Sparkling Spring became a PFIC. In addition, a step-up in the tax basis of the PFIC stock may not be available upon the death of a non-corporate U.S. Holder. In many cases, application of the interest charge regime will have substantially more onerous United States federal income tax consequences than would result if a timely QEF election is made by a U.S. holder. Accordingly, if Sparkling Spring is treated as a PFIC for any taxable year, U.S. holders are urged to carefully consider whether to make a QEF election and the consequences of not making the election. As an alternative to the QEF election, a U.S. Holder of marketable stock in a PFIC may make a mark-to-market election, provided the PFIC stock is regularly traded on a qualified exchange . Under applicable Treasury Regulations, a qualified exchange includes a national securities exchange that is registered with the SEC or the national market system established under the Securities Exchange Act of 1934. Under applicable Treasury Regulations, PFIC stock traded on a qualified exchange is regularly traded on the exchange for any calendar year during which the stock is traded, other than in de minimis quantities, on at least 15 days during each calendar quarter. Sparkling Spring cannot assure U.S. Holders that the common stock will be treated as regularly traded on a qualified exchange. If a valid mark-to-market election is made, the electing U.S. Holder generally would (a) include in gross income, entirely as ordinary income, an amount equal to the difference between the fair market value of the PFIC stock as of the close of the taxable year and the U.S. Holder s adjusted basis in the PFIC stock, and (b) deduct as an ordinary loss the excess, if any, of the adjusted tax basis of the PFIC stock over its fair market value at the end of the taxable year, but only to the extent of the amount previously included in income as a result of the mark-to-market election. Foreign Personal Holding Company U.S. persons owning, directly or indirectly (on the last day of the corporation s taxable year), shares of a foreign corporation that is a foreign personal holding company ( FPHC ) are required to include in their gross income a pro rata share of the FPHC s foreign personal holding company income that has not been distributed by the corporation to its shareholders during its taxable year. A foreign corporation will constitute a FPHC if more than 50% of its stock (by vote or value) is owned (directly or indirectly) by five or fewer individuals who are U.S. citizens or residents and at least 60% (50% in certain years following the year in which the corporation becomes a FPHC) of its gross income consists of foreign personal holding company income . Foreign personal holding company income includes interest, dividends, royalties, certain rents, and gain from the sale of stock or securities. Based upon the expected size and distribution of common shares in the offering and among current holders, Sparkling Spring does not expect to meet the FPHC stock ownership test immediately after the offering and, therefore, will not be a FPHC at such time. Sparkling Spring does not expect to meet the income test immediately after the offering and, therefore, will not qualify as a FPHC based upon our income. However, future changes of ownership and income could cause Sparkling Spring to become a FPHC. Table of Contents CAPITALIZATION The following table sets forth: our actual capitalization as of March 31, 2002; and our capitalization as adjusted to reflect (1) this offering at an assumed initial public offering price of $18.50 per share, after deducting an assumed underwriting commission and estimated offering expenses payable by us, (2) the redemption of our outstanding 11.5% senior subordinated notes due 2007 at their stated principal amount for $74.6 million plus a redemption premium of $4.3 million, (3) the repayment of $12.9 million of indebtedness outstanding under our senior credit facility and (4) the reclassification of our Class A common shares and Class B common shares into common shares, as if each had occurred on March 31, 2002. You should read the following table in conjunction with our consolidated financial statements and related notes and the unaudited pro forma consolidated financial statements and related notes included elsewhere in this prospectus. See Selected Consolidated Financial and Other Data , Use of Proceeds and Management s Discussion and Analysis of Financial Condition and Results of Operations . March 31, 2002 Table of Contents CANADIAN FEDERAL INCOME TAX CONSIDERATIONS In the opinion of Stewart McKelvey Stirling Scales, Canadian tax counsel to Sparkling Spring, the following summary is a general description of the principal Canadian federal income tax considerations generally applicable to the holders of common shares acquired pursuant to this offering who at all relevant times hold such common shares as capital property, deal at arm s length with Sparkling Spring, and are not affiliated with Sparkling Spring, all within the meaning of the Income Tax Act (Canada) (the Canadian Tax Act ). The common shares will generally be considered to be capital property to you unless held in the course of carrying on a business, in an adventure in the nature of trade, or as mark-to-market property for purposes of the Canadian Tax Act. Shareholders who will not hold their Sparkling Spring common shares as capital property should consult their own tax advisors regarding their particular circumstances, as this summary does not apply to these holders. This summary does not take into account the potential application to certain financial institutions , as defined in the Canadian Tax Act, of the mark-to-market rules. This summary is based on the current provisions of the Canadian Tax Act, the regulations thereunder, and counsel s understanding of the current published administrative practices and policies of the Canada Customs and Revenue Agency, all in effect as of the date of this document. This summary takes into account all specific proposals to amend the Canadian Tax Act or the regulations publicly announced by the Minister of Finance (Canada) prior to the date of this document, although no assurances can be given that the proposed amendments will be enacted in the form proposed, or at all. This summary does not take into account or anticipate any other changes in law, whether by judicial, governmental or legislative action or decision, nor does it take into account provincial, territorial or foreign income tax legislation or considerations, which may differ from the Canadian federal income tax considerations described herein. This summary should not be construed to be legal or tax advice to any particular holder of common shares. Accordingly, prospective investors are urged to consult their own tax advisors for advice with respect to the tax consequences to them of acquiring, holding and disposing of Sparkling Spring common shares. Holders Resident in Canada The following section of this summary applies to a holder of Sparkling Spring common shares who, for purposes of the Canadian Tax Act and any applicable tax treaty or convention, is or is deemed to be resident in Canada at all relevant times (referred to in this summary as a Canadian holder ). A Canadian holder whose Sparkling Spring common shares might not otherwise qualify as capital property may be entitled to obtain such qualification in certain circumstances by making an irrevocable election permitted by subsection 39(4) of the Canadian Tax Act. Taxation of Dividends In the case of a Canadian holder who is an individual, dividends received or deemed to be received by the holder on Sparkling Spring common shares will be included in computing the holder s income and will be subject to the gross-up and dividend tax credit rules normally applicable to taxable dividends received from taxable Canadian corporations. Dividends received by a corporation on Sparkling Spring common shares must be included in computing the corporation s income but generally will be deductible in computing its taxable income. A private corporation (as defined in the Canadian Tax Act) or any other corporation resident in Canada and controlled or deemed to be controlled by or for the benefit of an individual or a related group of individuals, generally will be liable under Part IV of the Canadian Tax Act to pay a refundable tax of 33 1/3% of dividends received or deemed to be received on Sparkling Spring common shares to the extent that such dividends are deductible in computing its taxable income. Actual As Adjusted Table of Contents Disposition of Common Shares A disposition or deemed disposition of Sparkling Spring common shares by a Canadian holder will generally result in a capital gain (or capital loss) equal to the amount by which the proceeds of disposition, net of any reasonable costs of disposition, exceed (or are less than) the adjusted cost base to the Canadian holder of such shares immediately before the disposition. Under the provisions of the Canadian Tax Act, one-half of any capital gain realized by a Canadian holder will be required to be included as a taxable capital gain in computing income for the year of disposition. One-half of any capital loss (an allowable capital loss ) realized by a Canadian holder may be deducted against taxable capital gains realized in the year of disposition. Subject to detailed rules contained in the Canadian Tax Act, any excess of allowable capital losses over taxable capital gains may be carried back up to three taxation years or forward indefinitely and deducted against net taxable capital gains of those other taxation years. Capital gains realized by an individual or trust (other than certain specified trusts) may be subject to alternative minimum tax under the Canadian Tax Act. If the Canadian holder of common shares is a corporation, the amount of any capital loss realized on the disposition or deemed disposition of a common share may be reduced by the amount of dividends received or deemed to have been received by it on such common share to the extent and under the circumstances prescribed by the Canadian Tax Act. Similar rules may apply where a corporation is a member of a partnership or beneficiary of a trust that owns common shares or that is itself a member of a partnership or a beneficiary of a trust that owns common shares. A Canadian-controlled private corporation (as defined in the Canadian Tax Act), may also be liable to pay a 6 2/3% refundable tax on certain investment income, including taxable capital gains. Holders Not Resident In Canada The following portion of the summary is generally applicable to a Sparkling Spring shareholder: who, at all relevant times, is neither a resident nor deemed to be a resident of Canada for purposes of the Canadian Tax Act and any applicable tax treaty or convention; who does not use or hold (and will not use or hold) and is not deemed to use or hold Sparkling Spring common shares in, or in the course of, carrying on a business in Canada; and to whom the Sparkling Spring common shares do not constitute taxable Canadian property for purposes of the Canadian Tax Act (referred to in this summary as a Non-Resident Shareholder ). Special rules which are not discussed in this summary apply to a non-resident that carries on an insurance business in Canada or elsewhere. Generally, Sparkling Spring common shares will not be taxable Canadian property to a Non-Resident Shareholder at a particular time provided that such shares are listed on a prescribed stock exchange (which includes the New York Stock Exchange and the Nasdaq National Market) at that time, and the holder, persons with whom the holder does not deal at arm s length, or the holder together with all such persons has not owned 25% or more of the issued shares of any class or series in the capital of Sparkling Spring at any time during the 60-month period that ends at the particular time. For this purpose, it is the position of the Canada Customs and Revenue Agency that holders of an interest in or option to acquire Sparkling Spring common shares will be considered to hold the common shares to which such interest or option relates. Common shares can be deemed to be taxable Canadian property in certain circumstances set out in the Canadian Tax Act. Table of Contents Taxation of Dividends Dividends on Sparkling Spring common shares paid or credited or deemed under the Canadian Tax Act to be paid or credited to a Non-Resident Shareholder generally will be subject to Canadian withholding tax at the rate of 25%, subject to any applicable reduction in the rate of withholding in any applicable tax treaty where the holder is a resident of a country with which Canada has an income tax treaty. If the Non-Resident Shareholder is a United States resident entitled to benefits under the Canada-United States Income Tax Convention, dividends on Sparkling Spring common shares generally will be subject to Canadian withholding tax at the rate of 15%. Disposition of Common Shares A Non-Resident Shareholder will not be subject to tax under the Canadian Tax Act in respect of any capital gain realized on the disposition of Sparkling Spring common shares. (unaudited; U.S. dollars in millions) Long-term debt (excluding current portions): Unsecured senior subordinated notes $ 74.6 Secured senior credit facility 26.3 $ 13.4 Other unsecured long-term obligations(1) 0.5 0.5 Other secured long-term obligations(2) 3.6 3.6 Table of Contents SHARES ELIGIBLE FOR FUTURE SALE U.S. Eligibility for Future Sales As described below, no common shares outstanding immediately before this offering will be available for sale in the United States immediately after this offering as a result of various contractual restrictions on resale. Sales of substantial amounts of our common shares in the public market after the restrictions lapse could adversely affect the prevailing market price and our ability to raise equity capital in the future. Upon completion of this offering, we will have 14,044,028 outstanding common shares, assuming no exercise of outstanding options or warrants after April 30, 2002. Of these common shares, the 5,400,000 common shares offered for sale through the underwriters, or 6,210,000 common shares if the underwriters exercise their option to purchase additional shares in this offering, will be freely tradable without restriction in the United States under the Securities Act of 1933 unless purchased by our affiliates or covered by a separate lockup agreement with the underwriters. Of the remaining 8,644,028 common shares, 35,596 common shares were offered and sold outside the United States to non-U.S. persons who are not affiliates of Sparkling Spring, 7,603,448 common shares are held by affiliates of Sparkling Spring and 1,004,984 common shares held by existing shareholders are restricted securities. Common shares held by affiliates of Sparkling Spring and restricted securities may be sold in the public market in the United States only if registered or if they qualify for an exemption from registration, including the exemptions described below under Rules 144, 144(k) or 701 promulgated under the Securities Act. As a result of the lockup agreements, which are described below, and the provisions of Rules 144, 144(k) and 701 described below, these shares will be available for sale in the U.S. public market as follows: no common shares may be sold on or before 180 days from the date of this prospectus without the written consent of Goldman, Sachs Co., subject to certain exceptions; 35,596 common shares were offered and sold outside the United States to non-U.S. persons who are not affiliates of Sparkling Spring and may be eligible to be resold freely in the United States upon expiration or waiver of the lockup agreement with the underwriters; and 8,608,432 of the common shares that are held by affiliates of Sparkling Spring or that are restricted securities will have been held long enough to be sold under Rule 144 or Rule 701 beginning upon expiration or waiver of the lockup agreement with the underwriters. Lockup Agreements. All of our officers, directors and shareholders have agreed that they will not, without the prior written consent of Goldman, Sachs Co., which consent may be withheld in its sole discretion, and subject to certain limited exceptions, directly or indirectly, offer, sell, contract to sell, pledge, grant any option to purchase, make any short sale or otherwise dispose of any of our common shares, options or warrants to acquire any of our common shares, or securities exchangeable or exercisable for, convertible into or that represent the right to receive any of our common shares currently owned either of record or beneficially by them, for a period beginning on the date of this prospectus and continuing to and including the date which is 180 days after the date of this prospectus. Goldman, Sachs Co. may, in its sole discretion and any time without notice, release all or any portion of the securities subject to these lockup agreements. Table of Contents Rule 144. In general, under Rule 144, a person, or group of persons whose shares are aggregated, that has beneficially owned any of our common shares that are restricted securities, as defined in Rule 144, for at least one year, is entitled to sell in the United States within any three-month period commencing 90 days after the date of this prospectus a number of shares that does not exceed the greater of: 1% of our common shares then outstanding, which will be approximately 140,440 shares immediately after this offering, or the average weekly trading volume of our common shares in the public market during the four calendar weeks immediately before the sale. Sales under Rule 144 are also subject to certain requirements as to the manner of sale, notice and availability of current public information about us. Rule 144(k). Under Rule 144(k), a person who is not deemed to have been one of our affiliates at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, including the holding period of any prior owner who is not one of our affiliates, is entitled to sell these shares in the United States without complying with the manner of sale provisions, availability of current public information requirement, volume limitations or notice requirements of Rule 144. Rule 701. In general under Rule 701, any of our employees, officers, directors, consultants or advisors who purchased or received shares from us before this offering under a compensatory stock or option plan or written agreement will be eligible to resell their shares in the United States in reliance on Rule 144. Non-affiliates will be able to sell their shares in the United States subject only to the manner of sale provisions of Rule 144. Affiliates are subject to all of the provisions of Rule 144 except that they will be able to sell their shares without compliance with the holding period requirement of Rule 144. Canadian Eligibility for Future Sales The 5,400,000 common shares sold in this offering, or 6,210,000 common shares if the underwriters exercise their option to purchase additional common shares in this offering, and qualified for sale in Canada by this prospectus in the Provinces of Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Prince Edward Island and Saskatchewan, which are referred to as the Qualifying Provinces , will be freely tradable under the securities laws of those provinces unless they are held by a control person within the meaning of Canadian securities laws. The remaining 8,644,028 common shares held by our existing shareholders, and common shares issuable upon the exercise of stock options granted prior to this offering, will be subject to resale restrictions in the Qualifying Provinces other than New Brunswick and Prince Edward Island. These resale restrictions will generally end one year from the date of this prospectus, except for common shares held by a control person within the meaning of Canadian securities laws. In some cases, the period will be reduced to four months for our employees, executives and consultants. The restrictions on resale imposed by the securities laws of the Qualifying Provinces may not in all cases apply to resales of our common shares by Canadian residents who make those resales in the United States. The common shares held by our existing shareholders, including those in Canada, will also be subject to the restrictions contained in lockup agreements to which each of them will be a party. See Shares Eligible for Future Sale U.S. Eligibility for Future Sales Lockup Agreements . Total long-term debt $ 105.0 $ 17.5 Shareholder s equity: Common shares, without par value, no shares authorized, issued or outstanding actual; and 100,000,000 shares authorized, and shares issued and outstanding as adjusted 134.3 Class A voting common shares, without par value; 10,000,000 shares authorized and 8,434,656 shares issued and outstanding actual; and no shares authorized, issued or outstanding as adjusted 41.2 Class B non-voting common shares, without par value; 10,000,000 shares authorized and 209,372 shares issued and outstanding actual; and no shares authorized, issued or outstanding as adjusted 1.3 Special preferred shares, Cdn$1.00 par value per share; 10,000,000 shares authorized and no shares issued and outstanding actual; and 50,000,000 shares authorized and no shares issued and outstanding as adjusted Subscriptions receivable (0.1 ) (0.1 ) Deferred stock-based compensation (0.5 ) (0.5 ) Cumulative translation adjustment (6.8 ) (6.8 ) Deficit (36.6 ) (40.9 ) Per Share $ $ $ $ $ $ Total $ $ $ $ $ $ Table of Contents Shares sold by the Underwriters to the public will initially be offered at the initial public offering price set forth on the cover of this prospectus. Any shares sold by the Underwriters to securities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any such securities dealers may resell any shares purchased from the Underwriters to certain other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial public offering price, the representatives may change the offering price and the other selling terms. An affiliate of TD Securities Inc. is an agent and lender under the senior credit facility Sparkling Spring intends to repay with part of the net proceeds of this offering. Because TD Securities Inc. is an Underwriter and may receive more than 10% of the entire net proceeds in this offering, the Underwriters may be deemed to have a conflict of interest under Rule 2710(c)(8) of the Conduct Rules of the National Association of Securities Dealers, Inc. Accordingly, this offering will be made in compliance with the applicable provisions of Rule 2720 of the conduct rules. Rule 2720 requires that the initial public offering price can be no higher than that recommended by a qualified independent underwriter , as defined by the NASD. Goldman, Sachs Co. has served in that capacity and performed due diligence investigations and reviewed and participated in the preparation of the registration statement of which this Prospectus forms a part. Goldman, Sachs Co. has received $10,000 from Sparkling Spring as compensation for such role. Sparkling Spring and its officers, directors and shareholders have agreed with the Underwriters not to dispose of or hedge any of their common shares or securities convertible into or exchangeable for common shares during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus, except with the prior written consent of Goldman, Sachs Co. This agreement does not apply to any existing employee benefit plans. See Shares Eligible for Future Sale for a discussion of certain transfer restrictions. Prior to this offering, there has been no public market for the shares. The initial public offering price will be negotiated among Sparkling Spring and the representatives of the Underwriters. Among the factors to be considered in determining the initial public offering price of the shares, in addition to prevailing market conditions, will be Sparkling Spring s historical performance, estimates of the business potential and earnings prospects of Sparkling Spring, an assessment of Sparkling Spring s management and the consideration of the above factors in relation to market valuation of companies in related businesses. In connection with this offering, the Underwriters may purchase and sell common shares in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the Underwriters of a greater number of shares than they are required to purchase in the offering. Covered short sales are sales made in an amount not greater than the Underwriters option to purchase additional shares from Sparkling Spring and the selling shareholders in this offering. The Underwriters may close out any covered short position by either exercising their option to purchase additional shares or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the Underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase additional shares pursuant to the option granted to them. Naked short sales are any sales in excess of such option. The Underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the Underwriters are concerned that there may be downward pressure on the price of the common shares in the open market after pricing that could adversely affect investors who purchase in the offering. Stabilizing transactions consist of various bids for or purchases of common shares made by the Underwriters in the open market prior to the completion of this offering. Total shareholders equity (deficit) (1.5 ) 86.0 Table of Contents The Underwriters may also impose a penalty bid. This occurs when a particular Underwriter repays to the other Underwriters a portion of the underwriting discount received by it because the representatives have repurchased shares sold by or for the account of such Underwriter in stabilizing or short covering transactions. Purchases to cover a short position and stabilizing transactions may have the effect of preventing or retarding a decline in the market price of the common shares, and together with the imposition of the penalty bid, may stabilize, maintain or otherwise affect the market price of the common shares. As a result, the price of the common shares may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued at any time. These transactions may be effected on a national securities exchange, in the over-the-counter market or otherwise. Each Underwriter represents, warrants and agrees that: (i) it has not offered or sold and, prior to the expiry of a period of six months from the closing date, will not offer or sell any common shares to persons in the United Kingdom except to persons whose ordinary activities involve them in acquiring, holding, managing or disposing of investments (as principal or agent) for the purposes of their businesses or otherwise in circumstances which have not resulted and will not result in an offer to the public in the United Kingdom within the meaning of the Public Offers of Securities Regulations 1995; (ii) it has only communicated or caused to be communicated and will only communicate or cause to be communicated any invitation or inducement to engage in investment activity (within the meaning of section 21 of the Financial Services and Markets Act of 2000 ( FSMA )) received by it in connection with the issue or sale of any shares in circumstances in which section 21(1) of the FSMA does not apply to the Issuer; and (iii) it has complied and will comply with all applicable provisions of the FSMA with respect to anything done by it in relation to the shares in, from or otherwise involving the United Kingdom. At the request of Sparkling Spring, the Underwriters are reserving up to 270,000 common shares for sale at the initial public offering price to directors, officers, employees and friends through a directed share program. The number of common shares available for sale to the general public in the public offering will be reduced to the extent these persons purchase these reserved shares. Any shares not so purchased will be offered by the Underwriters to the general public on the same basis as the other shares offered by this prospectus. The Underwriters do not expect sales to discretionary accounts to exceed five percent of the total number of shares offered. Sparkling Spring estimates that its share of the total expenses of this offering, excluding underwriting commissions, will be approximately $1.1 million. Sparkling Spring and the selling shareholders have agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act of 1933 and the securities laws of the Qualifying Provinces. Table of Contents LEGAL MATTERS Certain legal matters in connection with the common shares offered by this prospectus and certain tax matters will be passed upon for us by Stewart McKelvey Stirling Scales, Halifax, Nova Scotia, Canada, our Canadian counsel, and certain tax matters will be passed on for us by Perkins Coie LLP, Portland, Oregon, our United States counsel. Certain legal matters will be passed upon for the underwriters by Sullivan Cromwell, Palo Alto, California, United States counsel for the underwriters, and by Osler, Hoskin Harcourt LLP, New York, New York, Canadian counsel for the underwriters. Partners and associates of each of Stewart McKelvey Stirling Scales and Osler, Hoskin Harcourt LLP do not own any of the outstanding shares of Sparkling Spring or its subsidiaries, other than 21,000 common shares or options to acquire common shares held by a partner of Stewart McKelvey Stirling Scales. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174010_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174010_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174010_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174014_chapel_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174014_chapel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174014_chapel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174015_hatfield_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174015_hatfield_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174015_hatfield_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174022_oak-woods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174022_oak-woods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174022_oak-woods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174024_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174024_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174024_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174029_woodlawn_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174029_woodlawn_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174029_woodlawn_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174032_advance_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174032_advance_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174032_advance_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174034_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174034_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174034_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174042_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174042_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174042_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174043_robert_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174043_robert_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174043_robert_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174045_st_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174045_st_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174045_st_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174046_zs_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174046_zs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174046_zs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174054_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174054_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174054_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174056_carothers_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174056_carothers_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174056_carothers_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174057_westminste_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174057_westminste_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174057_westminste_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174062_neweol_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174062_neweol_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174062_neweol_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174066_funeral_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174066_funeral_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174066_funeral_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174070_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174070_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174070_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174073_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174073_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174073_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174083_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174083_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174083_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174086_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174086_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174086_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174088_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174088_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174088_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174094_riemann_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174094_riemann_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174094_riemann_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174095_stephens_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174095_stephens_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174095_stephens_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174101_advanced_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174101_advanced_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174101_advanced_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174108_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174108_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174108_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174110_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174110_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174110_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174121_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174121_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174121_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174124_dma-corp_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174124_dma-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174124_dma-corp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174137_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174137_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174137_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174139_evergreen_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174139_evergreen_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174139_evergreen_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174144_alderwoods_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174144_alderwoods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174144_alderwoods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174152_h-samson_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174152_h-samson_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174152_h-samson_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174221_northern_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174221_northern_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e4f11722f4ec9da1034a4bbe8be0ebaa3f101fd --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174221_northern_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities being offered by this prospectus will be passed upon for us by Bradley D. Stam, Senior Vice President, Legal & Asset Management of Alderwoods Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174742_ion-track_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174742_ion-track_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..012d454b201c88d9941e09992b2e2fa5eda6a0e5 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174742_ion-track_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered by this prospectus will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. Certain legal matters in connection with the offering will be passed upon for the underwriters by Willkie Farr & Gallagher, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001174799_valvino_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001174799_valvino_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..be0bb044e4a8cb70ed0337c69c79ed43465ad66e --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001174799_valvino_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Selected legal matters in connection with this offering, including the validity of the second mortgage notes offered hereby, will be passed upon for Wynn Las Vegas, Wynn Capital and the guarantors listed herein by Irell & Manella LLP, Los Angeles, California. Certain matters of Nevada law will be passed upon for Wynn Las Vegas, Wynn Capital and the guarantors listed herein by Schreck Brignone, Las Vegas, Nevada. Selected legal matters in connection with this offering will be passed upon for the underwriters by Latham & Watkins, Los Angeles, California. Latham & Watkins is acting as counsel to the underwriters for the second mortgage notes, the underwriters for the initial public offering of common stock of Wynn Resorts and the arrangers under the credit facilities. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001176585_monday_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001176585_monday_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e841c4a8543c0f0167693c2fc50fe83fb0d96ee --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001176585_monday_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the purchase contracts and the underlying Class A common shares offered by this prospectus will be passed upon for us by Conyers Dill Pearman, Hamilton, Bermuda. The validity of the issuance of the senior notes offered by this prospectus will be passed upon for us by Linklaters Loesch, Luxembourg. Certain legal matters of United States and New York law will be passed upon for us by Davis Polk Wardwell, New York, New York. Appleby Spurling Kempe, Hamilton, Bermuda, will pass upon the validity of the issuance of the purchase contracts and the underlying Class A common shares offered by this prospectus for the underwriters. Beghin Feider en association avec Allen Overy, Luxembourg, will pass for the underwriters upon the validity of the issuance of the senior notes offered by this prospectus. Certain legal matters of United States and New York law will be passed upon for the underwriters by Hughes Hubbard Reed LLP, New York, New York. Hughes Hubbard Reed LLP has provided, and will continue to provide, legal services to firms in the PricewaterhouseCoopers network of firms and their affiliates from time to time for which they have received, and will receive, customary fees and reimbursement of expenses. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001177292_meridian_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001177292_meridian_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..bf34f0d18541f0badce646ef6c74f13adf998353 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001177292_meridian_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of our common shares offered in this offering will be passed upon for us by Seyfarth Shaw, Chicago, Illinois. Certain legal matters will be passed upon for the underwriters by Debevoise & Plimpton, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001178537_constar_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001178537_constar_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f729c98b754818f2446b57447ed7bc04542cc84e --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001178537_constar_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered hereby will be passed upon for us and for Crown by Dechert, Philadelphia, Pennsylvania and for the underwriters by Cleary, Gottlieb, Steen & Hamilton, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001178585_gre_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001178585_gre_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d5cf09028d6ff2de9815167a70122de0cf718a28 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001178585_gre_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock and the notes offered hereby will be passed upon for our company by Akin, Gump, Strauss, Hauer & Feld, L.L.P., New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001180050_community_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001180050_community_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6f25bc247bf6421b35bc5d99888b0b59a2fb061f --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001180050_community_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of the common stock offered hereby will be passed upon for us by Morris Manning & Martin LLP, Atlanta, Georgia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001180636_wynn_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001180636_wynn_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..be0bb044e4a8cb70ed0337c69c79ed43465ad66e --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001180636_wynn_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Selected legal matters in connection with this offering, including the validity of the second mortgage notes offered hereby, will be passed upon for Wynn Las Vegas, Wynn Capital and the guarantors listed herein by Irell & Manella LLP, Los Angeles, California. Certain matters of Nevada law will be passed upon for Wynn Las Vegas, Wynn Capital and the guarantors listed herein by Schreck Brignone, Las Vegas, Nevada. Selected legal matters in connection with this offering will be passed upon for the underwriters by Latham & Watkins, Los Angeles, California. Latham & Watkins is acting as counsel to the underwriters for the second mortgage notes, the underwriters for the initial public offering of common stock of Wynn Resorts and the arrangers under the credit facilities. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001192308_american_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001192308_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2b49c71acbc3b0dc7d27cca39799f2150e0327b4 --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001192308_american_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters of Delaware law relating to the validity of the preferred securities will be passed upon on behalf of American Safety Holdings and the Trust by Richards, Layton & Finger, P.A., Wilmington, Delaware, special Delaware counsel to American Safety Holdings and the Trust. The validity of the debentures, the debenture guarantee, the preferred securities guarantee and certain matters relating thereto will be passed upon on behalf of American Safety Insurance and American Safety Holdings by Troutman Sanders LLP, Atlanta, Georgia, and, with regard to Bermuda law, by Conyers, Dill & Pearman, Hamilton, Bermuda. Troutman Sanders LLP will also pass upon certain matters relating to United States federal income tax consequences. Certain legal matters will be passed upon for the Underwriters by Arnold & Porter, Washington, D.C. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CIK0001205537_converium_legal_matters.txt b/parsed_sections/legal_matters/2002/CIK0001205537_converium_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..acd4b6c54ec4d80d40e6bbe8aba842fbe7ea78aa --- /dev/null +++ b/parsed_sections/legal_matters/2002/CIK0001205537_converium_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Willkie Farr Gallagher, 1 Angel Court, London EC2R 7HJ, England, our U.S. counsel, and Davis Polk Wardwell, 99 Gresham Street, London EC2V 7NG, England, U.S. counsel for the underwriters, will pass upon matters of U.S. law related to the offering. Arendt Medernach, our Luxembourg counsel, will pass upon matters of Luxembourg law related to the offering. Schellenberg Wittmer, our Swiss counsel and B r Karrer, Swiss counsel for the underwriters will pass upon matters of Swiss law related to the offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/CNC_centene_legal_matters.txt b/parsed_sections/legal_matters/2002/CNC_centene_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6d271d0d3e21e5f76b79dc9e0a071a622f43d3fe --- /dev/null +++ b/parsed_sections/legal_matters/2002/CNC_centene_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered by this prospectus will be passed upon for us by Hale and Dorr LLP, Boston, Massachusetts. Certain legal matters in connection with the offering will be passed upon for the underwriters by Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/DAR_darling_legal_matters.txt b/parsed_sections/legal_matters/2002/DAR_darling_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..269f5b5d8aadb4bc1c8f8a4dfc1eecbda21a3620 --- /dev/null +++ b/parsed_sections/legal_matters/2002/DAR_darling_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of our common stock and Series A Preferred Stock offered hereby will be passed upon by Dechert, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/NFLX_netflix_legal_matters.txt b/parsed_sections/legal_matters/2002/NFLX_netflix_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..fc89a8772579b99f3bcd253a0d749c05feaeb40a --- /dev/null +++ b/parsed_sections/legal_matters/2002/NFLX_netflix_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. Certain legal matters will be passed upon for the underwriters by Cahill Gordon & Reindel, New York, New York. As of the date of this prospectus, WS Investment Company 99A, WS Investment Company 98A and WS Investments 97B, investment partnerships composed of certain current and former members of and persons associated with Wilson Sonsini Goodrich & Rosati, Professional Corporation, as well as certain individual attorneys of this firm, beneficially own an aggregate of 42,199 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/SVA_sinovac_legal_matters.txt b/parsed_sections/legal_matters/2002/SVA_sinovac_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..063416576f818b1d9c0c2a21d849e6bf41aa1e61 --- /dev/null +++ b/parsed_sections/legal_matters/2002/SVA_sinovac_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS................................................................43 EXPERTS......................................................................43 WHERE YOU CAN FIND MORE INFORMATION..........................................44 THE COMPANY'S LOCATIONS......................................................44 REPRESENTATIONS..............................................................45 SCHEDULE "A" - Financial Statements..........................................46 PART II......................................................................67 -------------------------------------------------------------------------------- Registration Statement Page i \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ SUMMARY ------- You should read the following summary together with the more detailed information about Net Force Systems Inc. and the common shares being sold in this offering, including our consolidated financial statements and the related notes appearing elsewhere in this prospectus. THE COMPANY ----------- Net-Force Systems Inc. was incorporated in March 1999 under the laws of Antigua and Barbuda as Net-Force Systems Inc. Our corporate website can be viewed on the World Wide Web at www.netforcesystems.com. We currently sub-license online ----------------------- gaming software and provide marketing and support services for Internet gaming website operators, through our wholly owned subsidiary, Netforce Entertainment Inc. Netforce Entertainment licenses Internet gaming software that offers a variety of casino-style gaming options as well as an on-line sports wagering service, utilizing the rapidly expanding medium known as the Internet. Netforce Entertainment Inc. acts as the operating company for all business activities relating to the online gaming operations. Common Shares for resale: 17,066,033 common shares ------------------------ The selling shareholders are offering 17,066,033 common shares which they beneficially own for resale at $0.10 USD per share. The company will not receive any of the proceeds from the resale of common shares. Proposed OTCBB Symbol: NFSPF --------------------- RISK FACTORS ------------ Investing in Net Force Systems Inc.'s common shares will subject you to risks inherent in our business. You should carefully consider the following factors as well as other information contained in this prospectus before deciding to invest in our units. If any of the risks described below occurs, our business, results of operations and financial condition could be adversely affected. In such cases, the price of our common shares could decline, and you may lose part or all of your investment. RISKS RELATED TO THE BUSINESS ----------------------------- Because we are a development stage company, we cannot guarantee our ------------------------------------------------------------------- profitability. -------------- The Company was recently formed in the year 2000 and has limited operating history. Since incorporation, the Company has expended resources on technology, license fees, website development, hiring of personnel and startup costs. As a result, losses were incurred since incorporation and management expects to experience operating losses and negative cash flow for the foreseeable future. We anticipate losses will continue to increase from current levels because we expect to incur additional costs and expenses related to: brand development, marketing and other promotional activities; the addition of customer service personnel; the continued development of the websites; the expansion of service offerings and website content; and development of relationships with strategic business partners. Current losses to date for the 12 month period ended April 30, 2002 are $(174,206). Cumulative Losses from inception at March 1, 1999 to date to April 30, 2002 are $(1,062,662). There can be no assurance at this time that we will operate profitably or that we will have adequate working capital to meet our obligations as they become due. We believe that our success will depend in large part on our ability to (i) offer aesthetic, interesting and diverse casino-style games on our websites, as well as sports and pari-mutuel wagering, (ii) attract players and provide them with outstanding service, (iii) instill consumer confidence, and (iv) achieve -------------------------------------------------------------------------------- Registration Statement Page 1 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ name recognition. Accordingly, we intend to invest heavily in site development, technology and operating infrastructure, as well as marketing and promotion. As a result, we expect to incur operating losses in the initial stages of our business and for the foreseeable future. Our business is speculative and dependent upon the acceptance of our websites and the effectiveness of our marketing program. Our only assets will be the offshore Internet gaming websites, some administrative office furniture and equipment and the revenues derived from the websites. There can be no assurance that our Internet gaming and sports wagering websites will be successful or result in revenue or profit. There is no assurance that we will earn significant revenues or that investors will not lose their entire investment. If we fail to respond to change our clients may use competitors products and ---------------------------------------------------------------------------- services. --------- If we face material delays in introducing new services, products and enhancements, customers may forego the use of our services and use those of competitors. To remain competitive, we must continue to enhance and improve the functionality and features of the websites. The Internet and the online commerce industry are rapidly changing. If competitors introduce new products and services, or if new industry standards and practices emerge, the existing websites, technology and systems may become obsolete. To develop the websites and technology entails significant technical and business risks. We may use new technologies ineffectively or may fail to adapt the technology to meet customer requirements or emerging industry standards. Because we use intellectual property, claims may be asserted against the company -------------------------------------------------------------------------------- for infringing intellectual property rights. -------------------------------------------- Other parties may assert infringement or unfair competition claims against the Company. We cannot predict whether they will do so, or whether any future assertions or prosecutions will harm the business. If we are forced to defend against any infringement claims, whether they are with or without merit or are determined in our favor, then we may face costly litigation, diversion of technical and management personnel, or product shipment delays. Further, the outcome of a dispute may be that management would need to develop non-infringing technology or enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may be unavailable on terms acceptable to management, or at all. If the trademarks, copyrights and trade secrets we rely on fail others will --------------------------------------------------------------------------- benefit reducing our competitive advantage. ------------------------------------------- We intend to take steps to protect proprietary rights which steps may be inadequate. Management regards copyrights, service marks, trademarks, trade secrets and similar intellectual property as critical to its success. We intend to rely heavily on trademark and copyright law, trade secret protection and confidentiality or license agreements with our employees, customers, partners and others to protect proprietary rights. Effective trademark, service mark, copyright and trade secret protection may not be available in every country in which we intend to provide its services. Furthermore, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear. Therefore, we may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of intended trademarks and other proprietary rights. The Internet and Internet-based casinos are new industries and therefore we do ------------------------------------------------------------------------------ not know if they will continue to be accepted by the public in the future. -------------------------------------------------------------------------- Both the Internet and Internet-based casinos are relatively new industries. The market for Internet and Sports wagering has only recently begun to develop, is rapidly evolving and is characterized by an increasing number of market entrants. As is typical in the case of a new and rapidly evolving industry, demand and market acceptance for recently introduced services are subject to a high level of uncertainty. There can be no assurance that gaming and wagering on the Internet will become widespread, or that our websites will become widely used. If the market fails to develop, develops more slowly than expected or becomes saturated with competitors or if our services do not achieve market -------------------------------------------------------------------------------- Registration Statement Page 2 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ acceptance, our business, operating results, and the financial condition will be materially adversely affected. Because of the uncertainty regarding the legality of Internet wagering in the United States, and the existing or possible prohibitions in other jurisdictions, we will not permit play by Canadian residents, and may be precluded from offering play to residents of other countries. Because e-commerce transactions are subject to security risks it may inhibit the -------------------------------------------------------------------------------- growth of the industry and the acceptance of our products and services. ----------------------------------------------------------------------- Concerns over the security of transactions conducted on the Internet and other on-line services as well as user's desires for privacy may also inhibit the growth of gaming and wagering on the Internet. The activities of the Company are expected to involve the storage and transmission of proprietary information, such as credit card numbers and other confidential information. Any such security breaches could damage our reputation and expose us to a risk of loss, litigation and possible liability. There can be no assurance that our security measures will prevent security breaches or that failure to prevent such security breaches will not have a material adverse effect on the Company's business, financial condition and results of operations. The Company is dependent on World Gaming for its software and the hosting of its websites. Businesses on the Internet are subject to the risk of credit card fraud and other types of theft and fraud perpetrated by "hackers" and on-line thieves. Credit card companies may hold merchants fully responsible for any fraudulent purchases made when the signature cannot be verified. Although credit card companies and others are in the process of developing anti-theft and anti-fraud protections, and while the Company itself will continually monitor this problem, at the present time the risk from such activities could have a material adverse effect on us. A party who is able to circumvent our security measures could misappropriate confidential information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. If a compromise of our security were to occur, or if World Gaming's software or website hosting fails, there could be a material adverse effect on our business, financial condition and the results of operations. Because Consumer's may lack confidence in how we set our odds our business may ------------------------------------------------------------------------------ not be accepted. ---------------- Concerns that a virtual casino's odds can be easily and arbitrarily manipulated may deter customers from using our website. There can be no assurance that we will be able to instill customer confidence in and alleviate negative perceptions about Internet gaming. If our efforts are unsuccessful, it could have a material adverse effect on our business, financial condition and the results of operations. We are subject to competition from other gaming and sports wagering operators ------------------------------------------------------------------------------ that are larger and have more resources to compete in the gaming industry and ------------------------------------------------------------------------------ that have been operating in the industry for longer. ---------------------------------------------------- The market for our Internet gaming and sports wagering services is intensely competitive. Our principal competitors include other on-line Internet casinos. These competitors have longer operating histories, greater name recognition, larger installed customer bases, and substantially greater financial, technical and marketing resources than us. We believe that the principal factors affecting competition in its proposed market include name recognition, ability to develop aesthetic and diverse casino-style games, customer confidence, ability to respond to changing customer needs, and ease of use. Other than technical expertise and the limited time available to enter the market, there are no significant proprietary or other barriers of entry that could keep potential competitors from developing or acquiring similar tools and providing competing services in our proposed market. Our ability to compete successfully in the on-line casino and sports wagering business will depend in large part on its ability to attract new players and respond effectively to continuing technological changes by developing more sophisticated on-line casino games. There can be no assurance that we will be able to compete successfully in the future, or that future competition will not have a material adverse effect on the business, operating results and financial condition of the Company. -------------------------------------------------------------------------------- Registration Statement Page 3 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Because we may have to borrow in the future to keep our business operating we ------------------------------------------------------------------------------ may not be able to satisfy our debt obligations or to obtain debt financing that -------------------------------------------------------------------------------- allows us to remain in business. -------------------------------- There is no assurance that we will not incur debt in the future, that it will have sufficient funds to repay its indebtedness or that we will not default on our debt, jeopardizing our business viability. Furthermore, we may not be able to borrow or raise additional capital in the future to meet our needs or to otherwise provide the capital necessary to conduct our business. As of the period ended April 30, 2001, the total outstanding long term indebtedness is $zero. Total liabilities are $136,813, comprised of $136,813 in current ------- ------- liabilities Because we do not intend to pay any dividends on our common shares, investors ------------------------------------------------------------------------------ seeking dividend income or liquidity should not purchase common shares in this ------------------------------------------------------------------------------ offering. --------- We do not currently anticipate declaring and paying dividends to our shareholders in the near future. It is our current intention to apply net earnings, if any, in the foreseeable future to increasing our capital base and marketing. Prospective investors seeking or needing dividend income or liquidity should therefore not purchase the Shares. There can be no assurance that we will ever have sufficient earnings to declare and pay dividends to the holders of our common stock, and in any event, a decision to declare and pay dividends is at the sole discretion of our Board of Directors. Because we are subject to government regulation we could have our license ------------------------------------------------------------------------- revoked at anytime. ------------------- The wagering and casino industry is subject to extensive government regulation and licensing requirements in certain jurisdictions of the world. Legal uncertainties may preclude us from offering our planned Internet gaming in certain jurisdictions like Canada. Some jurisdictions may impose restrictions, licensing requirements or prohibitions on Internet wagering. At present, we do not anticipate any such restrictions, prohibitions or licensing requirements in our target markets but no assurance can be made that such restrictions, prohibitions or licensing requirements will not arise which would materially adversely effect our business, operating results and financial condition of the Company. Also see VII, Regulatory Background, for further discussion on the state of Internet Gaming legislation in the U.S. Because we depend on a small group of qualified people, if we cannot hire and ------------------------------------------------------------------------------ retain qualified personnel, we might be forced to discontinue our operations. ----------------------------------------------------------------------------- Our success is substantially dependent on the performance of our executive officers and key employees. Given our early stage of development in the Internet gaming business, we are dependent on our ability to retain and motivate high quality personnel. Although we believe we will be able to attract, retain and motivate qualified personnel for such purposes, an inability to do so could materially adversely affect the Company's ability to market, sell, and enhance our services. The loss of one or more of our employees or our inability to hire and retain other qualified employees could have a material adverse effect on the Company. Currently, we identify Mr. Terry G. Bowering, President and Chief Executive Officer, as a key person, as he is involved in the direction of all aspects of the daily operations of the Company. Mr. Bowering does not have an employment contract in place, nor is there any key person insurance on himself. We also depend on Mr. Derek C. Ferguson, Internet Technology Consultant, Mr. Clint Jendyk, Director of Website Design and Development, and Mr. Richard Pestes, Internet Marketing Consultant. We have not entered into any employment or management contracts with our employees nor do we maintain "key-person" insurance of any kind. Because our current or proposed insurance coverage may not be adequate uninsured -------------------------------------------------------------------------------- losses may occur. ----------------- There is no assurance that we will not incur uninsured liabilities and losses as a result of the conduct of its proposed business. We plan to maintain comprehensive liability and property insurance at customary levels. We will also evaluate the availability and cost of business interruption insurance. However, should uninsured losses occur, the shareholders could lose their invested capital. -------------------------------------------------------------------------------- Registration Statement Page 4 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ There is no assurance that we can pay our liabilities. ------------------------------------------------------ We have liabilities to affiliated and unaffiliated lenders. As at April 30, 2002, our total amount of liabilities is $136,813. Current liabilities to ------- unaffiliated lenders (accounts payable) consist of accrued wages payable, International telephone and Internet service payable to Cable and Wireless Telecommunications Company, and fees payable to Pannell Kerr Forster for accounting and auditing services. Customer account deposits account for $47,002 or 34% of total liabilities. We currently have no long term liabilities. These liabilities represent fixed costs, which are required to be paid regardless of the level of profitability experienced by us. There is no assurance that we will be able to pay all of our liabilities. Furthermore, we are always subject to the risk of litigation from players, employees, suppliers or others because of the nature of our business. Litigation could cause us to incur substantial expenses and, if cases are lost, judgments and awards could add to the Company's costs. Because Net Force and its officers and directors are located in NON-U.S. ------------------------------------------------------------------------ JURISDICTIONS, investors may have no effective recourse against Net Force or its -------------------------------------------------------------------------------- management for misconduct and you may not be able to enforce judgments and civil -------------------------------------------------------------------------------- liabilities against Net Force and its officers, directors, experts and agents. ------------------------------------------------------------------------------ Net Force Systems Inc. has been incorporated under the laws of Antigua and Barbuda, and our executive offices are located in Antigua. Our directors, controlling persons and officers, and representatives of the experts named in this prospectus, are not residents of the Unties States of America, and a substantial portion of their assets and all of our assets are located outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon us, the directors, controlling persons, officers and representatives of experts who are not residents of the United States or to enforce against them judgments of courts of the United States based upon civil liability under the federal securities laws of the United States. There is doubt as to the enforceability in Antigua against us or against any of our directors, controlling persons, officers or representatives of the experts who are not residents of the United States, in original actions or in actions for enforcement of judgments of United States courts and of liabilities based solely upon the federal securities laws of the United States. RISKS RELATED TO THE INDUSTRY ----------------------------- Our business is dependent upon the continued acceptance of our e-commerce gaming -------------------------------------------------------------------------------- industry by the public. ----------------------- Our future revenues substantially depend upon the increased acceptance and use of the Internet and other online services as a medium of commerce. Rapid growth in the use of the Internet, the Web and online services is a recent phenomenon. As a result, acceptance and use may not continue to develop at historical rates and a sufficiently broad base of customers may not adopt, and/or continue to use, the Internet and other online services as a medium of commerce and entertainment. Demand and market acceptance for recently introduced services and products over the Internet are subject to a high level of uncertainty and there exist few proven services and products. In addition, the Internet may not be accepted as a viable long-term commercial marketplace for a number of reasons, including potentially inadequate development of the necessary network infrastructure or delayed development of enabling technologies and performance improvements. If the Internet continues to experience significant expansion in the number of users, frequency of use or bandwidth requirements, the infrastructure for the Internet may be unable to support the demands placed upon it. In addition, the Internet could lose its viability as a commercial medium due to delays in the development or adoption of new standards and protocols required to handle increased levels of Internet activity, or due to increased governmental regulation. Changes in, or insufficient availability of, telecommunications services to support the Internet also could result in slower response times and adversely affect usage of the Internet generally. Our business, financial condition and results of operations would be seriously harmed if: use of the Internet, the Web and other online services does not continue to increase or increases more slowly than expected; the infrastructure -------------------------------------------------------------------------------- Registration Statement Page 5 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ for the Internet, the Web and other online services does not effectively support expansion that may occur; the Internet, the Web and other online services do not become a viable commercial marketplace; or traffic to the websites decreases or fails to increase as expected or if management spends more than was expected to attract visitors to the websites. Because we may not be able to maintain or obtain present and future domain names -------------------------------------------------------------------------------- we may not be able to prevent third parties from benefiting from our domain --------------------------------------------------------------------------- names. ------ We may be unable to acquire or maintain Web domain names relating to the brand in the jurisdictions in which management may conduct business. As a result, we may be unable to prevent third parties from acquiring and using domain names relating to our brand, which could damage our brand and reputation and take customers away from our websites. We currently hold the www.aogaming.com, ---------------- www.aocasino.com and www.aosportsbook.com domain names and may seek to acquire ---------------- -------------------- additional domain names. Governmental agencies and their designees generally regulate the acquisition and maintenance of domain names. The regulation of domain names in the United States and in foreign countries is subject to change in the near future. The changes in the United States are expected to include a transition from the current system to a system that is controlled by a non-profit corporation and the creation of additional top-level domains. Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. Because laws may change in the future to protect the public there may be a -------------------------------------------------------------------------- requirement to change the manner of how we do business. ------------------------------------------------------- The adoption or modification of laws or regulations relating to the Internet could adversely affect the manner in which we propose to conduct our business. In addition, the growth and development of the market for online gaming may lead to more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on the Company. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. The United States Congress recently enacted Internet laws regarding children's privacy, copyrights, taxation and the transmission of sexually explicit material. The European Union recently enacted its own privacy regulations. Laws regulating the Internet, however, remain largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel, and taxation apply to the Internet. In order to comply with new or existing laws regulating online commerce, we may need to modify the manner in which we propose to do business, which may result in additional expenses. For instance, we may need to spend time and money revising the process by which we intend to accept players' wagers to ensure that each wager complies with applicable laws. We may need to hire additional personnel to monitor compliance with applicable laws. We may also need to modify our software to further protect players' personal information. Because we are liable for the content of our website we may be subject to ------------------------------------------------------------------------- regulation and law suits arising from the content. -------------------------------------------------- As a publisher of online content, we face potential liability for defamation, negligence, copyright, patent or trademark infringement, or other claims based on the nature and content of materials that we publish or distribute. If we face liability, then our reputation and our business may suffer. In the past, plaintiffs have brought these types of claims and sometimes successfully litigated them against online companies. In addition, we could be exposed to liability with respect to the unauthorized duplication of content or unauthorized use of other parties' proprietary technology. Although we intend to carry general liability insurance, such insurance may not cover claims of these types. We cannot be certain that we will be able to obtain insurance to cover the claims on reasonable terms or that we will be adequate to indemnify the management or the Company for all liability that may be imposed. Any imposition of liability that is not covered by our insurance or is in excess of insurance coverage could harm the business. -------------------------------------------------------------------------------- Registration Statement Page 6 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Because government regulation may force us to collect and remit taxes we may ---------------------------------------------------------------------------- have to modify our system which would be expensive and reduce potential ----------------------------------------------------------------------- profitability. -------------- If one or more states or any foreign country successfully asserts that we should collect taxes on the winnings earned by players, the financial position and results of operations could be harmed. If we become obligated to collect taxes, we will need to update our system that processes wagers and winnings to calculate the appropriate sales tax for each player and to remit the collected sales to the appropriate authorities. These upgrades will increase operating expenses. In addition, players may be discouraged from utilizing our websites because they have to pay tax, causing net sales to decrease. As a result, we may be adversely materially affected. Risks Related to Securities Market ---------------------------------- We cannot be certain that additional financing will be available on favorable ----------------------------------------------------------------------------- terms when required, or at all. ------------------------------- If we raise additional funds through the issuance of equity, equity-related or debt securities, the securities may have rights, preferences or privileges senior to those of the rights of the common stock and those stockholders may experience additional dilution. We expect to require substantial working capital to fund the business. Since inception, we have experienced negative cash flow from operations and expect to experience significant negative cash flow from operations for the foreseeable future. Management currently anticipates that the private financing done to date, together with expected revenues, will be sufficient to meet anticipated needs for working capital and capital expenditures through at least the next 12 months. After that, we may need to raise additional funds. The market price for our common stock is likely to be highly volatile and ------------------------------------------------------------------------- subject to wide fluctuations. ----------------------------- As a result of this volatility some or all of the following can occur: actual or anticipated variations in the quarterly operating results; announcements of technological innovations or new services by us or our competitors; changes in financial estimates by securities analysts; conditions or trends in the Internet and/or online commerce or gaming industries; changes in the economic performance and/or market valuations of other Internet, online gaming companies; announcements by management or competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; additions or departures of key personnel; release of lock-up or other transfer restrictions on the outstanding shares of common stock or sales of additional shares of common stock; and potential litigation. In addition, the stock market has from time to time experienced extreme price and volume fluctuations. These broad market fluctuations may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of their stock, -------------------------------------------------------------------------------- many companies have been the subject of securities class action litigation. --------------------------------------------------------------------------- If we were sued in a securities class action, it could result in substantial costs and a diversion of management's attention and resources and would cause the stock price to fall. FORWARD LOOKING STATEMENTS -------------------------- Net-Force Systems Inc. (the "Company" or "Net-Force") cautions readers that certain important factors (including without limitation those set forth in this Form F-1) may affect the Company's actual results and could cause such results to differ materially from any forward-looking statements that may be deemed to have been made in this Form F-1 registration statement, or that are otherwise made by or on behalf of the Company. For this purpose, any statements contained in the registration statement that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the generality of the -------------------------------------------------------------------------------- Registration Statement Page 7 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ foregoing, words such as "may", "expect", believe", "anticipate", "intend", "could", "estimate" or "continue" or the negative or other variations of comparable terminology, are intended to identify forward-looking statements. USE OF PROCEEDS --------------- We will not be receiving any proceeds from this offering as the shares are being registered for resale by the selling shareholders. DETERMINATION OF OFFERING PRICE ------------------------------- The offering price of the 17,066,033 common shares being offered by the selling shareholders has been determined arbitrarily and has no relationship to any established criteria of value, such as book value or earnings per share. Additionally, because we have no significant operating history and have not generated any material revenues to date, the price of the common shares is not based on past earnings, nor is the price of the common shares indicative of current market value for the assets owned by us. CAPITALIZATION -------------- The following table sets forth our capitalization as of April 30, 2002 on an actual basis: This table should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and related notes appearing elsewhere in this prospectus. April 30 2002 ---- Shareholders' equity (deficiency): Common shares; 100,000,000 shares of $0.001 par value authorized with contributed surplus; Shares issued and outstanding: Actual (17,066,033) $ 1,162,103 Accumulated deficit $(1,062,662) ----------- Total shareholders Equity 99,441 ----------- DILUTION -------- There will be no dilution as this offering is registering for sale shares owned by existing shareholders only. SELLING SECURITY HOLDERS ------------------------ The following table sets forth the number of shares, which may be offered for sale from time to time by the selling security holder. The shares offered for sale constitute all of the shares known to us to be beneficially owned by the selling security holder. -------------------------------------------------------------------------------- Registration Statement Page 8 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\
Amount of Shares of Common Stock Amount of Beneficial Ownership Beneficial Ownership Being Sold Pursuant to Beneficial Ownership After Prior to this Offering this Prospectus this Offering Name of Beneficial Owner Number Percent Number Number Percent ------------------------ ------ ------- ------ ------ ------- Geneva Overseas Holdings Ltd.(1) 6,544,830 38.35% 6,544,830 0 0% IFG Investments Services Inc.(2) 6,027,870 35.32% 6,027,870 0 0% Low Tide Investments Inc.(3) 533,333 3.13% 533,333 0 0% Atkins Financial Ltd.(4) 500,000 2.93% 500,000 0 0% Loire International Limited(5) 500,000 2.93% 500,000 0 0% Multi Asian Venture Ltd.(6) 500,000 2.93% 500,000 0 0% JPKT Metro Investment Corporation(1) 500,000 2.93% 500,000 0 0% Shanghai Ltd.(7) 500,000 2.93% 500,000 0 0% Solinvest Group Ltd.(8) 500,000 2.93% 500,000 0 0% CDM Caribbean Digital Management Inc.(9) 400,000 2.34% 400,000 0 0% Trevor L. Bowering 200,000 1.17% 200,000 0 0% Sable Holdings Ltd.(10) 100,000 0.59% 100,000 0 0% Derek C. Ferguson 50,000 * 50,000 0 0% Dwight Lewis 50,000 * 50,000 0 0% Larry Chudak 20,000 * 20,000 0 0% David Gates 20,000 * 20,000 0 0% Donald C. Jones 5,000 * 5,000 0 0% Easter Lily A. Dalmacio 5,000 * 5,000 0 0% Anthony C. Gibson 5,000 * 5,000 0 0% Ronald Darvin Jones 5,000 * 5,000 0 0% Tammy L. Jones 5,000 * 5,000 0 0% Earl Jones 5,000 * 5,000 0 0% Sean T. Burns 5,000 * 5,000 0 0% Shawn W. Erickson 5,000 * 5,000 0 0% Eddy Damien Granados 5,000 * 5,000 0 0% Gyneth McAllister 5,000 * 5,000 0 0% Mark M. Piazza 5,000 * 5,000 0 0% John David Sorlie 5,000 * 5,000 0 0% Lawrence R. Busha 5,000 * 5,000 0 0% Jon Canale 5,000 * 5,000 0 0% Kenneth M. Gerspatch 5,000 * 5,000 0 0% Traci Fornoff 5,000 * 5,000 0 0% Saverio J. Barbera 5,000 * 5,000 0 0% Ron Dillard 5,000 * 5,000 0 0% David M. Filburn 5,000 * 5,000 0 0% Donald Heitz 5,000 * 5,000 0 0% Randy Baldwin 5,000 * 5,000 0 0% -------------------------------------------------------------------------------- Registration Statement Page 9 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Joseph A. Angelini 5,000 * 5,000 0 0% Donald Wayne Kipp 5,000 * 5,000 0 0% Michael James Steele 5,000 * 5,000 0 0% ========== ==== Total shares outstanding: 17,066,033 100% ---------- ---- *Less than 1 % (1) Terry G. Bowering has voting or investment control over these shares; (2) Daniel MacMullin has voting or investment control over these shares; (3) Rusty Catania has voting or investment control over these shares; (4) Greg S. Hurd has voting or investment control over these shares; (5) Dwight C. Crozier has voting or investment control over these shares; (6) Francis Pan has voting or investment control over these shares; (7) Jean-Claude Roder has voting or investment control over these shares; (8) M. Dierkes has voting or investment control over these shares; (9) Dan MacMullin has voting or investment control over these shares; (10) Douglas N. Bolen has voting or investment control over these shares.
Acquisition of Shares by the Shareholders ----------------------------------------- The following table and notes sets forth the date of issuance or transfer date for the shares, the number of shares held by the shareholder, the regulation the shares were issued pursuant to and the consideration paid:
Date of Date of Issuance Transfer No. of Private Placement Name of Shareholder of Shares of Shares Shares Regulation D-506 Regulation S ------------------- -------- --------- ------ ------------------------------- Geneva Overseas Holdings Ltd (1)(5)(6) March 1, 1999 4,400,000 * JPKT Metro Investment Corporation(1)(5) March 1, 1999 500,000 * Derek C. Ferguson(4)(6) October 25, 2000 50,000 * Dwight Lewis(4)(6) October 25, 2000 50,000 * Atkins Financial Ltd.(1) November 2, 2000 500,000 * Loire International Limited(1)(9) November 2, 2000 500,000 * Multi Asian Venture Ltd.(1) November 2, 2000 500,000 * Shanghai Ltd.(1) November 2, 2000 500,000 * Solinvest Group Ltd.(1) November 2, 2000 500,000 * IFG Investments Services Inc.(2) September 15, 2001 6,027,870 * Geneva Overseas Holdings Ltd.(2) September 15, 2001 2,144,830 * CDM Caribbean Digital Management Inc.(7) October 5, 2001 400,000 * Sable Holdings Ltd.(7) October 5, 2001 100,000 * Trevor L. Bowering(3)(4) October 25, 2001 200,000 * Low Tide Investments Inc. (2) November 6, 2001 533,333 * Donald C. Jones(1) February 7, 2002 5,000 * Easter Lily A. Dalmacio (1) February 7, 2002 5,000 * Anthony C. Gibson (1) February 7, 2002 5,000 * -------------------------------------------------------------------------------- Registration Statement Page 10 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Ronald Darvin Jones(1) February 7, 2002 5,000 * Tammy L. Jones (1) February 7, 2002 5,000 * Earl Jones (1) February 7, 2002 5,000 * Sean T. Burns (1) February 7, 2002 5,000 * Shawn W. Erickson (1) February 7, 2002 5,000 * Eddy Damien Granados (1) February 7, 2002 5,000 * Gyneth McAllister (1) February 7, 2002 5,000 * Mark M. Piazza(1) February 7, 2002 5,000 * John David Sorlie (1) February 7, 2002 5,000 * Lawrence R. Busha (1) February 7, 2002 5,000 * Jon Canale (1) February 7, 2002 5,000 * Kenneth M. Gerspatch (1) February 7, 2002 5,000 * Traci Fornoff (1) February 7, 2002 5,000 * Saverio J. Barbera (1) February 7, 2002 5,000 * Ron Dillard (1) February 7, 2002 5,000 * David M. Filburn (1) February 7, 2002 5,000 * Donald Heitz (1) February 7, 2002 5,000 * Randy Baldwin (1) February 7, 2002 5,000 * Joseph A. Angelini(1) February 7, 2002 5,000 * Donald Wayne Kipp (1) February 7, 2002 5,000 * Michael James Steele(1) February 7, 2002 5,000 * Larry Chudak(1)(8) February 7, 2002 20,000 * David Gates(1)(8) February 7, 2002 20,000 * Consideration paid: (1) Cash Consideration; (2) Conversion of debt plus accrued interest to equity at a price of $0.10 per share; (3) For services rendered or to be rendered for director services; (4) Directors of the Company. (5) Founders stock issued for cash at $0.001 per share; (6) Acquired from Geneva Overseas Holdings Ltd. for director services. Geneva Overseas Holdings Ltd. had 4,500,000 of founders shares (issued March 1, 1999) at October 25, 2000 and transferred 100,000 shares to the directors; (7) Acquired from BRF Family Trust in a private transfer. BRF Family Trust was originally issued a total 500,000 founders shares at $0.001 per share from the treasury on March 1st, 1999. BRF Family Trust was beneficially owned by Douglas N. Bolen, director and secretary for the Company from its inception at March 1st, 1999 to his resignation October 26th, 2000. On October 5th, 2001, BRF Family Trust privately transferred 100,000 shares of Net-Force Systems Inc. to Sable Holdings Ltd. and 400,000 shares to CDM Caribbean Digital Management Inc.; (8) These shareholders are close friends and associates of Trevor L. Bowering, director; (9) Originally issued November 2nd, 2000 under incorrect company name, new certificate issued December 4, 2001.
Material relationships between shareholders and the Company: 1. Geneva Overseas Holdings Ltd. and JPKT Metro Investment Corporation have Terry G. Bowering, director and officer of the Company, as its beneficial owner; 2. Terry Bowering and Trevor Bowering are directors and officers of the Company and brothers; 3. Dwight Lewis and Derek C. Ferguson are directors of the Company; PLAN OF DISTRIBUTION OF SHARES BY SELLING SECURITY HOLDER. ---------------------------------------------------------- The selling security holder may sell our common shares in the over-the-counter market, or on any securities exchange on which our common shares are or become listed or traded, in negotiated transactions or otherwise. The shares will not be sold in an underwritten public offering. The shares may be sold directly or through brokers or dealers. The methods by which the shares may be sold include: o Purchases by a broker or dealer as principal and resale by such broker or dealer for its account; o Ordinary brokerage transactions and transactions in which the broker solicits purchasers; and o Privately negotiated transactions. -------------------------------------------------------------------------------- Registration Statement Page 11 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Brokers and dealers engaged by the selling security holder may arrange for other brokers or dealers to participate. Brokers or dealers may receive commissions or discounts from the selling security holder (or, if any such broker-dealer acts as agent for the purchaser of such shares, from such purchaser) in the amounts to be negotiated. Broker-dealers may agree with the selling security holder to sell a specified number of such shares and, to the extent such broker-dealer is unable to do so acting as agent for the selling security holder, to purchase as principal any unsold shares. The selling security holder and any broker-dealers participating in the distributions of the shares may be deemed to be "underwriters" within the meaning of Section 2(11) of the Securities Act of 1933. Any profit on the sale of shares by the selling security holder and any commissions or discounts given to any such broker-dealer may be deemed to be underwriting commissions or discounts. The shares may also be sold pursuant to Rule 144 under the Securities Act of 1933 beginning one year after the shares were issued. There can be no assurance that the selling security holder will sell any or all of the shares. None of our officers, directors, or other "associated persons" are participating in the offer or sale of our securities, except to the extent permitted by Exchange Act Rule 3a4-1. Moreover, we will not represent to any person, and we have informed the selling security holder that it must not represent to any person, that the registered shares are being offered on an "all-or-none" basis or being offered or sold on any other basis whereby all or part of the consideration paid for any such security will be refunded to the purchaser if all or some of the securities are not sold. IFG Investments Services, Inc., Low Tide Investments, Inc. and Shanghai Ltd. and the other corporate selling shareholders are not affiliates of registered broker-dealers. Expenses of the Offering: ------------------------- Printing and Engraving Costs $5,000 estimated Registration Fee to SEC $ 451 Delivery and Postage Charges $ 500 estimated Edgar - DTCFP $3,000 estimated Federal Taxes n/a Trustees n/a State Taxes and Fees n/a Transfer Agent Fees n/a Legal Fees $5,000 estimated Accounting Fees $5,000 estimated DESCRIPTION OF SECURITIES TO BE REGISTERED ------------------------------------------ The securities to be registered pursuant to this F-1 are all of the outstanding common stock of Net-Force Systems Inc. Holders of the common stock are entitled to cast one vote for each share held at all shareholder meetings for all purposes, except that in the election of Directors, each shareholder of common stock shall have as many votes for each share held by him or her as there are directors to be elected and for whose election the shareholder has a right to vote. There are no preemptive rights associated with the securities and no cumulative voting is authorized by the Articles of Incorporation or the By-Laws. The total amount of shares authorized by the Company's Articles of Incorporation is 150,000,000 being 100,000,000 common shares having a $0.001 par value per share and 50,000,000 preferred shares having a $0.001 par value per share. There has been no issuance of any Preferred stock. Dividend, voting, conversion rights, liquidation rights and other rights of the preferred stock, if any, will be established by the Board of Directors upon issuance. The Company has never declared or paid cash dividends on the common stock of the Company. Management intends to retain all available funds and any future earnings for use in the operation and expansion of the business and does not anticipate paying any cash dividends in the foreseeable future. -------------------------------------------------------------------------------- Registration Statement Page 12 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ TAXES AND TREATIES ------------------ There are no stamp duties, income taxes, withholding taxes, registrations taxes, or other duties or taxes or similar charges imposed in connection with the issuance or registered ownership of shares in the company. The holder of shares in the company with respect to their ownership of the shares is exempt from taxes in Antigua. There is no reciprocal tax treaty between Antigua and the United States of America. Please review the tax discussion regarding Antigua and the Unites States of America contained at pages 29 - 31. LIMITATION ON HOLDING SHARES BY NONRESIDENT OR FOREIGN OWNERS ------------------------------------------------------------- There is no limitation on nonresidents or foreign owners to hold or vote the common shares. INTEREST OF NAMED EXPERTS AND COUNSEL ------------------------------------- No "expert", as that term is defined pursuant to Regulation Section 229.509(a) of Regulation S-K, or our "counsel", as that term is defined pursuant to Regulation Section 229.509(b) of Regulation S-K, was hired on a contingent basis, or will receive a direct or indirect interest in us, or was a promoter, underwriter, voting trustee, director, officer, or employee of the company, at any time prior to the filing of this registration statement. SELECTED CONSOLIDATED FINANCIAL DATA ------------------------------------ You should read the selected consolidated financial data set forth below in conjunction with our consolidated financial statements and the related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this prospectus. The selected consolidated financial data are derived from our consolidated financial statements that have been audited by HJ & Associates, LLC, independent auditors, and are included elsewhere in this prospectus. -------------------------------------------------------------------------------- Registration Statement Page 13 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\
NET-FORCE SYSTEMS, INC. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended April 30, ------------------------------------------------------ 2002 2001 2000 ---------------- ---------------- ---------------- STATEMENT OF OPERATIONS: ------------------------ Sales......................................... $ 519,237 $ 318,490 $ 1,399 Cost of sales................................. 282,020 217,769 1,477 General & Administrative expenses............. 275,896 489,278 349,175 Depreciation and amortization expense......... 101,873 18,241 6,428 Total expenses................................ 377,769 507,519 355,603 Loss from operations.......................... (140,552) (406,798) (355,681) Interest income............................... 198 1,013 3,635 Interest (expense)............................ (34,141) (80,259) (55,690) Net Loss...................................... (174,206) (484,597) (397,366) BALANCE SHEET DATA (AT PERIOD END): ----------------------------------- Cash.......................................... 68,462 33,292 131,269 Total assets.................................. 236,254 269,194 221,512 Total liabilities............................. 136,813 952,150 589,871 Total stockholders' equity (deficit).......... 99,441 (682,956) (368,359) STATEMENT OF CASH FLOW DATA: ---------------------------- Net cash used by operating activities......... (58,048) (494,797) (349,919) Net cash used by investing activities......... (282) (1,777) (47,319) Net cash provided by financing activities..... 93,500 398,597 495,000 Net increase (decrease) in cash............... $ 35,170 $ (97,977) $ 97,762
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF -------------------------------------------------------------------------- OPERATIONS ---------- The following discussion should be read in conjunction with our consolidated financial statements and the related notes appearing at Schedule "A" in this prospectus. PLAN OF OPERATIONS ------------------ Revenues and Financing ---------------------- Our principal source of revenue is generated from our operating subsidiary, Netforce Entertainment, Inc. Netforce Entertainment Inc. is a gaming company, which oversees Internet wagering websites. It is anticipated that the Internet will continue to become more accessible and that the market opportunities for us will continue to expand. This tremendous growth will also attract many potential -------------------------------------------------------------------------------- Registration Statement Page 14 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ new competitors. In order to maintain revenue growth, we intend to expand the content and to improve the services on the Internet websites on a global basis, as well as researching and developing other projects that will utilize our existing facilities and expertise. Revenue Generation Process. Revenues for the Company are generated each time a customer makes a wager on the website. Net monthly revenues are calculated as the total dollar amount wagered by customers in the virtual casino and/or the sportsbook wagering website less winnings by customers in the virtual casino and/or sportsbook wagering website for a given calendar month. The software royalty fee and transaction processing fees are included in the cost of sales. Transaction processing fees consist of credit card discount fees of 5.50 % per deposit, $1.60 per transaction, $5.00 fee for each check processed, and a $25.00 fee to process each credit card chargeback. As well, deposit bonus credits used to encourage customer deposits are also included in cost of sales. See Exhibit 10.1, Software License Agreement, Section 2.3 Financial Transactions, and Schedule A. Netforce Entertainment Inc. does not directly process player deposits and winnings. Electronic Financial Services Caribbean, Inc., the transaction processing subsidiary of World Gaming, is under contract to Netforce Entertainment to process all deposits and credits on behalf of the Company's gaming websites. Daily online activity reports of all financial transactions are produced by Electronic Financial Services Caribbean, Inc. These reports include an account summary and an exposure report. The account summary details dollar amounts deposited and withdrawn for each individual customer account for the date queried. The exposure report provides an actual detailed breakdown of the total dollar amounts wagered (i.e., total bets) and total winnings (i.e., payouts to winners of successful wagers) by each specific casino game played and by each sports wagering type and event. The net amount (i.e., wagers less payouts) is recognized as revenue. Electronic Financial Service Caribbean, Inc. produces a monthly summary report of total net monthly revenue (i.e., total dollar amount wagered less winnings) less transaction processing fees less calculated software licensing fees (i.e., a percentage of net revenues calculated according to the terms of the Software Licensing Agreement attached hereto as an Exhibit). We have been funded to date through debt financing from private arm's length lenders. The Company has secured approximately $495,000 US through debt financing. The sum was received by us pursuant to a note payable dated July 13, 1999 payable to Mountain High Management Inc. The loan was unsecured, with interest at the rate of 15% per annum and was due on July 29, 2001. The Company received the sum on or about July 13, 1999. On June 1, 2000, pursuant to Regulation S, the Board authorized the issuance of 2,500,000 Units comprised of one (1) $0.001 par value common stock and one (1) warrant that allows the holder to purchase one (1) share of the Company's $0.001 par value common stock at an exercise price of $2.00 per share, to be exercised no later than December 31, 2002 after which the warrants would become null and void. Each Unit was offered at the price of $0.10. This offering was sold out on or about June 30, 2000. Subsequent to the due date of July 13, 2001, the promissory note was acquired from Mountain High Management Inc. by IFG Investments Inc. On September 15, 2001, Netforce Systems Inc. entered into an agreement with IFG Investments Inc. to convert the total principal and accrued interest on the note to equity at a value of $0.10 per share for a total of 6,027,870 shares issued. Related-party unsecured shareholder loans with an interest rate of 8.0% made by Geneva Overseas Holdings Ltd. totaled $208,121 as at September 15, 2001. Geneva Overseas Holdings Ltd. is controlled by the President of Net-Force Systems Inc., Terry G. Bowering. On September 15, 2001, Net-Force Systems Inc. entered into an agreement with Geneva Overseas Holdings Ltd. to convert the principal plus accrued interest of $214,483 of the loan to equity at a share value of $0.10 per share for a total of 2,144,830 shares issued. On November 20, 2000, Net-Force Systems Inc. issued a promissory note for $50,000 with interest rate of 8.0% to Low Tide Investments Inc. On September 15, 2001, Net-Force Systems Inc. converted the loan payable plus accrued interest to Low Tide Investments Inc. to equity at a value of $0.10 per share for a total of 533,333 shares issued. (See Financial Statements, Note 5 - Material Events). Management believes that the reduction of this total debt burden combined with existing cash resources and ongoing revenues from operations will enable the Company to meet its financial obligations for the next 12 months. No assurance can be given that revenues from gaming activities and/or proposed secondary -------------------------------------------------------------------------------- Registration Statement Page 15 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ revenues will enable us to meet our financial obligations. As such, we may solicit and arrange for additional debt financing from private arm's length lenders in the event existing financing and revenues do not meet our financial obligations. In addition, we may consider raising additional equity financing through the sale of common stock of the Company through private placements to sophisticated investors. The combination of existing financing, expected revenues from operations and additional debt and/or equity financing is intended to provide us with sufficient operating capital for a period of approximately two years. Historical Expenditures. Historical expenditures up to the period ending April 30, 2002 have consisted primarily of monthly expenditures for such costs as office overhead, office rent, utilities, marketing expenditures, wages, ongoing web-site design and maintenance, and accounting services. The period consisted of comparatively less expenditures on organizational/set-up costs such as office leasehold improvements, security deposits for rent, utilities, and licenses, financing costs, and legal services. Payments to be made to World Gaming for the gaming software are comprised of the following 2 components: 1. Payment for the software: a one-time US$100,000 fee for the set-up and --------------------------------------------------- configuration. This fee includes all future versions and upgrades of the software at no additional cost. Actual payments made by Netforce Systems Inc. to Softec Systems to date consist of a deposit of US$ 10,000.00 upon the signing of the software agreement. This payment was the first installment of the total US$100,000.00 one-time software set-up and configuration fee. The balance of payments as detailed in the software agreement called for the balance of US$90,000 to be paid in monthly installments @ US$10,000 until fully paid. The payment schedule for the software commenced on the date of `live' operations, the design and testing of the gaming website is complete and the first wager. That date was April 7th, 2000. 2. Ongoing royalty payments to World Gaming consisting of a percentage of ---------------------------------------- the net revenue generated on a monthly basis. As detailed in the software agreement, these payments will begin upon commencement of live operations of the gaming website. The schedule of royalty payments payable to World Gaming as detailed in Schedule "A" of the software agreement is as follows: *Net Monthly Revenue (US$) Royalty Fee Payable -------------------------- ------------------- 0 to < or = $500,000 25% $500,000 to < = $1,000,000 20% $1,000,000 to < = $5,000,000 15% $5,000,000 < = $10,000,000 12.5% $10,000,000 plus 10% *Net Monthly Revenue is calculated as the total dollar amount wagered in the virtual casino and/or the sportsbook wagering site LESS winnings in the virtual casino and/or sportsbook wagering site LESS transaction processing fees, for a given calendar month. 3. Payment Processing Agreement: Section 2.3.1 of the software agreement ---------------------------- states: "Softec shall provide a transaction processing system that will allow the licensee's customers to deposit funds for use of the Games (the "Transaction Processing System").". Deposits are made electronically by Visa or Mastercard credit cards and by other methods such as bank wire transfer and bank draft. This transaction processing system is provided by Electronic Financial Services Caribbean Inc., wholly owned subsidiary of World Gaming. Electronic Financial Service Caribbean, Inc. will also facilitate payouts of winnings for the licensee by processing credits to credit cards and by bank draft. As stated, actual cost to the company for payment processing include transaction fees of 5.50 % and a flat fee of US$1.60 per transaction. As well, there is a monthly 10% rolling reserve held which is rolled back to the licensee after 180 -------------------------------------------------------------------------------- Registration Statement Page 16 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ days. This deposit reserve is required to offset any credit card chargebacks that may occur. Finally, there is a US$5.00 charge for each bank draft that is processed for payouts of winnings. The only significant trends in expenditures in this industry of note, relate to marketing expenditures and its direct relationship with net revenues generated. Marketing expenditures are a variable cost, so it is anticipated that as these expenditures are increased revenues will respond as a direct result, further enhancing the company's liquidity. It is important to note that the revenues generated are entirely of a cash nature as no credit is extended to customers. Therefore since there are no customer receivables generated of a material nature, there is no need to establish an allowance for doubtful accounts. Any accounts receivable carried on the balance sheet consists of monthly net revenues payable by Electronic Financial Services Caribbean Inc. and World Gaming Plc. Typically net revenue is due and payable at month-end but not actually paid until the 15th of the following month. As was stated in the previous paragraph, EFS Caribbean Inc., the credit card transaction processor, maintains a 10% rolling reserve hold on credit card deposits on behalf of the company. These reserved funds are released after a 180-day period on a monthly rolling basis. EFS had increased the rolling reserve to 10% of deposits from 5% to allow for a slightly increased level of credit card chargebacks industry-wide. For the twelve-month period ended April 30, 2002, Net-Force Systems Inc. recorded sales of $519,237, an increase of 63% as compared to sales of $318,490 for the previous fiscal period ended April 30, 2001. Gross margin for the period was 46% versus 32% for the previous period due to the reduction in cost of sales as a percentage of total sales combined with an increase in overall sales. A reduction in aggressive customer promotion bonuses as well as a reduction in realized credit card chargebacks contributed to this result. General and Administrative expenses were for 2002 were $275,896 versus $489,278 in 2001, a decrease of 44% year over year. Due to the reorganization and elimination of long- term debt and total liabilities on the balance sheet during the period, interest expense on notes payable decreased from $80,259 in 2001 to $34,141 for 2002, a 57% decrease. Based on this long-term debt restructure that took place on September 15, 2001, we expect that interest expense going forward into fiscal period 2003 will be minimal. The total annual net loss for the period was ($174,206) versus a total net loss of ($484,597) in period ended April 30, 2001, representing a decrease (improvement) of 64%. The above improvements in operating performance are a direct result of our efforts to substantially reduce overhead expenses such as wages and salaries, legal expenses, general office overhead, as well as realizing an overall reduction of one-time expenses and initial setup costs realized during the fiscal period ended April 30, 2001. We are concentrating on employing more cost-effective methods of generating revenue. We continue to develop our affiliate base and rely on this network to drive traffic and new customer signups. We are also increasingly focused on customer retention strategies such as weekly internal customer promos, weekly newsletters providing each week's schedule of sporting events, industry and sports news, sports scores, and general updates regarding site changes and soliciting customer feedback to maintain interest and generate customer referrals. Our gross margin tends to fluctuate from period to period. There are two primary factors that influence our cost of sales, which in turn affects the gross margin from period to period. First, we use deposit bonus credits in promotions in order to generate new member signups and to encourage customer deposits. Bonus credits given are typically 10% to 20% of the customer's deposit and will vary from period to period depending on the promotion and season of the year. Higher deposit bonus credits result in a higher cost of sales. Second, the credit card charge back rate varies from period to period which can adversely affect the gross margin. As a result of more efficient fraud controls undertaken by the transaction processor, Electronic Financial Services Caribbean Inc., the most recent financial quarters showed a much lower rate of credit card chargebacks than the first two quarters of the fiscal year 2002. We fully expect this trend to continue into the fiscal period 2003. -------------------------------------------------------------------------------- Registration Statement Page 17 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Operations for the Next Twelve Months ------------------------------------- Our primary on-line wagering website, www.aogaming.com, went live on the ---------------- Internet on April 7th, 2000. Since that time, the Web site has gone through several changes, re-designs, and upgrades as management had deemed necessary as a result of evolving customer needs and competitive influences. We intend to hire additional product, marketing, website and graphic design personnel over the next twelve months as is deemed necessary by management. From player data obtained from the websites during the first twelve to fifteen months of operations, we plan to make adjustments to the operations as is deemed necessary by management. The tighter controls on administrative expenses cited in A. Revenues and Financing above, will positively affect future operations by allowing us to re-invest the additional cashflow into advertising and marketing strategies to further drive growth and ultimately, profitability. We now have an established and growing database of "play for real" customers generating growing monthly revenues from operations during the seasonal peak periods which are typically during the months of September through to April. Considering current revenues now generated from operations and reduced overhead, combined with additional capital resources cited above, we believe that we will remain viable over the next twelve-month period. To further enhance revenues, we will continue to shift our focus to sub-licensing casino and sports wagering software to third-party operators. Netforce Entertainment Inc. will market turn-key Internet Casino and gaming systems to potential sub-licensees. This complete system will include a custom-designed themed graphic user interface and gaming web-site, electronic financial transaction processing and accounting systems, customer service support, marketing consultation, and offshore administrative services. In exchange for this package, Netforce Entertainment Inc. will contract with each sub-licensee for an up-front fee ranging from US$10,000 to US$25,000 combined with a royalty percentage of the ongoing revenue stream generated by each web-site. Netforce Entertainment Inc. also anticipates that within the next twelve months, software provider World Gaming Plc. will release its gaming software upgrades and additional gaming products such as pari-mutuel horse racing wagering and enhanced casino game play. These factors will contribute to further growth in our customer base and our revenue stream. Balance Sheet Data ------------------
At April 30, 2002 At April 30,2001 April 30, 2000 ----------------- ---------------- -------------- Total Assets 236,254 269,194 221,512 Shareholders' Equity (deficit) 99,441 (682,956) (368,359)
LIQUIDITY AND CAPITAL RESOURCES ------------------------------- As at April 30, 2002, available unrestricted cash on hand plus net accounts receivable due in less than 30 days amounted to $84,085 versus $43,097 for April 30, 2001, an increase of 95%. Current assets less player deposits as at April 30, 2002 were $166,371 and current liabilities less players deposits were $89,811. Funding for the next year will be derived from current cash resources and expected revenues from ongoing operations. However, to fuel the growth of the company through the funding of marketing expenditures, we may seek further funding in the form of a promissory note combined with the issuance of additional stock from our treasury. The company anticipates revenues from operations will provide sufficient cash flow to supplement existing current cash resources to allow the company to adequately cover all overhead expenses over the balance of the calendar year 2003. Because of the very nature of the Internet, our company operates and delivers its service with relatively low fixed overhead costs. The material variable cost factor is marketing expenditures, which in turn drives revenues. -------------------------------------------------------------------------------- Registration Statement Page 18 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ During the fiscal period-ended April 30, 2002, an agreement was reached whereby the promissory note issued by Netforce Systems, Inc. to Mountain High Management, Inc. on July 15, 1999 was swapped for equity. IFG Investments, Inc. reached an agreement with Mountain High Management, Inc. to purchase the note at a discount. IFG then approached Netforce Systems, Inc. with a proposal to convert the note to equity. On September 15, 2001, under an agreement between the company and IFG Investments, Inc., the principal plus accrued interest on the note was converted to equity at a value of $0.10 per share. Also on September 15, 2001, Net-Force Systems Inc. entered into an agreement with Geneva Overseas Holdings Ltd. to convert the principal and accrued interest of its related party shareholder loan to equity at a share value of $0.10 per share. In addition, on September 15, 2001, Net-Force Systems Inc. converted a loan payable to Low Tide Investments Inc. to equity at a value of $0.10 per share. Management believes that these transactions substantially increases our liquidity and reduces the financial risk for our company by effectively eliminating the long-term debt on our balance sheet. (See Financial Statements, note 5-Material Events). As a result of the debt restructure and equity issuances during the period, total liabilities as at April 30, 2002 were $136,813 versus $952,150 as at April 30, 2001. Current liabilities less player deposits as at April 30, 2002 were $89,811 versus $699,726 as at April 30, 2001, a decrease of approximately 87%. Total stockholders Equity was $99,441 as at April 30, 2002, versus a deficit of ($682,956) as at April 30, 2001. Initially, the software license fee agreement booked on the balance sheet as a current payable, (net payable = $90,000), was payable in monthly installments of US$10,000 per month until the balance of $100,000 was fully paid. The first payment of the balance was to commence 90 days from the date of commencement of live operations. We negotiated an agreement to have the balance of payments waived as compensation for the failure of its software provider (Starnet Systems International), to deliver on promised software upgrades and support services. As of April 7, 2000, Netforce Entertainment, Inc. launched its primary online gaming site Antigua Online Gaming at www.aogaming.com. The gaming website has ---------------- grown steadily from that date. However, to continue to grow our gaming websites' customer traffic, member base, and revenues, we will need to increase our investment in marketing expenditures. We may therefore find it necessary to raise additional funds as is deemed necessary by management through private placements of stock issued out of our treasury to individuals or corporations who have expressed interest in obtaining stock in the Company. During the fiscal period 2002 we made no major capital expenditures and we have no immediate need to make any major capital expenditures for the upcoming fiscal year 2003. MATERIAL COMMITMENTS FOR CAPITAL EXPENDITURES --------------------------------------------- Material commitments for capital expenditures as of the end of the latest interim period consisted of computer hardware and office furniture and equipment (desks and chairs), and office leasehold improvements. The office and computer hardware specifically included personal computers, printers, fax machines, and backup power supply units, which maintain operation of the electronic office equipment during short power outages. The purpose of these capital expenditure commitments was to establish a corporate and administrative office for the company. From this office, the company conducts web-site design, marketing, customer service support services for the company's websites. The company also manages corporate communications and investor relations from this office. The company maintains access to the Internet, which requires personal computers, communications hardware and software, and backup power supply units. All of the above commitments were settled in full payment from cash resources made available from the initial share issuances and from the proceeds from the promissory note. The details of the note are provided in the financial statements and in the body of the registration statement. As stated, the major capital expenditure for software was US$100,000 payable to Starnet Systems International (formerly Softec Systems). An initial payment of US$10,000.00 was paid upon execution of the agreement leaving a balance of US$90,000.00 payable upon completion of the configuration/design of the software and commencement of live operations. The balance was negotiated to zero as a result of a compensation agreement with Starnet Systems International. -------------------------------------------------------------------------------- Registration Statement Page 19 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ MATERIAL COMMITMENTS FOR RESOURCES ---------------------------------- As already stated, the only material commitment of resources anticipated over the next year will be marketing expenditures. Being a variable cost, marketing and advertising expenses are controlled by management. There will be no additional material capital expenditures necessary over the next year. Given that the product delivery process utilizes the Internet, overhead expenses are kept at a minimal level, as an increase in customer base and revenues does not necessarily require incremental investment in personnel or equipment. The customer service function and transaction processing system; as well as web-hosting costs are absorbed by World Gaming as outlined in the software agreement. After the one-time set-up fee is accounted for, the cost of the software to the company on an ongoing basis is a variable cost (percentage of monthly net revenues). Any material commitments of resources and normal monthly operating expenses over the next year will be funded from a combination of existing cash resources, cash flow generated from anticipated proceeds from an additional financing. This additional financing, if necessary, may consist of a combination of equity financing and issuing a promissory note with a possible convertible equity component attached. IMPACT OF INFLATION ------------------- The Company believes that inflation will not materially affect its business. YEAR 2000 RISKS AND COMPLIANCE ------------------------------ The Year 2000 issue did not in any way adversely affect us. We experienced no negative affects in the three of the potential areas of its computer systems that it identified as potential for risk; its internal systems, its third-party providers of computer systems, and the general infrastructure of the Internet. BUSINESS -------- BUSINESS DEVELOPMENT -------------------- Net-Force Systems Inc. ---------------------- Net-Force Systems Inc. was incorporated in March 1999 under the laws of Antigua and Barbuda as Net-Force Systems Inc. Our corporate website can be viewed on the World Wide Web at www.netforcesystems.com. We currently sub-license online ----------------------- gaming software and provide marketing and support services for Internet gaming website operators, through our wholly owned subsidiary, Netforce Entertainment Inc. Netforce Entertainment licenses Internet gaming software that offers a variety of casino-style gaming options as well as an on-line sports wagering service, utilizing the rapidly expanding medium known as the Internet. Netforce Entertainment Inc. acts as the operating company for all business activities relating to the online gaming operations. Netforce Entertainment Inc. has entered into a non-exclusive software agreement to license proprietary Internet casino software and systems from World Gaming Plc., a publicly traded corporation domiciled in the United Kingdom and formerly know as Starnet Systems, Inc. Included in this software agreement is a contract between Netforce Entertainment Inc. and EFS Caribbean Inc., a secure online financial transaction processor, to collect and process revenues generated from our Internet gaming websites. The agreement with EFS Caribbean Inc. includes the payment processing fees, terms, and conditions (see Exhibit 10.1). Any reference to the term `master agreement' or `master license' should be defined as having a direct software license agreement with a software provider (World Gaming). A sub-license agreement is defined as being an agreement whereby Netforce -------------------------------------------------------------------------------- Registration Statement Page 20 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Entertainment Inc. acts as licensor of a software provider's (World Gaming) software to a third-party operator in exchange for an up-front fee plus a negotiated a revenue sharing agreement. Typically, there are web-site design and development costs incurred for initial set up and custom-designing a prospective sub-licensee's casino website. The commission paid to a sub-licensee starts at 50% of net revenue and moves up incrementally as volume increases. There are currently no sub-licence agreements in place at this time. A marketing agreement (also known as "Partners" or "Affiliates" or "Resellers") is defined as an agreement between Netforce Entertainment Inc. and either a webmaster with an Internet site that has established customer traffic of their own or another casino site linked to our primary casino site as a partner. There is no up-front fee charge for a partner. A monthly commission starting at 25% of the net revenues is paid to these as compensation for sending playing customers to our sites. Special online tracking software provided by World Gaming accounts for an affiliate's customer activity and calculates net revenue upon which the commission is based. We currently have approximately 200 registered partners with marketing agreements in place. Agreements are consummated online by accepting the `terms and conditions' prior to completing the online registration form. We oversee a number of Internet gaming websites under marketing agreements and we have implemented a substantial marketing program with initial advice from World Gaming. Headquartered in Antigua, EFS Caribbean, Inc. is a wholly owned offshore subsidiary of World Gaming Plc. We intend to engage in additional software agreements with other online gaming software providers with the objective of offering a wide variety of online gaming and wagering products and services thus reducing our reliance on any single technology provider and/or software platform. The Company, including our subsidiaries, employs 6 full time persons on a contract as-needed basis. The individuals are either involved in developing and implementing a marketing strategy for us or are providing website maintenance and development and customer support. Net-Force Systems Inc. Corporate History ---------------------------------------- In March 1999, we filed our Articles of Incorporation with the Director of International Business Corporations, Government of Antigua and Barbuda as Net-Force Systems Inc., in which, among other things, the Board of Directors was elected as follows: Terry G. Bowering and Douglas N. Bolen. The authorized capital of the Company consists of 100,000,000 Common Shares and 50,000,000 Preferred Shares. On March 15, 1999, the Directors, by way of Organizational Consent of the Directors of the Company, accepted the stock subscriptions and payment for the number of shares issued to the individuals referred to above at a price of $0.001 per share. In addition, the Directors appointed Terry G. Bowering to the office of President, CEO and Chairman of the Board, and Douglas N. Bolen to the office of Secretary. On December 20, 1999, Mr. Dwight Lewis was appointed to the Board of Directors. On March 15, 1999, we accepted subscription agreements from six entities to acquire securities of the Company pursuant to a Rule 504 offering under Regulation D. The Board authorized the Company to proceed with the sale of its shares pursuant to the subscriptions received for the sale of 3,000,000 Common Shares at a price of $0.01 per Common Share. Pacific Stock Transfer Company was appointed as the Transfer Agent of the Common Shares of the Company. On July 15, 1999, we signed a software licensing agreement with Softec Systems Caribbean Inc., now known as World Gaming Plc., to launch and market a turnkey Internet Gaming website. On July 15, 1999, we issued a promissory note to Mountain High Management Inc. to borrow $495,000 at an interest rate of 15%. August 5, 1999 marked the date of incorporation of Netforce Entertainment Inc., wholly owned subsidiary of Net-Force Systems Inc., under the laws of Antigua and Barbuda. Netforce Entertainment Inc. acts as the operating subsidiary for the Internet Gaming web site operations. The Internet Gaming website www.aogaming.com was initially launched on April 7, ---------------- 2000. -------------------------------------------------------------------------------- Registration Statement Page 21 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ On June 1, 2000, the Board of Directors resolved to authorize the redemption of the common stock, which was issued pursuant to Rule 504 on or about March 15, 1999 and the same was effected shortly thereafter. On the same date, pursuant to Regulation S, the Board authorized the issuance of 2,500,000 Units comprised of one (1) $0.001 par value common stock and one (1) warrant that allows the holder to purchase one (1) share of the Company's $0.001 par value common stock at an exercise price of $2.00 per share, to be exercised no later than December 31, 2002 after which the warrants would become null and void. Each Unit was offered at the price of $0.10. This offering was sold out on or about June 30, 2000. On October 26, 2000, Douglas Bolen resigned as Director and secretary of the Company. On August 15, 2001, Mr. Trevor Bowering was appointed to the Board of Directors. On September 10, 2001, Mr. Derek Ferguson was appointed to the Board of Directors. On September 15, 2001, all long-term debt and promissory notes including related party shareholder loan from Geneva Overseas Holdings Ltd. were converted to equity for a total of 8,705,993 shares issued at $0.10 per share. (See Financial Statements, Note 5 - Material Events). On November 15, 2001, pursuant to a Rule 506 Offering, the Board authorized the Company to proceed with the sale of its shares pursuant to subscriptions received at a price of $0.10 per Common share. The Company accepted subscription agreements from U.S. residents from states including California, Arizona, and Florida. On January 29, 2002, the offering was closed and the Board resolved to authorize the issuance of 160,000 Common shares at $0.10 per share. BUSINESS OF THE ISSUER ---------------------- Netforce Entertainment Inc. was incorporated on August 5, 1999 pursuant to the International Business Corporations Act of Antigua and Barbuda and is based in Antigua. Netforce Entertainment is a wholly owned subsidiary of the Company and acts as the operating entity for our online gaming operations. Netforce Entertainment Inc. currently maintains an international gaming website called Antigua Online Gaming located on the World Wide Web at www.aogaming.com. ---------------- Netforce Entertainment Inc. has entered into agreements with software vendors, including, World Gaming, Plc. for the rights to use its proprietary Internet gaming software, and with Electronic Financial Services Caribbean, Inc. for the use of its electronic financial conversion system in relation to the processing of credit cards. Electronic Financial Services Caribbean, Inc. is a wholly owned subsidiary of World Gaming, Plc. (see Exhibit 10.1). For specific terms and fees for payment processing under Electronic Financial Services Caribbean Inc., see Exhibit 10.1. World Gaming, Plc., a United Kingdom, publicly-traded corporation with operating subsidiaries in Antigua is in the business of licensing complete, customized Internet gaming systems to third-party offshore gaming license holders. World Gaming currently supports in excess of 20 such licensees operating worldwide and has endorsed Net-Force Entertainment as a master licensee. World Gaming provides customized software, website development and management on its network, custom database systems to manage player accounts, and technical support. Netforce Entertainment Inc., has entered into a software licensing agreement with World Gaming (See Exhibit 10.1) whereby World Gaming licenses certain Internet casino software to Netforce Entertainment Inc. and has developed the graphical front end of the gaming site in exchange for a one-time payment and an on-going percentage of the gross revenues from our website. (See Exhibit 10.1). World Gaming hosts our offshore subsidiary's websites. World Gaming also provides and maintains all hardware necessary for the operation of the websites and provides a complete transaction processing system that allows players to deposit funds for use of the games. The hardware is maintained in World Gaming's offices and co-location facilities located in Antigua. -------------------------------------------------------------------------------- Registration Statement Page 22 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ To ensure the security of funds transfers over the Internet, Netforce Entertainment, Inc. utilizes the services of Electronic Financial Services Caribbean, Inc. Electronic Financial Services Caribbean, Inc., also an Antigua corporation and wholly owned subsidiary of World Gaming, is in the business of securely converting electronic funds between financial institutions and other companies. Through alignments with major banks, Electronic Financial Service Caribbean processes conversions of worldwide currencies into "e-cash." Electronic Financial Service Caribbean utilizes World Gaming's proprietary STAR-MX encoding and processing technology to process tens of thousands of Internet credit card transactions per month. The World Gaming software license agreement allows us to pursue our objective of establishing ourselves as one of the leading providers of Internet gaming and sports wagering services. Through our subsidiary, Netforce Entertainment, Inc. we currently offer via the Internet up to 25 casino-style gaming opportunities, including baccarat, Japanese Pachinko, Chinese Pai Gow Poker, Blackjack and Video Poker as well as a variety of live betting lines on all of the world's major sporting events. The initial term of the master license is one year, renewable indefinitely unless we give the licensor written notice of termination of the license at least 45 days prior to the end of any one-year period. On August 5, 1999, Netforce Entertainment Inc. was approved for and received an official gaming license from the Antigua and Barbuda Free Trade and Processing Zone enabling us to legally conduct Virtual Casino and Sports Wagering operations. Antigua is a jurisdiction that has clearly defined Internet Gaming legislation in place that licenses and regulates Internet Gaming Operators. Antigua charges license holders an annual license fee to maintain the gaming license in good standing. The International Press recognizes Antigua and Barbuda as the leader in the regulation of the Internet Gaming industry. At a time when the issue of regulation is being focused upon by the US media, a reputation of this kind is of great importance to the Company and most especially to the Internet gambler. Antigua and Barbuda is an independent country that has deemed Internet Gaming to be a legitimate and legal business activity protected and supported under enacted legislation on that Caribbean island nation. Of vital importance, Cable and Wireless (West Indies) Telecommunications Company has established Antigua as a primary hub to facilitate the Internet Gaming industry for its regional network of submarine fiber-optic cables laid across the Atlantic and Caribbean enabling Antigua to offer diversified high quality Internet connections into North America. Net-Force Entertainment Inc. is fully licensed and regulated by the Antigua and Barbuda Free Trade & Processing Zone under clearly defined legislation in that sovereign nation. Netforce Entertainment Inc. has the added distinction of having acquired the "preferential seal of approval" status from the Antigua and Barbuda Free Trade and Processing Zone. We display this seal on the Gaming websites with an associated link to the Antigua and Barbuda Free Trade & Processing Zone website so that consumers (players) will be able to contact the Antigua regulatory authorities with any concerns, complaints and/or inquiries. This distinction further signifies that we have consented to and successfully undergone intense scrutiny under the legislated due diligence requirements in Antigua. This mechanism provides the consumer (player) recourse to register any complaints with the Antigua regulatory body and instills credibility and confidence in the operator and the industry as a whole in that particular jurisdiction. Netforce Entertainment's primary casino and sportsbook gaming website is appropriately named Antigua Online Gaming, capitalizing on the recognized brand identity that Antigua has established as a result of becoming the hub of the Internet Gaming Industry. The websites' URLs can be found on the World Wide Web at www.aogaming.com, www.aocasino.com, and www.aosportsbook.com. ---------------- ---------------- -------------------- Our policy for the gaming websites we oversee is to accept subscriptions only from persons over the age of 18 years and believed to reside in jurisdictions that are not explicitly known to expressly prohibit Internet gaming. To date, our activities have included the market analysis, website development, acquisition of a gaming license, obtaining the software license from World Gaming and developing the general infrastructure necessary to fulfill our -------------------------------------------------------------------------------- Registration Statement Page 23 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ business objectives. The development of our primary gaming website, www.aogaming.com, was initially completed and launched on April 7, 2000. ---------------- Through the software license acquired from World Gaming, we offer up to 25 virtual casino games and live sportsbook wagering on most of the world's major sporting events. We also intend to offer twenty-four hour live simulcast and/or pari-mutuel betting on horse and dog racing tracks in North America and abroad by the end of 2002. More specifically, pari-mutuel wagering involves a situation whereby individuals' combined real money wagers combine to form a `pool'. Individuals essentially wager against each other as opposed to the house. The house assumes no risk as it simply takes a small percentage of the betting pool as compensation for providing the service. The balance of the pooled wagers are paid out to the winner(s) accordingly. Included with the software license is the procurement of an initial Internet gaming license, concept development and design of the Web based casino(s), all odds-making rules and regulations, complete graphical user interface with sophisticated visual and sound effects to create a total gaming experience, real time wagering, complete secure electronic funds transfer, retention and analysis of all gaming data, including win/loss, game preferences and monitoring of player activities, administration and complete 24 hour per day, 7 days per week customer support services, ongoing customization of the websites, the monitoring of all funds flow, the hosting of server software, customization and server integration, the provision of credit card processing and other banking services, discussion, liaison and co-operation with testing agencies, regulatory boards, governing bodies and governments and marketing consulting. BUSINESS AND MARKETING STRATEGIES --------------------------------- We intend to capitalize on the evolving opportunities on the Internet by developing and marketing Internet casinos and sports wagering websites to small and medium sized third-party operators at a reduced initial investment. To capitalize on this lucrative opportunity, Netforce Entertainment Inc., a wholly owned subsidiary of Netforce Systems Inc., and based in Antigua West Indies, was established. Netforce Entertainment Inc.'s corporate mission is to deliver efficient and entertaining online gaming services to a global market of end user customers. Netforce Entertainment Inc. will provide online gaming software licensing through third-party marketing agreements. Netforce Entertainment Inc. will also provide marketing, support, and web-site design capabilities for online gaming operators. Netforce Entertainment Inc. will utilize the Internet to deliver these products in a cost-effective, efficient and profitable manner. Netforce Entertainment Inc. aims to accomplish its objectives by applying the following Business strategy: 1. Netforce Entertainment Inc. will only enter into primary master software license agreements with the world's premiere online gaming software systems providers. 2. To enhance the Company's reach on the Internet and to accelerate market penetration on the Internet, Netforce Entertainment Inc. will enter into agreements to market the gaming software technology to third party operators. Netforce Entertainment Inc. intends to establish a sales department solely responsible for marketing its turnkey Internet Casino and gaming systems packages to potential third-party sub-licensee operators. NE will target small to medium-sized operators and entrepreneurs and high-traffic web-site operators (`webmasters') that have experience in Internet commerce, hence increasing their odds of successfully adding to the company's customer base and income stream. This complete system will include a custom-designed themed graphic user interface and gaming Web-site, access to a legitimate Gaming License, transaction processing and accounting system, customer service support, marketing consultation, and offshore administrative services. In exchange for this package, Netforce Entertainment Inc. intends to receive an up-front fee and a percentage of ongoing revenues. 3. Accelerated growth through acquisition. The offshore online gaming industry is currently fragmented and made up of a number of predominantly smaller private companies offering a variety of gaming services to a growing global customer base. Expected future industry consolidation provides an opportunity for Netforce to execute a strategy of actively seeking acquisitions of these small to -------------------------------------------------------------------------------- Registration Statement Page 24 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ medium-size established Internet gaming websites and operations, and therefore continually adding to the company's database of active customers at an accelerated pace. Netforce Entertainment Inc. will seek to acquire operations that present an opportunity for value creation through enhanced marketing and operational initiatives and synergies. This will further enhance the value of the Company's portfolio of Internet properties. 4. Offer superior 24/7 customer support services to all of the playing customers that fall under the umbrella of Netforce Entertainment Inc.'s web site operations. This is essential to maintain and grow the customer database and to differentiate the Company's product offering in the market place. Customer service support for the websites is provided by World Gaming through Electronic Financial Services Caribbean Inc. as a condition of the software agreement. Customer support representatives deliver 24-hour customer and technical support to deal with casino games problems, deposit and payment inquiries, system downtime problems, and general questions. Netforce Entertainment Inc. provides secondary customer support via e-mail dealing with marketing, special promotions, and customer retention programs. Customers cannot place wagers over the telephone with either of the above customer service options. Our business strategy is designed to promote the Net-Force brands and strive for the industry leadership position by focusing on gaming, providing an innovative and easy to use concept, acquiring players on an efficient basis, maximizing player retention and expanding and leveraging our player base through multiple marketing channels and third-party operators. We believe that this strategy enables us to reduce reliance on any one source of players, maximize brand awareness and lower average player acquisition costs. By combining expertise in marketing, sophisticated computer software systems and a focus on excellent customer service, we believe that we will be able to deliver an entertaining online gaming experience for players. With our mandate of providing a gaming experience with unmatched options and technology allowing for three-dimensional displays and a wide gaming selection, Management believes players will be provided with a product unparalleled in the marketplace. Management believes that the Internet is a well-suited medium for the provision of entertainment products and services, especially those related to user-friendly, innovative casino-style games and sports wagering services. We note that the auditor's opinion contains a going concern statement as of the April 30, 2002 year-end audit (see Independent Auditor's Report, of the Audited Financial Statements for April 30, 2002, also see note 5 to the financial statements of the financial statements). Since April 30, 2002, we have taken and will continue to take the necessary steps to ensure ongoing viability of the business. Specifically, we have reduced the total debt burden on the balance sheet. Long-term debt was reduced from $178,596 as at April 30, 2001 to zero as at April 30, 2002. For the same period, current assets have increased from $165,622to $166,371while at the same time current liabilities have decreased from $773,554 to $136,813. These significant changes in the balance sheet substantially reduce the financial risk for our company. In addition to reducing the debt burden, management has focused on growing the database of customers to enhance revenue growth as well as tightening controls on expenses. Revenues for the annual period ended April 30, 2002 have increased by 55%, as compared to the same period in the previous year while general and administrative expenses for the same period have decreased by 43%, as compared to the same period in the previous year. To fuel further growth, we also plan to raise additional capital through a private placement equity issuance near the end of the current fiscal year 2002 or by the first quarter of fiscal period 2003. However, there can be no assurance of this. THE COMPANY'S SERVICES AND PRODUCTS ----------------------------------- We have established websites, located on the Internet at www.aogaming.com, ---------------- www.aocasino.com and www.aosportsbook.com, that offer a comprehensive ---------------- -------------------- interactive gaming service including a virtual casino and live online sportsbook wagering service. A pari-mutuel wagering service for horse and dog racing is in the planning stages and is anticipated to be added to the product line in late 2002. The websites are accessible to the general public, however only established customers or players are permitted to play the gaming opportunities offered for money. Established customers are defined as being customers who; have agreed to the online terms and conditions by affirming and submitting, have completed an online application (i.e. the "join" form) providing complete -------------------------------------------------------------------------------- Registration Statement Page 25 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ identity and address information, and have submitted via fax a photocopy copy of his/her credit card, signature, and identification to the customer service department of Electronic Financial Services Caribbean Inc. This procedure both verifies the identity of the customer and reduces risk of credit card fraud. Customers who wish to try the games for fun are not required to go through this procedure and are therefore not considered established customers. Our websites are accessible by a minimum hardware configuration consisting of a 486 personal computer with Windows 95 or greater, with 16 Mega Bites RAM, 20 Mega Bites free hard disk space, a 14,400 modem and a direct PPP Internet connection. All games are provided in a Windows-based, menu driven format with "point and click" interactivity. Players who wish to conduct gaming operations at the websites are able to subscribe over the Internet by completing an application appearing on the websites. Part of the application process requires that the subscriber open an account and make a minimum deposit with the company of $20. Our websites are designed to invite the players to sign up and apply for a casino and sports book wagering membership. After a player's membership application is received and reviewed by us, it is either accepted or rejected based on criterion including, but not limited to, age and geographic location of the player. Upon accessing our Websites, every new customer must review and accept our online terms and conditions agreement which states that only players over the age of 18 will be accepted and proof of age and identification will be required. Our policy is to accept subscriptions only from players over the age of 18 years and believed to reside in jurisdictions that are not known to expressly prohibit Internet gaming. To monitor this policy, the online financial transaction processor for our Websites, Electronic Financial Services Caribbean Inc., utilizes a staff of customer service personnel who are available 24 hours per day, 7 days per week, to administer a policy of requiring personal identification documents (via fax or e-mail scanned copy) from each new customer who deposits funds using a credit card. This typically includes a faxed photocopy of front and back of the credit card used for the account along with a copy of the signature, and a photocopy of both a driver's license and/or a utility bill, as proof of both identity and address. The customer service individual is also able to identify the customer's card-issuing bank to confirm or verify any customer credit card information. Upon acceptance, the approved player is allowed to download the gaming software over the Internet for installation on their personal computer. We then provide the player with a username and password through which the player is able to access the computer servers on which the software is hosted, over the Internet through their Internet service provider. This policy has proved to be adequate in identifying and verifying a prospective customer's true identity and address. World Gaming's Internet gaming software currently allows for acceptance of account applications from all countries except Canada. It is our policy that in the event that we become aware that any country or jurisdiction by law expressly prohibits gaming activities over the Internet, we will block our services from being offered to such countries and/or jurisdictions. A list of countries from which we have accepted member subscriptions to date include Australia, France, Germany, United Kingdom, Italy, Greece, Spain, Mexico, Argentina, Switzerland, United States, Venezuela, The Netherlands, Singapore, Thailand, New Zealand, Brazil, Panama, Ukraine, Israel, China, India, Belgium, Austria, Sweden, Finland, and Turkey. Our website allows the player to review all the terms, rules and conditions applicable to gaming and other uses at the websites. All gaming winnings and losses are debited and credited to the player's account on a real-time basis. All games are conducted pursuant to house rules and advantages that are published at the websites and which are at least favorable or more favorable than those used by the major casinos in Las Vegas, Nevada. We completed the process of designing the interfaces between the players and the World Gaming software for Antigua Online Casino and Sportsbook by March 2000. We have beta tested the website for ease of use, clarity and accuracy prior to officially launching the same on April 7, 2000. The gaming opportunities offered at the website have been designed, in conjunction with World Gaming, to evoke sights and sounds similar to a Las Vegas style casino. Computer graphics present the "lobby" of the casino, and consist of several menu items that the player can choose to enter. We include in these menu choices the various gaming rooms, including black jack, baccarat, slot machines, roulette and video poker. In addition, the player has the option to use the sports betting option to place bets on sports events taking place around the world. The players use the Windows -------------------------------------------------------------------------------- Registration Statement Page 26 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ format of commands to carry out the gaming activities. The websites also include special effects such as three-dimensional displays, sounds of cards shuffling, coins falling from virtual machines and other generally familiar background casino sounds. In addition to English, we also intend to offer players the ability to engage in the proposed gaming activities in such languages as Spanish, German, Japanese and Chinese or in whatever languages and/or ethnic identities as Management deems practical in order to facilitate worldwide expansion of its player base. We intend to conduct continuing development of our websites (and such additional websites as we deem appropriate with varying themes and languages) and the products offered thereat in accordance with our players' demonstrated preferences, demographics, and the evolution of new technologies. Our goal is to utilize the World Gaming software and such other software, which may be identified by us as useful in order to provide the players with gaming services, which is competitive, innovative and easy to use in the Internet gaming industry. MARKETING --------- We have implemented a comprehensive marketing program in conjunction with our software provider. We have customized various facets of the marketing program for specific cultures including prospective Asian, European, South African, South American and Indian players. World Gaming combines Internet broadcasting capabilities with a fully equipped multimedia production studio to create an advanced Internet production facility. We believe that international markets will represent a significant portion of our revenues in the near future since many of the products and services intended to be offered are not currently available in these markets. Our websites are intended to contain translations of account registration forms and playing instructions and the proposed customer service representatives are intended to be fluent in all languages offered at the websites. We have established our offices in St. John's, Antigua, British West Indies at Suite #10, Woods Centre, Friars Hill Road, PO Box W-645, St. John's, Antigua, British West Indies. From these offices, the Company conducts all head office administrative activities. Also, from these offices, Netforce Entertainment Inc. conducts all marketing and customer support activities for the Internet Gaming sites that we oversee. The marketing program incorporates the following strategies to target its players: Strategic Alliances with Major Content and Service Providers. We intend to seek ------------------------------------------------------------ to enter into strategic alliances with major Internet content and service providers in order to enhance our new customer acquisition efforts, increase purchases by current customers and expand brand recognition. We are striving to enter into alliances with Internet search engines services that provide for us to be the premier online gaming provider on certain of their sites with the exclusive right to place gaming banner advertisements and integrated links to the Net-Force sites on certain gaming-related Web pages. To date, no such alliances have been identified or entered into by us. We currently do not advertise with any major Internet content and/or service providers. However, in the past, we have placed advertising on Internet sports content sites such as The Sports Network, Football.com, Basketball.com, and Rotonews.com. We have not advertised in the past with any Internet Service Providers. On-Line and Traditional Advertising. We promote our brands through an aggressive ----------------------------------- marketing campaign using a combination of on-line and traditional advertising. We advertise on the websites of major Internet content and service providers, and targeted gaming-related websites. Our traditional advertising efforts include print advertising in major magazines and gaming related publications, and may also include radio advertising and television advertising. We have advertised in the past in the following publications: High Roller Magazine - Spring 2000 Special Issue, Time Magazine/Atlantic Edition, April 17, 2000, Special Advertising Section - World Focus: Antigua and Barbuda, Alaska Airlines In-Flight Magazine (scheduled flights to Las Vegas), April, June, and August 2000 Issues. We currently have no print advertising placed. -------------------------------------------------------------------------------- Registration Statement Page 27 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Direct Marketing. We use direct marketing techniques to target new and existing ---------------- players with communications and promotions. We send a personalized e-mail newsletter to registered players that includes, recommendations based on demonstrated player preferences and prior usage. Banner Advertisements. Banner advertisements are rectangular graphical/text --------------------- images that can be positioned in various strategic places on Web pages and search engines on the Internet. When a potential player clicks on the banner advertisement, the player's Web Browser points the player to the advertiser's home page. We pay for such banner advertisements on a variety of Web pages and search engines, and participate in a banner exchange program. Examples of sites where the company has placed banners for the casino sites it oversees including www.football.com, www.basketball.com, www.tsn.com, www.rgtonline.com, casino and ---------------- ------------------ ----------- ----------------- sports categories on www.about.com, www.gambling.net, as well as other gaming ------------- ---------------- portal sites such as Wager Talk, Wagerline, and Talk Sports. As of the current date, we have no banner advertising in place. We are focused on developing our webmaster/affiliate network base to drive Internet traffic and customers to our websites. We intend to continue to enter into agreements with Webmasters in which Webmasters agree to place our banner advertisements on their Web pages in exchange for a commission for each unique player who clicks through banners to our home page or for a percentage of the profits generated by the Webmaster. Submissions to Search Engines. Potential players often learn about websites on ----------------------------- the Internet from listings on search engines. We have submitted its URL's and a brief description of its Internet casino gaming and sports wagering websites to various search engines so that our information is available to potential players who use search engines to locate Internet gaming sites. Examples of the search engines that the company's URLs have been submitted to include: www.yahoo.com, ------------- www.altavista.com, www.lycos.com, www.dmoz.com, www.directhit.com, ----------------- ------------- ------------ ----------------- www.euroseek.com, www.google.com, www.excite.com, www.looksmart.com, ---------------- -------------- -------------- ----------------- www.hotbot.com. The websites have also been submitted to the following Internet -------------- casino directories including but not limited to www.gamblingregistry.com, ------------------------ www.casinolocator.com, www.casinoseek.com, www.gambling.com, and --------------------- ------------------ ---------------- www.top100casinos.com. These Directories are centralized search tools for --------------------- locating Web sites in a particular industry. Player Incentive Programs. In order to attract new players, we have instituted ------------------------- an initial balance credit promotion. This program is designed to attract new players by offering a credit to new player accounts in amounts based on a percentage of the amount of the initial deposit by the player. To attract repeat players to the website, we institute periodic prizes, cash draws, special jack pots, competitions and/or a frequent player program where the player would be rewarded based on the frequency and dollar amount of play. Development of Related Websites. We may design related websites such as a site ------------------------------- containing tips on how to play certain casino games or a site providing interesting gaming news. We intend to design, develop, and promote a sports information portal site which will feature up-to-date sports information content including scores, statistics, news, headlines, and odds on all of the world's major sporting events. This site will be linked to the online sportsbook to generate traffic with the intention of enhancing revenues. Banner advertisements would then be placed on all pages of each related website to attract players to our Internet gaming and sports wagering websites. Celebrity Endorsements. We intend to seek out a number of celebrities ranging ---------------------- from film and television to sports professionals to endorse a website developed by us. The result of such celebrity endorsement would be to entice new players to establish accounts based on the endorsement of the chosen celebrity. To date, no such celebrity endorsements have been confirmed by us. Distribution of a CD-ROM. We have, in conjunction with World Gaming, produced a ------------------------ CD-ROM on which our casino games are contained. When an individual obtains the CD-ROM, they are able to play all our casino games without the necessity of wagering real money. This promotional idea is intended to give us the ability to distribute, to a large number and variety of potential players, quality examples of the services and products offered at its websites. Once a potential player plays the games offered for fun, we hope that the potential player may make an application on our websites and eventually play the same games for money. We -------------------------------------------------------------------------------- Registration Statement Page 28 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ intend to distribute such CD-ROM's by direct mail-outs, insertions in magazines, distributions through Internet Service Providers to their subscribers and distributions at tradeshows. INDUSTRY OVERVIEW ----------------- GLOBAL GAMING INDUSTRY ---------------------- United States of America ------------------------ In the U.S., Americans legally wager over $500 billion per year. This level of legalized gambling is the result of rapid expansion in the industry over the past decade. Since 1988, the number of states allowing casino gambling has increased from two, Nevada and New Jersey, to 24, (including those with Native American Casinos). At this time, only the states of Utah and Hawaii prohibit all forms of gambling. U.S. casino revenues were projected to be about $24 billion in 1998, reflecting an expected 6% growth from 1997, lower than the double-digit increases earlier in the decade. Gambling in the U.S. has many forms, including casinos, horse and dog racing, government run lotteries, riverboat casinos and Jai Alai, all of which are highly regulated. At the present time, there is no existing regulation of Internet gambling in the U.S. In July 1998, the U.S. Congress defeated a proposed bill (the "Kyl" bill) that would prohibit gambling over the Internet, but exempted certain forms, such as horse and dog racing, and lotteries. On March 12th, 2002, a U.S. House panel voted to update the 40-year-old law banning interstate betting (the Wire Act of 1961) so that it would apply to fast-growing Internet gambling sites as well. This bill has become known as the Goodlatte Bill and contains provisions to deal with, among other things, the payment systems to offshore operators of Internet Gaming sites, something that the previous Kyl bills did not address. Also see VII Regulatory Background). Geographic growth prospects have remained relatively flat over the past two years. With more people employed and improved economic conditions in various parts of the United States, states and localities have fewer incentives to encourage gaming development as a prospective source of taxes, tourism and jobs. Additionally, economic downturns in Asia, and to a lesser extent, South America, have led to significant decreases in "high roller" traffic to North American gaming locations, such as Las Vegas and Atlantic City. In response to the downturn in travelers from this section of its revenue base, the traditional gaming companies in Las Vegas have continued their rapid growth campaign to transform the city from a gaming community into a world wide family resort destination. In recent months Las Vegas in particular has made strides in trying to upgrade the entertainment it offers. Major U.S. casino destinations are competing more for resort and vacation population than the average gambling client. International Gaming Markets ---------------------------- Gaming outside of the U.S. and Canada is a mixture of active markets, large and small resort destinations, and strictly regulated, often state-run, operations. Asia and South Africa provide the most dynamic markets and opportunities for growth, with Latin America and the Caribbean also active in the gaming industry. Western Europe consists mostly of mature, state-controlled markets. In discussing the potential worldwide Internet Gaming market, it must be noted that we have not yet done business with all of the countries and jurisdictions discussed in the following International Market overview and we may never do business with more than the countries we have accepted member subscriptions from to date. For a list of countries from which we currently have registered members, see "The Companies Products and Services" section. Based on the Industry data table, the year 2001 projected industry revenue was $2.3 Billion. Assuming that for the April 30, 2002 year-ended fiscal period our total revenues will not exceed US$1 million, our current position in the worldwide market is approximately 0.043 of one percent. The following is an overview of selected foreign markets: -------------------------------------------------------------------------------- Registration Statement Page 29 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Europe ------ There were a total of 531 European Casinos generating gross Revenues of $5,336,971,600 US as of February 1999 (International Gaming and Wagering Business, 1999 European Casino Report, February 1999). The European Commission last reviewed the issue of gambling in 1991 and found no need for EU-wide regulation. This position has remained in accordance with the many of the EU's member states' positions that gaming, including Internet gambling, should remain an issue for the sovereign state (Cabot, Anthony, THE INTERNET GAMBLING REPORT III, "European Overview," by Steven Philippsohn, (Trace Publications, Las Vegas), 1999, P.211-216). Among the member nations of the EU, views on Internet gambling vary widely. Some states are slowly accepting the idea of interactive gaming. For example, the Dutch government recently allowed telephone betting, while certain European states, notably Finland and Sweden, are allowing providers to offer Internet gambling, but only to their own respective residents. Conversely, the German position on Internet gaming reflects the view taken on traditional forms of gambling. That is, games of chance are morally corrupting and should only be allowed in connection with charitable purposes. Countries such as France, Italy, Spain, England and Portugal are merely monitoring Internet gambling development to see if it becomes a problem. This is consistent with these nations' actions toward e-commerce in general, of which, they have no immediate plans to introduce new legislation. Prospects for growth in Europe are brightest in Scandinavia, Spain and Eastern Europe. Sweden is setting up its regulatory system for its new casino market, and state-sanctioned monopolies are being challenged in Norway and Finland in the casino and machine markets. In Spain, a more relaxed regulatory climate is emerging, and new casino operations are coming on line. Three Spanish firms dominate this market: Cirsa/Unidesa, Recreativos Franco and Sega. Eastern Europe continues to grow and refine is regulatory structures. Uncertainty and prohibitions against foreign investment, however, hamper participation by international operators. Casino Austria is a major player, although its activity there is shrinking. The path, which European regulation of Internet gambling is taking is more akin to that which the Australian states are taking. The cultural differences between European countries, however, are more marked than between the Australian states. The consequent diversity in attitudes to gambling may slow down the process (Steven Philippsohn, Internet Gambling, European Overview," 1998, p.215). Asia ---- Large capital projects and debt levels in Australia left many casinos highly exposed to the Asian economic crisis. Stung by a US$150 million drop in revenues from international players, stock prices for Australia's leading casinos are now a fraction of previous levels. The domestic market remains solid, however, and long-term prospects are optimistic. The next year should bring the beginning of a recovery and a more realistic assessment of the international market. Despite the economic crisis, the casino industry in the Philippines is experiencing the strongest expansion in the region, with three new operations having opened in recent years and another scheduled to open in 1999. The Manila market is being reorganized and partially privatized, providing the opportunity for change and market growth. Three publicly traded companies are active in the Philippines casino market: Starwood Hotels & Resorts, Malaysian-based Metroplex and Manila-based Belle Bay Corporation. Taiwan offers the most interesting potential for change. The government took another step toward legislation in 1998 by commissioning a report recommending a tightly regulated industry of casinos in recreational areas. Foreign investment would be permitted up to 40%. -------------------------------------------------------------------------------- Registration Statement Page 30 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Africa and the Middle East -------------------------- The most significant activity is occurring at opposite ends of the region. South Africa is progressing with the transformation of its casino industry and the opening of a route market for gaming devices. The current estimated size of this market is US$1.5 billion, with the majority of revenues coming from casino gaming operations (US$935 million). The Middle East market is growing in response to the closing of gaming operations in Turkey and limited choices in Northern Europe. With gaming illegal in Israel, further growth in border areas is expected. New operations are expected to grow quickly in Palestine-controlled Jericho to support public demand. In Egypt, across the border from Eilat, major project development is underway in the Taba Heights. Additional operations have also opened recently in North Africa, with more than the planning stages. Latin America ------------- Gaming in Latin America remains decentralized and difficult for operators. However, for patient companies with deep pockets, the market potential in the region is large, especially in countries such as Argentina and Peru. The level of optimism has been raised in Brazil and Mexico for gaming legislation in the near future. Legislation in Brazil, the most populous country in Latin America, would affect regional markets that target Brazilian players, notable Argentina, Uruguay and Paraguay. Sodak Gaming, International Thunderbird, Starwood, Hilton Hotels (Conrad International), IGT and also very active, especially Recreativos Franco, Cirsa/Unidesa and Leisure & Gaming. Caribbean --------- Although dominated by small hotel and resort-based casino operations, gaming in the Caribbean is expanding into new areas, as well as growing in established markets. The Bahamas offers the most substantial casinos in the region, followed by Puerto Rico and Aruba. Casinos can also be found on other islands such as St. Maarten, Curacao, and Antigua. INTERNET GAMBLING INDUSTRY -------------------------- Internet gambling offers people the opportunity to play virtual sports, horseracing, slot machines and other casino games without the inconvenience of leaving their home. While Internet gambling provides some amount of competition for existing casinos, it is not a substantial threat to the traditional gaming industry. The social aspect of gaming - the primary reason for the transformation of the Las Vegas gaming market into a destination leisure market - - cannot be replicated in the artificial environment of the Internet. Most visitors to casinos are motivated by the ambiance of the casinos, not just the opportunity to gamble. Small markets, however, may incur negative impacts associated with Internet gambling as these markets have been established themselves as leisure destinations. The popularity of gaming has transcended beyond the physical boundaries of the casinos to the borderless and unregulated realm of the Internet. Gambling websites, offering computer users the opportunity to wager on such games as bingo, sports and horse wagering, poker and roulette, are beginning to thrive on the Internet. To participate as one of these websites, the player needs only to set up an account, typically supplying credit card information, wire transfers or E-cash. With a click of the mouse, the player is now able to gamble. Losses are typically deducted from the players' credit cards or established credit line, and winnings, upon the request of the player, can be electronically transferred or mailed to the person. Modern technology has eliminated the physical requirement of visiting a casino or racetrack before engaging in such games as slot machines, black jack, roulette and thoroughbred or harness racing. With Internet gambling, patrons need not leave the comfort of their homes or offices. -------------------------------------------------------------------------------- Registration Statement Page 31 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\
ESTIMATED WORLD WIDE INTERNET GAMBLING REVENUES ($ MILLIONS) 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- # of home users (in millions) 46 81 121 145 159 % users conducting online transactions 15% 18% 21% 24% 27% Potential Internet Gamblers (in millions) 6.9 14.5 25.4 34.8 43 Per-capita expenditure $146 $154 $155 $160 $160 Potential Internet gambling market $1,009 $2,182 $3,933 $5,555 $7,080 Estimated actual Internet Gambling revenues $300 $651 $811 $1,520 $2,330 Penetration rate 30% 30% 21% 27% 33% ----------------
Source: Christian/Cummings Associates, Inc. The popularity of Internet gambling is increasing as illustrated by the growth of gaming-related websites. Currently, it is estimated that more than 1,000 gambling websites are offered on the Internet, which Management estimates are owned by approximately 500 operators. With the current licensing of gambling websites by foreign governments and increased usage of Internet services, this market will continue to grow. It is estimated that almost 300 million people will have used the Internet as of the year 2000. With casino gambling garnering public acceptance as a form of entertainment and Internet usage increasing, every personal home computer now has the capacity to become a "cybercasino." According to Datamonitor, the market size estimates for Internet gambling are that it will grow to more than $10.0 billion by 2002. The offshore wagering industry is flourishing and, particularly since everyday sports betting is common in countries such as Great Britain, much of the traffic is generated by Americans. See Marc Falcone, Bear, Stearns & Co., Gaming Industry 12 (Mar. 2001). In 2000, an estimated $1.5 billion was wagered on the Internet, of which approximately $553.3 million was wagered on sporting events, and those amounts are estimated to have nearly doubled in 2001; the number of websites that offer wagering is now believed to be 1,200 to 1,400, half of which have appeared in just the last year. See Falcone, supra, at 6, 48. In Antigua and Barbuda alone, there are more than 50 on-line sportsbooks in current operation, see http://www.tbwsport.com/bookmakers/america.html, and more than 50 jurisdictions all over the world license and regulate sports betting websites and wagering operations. See Mike Brunker, On-Line Gambling Goes Global, MSNBC, Apr. 10, 2001, at http://www. msnbc.com/news . INTERNATIONAL OUTLOOK ON INTERNET GAMING ---------------------------------------- While the U.S. is debating whether to prohibit Internet gaming or create legislation to severely regulate the industry, other countries are viewing it as a revenue generator. Most Internet gambling websites are located in the Caribbean and South America, along with other sites in Australia, South Africa, the Netherlands and New Zealand. The Caribbean governments charge Internet "casino" operators up to $100,000 annually for a license and require operators to post bonds. In Antigua, the government requires the employment of local residents and payment of education taxes. The governments of Liechtenstein and Finland operate their national lottery via the Internet. Australia and New Zealand have recently decided to legalize Internet gambling, choosing to regulate and tax the activity as opposed to banning it. The State of Queensland in Australia passed a law in March 1998, licensing cyber casinos and sports betting operations. The other Australian states are expected to pass similar laws. The states of Australia maintain pro-gambling environments - Australians spend more than $40 billion a year gambling, or $2,000 per person per year on average ("Aussies Love Their Gambling." Las Vegas Review-Journal, Rohan Sullivan, March 9, 1998). Placing bets over the phone is legal in Australia, making legalization of Internet gambling a less controversial issue. To regulate the industry, the governments propose the establishment of gambling service providers who will check the identity and address of the gambler. Winnings will then be taxed accordingly, with the taxes forwarded at the appropriate rate for the state in which the service provider is based. -------------------------------------------------------------------------------- Registration Statement Page 32 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ On May 15, 1998, European gambling regulators from 18 European countries signed a recommendation on good practices for Internet gambling services. In the non-binding statement, the countries agreed that European countries should be free to regulate Internet gambling services. In addition, the countries should ensure that Internet gambling is not used for money laundering or under-aged gambling. COMPETITION ----------- The online commerce market is new, rapidly evolving and intensely competitive, and we expect that competition will further intensify in the future. Barriers to entry are minimal, and current and new competitors can launch new sites at a relatively low cost. Management estimates that there are over 2,000 online gaming and related sites in operation today with potentially thousands more "affiliate" sites. . However, the majority of these sites do not produce substantial revenues as compared to the established, brand name sites, whose operators have invested heavily in their marketing, affiliate, and customer service programs to continuously increase their customer bases and maximize customer retention. Some of the more established Internet Gaming sites that provide similar gaming services as Netforce Entertainment's web sites and that the Company has identified as its competitors include http://globalinteract.com, ------------------------- http://www.intertops.com/, http://www.playersonly.com/, ------------------------- --------------------------- http://www.casinoonnet.com/, http://www.goldclubcasino.com/, --------------------------- ------------------------------- http://www.intercasino.com/, http://www.englishharbourcasino.com/, --------------------------- ------------------------------------ http://www.usacasino.com/, http://www.thesandscasino.com/, ------------------------ ------------------------------ http://www.betonsports.com/, http://www.sportingbet.com/, http://www.wwts.com/, --------------------------- --------------------------- -------------------- and http://www.poker.com/. ------------------------- In addition, the broader gaming industry is intensely competitive. We compete with a variety of companies, including (i) online vendors of gaming and gaming related products, (ii) online service providers which offer gaming products directly or cooperation with other retailers, (iii) traditional providers of gaming products, including specialty gaming providers, and (iv) other retailers that offer gaming products. Many of these traditional providers also support dedicated websites, which may compete directly with us. We believe that the principal competitive factors in our online market are brand recognition, selection, variety of value-added services, ease of use, site content, quality of service, technical expertise and product availability. Many of our intended and potential competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than us. We are aware that certain of our proposed competitors have and may continue to adopt more aggressive pricing or marketing policies and devote substantially more resources to website and systems development than us. Increased competition may result in reduced operating margins, loss of market share and a diminished brand franchise. There can be no assurance that we will be able to compete successfully against intended and future competitors. New technologies and the expansion of existing technologies may increase the competitive pressures of the Company. There can be no assurance of the economic success of any marketing effort by us since the revenues derived from the Internet casino gaming and sports wagering websites depend primarily upon the site's acceptance by the international public, which cannot be predicted with certainty. To be ultimately successful, we will be faced with the challenge of marketing our gaming websites to a variety of foreign cultures. Our websites will compete for consumer acceptance with similar websites hosted by other companies. As a result, the success of our marketing efforts is dependent not only on the quality and acceptance of the our virtual casino games and on-line sports wagering websites, but also on the acceptance of other competing virtual casino games and websites offered in the marketplace during the same time period. -------------------------------------------------------------------------------- Registration Statement Page 33 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ DESCRIPTION OF PROPERTY ----------------------- The Company occupies 240 square feet of commercial office space at Suite #10, Friars Hill Road, Woods Centre, St. John's, Antigua, West Indies. This office houses our operations including workstations for four individuals engaged in customer support, production, marketing, website development, and accounting, and administration functions. All gaming transaction servers website hosting facilities are physically housed and maintained by World Gaming's co-location facilities in Antigua. The building in which we leased space is in the heart of St. John's and is home to several other Technology and Internet based companies. This arrangement and proximity to other similar companies is expected to lend itself well to promoting the Company as being in the right area and on the leading edge of technology. As well, our offices are in close proximity to banking services, the post office, money transfer services, courier services, and other essential business service providers and their offices. The terms of the Woods Centre office lease are as follows: We lease 240 square feet through to July 31, 2002 at an annual rent of $8,400 USD. Our lease said space on a month-to-month basis during the term. We have a renewal option thereafter of up to five years on terms to be negotiated at the time. It is our intention to renew the lease at the end of the first year for an extended term. MANAGEMENT ---------- DIRECTORS AND EXECUTIVE OFFICERS -------------------------------- Terry G. Bowering ----------------- Chairman, President and Chief Executive Officer ----------------------------------------------- # 2, Flamboyant Avenue P.O. Box W-645 St. John's, Antigua, West Indies DOB: August 30, 1960 (Age 41) Regina, Saskatchewan, Canada Terry G. Bowering, B.Admin, M.B.A. Mr. Bowering brings over fifteen years of experience in business management. Mr. Bowering has considerable experience in both large corporations and entrepreneurial enterprises and is qualified in the areas of business development, finance, information systems, marketing, and sales. From January 1998 until his resignation June 20, 1999, Mr. Bowering was Vice President, Offshore Operations for Starnet Communications International Inc., a Delaware corporation, which is a fully reporting issuer on the NASD OTC:BB. Described as being the "Microsoft of Internet Gaming", Starnet Communications International, Inc., now World Gaming, is one of the world's leading Internet Gaming Software providers. Mr. Bowering was instrumental in establishing and developing offshore operations and foreign government relations for World Gaming in Antigua and for establishing worldwide offshore banking relationships in concert with the corporate development of World Gaming's subsidiaries, Electronic Financial Services Caribbean Inc. and its group of International companies. Mr. Bowering has been interviewed and quoted in the International press including FOX TV, COMPUTER WORLD MAGAZINE, SHIFT MAGAZINE, TIME MAGAZINE (Atlantic Edition), and ESPN, specifically on the subject of offshore Internet Gaming. From 1996 to 1998, Mr. Bowering was an Investment Advisor, Vancouver office, with Levesque Securities Inc., a major Canadian brokerage firm. From May 1992 to June 1996, Mr. Bowering was a financial analyst with the Asset Management Group Dept. of Crown Life Insurance in Regina, Saskatchewan, Canada. Mr. Bowering holds a Bachelor of Administration in Finance from the University of Regina, and a Master of Business Administration with a concentration in Strategic Management from the University of Saskatchewan. Mr. Bowering resides in Antigua, West Indies. -------------------------------------------------------------------------------- Registration Statement Page 34 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Mr. Bowering was appointed to the above positions on March 1, 1999 to serve until his successor has been elected and qualifies. Dwight Lewis ------------ Director -------- Cassada Gardens P.O. Box W-386 St. John's, Antigua, West Indies DOB: May 24, 1961 (Age 40) St. Lucia, West Indies Dwight Lewis, MA, BSc. Mr. Lewis is presently engaged as a Financial Consultant to Hanson International Investment Services Ltd., an investment advisory organization. He also is Managing Director of Mahaut Ltd., a corporation that provides offshore financial services to its clients. Most recently Mr. Lewis was engaged as a Financial Consultant and Interim Manager of RYO International Corporation and SAGA Corporation, which were eventually merged to form International Data Processing. This corporation owns and operates a number of Internet Casinos based and licensed in Antigua. On behalf of the corporation's overseas principals, Mr. Lewis was responsible for establishing these operations from conception to live operation, having dealt with all aspects of the company's operations and providing ongoing management and supervisory services. From 1992 to 1997, Mr. Lewis was employed with the Bank of Antigua Ltd. as a Senior Manager dealing with management of the investment portfolio and general supervision of all bank operations. From 1988 to 1992, Mr. Lewis was employed with the Eastern Caribbean Central Bank, located in St. Kitts, as a Senior Bank Examiner. This entailed general supervision of commercial banking activities in all member banks of the Eastern Caribbean Central Bank. From 1986 to 1988, Mr. Lewis worked as a Budget Analyst with the Ministry of Finance, Government of St. Lucia, and with Barclays Bank, St. Lucia, from 1980 to 1983. Mr. Lewis graduated from the University of West Indies, Cave Hill Campus, Barbados, with a Bachelor of Science Degree in Economics and Management. Mr. Lewis also attended the University of Sheffield, Management School, England, where he obtained an MA in Banking and International Finance. Mr. Lewis resides in Antigua, West Indies. Mr. Lewis was appointed to the position of Director on December 20, 1999 to serve until his successor has been elected and qualifies. Derek C. Ferguson ----------------- Director -------- 512-1238 Seymor St. Vancouver, B.C., V6B 6J3 Canada DOB: August 12, 1972 (Age 30) Vancouver, Canada Derek C. Ferguson, B.Comm Mr. Ferguson advises on and oversees technical and systems-related issues and initiatives for Netforce Systems Inc. Mr. Ferguson is presently a Director and Chief Operations Officer for eTunnels Inc., a Delaware corporation that delivers mass-market and corporate virtual private networking solutions over the Internet. -------------------------------------------------------------------------------- Registration Statement Page 35 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ From April 1998 to October of 1999, Mr. Ferguson acquired in-depth experience in the online gaming industry in his role as Senior Systems Administrator for Starnet Communications International Inc., an International Internet Technology company. Starnet is recognized as the world's leading Internet Gaming Software provider. In addition to providing technical design and maintenance leadership for the Systems Administration department, Mr. Ferguson redesigned its systems infrastructure to dramatically improve the reliability and scalability of Starnet's Internet services. Mr. Ferguson was also Network Manager for I.D. Internet Direct Ltd., a division of Look Communications Inc., a publicly traded Canadian company operating in the fields of broadcast distribution services and Internet solutions. At Internet Direct, Mr. Ferguson directed technical design and support operations for their national consumer dial and corporate broadband services, helping to grow the service to 35,000 subscribers. Mr. Ferguson received his Bachelor of Commerce degree with a concentration in Management and Information Systems (MIS) from Dalhousie University, Halifax, Canada. Mr. Ferguson resides in Vancouver, Canada. Mr. Ferguson was appointed to the position of Director on September 10, 2001 to serve until his successor has been elected and qualifies. Trevor L. Bowering ------------------ Director -------- 370 Cedar Meadow Drive Regina, Saskatchewan, Canada, S4X 3J5 DOB: March 14, 1959 (Age 42) Regina, Canada Trevor L. Bowering - Technical Consultant Mr. Bowering has been employed in the telecommunications field with SaskTel for over 22 years. With assets of over $1.2 billion, SaskTel has been in operation for 90 years and provides a full range of hi-tech communication solutions for more than 454,000 business and residential customers worldwide. SaskTel is a crown corporation, wholly-owned by the province of Saskatchewan, Canada, and a world leader in providing the latest technological and software solutions telecommunications expertise as well as Internet and Interactive services. Mr. Bowering currently manages SaskTel's Local and Long-distance switching network including DMS100's, DMS200, STP, DC Power Plants, Operator Services, Interexchange Carriers (Telus, ATT, Bell, Nexia), 911, Mobility (cellular), CCS7, and Network Management. He personally oversees a staff of staff of 39 Trunking and Switching Technicians responsible for installing, maintaining and trouble shooting on a 24/7 basis. SaskTel's entire high-speed Internet system interfaces to its customers via this Switching equipment. Mr. Bowering and his staff have been on assignment with SaskTel International in England, Italy, Spain, Chile, Belgium, and France. Mr. Bowering currently resides in Regina, Saskatchewan, Canada. Mr. Bowering was appointed to the position of Director on August 15, 2001 to serve until his successor has been elected and qualifies. DIRECTOR AND OFFICERS COMPENSATION ---------------------------------- In the fiscal years ended April 2000 and April 2001, our Chairman, President and Chief Executive Officer, Terry G. Bowering, received a salary of $52,000 and $38,000, respectively. Mr. Douglas Bolen, acting as Secretary and Director, received a salary of $18,000 during the fiscal year ended April 2000 and in the fiscal year ended April 2001. In the current fiscal year, Mr. Bowering is not receiving a salary but is reimbursed for business travel expenses. Currently, no other Directors or Officers are receiving a salary. The members of our Board are reimbursed for actual expenses incurred in attending Board meetings. There are no other arrangements for compensation to the Board of Directors' members. -------------------------------------------------------------------------------- Registration Statement Page 36 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ There are no written employment contracts or agreements with any executive officers or contract employees. Employee salaries are set by the Members of the Board of Directors. DIRECTOR AND OFFICERS COMPENSATION ---------------------------------- In the fiscal years ended April 2000 and April 2001, our Chairman, President and Chief Executive Officer, Terry G. Bowering, received a salary of $52,000 and $38,000, respectively. Mr. Douglas Bolen, acting as Secretary and Director, received a salary of $18,000 during the fiscal year ended April 2000 and in the fiscal year ended April 2001. In the current fiscal year, Mr. Bowering is not receiving a salary but is reimbursed for business travel expenses. Currently, no other Directors or Officers are receiving a salary. The members of our Board are reimbursed for actual expenses incurred in attending Board meetings. There are no other arrangements for compensation to the Board of Directors' members. There are no written employment contracts or agreements with any executive officers or contract employees. Employee salaries are set by the Members of the Board of Directors. PRINCIPAL SHAREHOLDERS ---------------------- The following table sets forth information about the beneficial ownership of our outstanding common shares on July 8, 2002 by: The following tables set forth certain information regarding beneficial ownership of our common stock as of July 8, 2002 by (i) each person who is known to us to own beneficially more than 5% of our outstanding common stock, (ii) each of our directors, (iii) executive officers and (iv) all current directors and executive officers as a group.
Name and Address Amount and Nature Percent of Beneficial Owner of Beneficial Owner (1) of Class ---------------------------------------------------------------------------------------------- Terry G. Bowering 6,544,830 40.0% #2, Flamboyant Ave. beneficial owner (2) P.O. Box W-645 St. John's, Antigua, West Indies Chairman,/President/Chief Executive Officer Terry G. Bowering 500,000 3.1% C/o High Street & Corn Alley beneficial owner (3) P.O. Box 1679 St. John's, Antigua, West Indies IFG Investments Services Inc. 6,027,870 36.8% Suite #4 - Temple Building beneficial owner (4) Main & Princess William St. Charelstown, Nevis, West Indies Dwight Lewis, Director 50,000 0.30% Cassada Gardens P.O. Box W 386 St. Johns, Antigua West Indies -------------------------------------------------------------------------------- Registration Statement Page 37 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Derek C. Ferguson, Director 50,000 0.30% 512-1238 Seymor St. Vancouver, British Columbia, Canada, V6B 6J3 Trevor Bowering, Director 200,000 1.2% 370 Cedar Meadow Drive Regina, Sask. Canada S4X 3J5 All Directors & Executive Officers And control persons as a Group (5 persons) 13,272,700 81.7% ---------- ----- Total shares outstanding 17,066,033 100% ========== ==== (1) No member of Management has the right to acquire within sixty days through options, warrants, rights, conversion, privilege or similar obligations any security of the Company. (2) Geneva Overseas Holdings Ltd., of which Terry G. Bowering is beneficial owner, enjoys legal ownership of said securities. (3) JPKT Metro Investment Corporation, of which Terry G. Bowering is a beneficiary, enjoys legal ownership of said securities. (4) IFG Investments Services Inc., of which Daniel MacMullin is beneficial owner, enjoys legal ownership of said securities.
Note: The table does not reflect the stock options that may be granted to Employees, Officers, Directors or Consultants nor does it reflect the warrants offered. RELATED PARTY TRANSACTIONS -------------------------- A related party transaction took place between Geneva Overseas Holdings Ltd. and Net-Force Systems Inc. Geneva Overseas Holdings Ltd. is controlled by the President of Net-Force Systems Inc., Mr. Terry G. Bowering. Geneva Overseas Holdings Ltd. provided a total of $214,483 in shareholder loans to Net-Force Systems Inc. On September 15, 2001, Geneva Overseas Holdings Ltd. entered into an agreement with Net-Force Systems Inc. to convert the principal and accrued interest at that date on the loans to equity at $0.10 per share. The total shares issued to Geneva Overseas Holdings Ltd. was 2,144,830. (See Financial Statements, Note 5 - Material Events). We are not aware of any other transactions or proposed transactions in respect of which we were or are to be a party, in which any director, executive officer, nominee for election as a director, 5% security holder, member of the immediate family of any of the previously named persons had a direct or indirect interest in the transaction. DESCRIPTION OF SHARE CAPITAL AND CORPORATE GOVERNANCE ----------------------------------------------------- The following description of our authorized share capital is subject to the detailed provisions of our Memorandum and Articles of Association, copies of which are available upon request by contacting us at - Net-Force Systems Inc. , Suite #10-Epicurean, Woods Centre, Friars Hill Road, St. John's, Antigua, West Indies, telephone: (268) 481-1970. The securities to be registered pursuant to this F-1 are all of the outstanding common stock of Net-Force Systems Inc. -------------------------------------------------------------------------------- Registration Statement Page 38 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Corporate Governance and Share Rights Pursuant to section 104 of the International Business Corporations Act of --------------------------------------- Antigua and Barbuda the directors of the Company must call an annual meeting of shareholders not later than 18 months after the Company comes into existence and subsequently not later than 15 months after holding the last preceding annual meeting and may at any time call a special meeting of shareholders. Section 113 states that a quorum of shareholders is present if the holders of a majority of the shares entitled to vote at the meeting is present in person or represented by proxy. Holders of the common stock are entitled to cast one vote for each share held at all shareholder meetings for all purposes, except that in the election of Directors, each shareholder of common stock shall have as many votes for each share held by him as there are directors to be elected and for whose election the shareholder has a right to vote. There are no preemptive rights associated with the securities and no cumulative voting is authorized by the Articles of Incorporation or the By-Laws. The holders of the shares have the right to a dividend when declared by the Board of Directors and a pro-rata right to the assets of the Company after payment of all liabilities and preferences conferred upon any preferred shares upon liquidation. Pursuant to section 51 of the International Business ---------------------- Corporations Act of Antigua and Barbuda the Company shall not declare or pay a ---------------- dividend if there are reasonable grounds for believing that the Company is unable or would after the payment be unable to pay its liabilities as they become due or the realizable value of the Company's assets would thereby be less than the aggregate of its liabilities and stated capital of all classes. Section 52 allows the payment of a dividend by issuing fully paid shares of the Company, money or property but the Company shall not pay a dividend out of unrealized profits. The Company has never declared or paid cash dividends on the common stock of the Company. Management intends to retain all available funds and any future earnings for use in the operation and expansion of the business and does not anticipate paying any cash dividends in the foreseeable future. A special resolution (requiring a 2/3 majority or signature of all shareholders entitled to vote) is required for a sale, lease or exchange of all or substantially all the property of the Company other than in the ordinary course of business (section 125 of the International Business Corporations Act of --------------------------------------- Antigua and Barbuda.); to amend the Company's articles in such circumstances as to change any maximum number of shares that the Company is authorized to issue, to create new classes of shares, to change the designation of all or any of its shares and add, change or remove any rights privileges, restrictions and conditions including rights to accrued dividends, in respect of all or any of its shares, whether issued or unissued (section 161 and 163 of the International ------------- Business Corporations Act of Antigua and Barbuda.); and for an amalgamation ------------------------- agreement to amalgamate with another corporation(s) (section 169 of the International Business Corporations Act of Antigua and Barbuda.). --------------------------------------- A shareholder is entitled to be paid the fair value of his or her shares if they dissent to the Company resolving to sell, lease or exchange all or substantially all of the property of the Company other than in the ordinary course of business of the Company (section 125 of the International Business Corporations Act of Antigua and Barbuda) or to an amalgamation of the Company with another company (section 169). Pursuant to section 125 a notice of meeting of shareholders must be sent that includes a copy or summary of the agreement of sale, lease or exchange and states that a dissenting shareholder is entitled to be paid the fair value of his or her shares in accordance with section 191. Pursuant to section 169 the directors of each amalgamating corporation must submit an amalgamation agreement for approval to a meeting of the shareholders of the amalgamating corporation of which they are directors and to the holders of each class or series of shares of that amalgamating corporation. A notice must be sent to each shareholder of each amalgamating corporation which includes the Company, specifying a copy or summary of the amalgamation agreement and must state that a dissenting shareholder is entitled to be paid the fair value of his or her shares in accordance with section 191. Pursuant to section 191 a shareholder who dissents is entitled to be paid by the Company the fair value of the shares held by him or her in respect of which he or she dissents determined as of the close of business on the day before the resolution was adopted or order made. Section 194 mandates that the Company must not later than seven days after the day on which the action approved by the resolution is effective or demand for payment has been made by the shareholder pursuant to section 192, whichever is later, send to each dissenting shareholder a written offer to pay for the shares at fair value with a statement showing how the fair value was -------------------------------------------------------------------------------- Registration Statement Page 39 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ determined or a notice that it is unable lawfully to pay the dissenting shareholders for their shares. The Company must pay the fair value of the shares within 10 days of an offer under section 194. If the Company fails to make an offer under section 194 or if a dissenting shareholder fails to accept the offer made by the Company, the Company may within 50 days after the action approved by the resolution is effective, apply to the court to fix a fair value for the shares of a dissenting shareholder. If the Company fails to apply to the court a dissenting shareholder may within a further period of 20 days apply to the court to fix a fair value for the shares of any dissenting shareholders. Section 67 of the International Business Corporations Act of Antigua and Barbuda --------------------------------------- provides that the shareholders of the Company must at the first meeting of the corporation and at each following annual meeting at which an election of directors is required, elect directors to hold office for a term expiring not later than the close of the third annual meeting of the shareholders of the Company following the election. Section 93 provides that the directors of the Company may designate the offices of the Company, appoint natural persons of full capacity as officers, specify their duties and delegate to them powers to manage the business and affairs of the Company. The directors also have the power to remove officers. Section 97, 98 and 99 of the International Business Corporations Act of Antigua --------------------------------------- and Barbuda provides that a director or officer or former director or officer or person who acted at the Company's request as a director or officer of a body corporate of which the Company is or was a shareholder or creditor or the legal representative of the foregoing persons may be indemnified against all costs, charges and expenses reasonably incurred in any civil, criminal or administrative action to which the aforementioned persons has been made a party unless the person did not act honestly and in good faith in the best interests of the Company or belief that his conduct was lawful. The aforementioned persons are also entitled to indemnification pursuant to section 99 if the persons were substantially successful on the merits in his or her defense of the action or proceeding, acted honestly and in good faith with a view to the best interests of the Company and is fairly and reasonably entitled to indemnity. Article VIII of the Company Articles of Incorporation provides that it shall indemnify any and all of its Directors, officers, employees or agents or former Directors, officers, employees or agents or any person who may have served at its request as a Director, officer, employee or agent of another company, partnership, joint venture, trust or other enterprise in which it owns shares of capital stock or of which it is a creditor, to the full extent permitted by law. The indemnification shall include, but not be limited to, the expenses, including the cost of any judgments, fines, settlements and counsel's fees, actually and necessarily paid or incurred in connection with any action, suit or proceeding, whether civil, criminal, administrative or investigative, and any appeals thereof, to which any such person or his legal representative may be made a party or may be threatened to be made a party by reason of his being or having been a Director, officer, employee or agent as herein provided unless such action, suit or proceeding is a result of the Director, officer, employee or agent's own negligence or illegal action. The foregoing right of indemnification shall not be exclusive of any other rights to which and Directors, officers, employee or agent may be entitled as a matter of law or which he may be lawfully granted. The total amount of shares authorized by the Company's Articles of Incorporation is 150,000,000. Of these, 100,000,000 are common stock and 50,000,000 are preferred stock. There has been no issuance of any preferred stock. Dividend, voting, conversion rights, liquidation rights and other rights of the preferred stock, if any, will be established by the Board of Directors upon issuance. OWNERSHIP RESTRICTIONS ---------------------- There is no law or governmental decree or regulation in Antigua that restricts the export or import of capital, or affects the remittance of dividends, interest or other payments to non-resident holders of ordinary shares. There is no limitation imposed by Antigua law or by the Articles of Incorporation or other charter documents of the company on the right of a non-resident to hold or vote ordinary shares. -------------------------------------------------------------------------------- Registration Statement Page 40 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ TRANSFER AGENT AND REGISTRAR ---------------------------- The registrar and transfer agent for our common shares is Pacific Stock Transfer Co. located at Suite # 240 - 500 East Warm Springs Road, Las Vegas, NV 89119. SHARES ELIGIBLE FOR FUTURE SALE ------------------------------- Upon completion of the offering, a total of 17,066,033 of our common shares will be outstanding. The sale of substantial numbers of common shares in the public market, or the possibility of such a sale, could adversely affect prevailing market prices for our ordinary shares. All of the common shares sold in the offering will be freely tradable without restriction under the U.S. Securities Act, except by "affiliates" as defined in ------------------- Rule 144 under the U.S. Securities Act, or "control persons" as defined under ------------------- the U.S. Securities Act. ------------------- For the reasons set forth below, we believe that the following presently outstanding common shares will be eligible for resale in the public market in the United States at the following times: No. of Shares ------------- At the date of this prospectus nil 180 days after the date of this prospectus 17,066,033 Later than 180 days after the date of this prospectus becoming effective nil U.S. RESALE RESTRICTIONS ------------------------ Upon completion of this offering, it is our estimation that some of the ordinary shares will be held by U.S. residents or others. As a result of the lock-up agreements and the provisions of Rule 144 under the U.S. Securities Act, such shares will be available for sale in the public market in the United States as set forth in the table above, subject in some cases to Rule 144 limitations. In general, under Rule 144, as in effect on the date of this prospectus, any person, including any of our affiliates, who has beneficially owned common shares for at least one year will be entitled to sell, in any three-month period, a number of shares that, together with sales of any ordinary shares with which such person's sales must be aggregated, does not exceed the greater of: o 1% of the then outstanding ordinary shares; and o The average weekly trading volume of the common shares on the Over-The-Counter Bulletin Board, governed by NASD, during the four calendar weeks immediately preceding the date on which such sale is made. Sales of restricted securities pursuant to Rule 144 are subject to requirements relating to manner of sale, notice and availability of current public information about the company. Persons who are our affiliates must also comply with the restrictions and requirements of Rule 144, other than the one-year holding period requirement, in order to sell ordinary shares in the public market, which are not restricted securities. -------------------------------------------------------------------------------- Registration Statement Page 41 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ AUDITORS -------- We have retained the accounting firm of HJ & Associates, L.L.C. of Salt Lake City, Utah, U.S.A. to be our auditors. MATERIAL AGREEMENTS AND DOCUMENTS --------------------------------- Agreements, the Memorandum and Articles of Association and documents which are material to this Offering and that are not confidential to the company, all of which are or will be in effect by the closing date, may be obtained and/or reviewed at our offices by contacting Mr. Terry Bowering at (268) 481-1970. We may require a prospective investor's prior execution of confidentiality and nondisclosure agreements before accessing certain of our documents. ADDITIONAL INFORMATION ---------------------- Our common shares are being offered exclusively through this prospectus. We have prepared no offering documents other than this prospectus in connection with our offering of the shares. Nevertheless, potential investors in the shares may obtain a copy of all non-confidential corporate documents that the company possesses by contacting, Mr. Terry Bowering directly at (268) 481-1970. TAXATION IN ANTIGUA AND THE UNITED STATES OF AMERICA ---------------------------------------------------- United States security holders of the registrant company are not subject to taxes or withholding provisions. Sections 271- 274 of the International Business Corporations Act, 1982, Antigua and Barbuda, Division G: Special Taxation Provisions detail the relevant tax provisions under the Act. Section 271, "Exempt corporations" states the following: "For the purposes of this Division, an exempt corporation shall mean any corporation formed or continued under this Act." Section 272, "Exemption from tax" states the following: (1) No income tax, capital gains tax, or other direct tax or impost may be levied in Antigua and Barbuda upon the profits or gains of an exempt corporation, in respect of the international trade and business it carries on from within Antigua and Barbuda. (2) No income tax, capital gains tax, or other direct tax or impost may be levied in Antigua and Barbuda in respect of any securities or assets of an exempt corporation that are beneficially owned by an exempt corporation or by a person who is not a resident. (3) No estate, inheritance, succession or similar tax or impost may be levied in Antigua and Barbuda in respect of any securities or assets of an exempt corporation that are beneficially owned by an exempt corporation or by a person who is not a resident. (4) No tax, duty or other impost may be levied upon the increment in value of the property, or other assets in Antigua and Barbuda or elsewhere of an exempt corporation other than upon such of them as are distributed to residents. -------------------------------------------------------------------------------- Registration Statement Page 42 \\\/// NETFORCE \\//\\ SYSTEMS INC. ///\\\ Section 273, "No assets transfer tax". (1) No tax, duty or other impost may be levied upon an exempt corporation, its security holders or transferees in respect of the transfer of all or any part of it's securities or other assets to another exempt corporation or to a person who is not a resident. (2) When an exempt corporation or a person who is not a resident transfers securities or assets of an exempt corporation that are held by that exempt corporation, or person to another exempt corporation, or to another person who is not a resident, the transfer is exempt from the payment of any tax, duty, or other impost thereon. (3) No income tax or capital gains tax, and no other direct tax or impost, may be levied or collected in Antigua and Barbuda, in respect of any dividends interests or other returns from any securities, deposits or borrowings of an exempt corporations or any assets managed by the exempt corporation if the dividends, interest or other returns are in respect of securities, deposits, borrowings or assets beneficially owned by another exempt corporation, or a person who is not a resident; but the onus of establishing ownership, lies upon the exempt corporation holding or managing the deposits, borrowings or assets. Section 274, "Withholding tax and report" (1) Notwithstanding, any provision of the Income Tax Ordinance, but subject to subsection (2), no exempt corporation need withhold any portion of any dividend, interest or other returns, payable of any person in respect of any borrowings of the exempt corporation from that person or in respect of securities of the exempt corporation held by that person. (2) All dividends interest or other returns attributable to the securities of, or the management of, assets by an exempt corporation that are payable to a resident who is known to be a resident, by the exempt corporation or who, with the exercise of reasonable care by the exempt corporation, could be known by him to be a resident, must be reported to the Commissioner of Inland Revenue by the exempt corporation. Section 276 of the Act, "Duration of tax exemption" states the following: "Any tax exemption provided under this Act, shall continue in effect for a period of fifty years from the date of incorporation of the exempt corporation." There is no reciprocal tax treaty in existence between the United States and Antigua and Barbuda regarding withholding taxes. LEGAL MATTERS ------------- Septimus A. Rhudd, No. 6 Temple Street, St. John's, Antigua will pass upon the legality of the common shares offered by this prospectus. Stepp Law Group, Newport Beach, California acts as our counsel on United States legal matters related to this prospectus. We are not aware of any material legal proceedings against the company. We may be involved, from time to time, in various legal proceedings and claims incident to the normal conduct of our business. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/SYNA_synaptics_legal_matters.txt b/parsed_sections/legal_matters/2002/SYNA_synaptics_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e30804c4c345fd3fcbaf408aa4ae8f5e46f45c09 --- /dev/null +++ b/parsed_sections/legal_matters/2002/SYNA_synaptics_legal_matters.txt @@ -0,0 +1 @@ +Three months ended September 30, 2001 compared to three months ended September 30, 2000 Revenue was $23.6 million for the three months ended September 30, 2001 compared to $14.0 million for the three months ended September 30, 2000, an increase of 68.5%. The increase in revenue was attributable to an increase in unit shipments, higher average selling prices resulting from the inclusion of both a touch pad and a pointing stick in our dual pointing solutions, which began shipping in the June 2000 quarter, and non-recurring engineering services. Revenue from our dual pointing solutions represented approximately 49% of our revenue for the three months ended September 30, 2001 compared to 16% for the three months ended September 30, 2000. Gross margin as a percentage of revenue was 38.0% for the three months ended September 30, 2001 compared to 36.0% for the three months ended September 30, 2000. The improvement in gross margin as Table of Contents SUMMARY CONSOLIDATED FINANCIAL DATA The following table sets forth our summary historical consolidated financial data. You should read this information in conjunction with our consolidated financial statements, including the related notes, and Management s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this prospectus. The financial data as of September 30, 2001 and for the three months ended September 30, 2000 and 2001 are derived from financial statements that are unaudited. Three Months Ended Years Ended June 30, September 30, Table of Contents a percentage of revenue resulted from the implementation of cost-improvement programs, which reduced the cost of our dual pointing solutions through the combination of design and process improvements, lower outside assembly costs, generally lower costs for materials and electronic components, and non-recurring engineering revenue. Research and development expenses increased 32% to $3.7 million, or 15.7% of revenue, for the three months ended September 30, 2001 from $2.8 million, or 20.0% of revenue, for the three months ended September 30, 2000. The major contributor to the increase in spending was higher compensation costs associated with increased staffing levels. Higher product development related expenses, including outside services and materials costs, also contributed to this increase. Selling, general, and administrative expenses increased to $2.7 million, or 11.3% of revenue, for the three months ended September 30, 2001 from $2.0 million, or 14.0% of revenue, for the three months ended September 30, 2000. The $713,000 increase reflected higher sales commissions and increased staffing and expenses related to our higher revenue and operating levels. The three months ended September 30, 2000 reflect a $197,000 charge for the amortization of goodwill and other acquired intangible assets related to the acquisition of ASL. In connection with the adoption of Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets on July 1, 2001, amortization of goodwill was terminated, which resulted in significantly lower amortization charges in the three months ended September 30, 2001 compared to the three months ended September 30, 2000. Amortization of other intangible assets continued in accordance with the previously determined useful economic lives. The three months ended September 30, 2001 includes amortization expense for deferred stock compensation of $121,000 compared to $154,000 for the three months ended September 30, 2000. We expect to record amortization expense of $361,000 in the remaining nine months of fiscal 2002, $475,000 in fiscal 2003, and the balance of $692,000 in future years. We generated operating income of $2.5 million for the three months ended September 30, 2001 compared to an operating loss of $75,000 for the three months ended September 30, 2000. The major contributors to the improvement in operating income included the increased revenue levels, the higher gross margin percentage resulting from the implementation of our cost improvement programs for our dual pointing solutions, lower assembly costs, lower materials and electronic components costs, non-recurring engineering revenue, and lower amortization expense for acquired intangible assets. These factors were partially offset by higher compensation costs resulting from our increased staffing levels, higher research and development project costs, and higher commissions associated with the increased revenue level. The provision for income taxes for the three months ended September 30, 2001 was $845,000 compared to $26,000 for the three months ended September 30, 2000, reflecting the higher pre-tax profit levels. The income tax provisions represent both the estimated federal and state taxes and the foreign taxes associated with our operations in the United Kingdom and Taiwan. The effective tax rate for the first three months of fiscal 2002 was 35%, reflecting the benefits of a research and development tax credit, partially offset by nondeductible deferred compensation. Fiscal year ended June 30, 2001 compared to fiscal year ended June 30, 2000 Revenue was $73.7 million for the year ended June 30, 2001 compared to $43.4 million for the year ended June 30, 2000, an increase of 69.6%. The increase in revenue was attributable to an increase in unit volume shipments, an increase in market share, and higher average selling prices resulting from the inclusion of both a touch pad and pointing stick in our dual pointing solutions, which we began shipping in production volumes in the June 2000 quarter. Revenue from our dual pointing solutions represented approximately 41% of our revenue for the year ended June 30, 2001. Gross margin as a percentage of revenue was 31.1% for the year ended June 30, 2001 compared to 41.0% for the year ended June 30, 2000. The decline in gross margin as a percentage of revenue resulted from sales of our dual pointing solutions, which during the year had significantly lower margins than our Table of Contents touch pad products as a result of the high content of third-party products, and higher costs for materials and components, which resulted from general market supply-demand imbalances during the year. Research and development expenses increased to $11.6 million, or 15.7% of revenue, for the year ended June 30, 2001 from $8.4 million, or 19.3% of revenue, for the year ended June 30, 2000. Major contributors to the increase in spending included the ongoing development of the inductive pen-sensing technology acquired in connection with the acquisition of ASL in October 1999, additional staffing, product development, and related materials expense in our San Jose research and development organization. Selling, general, and administrative expenses increased to $9.1 million, or 12.4% of revenue, for the year ended June 30, 2001 from $7.4 million, or 17.0% of revenue, for the year ended June 30, 2000. The $1.7 million increase in selling, general, and administrative expenses reflects non-cash stock compensation charges, increased staffing, and expenses related to our higher revenue and operating levels. The year ended June 30, 2000 included an $855,000 charge for the write-off of in-process research and development associated with our October 1999 acquisition of ASL. In connection with the ASL acquisition, we acquired ASL s primary technology, called Spiral. See Purchased In-Process Research and Development. The amortization of goodwill and other acquired intangible assets related to the acquisition of ASL resulted in total amortization expense of $753,000 in the fiscal year ended June 30, 2001 compared to $502,000 for eight months included in the fiscal year ended June 30, 2000. In July 2001, the Financial Accounting Standards Board issued two new accounting standards that change the accounting for business combinations and goodwill and other intangible assets acquired in a business combination. We are required to adopt the new standards on July 1, 2001 after which date goodwill and certain other acquired intangible assets will not be amortized. However, we will be required to perform an impairment review on at least an annual basis to determine whether any charge should be booked to reduce the carrying value of goodwill and other acquired intangible assets to their respective recoverable values. See Recent Accounting Pronouncements. The year ended June 30, 2001 included amortization of deferred stock compensation of $597,000. In connection with deferred compensation recorded for stock option grants through fiscal 2001, we expect to record amortization of $482,000 in fiscal 2002, $475,000 in fiscal 2003, and the balance of $692,000 in future years. We generated operating income of $810,000 for the year ended June 30, 2001 compared to $460,000 for the year ended June 30, 2000. The increase in operating income primarily reflects the $5.1 million of additional gross margin resulting from the significant increase in revenue. This increase was partially offset by the lower gross margin percentage attributable to the high percentage of lower margin dual pointing products included in the revenue mix, incremental operating expenses associated with a larger operation, and higher materials and components costs resulting from general market supply-demand imbalances. The provision for income taxes was $180,000 for the year ended June 30, 2001 compared to $120,000 for the year ended June 30, 2000. The income tax provision for both years represents the federal and state taxes and the foreign taxes associated with our operations in the United Kingdom and Taiwan. The effective tax rate was 18% for fiscal 2001 compared to 15% for fiscal 2000. The effective rate for both years is lower than the statutory rate of 35%, primarily due to the benefits of utilizing net operating loss carryforwards partially offset by nondeductible deferred compensation and goodwill amortization. Additionally, research and development tax credits were used to reduce the tax provision in fiscal 2001. The effective tax rate for fiscal 2001 is higher than the effective tax rate for fiscal 2000 because the net operating loss carryforwards were fully utilized during fiscal 2001. Fiscal year ended June 30, 2000 compared to fiscal year ended June 30, 1999 Revenue was $43.4 million for the year ended June 30, 2000 compared to $29.8 million for the year ended June 30, 1999, an increase of 45.6%. This increase reflects an increase in unit volume shipments of Table of Contents TouchPads, which was partially offset by a reduction in overall average selling prices. The reduction in overall average selling prices resulted from the combination of lower shipments of a specific higher-priced touch pad that was discontinued by its OEM during fiscal 2000 and general competitive pricing pressures. Gross margin as a percentage of revenue was 41.0% for the year ended June 30, 2000 compared to 40.3% for the year ended June 30, 1999. The increase reflects the successful execution of cost improvement programs, partially offset by a decrease in average selling prices. The most significant cost reduction resulted from transitioning to our next-generation ASIC, which is used in all of our interface solutions. Research and development expenses increased to $8.4 million, or 19.3% of revenue, for the year ended June 30, 2000 from $4.9 million, or 16.3% of revenue, for the year ended June 30, 1999. The primary contributor to both the increase in absolute spending and the increase as a percentage of revenue was the on-going development of the pen-sensing technology associated with the acquisition of ASL in October 1999. Other factors that contributed to this increase included additional staffing, product development, and related materials expense in our San Jose research and development organization. Selling, general, and administrative expenses increased to $7.4 million, or 17.0% of revenue, for the year ended June 30, 2000 from $5.5 million, or 18.5% of revenue, for the year ended June 30, 1999. The $1.9 million increase in selling, general, and administrative expenses reflects higher sales commissions associated with higher revenue levels and additional sales and management personnel. The fiscal year ended June 30, 2000 includes an $855,000 charge for the write-off of in-process research and development associated with our October 1999 acquisition of ASL. (See Note 3 of notes to consolidated financial statements.) In addition, the amortization of goodwill and other acquired intangibles related to the ASL transaction resulted in total amortization expense of $502,000 for the remaining eight months of fiscal 2000. We generated operating income of $460,000 for the year ended June 30, 2000 compared to $1.6 million for the year ended June 30, 1999. The reduction in operating income primarily reflects the write-off of in-process research and development, amortization of goodwill and other acquired intangible assets, higher research and development expenses, and higher sales commissions associated with higher revenue levels. These expenses were partially offset by higher gross margins. The provision for income taxes for the year ended June 30, 2000 was $120,000, which represents U.S. alternative minimum taxes and the foreign taxes associated with our operations in the United Kingdom and Taiwan. The effective tax rate for fiscal 2000 is 15%, which is lower than the statutory rate of 35% primarily due to the benefits of utilizing net operating loss carryforwards partially offset by nondeductible goodwill amortization. For the fiscal year ended June 30, 1999, the income tax provision was $40,000, which consisted primarily of U.S. alternative minimum taxes. During fiscal 2000, we recorded equity losses of $2,712,000, representing our share of losses incurred by Foveon. The total amount of the equity losses recognized were determined on the basis of our ownership interest in Foveon s convertible preferred shares and our proportionate share of new funds provided to Foveon in exchange for convertible promissory notes and have been limited to the maximum of our total investment. Accordingly, the carrying value of our investment in Foveon has been reduced to zero at the end of fiscal 2000. Purchased In-Process Research and Development Purchased in-process research and development, or IPRD, of $855,000 in fiscal 2000 represents the write-off of in-process inductive position sensing technology associated with our acquisition of ASL. We used available information to calculate the amounts allocated to IPRD. In calculating IPRD, we used established valuation techniques accepted in the high-technology industry. These calculations gave Table of Contents consideration to relevant market sizes and growth factors, expected industry trends, the anticipated nature and timing of new product introductions by us and our competitors, individual product sales cycles, and the estimated lives of each of the products underlying technology. The value of the IPRD reflects the relative value and contribution of the acquired research and development. We used a discount rate of 30% to compute the net present value of the future cash flows for the purpose of determining the value attributed to IPRD. We also gave consideration to the IPRD s stage of completion, which was estimated to be approximately 75% complete at the time of the acquisition, the complexity of the work completed to date, the difficulty completing the remaining development, costs already incurred, and the projected cost to complete the project in determining the value assigned to IPRD. At the time of the acquisition, the Spiral technology had not reached technological feasibility and the IPRD did not have alternative future uses. At the time of acquisition of ASL, the estimated cost to complete the project was estimated to be $6.0 million. The value assigned to developed technologies related to the acquisition was based upon discounted cash flows related to the future products projected income streams. Elements of the projected income stream included revenue, cost of sales, selling, general, and administrative expenses, and research and development expenses. The discount rates used in the present value calculations were generally derived from a weighted average cost of capital, adjusted upward to reflect the additional risks inherent in the development life cycle, including the useful life of the technology, profitability levels of the technology, and the uncertainty of technology advances that were known at the date of the acquisition. The overall valuation methodology assumed a core technology leverage factor of 15%, a projection of three-year revenue stream beginning fiscal 2001, and a discount factor of 30% to determine the present value of future cash flows. Given the uncertainties of the commercialization process, no assurance can be given that deviations from our estimates will not occur. At the time of the ASL acquisition, we believed there was a reasonable chance of realizing the economic return expected from the acquired in-process technology. Although we have experienced delays in completing the development of IPRD, our assumptions to compute the value of IPRD have generally been reasonable and consistent with our actual results. There can be no assurance, however, that any project will achieve commercial success because of the risk associated with the realization of benefits related to commercialization of an in-process project due to rapidly changing customer needs, the complexity of the technology, and growing competitive pressures. Failure to successfully commercialize an in-process project would result in the loss of the expected economic return inherent in the fair value allocation. Additionally, the value of our intangible assets acquired may become impaired. We expect to continue the development of the Spiral technology and derivative commercial products and believe that there is a reasonable chance of successfully completing these development efforts. There is, however, risk associated with the completion of the in-process projects, and there can be no assurance that any project will achieve either technological or commercial success. Quarterly Results of Operations The following table sets forth our unaudited quarterly results of operations for the nine quarters in the period ended September 30, 2001. You should read the following table in conjunction with the financial statements and related notes contained elsewhere in this prospectus. We have prepared this unaudited information on the same basis as our audited financial statements. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. You should not draw any conclusions about our future results from the results of operations for any quarter. Revenue has increased in each of the last nine quarters, except for the quarter ended March 31, 2000. Revenue in our March quarters traditionally has been lower than in our December quarters, reflecting the seasonality of consumer spending in the second half of the year, resulting in part from back to school and holiday purchases. The quarter ended March 31, 2001 did not reflect our normal trend as a result of the higher average selling prices associated with revenue from our dual pointing solutions. In addition to this normal seasonality, we believe that revenue in the December 1999 quarter was higher as a result of customers building inventories in expectation of potential supply-chain problems associated with the widely publicized year 2000 computer issue. Beginning in April 2000, revenue growth also increased as a result of shipments of our dual pointing solutions, which have higher average selling prices because of the inclusion of two interface solutions rather than one. In the September 2000 quarter, we began shipping interface solutions for the iAppliance markets, which solutions represented approximately 2.5% of our total revenue for the year ended June 30, 2001. The initial applications included touch sensing interfaces for Internet appliances, which allow for Internet access and sending and receiving e-mail, and set-top-boxes used for Operating income (loss) 832 284 (237 ) (419 ) (75 ) (214 ) Interest and other income (expense), net 89 105 112 59 102 Table of Contents Internet access and home entertainment, which utilize the end user s television as the monitor. Lower than expected adoption rates for certain of these devices have lowered our shipments in these areas. Gross margin as a percentage of revenue declined over the six quarters ended December 31, 2000, as we continued to grow market share. This reflects the combination of generally lower prices, higher materials and components costs resulting from general market supply-demand imbalances, increasing production costs, and the introduction of our initial lower-margin dual pointing solutions, partially offset by our incremental cost-improvement programs. The significant decline in gross margin percentage in the December 2000 quarter was primarily a result of a much higher percentage of our sales being lower- margin dual pointing solutions. The increase in gross margin percentage in the last three quarters reflects the impact of our cost-improvement programs, particularly those related to our dual pointing solutions, a general price increase we announced in the December 2000 quarter, lower production costs, and lower materials and components costs resulting from an easing of the supply-demand pressures we experienced in the second half of calendar 2000. We began shipping our proprietary dual pointing solution in the September 2001 quarter, which also has a positive impact on gross margins. We are currently developing our next generation ASIC and planning additional cost improvement programs that we expect will reduce our overall product costs once fully developed, qualified by our OEM customers, and implemented in our manufacturing process, which we expect to begin phasing in during 2002. Operating expenses, exclusive of the non-recurring charge for in-process research and development in the December 1999 quarter, amortization of goodwill and other acquired intangible assets, and deferred stock compensation, have generally increased over the nine quarters ended September 30, 2001, primarily reflecting the combination of the following four factors: (1) increased staffing in all departments to support our overall business growth; (2) increased spending on research and development to continue to improve our existing technologies and develop new technologies for new product applications, including ClearPad and Spiral; (3) increased selling costs related to the higher revenue levels; and (4) increased management and infrastructure spending to support our planned growth and penetration into new markets. Liquidity and Capital Resources Since our inception, we have financed our operations through cash flows from operations, private sales of securities, and to a lesser extent, capital equipment financing. During the three months ended September 30, 2001, net cash generated from operating activities was $2.0 million, primarily reflecting our net income of $1.6 million plus non-cash adjustments for depreciation and amortization of acquired intangible assets and deferred stock compensation. Working capital for the September 2001 quarter was unchanged from the June 2001 quarter. We expect that accounts receivable and inventory will continue to increase if our revenue continues to grow and that we will continue to increase our investment in capital assets to expand our business. During fiscal 2001, net cash used in operating activities totaled $2.3 million, primarily reflecting increased working capital, excluding cash and capital lease and equipment financing obligations, of $5.2 million related to our higher operating levels, partially offset by non-cash adjustments for depreciation, amortization, and stock compensation of $2.5 million. During fiscal 2000, we used $40,000 in cash from operating activities compared to generating $301,000 in fiscal 1999. In fiscal 2000, net cash used in operations of $40,000 reflects our net loss of $2.0 million, offset by the combination of the following items: (1) adjustments for non-cash charges, including our proportionate share of equity losses in an affiliated company, Foveon, which totaled $2.7 million, a write-off of $855,000 of in-process research and development, $1.2 million of amortization and depreciation, and $137,000 of stock based compensation; and (2) increases in accounts receivable, inventories, and accounts payable of $3.7 million, $1.5 million, and $2.5 million, respectively, relating to our increased business activities. In fiscal 1999, net cash generated from operations of $301,000 reflects our net income of $1.9 million, adjusted for non-cash depreciation and amortization of $535,000, partially offset by increased working capital, excluding cash and capital lease and equipment financing obligations, of $2.3 million, primarily reflecting increases in accounts Table of Contents receivable of $1.9 million and reductions in accounts payable of $802,000 and inventory of approximately $297,000. Investing activities typically relate to purchases of capital assets, which totaled $277,000 for the three months ended September 30, 2001, $982,000 for fiscal 2001, $1.1 million for fiscal 2000, and $315,000 for fiscal 1999. In addition, we advanced $2.7 million in fiscal 2000 in the form of convertible promissory notes to Foveon, an affiliated company, and invested $1.5 million in cash in the October 1999 acquisition of ASL, which together with the capital asset purchases referred to above resulted in total cash used in investing activities of $5.3 million in fiscal 2000. We also issued 652,025 shares of our common stock in connection with the acquisition of ASL. In connection with the acquisition of the sales representative workforce of our former outside sales agent in Taiwan, we issued 37,500 shares of our common stock and are obligated to issued an additional 37,500 shares if certain covenants are fulfilled. Financing activities over the prior three years have generally been related to the proceeds obtained from the financing of capital assets, offset by the related repayments under those transactions, plus the proceeds from the exercise of vested stock options. Net cash provided by financing activities for fiscal 2001 was $536,000, reflecting net usage of cash from equipment financing of $71,000 offset by proceeds from stock option exercises totaling $607,000. Net cash provided by financing activities was approximately $99,000 for fiscal 2000 and $212,000 for fiscal 1999. Our principal sources of liquidity as of September 30, 2001 consisted of $5.5 million in cash and cash equivalents, a $4.2 million working capital line of credit with Silicon Valley Bank, and a master equipment financing agreement, dated November 28, 2000, with KeyCorp Leasing, which has $251,000 available for additional capital asset financing. The Silicon Valley Bank revolving line of credit expires on August 29, 2002, has an interest rate equal to 50 basis points above the bank s prime rate, and provides for a security interest in substantially all of our assets. We have not borrowed any amounts under the line of credit to date. The KeyCorp financing agreement is based on a 36-month term from the date KeyCorp funds capital asset purchases and an interest rate equal to approximately 250 basis points over the U.S. Treasury 18-month index at the time of funding, which is then fixed for the 36-month term. Capital assets currently financed under the KeyCorp master financing agreement total $499,000 and borrowings have an annual interest rate of 8.25%. The long-term note payable to National Semiconductor represents limited-recourse debt that is secured solely by a portion of our preferred stockholdings in Foveon, in which National Semiconductor is also an investor. We do not anticipate making any payments under the limited-recourse loan with National Semiconductor, either prior to or at maturity, unless Foveon is participating in a liquidity event, such as an initial public offering of its equity securities or a merger, through which we would be able to receive amounts in excess of the carrying amount of our $1.5 million investment. We believe our existing cash balances, the working capital line of credit with Silicon Valley Bank, the available funds remaining under the KeyCorp master equipment lease agreement, and the net proceeds of this offering will be sufficient to meet our cash requirements at least through the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity, and the continuing market acceptance of our product solutions. We cannot assure you that additional equity or debt financing will be available to us on acceptable terms or at all. As of the date of this prospectus, our sources of liquidity beyond 12 months will be our then current cash balances, funds from operations, and any long-term credit facilities that we arrange. We have no other agreements or arrangements with third parties to provide us with sources of liquidity and capital resources beyond the next 12 months. Disclosure of Market Risks Interest rate risk Our exposure to market risk for changes in interest rates relates primarily to our cash and cash equivalents. Due to the conservative nature of our investment portfolio, which is predicated on capital (unaudited) (in thousands, except for share and per share data) Consolidated Statement of Operations Data: Net revenue $ 29,842 $ 43,447 $ 73,698 $ 13,988 $ 23,569 Cost of revenue(1) 17,824 25,652 50,811 8,959 14,607 Assets Cash equivalents Fixed rate amounts $ 180 $ $ $ $ $ $ 180 $ 180 Average rate 4.6 % 4.6 % Variable rate amounts $ 3,404 $ $ $ $ $ $ 3,404 $ 3,404 Average rate 7.3 % 7.3 % Liabilities Capital leases and equipment financing obligations Fixed rate amounts $ 547 $ 253 $ 75 $ $ $ $ 875 $ 875 Average rate 8.32 % 8.32 % 8.32 % 8.32 % Note payable to related party Fixed rate amounts $ $ $ $ $ $ 1,500 $ 1,500 $ 1,500 Average rate 6.0 % 6.0 % There have been no significant changes in the maturity dates and average interest rates for our investment portfolio and debt obligations subsequent to June 30, 2001. Foreign currency exchange risk All of our sales and our expenses, except those expenses related to our U.K. and Taiwan operations, are denominated in U.S. dollars. As a result, we have relatively little exposure to foreign currency exchange risks and foreign exchange losses have been minimal to date. We do not currently enter into forward exchange contracts to hedge exposure denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. In the future, if we feel that our foreign exchange exposure has increased, we may consider entering into hedging transactions to help mitigate that risk. Recent Accounting Pronouncements In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, Impairment of Long-Lived Assets. FAS 144 supercedes Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. FAS 144 retains the requirements of FAS 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and the fair value of the asset. FAS 144 specifically removes goodwill from the scope of FAS 121 and is applicable to financial statements issued for fiscal years beginning after December 15, 2001, which in our case is our fiscal year ending June 30, 2003. The adoption of FAS 144 is not expected to have any material adverse impact on our financial position or results of operations. Table of Contents BUSINESS Overview We are the leading worldwide developer and supplier of custom-designed user interface solutions for notebook computers. In our fiscal year ended June 30, 2001, we supplied approximately 61% of the touch pads used in notebook computers throughout the world. Our new pointing stick is designed to address the portion of the notebook market that uses the pointing stick as an interface solution. We estimate that in fiscal 2001 approximately 55% of all notebook computers sold used solely a touch pad interface, 29% used solely a pointing stick interface, 10% used a dual pointing interface, which consists of both a touch pad and a pointing stick, and 6% used some other type of interface. Our new pointing stick can be used with our touch pad to take advantage of the growing trend toward dual pointing interface solutions. Our OEM customers include Acer, Apple, Compaq, Dell, Hewlett-Packard, and Samsung, as well as Fujitsu/Siemens, IBM, NEC, Sony, and Toshiba. We believe our extensive intellectual property portfolio, our experience in providing interface solutions to major OEMs, and our proven track record of growth in our expanding core notebook computer interface business position us to be a key technological enabler for multiple applications in many fast-growing markets. Based on these strengths, we are addressing the opportunities created by the growth of a new class of mobile computing and communications devices, which we call iAppliances. These iAppliances include PDAs and smart phones, as well as a variety of mobile, handheld, wireless, and Internet devices. We believe our existing technologies, our new product solutions, and our emphasis on ease of use, small size, low power consumption, advanced functionality, durability, and reliability will enable us to penetrate the markets for iAppliances. Industry Overview The Notebook Computer Market Trends toward mobile computing and communications, supported by technological advances in computer processing power, continued development of the Internet and network infrastructure, and improved remote connectivity, are driving significant growth of the notebook computer market. Notebook computers provide the functionality of a desktop PC, and their small form factor enables portable computing with remote access and connectivity to the Internet and other networks. Notebook computers can be used in conjunction with a full-size monitor, keyboard, and docking station to provide an experience comparable to a desktop PC. For these reasons, the corporate market continues to replace desktop PCs with notebook computers, enabling workers to be more productive away from the office. At the same time, the availability of notebook computers with increased processing power, longer battery life, larger displays, and thinner and lighter designs is prompting companies to upgrade their notebook computers to higher performance models. These trends are the primary drivers for the growth of notebook computer sales in the corporate market. In the consumer market, notebook computers also are replacing desktop PCs as small-office, home-office, and other individual users demand the flexibility and benefits of mobile computing and connectivity. Other factors promoting this replacement trend include the smaller cost differential between notebook computers and desktop PCs and a shorter lag time for technology migration from desktop PCs to notebook computers. In addition, the continued development of wired dormitories, classrooms with Internet connections, and wireless local area networks in schools and universities are driving significant growth of notebook computer sales in the education market. Another factor contributing to higher relative growth of notebook computers versus desktop PCs is the difference in product life cycles. Desktop PCs generally have product lifecycles of approximately three years, while product lifecycles are shorter for notebook computers, owing to technological advances, harsh usage patterns that often test durability and reliability, theft, and loss. As a result, individuals and corporations generally replace and upgrade notebook computers more frequently than desktop PCs. Table of Contents As a result of these factors, notebook computers are experiencing rapid growth in both the corporate and consumer markets, resulting in market share gains at the expense of desktop PCs. According to IDC, worldwide shipments of notebook computers increased 31.0% for calendar year 2000 compared to 12.5% for desktop PCs during the same period. According to IDC estimates, worldwide shipments of notebook computers will increase 4.3% for calendar year 2001 compared to a decrease of 9.1% for desktop PCs during the same period. IDC forecasts that the market for notebook computers will grow from an estimated 27.3 million units in 2001 to 43.0 million units in 2005, a compound annual growth rate of 12.1%. This compound annual growth rate of notebook computers exceeds that of desktop PCs, which are estimated to grow at 8.1% annually during the same period. The Emerging iAppliance Markets Individuals increasingly desire the ability to access information, such as e-mail, corporate intranets, the Internet, calendars, and databases, when they are away from their homes or offices. This demand for universal access to information is being driven by the desire for increased productivity and convenience. These factors are prompting the development of a new generation of intelligent and connected devices that are intended to be easy to use, enhance productivity, and provide convenience at low cost. Technological advances, the convergence of mobile computing and communications, and the growth of the Internet have collectively served as a catalyst for the development of these devices, which we refer to as iAppliances. iAppliances exist in many form factors and have broad applications, including personal information management, consumer entertainment, home networking and automation, automotive controls and displays, and other Internet access terminals located away from the home or office. Examples of iAppliances include PDAs, mobile handheld computing devices, smart phones, consumer Web terminals, e-mail terminals, Internet gaming devices, and Internet screenphones. iAppliances allow users to more easily and intuitively access, manage, and store information anytime and anywhere. iAppliances are generally smaller, lighter weight, easier to use, and in the case of mobile iAppliances, consume less battery power than PCs. These benefits are driving significant growth of the iAppliance markets. Today, the markets for iAppliances are in their infancy and still evolving. iAppliances, however, are expected to achieve widespread consumer acceptance. Industry experts believe that the proliferation of iAppliances that address disparate functions will cause these markets to grow rapidly. Unlike the market for PCs in which users typically operate a single PC, industry experts believe that the markets for iAppliances will be characterized by multiple devices for each person. Furthermore, iAppliances have begun to generate interest from people that do not actively use PCs. In addition, a combination of technological advances and infrastructure development, such as the deployment of third-generation broadband wireless services, advances in device miniaturization, and the adoption of wireless protocols, such as Bluetooth and 802.11b, which increases the users ability to access information anytime and anyplace, will accelerate the demand for iAppliances. Consequently, the iAppliance markets are anticipated to grow significantly faster than the market for PCs. For example, IDC forecasts that the worldwide market for smart handheld devices will grow from an estimated 15.9 million units in 2001 to 49.5 million units in 2005, a compound annual growth rate of 32.8%. Interface Solutions In the desktop PC market, the keyboard and the mouse have been adopted as universal user interface devices. Notebook computers, however, require highly integrated interfaces that are compact and easy to use. As a result, the traditional PC mouse has largely been replaced by the touch pad and by the pointing stick in notebook computers. A touch pad allows the user to navigate the screen using a finger or stylus on a touch-sensitive pad. A pointing stick allows the user to navigate the screen by using a finger to apply pressure on a small stick device. Each of these interfaces provides a different user experience that appeals to a range of user preferences. We estimate that in fiscal 2001 approximately 55% of all notebook computers sold used solely a touch pad interface, 29% used solely a pointing stick interface, 10% used a dual pointing interface, which consists of both a touch pad and a pointing stick, and 6% used some other type of interface. Table of Contents Recently, OEMs have developed and introduced notebook computers that incorporate dual pointing solutions, containing both a touch pad and a pointing stick. Dual pointing solutions provide users with enhanced flexibility and alternative means of interacting with a notebook computer. Dual pointing solutions are gaining popularity with corporate information technology departments because of their ability to satisfy most user preferences with a single notebook computer. In addition, by purchasing notebook computers with dual pointing solutions, corporate information technology departments can consolidate vendor relationships and technical support. The vast array of functionality incorporated in iAppliances and their emphasis on universal access to information, including through an Internet or other network connection, has resulted in many different form factors, many of which are too small to accommodate either a keyboard or a mouse. As a result, iAppliances require innovative interface solutions to input, access, and manage information. A variety of interfaces have been developed and incorporated in iAppliances to facilitate user interaction with these devices. For example, many handheld PDAs utilize a touchscreen interface as the primary means to input, manage, and retrieve information, while mobile phones generally utilize a numeric keypad and a push-button option menu, or in some cases, a dial to scroll through option menus. Users are finding through experience that certain interfaces are more suitable for specific functions while severely limiting for other functions. As a result, as OEMs compete for market share and consumer acceptance, the interface solution represents one of the primary means to differentiate iAppliances among competing products. The optimum interface solution must operate intuitively and be easy to use; facilitate portability in terms of size, weight, and power usage; offer advanced features to enhance user experience; and satisfy consumer demand for reliability and durability. The Synaptics Solution We develop, acquire, and enhance interface technologies that improve the way people interact with mobile computing and communications devices. Our innovative and intuitive interfaces accommodate many diverse platforms. Our technologies include an extensive array of ASICs, firmware, software, and pattern recognition and touch sensing technologies. Through our technologies, we seek to provide our customers with customized solutions that address their individual design issues and result in high-performance, feature-rich, and reliable interface solutions. Our new TouchStyk addresses the pointing stick and dual pointing portions of the notebook computer market; our new ClearPad addresses the notebook computer and iAppliance markets; and our new Spiral solution addresses the iAppliance markets. We believe our interface solutions offer the following characteristics: Ease of Use. Our interface solutions offer the ease of use and intuitive interaction that users demand. Small Size. The small, thin size of our interface solutions enables our customers to reduce the overall size and weight of their products in order to satisfy consumer demand for portability. Low Power Consumption. The low power consumption of our interface solutions enables our customers to offer products with longer battery life or smaller battery size. Advanced Functionality. Our interface solutions offer many advanced features to enhance user experience. Reliability. The reliability of our interface solutions satisfies consumer demand for dependability, which is a major component of consumer satisfaction. Durability. Our interface solutions withstand repeated use, severe physical treatment, and temperature fluctuations while providing a superior level of performance. We believe these characteristics will enable us to maintain our leadership position in the notebook computer market and will enhance our position as a technological enabler of iAppliances and a differentiator for OEMs of these devices. Table of Contents Our emphasis on technological leadership and customized-design capabilities positions us to provide unique interface solutions that address specific customer requirements. Our long-term working relationships with large, global OEMs provide us with experience in satisfying their demanding design specifications and other requirements. Our custom product solutions provide OEMs with numerous benefits, including the following: customized, modular integration; reduced product development costs; shorter product time to market; compact and efficient platforms; improved product functionality and utility; and product differentiation. We work with our customers to customize our solutions in order to meet their design requirements. This collaborative effort reduces the duplication and overlap of investment and resources, enabling our OEM customers to devote more time and resources to the market development of their products. We utilize capacitive and inductive technologies rather than traditional resistive technology in our product solutions. Unlike resistive technology, our capacitive and inductive technologies require no activation force, thereby permitting easy movement across the touch surface, and use no moving parts. Our capacitive technology also can be integrated with both curved and flat surfaces. Capacitive and inductive technologies provide additional key benefits over resistive technology. Capacitive and inductive sensors can be fabricated without the air or liquid gap required by resistive technology, reducing undesirable internal reflections and the power requirements for the LCD backlight, thereby extending the battery life of small handheld devices. Capacitive and inductive technologies also allow much thinner sensors than resistive technology, allowing for slimmer, more compact, and unique industrial designs. Our Strategy Our objective is to continue to enhance our position as the world s leading supplier of interface solutions for the notebook computer market and to become a leading supplier of interface solutions for the emerging high-growth iAppliance markets. Key aspects of our strategy to achieve this objective include the following: Extend Our Technological Leadership We plan to utilize our extensive intellectual property portfolio and technological expertise to provide competitive advantages, extend the functionality of our product solutions, and offer innovative product solutions to our customers across multiple market segments. We intend to continue to utilize our technological expertise to reduce the overall size, weight, cost, and power consumption of our interface solutions while increasing their applications, capabilities, and performance. We plan to expand our research and development efforts through strategic acquisitions and alliances, increased expenses, and the hiring of additional engineering personnel. We believe that these efforts will enable us to meet customer expectations and to achieve our goal of supplying on a timely and cost-effective basis the most advanced, easy-to-use, functional interface solutions integrating touch, handwriting, vision, and voice capabilities. Enhance Our Leadership Position in the Notebook Computer Market We intend to continue to introduce market-leading interface solutions in terms of performance, functionality, size, and ease of use. Our new TouchStyk enables us to address the pointing stick and the expanding dual pointing segments of the notebook interface market. Our new electronic signature, or e-signature, capabilities, pen-computing applications, multi-finger navigation, and scroll strip products are Table of Contents designed to provide additional functionality that results in competitive advantages. Our hyper-thin TouchPad solution allows our customers to produce even thinner notebook computers. Capitalize on Growth of the iAppliance Markets We intend to capitalize on the growth of the iAppliance markets brought about by the convergence of computing and communications. We plan to offer innovative, easy-to-use interface solutions that address the evolving portability, connectivity, and functionality requirements of these new markets. We plan to offer these solutions to existing and potential OEM customers as a means to increase the functionality, reduce the size, lower the cost, and enhance the user experience of our customers products. We plan to utilize our existing technologies as well as aggressively pursue new technologies as these markets evolve and demand new solutions. Emphasize and Expand Customer Relationships We plan to emphasize and expand our strong and long-lasting customer relationships and to provide the most advanced interface solutions for our customers products. We recognize that our interface solutions enable our customers to deliver a positive user experience and to differentiate their products from those of their competitors. We continually attempt to enhance the competitive position of our customers by providing them with innovative, distinctive, and high-quality interface solutions on a timely and cost-effective basis. To do so, we work continually to improve our productivity, to reduce costs, and to speed the delivery of our interface solutions. We endeavor to streamline the entire design and delivery process by maintaining an ongoing design, engineering, and production improvement effort. We also devote considerable effort to support our customers after the purchase of our interface solutions. Pursue Strategic Relationships and Acquisitions We intend to develop and expand strategic relationships to enhance our ability to offer value-added customer solutions, address new markets, rapidly gain market share, and enhance the technological leadership of our product solutions. Our strategic relationship with Three-Five Systems, a leading supplier of custom designed display modules, provides for the joint development and marketing of touch screen LCD products and the integration of our Spiral and ClearPad product solutions with their LCD display drivers for use in cellular phones, PDAs, and other electronic devices. We established our relationship with AuthenTec, a leading developer of fingerprint sensing technology, to develop fingerprint recognition security capabilities for the notebook computer and iAppliance markets. Our strategic relationship with Zytronic, a developer of large touch screen products, provides for the development of a capacitive touch sensing controller module to be integrated by Zytronic into its products. We intend to enter into additional strategic relationships with other leading companies in our target markets. We also intend to acquire companies in order to expand our technological expertise and to establish or strengthen our presence in selected target markets. Continue Virtual Manufacturing We plan to expand and diversify our production capacity through third-party relationships, thereby strengthening our virtual manufacturing platform. This strategy results in a scalable business model; enables us to concentrate on our core competencies of research and development, technological advances and product design; and reduces our capital expenses. Our virtual manufacturing strategy allows us to maintain a variable cost model, in which we do not incur most of our manufacturing costs until our product solutions have been shipped and billed to our customers. Products We offer customers in the PC and iAppliance markets user interface solutions that provide competitive advantages. Our family of product solutions allows our customers to solve their interface needs and differentiate their products from those of their competitors. TouchPad In fiscal 2001, we supplied approximately 61% of the touch pads used in notebook computers throughout the world. Our TouchPad, which takes the place of a mouse, is a small, touch-sensitive pad that senses the position of a person s finger on its surface through the measurement of capacitance. Our TouchPad provides the most accurate, comfortable, and reliable method to provide screen navigation, cursor movement, and a platform for interactive input and allows customers to provide a stylish, simple, user-friendly, and intuitive terminal for both the consumer and professional markets. Our TouchPads offer various advanced features, including the following: Virtual scrolling. This feature enables the user to scroll through any document by swiping a finger along the side or bottom of the TouchPad. Customizable tap zones. These zones permit separate portions of the TouchPad to be used to simulate mouse clicks, launch applications, and perform other selected functions. Palm Check. Palm Check eliminates false activation when a person s palm accidentally rests on the TouchPad. Edge Motion. This permits cursor movement to continue when a user s finger reaches the edge of the TouchPad. Tapping and dropping of icons. This feature allows the user to simply tap on an icon in order to drag it, rather than being forced to hold a button down in order to drag an icon. Multi-finger gestures. This feature allows the user to designate specific actions when more than one finger is used on the TouchPad. Our TouchPads are available in a variety of sizes and can be designed to meet the specifications of our customers. Customized driver software ensures the availability of specialized features. We also can provide e-signature capabilities for our TouchPads utilizing third-party software. This allows users to sign their names directly on the TouchPad itself, providing a reliable and binding e-signature solution without additional hardware costs. Table of Contents Utilizing our TouchPad technology, we recently introduced our scroll strip, a touch-sensitive device similar to a TouchPad. Our initial applications will be to mount the scroll strip within keyboards, external mice, and portable communication devices. Users can take advantage of the scroll strip to easily scroll up and down Web pages or word processing documents. Future applications for the scroll strip may include cellular phones and other communications and computing devices. A new generation of our TouchPad responds to both finger touch and stylus-pointing devices. This solution adds stylus capabilities to our TouchPad so notebook computers and other devices that use finger touch input can now take advantage of pen-computing applications, such as drawing, signature capture, and handwriting recognition, without sacrificing the accurate, comfortable finger input capability of the TouchPad. TouchStyk TouchStyk, our pointing stick interface solution, is a self-contained, easily integrated module that uses the same capacitive technology as our TouchPad. TouchStyk is enabled with press-to-select and tap-to-click capabilities and can be easily integrated into multiple computing and communications devices. We have reduced the number of components needed to control the pointing device, allowing the electronics for TouchStyk to be mounted directly on the printed circuit board, or PCB, of the unit. In addition, restricting analog signals to the module greatly reduces exposure to electromagnetic interference, which provides for greater pointing accuracy and prevents the pointer from drifting when not in use. Our TouchStyk can operate either with our proprietary algorithms or algorithms licensed from IBM. This allows OEMs to select the algorithms of their choice while still gaining the advantages of our pointing stick solution. Our modular approach allows OEMs to include our TouchPad, our TouchStyk, or a combination of both interfaces in their notebook computers. We recently began shipping our TouchStyk in connection with our dual pointing solutions. With respect to the portion of the notebook computer market that uses a pointing stick as the sole interface, we have one design win for our TouchStyk with one OEM customer and are in qualification with two other OEM customers. Dual Pointing Solution Our dual pointing solution offers both a touch pad and a pointing stick in a single notebook computer, enabling users to select their interface of choice. Our dual pointing solution also provides the end user the ability to use both interfaces simultaneously. Our dual pointing solution provides the following advantages: cost-effective and simplified OEM integration; simplified OEM product line since one device contains both solutions; single-source supplier, which eliminates compatibility issues; and end user flexibility since one notebook can address both user preferences. We have developed two solutions for use in the dual pointing market. Our first solution integrates all the electronics for controlling a third-party resistive strain gauge pointing stick onto our TouchPad PCB. This solution simplifies OEM integration by eliminating the need to procure the pointing stick electronics from another party and physically integrate them into the notebook. Our second dual pointing solution uses our TouchStyk rather than a third-party pointing stick, and offers the same simplified OEM integration. The second solution is a completely modular design, allowing OEMs to offer TouchPad-only, TouchStyk-only, or dual pointing on a build-to-order basis. ClearPad ClearPad, our innovative and customizable touch screen solution, consists of a clear thin sensor that can be placed over any viewable surface, including display devices, such as LCDs. ClearPad is controlled Table of Contents by a small electronics module, which can be located remotely from the sensor. Similar to our traditional TouchPad, our ClearPad has various distinct advantages, including light weight; low profile form factor; high reliability, durability, and accuracy; and low power consumption. In addition, ClearPad enables visual information display in conjunction with touch commands. The size and shape of both the sensor surface and electronics module can be customized for many applications. ClearPad can be mounted on any curved surface, resulting in new opportunities for industrial design. In applications with extreme space constraints, the electronic module can be integrated into an existing PCB. ClearPad also can emulate physical buttons or slider switches displayed on an active display device or printed on an underlying surface. ClearPad is an extension of our capacitive TouchPad technologies. Standard resistive touch screens include an air gap, causing significant internal reflections that degrade the quality of the display. When used as a touch screen, ClearPad eliminates the internal air gap present in resistive touch screens, significantly decreasing internal reflections and their associated impact on display quality. This makes ClearPad an excellent solution for use outdoors and for devices with color displays. ClearPad is well suited for widespread application in the iAppliance markets. These applications include the following: PDAs smart phones smart handheld devices Web terminals Internet devices e-mail terminals automotive controls and displays interactive games and toys We have used our ClearPad technology to develop a product solution that replaces the touch pad in notebook computers. Our solution consists of a ClearPad mounted over an LCD display. This solution provides all of the features of a standard touch pad while providing information content and significant additional features. We have developed this solution with a USB interface for significant and rapid data transfer and easy integration into notebook computer designs. Spiral Spiral is a thin, lightweight, low power, inductive pen-sensing solution. The Spiral sensor lies behind an LCD screen, effectively permitting 100% light transmissivity and lower overall power consumption resulting from reduced backlighting requirements. Spiral uses a patented inductive coupling technology that offers the unique feature of proximity sensing to measure the precise position of the tip of the pen to be measured relative to a pen-based device. Spiral also has a high tolerance to user abuse. Spiral combines 100% light transmissivity, high accuracy, high-noise immunity, and a passive stylus into a solution that provides alternatives for richer user interfaces. We anticipate that Spiral will be used in new markets that require high-quality pen-based solutions. The applications in the iAppliance markets are expected to be similar to those of ClearPad. QuickStroke QuickStroke provides a fast, easy, and accurate way to input Chinese characters. Using our recognition technology that combines our patented software with our TouchPad, QuickStroke can recognize handwritten, partially finished Chinese characters, thereby saving considerable time and effort. Our QuickStroke operates with our TouchPad or our stand-alone touch pad and can be integrated into notebook computers, keyboards, and a host of stand-alone devices that use either a pen or a finger. Our patented Incremental Recognition Technology allows users to simply enter the first few strokes of a Chinese character and QuickStroke accurately interprets the intended character. Since the typical Chinese character consists of an average of 13 strokes, QuickStroke technology saves considerable time and effort. QuickStroke provides a solution to enhance Chinese communication for business and personal use. Table of Contents Technologies We have developed and own an extensive array of ASICs, firmware, software, and pattern recognition and touch sensing technologies. With 58 patents issued and 25 patents pending, we continue to develop technology in those areas. We believe these technologies and the related intellectual property create significant barriers for competitors and allow us to provide interface solutions in a variety of high-growth market segments. Our broad line of interface solutions currently is based upon the following key technologies: capacitive position sensing technology; capacitive force sensing technology; transparent capacitive position sensing technology; inductive position sensing technology; pattern recognition technology; mixed signal very large scale integrated circuit, or VLSI, technology; and proprietary microcontroller technology. In addition to these technologies, we have the core competency of developing software that provides unique features, such as virtual scrolling, customizable tap zones, Palm Check, Edge Motion, tapping and dragging of icons, and multi-finger gestures. In addition, our ability to integrate all of our products to interface with major operating systems, including Windows 98, Windows 2000, Windows NT, Windows CE, Windows XP, Windows ME, Mac OS, Pocket PC, Palm OS, Symbian, UNIX, and LINUX, provides us with a key competitive advantage. Capacitive Position Sensing Technology. This technology provides a method for sensing the presence, position, and contact area of one or more fingers or a conductive stylus on a flat or curved surface, such as our TouchPad. Our technology works with very light touch and provides highly responsive cursor motion and scrolling. It uses no moving parts, can be embedded in a tough plastic coating, and is extremely durable. Capacitive Force Sensing Technology. This technology senses the direction and magnitude of a force applied to an object. The object can either move when force is applied, like a typical joystick used for gaming applications, or it can be isometric, with no perceptible motion during use, like our TouchStyk. The primary competition for this technology is resistive strain gauge technology. Resistive strain gauge technology requires electronics that can sense very small changes in resistance, presenting significant challenges to the design of that circuitry, including sensitivity to electrical noise and interference. Our electronic circuitry determines the magnitude and direction of an applied force, permits very accurate sensing of tiny changes in capacitance, and minimizes interference from electrical noise. Transparent Capacitive Position Sensing Technology. This technology allows us to build transparent sensors for use with our capacitive position sensing technology, such as in our ClearPad. It has all the advantages of our capacitive position sensing technology and allows for visual feedback when incorporated with a display device like an LCD. Our technology never requires calibration, does not produce undesirable internal reflections, and has reduced power requirements, allowing for longer battery life. Inductive Position Sensing Technology. This technology provides a method for sensing the presence and position, in three dimensions, of a pen on surfaces like the touch screen used in smart handheld devices. The sensor board can be placed behind the display screen, such as an LCD, thus eliminating any undesirable reflections or transmissivity losses and the need for backlighting, which enhances battery life. This technology could be used in the future for other position sensing applications. Pattern Recognition Technology. This technology is a set of software algorithms for converting real-world data, such as handwriting, into a digital form that can be manipulated within a computer, such as Total operating expenses 10,385 17,335 22,077 5,104 6,499 Table of Contents our QuickStroke product and gesture decoding for our TouchPad and TouchStyk products. Our technology provides reliable handwriting recognition and facilitates signature verification. Mixed Signal VLSI Technology. This is hybrid analog-digital integrated circuit technology that combines the power of digital computation with the ability to interface with non-digital real-world signals like the positioning of a finger or stylus on a surface. Our patented design techniques permit us to utilize this technology in the optimization of our core ASIC engine for all our products, which provides cost and performance advantages over our competitors. Proprietary Microcontroller Technology. This technology consists of proprietary 16-bit microcontroller cores embedded in the digital portion of our mixed signal ASIC and optimized for position sensing tasks. Our embedded microcontroller provides great flexibility in customizing product solutions, which eliminates the need to design new circuitry for each new application. Competing Technology Many interface solutions currently utilize resistive sensing technology. Resistive sensing technology consists of a flexible membrane stretched above a flat, rigid, electrically conductive surface. When finger or stylus pressure is applied to the membrane, it deforms until it makes contact with the rigid layer below, at which point attached electronics can determine the position of the finger or stylus. Since the flexible membrane is a moving part, it is susceptible to mechanical wear and will eventually suffer degraded performance. Due to the way that resistive position sensors work, it is not possible for them to detect more than a single finger or stylus at any given time. The positional accuracy of a resistive sensor is limited by the uniformity of the resistive coating as well as by the mechanics of the flexible membrane. Finally, due to reduced transmissivity, or the amount of light that can pass through the display, resistive technology requires the use of a backlight, thereby reducing the battery life of the device. Research and Development We conduct active and ongoing research and development programs that focus on advancing our technologies, developing new products, improving design processes, and enhancing the quality and performance of our product solutions. Our goal is to provide our customers with innovative solutions that address their needs and improve their competitive positions. Our research and development concentrates on our market-leading interface technologies, especially on improving the performance of our current product solutions and expanding our technologies to serve new markets. Our vision is to develop solutions that integrate touch, handwriting, voice, and vision capabilities that can be readily incorporated into varied electronic devices. Our research and development programs focus on the development of accurate, easy to use, feature rich, reliable, and intuitive user interface devices for the notebook market. We believe our innovative interface technologies can be applied to many diverse platforms. As a result, we are currently focusing considerable research and development efforts on interface solutions for the rapidly developing iAppliance markets. We believe the interface will be a key factor in the differentiation of iAppliance products. We anticipate that our interface technologies will enable us to provide customers with product solutions for iAppliances that have significant advantages over alternative technologies in terms of functionality, size, power consumption, durability, and reliability. We also pursue strategic acquisitions and enter into strategic relationships to enhance our research and development capabilities, leverage our technology, and shorten our time to market with new technological applications. Our research, design, and engineering teams frequently work directly with our customers to design custom solutions for specific applications. We focus on enabling our customers to overcome technological barriers and enhance the performance of their products. We believe our efforts provide significant benefits to customers by enabling them to concentrate on their core competencies of production and marketing. As of December 31, 2001, we employed 101 people in our technology, engineering, and product design functions in the United States, the United Kingdom, and Taiwan. Our research and development Table of Contents expenses were approximately $4.9 million in fiscal 1999, $8.4 million in fiscal 2000, $11.6 million in fiscal 2001, and $3.7 million in the three months ended September 30, 2001. Intellectual Property Rights Our success and ability to compete depend in part on our ability to maintain the proprietary aspects of our technologies and products. We rely on a combination of patents, copyrights, trade secrets, trademarks, confidentiality agreements, and other contractual provisions to protect our intellectual property, but these measures may provide only limited protection. As of December 31, 2001, we held 58 patents and had 25 pending patent applications. These patents and patent applications cover various aspects of our key technologies, including touch sensing, pen sensing, handwriting recognition, edge motion, and virtual scrolling technologies. Our proprietary software is protected by copyright laws. The source code for our proprietary software is also protected under applicable trade secret laws. Patents may not issue from the patent applications that we have filed or may file. Our issued patents may be challenged, invalidated, or circumvented, and claims of our patents may not be of sufficient scope or strength, or issued in the proper geographic regions, to provide meaningful protection or any commercial advantage. We have not applied for, and do not have, any copyright registration on our technologies or products. We have applied to register certain of our trademarks in the United States and other countries. There can be no assurances that we will obtain registrations of principle or other trademarks in key markets. Failure to obtain registrations could compromise our ability to protect fully our trademarks and brands and could increase the risk of challenge from third parties to our use of our trademarks and brands. In addition, our failure to enforce and protect our intellectual property rights or obtain from third parties the right to use necessary technology could have a material adverse effect on our business, financial condition, and results of operations. Our technologies include an extensive array of ASICs, firmware, software, and pattern recognition and touch sensing technologies. Any one of our products rely on a combination of these technologies, making it difficult to use any single technology as the basis for replicating our products. Furthermore, the length and customization of the customer design cycle serve to protect our intellectual property rights. Our research, design, and engineering teams frequently work directly with our customers to design custom solutions for specific applications. We do not consistently rely on written agreements with our customers, suppliers, manufacturers, and other recipients of our technologies and products, and therefore some trade secret protection may be lost and our ability to enforce our intellectual property rights may be limited. Furthermore, our customers, suppliers, manufacturers, and other recipients of our technologies and products may seek to use our technologies and products without appropriate limitations. In the past, we did not consistently require our employees and consultants to enter into confidentiality agreements, employment agreements, or proprietary information and invention agreements. Therefore, our former employees and consultants may try to claim some ownership interest in our technologies and products and may use our technologies and products competitively and without appropriate limitations. Other companies, including our competitors, may develop technologies that are similar or superior to our technologies, duplicate our technologies, or design around our patents and may have or obtain patents or other proprietary rights that would prevent, limit, or interfere with our ability to make, use, or sell our products. Effective intellectual property protection may be unavailable or limited in some foreign countries, such as China and Taiwan, in which we operate. Unauthorized parties may attempt to copy or otherwise use aspects of our technologies and products that we regard as proprietary. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competitors will not independently develop similar technologies. If our intellectual property protection is insufficient to protect our intellectual property rights, we could face increased competition in the market for our technologies and products. Table of Contents We may receive notices from third parties that claim our products infringe their rights. From time to time, we receive notice from third parties of the intellectual property rights such parties have obtained. We cannot be certain that our technologies and products do not and will not infringe issued patents or other proprietary rights of others. While we are not currently subject to any infringement claim, any future claim, with or without merit, could result in significant litigation costs and diversion of resources, including the payment of damages, which could have a material adverse effect on our business, financial condition, and results of operations. Customers We currently serve the world s ten largest PC OEMs, based on unit shipments, as well as a variety of consumer electronics manufacturers. Our demonstrated track record of technological leadership, design innovation, product performance, and on-time delivery have resulted in our serving as the sole source of notebook interfaces for many of our customers. We believe our strong relationship with our OEM customers, many of which are currently developing iAppliance products, will position us as a primary source of supply for their iAppliance offerings. Our OEM customers include the following: Acer Apple Asustek Compaq Dell Fujitsu/Siemens Gericom Hewlett-Packard IBM Legend NEC Samsung Sony Toshiba The above list includes each of our largest current OEM customers in terms of unit volume as well as Fujitsu/ Siemens, IBM, Sony, and Toshiba, which recently became our OEM customers. We supply our OEM customers through their contract manufacturers. These contract manufacturers include Arima, Compal, Inventec, Mitac, Nypro, Quanta, and Wistron. During fiscal 2001, sales to Quanta and Nypro accounted for 32% and 11%, respectively, of our revenue. No other customer accounted for more than 10% of our revenue during this period. We consider both the OEMs and the contract manufacturers to be our customers. The OEMs typically determine the design and pricing requirements and make the overall decision regarding the use of our interface solutions in their products. The contract manufacturers place orders with us for the purchase of our products, take title to the products purchased upon shipment by us, and pay us directly for those purchases. These customers have no return privileges, except for warranty provisions. Strategic Relationships We have established key strategic relationships to enhance our ability to offer value-added customer solutions and rapidly gain market share. We intend to enter into additional strategic relationships with other leading companies in our target markets. Three-Five Systems Our strategic relationship with Three-Five Systems, a leading supplier of custom designed display modules, provides for the joint development and marketing of touch screen LCD products. We plan to expand our product solutions by integrating our ClearPad and Spiral touch screen solutions with the LCD display modules developed by Three-Five Systems. We believe that LCD screens that incorporate our ClearPad technology result in superior LCD touch screens for use in a variety of OEM products, especially cellular phones and PDAs. Table of Contents AuthenTec We established our relationship with AuthenTec, a leading developer of fingerprint sensing technology, to develop fingerprint recognition security capabilities. We plan to incorporate fingerprint recognition capabilities into our TouchPad products, allowing us to offer our customers enhanced security for their notebook computers and iAppliances. Users will be required to authenticate their identity by placing a finger on our TouchPad before gaining access to the computer. Zytronic We established a relationship with Zytronic, a developer of large touch screen products, to develop a capacitive touch sensing module to be integrated with Zytronic s glass sensor. Our goal is to develop a capacitive touch sensing controller module to be used in conjunction with touch screen products to be integrated, marketed, and sold by Zytronic. These products are devices that utilize large screen interface displays. Zytronic has agreed to develop the glass sensor, and we have agreed to provide the electronic controls that allow the sensor to interact with the device that incorporates the sensor. Sales and Marketing We sell our product solutions for incorporation into the products of OEMs. We generate sales through direct sales employees and sales representatives. Our sales personnel receive substantial technical assistance and support because of the highly technical nature of our product solutions. Sales frequently result from multi-level sales efforts that involve senior management, design engineers, and our sales personnel interacting with our customers decision makers throughout the product development and order process. We currently employ 24 sales professionals, including nine field application engineers, and 10 marketing professionals. We maintain four sales offices domestically and internationally, which are in the United States, the United Kingdom, Taiwan, and China. In addition, we maintain sales representatives in offices in the United States, Singapore, Korea, Japan, and Europe. International sales, primarily in the Asian and European markets, constituted approximately 97%, 95%, and 86% of our revenue in fiscal 1999, 2000, and 2001, respectively. Substantially all of these sales were made to companies that provide manufacturing services for major notebook computer OEMs. All of these sales were denominated in U.S. dollars, and we believe most of the notebooks were ultimately shipped to the United States. Manufacturing We employ a virtual manufacturing platform through third-party relationships. We currently utilize a single semiconductor manufacturer to supply us with our requirements of ASICs based on our proprietary designs. After production and testing, the ASICs are shipped to our subcontractors for assembly. During the assembly process, our ASIC is combined with other components to complete our product solution. The finished assembly is then shipped by our subcontractors directly to our customers for integration into their products. We believe our virtual manufacturing strategy provides a scalable business model; enables us to concentrate on our core competencies of research and development, technological advances, and product solution design; and reduces our capital expenditures. In addition, this strategy significantly reduces our inventory costs because we do not incur most of our manufacturing costs until we have actually shipped our product solutions to our customers and billed those customers for those products. Our third-party manufacturers are large, world-class, cost-effective, Asian-based organizations. We provide our manufacturing subcontractors with six-month rolling forecasts of our production requirements. We do not, however, have long-term agreements with any of our manufacturing subcontractors that Table of Contents guarantee production capacity, prices, lead times, or delivery schedules. The strategy of relying on those parties exposes us to vulnerability owing to our dependence on few sources of supply. We believe that other sources of supply are available. In addition, we may establish relationships with other manufacturing subcontractors in order to reduce our dependence on any one source of supply. Backlog As of December 31, 2001, we had a backlog of orders of approximately $10.9 million. The backlog of orders as of December 31, 2000 was approximately $12.9 million. Our backlog consists of product orders for which purchase orders have been received and which are scheduled for shipment within six months. Most orders are subject to rescheduling or cancellation with limited penalties. Because of the possibility of customer changes in product shipments, our backlog as of a particular date may not be indicative of net sales for any succeeding period. Competition Our principal competitor in the sale of notebook touch pads is Alps Electric, a Japanese conglomerate. Our principal competitors in the sale of notebook pointing sticks are Alps Electric, Brother, and CTS. In the iAppliance interface markets, our potential competitors include Alps Electric, Panasonic, Gunze, and various other companies involved in user interface solutions. In certain cases, large OEMs may develop alternative interface solutions for their own products. In the notebook interface markets, we plan to continue to compete primarily on the basis of our technological expertise, design innovation, customer service, and the long track record of performance of our interface solutions, including their ease of use, reliability, and cost-effectiveness as well as their timely design, production, and delivery schedules. Our new TouchStyk now enables us to address the approximate 29% of the notebook computer market that uses solely a pointing stick rather than a touch pad as the user interface as well as to address the growing trend toward dual pointing interfaces. Our ability to supply OEMs with both TouchPads and TouchStyks will also enhance our competitive position since we can provide OEMs with the following advantages: single source supplier that eliminates compatibility issues; cost-effective and simplified OEM integration; simplified product line to address both markets; end user flexibility since one notebook can address both user preferences; and modular approach allowing OEMs to utilize our TouchPad, our TouchStyk, or a combination of both interfaces. In the iAppliance interface markets, we intend to compete primarily based on the advantages of our capacitive, inductive, and neural pattern recognition technologies. We believe our technologies offer significant benefits in terms of size, power consumption, durability, light transmissivity, resolution, ease of use, and reliability when compared to other technologies. While these markets are just beginning to emerge, and we cannot know what the competitive factors will ultimately be, we intend to compete aggressively for this business. In addition, we believe our proven track record, our marquee global customer base, and our reputation for design innovation in the notebook market will provide competitive advantages in the iAppliance markets. However, some of our competitors, particularly in the iAppliance markets, have greater market recognition, large customer bases, and substantially greater financial, technical, marketing, distribution, and other resources than we possess and that afford them competitive advantages. As a result, they may be able to introduce new product solutions and respond to customer requirements more quickly than we can. In addition, new competitors, alliances among competitors, or alliances among competitors and OEMs may emerge and allow competitors to rapidly acquire significant market share. Furthermore, our competitors may in the future develop technologies that more effectively address the interface needs of the notebook computer and iAppliance markets. Table of Contents Our sales, profitability, and success depend on our ability to compete with other suppliers of interface solutions. Our competitive position could be adversely affected if one or more of our current OEMs reduce their orders or if we are unable to develop customers for our new iAppliance interface solutions. Employees As of December 31, 2001, we employed a total of 160 persons, including 25 in finance, administration, and operations, 34 in sales and marketing, and 101 in research and development. Of these employees, 118 were located in the United States, 24 in the United Kingdom, and 18 in Taiwan. We consider our relationship with our employees to be good, and none of our employees are represented by a union in collective bargaining with us. Competition for qualified personnel in our industry is extremely intense, particularly for engineering and other technical personnel. Our success depends in part on our continued ability to attract, hire, and retain qualified personnel. Facilities Our principal executive officers as well as our principal research, development, sales, marketing, and administrative functions are located in a 34,000 square foot leased facility in San Jose, California. The lease extends through January 2005 and provides for an average monthly rental payment of $58,292. We believe this facility will be adequate to meet our needs for at least the next 18 months. Our European headquarters are located in Cambridge, United Kingdom, where we lease approximately 4,000 square feet. We also maintain a 5,000 square foot office in Taiwan. In addition, we maintain a satellite sales and support office in China. Legal Proceedings We currently are not involved in any legal proceeding that we believe would have a material adverse effect on our business or financial condition. Federico Faggin 60 Chairman of the Board Francis F. Lee 49 President, Chief Executive Officer, and Director Donald E. Kirby 53 Senior Vice President and General Manager PC Products Russell J. Knittel 51 Senior Vice President, Chief Financial Officer, Chief Administrative Officer, Secretary, and Treasurer Shawn P. Day, Ph.D. 36 Vice President of Research and Development Richard C. McCaskill 54 Vice President of Marketing and Business Development David T. McKinnon 54 Vice President of System Silicon Thomas D. Spade 35 Vice President of Worldwide Sales William T. Stacy, Ph.D. 59 Vice President of Operations Keith B. Geeslin 48 Director Richard L. Sanquini 67 Director Joshua C. Goldman 36 Director Federico Faggin co-founded our company and has served as the Chairman of the Board of our company since January 1999. He served as a director and the President and Chief Executive Officer from March 1987 to December 1998. Mr. Faggin also co-founded Cygnet Technologies, Inc. in 1982 and Zilog, Inc. in 1974. Mr. Faggin served as Department Manager in Research and Development at Intel Corporation from 1970 to 1974 and led the design and development of the world s first microprocessor and more than 25 integrated circuits. In 1968, Mr. Faggin was employed by Fairchild Semiconductor and led the development of the original MOS Silicon Gate Technology and designed the world s first commercial integrated circuit to use such technology. Mr. Faggin is also chairman of Integrated Device Technology, Inc., a producer of integrated circuits; and a director of Avanex Corp., a producer of fiber optic-based products, known as photonic processors; each of which is a public company. He is the recipient of many honors and awards including the 1988 International Marconi Fellowship Award, the 1994 IEEE W. Wallace McDowell Award, and the 1997 Kyoto Prize. In addition, in 1996, Mr. Faggin was inducted in the National Inventor s Hall of Fame for the co-invention of the microprocessor. Mr. Faggin holds a Dottore in Fisica degree in physics, summa cum laude, from the University of Padua, Italy. He also holds an honorary doctorate degree in computer science from the University of Milan, Italy. Francis F. Lee has served as a director and the President and Chief Executive Officer of our company since December 1998. He was a consultant from August 1998 to November 1998. From May 1995 until July 1998, Mr. Lee served as General Manager of NSM, a Hong Kong-based joint venture between National Semiconductor Corporation and S. Megga. Mr. Lee held a variety of executive positions for National Semiconductor from 1988 until August 1995. These positions included Vice President of Communication and Computing Group, Vice President of Quality and Reliability, Director of Standard Logic Business Unit, and various other operations and engineering management positions. Mr. Lee holds a Bachelor of Science degree, with honors, in electrical engineering from the University of California at Davis. Donald E. Kirby has been Senior Vice President and General Manager PC Products of our company since November 2001. He served as the General Manager PC Products and Vice President of Operations of our company from August 1999 until October 2001. From September 1997 to July 1999, Mr. Kirby served as Vice President of Technology Infrastructure and Core Technology Group of National Semiconductor; from January 1997 to August 1997, he served as Director of Strategic Technology Group Table of Contents of National Semiconductor; and from October 1995 to December 1996, he served as Director of Operations/ Co-GM, LAN Division of National Semiconductor. Mr. Kirby holds a patent for a Micro-controller ROM Emulator. Russell J. Knittel has been Senior Vice President, Chief Financial Officer, Chief Administrative Officer, Secretary, and Treasurer of our company since November 2001. He served as the Vice President of Administration and Finance, Chief Financial Officer, and Secretary of our company from April 2000 until October 2001. Mr. Knittel served as Vice President and Chief Financial Officer of Probe Technology Corporation from May 1999 to March 2000. He was a consultant from January 1999 until April 1999. Mr. Knittel held Vice President and Chief Financial Officer positions at Starlight Networks from November 1994 to December 1998. Mr. Knittel holds a Bachelor of Arts degree in accounting from California State University at Fullerton and a Masters of Business Administration from San Jose State University. Shawn P. Day, Ph.D. has been the Vice President of Research and Development of our company since June 1998. He served as the Director of Software Development of our company from November 1996 until May 1998 and as principal software engineer from August 1995 until October 1996. Mr. Day holds a Bachelor of Science degree and a Doctorate, both in electrical engineering, from the University of British Columbia in Vancouver, Canada. Richard C. McCaskill has been the Vice President of Marketing and Business Development of our company since May 2000. Mr. McCaskill served as the Executive Vice President and General Manager for ART Inc., a speech and handwriting recognition company, from December 1996 to April 2000. Mr. McCaskill served as a consultant for ART Inc. and Micropolis from June 1996 to December 1996. From April 1993 to May 1996, Mr. McCaskill held the position of Vice President of Technology at Reveal Computer Products, a sister company to Packard Bell Computers. Mr. McCaskill holds a Bachelor of Science degree in electrical engineering from California State University at Los Angeles. David T. McKinnon has been the Vice President of System Silicon of our company since September 2001. From May 2000 until September 2001, Mr. McKinnon served as a consultant to start-up companies in the networking IC sector. From April 1998 until April 2000, Mr. McKinnon served as Vice President of Networking Business for Level One Communications. From December 1995 until April 1998, Mr. McKinnon served as the Chief Operating Officer/ Chief Technical Officer of the Japan Business Group of National Semiconductor. Mr. McKinnon holds a Bachelor of Science degree with Honors in Electrical and Electronic Engineering and a Masters in Science, Digital Techniques in Communications Control from Heriot-Watt University in Edinburgh, Scotland. Thomas D. Spade has been the Vice President of Worldwide Sales of our company since July 1999. From May 1998 until June 1999, he served as our Director of Sales. From May 1996 until April 1998, Mr. Spade was the Director of International Sales for Alliance Semiconductor. Mr. Spade previously has held additional sales and management positions at Alliance Semiconductor, Anthem Electronics, Arrow Electronics, and Andersen Consulting. Mr. Spade holds a Bachelor of Arts degree in economics and management from Albion College. William T. Stacy, Ph.D. has been the Vice President of Operations of our company since October 2001. From August 1992 to June 2001, Mr. Stacy held a number of business management positions in the Data Management and Analog Groups of National Semiconductor. Most recently, from April 1999 until June 2001, he was Vice President of the Wireless Division. Prior to joining National, he held a series of operational and business management positions at Philips Semiconductors. He started his career in Philips Research Laboratories in Eindhoven, where he worked on magnetic and semiconducting device structures. Mr. Stacy holds a Bachelor of Science degree in physics and mathematics from Oregon State University and a Masters and Ph.D. degree in physics from the University of Illinois. Keith B. Geeslin has been a director of our company since 1986. Mr. Geeslin serves as Managing General Partner of the Sprout Group, a venture capital firm. He joined the Sprout Group in 1984 and became a General Partner in 1988 and the Managing General Partner in 2001. In addition, he is a general Table of Contents or limited partner in a series of investment funds associated with the Sprout Group, a division of DLJ Capital Corporation, which is a subsidiary of Credit Suisse First Boston (USA), Inc. Mr. Geeslin is currently a director of Innoveda, Inc., a design automation software company, and Paradyne Networks Inc., a producer of communication products for network service providers and business customers; each of which is a public company. Mr. Geeslin is also a director of several privately held companies. He has also served as a director of the Western Association of Venture Capitalists. Mr. Geeslin holds a Bachelor of Science degree in electrical engineering and a Masters of Science degree in engineering and economic systems from Stanford University and a Masters of Arts degree in philosophy, politics, and economics from Oxford University. Richard L. Sanquini has been a director of our company since 1994. Mr. Sanquini is currently a consultant for our company, Foveon, Inc., National Semiconductor, and several privately held companies. From January 1999 to November 1999, Mr. Sanquini served as Senior Vice President and General Manager of the Consumer and Commercial Group of National Semiconductor; from April 1998 to December 1998, he served as Senior Vice President and General Manager of the Cyrix Group of National Semiconductor; from November 1997 to March 1998, he served as Senior Vice President and General Manager of the Personal Systems Group of National Semiconductor; from April 1996 to October 1997, he served as Senior Vice President and Chief Technology Officer of the Corporate Strategy, Business Development, and Intellectual Property Protection Group of National Semiconductor; and from December 1995 to March 1996, he served as Senior Vice President of the Business Development and Intellectual Property Protection Group of National Semiconductor. Prior to National Semiconductor, he was with RCA where he directed its memory and microprocessor businesses. Mr. Sanquini also has been a director of Foveon, Inc. since August 1997. Mr. Sanquini holds a Bachelor of Science degree in electrical engineering from the Milwaukee School of Engineering, Wisconsin. Joshua C. Goldman has been a director of our company since January 2001. Mr. Goldman became an entrepreneur in residence at Sprout Group in April 2001. Mr. Goldman was employed by mySimon, an online comparison shopping site, as President and Chief Executive Officer from January 1999 to March 2001 and as Vice President of Marketing from November 1998 to January 1999. From October 2000 to March 2001, Mr. Goldman also served as the executive in charge of the Consumer Division of CNet Networks, which acquired mySimon in February 2000. He served as Vice President of Marketing at 4th Networks, Inc. from June 1998 until October 1998. From April 1996 until May 1998, Mr. Goldman was with USWeb, where he last served as Vice President of Business Solutions. Mr. Goldman has also served in management roles at Apple Computer, Phoenix Technologies, and Softbank Content Services. He earned a Bachelor of Science degree in computer science with an emphasis in artificial intelligence, with honors, from Tufts University and a Masters of Business Administration from Harvard Business School. There are no family relationships among any of our directors, officers, or key employees. Board Committees Our board of directors established an audit committee in February 2001, consisting of independent directors. The members are Messrs. Geeslin, Sanquini, and Goldman. The functions of the audit committee are as follows: review our internal accounting principles and auditing practices and procedures; consult with and review the services provided by our independent accountants; and make recommendations to the board of directors about selecting independent accountants. We established a compensation committee in September 2000. The compensation committee consists of Messrs. Geeslin and Sanquini. The compensation committee reviews and recommends to the board of directors the salaries, incentive compensation, and benefits of our officers and employees, including stock compensation and loans, and administers our stock plans and employee benefit plans. Prior to the establishment of the audit and compensation committees, these functions were performed by our board of directors. (1) Mr. Spade also received certain perquisites, the value of which did not exceed the lesser of $50,000 or 10% of his salary and bonus during fiscal 2001. (1) Of Mr. Lee s options, 50,000 vest and become exercisable 1/12 on the 18th day of each month, commencing on February 18, 2003, and 200,000 vest and become exercisable 1/12 on the 18th day of each month, commencing on February 18, 2004. Mr Knittel s options vest and become exercisable 1/12 on the first day of each month, commencing on April 1, 2004. Mr. Day s and Mr. Spade s options vest and become exercisable 1/24 on the 12th day of each month, commencing on February 12, 2003. Mr. Kirby s options vest and become exercisable 1/12 on the last day of each month, commencing on September 30, 2003. (2) Potential gains are net of the exercise price, but before taxes associated with the exercise. Amounts represent hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. The potential realizable value assumes that the stock price appreciates from the assumed public offering price of $10.00 per share. The assumed 5% and 10% rates of stock price appreciation are provided in accordance with the rules of the SEC and do not represent our estimate or projection of the future price of our company s common stock. Actual gains, if any, on stock option exercises will depend upon the future market prices of our common stock. (1) Includes 65,625 shares acquired by Mr. Lee pursuant to the early exercise of options in a prior year that are subject to a repurchase option until vesting requirements are met. (2) The options were exercised early and 556 of the shares are subject to a repurchase option until vesting requirements are met. Employment Arrangements We anticipate entering into employment arrangements with persons who are believed to make significant contributions to our company, and will implement compensation packages for certain members of management as well as for other personnel. The terms of such agreements may include payment of salary for the period of tenure with the company. Other key employees will be offered incentive compensation payable in our common stock. Issuance of these shares will dilute existing stockholders. These arrangements will not be the result of arms length negotiation. However, management anticipates the terms thereof will be reasonable when compared to similar arrangements within the industry. Change of Control Agreements Mr. Knittel, our chief financial officer who was hired in April 2000, is entitled to six months severance pay in the event of a change of control or a constructive termination as a result of reduced responsibilities or stature within our company. Options granted at the time of joining the company include accelerated vesting for Mr. Lee for 50% of his unvested options and for Mr. Knittel for 100% of his unvested options upon a change of control or a constructive termination as a result of reduced responsibilities or stature within our company. Mr. Faggin holds options for 415,000 shares that provide for immediate vesting of 50% of the unvested options in the event of a change of control. 1986 Incentive Stock Option Plan and 1986 Supplemental Stock Option Plan The 1986 incentive stock option plan provided for the grant of incentive stock options to our key employees, including employee directors. The 1986 supplemental stock option plan provided for the grant of nonstatutory stock options to employees, directors, and consultants. As of September 30, 2001, there were outstanding options to acquire 20,000 shares of our common stock under the two 1986 plans. The 1986 incentive stock option plan and the 1986 supplemental stock option plan expired November 1996, and no additional options will be issued under those plans. The expiration date, maximum number of shares purchasable, and the other provisions of the options, including vesting provisions, were established at the time of grant. Options were granted for terms of up to 10 years and become exercisable in whole or in Table of Contents one or more installments at such time as was determined by the administrator upon the grant of the options. Under the 1986 incentive stock option plan, exercise prices of options are equal to not less than 100% of the fair market value of our common stock at the time of the grant. Under the 1986 supplemental stock option plan, exercise prices of options are equal to not less than 85% of the fair market value of our common stock at the time of the grant. The exercise price for any options granted under the 1986 incentive stock option plan and the 1986 supplemental stock option plan may be paid in cash, in shares of our common stock valued at fair market value on the exercise date, or in any other form of legal consideration that may be acceptable to the board of directors or administrator in their discretion. In addition, the administrator may provide financial assistance to one or more optionees in the exercise of their outstanding options by allowing any such individual to deliver an interest-bearing promissory note in payment of the exercise price and any associated withholding taxes incurred in connection with the exercise or purchase. In the event of a change of control of our company, we would expect that options outstanding under the 1986 incentive stock option plan and the 1986 supplemental stock option plan at the time of the transaction would be assumed or replaced with substitute options by the acquiror. If our acquiror did not agree to assume or replace outstanding awards, either the exercise period of all options will accelerate and terminate if not exercised upon consummation of the acquisition, or such options will remain in effect. Outstanding awards under the 1986 incentive stock option plan and the 1986 supplemental stock option plan will be adjusted in the event of a stock split, stock dividend, or other similar change in our capital stock without the receipt of consideration by us. 1996 Stock Option Plan Our 1996 stock option plan provides for the grant of incentive stock options to employees, including employee directors, and of nonstatutory stock options to employees, directors, and consultants. The purposes of the 1996 stock option plan are to attract and retain the best available personnel, to provide additional incentives to our employees and consultants, and to promote the success of our business. The 1996 stock option plan was originally adopted by our board of directors in December 1996 and approved by our stockholders in November 1996. The 1996 stock option plan provides for the issuance of options and rights to purchase up to 5,380,918 shares of our common stock. Unless terminated earlier by the board of directors, the 1996 stock option plan will terminate in December 2006. As of September 30, 2001, 3,991,995 options to purchase shares of common stock were outstanding under the 1996 stock option plan and 1,333,234 shares had been issued upon exercise of outstanding options. The 1996 stock option plan may be administered by the board of directors or a committee of the board, each known as the administrator. The administrator determines the terms of options granted under the 1996 stock option plan, including the number of shares subject to the award, the exercise or purchase price, the vesting and exercisability of the award, and any other conditions to which the award is subject. Incentive stock options granted under the 1996 stock option plan must have an exercise price of at least 100% of the fair market value of the common stock on the date of grant (110% if the option is granted to a stockholder who, at the time the option is granted, owns stock representing more than 10% of the total combined voting power of all classes of our stock). Nonstatutory stock options granted under the 1996 stock option plan must have an exercise price of at least 85% of the fair market value of the common stock on the date of grant (110% if the option is granted to a stockholder who, at the time the option is granted, owns stock representing more than 10% of the total combined voting power of all classes of our stock). The exercise price for any options granted under the 1996 stock option plan may be paid in cash, in shares of our common stock valued at fair market value on the exercise date, or in any other form of legal consideration that may be acceptable to the board of directors or administrator in their discretion. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. In addition, the administrator may provide financial assistance to one or more optionees in the exercise of their outstanding options by allowing any such individual to deliver an interest-bearing Table of Contents promissory note in payment of the exercise price and any associated withholding taxes incurred in connection with the exercise or purchase. With respect to options granted under the 1996 stock option plan, the administrator determines the term of options, which may not exceed 10 years, or five years in the case of an incentive stock option granted to a holder of more than 10% of the total voting power of all classes of our stock. An option is nontransferable other than by will or the laws of descent and distribution and may be exercised during the lifetime of the optionee only by the optionee. Stock options are generally subject to vesting, meaning that the optionee earns the right to exercise the option over a specified period of time only if he or she continues to provide services to our company over that period. If our company or its business is acquired by another corporation, we would expect that options outstanding under the 1996 stock option plan at the time of the transaction would be assumed or replaced with substitute options by our acquiror. If our acquiror did not agree to assume or replace outstanding awards, all options will terminate upon consummation of the acquisition. Outstanding awards and the number of shares remaining available for issuance under the 1996 stock option plan will adjust in the event of a stock split, stock dividend, or other similar change in our capital stock without the receipt of consideration by us. The administrator has the authority to amend or terminate the 1996 stock option plan, but no action may be taken that impairs the rights of any holder of an outstanding option without the holder s consent. In addition, we must obtain stockholder approval of amendments to the plan as required by applicable law. 2000 Nonstatutory Stock Option Plan Our 2000 nonstatutory stock option plan provides for the grant of nonstatutory stock options to employees and consultants. The purposes of the 2000 nonstatutory stock option plan are to attract and retain the best available personnel, to provide additional incentives to our employees and consultants, and to promote the success of our business. The 2000 nonstatutory stock option plan was adopted by our board of directors in September 2000. The 2000 nonstatutory stock option plan provides for the issuance of options to purchase up to 200,000 shares of our common stock. As of September 30, 2001, there were outstanding options to acquire 194,000 shares of our common stock. Unless terminated earlier by the board of directors, the 2000 nonstatutory stock option plan will terminate in September 2010. The 2000 nonstatutory stock option plan may be administered by the board of directors or a committee of the board, each known as the administrator. The administrator determines the terms of options granted under the 2000 nonstatutory stock option plan, including the number of shares subject to the award, the exercise or purchase price, the vesting and/or exercisability of the award, and any other conditions to which the award is subject. The exercise price for any options granted under the 2000 nonstatutory stock option plan may be paid in cash, in shares of our common stock valued at fair market value on the exercise date, or in any other form of legal consideration that may be acceptable to the board of directors or administrator in their discretion. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. In addition, the administrator may provide financial assistance to one or more optionees in the exercise of their outstanding options by allowing such individuals to deliver an interest-bearing promissory note in payment of the exercise price and any associated withholding taxes incurred in connection with such exercise or purchase. The term of options granted under the 2000 nonstatutory stock option plan may not exceed 10 years. If our company or its business is acquired by another corporation, we would expect that options outstanding under the 2000 nonstatutory stock option plan at the time of the transaction would be assumed or replaced with substitute options by our acquiror. If our acquiror did not agree to assume or replace outstanding awards, all options will terminate upon consummation of the acquisition. Outstanding awards and the number of shares remaining available for issuance under the 2000 nonstatutory stock option plan will be adjusted in the event of a stock split, stock dividend, or other similar change in our capital stock. The administrator has the authority to amend or terminate the 2000 nonstatutory stock option plan, but no Table of Contents action may be taken that impairs the rights of any holder of an outstanding option without the holder s consent. 2001 Incentive Compensation Plan Our 2001 incentive compensation plan is designed to attract, motivate, retain, and reward our executives, employees, officers, directors, and independent contractors, by providing such persons with annual and long-term performance incentives to expend their maximum efforts in the creation of stockholder value. The 2001 incentive compensation plan was adopted by our board of directors in March 2001 and approved by our stockholders in November 2001. Under the 2001 incentive compensation plan, an aggregate of 1,000,000 shares of common stock may be issued pursuant to the granting of options to acquire common stock, the direct granting of restricted common stock and deferred stock, the granting of stock appreciation rights, or the granting of dividend equivalents. On the effective date of the registration statement of which this prospectus forms a part, an additional number of shares equal to 6% of the total number of shares then outstanding will be added and thereafter on the first day of each succeeding calendar quarter an additional number of shares equal to 1 1/2% of the total number of shares then outstanding will be added to the number of shares that may be subject to the granting of awards. As of September 30, 2001, there were no outstanding options to acquire shares of our common stock under the 2001 incentive compensation plan. The 2001 incentive compensation plan may be administered by the board of directors or a committee of the board. The committee or the board of directors determines the persons to receive awards, the type and number of awards to be granted, the vesting and exercisability of the award, and any other conditions to which the award is subject. Awards may be settled in the form of cash, shares of common stock, other awards, or other property in the discretion of the committee or the board of directors. The committee or the board of directors may, in its discretion, accelerate the exercisability, the lapsing of restrictions, or the expiration of deferral or vesting periods of any award, and such accelerated exercisability, lapse, expiration and, if so provided in the award agreement, vesting will occur automatically in the case of a change in control of our company. In addition, the committee or the board or directors may provide in an award agreement that the performance goals relating to any performance based award will be deemed to have been met upon the occurrence of any change in control. Upon the occurrence of a change in control, if so provided in the award agreement, stock options and certain stock appreciation rights may be cashed out based on a change in control price, which will be the higher of (1) the cash and fair market value of property that is the highest price per share paid in any reorganization, merger, consolidation, liquidation, dissolution, or sale of substantially all assets of our company, or (2) the highest fair market value per share at any time during the 60 days before and 60 days after a change in control. The board of directors may amend, alter, suspend, discontinue, or terminate the 2001 incentive compensation plan or the committee s authority to grant awards without further stockholder approval, except stockholder approval must be obtained for any amendment or alteration if such approval is required by law or regulation or under the rules of any stock exchange or quotation system on which shares of common stock are then listed or quoted. Unless terminated earlier by the board of directors, the 2001 incentive compensation plan will terminate at such time as no shares of common stock remain available for issuance under the plan and the company has no further rights or obligations with respect to outstanding awards under the plan. 2001 Employee Stock Purchase Plan Our 2001 employee stock purchase plan is designed to encourage stock ownership in our company by our employees, thereby enhancing employee interest in our continued success. The plan was adopted by our board of directors in February 2001 and approved by our stockholders in November 2001. The plan will become effective on the effective date of the registration statement of which this prospectus forms a part. One million shares of our common stock will initially be reserved for issuance under the plan. An annual increase will be made of the lesser of 500,000 shares, 1% of all shares of common stock Table of Contents outstanding, or a lesser amount determined by the board of directors. The plan is currently administered by our board of directors. Under the plan s terms, however, the board may appoint a committee to administer the plan. The plan gives broad powers to the board or the committee to administer and interpret the plan. The plan permits employees to purchase our common stock at a favorable price and possibly with favorable tax consequences to the participants. All employees of our company or of those subsidiaries designated by the board who are regularly scheduled to work at least 20 hours per week for more than five months per year are eligible to participate in any of the purchase periods of the plan after completing 90 days of continuous employment. However, any participant who would own (as determined under the Internal Revenue Code), immediately after the grant of an option, stock possessing 5% or more of the total combined voting power or value of all classes of the stock of our company will not be granted an option under the plan. The plan will be implemented in a series of successive offering periods, each with a maximum duration of 24 months. The initial offering period, however, will begin on the effective date of the registration statement of which this prospectus forms a part and will end on December 31, 2003. If the fair market value per share of our common stock on any purchase date is less than the fair market value per share on the start date of a 24-month offering period, then that offering period will automatically terminate, and a new 24-month offering period will begin on the next business day. All participants in the terminated offering will be transferred to the new offering period. All eligible employees will automatically become participants on the effective date of the registration statement of which this prospectus forms a part. Eligible employees may elect to participate in the plan on January 1 or July 1 of each year. Subject to certain limitations determined in accordance with calculations set forth in the plan, a participating employee is granted the right to purchase shares of common stock on the last business day on or before each June 30 and December 31 during which the employee is a participant in the plan. Upon enrollment in the plan, the participant authorizes a payroll deduction, on an after-tax basis, in an amount of not less than 1% and not more than 15% of the participant s compensation on each payroll date. Payment on the initial purchase date in the first offering period will be a lump-sum payment unless the participant elects otherwise. Unless the participant withdraws from the plan, the participant s option for the purchase of shares will be exercised automatically on each exercise date, and the maximum number of full shares subject to the option will be purchased for the participant at the applicable exercise price with the accumulated plan contributions then credited to the participant s account under the plan. The option exercise price per share may not be less than 85% of the lower of the market price on the first day of the offering period or the market price on the exercise date, unless the participant s entry date is not the first day of the offering period, in which case the exercise price may not be lower than 85% of the greater of the market price on the first day of the offering period or the market price of the common stock on the entry date. As required by tax law, no participant may receive an option under the plan for shares that have a fair market value in excess of $25,000 for any calendar year, determined at the time the option is granted. Any funds not used to purchase shares will remain credited to the participant s bookkeeping account and applied to the purchase of shares of common stock in the next succeeding purchase period. No interest is paid on funds withheld, and those funds are used by our company for general operating purposes. No plan contributions or options granted under the plan are assignable or transferable, other than by will or by the laws of descent and distribution or as provided under the plan. During the lifetime of a participant, an option is exercisable only by that participant. The expiration date of the plan will be determined by the board and may be made any time following the close of any six-month exercise period, but may not be longer than 10 years from the date of the grant. If our company dissolves or liquidates, the offering period will terminate immediately prior to the consummation of that action, unless otherwise provided by the board. In the event of a merger or a sale of all or substantially all of our company s assets, each option under the plan will be assumed or an equivalent option substituted by the successor corporation, unless the board, in its sole discretion, accelerates the date on which the options may be (unaudited) Financing activities Payments on capital leases and equipment financing obligations $ (285 ) $ (397 ) $ (570 ) $ (93 ) $ (146 ) Proceeds from equipment financing 396 222 499 Proceeds from issuance of common stock upon exercise of options, net of notes receivable 101 212 607 173 110 Repayment of notes receivable from stockholders Table of Contents exercised. The unexercised portion of any option granted to an employee under the plan will be automatically terminated immediately upon the termination for any reason, including retirement or death, of the employee s employment. The plan provides for adjustment of the number of shares for which options may be granted, the number of shares subject to outstanding options, and the exercise price of outstanding options in the event of any increase or decrease in the number of issued and outstanding shares as a result of one or more reorganizations, restructurings, recapitalizations, reclassifications, stock splits, reverse stock splits, or stock dividends. The board or the committee may amend, suspend, or terminate the plan at any time, provided that such amendment may not adversely affect the rights of the holder of an option and the plan may not be amended if such amendment would in any way cause rights issued under the plan to fail to meet the requirements for employee stock purchase plans as defined in Section 423 of the Internal Revenue Code, or would cause the plan to fail to comply with Rule 16b-3 under the Exchange Act. The company s stockholders will not have any preemptive rights to purchase or subscribe for the shares reserved for issuance under the plan. If any option granted under the plan expires or terminates for any reason other than having been exercised in full, the unpurchased shares subject to that option will again be available for purposes of the plan. 401(k) Profit Sharing Plan In July 1991, we adopted a 401(k) profit sharing plan for which our employees generally are eligible. The plan is intended to qualify under Section 401(k) of the Internal Revenue Code, so that contributions to the plan by employees or by us and the investment earnings on the contributions are not taxable to the employees until withdrawn. Our contributions are deductible by us when made. Our employees may elect to reduce their current compensation by an amount equal to the maximum of 25% of total annual compensation or the annual limit permitted by law ($11,000 in 2002) and to have those funds contributed to the plan. Although we may make matching contributions to the plan on behalf of all participants, we have not made any contributions since the plan s adoption. Indemnification Under our Certificate of Incorporation and Bylaws The certificate of incorporation of our company provides that no director will be personally liable to the company or its stockholders for monetary damages for breach of a fiduciary duty as a director, except to the extent such exemption or limitation of liability is not permitted under the Delaware General Corporation Law (the Delaware GCL ). The effect of this provision in the certificate of incorporation is to eliminate the rights of the company and its stockholders, either directly or through stockholders derivative suits brought on behalf of the company, to recover monetary damages from a director for breach of the fiduciary duty of care as a director except in those instances described under the Delaware GCL. In addition, we have adopted provisions in our bylaws and entered into indemnification agreements that require the company to indemnify its directors, officers, and certain other representatives of the company against expenses and certain other liabilities arising out of their conduct on behalf of the company to the maximum extent and under all circumstances permitted by law. Indemnification may not apply in certain circumstances to actions arising under the federal securities laws. (1) Mr. Sanquini is a consultant to, and is a former officer of, National Semiconductor Corporation. (2) Mr. Geeslin is a general partner of the general partner of these entities. Cost of revenue $ 11 $ 7 $ 7 Research and development 55 47 49 Selling, general, and administrative 100 65 * Upon termination, Mr. Agrawal paid for the vested portion of his shares in the amount of $62,220 plus interest and the balance of the note was cancelled. Transactions regarding Foveon In August 1997, we entered into an agreement with National Semiconductor in connection with a new development stage company, Foveonics, Inc., now known as Foveon, Inc., which produces digital cameras and digital imaging components. We contributed imaging patents and other technology in exchange for 1,728,571 shares of Foveon s Series A preferred stock. Under the agreement, we had the right to acquire additional shares of Series A preferred stock at a specified price using funds provided under a limited-recourse loan arrangement with National. National loaned our company $1.5 million, which we contributed to Foveon in exchange for 1,371,429 additional Series A preferred shares. The limited-recourse loan is secured only by a portion of these Series A preferred shares. National s sole remedy under the loan, if we do not repay the loan, is to require us to return those shares to National. Under the same agreement, National purchased 3,200,000 shares of Series A preferred stock and a warrant to purchase 1,700,000 shares of Foveon s Series B preferred stock. In August 1998, National purchased 514,047 shares of Foveon s Series B preferred stock. During the year ended June 30, 2000, we loaned Foveon a total of approximately $2.7 million in return for convertible promissory notes. The notes are convertible into shares of preferred stock in accordance with the defined terms, mature in 10 years, and bear interest at rates ranging from 6.5% to 6.85%, payable at maturity. In August 2000, a new venture capital firm bought a 20% interest in Foveon for $21.0 million. In connection with the August 2000 financing, we received from Foveon 329,375 shares of Series B preferred stock and 114,590 shares of Series C preferred stock upon the automatic conversion of the promissory notes we held. Also in August 2000, National received from Foveon 520,625 shares of Series B preferred stock and 476,844 shares of Series C preferred stock upon the conversion of similar notes. National also purchased 1,185,953 shares of Series B preferred stock upon exercise of a warrant. National cancelled a promissory note issued by Foveon as payment for the exercise price of the warrant. In August 1997, Carver Mead, a founder and director of Foveon, purchased 350,000 shares of common stock of Foveon. In a December 2000 additional closing of the Series C preferred financing, Francis F. Lee, Federico Faggin, and Richard L. Sanquini purchased an aggregate of 113,715 shares of Foveon s Series C preferred stock out of a total of 3,979,418 shares of Series C preferred stock issued to date. * Less than one percent. (1) Includes 100,000 shares held by 1999 Faggin Trust fbo Marc Faggin, 100,000 shares held by 1999 Faggin Trust fbo Eric Faggin, and 100,000 shares held by 1999 Faggin Trust fbo Marzia Faggin. Includes 14,438 shares issuable upon exercise of vested stock options. Less amounts representing interest Net income (loss) per share: Basic $ 0.46 $ (0.38 ) $ 0.13 $ ** $ 0.24 Table of Contents (2) Includes 4,000 shares held by Francis Lee as custodian for Grace Evelyn Lee and 4,000 shares held by Francis Lee as custodian for Christopher Thomas Lee. Includes 517,000 shares held by Francis F. Lee and Evelyn C. Lee as Co-Trustees of the Lee 1999 Living Trust. Includes 57,813 shares issuable upon exercise of vested stock options. (3) Represents 155,729 shares issuable upon exercise of vested stock options. (4) Includes 43,382 shares issuable upon exercise of vested stock options. (5) Includes 42,236 shares issuable upon exercise of vested stock options. (6) Includes 75,625 shares issuable upon exercise of vested stock options. (7) Represents 64,854 shares issuable upon exercise of vested stock options. (8) Includes 22,257 shares issuable upon exercise of vested stock options. Also includes 2,131,665 shares held by entities affiliated with Sprout Group as set forth in footnote 13 below. Mr. Geeslin is a general partner of the general partner of each of those entities. He disclaims beneficial ownership of these shares except to the extent of his pecuniary interest therein. (9) Includes 28,403 shares issuable upon exercise of vested stock options. (10) Includes 13,681 shares issuable upon exercise of vested stock options. (11) The address for National Semiconductor Corporation is 1090 Kifer Road, Sunnyvale, California 94086. Mr. Brian L. Halla, Mr. Louis Chew, and Mr. John M. Clark III exercise shared voting and dispositive power over these shares. (12) Includes 1,612,686 shares held by Technology Venture Investors-3; 27,075 shares held by TVI Management-3; and 437,578 shares held by Technology Venture Investors-IV. The address for these entities is 2480 Sand Hill Road, Suite 101, Menlo Park, California 94025. Mr. Mark G. Wilson, Mr. Burton McMurtry, Mr. David F. Marquardt, Mr. Robert C. Kagle, and Mr. John Johnston exercise shared voting and dispositive power over these shares. (13) Includes 1,555,170 shares held by Sprout Capital V; 129,515 shares held by Sprout Technology Fund; and 332,595 shares held by Sprout Capital VI, L.P.; 102,983 shares held by DLJ Venture Capital Fund; and 11,402 shares held by DLJ Venture Capital Fund II, L.P. The address for these entities is 3000 Sand Hill Road, Building 3, Suite 170, Menlo Park, California 94025. Mr. Keith B. Geeslin and Ms. Janet A. Hickey exercise shared voting and dispositive power over the shares held by Sprout Capital V; Mr. Keith B. Geeslin, Ms. Janet A. Hickey, Mr. Robert Finzi, Ms. Kathleen D. La. Porte, and Mr. Arthur S. Zuckerman exercise shared voting and dispositive power over the shares held by Sprout Capital VI, L.P.; Mr. Keith B. Geeslin exercises voting and dispositive power over the shares held by Sprout Technology Fund; Mr. Keith B. Geeslin and Ms. Janet A. Hickey exercise shared voting and dispositive power over the shares held by DLJ Venture Capital Fund; and Mr. Keith B. Geeslin, Ms. Janet A. Hickey, and Mr. Robert Finzi exercise shared voting and dispositive power over the shares held by DLJ Venture Capital Fund II, L.P. (14) Includes 1,581,855 shares held by Oak Investment Partners IV, Limited Partnership, and 72,112 shares held by Oak IV Affiliates Fund, Limited Partnership. The address for these entities is 525 University Ave., Palo Alto, California 94301. Mr. Bandel L. Carano, Ms. Ann H. Lamont, Mr. Edward F. Glassmeyer, and Mr. Gerald R. Gallagher exercise shared voting and dispositive power over these shares. Mr. Carano, Ms. Lamont, Mr. Glassmeyer, and Mr. Gallagher disclaim beneficial ownership of these shares except to the extent of their pecuniary interest therein. (15) The address for Kleiner, Perkins, Caufield Byers IV is 2750 Sand Hill Road, Menlo Park, California 94025. Mr. Vinod Khosla exercises sole voting and dispositive power over these shares. (16) Includes 3,196 shares held by Delphi BioInvestments, L.P.; 872 shares held by Delphi BioInvestments II, L.P.; 901,294 shares held by Delphi Ventures, L.P.; and 170,210 shares held by Delphi Ventures II, L.P. The address for these entities is 3000 Sand Hill Road, Building 1, Suite 135, Menlo Park, California 94025. Mr. James J. Bochnowski and Mr. David L. Douglass exercise shared voting and dispositive power over the shares held by Delphi BioInvestments, L.P. and (1) The Generics Group AG acquired its shares in connection with our acquisition of Absolute Sensors Limited in October 1999. The address for this entity is Harston Mill, Harston, Cambridge CB2 5NH, United Kingdom. Table of Contents DESCRIPTION OF CAPITAL STOCK Upon the completion of this offering, we will be authorized to issue 60,000,000 shares of common stock, $.001 par value, and 10,000,000 shares of undesignated preferred stock, $.001 par value. The following description of our capital stock is intended to be a summary and does not describe all provisions of our certificate of incorporation or bylaws or Delaware law applicable to us. For a more thorough understanding of the terms of our capital stock, you should refer to our certificate of incorporation and bylaws, which are included as exhibits to the registration statement of which this prospectus is a part. Common Stock As of September 30, 2001, there were 17,782,052 shares of common stock outstanding held by approximately 234 stockholders, which reflects the conversion into common stock of all outstanding shares of preferred stock, including the shares of Series A preferred stock issued in June 1986; the shares of Series B preferred stock issued in June 1987; the shares of Series C preferred stock issued in September 1989; the shares of Series D preferred stock issued in September 1990; the shares of Series E preferred stock issued in November 1994 and February 1995 and to be issued in connection with the warrant dated June 1995; and the shares of Series F preferred stock issued in November 1995 and February 1996. In addition, as of September 30, 2001, there were options outstanding to purchase 4,205,995 shares of common stock. Upon completion of this offering, there will be 22,782,052 shares of common stock outstanding, assuming no exercise of outstanding options under our stock plans. The holders of common stock are entitled to one vote per share on all matters to be voted upon by stockholders. Subject to preferences that may be applicable to any outstanding preferred stock, holders of common stock are entitled to receive ratably dividends as may be declared by the board of directors out of funds legally available for that purpose. In the event of our liquidation, dissolution, or winding up, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preferences of any outstanding preferred stock. The common stock has no preemptive or conversion rights, other subscription rights, or redemption or sinking fund provisions. All outstanding shares of common stock are fully paid and non-assessable, and the shares of common stock to be issued upon completion of this offering will be fully paid and non-assessable. Preferred Stock Upon the closing of this offering, the following series of preferred stock will be converted: 496,095 outstanding shares of Series A preferred stock issued in June 1986 will be converted on a 3.3391594-for-1 basis into 1,656,537 shares of common stock; 871,428 outstanding shares of Series B preferred stock issued in June 1987 will be converted on a 3.0000171-for-1 basis into 2,614,296 shares of common stock; 545,455 outstanding shares of Series C preferred stock issued in September 1989 will be converted on a 1-for-1 basis into 545,455 shares of common stock; 2,314,284 outstanding shares of Series D preferred stock issued in September 1990 will be converted on a 1-for-1 basis into 2,314,284 shares of common stock; 2,887,703 outstanding shares of Series E preferred stock issued in November 1994 and February 1995 and 32,000 shares of Series E preferred stock issuable in connection with a warrant dated June 1995 will be converted on a 1-for-1 basis into 2,887,703 and 32,000 shares of common stock, respectively; and 1,055,242 shares of Series F preferred stock issued in November 1995 and February 1996 will be converted on a 1-for-1 basis into 1,055,242 shares of common stock. Thereafter, the board of directors will have the authority, without further action by the stockholders, to issue up to 10,000,000 shares of preferred stock in one or more series and to designate the rights, Table of Contents preferences, privileges, and restrictions of each series. The issuance of preferred stock could have the effect of restricting dividends on the common stock, diluting the voting power of the common stock, impairing the liquidation rights of the common stock, or delaying or preventing a change in control of our company, all without further action by the stockholders. Upon the closing of this offering, no shares of preferred stock will be outstanding and we have no present plans to issue any shares of preferred stock. Registration Rights Pursuant to an amended and restated investors rights agreement entered into between us and holders of 11,105,517 shares of common stock issuable upon conversion of our preferred stock, we are obligated, under limited circumstances and subject to specified conditions and limitations, to use our best efforts to register the registrable shares. We must use our best efforts to register the registrable shares if we receive written notice from holders of 42.5% or more of the registrable shares requesting that we effect a registration with respect to not less than 750,000 of the registrable shares (or a lesser number of registrable shares if the anticipated aggregate offering price would exceed $5.0 million, prior to underwriting discounts and commissions); if we decide to register our own securities (except in connection with this offering or certain offerings for employee benefit plans or acquisitions); or if (1) we are eligible to use Form S-3 (a shortened form of registration statement) and (2) we receive written notice from any holder of registrable shares requesting that we effect a registration on Form S-3 with respect to the registrable shares, the reasonable anticipated price to the public of which is not less than $500,000 (net of underwriting discounts or commissions). However, in addition to certain other conditions and limitations, if requested to register registrable shares, we can delay registration for not more than 120 days. In any case where we decide to register our own securities pursuant to an underwritten offering, the managing underwriter may limit the registrable shares to be included in the registration. We will bear all registration expenses other than underwriting discounts and commissions, except in the case of registrations on Form S-3 subsequent to the first two registrations on Form S-3. These registration rights terminate upon the holder being able to transfer all of his or her registrable shares pursuant to Rule 144. Table of Contents SYNAPTICS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Information as of September 30, 2001 and for the three months ended September 30, 2000 and 2001 is unaudited (the agent ) to transfer certain of the agent s employees to the Company s subsidiary. In consideration for the transfer of the assembled workforce, the Company entered into a restricted stock purchase agreement (the Agreement ) with the agent. The Agreement required the Company to issue 37,500 fully paid shares of common stock to the agent on the closing date of the agreement and also required the Company to place an additional 37,500 shares in escrow. The escrow shares are to be released to the agent in December 2001, provided that the agent fulfills the covenant not to solicit any employee or consultant for two years from the transfer of the agent s employee to the Company. The Company recorded the acquisition of assembled sales representative workforce as an intangible asset in the amount of $150,000, representing the fair value of the total stock-based consideration, which is being amortized on a straight line basis over thirty months. The Company was also obligated to pay the agent royalties on net sales in Taiwan between July 1, 1999 and December 31, 1999 and certain administrative services expenses for a period of three months after the closing of the Agreement. Royalties paid to the agent for the period from July 1, 1999 through December 31, 1999 totaled $202,000 and were expensed in the period in which such cost was incurred. Administrative expenses paid to the agent for the required three-month period were not material. Acquisition of Absolute Sensors Limited On October 26, 1999, the Company completed the acquisition of Absolute Sensors Limited (ASL), now known as Synaptics (UK) Limited. ASL, a United Kingdom-based company, is a developer of inductive sensing technology. The Company acquired all of the outstanding shares and certain assets of ASL in exchange for approximately $1,450,000 in cash and 652,025 shares of the Company s common stock. The total purchase price of ASL, including acquisition-related costs of approximately $232,000, was $3,103,000. The total purchase price was allocated by the Company based on available information with respect to the fair value of assets acquired and liabilities assumed as follows (in thousands): Acquired core technology $ 201 Acquired in-process research and development 855 Acquired workforce 160 Purchased patents 154 Goodwill 1,663 Net book value of acquired assets and liabilities, which approximates fair value Table of Contents SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no market for our common stock. Sales of substantial amounts of our common stock in the public market could adversely affect the prevailing market price and impair our ability to raise equity capital in the future. Upon completion of this offering, we will have 22,782,052 outstanding shares of common stock, based on 17,782,052 shares of common stock outstanding as of September 30, 2001 on an as converted basis. Of these shares, the shares sold in this offering, plus any shares sold upon exercise of the underwriters over-allotment option, will be freely tradable without restriction under the Securities Act, unless purchased by our affiliates as that term is defined in Rule 144 under the Securities Act. In general, affiliates include executive officers, directors, and 10% stockholders. Shares purchased by affiliates will remain subject to the resale limitations of Rule 144. The remaining shares outstanding prior to this offering are restricted securities within the meaning of Rule 144. Restricted securities may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144, 144(k), or 701 promulgated under the Securities Act, which are summarized below. Our directors, executive officers, and certain stockholders have entered into lock-up agreements in connection with this offering, generally providing that they will not offer, sell, contract to sell, or grant any option to purchase or otherwise dispose of our common stock or any securities exercisable for or convertible into our common stock owned by them for a period of 180 days after the date of this prospectus without the prior written consent of Bear, Stearns Co. Inc. Despite possible earlier eligibility for sale under the provisions of Rules 144, 144(k), and 701, shares subject to lock-up agreements will not be salable until these agreements expire or are waived by Bear, Stearns Co. Inc. These agreements are more fully described in Underwriting. Taking into account the lock-up agreements, and assuming Bear, Stearns Co. Inc. does not release stockholders from these agreements, the following shares will be eligible for sale in the public market at the following times: beginning on the effective date of the registration statement of which this prospectus forms a part, the shares sold in this offering will be immediately available for sale in the public market and approximately 214,201 shares will be eligible for sale pursuant to Rule 144(k), none of which are held by affiliates; beginning 90 days after the effective date of the registration statement of which this prospectus forms a part, approximately 49,597 additional shares will be eligible for sale pursuant to Rule 701 that are not subject to lock-up agreements; and beginning 180 days after the effective date of the registration statement of which this prospectus forms a part, approximately 6,658,332 additional shares held by affiliates will be eligible for sale subject to volume, manner of sale, and other limitations under Rule 144; 510,115 additional shares held by nonaffiliates will be eligible for sale pursuant to Rule 701; and 10,349,807 additional shares will be eligible for sale pursuant to Rule 144(k). In general, under Rule 144 as currently in effect, after the expiration of the lock-up agreements, a person who has beneficially owned restricted securities for at least one year would be entitled to sell within any three-month period a number of shares that does not exceed the greater of the following: one percent of the number of shares of common stock then outstanding, which will equal about 227,800 shares immediately after this offering; or the average weekly trading volume of the common stock during the four calendar weeks preceding the sale. Sales under Rule 144 are also subject to requirements with respect to manner of sale, notice, and the availability of current public information about us. Under Rule 144(k), a person who is not deemed to have been our affiliate at any time during the three months preceding a sale, and who has beneficially Diluted $ 0.12 $ (0.38 ) $ 0.04 $ ** $ 0.08 Table of Contents owned the shares proposed to be sold for at least two years, is entitled to sell his or her shares without complying with the manner of sale, public information, volume limitation, or notice provisions of Rule 144. Rule 701, as currently in effect, permits our employees, officers, directors, and consultants who purchased shares pursuant to a written compensatory plan or contract to resell these shares in reliance upon Rule 144, but without compliance with specific restrictions. Rule 701 provides that affiliates may sell their Rule 701 shares under Rule 144 without complying with the holding period requirement and that non-affiliates may sell their shares in reliance on Rule 144 without complying with the holding period, public information, volume limitation, or notice provisions of Rule 144. In addition, we intend to file registration statements under the Securities Act as promptly as possible after the completion of this offering to register shares issued upon the exercise of options and shares to be issued under our employee benefit plans. As a result, any options or rights exercised under the 1986 stock option plan and supplemental plan, 1996 stock option plan, the 2000 nonstatutory stock option plan, the 2001 incentive compensation plan, or any other benefit plan after the effectiveness of the registration statements will also be freely tradable in the public market. However, such shares held by affiliates will still be subject to the volume limitation, manner of sale, notice, and public information requirements of Rule 144 unless otherwise resalable under Rule 701. As of September 30, 2001, there were outstanding options for the purchase of 4,205,995 shares of common stock, of which options to purchase 1,064,132 shares were exercisable, and 3,460,898 shares of common stock had been previously issued upon exercise of options. Also, beginning six months after the completion of this offering, holders of 11,105,517 restricted shares will be entitled to registration rights on these shares for sale in the public market. See Description of Capital Stock Registration Rights. Registration of these shares under the Securities Act would result in their becoming freely tradable without restriction under the Securities Act immediately upon effectiveness of the registration. Transfer Agent and Registrar The transfer agent and registrar for our common stock is American Stock Transfer Trust Company. The transfer agent s address is 59 Maiden Lane, New York, New York 10038 and its telephone number is (877) 777-0800. The underwriting agreement provides that the obligations of the several underwriters thereunder are subject to approval of certain legal matters by their counsel and to various other conditions. Under the underwriting agreement, the underwriters are obligated to purchase and pay for all of the above shares of common stock, other than those covered by the over-allotment option described below, if they purchase any of the shares. The underwriters propose to initially offer some of the shares directly to the public at the offering price set forth on the cover page of this prospectus and some of the shares to dealers at this price less a concession not in excess of $ per share. The underwriters may allow, and dealers may re-allow, concessions not in excess of $ per share on sales to other dealers. After the initial offering of the shares to the public, the underwriters may change the offering price, concessions and other selling terms. The underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. The selling stockholders have granted the underwriters an option exercisable for 30 days from the date of the underwriting agreement to purchase up to 750,000 additional shares, at the offering price less the underwriting discount. The underwriters may exercise this option solely to cover over-allotments, if any, made in connection with this offering. To the extent underwriters exercise this option in whole or in part then each of the underwriters will become obligated, subject to conditions, to purchase a number of additional shares approximately proportionate to each underwriter s initial purchase commitment as indicated in the preceding table. We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act. Our directors, executive officers, and certain stockholders, who collectively hold a total of 17,518,254 shares of common stock, have agreed, subject to limited exceptions, not to sell or offer to sell or otherwise dispose of any shares of common stock or securities convertible into or exercisable or exchangeable for our common stock, for a period of 180 days after the date of this prospectus, without the prior written consent of Bear, Stearns Co. Inc., on behalf of the underwriters. In addition, we have agreed that for a period of 180 days after the date of this prospectus we will not offer, sell, or otherwise dispose of any shares of common stock, except for the shares offered in this offering and any shares offered in connection with employee benefit plans, without the consent of Bear, Stearns Co. Inc., on behalf of the underwriters. Table of Contents Prior to this offering, there has been no public market for our common stock. Consequently, the initial offering price for the common stock will be determined by negotiations between us and the representatives of the underwriters. Among the factors to be considered in these negotiations will be the following: our results of operations in recent periods; estimates of our business potential; an assessment of our management; prevailing market conditions; and the prices of similar securities of generally comparable companies. We have applied to have our common stock approved for quotation on the Nasdaq National Market under the symbol SYNA. We cannot assure you, however, that an active or orderly trading market will develop for our common stock or that our common stock will trade in the public markets subsequent to the offering at or above the initial offering price. In order to facilitate this offering, the underwriters may engage in transactions that stabilize, maintain, or otherwise affect the price of the common stock during and after this offering. Specifically, the underwriters may over-allot or otherwise create a short position in the common stock for their own account by selling more shares of common stock than we have actually sold to them. The underwriters may elect to cover any short position by purchasing shares of common stock in the open market or by exercising the over-allotment option granted to the underwriters. In addition, the underwriters may stabilize or maintain the price of the common stock by bidding for or purchasing shares of common stock in the open market and may impose penalty bids, under which selling concessions allowed to syndicate members or other broker-dealers participating in this offering are reclaimed if shares of common stock previously distributed in this offering are repurchased in connection with stabilization transactions or otherwise. The effect of these transactions may be to stabilize or maintain the market price at a level above that which might otherwise prevail in the open market and these transactions may be discontinued at any time. The imposition of a penalty bid may also affect the price of the common stock to the extent that it discourages resales. No representation is made as to the magnitude or effect of these activities. A prospectus in electronic format may be made available on Web sites maintained by one or more of the underwriters for sale to their online brokerage account holders. Internet distributions will be allocated by the underwriters that will make Internet distributions on the same basis as other allocations. Other than the prospectus in electronic format, the information on these Web sites is not part of this prospectus or the registration statement of which this prospectus forms a part, has not been approved or endorsed by us or any underwriter in its capacity as underwriter, and should not be relied upon by investors. In addition, a prospectus in electronic format is being made available on an Internet website maintained by E*TRADE Securities, Inc. SoundView Technology Corporation, pursuant to a Relationship Agreement with E*TRADE, may offer shares that it underwrites to customers of E*TRADE. The underwriters may allocate a number of shares to SoundView Technology Corporation for sale to online brokerage account holders of E*TRADE Securities, Inc. These online brokerage account holders will have the opportunity to purchase shares using the Internet in accordance with procedures established by E*TRADE Securities, Inc. The underwriters have reserved for sale, at the initial public offering price, up to 250,000 shares of common stock for employees, directors, and other persons associated with us who express an interest in purchasing these shares of common stock in this offering. The number of shares available for sale to the general public in the offering will be reduced to the extent these persons purchase reserved shares. Any reserved shares not purchased by these persons will be offered by the underwriters to the general public on the same terms as the other shares offered in this offering. The underwriters may, from time to time, engage in transactions with, and perform services for, us in the ordinary course of their business. Assumed initial public offering price $ 10.00 $ 50,000,000 $ 57,500,000 Underwriting discounts and commissions payable by us 0.70 3,500,000 3,500,000 Underwriting discounts and commissions payable by the selling stockholders 0.70 525,000 Proceeds, before expenses, to us 9.30 46,500,000 46,500,000 Proceeds to selling stockholders 9.30 6,975,000 Other expenses of this offering, including the registration fees and the fees of financial printers, legal counsel, and accountants, payable by us are expected to be approximately $1,600,000. LEGAL MATTERS The validity of the common stock in this offering will be passed upon for us by Greenberg Traurig, LLP, Phoenix, Arizona. Certain legal matters in connection with this offering will be passed upon for the underwriters by Brobeck, Phleger Harrison LLP, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2002/TBHC_brand_legal_matters.txt b/parsed_sections/legal_matters/2002/TBHC_brand_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5b3187a7fd78c33f8d6019a6dbba2c76003655e6 --- /dev/null +++ b/parsed_sections/legal_matters/2002/TBHC_brand_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby is being passed upon for us by Baker, Donelson, Bearman & Caldwell, a Professional Corporation, and certain other matters will be passed upon for us by Pepper Hamilton LLP. The underwriters are being represented by Fried, Frank, Harris, Shriver & Jacobson (a partnership including professional corporations). Pepper Hamilton LLP and Fried, Frank, Harris, Shriver & Jacobson will rely upon Baker, Donelson, Bearman & Caldwell with respect to matters governed by Tennessee law. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/ALK_alaska_legal_matters.txt b/parsed_sections/legal_matters/2003/ALK_alaska_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5caea61c71cd34b08d70fee04ac437f1c42fbaf4 --- /dev/null +++ b/parsed_sections/legal_matters/2003/ALK_alaska_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters 110 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/ANG-PD_american_legal_matters.txt b/parsed_sections/legal_matters/2003/ANG-PD_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..35b59e542d4a336bd236e039adfd0ad5cb4542f6 --- /dev/null +++ b/parsed_sections/legal_matters/2003/ANG-PD_american_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered hereby and certain matters relating thereto will be passed upon on our behalf by Wendy L. Carlson, our General Counsel, and Skadden, Arps, Slate, Meagher & Flom (Illinois). Ms. Carlson is a full-time employee and officer of our company, and she currently owns 13,800 shares of our common stock and holds options and management subscription rights to purchase an additional 197,500 shares of our common stock. Certain legal matters will be passed upon on behalf of the underwriters by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CHT_chunghwa_legal_matters.txt b/parsed_sections/legal_matters/2003/CHT_chunghwa_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36f53bb06de91216ad021d134301fb8920d1210e --- /dev/null +++ b/parsed_sections/legal_matters/2003/CHT_chunghwa_legal_matters.txt @@ -0,0 +1,8122 @@ +Legal Proceedings + + +We are not involved in any litigation, +arbitration or administrative proceedings relating to claims +that could have a material adverse effect on our financial +condition and results of operations, and, so far as we are +aware, no such litigation, arbitration or administrative +proceedings are pending or threatened. + +109 + +Table of Contents + +REGULATION" --> + +REGULATION + + +The following is a summary of the significant +laws and regulations of the Republic of China relating to us. +Unless otherwise specified, all the laws and regulations +referred to herein are laws and regulations of the Republic of +China and all the government authorities referred to herein are +the government authorities of the Republic of China. + +Overview + + +The Taiwan telecommunications industry is subject +to extensive regulation by and under the supervision of the +Ministry of Transportation and Communications and the +Directorate General of Telecommunications pursuant to the +provisions of the Telecommunications Act and various other +telecommunications laws and regulations, as well as regulations +under various laws of general application. + + +As a state owned enterprise, we are also +regulated by the Law Governing Administration of State Owned +Enterprises, the Audit Law and the Budget Law. We are also +subject to the Statute Governing Privatization of State Owned +Enterprises. + + +In addition, we are subject to the Statute of +Chunghwa Telecom Co., Ltd. + +Regulatory Authorities + + +The primary regulatory authority of the Taiwan +telecommunications industry is the Ministry of Transportation +and Communications. The Ministry of Transportation and +Communications issues policy directives and telecommunications +licenses and oversees the activities of the Directorate General +of Telecommunications, which is responsible for the +implementation of these directives and the day-to-day +supervision of the telecommunications industry. The Ministry of +Transportation and Communications and the Directorate General of +Telecommunications are responsible for: + + + + + + + + + formulating, implementing and interpreting + telecommunications laws and regulations; + + + + + + + + issuing telecommunications licenses and + regulating the operation of telecommunications industry + participants; + + + + + + + + establishing and reviewing tariff structures and + numbering plans; and + + + + + + + + managing and facilitating the resolution of + disputes pertaining to the Taiwan telecommunications industry. + + + +The operations of cable television enterprises +are regulated by the news and broadcasting division of the +Government Information Office under the Executive Yuan. Internet +access through cable is regulated by the Directorate General of +Telecommunications. + + +In each fiscal year, the Legislative Yuan +approves the annual budget prepared by us, as a state owned +enterprise, and the Ministry of Audit under the Control Yuan +must audit and may adjust, our financial statements, including +our earnings and losses. + +110 + +Table of Contents + +Telecommunications Act + + +The Telecommunications Act and the regulations +under the Telecommunications Act establish the framework and +govern the various aspects of the Taiwan telecommunications +industry, including: + + + + + + + + + licensing of telecommunications services; + + + + + + + + restrictions on dominant telecommunications + service providers; + + + + + + + + tariff control and price cap regulation; + + + + + + + + accounting separation system; + + + + + + + + interconnection arrangements; + + + + + + + + bottleneck facilities; + + + + + + + + spectrum allocation; + + + + + + + + provision of universal services; + + + + + + + + equal access; + + + + + + + + number portability; + + + + + + + + foreign ownership limitations; and + + + + + + + + administration fees. + + + +Each of these aspects is described below. The +Telecommunications Act also establishes a non-auction pricing +system for assignment of radio frequencies. + +Licensing of Telecommunications +Services + + Type +I and Type II Service Providers + + +Under the Telecommunications Act, +telecommunications service providers are classified into two +categories: + + +Type I. +Type I service providers are providers that install network +infrastructure, such as network transmission, switching and +auxiliary equipment for the provision of telecommunications +services. Type I services include fixed line services such +as local, domestic long distance and international long distance +services, as well as interconnection, leased line, asymmetrical +digital subscriber line and satellite services and wireless +services such as cellular, including third generation cellular, +paging, mobile data and trunked radio services. + + +Type II. Type II +service providers are defined as all telecommunications service +providers other than Type I service providers. Type II +services are divided into special services and general services. +Special services include simple resale, voice over Internet +protocol, international leased circuit and other services +specified by the Ministry of Transportation and Communications. +General services include any Type II service other than +special services. + + +Until 1996, we were the sole provider of Type I +services in Taiwan. In 1996, the government opened the market +for cellular, paging and trunked radio, mobile data and digital +low power cordless telephone services. In 1998, the government +opened the market for fixed line and mobile satellite services. +In June 2001, the government granted licenses to three operators +for establishing fixed line services, thereby opening the market +for fixed line + +111 + +Table of Contents + +services. Since August 2000, the government has +permitted four undersea cable operators to engage in the +undersea cable leased-circuit business. + + Granting +of Licenses + +Type I + + +Type I service providers are more closely +regulated than Type II service providers. The government +has broad powers to limit the number of providers and their +business scope and to ensure that they meet their facilities +roll-out obligations. Under the Telecommunications Act, +Type I service providers are subject to pre-licensing merit +review of their business plans and tariff rates. + + +Licenses for Type I services are granted by +the Ministry of Transportation and Communications through a +three-step procedure. Applicants must first obtain a concession +from the Ministry of Transportation and Communications. After +obtaining a concession, the applicant must obtain a network +construction permit and an assignment of spectrum in the case of +cellular telephone services and satellite services, from the +Directorate General of Telecommunications or the Ministry of +Transportation and Communications prior to applying for a +license. Upon completion of construction of its network and +review by the Directorate General of Telecommunications, the +applicant may be granted a Type I license. The Ministry of +Transportation and Communications has the authority to grant +Type I licenses for each of fixed line services, wireless +services and satellite services. Type I licenses have +different minimum paid-in capital requirements for applicants +and varying durations depending on the particular type of +service. + + +The Telecommunications Act further authorizes the +Ministry of Transportation and Communications to promulgate +separate regulations governing each Type I service +including the business scope of the Type I service +provider, as well as the procedures and conditions for granting +special permits and the length of the period of the special +permits of each Type I service. Each holder of a +Type I license will pay a fee ranging from 0.5% to 2% of +the annual revenues generated from the particular Type I +service for which a license has been granted. + + +Fixed Line Services. +Under the Telecommunications Act, the +Fixed Network Regulations adopted by the Ministry of +Transportation and Communications govern the issuance of fixed +line service licenses and the business scope of fixed line +providers. Fixed line service licenses are subdivided into the +following categories: + + + + + + + + + integrated services, including local, domestic + long distance, international long-distance telephone services; + + + + + + + + local telephone services; + + + + + + + + domestic long distance telephone services; + + + + + + + + international long distance telephone services; + and + + + + + + + + local, domestic long distance and international + long distance leased line services. + + + +We conduct our fixed line services through a +license for integrated services. + + +Licenses for local telephone and integrated +services are valid for 25 years, licenses for domestic long +distance and international long distance telephone services are +valid for 20 years and licenses for leased line services +are valid for 15 years. The minimum paid-in capital +requirement for integrated services providers and international +undersea cable service providers are NT$40 billion and +NT$800 million, respectively. + +112 + +Table of Contents + + +In March 2000, the government granted three +new concessions to fixed line services providers for integrated +services. Recipients of these concessions are required to apply +for a network construction permit to deploy broadband local +access networks. Each recipient of these concessions is required +to have capacity for 150,000 subscribers before they are +able to apply for a fixed line license to launch their proposed +services. The three fixed line services providers have since +obtained fixed line licenses and are required to achieve +capacity for one million subscribers by the sixth year following +the date of the grant of the network construction permit awarded. + + +Wireless Services. +Under the Telecommunications Act, the Wireless Regulations +adopted by the Ministry of Transportation and Communications +govern the issuance of wireless services licenses and the +business scope of wireless service providers. Wireless service +licenses are subdivided into the following categories: + + + + + + + + + cellular services; + + + + + + + + paging services; + + + + + + + + mobile data services; + + + + + + + + digital low-power cordless telephone services; and + + + + + + + + trunked radio services. + + + +Wireless service licenses are granted to both +regional and national service providers through review and +bidding procedures. + + +Wireless services licenses for cellular and +paging services are valid for 15 years, and licenses for mobile +data, digital low-power cordless telephone and trunked radio are +valid for ten years. The minimum paid-in capital requirement for +regional cellular service providers and national service +providers are NT$1 billion and NT$6 billion, respectively. + + +We are licensed to provide cellular and paging +services in Taiwan. + + +Third Generation Cellular Services. +The Ministry of Transportation and +Communications promulgated the Third Generation Mobile +Telecommunications Services Regulations on October 15, +2001. These regulations govern voice and non-voice +telecommunications services provided using the spectrum assigned +by the Ministry of Transportation and Communications that +utilizes the IMT-2000 technical standards as announced by the +International Telecommunications Union. + + +Licenses for third generation cellular services +are granted by the Ministry of Transportation and Communications +through a three-step procedure. Applicants must first obtain a +concession from the Ministry of Transportation and +Communications through a bidding process. The concession will be +valid from the issue date to December 31, 2004. After +obtaining the concession, the applicant must inject the minimum +paid-in capital of NT$6 billion, amend its corporation +registration and obtain a system and station installation permit +to commence the construction of the third generation cellular +services network infrastructure from the Directorate General of +Telecommunications. After the completion of such construction +and obtaining an approval from the Directorate General of +Telecommunications, the applicant may apply for the third +generation cellular services license. Each license is valid +until December 31, 2018. If the applicant is unable to +apply for and obtain a license before the expiry date of the +concession, the applicant may apply for an extension of one +year. We have obtained the system and station installation +permit and are in the process of building our third generation +cellular services network infrastructure. + +113 + +Table of Contents + + +Pursuant to the Third Generation Mobile +Telecommunications Services Regulations, the Ministry of +Transportation and Communications granted third generation +cellular services concessions to five bidders, including our +company, in February 2002. + + +Satellite Services. +Under the Telecommunications Act, the +Satellite Regulations adopted by the Ministry of Transportation +and Communications govern the issuance of satellite services +licenses and the business scope of satellite service providers. +Satellite services licenses are subdivided into fixed satellite +services licenses and mobile satellite services licenses. + + +Satellite services licenses are valid for +10 years. Minimum paid-in capital requirements for fixed +satellite services providers and mobile satellite services +providers are NT$100 million and NT$500 million, +respectively. + + +We currently hold a fixed satellite services +license, valid from December 10, 1998 to December 9, +2008. + +Type II + + +The Telecommunications Act was amended in 1996 to +open the market for all Type II services. Under +Type II Services Regulations as amended on June 28, +2001, Type II services are divided into special services +and general services. Special services include simple resale, +voice over internet protocol, international leased circuit and +other services specified by the Ministry of Transportation and +Communications. General services include any Type II +service other than special services. The policy for granting a +Type II service license has the following characteristics: + + + + + + + + + there is no limit on the number of licenses to be + issued; + + + + + + + + licenses are granted by the Directorate General + of Telecommunications; and + + + + + + + + no bidding procedure is required. + + + +We hold a license to operate all Type II +services. Type II service licenses are valid for ten years +and may be renewed by application six months prior to the +expiration date. There is no minimum paid-in capital requirement +for Type II service providers. Our license to operate +Type II services was issued on October 23, 2000. Prior +to October 23, 2000, we conducted our Type II services +pursuant to a letter from the Ministry of Transportation and +Communications to the Directorate General of Telecommunications +stating that we should be permitted to operate Type II +services. + + +On December 19, 2001, the Ministry of +Transportation and Communications announced new regulations +governing Type II licenses. Under the new regulations, +operators of simple resale or voice over internet protocol +services must pay an annual license fee equal to 0.5% of annual +revenues generated from these services. Type II service +operators providing services other than simple resale or voice +over internet protocol services must pay license fees ranging +from NT$6,000 to NT$90,000 depending on their paid-in capital. +These new regulations do not apply to integrated services +providers who also provide Type II services. The annual +license fee for an integrated services provider operating +Type II businesses is 1% of its annual revenues generated +from its Type II services. + +Restrictions on Dominant Telecommunications +Services Providers + + +Under the Telecommunications Act, the regulations +governing dominant telecommunications services providers apply +only to Type I service providers. A Type I service +provider is + +114 + +Table of Contents + +deemed to be dominant if it meets any of the +following criteria and is declared by the Ministry of +Transportation and Communications as dominant: + + + + + + + (1) + + controls key basic telecommunications + infrastructure; + + + + + + (2) + + has dominant power over market price; or + + + + + + (3) + + has more than a 25% market share in terms of + customers or revenues. + + + +We have been declared by the Ministry of +Transportation and Communications as a dominant Type I +service provider for fixed line and cellular services. + + +Under the Telecommunications Act, a dominant +Type I service provider must not engage in the following +activities: + + + + + + + + + hinder a request for interconnection with its + networks by other Type I service providers; + + + + + + + + refuse to release to other Type I service + providers the calculation methods of its interconnection fees + and other relevant materials; + + + + + + + + improperly determine, maintain or change its + tariffs or means of services; + + + + + + + + reject, without due cause, a request for leasing + network components by other Type I service providers; + + + + + + + + reject, without due cause, a request for leasing + lines by other services providers; + + + + + + + + reject, without due cause, a request for + negotiation (including negotiation on co-location) or testing by + other services providers; + + + + + + + + discriminate, without due cause, against other + services providers or users; or + + + + + + + + abuse its position as a dominant provider, or + engage in other unfair competition activities. + + + +In addition, a dominant Type I service provider +is subject to special regulations limiting its tariff changes. + +Tariff Control and Price Cap +Regulation + + +In order to promote competition in the +telecommunications market, and as part of the government s +overall policy toward deregulation, the Telecommunications Act +was amended in 1999 to abolish the former rate of return system +on tariff setting in favor of price cap regulation of +Type I services. + + +Under the Regulations Governing Tariffs of +Type I Service Providers promulgated by the Ministry of +Transportation and Communications, a dominant Type I +service provider must submit its proposed adjustment in primary +tariffs and promotional packages for approval at least +14 days prior to the date of the proposed tariff changes +and announce such changes seven days prior to their +effectiveness. Such an announcement may be made during the +14-day Ministry of Transportation and Communications approval +period. + + +Primary tariffs include: + + + + + + + (1) + + for fixed line local telephone services: monthly + fees, usage fees, monthly rental fees of leased lines and pay + telephone usage fees; + + + + + + (2) + + for fixed line domestic long distance telephone + services: usage fees and monthly rental fees of leased lines; + + +115 + +Table of Contents + + + + + + + (3) + + for fixed line international long distance + telephone services: usage fees and monthly rental fees of leased + lines; + + + + + + (4) + + for wireless services, including third generation + cellular services: monthly rental fees and usage fees; and + + + + + + (5) + + other fees or tariffs announced by the + Directorate General of Telecommunications. + + + +In comparison, all non-dominant Type I +service providers are required to notify the Directorate General +of Telecommunications and the public of their proposed tariff +adjustments seven days prior to the date of the proposed +tariff change with respect to all tariffs. In addition, changes +in tariffs charged by Type I service providers +(notwithstanding the type of their respective services) may not, +in any event, be greater than the annual growth rate of the +consumer price index in Taiwan adjusted by a set constant, which +will be periodically determined and announced by the Directorate +General of Telecommunications. For example, if: + + + + + + + (1) + + the annual growth rate of the consumer price + index in Taiwan minus the set constant is positive, the + increased percentage of tariffs must not exceed such positive + figure, + + + + + + (2) + + the annual growth rate of the consumer price + index in Taiwan minus the set constant is negative, the + decreased percentage of tariffs must be at least the absolute + value of such negative figure, and the tariffs subsequently + changed must not be higher than the tariff originally charged, + and + + + + + + (3) + + the annual growth rate of the consumer price + index in Taiwan minus the set constant equals to zero, no + increase in tariffs is allowed to be made by any Type I + service providers. + + + +In October 2000, the Directorate General of +Telecommunications announced that effective from the date of the +announcement, the set constant to be applied for all tariff +adjustments, except tariffs for our fixed line local telephone +services, will be equal to the annual growth rate of the +consumer price index in Taiwan. Accordingly, for the time being, +the adjustment would be equal to zero as calculated in (3) above +and thus no increase in tariffs by Type I services providers +will be allowed, except for increases in tariffs for fixed line +local telephone services. The set constant to be applied for +adjustments in fixed line local telephone services has yet to be +announced by the Directorate General of Telecommunications. + + +Type II service providers are free to +establish their own tariff schemes, but are required to notify +the Directorate General of Telecommunications and the public +upon adoption and upon any subsequent adjustments. + +Accounting Separation System + + +The Telecommunications Act requires that a +Type I service provider, including one who concurrently +offers Type II services, separately calculate the profits +and losses for its different services and prohibits any +cross-subsidization among services that will impede fair +competition. + +Interconnection Arrangements + + +The Telecommunications Act requires all +Type I service providers to allow other Type I service +providers access to their networks. It further requires +Type I service providers, within three months upon request +by the other Type I service provider, to reach an agreement +on the relevant terms for the interconnection. Prices charged +for interconnection must be based on cost. If the parties fail +to reach an agreement within three months, the Directorate + +116 + +Table of Contents + +General of Telecommunications may arbitrate and +determine the interconnection terms for the parties. According +to the Administrative Rules for Network Interconnection Between +Type I Service Providers, the tariffs for communications +between a cellular telecommunications network and a fixed line +telecommunications network shall be collected by the +call-originating services provider from its subscribers pursuant +to the tariff schedules set by the cellular services provider, +and the revenue from such tariffs shall go to the cellular +services provider. + + +When a Type I service provider leases +unbundled network components to another Type I service +provider, the parties are required to negotiate the rental fee. +Unbundled network components include: + + + + + + + (1) + + local loops; + + + + + + (2) + + local switch transmission equipment; + + + + + + (3) + + local trunks; + + + + + + (4) + + toll switch transmission equipment; + + + + + + (5) + + long-distance trunks; + + + + + + (6) + + international switch transmission equipment; + + + + + + (7) + + network interfaces; + + + + + + (8) + + directory equipment and services; and + + + + + + (9) + + signaling network equipment. + + + +The Telecommunications Act authorizes the +Directorate General of Telecommunications to issue rules and +regulations pertaining to interconnection. Under the +Administrative Rules for Network Interconnection between +Type I Service Providers issued by the Directorate General +of Telecommunications, we, as a dominant Type I service +provider for fixed line and cellular services, are required to +unbundle our network and provide cost-based interconnection +charges calculated with reference to the total element long-run +incremental cost incurred by us. We are required to submit our +proposed calculations of the total element long-run incremental +cost to the Directorate General of Telecommunications for its +approval. + +Bottleneck Facilities + + +Under the Telecommunications Act, when a +Type I service provider cannot construct bottleneck +facilities within a reasonable period of time or substitute +those facilities by other available technologies, it may request +for co-location on a fee basis from the owner of the facilities +located at the bottleneck of relevant telecommunications +network. The owner of the facilities so requested may not reject +these requests without due cause. The Ministry of Transportation +and Communications has the authority to prescribe facilities as +bottleneck facilities, and has prescribed bridges, tunnel, +lead-in tubes and telecommunication chambers located within +buildings and horizontal and vertical telecommunication cables +and lines as bottleneck facilities in relation to fixed line +telecommunication networks. + +Spectrum Allocation + + +The Ministry of Transportation and Communications +allocates all telecommunications related frequencies primarily +according to the standards set by the International +Telecommunications Union. The 900 MHz and 1,800 MHz +frequency bands have been allocated for cellular applications. A +total of 40 MHz spectrum around the 800 MHz frequency band +and a + +117 + +Table of Contents + +total of 130 MHz of spectrum around the 2 +GHz band have been allocated for third generation cellular +services. + + +Frequency allocation for fixed wireless +platforms, such as wireless local loop and local multipoint +distribution services, has already been set. Only some bands of +the spectrum made available for these services are completely +clear and there is partial usage in all other bands. The cost of +frequency usage will be based on quantity. + +Provision of Universal +Services + + +A Type I service provider may be required by +the Ministry of Transportation and Communications, under the +Telecommunications Act, to provide universal telecommunications +services in remote or unprofitable areas. All Type I +service providers and certain Type II service providers +designated by the Ministry of Transportation and Communications +will be required to contribute a fixed portion of their annual +revenues to a universal services fund. Such a fund will be used +to compensate any losses and management fees incurred by the +relevant Type I service provider in providing the universal +services. In June 2001, the Ministry of Transportation and +Communications promulgated the Regulations on Telecommunications +Universal Services, pursuant to which Type I service +providers are required to provide universal telecommunications +services and contribute to the costs and expenses of providing +such services on a pro rata basis according to their respective +revenues. + +Equal Access + + +As a result of the liberalization of +Taiwan s telecommunications industry, a Type I service +provider, including a third generation cellular services +provider, is required to provide its subscribers with equal +access to the domestic and international long distance telephone +services provided by other services providers. A Type I +service provider may provide equal access through pre-selection +or call-by-call selection. Currently, all Type I service +providers, including us, provide equal access only through +call-by-call selection. When a subscriber makes a call using +call-by-call selection, such subscriber has the option to select +a service provider by dialing the network identification prefix +assigned to the services provider of his choice. This will +result in the automatic selection of the preferred services +provider for the provision of relevant telecommunication +services. + +Number Portability + + +The Ministry of Transportation and Communications +has adopted principles on fixed line number portability that +will enable customers to migrate their local and toll free fixed +line telephone numbers. Under these regulations, we are required +to provide fixed line number portability in seven major cities +and counties in Taiwan upon the grant of the first fixed line +license to a new entrant. We are also required to provide such +number portability in other service areas no later than +181 days from the grant of such license and upon +six months advanced written notification received +from the new fixed line service provider. Since May 2002, fixed +line number portability has been made available to all customers. + + +According to the Third Generation Mobile +Telecommunications Services Regulations, third generation +cellular services providers should provide mobile number +portability services to their customers. The details and time +schedule of such mobile number portability are to be prescribed +by the Directorate General of Telecommunications. + +118 + +Table of Contents + +Foreign Ownership Limitations + + +The Telecommunications Act provides that direct +foreign ownership in Type I service providers, except for +us, may not exceed 49%, and combined direct and indirect foreign +ownership in Type I service providers, except for us, may +not exceed 60%. The Telecommunications Act places no limitation +on foreign ownership in Type II service providers. The +Ministry of Transportation and Communications separately +prescribes limits on our foreign ownership. Currently, direct +and indirect foreign ownership of our common shares is limited +to 20%. A fine of between NT$500,000 to NT$2,500,000 may be +imposed on us if we fail to comply with this limitation within a +prescribed period of time after receiving a notice to comply. If +we fail to comply within a prescribed period of time after such +further notification, our licenses to operate our Type I +services may be revoked. + + +Under the current Telecommunications Act, the +Chairman of a Type I service provider is required to be a +citizen of the Republic of China. + +Administrative Fee + + +According to the Administrative Fee Law +promulgated in December 2002, central and local governments, +government agencies and schools are empowered to collect +administrative fees from us and other telecommunications +services providers for the telecommunications facilities built +on public roads and properties. Such administrative fees are +further specified in the draft amendment to the Public Road Law, +under which fixed line services operators, such as us, and +public facility providers shall pay a usage fee when utilizing +public roads to install pipelines or other public facilities. +The types of telecommunications facilities that will be subject +to these fees and the amount of these fees will be determined +under the rules to be promulgated by the relevant government, +government agency or school. + +Laws and Regulations Relating to State Owned +Enterprises and Our Privatization + +Law Governing Administration of State Owned +Enterprises + + +As a state owned enterprise, we are subject to +the Law Governing Administration of State Owned Enterprises. + +Generally same rights and obligations as +private enterprises + + +Unless otherwise stipulated by laws, we have the +same rights and obligations as non-state owned enterprises. + +Approval Required for Certain +Activities + + +We are required to obtain the approval of the +Ministry of Transportation and Communications for the certain +activities, including: + + + + + + + (1) + + entering into purchase or sale agreements of a + long term nature or of an amount exceeding that prescribed by + the Ministry of Transportation and Communications; + + + + + + (2) + + issuing corporate bonds; + + + + + + (3) + + purchasing any equipment or buildings outside the + scope of our business; and + + + + + + (4) + + technical cooperation with foreign persons. + + +119 + +Table of Contents + +Labor Union Representative Required for Board +Member + + +At least one fifth of our directors representing +the government s shareholding must be representatives of +our labor union. + +Statute Governing Privatization of State +Owned Enterprises + + +Under the Statute Governing Privatization of +State Owned Enterprises, the privatization of a state owned +enterprises, including us, can be conducted through the +following: + + + + + + + + + sales of shares or assets; + + + + + + + + incorporation of non-state owned joint ventures + with assets injection as share capital; + + + + + + + + merger with an existing company to be a non-state + owned enterprise; or + + + + + + + + rights offering. + + +The sale must be open to the public and may be +made through negotiation if approved by the Executive Yuan. In +addition, the price of the sale must be determined by an +evaluation commission comprising of the representatives from the +Ministry of Transportation and Communications and other +authorities. + + Pension +Payment + + +Upon the completion of our privatization, we will +make a settlement payment to our employees who choose to remain +with us, based on their seniority and in accordance with the +pension payment determined under the Labor Standards Law as if +they have retired at the time of privatization. Those employees +who remain with us and who are laid off within five years after +the completion of our privatization will be entitled to a +severance payment plus six-months salary and one-month wages. +The government has agreed to assume the cost of paying the +six-months salary to the laid-off employees. In addition, if +these laid-off employees qualify for retirement benefits, they +will also be entitled to pension payments. + + +On the date of our privatization, we will make +termination payments in accordance with the pension payment +determined under the Labor Standards Law plus six-months salary +and one-month wages to our employees who choose to resign. The +government has agreed to assume the cost of paying the +six-months salary to our employees who choose to resign. + + Indemnification + + +The government will indemnify those employees who +have suffered from any losses and damages due to our +privatization, such as losses arising from change of an +insurance program. + + +Part of the funds realized from our privatization +will be allocated to the Privatization Fund and the rest of the +funds will go to the Treasury of the Republic of China. +Indemnification payments by the government will be made from the +Privatization Fund. + + Employee +Subscription Rights for Privatization + + +The statute also provides that when our shares +are sold for privatization, a certain portion of these shares +must be reserved for purchase by our employees at favorable +terms approved by the Executive Yuan in accordance with the +regulations issued by the Ministry of Transportation and +Communications. + +120 + +Table of Contents + +Government Procurement Law + + +As a state owned enterprise, we are subject to +the Government Procurement Law for all procurements, including +contracting of construction works, purchase or lease of +properties or retention of services or employment. + + +Under the Government Procurement Law, subject to +limited special relief granted to us by the Ministry of +Transportation and Communications, all procurements over NT$1 +million must be made by open tender, selective tender or limited +tender procedures. Open tender means the procedures under which +a public notice is given to invite suppliers to submit their +tenders. Selective tender means the procedure under which a +public notice is given to invite all interested suppliers to +submit their qualification documents for pre-qualification +evaluation based upon specific qualification requirements. After +such evaluation, the qualified suppliers are invited to tender. +Limited tender means the procedure under which, where no public +notice is given, two or more suppliers are invited to compete or +only one supplier is invited to tender. + +Budget Law and Audit Law + + +Under the Budget Law, we are required to submit +our budget for each fiscal year to the Legislative Yuan for +their approval. In addition, under the Audit Law our financial +statements, including our earnings and losses, will be reviewed +and will be subject to adjustments by the Ministry of Audit +under the Control Yuan. Our financial statements presented in +this prospectus are prepared in accordance with US GAAP and +have not been subject to adjustments by the government. + +Statute of Chunghwa Telecom Co., +Ltd. + +Approval of Ministry of Transportation and +Communications + + +Under the Statute of Chunghwa Telecom Co., Ltd, +we must obtain approval of the Ministry of Transportation and +Communications for: + + + + + + + (1) + + the adoption of and any changes to our articles + of incorporation and board of directors organization rules; + + + + + + (2) + + any changes to our authorized capital and any + issuance of our common shares; + + + + + + (3) + + any changes to primary tariffs for Type I + service; and + + + + + + (4) + + any changes to operational procedures of + Type I services. + + +Pension Obligation + + +We are required to fund any shortfall in our +pension fund reserves within eight years after our +incorporation. Consequently, if we record any extra earnings +over our previous estimated earnings approved by the Legislative +Yuan, these extra earnings must be first allocated to pension +fund reserves. In addition, as required by the Statute Governing +Privatization of State Owned Enterprises, we are required to +perform all of our pension obligations upon the completion of +our privatization. + +Employees Subscription Rights for New Issue +of Our Common Shares + + +Our employees have rights to subscribe for not +more than 10% of a new issuance of our common shares at +favorable terms in accordance with the subscription rules +announced by the Ministry of Transportation and Communications. + +121 + +Table of Contents + +Recent Resolution Passed by Legislative +Yuan + + +The Legislative Yuan, the Republic of +China s highest legislative body, passed a resolution on +May 30, 2003 with respect to our privatization through a +sale of our common shares, which resolved that: + + + + + + + (1) In case of our privatization by way of a + sale of our common shares or a capital increase for cash, such + privatization shall not be made through negotiated transactions; + + + + + + + (2) Open tenders for our common shares may + be conducted only after 10 offers of our common shares to the + general public in Taiwan; + + + + + + + (3) The notice period for open tenders shall + be: + + + + + + + + (a) not less than 28 days for open + tenders in an amount less than NT$200 million; + + + + + + + (b) not less than two months for open + tenders in an amount of NT$200 million or above but less + than NT$1 billion; + + + + + + + (c) not less than three months for open + tenders in an amount of NT$1 billion or above but less than + NT$10 billion; + + + + + + + (d) not less than four months for open + tenders in an amount of NT$10 billion or above but less + than NT$20 billion; and + + + + + + + (e) not less than five months for open + tenders in an amount of NT$20 billion or above; and + + + + + + + + (4) In the event the amount of an open + tender is more than NT$10 billion, or the shareholding + subject to the open tender would be able to effect the change of + one or more directors or supervisors of our company, prior + approvals from our board of directors and the Chunghwa Telecom + Share Sale Supervisory Committee of the Legislative Yuan, which + shall be formed by the Legislative Yuan in proportion to the + seats held by legislators of various parties, would be required. + + + +There is no further legislative interpretation +with respect to the above resolution. We have been advised by +our Republic of China counsel, Baker McKenzie, that +according to their interpretation of the above resolution, based +on the nature of the offering of the ADSs, the sale of our +common shares in the form of ADSs and the repurchase of our +common shares will not be affected by the above resolution. + + +This resolution may constrain the means available +to the Ministry of Transportation and Communications to achieve +our privatization through future offerings. After this offering, +the Ministry of Transportation and Communications will own +approximately 69.56% of our outstanding common shares. Prior to +the Legislative Yuan s passage of the resolution, the +Ministry of Transportation and Communications has publicly +announced its intention to reduce its ownership in our company +to below 50% by December 31, 2003. This privatization can +be achieved through several means, including the sale of our +common shares in Taiwan, the sale of our common shares outside +of Taiwan in the form of depositary receipts, the sale of our +common shares to a strategic investor and our repurchase of our +common shares. + + +The Legislative Yuan s resolution restricts +the Ministry of Transportation and Communications from selling +our common shares through an open tender in Taiwan until it has +engaged in 10 offers of our common shares to the general public +in Taiwan. In addition, the Ministry of Transportation and +Communications may not be able to sell our common shares to +strategic investors, to the extent that such sale would be +deemed a negotiated transaction , as described above +in clause (1). + +122 + +Table of Contents + +MANAGEMENT" --> + +MANAGEMENT + + +Members of our board of directors are elected by +our shareholders. The chairman of our board of directors is +elected by our directors. Our chairman presides at all meetings +of our board of directors and also has the authority to act as +our representative. The term of office for each of our directors +is three years. + + +Our articles of incorporation provide for a +15-member board of directors, of which at least one fifth must +be comprised of expert representatives. Although expert +representatives are not required by Republic of China law or +regulation, our articles of incorporation require our board of +directors to include representatives who possess a high level of +professional experience and achievement in their respective +fields of expertise so that we can benefit from their knowledge +and experience. Dr. Jing-Twen Chen, Dr. Zsehong Tsai +and Mr. Tse-Ming Chang serve as our expert representatives. +The Republic of China government recently enacted a law +requiring each state owned company to have at least one fifth of +its directors designated by the government to be labor union +representatives. Messrs. Shih-Peng Tsai, Yauh Hong Lin and Yi +Maw Lin serve as our labor union representatives. The term of +office for our directors is three years. + + +Our articles of incorporation provide that we +should have four supervisors. In accordance with the Republic of +China Company Law, our supervisors are elected by our +shareholders and may not concurrently serve as our directors, +executive officers or other staff members. The term of office +for our supervisors is three years. Supervisors duties and +powers include, but are not limited to, supervision of our +business operations, investigation of our financial condition, +inspection of corporate records, verification of statements by +the board of directors, calling of and giving reports at +shareholders meetings, representation of us in +negotiations with our directors and giving notification, when +appropriate, to the board of directors to cease acting in +contravention of applicable law or regulations, our articles of +incorporation or the resolutions of our shareholders. + + +In the event preferred shares are outstanding, +the holder of these preferred shares will be entitled to appoint +one director and one supervisor. Under the Telecommunications +Act of the Republic of China, the preferred shares may only be +issued to the Ministry of Transportation and Communications. See + Description of Share Capital Preferred +Shares beginning on page 136. + + +Under the Republic of China Company Law, a person +may serve as our director or supervisor in his personal capacity +or as the representative of another legal entity. A director or +supervisor who serves as the representative of a legal entity +may be removed or replaced at any time at the discretion of that +legal entity, and the replacement director or supervisor may +serve the remainder of the term of office of the replaced +director or supervisor. All of our directors and supervisors are +representatives of the Ministry of Transportation and +Communications. However, the Ministry of Transportation and +Communications has agreed that at least two directors will not +have any current or previous affiliation with either the +Ministry of Transportation and Communications or us, and that +these two directors will not be removed or replaced during their +three year terms of office, except for cause. Currently, Dr. +Jing-Twen Chen and Dr. Zsehong Tsai serve as our directors +satisfying these criteria. + + +The Sarbanes-Oxley Act of 2002 directs the +Securities and Exchange Commission to require U.S. national +securities exchanges, such as the New York Stock Exchange, and +national securities associations to adopt rules that prohibit +the listing of any security of an issuer that is not in +compliance with the relevant audit committee requirements set +forth in such act. We do not currently have an audit committee +or an audit committee financial + +123 + +Table of Contents + +expert. We intend, however, to fully comply with +all applicable rules and regulations and New York Stock Exchange +listing requirements regarding the need for, and composition of, +an audit committee, and SEC rules and regulations and New York +Stock Exchange listing requirements regarding audit committee +financial experts. The Securities and Exchange Commission +adopted final rules relating to the audit committee requirements +on April 1, 2003. The related New York Stock Exchange +listing requirements for non-U.S. issuers are required to be +adopted and come into effect by July 31, 2005. + + +The business address of our directors, +supervisors and executive officers is the same as our registered +address. The current term of all our directors and supervisors +will end on July 12, 2005. + + +The following table sets forth the name, age, +position and tenure of each of our directors, supervisors and +executive officers and such person s position as of +March 31, 2003. There is no family relationship between any +of these persons. + + + + + + + + + + + + + + + + + + Tenure + + Name + + Age + + Position + + with us + + + + + + + + + + + + Tan Ho Chen + + + + + + 53 + + + + Chairman + + + + 2 months + + + + + Shyue-Ching Lu + + + + + + 54 + + + + Director, President and + + Chief Executive Officer + + + + 25 years + + + + + Oliver F.L. Yu + + + + + + 57 + + + + Director + + + + 9 months + + + + + Joseph Jye-Cheng Lyu + + + + + + 46 + + + + Director + + + + 2 years + + + + + Lai-Hsi Lee + + + + + + 49 + + + + Director + + + + 5 months + + + + + Yu-Huei Jea + + + + + + 60 + + + + Director + + + + 5 years + + + + + Chung-Hsiuing Wang + + + + + + 60 + + + + Director + + + + 2 months + + + + + Ching-Tern Huang + + + + + + 62 + + + + Director + + + + 2 months + + + + + Peter C. Lin + + + + + + 66 + + + + Director + + + + 2 years + + + + + Jing-Twen Chen + + + + + + 48 + + + + Director + + + + 2 years + + + + + Tse-Ming Chang + + + + + + 35 + + + + Director + + + + 2 months + + + + + Zsehong Tsai + + + + + + 41 + + + + Director + + + + 9 months + + + + + Shih-Peng Tsai + + + + + + 44 + + + + Director + + + + 30 years + + + + + Yauh Hong Lin + + + + + + 48 + + + + Director + + + + 24 years + + + + + Yi Maw Lin + + + + + + 45 + + + + Director + + + + 29 years + + + + + Judy Fu-Meei Ju + + + + + + 45 + + + + Supervisor + + + + 4 months + + + + + Ching-Nain Tsai + + + + + + 50 + + + + Supervisor + + + + 1 month + + + + + Jui-Min Chen + + + + + + 47 + + + + Supervisor + + + + 9 months + + + + + Yeong-Chwan Hwang + + + + + + 47 + + + + Supervisor + + + + 4 years + + + + + Chun-Ming Hsieh + + + + + + 58 + + + + Senior Vice President + + + + 34 years + + + + + Feng-Hsiung Chang + + + + + + 58 + + + + Senior Vice President + + + + 33 years + + + + + Cheng-Chang Chen + + + + + + 63 + + + + Secretary General and Senior Vice President + + + + 39 years + + + + + John C.C. Hsueh + + + + + + 57 + + + + Executive Vice President + + + + 31 years + + + + + Jui-Hsiung Chen + + + + + + 63 + + + + Executive Vice President + + + + 39 years + + + + + Cheng-Tsun Chiang + + + + + + 55 + + + + Executive Vice President + + + + 31 years + + + + + Chin-Yi Yue + + + + + + 60 + + + + Executive Vice President + + + + 36 years + + + + + Shaio-Tung Chang + + + + + + 56 + + + + Executive Vice President + + + + 33 years + + + + + Yen-Sung Lee + + + + + + 54 + + + + Executive Vice President + + + + 29 years + + + + + Tse-Min Chen + + + + + + 63 + + + + Chief Accounting Officer + + + + 43 years + + + +Tan Ho Chen is our +Chairman. Mr. Ho Chen is also currently an Executive +Officer of The National Land Policy Advisory Committee, Office +of the President, Republic of China. Mr. Ho Chen was the +Executive Vice Minister of the Ministry of Transportation and +Communications from 2000 to 2001. Mr. Ho Chen holds a +Master s degree in regional and urban planning + +124 + +Table of Contents + +from Virginia Polytechnic Institute State +University and a Bachelor s degree in civil engineering +from Chung-Hsing University and studied urban planning while on +a Humphrey fellowship at Hunter College in New York. + + +Shyue-Ching Lu is a +director and the President and Chief Executive Officer of our +company. Dr. Lu is also currently a board member of the +Industrial Technology Research Institute. Dr. Lu was the +Director General of the Department of Posts and Communications +of the Ministry of Transportation and Communications from 1993 +to 1994, and the Deputy Director General of the Directorate +General of Telecommunications from 1994 to 1996. Dr. Lu +holds a Ph.D. degree in electrical engineering from the +University of Hawaii and a Bachelor of Science degree in +engineering from the National Cheng-Kung University in Taiwan. + + +Oliver F.L. Yu is a +director of our company. Mr. Yu is also currently the Vice +Minister of the Ministry of Transportation and Communications. +Mr. Yu was the Director of Kaohsiung Harbor Bureau from +1996 to 2001, and the Director General of Civil Aeronautics +Administration, Ministry of Transportation and Communications +from 2001 to 2002. Mr. Yu holds a Master of Business +Administration degree from the Institute of Management Science, +National Chiao Tung University, and a Bachelor s degree in +transportation and communications management science from the +National Cheng Kung University in Taiwan. + + +Joseph Jye-Cheng Lyu +is a director of our company. Mr. Lyu is also currently the +Vice Chairman of the Commission of National Corporations, the +Ministry of Economic Affairs, a Director of China Steel Co., +Ltd. and an Adjunct Professor in global corporate finance at the +National Chengchi University in Taiwan. Mr. Lyu was the +Senior Executive Vice President of our company from July 2001 to +February 2002 and the Deputy General Manager of KBC +Bank N.V. from 1995 to July 2001. Mr. Lyu holds a +Master of Management degree from the Kellogg Graduate School of +Management, Northwestern University. + + +Lai-Hsi Lee is a +director of our company. Mr. Lee is also currently the +Director of Labor Relations Department of the Council of Labor +Affairs. Mr. Lee graduated from the Law School of Soochow +University in Taiwan in 1978. He also holds a Master s +degree from the University of Wisconsin Madison. + + +Yu-Huei Jea is a +director of our company. Dr. Jea is also a Senior Counselor +of the Ministry of Transportation and Communications. +Dr. Jea was the Director General of the Department of Posts +and Telecommunications from 1994 to 1996, and the Director +General of the Directorate General of Telecommunications from +1996 to 1997. Dr. Jea holds a Ph.D. degree from the +University of Texas at Austin. + + +Chung-Hsiuing Wang +is a director of our company. +Mr. Wang is also the Director of the Keelung Harbor Bureau, +the Ministry of Transportation and Communications. Mr. Wang +was the Secretary General of the Keelung Harbor Bureau between +May 1992 and May 1994, and the Deputy Director of the same +institution between May 1994 and January 2002. He holds a +Master s degree in shipping and transportation management +from National Taiwan Ocean University. He also serves as a +Commissioner of the Tariff Stipulating Commission of the +Ministry of Transportation and Communications. + + +Ching-Tern Huang is +a director of our company. Mr. Huang is also a Director of +Kaohsiung Harbor Bureau, the Ministry of Transportation and +Communications. Mr. Huang was the Director of the Hualien, +Keelung and Taichung Harbor Bureaus from 1994 to 2001. He +graduated from the National Taiwan Ocean University. + +125 + +Table of Contents + + +Peter C. Lin is a +director of our company. Dr. Lin is also a Professor and +Director of the Institute of Management and Operation at Kao +Yuan Institute of Technology in Taiwan and an advisor to the +President of the Republic of China. Dr. Lin was the +Director of the Institute of Economics of the National Sun +Yat-Sen University in Taiwan from August 1996 to September 2001. +Dr. Lin holds a Ph.D degree in agricultural economics from +the University of Wisconsin Madison. + + +Jing-Twen Chen is a +director of our company. Dr. Chen is also a Professor at +the Department of Finance of the National Central University in +Taiwan. Dr. Chen holds a Ph.D degree in finance from the +National Taiwan University of Science and Technology. + + +Tse-Ming Chang is a +director of our company. Mr. Chang is also currently the +Chairman of Taipei Digital Content Protection Association, a +Director of China Multimedia Association and a Director of Atlas +Internet Life International, Inc. Mr. Chang +holds a Master s of Business Administration degree and a +Bachelor s degree in International Business from the +National Taiwan University. + + +Zsehong Tsai is a +director of our company. Dr. Tsai is also currently a +Professor of Electrical Engineering at the National Taiwan +University, a member of Telecommunications Advisory Board of the +Ministry of Transportation and Communications, Group Leader of +National Telecommunication Program Office, Broadband Internet +Group, and a Director of the Broadcasting Development Fund. +Mr. Tsai holds a Ph.D. degree and a Master of Science +degree in electrical engineering from the University of +California, and a Bachelor of Science degree in electrical +engineering from the National Taiwan University. + + +Shih-Peng Tsai is a +director of our company. Mr. Tsai is also currently a +representative of Member s Convention, Chunghwa Telecom +Workers Union, and serves as Manager of our SeeKoo Service +Center. Mr. Tsai graduated from Ta Tung Junior +Technological College of Commerce. + + +Yauh Hong Lin is a +director of our company. Mr. Lin is also currently a +representative of Member s Convention, Chunghwa Telecom +Workers Union, and serves as Technical Assistant at Network +Department of our Central Taiwan Business Group. Mr. Lin +graduated from the Kuang-Hwa Vocational High School of +Technology. + + +Yi Maw Lin is a +director of our company. Mr. Lin is also currently a +representative of Member s Convention and a member of +Publication Editorial Committee, Chunghwa Telecom Workers Union, +a Standing Director of Taichung Branch, Chunghwa Telecom Workers +Union, and serves as Assistant Engineer at Network Department of +our Central Taiwan Business Group. Mr. Lin graduated from +the Chin-Yi Institute of Technology. Mr. Lin is currently +studying public administration and information management at the +National Open University in Taiwan. + + +Judy Fu-Meei Ju is a +supervisor of our company. Ms. Ju also serves as the Third +Department Director General of the Executive Yuan and a public +prosecutor at the Taiwan Superior Court Prosecutor s +Office. In addition to holding LL.M. and Master in Civil Law +degrees from the National Taiwan University and Indiana +University, respectively, Ms. Ju is currently a Ph.D. +degree candidate at the National Taiwan University. + + +Ching-Nain Tsai is a +supervisor of our company. Mr. Tsai is currently the Deputy +Director General of Bureau of Monetary Affairs of the Ministry +of Finance. Mr. Tsai was the Deputy Director General of the +Department of National Treasury from 1997 to 1999, and the +Commissioner and Secretary General of Securities and Futures +Commission of the Republic + +126 + +Table of Contents + +of China from 1955 to 1997. Mr. Tsai holds a +Master s degree in industrial management from the National +Cheng Kung University in Taiwan. + + +Jui-Min Chen is a +supervisor of our company. Mr. Chen is currently the +Director of the Department of Accounting of the Ministry of +Transportation and Communications. Mr. Chen was previously +the Director of the Department of Accounting of the Coast Guard +Administration, the Executive Yuan. Mr. Chen graduated from +the College of Business Department of Accounting, Feng Chia +University. + + +Yeong-Chwan Hwang is +a supervisor of our company. Mr. Hwang is also currently +the Director of Accounting Office and the Vice Chairperson of +Accounting Operations Unit of the Directorate General of Budget, +Accounting and Statistics of the Executive Yuan. Mr. Hwang +holds a Master s degree from Soochow University and a +Bachelor s degree in accounting from the Fu-Jen Catholic +University, both in Taiwan. + + +Chun-Ming Hsieh is a +Senior Vice President of our company. Mr. Hsieh is also a +member of the board of directors of Lucent Technologies Taiwan +Telecommunications Co., Ltd., one of our affiliates, and Taipei +Financial Center Corp. Mr. Hsieh served as Deputy Managing +Director of the Central Taiwan Telecommunications Administration +from 1994 to 1996. Mr. Hsieh holds a Bachelor s degree +in electrical engineering from the National Cheng-Kung +University and a Master s degree in management science from +the National Chiao Tung University, both in Taiwan. + + +Feng-Hsiung Chang is +a Senior Vice President of our company. Mr. Chang is also a +director of Siemens Telecommunications Systems and Chunghwa +Investment Co., Ltd. Mr. Chang served as Deputy Managing +Director of the Northern Taiwan Telecommunications +Administration from 1994 to 1996. Mr. Chang holds a +Bachelor s degree from Chung-Hsing University and a Master +of Business Administration degree from the National Chiao Tung +University, both in Taiwan. + + +Cheng-Chang Chen is +the Secretary General and a Senior Vice President of our +company. Mr. Chen is also a supervisor of Siemens +Telecommunications Systems Limited and a director of Chunghwa +Investment Co., Ltd. Mr. Chen served as Managing Director +of the Personnel Department of the Directorate General of +Telecommunications from 1992 to 1995 and the Secretary General +of the Directorate General of Telecommunications in 1996. +Mr. Chen holds a Bachelor s degree in business +administration from the National Cheng-Kung University and a +Master of Business Administration degree from the National Chiao +Tung University, both in Taiwan. + + +John C.C. Hsueh is +an Executive Vice President of our company. Dr. Hsueh is also a +member of the board of directors of RPTI International. +Dr. Hsueh served as Vice President of our Northern Taiwan +Business Division from 1996 to 1998 and as President of our +Telecommunications Laboratories from 1998 to 2000. +Dr. Hsueh holds a Ph.D. degree in electrical engineering +and computer science from Northwestern University. + + +Jui-Hsuing Chen is +an Executive Vice President of our company. Mr. Chen is +also a director of International Telecommunications Development +Corporation, one of our affiliates. Mr. Chen served as +Managing Director of the Central Taiwan Telecommunications +Administration Office of the Directorate General of +Telecommunications from 1994 to 1996. Mr. Chen holds a +Bachelor s degree from the National Cheng-Kung University +in Taiwan. + + +Cheng-Tsun Chiang is +an Executive Vice President of our company. Mr. Chiang is +also a director of RPTI International. Mr. Chiang served as +the Managing Director for our + +127 + +Table of Contents + +Network Department from 1999 to 2001. +Mr. Chiang holds a Master s degree from Feng Chia +University in Taiwan. + + +Chin-Yi Yue is an +Executive Vice President of our company. Mr. Yue is also a +supervisor to the International Telecommunications Development +Corp. Mr. Yue served as Vice President for our Long +Distance and Mobile Division from 1996 to 2000 and Vice +President of our Long Distance Communications Administration +from 1994 to 1996. Mr. Yue holds a Master s degree in +electrical engineering from the National Taiwan University. + + +Shaio-Tung Chang is +an Executive Vice President of our company. Mr. Chang was +the general manager of our Marketing Department from 1996 to +2001. Mr. Chang holds a Master of Business Administration +degree from the National Chiao Tung University in Taiwan. + + +Yen-Sung Lee is an +Executive Vice President of our company. Mr. Lee was the +general manager of our Information Department from 1996 to 2002. +Mr. Lee is also a supervisor of RPTI International and +holds a Ph.D. degree in information science from the National +Chiao Tung University in Taiwan. + + +Tse-Min Chen is our +chief accounting officer. Mr. Chen served as the division +chief of the Accounting Department of the Directorate General of +Telecommunications and supervisor of Taipei Financial Co., Ltd. +Mr. Chen received a Bachelor s degree in accounting +and statistics from Tamkang University in Taiwan. + + Compensation of Directors, +Supervisors and Executive Officers + + +The aggregate amount of compensation that we paid +to our directors, supervisors and executive officers for +services performed as our directors, supervisors, officers or +employees was NT$32.8 million during the year ended +June 30, 2000, NT$15.9 million during the six months +ended December 31, 2000, NT$33.9 million during the +year ended December 31, 2001, NT$30.2 million +(US$0.9 million) during the year ended December 31, +2002 and NT$7 million (US$0.2 million) during the +three months ended March 31, 2003. None of our directors +receives any benefits upon expiration of his or her service as +director. Under our articles of incorporation, the compensation +of our directors and supervisors may not exceed 0.2% of our +distributable retained earnings and may be approved only +pursuant to a validly convened shareholders meeting. + + Share Ownership + + +As of April 30, 2003, our directors, +supervisors and executive officers held in the aggregate +120,655 of our common shares, representing a negligible +percentage of our outstanding common shares. As of the same +date, we do not have any outstanding or unexercised options. + +128 + +Table of Contents + +RELATIONSHIP WITH THE GOVERNMENT OF THE REPUBLIC OF CHINA" --> + +RELATIONSHIP WITH THE GOVERNMENT OF THE +REPUBLIC OF CHINA + + +The Ministry of Transportation and +Communications, on behalf of the Republic of China government, +currently owns approximately 79.56% of our outstanding common +shares and will own approximately 69.56% of our outstanding +common shares after the completion of this offering. As a +result, the Ministry of Transportation and Communications will +be able to determine the outcome of any corporate transaction or +other matters submitted to our shareholders for approval. In +addition, for so long as the government continues to own a +majority of our common shares, our autonomy will continue to be +limited by governmental regulations relating to state owned +enterprises. These regulations limit our autonomy on matters +relating to our budget and dividend policies and key employment +terms for our employees, including salary, pension and discharge +policies. The Ministry of Transportation and Communications +currently has the power to appoint our president and a majority +of our directors and supervisors. Furthermore, the +Telecommunications Act and our articles of incorporation provide +that the Ministry of Transportation and Communications has the +right to subscribe for two of our preferred shares upon the +government owning less than 50% of our outstanding common +shares. The Ministry of Transportation and Communications, as +owner of these preferred shares, will be entitled to appoint one +director and one supervisor and will have the right to veto any +change in our name or our businesses and any transfer of a +substantial part of our business or property for so long as +these preferred shares are outstanding. These preferred shares +will be redeemed by us at their initial issue price of NT$10 per +share three years after their issuance. See Description of +Share Capital Preferred Shares beginning on +page 136. + + +As a state owned enterprise, we are required, +subject to limited special relief granted to us by the Ministry +of Transportation and Communications, to undergo a lengthy +governmental procurement process relating to the acquisition of +goods and services. In addition, our budget must be approved by +the Legislative Yuan as part of the government budget. The +Ministry of Audit under the Control Yuan has the authority to +audit our accounts and to adjust our profits and losses. Our +financial statements presented in this prospectus and prepared +in accordance with US GAAP have not been subject to adjustment +by the government. + + +The government is one of our largest customers. +We transact business with various departments and agencies of +the government, as separate customers, on an arm s length +basis. + + +The government also has the power to take actions +with respect to our networks in the interests of national +security. + +129 + +Table of Contents + +PRINCIPAL SHAREHOLDERS AND SELLING SHAREHOLDER" --> + +PRINCIPAL SHAREHOLDERS AND SELLING +SHAREHOLDER + + +The following table sets forth information known +to us with respect to the beneficial ownership of our shares as +of the date of this prospectus, for the Republic of China +Government and the Ministry of Transportation and +Communications, and as of April 18, 2003, the most recent +practicable date, for (1) the shareholders known by us to +own at least 5.0% of our outstanding common shares and +(2) all directors, supervisors and executive officers as a +group. The Ministry of Transportation and Communications is +selling up to an aggregate of 965,000,000 shares in this +offering, subject to the exercise by the underwriters of their +overallotment option. + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Shares Beneficially Owned + + Shares Being Sold in the + + Shares Beneficially Owned + + + + Prior to the Offering + + Offering + + After the Offering + + + + + + + + + + Name + + Number + + Percent + + Number + + Percent + + Number + + Percent + + + + + + + + + + + + + + + + + + Republic of China Government(1)(2) + + + + + + 7,839,423,649 + + + + 81.26 + % + + + 965,000,000 + + + + 10.00 + % + + + 6,874,423,649 + + + + 71.25 + % + + + + Ministry of Transportation and Communications(1) + + + + + + 7,675,953,649 + + + + 79.56 + % + + + 965,000,000 + + + + 10.00 + % + + + 6,710,953,649 + + + + 69.56 + % + + + + Cathay Life Insurance Co., Ltd.(3) + + + + + 664,971,000 + + + + 6.89 + % + + + + + + + + + + + 664,971,000 + + + + 6.89 + % + + + + + (1) + + The number of shares being sold in the offering + may be increased to 1,109,750,000, if the underwriters exercise + the option granted to them by the Ministry of Transportation and + Communications to purchase up to an additional 144,750,000 of + our common shares owned by the Ministry of Transportation and + Communications. + + + (2) + + Includes: (a) the 7,675,953,649 of our common + shares owned by the Ministry of Transportation and + Communications, (b) the 15.0 million of our common + shares owned by The Development Fund, (c) the + 37.2 million of our common shares owned by The Labor + Insurance Fund, (d) the 86.7 million of our common + shares owned by the Directorate General of Postal Remittances + and Savings Banks, (e) the 23.5 million of our common + shares owned by the Public Service Pension Fund, and + (f) the 1.0 million of our common shares owned by the Labor + Retirement Fund, all of which entities are controlled, directly + or indirectly, by the Republic of China government. + + + (3) + + Cathay Life Insurance Co., Ltd. is a wholly owned + subsidiary of Cathay Financial Holdings Co., Ltd., which is a + widely held public company in the Republic of China. + + + +As of April 18, 2003, (1) Taiwan Cellular +Corporation owned 375,000,000, or 3.89%, (2) TransAsia +Telecommunication owned 75,000,000, or 0.78%, (3) Howin +Technologies Corporation owned 50,000,000, or 0.52%, +(4) Taiwan Hoyuan Investment Co. owned 42,000,000, or +0.44%, and (5) Taiwan Fixed Network Co., Ltd., through its +wholly owned subsidiary TFN Investment Co., Ltd., owned +33,000,000, or 0.34%, of our outstanding common shares, +respectively. Taiwan Cellular Corporation is a 33.35% owned +subsidiary of Taiwan Fixed Network Co., Ltd. Taiwan Cellular +Corporation owned approximately 10% of shares of Taiwan Fixed +Network Co., Ltd. TransAsia Telecommunication is a wholly owned +subsidiary of Taiwan Cellular Corporation. Howin Technologies +Corporation and Taiwan Hoyuan Investment Co. are 66.67% and +100.00%, respectively, owned subsidiaries of Taiwan Fixed +Network Co., Ltd. + + +As of the date of this prospectus, the Ministry +of Transportation and Communications of the Republic of China, +located at 2 Chang Sha Street, Section 1, Taipei, +Taiwan, Republic of China, owns 7,675,953,649, or approximately +79.56%, of our 9,647,724,900 outstanding common shares. +Following the sale of the ADSs by the Ministry of Transportation +and Communications as described in this prospectus, the Ministry +of Transportation and + +130 + +Table of Contents + +Communications will own 6,710,953,649, or +approximately 69.56% of our 9,647,724,900 outstanding common +shares. + + +In connection with our privatization, the +Ministry of Transportation and Communications currently intends +to conduct an auction of our common shares in the Republic of +China concurrently with the offering on the date of this +prospectus. + + +The Ministry of Transportation and Communications +owned 9,371,214,104, or 97.13%, 9,196,806,888, or 95.33%, and +7,896,533,299, or 81.85% of our outstanding common shares as of +December 31, 2000, 2001 and 2002, respectively. Following +the completion of our privatization, the Ministry of +Transportation and Communications will be issued certain +preferred shares. Under our articles of incorporation, the +holder of preferred shares is entitled to certain rights, +including the right to act as our director and/or supervisor. +See Description of Share Capital Preferred +Shares beginning on page 136. + + +In addition, The Development Fund and The Labor +Insurance Fund, both of which are associated with the Republic +of China government, purchased an aggregate of 19 million +of the common shares offered in our initial public offering in +Taiwan. The Development Fund and The Labor Insurance Fund owned +15.0 million and 37.2 million of our common shares, +respectively, as of April 18, 2003. Furthermore, the +Directorate General of Postal Remittances and Savings Banks, +under the Ministry of Transportation and Communications, +purchased 15 million of the common shares offered in our +initial public offering in Taiwan, and acquired additional +common shares in open market transactions. The Directorate +General of Postal Remittances and Savings Banks owned +82.6 million common shares, representing 0.8% of our +outstanding common shares as of April 18, 2003. See + Shares Eligible For Future Sale on page 132. + + +In December 2002, several local investors won an +auction of our common shares held by the Ministry of +Transportation and Communications, and purchased an aggregate of +1.3 billion common shares of our company. Among these +investors, Cathay Life Insurance Co., Ltd. acquired 6.74% of our +outstanding common shares, Taiwan Cellular Corporation and its +affiliates collectively acquired 5.96% of our outstanding common +shares, and Fubon Life Insurance Co., Ltd. and its affiliate +collectively acquired 0.78% of our outstanding common shares. + + +In connection with the establishment of the +National Financial Stabilization Fund, the Ministry of +Transportation and Communications has pledged 2.8 billion +of our common shares as security to support borrowings by the +National Financial Stabilization Fund from a syndicate of +commercial banks in Taiwan. These 2.8 billion pledged +shares represent 29.0% of our total outstanding common shares, +and 36.5% of our outstanding common shares owned by the Ministry +of Transportation and Communications. See The Securities +Markets of Taiwan National Financial Stabilization +Fund beginning on page 153. + +131 + +Table of Contents + +SHARES ELIGIBLE FOR FUTURE SALE" --> + +SHARES ELIGIBLE FOR FUTURE SALE + + +Upon completion of this offering, the ADSs sold +in this offering will be freely tradeable within the United +States without restriction or further registration under the +Securities Act by persons other than us or our affiliates as +defined in Rule 144 under the Securities Act. + + +We and the Ministry of Transportation and +Communications have agreed for a period of 90 days after +the date of this prospectus not to offer, sell, contract to +sell, hedge or otherwise dispose of, without the prior written +consent of the representatives of the underwriters: + + + + + + + + + any of our common shares or depositary receipts + representing our common shares; + + + + + + + + any common shares of our subsidiaries or + controlled affiliates or depositary receipts representing those + shares; and + + + + + + + + any securities that are substantially similar to + the common shares or depositary receipts referred to above, + including any securities that are convertible into, exchangeable + for or otherwise represent the right to receive the common + shares or depositary receipts referred to above; + + +other than pursuant to, as applicable: + + + + + + + + + an employee benefits plan or distribution of + dividends or employee bonuses in the form of shares; + + + + + + + + the employee share purchase plans relating to our + privatization (which employee share purchase plans are described + in this prospectus under the caption Business + Employees ); + + + + + + + + sales to certain strategic investors, provided + that such strategic investors are subject to the restrictions + described above; + + + + + + + + sales of common shares to us by the Ministry of + Communications and Transportation in connection with the + repurchases of our common shares conducted by us; or + + + + + + + + an auction of our common shares to be conducted + by the Ministry of Transportation and Communications in the + Republic of China concurrently with the offering. + + + +In addition, the Ministry of Transportation and +Communications has agreed that, after the completion of our +privatization, until the earlier of (1) 180 days after +the completion of our privatization and +(2) December 31, 2004, not to offer, sell, contract to +sell, hedge or otherwise dispose of, without the prior consent +of the representatives of the underwriters: + + + + + + + + + any of our common shares or depositary receipts + representing our common shares; + + + + + + + + any common shares of our subsidiaries or + controlled affiliates or depositary receipts representing those + shares; and + + + + + + + + any securities that are substantially similar to + the common shares or depositary receipts referred to above, + including any securities that are convertible into, exchangeable + for or otherwise represent the right to receive the common + shares or depositary receipts referred to above; + + +other than pursuant to: + + + + + + + + + sales to certain strategic investors, provided + that such strategic investors are subject to the restrictions + described above; or + + +132 + +Table of Contents + + + + + + + + + sales of our common shares to us in connection + with the repurchases of our common shares conducted by us. + + + +Two funds associated with the government of the +Republic of China, the Development Fund of the Executive Yuan +and the Labor Insurance Fund, purchased an aggregate of +19 million of the common shares offered in our initial +public offering in Taiwan in October 2000. In addition, the +Directorate General of Postal Remittances and Savings Banks, +under the Ministry of Transportation and Communications, +purchased 15 million of our common shares during our initial +public offering in Taiwan. Furthermore, the Public Service +Pension Fund, which is also a fund associated with the +government, acquired and subsequently sold 60,000 of our common +shares during November 2000 in open market transactions on +the Taiwan Stock Exchange. + + +As of the date of this prospectus, The +Development Fund of the Executive Yuan, The Labor Insurance +Fund, the Directorate General of Postal Remittances and Savings +Banks, the Public Service Pension Fund and the Labor Retirement +Fund respectively owned approximately 15.0 million, 37.2 +million, 86.7 million, 23.5 million and 1.0 million of our +common shares. + + +The Development Fund of the Executive Yuan, the +National Financial Stabilization Fund, the Labor Insurance Fund, +the Labor Retirement Fund, the Directorate General of Postal +Remittances and Savings Banks and the Public Service Pension +Fund have agreed not to, among other things: + + + + + + + + + purchase any of our common shares or any + securities substantially similar to our common shares or ADSs + until 25 days after the date of this prospectus; or + + + + + + + + offer, sell or otherwise dispose of any of our + common shares or any securities substantially similar to our + common shares or ADSs until 90 days after the date of this + prospectus. + + +However, the foregoing 90 day lock-ups do +not apply to any common shares acquired after the expiration of +25 days after the date of this prospectus by these entities +through open market purchases on the Taiwan Stock Exchange. + + +The government has publicly announced its +intention to further reduce its ownership of our outstanding +common shares to less than 50% through future offerings of our +common shares and ADSs by December 31, 2003. Sales of +substantial amounts of our ADSs or common shares in the public +market, or the perception that future sales may occur, could +depress the prevailing market price of ADSs and common shares. + + +In connection with the establishment of the +National Financial Stabilization Fund, the Ministry of +Transportation and Communications has pledged 2.8 billion +of our common shares as security to support borrowings by the +National Financial Stabilization Fund from a syndicate of +commercial banks in Taiwan. These 2.8 billion pledged +shares represent 29.0% of our total outstanding common shares, +and 36.5% of our outstanding common shares owned by the Ministry +of Transportation and Communications. See The Securities +Markets of Taiwan National Financial Stabilization +Fund beginning on page 153. + + +In December 2002, several local investors won an +auction of our common shares held by the Ministry of +Transportation and Communications, and purchased an aggregate of +1.3 billion of our common shares. Among these investors, Cathay +Life Insurance Co., Ltd. acquired 6.74% of our outstanding +common shares, Taiwan Cellular Corporation and its affiliates +collectively acquired 5.96% of our outstanding common shares, +and Fubon Life Insurance Co., Ltd. and its affiliate +collectively acquired 0.78% of our outstanding common + +133 + +Table of Contents + +shares. These entities have not entered into any +lock-up arrangements relating to our common shares. However, +within one year from the acquisition of our common shares by +such entities, such entities may dispose of our common shares +only in accordance with the procedures set forth in + Description of Share Capital Substantial +Shareholders and Transfer Restrictions on page 141. +Except for the foregoing restriction, there are no restrictions +on the ability of these entities to dispose of our common +shares. Sales or other dispositions of our common shares by +these entities may materially and adversely affect the trading +price of our common shares as well as our ADSs. See Risk +Factors Risks Relating to Ownership of Our +ADSs The value of your investment may be reduced by +future sales of ADSs or common shares by us, the Republic of +China government or by other shareholders on page 9. + +134 + +Table of Contents + +RELATED PARTY TRANSACTIONS" --> + +RELATED PARTY TRANSACTIONS + + +We have not extended any loans or credit to any +of our directors, supervisors or executive officers, and we have +not provided guarantees for borrowings by any of these persons. +We have not entered into any fee-paying contract with any of +these persons for him or her to provide services not within his +or her capacity as a director, supervisor or executive officer +of our company, except that three of our directors who are also +our employees receive salaries from our company in their +capacity as our employees. + + +We currently own 40% of Taiwan International +Standard Electronics. We have purchased telecommunications +exchange facilities and related supplies and replacement parts +from Taiwan International Standard Electronics. We acquired from +Taiwan International Standard Electronics several +telecommunications exchange facilities and related supplies and +replacement parts for approximately NT$4.3 billion in the year +ended June 30, 2000, NT$1.8 billion in the six months +ended December 31, 2000, NT$3.0 billion in the year +ended December 31, 2001 and NT$6.9 billion +(US$198.2 million) in the year ended December 31, 2002 +for these purchases. We believe that these transactions with +Taiwan International Standard Electronics have been conducted on +arms length terms. + +135 + +Table of Contents + +DESCRIPTION OF SHARE CAPITAL" --> + +DESCRIPTION OF SHARE CAPITAL + + +Set forth below is a summary of information +relating to our share capital, including brief summaries of the +relevant provisions of our articles of incorporation, the +Republic of China Securities and Exchange Law, the Republic of +China Company Law, the Statute of Chunghwa Telecom Co., Ltd. and +the Telecommunications Act. + +General + + +Our authorized capital is NT$96,477,249,020, +divided into 9,647,724,900 common shares, par value NT$10 per +share, all of which are issued and outstanding and in registered +form, and two non-transferable preferred shares. These preferred +shares are to be issued for a three-year term at par value of +NT$10 per share to the Ministry of Transportation and +Communications upon completion of our privatization. + + +The Ministry of Transportation and +Communications, on behalf of the government of the Republic of +China, owns approximately 79.61% of our outstanding common +shares as of the date of this prospectus. The remainder of our +outstanding shares are held by public shareholders and other +investors. We do not have any other equity in the form of +preferred shares, convertible bonds or otherwise outstanding as +of the date of this prospectus. + +Preferred Shares + + +Under our articles of incorporation, the holder +of preferred shares is entitled to the same rights as holders of +common shares with respect to receiving distributions of +dividends and bonuses, remaining assets available for +distribution upon our dissolution, liquidation or winding up, +distribution of retained earnings or capital reserve, or capital +allocation. + + +In addition, the holder of preferred shares will +be entitled to the same voting rights as holders of common +shares at any of our meetings of holders of common shares. + + +The holder of preferred shares, or its nominated +representative, will act as our director and/or supervisor +during the existing period of the preferred shares. Any such +representative is subject to removal and replacement by the +Ministry of Transportation and Communications from time to time. + + +When we issue new shares for cash, the holder of +preferred shares will be entitled to the same pre-emptive rights +as holders of common shares. + + +Without the prior consent of the holder of +preferred shares, we may not: + + + + + + + + + change our corporate name; + + + + + + + + change the scope of our business; or + + + + + + + + transfer the whole or a substantial portion of + our business or assets. + + + +The holder of preferred shares may not transfer +its preferred shares. We must redeem all outstanding preferred +shares at par value three years from the date of their issuance. +We are required to cancel these preferred shares immediately +after their redemption. + +Dividends and Distributions + + +At each annual general shareholders +meeting, our board of directors submits to the shareholders for +their approval any proposal for the distribution of a dividend +or the making of any other distribution to shareholders from our +net income for the preceding fiscal year. All common shares +outstanding and fully paid as of the relevant record date are +entitled to + +136 + +Table of Contents + +share equally in any dividend or other +distribution so approved. Dividends may be distributed in cash, +in the form of common shares or a combination of the two, as +determined by the shareholders at the meeting. + + +We are not permitted to distribute dividends or +make other distributions to shareholders in any year in which we +do not have any net income or retained earnings (excluding +reserves). The Republic of China Company Law also requires that +10% of our annual net income, less prior years losses and +outstanding tax, if any, be set aside as a legal reserve until +the accumulated legal reserve equals our paid-in capital. In +addition, our articles of incorporation provide that at least +50% of the remaining portion of the net income, less prior +years losses, outstanding taxes, the legal reserve and any +special reserve, plus undistributed retained earnings from prior +years will be distributed as dividends to shareholders. Not less +than 10% of the total amount of the distributed dividends must +be in cash, but if the cash dividends to be distributed are less +than NT$0.10 per share, the dividends may be distributed in the +form of shares. Commencing with the first fiscal year +immediately following our privatization, prior to distributing +any dividends to our shareholders, we must first distribute +(1) not less than 1% of the distributable amount to +employees as bonuses and (2) not more than 0.2% of the +distributable amount to directors and supervisors as bonuses. +The above percentages may be adjusted, with our +shareholders approval, according to our actual profits, +capital budget and funding conditions of that year. + + +In addition, under the Statute of Chunghwa +Telecom Co., Ltd., we are required to make up any shortfall in +the required pension fund reserve within eight years after our +incorporation. Consequently, if we record any extra earnings +over our previous estimated earnings approved by the Legislative +Yuan, these extra earnings shall be first allocated as our +pension fund reserve. + + +Under the Republic of China Audit Law, the +earnings and losses of a state owned enterprise are audited by +the Ministry of Audit under the Control Yuan of the Republic of +China. As a result, if the amount of our earnings or loses +decided by the auditing authority is different from the amount +approved at our shareholders meeting, the latter amount +shall be adjusted accordingly to be identical with the former +amount, and the dividends and bonuses approved at our +shareholders meeting will be adjusted accordingly and +reported to the shareholders at the next shareholders +meeting. + + +Under our articles of incorporation, if we do not +have current or retained earnings (excluding reserves) but our +legal reserve exceeds 50% of our paid-in capital, we may use the +excess amount to distribute dividends and bonuses. In addition, +we are also permitted to make distributions to our shareholders +of additional common shares by capitalizing reserves (including +the legal reserve and capital surplus). However, amounts payable +by capitalizing our legal reserve are limited to 50% of the +total accumulated legal reserve and this capitalization can only +be effected when the accumulated legal reserve exceeds 50% of +our paid-in capital. + +Changes in Share Capital + + +Under the Republic of China Company Law and the +Statute of Chunghwa Telecom Co., Ltd., any change in our +authorized share capital requires an amendment to our articles +of incorporation, which in turn requires approval at our +shareholders meeting, as well as the approval of Ministry +of Transportation and Communications. Authorized but unissued +common shares may be issued, subject to applicable Republic of +China law, upon terms as our board of directors may determine +and approval by the Ministry of Transportation and +Communications. + +137 + +Table of Contents + +Preemptive Rights + + +Under the Republic of China Company Law and the +Statute of Chunghwa Telecom Co., Ltd., when we issue new shares +for cash, existing shareholders who are listed on the +shareholders register as of the record date have +preemptive rights to subscribe for the new issue in proportion +to their existing shareholdings, while a company s +employees, whether or not they are our shareholders, have rights +to subscribe in accordance with the subscription rules announced +by the Ministry of Transportation and Communications for not +more than 10% of the new issue at favorable terms. Any new +shares that remain unsubscribed at the expiration of the +subscription period may be offered by us to the public or +privately placed. + + +In addition, in accordance with the Republic of +China Securities and Exchange Law, a public company that intends +to offer new shares for cash must offer to the public at least +10% of the shares to be sold. This percentage can be increased +by a resolution passed at a shareholders meeting, which +would diminish the number of new shares subject to the +preemptive rights of existing shareholders. + + +Under the Statute Governing Privatization of +State Owned Enterprises, when shares of a state owned enterprise +are sold in a privatization, a certain portion of these shares +must be reserved for purchase by the employees of the state +owned enterprise. Our articles of incorporation also provide +that when the government sells shares of us held by them, our +employees will be entitled to the right to purchase up to a +number of shares as provided for under the Statute Governing +Privatization of State Owned Enterprises and relevant +regulations. + +Meetings of Shareholders + + +We are required by the Republic of China Company +Law and our articles of incorporation to hold a general meeting +of our shareholders within six months following the end of each +fiscal year. These meetings are generally held in Taipei, +Taiwan. Special shareholders meetings may be convened by +resolution of the board of directors or by the board of +directors upon the written request of any shareholder or +shareholders who have held 3% or more of the outstanding common +shares for more than one year. Special shareholders +meetings may also be convened by a supervisor. Notice in writing +of general meetings of shareholders, stating the place, time and +agenda must be dispatched to each shareholder at least +30 days, in the case of general meetings, and 15 days, +in the case of special meetings, before the date set for each +meeting. Except in certain circumstances described below, a +majority of the holders of all issued and outstanding common +shares present at a shareholders meeting constitutes a +quorum for meetings of shareholders. + +Voting Rights + + +As previously required by the Republic of China +Company Law, our articles of incorporation provide that a holder +of common shares has one vote for each common share. Cumulative +voting applies to the election of our directors and supervisors. + + +In general, a resolution can be adopted by the +holders of at least a majority of the common shares represented +at a shareholders meeting at which the holders of a +majority of all issued and outstanding common shares are +present. Under the Republic of China Company Law, the approval +by at least a majority of the common shares represented at a + +138 + +Table of Contents + +shareholders meeting in which a quorum of +at least two-thirds of all issued and outstanding common shares +are represented is required for major corporate actions, +including: + + + + + + + + + amendment to our articles of incorporation; + + + + + + + + entering into, modification or termination of any + contracts regarding leasing of all business, outsourcing of + operations or joint operations. + + + + + + + + transfer of the whole or substantial part of our + business or assets; + + + + + + + + taking over of the whole of the business or + assets of any other company which would have significant impact + on our operations; + + + + + + + + distribution of any share dividend; + + + + + + + + dissolution or amalgamation; + + + + + + + + merger or spin-off; and + + + + + + + + removing of directors or supervisors. + + + +Alternatively, the Republic of China Company Law +provides that in the case of a public company, such as us, a +resolution may be adopted by the holders of at least two-thirds +of the common shares represented at a meeting of shareholders at +which holders of at least a majority of issued and outstanding +common shares are present. + + +A shareholder may be represented at a general or +special meeting by proxy if a valid proxy form is delivered to +us five days before the commencement of the general or special +shareholders meeting. Except for trust enterprises or +share registrar approved by the Securities and Futures +Commission, where one person is appointed as proxy by two or +more shareholders who together hold more than 3% of the total +issued common shares, the votes of those shareholders in excess +of 3% of the outstanding common shares shall not be counted. + + +Holders of ADSs may exercise voting rights with +respect to the underlying common shares in the manner as +described in Description of American Depositary +Receipts Voting Rights beginning on +page 145. + +Register of Shareholders and Record +Dates + + +Our share registrar, Taiwan Securities Co., Ltd., +maintains our register of shareholders at its offices in Taipei, +Taiwan, and enters transfers of common shares in our register +upon presentation of, among other documents, certificates +representing the common shares transferred. Under the Republic +of China Company Law and our articles of incorporation, we may, +by giving advance public notice, set a record date and close the +register of shareholders for a specified period in order for us +to determine the shareholders or pledgees that are entitled to +rights pertaining to the common shares. The specified period +required is as follows: + + + + + + + + + general shareholders meeting 60 + days; + + + + + + + + special shareholders meeting + 30 days; and + + + + + + + + relevant record date five days. + + +139 + +Table of Contents + +Annual Financial Statements + + +At least ten days before the annual general +shareholders meeting, our annual financial statements must +be available at our principal office in Taipei, Taiwan for +inspection by the shareholders. + +Transfer of Common Shares + + +The transfer of common shares in registered form +is effected by endorsement and delivery of the related share +certificates but, in order to assert shareholders rights +against us, the transferee must have his name and address +registered on our register of shareholders. Shareholders are +required to file their respective specimen seals, also known as +chops, with us. Chops are official stamps widely used in Taiwan +by individuals and other entities to authenticate the execution +of official and commercial documents. + +Acquisition of Our Own Common Shares + + +Under the Republic of China Company Law, with +minor exceptions, we cannot acquire our own common shares. Any +common shares acquired by us, under certain of such minor +exceptions, must be sold at the market price within six months +after their acquisition. + + +In addition, under the Republic of China +Securities and Exchange Law, a company whose shares are listed +on the Taiwan Stock Exchange or traded on the GreTai Securities +Market may, pursuant to a board resolution adopted by a majority +consent at a meeting attended by more than two-thirds of the +directors and pursuant to the procedures prescribed by the +Republic of China Securities and Futures Commission, purchase +its shares for the following purposes on the Taiwan Stock +Exchange, the GreTai Securities Market or by a tender offer: + + + + + + + (1) + + for transfers of shares to its employees; + + + + + + (2) + + for conversion into shares from bonds with + warrants, preferred shares with warrants, convertible bonds, + convertible preferred shares or certificates of warrants issued + by the company; and + + + + + + (3) + + for maintaining its credit and its + shareholders equity, provided that the shares so purchased + shall be cancelled thereafter. + + + +The total shares purchased by the company shall +not exceed 10% of its total issued and outstanding shares. In +addition, the total amount for purchase of the shares shall not +exceed the aggregate amount of the retained earnings, the +premium from shares issues and the realized portion of the +capital reserve. + + +The shares purchased by the company pursuant to +items (1) and (2) above shall be transferred to the +intended transferees within three years after the purchase, +otherwise the same shall be cancelled. For the shares to be +cancelled pursuant to item (3) above, the company shall +complete amendment registration for such cancellation within six +months after the purchase. + + +The shares purchased by the company shall not be +pledged or hypothecated. In addition, the company may not +exercise any shareholders rights attaching to these +shares. The company s affiliates (as defined in +Article 369-1 of the Republic of China Company Law), +directors, supervisors, managers and their respective spouses +and minor children and/or nominees are prohibited from selling +the shares of the company held by them during the purchase +period of such shares reported by the company to the Republic of +China Securities and Futures Commission. + +140 + +Table of Contents + +Liquidation Rights + + +In the event of our liquidation, the assets +remaining after payment of all debts, liquidation expenses and +taxes will be distributed pro rata to the shareholders in +accordance with the relevant provisions of the Republic of China +Company Law and our articles of incorporation. + +Substantial Shareholders and Transfer +Restrictions + + +The Republic of China Securities and Exchange Law +currently requires (1) each director, supervisor, manager, +as well as their respective spouses, minor children and +nominees, and substantial shareholder (i.e., shareholder +who together with his or her spouse, minor children or nominees, +holds more than 10% of the shares of a public company) to report +any change in that person s shareholding to the issuer of +the shares and (2) each director, supervisor, manager or +substantial shareholder holding such common shares for more than +a six month period to report his or her intent to transfer any +shares listed on the Taiwan Stock Exchange or traded on the +Over-the-Counter Securities Exchange to the Republic of China +Securities and Futures Commission at least three days before the +intended transfer, unless the number of shares to be transferred +is less than 10,000 shares. ADS holders holding more than 10% of +our common shares, including common shares represented by ADSs, +may be subject to the reporting obligation in above +item (1). + + +In addition, the number of shares that can be +sold or transferred on the Taiwan Stock Exchange by any person +subject to the restrictions described above on any given day may +not exceed: + + + + + + + + + 0.2% of the outstanding shares of the company in + the case of a company with no more than 30 million + outstanding shares; or + + + + + + + + 0.2% of 30 million shares plus 0.1% of the + outstanding shares exceeding 30 million shares in the case + of a company with more than 30 million outstanding shares; + or + + + + + + + + in any case, 5% of the average daily trading + volume (number of shares) on the Taiwan Stock Exchange or the + GreTai Securities Market for the ten consecutive trading days + preceding the reporting day on which day the director, + supervisor, manager or substantial shareholder or their + respective spouse, minor child or nominee reports the intended + share transfer to the Republic of China Securities and Futures + Commission. + + + +These restrictions do not apply to block trading, +auction sale, purchase by auction, after-hour trading and sales +or transfers of our ADSs. However, these restrictions will apply +to sales of common shares upon withdrawal. + +141 + +Table of Contents + +DESCRIPTION OF AMERICAN DEPOSITARY SHARES" --> + +DESCRIPTION OF AMERICAN DEPOSITARY +SHARES + +American Depositary Shares + + +ADSs are evidenced by certificates that are +commonly known as American depositary receipts, or ADRs. We are +selling our common shares in the form of ADSs evidenced by ADRs. +Our depositary, The Bank of New York, will execute and deliver +the ADRs. Each ADS will represent ownership interests in our +common shares (or the right to receive ten common shares) which +we will deposit with the custodian, The International Commercial +Bank of China, in Taipei, Taiwan, Republic of China. Each ADS +will also represent securities, cash or other property deposited +with the depositary but not distributed to ADS holders. The +depositary s Corporate Trust Office is located at 101 +Barclay Street, New York, New York 10286. Its principal +executive office is located at The Bank of New York, One Wall +Street, New York, New York 10286. The custodian s office is +located at 3rd Floor, #2, Chung-King South Road, Section 1, +Taipei, Taiwan, Republic of China. + + +You may hold ADS either directly or indirectly +through your broker or other financial institution. If you hold +ADSs directly, you are an ADR holder. This description assumes +you hold your ADS directly. If you hold the ADRs indirectly, you +must rely on the procedures of your broker or other financial +institution to assert the rights of ADS holders described in +this section. You should consult with your broker or financial +institution to find out what those procedures are. + + +Because the depositary will actually hold the +common shares, you must rely on it to exercise the rights of a +shareholder. The obligations of the depositary are set out in a +deposit agreement among us, the depositary and you, as an ADS +holder. + + +The deposit agreement and the ADSs are generally +governed by New York law. However, our obligations to our +shareholders will continue to be governed by the laws of the +Republic of China, which are different from the laws of the +United States. In addition, we note that laws and regulations of +the Republic of China may restrict the deposit and withdrawal of +our common shares in or from the ADS facility. See Foreign +Investment and Exchange Controls in Taiwan +Depositary Receipts beginning on page 158. + + +The following is a summary of the deposit +agreement. Because it is a summary, it does not contain all the +information that may be important to you. For more complete +information, you should read the entire agreement and the ADR. +Directions on how to obtain copies of these are provided under +the caption Where You Can Find More Information +beginning on page 173. + +Dividends and Other Distributions + + How will you receive dividends +and other distributions on the shares? + + +The depositary has agreed to pay to you the cash +dividends or other distributions it or the custodian receives on +common shares or other deposited securities, after deducting +taxes, fees and expenses. You will receive these distributions +in proportion to the number of common shares your ADRs represent. + + + + + + + + + Cash. The depositary + will convert any cash dividend or other cash distribution we pay + on the common shares into U.S. dollars, if it can do so on a + reasonable basis and can transfer the U.S. dollars to the United + States. If that is not possible or if any approval from the + government is needed and cannot be obtained, the agreement + allows the depositary to distribute the NT dollars only to those + ADS holders to whom it is possible to do so or, in its + discretion, it will hold the NT dollars for and on your behalf + if it cannot convert for the account of the ADS holders who have + not been paid. It will not invest the NT dollars and it will not + be liable for any interest. + + +142 + +Table of Contents + + + + + + + + + Before making a distribution the depositary will + deduct any withholding taxes that must be paid under Republic of + China law. See Taxation Republic of China + Taxation Dividends beginning on page 160. + The depositary will distribute only whole U.S. dollars and cents + and will round fractional cents to the nearest whole cent. If + the exchange rates fluctuate during a time when the depositary + cannot convert the NT dollars, you may lose some or all of the + value of the distribution. + + + + + + + + Common shares. The + depositary may distribute new ADSs representing any common + shares we distribute as a dividend or free distribution, if we + furnish it promptly with satisfactory evidence that it is legal + to do so. The depositary will only distribute whole ADSs. It + will sell common shares which would require it to issue a + fractional ADS and distribute the net proceeds in the same way + as it does with cash. If the depositary does not distribute + additional ADSs, subject to applicable laws and regulations, + each ADS will also represent the new common shares. + + + + + + + + Rights to receive additional common shares. + If we offer holders of our securities + any rights to subscribe for additional common shares or any + other rights, the depositary may make these rights available to + you. We must first instruct the depositary to do so and furnish + it with satisfactory evidence that it is legal to do so. If we + do not furnish this evidence and/or give these instructions, and + the depositary decides it is practical to sell, the depositary + will sell the rights that are not exercised or distributed. The + proceeds of the sale will be distributed to holders as a cash + distribution. The depositary may allow rights that are not + distributed or sold to lapse. In that case, you will receive + no value for them. + + + + + + + + If the depositary makes rights available to you, + it will exercise the rights and purchase the common shares on + your behalf. The depositary will then deposit the common shares + and issue ADSs to you. It will only exercise rights if you pay + it the exercise price and any other charges the rights require + you to pay. + + + + + + + + U.S. securities laws may restrict the sale, + deposit, cancellation and transfer of the ADSs issued after + exercise of rights. For example, you may not be able to trade + the ADSs freely in the United States. In this case, the + depositary may issue the ADSs under a separate restricted + deposit agreement which will contain the same provisions as the + agreement, except for changes needed to put the restrictions in + place. + + + + + + + + Other Distributions. + The depositary will send to you + anything else we distribute on deposited securities by any means + it thinks is legal, fair and practical. If it cannot make the + distribution in that way, the depositary has a choice. It may + decide to sell what we distributed and distribute the net + proceeds, in the same way as it does with cash. Or, it may + decide to hold what we distributed for and on your behalf, in + which case ADSs will also represent the newly distributed + property. + + + +The depositary is not responsible if it decides +that it is unlawful or impractical to make a distribution +available to any ADS holders. We have no obligation to register +ADSs, common shares, rights or other securities under the +Securities Act. We also have no obligation to take any other +action to permit the distribution of ADSs, common shares, rights +or anything else to ADS holders. This means that you may not +receive the distributions we make on our common shares or any +value for them if it is illegal or impractical for us to make +them available to you. + +143 + +Table of Contents + +Deposit, Withdrawal and Cancellation + + How does the depositary issue +ADSs? + + +Subject to the procedures required by Republic of +China law described below, the depositary will issue ADSs if you +or your broker deposit common shares or evidence of rights to +receive common shares with the custodian. Upon payment of its +fees and expenses and of any taxes or charges, such as stamp +taxes or stock transfer taxes or fees, the depositary will +register the appropriate number of ADSs in the names you request +and will deliver the ADSs at its office to the persons you +request. + + +Purchase by you of our shares on the Taiwan Stock +Exchange or delivery by you of our common shares to the +custodian for deposit in our ADS facility for issuances of +additional ADSs against such deposits will be permitted only to +the extent that the total number of ADSs outstanding after an +issuance may not exceed the number of issued ADSs previously +approved by the Republic of China Securities and Futures +Commission (plus any ADSs created by dividends or free +distributions and exercise of pre-emptive rights). + + How do ADR holders cancel an ADS +and obtain common shares? + + +In order to withdraw our common shares +represented by your ADSs, you will be required to pay to the +depositary the fees for cancellation of ADSs and any charges and +taxes, including stamp taxes or stock transfer taxes or fees, +payable upon the transfer of our common shares. You assume the +risk for delivery of all funds and securities upon withdrawal. +Once canceled, the ADSs will not have any rights under the +deposit agreement. + + +Upon surrender of ADRs and upon payment of the +fees and expenses of the depositary and any taxes or other +governmental charges, you may generally request the depositary +to sell the common shares underlying your ADSs on your behalf. +The depositary may require you to enter into a separate +agreement to arrange the sale. These sales will be conducted +through a securities company in the Republic of China on the +Taiwan Stock Exchange. You assume the risk and expense of any +sale. + + +You will have the right to withdraw the common +shares represented by your ADSs except: + + + + + + + + + for temporary delays that may arise because + (1) the transfer books for our common shares or ADSs are + closed or (2) our common shares are temporarily transfer + restricted due to shareholders meeting or a payment of + dividends; + + + + + + + + when you or other ADR holders seeking to withdraw + shares owe money to pay fees, taxes and similar charges; and + + + + + + + + for restrictions imposed by any U.S. or foreign + law or governmental regulations relating to ADRs or the + withdrawal of the common shares represented by your ADSs. + + + +The deposit agreement may not be amended to +impair your right to withdraw our common shares represented by +your ADSs, except in order to comply with mandatory provisions +of applicable law. + + +If you wish to withdraw common shares from the +ADS facility, unless you are a qualified foreign institutional +investor or a general foreign investor and have obtained the +relevant governmental approval, you will be required to obtain +the relevant governmental approval as a qualified foreign +institutional investor or a general foreign investor and you +will be required to appoint a local agent in the Republic of +China and to open a securities trading account with a local +brokerage firm and a bank account to remit funds, exercise +stockholders rights. Without obtaining the governmental +approval, appointing the agents and opening a securities trading +account, you would not be able to hold or to sell or otherwise +transfer our common + +144 + +Table of Contents + +shares on the Taiwan Stock Exchange. In addition, +you are required to appoint a local bank to act as custodian and +for handling confirmation and settlement of trades, safekeeping +of securities or cash proceeds and declaration of information. +You also would be required to appoint a tax guarantor who will +act as guarantor for your tax payment obligations. + + Taiwan Disclosure +Obligations + + +We may have various disclosure and reporting +obligations to the Republic of China government upon the +withdrawal of ADSs if: + + + + + + + (a) + + the person to be registered as our shareholder + is our related party under Statement of Financial + Accounting Standard No. 6 of the Republic of China and + beneficially owns common shares withdrawn from the ADS facility; + or + + + + + (b) + + the person to be registered as the holder of + the underlying common shares withdrawn against the surrender of + the ADSs will then own a number of common shares withdrawn from + the ADS facility exceeding 10% of the common shares represented + by ADSs. + + +Because of these obligations, we may ask the +depositary to ask you to disclose certain information to us in +accordance with the deposit agreement, including the name of the +beneficial owner of the ADSs delivered for cancellation, and ask +you to provide proof of identity and genuineness of any +signature and other documents before it will cancel your ADSs. +The withdrawal of shares represented by your ADSs may be delayed +until the depositary receives the information and proof so +requested and satisfactory evidence of your compliance with all +laws and regulations. The information you are required to +provide may include the name and nationality of the beneficial +owner and the number of shares the beneficial owner is +withdrawing or has withdrawn in the past. + +Voting Rights + + +You may direct the exercise of voting rights +with respect to the common shares represented by ADSs only in +accordance with the provisions of the deposit agreement as +described below and applicable Republic of China law. See + Risk Factors Risks Relating to Ownership of +Our ADSs You will be more restricted in your ability +to exercise voting rights than the holders of our common shares, +which may diminish your influence over our corporate affairs and +may reduce the value of your ADSs beginning on +page 15. You will not have the same voting rights as the +holders of our common shares, which may affect the value of your +ADSs. If you wish to withdraw the common shares, you must +appoint a local agent and open a securities trading account with +a local brokerage firm and a bank account as discussed above. +Even if you do all this, however, you might not have enough time +to register your common shares for voting purposes before the +shareholder register is closed. See Description of Share +Capital Meetings of Shareholders beginning on +page 138 and Register of Shareholders and +Record Dates beginning on page 139. + + +Except as described below, you will not be able +to exercise voting rights attaching to the common shares +represented by the ADSs on an individual basis. Under the +deposit agreement, a shareholder s voting rights attaching +to shareholdings in a Republic of China company must, as to all +matters subject to a vote of shareholders (other than the +election of directors and supervisors), be exercised as to all +shares held by the shareholder in the same manner. Accordingly, +the voting rights attaching to the common shares represented by +ADSs must be exercised as to all matters subject to a vote of +shareholders by the depositary or its nominee, who represents +all holders of ADSs, collectively in the same manner, except in +the case of an election of directors and supervisors. Directors +and supervisors are elected by cumulative voting. + +145 + +Table of Contents + + +In the deposit agreement, you will appoint the +depositary as your representative to exercise the voting rights +with respect to the common shares represented by your ADSs. + + +We will provide the depositary with copies +(including English translations) of notices of meetings of our +shareholders and the agenda of these meetings. These materials +will contain an indication of the number of directors or +supervisors to be elected if an election of directors or +supervisors is to be held at the meeting. The depositary will +also mail to holders a voting instruction form. In order to be +valid, the holder of ADSs must complete, sign and return to the +depositary the voting instruction form by a date specified by +the depositary. The number of directors or supervisors to be +elected may change after the depositary has mailed the voting +instruction form to you. If a change were to occur, the +depositary would be unable to follow your exact voting +instructions and may calculate your votes according to +procedures not inconsistent with the provisions of the deposit +agreement. + + +We cannot assure you that you will receive the +materials in time to ensure that you can instruct the depositary +to vote the common shares represented by your ADSs. In addition, +the depositary and its agents are not responsible for failing to +carry out voting instructions or for the manner of carrying out +voting instructions. This means that you may not be able to +exercise your right to vote and there may be nothing you can do +if the common shares represented by your ADSs are not voted as +you requested. + + +Subject to the provisions described in the second +succeeding paragraph, which will apply to the election of +directors and supervisors, if persons together holding at least +51% of the ADSs outstanding at the relevant record date instruct +the depositary to vote in the same manner in respect of one or +more resolutions to be proposed at the meeting (other than the +election of directors or supervisors), the depositary will +notify the instructions to our chairman or such person as he may +designate. The depositary will appoint the chairman or his +designated person to serve as your designated representative and +that of the depositary s or its nominee. The designated +representative will attend the meeting and vote all the common +shares represented by ADSs in the manner so instructed by you. + + +If, for any reason, the depositary has not by the +date specified by it received instructions from persons together +holding at least 51% of all the ADSs outstanding at the relevant +record date to vote in the same manner in respect of any +resolution specified in the agenda for a meeting (other than for +the election of directors or supervisors), then you will be +deemed to have instructed the depositary or its nominee to +authorize and appoint the designated representative as your +representative and that of the depositary s or its nominee +to attend the meeting and vote all the common shares represented +by all ADSs as the designated representative deems appropriate +in his sole discretion with respect to the resolution or +resolutions, which may not be in your interests. However, no +authorization will be given with respect to any matter as to +which the designated representative informs the depositary that +he does not wish to be so authorized, in which event the +depositary will not vote at the relevant meeting. The depositary +will, however, take such action as is necessary to cause all the +common shares represented by ADSs to be counted for the purpose +of satisfying applicable quorum requirements. + + +The depositary will notify the designated +representative of the instructions for the election of directors +and supervisors received from you and appoint the designated +representative as your representative and that of the +depositary s or its nominee to attend any meeting and vote +the common shares represented by ADSs as to which the depositary +has received instructions from you for the election of directors +and supervisors, subject to any restrictions imposed by the law +of the Republic of China and our articles of incorporation. If, +by the date specified by the depositary, you have not delivered +instructions to the depositary, you will be deemed to have +instructed the depositary to authorize and + +146 + +Table of Contents + +appoint the designated representative as your +representative and that of the depositary s or its nominee +to attend the meeting and vote, at his sole discretion, all the +common shares represented by ADSs as to which the depositary has +not received instructions from you for the election of directors +and supervisors as the designated representative deems +appropriate, which may not be in your best interests. However, +no authorization will be given with respect to any election of +directors or supervisors as to which the designated +representative informs the depositary that he does not wish to +be so authorized, in which event the depositary will attend such +meeting and will vote those common shares represented by the +ADSs as to which it has received instructions from you for the +election of directors and supervisors in the manner so +instructed. The depositary will not vote at the relevant meeting +any common shares evidenced by ADSs if the depositary has not +received instructions from you for the election of directors and +supervisors. However, the depositary will take all necessary +actions to cause all common shares evidenced by the ADSs to be +counted for the purpose of satisfying quorum requirements. + + +By continuing to hold ADSs or any interest in the +ADSs, you will be deemed to have agreed to the voting provisions +set forth in the deposit agreement, as these provisions may be +amended from time to time. + + +The depositary will not, and the depositary will +endeavor to ensure that the custodian and their respective +nominees (including the designated representative) do not +(except as described above), exercise any discretion as to +voting, nor vote or attempt to exercise the right to vote that +attaches to deposited securities, other than in accordance with +instructions received as herein provided. + + +Beneficial owners of ADSs are entitled to +exercise their voting rights only through the procedures +applicable to the representative holder of the ADSs in which +they have a beneficial interest. + + +When exercising voting rights on a cumulative +basis for the election of directors and supervisors, the +aggregate votes to be cast for each candidate will be reduced by +the applicable amount. You may vote the common shares that you +have withdrawn and transferred on our register of shareholders. +However, you may not receive sufficient advance notice of our +shareholder meetings to enable you to withdraw your shares and +vote at such meetings. + +Fees and Expenses + + + + + + + + + ADS holders must pay: + + + For: + + + + + US$5.00 (or less) per 100 ADSs (or portion + thereof) + + + + Each issuance of an ADS, including as + a result of a distribution of common shares or rights or other + property + + + + + + + + + Each cancellation of an ADS, + including if the deposit agreement terminates + + + + + + US$0.02 (or less) per ADS (or portion thereof) + + + + Any cash payment + + + + + + + Registration or transfer fees + + + + Transfer and registration of common + shares on the common shares register of the registrar in the + Republic of China from your name to the name of the depositary + or its agent when you deposit or withdraw common shares + + + + + + Expenses of the depositary + + + + Conversion of NT dollars to U.S. + dollars + + +147 + +Table of Contents + + + + + + + + + + + + Cable, telex, and facsimile + transmission expenses as are expressly provided in the deposit + agreement + + + + + + Taxes and other governmental charges the + depositary or the custodian have to pay on any ADS or common + share underlying an ADS + + + + As necessary + + + + + + + +Payment of Taxes + + +The depositary may deduct the amount of any taxes +owed from any payment to you. It may also sell deposited +securities, by public or private sale, subject to applicable +laws and regulations, to pay any taxes owed. You will remain +liable if the proceeds of the sale are not enough to pay the +taxes. If the depositary sells deposited securities, it will, if +appropriate, reduce the number of ADSs to reflect the sale and +pay to you any proceeds, or send to you any property, remaining +after it has paid the taxes. + +Reclassifications, Recapitalizations and +Mergers + + + + + + If we: + + Then: + + + Change the nominal or par value of + our common shares + + + + Reclassify, split up or consolidate any of the + deposited securities + + + + Distribute securities on the common shares that are + not distributed to you + + + + Recapitalize, reorganize, merge, liquidate, sell + all or substantially all of our assets, or take any similar + action + + + + The cash, common shares or other securities + received by the depositary will become deposited securities. + Subject to applicable laws and regulations, each ADS will + automatically represent its equal common share of the new + deposited securities. + + + + The depositary may, and will if we ask them to, distribute some + or all of the cash, common shares or other securities it + received. Subject to applicable laws and regulations, it may + also issue new ADSs or ask you to surrender your outstanding + ADRs in exchange for new ADRs identifying the new deposited + securities. + + +Amendment and Termination + + How may the depositary +agreement be amended? + + +We may agree with the depositary to amend the +deposit agreement and the ADSs without your consent for any +reason. If the amendment adds or increases fees or charges, +except for taxes and other governmental charges or certain +expenses of the depositary, or prejudices an important right of +ADS holders, it will only become effective 30 days after the +depositary notifies you of the amendment. In no event may any +amendment impair your right to surrender your ADRs and receive +the common shares represented thereby, except in order to comply +with mandatory provisions of applicable law. At the time an +amendment becomes effective, you are considered, by continuing +to hold your ADSs, to agree to the amendment and to be bound by +the ADSs and the agreement as amended. + + +How may the depositary agreement be +terminated? + + +The depositary will terminate the deposit +agreement if we ask it to do so. The depositary may also +terminate the agreement if the depositary has told us that it +would like to resign and we have not appointed a new depositary +bank within 180 days. In both cases, the depositary must notify +you at least 30 days before termination. + +148 + +Table of Contents + + +After termination, the depositary and its agents +will be required to do only the following under the agreement: + + + + + + + + + advise you that the agreement is terminated; + + + + + + + + collect distributions on the deposited + securities; and + + + + + + + + deliver common shares and other deposited + securities upon cancellation of ADSs. + + + +One year after termination, the depositary will, +if practical, sell any remaining deposited securities by public +or private sale, subject to applicable laws and regulations. +After that, the depositary will hold the money it received on +the sale, as well as any other cash it is holding under the +agreement, for the pro rata benefit of the ADS holders +that have not surrendered their ADSs. It will not invest the +money and has no liability for interest. The depositary s +only obligations will be to account for the money and other cash +and with respect to indemnification. After termination, our only +obligations will be with respect to indemnification and to pay +certain amounts to the depositary. + +Limitations On Obligations and Liability to +ADS Holders + + + + + + + + + Limits on our Obligations and the + Obligations of the Depositary; Limits on Liability to Holders of + ADSs + + +The deposit agreement expressly limits our +obligations and the obligations of the depositary. It also +limits our liability and the liability of the depositary. We and +the depositary: + + + + + + + + + are only obligated to take the actions + specifically set forth in the deposit agreement without + negligence or bad faith; + + + + + + + + are not liable if either of us is prevented or + delayed by law or circumstances beyond our control from + performing our obligations under the deposit agreement; + + + + + + + + are not liable if either of us exercises + discretion permitted under the deposit agreement; + + + + + + + + have no obligation to become involved in a + lawsuit or other proceeding related to the ADSs or the deposit + agreement on your behalf or on behalf of any other party; and + + + + + + + + may rely upon any documents we believe in good + faith to be genuine and to have been signed or presented by the + proper party. + + + +In the deposit agreement, we and the depositary +agree to indemnify each other under certain circumstances. + + Requirements for Depositary +Actions + + +Before the depositary will issue or register +transfer of an ADS, make a distribution on an ADS, or permit +withdrawal of common shares, the depositary may require: + + + + + + + + + payment of stock transfer or other taxes or other + governmental charges and transfer or registration fees charged + by third parties for the transfer of any common shares or other + deposited securities; + + + + + + + + production of satisfactory proof of the identity + and genuineness of any signature or other information it deems + necessary; and + + + + + + + + compliance with regulations it may establish, + from time to time, consistent with the deposit agreement, + including presentation of transfer documents. + + + +The depositary may refuse to deliver, transfer or +register transfers of ADSs generally when the transfer books of +the depositary, our company or the registrar in Taiwan are +closed or at any time if the depositary or our company thinks it +advisable to do so. + +149 + +Table of Contents + +Pre-Release of ADSs + + +In certain circumstances, subject to the +provisions of the deposit agreement and to the extent permitted +by any applicable law or regulation, the depositary may issue +ADSs before deposit of the underlying common shares. This is +called a pre-release of the ADS. To the extent permitted by law, +the depositary may also deliver common shares upon cancellation +of pre-released ADSs, even if the ADSs are cancelled before the +pre-release transaction has been closed out. A pre-release is +closed out as soon as the underlying common shares are delivered +to the depositary. The depositary may receive ADSs instead of +common shares to close out a pre-release. The depositary may +pre-release ADSs only under the following conditions: + + + + + + + + + before or at the time of the pre-release, the + person to whom the pre-release is being made must represent to + the depositary in writing that it or its customer owns the + common shares or ADSs to be deposited; + + + + + + + + the pre-release must be fully collateralized with + cash, U.S. government securities or such other collateral that + the depositary considers appropriate; and + + + + + + + + the depositary must be able to close out the + pre-release on not more than five business days notice. + + + +In addition, the depositary will limit the number +of ADSs that may be outstanding at any time as a result of +pre-release, although the depositary may disregard the limit +from time to time, if it thinks it is appropriate to do so. + +Ownership Restrictions + + +We may restrict deposits of our common shares +where such deposit might result in ownership or beneficial +ownership of our common shares that exceed the limits under +applicable law or our articles of incorporation. We may instruct +the depositary to take action with respect to the ownership +interest of any holder in excess of any such limitation, +including but not limited to refusing to accept common shares +for deposit from a holder in excess of the applicable limitation +if a deposit of common shares would result in a violation of the +applicable limitations, to the extent such action is permitted +by applicable law. + +150 + +Table of Contents + +THE SECURITIES MARKETS OF TAIWAN" --> + +THE SECURITIES MARKETS OF TAIWAN + + +We have extracted from publicly available +documents the information presented in this section which have +not been prepared or independently verified by the underwriters, +the depositary or any of their respective affiliates or advisors +in connection with this offering. + + +In September 1960, the Republic of China +Securities and Exchange Commission was established to supervise +and control all aspects of the existing domestic securities +market in Taiwan, and the Taiwan Stock Exchange began to take +shape soon thereafter. In the 1970s and the early 1980s, the +Republic of China government implemented a number of steps +designed to upgrade the quality and importance of the securities +markets, such as encouraging listing on the Taiwan Stock +Exchange and establishing the GreTai Securities Market. In the +mid-1980s, the Republic of China government began to revise its +laws and regulations in a manner designed to facilitate the +gradual internationalization of the Taiwan securities markets. +In 1997, the Republic of China Securities and Exchange +Commission was renamed the Republic of China Securities and +Futures Commission. + +The Taiwan Stock Exchange + + +In 1961, the Securities and Futures Commission +established the Taiwan Stock Exchange to provide a marketplace +for securities trading. The Taiwan Stock Exchange is a +corporation owned by government-controlled entities and private +banks and enterprises. The Taiwan Stock Exchange is independent +of entities transacting business through it, each of which pays +a user s fee. Subject to limited exceptions, all +transactions in listed securities by brokers, traders and +securities firms must be made through the Taiwan Stock Exchange. + + +The Taiwan Stock Exchange commenced operations in +1962. During the early 1980 s, the Securities and Futures +Commission actively encouraged new listings on the Taiwan Stock +Exchange, and the number of listed companies grew from 119 in +1983 to 637 as of June 23, 2003. As of June 23, 2003, +the market capitalization of companies listed on the Taiwan +Stock Exchange was approximately NT$10.0 trillion. + + +Historically, Taiwan companies have listed only +shares and bonds on the Taiwan Stock Exchange. However, the +Securities and Futures Commission has encouraged companies to +list other types of securities. In 1988, the Securities and +Futures Commission permitted the issuance of Taiwan s first +exchangeable bonds. Since 1989, there have been offerings of +domestic convertible bonds and convertible preferred shares. In +addition, beneficiary units evidencing beneficiary interests in +closed-end investment funds and bonds issued by Asian +Development Bank and other supra-national financial institutions +are also listed on the Taiwan Stock Exchange or traded on the +GreTai Securities Market. + + +Currently only four non-Taiwan companies are +listed on the Taiwan Stock Exchange through the use of +depositary receipts. The Securities and Futures +Commission s regulations, however, permit foreign issuers +to list their equity securities directly on the Taiwan Stock +Exchange or through the use of depositary receipts. The Taiwan +Stock Exchange requirements for listing are based on: + + + + + + + + + length of time the company has been in business; + + + + + + + + amount of capital; + + + + + + + + profitability; and + + + + + + + + shareholder concentration. + + + +However, special listing criteria apply to +technology companies and key businesses engaging in national +economic development. + +151 + +Table of Contents + + +We, as a public company in Taiwan, are obligated +to make the following reports to the Securities and Futures +Commission and the Taiwan Stock Exchange, including without +limitation: + + + + + + + + + regular reports regarding monthly sales revenues; + quarterly, semi-annual and annual financial information; public + financial forecasts in the event of rights offering; annual + reports; minutes of shareholders meetings; regular reports + regarding solicitations of proxies; the execution of internal + audits; and statements of internal controls; + + + + + + + + special reports regarding events which have had a + significant impact on shareholders rights or the price of + our securities; resolutions of our board of directors related to + a merger; prospectuses for approved issuances of securities; + material changes that have been made regarding cash injections + and corporate bond issuances; financial forecasts; approvals of + changes of accounting principles; and + + + + + + + + special reports regarding the issuance of + securities; details of the issuance of overseas depositary + receipts; revisions to procedures of acquiring or selling + assets; and revisions to operating procedures for making + third-party loans. + + +The GreTai Securities Market + + +To complement the Taiwan Stock Exchange, the +GreTai Securities Market was established in September 1982 on +the initiative of the Securities and Futures Commission to +encourage trading of securities of companies who do not qualify +for listing on the Taiwan Stock Exchange. As of June 23, +2003, 423 companies had equity securities listed on the +GreTai Securities Market. As of June 23, 2003, the total +market capitalization of companies with equity securities listed +on the GreTai Securities Market was approximately +NT$926 billion. In addition, the Emerging Stock Trading +System of the GreTai Securities Market was established on +January 1, 2002 on the initiative of the Securities and +Futures Commission to encourage trading of securities of +publicly listed companies that do not qualify for trading on the +Taiwan Stock Exchange or the GreTai Securities Market. + +Taiwan Stock Exchange Index + + +The Taiwan Stock Exchange Index is calculated on +the basis of a wide selection of listed shares weighted +according to the number of shares outstanding. This weighted +average method is also used for the Standard and Poor s +Index in the United States and the Nikkei Stock Average in +Japan. The Taiwan Stock Exchange Index is compiled by dividing +the market value by the base day s total market value for +the index shares. The Taiwan Stock Exchange Index is the oldest +and most widely quoted market index in Taiwan. + + +The weighting of stocks in the index is fixed as +long as the number of shares outstanding remains constant. When +the total number of shares outstanding changes, the weight of +each stock is adjusted. Stock splits and stock dividends are +adjusted automatically. Cash dividends are not included in the +calculation. + +152 + +Table of Contents + + +The following table shows for the periods +indicated information relating to the Taiwan Stock Exchange +Index. + + + + + + + + + + + + + + + + + + + + + + + + + + Number of + + + + + + + + + + + + Listed + + + + + + + + + + + + Companies + + + + + + + + + + + + at the + + Trading + + + + + + Index at + + Period ended December 31, + + Period End + + values + + Index High + + Index Low + + Period End + + + + + + + + + + + + + + + + + + (in NT$ + + + + + + + + + + + + billions) + + + + + + + + + + 1990 + + + + + + 199 + + + + 19,031.3 + + + + 12,495.34 + + + + 2,560.47 + + + + 4,530.16 + + + + + 1991 + + + + + + 221 + + + + 9,682.7 + + + + 6,305.22 + + + + 3,316.26 + + + + 4,600.67 + + + + + 1992 + + + + + + 256 + + + + 5,917.1 + + + + 5,391.63 + + + + 3,327.67 + + + + 3,377.06 + + + + + 1993 + + + + + + 285 + + + + 9,056.7 + + + + 6,070.56 + + + + 3,135.56 + + + + 6,070.56 + + + + + 1994 + + + + + + 313 + + + + 18,812.1 + + + + 7,183.75 + + + + 5,194.63 + + + + 7,124.66 + + + + + 1995 + + + + + + 347 + + + + 10,151.5 + + + + 7,051.49 + + + + 4,503.37 + + + + 5,173.73 + + + + + 1996 + + + + + + 382 + + + + 12,907.6 + + + + 6,982.81 + + + + 4,690.22 + + + + 6,933.94 + + + + + 1997 + + + + + + 404 + + + + 37,241.2 + + + + 10,116.84 + + + + 6,820.35 + + + + 8,187.27 + + + + + 1998 + + + + + + 437 + + + + 29,619.0 + + + + 9,277.09 + + + + 6,251.38 + + + + 6,418.43 + + + + + 1999 + + + + + + 462 + + + + 29,291.5 + + + + 8,608.91 + + + + 5,474.79 + + + + 8,448.84 + + + + + 2000 + + + + + + 531 + + + + 30,526.6 + + + + 10,202.20 + + + + 4,614.63 + + + + 4,739.09 + + + + + 2001 + + + + + + 584 + + + + 18,354.9 + + + + 6,104.24 + + + + 3,446.26 + + + + 5,551.24 + + + + + 2002 + + + + + + 638 + + + + 21,874.0 + + + + 6,462.30 + + + + 3,850.04 + + + + 4,432.45 + + + + + 2003 (through June 23, 2003) + + + + + + 637 + + + + 7,831.0 + + + + 5,078.80 + + + + 4,139.50 + + + + 4,921.72 + + + + + + Sources: + + Status of Securities Listed on Taiwan Stock + Exchange. + + + +As indicated above, the performance of the Taiwan +Stock Exchange has in recent years been characterized by extreme +price volatility. + +Price Limits, Commissions, Transaction Tax and +Other Matters + + +The Taiwan Stock Exchange has placed limits on +block trading and on the range of daily price movements. +Transactions that involve 500 trading lots, that is +500,000 shares, or more must be registered and executed +under Taiwan Stock Exchange block trade guidelines. Fluctuations +in the price of securities traded on the Taiwan Stock Exchange +is restricted to 7% above and below the previous day s +closing price in the case of equity securities, and 5% in the +case of debt securities. However, these restrictions have been +modified from time to time by the Ministry of Finance based on +market conditions. + + +Brokerage commission can be in any rates, as +reported to the Taiwan Stock Exchange, not exceeding 0.1425% of +the transaction price. + + +A securities transaction tax of 0.3% of the +transaction price is payable by the seller of equity securities +and a tax of 0.1% of the transaction price is payable by the +seller of debt securities other than government bonds. These +securities transaction taxes are withheld at the time of the +transaction. In addition, according to the amended Statute of +Upgrading Industries, effective on February 1, 2002, no +securities transaction tax will be imposed on the transfer of +financial debentures and corporate bonds. These securities +transaction taxes are exempted until December 31, 2009. + + +Sales of shares of listed companies on the Taiwan +Stock Exchange are generally sold in round lots of +1,000 shares. Investors who desire to sell less than 1,000 +shares of a listed company occasionally experience delays in +making these sales. + +National Financial Stabilization +Fund + + +In response to recent declines and volatility in +the securities markets in Taiwan, the government recently formed +the National Financial Stabilization Fund which has purchased +and may from time to time purchase shares of Taiwan companies to +support these markets. + +153 + +Table of Contents + +The details of the transactions of the National +Financial Stabilization Fund have not been made public. In +addition, the government s Labor Insurance Fund and other +funds associated with the government have in the past purchased, +and may from time to time purchase, shares of Taiwan companies +on the Taiwan Stock Exchange or other markets. + + +In connection with the establishment of the +National Financial Stabilization Fund, the Ministry of +Transportation and Communications, at the request of the +government, has pledged 2.8 billion of our common shares as +security to support borrowings by the National Financial +Stabilization Fund from a syndicate of commercial banks in +Taiwan. Ownership of these shares, which represent approximately +29% of our outstanding common shares, may be forfeited to those +banks if those secured loans are not repaid. + +Regulation and Supervision + + +The Securities and Futures Commission has +extensive regulatory authority over public companies. Public +companies are generally required to obtain approval from, or +registration with, the Securities and Futures Commission for all +securities offerings. The Securities and Futures Commission +requires periodic reporting of financial and operating +information by all public companies. In addition, the Securities +and Futures Commission establishes standards for financial +reporting and carries out licensing and supervision of +participants in the Taiwan securities market. + + +The Securities and Futures Commission has +responsibility for implementing the Securities and Exchange Law +and for overall administration of governmental policies in the +Taiwan securities market. It has extensive regulatory authority +over the offering, issuing and trading of securities. In +addition, the Securities and Exchange Law specifically empowers +the Securities and Futures Commission to promulgate necessary +rules. + + +The Securities and Exchange Law prohibits market +manipulation. For example, it permits an issuer to recover +short-term trading profits made through purchases and sales +within six months by directors, managerial personnel, +supervisors, as well as spouses, minor children and nominees of +these parties, and stockholders together with their spouses, +minor children and nominees holding 10% or more stocks of the +issuer. The Securities and Exchange Law prohibits trading by + insiders based on non-public information that +materially affects share price movement. Insiders +include: + + + + + + + + + directors, supervisors, managers, as well as + spouses, minor children and nominees of these parties, and + stockholders together with their spouses, minor children and + nominees holding 10% or more of the issuing company; + + + + + + + + any person who has learned material, non-public + information due to an occupational or controlling relationship + with our issuing company, and + + + + + + + + any person who has learned material, non-public + information from any of the above. + + + +Sanctions include imprisonment. In addition, +damages may be awarded to persons injured by the transaction. + + +The Securities and Exchange Law also imposes +criminal liability on certified public accountants and lawyers +who intentionally make false certifications in their examination +and audit of an issuer s contracts, reports and other +documents related to securities transactions. The Securities and +Futures Commission regulations require that financial reports of +listed companies be audited by accounting firms consisting of at +least three certified public accountants and be signed by at +least two certified public accountants. + +154 + +Table of Contents + + +In addition, the Securities and Exchange Law +provides for: + + + + + + + + + civil liability for material misstatements or + omissions made by issuers; and + + + + + + + + regulation of tender offers. + + + +The Securities and Futures Commission does not +have criminal or civil enforcement powers under the Securities +and Exchange Law. Criminal actions may be pursued only by the +government prosecutors. Civil actions may only be brought by +plaintiffs who assert that they have suffered damages. The +Securities and Futures Commission is empowered to curb abuses +and violations of laws and regulations only through +administrative measures. + + +In addition to providing a market for securities +trading, the Taiwan Stock Exchange reviews applications by +Taiwan issuers to list securities on the Taiwan Stock Exchange. +If issuers of listed securities violate laws and regulations or +encounter significant difficulties, the Taiwan Stock Exchange +may, with the approval of the Securities and Futures Commission, +delist securities of these issuers. + +155 + +Table of Contents + +FOREIGN INVESTMENT AND EXCHANGE CONTROLS IN TAIWAN" --> + +FOREIGN INVESTMENT AND EXCHANGE CONTROLS IN +TAIWAN + + +We have extracted from publicly available +documents the information presented in this section which have +not been prepared or independently verified by the underwriters, +the depositary or any of their respective affiliates or advisors +in connection with this offering. Please note that citizens of +the People s Republic of China and entities organized in +the People s Republic of China are subject to special +Republic of China laws, rules and regulations, which are not +discussed in this section. + +General + + +Historically, foreign investments in the +securities market of Taiwan were restricted. However, commencing +in 1983, the Taiwan government has from time to time enacted +legislation and adopted regulations to make foreign investment +in the Taiwan securities market possible. Initially, only +overseas investment trust funds of authorized securities +investment trust enterprises established in Taiwan were +permitted to invest in the Taiwan securities market. Since +January 1, 1991, qualified foreign institutional investors +are allowed to make investments in the Taiwan listed securities +market. Since March 1, 1996, overseas Chinese, non-resident +foreign institutional and individual investors (other than +qualified foreign institutional investors), called general +foreign investors , are permitted to make direct +investments in the Taiwan listed securities market. + +Qualified Foreign Institutional +Investors + + +The Executive Yuan, the cabinet of the Republic +of China government, has approved guidelines for direct +investment in listed securities in Taiwan or traded on the +GreTai Securities Market by qualified foreign institutional +investors. Qualified foreign institutional investors include: + + + + + + + + + banks; + + + + + + + + insurance companies; + + + + + + + + fund management institutions; + + + + + + + + offshore fund management companies of which at + least 50% owned by a Taiwan securities investment trust + enterprise, provided that the funds to be invested are not + derived from sources in Taiwan or Mainland China or owned by + these offshore fund management companies; + + + + + + + + general securities firms; + + + + + + + + offshore subsidiary securities firms that are at + least 50% owned by a Taiwan securities firm, or other securities + firms that are wholly owned by these offshore subsidiary + securities firms; + + + + + + + + offshore subsidiary securities firms that are + wholly owned by a Taiwan securities firm, or other securities + firms that are at least 51% owned by these offshore subsidiary + securities firms; + + + + + + + + foreign government-owned investment institutions, + provided that all of the funds to be invested are owned by the + foreign government; + + + + + + + + pension funds; + + + + + + + + mutual funds, unit trusts or investment trusts, + provided that the investment application shall be made under the + name of their trustees with notes stating their names; + + + + + + + + trust companies; + + +156 + +Table of Contents + + + + + + + + + academic or charitable institutions, according to + its articles of incorporation may invest their funds, provided + those investments are managed by a third-party manager; and + + + + + + + + any other professional institutional investors. + + + +Each qualified foreign institutional investor +wishing to invest directly in the Taiwan securities market is +required to apply for an investment permit from the Securities +and Futures Commission. If the investment amount exceeds US$50 +million, an approval from the Central Bank of China is also +required. The application to the Securities and Futures +Commission requires among others: + + + + + + + + + the appointment of a local agent and custodian; + + + + + + + + proof of qualification; + + + + + + + + a copy of the custodian contract; and + + + + + + + + an affidavit to the Securities and Futures + Commission certifying that the foreign institutional investors + will not enter into any quota-sharing arrangement with other + foreign investors, that their funds do not come from Mainland + China or Taiwan, and that the application and investment are + under single investment status. + + + +Qualified foreign institutional investors who +receive a permit may invest without ceiling and, unless limited +by certain laws and regulations, remit the amount into Taiwan at +any time and from time to time after receiving the investment +permit. Capital remitted into Taiwan by the qualified foreign +institutional investors may be repatriated at any time. The +repatriated capital may also be returned to Taiwan at any time +without the approval of the Securities and Futures Commission. +Capital gains and income on investments may also be repatriated +at any time. The lifting of the investment period limitations +and investment ceilings also applies to the qualified foreign +institutional investors whose approvals have already expired. + +General Foreign Investors + + +General foreign investors meeting qualifications +set by the Securities and Futures Commission may generally +invest in Taiwan Stock Exchange-listed securities or securities +traded on the Over-the-Counter Securities Exchange up to a limit +of US$50 million if they are institutional investors and US$5 +million if they are individual investors after obtaining +approval issued by Taiwan Stock Exchange. + +Foreign Investment Approval + + +Other than: + + + + + + + + + qualified foreign institutional investors; + + + + + + + + general foreign investors; and + + + + + + + + investors in overseas convertible bonds and + depositary receipts, + + +foreign investors who wish to make direct +investments in the shares of Taiwan companies may submit a + foreign investment approval application to the +Investment Commission of the Ministry of Economic Affairs of +Taiwan or other government authority for enjoyment of benefits +granted under the Regulations Governing Investments by +Foreigners. The Investment Commission or other government +authority reviews each foreign investment approval application +and approves or disapproves the application after consultation +with other governmental agencies. Any non-Taiwan person +possessing a foreign investment approval may repatriate annual +net profits and interests and cash dividends attributable to an +approved investment. Stock dividends, investment capital and +capital gains attributable to the investment may be repatriated +with approval of the Investment Commission or other government +authority. + +157 + +Table of Contents + + +In addition to the general restrictions against +direct investment by non-Taiwan persons in Taiwan companies, +non-Taiwan persons are currently prohibited from investing in +prohibited industries in Taiwan under the Negative List +promulgated by the Executive Yuan from time to time. The +prohibition on direct foreign investment in the prohibited +industries in the Negative List is absolute with the consequence +of certain specific exemption from the application of the +Negative List. Under the Negative List, some other industries +are restricted so that non-Taiwan persons may directly invest +only up to a specified level and with the specific approval of +the relevant authority which is responsible for enforcing the +legislation which the negative list is intended to implement. +The telecommunication industry is a restricted industry under +the Negative List. + +Depositary Receipts + + +In April 1992, the Securities and Futures +Commission began allowing Taiwan companies listed on the Taiwan +Stock Exchange, with the prior approval of the Securities and +Futures Commission, to sponsor the issuance and sale of +depositary receipts evidencing depositary shares. In December +1994, the Republic of China Ministry of Finance began allowing +companies whose shares are traded on the GreTai Securities +Market also to sponsor the issuance and sale of depositary +receipts evidencing depositary shares representing shares of its +capital stock. Approvals for these issuances are still required. + + +Commencing three months (if the deposited shares +are new shares) or immediately (if the deposited shares are +existing shares) after the issuance of a depositary share, a +holder of the depositary receipt evidencing the depositary +shares may request the depositary issuing the depositary share +to cause the underlying shares to be sold in Taiwan and to +distribute the proceeds of the sale to or to withdraw the shares +and deliver the shares to the depositary receipt holder. A +citizen of the People s Republic of China is not permitted +to withdraw and hold our shares. + + +A depositary receipt holder wishing to withdraw +shares represented by depositary receipts, unless such holder is +a qualified foreign institutional investor or a general foreign +investor and has obtained the relevant governmental approval, +will be required to obtain the relevant governmental approval as +a qualified foreign institutional investor or a general foreign +investor and will be required to appoint a qualified local agent +to, among other things, open a securities trading account with a +local securities brokerage firm, remit funds and exercise +shareholders rights. In addition, the withdrawing holder +is also required to appoint a custodian bank to hold the +securities and cash proceeds in safekeeping, make confirmations, +settle trades and report all relevant information. Without +obtaining the governmental approval, making this appointment and +the opening of accounts, the withdrawing holder would be unable +to subsequently hold or transfer the shares withdrawn from a +depositary receipt facility on the Taiwan Stock Exchange or +otherwise. The withdrawing holder is also generally required to +appoint a tax guarantor as guarantor for the withdrawing +depositary receipt holder s Republic of China tax filing +and payment obligations. + + +No deposits of shares may be made in a depositary +receipt facility and no depositary shares may be issued against +deposits without specific Securities and Futures Commission +approval, unless they are: + + + + + + + (1) + + stock dividends, + + + + + + (2) + + free distributions of shares; + + + + + + (3) + + due to the exercise by the depositary receipt + holder preemptive rights in the event of capital increases for + cash; or + + +158 + +Table of Contents + + + + + + + (4) + + if permitted under the deposit agreement and + custody agreement, due to the direct purchase by depositary + receipt holders of shares or purchase through the depositary on + the Taiwan Stock Exchange or the GreTai Securities Market for + deposit in the depositary receipt facility. In this event, the + total number of depositary receipts outstanding after an + issuance cannot exceed the number of issued depositary receipts + previously approved by the Securities and Futures Commission in + connection with the offering plus any ADSs issued pursuant to + the events described in (1), (2) and (3) above. + + + +An ADS holder or the depositary, without +obtaining further approvals from the Central Bank of China or +any other governmental authority or agency of the Republic of +China, may convert NT dollars into other currencies, including +U.S. dollars, in respect of: + + + + + + + + + the proceeds of the sale of common shares + represented by ADSs or received as share dividends with respect + to the common shares and deposited into the depositary receipt + facility; and + + + + + + + + any cash dividends or distributions received from + the common shares. + + + +In addition, the depositary may also convert into +NT dollars incoming payments for purchases of common shares for +deposit in the depositary receipt facility against the creation +of additional ADSs. If you withdraw the common shares underlying +your ADSs and become a holder of our common shares, you may +convert into NT dollars subscription payment for rights +offerings. The depositary may be required to obtained foreign +exchange payment approval from the Central Bank of China on a +payment-by-payment basis for conversion from NT dollars into +foreign currencies of the proceeds from the sale of subscription +rights of new common shares. Although it is expected that the +Central Bank of China will grant approval as a routine matter, +required approvals may not be obtained in a timely manner, or at +all. + +Exchange Controls + + +Taiwan s Foreign Exchange Control Statute +and regulations provide that all foreign exchange transactions +must be executed by banks designated to handle foreign exchange +transactions by the Ministry of Finance and by the Central Bank +of China. Current regulations favor trade-related foreign +exchange transactions. Consequently, foreign currency earned +from exports of merchandise and services may now be retained and +used freely by exporters. All foreign currency needed for the +importation of merchandise and services may be purchased freely +from the designated foreign exchange banks. + + +Aside from trade-related foreign exchange +transactions, Taiwan companies and residents may remit to and +from Taiwan foreign currencies of up to US$50 million (or its +equivalent) and US$5 million, (or its equivalent) respectively +in each calendar year. These limits apply to remittances +involving a conversion between New Taiwan dollars and U.S. +dollars or other foreign currencies. A requirement is also +imposed on all private enterprises to register all medium and +long-term foreign debt with the Central Bank of China. + + +In addition, a foreign person without an alien +resident card or an unrecognized foreign entity may remit to and +from Taiwan foreign currencies of up to US$100,000 per +remittance if required documentation is provided to Taiwan +authorities. This limit applies only to remittances involving a +conversion between New Taiwan dollars and U.S. dollars or other +foreign currencies. + +159 + +Table of Contents + +TAXATION" --> + +TAXATION + +Republic of China Taxation + + +This section constitutes the opinion of Baker + McKenzie, our Republic of China counsel. The discussion +describes the principal Republic of China tax consequences of +the ownership and disposition of ADSs representing common shares +and of common shares. It applies to you only if you are: + + + + + + + + + an individual who is not an citizen of the + Republic of China, who owns ADSs and who is not physically + present in Taiwan for 183 days or more during any calendar year; + or + + + + + + + + a corporation or a non-corporate body that is + organized under the laws of a jurisdiction other than the + Republic of China for profit-making purposes and has no fixed + place of business or other permanent establishment in Taiwan. + + + +You should also consult your tax advisors +concerning the Republic of China tax consequences of owning ADSs. + + + + + + + + + Dividends + + +Dividends declared by us out of our retained +earnings and distributed to you are subject to Republic of China +withholding tax, currently at the rate of 20%, on the amount of +the distribution in the case of cash dividends or on the par +value of the common shares in the case of stock dividends. +However, a 10% Republic of China retained earnings tax paid by +us on our undistributed after-tax earnings, if any, would +provide a credit of up to 10% of the gross amount of any +dividends declared out of such earnings that would reduce the +20% Republic of China tax imposed on these distributions. + + +Share dividends paid by us out of our capital +reserves are not subject to Republic of China withholding tax. + + + + + + + + + Capital gains + + +Gains from the sale of property in the Republic +of China are generally subject to Republic of China income tax. +However, under current Republic of China law, capital gains on +securities transactions (including sale of common stock) are +exempt from income tax. + + +Sales of ADRs by you are regarded as transactions +relating to property located outside the Republic of China and +thus any gains derived therefrom are currently not subject to +Republic of China income tax. + + + + + + + + + Subscription rights + + +Distributions of statutory subscription rights +for common shares in compliance with Republic of China law are +not subject to any Republic of China tax. Proceeds derived from +sales of statutory subscription rights evidenced by securities +are exempted from income tax but are subject to securities +transaction tax at the rate of 0.3% of the gross amount +received. Proceeds derived from sales of statutory subscription +rights which are not evidenced by securities are subject to +capital gains tax at the rate of: + + + + + + + + + 35% of the gains realized if you are a natural + person; or + + + + + + + + 25% of the gains realized if you are an entity + that is not a natural person. + + + +Subject to compliance with Republic of China law, +we, at our sole discretion, can determine whether statutory +subscription rights shall be evidenced by issuance of securities. + +160 + +Table of Contents + + Securities transaction +tax + + +A securities transaction tax, at the rate of 0.3% +of the gross amount received, payable by the seller will be +withheld upon a sale of common shares in Taiwan. Transfers of +ADSs are not subject to Republic of China securities transaction +tax. According to a letter issued by the Ministry of Finance of +the Republic of China in 1996, withdrawal of common shares from +the deposit facility will not be subject to Republic of China +securities transaction tax. + + Estate and gift +tax + + +Republic of China estate tax is payable on any +property within Taiwan of a deceased who is a non-resident +individual, and Republic of China gift tax is payable on any +property within Taiwan donated by any such person. Estate tax is +currently payable at rates ranging from 2% of the first +NT$600,000 to 50% of amounts over NT$100,000,000. Gift tax is +payable at rates ranging from 4% of the first NT$600,000 to 50% +of amounts over NT$45,000,000. Under Republic of China estate +and gift tax law, common shares issued by Taiwan companies are +deemed located in Taiwan regardless of the location of the +owner. It is not clear whether the ADSs will be regarded as +property located in Taiwan under Republic of China estate and +gift tax law. + + Tax treaty + + +The Republic of China does not have an income tax +treaty with the United States. On the other hand, the Republic +of China has income tax treaties with Indonesia, Singapore, +South Africa, Australia, Vietnam, New Zealand, Malaysia, +Macedonia, Swaziland, the Netherlands, United Kingdom and +Gambia, which may limit the rate of Republic of China +withholding tax on dividends paid with respect to common shares +in Taiwan companies. It is unclear whether if you hold ADSs, you +will be considered to hold common shares for the purposes of +these treaties. Accordingly, if you may otherwise be entitled to +the benefits of the relevant income tax treaty, you should +consult your tax advisors concerning your eligibility for the +benefits with respect to the ADSs. + +U.S. Federal Income Tax Considerations For +U.S. Persons + + +The following is a summary of the material U.S. +federal income tax consequences for beneficial owners of our +shares or ADSs that purchase such shares or ADSs in connection +with this offering, that hold the shares or ADSs as capital +assets, and that are U.S. holders and non-residents of the +Republic of China. You are a U.S. holder if you are: + + + + + + + + + a citizen or resident of the United States; + + + + + + + + a corporation or partnership created or organized + in or under the laws of the United States or any political + subdivision thereof; + + + + + + + + an estate the income of which is subject to U.S. + federal income taxation regardless of its source; + + + + + + + + a trust that is subject to the supervision of a + court within the United States and the control of one or more + U.S. persons; or + + + + + + + + a trust that has a valid election in effect under + applicable U.S. Treasury regulations to be treated as a U.S. + person. + + + +This summary is based on current law, which is +subject to change, perhaps retroactively. It is for general +purposes only and you should not consider it to be tax advice. +In addition, it is also based in part on representations by the +depositary and assumes that each obligation under the deposit +agreement and any related agreement will be performed in +accordance with its terms. This summary does not represent a +detailed description of all the + +161 + +Table of Contents + +federal income tax consequences to you in light +of your particular circumstances. In addition, it does not +represent a detailed description of the U.S. federal income tax +consequences applicable to you if you are subject to special +treatment under the U.S. federal income tax laws including if +you are: + + + + + + + + + a dealer in securities or currencies; + + + + + + + + a trader in securities if you elect to use a + mark-to-market method of accounting for your securities holdings; + + + + + + + + a financial institution or an insurance company; + + + + + + + + a tax-exempt organization; + + + + + + + + a person liable for alternative minimum tax; + + + + + + + + a person holding shares as part of a hedging, + integrated or conversion transaction, constructive sale or + straddle; + + + + + + + + a person owning, actually or constructively, 10% + or more of our voting stock; or + + + + + + + + a U.S. holder whose functional + currency is not the United States dollar. + + + +We cannot assure you that a later change in law +will not alter significantly the tax considerations that we +describe in this summary. + + +If a partnership holds our shares or ADSs, the +tax treatment of a partner will generally depend upon the status +of the partner and the activities of the partnership. If you are +a partner of a partnership holding our shares or ADSs, you +should consult your tax advisor. + + +You should consult your own tax advisor +concerning the particular U.S. federal income tax consequences +to you of the ownership and disposition of the shares or ADSs, +as well as the consequences to you arising under the laws of any +other taxing jurisdiction. + + +In general, for U.S. federal income tax purposes, +a U.S. person who is the beneficial owner of an ADS will be +treated as the owner of the shares underlying its ADS. However, +the United States Treasury has expressed concerns that parties +involved in transactions in which depositary shares are +pre-released may be taking actions that are inconsistent with +the claiming of foreign tax credits by the holders of ADSs. +Accordingly, the analysis of the creditability of Republic of +China taxes described below could be affected by future actions +that may be taken by the United States Treasury. + + Taxation of +Dividends + + +The amount of distributions (other than certain +pro rata distributions of shares to all shareholders) you +receive on your shares or ADSs, including net amounts withheld +in respect of Republic of China withholding taxes, will +generally be treated as dividend income to you if the +distributions are made from our current and accumulated earnings +and profits as calculated according to U.S. federal income tax +principles. These amounts will be includible in your gross +income as ordinary income on the day you actually or +constructively receive the distributions, which in the case of +an ADS will be the date received by the depositary. You will not +be entitled to claim a dividends received deduction with respect +to distributions you receive from us. + + +With respect to U.S. holders who are individuals, +certain dividends received from a foreign corporation before +January 1, 2009, on shares (or ADSs backed by such shares) +that are readily tradable on an established securities market in +the United States may be subject to reduced rates of taxation. +We have applied for listing of our ADSs on the New York Stock +Exchange, which we believe is an established securities market +in the United States for purposes of these rules. However, there +can be no assurance that our ADSs will + +162 + +Table of Contents + +be readily tradable on an established securities +market in this or later years (or that our shares will be +readily tradable on an established securities market in any +given year). Individuals that do not meet a minimum holding +period requirement during which they are not protected from the +risk of loss or that elect to treat the dividend income as + investment income pursuant to section 163(d)(4) +of the Code will not be eligible for the reduced rates of +taxation regardless of the trading status of our shares or ADSs. +You should consult your own tax advisor regarding the +application of these rules given your particular circumstances. + + +The amount of any dividend paid in NT dollars +will equal the U.S. dollar value of the NT dollars you receive, +calculated by reference to the exchange rate in effect on the +date you actually or constructively receive the dividend, which +in the case of an ADS will be the date received by the +depositary, regardless of whether the NT dollars are actually +converted into U.S. dollars. If the NT dollars received as a +dividend are not converted into U.S. dollars on the date of +receipt, you will have a basis in the NT dollars equal to its +U.S. dollar value on the date of receipt. Any gain or loss you +realize if you subsequently sell or otherwise dispose of the NT +dollars will be ordinary income or loss from sources within the +United States for foreign tax credit limitation purposes. + + +Subject to certain limitations under the Internal +Revenue Code, you may be entitled to a credit or deduction +against your federal income taxes for the net amount of any +Republic of China taxes that are withheld from dividend +distributions made to you. The limitation on foreign taxes +eligible for credit is calculated separately with respect to +specific classes of income. For this purpose, dividends we pay +with respect to shares or ADSs will generally be considered + passive income or, for certain holders, + financial services income. You may be subject to +special rules if your foreign source income during the taxable +year consists entirely of qualified passive income +and if you have US$300 or less, or US$600 or less if you file a +joint return, of creditable foreign taxes which you have paid or +accrued during the taxable year. Further, a U.S. holder that: + + + + + + + + + has held shares or ADSs for less than a specified + minimum period during which it is not protected from risk of + loss, + + + + + + + + is obligated to make payments related to the + dividends or + + + + + + + + holds the shares or ADSs in arrangements in which + the U.S. holder s expected economic profit, after non-U.S. + taxes, is insubstantial, + + +may not be allowed a foreign tax credit for +foreign taxes imposed on dividends paid on shares or ADSs. The +rules governing the foreign tax credit are complex. We therefore +urge you to consult your tax advisor regarding the availability +of the foreign tax credit under your particular circumstances. + + +To the extent that the amount of any distribution +you receive exceeds our current and accumulated earnings and +profits for a taxable year, the distribution will first be +treated as a tax-free return of capital, causing a reduction in +your adjusted basis in the shares or ADSs and thereby increasing +the amount of gain, or decreasing the amount of loss, you will +recognize on a subsequent disposition of the shares or ADSs. The +balance in excess of adjusted basis, if any, will be taxable to +you as capital gain recognized on a sale or exchange. + + +It is possible that pro rata distributions of +shares to all shareholders may be made in a manner that is not +subject to U.S. federal income tax. The basis of any new shares +so received will be determined by allocating your basis in the +old shares between the old shares and the new shares, based on +their relative fair market values or the date of distribution. + +163 + +Table of Contents + + +For U.S. tax purposes, any such tax-free share +distribution and any distributions in excess of current and +accumulated earnings and profits generally would not result in +foreign source income to you. Consequently, you may not be able +to use the foreign tax credit associated with any Republic of +China withholding tax imposed on such distributions unless you +can use the credit against United States tax due on other +foreign source income in the appropriate category for foreign +tax credit purposes. + + Taxation of Capital +Gains + + +When you sell or otherwise dispose of your shares +or ADSs, you will recognize capital gain or loss in an amount +equal to the difference between the U.S. dollar value of the +amount realized for the shares or ADSs and your basis in the +shares or ADSs, determined in U.S. dollars. For foreign tax +credit limitation purposes, such gain or loss will generally be +treated as U.S. source. If you are an individual, and the shares +or ADSs being sold or otherwise disposed of are capital assets +that you have held for more than one year, your gain recognized +will be eligible for reduced rates of taxation. Your ability to +deduct capital losses is subject to limitations. + + +Any Republic of China securities transaction tax, +or any Republic of China capital gain tax imposed on the +proceeds derived from sales of statutory subscription rights +which are not evidenced by securities, that you pay generally +will not be creditable foreign taxes for United States federal +income tax purposes, but you may be able to deduct such taxes, +subject to certain limitations under the Code. You are urged to +consult your tax advisors regarding the United States federal +income tax consequences of these taxes. + + Information Reporting and +Backup Withholding + + +In general, dividend payments, or other taxable +distributions, made within the United States to you will be +subject to information reporting requirements and backup +withholding if you are a non-corporate United States person and +you: + + + + + + + + + fail to provide an accurate taxpayer + identification number, + + + + + + + + are notified by the Internal Revenue Service that + you have failed to report all interest or dividends required to + be shown on your federal income tax returns, or + + + + + + + + in certain circumstances, fail to comply with + applicable certification requirements. + + + +If you sell your shares or ADSs to or through a +United States office of a broker, the payment of the proceeds is +subject to both United States backup withholding and information +reporting unless you establish an exemption. If you sell your +shares or ADSs outside the United States through a non-U.S. +office of a non-U.S. broker, and the sales proceeds are paid to +you outside the United States, then United States backup +withholding and information reporting requirements generally +will not apply to that payment. However, United States +information reporting, but not backup withholding, will apply to +a payment of sales proceeds, even if that payment is made +outside the United States, if you sell your shares or ADSs +through a non-U.S. office of a broker that: + + + + + + + + + is a United States person, + + + + + + + + derives 50% or more of its gross income for a + specified three-year period from the conduct of a trade or + business in the United States, + + + + + + + + is a controlled foreign corporation + as to the United States, or + + +164 + +Table of Contents + + + + + + + + + is a foreign partnership, if at any time during + its tax year: + + + + + + + + + + one or more of its partners are U.S. persons, as + defined in U.S. Treasury regulations, who in the aggregate hold + more than 50% of the income or capital interest in the + partnership or + + + + + + + + at any time during its tax year the foreign + partnership is engaged in a United States trade or business, + + +unless you establish an exemption. + + +You generally may obtain a refund of any amounts +withheld under the backup withholding rules that exceed your +income tax liability by filing a refund claim with the United +States Internal Revenue Service. + + Inheritance and Gift +Tax + + +As discussed above in Republic +of China Taxation , certain Republic of China inheritance +and gift taxes may be imposed on holders of ADSs. You should +consult your own tax advisor regarding the U.S. tax consequences +of such taxes on your particular situation. + +165 + +Table of Contents + +UNDERWRITING" --> + +UNDERWRITING + + +We, the Ministry of Transportation and +Communications and the underwriters named below have entered +into an underwriting agreement with respect to the ADSs being +offered by this prospectus. Subject to certain conditions, each +underwriter has severally agreed to purchase the number of ADSs +indicated in the following table. Goldman Sachs International, +Peterborough Court, 133 Fleet Street, London EC4A 2BB, United +Kingdom, is the representative of the underwriters named below. + + + + + + + + + Underwriters + + Number of ADSs + + + + + + + + Goldman Sachs International + + + + + 27,792,000 + + + + + Oriental Securities Corporation + + + + + 5,790,000 + + + + + + + + + + + + Total + + + + + + 33,582,000 + + + + + + + + + +We, the Ministry of Transportation and +Communications and the underwriters named below have entered +into an underwriting agreement with respect to the ADSs being +offered by this prospectus. Subject to certain conditions, each +underwriter has severally agreed to purchase the number of ADSs +indicated in the following table. Merrill Lynch International, +Merrill Lynch Financial Centre, 2 King Edward Street, +London EC1A 1HQ, United Kingdom, is the representative of the +underwriters named below. + + + + + + + + + Underwriters + + Number of ADSs + + + + + + + + Merrill Lynch International + + + + + + 20,844,000 + + + + + Deutsche Bank Securities Inc. + + + + + 5,790,000 + + + + + CLSA Limited + + + + + + 1,930,000 + + + + + The Hongkong and Shanghai Banking Corporation + Limited + + + + + + 1,930,000 + + + + + + + + + + + + Total + + + + + + 30,494,000 + + + + + + + + + +We, the Ministry of Transportation and +Communications and the underwriters named below have entered +into an underwriting agreement with respect to the ADSs being +offered by this prospectus. Subject to certain conditions, each +underwriter has severally agreed to purchase the number of ADSs +indicated in the following table. UBS AG, 25/F, One +Exchange Square, 8 Connaught Place, Central, Hong Kong, is the +representative of the underwriters named below. + + + + + + + + + Underwriters + + Number of ADSs + + + + + + + + UBS AG + + + + + + 20,844,000 + + + + + Credit Suisse First Boston (Hong Kong) Limited + + + + + + 5,790,000 + + + + + Daiwa Securities SMBC Hong Kong Limited + + + + + + 5,790,000 + + + + + + + + + + + + Total + + + + + + 32,424,000 + + + + + + + + + +The closing of the sale of ADSs under each +underwriting agreement described above is conditioned on the +closings of the sales of ADSs under the other two underwriting +agreements described above. + + +If the underwriters sell more ADSs than the total +number set forth in the tables above, the underwriters have an +option to purchase up to 14,475,000 additional ADSs from the +Ministry of Transportation and Communications. They may exercise +that option within 30 days of the date of this prospectus. +If any ADSs are purchased pursuant to this option, the +underwriters will severally purchase ADSs in approximately the +same proportion as set forth in the table above. + +166 + +Table of Contents + + +The following table shows the per ADS and total +underwriting discounts and commissions to be paid to the +underwriters by the Ministry of Transportation and +Communications. These amounts are shown assuming both no +exercise and full exercise of the underwriters option to +purchase additional ADSs. + + + + + + + + + + + + + + + + + + Paid by the Ministry of + + + + Transportation and + + + + Communications + + + + + + + + No Exercise + + Full Exercise + + + + + + + + + + Per ADS + + + + + US$ + + + + US$ + + + + + + Total + + + + + US$ + + + + US$ + + + + +ADSs sold by the underwriters to the public will +initially be offered at the initial public offering price set +forth on the cover of this prospectus. Any ADSs sold by the +underwriters to securities dealers may be sold at a discount of +up to US$ per ADS from the initial +public offering price. Any such securities dealers may resell +any ADSs purchased from the underwriters to certain other +brokers or dealers at a discount of up to +US$ per +ADS from the initial public offering price. If all the ADSs are +not sold at the initial public offering price, the +representatives may change the offering price and the other +selling terms. + + +We have been advised by the underwriters that +some of the underwriters are expected to make offers and sales +both inside and outside the United States through their +respective selling agents. Any offers and sales in the United +States will be conducted by brokers and dealers registered with +the Securities and Exchange Commission. Goldman Sachs +International is expected to make offers and sales in the United +States through its selling agent, Goldman, Sachs Co. +Merrill Lynch International is expected to make offers and sales +in the United States through its registered broker-dealer +affiliate, Merrill Lynch, Pierce, Fenner Smith +Incorporated. CLSA Limited is expected to make offers and sales +in the United States through its registered broker-dealer +affiliate, Credit Lyonnais Securities (U.S.A.) Inc. The +Hongkong and Shanghai Banking Corporation Limited is expected to +make offers and sales in the United States through its +registered broker-dealer affiliate, HSBC Securities Inc. +UBS AG is expected to make offers and sales in the United +States through its registered broker-dealer affiliate, UBS +Securities LLC. Credit Suisse First Boston (Hong Kong) +Limited is expected to make offers and sales in the United +States through its registered broker-dealer affiliate, Credit +Suisse First Boston LLC. Daiwa Securities SMBC Hong Kong +Limited is expected to make offers and sales in the United +States through its registered broker-dealer affiliate, Daiwa +Securities America Inc. + + +We and the Ministry of Transportation and +Communications have agreed with the underwriters, subject to +certain exceptions, not to offer, sell, contract to sell, hedge +or otherwise dispose of any of our common shares, ADSs or any +securities convertible into or exchangeable for common shares or +ADSs during the period from the date of this prospectus +continuing through the date 90 days after the date of this +prospectus, except with the prior written consent of the +representatives of the underwriters. In addition, the Ministry +of Transportation and Communications has agreed with the +underwriters, subject to certain exceptions, not to, after the +completion of our privatization, offer, sell, contract to sell, +hedge or otherwise dispose of any of our common shares, ADSs, or +any securities convertible into or exchangeable for common +shares or ADSs, until the earlier of (1) 180 days +after the completion of our privatization and +(2) December 31, 2004, except with the prior written +consent of the representatives of the underwriters. See + Shares Eligible for Future Sale beginning on +page 132. + + +In connection with the offering, the underwriters +may, subject to applicable laws and regulations, purchase and +sell ADSs in the open market. These transactions may include + +167 + +Table of Contents + +short sales, stabilizing transactions and +purchases to cover positions created by short sales. Short sales +involve the sale by the underwriters of a greater number of ADSs +than they are required to purchase in the offering. + Covered short sales are sales made in an amount not +greater than the underwriters option to purchase +additional ADSs from the Ministry of Transportation and +Communications in the offering. The underwriters may close out +any covered short position by either exercising their option to +purchase additional ADSs or purchasing ADSs in the open market. + Naked short sales are any sales in excess of such +option. The underwriters must close out any naked short position +by purchasing ADSs in the open market. A naked short position is +more likely to be created if the underwriters are concerned that +there may be downward pressure on the price of the ADSs in the +open market after pricing that could adversely affect investors +who purchase in the offering. Stabilizing transactions consist +of various bids for or purchases of ADSs made for the purpose of +preventing or retarding a decline in the market price of the +ADSs while the offering is in progress. + + +The underwriters may also impose a penalty bid. +This occurs when a particular underwriter repays to the +underwriters a portion of the underwriting discount received by +it because the representatives have repurchased ADSs sold by or +for the account of such underwriter in stabilizing or short +covering transactions. + + +These activities by the underwriters may +stabilize, maintain or otherwise affect the market price of the +ADSs. As a result, the price of the ADSs may be higher than the +price that otherwise might exist in the open market. If these +activities are commenced, they may be discontinued at any time. +These transactions may be effected on the New York Stock +Exchange or relevant exchange, in the over-the-counter market or +otherwise. + + +No ADSs are offered or sold and, prior to the +expiry of a period of six months from the closing date of +the issuance of the ADSs no ADSs will be offered or sold to +persons in the United Kingdom, except to persons whose ordinary +activities involve them in acquiring, holding, managing or +disposing of investments (as principal or agent) for the +purposes of their businesses or otherwise in circumstances that +have not resulted and will not result in an offer to the public +in the United Kingdom within the meaning of the Public Offers of +Securities Regulations 1995. Each underwriter has only +communicated or caused to be communicated and will only +communicate or cause to be communicated any invitation or +inducement to engage in investment activity (within the meaning +of section 21 of the Financial Services and Markets Act +2000) received by it in connection with the issue or sale of any +ADSs in circumstances in which section 21(1) of the +Financial Services and Markets Act 2000 does not apply to our +company. Each underwriter has complied, and will comply with, +all applicable provisions of the Financial Services and Markets +Act 2000 and the Public Offers of Securities Regulations +1995 with respect to anything done by it in relation to the ADSs +in, from or otherwise involving the United Kingdom. + + +It is expected that a public offering without a +listing of the ADSs will be made in Japan. No ADSs have been or +will be offered or sold, directly or indirectly, in Japan or to +or for the account of any resident of Japan, except in +accordance with the terms and conditions of the public offering +without a listing of the ADSs in Japan, as stated in the +securities registration statement filed on June 18, 2003, +as amended, with the Japanese authority under, or pursuant to +any exemption from the registration requirements of, the +Securities and Exchange Law of Japan and otherwise in compliance +with applicable provisions of Japanese law. Each underwriter +will send any dealer who purchases from it any ADSs a notice +stating in substance that, by purchasing such ADSs, the dealer +represents and agrees that it has not offered or sold, and will +not offer or sell, any ADSs, directly or indirectly, in Japan or +to or for the account of any resident thereof, except in +accordance with the terms and + +168 + +Table of Contents + +conditions of the public offering without a +listing of the ADSs in Japan, as stated in the securities +registration statement filed on June 18, 2003, as amended, +with the Japanese authority under, or pursuant to any exemption +from the registration requirements of, the Securities and +Exchange Law of Japan and otherwise in compliance with +applicable provisions of Japanese law, and that such dealer will +send to any other dealer to whom it sells any of such ADSs a +notice containing substantially the same statement as is +contained in this sentence. As used in this paragraph, + resident of Japan means any person residing in +Japan, including any corporations or other entities organized +under the laws of Japan. Each underwriter has also acknowledged +that it may not conduct marketing activities in Japan. + + +The ADSs have not been offered or sold, and will +not be offered or sold in Hong Kong, by means of any +document, other than to persons whose ordinary business is to +buy or sell shares or debentures, whether as principal or agent, +or in circumstances which do not constitute an offer to the +public within the meaning of the Companies Ordinance +(Cap. 32) of Hong Kong. No advertisement, invitation +or document relating to the ADSs, whether in Hong Kong or +elsewhere, has been or will be issued, which is directed at, or +the contents of which are likely to be accessed or read by, the +public in Hong Kong (except if permitted to do so under the +securities laws of Hong Kong) other than with respect to +ADSs which are or are intended to be disposed of only to persons +outside Hong Kong or only to professional +investors within the meaning of the Securities and Futures +Ordinance (Cap. 571) of Hong Kong and any rules made +thereunder. + + +This prospectus has not been registered as a +prospectus with the Monetary Authority of Singapore. +Accordingly, this prospectus and any other document or material +in connection with the offer or sale, or invitation for +subscription or purchase, of the ADSs may not be circulated or +distributed, nor may the ADSs be offered or sold, or be made the +subject of an invitation for subscription or purchase, whether +directly or indirectly, to the public or any member of the +public in Singapore other than (1) to an institutional +investor or other person specified in Section 274 of the +Securities and Futures Act, Chapter 289 of Singapore (the + Securities and Futures Act ), (2) to a +sophisticated investor, and in accordance with the conditions, +specified in Section 275 of the Securities and Futures Act +or (3) otherwise pursuant to, and in accordance with the +conditions of, any other applicable provision of the Securities +and Futures Act. + + +The ADSs may not be, directly or indirectly, +offered, sold, transferred or delivered in or from The +Netherlands, as part of their initial distribution or as part of +any re-offering, and neither this prospectus nor any other +document in respect of the offering may be distributed or +circulated in The Netherlands, other than to individuals or +legal entities which include, but are not limited to, banks, +brokers, dealers, institutional investors and undertakings with +a treasury department, who or which trade or invest in +securities in the conduct of a business or profession. + + +No action has been or will be taken in any +jurisdiction other than the United States and Japan that would +permit a public offering of the ADSs or the possession, +circulation or distribution of this prospectus in any +jurisdiction where action for that purpose is required. +Accordingly, the ADSs may not be offered or sold, directly or +indirectly, and neither this prospectus nor any other offering +material or advertisements in connection with the ADSs may be +distributed or published in or from any country or jurisdiction +except under circumstances that will result in compliance with +any applicable rules and regulations of any such country or +jurisdiction. + + +The ADSs have not been offered or sold, and will +not be offered or sold, directly or indirectly, in the Republic +of China. + +169 + +Table of Contents + + +A prospectus in electronic format may be made +available on the Internet web sites maintained by one or more +underwriters or securities dealers. The representatives of the +underwriters may agree to allocate a number of ADSs to the +underwriters for sale to their online brokerage account holders. +ADSs to be sold pursuant to an Internet distribution will be +allocated by the representatives to the underwriters that may +make Internet distribution on the same basis as other +allocations. In addition, ADSs may be sold by the underwriters +to securities dealers who resell ADSs to online brokerage +account holders. + + +Prior to the offering, there has been no public +market for the ADSs in the United States. The initial public +offering price of the ADSs being sold in this offering will be +determined through negotiations among the representatives of the +several underwriters and a pricing committee representing the +interests of the Ministry of Transportation and Communications +and the government of the Republic of China. In addition to +prevailing market conditions and the level of investor interest +in the ADSs, the price will be determined by reference to the +most recent closing price of our common shares on the Taiwan +Stock Exchange prior to the pricing date, and may be at a +premium or a discount to that price. + + +Application has been made for listing of the ADSs +offered by this prospectus on the New York Stock Exchange under +the symbol CHT . In order to meet one of the +requirements for listing of the ADSs on the New York Stock +Exchange, the underwriters have undertaken to sell lots of 100 +or more ADSs to a minimum of 2,000 beneficial holders. + + +We expect that the initial public offering price +of the ADSs offered in this offering will be determined on or +about July 23, 2003. Assuming that New York Stock Exchange +approval is received, we expect the ADSs to begin trading on the +New York Stock Exchange on the date on which the initial public +offering price is determined. We expect to deliver the ADSs +against payment in New York, New York on the fourth business day +after the date on which the initial public offering price is +determined. + + +The underwriters or their respective affiliates +may have, for their own accounts, entered into asset swaps, +credit derivatives or other derivative transactions relating to +the ADSs and/or our common shares in secondary market +transactions. As a result of such transactions, the underwriters +may hold long or short positions in the ADSs or derivatives or +in our common shares. No disclosure will be made of any such +positions. The underwriters or their respective affiliates may +have purchased the ADSs and been allocated the ADSs for asset +management and/or proprietary purposes and not with a view to +distribution. Such purchases in aggregate accounted for less +than 10% of the overall offering size. + + +We estimate that our total expenses and the total +expenses of the Ministry of Transportation and Communications +for this offering, excluding underwriting discounts and +commissions, will be approximately US$134,668 and US$3,000,000 +respectively. The underwriters have agreed to reimburse us or +the Ministry of Transportation and Communications or pay on our +behalf or on behalf of the Ministry of Transportation and +Communications the printing and engraving expenses and roadshow +and other miscellaneous fees and expenses. The following table +sets forth the various expenses incurred or to be incurred by + +170 + +Table of Contents + +us and the Ministry of Transportation and +Communications, as selling shareholder, in connection with this +offering, other than underwriting discounts and commissions. + + + + + + + + + + + + + + + + Amount + + + + Amount + + borne by + + + + borne by + + selling + + + + us + + shareholder + + + + + + + + + + US$ + + US$ + + + + Securities and Exchange Commission registration + fees + + + + + + 134,668 + + + + + + + + + Printing and engraving expenses + + + + + + + + + + 1,000,000 + + + + + Accounting fees + + + + + + + + + + 450,000 + + + + + Legal Fees + + + + + + + + + + 700,000 + + + + + Roadshow and other miscellaneous fees and expenses + + + + + + + + + + 850,000 + + + +We and the Ministry of Transportation and +Communications have agreed to indemnify the several underwriters +against certain liabilities including liabilities under the +Securities Act of 1933. + + +Purchasers of the ADSs offered hereby may be +required to pay stamp taxes and other charges in accordance with +the laws and practices of the country of purchase in addition to +the offering price set forth on the cover page of this +prospectus. + + +This prospectus may be used by underwriters and +dealers in connection with offers and sales of the ADSs to +persons located in the United States, including ADSs initially +sold outside the United States. + + +Goldman Sachs International is acting as the +global coordinator for this offering. Goldman Sachs +International, Merrill Lynch International and UBS AG are acting +as the joint bookrunners for this offering. + + +We expect that delivery of the ADSs will be made +against payment therefor on or about the closing date specified +on the cover page of this prospectus, which will be the fourth +business day following the date of pricing of the ADSs (this +settlement cycle being referred to as T+4 ). + +171 + +Table of Contents + +ENFORCEABILITY OF CIVIL LIABILITIES" --> + +ENFORCEABILITY OF CIVIL LIABILITIES + + +We are a company limited by shares and +incorporated under the Republic of China Company Law and the +Statute of Chunghwa Telecom Co., Ltd. All of our directors and +executive officers, our supervisors and some of the experts +named in this prospectus are residents of Taiwan and a +substantial portion of our assets and the assets of those +persons are located in Taiwan. As a result, it may not be +possible for investors to effect service of process upon us or +those persons within the United States, or to enforce against +them judgments obtained in the United States courts, including +those predicated upon the civil liability provisions of the +federal securities laws of the United States. We have been +advised by Baker McKenzie, our Republic of China counsel, +that in their opinion any final judgment obtained against us in +any court other than the courts of the Republic of China in +connection with any legal suit or proceeding arising out of or +relating to the ADSs will be enforced by the courts of the +Republic of China without further review of the merits only if +the court of the Republic of China in which enforcement is +sought is satisfied that: + + + + + + + + + the court rendering the judgment has jurisdiction + over the subject matter according to the laws of the Republic of + China; + + + + + + + + the judgment is not contrary to the public order + or good morals of the Republic of China; + + + + + + + + if the judgment was rendered by default by the + court rendering the judgment, we were served within the + jurisdiction of the court or process was served on us with + judicial assistance of the Republic of China; and + + + + + + + + judgments at the courts of the Republic of China + are recognized and enforceable in the court rendering the + judgment on a reciprocal basis. + + + +A party seeking to enforce a foreign judgment in +the Republic of China would be required to obtain foreign +exchange approval from the Central Bank of China for the payment +out of Taiwan of any amounts recovered in connection with the +judgment denominated in a currency other than NT dollars if a +conversion from NT dollars to a foreign currency is involved. + +VALIDITY OF SECURITIES" --> + +VALIDITY OF SECURITIES + + +We are being represented by Simpson Thacher +Bartlett LLP regarding matters of United States law and by Baker + McKenzie regarding matters of Republic of China law. +Simpson Thacher Bartlett LLP will pass upon the validity +of the ADSs and Baker McKenzie will pass upon the validity +of the common shares. The underwriters are being represented by +Sullivan Cromwell LLP regarding matters of United +States federal and New York state law and by Lee and Li +regarding matters of Republic of China law. + +EXPERTS" --> + +EXPERTS + + +The financial statements as of June 30, +2000, December 31, 2000, 2001 and 2002, and for the year +ended June 30, 2000, the six-month period ended +December 31, 2000 and each of the two years in the period +ended December 31, 2002 included in this prospectus have +been audited by T.N. Soong Co., independent auditors, +an associate member firm of Deloitte Touche Tohmatsu effective +April 22, 2002, and formerly a member firm of Andersen +Worldwide, SC, as stated in their reports appearing herein, and +are included with their consent in reliance upon the reports of +such firm given upon their authority as experts in accounting +and auditing. T.N. Soong Co. and Deloitte Touche +(Taiwan) established Deloitte Touche effective +June 1, 2003. + +172 + +Table of Contents + + +The offices of T.N. Soong Co. are +located at 12/F, 156 Minsheng East Road, Sec. 3, +Taipei, Taiwan, Republic of China. + +WHERE YOU CAN FIND MORE INFORMATION" --> + +WHERE YOU CAN FIND MORE INFORMATION + + +We have filed a registration statement on \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000034863_federal_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000034863_federal_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b0623349187dd58cef7ff5488f492ec3a766ec0e --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000034863_federal_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters with respect to our organization, our authority to issue annuity contracts and the validity of the Contract, have been passed upon by Debra P. Rezabek, our Executive Vice President, General Counsel and Corporate Secretary. Jorden Burt LLP, Washington, D.C., has advised us on certain legal matters concerning federal securities laws applicable to the issue and sale of the Contracts. SPECIAL CONSIDERATIONS We reserve the right to amend the Contract to meet the requirements of federal or state laws or regulations. We will notify you in writing of these amendments. Your rights under a Contract may be assigned as provided by law. An assignment will not be binding upon us until we receive a written copy of the assignment. You are solely responsible for the validity or effect of any assignment. You, therefore, should consult a qualified tax adviser regarding the tax consequences, as an assignment may be a taxable event. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000109261_zenith_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000109261_zenith_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..77bdb9eb8fed1f1f753f848ff9bf8d18914e9cfc --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000109261_zenith_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters 124 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000230131_comdial_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000230131_comdial_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ada2d2845b7533ead6381f5e0f729b670681423f --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000230131_comdial_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the common stock offered hereby will be passed upon for us by Greenberg Traurig, LLP (New York, New York). \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000277375_delta_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000277375_delta_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c31e9c95d9fab34df47ba4ec93d52622fa651f88 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000277375_delta_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Our counsel, Stoll, Keenon & Park, LLP, Lexington, Kentucky, will pass on the validity of the common stock. Certain legal matters will be passed upon for the underwriters by their counsel, Thompson Coburn LLP, St. Louis, Missouri. Attorneys in the firm of Stoll, Keenon & Park, LLP representing us in this common stock offering own collectively 7,534 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000355199_essex-corp_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000355199_essex-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b9f206a21e0df66dcd4ef7e11783d9628fddac00 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000355199_essex-corp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of our common stock offered by this prospectus will be passed upon for us by Whiteford, Taylor & Preston L.L.P., Baltimore, Maryland. Certain legal matters relating to the offering will be passed upon for the underwriters by Akin Gump Strauss Hauer & Feld LLP, Washington, D.C. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000761237_imcor_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000761237_imcor_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c8155804ff4098e838ec7ce83f5929f523c12acd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000761237_imcor_legal_matters.txt @@ -0,0 +1,13862 @@ +LEGAL MATTERS + + + The validity of the issuance of common stock will be passed upon for the company by Grippo & Elden, 227 West Monroe, Suite 3600, Chicago, Illinois 60606. +As of the date of this prospectus, partners of Grippo & Elden, who are representing us in this offering, beneficially own 45,648 shares of common stock. + + + + +EXPERTS + + + The consolidated financial statements of Photogen Technologies, Inc. and the financial statements of Sentigen, Ltd. included in this Prospectus and +in the Registration Statement have been audited by BDO Seidman, LLP, independent certified public accountants, to the extent and for the periods set forth in their reports appearing elsewhere herein +and in the Registration Statement, and are included in reliance upon such reports given upon the authority of said firm as experts in auditing and accounting. The report of Photogen +Technologies, Inc. contains an explanatory paragraph regarding the company's ability to continue as a going concern. + + WE +HAVE NOT AUTHORIZED ANY DEALER, SALESPERSON OR ANY OTHER PERSON TO GIVE ANY INFORMATION OR TO REPRESENT ANYTHING NOT CONTAINED IN THIS PROSPECTUS. YOU MUST NOT RELY ON ANY +UNAUTHORIZED INFORMATION. THIS PROSPECTUS DOES NOT OFFER TO SELL OR SEEK AN OFFER TO BUY ANY SHARES IN ANY JURISDICTION WHERE IT IS UNLAWFUL. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT +ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF THE DELIVERY OF THIS PROSPECTUS OR ANY SALE OF THE SHARES. + + Until July 13, 2003, all dealers that effect transaction in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition +to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. + +52 + + + + + + +Index to Financial Statements + + +Report of Independent Certified Public Accountants (Photogen Technologies, Inc.) + +F-2 + + + +Audited Annual Financial Statements (Photogen Technologies, Inc.) + + + + + + + + + + + +Consolidated Balance Sheets + + + +F-3 + + + + + + + +Consolidated Statements of Operations + + + +F-5 + + + + + + + +Consolidated Statements of Shareholders' Equity + + + +F-6-7 + + + + + + + +Consolidated Statements of Cash Flows + + + +F-8-9 + + + + + + + +Notes to Consolidated Financial Statements + + + +F-10-23 + + + + + +Report of Independent Certified Public Accountants (Sentigen, Ltd.) + + + +F-24 + + + + + +Audited Annual Financial Statements (Sentigen, Ltd.) + + + + + + + + + + + +Balance Sheets + + + +F-25 + + + + + + + +Statements of Operations + + + +F-26 + + + + + + + +Statements of Shareholders' Equity + + + +F-27 + + + + + + + +Statements of Cash Flows + + + +F-28 + + + + + + + +Notes to Financial Statements + + + +F-29-30 + + + + + +Unaudited Quarterly Financial Statements + + + +F-31 + + + + + +Notes to Unaudited Quarterly Financial Statements + + + +F-36-38 + + + + + +F-1 + + + + + + + +Report of Independent Certified Public Accountants + + + + +Board +of Directors + +Photogen Technologies, Inc. + +New Hope, Pennsylvania + + We +have audited the accompanying consolidated balance sheets of Photogen Technologies, Inc., a development stage company, as of December 31, 2001 and 2002, and the related +consolidated statements of operations, shareholders' equity and cash flows for the period from November 3, 1996 (inception) to December 31, 2002 and for each of the three years in the +period ended December 31, 2002. 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. + + We +conducted our audits in accordance with auditing standards generally accepted in the United States. 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. + + In +our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Photogen Technologies, Inc. at +December 31, 2001 and 2002, and the results of its operations and its cash flows for the period from November 3, 1996 (inception) to December 31, 2002 and for each of the three +years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. + + The +accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the +Company has reported accumulated losses of $28,745,194, which raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are described in +Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. + +/s/ +BDO Seidman, LLP + +Chicago, +Illinois + +March 7, 2003 + +F-2 + + + + + + + +Photogen Technologies, Inc. + + Consolidated Balance Sheets + + + + + +December 31, + + + + +2001 + +2002 + +Assets + + + + + + + +Current Assets + + + + + + + + + + + + + + +Cash and cash equivalents + +$ +1,352,904 + +$ +6,090,904 + + +Deposits (Note 5(a)) + + +474,580 + + +98,721 + + +Prepaid expenses + + +29,775 + + +693,313 + + + + + + +Total Current Assets + + + + + +1,857,259 + + + + + +6,882,938 + +Equipment and Leasehold Improvements, less accumulated depreciation of $1,059,997 and $12,739 (Note 13) + + + + + +882,220 + + + + + +36,000 + +Patent Costs, net of amortization of $100,693 and $142,359, respectively + + + + + +399,307 + + + + + +357,641 + +Deposits (Note 5(a)) + + + + + +69,173 + + + + + +14,383 + +Notes Receivable (Note 11) + + + + + + + + + + + +1,255,000 + +Investment in and Advances to Affiliates (Note 3) + + + + + +10,994,680 + + + + + +8,192,452 + + + + + + + + + + +$ + +14,202,639 + + + +$ + +16,738,414 + + + + + + +F-3 + + + + + + +December 31, + + + + + +2001 + +2002 + + +Liabilities and Shareholders' Equity + + + + + + + + +Current Liabilities + + + + + + + + + +Accounts payable + +$ +373,774 + +$ +835,003 + + + +Accrued expenses (Note 4) + + +568,174 + + +34,132 + + + +Accrued equipment lease (Note 5(a)) + + +374,580 + + +401,664 + + + + + + + + + +Total Current Liabilities + + + + + +1,316,528 + + + + + +1,270,799 + + + + + + + + + + +Accrued Equipment Lease (Note 5(a)) + + + + + +749,160 + + + + + +401,664 + + + + + + + + + + +Long-Term Debt (Note 3) + + + + + +2,314,005 + + + + + + + + + + + + + + + + +Shares Subject to Rescission (Note 6(f)) + + + + + +650,000 + + + + + +650,000 + + + + + + + + + + +Shareholders' Equity (Notes 1, 2, 3, 6 and 7) + + + + + + + + + + + + + + + + +Preferred stock; par value $.01 per share; 5,000,000 shares authorized including: + + + + + + + + + + +Series A Preferred Stock; 12,856 shares authorized, issued and outstanding, liquidation preference $1,000 per share (in aggregate $12,856,000) + + +128 + + +128 + + + + +Series B Preferred Stock; 402,000 shares authorized; 357,280 issued and outstanding at December 31, 2001, liquidation preference $16.88 per share (in aggregate $6,030,886 at December 31, +2001) + + +3,572 + + + + + + +Common stock; par value $.001 per share; 150,000,000 shares authorized; 9,585,948 and 16,137,465 shares issued and outstanding, respectively + + +9,586 + + +16,137 + + + +Additional paid-in capital + + +38,252,973 + + +43,144,880 + + + +Deficit accumulated during the development stage + + +(29,093,313 +) + +(28,745,194 +) + + + + + + + + +Total Shareholders' Equity + + + + + +9,172,946 + + + + + +14,415,951 + + + + + + + + + + + + + + +$ + +14,202,639 + + + +$ + +16,738,414 + + + + + + + + + + +See accompanying notes to consolidated financial statements. + +F-4 + + + + + + + +Photogen Technologies, Inc. + + Consolidated Statements of Operations + + + + + +Year Ended December 31, 2000 + +Year Ended December 31, 2001 + +Year Ended December 31, 2002 + +Cumulative Amounts From November 3, 1996 (Inception) to December 31, 2002 + + +Operating Expenses (Notes 5, 6 and 9) + + + + + + + + + + + + + + + +Research and development + +$ +1,665,450 + +$ +437,958 + +$ +1,227,897 + +$ +4,356,637 + + + +General and administrative + + +5,095,442 + + +3,220,584 + + +4,030,083 + + +16,647,522 + + + +Restructuring charges + + +597,025 + + + + + +807,483 + + +1,404,508 + + + +Provision for future lease payments + + + + + +1,264,208 + + + + + +1,264,208 + + + + + + + + + + + + + +Total operating expenses + + + + + +7,357,917 + + + + + +4,922,750 + + + + + +6,065,463 + + + + + +23,672,875 + + + +Loss From Joint Venture (Note 3) + + + + + +(1,203,392 + +) + + + +(1,952,758 + +) + + + +(3,452,837 + +) + + + +(6,915,016 + +) + +Investment Income + + + + + +417,110 + + + + + +110,741 + + + + + +1,563 + + + + + +1,208,941 + + + +Interest Expense + + + + + + + + + + + +(48,429 + +) + + + +(418,466 + +) + + + +(466,895 + +) + + + + + + + + + + + + +Loss from continuing operations + + + + + +(8,144,199 + +) + + + +(6,813,196 + +) + + + +(9,935,203 + +) + + + +(29,845,845 + +) + +Discontinued Operations (Note 13) + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Loss from operations of discontinued therapeutic business + + +(2,642,863 +) + +(2,909,820 +) + +(1,496,430 +) + +(10,679,101 +) + + +Gain from split-off of therapeutic business + + + + + + + + +11,779,752 + + +11,779,752 + + + + + + + + + + + + + +Income (loss) from discontinued operations + + + + + +(2,642,863 + +) + + + +(2,909,820 + +) + + + +10,283,322 + + + + + +1,100,651 + + + + + + + + + + + + + + +Net Income (Loss) + + + + + +(10,787,062 + +) + + + +(9,723,016 + +) + + + +348,119 + + + +$ + +(28,745,194 + +) + + + + + + + + + + + + + + + + + + + + + + + + + +Dividends on Preferred 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credit with Elan to common stock + + + + + + + + + + + +128,437 + + +128 + + + + + +3,082,359 + + + + + +3,082,487 + + + +Conversion of line of credit with entity controlled by director of company to common stock + + + + + + + + + + + +2,314,815 + + +2,315 + + + + + +2,497,685 + + + + + +2,500,000 + + + +Retirement of common stock returned in shareholder transaction (Note 6(f)) + + + + + + + + + + + +(5,137,109 +) + +(5,137 +) + + + + +(12,221,182 +) + + + + +(12,226,319 +) + + +Issuance of common stock for cash + + + + + + + + + + + +8,823,058 + + +8,823 + + + + + +9,133,078 + + + + + +9,141,901 + + + +Net income for the year ended December 31, 2002 + + + + + + + + + + + + + + + + + + + + + + + +348,119 + + +348,119 + + + + + + + + + + + + + + + + + + + + + + + + + +Balance, at December 31, 2002 + +12,856 + +$ +128 + + + +$ + + +16,137,465 + +$ +16,137 + +$ + + +$ +43,144,880 + +$ +(28,745,194 +) +$ +14,415,951 + + + + + + + + + + + + + + + + + + + + + + + + + +See accompanying notes to consolidated financial statements. + +F-7 + + + + + + +Photogen Technologies, Inc. + + Consolidated Statements of Cash Flows + + + + + +Year Ended + +December 31, 2000 + +Year Ended + +December 31, 2001 + +Year Ended + +December 31, 2002 + +Cumulative Amounts From + +November 3, 1996 + +(Inception) to + +December 31, 2002 + + +Cash Flows From Operating Activities + + + + + + + + + + + + + + + +Net income (loss) + +$ +(10,787,062 +) +$ +(9,723,016 +) +$ +348,119 + +$ +(28,745,194 +) + + +Loss from discontinued operations + + +2,642,863 + + +2,909,820 + + +1,496,430 + + +10,679,101 + + + +Depreciation and amortization + + +416,511 + + +442,191 + + +371,319 + + +1,677,904 + + + +Loss (gain) on disposal of equipment and leasehold improvements + + +43,041 + + +(4,617 +) + + + + +38,424 + + + +Gain on sale of marketable securities + + + + + + + + + + + +(18,503 +) + + +United States Treasury Notes amortization + + +(41,437 +) + +(1,029 +) + + + + +12,586 + + + +Gain on sale of therapeutic 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+ +(237,335 +) + + +Investment in and advances to affiliate + + +93,548 + + +(2,245,948 +) + +(650,609 +) + +(15,107,468 +) + + +Increase in note receivable + + + + + + + + +(1,255,000 +) + +(1,255,000 +) + + +Decrease in restricted cash + + +100,000 + + + + + + + + + + + + +Decrease (increase) in deposit + + +(500,000 +) + +(14,383 +) + +100,000 + + +(443,753 +) + + + + + + + + + + + + +Net cash (used in) provided by investing activities + + +(302,608 +) + +2,784,282 + + +(1,805,609 +) + +(16,431,810 +) + + + + + + + + + + + + +Net cash used in investing activities of discontinued operations + + + + + + + + + + + +(1,306,676 +) + + + + + + + + + + + + +F-8 + + +Photogen Technologies, Inc. + + Consolidated Statements of Cash Flows + + + + +Year Ended + +December 31, + +2000 + +Year Ended + +December 31, + +2001 + +Year Ended + +December 31, + +2002 + +Cumulative + +Amounts + +From + +November 3, + +1996 + +(Inception) to + +December 31, + +2002 + + +Cash Flows From Financing Activities + + + + + + + + + + + + + + + +Principal payments on capital leases + +$ +(21,148 +) +$ +(18,356 +) +$ + + +$ +(291,704 +) + + +Net proceeds from issuance of equity + + +5,276,340 + + +1,068,723 + + +9,141,901 + + +40,509,340 + + + +Proceeds from capital contributions by shareholders + + + + + + + + + + + +1,911,674 + + + +Proceeds from issuance of debt + + + + + +2,314,005 + + +3,032,905 + + +5,346,910 + + + +Cost of recapitalization + + + + + + + + + + + +(371,111 +) + + + + + + + + + + + + +Net cash provided by financing activities + + +5,255,192 + + +3,364,372 + + +12,174,806 + + +47,105,109 + + + + + + + + + + + + + +Net Increase (Decrease) in Cash and Cash Equivalents + + +(1,058,978 +) + +730,109 + + +4,738,000 + + +6,090,904 + + +Cash and Cash Equivalents, at beginning of year + + +1,681,773 + + +622,795 + + +1,352,904 + + + + + + + + + + + + + + + + +Cash and Cash Equivalents, at end of year + +$ +622,795 + +$ +1,352,904 + +$ +6,090,904 + +$ +6,090,904 + + + + + + + + + + + + + +Supplemental Schedule of Noncash Investing and Financing Activities + 2002 + +Payments +due on the accrued equipment lease were made through a reduction in deposits due to the Company in the amount of $330,649. + +Debt +of $5,346,910 and accrued interest of $235,577 were converted to common stock. + +Split-off +of the therapeutic business which included equipment and leasehold improvements of $516,567 and accounts payable of $70,000 in exchange for the Company's common stock valued at $12,226,319. + +See +accompanying notes to consolidated financial statements. + +F-9 + + + + + + +Photogen Technologies, Inc. + + Notes to Consolidated Financial Statement + + +1. Organization and Significant Accounting Policies + + Nature of Operations + + Photogen Technologies, Inc. (the "Company"), through its subsidiary Photogen, Inc., successor to Photogen, L.L.C., is a development stage biopharmaceutical +company that is focusing on developing a novel contrast agent with potential applications (1) as a blood pool agent to diagnose diseased tissue in the cardiovascular system and other organs and (2) to +diagnose cancer metastasizing into the lymphatic system. The Company also has in development certain minimally invasive products for the treatment of psoriasis and other topical diseases and cancer +and certain laser device technology (the therapeutic business). The Company also has an investment in a joint venture (Note 3). In November 2002, the Company split off the therapeutic business to its +original shareholders (see Note 13). + + Principles of Consolidation + + Intercompany balances and transactions have been eliminated in consolidation. + + Liquidity and Basis of Presentation + + The accompanying financial statements are prepared assuming the Company is a going concern. The Company believes it lacks sufficient working capital to fund +operations for the entire fiscal year ending December 31, 2003. Therefore, substantial additional capital resources will be required to fund the ongoing operations related to the Company's research +and business development activities. Management believes there are a number of potential alternatives available to meet the continuing capital requirements such as public or private financings or +collaborative agreements. The Company is taking continuing actions to reduce its ongoing expenses. If adequate funds are not available, the Company will be required to significantly curtail its +operating plans and may have to sell or license out significant portions of the Company's technology or potential products. The 2002 financial statements do not include any adjustment to reflect the +possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of this uncertainty. + + Estimates + + The financial statements include estimated amounts and disclosures based on management's assumptions about future events. Actual results may differ from those +estimates. + + Cash Equivalents + + Highly liquid investments with a maturity of three months or less when purchased are classified as cash equivalents. + + Equipment and Leasehold Improvements + + Equipment and leasehold improvements are stated at cost. Depreciation and amortization of equipment are provided for using the straight-line method over the +estimated useful lives of the assets. Computers and laboratory equipment are being depreciated over five years, furniture and fixtures are being depreciated over seven years and leasehold improvements +are being amortized over five years. Leasehold improvements are being amortized on a straight-line basis over the lives of the respective leases or the service lives of the improvements, whichever is +shorter. Depreciation expense was + +F-10 + + + +$374,845, +$400,525 and $329,653 for 2000, 2001 and 2002, respectively. All equipment and leasehold improvements, except a net amount of $36,000, were transferred in the split-off of the therapeutic +business. + + Long-Lived Assets + + The Company reviews the carrying values of its long-lived assets for possible impairment whenever an event or change in circumstances indicates that the carrying +amount of the assets may not be recoverable. Any long-lived assets held for disposal are reported at the lower of their carrying amounts or fair value less cost to sell. + + Patent Costs + + Internal patent costs are expensed in the period incurred. Patents purchased are capitalized and amortized over the life of the patent. Amortization expense was +$41,666 for 2000, 2001 and 2002. Amortization of patent costs is expected to be $41,666 over the remaining life of the patent. + + Research and Development + + Research and development costs are charged to expense when incurred. + + Income Taxes + + The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the tax basis and financial +reporting basis of certain assets and liabilities based upon currently enacted tax rates expected to be in effect when such amounts are realized or settled. + + Basic and Diluted Loss Per Common Share + + Basic and diluted loss per common share is computed based on the weighted average number of common shares outstanding. Loss per share excludes the impact of +outstanding options, warrants and convertible preferred stock as they are antidilutive. Potential common shares excluded from the calculation at December 31, 2002 are 4,535,481 options, 237,431 +warrants and 151,819 shares issuable upon the conversion of Series A Preferred Stock. Basic and diluted loss per common share includes 124,627 shares of common stock subject to rescission (Note 6(f)). + + Financial Instruments + + The carrying amounts reported in the consolidated balance sheets for cash, accounts payable and accrued expenses approximate fair value because of the short-term +nature of these amounts. The Company's note receivable approximates fair value based on instruments with similar terms. + + Stock Options + + The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS No. +123), but applies the intrinsic value method set forth in Accounting Principles Board Opinion No. 25 for stock options granted to employees and directors. The Company expenses the fair value of stock +options granted to nonemployees. In 2002, the Company issued stock options to employees with an exercise price less than + +F-11 + + + +the +market price on the date of grant. Accordingly, compensation expense of $988,184 has been recorded. + + For +stock options granted to employees and directors, the Company has estimated the fair value of each option granted using the Black-Scholes option pricing model with the following +assumptions: + + + + +2000 + +2001 + +2002 + + +Weighted average fair value per options granted + +$ +18.68 + +$ +3.64 + +$ +1.31 + + +Significant assumptions (weighted average) + + + + + + + + + + + + +Risk-free interest rate at grant date + + +6.2 +% + +4.8 +% + +2.8 +% + + +Expected stock price volatility + + +94.3 +% + +95.5 +% + +98.0 +% + + +Expected option life (years) + + +5 + + +5 + + +5 + + + If +the Company had elected to recognize compensation expense based on the fair value at the grant dates, consistent with the method prescribed by SFAS No. 123, net loss per share would +have been changed to the pro forma amount indicated below: + + + + +2000 + +2001 + +2002 + + +Net income (loss), as reported + +$ +(13,491,813 +) +$ +(12,666,771 +) +$ +(1,649,604 +) + +Add stock based employee compensation expense included in reported net income + + + + + + + + + + + + + + + + + +988,184 + + + +Less total stock-based employee compensation expense determined under the fair value based method for all awards + + + + + +(8,356,534 + +) + + + +(11,314,458 + +) + + + +(6,084,842 + +) + + + + + + + + + + +Pro forma net loss + +$ +(21,848,347 +) +$ +(23,981,229 +) +$ +(6,746,262 +) + + + + + + + + + + +Basic and diluted loss per common share, as reported + + + +$ + +(1.44 + +) + +$ + +(1.33 + +) + +$ + +(0.16 + +) + +Basis and diluted loss per common share, pro forma + + + +$ + +(2.34 + +) + +$ + +(2.52 + +) + +$ + +(0.66 + +) + +F-12 + + + + Reclassification + + Certain 2001 amounts have been reclassified to conform with the 2002 presentation. + + Recent Accounting Pronouncements + + In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement +addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for +Long-Lived Assets to Be Disposed of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a +Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business. The provisions of SFAS 144 are effective for fiscal years +beginning after December 15, 2001. The Company has recorded the split-off of its therapeutic business as a discontinued operation in accordance with SFAS 144. + + In +June 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The standard requires companies to recognize costs associated with +exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination cost and +certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. Previous accounting guidance provided by EITF +Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" is replaced by this +Statement. Statement 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. Management does not anticipate that the adoption of this Statement will have a +significant effect on the Company's financial statements. + + In +November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others" +("Interpretation"). This Interpretation elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at +the time +a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligations it assumes under that guarantee and must disclose that information in its +interim and annual financial statements. The initial recognition and measurement provisions of the Interpretation apply on a prospective basis to guarantees issued or modified after December 31, 2002. + + In +January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities." The objective of this interpretation is to provide guidance on how to identify +a variable interest entity ("VIE") and determine when the assets, liabilities, noncontrolling interests and results of operations of a VIE need to be included in a company's consolidated financial +statements. A company that holds variable interests in an entity may need to consolidate the entity if the Company's interest in the VIE is such that the Company will absorb a majority of the VIE's +expected losses and/or receive a majority of the entity's expected residual returns, if they occur. Interpretation No. 46 also requires additional disclosures by primary beneficiaries and other +significant variable interest holders. The provisions of this interpretation became effective upon issuance. The Company believes that Sentigen will be considered a VIE; however, the Company does not +expect its accounting for its interest in Sentigen to change. + + In +December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based +Compensation." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based compensation and requires pro forma disclosures of + +F-13 + + + +the +effect on net income and earnings per share had the fair value method been used to be included in annual and interim reports and disclosure of the effect of the transition method used if the +accounting method was changed, among other things. SFAS No. 148 is effective for annual reports of fiscal years ending after December 15, 2002 and interim reports beginning after December 15, 2002. +The Company plans to continue using the intrinsic value method of accounting for stock-based compensation and, therefore, the new rule will have no effect on the Company's financial condition or +results of operations. The Company adopted the disclosure requirements effective December 15, 2002. + +2. Recapitalization and Merger + + On May 16, 1997, MT Financial Group, Inc. (an inactive public company), through its wholly owned subsidiary, effected a reverse merger with Photogen, Inc. +("Photogen"), successor to Photogen, L.L.C. Photogen, L.L.C. was formed on September 10, 1996 and commenced operations November 3, 1996. Photogen, L.L.C. was formed to develop proprietary laser-based +technologies related to photodynamic therapy. Legally, Photogen was a wholly owned subsidiary of Photogen Technologies, Inc. (formerly known as MT Financial Group, Inc.). + + For +financial reporting purposes, Photogen was deemed to be the acquiring entity. The transaction has been reflected in the accompanying financial statements as (1) a recapitalization of +Photogen (consisting of a 48,000-for-one stock split and change in par value) and (2) an issuance of shares by Photogen in exchange for all of the outstanding shares of MT Financial Group, Inc. + + As +part of the recapitalization, the Company sold 1,578,208 shares of common stock for a total purchase price of approximately $1,803,450. Legal and brokerage fees of approximately +$371,000 were charged to additional paid-in capital as costs of the recapitalization and merger. Included in the paid-in capital is the net cash of approximately $109,000 from MT Financial Group, Inc. + +3. Joint Venture/ Investment in Affiliate + + On October 7, 1999, the Company formed a joint venture with Elan International Services, Ltd. ("Elan") to develop and commercialize nanoparticulate diagnostic +imaging agents for the detection and treatment of cancer through lymphography. + + Sentigen +Ltd. ("Sentigen") was formed to hold the operations, assets and liabilities of the joint venture. Elan purchased 2,980 shares of Sentigen nonvoting convertible preferred stock +for $2,985,000 representing a 19.9% ownership interest. Elan also purchased 12,015 shares of the Company's Series A convertible exchangeable preferred stock for $12,015,000. In connection with the +issuance of the preferred stock to Elan, the Company granted warrants to Elan to purchase 100,000 shares of the Company's common stock at $84.68 per share which was valued at $678,000. As a result, a +preferred stock dividend of $436,041 was recorded for the accretion of the preferred stock to its face value of $12,015,000 over the period until it is first convertible. Beginning in 2000, in +accordance with EITF 00-27, the Company recorded an additional preferred stock dividend to represent the beneficial conversion feature associated with the intrinsic value of the Series A Preferred +conversion option. As a result, an additional preferred stock dividend of $436,041 was recorded over the period until it is first convertible. As of December 31, 2001, the beneficial conversion +feature was fully recorded. + + The +Company purchased 12,000 shares of Sentigen's common stock for $12,015,000 representing an 80.1% ownership interest. + + Sentigen +used the $15,000,000 received from the Company and Elan to purchase from Elan a worldwide license to certain patented Elan technology related to the joint venture. Expenses +incurred by the Company and Elan, which relate to the development of the diagnostic imaging agents, are charged to Sentigen. + +F-14 + + + + Elan +granted the Company a line of credit of $4,806,000 to be used by the Company to fund their portion of Sentigen's research and development. Principal and interest under the line of +credit, if any, become due and payable in 2005 or, at the option of Elan, can be converted into the Company's common stock at $72.60 per share. Any borrowings under the line of credit would bear +interest at 8%. At December 31, 2001, borrowings on this line of credit were $2,314,005 and accrued interest was $48,429. During 2002, the Company borrowed an additional $532,905 and incurred +additional accrued interest of $187,148. On November 12, 2002, the total borrowings of $2,846,910 and accrued interest of $235,577 were converted to common stock at a conversion price of $24 per +share. A beneficial conversion amount of $206,348 was recorded as a result of the decrease in the original conversion price. + + In +connection with the joint venture agreement, Elan also purchased 115,385 shares of the Company's common stock for $6,000,000. If, in the Company's next third-party offering after the +issuance of the Series A Preferred, it sells common stock at a price less than $52 per share, the Company must issue additional shares to Elan so that Elan's overall price for its common stock equals +the effective price in that third-party offering. During 2001, the Company issued 190,857 shares of common stock to satisfy this requirement. + + The +total cash proceeds from the equity issuance to Elan of $18,015,000 were allocated to the common stock, preferred stock and the warrants. + + Elan +has substantive participating rights in Sentigen, including the requirement for approval of the business plan and budgets and equal representation on the management committee which +decides all day-to-day functions. As a result, the Company's investment in Sentigen is recorded under the equity method. + + Following +is summarized financial information for Sentigen at December 31, 2001 and 2002: + + + + +2001 + +2002 + + +Cash + +$ +9,345 + +$ +410 + + +License purchased from Elan, net of amortization of $1,222,829 and $2,201,093, respectively + + +13,777,171 + + +10,298,907 + + + + + + + + + +Total assets + +$ +13,786,516 + +$ +10,299,317 + + + + + + + + + +Due to affiliates + +$ +210,596 + +$ +378,099 + + +Total shareholders' equity + + +13,575,920 + + +9,921,218 + + + + + + + + + +Total liabilities and equity + +$ +13,786,516 + +$ +10,299,317 + + + + + + + + + +Research and development expense + +$ +1,450,291 + +$ +823,409 + + +General and administrative expense + + + + + +18,329 + + +Amortization of license + + +978,264 + + +978,264 + + +Impairment of license + + + + + +2,500,000 + + + + + + + + + +Net loss + +$ +(2,428,555 +) +$ +(4,320,002 +) + + + + + + + + +F-15 + + 4. Accruals + + Accrued expenses consist of the following: + + + + +December 31, + + + + +2001 + +2002 + +Accrued salaries + +$ +93,963 + +$ + + +Accrued bonuses + + +251,850 + + + + +Accrued interest (Note 3) + + +48,429 + + + + +Accrued restructuring (Note 9) + + +173,932 + + + + +Payroll liabilities + + + + + +34,132 + + + + + + + + +$ +568,174 + +$ +34,132 + + + + + + +5. Commitments + +(a)At +December 31, 2002, the Company has a lease for office space in New Hope, Pennsylvania, expiring in August 2004. + + The +Company also has an operating lease for laboratory equipment expiring in 2004. During 2001, the Company determined that equipment leased by the Company under this operating lease +would no longer be used by the Company in its research. As a result, in 2001, the Company recorded a provision for all future lease payments of $1,264,208. $568,138 of this provision was recorded in +the fourth quarter. At December 31, 2002, $803,328 remains to be paid. In conjunction with this operating lease, the Company provided $500,000 as cash collateral to be refunded over the term of the +lease. In 2002, $100,000 was refunded and, accordingly, this amount was recorded as a current deposit at December 31, 2001. The Company and the lessor agreed to offset certain remaining lease payments +with the remaining $400,000 deposit. In 2002, lease payments of approximately $331,000 were offset with the deposit. + + Total +rental expense charged to operations for the years ended December 31, 2000, 2001 and 2002 aggregated approximately $352,000, $358,000 and $227,000, respectively. + + Minimum +future rental payments under these leases are as follows: + +Year ending December 31, + + +Operating + +Leases + +2003 + +$ +574,000 + +2004 + + +502,000 + + + + +Total + +$ +1,076,000 + + + + +(b)The +Company has entered into employment agreements with certain officers and employees. The officers and employees are each entitled to severance ranging from six months to one year +of their annual salary if terminated without cause. Total severance commitments are $500,000 under these agreements. + +6. Equity Transactions + +(a)The +Company applies the recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," in accounting for stock options issued to nonemployees. The Company has +issued options and warrants in exchange for consulting services rendered. The Company issued 10,000 options in 1998, 2,500 options and 125,500 warrants in 1999, 5,250 options and 128,750 warrants in +2000, 7,500 options in 2001 and 200,000 warrants in 2002. In addition, there were 190,000 +F-16 + + + +contingent +warrants issued for which no expense has been recognized as of December 31, 2002. As the fair market value of these services was not readily determinable, these services were valued based +on the fair market value, determined using the Black-Scholes option pricing model. Fair market value for options and warrants ranged from $5.36 to $38.04 in 2000, $3.08 in 2001 and $1.01 to $1.81 in +2002. Consulting costs charged to operations were $2,316,282 in 2000, $825,092 in 2001 and $395,870 in 2002. In 2002, the Company also issued 390,556 options in settlement of a lawsuit associated with +restructuring costs (Note 9). The value of these options was $806,415 which was recorded as restructuring charges in 2002. + +(b)In +August 1999, the Company purchased patents for $500,000 which were satisfied by the issuance of 10,832 shares of the Company's common stock valued at $300,000 and cash of $200,000. + +(c)In +1999, the Company issued 185,000 variable stock options to employees which would vest upon completion of performance milestones. Exercise prices ranged from $37.52 to $72.52 and +expired in 10 years. As of December 31, 1999, 18,750 of these shares had vested. Compensation charged to operations was $225,000 in 1999. In 2000, all of these variable stock options were cancelled. + +(d)Series +A Preferred Stock The Company originally designated 12,015 shares of preferred stock as Series A Preferred Stock ("Series A Preferred"). For the first six years +from issuance, the preferred stock has a mandatory dividend of 7%. Such dividends are cumulative and compound on a semiannual basis and are payable semiannually solely by the issuance of additional +preferred Series A stock. The Company has a deficit and, as a result, the dividends have been recorded against paid-in capital. In accordance with the provisions of the agreement, the Company issued +additional preferred shares of 841 in 2000 in settlement of dividend requirements. Therefore, at December 31, 2002, there were 12,856 shares of Series A Preferred outstanding. The Company has accrued +and will issue 1,914 preferred shares in fulfillment of the 2001 and 2002 dividend requirement. The Series A Preferred shall rank senior to any future series of preferred stock unless the majority of +the Series A shareholders agree to rank pari passu with any future issuances. The liquidation preference is $1,000 per share. The Series A Preferred is +convertible, after two years but before six years from issuance, into common stock of the Company with an initial conversion price of $84.68. The conversion price is subject to adjustment for certain +dilutive events. Alternatively, the holder of the Series A Preferred can elect to exchange the Series A preferred shares for the number of shares in Sentigen which would allow the Series A holder to +then own a total of 50% of Sentigen. The Series A holder is currently the minority shareholder in Sentigen. The exchange right is not available for any shares which have been converted to common +stock. The exchange right terminates six years from the issuance of the Series A Preferred. The Series A Preferred was issued in October 1999. + +The +holder of Series A Preferred is only entitled to vote on matters that adversely affect or change the rights of holders of Series A Preferred and does not have the right to vote on the election of +directors of the Company. The holder of Series A Preferred also has a preemptive right until October 2003 to participate in any offering of the Company. + +(e)Series +B Preferred Stock In February 2000, the Company completed a private placement of its Series B Convertible Preferred Stock ("Series B Preferred"). The Company +received cash proceeds, net of related expenses, of $5,276,340 in exchange for 337,056 shares of the Series B Preferred. The Series B Preferred has an annual dividend rate of 6%. Such dividends are +cumulative, shall compound on an annual basis and are payable annually by the issuance of additional preferred Series B stock. The Company has a deficit and, as a result, the dividends will be +recorded against paid-in capital. In accordance with the provisions of the agreement, the Company issued additional preferred shares of 20,224 in 2001 and 40,194 in 2002 in settlement of dividend +requirements. +F-17 + + + +Subject +to the senior liquidation preference of the Series A Preferred stockholder, and the liquidation preference of any senior or pari passu securities created by the Company in the future with the +requisite consent of the holders of Series B Preferred, each share of Series B Preferred is entitled to a liquidation preference equal to $16.88 per share, before any amounts are paid on the common +stock on liquidation. If the Company is acquired by another entity or sells all or substantially all of its assets, +and if it pays an amount equal to the liquidation preference of the Series A Preferred and any other senior security, holders of Series B Preferred will be entitled to receive the liquidation +preference unless the stockholders prior to the transaction hold at least 50% of the voting power of the surviving or acquiring entity or if the holders of a majority of Series B Preferred agree by +vote or written consent to exclude the acquisition or sale from this provision. + +Each +share of Series B Preferred has the number of votes equal to the number of shares of common stock into which the share of Series B Preferred would be convertible, and is entitled to vote together +with the common stock. Certain matters, such as an amendment to the terms of the Series B Preferred Certificate of Designation or a change in the preferences or any relative or other rights of the +Series B Preferred (except for issuance of a special senior security), may have to be approved by a majority of the holders of Series B Preferred voting as a separate class. This right is subject to +the Company's ability to require mandatory conversion of Series B Preferred if a special senior security (discussed below) is not approved. + +Holders +of Series B Preferred may convert shares of Series B Preferred into 0.36 shares of common stock at any time. + +The +Series B Preferred contains beneficial conversion features. Emerging Issues Task Force Issue 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently +Adjustable Conversion Ratios," requires the issuer to assume that the holder will not convert the instrument until the time of the most beneficial conversion, which would occur after January 1, 2002. +Using the conversion ratio at January 1, 2002 of 0.36 shares of common stock and the stock price at the date of issuance, the maximum beneficial conversion amount is $2,322,316. This amount was +recorded as additional preferred stock dividends over the period from issuance until January 1, 2002. Through December 31, 2001, this full amount has been recorded as additional dividends. + +The +conversion ratio is subject to adjustment for certain dilutive events, including issuance of common stock or equivalent securities at less than $16.88 per share. In 2001, the Company issued common +stock at less than $16.88. As a result, the revised conversion ratio for the number of shares of common stock issuable upon conversion of Series B Preferred is 0.36175. + +The +Company may require holders of Series B Preferred to convert their shares into common stock (at the same ratios that would apply for a voluntary conversion, except as described in the second and +third bullet points below) in connection with any of the following events: + + If +the holders of a majority of the Series B Preferred approve a mandatory conversion; + + Immediately +prior to a firm commitment, underwritten public offering of the Company's common stock in which they receive $20 million or more in gross proceeds; + + If +the holders of a majority of Series B Preferred do not approve any transaction to issue a security senior or pari passu to the Series B Preferred in a transaction +involving any vendor, licensor or joint venturer or other commercial transaction (a "special senior security"), the purpose of which is not solely to provide financing, and which the Board has +approved and recommended; or + + At +any time after January 1, 2005. + +F-18 + + + +In +conjunction with the financing on November 12, 2002 (see Note 6(f)), all of the Series B Preferred was converted into common stock. In exchange for this conversion, the conversion ratio of 0.36175 +was changed to 1.0625. As a result, the Series B Preferred was converted into 422,316 shares of common stock and a beneficial conversion amount of $668,464 has been recorded. The Series B Preferred is +no longer outstanding, nor is there any liquidation preference associated with the Series B Preferred. + +(f)Common +Stock The Company is subject to six sets of registration rights agreements covering an aggregate of 11,912,779 shares of the Company's common stock, warrants that +have vested covering the Company's common stock and common stock issuable upon conversion of the Company's Series A Preferred. All of the agreements contain piggyback registration rights and two +contain demand registration rights upon the occurrence of certain events and subject to various terms and conditions. Of the 11,912,779 shares, 1,000,000 shares are entitled to piggyback registration +only, 50,000 shares are entitled to both demand and piggyback registration and 10,862,779 shares will be registered by the Company within the time frames set forth in the respective registration +agreements. Warrants that have vested covering 237,431 shares of the Company's common stock have weighted average anti-dilution rights. + +On +March 13, 1998, the Company completed a private placement of 218,755 shares of common stock for $32 per share to a number of accredited investors. The Company received $7,000,000 in gross proceeds +from this offering. + +On +February 9, 2001, the Company's shelf registration on Form S-3 was declared effective. Under the shelf registration, the Company could have issued up to $40,000,000 of common stock. As of December +31, 2002, 173,872 shares have been issued under the shelf registration for cash proceeds of $1,068,723, net of related expenses of $56,252. The Company's registration statement is no longer effective. + +As +of April 2, 2001, the Company no longer met the eligibility requirements to continue selling shares under the S-3. Prior to realizing it was ineligible to continue using the S-3, the Company sold +124,627 shares of common stock for $650,000. This amount has been reclassified from permanent equity to mezzanine equity as the Company could be required to repay a portion of this amount to the +purchaser. + +On +November 12, 2002, the Company completed a private placement of 8,333,334 shares of common stock for $1.08 per share to a number of accredited investors. The Company received proceeds of +$8,613,000, net of related expenses of $387,000. Proceeds included cash of $6,113,000 and the conversion of a credit facility with an entity controlled by a director of the Company with borrowings of +$2,500,000 which converted into 2,314,815 shares of common stock. + + In +December 2002, the Company completed a second closing of the November 12, 2002 private placement in which 2,804,539 shares of common stock were sold for $1.08 per share for proceeds +of $3,028,902. + + On +November 12, 2002, the Company also effected the split-off of Photogen, Inc. and the assets and liabilities related to the Company's therapeutic line of business to the five founding +stockholders of the Company (the "Tennessee Stockholders") in exchange for all of their common stock in the Company. The Tennessee Stockholders owned 5,137,109 shares of the Company and those shares +were cancelled prior to December 31, 2002. The market value of the 5,137,109 shares on the date of the split-off was $12,226,319. + + In +conjunction with the November 12, 2002 transactions, the Company implemented a one-for-four reverse split of its common stock. All amounts have been retroactively stated to reflect +this reverse stock split. + +F-19 + + 7. Stock Incentive Plans and Warrants + + The Company maintains three long-term incentive compensation plans, which are described as follows: + + The +1998 Long-Term Incentive Compensation Plan, which provides for the granting of up to 500,000 stock options to key employees, directors and consultants; + + The +2000 Long-Term Incentive Compensation Plan, which provides for the granting of up to 4,568,750 stock options to key employees, directors and consultants; + + The +2000 Senior Executive Long-Term Incentive Compensation Plan, which provides for the granting of up to 1,000,000 stock options to senior executives. + + Options +granted under these plans may be either "incentive stock options" within the meaning of Section 422A of the Internal Revenue Code, or nonqualified options. + + The +stock options are exercisable over a period determined by the Board of Directors (through its Compensation Committee), but generally no longer than 10 years after the date they are +granted. + + Information +with respect to the plans follows: + + + + +Year ended December 31, + + + + + +2000 + +2001 + +2002 + + +Options outstanding at beginning of year + + +301,375 + + +1,411,000 + + +1,629,750 + + +Options granted + + +1,386,500 + + +218,750 + + +2,914,356 + + +Options forfeited + + +(276,875 +) + + + + +(8,625 +) + + + + + + + + + + +Options outstanding at end of year + + +1,411,000 + + +1,629,750 + + +4,535,481 + + + + + + + + + + + +Option prices per share granted + +$ +11.00 - 60.00 + +$ +4.56 - 21.24 + +$ +1.08 - 4.20 + + + + + + + + + + + +Weighted average exercise price + + + + + + + + + + + + +Options granted + +$ +41.52 + +$ +8.12 + +$ +1.14 + + + +Options granted at less than market price + + + + + + + + +1.08 + + + +Options granted at the market price + + +41.52 + + +8.12 + + +1.55 + + + +Options forfeited + + +47.28 + + + + + +18.41 + + + +Options outstanding at end of year + + +41.88 + + +37.16 + + +14.05 + + + +Options exercisable at end of year + + +25.48 + + +43.04 + + +19.85 + + +Number of shares exercisable + + +28,125 + + +458,333 + + +2,057,208 + + +F-20 + + + + In 2002, all stock options granted, except for 390,556 options granted in settlement of a lawsuit, were granted to employees at an exercise price less than the +market value at grant date. The weighted average fair value of the options issued below market is $1.31. + +Options Outstanding + +Options Exercisable + +Range of Exercise Price + +Number Outstanding at December 31, 2002 + +Weighted Average Exercise Price + +Weighted Average Remaining Contractual Life (Years) + +Number Outstanding at December 31, 2002 + +Weighted Average Exercise Price + +$1.08 + +2,876,856 + +$ +1.08 + +9.5 + +1,044,416 + +$ +1.08 + +$4.20 - 4.56 + +81,250 + +$ +4.39 + +7.8 + +71,875 + +$ +4.37 + +$6.80 - 8.52 + +157,500 + +$ +8.15 + +8.1 + +45,000 + +$ +7.98 + +$11.00 + +381,625 + +$ +11.00 + +7.9 + +200,375 + +$ +11.00 + +$21.25 - 27.50 + +16,250 + +$ +22.69 + +8.1 + +6,875 + +$ +24.66 + +$33.00 - 44.50 + +259,500 + +$ +33.42 + +7.6 + +176,167 + +$ +33.62 + +$51.00 - 53.00 + +10,000 + +$ +52.50 + +5.8 + +10,000 + +$ +52.50 + +$60.00 - 60.25 + +752,500 + +$ +60.00 + +7.5 + +502,500 + +$ +60.00 + + Information with respect to warrants follows: + + + + +Year ended December 31, + + + + + +2000 + +2001 + +2002 + + +Warrants outstanding at beginning of year + + +150,500 + + +287,431 + + +287,431 + + +Warrants granted + + +136,931 + + + + + +390,000 + + +Warrants forfeited + + + + + + + + +(250,000 +) + + + + + + + + + + +Warrants outstanding at end of year + + +287,431 + + +287,431 + + +427,431 + + + + + + + + + + + +Warrant prices per share outstanding + +$ +37.80 - 84.68 + +$ +37.80 - 84.68 + +$ +1.08 - 84.68 + + + + + + + + + + + +Weighted average exercise price + + + + + + + + + + + + +Warrants granted + +$ +40.24 + +$ + + +$ +1.78 + + + +Warrants forfeited + +$ + + +$ + + +$ +37.80 + + + +Warrants outstanding at end of year + +$ +43.08 + +$ +43.08 + +$ +7.94 + + + +Warrants exercisable at end of year + +$ +43.08 + +$ +43.08 + +$ +12.27 + + + +Number of warrants exercisable + + +287,431 + + +287,431 + + +237,431 + + +Warrants Outstanding + + + +Warrants Exercisable + +Range of Exercise Price + +Number Outstanding at December 31, 2002 + +Weighted Average Exercise Price + +Weighted Average Remaining Contractual Life (Years) + +Number Outstanding at December 31, 2002 + +Weighted Average Exercise Price + +$1.08 - 2.52 + +390,000 + +$ +1.78 + +4.5 + +200,000 + +$ +1.08 + +$44.20 - 47.78 + +12,431 + +$ +46.67 + +3.8 + +12,431 + +$ +46.67 + +$84.68 + +25,000 + +$ +84.68 + +1.7 + +25,000 + +$ +84.68 + +F-21 + + + +8. Dividends + + Dividends are comprised of the following: + + + + +Year ended December 31, + + + + +2000 + +2001 + +2002 + +Accrual of dividend on Series A Convertible Preferred + +$ +868,248 + +$ +930,090 + +$ +996,335 + +Deemed dividend associated with beneficial conversion feature of Series A Convertible Preferred + + +480,928 + + +391,154 + + + + +Accrual of dividend on Series B Convertible Preferred + + +296,478 + + +359,292 + + +332,924 + +Deemed dividend associated with beneficial conversion feature of Series B Convertible Preferred + + +1,059,097 + + +1,263,219 + + + + +Deemed dividend associated with beneficial conversion of Series B Convertible Preferred to Common Stock + + + + + + + + +668,464 + + + + + + + + +Total + +$ +2,704,751 + +$ +2,943,755 + +$ +1,997,723 + + + + + + + + +9. Restructuring + + In 2000, the Company recorded a restructuring charge of $597,025, included in operating expenses, relating to the closure of its operations in Westborough, +Massachusetts. The restructuring charge includes accruals related to estimated lease termination costs and accruals related to employee severance and related expenses in connection with their +termination. All employees at the Westborough facility were terminated. The activities previously performed at the Westborough facility were continued at other company locations or with outside +consultants. In 2002, the Company recorded an additional restructuring charge related to additional termination costs for one of the Westborough employees. As of December 31, 2002, all restructuring +costs have been settled. The restructuring charge is summarized as follows: + + + + +Charged in + +2000 + +Utilized in + +2000 + +Balance + +at + +December 31, + +2000 + +Utilized in + +2001 + +Balance + +at + +December 31, + +2001 + +Charged in + +2002 + +Utilized in + +2002 + +Balance + +at + +December 31, + +2002 + +Employee costs + +$ +395,223 + +$ +65,223 + +$ +330,000 + +$ +156,068 + +$ +173,932 + +$ +807,483 + +$ +981,415 + +$ + + +Lease costs + + +201,802 + + +201,802 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Total + +$ +597,025 + +$ +267,025 + +$ +330,000 + +$ +156,068 + +$ +173,932 + +$ +807,483 + +$ +981,415 + +$ + + + + + + + + + + + + + + + + + + + +10. Income Taxes + + In 2002, the Company had taxable income due to the gain from the split-off of the therapeutic business (Note 13). This resulted in current income tax expense of +approximately $2,300,000 which was completely off-set by net operating losses. + + The +Company has not recorded an income tax benefit for net operating losses remaining of approximately $14,000,000, primarily expiring in 2018 through 2021, or for equity losses in +affiliate of approximately $7,000,000. The Company is in the development stage and realization of the losses is not considered more likely than not. An income tax valuation allowance has been provided +for the deferred tax assets related to the net operating loss carryforwards and the losses in affiliate. + + A +portion of the net operating loss carryforwards will not remain with the Company as a result of the split-off of the therapeutic business. However, the amount of these net operating +losses is not known. + +11. Notes Receivable + + The Company has executed a term sheet with Alliance Pharmaceutical Corp. ("Alliance") to buy certain assets of Alliance. As of December 31, 2002, the Company has +loaned to Alliance $1,255,000 for Alliance's working capital purposes. These loans are evidenced by 8% convertible secured promissory notes which are secured by certain assets of Alliance. Based on +the nature of the Company's security interest in the collateral and the estimated value of the collateral, management has determined that a reserve for doubtful collection of the notes receivable is +not necessary at December 31, 2002. + +F-22 + + + +12. Selected Quarterly Financial Data (Unaudited) + + Summarized quarterly financial data for 2002 and 2001 is as follows: + + + + +Quarter + + +2002 + +First + +Second + +Third + +Fourth + + +Operating expenses (a) + +$ +1,208,285 + +$ +906,957 + +$ +1,218,083 + +$ +2,732,138 + + +Loss from continuing operations (b) + + +(1,813,246 +) + +(1,341,652 +) + +(1,594,897 +) + +(5,185,408 +) + +Income (loss) from discontinued operations (c) + + +(502,449 +) + +(544,657 +) + +(244,719 +) + +11,575,147 + + +Net income (loss) + + +(2,315,695 +) + +(1,886,309 +) + +(1,839,616 +) + +6,389,739 + + +Basic and diluted loss per share from continuing operations + + +(0.23 +) + +(0.17 +) + +(0.20 +) + +(0.51 +) + +Basic and diluted income (loss) per share from discontinued operations + + +(0.05 +) + +(0.06 +) + +(0.03 +) + +0.96 + + +Basic and diluted income (loss) per share + + +(0.28 +) + +(0.23 +) + +(0.23 +) + +0.45 + + + + + + + + + + + + + + + + +Quarter + + +2001 + +First + +Second + +Third + +Fourth + + +Operating expenses + +$ +1,930,626 + +$ +714,271 + +$ +931,288 + +$ +1,346,565 + + +Loss from continuing operations + + +(2,346,978 +) + +(1,375,848 +) + +(1,264,813 +) + +(1,825,557 +) + +Loss from discontinued operations + + +(680,134 +) + +(698,149 +) + +(738,562 +) + +(792,975 +) + +Net loss + + +(3,027,112 +) + +(2,073,997 +) + +(2,003,375 +) + +(2,618,532 +) + +Basic and diluted loss per share from continuing operations + + +(0.33 +) + +(0.23 +) + +(0.31 +) + +(0.26 +) + +Basic and diluted loss per share from discontinued operations + + +(0.07 +) + +(0.07 +) + +(0.08 +) + +(0.08 +) + +Basic and diluted loss per share + + +(0.40 +) + +(0.30 +) + +(0.29 +) + +(0.34 +) + + + + + + + + + + + + +(a)Operating +expenses for the fourth quarter 2002 includes a charge of $988,184 from the issuance of stock options to employees. + +(b)Loss +from continuing operations for the fourth quarter 2002 includes an increase in loss from joint venture of $2,000,000 resulting from the impairment of the joint venture's licensed +technology. + +(c)Income +(loss) from discontinued operations for the fourth quarter 2002 includes a gain of $11,779,752 from the sale of the therapeutic business. + +(d)Earnings +per share calculations for each of the quarters are based on the weighted average shares outstanding for each period. The sum of the quarters may not necessarily be equal to +the full year earnings per share amounts. + +13. Discontinued Operations + + On November 12, 2002, the Company split off its therapeutic business to the Tennessee Stockholders in exchange for all of the Tennessee Stockholders' stock in the +Company which totaled 5,137,109 shares. Net assets transferred in the split-off included fixed assets with net book value of $516,567 and accounts payable of $70,000. At December 31, 2001, the net +book value of the fixed assets transferred was $882,220 and the related payable was $70,000. + + The +Company has reviewed the provisions of SFAS 144 and has determined that the sale of therapeutic business meets the two conditions necessary for presentation as discontinued +operations. Those conditions are (a) the operations and cash flow of the component have been or will be eliminated from the ongoing operations of the entity as a result of the disposal transaction and +(b) the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. + + The +split-off of the therapeutic business was effective on November 12, 2002 and, as such, the consolidated balance sheet of the Company at December 31, 2002 does not include the assets +or liabilities of the therapeutic business. The Company recorded a loss from operations of the therapeutic business of $1,454,430 and a gain on the sale of the therapeutic business of $11,779,752 for +the year ended December 31, 2002. There were no revenues from the therapeutic business since its inception. + +F-23 + + + +Independent Auditors' Report + + + +Board of Directors + +Sentigen Ltd. + +Bermuda + + + +We have audited the accompanying balance sheets of Sentigen Ltd., a development stage company, as of December 31, 2002 and 2001, and the related statements of operations, shareholders' +equity and cash flows for the period from October 7, 1999 (inception) to December 31, 2002 and for each of the three years in the period ended December 31, 2002. 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. + +We conducted our audits in accordance with auditing standards generally accepted in the United States. 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. + +In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sentigen Ltd. at December 31, 2002 and 2001, and the +results of its operations and its cash flows for the period from October 7, 1999 (inception) to December 31, 2002 and each of the three years in the period ended December 31, +2002, in conformity with accounting principles generally accepted in the United States. + + + +/s/ BDO Seidman, LLP + +Chicago, Illinois + +April 8, 2003 + +F-24 + + + + + + + +Sentigen Ltd. + + + + +Balance Sheets + + + + +December 31, + + +2002 + +2001 + + +Assets + + + + + + + + +Current Assets + + + + + + + + + + + + + + + + + +Cash + +$ +410 + +$ +9,345 + + + + + + + + + +License of Elan Technology, net of amortization of $2,201,093 and $1,222,829, + + respectively + + + + + +10,298,907 + + + + + +13,777,171 + + + + + + + + + + + + +$ +10,299,317 + +$ +13,786,516 + + + + + + + + + +Liabilities and Shareholders' Equity + + + + + + + + + + + + + + + +Current Liabilities + + + + + + + + + + + + + + + + + +Due to shareholders + +$ +378,099 + +$ +210,596 + + + + + + + + + +Shareholders' Equity + + + + + + + + + + + + + + + + + +Preferred stock; par value $1.00 per share; 2,980 shares authorized, issued and + + outstanding + + +2,980 + + +2,980 + + + + +Common stock; par value $1.00 per share; 12,000 shares authorized, issued and + + outstanding + + +12,000 + + +12,000 + + + + +Additional paid-in capital + + +18,539,215 + + +17,873,915 + + + + +Deficit accumulated during the development stage + + +(8,632,977 +) + +(4,312,975 +) + + + + + + + + +Total Shareholders' Equity + + +9,921,218 + + +13,575,920 + + + + + + + + + + + +$ +10,299,317 + +$ +13,786,516 + + + + + + + + + +See accompanying notes to financial statements. + + + +F-25 + + + + + + + +Sentigen Ltd. + + + + +Statements of Operations + + + + + + + +Year ended + +December 31, + +2002 + +Year ended + +December 31, + +2001 + +Year ended + +December 31, + +2000 + +Cumulative + +Amounts From + +October 7, + +1999 + +(Inception) to + +December 31, + +2002 + + +Operating Expenses + + + + + + + + + + + + + + + + +Research and development + +$ +823,409 + +$ +1,450,291 + +$ +1,257,815 + +$ +3,913,555 + + + + +General and administrative + + +18,329 + + + + + + + + +18,329 + + + + +Amortization of license + + +978,264 + + +978,264 + + +244,565 + + +2,201,093 + + + + +Impairment of license + + +2,500,000 + + + + + + + + +2,500,000 + + + + + + + + + + + + + +Net Loss + +$ +(4,320,002 +) +$ +(2,428,555 +) +$ +(1,502,380 +) +$ +(8,632,977 +) + + + + + + + + + + + + +See accompanying notes to financial statements. + + + +F-26 + + + + + + + +Sentigen Ltd. + + + + +Statements of Shareholders' Equity + + + + + + + + + + + + + + + + + + + + + + +Deficit + +Accumulated + +During the + +Development + +Stage + + + + + + + + +Preferred Stock + +Common Stock + + + + + + + + + + + +Additional + +Paid-in + +Capital + + + + + + + + +Shares + +Amount + +Shares + +Amount + +Total + + +Issuance of common stock + + + +$ + + +12,000 + +$ +12,000 + +$ +12,003,000 + +$ + + +$ +12,015,000 + + +Issuance of preferred stock + +2,980 + + +2,980 + + + + + + + +2,982,020 + + + + + +2,985,000 + + +Net loss for the period October 7, 1999 to + + December 31, 1999 + + + + + + + + + + + + + + + +(382,040 +) + +(382,040 +) + + + + + + + + + + + + + + + + + + +Balance, at December 31, 1999 + +2,980 + + +2,980 + +12,000 + + +12,000 + + +14,985,020 + + +(382,040 +) + +14,617,960 + + +Net loss for the year ended December 31, 2000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +(1,502,380 + +) + + + +(1,502,380 + +) + + + + + + + + + + + + + + + + + + +Balance, at December 31, 2000 + +2,980 + + +2,980 + +12,000 + + +12,000 + + +14,985,020 + + +(1,884,420 +) + +13,115,580 + + +Contribution of capital + + + + + + + + + + + + + + + + + + + + + + + + + +2,888,895 + + + + + + + + + + + +2,888,895 + + + +Net loss for the year ended December 31, 2001 + + + + + + + + + + + + + + + +(2,428,555 +) + +(2,428,555 +) + + + + + + + + + + + + + + + + + + +Balance, at December 31, 2001 + +2,980 + + +2,980 + +12,000 + + +12,000 + + +17,873,915 + + +(4,312,975 +) + +13,575,920 + + +Contribution of capital + + + + + + + + + + + + + + + + + + + + + + + + + +665,300 + + + + + + + + + + + +665,300 + + + +Net loss for the year ended December 31, 2002 + + + + + + + + + + + + + + + +(4,320,002 +) + +(4,320,002 +) + + + + + + + + + + + + + + + + + + +Balance, at December 31, 2002 + +2,980 + +$ +2,980 + +12,000 + +$ +12,000 + +$ +18,539,215 + +$ +(8,632,977 +) +$ +9,921,218 + + + + + + + + + + + + + + + + + + + +See accompanying notes to financial statements. + + + +F-27 + + + + + + + +Sentigen Ltd. + + + + +Statements of Cash Flows + + + + + + + +Year ended + +December 31, 2002 + +Year ended + +December 31, 2001 + +Year ended + +December 31, 2000 + +Cumulative + +Amounts From + +October 7, + +1999 + +(Inception) to + +December 31, + +2002 + + +Cash Flows From Operating Activities + + + + + + + + + + + + + + + +Net loss + +$ +(4,320,002 +) +$ +(2,428,555 +) +$ +(1,502,380 +) +$ +(8,632,977 +) + + +Amortization + + +978,264 + + +978,264 + + +244,565 + + +2,201,093 + + + +Impairment of license + + +2,500,000 + + + + + + + + +2,500,000 + + + +Changes in operating assets and liabilities + + + + + + + + + + + + + + + + +Due to shareholders + + +167,503 + + +(1,429,259 +) + +1,257,815 + + +378,099 + + + + + + + + + + + + + +Net cash used in operating activities + + +(674,235 +) + +(2,879,550 +) + + + + +(3,553,785 +) + + + + + + + + + + + + +Cash Flows From Investing Activities + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Cost to acquire license + + + + + + + + + + + +(15,000,000 +) + + + + + + + + + + + + +Net cash used in investing activities + + + + + + + + + + + +(15,000,000 +) + + + + + + + + + + + + +Cash Flows From Financing Activities + + + + + + + + + + + + + + + +Proceeds from issuance of equity + + + + + + + + + + + +15,000,000 + + + +Contribution of capital + + +665,300 + + +2,888,895 + + + + + +3,554,195 + + + + + + + + + + + + + +Net cash provided by financing activities + + +665,300 + + +2,888,895 + + + + + +18,554,195 + + + + + + + + + + + + + +Net (Decrease) Increase in Cash + + +(8,935 +) + +9,345 + + + + + +410 + + +Cash, at beginning of period + + +9,345 + + + + + + + + + + + + + + + + + + + + + + +Cash, at end of period + +$ +410 + +$ +9,345 + +$ + + +$ +410 + + + + + + + + + + + + + +See accompanying notes to financial statements. + + + +F-28 + + + + + + + +Sentigen Ltd. + + + + +Notes to Financial Statements + + + + +1. + +Organization and Significant Accounting Policies + + + + + + + +Nature of Operations + + + +Sentigen Ltd. (the "Company") was incorporated on October 7, 1999 in Bermuda. The Company is owned jointly by Photogen Technologies, Inc. ("Photogen") and Elan International Services, Ltd. ("EIS"), a wholly owned subsidiary of +Elan Corporation plc ("Elan"), holding 80.1% and 19.9% (nonvoting shares) of the shares, respectively. The primary objective of the Company is to develop and commercialize nanoparticulate diagnostic imaging agents for the detection and treatment of +cancer through lymphography. + + + + + +Basis of Presentation + + + +The Company's ability to continue as a going concern is entirely dependent upon the funds it receives from its shareholders per the Subscription, Joint Development and Operating Agreement. + + + + + +Estimates + + + +The financial statements include estimated amounts and disclosures based on management's assumptions about future events. Actual results may differ from those estimates. + + + + + +Research and Development + + + +Research and development costs are charged to expense when incurred. + + + + + +Income Taxes + + + +Under current Bermuda law, the Company is not required to pay any taxes in Bermuda on either income or capital gains. + + + + + +Recent Accounting Pronouncements + + + +In October 2001, the Financial Accounting Standards Board issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). This statement addresses financial accounting and reporting for the impairment or +disposal of long-lived assets. This statement supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and the accounting and reporting provisions of APB Opinion +No. 30, "Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business. The +provisions of SFAS 144 will be effective for fiscal years beginning after December 15, 2001. The Company has recorded an impairment of its Elan license in accordance with SFAS 144 (Note 3). + + + + + + + +F-29 + + + +2. + + + +Related Party Transactions + + + +The amount due to shareholders represents costs for research and development that are subcontracted to Photogen and Elan. The amount due to shareholders is unsecured, and interest free with no set terms of repayment. Research and development expense +represents costs under the subcontract agreements with Photogen and Elan. These transactions are in the normal course of operations and are measured at the exchange amount, which is the amount of consideration established and agreed to by the related +parties. + +3. + + + +License of Elan Technology + + + +In 1999, the Company paid a license fee to Elan in the amount of $15,000,000 to acquire rights to certain Elan intellectual property. This license is being amortized on a straight-line basis over 184 months, which is the end of the life of the +latest licensed patent. + + + + + + + + + +The Company reviews the carrying values of its license for possible impairment whenever an event or change in circumstances indicates that the carrying amount of the asset may not be recoverable. + + + + + + + + + +During 2002, management assessed the recoverability of the carrying value of the Elan license. Based on discounted cash flows and changing priorities of the joint venture partners, management has determined that an impairment of $2,500,000 is +appropriate. + +4. + + + +Shareholders' Equity + + + +Preferred Stock + + + + + + + + + +In October 1999, the Company issued 2,980 shares of nonvoting convertible preferred stock to EIS for $2,985,000 with a par value of $1.00 per share. At any time after October 2002, the holder of the preferred stock has the right to convert +the preferred stock on a one-to-one basis into common shares. Additionally, there exists an exchange right which upon exercise, could increase EIS's ownership to 50% of Sentigen Ltd. + + + + + + + + + +Common Stock + + + + + + + + + +In October 1999, the Company issued 12,000 voting common shares to Photogen for $12,015,000 with a par value of $1.00 per share. + +F-30 + + + +UNAUDITED QUARTERLY FINANCIAL STATEMENTS + + + + + + + + +Photogen Technologies, Inc. + + + + +Balance Sheets + + + + + + + +March 31, 2003 + +(Unaudited) + +December 31, 2002 + +(Audited) + + +Assets + + + + + + + + +Current Assets + + + + + + + + + + + + + + + + +Cash and cash equivalents + +$ +2,393,058 + +$ +6,090,904 + + + +Deposits + + +108,721 + + +98,721 + + + +Prepaid expenses + + +500,230 + + +693,313 + + + + + + + + + +Total Current Assets + + +3,002,009 + + +6,882,938 + + +Equipment and Leasehold Improvements, less accumulated depreciation of $16,124 and $14,651 + + + + + +34,527 + + + + + +36,000 + + + +Patent Costs, net of amortization of $152,775 and $142,359, 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+ +(237,335 +) + + +Investment in and advances to affiliate + + + + + +(168,011 +) + +(15,107,468 +) + + +Increase in notes receivable + + +(1,728,000 +) + + + + +(2,983,000 +) + + +Decrease in restricted cash + + + + + +(150,000 +) + + + + + +Decrease (increase) in deposit + + +(10,000 +) + +200,523 + + +(453,753 +) + + + + + + + + + + +Net cash used in investing activities (continuing operations) + + +(1,738,000 +) + +(117,488 +) + +(18,169,810 +) + + + + + + + + + + +Net cash used in investing activities of discontinued operations + + + + + + + + +(1,306,676 +) + + + + + + + + + + +Cash Flows From Financing Activities + + + + + + + + + + + + +Principal payments on capital leases + +$ + + +$ + + +$ +(291,704 +) + + +Net proceeds from issuance of equity + + +30,000 + + + + + +40,539,340 + + + +Proceeds from capital contributions by shareholders + + + + + + + + +1,911,674 + + + +Proceeds from issuance of debt + + + + + + + + +5,346,910 + + + +Cost of recapitalization + + + + + + + + +(371,111 +) + + + + + + + + + + +Net cash provided by financing activities + + +30,000 + + + + + +47,135,109 + + + + + + + + + + + +Net Increase (Decrease) in Cash and Cash Equivalents + + +(3,697,846 +) + +(1,036,103 +) + +2,393,058 + + +Cash and Cash Equivalents, at beginning of period + + +6,090,904 + + +1,352,904 + + + + + + + + + + + + + + +Cash and Cash Equivalents, at end of period + +$ +2,393,058 + +$ +316,801 + +$ +2,393,058 + + + + + + + + + + + +See accompanying notes to financial statements. + + + +F-35 + + + +1. + +Basis of Presentation + +The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information pursuant to Regulation SB. Accordingly, they do not include +all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair +presentation have been included. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003. + +2. + + + +Going Concern + + + +The accompanying financial statements are prepared assuming the Company is a going concern. The Company believes it lacks sufficient working capital to fund operations for the entire fiscal year ending December 31, 2003 without additional debt or +equity financing. Therefore, substantial additional capital resources will be required to fund the ongoing operations related to the Company's research and business development activities. Management believes there are a number of potential +alternatives available to meet the continuing capital requirements such as public or private financings or collaborative agreements. The Company is taking continuing actions to reduce its ongoing expenses. If adequate funds are not available, the +Company will be required to significantly curtail its operating plans and may have to sell or license out significant portions of the Company's technology or potential products. The financial statements do not include any adjustment to reflect the +possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of this uncertainty. + +3. + + + +Basic and Diluted Loss Per Common Share + + + +Basic and diluted loss per common share is computed based on the weighted average number of common shares outstanding. Loss per share excludes the impact of outstanding options, warrants and convertible preferred stock as they are antidilutive. +Potential common shares excluded from the calculation at March 31, 2003 are 4,575,481 options, 237,431 warrants and 151,819 shares issuable upon the conversion of Series A Preferred Stock. Basic and diluted loss per common share includes 124,627 +shares of common stock subject to rescission. + +4. + + + +Stock Options + + + +The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS No. 123), but applies the intrinsic value method set forth in Accounting +Principles Board Opinion No. 25 for stock options granted to employees and directors. The Company expenses the fair value of stock options granted to nonemployees. In 2002, the Company issued stock options to employees with an exercise price less +than the market price on the date of grant that vest over five years. Accordingly, compensation expense of $151,177 has been recorded in the first quarter of 2003. + + + + + + + + + +For stock options granted to employees and directors during the first quarter of 2003, the Company has estimated the fair value of each option granted using the Black-Scholes option pricing model with the following assumptions: + + + + + + + +2003 + + + +Weighted average fair value per options granted + +$ +0.93 + + + +Significant assumptions (weighted average) + + + + + + + Risk-free interest rate at grant date + + +3.0 % + + + + Expected stock price volatility + + +99% + + + + Expected option life (years) + + +5 + + + +If the Company had elected to recognize compensation expense based on the fair value at the grant dates, consistent with the method prescribed by SFAS No. 123, net loss per share would have been changed to the pro +forma amount indicated below: + + + + + + + + +F-36 + + + + + + + + + +2003 + + + + +Net income (loss), as reported + +$ +(5,199,362 +) + + + +Add stock based employee compensation expense included in reported net income + + +151,177 + + + + +Less total stock-based employee compensation expense determined under the fair value based method for all awards + + +(559,222 +) + + + + + + + + + + +Pro forma net loss + +$ +(5,607,407 +) + + + + + + + + + + +Basic and diluted loss per common share, as reported + +$ +(0.31 +) + + + +Basis and diluted loss per common share, pro forma + +$ +(0.34 +) + +5. + +Joint Venture/Investment in Affiliate + +Following is summarized financial information for Sentigen at March 31, 2003 and 2002: + + + + +March 31, + + +2003 + +2002 + + + + +Cash + +$ +410 + +$ + + + + + +License purchased from Elan, net of amortization of $2,445,659 and $1,467,395, respectively + + +10,054,341 + + +13,532,605 + + + + + + + + + + + + + +Total assets + +$ +10,054,751 + +$ +13,532,605 + + + + + + + + + + + + + +Due to affiliates + +$ +378,099 + +$ +665,299 + + + + +Total shareholders' equity + + +9,676,652 + + +12,867,306 + + + + + + + + + + + + + +Total liabilities and equity + +$ +10,054,751 + +$ +13,532,605 + + + + + + + + + + + + + +Research and development expense + +$ + + +$ +445,310 + + + + +General and administrative expense + + + + + +18,739 + + + + +Amortization of license + + +244,566 + + +244,566 + + + + +Impairment of license + + + + + + + + + + + + + + + + + + + +Net loss + +$ +(244,566 +) +$ +(708,615 +) + + + + + + + + + + +6. + +Equity Transactions + +During the first quarter, pursuant to a standstill agreement with a secured creditor of Alliance Pharmaceutical Corp. ("Alliance"), the Company issued a total of 750,000 shares to the creditor and the creditor agreed to +not exercise any rights against Alliance as a creditor. The value of these shares has been treated as an expense. + +7. + + + +Advances to Alliance Pharmaceutical Corp. + + + +Through March 31, 2003, the Company has provided bridge financing to Alliance of an aggregate of $2,983,000 evidenced by 8% convertible secured promissory notes (the "Alliance Notes") issued pursuant to a Convertible Secured Note Purchase +Agreement dated as of October 4, 2002 (the "Note Purchase Agreement"). The Notes are collateralized by certain assets of Alliance, some of which are subject to prior liens held by Xmark Fund, L.P., Xmark Fund, Ltd. and PFC (a joint venture +between Alliance and Baxter Healthcare Corporation). Based upon the Company's security interest in the Alliance assets and the potential value of those assets should the Company not acquire the Imagent business, management established a reserve of $1,491,500 for the value of the notes receivable. This is a significant estimate and it is subject to change based on Alliance's activity and its ability to continue operations or its ability +to liquidate the underlying collateral. + +8. + + + +Subsequent Events + + + +On May 1, 2003, the Company executed a Going Forward Agreement with Xmark Fund, L.P. and Xmark Fund, Ltd. (collectively, "Xmark"). Xmark holds secured debt of Alliance Pharmaceutical Corp.. The Going Forward Agreement provides, among other +things, that the Company will use commercially reasonable efforts to purchase by June 30, 2003 the assets related to Alliance's imaging and diagnostics business, including Alliance's Imagent +product. Separately, Alliance and the Company agreed to amend their term sheet to extend the Company's exclusive option to acquire the Imagent business until July 15, 2003. + + + + + + + +F-37 + + + + + + + + + + + +On May 1, 2003, the Company also executed a Participation Agreement with Xmark pursuant to which the Company agreed to purchase a one-third undivided interest in Xmark's loan to Alliance. The Company paid $1,250,000 for this participation. As a +result, the Company will have an undivided one-third interest in amounts Xmark collects from Alliance in connection with this loan. + + + + + + + + + +To obtain funds for acquiring the participation in Xmark's loan to Alliance, the Company issued a Revolving Convertible Senior Secured Promissory Note to Oxford BioScience Partners IV L.P. in the principal amount of up to $1,500,000. This Note is +secured by a first priority security interest on all of the Company's assets, bears interest at 7.25% per annum and is due on the earlier of August 5, 2003 or upon the occurrence of an "acceleration event." All principal and interest under the +Note will convert into the Company's common stock upon completion of a qualified financing that closes before August 5, 2003 at the same price and on the same terms as are in effect for the other investors in the qualified financing; and Oxford +BioScience will have the same rights, benefits and obligations as other investors in that financing. The acceleration events include a breach of the Company's obligations or representations under a Security Agreement in favor of Oxford BioScience +Partners; if the Company files for bankruptcy protection or similar events occur indicating insolvency; if the Company liquidates; or if the Company incurs any debt senior or pari passu to the debt to +Oxford BioScience. + +F-38 + + + + + + +PART II + INFORMATION NOT REQUIRED IN PROSPECTUS + + + + ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. + + + The following table sets forth expenses payable by the Registrant in connection with this Prospectus +dated , 2003. All of the amounts shown are +estimates except the SEC registration fee. + +SEC Registration Fee + +$ +55.29 + +Printing expenses + +$ +5,000 + +Legal fees and expenses + +$ +25,000 + +Accounting fees and expenses + +$ +10,000 + +Blue Sky qualification fees and expenses + +$ +3,000 + +Miscellaneous fees + +$ +1,945 + + + + + +Total + +$ +45,000.29 + + + + + + + +ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS + + + Section 78.7502 of the Corporation Law authorizes a corporation to indemnify its directors, officers, employees or other agents in terms sufficiently broad +to permit indemnification (including reimbursement for expenses incurred) under certain circumstances for liabilities arising under the Securities Act. Our articles of incorporation and bylaws provide +indemnification of directors and officers to the maximum extent permitted by the Nevada General Corporation Law. In addition, we have entered into Indemnification Agreements with our directors. Our +bylaws also permit us to purchase and maintain insurance on behalf of directors, officers, employees and agents of the company for any liability and expenses incurred in his capacity as such, whether +or not the company has the authority to indemnify him against such liability and expenses. We maintain directors and officers insurance for our directors and officers. + + + + +ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES + + + During the three year period preceding the date of filing of this registration statement, we have issued securities in the transactions described below without +registration under the Securities Act. These securities were offered and sold by us in reliance upon exemptions from the registration requirements provided by Section 4(2) of the Securities Act +and Regulation D under the Securities Act relating to sales not involving any public offering, and/or Rule 701 under the Securities Act relating to transactions occurring under +compensatory benefit plans. The share numbers and prices set forth below have been adjusted to reflect the one-for-four reverse split of our common stock effected in November, +2002. + + On +January 24, 2000, we issued warrants covering 3,750 shares of our common stock to a consultant. The warrants are exercisable at any time before January 24, +2010 for an exercise price of $44.23. + + On +February 18, 2000, we issued 327,240 shares of Series B Preferred Stock to 32 accredited investors in a private placement, for a purchase price of $16.88 +per share and 9,816 shares of Series B Preferred Stock and warrants to acquire 32,724 shares of our common stock at an exercise price of $16.88 per share to the placement agent in connection +with services rendered in our private placement of Series B Preferred Stock. All of the issued and outstanding shares of Series B Preferred Stock were converted into an aggregate of +422,316 shares of common stock at the conversion ratio of 4.25 shares of common for each share of Series B Preferred Stock on + +II-1 + + + +November 12, +2002. Upon effecting the one-for-four reverse split the number of shares subject to the warrants was adjusted to 8.181 and the exercise price was adjusted +to $47.78 per share. + + On +August 9, 2000, we issued warrants to acquire a total of 500,000 shares of common stock to Farcap Group, LLC as consideration for consulting services Farcap agreed +to perform for us. The warrants are exercisable at any time before August 9, 2004 for an exercise price of $9.45 per share. In connection with our sale of 8,333,334 shares of common stock to a +group of institutional investors in November, 2002, Farcap agreed to adjust the number of shares subject to the warrants to 50,000 post-reverse split shares and to adjust the exercise +price to $1.08 per share. + + During +2000, we also awarded 383,565 options to acquire our common stock pursuant to our 1998 Long Term Incentive Compensation Plan and 1,000,000 options to acquire common +stock pursuant to our Senior Executive Long Term Incentive Compensation Plan. Those options are exercisable at prices ranging from $11.00 to $60.25 and are subject to various vesting criteria. + + During +2001, we awarded 86,250 options to acquire our common stock pursuant to our 1998 Long Term Incentive Plan and 127,500 options to acquire our common stock pursuant to +our 2000 Plan. + + Pursuant +to the terms of a Settlement Agreement dated June 13, 2002, and as amended on February 28, 2003, we issued options to acquire an aggregate of 390,556 +shares of our common stock to Dr. Wolf. + + In +a series of closings occurring in November and December, 2002, and January, 2003, we sold and issued 11,165,551 shares of our common stock to a group of institutional and +individual accredited investors at $1.08 per share. + + In +each of December, 2002 and January and February, 2003, we issued 250,000 shares (an aggregate of 750,000 shares) to Xmark Fund, L.P. and Xmark Fund, Ltd. in +connection with the Standstill and Make Whole Agreement dated as of December 30, 2002. + + During +2002, we awarded 2,523,800 options to acquire our common stock under the 2000 Plan. + + Pursuant +to the terms of a Consulting Agreement dated as of January 30, 2003, we issued 75,000 shares of our common stock to a consultant, subject to certain +forfeiture provisions. + + During +January and February, 2003 we awarded 40,000 options to acquire common stock pursuant to our 2000 Plan. + + In +each of the transactions described above: + + We +did not use any underwriters or brokers and we paid no commissions or underwriting discounts, except for a commission of 9,816 shares of Series B Preferred Stock, +warrants in the amount of 8,181 shares of our common stock and $25,000 expense reimbursement we paid to the placement agent for our Series B Preferred Stock. + + Wherever +we received cash consideration, we used the proceeds for working capital, the possible acquisition of the medical imaging assets of Alliance and other general +corporate purposes. + + + + +ITEM 16. EXHIBITS + + + The following exhibits are filed as part of this Registration Statement: + +EXHIBIT NO. + +DESCRIPTION + + +3.1 + +Articles of Incorporation of Photogen Technologies, Inc., as amended (Filed as Exhibit E to the company's Proxy Statement on Form DEFM 14A dated September 12, 2002 and incorporated herein by reference.) + + + + + +II-2 + + + +3.2 + +Amended and Restated Certificate of Designations, Preferences and Rights of Series A Preferred Stock. (Filed as Exhibit 3.5 to the company's Quarterly Report on Form 10-QSB for the quarter ended September 30, 1999 and +incorporated herein by reference.) + +3.4 + +Amended and Restated Bylaws of Photogen Technologies, Inc. (Filed as Exhibit C to the company's Information Statement on Form DEF 14C dated December 23, 2002 and incorporated herein by reference.) + +5.1 + +Opinion of Grippo & Elden + +9.1 + +Voting, Drag-Along and Right of First Refusal Agreement entered into as of November 12, 2002 by and among Robert J. Weinstein, M.D., Stuart P. Levine, Tannebaum, LLC, Mi3 L.P., Oxford Bioscience Partners IV L.P. and MRNA +Fund II L.P. (Filed as Exhibit G to the company's Proxy Statement on Form DEFM 14A dated September 12, 2002 and incorporated herein by reference.) + +10.1 + +Common Stock Purchase Agreement dated as of August 2, 2002 by and among Photogen Technologies, Inc., Mi3 L.P., Oxford Bioscience Partners IV L.P., MRNA Fund II L.P., New England Partners Capital, L.P. and Tannebaum LLC. +(Filed as Exhibit C to the company's DEFM 14A dated September 12, 2002 and incorporated herein by reference.) + +10.2 + +Amendment No. 1 to the Common Stock Purchase Agreement dated as of August 2, 2002 by and among Photogen Technologies, Inc., Mi3 L.P., Oxford Bioscience Partners IV L.P., MRNA Fund II L.P., New England Partners Capital, +L.P. and Tannebaum LLC. (Filed as Exhibit A to the company's DEFR 14A Proxy Supplement dated October 18, 2002 and incorporated herein by reference.) + +10.3 + +Separation Agreement dated as of July 29, 2002 by and among the following: Craig Dees, Ph.D. and Dees Family Foundation, Eric A. Wachter, Ph.D. and Eric A. Wachter 1998 Charitable Remainder Unitrust, Timothy D. Scott, +Ph.D. and Scott Family Investment Limited Partnership, Walter Fisher, Ph.D., Fisher Family Investment Limited Partnership, and Walt Fisher 1998 Charitable Remainder Unitrust, and John A. Smolik and Smolik Family LLP, Photogen Technologies, Inc., +Photogen, Inc., Robert J. Weinstein, M.D., Stuart P. Levine and Tannebaum, LLC (Filed as Exhibit A to the company's DEFM 14A dated September 12, 2002 and incorporate herein by reference.) + +10.4 + +Registration Rights Agreement entered into as of November 12, 2002 by and among Photogen Technologies, Inc., Mi3 L.P., Oxford Bioscience Partners IV L.P., MRNA Fund II L.P. and Tannebaum, LLC (Filed as Exhibit D to the +company's Proxy Statement on Form DEFM 14A dated September 12, 2002 and incorporated herein by reference.) + +10.5 + +Letter Agreement entered into as of August 29, 2002 by and between Photogen Technologies, Inc. and Clinical Regulatory Strategies, LLC (Filed as Exhibit 10.2 to the company's quarterly report on Form 10-Q for the quarter +ended September 30, 2002 and incorporated herein by reference.) + +10.6 + +Office Lease dated February 19, 2001 by and between Photogen, Inc. and Union Square, Limited Partnership. (Filed as Exhibit 10.5 to the company's Annual Report on Form 10-K for the year ended December 31, 2000 and +incorporated herein by reference.) + +10.7 + +Form of Registration Rights Agreement dated as of December 30, 2002 entered into by and between Photogen Technologies, Inc. and each of Oxford Bioscience Partners IV L.P., MRNA Fund II L.P., DMG Legacy Institutional Fund +LLC, DMG Legacy Fund LLC, and DMG Legacy International Ltd. (Filed as Exhibit 10.7 to the company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference.) + + + + + +II-3 + + + +10.8 + +Employment Agreement entered into by the company and Taffy J. Williams, Ph.D., dated October 28, 2002. (Filed as Exhibit 10.8 to the company's Annual Report on Form 10-K for the year ended December 31, 2002 and +incorporated by reference herein.) + +10.9 + +Employment Agreement entered into by the company and Brooks Boveroux, dated October 28, 2002. (Filed as Exhibit 10.9 to the company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated by +reference herein.) + +10.10 + +Employment Agreement with Reinhard Koenig, Ph.D., M.D., RAC dated October 28, 2002. (Filed as Exhibit 10.10 to the company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated by reference +herein.) + +10.11 + +Incentive Stock Option Award Agreement entered into by and between the company and Taffy J. Williams, Ph.D. dated May 17, 2000. (Filed as Exhibit 10.4 to the company's Current Report on Form 8-K dated May 17, 2001 and +incorporated herein by reference.) + +10.12 + +Incentive Stock Option Award Agreement entered into by the company and Brooks Boveroux dated August 1, 2000. (Filed as Exhibit 10.13 to the company's Annual Report on Form 10-K dated December 31, 2000 and incorporated +herein by reference.) + +10.13 + +Form of Indemnification Agreement entered into by and between the company and each Director and Senior Vice President of the company. (Filed as Exhibit 10.13 to the company's Annual Report on Form 10-K to for the year +ended December 31, 2002 and incorporated by reference herein.) + +10.14 + +Tufts University Sponsored Research Agreement dated August 1, 1999 by and between Photogen, Inc. and Tufts University, a/k/a Trustees of Tufts College. (Filed as Exhibit 10.3 to the company's Quarterly Report on Form +10-QSB for the quarter ended September 30, 1999 and incorporated herein by reference.) Confidential portions of this exhibit were redacted. + +10.15 + +Amended Warrant Certificates between Photogen Technologies, Inc. and Farcap Group LLC dated as of January 31, 2003. (Filed as Exhibit 10.15 to the company's Annual Report on Form 10-K for the year ended December 31, 2002 +and incorporated by reference herein.) + +10.16 + +License Agreement effective as of September 30, 1999 between The General Hospital Corporation and Photogen, Inc. (Filed as Exhibit 10.7 to the company's Quarterly Report on Form 10-QSB for the quarter ended September 30, +1999 and incorporated herein by reference.) Confidential portions of this exhibit were redacted. + +10.17 + +Securities Purchase Agreement dated as of October 20, 1999, among Photogen Technologies, Inc. and Elan International Services, Ltd. (Filed as Exhibit 10.8 to the company's Quarterly Report on Form 10-QSB for the quarter +ended September 30, 1999 and incorporated herein by reference.) Confidential portions of this exhibit were redacted. + +10.18 + +Warrant to Purchase Shares of Common Stock dated October 20, 1999 between Photogen Technologies, Inc. and Elan International Services, Ltd. (Filed as Exhibit 10.9 to the company's Quarterly Report on Form 10-QSB for the +quarter ended September 30, 1999 and incorporated herein by reference.) + +10.19 + +License Agreement dated October 20, 1999 between Photogen Technologies, Inc, Photogen Newco Ltd. and Elan Pharma International Limited. (Filed as Exhibit 10.13 to the company's Quarterly Report on Form 10-QSB for the +quarter ended September 30, 1999 and incorporated herein by reference.) Confidential portions of this exhibit were redacted. + + + + + +II-4 + + + +10.20 + +License Agreement dated October 20, 1999 between Elan Pharma International Limited, Photogen Newco Ltd. and Photogen Technologies, Inc. (Filed as Exhibit 10.14 to the company's Quarterly Report on Form 10-QSB for the +quarter ended September 30, 1999 and incorporated herein by reference.) Confidential portions of this exhibit were redacted. + +10.21 + +Subscription, Joint Development and Operating Agreement dated October 20, 1999 between Elan Pharma International Limited, Elan International Services, Ltd., Photogen Technologies, Inc. and Photogen Newco Ltd. (Filed as +Exhibit 10.15 to the company's Quarterly Report on Form 10-QSB for the quarter ended September 30, 1999 and incorporated herein by reference.) Confidential portions of this exhibit were redacted. + +10.22 + +Equipment Lease between Picker Financial Group, L.L.C. and Photogen, Inc. dated October 25, 1999. (Filed as Exhibit 10.37 to the company's Annual Report on Form 10-KSB for the year ended December 31, 1999 and incorporated +herein by reference.) + +10.23 + +Standstill and Make-Whole Agreement dated as of December 30, 2002 among Xmark Fund, L.P., Xmark Fund, Ltd., Alliance Pharmaceutical Corp. and Photogen Technologies. (Filed as Exhibit 10.23 to the company's Annual Report +on Form 10-K for the year ended December 31, 2002 and incorporated by reference herein.) + +10.24 + +Convertible Secured Note Purchase Agreement dated as of October 4, 2002 by and between Alliance Pharmaceutical Corp. and Photogen Technologies, Inc. (Filed as Exhibit 10.24 to the company's Annual Report on Form 10-K for +the year ended December 31, 2002 and incorporated by reference herein.) + +10.25 + +Form of 8% Convertible Secured Promissory Note by Alliance Pharmaceutical Corp. for the benefit of Photogen Technologies, Inc. (Filed as Exhibit 10.25 to the company's Annual Report on Form 10-K for the year ended +December 31, 2002 and incorporated by reference herein.) + +10.26 + +Amendment to the 8% Convertible Secured Note Purchase Agreement, 8% Convertible Secured Notes and Related Security Agreements dated as of February 26, 2003 by and among Alliance Pharmaceutical Corp., Photogen Technologies, + Inc. and the other noteholders. (Filed as Exhibit 10.26 to the company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated by reference herein.) + +10.27 + +Warrant Agreement dated as of November 12, 2002 between Broadmark Capital LLC and Photogen Technologies, Inc. (Filed as Exhibit 10.27 to the company's Annual Report on Form 10-K for the year ended December 31, 2002 and +incorporated by reference herein.) + +21 + +Subsidiaries of Registrant (Filed as Exhibit 21 to the company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated by reference herein.) + +23.1 + +Consent of BDO Seidman, LLP, Independent Auditors (Photogen Technologies, Inc.) + +23.2 + +Consent of BDO Seidman, LLP, Independent Auditors (Sentigen, Ltd.) + +23.3 + +Consent of Counsel (included in Exhibit 5.1) + +24.1 + +Power of Attorney (included on page S-2). + + + + + + +ITEM 17. UNDERTAKINGS + + + + +(a)The +undersigned Registrant hereby undertakes: + +(1)To +file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: + +(i)To +include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; + +II-5 + + + +(ii)To +reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) +which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of +securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may +be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum +aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; + +(iii)To +include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the +registration statement; + + PROVIDED, +HOWEVER, that paragraphs (a)(1)(i) and (a)(1)(ii) do not apply if the registration statement is on Form S-3, Form S-8 or +Form F-3, and the information required to be included in a post-effective amendment by those paragraphs +is contained in periodic reports filed by the Registrant pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the +registration statement. + +(2)That, +for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement +relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. + +(3)To +remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. + +(b)The +undersigned Registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the Registrant's annual report pursuant +to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) +of the Securities Exchange Act of 1934) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, +and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. + +(c)Insofar +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 Securities Act and will be governed by the final adjudication of such issue. + +II-6 + + + +(d)The +undersigned Registrant hereby undertakes that: + +(1)For +purposes of determining liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance +upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of +this registration statement as of the time it was declared effective. + +(2)For +the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new +registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. + +II-7 + + + + + + +Signatures + + + Pursuant to the requirements of the Securities Act of 1933, Registrant has duly caused this registration statement to be signed on its behalf by the undersigned, +thereunto duly authorized, in the City of New Hope, State of Pennsylvania, on June 2, 2003. + + + + + +Photogen Technologies, Inc. + + + + + + + +/s/ TAFFY J. WILLIAMS Taffy J. Williams, Ph.D., President and + +Chief Executive Officer + + Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed below by the following persons in the capacities and on the dates indicated. + + + +Signature + +Title + +Date + +/s/ TAFFY J. WILLIAMS Taffy J. Williams + + + +President, Chief Executive + +Officer and Director + + + +June 2, 2003 + +* Robert J. Weinstein + + + +Director + + + +June 2, 2003 + +* Lester H. McKeever + + + +Director + + + +June 2, 2003 + +* Gene Golub + + + +Director + + + +June 2, 2003 + +* William D. McPhee + + + +Director + + + +June 2, 2003 + +* Alan D. Watson + + + +Director + + + +June 2, 2003 + +/s/ BROOKS BOVEROUX Brooks Boveroux + + + +Chief Financial Officer, Senior Vice President-Finance and Treasurer + + + +June 2, 2003 + +*By: + + + +/s/ TAFFY J. WILLIAMS Taffy J. Williams + as attorney-in-fact + + + + + + + + + +S-1 + + + +Power of Attorney + + We, the undersigned officers and directors of Photogen Technologies, Inc. hereby constitute Taffy J. Williams and Brooks Boveroux, each acting alone, our +true and lawful attorney-in-fact and agent (with full power of substitution) with full power to sign for us in our names in the capacities indicated below the registration +statement filed herewith and any and all amendments to said registration statement, to file the same, and generally to do all such things in our name and behalf in our capacities as officers and +directors to enable Photogen Technologies, Inc. to comply with the provisions of the Securities Act of 1933, as amended, and all requirements of the Securities and Exchange Commission, hereby +ratifying and confirming our signatures as they may be signed by our said attorney-in-fact and agent to said registration statement and any and all amendments thereto. + + Pursuant +to the requirements of the Securities Act of 1933, this registration statement and Power of Attorney has been signed below by the following persons in the capacities and on the +dates indicated. + +Signature + +Title + +Date + +/s/ TAFFY J. WILLIAMS Taffy J. Williams, Ph.D. + + + +President, Chief Executive + +Officer and Director + + + +April 22, 2003 + +/s/ ROBERT J. WEINSTEIN Robert J. Weinstein, M.D. + + + +Director + + + +April 22, 2003 + +/s/ LESTER H. MCKEEVER, JR. Lester H. McKeever, Jr. + + + +Director + + + +April 22, 2003 + +/s/ GENE GOLUB Gene Golub + + + +Director + + + +April 22, 2003 + +/s/ WILLIAM D. MCPHEE William D. McPhee + + + +Director + + + +April 22, 2003 + +/s/ ALAN D. WATSON Alan D. Watson + + + +Director + + + +April 22, 2003 + +/s/ BROOKS BOVEROUX Brooks Boveroux + + + +Chief Financial Officer, Senior Vice President-Finance and Treasurer + + + +April 22, 2003 + +S-2 + +QuickLinks + +TABLE OF CONTENTS \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000768119_datatec_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000768119_datatec_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4c586499048e192d9080ae1320d57a5b517f2cbe --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000768119_datatec_legal_matters.txt @@ -0,0 +1,4842 @@ +LEGAL MATTERS + +The legality of the securities offered hereby will be passed upon for us by Olshan Grundman Frome Rosenzweig & Wolosky LLP, New York, New York. Certain members of Olshan Grundman Frome Rosenzweig & Wolosky LLP hold shares of common stock. Robert Friedman, one of our directors and a member of this firm, also holds options to purchase additional shares of our common stock. + +EXPERTS + +The consolidated financial statements as of April 30, 2002 and 2003 and for the years ended April 30, 2001, 2002 and 2003 included in this prospectus, and the related financial statement schedule for the years ended April 30, 2001, 2002 and 2003 included elsewhere in the registration statement have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein and elsewhere in the registration statement (which report expresses an unqualified opinion and includes an explanatory paragraph referring to the retroactive application of a change in accounting principle), and have been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. + + + +WHERE YOU CAN FIND MORE INFORMATION + +We have filed with the SEC a registration statement on Form S-1 under the Securities Act for the common stock sold in this offering. This prospectus constitutes a part of that registration statement. This prospectus does not contain all of the information set forth in the registration statement and the accompanying exhibits and schedules because some parts have been omitted in accordance with the rules and regulations of the SEC. Accordingly, you should refer to the registration statement and its exhibits for further information with respect to us and the shares being sold in this offering. Copies of the registration statement and its exhibits are on file at the offices of the SEC and on its Web site. + +You may read and copy the registration statement, including the attached exhibits, and any report, statements or other information that we file at the SEC's public reference facilities located in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of its public reference facilities. Our SEC filings will also be available to the public from commercial document retrieval services and at the SEC's Web site at www.sec.gov. + +If you are a stockholder, you may request a copy of these filings, at no cost, by writing or telephoning us at the following address: + + Datatec Systems, Inc. + + 23 Madison Road + + Fairfield, New Jersey 07004 + + Attn: Mr. Isaac Gaon + + (973) 808-4000 + +For further information about us and the shares being sold in this offering, we refer you to the registration statement and the accompanying exhibits and schedules. Statements contained in this prospectus concerning any document filed as an exhibit are not necessarily complete and we refer you to the copy of such document filed as an exhibit to the registration statement. + + + +Consolidated Financial Statements + +Page + +Independent Auditors' Report + +F-1 + +Consolidated Balance Sheets as of April 30, 2002 and 2003 + +F-2 + +Consolidated Statements of Operations For the Years Ended April 30, 2001, 2002 and 2003 + +F-3 + +Consolidated Statements of Comprehensive Income (Loss) For the Years Ended April 30, 2001, 2002 and 2003 + +F-4 + +Consolidated Statements of Changes in Stockholders' Equity (Deficit) For the Years Ended April 30, 2001, 2002 and 2003 + +F-5 + +Consolidated Statements of Cash Flows For the Years Ended April 30, 2001, 2002 and 2003 + +F-6 + +Notes to Consolidated Financial Statements + +F-7 + +Unaudited Condensed Consolidated Financial Statements + +Condensed Consolidated Balance Sheet (unaudited) as of July 31, 2003 + +F-29 + +Condensed Consolidated Statements of Operations (unaudited) For the Three Months Ended July 31, 2002 and 2003 + +F-30 + +Condensed Statements of Comprehensive Income (Loss) (unaudited) For the Three Months Ended July 31, 2002 and 2003 + +F-31 + +Condensed Consolidated Statements of Cash Flows (unaudited) For the Three Months Ended July 31, 2002 and 2003 + +F-32 + +Notes to Condensed Consolidated Financial Statements (unaudited) + +F-33 + +Schedules + +Page + +Schedule II -Valuation and Qualifying Accounts + +S-1 + +Schedules other than the one listed above have been omitted since they are either not required, are not applicable, or the required information is shown in the consolidated financial statements or related notes. + +INDEPENDENT AUDITORS' REPORT + +To the Board of Directors and Stockholders + +of Datatec Systems, Inc. and Subsidiaries + +Fairfield, New Jersey + +We have audited the accompanying consolidated balance sheets of Datatec Systems, Inc. and Subsidiaries (the "Company") as of April 30, 2003 and 2002, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders' equity (deficit), and cash flows for each of the three years in the period ended April 30, 2003. Our audits also include the financial statement schedule listed in the Index at Item 16(b)(1). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. + +We conducted our audits in accordance with the auditing standards generally accepted in the United States of America. 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. + +In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of April 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. + +As discussed in Note 2 to the consolidated financial statements, in 2003 the Company changed its method of accounting for estimating progress towards completion of contracts and retroactively adjusted the 2001 and 2002 consolidated financial statements for the change. + + + + + +Deloitte & Touche LLP + +New York, New York + +July 22, 2003 (October 15, 2003 as to Note 20) + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +CONSOLIDATED BALANCE SHEETS + +(IN THOUSANDS, EXCEPT SHARE DATA) + + + +April 30, + + + +2002 + + +2003 + +ASSETS + + + + +Current Assets: + + + + + +Cash and cash equivalents + +$ 49 + + +$ 3,032 + +Accounts receivable, net + +14,578 + + +27,814 + + Costs and estimated earnings in excess of billings + +7,224 + + +20,727 + + Inventory + +3,176 + + +3,043 + + Prepaid expenses and other current assets + + 725 + + +1,150 + +Total current assets + +25,752 + + +55,766 + +Property and equipment, net + +3,259 + + +3,198 + +Goodwill + +2,665 + + +2,665 + +Other assets + +4,170 + + +3,098 + +Total assets + +$35,846 + + +$64,727 + +LIABILITIES AND STOCKHOLDERS' EQUITY + + + + +Current Liabilities: + + + + + +Short-term borrowings + +$17,464 + + +$28,758 + +Current portion of long-term debt + +42 + + +2 + +Accounts payable + +7,789 + + +16,635 + +Accrued expenses and other current liabilities + +3,700 + + +5,688 + +Subordinated secured convertible debentures (net of unamortized discount of $78 for 2003) + +-- + +1,322 + +Due to related parties + +-- + + +1,414 + + + + + + + Total current liabilities + +28,995 + + +53,819 + +Long-Term Debt: + + + + + +Due to related parties + + 1,414 + + +-- + +Other long-term debt + +2 + + +-- + +Subordinated secured convertible debentures (net of unamortized discount of $543 for 2002) + +1,457 + + +-- + +Total Liabilities + +31,868 + + +53,819 + +Commitments and Contingencies + +-- + + +-- + +STOCKHOLDERS' EQUITY: + + + + + +Common stock, $.001 par value (authorized 75,000,000 shares; issued and outstanding 35,591,000 shares and 41,209,000 shares as of April 30, 2002 and 2003, respectively) + + + +35 + + + + +41 + +Additional paid-in capital + +53,532 + + +59,040 + +Accumulated deficit + +(49,239) + + +(47,822) + +Accumulated other comprehensive loss + + (350) + + +(351) + +Total stockholders' equity + + 3,978 + + +10,908 + + Total liabilities and stockholders' equity + +$ 35,846 + + + $ 64,727 + +The accompanying notes are an integral part of these consolidated statements. + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +CONSOLIDATED STATEMENTS OF OPERATIONS + +(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA) + + + +For the Years Ended + +April 30, + + + +2001 + + +2002 + + +2003 + + + + + + + + +Revenue + +$ 96,149 + + +$ 75,299 + + +$ 125,091 + +Cost of revenue + +79,956 + + +51,426 + + +97,886 + +Gross margin + +16,193 + + +23,873 + + +27,205 + +Selling, general and administrative expenses + +33,232 + + +24,118 + + +22,073 + +Operating income (loss) + +(17,039) + + +(245) + + +5,132 + +Interest expense + +(1,715) + + +(2,125) + + +(3,715) + +Income (loss) before income taxes and minority interest + +(18,754) + + +(2,370) + + +1,417 + +Income taxes + +-- + + +-- + + +-- + +Minority interest + +(682) + + +(318) + + +-- + +Net income (loss) + +$ (19,436) + + +$ (2,688) + + + $ 1,417 + + + + + + + + +Net income (loss) per common share + + + + + + +-Basic + +$ (0.58) + + +$ (0.08) + + +$ 0.04 + +-Diluted + +$ (0.58) + + +$ (0.08) + + +$ 0.04 + + + + + + + + +Weighted Average Common And Common Equivalent Shares Outstanding + + + + + + +-Basic + +33,608,000 + + +35,162,000 + + +36,067,000 + +-Diluted + +33,608,000 + + +35,162,000 + + +36,291,000 + + + + + + + + +The accompanying notes are an integral part of these consolidated statements. + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) + +(IN THOUSANDS) + + + + + +For the Years Ended + +April 30, + + + +2001 + + +2002 + + +2003 + +Net income (loss) + +$(19,436) + + +$(2,688) + + +$1,417 + +Other comprehensive (income) loss - foreign currency translation adjustment + +(5) + + +3 + + +(1) + +Comprehensive income (loss) + +$(19,441) + +$(2,685) + +$1,416 + + + +The accompanying notes are an integral part of these consolidated statements. + +Datatec Systems Inc. and Subsidiaries + +Consolidated Statements of Changes in Stockholders' Equity (Deficit) + +(IN THOUSANDS) + +Common Stock + +Additional + +Accumulated + +Accumulated + +Total + +Paid-in Capital + +Deficit + +Comprehensive + +Stockholders' + +Shares + +Amount + +Common + + Income (Loss) + +Equity (Deficit) + +Balance at May 1, 2000, as previously reported + +33,413 + +$33 + +$42,268 + +$(26,693) + +$(348) + +$15,260 + +Effect of change in accounting principle (see Note 2) + +-- + +-- + +-- + +(422) + +-- + +(422) + +Balance at May 1, 2000, as retroactively adjusted + +33,413 + +33 + +42,268 + +(27,115) + +(348) + +14,838 + +Exercise of warrants and options + +106 + +-- + +325 + +-- + +-- + +325 + +Issuance of common stock under Employee Stock Purchase Plan + +235 + +1 + +648 + +-- + +-- + +649 + +Net loss + +-- + +-- + +-- + +(19,436) + +-- + +(19,436) + +Effect of exchange rate changes + +-- + +-- + +-- + +-- + +(5) + +(5) + +Balance at April 30, 2001 + +33,754 + +34 + +43,241 + +(46,551) + +(353) + +(3,629) + +Exercise of warrants and options + +405 + +-- + +32 + +-- + +-- + +32 + +Issuance of common stock in connection with Private Placement + +1,021 + +1 + +9,617 + +-- + +-- + +9,618 + +Issuance of warrants in connection with Private Placement + +-- + +-- + +412 + +-- + +-- + +412 + +Issuance of common stock under Employee Stock Purchase Plan + +411 + +230 + +-- + +-- + +230 + +Net loss + +-- + +-- + +-- + +(2,688) + +-- + +(2,688) + +Effect of exchange rate changes + +-- + +-- + +-- + +-- + +3 + +3 + +Balance at April 30, 2002 + +35,591 + +35 + +53,532 + +(49,239) + +(350) + +3,978 + +Exercise of warrants and options + +55 + +-- + +27 + +-- + +-- + +27 + +Issuance of common stock and warrants in connection with Private Placement + +4,000 + +4 + +4,272 + +-- + +-- + +4,276 + +Conversion of debt and issuance of common stock in lieu of cash in connection with interest and penalties on debt financing + +1,189 + +1 + +929 + +-- + +-- + +930 + +Issuance of common stock under Employee Stock Purchase Plan + +374 + +1 + +280 + +-- + +-- + +281 + +Net income + + +-- + + +-- + + +-- + + +1,417 + + +-- + + +1,417 + +Effect of exchange rate changes + + +-- + + +-- + + +-- + + +-- + + +(1) + + +(1) + +Balance at April 30, 2003 + + +41,209 + + +$41 + + +$59,040 + + +$(47,822) + + +$(351) + + +$10,908 + +The accompanying notes are an integral part of these consolidated statements. + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +CONSOLIDATED STATEMENTS OF CASH FLOWS + +(IN THOUSANDS) + + + +For the Years Ended April 30, + + + +2001 + + +2002 + + +2003 + +Cash Flows From Operating Activities: + + + + + + +Net income (loss) + +$ (19,436) + + +$ (2,688) + + +$ 1,417 + +Adjustments to reconcile net income (loss) to net + + cash used in operating activities- + + + + + + + +Depreciation and amortization + +5,316 + + +4,274 + + +4,285 + +Accretion of interest on subordinated notes + +82 + + +38 + + +465 + +Changes in operating assets and liabilities -- + + + + + + + +(Increase) decrease in accounts receivable, net + +2,092 + + +394 + + +(13,236) + +(Increase) decrease in costs and estimated earnings in excess of billings + +21 + + +(4,295) + + +(13,503) + +(Increase) decrease in inventory + +(144 ) + +2,097 + +133 + +(Increase) decrease in prepaid expenses and other assets + +468 + + +491 + + +(509) + +Increase (decrease) in accounts payable and accrued other liabilities + +1,816 + + +(5,229) + + +11,195 + +Net cash used in operating activities + + (9,785) + + +(4,921) + + +(9,753) + +Cash Flows From Investing Activities: + + + + + + + Purchases of property and equipment + + (2,406) + +(195) + +(2,035) + + Investment in software development + + (2,371) + + +(817) + + +(1,033) + +Net cash used in investing activities + + (4,777) + + +(1,012) + + +(3,068) + +Cash Flows From Financing Activities: + + + + + + + Net proceeds from short-term borrowings + +4,842 + + +3,552 + + +11,294 + +Payments of indebtedness + +(778) + + +(180) + + +(42) + +Proceeds from subordinated secured convertible debentures + +-- + + +2,000 + + + +Proceeds from issuances of common stock + +973 + +264 + +4,750 + +Cost incurred in connection with issuance + + of subordinated secured convertible debentures and private placement + + + + +(170) + + +(197) + +Payment for conversion of preferred stock + +-- + + +(58) + + +-- + +Net increase in due to related parties + +24 + + +-- + + +-- + + Net cash provided by financing activities + + 5,061 + +5,408 + +15,805 + + Net effect of foreign currency translation on cash + + (5) + +3 + +(1) + + Net (decrease) increase in cash and cash equivalents + +(9,506) + +(522) + +2,983 + +CASH AND CASH EQUIVALENTS at beginning of year + + 10,077 + +571 + +49 + +cASH AND CASH EQUIVALENTS at end of year + +$571 + + + $49 + + + $3,032 + +The accompanying notes are an integral part of these consolidated statements. + + + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +(1) The Company and Summary of Significant Accounting Policies + +The Company + +Datatec Systems, Inc. and its subsidiaries (the "Company") are in the business of providing rapid and accurate technology deployment services and licensing software tools to support enterprises in the delivery and management of complex IT solutions. + +During the fiscal year ended April 30, 2000, the Company changed the name of its subsidiary CASI, Inc. to eDeploy.com Inc., ("eDeploy.com"). During the fiscal year ended April 30, 2002, the Company integrated eDeploy.com's activities into Datatec Systems, Inc. eDeploy's activities include developing, marketing and managing the licensing of software tools to support enterprises in the delivery of complex IT solutions (See Note 9). + +The net loss of $19.4 million for the fiscal year ended April 30, 2001 and the net loss of $2.7 million for the fiscal year ended April 30, 2002 resulted in a strain on the Company's cash resources. Although the Company realized net income of $1.4 million for fiscal year ended April 30, 2003 and took dramatic measures to cut costs and to manage cash, it is still experiencing a significant strain on cash resources. The primary reason for the strain on resources is the increased requirements for expenditures for field personnel, job expenses and materials related to the increased revenue. As a result, the working capital financing line regularly remains at or close to its maximum allowable levels and the average days outstanding on trade payables have extended beyond normal credit terms granted by vendors. + +Achievement of the Company's fiscal 2004 operating plan, including maintaining adequate capital resources, depends upon the timing of work performed on existing projects, ability to gain and perform work on new projects, ability to maintain positive relations with key vendors and the ability to raise permanent capital and replace the current working capital financing line within the timeframe required to meet spending requirements. Multiple project cancellations, job performance related losses, delays in the timing of work performed on existing projects, inability to gain and perform work on new projects, or inability to raise permanent capital and replace the current working capital financing line in a timely fashion could have an adverse impact on the Company's liquidity and on the ability to execute its operating plan. + +The Company has taken a variety of actions to ensure continuation as a going concern. A summary of recent events are as follows: + + + +In April 2003, the Company raised aggregate gross proceeds of $5.0 million in a private placement of common stock and warrants. The proceeds were raised for working capital purposes. + + + +On July 3, 2003, the Company raised an additional $4.9 million by issuing subordinated secured convertible notes and warrants to one of its existing lender groups. The proceeds are being used to pay down the IBM credit facility and for working capital purposes. + +Basis of Presentation + +The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. + +On May 1, 2003, the Company purchased 100% of Millennium Care, Inc. which is based in Toronto, Canada. Beginning in fiscal 2004, the acquisition will be accounted for as a purchase under Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" (see Note 20). + +Use of Estimates + +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates underlying the accompanying consolidated financial statements include estimated revenues under long-term contracts, estimated costs to complete long-term contracts, recoverability of intangibles and other long-lived assets, allowance for doubtful accounts and inventory carrying values. Actual results could differ from those estimates. + +Revenue Recognition + +The Company generates revenue from: (1) providing technology deployment services, including configuring Internetworking and computing devices to meet the specific needs of its customers, integrating these devices as well as operational and application software with a customer's existing hardware and software, and physically installing the technology on the customer's network and (2) from licensing its software to third parties. + +Services from deployment activities are performed primarily under long-term contracts, but may be performed under short-term workorders or time and material arrangements. The Company's typical long-term contract contains multiple elements designed to track the various services required under the arrangement with the customer. These elements are used to identify components of progress billings, but are combined for revenue recognition purposes. The Company recognizes revenue earned under long-term contracts utilizing the percentage of completion method of accounting by measuring total costs incurred to total estimated costs (see Note 2). Under the percentage of completion method of accounting, revenue, costs and gross margin are recognized as work is performed based on the relationship between total costs incurred and total estimated costs. + +Contracts are reviewed at least quarterly and, if necessary, revenue, costs and gross margin are adjusted prospectively for revisions in estimated total contract value and total estimated contract costs. Estimated losses are recognized when identified. + +Payment milestones differ according to the customer and the type of work performed. Generally, the Company invoices customers and payments are received throughout the deployment process and, in certain cases, in advance of work performed if a substantial amount of up front costs are required. In certain cases payments are received from customers after the completion of site installation. However, revenue and costs are only recognized on long-term contracts to the extent of the contracts' percentage of completion. Costs and estimated earnings in excess of billings, which is classified as a current asset, is recorded for the amount of revenue earned in excess of billings to customers. Accrued costs or deferred revenue is recorded as a current liability for the amount of billings in excess of revenue earned. + +Revenue earned under short-term workorders and time and material arrangements is recognized as the work is completed. Billings under these arrangements are typically done when the work is completed. + +Revenue from software licensing arrangements is recognized in accordance with Statement of Position ("SOP") No. 97-2, as amended, "Software Revenue Recognition". Revenue from license fees is recognized when an agreement has been signed, delivery of the product has occurred, the fee is fixed or determinable and collectibility is not probable. Revenue is deferred if such criteria are not met. If the fee due from the customer is not fixed or determinable, revenue is recognized as payments become due from the customer. If collectibility is not reasonably assured, revenue is recognized when the fee is collected. Maintenance revenue, if applicable, is negotiated separately and the contract identifies the specific charges related to this service. This revenue is recognized ratably over the contract maintenance period. The Company also recognizes revenue as an Application Service Provider ("ASP"). Under this scenario, the Company does not license the software, but provides access to the software through its hosting activities. For this access, the Company bills its customers and recognizes this revenue over the period of access. Revenue from licensing, maintenance and hosting activities remain immaterial in amount. + +Cash and Cash Equivalents + +The Company considers cash equivalents to be all highly liquid investments purchased with an original maturity of three months or less. + +Inventory + +Inventory, which is comprised of parts and materials to be installed as part of the Company's deployment services, is stated at the lower of average cost or market. The Company has written down, with charges to cost of revenue, the inventory for the years ended April 30, 2001, 2002 and 2003 in the amounts of $560,000 and $1,189,000 and zero, respectively, to reflect estimated market value. + +Property and Equipment, Net + +Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives or lease terms of the related assets, whichever is shorter. + +Capitalized Software Development Costs + +The Company capitalizes certain computer software costs, including product enhancements, after technological feasibility has been established, in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." These costs are amortized using the greater of the ratio that current gross revenue for a product bears to the total of current and anticipated future gross revenues for the product, or a maximum of three years using the straight-line method beginning when the products are available for general release to customers. Approximately $2,208,000 and $1,274,000 of net capitalized software costs are included in other assets in the accompanying consolidated balance sheets as of April 30, 2002 and 2003, respectively (See Note 6). Amortization expense of capitalized software costs for the years ended April 30, 2001, 2002 and 2003 was $1,544,000, $1,722,000 and $1,501,000, respectively, and is included in project costs. Costs incurred prior to technological feasibility and those incurred for minor enhancements and maintenance have been charged to general and administrative expense as incurred. + +Long-Lived Assets + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supercedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of", and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. This Statement also amends ARB No. 51, "Consolidated Financial Statements", to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 in fiscal 2003, with no material impact on its consolidated financial position or consolidated results of operations. + +Prior to adopting SFAS No. 144, SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets" required, among other things, that an entity review its long-lived assets and certain related intangibles for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. The amount of impairment of goodwill would be determined as part of the long-lived asset grouping being evaluated. Impairment losses are recognized when a long-lived asset's carrying amount may not be recoverable. Impairment losses are recognized when a long-lived asset's carrying value exceeds the expected undiscounted future cash flows related to that asset. The amount of the impairment loss is the difference between the carrying value and the fair market value of the asset. The fair market value of the asset is determined based upon discounted cash flows. Due to the losses incurred for the fiscal years ended April 30, 2001 and 2002, the Company has assessed its long-lived assets for impairment. Based on estimated undiscounted future cash flows, the Company believes that there was no impairment of its long-lived assets as of April 30, 2002. + +Income Taxes + +The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes". Certain transactions are recorded in the accounts in a period different from that in which these transactions are reported for income tax purposes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and the tax effect of net operating loss carry-forwards. A valuation allowance is recorded against deferred tax assets if it is more likely than not that such assets will not be realized. + +Fair Value of Financial Instruments + +The carrying value of cash and cash equivalents, accounts receivable, costs and estimated earnings in excess of billings, accounts payable, deferred income and the current portion of long-term debt approximate fair value due to the short-term maturities of these instruments. The carrying value of the long-term debt obligations approximate fair value based on current rates offered to the Company for debt with similar collateral and guarantees, if any, and maturities. + +Foreign Currency Translation + +The local currency of the Company's foreign (Canada) subsidiary is its functional currency. Assets and liabilities of the Company's foreign subsidiary are translated into U.S. dollars at the current exchange rate. Statement of operations accounts are translated at the average rate of exchange prevailing during the year. Translation adjustments arising from the use of differing exchange rates from period to period are a component of accumulated comprehensive loss included in stockholders' equity. + +Stock Based Compensation + +SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") requires that an entity account for employee stock-based compensation under a fair value based method. However, SFAS 123 also allows an entity to continue to measure compensation cost for employee stock-based compensation arrangements using the intrinsic value based method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees". The Company continues to account for employee stock-based compensation using the intrinsic value based method. + +In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation- Transition and Disclosure". SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effect of the method used on reported results. The provisions of SFAS No. 148 are effective for financial statements for fiscal years and interim periods ending after December 15, 2002. The disclosure provisions of SFAS No. 148 have been adopted by the Company. SFAS No. 148 did not require the Company to change to the fair value based method of accounting for stock based compensation. + +The following table illustrates the effect on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based employee compensation. + + + +For the Years Ended April 30, + + + +2001 + + +2002 + + +2003 + +Net income (loss) as reported + +$(19,436) + + +$(2,688) + + +$1,417 + +Total stock-based employee compensation expenses determined under fair value based method for all awards + +(1,563) + + +(3,496) + + +(339) + +Pro forma net income (loss) + +$(20,999) + + +$(6,184) + + +$1,078 + + + + + + + + +Net income (loss) per share of common stock: + + + + + + +As reported - basic + +$(0.58) + + +$(0.08) + + +$0.04 + +As reported - diluted + +$(0.58) + + +$(0.08) + + +$0.04 + +Pro forma - basic + +$(0.62) + + +$(0.18) + + +$0.03 + +Pro forma - diluted + +$(0.62) + + +$(0.18) + + +$0.03 + +The per share weighted-average fair value of stock options granted during 2001, 2002 and 2003 was $2.45, $0.60 and $1.18, respectively, on the date of grant using the Black Scholes option-pricing model with the following assumptions: expected life for options of 5 years for all periods, expected dividend yield 0% in all periods, average risk free interest rate of 5.6% in 2001, 4.4% in 2002 and 2.9% in 2003 average annualized volatility of 113% for 2001, 113% for 2002 and 66% for 2003. + +Internal Use Software + +In accordance with SOP No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," the Company capitalizes certain costs of computer software developed or obtained for internal use. Approximately $733,000, $770,000 and $688,000 of amortization expense were incurred during the years ended April 30, 2001, 2002 and 2003, respectively, and is included in general, administrative and selling expense. The Company has expensed costs incurred during the preliminary and post implementation phases in the periods in which these costs were incurred. + +Comprehensive Loss + +SFAS No. 130, "Reporting Comprehensive Income", establishes standards for reporting and displaying of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. The Company's component of other comprehensive income (loss) is foreign currency translation adjustments generated from the Company's Canadian subsidiary. + +Recent Accounting Pronouncements + +In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangible Assets" (collectively "the Standards"). The Standards require all business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, that goodwill is no longer subject to amortization but rather be reviewed periodically for impairment and that other identifiable intangibles be separated and those with finite lives be amortized over their useful lives. Goodwill and intangible assets with indefinite lives must be assessed once a year for impairment, and more frequently if circumstances indicate a possible impairment. The first step of the two-step impairment assessment identifies potential impairment and compares the fair value of the applicable reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered impaired, and the second step of the impairment test is not necessary. If the carrying value of the reporting unit exceeds its fair value, the second step of the impairment test shall be performed to measure the amount of impairment loss, if any. The Company elected to early adopt these standards as of May 1, 2001 as permitted and evaluated the carrying value of its goodwill and other intangible assets. Based on its evaluation, the Company determined that there was no impairment to its Goodwill and other intangible assets. Subsequent impairment tests will be performed, at a minimum, in the fourth quarter of each fiscal year, in conjunction with the Company's annual planning process. + +The Company has adopted SFAS No. 142 effective May 1, 2001. Under SFAS No. 142 goodwill is no longer amortized. Amortization expense of goodwill for the fiscal year ended April 30, 2001 was $0.4 million. Amortization expense of internal use software and software development for the fiscal years ended April 30, 2001, 2002 and 2003 was $2.3 million, $2.5 million and $2.2 million, respectively. For fiscal years ending April 30, 2004, 2005 and 2006, the amortization expense relating to these defined intangibles will be approximately $1.0 million, $0.4 million and $0.1 million, respectively. Goodwill and other intangible assets are summarized in the following table (in thousands): + + + +April 30, 2002 + + +April 30, 2003 + + + +Gross Carrying Amount + + +Accumulated Amortization + + +Gross Carrying Amount + + +Accumulated Amortization + +Goodwill + +$ 4,370 + + +$ (1,705) + + +$ 4,370 + + +$ (1,705) + +Internal Use Software + +3,626 + + +(2,166) + + +4,113 + + +(2,867) + +Software Development Costs + +6,303 + + +(4,095) + + +6,858 + + +(5,584) + +Internal use software and software development costs are included in other assets on the accompanying consolidated balance sheets (see Note 6). + +As required by SFAS No. 142, the results for the prior year have not been restated to reflect the impact of adopting SFAS No. 142. A reconciliation of net loss as if SFAS No. 142 had been adopted is presented below for the year ended April 30, 2001 (in thousands): + + + +Fiscal year ended + + + +April 30, 2001 + + + + +Reported net loss + +$(19,436) + +Add back: Goodwill amortization + + 437 + + + + +Adjusted net loss + +$(18,999) + + + + +Net loss per share - Basic and Diluted + + +Reported net loss: + +$(0.58) + +Adjusted net loss: + +$(0.58) + +In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations", which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated retirement costs. SFAS No. 143 applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and normal operation of long-lived assets, except for certain obligations of lessees. The provisions of this Statement are required to be applied starting with fiscal years beginning after June 15, 2001. This standard, which the Company adopted in fiscal 2003 did not have a material effect on the Company's consolidated financial position or consolidated results of operations. + +In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This Statement eliminates the automatic classification of gain or loss on extinguishment of debt as an extraordinary item of income and requires that such gain or loss be evaluated for extraordinary classification under the criteria of APB No. 30. This Statement also requires sales-leaseback accounting for certain lease modifications that have economic effects that are similar to sales-leaseback transactions, and makes various other technical corrections to existing pronouncements. This Statement will be effective for the Company for the fiscal year ending April 30, 2004. The Company does not believe that adoption of this Statement will have a material effect on the Company's consolidated financial position or consolidated results of operations. + +In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 will supersede Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that costs associated with an exit or disposal plan be recognized when incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. + +In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." Such interpretation elaborates on the disclosures to be made by a guarantor about its obligations under certain guarantees issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair market value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation apply to guarantees issued or modified after December 31, 2002. The Company applied the provisions of this interpretation on January 1, 2003. The disclosure provisions of this interpretation are effective for financial statements with annual periods ending after December 15, 2002. The Company adopted the required disclosure provisions of this interpretation as of April 30, 2003. The adoption of the recognition and measurement provisions of this statement did not have a material impact on the Company's consolidated financial position or consolidated results of operations. + +In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This standard amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, collectively referred to as derivatives, and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Relationships." SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships after June 30, 2003. The Company does not believe that the implementation of this standard will materially impact its consolidated financial position or consolidated results of operations. + +Segment Reporting + +The Company operates its business as one segment, therefore segment information is not presented. + +(2) Change In Accounting: + +At the start of fiscal 2003, the Company changed its method of estimating progress toward completion of contracts. Under the Company's previous method, the percentage of direct labor incurred to date to total estimated direct labor to be incurred on a project was used to determine a contract's percentage of completion, while under the new method, the percentage of total costs incurred to date to total estimated costs to be incurred on a project is used to determine a contract's percentage of completion. The change was made to reflect the effect of non-labor charges and to more accurately measure a contract's progress towards completion. In accordance with APB No. 20, "Accounting Changes," paragraph 27, the consolidated financial statements of prior periods have been adjusted to apply the new method retroactively. + +A summary of the significant effects of the accounting change applied to the Company's results are as follows: + + + + + +For the Fiscal Year Ended + + +For the Fiscal Year Ended + +April 30, 2001 + +April 30, 2002 + +As previously reported + +Effect of change in accounting principle + +As retroactively adjusted + +As previously reported + +Effect of change in accounting principle + +As retroactively adjusted + + + +(Dollars in thousands, except per share amounts) + +Consolidated Statements of Operations Data: + + + + + + + + +Revenue + +$ 94,352 + +$ 1,797 + +$ 96,149 + + +$ 70,277 + +$ 5,022 + +$ 75,299 + +Cost of revenue + +78,581 + +1,375 + +79,956 + + +48,103 + +3,323 + +51,426 + +Gross margin (loss) + +15,771 + +422 + +16,193 + + +22,174 + +1,699 + +23,873 + +Selling, general and administrative expenses + +33,232 + +-- + +33,232 + + +24,118 + +-- + +24,118 + +Operating loss + +(17,461) + +422 + +(17,039) + + +(1,944) + +1,699 + +(245) + +Net loss + +(19,858) + +422 + +(19,436) + + +(4,387) + +1,699 + +(2,688) + +Net loss per share: + + + + + + + + +Basic + +(0.59) + +0.01 + +(0.58) + + +(0.12) + +0.04 + +(0.08) + + + + + + + + + + +Consolidated balance sheet data: + + + + + + + + +Receivables, net + +20,024 + +(2,126) + +17,898 + + +17,204 + +4,598 + +21,802 + +Prepaid expenses and other current assets + +1,126 + +(424) + +702 + + +4,096 + +(3,371) + +725 + +Accrued and other liabilities + +9,555 + +(2,550) + +7,005 + + +4,172 + +(472) + +3,700 + +Accumulated deficit + +(46,551) + +-- + +(46,551) + + +(50,938) + +1,699 + +(49,239) + +Stockholders' equity (deficit) + +(3,629) + +-- + +(3,629) + + +2,279 + +1,699 + +3,978 + +(3) Net Income (Loss) Per Share: + +SFAS No. 128, "Earnings Per Share" requires the presentation of basic earnings per share ("Basic EPS") and diluted earnings per share ("Diluted EPS"). Basic EPS is calculated by dividing income or loss applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted EPS is calculated by dividing income available to common stockholders by the weighted average number of common and potentially dilutive common shares outstanding during the period. + +In accordance with SFAS No. 128, the following table reconciles net loss and per share amounts used to calculate basic and diluted earnings per share (in thousands): + + + + +For the Years Ended April 30, + + + + + + +2001 + + +2002 + + +2003 + +Numerator: + + + + + + + +Net income (loss) + + +$(19,436) + + +$(2,688) + + +$1,417 + +Denominator: + + + + + + + +Weighted average Common Shares outstanding + + + + + + + +-Basic + + +33,608 + + +35,162 + + + 36,067 + +-Diluted + + +33,608 + + +35,162 + + + 36,291 + + + + + + + + + + Net income (loss) per share + + + + + + + +-Basic + + +$(0.58) + + +$(0.08) + + +$0.04 + +-Diluted + + +$(0.58) + + +$(0.08) + + +$0.04 + +Outstanding options and warrants totaling 5,335,991, 5,163,672 and 5,142,356, for the fiscal years ended April 30, 2001, 2002 and 2003, respectively, have been excluded from the computation of Diluted EPS, as their inclusion would have been anti-dilutive. + + + +(4) Receivables: + +Accounts receivable are comprised of amounts due from customers in connection with services provided by the Company in its normal course of business. Amounts billed are shown separately from unbilled amounts determined under the percentage of completion method of accounting. + + + +As of April 30, + + + +2002 + + +2003 + +(in thousands) + +Billed accounts receivable + +$15,257 + +$28,100 + +Allowance for doubtful accounts + + (679) + + (286) + +Accounts receivable, net + +$14,578 + + +$27,814 + + + +(5) Property and Equipment: + +The following is a summary of property and equipment: + + + +As of April 30, + + + +2002 + + +2003 + + + +(in thousands) + +Equipment + +$3,706 + + +$5,315 + +Computer equipment + +7,724 + + +8,006 + +Furniture, fixtures and leasehold improvements + + 5,472 + + + 5,611 + + + +16,902 + + +18,932 + +Less - Accumulated depreciation and amortization + +(13,643) + + +(15,734) + +Property and equipment, net + +$ 3,259 + + +$ 3,198 + +Depreciation and amortization expense for the years ended April 30, 2001, 2002 and 2003 amounted to $2.5 million, $2.2 million, and $2.1 million, respectively. + +The estimated useful lives of these assets are: + +Equipment + +2 to 5 years + +Computer Equipment + +3 to 5 years + +Furniture, Fixtures and Leasehold Improvements + +5 to 11 years + +(6) Other Assets: + +Other assets consist of the following (in thousands): + + + +As of April 30, + + + +2002 + + +2003 + +Internal use software + +$3,626 + +$4,113 + +Less accumulated amortization + +2,166 + +2,867 + + Net + +1,460 + +1,246 + +Software development + +6,303 + + +6,858 + +Less accumulated amortization, + +4,095 + + +5,584 + + Net + +2,208 + + +1,274 + +Security deposits and other + +502 + + +578 + + Total other assets + +$4,170 + + +$3,098 + +Amortization expense of internal use software and software development for the years ended April 30, 2001, 2002 and 2003 amounted to $2.3 million, $2.5 million and $2.2 million, respectively. + +(7) Short-term Borrowings: + +The Company maintains a credit facility with IBM Credit. At the beginning of fiscal 2003, the credit facility consisted of: (i) a $16 million, three-year revolving credit facility and (ii) a $3 million, three-year term loan, payable in monthly installments of principal and interest. During fiscal 2003, the credit facility was amended several times. + +On April 14, 2003, the credit facility was amended to: (i) extend the credit facility to August 1, 2004 from August 1, 2003; (ii) provide for a maximum availability of $29 million until May 31, 2003, $25 million from June 1, 2003 until December 31, 2003, $20 million from January 1, 2004 until March 31, 2004 and $15 million from April 1, 2004 until August 1, 2004; (iii) lower the interest rate on the facility from prime plus 4.25% to prime rate plus 1.75% effective May 1, 2003; (iv) amend certain finance charges and financial covenants (described below); and (v) require the Company to pay off the remaining balance of the $3 million term loan with IBM Credit after the closing of an equity financing. The Company repaid the term loan after closing on the $5 million private equity placement in April 2003 (see Note 11). + +On June 3, 2003, the credit facility was further amended to provide for a maximum availability as follows: (i) $25 million from June 1, 2003 until January 14, 2004; (ii) $23 million from January 15, 2004 until March 31, 2004; and (iii) $20 million from April 1, 2004 until August 1, 2004. In addition, IBM Credit agreed to increase the Company's maximum availability from $25,000,000 to $28,000,000 until August 31, 2003, at which time the maximum borrowings under the credit facility available must be reduced to $25,000,000. The Company is required to pay interest at the rate of prime rate plus 4% on any amounts borrowed over $25 million, instead of prime rate plus 1.75%. + +The borrowings under the revolving line of credit are based on a formula of 85% of eligible receivables and 25-35% of eligible inventory. The amounts outstanding under the credit facility as of April 30, 2002 and April 30, 2003 were $14.5 million and $28.8 million, respectively, while the amounts outstanding under the term loan as of April 30, 2002 and April 30, 2003 were $3.0 million and zero, respectively. At times, IBM Credit has allowed the Company to borrow amounts in excess of our maximum allowable. + +As set forth in the table below, the Company has failed to comply with one or more of the financial covenants of its credit facility for each fiscal quarter beginning in the fiscal quarter ended as of January 31, 2001, through and including the fiscal quarter ended as of April 30, 2003. The Company and IBM Credit Corporation entered into an Acknowledgment, Waiver and Amendment to the Inventory and Working Capital Financing Agreement as of the end of each of these quarters by which IBM Credit has waived the Company's defaults. The amounts outstanding under the revolving credit facility and term loan as of April 30, 2002 and 2003 have been classified as current in the Company's consolidated balance sheets. The following is a summary of the covenant violations for each of the quarters referred to above. + +Period + +Covenant + +Requirement + +Actual + +Jan 31, 2001 + +Net Profit to Revenue + +Equal to or greater than 0.0% + +Net loss + +Apr 30, 2001 + +Annual Revenue to Working Capital + +Greater than 0 and equal to or less than 25.0 to 1.0 + +(25.5) to 1.0 + +Jul 31, 2001 + +Annual Revenue to Working Capital + +Greater than 0 and equal to or less than 25.0 to 1.0 + +(4.5) to 1.0 + + + +Net Profit to Revenue + +Equal to or greater than 0.1% + +(1.7)% + + + +Tangible Net Worth + +Equal to or greater than $2.5 million + +$(1.1) million + +Oct 31, 2001 + +Annual Revenue to Working Capital + +Greater than 0 and equal to or less than 25.0 to 1.0 + +(22.2) to 1.0 + + + +Net Profit to Revenue + +Equal to or greater than 0.1% + +(1.7)% + + + +Tangible Net Worth + +Equal to or greater than $2.5 million + +$(3.8) million + +Jan 31, 2002 + +Net Profit to Revenue + +Equal to or greater than 0.1% + +(9.0)% + +Apr 30, 2002 + +Net Profit to Revenue + +Equal to or greater than 0.1% + +(10.7)% + + + +Debt Service Ratio + +Equal to or greater than 2.0 to 1.0 + +(2.5) to 1.0 + +July 31, 2002 + +Annual Revenue to Working Capital + +Greater than 5.0:1.0 and equal to or less than 25.0 to 1.0 + +(24.7) to 1.0 + + + +Tangible Net Worth + +Equal to or greater than $2.5 million + +$2.1 million + +Oct 31, 2002 + +Annual Revenue to Working Capital + +Greater than 5.0:1.0 and equal to or less than 25.0 to 1.0 + +(86.0) to 1.0 + +Jan 31, 2003 + +Annual Revenue to Working Capital + +Greater than 5.0:1.0 and equal to or less than 25.0 to 1.0 + +(126.9) to 1.0 + + + +Debt Service Ratio + +Equal to or greater than 2.0 to 1.0 + +0.20 to 1.0 + +April 30, 2003 + +Debt Service Ratio + +Equal to or greater than 1.25 to 1.0 + +(1.73) to 1.0 + + + +Net Profit to Revenue + +Equal to or greater than 0.10 percent + +(3.38%) + +IBM Credit, the Company's working capital lender, has notified the Company that it does not intend to renew its working capital line beyond August 2004. As a result, the Company is seeking replacement financing for its credit facility. + +(8) Accrued and Other Liabilities: + +Accrued and other liabilities consist of: + + + +As of April 30, + + + +2002 + + +2003 + +(in thousands) + +Accrued payroll and related costs + +$1,946 + +$3,463 + +Taxes, interest and other + +1,685 + +2,225 + +Deferred revenue under percentage of completion + + 69 + + -- + + + + + + + Total accrued and other liabilities + + $3,700 + + + $5,688 + +(9) eDeploy.com Inc.: + +On November 2, 2001, the Company acquired 100,000 shares of Series A Preferred Stock of eDeploy.com, Inc. (the "Shares"), a wholly-owned subsidiary ("eDeploy.com"), held by Cisco Systems, Inc. ("Cisco") through an exchange of 1,021,382 shares of the Company's common stock. Dividends payable to Cisco during the period it held the 100,000 shares of Series A Preferred Stock of eDeploy.com, Inc. are included in accrued and other liabilities and annual dividends, recorded prior to the exchange, are reflected as minority interest in the statements of operations. + +(10) Subordinated Secured Convertible Debentures: + +On April 3, 2002, the Company raised $2.0 million (less transaction costs of $0.170 million) to be used for working capital purposes by issuing an aggregate of $2.0 million principal amount of Subordinated Secured Convertible Debentures and Warrants to purchase an aggregate of 270,000 shares of the Company's common stock at $1.416 per share. The debentures matured on July 2, 2003 and had an interest rate of 5% per annum. Interest was due quarterly on March 31, June 30, September 30, and December 31 of each year (with the first interest payment due and payable on September 30, 2002) and was paid in cash or Common Stock, at the Company's option. The Company recorded a discount of $582,000 in connection with the issuance of the Debentures. The warrants have been valued at approximately $291,000, based on the Black Scholes Pricing Model utilizing the following assumptions: expected life of 5.0 years; volatility of 119 percent; risk free borrowing rate of 4.405 percent. This amount has been recorded as a discount against the debt and will be accreted as interest expense over the remaining life of the debt. In addition, in accordance with Emerging Issues Task Force No. 98-5, an embedded beneficial conversion feature of approximately $291,000 has been recognized as additional paid-in-capital and will be accreted as additional interest expense over the remaining life of the debt. Through April 30, 2003, $504,000 of the above discounts has been accreted. + +The warrants are exercisable at any time from April 3, 2002 to April 3, 2007 and are not redeemable by the Company. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets and issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. + +At April 30, 2003, $0.6 million of the Debentures had been converted into 518,517 shares of the Company's Common Stock. Subsequently, and prior to the maturity date of the Debentures, all of the remaining Debentures have been converted into an additional 1,236,771 shares of the Company's Common Stock. + +The agreement with the investors contains a requirement for the Company to have effected the registration of a sufficient number of shares of its common stock by July 2, 2002 or incur penalties equal to: (1) 2% of the product obtained by multiplying the average closing sale price for the immediately preceding 30 day period times the number of registrable securities the investor holds or may acquire pursuant to conversion of the Convertible Debenture and the exercise of Warrants on the last day of the applicable 30 day period (without giving effect to any limitation on conversion or exercise) and (2) 3% of the product for all continuing or subsequent registration defaults. + +Although the Company filed the required registration statement with the Securities and Exchange Commission within the required time period, such registration statement had not been declared effective prior to July 2, 2002, as a result, the company incurred the penalties described above. The Company issued an aggregate 669,794 shares of common stock to the investors of the Debentures to satisfy the penalties in full, which amounted to $613,927. + +(11) Stockholders Equity: + +Warrants + +The following table is a summary and status of warrants issued by the Company: + +Outstanding Warrants + +Number + +of Warrants + +Weighted Average Exercise Price + +Balance, May 1, 2000 + +690,000 + +$5.50 + +Cancellations + +(90,000) + +$6.29 + +Balance, April 30, 2001 + +600,000 + +$5.38 + +Grants + +360,000 + +$1.40 + +Cancellations + +(525,000) + +$5.25 + +Balance, April 30, 2002 + +435,000 + +$2.48 + +Grants + +2,480,000 + +$1.65 + +Cancellations + +(75,000) + +$6.29 + +Balance, April 30, 2003 + +2,840,000 + +$1.62 + + + + + + +Outstanding Warrants + + + + + + + +Range of Exercise Prices + + +Number + +of Warrants + + +Warrants + +Exercisable + + +Weighted Average Contractual Life + +(in years) + + +Weighted Average Exercise Price + +$0.98 - $1.75 + +2,840,000 + +2,840,000 + +3.99 + +$1.62 + +Private Placement of Common Stock. On April 28, 2003, we raised $5.0 million in private equity financing (less out-of-pocket transaction costs of approximately $0.425 million) for working capital purposes by selling 4 million shares of our common stock and warrants to purchase an additional 2 million shares of common stock at an exercise price of $1.625 per share. The warrants are exercisable at any time from April 28, 2003 to April 28, 2007. We may redeem the warrants at any time after April 28, 2004 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. We also issued a four-year warrant to purchase 480,000 shares of common stock at an exercise price of $1.75 per share to the placement agent for the financing. These warrants are exercisable at any time from April 28, 2003 to April 28, 2007 and are not redeemable by us. The exercise price on both the warrants issued to investors in the private placement and the warrants issued to the placement agent is subject to adjustment upon certain events, including stock dividends, reclassifications, recapitalizations, reorganizations and mergers. In addition, the exercise price of the warrants issued to the investors in the private placement is subject to adjustment upon issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. The agreement with the investors in the private placement requires us to file a registration statement for the resale of the shares of the common stock issued, as well as the shares underlying the warrants, with the SEC within 45 days of April 28, 2003 and have such registration statement be declared effective within 90 days of April 28, 2003. + +(12) Income Taxes: + +The following indicates the significant elements contributing to the difference between the U.S. Federal statutory tax rate and the Company's effective tax rate for the years ended April 30: + + + +For The Year Ended April 30, + + + +2001 + + +2002 + + +2003 + +U.S. Federal statutory tax rate + +(34.0%) + + +(34.0%) + + +34.0% + +State and foreign income taxes + +(6.0%) + +(6.0)% + +6.0% + +Valuation allowance on deferred tax asset + +40.0% + + +40.0% + + +(40.0%) + +Effective tax rate + +-- + + +-- + + +-- + +Deferred income taxes result primarily from temporary differences in the recognition of expenses for tax and financial reporting purposes. Deferred income taxes consisted of the following: + +As of April 30, + +2002 + +2003 + +Deferred tax asset: + +Net operating loss carryforwards + +$21,343 + +$19,967 + +Allowance for doubtful accounts + +272 + +114 + +Inventory reserve + +716 + +802 + +Revenue recognition + +525 + +525 + +Other + +900 + +65 + +Total deferred tax asset + +23,756 + +21,474 + +Deferred tax liability: + +Depreciation + +(307) + +(4) + +Net deferred tax asset + +23,449 + +21,470 + +Valuation allowance + +(23,449) + +(21,470) + +Net deferred tax asset + +$ -- + +$ -- + +As of April 30, 2003, the Company had net operating loss carryforwards for Federal tax purposes of approximately $50 million, of which approximately $10 million is subject to separate return year limitations. United States tax rules limit the amount of net operating losses that companies may utilize in any one year in the event of a 5% shareholder having cumulative changes in ownership over a three-year period in excess of 50%. The Company does not believe that it incurred a change of ownership that limits its ability to utilize its net operating loss carryforwards as of April 30, 2003, although ownership changes in future periods may pose limitations on the Company's use of net operating loss carryforwards. No federal tax provision has been recorded against 2003 net income since net operating loss carryforwards will be utilized to reduce any tax obligation to zero. At April 30, 2003 and 2002, the Company determined that it was unlikely that it would realize remaining net operating loss carry forwards, and as such, has provided a full valuation allowance offsetting these carryforwards. The Company's net operating loss carry forwards expire between 2009 through 2022. + +(13) Due to Related Party: + +The Company owes a former executive officer $1,414,000. The original note, which bore an annual interest rate of 12.5%, was renegotiated on April 15, 2001. Under the new terms, the maturity date was extended to April 15, 2004, principal payments are not due until maturity, the interest rate was reset at 17.5% per annum and interest payments are due monthly. The note is subordinated to the working capital line and term loan with IBM Credit, the Company's primary lender. + +(14) Incentive Plans: + +At April 30, 2003, the Company had several stock-based incentive plans, including an employee stock purchase plan, which are described below. The Company applies APB Opinion No. 25 for its plans. Accordingly, no compensation cost has been recognized for the stock-based incentive plans, because the exercise price equaled the fair value on the date of grant for all options granted. + +Common Stock Options + +The 1990 Stock Option Plan (the "1990 Plan") provides for grants of 1,500,000 common stock options to employees, directors, and consultants to purchase common stock at a price at least equal to 100% of the fair market value of such shares on the grant date. The exercise price of any options granted to a person owning more than 10% of the combined voting power of all classes of stock of the Company ("10% shareholder"), shall be at least equal to 110% of the fair market value of the share on the grant date. The options are granted for no more than a 10-year term (5 years for 10% shareholders) and the vesting period's range from 2 to 4 years. Options granted under this plan during the year ended April 30, 2001 was 47,750 and no options were granted under this plan during the years ended April 30, 2002 and 2003. As of April 30, 2003, 133,127 shares remain reserved for future issuance under the 1990 Plan. + +The 1993 Consultant Stock Option Plan (the "1993 Plan") provides for grants of 30,000 shares of common stock to selected persons who provide consulting and advisory services to the Company at a price at least equal to 100% of the fair market value of such shares on the grant date, as determined by the Board of Directors. The exercise price of any options granted to a person owning more than 10% of the combined voting power of all classes of stock of the Company ("10% shareholder"), shall be at least equal to 110% of the fair market value of such shares on the grant date. The options are granted for no more than a 10-year term (5 years for 10% shareholders) and the Board of Directors determines the vesting periods. During the year ended April 30, 2001, 2002 and 2003, there were no options granted under this plan. As of April 30, 2003, 4,000 shares remain reserved for future issuance under the 1993 Plan. + +The 1995 Directors Stock Option Plan (the "Directors Plan") provides for grants of 500,000 shares of Common Stock at exercise prices equal to the average closing price of the shares for the six trading days prior to the grant date. All members of the Board of Directors who are not employees of the Company ("Eligible Directors") are eligible to receive grants of options. Each Eligible Director is granted an option to purchase 24,000 shares of Common Stock on the date the Eligible Director is elected to the Board of Directors, and will be granted another option to purchase 24,000 shares of Common Stock annually thereafter so long as he remains an Eligible Director. Generally, each option vests ratably over a three-year period provided such individual continues to serve as Director of the Company. No options were granted under this plan during the years ended April 30, 2001, 2002 and 2003. As of April 30, 2003, 236,000 shares remain reserved for future issuance under the Directors Plan. + +The 1996 Employee and Consultant Stock Option Plan (the "1996 Plan") provides for grants of 2,000,000 shares of common stock to employees and consultants to purchase common stock at a price equal to 100% of the fair market value of such shares on the grant date. The options are granted for no more than a 10-year term and the Board of Directors determines the vesting periods. No options were granted under this plan during the years ended April 30, 2001, 2002 and 2003. As of April 30, 2003, 354,037 shares remain reserved for future issuance under the 1996 Plan. + +The Senior Executive Stock Option Plan (the "Executive Plan") provides for grants of 560,000 shares of common stock to senior executive officers of the Company at exercise prices and vesting periods as determined by the Board of Directors at the time of grant. During the years ended April 30, 2002 and 2003, there were no options granted under this plan. As of April 30, 2003, 200,000 shares remain reserved for future issuance under the Executive Plan. + +The 1996 Stock Option Conversion Plan (the "Conversion Plan") was primarily established to replace stock options previously granted by the Company's subsidiary, Datatec Industries, Inc., with Company options on the same terms as indicated in the merger agreement. The Conversion Plan provides for grants of 470,422 shares of common stock. No options were granted under this plan during the years ended April 30, 2001, 2002 and 2003. As of April 30, 2003, 64,560 shares remain reserved for future issuance under the Conversion Plan. + +The 2000 Stock Option Plan (the "2000 Plan") provides for grants of 5,000,000 shares of common stock to employees, directors, consultants and advisors at a price equal to 100% of the fair market value of such shares on the grant date. The options are granted for no more than a 10-year term and the Board of Directors determines the vesting periods. During the years ended April 30, 2001, 2002 and 2003, 2,017,771, 600,834 and 495,000 options, respectively, were granted under this plan. As of April 30, 2003, 461,619 shares remain reserved for future issuance. On May 1, 2003, the stockholders of the Company approved an amendment to the 2000 Plan to increase the number of shares of Common Stock issuable under the Plan by 2,000,000 shares. + +Summary of the status of stock option activity follows: + +Outstanding Options + + + + + + + + + + +Options Available + +for Future Grants + + +Number + +Of Shares + + +Weighted Average Exercise Price + + + + + + + + +Balance as of May 1, 2000 + +3,399,422 + + +3,449,606 + + +$3.59 + +Grants + +(2,033,071) + + +2,033,071 + + +$3.20 + +Exercises + +-- + + +(106,316) + + +$3.07 + +Cancellations + +422,719 + + +(422,719) + + +$3.47 + + + + + + + + +Balance as of April 30, 2001 + +1,789,070 + + +4,953,642 + + +$3.47 + +Grants + +(605,334) + + +605,334 + + +$0.73 + +Exercises + +-- + + +(405,578) + + +$0.08 + +Cancellations + +446,042 + + +(446,042) + + +$3.45 + +Expired + +(2,163) + + +-- + + +$0.05 + +Balance as of April 30, 2002 + +1,627,615 + + +4,707,356 + + +$3.41 + +Grants + +(495,000) + + +495,000 + + +$1.18 + +Exercises + +-- + + +(55,085) + + +$0.73 + +Cancellations + +641,191 + + +(641,191) + + +$5.53 + + + + + + + + +Balance as of April 30, 2003 + +1,773,806 + + +4,506,080 + + +$2.90 + +Options exercisable at April 30, 2003 + + + +4,001,556 + + +$3.01 + + + + + + +Outstanding Options + +Range of Exercise Prices + + +Number of Shares + + +Weighted Average Contractual Life + +(in years) + + +Weighted Average Exercise Price + +$.005 - $0.99 + + +626,499 + + +8.64 + + +$0.73 + +$1.00 - $1.99 + + +743,209 + + +6.95 + + +$1.42 + +$2.00 - $2.99 + + +542,276 + + +4.48 + + +$2.62 + +$3.00 - $3.99 + + +1,374,947 + + +6.21 + + +$3.17 + +$4.00 - $4.99 + + +1,000,668 + + +3.96 + + +$4.02 + +>$4.99 + + +218,481 + + +6.41 + + +$7.98 + +T7otal + + +4,506,080 + + + + +$2.90 + + + +Range of Exercise Prices + + +Exercisable Options + +Number of Shares + + +Exercisable Options Weighted Average Exercise Price + +$.005 - $0.99 + + +429,497 + + +$0.73 + +$1.00 - $1.99 + + +548,542 + + +$1.36 + +$2.00 - $2.99 + + +542,276 + + +$2.62 + +$3.00 - $3.99 + + +1,295,425 + + +$3.18 + +$4.00 - $4.99 + + +1,000,668 + + +$4.02 + +>$4.99 + + +185,148 + + +$7.78 + +Total + + +4,001,556 + + +$3.01 + +Employee Stock Purchase Plan + +During fiscal 1999, the Company implemented an employee stock purchase plan (the "stock plan") whereby eligible employees, as defined, may purchase shares of the Company's common stock at a price equal to 85% of the lower of the closing market price on the first or last trading day of the stock plan's quarter. A total of 1,750,000 shares of common stock have been reserved for issuance under the plan. During the years ended April 30, 2001, 2002 and 2003, the Company issued 229,000, 415,000 and 374,000 shares, respectively, of common stock to participants of the stock plan. As of April 30, 2003, 354,000 shares are available for issuance under the stock plan. + +Retirement Plan + +The Company has a 401(k) Saving Plan (the "Plan") which permits employees to contribute if they are at least 21 years of age and have been a full-time employee of the Company for six months. The Plan requires a minimum contribution of 1% of gross earnings and no more than 15% of gross earnings up to the maximum allowed under the Internal Revenue Service Code. The Company is not required to contribute to this Plan. + +(15) Commitments and Contingencies: + +The Company leases offices and staging and configuration facilities in addition to certain office equipment throughout the United States and Canada. The minimum annual rentals for future years are as follows: + +Fiscal Years + +Ending April 30, + + + +Amount + +2004 + + + +$1,859 + +2005 + + + +1,568 + +2006 + + + +1,440 + +2007 + + + +1,111 + +2008 + + + +783 + +Thereafter + + + +3,362 + +Total + + + +$10,123 + +Rent expense was $2,819,000, $2,700,000 and $2,523,000 for the years ended April 30, 2001, 2002 and 2003, respectively. + +The Company has entered into employment agreements with three key employees. These agreements provide for an aggregate annual salary of $875,000. The Chief Executive Officer's employment agreement expires in May 2006 and although the other key employees are at will agreements; they both contain six month severance provisions. + +The Company, from time to time, is involved in routine litigation and various legal matters in the ordinary course of business. The Company does not expect that the ultimate outcome of this litigation will have a material adverse effect on its consolidated financial position or consolidated results of operations. + +On September 22, 2000, Petsmart, Inc. filed a complaint against the Company in the Superior Court of Maricopa County, Arizona. Petsmart has alleged that it has been damaged by the Company's failure to satisfactorily complete work contemplated by an agreement between the parties. Damages were unspecified. At a settlement meeting held on April 17, 2002, discussions were held in which Petsmart proposed a series of settlement offers ranging between $7,000,000 and $8,000,000. In a letter to the Company dated May 3, 2002, Petsmart proposed settlement offers ranging between $5,000,000 and $7,000,000. On March 7, 2003, Petsmart filed an Offer of Judgment offering to settle the litigation for a payment of $2,300,000. Datatec has further counter-claimed against Petsmart for amounts owing to the Company under the contract. These amounts have been reserved as part of the allowance for uncollectable accounts (see Note 20). + +(16) Concentrations of Credit Risk: + +The Company's financial instruments subject to credit risk are primarily trade accounts receivable. Generally, the Company does not require collateral or other security to support customer receivables. At April 30, 2002 and 2003, the Company's customers were within the United States. + +For the year ended April 30, 2003, two customers accounted for approximately 37% and 28% of revenues. For the year ended April 30, 2002, one customer accounted for 33% of revenues. For the year ended April 30, 2001, two customers accounted for 27% and 21% of revenues. + +(17) Shareholder Rights Plan: + +On January 30, 1998, the Board of Directors adopted a shareholder rights plan (the "rights plan"). Under the rights plan, each shareholder on record as of March 9, 1998, received a dividend of one right for each outstanding share of Common Stock. The rights are attached to, and presently only trade with, the Common Stock and currently are not exercisable. Accordingly, they are not considered in the computation of earnings per share. Except as specified below, upon becoming exercisable, all rights holders will be entitled to purchase from the Company one one-hundredth of a share of Series D Preferred Stock ("Participating Preferred Stock") at a price of $40, subject to adjustment. + +The rights become exercisable and will begin to trade separately from the Common Stock upon the earlier of (i) the first date of public announcement that a person or group (other than certain exempted shareholders as described in the Rights Agreement) has acquired beneficial ownership of 15% or more of the outstanding Common Stock or (ii) 10 business days following a person's or group's commencement of, or announcement of, and intention to commence a tender or exchange offer, the consummation of which would result in beneficial ownership of 15% or more of the Common Stock. The rights will entitle holders (other than an Acquiring Person, as defined) to purchase Company Common Stock having a market value (immediately prior to such acquisition) of twice the exercise price of the right. If the Company is acquired through a merger or other business combination transaction after a person or group has become an Acquiring Person, each right will entitle the holder to purchase $80 worth of the surviving Company's Common Stock for $40, at a 50% discount. The Company may redeem the rights for $0.01 each at any time prior to the acquisition of 15% or more of the outstanding shares of Common Stock by a person or group of persons. The rights will expire on February 24, 2008. + +Until the rights are exercised, the holder thereof, as such will have no rights as a stockholder of the Company, including without limitation, the right to vote or to receive dividends. + +The holders of the Participating Preferred Stock will be entitled to receive dividends, if declared by the Board of Directors, from funds legally available. Each share of Participating Preferred Stock will be entitled to one hundred votes on all matters submitted for stockholder vote. The shares of Participating Preferred Stock are not redeemable by the Company or convertible into Common Stock or any other security of the Company. + +(18) Supplemental Disclosures of Cash Flow Information: + +Non-cash transactions: + + + +2001 + + +2002 + + +2003 + +Exchange of minority interest for common stock + +$ -- + + +$9,618,000 + + +$ -- + +Issuance of warrants in connection with subordinated secured convertible debentures + +$ -- + + +$ 291,000 + + +$960,650 + +Beneficial conversion feature in connection with subordinated secured convertible debentures + +$ -- + + +$ 291,000 + + +$ -- + +Conversion of debt and issuance of common stock in lieu of cash + +$ -- + + +$ -- + + +$930,000 + +Cash paid during the year for: + + + +2001 + + +2002 + + +2003 + +Interest + +$1,495,000 + + +$ 1,912,000 + + +$2,754,000 + +Income taxes + +$ 149,000 + + +$ 52,000 + + +$ -- + +(19) Selected Quarterly Financial Data (Unaudited): + +The Company's quarterly results for each of the quarterly periods in fiscal 2001 and 2002 have been retroactively adjusted to reflect the effect of the Company's change in the method of determining percentage of completion (see Note 2). A summary of quarterly financial information for fiscal 2001, 2002 and 2003 is as follows (in thousands, except per share data): + + + +Retroactively Adjusted + +Year Ended April 30, 2001 + + + +First Quarter + + +Second Quarter + + +Third Quarter + + +Fourth Quarter + +Revenue + +$24,046 + + +$33,276 + + +$20,561 + + +$18,266 + +Gross margin (loss) + +5,818 + + +9,264 + + +(718) + + +1,829 + +Net income (loss) + +(1,315) + + +1,303 + + +(10,769) + + +(8,655) + +Basic income (loss) per share + +(0.04) + + +0.04 + + +(0.32) + + +(0.26) + +Diluted income (loss) per share + +(0.03) + + +0.03 + + +(0.28) + + +(0.22) + + + +Retroactively Adjusted + +Year Ended April 30, 2002 + + + +First Quarter + + +Second Quarter + + +Third Quarter + + +Fourth Quarter + +Revenue + +$18,063 + + +$19,598 + + +$16,237 + + +$21,401 + +Gross margin + +5,747 + + +6,509 + + +3,827 + + +7,790 + +Net income (loss) + +(1,185) + + +(62) + + +(2,013) + + +572 + +Basic income (loss) per share + +(0.04) + + +0.00 + + +(0.06) + + +0.02 + +Diluted income (loss) per share + +(0.03) + + +0.00 + + +(0.05) + + +0.01 + + + +Year Ended April 30, 2003 + + + +First Quarter + + +Second Quarter + + +Third Quarter + + +Fourth Quarter + +Revenue + +$23,072 + + +$33,203 + + +$35,275 + + +$33,541 + +Gross margin + +6,526 + + +7,758 + + +7,009 + + +5,912 + +Net income (loss) + +732 + + +1,617 + + +201 + + +(1,133) + +Basic income (loss) per share + +0.02 + + +0.05 + + +0.01 + + +(0.03) + +Diluted income (loss) per share + +0.02 + + +0.04 + + +0.00 + + +(0.03) + +(20) Subsequent Events + +Acquisition of Millennium Care, Inc. On May 1, 2003, the Company acquired 100% of a privately-held provider of help desk outsourcing and related technologies. Pursuant to the stock purchase agreement, the Company issued 1,546,247 shares of common stock, warrants to purchase 200,000 shares of common stock and employee stock options to purchase 56,490 shares of common stock in exchange for all of the outstanding equity of Millennium. In addition, the Company has agreed to issue to the sellers of Millennium additional shares of common stock in the event certain revenue targets are met by Millennium during calendar years 2003 and 2004. If Millennium achieves qualified (as defined) revenue of over $6 million (Canadian) in calendar 2003 or $10 million (Canadian) in calendar year 2004, the Company would be required to issue additional shares of common stock in an amount equal to 40% of any such excess for calendar year 2003 and 35% of any such excess for calendar year 2004. The warrants are exercisable at $1.82 per share and are not exercisable before January 31, 2004 or after May 1, 2008. These warrants also require Millennium to achieve a revenue target of $5.4 million (Canadian) for calendar year 2003 in order to become exercisable. The Company may redeem the warrants at any time after January 31, 2005 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets. The stock options are exercisable at $1.40 per share and were issued to replace Millennium employee options, which were canceled as a result of the acquisition. + +The Company has not completed its assessment of the fair values of the assets acquired and liabilities assumed. Beginning in fiscal 2004, the Company will account for the acquisition of Millennium using the purchase method of accounting under SFAS No. 141, "Business Combinations". + +Issuance of Subordinated Secured Convertible Notes and Warrants. On July 3, 2003, the Company issued an aggregate of $4.9 million principal amount of subordinated secured convertible notes and warrants to purchase an aggregate of 875,000 shares of our common stock, pursuant to a Note Purchase Agreement by and among the Company and the investors signatory thereto. The investors are six funds managed by the Palladin Group L.P., which also manages two funds that were among the Company's current lenders. The notes are to be repaid by the Company in ten equal monthly installments beginning on January 1, 2004 and ending on October 1, 2004 and bear interest at a rate of 2% per annum. The monthly installments of principal and interest are payable in cash or common stock at the Company's option, subject to certain listing and registration requirements relating to the common stock. If the Company elects to pay the monthly installments in common stock, the conversion rate is the lower of: (a) $1.40 or (b) a 10% discount to the then fair market value of the common stock. The holder of each note is entitled, at its option, to convert at any time the principal amount of the note or any portion thereof, together with accrued but unpaid interest, into shares of the Company's common stock at a conversion price for each share of common stock equal to $1.40. In connection with the financing, the Company issued to the investors four-year warrants to purchase an aggregate of 875,000 shares of common stock at an exercise price of $1.3224 per share. The warrants are exercisable at any time from July 3, 2003 to July 3, 2007 and are not redeemable by the Company. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets and issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. + +The Company agreed to prepare and file a registration statement covering the resale of the shares of common stock issuable upon the redemption or conversion of the notes and the exercise of the warrants. The registration statement was required to be filed with the SEC not later than August 3, 2003. The Company filed such registration statement on July 31, 2003. The Company will incur a 2% penalty on the value of the shares of common stock underlying the notes and the warrants if the SEC does not declare such registration statement effective by November 1, 2003. + +On July 28, 2003, the Company agreed to issue to the investors an aggregate of 700,000 four-year warrants to purchase shares of the Company's common stock at an exercise price of $0.9441 per share in exchange for the following: (i) a waiver of the investors' rights of first refusal in connection with the July 28, 2003 private placement (described below); (ii) a waiver of the investors' right to a redemption price adjustment to their notes which would cause an increased number of shares to be issuable upon redemption of their notes as a result of the July 28, 2003 private placement; and (iii) an extension of the maturity date of the notes from October 1, 2004 to April 3, 2005. + +Private Placement of Common Stock - July 2003. On July 28, 2003, the Company raised $3.49 million in private equity financing (less out-of-pocket transaction costs of approximately $0.42 million) for working capital purposes and to reduce outstanding indebtedness by selling 3,696,621 shares of the Company's common stock and warrants to purchase and additional 1,848,306 shares of the Company's common stock at an exercise price of $1.3637 per share. The warrants are exercisable at any time from July 28, 2003 to July 28, 2008. The Company may redeem the warrants at any time after July 28, 2004 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. The Company also issued a five-year warrant to purchase 554,492 shares of common stock at an exercise price of $1.3637 per share to the placement agent for the financing. These warrants are exercisable at any time from July 28, 2003 to July 28, 2008 and are not redeemable by the Company. The exercise price on both the warrants issued to investors in the private placement and the warrants issued to the placement agent is subject to adjustment upon certain events, including stock dividends, reclassifications, recapitalizations, reorganizations and mergers. In addition, the exercise price of the warrants issued to the investors in the private placement is subject to adjustment upon issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. The agreement with the investors in the private placement requires the Company to use commercially reasonable efforts to cause a registration statement covering the shares of common stock issued in the private placement and the shares of common stock underlying the warrants, to be declared effective by the SEC by October 27, 2003. + +In addition, the Company issued to the placement agent 127,168 shares of common stock to cancel $133,400 in fees the Company owed to the placement agent. + +Agreement related to debt due related party. On August 29, 2003, the Company entered into an agreement with a former employee by which the Company agreed to pay down amounts owed in monthly amounts of $316,667, plus interest, beginning in September 2003 and ending in February 2004. Prior to entering into this agreement, the Company was required to pay the full amount owed in April 2004 in cash. The agreement permits the Company, at its option, to pay such monthly amounts in cash or in shares of common stock determined using a five-day average trading price prior to the monthly payment date. + +Petsmart Litigation. On September 4, 2003, after a jury trial on the matter, the jury returned a verdict rejecting Petsmart's claim against the Company and accepted a counterclaim against Petsmart for approximately $172,000. On October 15, 2003, the court issued a judgement in favor of the Company for approximately $847,000 which included the amount of the counterclaim of approximately $172,000 and the legal expenses that the Company incurred. + + + + + +DATATEC SYSTEMS, INC. AND SUBSDIARIES + +CONDENSED CONSOLIDATED BALANCE SHEET + +(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA) + + + + +July 31, 2003 + +(unaudited) + +ASSETS + + + +Current Assets: + + + + +Cash and cash equivalents + + + +$ 1,952 + +Accounts receivable, net + + + +26,653 + + Costs and estimated earnings in excess of billings + + + +20,463 + + Inventory + + +3,793 + + Prepaid expenses and other current assets + + +1,331 + +Total current assets + + + +54,192 + +Property and equipment, net + + + +3,339 + +Goodwill + + + +4,575 + +Intangible assets, net + + + +909 + +Other assets + + + +3,349 + +Total assets + + + +$66,364 + +LIABILITIES AND STOCKHOLDERS' EQUITY + + + +Current Liabilities: + + + + +Short-term borrowings + +$24,560 + +Accounts payable + +11,399 + +Accrued expenses and other current liabilities + +5,411 + +Subordinated secured convertible debentures, net of unamortized discount + +1,795 + +Due to related parties + +1,650 + + Total current liabilities + + + +44,815 + +Long-Term Debt: + + + + +Subordinated secured convertible debentures, less current portion, and net of unamortized discount + + + +2,312 + +Other + + + 521 + +Total Liabilities + + + +47,648 + +Commitments and Contingencies + + + +-- + +STOCKHOLDERS' EQUITY: + + + + +Common stock, $.001 par value (authorized 75,000,000 shares; issued and outstanding; 41,209,000 shares and 44,123,000 shares as of April 30, 2003 and July 31, 2003, respectively) + + + + + +44 + +Additional paid-in capital + + +67,017 + +Accumulated deficit + + +(47,997) + +Accumulated other comprehensive loss + + + +(348) + +Total stockholders' equity + + + +18,716 + +00 + + Total liabilities and stockholders' equity + + + + $ 66,364 + + + + + +The accompanying notes to unaudited condensed consolidated financial statements + +are an integral part of these condensed consolidated financial statements. + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS + +(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA) + +(unaudited) + + + + + + + + +For The Three Months Ended July 31, + + + + +2002 + + +2003 + + + + + + + +Revenue + +$ + +23,072 + +$ + +32,398 + +Cost of revenue + + +16,546 + + +25,997 + +Gross profit + + +6,526 + + +6,401 + + + + + + + +Selling, general and administrative expenses + + +5,054 + + +5,788 + +Operating income + + +1,472 + + +613 + +Interest expense + + +(740) + + +(788) + +Income (loss) before income taxes + + +732 + + +(175) + +Income taxes + + +-- + + +-- + +Net income (loss) + +$ + +732 + +$ + +(175) + + + + + + + +Net income (loss) per common share: + + + + + + - Basic + +$ + +0.02 + +$ + +0.00 + + - Diluted + +$ + +0.02 + +$ + +0.00 + + + + + + + +Weighted average common and common equivalent shares outstanding - + + + + + + - Basic + + +35,672,000 + + +43,800,000 + + - Diluted + + +35,750,000 + + +43,800,000 + +The accompanying notes to unaudited condensed consolidated financial statements + + are an integral part of these condensed consolidated financial statements. + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +CONDENSED CONSOLIDATED STATEMENTS OF + +COMPREHENSIVE INCOME (LOSS) + +(IN THOUSANDS) + +(unaudited) + + + + +For The Three Months Ended July 31, + + + + +2002 + + +2003 + + + + + + + +Net income (loss) + +$ + +732 + +$ + +(175) + +Other comprehensive income (loss) - + +foreign currency translation adjustment + + + +(2) + + +3 + +Comprehensive income (loss) + +$ + +730 + +$ + +(172) + +The accompanying notes to unaudited condensed consolidated financial statements + +are an integral part of these condensed consolidated statements. + + + + + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS + +(IN THOUSANDS) + +(unaudited) + +For the Three Months Ended + +July 31, + +2002 + +2003 + +Cash Flows From Operating Activities: + +Net income (loss) + +$ + +732 + +$ + +(175) + +Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities + +Depreciation and amortization + +1,013 + +873 + +Accretion of interest on subordinated notes + +116 + +118 + +Changes in operating assets and liabilities: + + (Increase) decrease in accounts receivable, net + +(1,310) + +1,630 + + + + (Increase) decrease in costs and estimated earnings in + + excess of billings + + +(2,264) + + +264 + + Increase in inventory + +(24) + +(750) + + Decrease in prepaid expenses and other assets + +13 + +43 + + Increase (decrease) in accounts payable, and accrued + + other liabilities + +2,475 + +(5,830) + +Net cash provided by (used in) operating activities + +751 + +(3,827) + +Cash flows from investing activities: + +Purchases of property and equipment + +(322) + +(303) + +Investment in software development + +(196) + +(524) + +Net cash used in investing activities + +(518) + +(827) + +Cash flows from financing activities: + +Payments of short-term borrowings + +(186) + +(4,480) + +Payments of indebtedness + +(17) + +(70) + +Proceeds from issuance of common stock and warrants + +-- + +3,490 + +Proceeds from issuance of subordinated secured convertible debentures + +- + +4,900 + +Payments of offering costs + +- + +(546) + +Proceeds from exercise of employee stock options + +61 + +118 + +Net cash (used in) provided by financing activities + +(142) + +3,412 + +Net effect of foreign currency translation on cash + +(2) + +3 + +Net increase (decrease) in cash and cash equivalents + +89 + +(1,239) + +Cash and cash equivalents at beginning of period + +49 + +3,191 + +Cash and cash equivalents at end of period + +$ + +138 + +$ + +1,952 + +The accompanying notes to unaudited condensed consolidated financial statements + +are an integral part of these condensed consolidated financial statements. + + + + + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + +(1) The Company and Summary of Significant Accounting Policies + +The Company + +Datatec Systems, Inc. and its subsidiaries (the "Company") are in the business of providing rapid and accurate technology deployment services and licensing software tools to support enterprises in the delivery and management of complex IT solutions. + +During the fiscal year ended April 30, 2000, the Company changed the name of its subsidiary CASI, Inc. to eDeploy.com Inc., ("eDeploy.com"). During the fiscal year ended April 30, 2002, the Company integrated eDeploy.com's activities into Datatec Systems, Inc. eDeploy's activities include developing, marketing and managing the licensing of software tools to support enterprises in the delivery of complex IT solutions. + +The net loss of $19.4 million for the fiscal year ended April 30, 2001 and the net loss of $2.7 million for the fiscal year ended April 30, 2002 resulted in a strain on the Company's cash resources. Although the Company realized net income of $1.4 million for fiscal year ended April 30, 2003 and took dramatic measures to cut costs and to manage cash, it is still experiencing a significant strain on cash resources. The primary reason for the strain on resources is the increased requirements for expenditures for field personnel, job expenses and materials related to the increased revenue. As a result, the working capital financing line regularly remains at or close to its maximum allowable levels and the average days outstanding on trade payables have extended beyond normal credit terms granted by vendors. + +Achievement of the Company's fiscal 2004 operating plan, including maintaining adequate capital resources, depends upon the timing of work performed on existing projects, ability to gain and perform work on new projects, ability to maintain positive relations with key vendors and the ability to raise permanent capital and replace the current working capital financing line within the timeframe required to meet spending requirements. Multiple project cancellations, job performance related losses, delays in the timing of work performed on existing projects, inability to gain and perform work on new projects, or inability to raise permanent capital and replace the current working capital financing line in a timely fashion could have an adverse impact on the Company's liquidity and on the ability to execute its operating plan. + +Basis of Presentation + +The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. The Company's July 31, 2003 financial statements include the results of its subsidiary Millennium Care, Inc. from May 1, 2003, the date of acquisition. All intercompany accounts and transactions have been eliminated. + +The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles applicable to interim financial information and with the instructions to Form 10-Q and Article 10 of the Securities and Exchange Commission ("SEC") Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the three months ended July 31, 2003 are not necessarily indicative of the results that may be expected for a full year. The accompanying financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Datatec's annual report on Form 10-K for the year ended April 30, 2003. + +Use of Estimates + + The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates underlying the accompanying consolidated financial statements include estimated revenues under long-term contracts, estimated costs to complete long-term contracts, recoverability of intangibles and other long-lived assets, allowance for doubtful accounts and inventory carrying values. Actual results could differ from those estimates. + +(2) Recent Developments: + +Acquisition of Millennium Care, Inc. On May 1, 2003, the Company acquired 100% of a privately-held provider of help desk outsourcing and related technologies. Pursuant to the stock purchase agreement, the Company issued 1,546,247 shares of common stock, warrants to purchase 200,000 shares of common stock and employee stock options to purchase 56,490 shares of common stock in exchange for all of the outstanding equity of Millennium. In addition, the Company has agreed to issue to the sellers of Millennium additional shares of common stock in the event certain revenue targets are met by Millennium during calendar years 2003 and 2004. If Millennium achieves qualified (as defined) revenue of over $6 million (Canadian) in calendar 2003 or $10 million (Canadian) in calendar year 2004, the Company would be required to issue additional shares of common stock in an amount equal to 40% of any such excess for calendar year 2003 and 35% of any such excess for calendar year 2004. The warrants are exercisable at $1.82 per share and are not exercisable before January 31, 2004 or after May 1, 2008. These warrants also require Millennium to achieve a revenue target of $5.4 million (Canadian) for calendar year 2003 in order to become exercisable. The Company may redeem the warrants at any time after January 31, 2005 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets. The stock options are exercisable at $1.40 per share and were issued to replace Millennium employee options, which were canceled as a result of the acquisition. + +The Company has accounted for the acquisition of Millennium using the purchase method of accounting under Statement of Financial Accountant Standards (SFAS) No. 141, "Business Combinations". The inclusion of Millennium for the quarter ended July 31, 2002 would have no material impact on the Company's July 31, 2002 consolidated financial statements. The Company has performed a preliminary assessment of the fair values of the assets acquired and liabilities assumed. The purchase price for Millennium was allocated to assets and liabilities based on Management's estimates of fair value based upon projected discounted cash flows. The following table sets forth the allocation of the purchase price (dollars U.S. in thousands): + +Current assets + + +$ 632 + +Property and equipment + + +331 + +Intangible asset - customer list, with a 3 year life + + +712 + +Goodwill + + +1,910 + + + +Total assets acquired + + +$ 3,585 + +Current liabilities + + +1,392 + + + +Total liabilities assumed + + +1,392 + +Net assets acquired + + +$ 2,193 + +In accordance with SFAS No.142 "Goodwill and Other Intangible Assets", the goodwill will not be amortized, but will be tested for impairment using a fair value approach at least annually. + +Issuance of Subordinated Secured Convertible Notes and Warrants. On July 3, 2003, the Company issued an aggregate of $4.9 million principal amount of subordinated secured convertible notes and warrants to purchase an aggregate of 875,000 shares of common stock, pursuant to a Note Purchase Agreement by and among the Company and the investors signatory thereto. The investors are six funds managed by the Palladin Group L.P., which also manages two funds that were among the Company's current lenders. Under the original Note Purchase Agreement, the notes are to be repaid in sixteen equal monthly installments beginning on January 1, 2004 and ending on April 1, 2005 and bear interest at a rate of 2% per annum. The monthly installments of principal and interest are payable in cash or common stock at our option, subject to certain listing and registration requirements relating to the common stock. If the Company elects to pay the monthly installments in common stock, the conversion rate is the lower of: (a) $1.40 or (b) a 10% discount to the then fair market value of the common stock. The holder of each note is entitled, at its option, to convert at any time the principal amount of the note or any portion thereof, together with accrued but unpaid interest, into shares of common stock at a conversion price for each share of common stock equal to $1.40. In connection with the financing, we issued to the investors four-year warrants to purchase an aggregate of 875,000 shares of common stock at an exercise price of $1.3224 per share. The warrants have been valued at approximately $384,000, based on the Black Scholes Pricing Model utilizing the following assumptions: expected life of 4.0 years; volatility of 66 percent; risk free borrowing rate of 2.120 percent. This amount has been recorded as a discount against the debt and will be accreted as interest expense over the remaining life of the debt. In addition, in accordance with Emerging Issues Task Force No. 98-5, an embedded beneficial conversion feature of approximately $384,000 has been recognized as additional paid-in-capital and will be accreted as additional interest expense over the remaining life of the debt. Through July 31, 2003, $40,000 of the above discounts has been accreted. The warrants are exercisable at any time from July 3, 2003 to July 3, 2007, and are not redeemable. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets and issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. + +The Company agreed to prepare and file a registration statement covering the resale of the shares of common stock issuable upon the redemption or conversion of the notes and the exercise of the warrants. The registration statement was required to be filed with the Securities and Exchange Commission ("SEC") not later than August 3, 2003. The Company filed such registration statement on July 31, 2003. The Company will incur a 2% penalty on the value of the shares of common stock underlying the notes and the warrants if the SEC does not declare such registration statement effective by November 1, 2003. + +On July 28, 2003, the Company agreed to issue to the investors an aggregate of 700,000 four-year warrants to purchase shares of the Company's common stock at an exercise price of $0.9441 per share in exchange for the following: (i) a waiver of the investors' rights of first refusal in connection with the July 28, 2003 private placement (described below); (ii) a waiver of the investors' right to a redemption price adjustment to their notes which would cause an increased number of shares to be issuable upon redemption of their notes as a result of the July 28, 2003 private placement; and (iii) an extension of the maturity date of the notes from October 1, 2004 to April 3, 2005. These warrants have been valued at approximately $483,000 using Black Scholes Pricing Model. The value has been accounted for as a cost of the July 28, 2003 private placement of common stock. The Company determined the fair value of the warrants based on the Black Scholes Pricing Model to be approximately $449,000 and included such costs in the issuance costs attributable to the Company's July 28, 2003 private placement of common stock. + +Private Placement of Common Stock. On July 28, 2003, the Company raised $3.49 million in private equity financing (less out-of-pocket transaction costs of approximately $0.48 million) for working capital purposes and to reduce outstanding indebtedness by selling 3,696,621 shares of the Company's common stock and warrants to purchase an additional 1,848,306 shares of the Company's common stock at an exercise price of $1.3637 per share. The warrants are exercisable at any time from July 28, 2003 to July 28, 2008. The Company may redeem the warrants at any time after July 28, 2004 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. The Company also issued a five-year warrant to purchase 554,492 shares of common stock at an exercise price of $1.3637 per share to the placement agent for the financing. These warrants are exercisable at any time from July 28, 2003 to July 28, 2008 and are not redeemable by the Company. The exercise price on both the warrants issued to investors in the private placement and the warrants issued to the placement agent is subject to adjustment upon certain events, including stock dividends, reclassifications, recapitalizations, reorganizations and mergers. In addition, the exercise price of the warrants issued to the investors in the private placement is subject to adjustment upon issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. The agreement with the investors in the private placement requires the Company to file a registration statement for the resale of the shares of common stock issued in the private placement and the shares of common stock underlying the warrants, with the SEC immediately following the closing on July 28, 2003. + +In addition, we issued to the placement agent 127,168 shares of our common stock to cancel $133,400 in fees the Company owed to them. + +Amendment of debt due to related party. On August 29, 2003, the Company entered into an agreement with Christopher J. Carey, by which it agreed to pay down amounts owed to Mr. Carey in equal monthly amounts of $316,666.67, plus interest, beginning September 2003 and ending February 2004. At its option, the Company may pay such monthly amounts in cash or in shares of the Company's common stock determined using a five-day average closing price prior to the monthly payment date. The agreement with Mr. Carey also requires the Company to register the shares of common stock issuable to Mr. Carey. + +Litigation. On September 4, 2003, a jury found in favor of the Company with respect to a lawsuit filed against it by Petsmart, Inc. in the Superior Court of Maricopa County, Arizona. The jury verdict rejected Petsmart's claims against the Company and accepted the Company's counterclaim for unpaid invoices of approximately $172,000. The Company intends to seek reimbursement of legal costs against Petsmart in connection with the litigation. + +(3) Critical Accounting Policies: + +Revenue Recognition + +The Company generates revenue from: (1) providing technology deployment services, including configuring Internetworking and computing devices to meet the specific needs of its customers, integrating these devices as well as operational and application software with a customer's existing hardware and software, and physically installing the technology on the customer's network and (2) from licensing its software to third parties. + +Services from deployment activities are performed primarily under long-term contracts, but may be performed under short-term workorders or time and material arrangements. The Company's typical long-term contract contains multiple elements designed to track the various services required under the arrangement with the customer. These elements are used to identify components of progress billings, but are combined for revenue recognition purposes. The Company recognizes revenue earned under long-term contracts utilizing the percentage of completion method of accounting by measuring total costs incurred to total estimated costs. Under the percentage of completion method of accounting, revenue, costs and gross margin are recognized as work is performed based on the relationship between total costs incurred and total estimated costs. + +Contracts are reviewed at least quarterly and, if necessary, revenue, costs and gross margin are adjusted prospectively for revisions in estimated total contract value and total estimated contract costs. Estimated losses are recognized when identified. + +Payment milestones differ according to the customer and the type of work performed. Generally, the Company invoices customers and payments are received throughout the deployment process and, in certain cases, in advance of work performed if a substantial amount of up front costs is required. In certain cases payments are received from customers after the completion of site installation. However, revenue and costs are only recognized on long-term contracts to the extent of the contracts' percentage of completion. Costs and estimated earnings in excess of billings, which is classified as a current asset, is recorded for the amount of revenue earned in excess of billings to customers. Accrued costs or deferred revenue is recorded as a current liability for the amount of billings in excess of revenue earned. + +Revenue earned under short-term workorders and time and material arrangements is recognized as the work is completed. Billings under these arrangements are typically done when the work is completed. + +Revenue from software licensing arrangements is recognized in accordance with Statement of Position ("SOP") No. 97-2, as amended, "Software Revenue Recognition". Revenue from license fees is recognized when an agreement has been signed, delivery of the product has occurred, the fee is fixed or determinable and collectibility is not probable. Revenue is deferred if such criteria are not met. If the fee due from the customer is not fixed or determinable, revenue is recognized as payments become due from the customer. If collectibility is not reasonably assured, revenue is recognized when the fee is collected. Maintenance revenue, if applicable, is negotiated separately and the contract identifies the specific charges related to this service. This revenue is recognized ratably over the contract maintenance period. The Company also recognizes revenue as an Application Service Provider ("ASP"). Under this scenario, the Company does not license the software, but provides access to the software through its hosting activities. For this access, the Company bills its customers and recognizes this revenue over the period of access. Revenue from licensing, maintenance and hosting activities remain immaterial in amount. + +Cash and Cash Equivalents + +The Company considers cash equivalents to be all highly liquid investments purchased with an original maturity of three months or less. + +Inventory + +Inventory, which is comprised of parts and materials to be installed as part of the Company's deployment services, is stated at the lower of average cost or market. + +Property and Equipment, Net + +Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives or lease terms of the related assets, whichever is shorter. + +Goodwill and Intangible Assets + +In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangible Assets" (collectively "the Standards"). The Standards require all business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, that goodwill is no longer subject to amortization but rather be reviewed periodically for impairment and that other identifiable intangibles be separated and those with finite lives be amortized over their useful lives. Goodwill and intangible assets with indefinite lives must be assessed once a year for impairment, and more frequently if circumstances indicate a possible impairment. The first step of the two-step impairment assessment identifies potential impairment and compares the fair value of the applicable reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered impaired, and the second step of the impairment test is not necessary. If the carrying value of the reporting unit exceeds its fair value, the second step of the impairment test shall be performed to measure the amount of impairment loss, if any. The Company elected to early adopt these standards as of May 1, 2001 as permitted and evaluated the carrying value of its goodwill and other intangible assets. Based on its evaluation, the Company determined that there was no impairment to its Goodwill and other intangible assets. Subsequent impairment tests will be performed, at a minimum, in the fourth quarter of each fiscal year, in conjunction with the Company's annual planning process. + +The Company determined the estimated fair values of goodwill and certain intangible assets with definitive lives based on purchase price allocations determined by performing fair value analyses. In addition, the Company capitalizes certain computer software costs, including product enhancements, after technological feasibility has been established, in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." These costs are amortized using the greater of the ratio that current gross revenue for a product bears to the total of current and anticipated future gross revenues for the product, or a maximum of three years using the straight-line method beginning when the products are available for general release to customers. Approximately $1,274,000 and $1,183,000 of net capitalized software costs are included in intangible assets in the accompanying consolidated balance sheets as of April 30, 2003 and July 31, 2003, respectively. Amortization expense of capitalized software costs for the three months ended July 31, 2002 and 2003 was $397,000 and $223,000, respectively, and is included in project costs. Costs incurred prior to technological feasibility and those incurred for minor enhancements and maintenance have been charged to general and administrative expense as incurred. + +Goodwill is not amortized, but tested at least annually for impairment using a fair value approach. Intangible assets with definitive lives are capitalized and amortized over their useful lives. + +Long-Lived Assets + +In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supercedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of", and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. This Statement also amends ARB No. 51, "Consolidated Financial Statements", to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 in fiscal 2003, with no material impact on its consolidated financial position or consolidated results of operations. + +Prior to adopting SFAS No. 144, SFAS No. 121, required, among other things, that an entity review its long-lived assets and certain related intangibles for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. The amount of impairment of goodwill would be determined as part of the long-lived asset grouping being evaluated. Impairment losses are recognized when a long-lived asset's carrying amount may not be recoverable. Impairment losses are recognized when a long-lived asset's carrying value exceeds the expected undiscounted future cash flows related to that asset. The amount of the impairment loss is the difference between the carrying value and the fair market value of the asset. The fair market value of the asset is determined based upon discounted cash flows. Due to the losses incurred for the fiscal years ended April 30, 2001 and 2002, the Company has assessed its long-lived assets for impairment. Based on estimated undiscounted future cash flows, the Company believes that there was no impairment of its long-lived assets as of July 31, 2003. + +Income Taxes + +The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes". Certain transactions are recorded in the accounts in a period different from that in which these transactions are reported for income tax purposes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and the tax effect of net operating loss carry-forwards. A valuation allowance is recorded against deferred tax assets if it is more likely than not that such assets will not be realized. + +Fair Value of Financial Instruments + +The carrying value of cash and cash equivalents, accounts receivable, costs and estimated earnings in excess of billings, accounts payable, deferred income and the current portion of long-term debt approximate fair value due to the short-term maturities of these instruments. The carrying value of the long-term debt obligations approximate fair value based on current rates offered to the Company for debt with similar collateral and guarantees, if any, and maturities. + +Foreign Currency Translation + +The local currency of the Company's foreign (Canada) subsidiary is its functional currency. Assets and liabilities of the Company's foreign subsidiary are translated into U.S. dollars at the current exchange rate. Statement of operations accounts are translated at the average rate of exchange prevailing during the year. Translation adjustments arising from the use of differing exchange rates from period to period are a component of accumulated comprehensive loss included in stockholders' equity. + +Stock Based Compensation + +SFAS No. 123, "Accounting for Stock-Based Compensation", requires that an entity account for employee stock-based compensation under a fair value based method. However, SFAS No.123 also allows an entity to continue to measure compensation cost for employee stock-based compensation arrangements using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees". The Company continues to account for employee stock-based compensation using the intrinsic value based method. + +In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation- Transition and Disclosure". SFAS No. 148 amends SFAS No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effect of the method used on reported results. The provisions of SFAS No. 148 are effective for financial statements for fiscal years and interim periods ending after December 15, 2002. The Company has adopted the disclosure provisions of SFAS No. 148. SFAS No. 148 did not require the Company to change to the fair value based method of accounting for stock based compensation. + +The following table illustrates the effect on net income and net income per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based employee compensation. + + + +Three Months Ended + +July 31, + + + +2002 + + +2003 + +Net income (loss) as reported + +$732 + + +$(175) + +Total stock-based employee compensation expenses determined under fair value based method for all awards + +(102) + + +(564) + +Pro forma net income (loss) + +$630 + + +$(739) + +Net income (loss) per share of common stock: + + + + +As reported - basic + +$ 0.02 + + +$ 0.00 + +As reported - diluted + +$ 0.02 + + +$ 0.00 + +Pro forma - basic + +$ 0.02 + + +$ (0.02) + +Pro forma - diluted + +$ 0.02 + + +$ (0.02) + +The per share weighted-average fair value of stock options granted during 2002 and 2003 was $0.82 and $1.34, respectively, on the date of grant using the Black Scholes option-pricing model with the following assumptions: expected life for options of 5 years for both periods, expected dividend yield 0% in both periods, average risk free interest rate of 3.53% in 2002 and 3.38% in 2003, average annualized volatility of 148% for 2002 and 66% in 2003. + +Internal Use Software + +In accordance with SOP No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," the Company capitalizes certain costs of computer software developed or obtained for internal use. Approximately $205,000 and $85,000 of amortization expense were incurred during the three months ended July 31, 2002 and 2003, respectively, and is included in general, administrative and selling expense. The Company has expensed costs incurred during the preliminary and post implementation phases in the periods in which these costs were incurred. + +Comprehensive Income + +SFAS No. 130, "Reporting Comprehensive Income", establishes standards for reporting and displaying of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. The Company's sole component of other comprehensive income is foreign currency translation adjustments generated from the Company's Canadian subsidiary. + +Recent Accounting Pronouncements + +In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This Statement eliminates the automatic classification of gain or loss on extinguishment of debt as an extraordinary item of income and requires that such gain or loss be evaluated for extraordinary classification under the criteria of APB No. 30. This Statement also requires sales-leaseback accounting for certain lease modifications that have economic effects that are similar to sales-leaseback transactions, and makes various other technical corrections to existing pronouncements. This Statement will be effective for the Company for the fiscal year ending April 30, 2004. This standard, which the Company adopted during the first quarter of fiscal 2004 did not have a material effect on the Company's consolidated financial position or consolidated results of operations. + +In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This standard amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, collectively referred to as derivatives, and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Relationships." SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships after June 30, 2003. The Company does not believe that the implementation of this standard will materially impact its consolidated financial position or consolidated results of operations. + +Segments of an Enterprise + +SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information" established standards for reporting of financial information in Company's Financial Statements. + +The Company's management considers its business to be a single business entity. + +(4) Net Income Per Share: + +SFAS No. 128, "Earnings Per Share" requires the presentation of basic earnings per share ("Basic EPS") and diluted earnings per share ("Diluted EPS"). Basic EPS is calculated by dividing income or loss applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted EPS is calculated by dividing income available to common stockholders by the weighted average number of common and potentially dilutive common shares outstanding during the period. + +In accordance with SFAS No. 128, the following table reconciles net loss and per share amounts used to calculate basic and diluted earnings per share (in thousands): + + + +For the Three Months Ended July 31, + + + + + +2002 + + +2003 + +Numerator: + + + + +Net income (loss) + +$ 732 + + +$ (175) + +Denominator: + + + + +Weighted average Common Shares outstanding + + + + +-Basic + +35,672,000 + + +43,800,000 + +-Diluted + +35,750,000 + + +43,800,000 + + + + + + + Net income (loss) per share + + + + +-Basic + +$ 0.02 + + +$ 0.00 + +-Diluted + +$ 0.02 + + +$ 0.00 + +Outstanding options and warrants totaling 10,407,479 for the three months ended July 31, 2003 have been excluded from the computation of Diluted EPS, as their inclusion would have been anti-dilutive. + +(5) Short-term Borrowings: + +The Company maintains a credit facility with IBM Credit. At the beginning of fiscal 2003, the credit facility consisted of: (i) a $16 million, three-year revolving credit facility and (ii) a $3 million, three-year term loan, payable in monthly installments of principal and interest. During fiscal 2003, the credit facility was amended several times. + +On April 14, 2003, the credit facility was amended to: (i) extend the credit facility to August 1, 2004 from August 1, 2003; (ii) provide for a maximum availability of $29 million until May 31, 2003, $25 million from June 1, 2003 until December 31, 2003, $20 million from January 1, 2004 until March 31, 2004 and $15 million from April 1, 2004 until August 1, 2004; (iii) lower the interest rate on the facility from prime plus 4.25% to prime rate plus 1.75% effective May 1, 2003; (iv) amend certain finance charges and financial covenants (described below); and (v) require the Company to pay off the remaining balance of the $3 million term loan with IBM Credit after the closing of an equity financing. The Company repaid the term loan after closing on the $5 million private equity placement in April 2003. + +On June 3, 2003, the credit facility was further amended to provide for a maximum availability as follows: (i) $25 million from June 1, 2003 until January 14, 2004; (ii) $23 million from January 15, 2004 until March 31, 2004; and (iii) $20 million from April 1, 2004 until August 1, 2004. In addition, IBM Credit agreed to increase the Company's maximum availability from $25,000,000 to $28,000,000 until August 31, 2003, at which time the maximum borrowings under the credit facility available must be reduced to $25,000,000. The Company is required to pay interest at the rate of prime rate plus 4% on any amounts borrowed over $25 million, instead of prime rate plus 1.75%. + +The borrowings under the revolving line of credit are based on a formula of 85% of eligible receivables and 25-35% of eligible inventory. The amounts outstanding under the credit facility as of April 30, 2003 and July 31, 2003 were $28.8 million and $24.6 million, respectively. At times, IBM Credit has allowed the Company to borrow amounts in excess of our maximum allowable. + +As set forth in the table below, the Company has failed to comply with one or more of the financial covenants of its credit facility for each fiscal quarter beginning in the fiscal quarter ended as of January 31, 2001, through and including the fiscal quarter ended as of July 31, 2003. The Company and IBM Credit Corporation entered into an Acknowledgment, Waiver and Amendment to the Inventory and Working Capital Financing Agreement as of the end of each of these quarters by which IBM Credit has waived the Company's defaults. The amounts outstanding under the revolving credit facility and term loan as of April 30, 2002 and 2003 have been classified as current in the Company's consolidated balance sheets. The following is a summary of the covenant violations for each of the quarters referred to above. + +Period + +Covenant + +Requirement + +Actual + +Jan 31, 2001 + +Net Profit to Revenue + +Equal to or greater than 0.0% + +Net loss + +Apr 30, 2001 + +Annual Revenue to Working Capital + +Greater than 0 and equal to or less than 25.0 to 1.0 + +(25.5) to 1.0 + +Jul 31, 2001 + +Annual Revenue to Working Capital + +Greater than 0 and equal to or less than 25.0 to 1.0 + +(4.5) to 1.0 + + + +Net Profit to Revenue + +Equal to or greater than 0.1% + +(1.7)% + + + +Tangible Net Worth + +Equal to or greater than $2.5 million + +$(1.1) million + +Oct 31, 2001 + +Annual Revenue to Working Capital + +Greater than 0 and equal to or less than 25.0 to 1.0 + +(22.2) to 1.0 + + + +Net Profit to Revenue + +Equal to or greater than 0.1% + +(1.7)% + + + +Tangible Net Worth + +Equal to or greater than $2.5 million + +$(3.8) million + +Jan 31, 2002 + +Net Profit to Revenue + +Equal to or greater than 0.1% + +(9.0)% + +Apr 30, 2002 + +Net Profit to Revenue + +Equal to or greater than 0.1% + +(10.7)% + + + +Debt Service Ratio + +Equal to or greater than 2.0 to 1.0 + +(2.5) to 1.0 + +July 31, 2002 + +Annual Revenue to Working Capital + +Greater than 5.0:1.0 and equal to or less than 25.0 to 1.0 + +(24.7) to 1.0 + + + +Tangible Net Worth + +Equal to or greater than $2.5 million + +$2.1 million + +Oct 31, 2002 + +Annual Revenue to Working Capital + +Greater than 5.0:1.0 and equal to or less than 25.0 to 1.0 + +(86.0) to 1.0 + +Jan 31, 2003 + +Annual Revenue to Working Capital + +Greater than 5.0:1.0 and equal to or less than 25.0 to 1.0 + +(126.9) to 1.0 + + + +Debt Service Ratio + +Equal to or greater than 2.0 to 1.0 + +0.20 to 1.0 + +April 30, 2003 + +Debt Service Ratio + +Equal to or greater than 1.25 to 1.0 + +(1.73) to 1.0 + + + +Net Profit to Revenue + +Equal to or greater than 0.10 percent + +(3.38%) + +July 31, 2003 + +Net Profit to Revenue + +Equal to or greater than 0.10 percent + +(0.05%) + +IBM Credit, the Company's working capital lender, has notified the Company that it does not intend to renew its working capital line beyond August 2004. As a result, the Company is seeking replacement financing for its credit facility. + +(6) Issuances of Subordinated Secured Convertible Debentures and Common Stock + +On April 3, 2002, the Company raised $2.0 million (less transaction costs of $0.170 million) to be used for working capital purposes by issuing an aggregate of $2.0 million principal amount of Subordinated Secured Convertible Debentures and Warrants to purchase an aggregate of 270,000 shares of the Company's common stock at $1.416 per share. The debentures matured on July 2, 2003 and had an interest rate of 5% per annum. Interest was due quarterly on March 31, June 30, September 30 and December 31 of each year (with the first interest payment due and payable on September 30, 2002) and was paid in cash and Common Stock. The Company recorded a discount of $582,000 in connection with the issuance of the Debentures. The warrants have been valued at approximately $291,000, based on the Black Scholes Pricing Model utilizing the following assumptions: expected life of 5.0 years; volatility of 119 percent; risk free borrowing rate of 4.405 percent. This amount has been recorded as a discount against the debt and will be accreted as interest expense over the remaining life of the debt. In addition, in accordance with Emerging Issues Task Force No. 98-5, an embedded beneficial conversion feature of approximately $291,000 has been recognized as additional paid-in-capital and was accreted as additional interest expense over the life of the debt. Through July 31, 2003, the total discount of $582,000 had been accreted. + +The warrants are exercisable at any time from April 3, 2002 to April 3, 2007 and are not redeemable by the Company. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets and issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. + +The agreement with the investors contains a requirement for the Company to have effected the registration of a sufficient number of shares of its common stock by July 2, 2002 or incur penalties. Although the Company filed the required registration statement with the Securities and Exchange Commission within the required time period, such registration statement had not been declared effective prior to July 2, 2002, as a result, the company incurred certain penalties. The Company issued an aggregate 669,794 shares of common stock to the investors of the Debentures to satisfy the penalties in full, which amounted to $613,927, the equivalent of the fair value of such shares at the time of issuance. + +Prior to July 31, 2003, all of the Debentures had been converted into an additional 1,755,318 shares of the Company's Common Stock. + +Private Placement of Common Stock. On April 28, 2003, the Company raised $5.0 million in private equity financing (less out-of-pocket transaction costs of approximately $0.425 million) for working capital purposes by selling 4 million shares of the Company's common stock and warrants to purchase an additional 2 million shares of common stock at an exercise price of $1.625 per share. The warrants are exercisable at any time from April 28, 2003 to April 28, 2007. The Company may redeem the warrants at any time after April 28, 2004 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. The Company also issued a four-year warrant to purchase 480,000 shares of common stock at an exercise price of $1.75 per share to the placement agent for the financing. These warrants are exercisable at any time from April 28, 2003 to April 28, 2007 and are not redeemable by us. The exercise price on both the warrants issued to investors in the private placement and the warrants issued to the placement agent is subject to adjustment upon certain events, including stock dividends, reclassifications, recapitalizations, reorganizations and mergers. In addition, the exercise price of the warrants issued to the investors in the private placement is subject to adjustment upon issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. The agreement with the investors in the private placement requires us to file a registration statement for the resale of the shares of the common stock issued, as well as the shares underlying the warrants, with the SEC. The SEC declared the Company's registration statement effective on July 29, 2003. + +Issuance of Subordinated Secured Convertible Notes and Warrants. On July 3, 2003, the Company issued an aggregate of $4.9 million principal amount of subordinated secured convertible notes and warrants to purchase an aggregate of 875,000 shares of the Company's common stock, pursuant to a Note Purchase Agreement by and among the Company and the investors signatory thereto. The investors are six funds managed by the Palladin Group L.P., which also manages two funds that were among the Company's current lenders. The notes are to be repaid by us in sixteen equal monthly installments beginning on January 1, 2004 and ending on April 1, 2005 and bear interest at a rate of 2% per annum. The monthly installments of principal and interest are payable in cash or common stock at the Company's option, subject to certain listing and registration requirements relating to the common stock. If the Company elects to pay the monthly installments in common stock, the conversion rate is the lower of: (a) $1.40 or (b) a 10% discount to the then fair market value of the common stock. The holder of each note is entitled, at its option, to convert at any time the principal amount of the note or any portion thereof, together with accrued but unpaid interest, into shares of common stock at a conversion price for each share of common stock equal to $1.40. In connection with the financing, the Company issued to the investors four-year warrants to purchase an aggregate of 875,000 shares of common stock at an exercise price of $1.3224 per share. The warrants have been valued at approximately $384,000, based on the Black Scholes Pricing Model utilizing the following assumptions: expected life of 4.0 years; volatility of 66 percent; risk free borrowing rate of 2.120 percent. This amount has been recorded as a discount against the debt and will be accreted as interest expense over the remaining life of the debt. In addition, in accordance with Emerging Issues Task Force No. 98-5, an embedded beneficial conversion feature of approximately $384,000 has been recognized as additional paid-in-capital and will be accreted as additional interest expense over the remaining life of the debt. Through July 31, 2003, $40,000 of the above discounts has been accreted. The warrants are exercisable at any time from July 3, 2003 to July 3, 2007 and are not redeemable. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets and issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. + +The Company agreed to prepare and file a registration statement covering the resale of the shares of common stock issuable upon the redemption or conversion of the notes and the exercise of the warrants. The registration statement was required to be filed with the SEC not later than August 3, 2003. The Company filed such registration statement on July 31, 2003. The Company will incur a 2% penalty on the value of the shares of common stock underlying the notes and the warrants if the SEC does not declare such registration statement effective by November 1, 2003. + +On July 28, 2003, the Company agreed to issue to the investors an aggregate of 700,000 four-year warrants to purchase shares of the Company's common stock at an exercise price of $0.9441 per share in exchange for the following: (i) a waiver of the investors' rights of first refusal in connection with the July 28, 2003 private placement (described below); (ii) a waiver of the investors' right to a redemption price adjustment to their notes which would cause an increased number of shares to be issuable upon redemption of their notes as a result of the July 28, 2003 private placement; and (iii) an extension of the maturity date of the notes from October 1, 2004 to April 3, 2005. + +Private Placement of Common Stock - On July 28, 2003, the Company raised $3.49 million in private equity financing (less out-of-pocket transaction costs of approximately $0.48 million) for working capital purposes and to reduce outstanding indebtedness by selling 3,696,621 shares of the Company's common stock and warrants to purchase and additional 1,848,306 shares of the Company's common stock at an exercise price of $1.3637 per share. The warrants are exercisable at any time from July 28, 2003 to July 28, 2008. The Company may redeem the warrants at any time after July 28, 2004 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. The Company also issued a five-year warrant to purchase 554,492 shares of common stock at an exercise price of $1.3637 per share to the placement agent for the financing. These warrants are exercisable at any time from July 28, 2003 to July 28, 2008 and are not redeemable by the Company. The exercise price on both the warrants issued to investors in the private placement and the warrants issued to the placement agent is subject to adjustment upon certain events, including stock dividends, reclassifications, recapitalizations, reorganizations and mergers. In addition, the exercise price of the warrants issued to the investors in the private placement is subject to adjustment upon issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. The agreement with the investors in the private placement requires the Company to file a registration statement for the resale of the shares of common stock issued in the private placement and the shares of common stock underlying the warrants, with the SEC immediately following the closing on July 28, 2003. The Company determined the fair value of the warrants based on the Black Scholes pricing Model to be approximately $449,000 and included such costs of in the issuance costs attributable to the company s July 28,2003 private placement of common stock. + +In addition, the Company issued to the placement agent, 127,168 shares of common stock to cancel $133,400 in fees owed to them. + +(7) Supplemental Disclosures of Cash Flow Information: + +Non-cash transactions: + +For the Three Months Ended July 31, + + + +2002 + + +2003 + +Issuance of warrants in connection with subordinated secured convertible debentures + +-- + + +$449 + +Beneficial conversion feature in connection with subordinated secured convertible debentures + +-- + + +$384 + +Conversion of debt and issuance of 127,168 shares of common stock in lieu of cash + +-- + + +$133 + +Conversion of 2002 subordinated secured convertible debentures and issuance of 1,258,323 shares of common stock in lieu of cash + +-- + + +$1,412 + +Issuance of 1,503,463 shares of common stock and warrants to purchase 200,000 shares of common stock in lieu of cash in consideration for the purchase of Millenniun - net assets acquired + +-- + + +$2,193 + +Cash paid for: + +2002 + +2003 + +Interest + +$500 + + +$321 + +Income taxes + +-- + + +$36 + +(8) Due to Related Party: + +The Company owes Christopher Carey, a former executive officer, $1,650,000 consisting of a promissory note in the amount of approximately $1,414,000 and other amounts owed to this former executive amounting to approximately $236,000. The maturity date of the note is April 15, 2004, principal payments are not due until maturity, the interest rate is 17.5% per annum and interest payments are due monthly. The note is subordinated to the working capital line and term loan with IBM Credit, the Company's primary lender. See Footnote 10 - Subsequent Events. + +(9) Commitments and Contingencies: + +On September 22, 2000, Petsmart, Inc. filed a complaint against the Company in the Superior Court of Maricopa County, Arizona. Petsmart has alleged that it has been damaged by the Company's failure to satisfactorily complete work contemplated by an agreement between the parties. Damages were unspecified. At a settlement meeting held on April 17, 2002, discussions were held in which Petsmart proposed a series of settlement offers ranging between $7,000,000 and $8,000,000. In a letter to the Company dated May 3, 2002, Petsmart proposed settlement offers ranging between $5,000,000 and $7,000,000. On March 7, 2003, Petsmart filed an Offer of Judgment offering to settle the litigation for a payment of $2,300,000. The Company believes that it has meritorious defenses to the claims and it intends to defend this vigorously. Datatec has further counter-claimed against Petsmart for amounts owing to the Company under the contract. These amounts have been reserved as part of the allowance for uncollectable accounts. See Footnote 10 - Subsequent Event. + +(10) Subsequent Events: + +Litigation + +On August 29, 2003, the Company entered into an agreement with Christopher J. Carey, by which it agreed to pay down amounts owed to Mr. Carey in equal monthly amounts of $316,666.67, plus interest, beginning September 2003 and ending February 2004. At its option, the Company may pay such monthly amounts in cash or in shares of the Company's common stock determined using a five day average prior to the monthly payment date. The agreement with Mr. Carey also requires the Company to register the shares of common stock issuable to Mr. Carey. + +On September 22, 2000, Petsmart, Inc. filed a complaint against the Company in the Superior Court of Maricopa County, Arizona. Petsmart alleged that it had been damaged the Company's failure to satisfactorily complete work contemplated by an agreement between the parties. The Company counter-claimed against Petsmart for amounts due and owing. A trial commenced on August 18, 2003. On September 4, 2003, the jury returned a verdict rejecting Petsmart's claim against the Company and accepting the Company's counterclaim for unpaid invoices of approximately $172,000. On October 15, 2003, the court issued a judgement in favor of the Company for approximately $847,000 which included the amount of the counterclaim of approximately $172,000 and the legal expenses that the Company incurred. + + + +DATATEC SYSTEMS, INC. AND SUBSIDIARIES + +SCHEDULE II, Valuation and Qualifying Accounts + + + +Balance, beginning + +of period + + +Charges to cost and expenses + + +Deductions (a) + + +Balance, end of period + + + + + + + + + + +Year ended April 30, 2003 + + + + + + + + +Allowance for doubtful accounts + +$679,000 + + +$100,000 + + +$(493,000) + + +$286,000 + + + + + + + + + + +Year ended April 30, 2002 + + + + + + + + +Allowance for doubtful accounts + +$572,000 + + +$226,000 + + +$(119,000) + + +$679,000 + + + + + + + + + + +Year ended April 30, 2001 + + + + + + + + +Allowance for doubtful accounts + +$235,000 + + +$608,000 + + +$ (271,000) + + +$ 572,000 + +. + +(a) Represents the net of write-off and recovery of uncollectable accounts. + + + + + +We have not authorized any person to make a statement that differs from what is in this prospectus. If any person does make a statement that differs from what is in this prospectus, you should not rely on it. This prospectus is not an offer to sell, nor is it seeking an offer to buy, these securities in any state in which the offer or sale is not permitted. The information in this prospectus is complete and accurate as of its date, but the information may change after that date. + + + +TABLE OF CONTENTS \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000771252_digital_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000771252_digital_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..449b55e12be74ec04a8f9ffe3525d1c71ac9ec92 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000771252_digital_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS An opinion has been rendered by the law firm of Baker & Hostetler LLP, to the effect that the shares of our common stock offered by the selling stockholders under this prospectus are legally issued, fully paid and non-assessable. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000787030_vistacare_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000787030_vistacare_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a0d2302467c3cb0d9808a50dcd4181b30a91e90c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000787030_vistacare_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Choate, Hall Stewart, Boston, Massachusetts. Certain legal matters will be passed upon for the underwriters by Clifford Chance US LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000824269_sandia_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000824269_sandia_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..45ca0973a27bb4eb32d16f261d6adc84a1a74253 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000824269_sandia_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the notes and the Abraxas common stock covered by this prospectus has been passed upon for Abraxas by Cox & Smith Incorporated, San Antonio, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000828119_therma_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000828119_therma_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f231b667a43e5ace336e3f7a225cd1303b7884 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000828119_therma_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Some of the legal matters in connection with the validity of the common stock will be passed upon for us by Kirkland Ellis LLP, Los Angeles, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000854399_premier_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000854399_premier_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..399559b0c9e59f162c8b7e85d89b5b3f99570106 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000854399_premier_legal_matters.txt @@ -0,0 +1 @@ +An analysis of the allowance for loan losses, including charge-off activity, is presented in the following table for the periods indicated. Six Months Ended June 30, Year Ended December 31, (In thousands) 2003 2002 2002 2001 2000 1999 1998 Balance, beginning of period $3,340 $2,459 $2,459 $2,000 $1,689 $1,591 $1,296 Less Charge-off s: Commercial 27 20 42 71 47 205 64 Real estate-mortgage 0 1 59 0 29 0 Real estate-construction 0 0 0 0 19 0 Consumer installment loans 74 167 242 165 235 71 122 Total $101 $187 $285 $295 $282 $324 $186 Plus Recoveries: Commercial 3 8 12 $0 $44 $17 $20 Real estate-mortgage 0 0 0 0 0 0 20 Real estate-construction 0 0 0 0 0 2 0 Consumer installment loans 32 16 54 67 66 23 12 Total $35 $24 $66 $67 $110 $42 $52 Additions charged to operating expense $490 $420 $1,100 $687 $483 $380 $429 Balance, end of period $3,764 $2,716 $3,340 $2,459 $2,000 $1,689 $1,591 Ratio of net charge-offs to average loans outstanding during the period 0.04% 0.13% 0.08% 0.11% 0.10% 0.19% 0.11% Allocation of the Allowance for Loan Losses The following table reflects management s allocation of the allowance for loan losses at the dates indicated. June 30, December 31, (In thousands) 2003 2002 2002 Percent Amount Percent Amount Percent Amount Loans secured by real estate: Construction and land development 16.2% 609 9.8% 266 12.0% 401 Secured by farmland 1.4% 54 0.9% 26 0.9% 30 Secured by 1-4 family residential 24.8% 934 21.3% 579 22.4% 748 Multi-family residential 4.4% 166 2.1% 57 2.0% 67 Non-farm, non-residential loans 33.1% 1,246 39.9% 1,083 39.1% 1,306 Loans to farmers (except those secured by real estate) 0.1% 3 0.0% - 0.0% - Commercial and industrial loans (except those secured by real estate) 12.9% 487 19.1% 518 16.8% 561 Loans to individuals (except those secured by real estate) 5.4% 202 6.7% 183 6.2% 207 All other loans 1.7% 64 0.2% 4 0.6% 20 100.0% 3,764 100.0% 2,716 100.0% 3,340 December 31, 2001 2000 1999 1998 Percent Amount Percent Amount Percent Amount Percent Amount Loans secured by real estate: Construction and land development 9.5% 234 7.7% 154 8.1% 137 7.7% 123 Secured by farmland 0.7% 17 0.5% 10 0.6% 10 0.7% 11 Secured by 1-4 family residential 23.0% 566 19.7% 394 19.0% 321 19.8% 315 Multi-family residential 1.7% 42 2.6% 52 1.8% 30 1.4% 22 Non-farm, non-residential loans 36.2% 890 28.0% 560 28.7% 485 21.1% 335 Loans to farmers (except those secured by real estate) 0.0% - 0.3% 6 0.1% 2 0.2% 3 Commercial and industrial loans (except those secured by real estate) 21.3% 524 29.9% 598 28.7% 485 33.6% 535 Loans to individuals (except those secured by real estate) 7.4% 182 10.6% 212 12.1% 204 15.3% 243 All other loans 0.2% 5 0.7% 14 0.9% 15 0.2% 3 100.0% 2,459 100.0% 2,000 100.0% 1,689 100.0% 1,591 Non-Performing Assets Non-accrual loans at June 30, 2003 were $618,000 compared to $631,000 at December 31, 2002. As of June 30, 2003, we had a total of $618,000 in non-performing assets and restructured loans, compared to $698,000 at December 31, 2002. As of June 30, 2003, we had no loans in addition to the past due and non-accrual loans mentioned above that are considered to be potential problem loans. The following table details information concerning non-accrual, past due and restructured loans at the dates indicated: June 30, December 31, 2003 2002 2002 2001 2000 1999 1998 ( In thousands) Non-accrual loans $618 $34 $631 $211 $371 $40 $261 Foreclosed properties 0 67 67 67 0 183 0 Restructured loans 0 0 0 0 0 0 0 Total non-performing assets $618 $101 $698 $278 $371 $223 $261 Loans past due 90 days or more and still accruing interest $236 $669 $223 $1,079 $154 $146 $200 Sources of Funds Deposits We primarily use deposits to fund our loans and investment securities. We offer individuals and small-to-medium-size businesses a variety of deposit accounts. Deposit accounts, including checking, savings, money markets and certificates of deposit, are obtained primarily from the communities which we serve. We attract both short-term and long-term deposits from the general public by offering a wide assortment of accounts and rates. We offer statement savings accounts, various checking accounts, various money market accounts, fixed-rate certificates with varying maturities and individual retirement accounts. At June 30, 2003, deposits were $378.2 million, an increase of 9.6% from $345.1 million at December 31, 2002 and up 28.1% from $295.2 million at June 30, 2002. The deposit growth is a reflection of branch office growth, aggressive pricing, increased marketing and bank consolidation in our principal market. In order to reduce the overall cost of funds and reduce our reliance on high cost time deposits and short term borrowings as a funding source, we continue to direct marketing efforts towards attracting lower cost transaction accounts. However, there is no assurance that these efforts will be successful, or if successful, will reduce our reliance on time deposits and short term borrowings. The following table details the average amount of, and the average rate paid on the following primary deposit categories for the periods indicated. Six Months Ended Six Months Ended (In thousands) June 30, 2003 June 30, 2002 Average Average Average Average Balance Rate Balance Rate Demand deposits $ 49,327 $ 40,283 Interest - bearing demand 77,005 1.01% 61,087 1.52% Savings 33,299 1.08% 26,923 1.41% Certificates of deposit 206,478 3.28% 152,274 4.19% Total interest - bearing deposits $316,782 2.48% $240,284 3.17% Borrowed money $ 17,406 4.02% $ 14,700 4.60% Total interest - bearing liabilities $334,188 2.56% $254,984 3.25% Total deposits & borrowed money $383,515 $295,267 Year Ended Year Ended Year Ended (In thousands) December 31, 2002 December 31, 2001 December 31, 2000 Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate Demand deposits $41,379 $34,570 $30,901 Interest - bearing demand 40,789 0.96% 32,679 1.90% 27,736 2.60% Savings 50,983 1.84% 35,585 2.71% 29,990 3.20% Certificates of deposit 165,927 3.89% 128,825 5.49% 109,601 5.70% Total interest - bearing deposits $257,699 3.02% $197,089 4.39% $167,327 4.72% Borrowed money $ 15,144 4.49% $ 7,663 5.25% $ 4,754 6.71% Total interest - bearing liabilities $272,843 3.10% $204,752 4.43% $172,081 4.77% Total deposits & borrowed money $314,222 $239,322 $202,982 The following is a summary of the maturity distribution of certificates of deposit and other time deposits in amounts of $100,000 or more as of June 30, 2003. ( In thousands) Amount Percent Three months or less $10,650 18.68% Over three-six months 23,413 41.07% Over six-twelve months 11,736 20.59% Over twelve months 11,203 19.66% 57,002 100.00% Certificates of deposit in the amounts of $100,000 or more were $57.0 million at June 30, 2003. This amount represents 27.6% of the total certificates of deposit balance of $206.5 million at June 30, 2003. We do not solicit such deposits. Further, we do bid for selected public funds deposits in large denominations, and such deposits may require a pledging of investment securities. We compete with the major regional financial institutions for money market accounts and certificates of deposits less than $100,000. While we are competitive with our interest rates, using a tiered rate system to increase individual account balances, we have found that we can continue to maintain a higher interest margin than our peers by matching loan maturities with certificate maturities and setting loan rates based on our cost of funds. Borrowings We had no short-term borrowings with an average balance outstanding of more than 30% of shareholders equity for the years ended December 31, 2002, 2001 and 2000. Liquidity and Capital Resources Liquidity is a measure of our ability to generate sufficient cash to meet present and future obligations in a timely manner. Our liquidity requirements are measured by the need to meet deposit withdrawals, fund loans, meet reserve requirements and maintain cash levels necessary for daily operations. To meet liquidity requirements, we maintain cash reserves and have an adequate flow of funds from maturing loans, securities, and short-term investments. In addition, our banks have the ability to borrow additional funds from various sources. Short-term borrowings are available from federal funds facilities at correspondent banks and from the discount window of the Federal Reserve Bank. Borrowings are available from the Federal Home Loan Bank. We consider our sources of liquidity to be ample to meet our estimated needs. Our ability to fund these daily commitments at June 30, 2003 and at December 31, 2002, 2001 and 2000 is illustrated in the table below: June 30, December 31, 2003 2002 2001 2000 (in Thousands) Liquid Assets: Cash and due from banks $31,147 $24,768 $17,680 $12,765 Federal funds sold 12,043 19,017 22,185 16,996 Liquid securities 252 5,494 12,396 16,048 Loans maturing in one year or less 121,100 118,794 90,764 72,898 Total liquid assets $164,542 $168,073 $143,025 $118,707 Total deposits and other liabilities $398,849 $363,931 $274,120 $223,008 Ratio of liquid assets to deposits and other liabilities 41.25% 46.18% 52.18% 53.23% The net loan to deposit ratio (92.50%) as of June 30, 2003 has provided the opportunity for us to achieve a high return on assets. For the quarter ended June 30, 2003, we experienced a return on assets of 1.25% and a net interest margin of 4.59%. The net loan to deposit ratio (90.58%) as of December 31, 2002 has provided the opportunity for us to achieve a high return on assets. For the year ended December 31, 2002, we experienced a return on assets of 1.27% and a net interest margin of 4.67%. We recognize that our loan to deposit ratio is high, as our industry is experiencing high loan demand due to record low lending rates. One step that we have taken to assure adequate liquidity is a recent issuance of subordinated debt. On September 25, 2003, we issued $6.2 million in subordinated debt in connection with a trust preferred pool transaction. This additional capital improves our liquidity position and insures our ability to fund our ever-increasing loan demand. The source of new funds is strong for both long-term and short-term duration. The growth in deposits was $87.4 million or 33.9% during 2002. We also have access to overnight federal funds from correspondent banks totaling up to $16.9 million. In addition, we have established borrowing limits through the Federal Reserve Bank s discount window for $1.6 million. Also, we have $85.4 million of funds available through the Federal Home Loan Bank of Atlanta of which $11.0 million has been utilized. Management believes that the opportunity for the sale of loans on the market is good. The following table summarizes historical trends in our significant cash flow items for the periods indicated: Six Months Ended June 30, Year Ended December 31, 2003 2002 2001 2000 CASH FLOWS PROVIDED: Operations 3,967 5,617 3,364 2,840 Investing Maturity, call and purchase of securities 4,801 10,578 13,206 2,151 Financing Growth in deposits 33,110 87,425 45,484 31,001 CASH FLOWS USED: Investing Growth in loans 37,732 84,353 44,586 33,715 Purchase of property, plant and equipment 1,953 2,763 858 537 Purchase of securities 4,147 14,209 11,465 5,865 The following table summarizes ratios considered to be significant indicators of our profitability and financial condition for the periods indicated. Six Months Ended June 30, Year Ended December 31, 2003 2002 2002 2001 2000 Return on average assets (Net income/average total assets) 1.23% 1.26% 1.27% 1.22% 1.12% Return on average equity (Net income/average equity) 16.41% 15.17% 15.63% 13.12% 11.45% Dividends payment ratio (Dividends declared/Net income) 0.00% 0.00% 15.65% 16.65% 18.00% Average equity to average asset ratio 7.55% 8.40% 8.13% 8.59% 9.46% Our risk-based capital position at June 30, 2002 was $39.2 million, or 11.29% of risk-weighted assets, for Tier I capital and $42.9 million, or 12.38% for total risk based capital. Tier I capital consists primarily of common shareholders equity and Trust Preferred Capital Notes. Total risk-based capital includes the allowance for loan losses in addition to Tier 1 Capital. Risk-weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet items. Under current risk-based capital standards, all banks are required to have Tier I capital of at least 4% and a total capital ratio of 8%. Our issuance of $7.0 million in Trust Preferred Capital Notes in the fourth quarter of 2001 is included in the Tier 1 capital base, and will serve as a long-term source of funding. In the normal course of business, we make various commitments and incur certain contingent liabilities, which are disclosed but not reflected in the accompanying financial statements. At June 30, 2003, commitments for standby letters of credit totaled $4.4 million and commitments to extend credit totaled $87.7 million. At December 31, 2002, commitments for standby letters of credit totaled $3.5 million and commitments to extend credit totaled $59.9 million. At December 31, 2001, commitments for standby letters of credit totaled $1.7 million and commitments to extend credit totaled $45.9 million. Recent Accounting Pronouncements In April 2003, the Financial Accounting Standards Board issued Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for contracts entered into or modified after June 30, 2003 and is not expected to have an impact on our consolidated financial statements. In May 2003, the Financial Accounting Standards Board issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic entities. Adoption of this statement did not result in an impact on the our consolidated financial statements. BUSINESS General Premier Community Bankshares, Inc. is a bank holding company that was incorporated in June 1989. We own all of the outstanding stock of The Marathon Bank, which was incorporated in August 1987, and Rockingham Heritage Bank, which was incorporated in June 1989. Our headquarters are in Frederick County, Virginia. Premier is a holding company for Marathon and Rockingham Heritage and is not directly engaged in the operation of any other business. All of our business is conducted through Marathon and Rockingham Heritage. Our subsidiary banks operate autonomously, with separate local identities, management teams and decision-making processes, and without strict operating control from the holding company. Each bank has full responsibility for day-to-day operations, with minimal support from the holding company level. As a result, each bank can tailor its services and products to the needs of its community. The board of directors of the holding company does monitor the financial and operational performance of both banks. Marathon and Rockingham Heritage, which are chartered under Virginia law, conduct a general banking business. Both banks deposits are insured by the Federal Deposit Insurance Corporation and both are members of the Federal Reserve System. We offer checking accounts, savings and time deposits, and commercial, real estate, personal, home improvement, automobile and other installment and term loans. We also offer travelers checks, safe deposit, collection, notary public, discount brokerage service, and other customary bank services (other than trust services). The three principal types of loans that we make are commercial and industrial loans, real estate loans and loans to individuals for household, family, and other consumer costs. Our banking offices include drive-up facilities. There are automated teller machines located at each of Marathon s offices and an additional four off-premise ATMs operated by Marathon. Rockingham Heritage has 18 ATMs throughout its market area. Principal Market Areas Our business in the area served by Marathon (the counties of Frederick, Clarke, Shenandoah, Warren and the city of Winchester, Virginia) and Rockingham Heritage (Rockingham and Augusta counties, and the cities of Harrisonburg, Waynesboro, and Staunton, Virginia) is highly competitive with respect to both loans and deposits. In our primary service area, there are numerous commercial banks (including large, multi-state banks with multiple offices) offering services ranging from deposits and real estate loans to full service banking. Certain of the commercial banks in this service area have higher lending limits than us and may provide various services for their customers that we do not offer. According to a market share report prepared by the FDIC, Marathon s deposits as a percentage of total deposits in financial institutions in its market areas was 8.0% as of June 30, 2002, the most recent date for which market share information is available. Rockingham Heritage s deposits as a percentage of total deposits in financial institutions in its market areas was 5.9% as of June 30, 2002 Expansion into West Virginia We intend to organize a third bank in West Virginia, which will be named Premier Bank. We plan to locate Premier Bank s headquarters in Martinsburg and its initial branch office in Shepherdstown in West Virginia. We expect that Premier Bank will open in the third quarter of 2004, after it receives a banking charter from West Virginia and insurance of accounts from the FDIC. Premier Bank will offer a wide variety of deposits and loans, including residential loans, commercial loans and commercial construction and development loans. On October 6, 2003, West Virginia s Division of Banking approved Marathon s opening of a new lending office in Martinsburg, West Virginia. This office is staffed by the individuals who will operate Premier Bank after it receives the necessary state and federal regulatory approvals and opens for business. At that time, we will transfer this office from Marathon to Premier Bank. This office will not accept deposits until Premier Bank opens for business. Martinsburg and Shepherdstown are located in Berkeley County and Jefferson County, respectively, in West Virginia s eastern panhandle. Martinsburg and Shepherdstown are approximately 80 and 60 miles, respectively, from both Washington, D.C. and Baltimore, Maryland. Many commuters to Washington and Baltimore and their populous suburbs in northern Virginia and Maryland live in Berkeley County and Jefferson County. There is commuter train service from Martinsburg to Washington and Baltimore. Since 1990, the projected market area for our new bank has experienced rapid growth. Berkeley County s population grew from 59,300 to 75,900 between 1990 and 2000. In 2000, its average unemployment rate was 3.0% and its per capita income was $23,000. Major employers in Berkeley County include Berkeley County Schools, General Motors and Quad Graphics, and a number of other companies maintain distribution centers there. The federal government also has a strong presence in the county, including an Internal Revenue Service center, the VA Medical Center and the West Virginia Air National Guard. As of June 30, 2002, the most recent date for which market share information is available, Berkeley County had $672 million of total bank deposits. From 1990 to 2000, Jefferson County s population grew from 36,000 to 42,000. In 2002, its per capita income was $26,900 and its unemployment rate was 3.1%. Major employers in Jefferson County include Penn National Gaming in Charles Town, Jefferson Memorial Hospital and the Jefferson County Board of Education. As of June 30, 2002, Jefferson County had $513 million of total bank deposits. Credit Policies The principal risk associated with each of the categories of loans in our portfolio is the creditworthiness of our borrowers. Within each category, such risk is increased or decreased, depending on prevailing economic conditions. In an effort to manage the risk, our policy gives loan amount approval limits to individual loan officers based on their position and experience. The risk associated with real estate mortgage loans and consumer loans varies, based on employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay indebtedness. The risk associated with real estate construction loans varies, based on the supply and demand for the type of real estate under construction. We have written policies and procedures to help manage credit risk. Our loan review process includes formulation of portfolio management strategy, guidelines for underwriting standards and risk assessment, procedures for ongoing identification and management of credit deterioration, and regular portfolio reviews to establish loss exposure and to ascertain compliance with our policies. Marathon uses an in-house management loan committee and a directors loan committee to approve loans. The in-house loan committee, which consists of the president or senior vice president and two vice presidents, meets weekly to review most applications for loans that are intended to be held in the portfolio. This committee, approves unsecured loans up to $400,000, secured loans with non-negotiable collateral up to $500,000 and secured loans with negotiable collateral up to $1,000,000. The directors loan committee, which is made up of six directors, approves loans up to the legal lending limit. The directors loan committee also reviews lending policies proposed by management. Rockingham s loan approval structure is similar to Marathon s. Rockingham s officer loan committee, which consists of the president or senior lending officer and 2 additional senior lending officers, approves loans in excess of individual loan officers lending authorities. These individual authorities vary up to $150,000. Loans in excess of $500,000 and up to the bank s legal lending limit are approved by a directors loan committee, which consists of the president and three outside directors. The directors loan committee also reviews loan policies and procedures, delinquent loans and other potential problem loans. Residential loan originations come primarily from walk-in customers, real estate brokers and builders. Commercial real estate loan originations are obtained through broker referrals, direct solicitation of developers and continued business from customers. All completed loan applications are reviewed by our salaried loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment and credit history of the applicant. If commercial real estate is involved, information is also obtained concerning cash flow after debt service. Loan quality is analyzed based on each subsidiary bank s experience and guidelines with respect to credit underwriting, as well as the guidelines issued by the Federal Home Loan Mortgage Corporation, Federal National Mortgage Association and other purchasers of loans, depending on the type of loan involved. The non-conforming one-to-four-family adjustable-rate mortgage loans that we originate, however, are not readily salable in the secondary market because they do not meet all of the secondary marketing guidelines. Real estate is appraised by independent fee appraisers who have been pre-approved by the board of directors. In the normal course of business, we make various commitments and incur certain contingent liabilities that are disclosed but not reflected in our annual financial statements, including commitments to extend credit. At June 30, 2003, commitments to extend credit totaled $92.3 million. Commercial Real Estate Lending Commercial real estate loans are secured by various types of commercial real estate in our market area, including multi-family residential buildings, commercial buildings and offices, small shopping centers and churches. At June 30, 2003, commercial real estate loans aggregated $132.7 million or 37.5% of our gross loans. In our underwriting of commercial real estate, we may lend up to 100% of the secured property s appraised value, although our loan to original appraised value ratio on such properties is 80% or less in most cases. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy generally. Our commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower s creditworthiness and prior credit history and reputation, and we generally require personal guarantees or endorsements of borrowers. We also carefully consider the location of the security property. One-to-Four-Family Residential Real Estate Lending We make loans secured by one-to-four-family residences, all of which are located in our market area. We evaluate both the borrower s ability to make principal and interest payments and the value of the property that will secure the loan. We make loans in amounts of up to 100% of the appraised value of the underlying real estate. Loans are made with a loan to value up to 95% for conventional mortgage loans and up to 100% for loans guaranteed by either the Federal Housing Authority or the Veterans Administration. For conventional loans in excess of 80% loan to value, private mortgage insurance is secured insuring the mortgage loans to 75% loan to value. Generally if the loans are not made to credit standards of FHLMC, additional fees and rate are charged. Although, due to competitive market pressures, we do originate long-term, fixed-rate mortgage loans, we currently underwrite and document all such loans to permit their sale in the secondary mortgage market. Certain loans that may not qualify for sale into the secondary market are structured as balloon notes payable in full within a five-year period and are held in our portfolio. All one-to-four-family real estate mortgage loans being originated by us contain a due-on-sale clause providing that we may declare the unpaid principal balance due and payable upon the sale of the mortgage property. It is our policy to enforce these due-on-sale clauses concerning fixed-rate loans. We require, in connection with the origination of residential real estate loans, title opinions and fire and casualty insurance coverage, as well as flood insurance where appropriate, to protect our interest. The cost of this insurance coverage is paid by the borrower. We expect that Premier Bank, once it is organized, will make adjustable rate mortgages, in addition to fixed rate mortgage loans. One-to-four-family residential adjustable-rate mortgage loans will have interest rates that adjust every one or three years, generally in accordance with the rates on one-year and three-year U.S. Treasury bills. We expect that these loans will generally limit interest rate increases for each rate adjustment period and have an established ceiling rate at the time the loans are made. To compete with other lenders in our market area, we may make one-year loans at interest rates that, for the first year, are below the index rate that would otherwise apply to these loans. There are unquantifiable risks resulting from potential increased costs to the borrower as a result of repricing. It is possible, therefore, that during periods of rising interest rates, the risk of defaults on these loans may increase due to the upward adjustment of interest costs to borrowers. Construction Lending We make local construction loans, both residential and commercial, and land development loans. At June 30, 2003, construction and land development loans outstanding were $57.3 million, or 16.2%, of gross loans. All of these loans are concentrated in our local market area. The average life of a construction loan is approximately nine months and they reprice monthly to meet the market, based on the prime rate. Because the interest charged on these loans floats with the market, they help us in managing our interest rate risk. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of the home or land under construction, which is of uncertain value prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. To minimize the risks associated with construction lending, we limit most of our loan amounts to 80.0% of appraised value, in addition to our usual credit analysis of our borrowers. We also obtain a first lien on the property as security for our construction loans and personal guarantees from the borrower s principal owners. Consumer Lending We offer various secured and unsecured consumer loans, including unsecured personal loans and lines of credit, automobile loans, deposit account loans, installment and demand loans, letters of credit, and home equity loans. At June 30, 2003, we had consumer loans of $19.0 million or 5.4% of gross loans. Such loans are generally made to customers with which we had a pre-existing relationship. We originate all of our consumer loans in our market area and intend to continue our consumer lending in this geographic area. Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured, such as lines of credit, or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loan such as us, and a borrower may be able to assert against such assignee claims and defenses which it has against the seller of the underlying collateral. We add general provisions to our loan loss allowance at the time that the loans are originated. Consumer loan delinquencies often increase over time as the loans age. We have very few unsecured consumer loans. The underwriting standards that we employ for consumer loans include a determination of the applicant s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant s monthly income may be determined by verification of gross monthly income for primary employment, and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes an analysis of the value of the security in relation to the proposed loan amount. Commercial Loans Commercial business loans generally have a higher degree of risk than residential mortgage loans, but have commensurately higher yields. To manage these risks, we generally secure appropriate collateral and monitor the financial condition of our business borrowers. Residential mortgage loans generally are made on the basis of the borrower s ability to make repayment from his employment and other income and are secured by real estate whose value tends to be easily ascertainable. In contrast, commercial business loans typically are made on the basis of the borrower s ability to make repayment from cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral for commercial business loans may depreciate over time and cannot be appraised with as much precision as residential real estate. Our standard operating procedure includes a credit review and monitoring process to review the cash flow of commercial borrowers. At June 30, 2003, commercial loans totaled $45.8 million, or 13.0% of the total loan portfolio. Issuance of common stock- exercise of stock options (9,000 shares) 9 36 CASH FLOWS FROM FINANCING ACTIVITIES Net increase in interest bearing deposits $ 29,608 $ 38,408 Net increase (decrease) in non interest bearing deposits 3,502 (857 ) Net increase in borrowings 1,996 2,033 Principal payments on capital lease obligation (4 ) (4 ) Cash dividends paid (683 ) (543 ) Proceeds from issuance of common stock 50 Employees As of June 30, 2003, we had 180 total employees, 149 of which were full-time employees. None of our employees is covered by any collective bargaining agreement, and relations with employees are considered excellent. Legal Proceedings In the course of our operations, we may become a party to legal proceedings. We are not aware of any material pending or threatened legal proceedings. Description of Property The following table provides certain information with respect to our properties: Location Date Facility Opened Ownership and Leasing Arrangements Marathon: Main Office 4095 Valley Pike Winchester, Virginia 1988 Owned by Marathon. Front Royal Branch 300 Warren Avenue Post Office Plaza Front Royal, Virginia 1993 Lease expires in 2016, subject to Marathon s option to renew for two additional five-year terms. Winchester Branch 1041 Berryville Avenue Winchester, Virginia 1995 Lease expires in 2004, subject to Marathon s option to renew for one additional five-year term. Sunnyside Branch 1447 North Frederick Pike Winchester, Virginia 1997 Lease expires in 2006, subject to Marathon s option to renew for two additional five-year terms. Woodstock Branch 1014 South Main Street Woodstock, Virginia 1997 Lease on real estate expires in 2007, subject to Marathon s option to renew for three additional five-year terms. Marathon owns the building. Old Town Branch 139 North Cameron Street Winchester, Virginia 2002 Owned by Marathon. 522 South Branch 199 Front Royal Pike Winchester, Virginia 2003 Owned by Marathon. Rockingham Heritage: Main Office 110 University Boulevard Harrisonburg, Virginia 1991 Owned by Rockingham. South Main Branch 1980 South Main Street Harrisonburg, Virginia 1996 Owned by Rockingham. Elkton Branch 410 West Spotswood Trail Elkton, Virginia 1998 Owned by Rockingham. Red Front Supermarket Branch 677 Chicago Avenue Harrisonburg, Virginia 1993 Lease expires in 2007, with automatic renewal for one additional five-year term. Weyers Cave Branch 54 Franklin Street Weyers Cave, Virginia 2000 Lease expires in 2005, subject to Rockingham Heritage s option to renew for four additional five-year terms. Waynesboro Branch 2556 Jefferson Highway Waynesboro, Virginia 2000 Lease expires in 2004, subject to Rockingham Heritage s option to renew for four additional five-year terms. Staunton Branch 49 Lee-Jackson Highway Staunton, Virginia 2001 Lease expires in 2006, subject to Rockingham Heritage s option to renew for four additional five-year terms. Marathon expects to open an eighth office at 1729 Shenandoah Avenue, Front Royal, Virginia in November 2003. Marathon owns the land and the improvements for that office. Rockingham also expects to open an eighth office at 309 N. Main Street, Bridgewater, Virginia in December 2003. Rockingham owns the land and the improvements for that office. Each of Marathon and Rockingham leases its operations center. Marathon s operation center is located at 175 Front Royal Pike, Winchester, Virginia, and the lease expires in 2012, subject to its option to renew for four additional five-year terms. Rockingham Heritage s operation center is located at 370 Neff Avenue, Suite P, Harrisonburg, Virginia, and the lease expires in 2004. In addition, each bank owns a vacant lot next to its main office for future use. On October 6, 2003, West Virginia s Division of Banking approved Marathon s opening of a new lending office in Martinsburg, West Virginia. This office is staffed by the individuals who will operate Premier Bank after it receives the necessary state and federal regulatory approvals and opens for business. At that time, we will transfer this office from Marathon to Premier Bank. At that time, we will transfer this office from Marathon to Premier Bank. Marathon currently leases the space for this office, which is located at 397-3 Mid-Atlantic Parkway in Martinsburg, and the lease expires in August 2004, subject to its option to renew on a month-to-month basis. We believe that all of our properties are maintained in good operating condition and are suitable and adequate for our operational needs. MANAGEMENT The Board of Directors Our board of directors currently consists of nine members. The board of directors is divided into three classes, each of which consists of three members. These directors serve for the terms of their respective classes, which expire in 2004, 2005 and 2006. The following table sets forth the composition of the board of directors. Class II (Term Expiring in 2004) Class III (Term Expiring in 2005) Class I (Term Expiring in 2006) Walter H. Aikens Meryl G. Kiser Paul R. Yoder, Jr. Clifton L. Good Joseph W. Hollis Wayne B. Ruck Stephen T. Heitz John K. Stephens Donald L. Unger The following information sets forth as of September 22, 2003 the names, ages, principal occupations and business experience for all nine directors. Unless otherwise indicated, the business experience and principal occupations shown for each nominee or incumbent director has extended five or more years. Walter H. Aikens, 53, has served as a director since 1998. He has also served as a director of Marathon since 1998. Mr. Aikens is President of H & W Construction Co., Inc. and President of Aikens Corporation, both in Winchester, Virginia, and develops real estate for rental property. Clifton L. Good, 65, has served as a director since 1989. He has also served as a director of Marathon since 1987. Mr. Good is President of Clifton L. Good Realty, Incorporated, in Front Royal, Virginia. Stephen T. Heitz, 49, has served as a director and our Assistant Secretary/Treasurer since 2000. He has also served as a director of Rockingham Heritage since 1989. Mr. Heitz is an attorney and partner in the firm of Litten and Sipe, L.L.P. in Harrisonburg, Virginia. Joseph W. Hollis, 49, has served as a director since 1989 and Secretary since 2000. He has also served as a director of Marathon since 1987. Mr. Hollis is President of B. J. Sager (beer distributor) in Winchester, Virginia. Meryl G. Kiser, 56, has served as a director since September 2003. He has been President West Virginia Operations for Marathon since August 1, 2003. Mr. Kiser was Chief Executive Officer of Jefferson Security Bank in Martinsburg, West Virginia from 1994 to June 2003. Wayne B. Ruck, 63, has served as a director since 2000. He has also served as a director of Rockingham Heritage since 1996. From 1970 to 2000, Mr. Ruck was a co-founder and co-owner of Packaging Services, Inc. of Weyers Cave, Virginia, and seven other packaging-related companies in the Mid-Atlantic region. Since 2000, he has served as co-founder and co-owner of The Warehouse Company, a public logistics company in Harrisonburg, Virginia, and Shen-Valley LLC, a real estate development company in Harrisonburg, Virginia, and has retained an ownership position in four other packaging-related companies. John K. Stephens, 60, has been our Chairman and a director since 2000. He has been President and Chief Executive Officer of Rockingham Heritage since 1994 and was elected Chairman of the Board of Rockingham Heritage in 1998. From 1990 to 1998, he served as Vice Chairman of the Board of Rockingham. Donald L. Unger, 61, has been our President and Chief Executive Officer since 1992 and a director since 1993. He has also been President and Chief Executive Officer of Marathon since 1992 and a director of Marathon since 1993. Mr. Unger was elected Chairman of Marathon in May 2000. Paul R. Yoder, Jr., 61, has served as a director since 2000. He has also served as a director of Rockingham Heritage since 1989. Mr. Yoder is a physician and surgeon and is a partner in the professional firm of Rockingham Eye Physicians, P.C. Executive Officers John K. Stephens serves as our Chairman and Donald L. Unger serves as our President and Chief Executive Officer. Additional information with respect to these individuals is set forth above. Security Ownership of Management The following table sets forth, as of September 30, 2003, certain information with respect to the beneficial ownership of shares of common stock by each of the members of the board of directors, by each of the executive officers named in the Summary Compensation Table below and by all directors and executive officers as a group. Beneficial ownership includes shares, if any, held in the name of the spouse, minor children or other relatives of a director living in such person s home, as well as shares, if any, held in the name of another person under an arrangement whereby the director or executive officer can vest title in himself at once or at some future time. The address for each of the following individuals is Premier Community Bankshares, Inc., 4095 Valley Pike, Winchester, Virginia 22602. Number of Shares (1) Percent of Class (%) Walter H. Aikens 22,535 .49 Clifton L. Good 71,943 1.56 Stephen T. Heitz 16,936 .37 Joseph W. Hollis 72,701 1.58 Meryl G. Kiser 2,500 .05 Wayne B. Ruck 162,463 3.54 John K. Stephens 90,038 1.96 Donald L. Unger 37,833 .82 Paul R. Yoder, Jr., M.D. 66,947 1.46 All directors and executive officers as a group (9 persons) 543,896 11.85 (1) Amounts disclosed include shares of common stock that certain directors have the right to acquire upon the exercise of stock options exercisable within 60 days, as follows: Mr. Aikens, 2,000 shares; Mr. Good, 11,000; Mr. Heitz, 4,000 shares; Mr. Kiser, 2,500; Mr. Ruck, 4,000; Mr. Stephens, 7,500 shares; Mr. Unger, 30,000; and Mr. Yoder, 4,000 shares. Issuance of common stock- exercise of stock options (7,100 shares) 7 43 Security Ownership of Certain Beneficial Owners The following table sets forth information as of September 30, 2003, regarding the number of shares of common stock beneficially owned by all persons known to us who own five percent or more of the outstanding shares of common stock. Common Stock Name and Address Beneficially Owned Percentage of Class Banc Fund IV L.P. (1) 352,127 7.7% Banc Fund V L.P. Banc Fund VI L.P. 208 S. LaSalle Street Chicago, Illinois (1) In a Schedule 13G filed with the SEC on February 14, 2003, Banc Fund IV L.P. reported beneficial ownership of, including sole voting and dispositive power with respect to, 118,700 shares of common stock, Bank Fund V L.P. reported similar beneficial ownership of 226,127 shares of common stock and Banc Fund VI L.P. reported similar beneficial ownership of 7,300 shares of common stock, as of December 31, 2002. Banc Fund IV L.P., Banc Fund V L.P. and Banc Fund VI L.P. are under common control, according to the Schedule 13G. Director Compensation Each of our directors is paid an annual retainer fee of $6,000 and directors fees for meetings attended as follows: Board of Directors Meetings $ 500 Audit and Compensation Committee Meetings $ 200 The chairman of our audit committee receives $400 for each meeting. In addition, on October 9, 2001 , we granted each outside director an option to purchase 8,000 shares of common stock at $7.30 per share. Each option was exercisable immediately with respect to 2,000 shares and will become exercisable with respect to an additional 2,000 shares on each of October 9, 2002, 2003 and 2004. Executive Officer Compensation The following table presents information concerning the compensation of Messrs. Unger and Stephens. This table presents compensation for services rendered in all capacities to us and our subsidiaries by Mr. Stephens and by Mr. Unger in 2002, 2001 and 2000. Summary Compensation Table Annual Compensation Long Term Compensation Name Year Salary Bonus Other Annual Compen- sation ($) Securities Underlying Options (#) All Other Compensation (1) John K. Stephens Chairman 2002 2001 2000 $141,900 137,800 135,555 $26,250 25,000 30,750 * * * -- -- -- $27,176 14,096 18,192 Donald L. Unger President and Chief Executive Officer 2002 2001 2000 $136,500 130,000 130,000 $26,250 25,000 8,050 * * * -- -- -- $31,603 26,022 20,301 * All benefits that might be considered of a personal nature did not exceed the lesser of $50,000 or 10% of total annual salary and bonus for all officers named in the table. (1) For Mr. Unger, amounts represent (i) contributions to Marathon s 401(k) Plan and to Marathon s Excess Benefit Plan on behalf of Mr. Unger pursuant to Mr. Unger s employment agreement and (ii) the payment of directors fees by us. For Mr. Stephens, amounts represent (i) contributions to the Rockingham Heritage Bank Employee Retirement Plan and the Rockingham Heritage Bank Money Purchase Plan on behalf of Mr. Stephens and (ii) the payment of directors fees by us. Stock Options We did not grant any stock options to Messrs. Stephens and Unger during 2002. The following table sets forth information with respect to stock options held by Messrs. Stephens and Unger as of December 31, 2002. Fiscal Year End Option Values Number of Securities Underlying Unexercised Options at December 31, 2002 (#) Value of Unexercised In-The-Money Options at December 31, 2002 ($)(1) Name Exercisable Unexercisable Exercisable Unexercisable John K. Stephens 7,500 7,500 21,975 21,975 Donald L. Unger 30,000 7,500 139,650 21,975 (1) The value of unexercised in-the-money options at fiscal year end was calculated by determining the difference between (i) the fair market value of common stock underlying the options at December 31, 2002 ($10.23) and (ii) the exercise price of the options. Equity Compensation Plan Information The following table summarizes information concerning our equity compensation plans at December 31, 2002: Number of Shares Remaining Available for Future Issuance Number of Shares to Under Equity be Issued upon Weighted Average Compensation Plans Exercise of Exercise Price of (Excluding Shares Outstanding Options Outstanding Options Reflected in First Plan Category and Warrants and Warrants Column) Equity compensation plans approved by shareholders 2002 Long-Term Incentive Plan 331,375 $ 7.40 318,750 Equity compensation plans not approved by shareholders N/A N/A N/A Total 331,375 $ 7.40 318,750 Employment Agreements We and Mr. Unger entered into an employment agreement on April 1, 1998. The agreement was automatically renewed on March 31, 2002 for a one year period and automatically renews for successive one year periods thereafter unless expressly terminated by us. As compensation under the agreement, Mr. Unger currently receives a base salary of $136,500. As additional compensation under the agreement and at the election and in the discretion of the board of directors, Mr. Unger may receive a bonus in the form of cash or options to purchase shares of common stock. The agreement permits Mr. Unger to participate in any benefit plans adopted by us under the same terms and conditions as our other employees. In the event of a change in control of us, the agreement provides that Mr. Unger shall receive a cash payment equal to the greater of (i) the amount of salary due to Mr. Unger for the remainder of the term of the agreement or (ii) the product of his annual salary and the multiple of the book value per share of common stock received by our shareholders in connection with such change of control, provided such multiple does not exceed three. Certain Relationships and Related Transactions Some of our directors and officers and their families are at present, as in the past, customers of Marathon or Rockingham Heritage, and have had and expect to have transactions with one or both of the subsidiary banks in the ordinary course of business. In addition, some of our directors and officers are at present, as in the past, also directors and officers of corporations that are customers of the subsidiary banks and that have had or expect to have transactions with the subsidiary banks in the ordinary course of business. Such transactions were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than normal risk of collectibility or present other unfavorable features. As of December 31, 2002, the aggregate amount of loans, direct and indirect, from Marathon and Rockingham Heritage to the directors and executive officers of us, Marathon and Rockingham Heritage, and entities in which they own significant interest, was $7,633,000. Rockingham Heritage has a lease agreement with Village Square Plaza, LLC, of which Wayne B. Ruck, one of our directors, owns 16.7%. The lease relates to Rockingham Heritage s branch at 54 Franklin Street, Suite 102, Weyers Cave, Virginia. The lease became effective in December 2000 and terminates in December 2026. The rent paid on the lease totaled $34,604 for the year 2002. Marathon also had a lease with Post Office Plaza, L.C., of which Donald L. Unger, our President and Chief Executive Officer and a director, owned 25% until he sold it in December 2002. The lease arrangement related to Marathon s branch at 300 Warren Avenue, Front Royal, Virginia. The land lease became effective in July 1993 and converted into a lease for both the land and building thereon in June 1996. The lease expires on June 30, 2016. The rent paid on the lease totaled $51,600 for the year 2002. The firm of Litten and Sipe, L.L.P. of which Stephen T. Heitz, one of our directors, is a partner, rendered legal services to Rockingham Heritage in 2002. We expect that all future transactions with our directors and officers, and any other affiliates, will be on terms no less favorable to us than the terms that we could obtain from independent third parties. DESCRIPTION OF CAPITAL STOCK General Our authorized capital stock consists of 20,000,000 shares of common stock, par value $1.00 per share, and 1,000,000 shares of preferred stock, no par value. We have 4,590,584 issued and outstanding shares of common stock held by 1,432 shareholders of record. We have 304,275 stock options presently issued and outstanding. All outstanding shares of common stock are fully paid and nonassessable. No shares of preferred stock are currently outstanding, and our board of directors has not authorized the issuance of any class or series of preferred stock. Common Stock Voting Rights. Each share of our common stock entitles the holder thereof to one vote on all matters voted on by shareholders. The shares of our common stock do not have cumulative voting rights, which means that the holders of more than 50% of the shares of our common stock voting for the election of directors can elect all of the directors, in which event the holders of the remaining shares of our common stock will not be able to elect any of the directors. The holders of our common stock shall, to the exclusion of the holders of any other class of stock, have the sole and full power to vote for the election of directors and for all other purposes without limitation except only (a) as otherwise provided in the articles of amendment for a particular class or series of preferred stock, and (b) as otherwise expressly provided by the then existing statutes of the Commonwealth of Virginia. Dividend Rights. Subject to the preferences of any preferred stock then outstanding, the holders of our common stock are entitled to receive dividends when, as and if declared by the board of directors out of funds legally available for the payment of dividends. Liquidation Rights. Upon any liquidation, dissolution or winding up of our affairs, the holders of our common stock are entitled to receive pro rata all of our assets for distribution to shareholders remaining after payment of all liquidation preferences, if any, applicable to any outstanding preferred stock. There are no redemption or sinking fund provisions applicable to the common stock. Assessment and Redemption. Shares of our common stock presently outstanding are validly issued, fully paid and nonassessable. There is no provision for any voluntary redemption of our common stock. Preferred Stock The board of directors is granted the authority to issue, without shareholder approval, the preferred stock in one or more classes or series. Prior to the issuance of any shares of a class or series of preferred stock, the board of directors will fix by resolution the number of shares of the class or series and the preferences, limitations and relative rights of such series or class. Such class or series will be established when the Virginia State Corporation Commission issues a certificate of amendment of our articles of incorporation setting forth the designation and number of shares of the class or series and its relative rights and preferences. Shareholder approval is not required to amend our articles of incorporation for this purpose. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of common stock, adversely affect the rights and powers, including voting rights, of holders of common stock, and have the effect of delaying, deterring or preventing a change in control of us. Preemptive Rights No holder of any share of our capital stock has any preemptive right to subscribe to an additional issue of our capital stock or to any security convertible into such stock. Certain Provisions of Our Articles of Incorporation, Bylaws and Virginia Law General Our articles of incorporation and bylaws contain provisions that could make more difficult an acquisition of us by means of a tender offer, a proxy contest or otherwise. These provisions are expected to discourage specific types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control to first negotiate with us. Although these provisions may have the effect of delaying, deferring or preventing a change in control, we believe that the benefits of increased protection through the potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure the company outweigh the disadvantages of discouraging these proposals because, among other things, negotiation of such proposals could result in an improvement of their terms. Restrictions on Transfer of Common Stock Our articles of incorporation prohibit the transfer of our common stock to any person who is or who, immediately following such transfer, would be an Interested Shareholder, unless such transfer has been approved in advance in a resolution adopted by a majority of the board of directors. For purposes of our articles of incorporation, an Interested Shareholder is defined as any person who or which is the beneficial owner, directly or indirectly, of 10% or more of the outstanding shares of our common stock; provided, however, that the term Interested Shareholder does not include our subsidiaries, or any of our subsidiaries savings, employee stock ownership or other employee benefit plans. Affiliated Transactions The Virginia Stock Corporation Act contains provisions governing Affiliated Transactions. Affiliated Transactions include certain mergers and share exchanges, material dispositions of corporate assets not in the ordinary course of business, any dissolution of the corporation proposed by or on behalf of an Interested Shareholder (as defined below), or reclassifications, including reverse stock splits, recapitalizations or mergers of the corporation with its subsidiaries which have the effect of increasing the percentage of voting shares beneficially owned by an Interested Shareholder by more than 5%. For purposes of the Virginia Act, an Interested Shareholder is defined as any beneficial owner of more than 10% of any class of the voting securities of a Virginia corporation. Subject to certain exceptions discussed below, the provisions governing Affiliated Transactions require that, for three years following the date upon which any shareholder becomes an Interested Shareholder, a Virginia corporation cannot engage in an Affiliated Transaction with such Interested Shareholder unless approved by the affirmative vote of the holders of two-thirds of the voting shares of the corporation, other than the shares beneficially owned by the Interested Shareholder, and by a majority (but not less than two) of the Disinterested Directors. A Disinterested Director means, with respect to a particular Interested Shareholder, a member of a corporation s board of directors who (i) was a member before the later of January 1, 1988 and the date on which an Interested Shareholder became an Interested Shareholder and (ii) was recommended for election by, or was elected to fill a vacancy and received the affirmative vote of, a majority of the Disinterested Directors then on the board. At the expiration of the three-year period, these provisions require approval of Affiliated Transactions by the affirmative vote of the holders of two-thirds of the voting shares of the corporation, other than those beneficially owned by the Interested Shareholder. The principal exceptions to the special voting requirement apply to Affiliated Transactions occurring after the three-year period has expired and require either that the transaction be approved by a majority of the Disinterested Directors or that the transaction satisfy certain fair price requirements of the statute. In general, the fair price requirements provide that the shareholders must receive the highest per share price for their shares as was paid by the Interested Shareholder for his shares or the fair market value of their shares, whichever is higher. They also require that, during the three years preceding the announcement of the proposed Affiliated Transaction, all required dividends have been paid and no special financial accommodations have been accorded the Interested Shareholder unless approved by a majority of the Disinterested Directors. None of the foregoing limitations and special voting requirements applies to an Affiliated Transaction with an Interested Shareholder whose acquisition of shares making such person an Interested Shareholder was approved by a majority of the corporation s Disinterested Directors. These provisions were designed to deter certain takeovers of Virginia corporations. In addition, the statute provides that, by affirmative vote of a majority of the voting shares other than shares owned by any Interested Shareholder, a corporation may adopt, by meeting certain voting requirements, an amendment to its articles of incorporation or bylaws providing that the Affiliated Transactions provisions shall not apply to the corporation. We have not adopted such an amendment. Control Share Acquisitions The Virginia Act also contains provisions regulating certain control share acquisitions, which are transactions causing the voting strength of any person acquiring beneficial ownership of shares of a public corporation in Virginia to meet or exceed certain threshold percentages (20%, 33/1/3% or 50%) of the total votes entitled to be cast for the election of directors. Shares acquired in a control share acquisition have no voting rights unless: (i) the voting rights are granted by a majority vote of all outstanding shares other than those held by the acquiring person or any officer or employee director of the corporation, or (ii) the articles of incorporation or bylaws of the corporation provide that these Virginia law provisions do not apply to acquisitions of its shares. The acquiring person may require that a special meeting of the shareholders be held to consider the grant of voting rights to the shares acquired in the control share acquisition. These provisions were designed to deter certain takeovers of Virginia public corporations. However, our bylaws contain a provision that makes these provisions inapplicable to acquisitions of our common stock. Board of Directors According to our bylaws, the board of directors must be composed of nine directors. However, the board of directors may, according to our articles of incorporation, amend our bylaws from time to time to increase or decrease the number of directors by up to 30% of the number of directors last elected by the shareholders. Our board consists of three classes, with the term of office of one class expiring each year. Directorships are apportioned among the classes so as to make all classes as nearly equal in number as possible. According to the articles of incorporation, a director may be removed only for cause by the affirmative vote of more than 66 2/3% of the outstanding voting shares. Directors Duties The standards of conduct for directors of Virginia corporations are listed in the Virginia Stock Corporation Act. Directors must discharge their duties in accordance with their good faith business judgement of the best interests of the corporation. Directors may rely on the advice or acts of others, including officers, employees, attorneys, accountants and board committees if they have a good faith belief in their competence. Directors actions are not subject to a reasonableness or prudent person standard. Virginia s federal and state courts have focused on the process involved with directors decision-making and are generally supportive of directors if they have based their decision on an informed process. These elements of Virginia law could make it more difficult to take over a Virginia corporation than corporations in other states. Indemnification and Limitations on Liability of Officers and Directors As permitted by the Virginia Stock Corporation Act, our articles of incorporation contain provisions that indemnify our directors and officers to the full extent permitted by Virginia law and eliminate the personal liability of our directors and officers for monetary damages to us or our shareholders for breach of their fiduciary duties, except to the extent that the Virginia Act prohibits indemnification or elimination of liability. These provisions do not limit or eliminate the rights of us or any shareholder to seek an injunction or any other non-monetary relief in the event of a breach of a director s or officer s fiduciary duty. In addition, these provisions apply only to claims against a director or officer arising out of his role as a director or officer and do not relieve a director or officer from liability if he engaged in willful misconduct or a knowing violation of the criminal law or any federal or state securities law. In addition, our articles of incorporation provide for the indemnification of both directors and officers for expenses that they incur in connection with the defense or settlement of claims asserted against them in their capacities as directors and officers. This right of indemnification extends to judgments or penalties assessed against them. We have limited our exposure to liability for indemnification of directors and officers by purchasing directors and officers liability insurance coverage. The rights of indemnification provided in our articles of incorporation are not exclusive of any other rights that may be available under any insurance or other agreement, by vote of shareholders or disinterested directors or otherwise. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling us pursuant to the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission this type of indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. Shares Eligible for Future Sale All of the shares that we will have issued in the offering will be freely tradeable without restriction or registration under the Securities Act, unless owned by our affiliates, subject to the lock-up agreements described below. All shares that we have issued prior to the offering, as well as any other shares that our affiliates hold are subject to resale restrictions under the Securities Act. Rule 144 under the Securities Act defines an affiliate of an issuer as a person that directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with the issuer. Rule 405 under the Securities Act defines the term control to mean the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of the person whether through the ownership of voting securities, by contract, or otherwise. All of our directors and executive officers will likely be deemed to be affiliates of us. Our directors and executive officers hold 478,896 shares of common stock. Shares that our affiliates hold and shares that we issued prior to the offering may be eligible for sale in the open market without registration in accordance with the provisions of Rule 144. After the closing of the offering, the shares of our common stock that we issued prior to the offering will be restricted securities, within the meaning of Rule 144. In general, under Rule 144, any person (or persons whose shares are aggregated) who has beneficially owned restricted securities for at least one year, including affiliates, and any affiliate who holds shares sold in a public offering, may sell, within any three-month period, a number of such shares that does not exceed the greater of 1% of the then outstanding shares of the common stock or the average weekly trading volume of the common stock during the four calendar weeks preceding the sale. Rule 144 also requires that the securities must be sold in brokers transactions, as defined in the Securities Act, and the person selling the securities may not solicit orders or make any payment in connection with the offer or sale of securities to any person other than the broker who executes the order to sell the securities. After restricted securities are held for two years, a person who is not deemed an affiliate of us may sell shares under Rule 144 without regard to the volume and manner of sale limitations described above. Sales of shares by our affiliates will continue to be subject to the volume and manner of sale limitations. We cannot predict the effect, if any, that future sales of shares of our common stock, or the availability of shares for future sales, will have on the market price prevailing from time to time. Sales of substantial amounts of shares of our common stock, or the perception that such sales could occur, could adversely affect the prevailing market price of the shares. GOVERNMENT SUPERVISION AND REGULATION General As a bank holding company, we are subject to regulation under the Bank Holding Company Act, and the examination and reporting requirements of the Federal Reserve. Under the Bank Holding Company Act, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve. The Bank Holding Company Act also generally limits the activities of a bank holding company to that of banking, managing or controlling banks, or any other activity which is determined to be so closely related to banking or to managing or controlling banks that an exception is allowed for those activities. The Gramm-Leach-Bliley Act, which we discuss below, has reduced some of these limitations. As state-chartered commercial banks, each of Marathon and Rockingham Heritage is subject to regulation, supervision and examination by the Virginia State Corporation Commission s Bureau of Financial Institutions. Each bank also is subject to regulation, supervision and examination by the Federal Reserve. State and federal law also governs the activities in which each bank engages, the investments that it makes and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect each bank s operations. Premier Bank, which we are currently organizing in West Virginia, will also be a state-chartered bank, but it will not be a member of the Federal Reserve. As a result, Premier Bank will be subject to regulation, supervision and examination by West Virginia s Division of Banking and the Federal Deposit Insurance Corporation. The earnings of our subsidiaries, and therefore our earnings, are affected by general economic conditions, management policies, changes in state and federal legislation and actions of various regulatory authorities, including those referred to above. The following description summarizes the significant federal and state laws to which we are, and each bank is, subject. To the extent that statutory or regulatory provisions or proposals are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals. Payment of Dividends We are a legal entity separate and distinct from our banking and other subsidiaries. The majority of our revenues result from dividends paid to us by each bank. Each bank is subject to laws and regulations that limit the amount of dividends that it can pay. In addition, we are, and each bank is, subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums. Banking regulators have indicated that banking organizations should generally pay dividends only if the organization s net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization s capital needs, asset quality and overall financial condition. We do not expect that any of these laws, regulations or policies will materially affect the ability of either bank to pay dividends. Insurance of Accounts, Assessments and Regulation by the FDIC The deposits of each bank are insured by the FDIC up to the limits set forth under applicable law. The deposits of each bank are subject to the deposit insurance assessments of the Bank Insurance Fund of the FDIC. The FDIC has implemented a risk-based deposit insurance assessment system under which the assessment rate for an insured institution may vary according to regulatory capital levels of the institution and other factors (including supervisory evaluations). Depository institutions insured by the Bank Insurance Fund that are well capitalized and that present few or no supervisory concerns are required to pay only the statutory minimum assessment of $2,000 annually for deposit insurance, while all other banks are required to pay premiums ranging from .03% to .27% of domestic deposits. These rate schedules are subject to future adjustments by the FDIC. In addition, the FDIC has authority to impose special assessments from time to time. However, because the legislation enacted in 1996 requires that both Savings Association Insurance Fund-insured and Bank Insurance Fund-insured deposits pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation, the FDIC is assessing Bank Insurance Fund-insured deposits an additional 1.30 basis points per $100 of deposits to cover those obligations. The FDIC is authorized to prohibit any Bank Insurance Fund-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the respective insurance fund. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution s primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. We are not aware of any existing circumstances that could result in the termination of either bank s deposit insurance. Capital The Federal Reserve has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises. Under the risk-based capital requirements, we are, and each bank is, generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. In addition, at least half of the total capital must be Tier 1 capital, which consists of common equity, retained earnings and qualifying perpetual preferred stock, less certain intangibles. Total capital consists of Tier 1 capital plus certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance. In addition, each of the federal banking regulatory agencies has established minimum leverage capital requirements for banking organizations. Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization s overall safety and soundness. The risk-based capital standards of the Federal Reserve explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution s overall capital adequacy. The capital guidelines also provide that a factor in evaluating a banking organization s capital adequacy is an institution s exposure to a decline in the economic value of its capital due to changes in interest rates. Premier Bank will be subject to similar guidelines that the FDIC has issued. Other Safety and Soundness Regulations There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event that the depository institution is insolvent or is in danger of becoming insolvent. For example, under the requirements of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so otherwise. In addition, the cross-guarantee provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure. The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the deposit insurance funds. The FDIC s claim for reimbursement under the cross guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled insured depository institutions. The federal banking agencies also have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law. As of December 31, 2002, each of Marathon and Rockingham Heritage was classified as well capitalized. State banking regulators also have broad enforcement powers over each bank, including the power to impose fines and other civil and criminal penalties, and to appoint a conservator. Community Reinvestment The requirements of the Community Reinvestment Act are also applicable to each bank. The act imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institution s efforts in meeting community needs currently are evaluated as part of the examination process pursuant to twelve assessment factors. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Marathon received an outstanding rating in its most recent CRA examination, and Rockingham Heritage received an outstanding rating in its most recent CRA examination. Interstate Banking and Branching Current federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Effective June 1, 1997, a bank headquartered in one state was authorized to merge with a bank headquartered in another state, as long as neither of the states had opted out of such interstate merger authority prior to such date. After a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable federal or state law. Gramm-Leach-Bliley Act The Gramm-Leach-Bliley Act was signed into law on November 12, 1999. The act covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. Most of the act s provisions require the federal bank regulatory agencies and other regulatory bodies to adopt regulations to implement the act, and for that reason an assessment of the full impact of the act on us and each bank must await completion of that regulatory process. The act repeals sections 20 and 32 of the Glass-Stegall Act, thus permitting unrestricted affiliations between banks and securities firms. The act also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, brokerage, investment and merchant banking; and insurance underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act rating. The act provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in certain areas identified in the act. The act directs the federal bank regulatory agencies to adopt insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures. The act adopts a system of functional regulation under which the Federal Reserve is confirmed as the umbrella regulator for financial holding companies, but financial holding company affiliates are to be principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the Securities and Exchange Commission for securities affiliates and state insurance regulators for insurance affiliates. The act repeals the broad exemption of banks from the definitions of broker and dealer for purposes of the Securities and Exchange Act of 1934, as amended, but identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a broker, and a set of activities in which a bank may engage without being deemed a dealer. The act also makes conforming changes in the definitions of broker and dealer for purposes of the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended. The act contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution s policies and procedures regarding the handling of customers nonpublic personal financial information. The act provides that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The act also provides that the states may adopt customer privacy protections that are more strict than those contained in the act. The act also makes a criminal offense, except in limited circumstances, obtaining or attempting to obtain customer information of a financial nature by fraudulent or deceptive means. UNDERWRITING The underwriter, McKinnon & Company, Inc., 555 Main Street, Norfolk, Virginia, has agreed, subject to the terms and conditions contained in an underwriting agreement with us, to sell, as selling agent, on a best efforts basis, up to 250,000 shares of common stock. Because the offering is on a best efforts basis and there is no minimum number of shares to be sold, the underwriter is not obligated to purchase any shares if they are not sold to the public. The underwriter has informed us that it proposes to sell the common stock as selling agent for us , subject to prior sale, when, as and if issued by us , in part to the public at the public offering price set forth on the cover page of this prospectus and, in part, through certain selected dealers, who are members of the National Association of Securities Dealers, Inc., to customers of such selected dealers at the public offering price. Each selected dealer will receive a commission of $ for each share that it sells. The underwriter reserves the right to reject any order for the purchase of common stock through it in whole or in part. The public offering is not contingent upon the occurrence of any event or the sale of a minimum or maximum number of shares of common stock. Funds received by the underwriter from investors in the public offering will be deposited with and held by the escrow agent in a non-interest bearing account until the closing of the public offering. Closing is expected to occur on or about , 2003. The public offering price will be determined through negotiations between us and the underwriter. A variety of factors will be considered in determining the price, including the trading history of our common stock (including the frequency and volume of trades and actual trading prices), our history and prospects, our past and present earnings and our prospects for future earnings, the current performance and prospects of the banking industry in general and the banking market in which we compete, and the general condition of the securities market and the prices of equity securities of comparable companies. We will pay our own expenses of the offering, including our legal, accounting, printing and other expenses and expenses associated with qualifying our shares for sale in various states. We will also reimburse the underwriter for the fees of its legal counsel. We expect that the total amount of offering expenses that we pay, including our reimbursement to the underwriter, will amount to approximately $100,000. The underwriting agreement also provides that we will indemnify the underwriter against certain liabilities, including liabilities under the Securities Act or contribute to payments the underwriter may be required to make in respect thereof. The underwriter has advised us that it may make a market in the common stock. The underwriter, however, is not obligated to make a market in the common stock. It also may discontinue any market making at any time without notice. The underwriter provides investment banking services to us from time to time in the ordinary course of business. LEGAL MATTERS The validity of the shares of our common stock offered and certain other legal matters will be passed upon by the law firm of Williams Mullen, Richmond, Virginia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000863061_odyssey_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000863061_odyssey_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..051634e619c5bee0e25ce48a252d699b214c9405 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000863061_odyssey_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock being offered hereby will be passed upon for us by Sichenzia Ross Friedman Ference LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000866048_leslies_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000866048_leslies_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6511cdbe395d75fb896bb079d0d6ad2d7cee8811 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000866048_leslies_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Gibson, Dunn & Crutcher LLP, Los Angeles, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000867665_abraxas_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000867665_abraxas_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..45ca0973a27bb4eb32d16f261d6adc84a1a74253 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000867665_abraxas_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the notes and the Abraxas common stock covered by this prospectus has been passed upon for Abraxas by Cox & Smith Incorporated, San Antonio, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000874663_alkermes_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000874663_alkermes_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..48eca937824c39d2a831947f34de9967993d03db --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000874663_alkermes_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered hereby will be passed upon for Alkermes by Ballard Spahr Andrews Ingersoll, LLP, Philadelphia, Pennsylvania. Morris Cheston, Jr., Secretary of Alkermes and of Alkermes Controlled Therapeutics, Inc., Alkermes Controlled Therapeutics Inc. II, and ADC II, all of which are wholly owned subsidiaries of Alkermes, and Jennifer L. Miller, Secretary of Alkermes Investments, Inc., a wholly owned subsidiary of Alkermes, are partners in the law firm of Ballard Spahr Andrews Ingersoll, LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000880765_decrane_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000880765_decrane_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000880765_decrane_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000882287_mariner_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000882287_mariner_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..171a859d9de1c6e8fa886a1ab6c2f3bf9b486035 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000882287_mariner_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed on for us by Powell, Goldstein, Frazer Murphy LLP, Atlanta, Georgia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000888455_petco_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000888455_petco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7a4c9e37a206157af420b5458ad4eeccc96c79f0 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000888455_petco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Latham & Watkins LLP, San Diego, California. Certain legal matters will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, Los Angeles, California. Skadden, Arps represented Leonard Green & Partners and its affiliates, Texas Pacific Group and its affiliates, and BD Recapitalization Holdings LLC in connection with the recapitalization of PETCO and continues to represent them in connection with matters unrelated to the offering, including in connection with their investment in PETCO. Skadden, Arps has also represented PETCO in connection with matters unrelated to the offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000892112_sirna_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000892112_sirna_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..645465f6031d440a45829c97fc9eac8afb54c265 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000892112_sirna_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS For purposes of this offering, O Melveny & Myers LLP, Menlo Park, California, will pass upon the legality of the securities being offered by this prospectus for us. Experts The financial statements of Ribozyme Pharmaceuticals, Inc. (now known as Sirna Therapeutics, Inc.) at December 31, 2002 and 2001, and for each of the three years in the period ended December 31, 2002, and the financial statements of Medizyme Pharmaceuticals, Ltd. at December 31, 2000 and for the year ended December 31, 2000 appearing in this prospectus and registration statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their reports thereon appearing elsewhere herein, and are included in reliance upon such reports given on the authority of such firm as experts in accounting and auditing. Forward-Looking Statements Statements in this prospectus which are not strictly historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that involve risks and uncertainties. These uncertainties include, but are not limited to, the following: general economic and business conditions; ability to obtain adequate financing in the future; ability to obtain and enforce patents; ability to obtain rights to technology; ability to develop, manufacture and commercialize products; ability to obtain and retain collaborators; changes in, or failure to comply with, governmental regulations; results of clinical studies; results of research and development activities; technological advances; competition; availability of qualified personnel; business abilities and judgment of personnel; and the like, are set forth in the section titled Risk Factors herein. We undertake no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date hereof. Where You Can Find More Information We file reports, proxy statements and other information with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934. You may read and copy any reports, statements or other information that we file with the SEC at the SEC s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information about issuers that file electronically with the SEC. The address of the SEC s internet site is http://www.sec.gov. The address of our internet site is http://www.sirna.com. Information contained on our website is not to be considered a part of this prospectus. We have included our website address only as an inactive textual reference and do not intend it to be an active link to our website. Total other income (expense) (238 ) (1,650 ) (5,690 ) (6,945 ) (5,983 ) Table of Contents SIRNA THERAPEUTICS, INC. (Formerly Ribozyme Pharmaceuticals, Inc.) NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued) into a commercialization agreement with a third party for HERZYME; or (b) a royalty on net sales of HERZYME by the Company. As of April 2003, the Company owns 100% of the capital stock of Medizyme and therefore will consolidate Medizyme s losses; however, the Company does not intend to pursue independent development of HERZYME. In addition, in connection with the Stock Purchase Agreement, Elan converted all of the outstanding shares of the Company s Series A and Series B Preferred Stock held by Elan into 541,929 shares of the Company s common stock. The unaudited results of operations of Medizyme for the three-month period ended March 31, 2003 are as follows (in thousands): Revenue $ Research and development Net loss applicable to common stock $ (5,476 ) $ (8,498 ) $ (36,277 ) $ (60,613 ) $ (16,598 ) Net loss per share (basic and diluted) (1) $ (1.62 ) $ (2.55 ) $ (10.81 ) $ (21.54 ) $ (6.92 ) Shares used in computing net loss per share (basic and diluted) (1) 3,381 3,336 3,356 2,814 2,398 As of March 31, 2003 Actual Pro Forma (2) Pro Forma As Adjusted (3) (unaudited) Balance Sheet Data: Cash $ 4,867 $ 49,067 $ 53,816 Working capital 267 44,467 49,216 Total assets 17,569 61,769 66,518 Current liabilities 5,662 5,662 5,662 Long-term debt, less current portion 6,450 5,815 5,815 Convertible Exchangeable Preferred Stock and accreted dividends 14,545 Total stockholders (deficit) equity (9,088 ) 50,292 55,041 Table of Contents USE OF PROCEEDS We expect to receive net proceeds from the offering of approximately $4.75 million at an offering price of $1.98 per share, assuming that all rights are exercised, and after deducting estimated offering expenses of $250,000. We intend to use up to approximately $3.8 million of the net proceeds for research and development of our RNA interference technologies and the balance for general corporate purposes, primarily working capital. Pending these uses, we will invest the net proceeds in U.S. dollar denominated, short-term, interest bearing, and investment-grade securities. Should we receive only a portion of the maximum amount obtainable from the offering, we intend to use approximately 80% of those net proceeds for research and development of our RNA interference technologies and the balance for working capital. PRICE RANGE OF COMMON STOCK Our common stock is traded on the Nasdaq National Market under the symbol RNAI. The last sale price of the common stock as reported on the Nasdaq National Market on July 28, 2003, was $8.22 per share. On July 28, 2003, there were approximately 228 holders of record of our common stock. Effective April 16, 2003, we declared a 1-for-6 reverse stock split. The sale prices below reflect the 1-for-6 reverse stock split. The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock as reported on the Nasdaq National Market. High Low Table of Contents CAPITALIZATION The following table sets forth our capitalization at March 31, 2003: on an actual basis; pro forma to reflect the conversion of our Series A preferred stock and Series B preferred stock, payment of interest accrued and a discount applied related to our Schering AG loan, and the completion of the private placement on April 21, 2003, net $3.8 million of estimated expenses; and pro forma, as adjusted to reflect the issuance of the shares of common stock underlying the rights offered hereby assuming all rights are sold and receipt and application of the proceeds net of $250,000 of expenses from this rights offering. You should read the following table in conjunction with our financial statements and the accompanying notes to our financial statements, Selected Financial Information and Management s Discussion and Analysis of Results of Operations and Financial Condition included elsewhere in this prospectus. March 31, 2003 Actual Pro Forma Pro Forma As Adjusted Total stockholders equity (9,088 ) 50,292 55,041 Total capitalization $ 12,398 $ 56,598 $ 61,347 Table of Contents SELECTED FINANCIAL DATA The following selected financial data for the fiscal years ended December 31, 2002, 2001, 2000 included herein, and 1999 and 1998 not included herein are derived from our audited financial statements. These historical results do not necessarily indicate future results. The unaudited financial data for the three months ended March 31, 2003 and 2002 are derived from the unaudited financial statements elsewhere in this prospectus and include all adjustments that we consider necessary for a fair presentation of our financial position and results of operations for such periods. When you read this data, it is important that you also read our financial statements and related notes, as well as the section Management s Discussion and Analysis of Results of Operations and Financial Condition. Quarters ended March 31, Years ended December 31, Total revenues 490 1,579 5,148 8,308 15,545 7,664 8,963 Expenses Research and development 3,777 6,741 28,659 56,689 21,721 15,395 16,941 General and administrative 1,389 1,483 5,505 4,512 3,723 2,132 1,813 Stock option plans 884,871 Employee stock purchase plan 4,575 Employee 401(k) stock match 23,359 Warrants at $30.00 per share (expires in 2006) 90,357 Warrants at $32.82 per share (expires in 2004) 1,500 Warrants at $59.64 per share (expires in 2004) 4,167 Warrants at $72.00 per share (expires in 2006) 58,333 Warrants at $94.50 per share (no expiration) Total operating expenses 5,166 8,224 34,164 61,201 25,444 17,527 18,754 Operating loss (4,676 ) (6,645 ) (29,016 ) (52,893 ) (9,899 ) (9,863 ) (9,791 ) Other income (expense): Interest income 21 155 389 2,165 3,196 614 634 Interest expense (125 ) (377 ) (803 ) (820 ) (151 ) (552 ) (704 ) Other income (1 ) (1 ) 51 4 25 Equity in loss of unconsolidated affiliates (133 ) (1,467 ) (5,276 ) (8,341 ) (9,032 ) (860 ) (1,082 ) (Unaudited) (Unaudited) ASSETS Current assets Cash and equivalents $ 828 $ 1,128 $ 10,449 Interest receivable Total other income (expense) (238 ) (1,650 ) (5,690 ) (6,945 ) (5,983 ) (798 ) (1,127 ) Net loss applicable to common stock $ (5,476 ) $ (8,498 ) $ (36,277 ) $ (60,613 ) $ (16,598 ) $ (10,661 ) $ (10,918 ) Net loss per share (basic and diluted) (1) $ (1.62 ) $ (2.55 ) $ (10.81 ) $ (21.54 ) $ (6.92 ) $ (6.30 ) $ (7.30 ) Shares used in computing net loss per share (basic and diluted) (1) 3,381 3,336 3,356 2,814 2,398 1,693 1,496 Balance Sheet Data: Cash, cash equivalents and securities available-for-sale $ 4,867 $ 28,748 $ 8,821 $ 34,995 $ 64,475 $ 14,000 $ 6,512 Working capital 267 24,925 5,027 31,908 65,002 14,086 8,568 Total assets 17,569 44,747 21,898 52,023 83,897 25,092 19,224 Long-term debt, current 491 169 480 169 200 498 Long-term debt, net of current portion 6,450 12,872 6,489 12,591 3,757 6,811 4,545 Series A preferred stock and accreted dividends 14,545 13,710 14,329 13,507 12,731 Accumulated deficit (199,423 ) (168,097 ) (194,509 ) (159,803 ) (99,965 ) (84,083 ) (73,422 ) Total stockholders (deficit) equity (9,088 ) 11,891 (3,953 ) 20,398 63,263 14,881 11,034 Table of Contents the same period in 2002. However, during the first quarter of 2003, we received $1.4 million in non-refundable fees from Geron that were recorded as deferred revenue and are to be recognized upon the release of product to Geron, which we currently expect to occur by the end of June 2003. Generally, revenue fluctuations result from changes in the number of funded research projects as well as the timing and completion of contract milestones. Expenses Research and development. Research and development expenses decreased to $3.8 million for the three months ended March 31, 2003, from $6.7 million for the corresponding period in 2002. The decrease in research and development expenses is primarily due to the decrease in contract services utilized to support our clinical trials as well as a reduction in personnel costs. During the first quarter of 2002, we incurred $1.4 million, net of partner reimbursements, in third party contract manufacturing and distribution costs for ANGIOZYME and HEPTAZYME to support our clinical trials. Subsequently in 2002, the scale and scope of the ANGIOZYME trials were decreased and the HEPTAZYME trial was discontinued. During the first quarter of 2003, we incurred $112,000, net of partner reimbursements, for third party contract manufacturing and distribution costs. We have completed our Phase II study of ANGIOZYME and are currently concentrating on implementing our revised business plan based on the development of RNA interference-based therapeutics. Our revised business plan resulted in a reduction of personnel from a research and development staff of 114 as of March 31, 2002 to a research and development staff of 60 as of March 31, 2003. The reduction in personnel resulted in lower salary and benefit expenses of $1.7 million for the period ended March 31, 2003 compared to $2.7 million for the period ended March 31, 2002. We have incurred the following expenses, net of partner reimbursements, related to our major research and development projects for the periods indicated (in thousands): Quarter ended March 31, Total $ 2,123 $ 4,407 Table of Contents HEPTAZYME drug to support our clinical trials, compared to $3.3 million, net, we incurred in 2002. The third-party manufacturing costs incurred in 2001, as well as an increase in clinical trial activities, were also reasons that research and development expenses increased $35.0 million from the prior year ended December 31, 2000. Clinical and preclinical trial expenses increased $3.5 million to $5.8 million in 2001, compared to $2.2 million in 2000. Over the next year, we expect certain research and development expenses, including preclinical studies, clinical trials and manufacturing expenses, to decrease as we complete current phases of clinical development programs for ANGIOZYME and HERZYME. However, as we move forward in our RNA interference research and preclinical development, we expect expenses related to such research and development to increase. Our research and development expenses currently include costs of scientific personnel, supplies, equipment, outsourced clinical and other research activities, consultants, patent filing, depreciation, utilities, administrative expenses and an allocation of corporate costs. We cannot predict the scope or magnitude of future research and development expenses at this time for our product candidates in the early phases of research and development as it is not possible to determine the nature, timing and extent of clinical trials and studies, the FDA s requirements for a particular drug and the requirement and level of participation, if any, by potential partners. As potential products proceed through the development process, each step typically is more extensive, and therefore more expensive, than the previous step. Success in development therefore results, generally, in increasing expenditures. Furthermore, our business strategy involves licensing certain of our drug candidates to collaborative partners. Depending upon when such collaborative arrangements are executed, the costs incurred solely by us will be impacted. We have incurred the following expenses, net of partner reimbursements, related to our three major research and development projects (in thousands): December 31, Total $ 13,780 $ 48,324 $ 11,880 Table of Contents DIRECTORS AND OFFICERS Our directors, executive officers and key employees as of July 28, 2003 are as follows: Name Age Position Table of Contents Compensation of Executive Officers Summary Compensation Table The following table summarizes the compensation paid to or earned by our Chief Executive Officer and the other four most highly compensated executive officers whose annual compensation exceeded $100,000 in 2002, the Named Executive Officers. Summary Compensation Table Annual Compensation Long-term Compensation Name and Principal Position Year Salary($) Bonus($) Other Annual Comp.($) Shares Underlying Options Granted(#)* All Other Comp.($) (1) Howard W. Robin Chief Executive Officer and President (2) 2002 2001 $ 344,500 309,231 $ 155,025 124,313 $ 181,203 678,273 (3) (3) 62,834 64,167 Marvin Tancer (4) Chief Financial Officer and Vice President of Operations 2002 2001 $ 266,000 135,417 $ 79,800 59,500 $ 91,370 480,447 (5) (5) 32,916 32,500 $ 6,000 Nassim Usman, Ph.D. Chief Scientific Officer, Vice President of Research and Development 2002 2001 2000 $ 254,000 240,000 218,330 $ 76,200 50,907 38,200 $ 23,367 43,958 43,958 (6) (6) (6) 26,984 3,333 5,834 $ 5,500 5,249 5,238 Lawrence E. Bullock (7) Vice President of Administration and Finance 2002 2001 2000 $ 185,400 180,000 166,275 $ 10,000 11,340 29,925 $ 3,000 25,700 25,797 (7) (7) (7) 8,833 1,666 5,000 $ 5,098 5,249 5,238 Table of Contents to our executive officers with a view to acquiring and retaining qualified personnel and facilitating job performance. We consider such benefits to be ordinary and incidental business costs and expenses. We also did not include in the table the aggregate value of such benefits in the case of the executive officers, which cannot be precisely ascertained but which is the lesser of either (a) 10% of the salary and bonus paid to each such executive officer or to the group, respectively, or (b) $50,000 or $50,000 times the number of individuals in the group, as the case may be. Option Grants in 2002 The following table contains information about stock options granted to each of the Named Executive Officers in the Summary Compensation Table during 2002 under our Stock Option Plans. We completed a one-for-six reverse stock split of our common stock on April 16, 2003. All option amounts in the table below reflect the one-for-six common stock reverse split on a retroactive basis. All options granted in 2002 vest in increments of 25% each year over a four-year period and become exercisable on the first anniversary of the grant date. The exercise price of each option was equal to the fair market value of the common stock on the date of the option grant as determined by the Board of Directors. The options are granted for a term of ten years, subject to earlier termination if employment is terminated. In 2002, we granted options representing an aggregate of 307,491 shares of our common stock to employees and directors, including the Named Executive Officers. Individual Grants Number of Shares Underlying Options Granted(#) % of Total Options Granted to Employees in 2002 Exercise Price ($/Share) Expiration Date Potential Realizable Value at Annual Rate of Stock Price Appreciation for Option Term (1) 5%($) 10%($) Howard W. Robin 29,500 16,667 16,667 9.6% 5.4% 5.4% $4.68 4.62 1.86 06-04-12 08-22-12 12-18-12 86,825 48,426 19,496 220,032 122,721 49,407 62,834 20.4% 154,747 392,160 Marvin Tancer 14,583 12,500 5,833 4.7% 4.1% 1.9% 4.68 4.62 1.86 06-04-12 08-22-12 12-18-12 42,921 36,319 6,823 108,770 92,039 17,291 32,916 10.7% 86,063 218,100 Nassim Usman 8,651 12,500 5,833 2.8% 4.1% 1.9% 4.68 4.62 1.86 06-04-12 08-22-12 12-18-12 25,462 36,319 6,823 64,525 92,039 17,291 8,833 2.9% 24,488 62,059 Table of Contents Aggregated Option Exercises and Fiscal Year-End Option Values The following table contains information about the stock options exercised in 2002 and the number and value of stock options held by each Named Executive Officer as of December 31, 2002. All share and option amounts reflect a one-for-six reverse split of our common stock effected on April 16, 2003. A stock option is in-the-money if the closing market price of common stock exceeds the exercise price of the stock option. The value of in-the-money unexercised stock options set forth in the table represents the difference between the exercise price of these options and the closing sales price of our common stock on December 31, 2002, as reported by the Nasdaq National Market ($1.44 per share). Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values Name Shares Acquired On Exercise(#) Value Realized($) (1) Number of Securities Underlying Unexercised Options at December 31, 2002(#) Exercisable/ Unexercisable Value of Unexercised In-the-Money Options at December 31, 2002($) Exercisable/ Unexercisable Howard W. Robin 20,218/106,787 0/0 Marvin Tancer 8,126/57,289 0/0 Nassim Usman 333 $ 6,633 24,610/36,733 0/0 Lawrence E. Bullock 23,301/14,074 0/0 (1) Value realized is the difference between the exercise price and the closing market price of the common stock on the day of exercise. Options Granted in Connection with the Private Placement In connection with the private placement, the Board of Directors and the Compensation Committee considered and approved contingent option grants to a number of our executive officers, employees and consultants. The option grants were conditioned on (a) stockholder approval, which occurred on April 16, 2003, of the private placement and the increase in the number of shares reserved for issuance in the 2001 Stock Option Plan; and (b) consummation of the private placement, which closed on April 21, 2003. All of these options were granted on February 11, 2003, the date on which we entered into the stock purchase agreement. All of the options are outstanding and exercisable at $2.10 per share (after giving effect to the one-for-six reverse stock split). The following table sets forth information regarding these stock options: Name of Individual and Position Number of Securities Underlying Option(#)* Dollar Value($) (1) Howard W. Robin Chief Executive Officer and President 1,434,166 $0 Marvin Tancer Chief Financial Officer and Vice President of Operations 465,000 $0 Nassim Usman Chief Scientific Officer and Vice President of Research and Development 470,833 $0 Bharat M. Chowrira 250,000 $0 All current officers as a group (4 persons) 2,619,999 $0 All other employees as a group (not including consultants) 2,116,669 $0 Table of Contents SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT As of July 28, 2003, there were 28,379,811 shares of common stock outstanding held of record by approximately 228 stockholders. The following table summarizes information regarding the beneficial ownership of our outstanding securities as of July 28, 2003 (which includes shares that may be acquired on the exercise of stock options or warrants exercisable within sixty days of July 28, 2003), by: each of our directors, all individuals who have served as our chief executive officer during our last completed fiscal year ended December 31, 2002, our four most highly compensated executives other than the chief executive officer who were serving as executive officers as of December 31, 2002, all of our current directors and executive officers as a group, and each person or entity who is known by us to own beneficially more than 5% of our outstanding shares of common stock. Beneficial ownership is determined in accordance with rules of the SEC and includes shares over which the indicated beneficial owner exercises voting and/or investment power. Shares of common stock subject to options or warrants currently exercisable or exercisable within 60 days are deemed outstanding for computing the percentage ownership of the person holding the options but are not deemed outstanding for computing the percentage ownership of any other person. Except as otherwise indicated in the footnotes to this table and subject to community property laws where applicable, we believe that each stockholder identified in the table has sole voting and investment power with respect to all shares listed opposite their names except that the Sprout Group, Venrock Associates, and Oxford Bioscience Partners IV entered into a voting agreement to elect or to cause to be appointed each other s designees as directors and Compensation Committee members and Nominating and Governance Committee members, as applicable. Unless otherwise indicated, the following officers, directors and stockholders can be reached at our principal offices. Name and Address Number of Shares Beneficially Owned (1) Percentage of Shares Outstanding (2) Table of Contents Table of Contents CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Compensation Committee Interlocks The members of our Compensation Committee have no interlocking relationships as defined under SEC regulations. Certain Relationships and Related Transactions Executive Loans. We made interest-free loans to our executive officers. These loans were made prior to the adoption of the Sarbanes-Oxley Act that prohibits such loans being extended to executive officers after the adoption of the act. We have forgiven all or a portion of the outstanding principal amount of each loan under the terms of each officer s employment agreement and agreed to increase the amount forgiven to cover the amount of any taxes incurred by any officer as a result of the loan forgiveness. See Employment Agreements above. Name Loan Amount Balance as of July 28, 2003 Howard W. Robin $ 400,000 (1) $ 240,000 Marvin Tancer 200,000 (2) 120,000 Nassim Usman 135,000 (3) 24,000 Bharat M. Chowrira 110,000 (4) 80,000 Table of Contents INDEX TO FINANCIAL STATEMENTS Page Table of Contents SIRNA THERAPEUTICS, INC. (Formerly Ribozyme Pharmaceuticals, Inc.) CONDENSED BALANCE SHEET (Unaudited) March 31, 2003 Pro Forma Stockholders Equity as of March 31, 2003 ASSETS Current Assets Cash and cash equivalents $ 1,377,393 Securities available-for-sale 3,489,252 Accounts receivable 228,596 Account receivable-joint venture 71,379 Account receivable-related parties 85,518 Prepaid expenses and other 676,494 Total current assets 5,928,632 Property, plant and equipment, net 4,270,443 Notes receivable-related parties 552,000 Deferred patent costs, net 6,082,592 Other assets, net 735,208 Total assets $ 17,568,875 LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT) Current liabilities Accounts payable trade $ 679,868 Accrued expenses 2,083,575 Deferred revenues 2,107,425 Deferred revenues related parties 299,960 Current portion of long-term debt 491,251 Total current liabilities 5,662,079 Long-term debt 2,930,387 Convertible debt 3,520,000 Convertible, exchangeable preferred stock; Series A 12,015,000 Accreted preferred stock dividend 2,529,638 Stockholders equity (deficit) Convertible preferred stock; Series B 99 $ 0 Preferred stock issuable 1,126,718 0 Accreted preferred stock dividend 1,094,957 0 Common stock 33,809 281,653 Additional paid-in capital 188,077,912 249,431,480 Unrealized gain on securities available-for-sale 1,107 1,107 Accumulated deficit (199,422,831 ) (199,422,831 ) Total stockholders equity (deficit) (9,088,229 ) 50,291,409 Total liabilities and stockholders equity (deficit) $ 17,568,875 $ 61,768,875 Table of Contents SIRNA THERAPEUTICS, INC. (Formerly Ribozyme Pharmaceuticals, Inc.) CONDENSED STATEMENTS OF OPERATIONS (Unaudited) Three months ended March 31, Revenues: Collaborative agreements $ 384,789 $ 926,408 Collaborative agreements joint venture 2,283 425,812 Collaborative agreements related parties 102,717 226,416 Total revenues 489,789 1,578,636 Expenses: Research and development 3,776,762 6,740,615 General and administrative 1,389,439 1,482,609 Total expenses 5,166,201 8,223,224 Operating loss (4,676,412 ) (6,644,588 ) Other income (expense): Interest income 20,537 154,407 Interest expense (124,466 ) (336,788 ) Other (729 ) (671 ) Equity in loss of unconsolidated affiliate (132,683 ) (1,467,023 ) Total other expense (237,341 ) (1,650,075 ) Net loss (4,913,753 ) (8,294,663 ) Accretion of dividends on preferred stock 562,388 202,916 Net loss applicable to common stock $ (5,476,141 ) $ (8,497,579 ) Net loss per share (basic and diluted) (split adjusted, Note 2) $ (1.62 ) $ (2.55 ) Shares used in computing net loss per share (split adjusted, Note 2) 3,380,893 3,335,840 Total operating expenses 6,745,104 10,423,787 11,266,437 28,435,328 Other income (expense) Net investment income 77 471 Total other income (expense) 77 471 Table of Contents SIRNA THERAPEUTICS, INC. (Formerly Ribozyme Pharmaceuticals, Inc.) CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) Three months ended March 31, Operating Activities Net loss $ (4,913,753 ) $ (8,294,663 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 425,385 505,882 Equity in loss of unconsolidated affiliate 132,683 1,467,023 Compensation for forgiveness of notes receivable-related parties 155,000 95,000 Accrued interest included in convertible debt 60,000 322,099 Accrued interest LT financing 28,873 Loss on disposal of equipment 729 671 Changes in operating assets and liabilities: Accounts receivable 98,152 (209,919 ) Prepaid expenses and other current assets 64,258 72,316 Accounts payable-trade (263,223 ) 498,505 Accrued expenses (232,996 ) (302,029 ) Deferred revenue 1,213,673 651,042 Deferred revenue-related parties (100,040 ) (99,999 ) Net cash used in operating activities (3,331,259 ) (5,294,072 ) Investing Activities Additions to property, plant and equipment (119,256 ) (688,368 ) Additions to deferred patent costs (249,351 ) (152,581 ) Net sales of securities available-for-sale 3,260,731 11,485,791 Investment in unconsolidated affiliate (132,683 ) (11,547 ) Loan repayments-related parties 150,000 Loan advances-related parties (200,000 ) RNA INTERFERENCE $ 1,625 $ ANGIOZYME 300 1,050 HEPTAZYME 85 2,793 HERZYME. 113 Net cash provided by investing activities 2,759,441 10,583,295 Financing Activities Net proceeds from issuance of common and preferred stock 1,327 Payments under loan facilities (115,729 ) (40,820 ) Net cash used in financing activities (115,729 ) (39,493 ) Net (decrease) increase in cash and cash equivalents (687,547 ) 5,249,730 Cash and cash equivalents at beginning of period 2,064,940 23,497,986 Cash and cash equivalents at end of period $ 1,377,393 $ 28,747,716 (unaudited) Statement of Operations Data: Revenues Collaborative agreements $ 385 $ 926 $ 3,488 $ 3,318 $ 8,302 $ 5,797 $ 8,963 Collaborative agreements joint venture 2 426 1,069 3,960 6,052 Collaborative agreements related parties 103 227 Net loss $ (77 ) Note 4: Accounting for stock-based compensation Statement of Financial Accounting Standards ( SFAS ) No. 123, Accounting for Stock-Based Compensation defined a fair value method of accounting for stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. As provided for in SFAS No. 123, the Company has elected to apply Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans. The following is a reconciliation of net income (loss) per weighted average share had the Company s adopted the fair value measurement provisions of SFAS No. 123. For the Three Months Ended March 31, 2003 March 31, 2002 Net loss as reported $ (4,913,753 ) $ (8,294,663 ) Add: Stock-based employee compensation expense included in reported income Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards (711,125 ) (1,056,171 ) Pro forma net loss $ (5,624,878 ) $ (9,350,834 ) Table of Contents RIBOZYME PHARMACEUTICALS, INC. BALANCE SHEETS December 31 Current assets: Cash and cash equivalents $ 2,064,940 $ 23,497,986 Securities available-for-sale 6,756,038 11,497,084 Accounts receivable 263,714 711,470 Accounts receivable joint venture 157,370 491,194 Accounts receivable related parties 62,561 340,533 Notes receivable related parties 214,000 324,000 Prepaid expenses and other 541,752 173,466 Total current assets 10,060,375 37,035,733 Property, plant, and equipment: Machinery and equipment 10,426,092 9,368,007 Leasehold improvements 5,227,380 4,799,381 Office furniture and equipment 2,019,564 2,001,064 17,673,036 16,168,452 Accumulated depreciation (13,149,227 ) (11,580,139 ) 4,523,809 4,588,313 Notes receivable related parties 692,000 541,000 Deferred patent costs, net of accumulated amortization (2002 $993,058; 2001 $772,157) 5,886,733 5,544,614 Investment in joint venture 3,577,340 Other assets. 735,208 736,208 Total assets $ 21,898,125 $ 52,023,208 LIABILITIES AND STOCKHOLDERS (DEFICIT) EQUITY Current liabilities: Accounts payable trade $ 943,091 $ 2,100,144 Accrued wages 1,136,610 810,922 Accrued liabilities 1,179,961 1,647,253 Deferred revenue, current portion related parties 400,000 400,000 Deferred revenue, current portion 893,752 Current portion of long-term debt 479,782 169,117 Total current liabilities 5,033,196 5,127,436 Deferred revenue, long-term portion related parties 400,010 Long term debt 3,028,712 474,018 Convertible debt joint venture 8,896,658 Convertible debt related parties 3,460,000 3,220,000 Commitments and contingencies Preferred stock, $.01 par value; Series A convertible exchangeable preferred stock, 25,000 shares authorized; 12,015 shares issued and outstanding at December 31, 2002 and 2001, respectively (preference in liquidation, including accreted dividends, of $14,329,366 and $13,506,802, in 2002 and 2001, respectively) 12,015,000 12,015,000 Accreted preferred stock dividends 2,314,366 1,491,802 Stockholders (deficit) equity: Preferred stock, $.01 par value; 5,000,000 shares authorized; Series B convertible preferred stock, 9,905 and zero shares issued and outstanding at December 31, 2002 and 2001, respectively (preference in liquidation of $11,032,670 and zero, in 2002 and 2001, respectively) 99 Preferred stock issuable 1,126,718 Accreted preferred stock dividends 747,841 Common stock, $.01 par value; 60,000,000 shares authorized; 3,380,894 and 3,335,436 shares issued and outstanding at December 31, 2002 and 2001, respectively 33,809 33,354 Additional paid-in capital 188,640,300 180,156,427 Accumulated deficit (194,509,078 ) (159,802,790 ) Unrealized gain on securities available-for-sale 7,162 11,293 Total stockholders (deficit) equity (3,953,149 ) 20,398,284 Total liabilities and stockholders (deficit) equity $ 21,898,125 $ 52,023,208 Table of Contents RIBOZYME PHARMACEUTICALS, INC. STATEMENTS OF OPERATIONS Year ended December 31 Revenues: Collaborative agreements $ 3,488,088 $ 3,318,246 $ 8,301,545 Collaborative agreements joint venture 1,069,295 3,959,411 6,052,429 Collaborative agreements related parties 590,323 1,030,226 1,191,338 Total revenues 5,147,706 8,307,883 15,545,312 Expenses: Research and development 28,659,341 56,688,960 21,721,055 General and administrative 5,505,035 4,512,197 3,723,158 Total expenses 34,164,376 61,201,157 25,444,213 Operating loss (29,016,670 ) (52,893,274 ) (9,898,901 ) Other income (expense): Interest income. 389,155 2,164,638 3,195,989 Interest expense (802,631 ) (819,576 ) (150,840 ) Other income 69 50,950 4,000 Equity in loss of unconsolidated affiliates (5,276,211 ) (8,340,899 ) (9,031,805 ) Total other expense (5,689,618 ) (6,944,887 ) (5,982,656 ) Net loss (34,706,288 ) (59,838,161 ) (15,881,557 ) Accretion of dividends on preferred stock 1,570,407 775,346 716,456 Net loss (4,914 ) (8,295 ) (34,706 ) (59,838 ) (15,882 ) Accretion of dividends on preferred stock 562 203 1,571 775 Net loss (4,914 ) (8,295 ) (34,706 ) (59,838 ) (15,882 ) (10,661 ) (10,918 ) Accretion of dividends on preferred stock 562 203 1,571 775 Net loss applicable to common stock $ (36,276,695 ) $ (60,613,507 ) $ (16,598,013 ) Table of Contents RIBOZYME PHARMACEUTICALS, INC. STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS (DEFICIT) EQUITY Convertible Exchangeable Preferred Stock Preferred Stock Common Stock Additional Paid-In Capital Accumulated Deficit (Loss)/ Gain on Securities Deferred Compensation Total Shares Amount Dividends Shares Amount Amount Dividends Shares Amount Balance at December 31, 1999. $ $ 5 $ $ $ 1,877,209 $ 18,772 $ 98,987,961 $ (84,083,072 ) $ (2,399 ) $ (40,618 ) $ 14,880,644 Issuance of common stock for cash public offering net of issuance costs of $3,886,887 525,000 5,250 52,867,903 52,873,153 Issuance of common stock for cash Elan Corporation, plc net of issuance costs of $38,547 106,838 1,068 4,959,441 4,960,509 Issuance of preferred stock for cash 12,015 12,015,000 Issuance of common stock for cash Eli Lilly 42,105 421 2,999,579 3,000,000 Conversion of convertible preferred stock for common shares (5 ) 106,107 1,061 (1,061 ) Conversion of convertible debt for common shares 7,073 71 997,134 997,205 Issuance of common stock upon the exercise of warrants 3,375 34 (34 ) Issuance of common stock under stock option, employee stock purchase and 401(k) plans 42,540 425 1,396,486 1,396,911 Expense for vesting of performance stock options 1,732,198 1,732,198 Compensation for issuance of common stock options (2,749 ) 26,142 23,393 Preferred stock dividends accreted 716,456 (716,456 ) (716,456 ) Net loss (15,881,557 ) (15,881,557 ) Change in unrealized loss on securities (3,025 ) (3,025 ) Comprehensive loss (15,884,582 ) Table of Contents RIBOZYME PHARMACEUTICALS, INC. STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS (DEFICIT) EQUITY (Continued) Convertible Exchangeable Preferred Stock Preferred Stock Common Stock Additional Paid-In Capital Accumulated Deficit (Loss)/ Gain on Securities Deferred Compensation Total Shares Amount Dividends Shares Amount Amount Dividends Shares Amount Issuance of common stock under stock option and employee stock purchase plan 21,394 214 447,686 447,900 Issuance of common stock under 401(k) plan 11,907 119 289,399 289,518 Issuance of warrants in exchange for professional services 197,914 197,914 Compensation for issuance of common stock options 14,476 14,476 Preferred stock dividends accreted 775,346 (775,346 ) (775,346 ) Net loss (59,838,161 ) (59,838,161 ) Change in unrealized gain on securities 16,717 16,717 Comprehensive loss (59,821,444 ) Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) The joint venture agreement provides for equal representation by the Company and Elan in the operating and management decisions of Medizyme. Due to the significant minority investor rights retained by Elan Corporation, and its subsidiaries, the Company accounts for its investment in Medizyme under the equity method of accounting. Separate financial statements for Medizyme are included in this Form 10-K. The following table presents unaudited summary financial information for Medizyme as of December 31, 2002. Balance Sheet: Assets Cash and cash equivalents $ Total Assets $ Total liabilities and stockholders (deficit) equity $ Total current assets $ Total assets $ Total Liabilities and Stockholders (Deficit) Equity $ Net cash provided by financing activities 2,120,938 6,922,215 19,232,647 28,275,800 Net (decrease) increase in cash and cash equivalents (300 ) (9,321 ) 10,449 Cash & cash equivalents at end of period $ 828 $ 1,128 $ 10,449 $ Balance at December 31, 2001 12,015 12,015,000 1,491,802 3,335,436 33,354 180,156,427 (159,802,790 ) 11,293 20,398,284 Issuance of common stock under stock option and employee stock purchase plan 45,458 455 123,590 124,045 Conversion of convertible debt to preferred stock, Series B Elan 9,905 99 9,905,853 9,905,952 Preferred stock issuable to Elan for financing 1,126,718 1,126,718 Compensation for issuance of stock options 24,835 24,835 Preferred stock dividends accreted 822,564 747,841 (1,570,405 ) (822,564 ) Net loss (34,706,288 ) (34,706,288 ) Change in unrealized gain on securities (4,131 ) (4,131 ) Comprehensive loss (34,710,419 ) Balance at December 31, 2002 12,015 $ 12,015,000 $ 2,314,366 9,905 $ 99 $ 1,126,718 $ 747,841 3,380,894 $ 33,809 $ 188,640,300 $ (194,509,078 ) $ 7,162 $ $ (3,953,149 ) Table of Contents RIBOZYME PHARMACEUTICALS, INC. STATEMENT OF CASH FLOWS Year ended December 31 Operating activities Net loss $ (34,706,288 ) $ (59,838,161 ) $ (15,881,557 ) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation 1,696,999 1,756,186 1,626,197 Amortization 276,555 197,869 194,730 Equity in loss of unconsolidated affiliates 5,276,211 8,340,899 9,031,805 Financed third party manufacturing cost 3,573,491 Write-off of deferred patent costs 684,389 Compensation related to common stock and options 24,835 303,994 1,975,189 Compensation for forgiveness of notes receivable related parties 189,000 201,187 136,466 Stock issued in exchange for product rights 275,000 Expense related to issuance of stock and warrants 197,914 Revenue recognized for stock received in licensing agreement (205,443 ) Loss (gain) on disposal of equipment 6,285 (50,950 ) Accrued interest included in convertible debt related parties 688,687 819,576 141,864 Recognition of deferred revenue related parties (400,010 ) (399,996 ) (399,995 ) Changes in operating assets and liabilities: Accounts receivable 1,059,552 2,052,686 (1,565,990 ) Prepaid expenses and other (368,286 ) 2,720 (58,518 ) Other assets 1,000 5,345 (79,519 ) Accounts payable trade (1,157,053 ) 1,014,947 110,888 Accrued wages and liabilities (141,604 ) 597,362 1,234,660 Deferred revenue 893,752 Net cash used by operating activities (22,402,485 ) (44,728,865 ) (3,533,780 ) Investing activities Additions to property, plant, and equipment (1,638,780 ) (2,822,972 ) (1,388,657 ) Proceeds from the disposition of property, plant and equipment 95,788 Additions to deferred patent costs (1,303,063 ) (884,445 ) (821,461 ) Net sales (purchases) of securities available-for-sale 4,736,915 20,823,794 (28,056,928 ) Initial investment in unconsolidated affiliate (12,015,000 ) Additional investment in joint venture (1,698,871 ) (5,544,694 ) (3,390,350 ) Loan repayments related parties 220,000 988,148 Loan advances related parties (450,000 ) (1,738,148 ) Net cash provided (used) by investing activities (133,799 ) 10,917,471 (45,672,396 ) Financing activities Net proceeds from issuance of common and preferred stock and exercised warrants 124,045 16,955,191 74,025,976 Payments under loan facilities (1,898,045 ) (7,100,455 ) Draw down on line of credit with Elan 1,687,325 5,540,537 2,701,351 Borrowings under loan facilities 1,189,913 2,643,134 2,000,000 Net cash provided by financing activities 1,103,238 25,138,862 71,626,872 Net (decrease) increase in cash and cash equivalents (21,433,046 ) (8,672,532 ) 22,420,696 Cash and cash equivalents at beginning of year 23,497,986 32,170,518 9,749,822 Cash and cash equivalents at end of year $ 2,064,940 $ 23,497,986 $ 32,170,518 Table of Contents F-15 RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS December 31, 2002 1. Summary of Significant Accounting Policies Description of Business Ribozyme Pharmaceuticals, Inc. (RPI or the Company) was founded in 1992 to capitalize on the broad potential of ribozymes for use in the development of human therapeutics and therapeutic target validation services. To date, the Company has engaged in the research and development of its ribozyme technology and has experienced significant operating losses in each fiscal year since inception. The Company has not generated any revenue from the commercialization of its ribozyme technology and it expects to continue to incur significant operating losses over at least the next several years. Capital Requirements, Management s Plans and Basis of Presentation The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business. The Company incurred a net loss of $34,706,288 for the year ended December 31, 2002 and has an accumulated deficit of $194,509,078 at December 31, 2002. The Company incurred significant costs during 2001 due to the scale up of clinical trials and the cost of manufacturing drugs. Development of the Company s products will require a commitment of substantial additional funds to conduct the costly and time-consuming research, preclinical and clinical testing necessary to bring its proposed products to market and to establish manufacturing and marketing capabilities. The Company s future capital requirements will depend on many factors, including, among others, the progress of the Company s research, development and drug discovery efforts, the ability of the Company to establish collaborative arrangements for clinical testing, progress with preclinical studies and clinical trials, the time and costs involved in obtaining regulatory approvals, the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims, competing technological and market developments, changes in the Company s existing research relationships, determination as to the commercial potential of the Company s potential products, effective commercialization activities and arrangements, and the cost and availability of third-party financing for capital expenditures. On February 11, 2003, the Company entered into a definitive common stock and warrant purchase agreement (SPA) with certain investors pursuant to which the Company has agreed to issue and sell to the investors the Company s common stock and five-year warrants to purchase common stock for aggregate consideration of $48 million. Consummation of the transaction is subject to a number of conditions, including, but not limited to, the approval of the Company s stockholders; appointment to the Board of the four investor designees; adoption of an amended and restated certificate of incorporation in order to effect a reverse stock split, change the Company s name, increase the number of authorized shares and adopt a provision permitting shareholder action to be taken by written consent in lieu of a meeting; there not having occurred any material adverse change prior to closing; and amendment of the Company s bylaws, see Note 13. Management intends to address the future requirements of the Company through corporate partnerships, potential equity and debt financing and management of resources as required. If the SPA is not approved by stockholders, or is not executed for any other reason, the Company would likely be forced to cease operations. Management believes that subject to the execution of the SPA, its financial resources will be sufficient to allow the Company to sustain its operations into 2005. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and Net loss as reported $ (34,706,288 ) $ (59,838,161 ) $ (15,881,557 ) Add: Stock-based employee compensation expense included in reported income 14,476 1,755,591 Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards (2,908,094 ) (4,286,507 ) (3,573,469 ) Pro forma net loss $ (37,614,382 ) $ (64,110,192 ) $ (17,699,435 ) 26,984 8.8% 68,604 173,855 Lawrence E. Bullock 7,167 833 833 2.3% 0.3% 0.3% 4.68 4.62 1.86 06-04-12 08-22-12 12-18-12 21,094 2,420 ANGIOZYME $ 5,194 $ 13,844 $ 5,852 HEPTAZYME 7,153 30,396 Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) method of accounting for stock based compensation. Further, the statement requires disclosure of comparable information for all companies regardless of whether, when, or how an entity adopts the preferable, fair value based method of accounting. These disclosures are now required for interim periods in addition to the traditional annual disclosure. SFAS is effective for fiscal periods ending after December 15, 2002. The disclosure requirements have been met. 2. Securities Available-for-Sale At December 31, 2002 and 2001 management determined that certain marketable securities held by the Company were available-for-sale. Securities available-for-sale are carried at fair value, with unrealized gains and losses reported as a component of stockholders equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income or expense, as appropriate. Realized gains and losses and declines in value judged to be other-than-temporary on securities available-for-sale are included in investment income. Interest and dividends on securities available-for-sale are included in investment income. The cost of securities sold is based on the specific identification method. The following is a summary of securities available-for-sale: Amortized Cost Basis Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value Equipment loan (I) $ 1,535,003 $ 643,135 Convertible debt related parties (II) 3,460,000 3,220,000 Convertible debt joint venture (III) 8,896,658 Note payable (IV) 1,973,491 6,968,494 12,759,793 Current portion (479,782 ) (169,117 ) Long-term debt $ 6,488,712 $ 12,590,676 Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) annum and under certain circumstances are convertible into equity, at the then current market price, at the option of the corporate partner. Principal and interest payments on the loans are deferred until their maturity which is in April 2004. In April 2000, the Company paid down $6.9 million of the outstanding debt with proceeds from a public offering. In June 2000, the corporate partner elected to convert the remaining balance of approximately $997,205 into 42,435 shares of the Company s common stock. Since the June 2000 conversion of the balance, the Company has drawn down the final $3.0 million on the debt facility, which as of December 31, 2002 remains outstanding. See Note 7 on Schering AG. III. In January 2000, the Company entered into a joint venture agreement with a corporate partner for the development and commercialization of a potential product to treat breast and other cancers. The development of the drug required funds of up to $15 million and therefore the corporate partner made available to the Company a convertible promissory note to fund up to $12,015,000 of development expenses through January 2006. The note carried an interest rate of 12% compounded on a semi-annual basis. Pursuant to the joint venture agreement, in June 2002 the note was converted into the Company s Series B Preferred Convertible Stock. See Note 7 on Elan Corporation. IV. In the fourth quarter of 2002 the Company purchased on credit $3.6 million of drug from a contract manufacturer. The terms of payment for the purchase were $1.6 million due paid October 30, 2002; $1.1 million to be paid on or before October 30, 2004; and $873,491 to be paid on or before June 30, 2005. The future payments will accrue interest at the rate of 6% compounded annually, calculated from January 1, 2003 until payment. The Company did not pay cash but accrued interest for the year ended December 31, 2001. Cash paid for interest for the years ended December 31, 2002, 2001 and 2000 was $110,890, $0 and $892,199, respectively. At December 31, 2002 the carrying amounts of the Company s long-term debt approximates the fair value as all borrowings bear interest rates which are comparable to the current market rate for such borrowings. As of December 31, 2002, maturities of long-term debt are as follows: Amount $ 6,968,494 $ 5,144,269 Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) individuals, as defined in the Plans. Options to purchase the Company s common stock are exercisable at a price as determined by the Board of Directors at the time the option is granted, which shall not be less than 100% of the fair market value (110% in the case of 10 percent shareholders) at the date of grant. Vesting rights are determined by the Board of Directors at the time the option is granted and generally past options became exercisable at twenty percent at the end of each of years one through five. However, in December 2000 the Board of Directors approved future vesting of grants at twenty-five percent at the end of each of years one through four. If not exercised, the options expire after ten years. The Board of Directors has also granted certain employees options that accelerate vesting upon achievement of certain contingent milestone events. Changes in stock options for the years ended December 31, 2002, 2001 and 2000 were as follows: Options Exercise Price Outstanding at December 31, 1999 288,740 $ 2.70 $ 76.68 Options granted 103,252 $54.78 $352.50 Options exercised/cancelled (46,006 ) $ 2.70 $352.50 Outstanding at December 31, 2000 345,986 $ 2.70 $187.50 Options granted 172,467 $24.00 $ 63.00 Options exercised/cancelled (41,160 ) $ 2.70 $173.28 Outstanding at December 31, 2001 477,293 $ 2.70 $187.50 Options granted 318,168 $ 1.62 $ 29.82 Options exercised/cancelled (167,602 ) $ 2.70 $186.00 Outstanding at December 31, 2002 627,859 $ 1.62 $187.50 The weighted average exercise price of options outstanding at December 31, 2002, 2001 and 2000 was $27.28, $50.64 and $52.98, respectively. Stock options vest as follows: Options Total 627,859 Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) The following table summarizes information concerning outstanding and exercisable options as of December 31, 2002: Options Outstanding Options Exercisable Range of Exercise Prices Number Outstanding Weighted Average Remaining Contractual Life Weighted Average Exercise Price Number Exercisable Weighted Average Exercise Price $ 1.62 $ 4.62 140,008 9.72 $ 3.45 24 $ 2.07 $ 4.68 $ 6.72 131,854 9.37 $ 5.11 2,218 $ 6.27 $ 7.02 $ 18.00 90,649 6.20 $ 15.87 65,954 $ 17.69 $ 18.06 $ 33.78 94,121 7.60 $ 28.04 46,766 $ 30.38 $ 34.50 $ 63.00 121,023 7.88 $ 53.54 53,454 $ 52.58 $ 65.28 $120.12 33,120 7.62 $ 83.85 20,491 $ 83.46 $148.14 $187.50 17,084 7.63 $154.45 9,269 $154.81 $ 1.62 $187.50 627,859 8.30 $ 27.28 198,176 $ 43.18 Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) Plan imposes a significant penalty upon any person or group that acquires 15 percent or more of the Company s outstanding common stock without the approval of the RPI Board. Under the Rights Plan, a dividend of one Preferred Stock Purchase Right was declared for each common share held of record as of the close of business on December 8, 2000. The rights generally will not become exercisable unless an acquiring entity accumulates or initiates a tender offer to purchase 15 percent or more of the Company s common stock. In that event, each right will entitle the holder, other than the unapproved acquirer and its affiliates, to purchase either the Company s common stock or shares in an acquiring entity at one-half of market value. The rights expire on December 8, 2010. Common Stock Reserved. Below is a summary of common stock reserved by the Company at December 31, 2002 for issuance upon the exercise of the various options, warrants, the 401(k) plan and Purchase Plan. Shares 1,192,189 Liabilities and Stockholders (Deficit) Equity Accounts payable and accrued liabilities to joint venture owners $ 159,808 Total current liabilities 159,808 Convertible preferred stock, $1.00 par value; 6,000 shares authorized, 6,000 shares issued and outstanding at December 31, 2002 6,000 Common stock, $1.00 par value; 6,000 shares authorized, 6,000 shares issued and outstanding at December 31, 2002 6,000 Contributed surplus 28,263,800 Deficit accumulated during the development stage (28,434,780 ) Results of Operations: License fee amortization $ 5,000,000 Research and development 1,729,069 General and administrative 16,035 Total operating expenses 6,745,104 Net loss $ (6,745,104 ) Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) 9. Related Party Transactions At December 31, 2002, 2001 and 2000, the Company had a total of $906,000, $865,000 and $316,187, respectively, of non-interest bearing loans due from executive officers. The balances may be forgiven by the Company under certain employment agreement provisions. The loan balances are forgivable or payable to the Company under various terms not to exceed 5 years. The Company forgave $189,000, $201,187 and $136,466, of these loans during each of the years ending December 31, 2002, 2001 and 2000, respectively. In 1998, the Company gave to its officers and certain other employees stock in the newly formed atugen at no personal cost to the individuals, but which was expensed by the Company. As of December 31, 2002, these officers and other employees still retain an equity interest in atugen. In addition, and related to the Archemix licensing agreement, an executive served on the Archemix Board of Directors during 2002, and accordingly, received compensation in cash and stock options. As of December 31, 2002, the executive no longer serves on the Archemix Board of Directors. In August 2002, the Company reached an agreement with Jeremy Curnock Cook, the Company s Chairman of the Board, whereby the Company utilized his consulting firm, Bioscience Management, plc, for strategic planning. During 2002, the Company paid $85,000 and $39,884 to Bioscience Management and Mr. Cook, respectively, in fees for consulting services provided. 10. Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes (SFAS 109). Under the provisions of SFAS 109, a deferred tax liability or asset (net of a valuation allowance) is provided in the financial statements by applying the provisions of applicable tax laws to measure the deferred tax consequences of temporary differences that will result in net taxable or deductible amounts in future years as a result of events recognized in the financial statements in the current or preceding years. At December 31, 2002, the Company has the following net operating loss and tax credit carryforwards for income tax purposes: Expiration Date Net Operating Losses Research and Development Credits State Investment Credits Total $ 169,176,000 $ 4,549,000 $ Deferred tax assets: Net operating loss carryforwards $ 63,054,000 $ 52,403,000 Research and development and state investment credit carryforwards 4,548,000 5,677,000 Depreciation 1,081,000 967,000 Equity in loss of unconsolidated affiliate 8,769,000 6,807,000 Deferred income 483,000 298,000 Other (1,000 ) 53,000 77,934,000 66,205,000 Valuation allowance (76,169,000 ) (64,443,000 ) Net deferred tax assets 1,765,000 1,762,000 Deferred tax liabilities: Deferred patent costs 1,678,000 1,632,000 Deferred income Other 87,000 130,000 Total deferred tax liabilities 1,765,000 1,762,000 $ $ Expected benefit from federal income taxes at statutory rate of 34% $ (11,800,138 ) $ (20,319,164 ) $ (5,399,729 ) Permanent differences 19,514 30,617 21,953 State taxes, net of federal benefit (1,067,948 ) (1,839,216 ) (487,517 ) Other 6,426 1,064,237 421,723 Valuation allowance 12,842,146 21,063,526 5,443,570 Effective income tax rate $ $ $ Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) $237,880, $289,518 and $219,598 for years ended 2002, 2001 and 2000, respectively. The Company stock match is subject to vesting restrictions. 12. Quarterly Results (Unaudited) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 2002 Total revenues $ 1,578,636 $ 1,622,253 $ 1,307,689 $ 639,128 Total expenses 8,223,224 9,175,992 6,733,627 10,031,533 Other expense 1,650,075 1,703,601 1,386,889 949,053 Accretion of dividends 202,916 300,856 520,498 546,137 Net loss (8,497,579 ) (9,558,196 ) (7,333,325 ) (10,887,595 ) Basic and diluted net loss per share $ (2.55 ) $ (2.85 ) $ (2.18 ) $ (3.23 ) 2001 Total revenues $ 2,117,262 $ 2,390,431 $ 2,029,181 $ 1,771,009 Total expenses 12,159,553 11,085,040 17,693,655 20,262,909 Other expense 1,870,069 1,652,032 1,720,299 1,702,486 Accretion of dividends 191,267 190,677 197,005 196,397 Net loss (12,103,627 ) (10,537,318 ) (17,581,778 ) (20,390,783 ) Table of Contents MEDIZYME PHARMACEUTICALS, LTD. (A Development Stage Company) (Incorporated in Bermuda) BALANCE SHEET (expressed in United States dollars) December 31, License fee 5,000,000 10,000,000 LIABILITIES AND STOCKHOLDERS (DEFICIT) EQUITY Current Liabilities Accounts payable and accrued liabilities to joint venture owners $ 159,808 $ 535,942 $ 2,044,015 Total current liabilities $ 159,808 $ 535,942 $ 2,044,015 Stockholders (deficit) equity Preferred stock, $1.00 par value; 6,000 non-voting shares authorized; 6,000 issued and outstanding 6,000 6,000 6,000 Common stock, $1.00 par value; 6,000 voting shares authorized; 6,000 issued and outstanding 6,000 6,000 6,000 Contributed surplus 28,263,800 26,142,862 19,220,647 Deficit accumulated during the development stage (28,434,780 ) (21,689,676 ) (11,265,966 ) Total stockholders (deficit) equity (158,980 ) 4,465,186 7,966,681 Table of Contents MEDIZYME PHARMACEUTICALS, LTD. (A Development Stage Company) (Incorporated in Bermuda) STATEMENT OF OPERATIONS (expressed in United States dollars) Year ended December 31, 2002 Year ended December 31, 2001 Year ended December 31, 2000 (Unaudited) (Unaudited) (Unaudited) Expenses License fee amortization $ 5,000,000 $ 5,000,000 $ 5,000,000 $ 5,000,000 Research and development 1,729,069 5,408,952 6,242,801 13,380,822 General and administrative 16,035 14,835 23,636 54,506 Net loss $ (6,745,104 ) $ (10,423,710 ) $ (11,265,966 ) $ (28,434,780 ) Table of Contents MEDIZYME PHARMACEUTICALS, LTD. (A Development Stage Company) (Incorporated in Bermuda) STATEMENT OF STOCKHOLDERS (DEFICIT) EQUITY Period from inception (December 21, 1999) to December 31, 2001 (expressed in United States dollars) Preferred Stock Common Stock Contributed Surplus Deficit Accumulated During the Development Stage Total Stockholders (Deficit) Equity Shares Amount Shares Amount Issuance of common shares on January 7, 2000 6,000 $ 6,000 $ 7,494,000 $ 7,500,000 Issuance of preferred shares on January 7, 2000 6,000 $ 6,000 7,494,000 7,500,000 Contributed surplus 4,232,647 4,232,647 Comprehensive and net loss $ (11,265,966 ) (11,265,966 ) Balances at December 31, 2000 6,000 6,000 6,000 6,000 19,220,647 (11,265,966 ) 7,966,681 Contributed surplus (unaudited) 6,922,215 6,922,215 Comprehensive and net loss (unaudited) (10,423,710 ) (10,423,710 ) Balances at December 31, 2001 (unaudited) 6,000 6,000 6,000 6,000 26,142,862 (21,689,676 ) 4,465,186 Contributed surplus (unaudited) 2,120,938 2,120,938 Comprehensive and net loss (unaudited) (6,745,104 ) (6,745,104 ) Balances at December 31, 2002 (unaudited) 6,000 $ 6,000 6,000 $ 6,000 $ 28,263,800 $ (28,434,780 ) $ (158,980 ) Table of Contents MEDIZYME PHARMACEUTICALS, LTD. (A Development Stage Company) (Incorporated in Bermuda) STATEMENT OF CASH FLOWS (expressed in United States dollars) Year ended December 31, 2002 Year ended December 31, 2001 Year ended December 31, 2000 Period from Inception (December 21, 1999) to December 31, 2002 (Unaudited) (Unaudited) (Unaudited) Operating Activities Net Loss $ (6,745,104 ) $ (10,423,710 ) $ (11,265,966 ) $ (28,434,780 ) Amortization of license fee 5,000,000 5,000,000 5,000,000 15,000,000 Adjustment to reconcile net loss to net cash used in operating activities: Interest receivable 247 (247 ) Accounts payable and accrued liabilities to joint venture owners (376,134 ) (1,508,073 ) 2,044,015 159,808 Net cash used in operating activities (2,121,238 ) (6,931,536 ) (4,222,198 ) (13,274,972 ) Investing Activities Purchase of license (15,000,000 ) (15,000,000 ) Net cash used in investing activities (15,000,000 ) (15,000,000 ) Finance Activities Proceeds from issuance of common shares 7,500,000 7,500,000 Proceeds from issuance of preferred shares 7,500,000 7,500,000 Increase in contributed capital 2,120,938 6,922,215 4,232,647 13,275,800 Table of Contents SIRNA THERAPEUTICS, INC. 2,525,252 Shares of Common Stock PROSPECTUS [ ], 2003 Table of Contents PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses Of Issuance And Distribution. The following table sets forth all expenses payable by Company in connection with the issuance and distribution of our securities being registered hereby. All amounts are estimated except the SEC registration fee: Expenses Amount SEC registration fee $ 404.50 Printing and mailing expenses 50,000.00 Legal fees and expenses 150,000.00 Accounting fees and expenses 20,000.00 Transfer agent fees 20,000.00 Miscellaneous expenses 9,595.50 TOTAL $ 250,000.00 Item 14. Indemnification Of Officers And Directors. Article VI of our Bylaws provides for indemnification of our directors to the fullest extent permitted by law, as now in effect or later amended. In addition, the Bylaws provide for indemnification against expenses incurred by a director, officer or other person entitled to indemnification to be paid by us from time to time in advance of the final disposition of such action, suit or proceeding and if required by the Delaware General Corporation Law upon receipt of an undertaking by or on behalf of the director, officer or other person to repay such amount if it shall be ultimately determined that he is not entitled to be indemnified by us. The Bylaws further provide for a contractual cause of action on the part of our directors for indemnification claims that have not been paid by us. Article VII of our Amended and Restated Certificate of Incorporation, as amended, limits under certain circumstances the liability of our directors for a breach of their fiduciary duty as directors. These provisions do not eliminate the liability of a director (1) for a breach of the director s duty of loyalty to us or our stockholders, (2) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (3) under Section 174 of the Delaware General Corporation Law ( DGCL ) (relating to the declaration of dividends and purchase or redemption of shares in violation of the DGCL) or (4) for any transaction from which the director derived an improper personal benefit. Section 145 of the DGCL contains provisions regarding indemnification, among others, of officers and directors. Section 145 of the DGCL provides in relevant part: (a) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person s conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, II-1 Table of Contents conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that the person s conduct was unlawful. (b) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. (c) To the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this section, or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys fees) actually and reasonably incurred by such person in connection therewith. (d) Any indemnification under subsections (a) and (b) of this section (unless ordered by a court) shall be made by the corporation only as authorized in the specific case upon a determination that indemnification of the present or former director, officer, employee or agent is proper in the circumstances because the person has met the applicable standard of conduct set forth in subsections (a) and (b) of this section. Such determination shall be made, with respect to a person who is a director or officer at the time of such determination, (1) by a majority vote of the directors who are not parties to such action, suit or proceeding, even though less than a quorum, or (2) by a committee of such directors designated by majority vote of such directors, even though less than a quorum, or (3) if there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion, or (4) by the stockholders. Delaware law also permits a corporation to purchase and maintain insurance on behalf of any person who is or was a director or officer against any liability asserted against him and incurred by him in such capacity or arising out of his status as such, whether or not the corporation has the power to indemnify him against that liability under Section 145 of the DGCL. We also have provided liability insurance for each director and officer for losses arising from claims or charges made against them while acting in their capacities as our directors or officers. The above discussion of our corporate documents is not intended to be exhaustive and is respectively qualified in its entirety by our corporate documents. II-2 Table of Contents Item 15. Recent Sales of Unregistered Securities The following is a summary of our sales of our securities during the past three years involving sales of our securities that were not registered under the Securities Act of 1933, as amended: In December 2001, Elan International Services, Ltd. purchased warrants to purchase 12,500 shares of our common stock at a purchase price per share of $30.00. The warrants expire on December 31, 2006. In April 2003, Sprout IX Plan Investors, L.P., Sprout Entrepreneurs Fund, L.P., Sprout Capital IX, L.P., DLJ Capital Corporation, Dr. James Niedel, Venrock Associates, Venrock Associates III, L.P., Venrock Entrepreneurs Fund III, L.P., Granite Global Ventures (Q.P.) L.P., Granite Global Ventures L.P., Oxford Bioscience Partners IV L.P., mRNA Fund II, L.P., and TVM V Life Science Ventures GmbH & Co. KG purchased an aggregate of 24,242,425 shares of our common stock at a price of $1.98 per share and warrants to purchase 5,015,152 shares of our common stock at an exercise price of $2.52 per share. The warrants expire in December 2008. The total aggregate offering price was $48,000,000. The above described issuances were exempt from registration (i) pursuant to Section 4(2) of the Securities Act or Regulation D or Rule 144 promulgated thereunder, as transactions not involving a public offering or (ii) Rule 701 promulgated under the Securities Act or (iii) as transactions not involving a sale of securities. With respect to the each transaction listed above, no general solicitation was made by either the Registrant or any person acting on its behalf; the securities sold are subject to transfer restrictions, and the certificates for the shares contained an appropriate legend stating such securities have not been registered under the Securities Act and my not be offered or sold absent registration or pursuant to an exemption therefrom. No underwriters were involved in connection with the sales of securities referred to in this Item 15. II-3 Table of Contents Item 16. Exhibits and Financial Statement Schedules. (a) Exhibits. Number Description 3.1 Amended and Restated Certificate of Incorporation of the registrant, dated July 17, 2003(25) 3.2 Bylaws of the registrant, as amended(24) 4.1 Specimen Stock Certificate(1) 4.2 Rights Agreement, dated November 22, 2000, between the registrant and American Stock Transfer & Trust Company(14) 4.3 Amendment, dated February 11, 2003, to Rights Agreement, dated November 22, 2000, between the registrant and American Stock Transfer & Trust Company(23) 5.1 Opinion of O Melveny & Myers LLP(25) 10.1 Form of Indemnity Agreement entered into between the registrant and its directors and officers, with related schedule(1) 10.2 Registrant s Incentive Stock Option Plan, including form of Incentive Stock Option Agreement(1) 10.3 Registrant s Non-Qualified Stock Option Plan, including form of Non-Qualified Stock Option Agreement(1) 10.4 Registrant s 1996 Stock Option Plan, including forms of Incentive Stock Option and Nonstatutory Stock Option Agreements(1) 10.5 Registrant s 1996 Employee Stock Purchase Plan(1) 10.6 Warrant Purchase Agreement, dated March 15, 1995, between the registrant and Hambrecht & Quist Guaranty Finance(1) 10.7 Warrant to Purchase Common Stock, dated March 15, 1995, issued to Hambrecht & Quist Guaranty Finance(1) 10.8 Warrant to Purchase Common Stock, dated February 22, 1993, issued to LINC Scientific Leasing(1) 10.9 Warrant to Purchase Common Stock, dated July 30, 1993, issued to Douglas E. Olson(1) 10.10 Warrant to Purchase Common Stock, dated July 30, 1993, issued to Richard J. Warburg and Ruth P. Warburg(1) 10.11 Warrant to Purchase Common Stock, dated December 28, 1994, issued to Competitive Technologies, Inc.(1) 10.12 Warrant to Purchase Common Stock, dated December 29, 1995, issued to Silicon Valley Bank(1) 10.13 Warrant to Purchase Common Stock, dated July 26, 1996, issued to Silicon Valley Bank(1) 10.14 Warrant to Purchase Common Stock, dated April 17, 1996, issued to Chiron Corporation(1) 10.15 Collaborative Research, Development and Commercialization Agreement, dated July 15, 1994, between the registrant and Chiron Corporation(1) 10.16 Financing Agreement, dated March 16, 1995, among Wilderness Place Holdings L.L.C., Hambrecht & Quist Guaranty Finance, L.P. and the registrant(1) 10.17 Lease for Real Property, dated May 20, 1992, between Aero-Tech Investments and the registrant(1) 10.18 Non-Disturbance and Attornment Agreement, dated March 31, 1995, among General American Life Insurance Company, Aero-Tech Investments, Wilderness Place Holdings L.L.C. and the registrant(1) 10.19 Master Lease Agreement, dated September 2, 1992, between the registrant and LINC Scientific Leasing(1) II-4 Table of Contents Number Description 10.20 Loan and Security Agreement, dated February 28, 1994, between the registrant and Silicon Valley Bank(1) 10.21 Loan Modification Agreement, dated December 21, 1994, between the registrant and Silicon Valley Bank(1) 10.22 Loan and Security Agreement, dated December 29, 1995, between the registrant and Silicon Valley Bank and MMC/GATX Partnership No. 1(1) 10.23 Warrant to Purchase Common Stock, dated December 29, 1995, issued to MMC/GATX Partnership No. 1(1) 10.24 Agreement, dated February 29, 1996, between the registrant and Chiron Corporation relating to research and development funding(1) 10.25 Amendments to original Employment Agreements between the registrant and each of Ralph E. Christoffersen, Lawrence E. Bullock and Nassim Usman, pursuant to letters dated November 14, 1996, November 22, 1996 and December 15, 1996, respectively(3) 10.26 Promissory Note, dated June 4, 1996, between the registrant and Nassim Usman(3) 10.27 Amendment to Lease for Real Property, dated March 13, 1997, between Aero-Tech Investments and the registrant(3) 10.28 Employment Agreement, dated May 2, 1996, between the registrant and Nassim Usman(2) 10.29 Amended and Restated License Agreement, dated November 20, 1996, between the registrant, University Research Corporation, University of Colorado and United States Biochemical Corporation(4)* 10.30 Amended and Restated Sublicense Agreement, dated November 20, 1996, between the registrant and United States Biochemical Corporation(4)* 10.31 Amended and Restated License Agreement, dated November 20, 1996, between the registrant and Competitive Technologies, Incorporated(4)* 10.32 Stock Subscription Agreement, dated September 1996, between the registrant and University of Research Corporation(4)* 10.33 Stock Subscription Agreement, dated November 20, 1996, between the registrant and United States Biochemical Corporation(4)* 10.34 Assignment of License and Restated License Agreement, dated November 20, 1996, among the registrant, United States Biochemical Corporation and Competitive Technologies(4)* 10.35 Stock Purchase Agreement, dated June 28, 1995, among the registrant and investors(1) 10.36 Stock Subscription Agreement, dated October 30, 1995, between the registrant and Gewestelijke Investeringsmaatschappij voor Vlaanderon n.v.(1) 10.37 Research, License, Supply and Royalty Agreement, dated April 9, 1997, between Schering Aktiengesellschaft and the registrant(5)* 10.38 Purchase Agreement, dated April 9, 1997, among the registrant, Schering Berlin Venture Corporation and Schering Aktiengesellschaft(5)* 10.39 Executive Bonus Plan, dated March 27, 1998(6) 10.40 Employment Agreement, dated September 8, 1998, between the registrant and Nassim Usman(7) 10.41 Participation Agreement, dated August 31, 1998, as amended, and related documents between the registrant and atugen Biotechnology GmbH(8)* 10.42 Research Collaboration and License Agreement, dated March 17, 1999, between the registrant and Eli Lilly and Company(10)* II-5 Table of Contents Number Description 10.43 Stock Purchase Agreement, dated April 30, 1999, between the registrant and Eli Lilly and Company(9) 10.44 Securities Purchase Agreement, dated January 7, 2000, among the registrant, Elan International Services, Ltd. and Elan Corporation, plc(11) 10.45 License Agreement, dated January 7, 2000, among Elan Pharmaceutical Technologies (a division of Elan Corporation, plc), Elan Pharma International Limited and Medizyme Pharmaceuticals, Ltd.(11)* 10.46 Warrant, dated January 7, 2000, issued to Elan International Services, Ltd. to purchase up to 200,000 shares of the registrant s common stock(11) 10.47 Warrant, dated January 7, 2000, issued to Elan International Services Ltd. to purchase up to 300,000 shares of the registrant s common stock(11) 10.48 Convertible Promissory Note, dated January 7, 2000, from the registrant to Elan International Services, Ltd.(11) 10.49 Subscription, Joint Development and Operating Agreement, dated January 7, 2000, among the registrant, Elan Corporation, plc, Elan Pharma International Limited, Elan International Services, Ltd. and Medizyme Pharmaceuticals, Ltd.(11)* 10.50 Funding Agreement, dated January 7, 2000, among the registrant, Elan Pharmaceutical Technologies (a division of Elan Corporation, plc), Elan Pharma International Limited and Elan International Services, Ltd.(11) 10.51 License Agreement, dated January 7, 2000, among the registrant and Medizyme Pharmaceuticals, Ltd.(11)* 10.52 Registration Rights Agreement, dated January 7, 2000, between the registrant and Elan International Services, Ltd.(11) 10.53 Registration Rights Agreement, dated January 7, 2000, among the registrant, Elan International Services, Ltd. and Medizyme Pharmaceuticals Ltd.(11) 10.54 Agreement, dated January 31, 2000, between the registrant and Avecia Limited(11)* 10.55 Employment Agreement, dated July 6, 2000, between the registrant and Dr. Nassim Usman(12) 10.56 Repurchase of Ribozyme Product Agreement, dated September 28, 2000, between the registrant and Eli Lilly and Company(13)* 10.57 Common Stock Purchase Agreement, dated December 29, 2000, by and between the registrant and Acqua Wellington North America Equities Fund, Ltd.(15) 10.58 Employment Agreement, dated January 4, 2001, between the registrant and Howard Robin(16) 10.59 Warrant to Purchase Shares of Common Stock, dated January 4, 2001, between the registrant and Heidrick & Struggles(17) 10.60 Amendment to Chiron-Ribozyme Collaborative Research, Development and Commercialization Agreement, dated March 20, 2001(17) 10.61 Employment Agreement, dated May 29, 2001, between Marvin Tancer and the registrant(18) 10.62 Amendment to Employment Agreement, dated April 30, 2001, between Nassim Usman and the registrant(18) 10.63 Amendment to Employment Agreement, dated June 18, 2001, between Howard W. Robin and the registrant(19) 10.64 Amendment to Employment Agreement, dated July 15, 2001, between Marvin Tancer and the registrant(19) II-6 Table of Contents Number Description 10.65 Securities Purchase Agreement, dated December 21, 2001, by and between the registrant and Elan International Services, Ltd.(20) 10.66 Warrant Agreement, dated November 28, 2001, by and between the registrant and ABN AMRO Incorporated(21) 10.67 Form of Warrant to Purchase Common Stock, dated November 28, 2001, issued to selected institutional investors(22) 10.68 Common Stock and Warrant Purchase Agreement, dated as of February 11, 2003, by and among the registrant and the investors named therein(23) 10.69 Form of Voting Agreement between the registrant and each stockholder who is a party thereto(23) 10.70 Schering AG Waiver Letter(23) 10.71 Elan Waiver and Conversion Letter(23) 10.72 Employment Agreement, dated as of February 11, 2003, between the registrant and Howard Robin(23) 10.73 Employment Agreement, dated as of February 11, 2003, between the registrant and Marvin Tancer(23) 10.74 Employment Agreement, dated as of February 11, 2003, between the registrant and Dr. Nassim Usman(23) 10.75 Indemnification Agreement, dated April 18, 2003, between the registrant and Howard W. Robin(24) 10.76 Indemnification Agreement, dated April 18, 2003, between the registrant and Jeremy L. Curnock Cook(24) 10.77 Indemnification Agreement, dated April 18, 2003, among the registrant and Douglas Fambrough and Alan G. Walton(24) 10.78 Indemnification Agreement, dated April 18, 2003, between the registrant and James Niedel(24) 10.79 Indemnification Agreement, dated April 18, 2003, between the registrant and Bryan Roberts(24) 10.80 Non-Competition and Non-Solicitation Agreement, dated February 11, 2003, between the registrant and Howard W. Robin(24) 10.81 Non-Competition and Non-Solicitation Agreement, dated February 11, 2003, between the registrant and Marvin Tancer(24) 10.82 Non-Competition and Non-Solicitation Agreement, dated February 11, 2003, between the registrant and Nassim Usman(24) 10.83 Non-Competition and Non-Solicitation Agreement, dated February 11, 2003, between the registrant and Barry Polisky(24) 10.84 Non-Competition and Non-Solicitation Agreement, dated February 11, 2003, between the registrant and Bharat Chowrira(24) 23.1 Consent of Ernst & Young LLP, Independent Auditors(26) 23.2 Consent of O Melveny & Myers LLP. Reference is made to Exhibit 5.1(25) 24.1 Power of Attorney can be found on the signature page * Company has applied for and received confidential treatment with respect to portions of these exhibits. (1) Documents incorporated by reference herein to certain exhibits to the registrant s Form SB-2 Registration Statement, File No. 333-1908-D. II-7 Table of Contents (2) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-QSB for the quarter ended June 30, 1996. (3) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-KSB and amendment for the year ended December 31, 1996. (4) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-KSB/A for the year ended December 31, 1996. (5) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated June 12, 1997. (6) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-KSB for the year ended December 31, 1997. (7) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-Q for the quarter ended September 30, 1998. (8) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K/A dated June 16, 1999. (9) Documents incorporated by reference herein to certain exhibits to the registrant s Form S-1 Registration Statement, Amendment No. 3, File No. 333-75079. (10) Documents incorporated by reference herein to certain exhibits to the registrant s Form S-1 Registration Statement, Amendment No. 5, File No. 333-75079. (11) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated February 8, 2000. (12) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-Q for the quarter ended June 30, 2000. (13) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated October 10, 2000. (14) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated December 5, 2000. (15) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated January 5, 2001. (16) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-K for the year ended December 31, 2000. (17) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-Q for the quarter ended March 31, 2001. (18) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-Q for the quarter ended June 30, 2001. (19) Documents incorporated by reference herein to certain exhibits to the registrant s Form 10-Q for the quarter ended September 30, 2001. (20) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated January 16, 2002. (21) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated February 25, 2002. (22) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated December 11, 2001. (23) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated February 14, 2003. (24) Documents incorporated by reference herein to certain exhibits to the registrant s Form 8-K dated April 24, 2003. (25) Previously filed with this Form S-1. (26) Filed herewith. II-8 Table of Contents Item 17. Undertakings. The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the Calculation of Registration Fee table in the effective registration statement. (iii) To include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement; (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at the time shall be deemed to be the initial bona fide offering thereof. (3) To remove from Registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (4) That, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant s annual report pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan s annual report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (5) Insofar 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 Act 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. II-9 Table of Contents SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Boulder, Colorado on the 29th day of July, 2003. SIRNA THERAPEUTICS, INC. By: /S/ HOWARD W. ROBIN Howard W. Robin President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints, Howard W. Robin, as his attorney-in-fact, with full power of substitution and resubstitution, for him in any and all capacities, to sign any and all amendments to this Registration Statement (including without limitation post-effective amendments and any amendments increasing the amount of securities for which registration is being sought), and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated: Signature Title Date * Howard W. Robin President and Chief Executive Officer (Principal Executive Officer), Director July 29, 2003 * Marvin Tancer Chief Financial Officer and Vice President of Operations (Principal Financial and Accounting Officer) July 29, 2003 * James Niedel Chairman of the Board of Directors July 29, 2003 * Bryan Roberts Director July 29, 2003 * Jeremy C. L. Cook Director July 29, 2003 * Douglas Fambrough Director July 29, 2003 /S/ R. SCOTT GREER R. Scott Greer Director July 29, 2003 *By: /S/ HOWARD W. ROBIN Howard W. Robin Attorney-in-Fact ASSETS Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Stock Based Compensation The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ( APB 25 ), and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recorded. The Company has adopted the disclosure-only provisions of Financial Accounting Standards Board Statement No. 123, Accounting and Disclosure of Stock Based Compensation ( SFAS No. 123 ). For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting period. The Company s pro forma information follows: At December 31, 2001: U.S. Corporate Debt Securities (maturing in 2002) $ 11,485,791 $ 11,293 $ $ 11,497,084 At December 31, 2002: U.S. Corporate Debt Securities (maturing in 2003) $ 6,748,876 $ 7,162 $ $ 6,756,038 3. Long-Term Debt Long-term debt as of December 31, 2002 and 2001, consists of the following: Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) The Tax Reform Act of 1986 contains provisions that limit the utilization of net operating loss and tax credit carryforwards if there has been a change of ownership as described in Section 382 of the Internal Revenue Code. Such a change of ownership may limit the Company s utilization of its net operating loss and tax credit carryforwards, and could have been triggered by the Company s initial public offering or by subsequent sales of securities by the Company or its shareholders. See Note 13 regarding potential change in ownership. The components of the Company s deferred tax assets and liabilities, net of taxes, as of December 31, 2002 and 2001 are as follows: A reconciliation between the statutory federal income tax rate of 34% and the Company s 0.0%, effective tax rates for the years ended December 31, 2002, 2001, and 2000, respectively, is as follows: Period from Inception (December 21, 1999) to December 31, Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) Deferred Patent Costs The Company capitalizes legal costs directly incurred in pursuing patent applications as deferred patent costs. When such applications result in an issued patent, the related costs are amortized over the remaining legal life of the patents, using the straight-line method. On a quarterly basis, the Company reviews its issued patents and pending patent applications, and if it determines to abandon a patent application or that an issued patent no longer has economic value, the unamortized balance in deferred patent costs relating to that patent is immediately expensed. During 2002 the Company expensed $684,389 related to abandoned patents which is included in Research and Development expense. Below is an estimate of patent amortization expense for the next five years: 2003 $ 479,782 2004 5,077,813 2005 1,279,089 Currently exercisable 198,176 2003 155,162 2004 137,814 2005 85,095 Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) The Company s minimum operating lease commitments at December 31, 2002 are as follows: 2003 $ 1,065,844 2004 1,080,621 2005 1,100,179 2006 1,120,421 2001 $ $ $ 2007 3,506,000 101,000 2008 7,363,000 185,000 2009 9,239,000 316,000 2010 11,953,000 139,000 2011 15,125,000 181,000 2012 15,291,000 296,000 2018 10,109,000 475,000 2019 8,215,000 405,000 2020 7,456,000 710,000 2021 52,169,000 646,000 See notes to condensed unaudited financial statements See notes to condensed unaudited financial statements See notes to condensed unaudited financial statements Table of Contents SIRNA THERAPEUTICS, INC. (Formerly Ribozyme Pharmaceuticals, Inc.) NOTES TO CONDENSED FINANCIAL STATEMENTS March 31, 2003 (Unaudited) Note 1: Basis of Presentation The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003. For further information, refer to the financial statements and footnotes thereto included in the Company s annual report on Form 10-K for the year ended December 31, 2002. Note 2: Subsequent Events Special Meeting of Stockholders and Private Placement On February 11, 2003, the Company entered into a common stock and warrant purchase agreement with the Sprout Group, Venrock Associates, Oxford Bioscience Partners IV, TVM V Life Science Ventures GmbH & Co. KG and Granite Global Ventures (the Investors ) to sell common stock and warrants for an aggregate amount of approximately $48 million (the Stock Purchase Agreement ). On April 16, 2003 the Company held a Special Meeting of Stockholders pursuant to which the terms of the Stock Purchase Agreement with the Investors were approved. At the Special Meeting and a subsequent adjournment, the stockholders approved the following proposals: The terms of the private placement to the Investors; An amendment to the Company s current amended and restated certificate of incorporation to effect a reverse split of its outstanding common stock of 1-for-6, to increase the number of authorized shares of capital stock, to change the Company s name from Ribozyme Pharmaceuticals, Inc. to Sirna Therapeutics, Inc. and to permit stockholders to act by written consent in lieu of a meeting; An amendment to the Company s 1996 Stock Option Plan and to the 2001 Stock Option Plan as a result of which the Company will (a) terminate the 1996 Stock Option Plan and have its outstanding options covered by the 2001 Stock Option Plan, (b) increase the number of shares reserved for issuance pursuant to its 2001 Stock Option Plan by a total of 5,666,667 shares (after giving effect to the reverse stock split), and (c) provide a maximum limit on options granted to any individual during any calendar year, of 2 million shares; and An increase in the number of shares reserved for issuance pursuant to the Company s Employee Stock Purchase Plan by a total of 833,333 shares (after giving effect to the reverse stock split). On April 21, 2003, pursuant to the Stock Purchase Agreement, the Company completed the sale of 24,242,425 shares of its common stock and warrants to purchase 5,015,152 shares of its common stock to the Investors for an aggregate consideration of approximately $48 million. The common stock was sold at a price per share of $1.98 and the warrants are exercisable at any time over the five-year period measured from the date of issuance at a price per share of $2.52. With the consummation of the above transactions the Investors own approximately 87.7% (after giving effect to the exercise of the warrants pursuant to the Stock Purchase Agreement, but prior to giving effect to Table of Contents SIRNA THERAPEUTICS, INC. (Formerly Ribozyme Pharmaceuticals, Inc.) NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued) exercise of any stock options) of the Company s outstanding capital stock. Further, pursuant to the Stock Purchase Agreement, some of the Investors have the right to designate four of the Company s seven members of the board of directors. As a result of the one-for-six reverse stock split, every six shares of the Company s common stock were replaced with one share of the Company s common stock. All references to common stock, common shares outstanding, average number of common shares outstanding and per share amounts in these Financial Statements and Notes to Financial Statements prior to the effective date of the reverse stock split have been restated to reflect the one-for-six common stock reverse split on a retroactive basis. In connection with the execution of the Stock Purchase Agreement, the Company obtained certain waivers and amendments to the Company s agreements with Schering AG ( Schering ) and to the Company s agreements with Elan Corporation ( Elan ). In exchange for warrants and the Company s agreement to pay accrued interest on the loan on a quarterly basis, Schering extended the due date for repayment of the loans from April 2004 to January 2005. Among other things, Elan converted all of the outstanding shares of the Company s Series A and Series B Preferred Stock into shares of the Company s common stock immediately prior to the closing of the transactions, waived certain pre-emptive rights, and waived its right to nominate a director for election to the Company s board of directors. The Series A Preferred Stock and accreted dividends have been reclassified to permanent equity-common stock following the conversion to common stock in April 2003. The pro forma balance sheet as of March 31, 2003 reflects the receipt of the net proceeds from the sale of 24,242,425 shares of the Company s common stock received in the private placement transaction at $1.98 per share. In addition, the amounts reflect the conversion of the Company s Series A and Series B Preferred Stock and accreted dividends into 541,929 shares of the Company s common stock, as well as payment of accrued interest on the Schering debt. Note 3: Medizyme In January 2000, the Company formed a joint venture with Elan for the development and commercialization of HERZYME , the Company s product to treat breast and other cancers. As part of this arrangement, the Company licensed HERZYME and Elan licensed its MEDIPAD and certain liposomal drug delivery technology to the joint venture, Medizyme Pharmaceuticals, Ltd. ( Medizyme ). The MEDIPAD system is a disposable continuous subcutaneous drug delivery system that allows a patient to administer the drug at home. The Company filed an Investigational New Drug for HERZYME in Canada in February 2001, which was approved in April 2001. While the Company owned 80.1% of the outstanding common stock of Medizyme, Elan retained significant minority investor rights that are considered participating rights as defined in EITF 96-16 Investors Accounting for an Investee When the Investor Owns a Majority of the Voting Stock but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights. Therefore, the Company did not consolidate the operations of Medizyme, but instead accounted for the investment in Medizyme under the equity method. As of March 31, 2003 the Company had absorbed the entire cost basis in its equity investment through its share of Medizyme s net losses. In April 2003, the Company entered into a termination agreement with Elan, under which the Company retains full rights to HERZYME and Elan transferred its 19.9% interest in Medizyme (held as preferred stock) to the Company in exchange for either (a) a portion of any future net revenues received by the Company if it enters Pro forma net loss applicable to common stock $ (6,187,266 ) $ (9,553,750 ) Pro forma loss per share (basic and diluted) $ (1.83 ) $ (2.86 ) Note 5: Recently adopted Accounting Standards In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 requires that a liability for a cost that is associated with an exit or disposal activity be recognized when the liability is incurred. It nullifies the guidance in EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under EITF 94-3, an entity recognized a liability for an exit cost on the date that the entity committed itself to an exit plan. Under SFAS 146, an entity s commitment to a plan does not, by itself, create a present obligation to other parties that meets the definition of a liability. SFAS 146 will be effective for exit or Table of Contents SIRNA THERAPEUTICS, INC. (Formerly Ribozyme Pharmaceuticals, Inc.) NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued) disposal activities that are initiated after December 31, 2002. The adoption of the provisions of SFAS 146 has not had a material effect on the financial statements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based Compensation Transition and Disclosure. SFAS 148 provides two additional transition methods for entities that adopt the preferable method (as set forth in SFAS 148) of accounting for stock based compensation. Further, the statement requires disclosure of comparable information for all companies regardless of whether, when, or how an entity adopts the preferable, fair value based method of accounting. These disclosures are now required for interim periods in addition to the traditional annual disclosure. SFAS 148 is effective for fiscal periods ending after December 15, 2002. See Note 4 to these Notes to Condensed Financial Statements for the quarterly disclosure requirements under SFAS No. 148. Note 6: Deferred revenue During the first quarter of 2003, the Company received $1.4 million in non-refundable fees from Geron Corporation ( Geron ) that was recorded as deferred revenue and is recognized upon the release of product to Geron, which occurred in June 2003. In addition, the Company recognized the remaining license revenue of $169,000 from Fujirebio that had been deferred over the term of the collaboration because all research activities under the collaboration have ended. Note 7: Payment to Contract Manufacturer In the fourth quarter of 2002 the Company took delivery for $3.6 million of ribozyme drugs that the Company was contractually obligated to purchase from a contract manufacturer. The terms of payment for the purchase were $1.6 million paid on October 30, 2002; $1.1 million to be paid on or before October 30, 2004; and $873,491 to be paid on or before June 30, 2005. In June 2003 the Company entered into an agreement with the contract manufacturer, wherein in lieu of the payments of $1.1 million and $873,491 together with the interest payable, the Company paid the contract manufacturer the sum of $1,726,805. Note 8: Subsequent Deferred Patent cost write-down The Company capitalizes legal costs directly incurred in pursuing patent applications as deferred patent costs and then amortizes these costs over the estimated remaining life of the patent on a straight-line method. On a quarterly basis, the Company reviews all issued patents and pending patent applications and if a determination is made to abandon a patent or a patent application, or that an issued patent or a patent application is deemed to no longer have significant economic value, the unamortized balance in deferred patent costs related to that patent is immediately expensed. On April 21, 2003, as previously discussed in Note 2, the Company completed a private placement, which resulted in a change of control for the company. The Company has also changed its business strategy which focused on development of ribozyme-based therapeutics and diagnostics to developing a new class of nucleic acid based therapeutics based on RNA interference. As a result of finalizing this change in strategic direction during the second quarter ended June 30, 2003, the Company undertook a detailed review of its existing patent portfolio. As a result of this review, the Company has written off in the second quarter $447,000 related to abandoned patents. In addition, since the Company is no longer pursuing the development of ribozymes internally, the Company expensed approximately $4.9 million of capitalized patent costs related to this ribozyme technology. This expense will be reflected as a separate line item in the Company s statement of operations for the second quarter. Table of Contents SIRNA THERAPEUTICS, INC. (Formerly Ribozyme Pharmaceuticals, Inc.) NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued) Patent costs directly related to the Company s existing RNAi technology and chemistry technology relating to process development, manufacturing, stabilization and delivery of oligonucleotides continue to remain capitalized and will be amortized over a shorter period due to the early stage of the Company s technology. The Company will continue to periodically review the estimated recoverability of the costs of these patents. If the Company determines that the estimated recoverability of the patent costs decreases significantly or that these patents or patent applications should be abandoned or have significantly reduced economic value, the Company will expense these costs. Due to the early stage of the technology, the Company intends to expense all future patent-related legal costs until the Company determines that the estimated recoverability of the associated legal costs is sufficiently probable, at which time such costs will be capitalized. Table of Contents REPORT OF INDEPENDENT AUDITORS To the Stockholders and Board of Directors Ribozyme Pharmaceuticals, Inc. We have audited the accompanying balance sheets of Ribozyme Pharmaceuticals, Inc., as of December 31, 2002 and 2001, and the related statements of operations, redeemable preferred stock and stockholders (deficit) equity, and cash flows for each of the three years in the period ended December 31, 2002. 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. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Ribozyme Pharmaceuticals, Inc. at December 31, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company has incurred significant operating losses since inception related to clinical trials and the cost of manufacturing drugs, has insufficient working capital to meet budgeted cash requirements for the next year without additional financing and has a stockholders deficit. These conditions raise substantial doubt about the Company s ability to continue as a going concern. Management s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of these uncertainties. /s/ ERNST & YOUNG LLP Denver, Colorado February 21, 2003, except for Note 13, as to which the date is March 7, 2003 See accompanying notes. Net loss per share (basic and diluted) $ (10.81 ) $ (21.54 ) $ (6.92 ) Shares used in computing net loss per share 3,355,727 2,813,887 2,398,345 See accompanying notes. Balance at December 31, 2000 12,015 12,015,000 716,456 2,710,247 27,102 163,220,402 (99,964,629 ) (5,424 ) (14,476 ) 63,262,975 Issuance of common stock and warrants for cash public offering, net of costs of $931,604 376,984 3,770 8,564,626 8,568,396 Issuance of common stock and warrants for cash Elan Corporation, net of costs of $64,105 208,417 2,084 7,936,811 7,938,895 Issuance of common stock in exchange for product rights Chiron Corporation 6,487 65 274,935 275,000 See accompanying notes. Non-cash activity Preferred stock dividends accreted 1,570,407 775,346 716,456 Note payable converted into Series B Preferred Stock 9,905,952 See accompanying notes. Pro forma net loss applicable to common stock $ (39,184,789 ) $ (64,885,538 ) $ (18,415,891 ) Pro forma loss per share (basic and diluted) $ (11.68 ) $ (23.06 ) $ (7.68 ) Financial Instruments Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents and short-term investments. The Company places its cash equivalents and short-term investments with high credit-quality financial institutions. The Company invests its excess cash primarily in money market instruments, and municipal and floating rate bonds. The Company has established guidelines relative to credit ratings, diversification and maturities that seek to maintain safety and liquidity. To date, the Company has not experienced significant losses on any of these investments. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The Company s cash equivalents are comprised of certificates of deposit, money market funds, and investment securities. Property, Plant, and Equipment Property, plant, and equipment is stated at cost. Depreciation is computed by the straight-line method over the estimated useful lives of the assets. Useful lives of laboratory equipment and furniture are estimated at five years and all computer equipment is estimated at three years. Leasehold improvements and equipment subject to financing obligations are amortized on a straight-line basis over the shorter of their estimated useful lives or the term of the lease. Estimated amortization expense $ 200,000 $ 247,059 $ 294,118 $ 341,176 $ 388,235 It is possible the above estimates of future economic life of the Company s commercialization revenues, the amount of anticipated future commercialization revenues, or both, will be reduced significantly in the near term due to alternative technologies developed by other biotechnology or pharmaceutical companies. As a result, the carrying amount of deferred patent costs may be reduced in the future. Revenue Recognition and Accounts Receivable Revenue from collaborative agreements typically consists of nonrefundable up-front fees, ongoing research and development funding, milestones, license fees and other payments. Revenue from nonrefundable up-front fees is recognized upon signing of the agreement when it represents a culmination of a separate earnings process. All other up-front fees are deferred and recognized systematically over the period the fees are earned. Revenue from ongoing research and development funding is recorded as the expenses are incurred and is typically based on the fully burdened cost of a researcher working on a collaboration. Revenue is recognized ratably over the period as services are performed, with the balance reflected as deferred revenue until earned. Revenue from milestones, license fees and other payments are recognized when earned. License revenue is recognized ratably over the term of the license and milestone revenue is recognized in full when the related milestone performance goal is achieved. Payments received in advance under these agreements are recorded as deferred revenue until earned. The Company has no further research commitments from its collaborators for any revenue recognized. The Company s accounts receivable are predominately collaborative agreement receivables, and to date, the Company has not experienced any losses with respect to the collection of its accounts receivables. In 2002, 2001 and 2000, Chiron accounted for approximately 42%, 37% and 29% of collaborative revenues, respectively. In 2002, 2001 and 2000 Medizyme accounted for approximately 21%, 48% and 39% of collaborative revenues, respectively. Revenues from Chiron and Medizyme were for nonrefundable, ongoing research and development fees. Research and Development Expenses Research and development costs are expensed as incurred. Segment Information Statement of Financial Accounting Standards No. 131, Disclosure About Segments of an Enterprise and Related Information, establishes standards for the reporting of information about operating segments. The Company s operations are one operating segment. Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) Accounting for Investments in Unconsolidated Affiliates The Company accounts for its investments in Medizyme Pharmaceuticals, Ltd. (Medizyme) and atugen under the equity method. The Company has recorded its share of Medizyme s net losses against its cost basis. At December 31, 2002 the Company had absorbed its entire cost basis in its investment in Medizyme; however, the Company is committed to fund future losses incurred by Medizyme and therefore may continue to invest in Medizyme and subsequently recognize its portion of ongoing losses. In 1999, the Company had absorbed its entire cost basis in atugen through its share of atugen s net losses and since the Company has no other funding commitments to atugen the Company has ceased recording it share of atugen s net losses. The Company s investment in Archemix is accounted for under the cost method. Impact of Recently issued Accounting Standards In June 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. SFAS No. 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. SFAS No. 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. The Company adopted SFAS No. 142 beginning January 1, 2002. The Company has not undergone any business combinations and therefore SFAS No. 141 and SFAS No. 142 has had no effect on the Company s financial statements. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, that is applicable to financial statements issued for fiscal years beginning after December 15, 2001. The FASB s new rules on asset impairment supersede SFAS No. 121, Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of, and portions of Accounting Principles Bulletin Opinion 30, Reporting the Results of Operations. This standard provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. Assets held-for-sale are not depreciated and are stated at the lower of fair value or carrying amount. This standard also requires expected future operating losses from discontinued operations to be displayed in the period(s) in which the losses are incurred, rather than as of the measurement date as presently required. The Company adopted SFAS No. 144 beginning January 1, 2002. The Company periodically reviews the carrying amounts of its long-lived assets to determine whether events or circumstances require adjustments to the carrying amounts. In such reviews, estimated undiscounted future cash flows associated with long-lived assets or operations are compared with their carrying value to determine if a write-down is required. In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 requires that a liability for a cost that is associated with an exit or disposal activity be recognized when the liability is incurred. It nullifies the guidance in EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under EITF 94-3, an entity recognized a liability for an exit cost on the date that the entity committed itself to an exit plan. Under SFAS 146, an entity s commitment to a plan does not, by itself, create a present obligation to other parties that meets the definition of a liability. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002. The Company has not adopted the provisions of SFAS 146 in the December 31, 2002 financial statements, or for any prior periods. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based Compensation Transition and Disclosure. SFAS 148 provides two additional transition methods for entities that adopt the preferable I. In December 2001, the Company negotiated an equipment credit facility of $4,000,000 with a financing company. The agreement requires monthly principal and interest payments for 36 or 48 months, depending on the type of equipment financed. The interest rate fixed to each draw down is 5.61% and 5.42% over the rates of 36 or 48-month treasury bills, respectively, at the time of the draw down. The facility expired in November 2002 and therefore no additional amounts can be borrowed. The interest rate on these borrowings averaged 9.5% at December 31, 2002. II. In April 1997, the Company entered into a collaboration agreement with a corporate partner whereby, among other items, the Company borrowed from the corporate partner up to $2.0 million annually through 2001. The loans are collateralized 50% by equipment purchases. The loans carry an interest rate of 8% per 4. Leases The Company leases office space in two buildings under noncancellable operating leases that expire in October 2007 and June 2007. According to the terms of the leases, rent for the buildings will increase each year based on Consumer Price Index increases, with a minimum of 3.5% and a maximum of 6.0%. Total rent expense, including miscellaneous laboratory equipment rentals, was $853,108, $782,819 and $453,686 in 2002, 2001 and 2000, respectively. Under a separate agreement, the Company sublet a portion of their building to atugen USA, an unconsolidated affiliate. Rental income from atugen USA for 2002, 2001 and 2000 was $105,062, $188,814 and $102,577, respectively. The sublease expired in October 2002 and atugen USA has ceased operations. 5. Redeemable Preferred Stock and Stockholders Equity Series A Preferred Stock. In January 2000, the Company issued 12,015 shares of Series A Preferred Stock to Elan Corporation (Elan) to fund its 80.1% share of the initial capitalization of Medizyme (see Note 7). At Elan s option, the Series A Preferred Stock is convertible into the Company s common stock or may be exchanged for a 30.1% interest in Medizyme. Because of this exchange feature, the Company has classified for the periods presented $12,015,000 of its Series A Preferred Stock and related preferred stock dividends of $2,314,366, $1,491,802 and $716,456 at December 31, 2002, 2001 and 2000, respectively, outside of permanent equity in accordance with EITF Topic No. D-98, Classification of and Measurement of Redeemable Securities. The right of Elan to exchange the Series A Preferred Stock is applicable for the period October 2002 through May 2003. Subsequent to May 2003 and if the exchange right expires unexercised, the Series A Preferred Stock will be reclassified to permanent equity. Employee Stock Purchase Plan. The Company adopted an Employee Stock Purchase Plan (the Purchase Plan), authorizing the issuance of 100,000 shares pursuant to purchase rights granted to employees of the Company. The Purchase Plan provides a means by which employees purchase common stock of the Company through payroll deductions. The Purchase Plan is implemented by offerings of rights to eligible employees. Generally, each offering is twenty-four months duration with purchases occurring on each October 31 and April 30 during each offering. Common stock is purchased for accounts of employees participating in the Purchase Plan at a price per share equal to the lower of (i) 85% of the fair market value of a share of common stock on the date of commencement of participation in the offering or (ii) 85% of the fair market value of a share of common stock on the date of purchase. Generally all regular employees, including executive officers, may participate in the Purchase Plan and may authorize payroll deduction of up to 15% of their base compensation for the purchase of stock under the Purchase Plan. The Company s Board of Directors has the authority to terminate the Purchase Plan at its discretion. Shares are deemed issued for accounting purposes in the year the shares are purchased. As of December 31, 2002, 95,426 shares have been issued under the Purchase Plan. The Company will require stockholders to approve additional shares for issuance under the Purchase Plan for the offering period commencing November 1, 2002. Shares approved subsequent to the beginning of an offering may require the Company to recognize a compensation expense for the period in which the shares are approved. The compensation expense will likely be incurred during the second quarter of 2003. Stock Option Plans. The Company has established a Non-Qualified Stock Option Plan and an Incentive Stock Option Plan (collectively, the Plans, as amended), under which it authorized stock option grants to purchase up to 961,192 shares of the Company s common stock to eligible employees, consultants, and other Stock Based Compensation. The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related Interpretations in accounting for its employee stock. Under APB 25, if the exercise price of the Company s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. During 2002, 2001, and 2000, the Company recorded $24,835, $14,476, and $23,393, respectively, of compensation relating to the grant of stock options and an anti-dilution agreement. The expense recorded in 2001 and 2000 relate to pre-IPO issuances that were deferred until vesting was completed. In addition, the Company recorded expense of $1.7 million during 2000 related to performance stock options that vested due to achievement of specific performance criteria during the year. The expense recorded in 2002 relates to options issued to consultants, which was accounted for under the requirements of SFAS 123. Pro forma information regarding net loss and loss per share is required by SFAS 123, which also requires that the information be determined as if the Company has accounted for its employee stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2002, 2001 and 2000, respectively: risk-free interest rates of 4.75%, 4.3% and 5.6%; a dividend yield of 0%; volatility factors of the expected market price of the Company s common stock of 1.09, 1.04 and 1.08; and a weighted-average expected life of the option of 6 years. The weighted average fair value of stock options granted during 2002, 2001 and 2000 was $5.04, $42.18 and $111.18, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. Shareholder Rights Plan. In November 2000, the Company adopted a Shareholder Rights Plan (the Rights Plan) designed to protect and maximize shareholder value and to assist the Board of Directors in ensuring fair and equitable benefit to all shareholders in the event of a hostile bid to acquire the Company. The Rights The Company s ability to pay dividends is restricted by the terms of its collaborative, convertible debt and equipment loan facility agreements. 6. Unconsolidated German Affiliate atugen In 1998, the Company transferred its gene function and target validation business and technology to atugen, a separately funded German affiliate. Financing for atugen was accomplished through an equity investment of $2.0 million in cash from the Company in 1998, a venture capital investment of $7.0 million and a commitment by the German government to provide grants and loans of up to $10.0 million. As a result, at December 31, 1998, the Company retained a 49.5% ownership in atugen. However, since formation, atugen has had additional rounds of financing and as a result, the Company retained approximately 31% ownership in atugen at the end of 2002. The Company accounts for its investment in atugen under the equity method of accounting. In connection with its formation, atugen received exclusive royalty-free licenses to the Company s patents and technologies for target validation and discovery in exchange for a one-time $2.0 million payment which was received by the Company in January 1999. The entire amount of this one-time payment was deferred at December 31, 1998 and is being amortized over the five-year term of the license agreement and is reflected in the Company s equity in earnings. As of December 31, 1999 the Company had absorbed its entire cost basis in this equity investment through its share of atugen s net losses. The Company will retain rights to develop ribozyme therapeutic agents against targets validated by atugen. Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) 7. Collaborative Agreements Chiron In July 1994, the Company entered into a research and development collaboration agreement with Chiron to research, develop and market products directed towards five genetic targets, and all human clinical indications associated with those targets. The Company and Chiron will share equally in the costs and profits of any jointly developed products. In addition, Chiron may, at its option, finance the Company s portion of its Phase II and Phase III drug development costs for mutually approved programs. The Company retains the option to reacquire its rights by reimbursing Chiron for such development costs plus a predetermined risk premium. As part of this agreement, Chiron made a $10,000,000 equity investment in the Company. Chiron and the Company are jointly collaborating in the development of ANGIOZYME, the Company s lead product candidate for the treatment of solid tumor cancers. The Company recorded revenues and credit to expenses from Chiron of $2,582,260, $11,935,567 and $4,529,795, in 2002, 2001 and 2000, respectively, for 50% of ANGIOZYME clinical development and manufacturing expenses incurred by the Company. There are no future obligations between the Company and Chiron related to revenues that were recognized in 2002, 2001 and 2000. In March 2001, the Company issued 6,487 shares of the Company s common stock to Chiron in exchange to reacquire all rights to develop any ribozyme product containing or utilizing an HIV target. An expense of $275,000 was recorded in 2001 in connection with the issuance of the stock. Schering AG, Berlin On April 9, 1997, the Company entered into a research collaboration with Schering AG, Berlin, (Schering AG) focusing on the use of ribozymes for therapeutic target validation, as well as the development of ribozymes as therapeutic agents. The collaboration utilized the special selectivity of ribozymes to validate new molecular therapeutic targets and to discover new therapeutic agents based on those targets. The Company provided its expertise in ribozyme design, synthesis and delivery, and Berlex Laboratories, Inc., a U.S. subsidiary of Schering AG (Berlex) provided candidate targets, cell culture screens, animal models and development and commercialization expertise to the collaboration. Since the formation of atugen in 1998, the Company subcontracted the work related to the collaboration to atugen. Subsequently, all revenues related to the collaboration with Berlex have been transferred to atugen as well. Schering AG made an equity investment in the Company in May 1997 of $2.5 million in exchange for 35,461 shares of common stock, and made an additional equity investment of $2.5 million for 77,520 shares in April 1998. Separately, Schering AG provided loans of $2.0 million in each of years 1997, 1998, 1999, 2000 and 2001. According to the terms of the Company s agreement with Schering AG, 50% of borrowings on the line of credit were collateralized by equipment purchases. The loans, which carry an interest rate of 8% per annum, are convertible into equity at the option of Schering AG under certain circumstances. In April 2000, after the completion of a public offering, the Company paid down $6.9 million of the outstanding borrowings from Schering AG. In June 2000, Schering AG converted the remaining balance of $997,205 into 7,073 shares of the Company s common stock at the market closing price on June 19, 2000 of $141.00. At December 31, 2002, the outstanding borrowings and accrued interest of $3.5 million were convertible into approximately 2.4 million shares of the Company s common stock. Principal and interest payments are deferred until maturity of the loans which is in April 2004. The Company may earn success fees upon product development milestones and will manufacture synthetic ribozyme products and receive royalties on sales of both ribozyme and non-ribozyme products resulting from the collaboration. All such payments are subject to some restrictions, including receipt of certain third party consents. The agreement expired in April 2002. Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) Eli Lilly and Company In March 1999, the Company entered into a collaboration with Eli Lilly and Company (Eli Lilly) to conduct research, development and commercialization of the Company s ribozyme for the treatment of Hepatitis C virus infection, HEPTAZYME. Under the terms of the agreement, the Company received approximately $9.2 million in 1999, which included $1.7 million of funding for research and clinical trial expenses and a $7.5 million equity investment purchasing five shares of the Company s non-voting convertible Series L preferred stock which was completed in April 1999. Each share of Series L Convertible Preferred Stock was convertible into shares of the Company s common stock based upon milestones related to the development and commercialization of HEPTAZYME. In September 2000, the Company entered into an agreement with Eli Lilly to repurchase all rights to HEPTAZYME. Eli Lilly had directed the clinical trials for HEPTAZYME to date under the licensing agreement. According to the repurchase agreement, the Company reacquired the global rights to HEPTAZYME and will direct all subsequent clinical trials. In addition, the Company agreed to pay royalties to Eli Lilly on future net sales of HEPTAZYME, as well as milestone payments if the Company completes an agreement for the development or marketing rights to HEPTAZYME with a third party or if the Company files a New Drug Application for HEPTAZYME, whichever comes first. Pursuant to the repurchase agreement, Eli Lilly converted the outstanding five shares of the Company s Series L Convertible Preferred Stock into 106,107 shares of common stock on December 28, 2000 (the Termination Date). The conversion price was based on a preferred share value of $1.5 million for each of the five shares outstanding. The price per share of the common stock was based on the average closing price of the Company s common stock for the 30 days prior to the Termination Date. In addition, the Company issued to Eli Lilly $3,000,000 of its common stock, which resulted in 42,105 shares, as payment for Eli Lilly s efforts in generating and providing data. The price per share was based on the closing market price of the Company s common stock on the Termination Date. In return, Eli Lilly paid the Company a termination fee of approximately $2.8 million. The Company recorded the $225,891 difference between the value of the stock issued and the termination fee as a collaboration expense in December 2000. Elan Corporation In January 2000, the Company formed a joint venture with Elan Corporation (Elan) for the development and commercialization of HERZYME, the Company s product to treat breast and other cancers. As part of this arrangement, the Company licensed HERZYME and Elan licensed its MEDIPAD drug delivery technology to the joint venture, Medizyme Pharmaceuticals, Ltd. (Medizyme). The MEDIPAD system is a disposable continuous subcutaneous drug delivery system that allows a patient to administer the drug at home. Initial funding of Medizyme included $12.0 million from the Company and $3.0 million from Elan. The Company s $12.0 million capital contribution was funded by the sale to Elan of (i) 12,015 shares of the Company s Series A Convertible Exchangeable Preferred Stock (the Series A Preferred Stock), (ii) a warrant to purchase up to 33,333 shares of the Company s common stock at an exercise price of $90.00 per share, which expired unexercised in January 2002, and (iii) a warrant to purchase up to 50,000 shares of the Company s common stock at an exercise price of $120.00 per share with a term of seven years. The Series A Preferred Stock has a stated dividend rate of 6.0% which is payable semi-annually through the issuance of additional shares of Series A Preferred Stock at a nominal value of $1,000 per share. The Series A Preferred Stock has a liquidation preference of $12,015,000 plus accrued and unpaid dividends. At December 31, 2002, the Company has recorded $2,314,366 as an accreted dividend related to this preferred stock arrangement. As a result of Medizyme s initial capitalization, the Company owns 80.1% of the outstanding capital stock of Medizyme and Elan owns 19.9%. However, Elan can exchange, at its option, all of its shares of the Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) Company s Series A Preferred Stock for 30.1% of RPI s interest in Medizyme. After such redemption, Elan would own 50% of the then outstanding capital stock of Medizyme. Elan also has the option of converting its shares of the Company s Series A Preferred Stock and any related accreted preferred stock dividends into shares of RPI s common stock at a fixed price. As of December 31, 2002, the Series A Preferred Stock and accreted dividends were convertible into 199,019 shares of the Company s common stock. Medizyme paid Elan in cash a $15.0 million non-refundable license fee for the MEDIPAD drug delivery technology. As a result of this licensing transaction, Medizyme capitalized the entire license fee and is amortizing the balance over the three-year term of the agreement since Medizyme s license of the MEDIPAD device was intended for use with any ribozyme drug developed by Medizyme targeting a gene believed responsible for certain breast cancers. The Company estimated that funding for Medizyme would require approximately $15.0 million in additional operating and development costs. In connection with expected funding requirements, Elan agreed to provide the Company with a $12.0 million credit facility to fund the Company s pro rata portion of Medizyme s operating costs over the development period, which was 42 months. At the end of December 2002, the Company had utilized the credit facility and had borrowed $9.9 million. The note carried an interest rate of 12% compounded on a semi-annual basis. In June 2002, Elan converted this debt and accrued interest into 9,905 shares of the Company s Series B Convertible Preferred Stock (the Series B Preferred Stock). The Series B Preferred Stock (the Series B Preferred Stock), ultimately is convertible into shares of the Company s common stock at a 50% premium to the average price of its common stock for the 60 days prior to the time of the applicable draw down on the credit facility. The Series B Preferred Stock has a stated dividend rate of 12%, which is payable semi-annually through the issuance of additional shares of Series B Preferred Stock at a nominal value of $1,000 per share. If converted at December 31, 2002, the Series B Preferred Stock, preferred stock issuable and the Series B accreted dividends would be convertible into 248,018 shares of the Company s common stock. For the year ended December 31, 2002, the Company recorded $1.4 million in revenues and reimbursements from Medizyme, of the total $6.7 million in research and development expenses recorded by Medizyme. The Company recorded $5.3 million as equity in the net loss of Medizyme. Also in connection with the Medizyme joint venture, Elan purchased 106,838 shares of the Company s common stock for a purchase price of $5.0 million in 2000. In addition, Elan purchased 83,417 shares of the Company s common stock for $5.0 million in May 2001 at a premium to the average closing price for the 45 trading days preceding the purchase. Elan also purchased 125,000 shares of the Company s common stock and a warrant to purchase 12,500 shares of common stock in December 2001 for $3.0 million. In January 2002, the Company expanded its collaboration with Elan. Under the terms of the amended agreement, for no cost Medizyme will license Elan s liposome technology for the development of HERZYME. The purpose of the amendment is to assess tumor localization and pharmacokinetics with several liposome formulations in conjunction with HERZYME. Archemix Corporation In May 2001, the Company announced the formation of a strategic alliance with Archemix Corporation, a Massachusetts privately held biotechnology company, that will allow both companies to capitalize on reciprocal intellectual property in the field of proteomics and molecular diagnostics. Under the terms of the agreement, Archemix received exclusive licenses and sublicenses to the Company s intellectual property covering the allosteric ribozyme technology for use in detecting proteins in connection with drug development and in a wide range of molecular detection applications. In exchange for the licenses, the Company received an equity position in Archemix, a seat on Archemix s Board of Directors and a seat on the Scientific Advisory Board. The Company accounts for its investment under the cost method. In addition, the Company received a license to Archemix s intellectual property covering allosteric ribozymes for use in molecular diagnostic applications. As of December 31, 2002, the Company no longer holds a seat on either Archemix s Board of Directors or Scientific Advisory Board. Geron Corporation In December 2001, the Company announced a collaboration with Geron Corporation, a biopharmaceutical company focused on developing and commercializing therapeutic and diagnostic products for applications in Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) oncology and regenerative medicine and research tools for drug discovery. Initially, Geron paid the Company for consultation in nucleic acid technology to improve process development, scale-up and the manufacturing process for GRN163. In July 2002, the Company announced an agreement whereby the Company will manufacture GRN163 for use in Geron s preclinical studies. Under the terms of the agreement, Geron will pay the Company approximately $2.2 million in non-refundable fees related to the process development and manufacture of GRN163. As of December 31, 2002, the Company had recognized $718,000 in revenues related to the agreement. Fujirebio In March 2002, the Company announced an agreement with Fujirebio to develop and commercialize ribozyme-based clinical diagnostic products. Under the terms of the agreement, Fujirebio will receive exclusive commercialization rights for East Asia, including Japan, for any resulting products from the collaboration. During 2002, the Company received $556,000 from Fujirebio related to the collaboration. If the programs are successful, the Company will receive licensing fees, research funding, milestone payments, and royalties as well as retain certain manufacturing rights. Recently the Company completed the first phase of its program with Fujirebio and are in the process of analyzing the results. It is uncertain at the present time if Fujirebio will continue with the collaboration. 8. Commitments and Contingencies At the core of the Company s technology are inventions and patents of the University of Colorado (CU) which were developed by Dr. Thomas R. Cech and various associates of Dr. Cech. Pursuant to the policies of CU, these inventions and the patents issued thereon, (the Cech Technology) became the property of CU. The Cech Technology was assigned to CU s affiliate, University Research Corporation (URC), which in turn assigned the rights to license certain of the Cech Technology to Competitive Technologies, Inc. (CTI), formerly known as University Patents, Inc. United States Biochemical Corporation (USB) licensed the Cech Technology pursuant to two sublicenses. One of these sublicenses was for the Cech Technology held by CTI. In November 1996, USB assigned to the Company its rights under the sublicense from CTI and the Company entered into an amended and restated license with CTI. The Company also has obtained a license from URC and a sublicense from USB for other Cech Technology held by URC. The CTI license, URC license and USB sublicense together grant the Company the exclusive (except for non-commercial academic research) worldwide right, among other things, to make, use and sell RNA enzymes covered by licensed patents and products incorporating them. The URC license and USB sublicense are fully paid. The CTI license provides for the payment of a royalty on sales of products incorporating RNA enzymes, covered by licensed patents, and for certain minimum annual royalties. The Company may grant sublicenses to the licensed technology subject to the payment to CTI of a share of royalty income from such sublicenses or a royalty on sales from sublicensed products, methods or services, depending on the particular licensed patents involved. In addition, the Company must pay CTI a share of any option fee, license fee, prepaid royalty or other front-end fee other than research and development funding paid in connection with such sublicense. At the Company s discretion, the payment may be in either cash or equity. The Company, along with one or more of its officers or directors, are defendants in several class action lawsuits brought on behalf of purchasers of the Company s common stock on November 16 and 17, 1999. The lawsuits, which are substantially identical, allege that that the Company violated certain federal securities laws based upon the Company having made an allegedly misleading announcement on November 15, 1999. On November 7, 2002, the Company announced that an agreement was reached with the plaintiffs to settle the shareholder class action lawsuit. At a hearing on March 27, 2003, the court approved the settlement as proposed and will issue an order confirming the approval shortly. The Company s liability insurance policy has agreed to cover the full amount of the settlement. 11. Employee Savings Plan The Company has a 401(k) plan that allows participants to contribute 1% to 25% of their salary, subject to eligibility requirements and annual limits. The Board may, at its sole discretion, approve matching contributions with the Company s common stock. In 2002, 2001 and 2000, the Board approved a 50% common stock match equal to total participant deferrals made in each respective year. Expense related to the stock match was Basic and diluted net loss per share $ (4.46 ) $ (3.82 ) $ (6.25 ) $ (6.87 ) 13. Subsequent Event On February 11, 2003, the Company entered into a definitive common stock and warrant purchase agreement (the Stock Purchase Agreement) with Sprout Group, Oxford Bioscience Partners IV, Venrock Associates, TVM V Life Science Ventures GmbH & Co. KG and Granite Global Ventures (the Investors) pursuant to which the Company has agreed to issue and sell and the Investors have agreed to purchase shares of the Company s common stock and five-year warrants to purchase common stock for aggregate consideration of $48 million. The purchase price will be $1.98 per share; however, the price is subject to reduction (if the Company breaches representations and warranties made in the Stock Purchase Agreement) to $1.68 per share. Based on the assumed $1.98 per share purchase price, the Company will issue to the Investors 24,242,425 shares of our common stock and warrants to purchase 5,015,152 shares of common stock exercisable at $2.52 per share. On March 7, 2003 the Company mailed a Notice of Special Meeting of Stockholders to be held on April 16, 2003 to vote on the terms of the Stock Purchase Agreement. Pursuant to the Stock Purchase Agreement, if stockholders approve the transaction, the Company and Investors will execute the Stock Purchase Agreement within a few business days of the stockholder meeting. As a result of their combined approximate 87% ownership (after giving effect to the exercise of the warrants and other stock issuances pursuant to the Stock Purchase Agreement), together with Board representation, the Investors will have control over the Company following consummation of the transactions contemplated by the Stock Purchase Agreement. The Investors will have the right to designate four of the Company s seven Board members. Consummation of the transactions is subject to a number of conditions, including, but not limited to, the approval of the Company s stockholders; appointment to the Board of the four Investor designees; adoption of an amended and restated certificate of incorporation in order to effect a reverse stock split, change the Company s Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) name, increase the number of authorized shares and adopt a provision permitting shareholder action to be taken by written consent in lieu of a meeting; the execution by the Company and its officers and consultants of non-competition and non-solicitation agreements; there not having occurred any material adverse change prior to closing; and amendment of the Company s bylaws. In connection with the execution of the Stock Purchase Agreement, the Company obtained certain waivers and amendments to the agreements with Schering AG and to the Company s agreements with Elan. Schering has agreed to restructure the Company s debt obligations to them. Among other things, Elan has agreed to convert all of the outstanding shares of the Company s Series A and Series B Preferred Stock into shares of the Company s common stock immediately prior to the closing of the transactions, to waive certain pre-emptive rights, and to waive its right to nominate a director for election to the Company s board of directors. Each of Schering and Elan granted these waivers based on the condition that the transactions are consummated without material changes from the terms that were presented to them. As one of the conditions to the Investors obligation to close, these waivers, and other consents, must be in effect at closing. 14. Unaudited Information Completion of Financing and Reverse Stock Split On April 16, 2003, the Company held a Special Meeting of the stockholders at which the stockholders approved the sale of common stock and warrants discussed in Note 13 above. Also at the meeting, the stockholders approved a one-for-six reverse stock split. All references to common stock and per share amounts in the Financial Statements and the Notes to Financial Statements have been restated to reflect the one-for-six common stock reverse split on a retroactive basis. On April 21, 2003, the Company completed the sale of 24,242,425 shares of its common stock and warrants to purchase 5,015,000 shares of its common stock to the Investors for an aggregate consideration of approximately $48 million. The common stock was sold at a price per share of $1.98 and the warrants are exercisable at any time over the five-year period measured from the date of issuance at a price per share of $2.52. With the consummation of this transaction, the Investors own approximately 87.7% (after giving effect to the exercise of the warrants issued in the private placement, but prior to giving effect to exercise of any stock options). Further, some of the Investors have the right to designate four of the Company s seven members of the Board of Directors. Deferred Patent Cost Write-Down The Company capitalizes legal costs directly incurred in pursuing patent applications as deferred patent costs and then amortizes these costs over the estimated remaining life of the patent on a straight-line method. On a quarterly basis, the Company reviews all issued patents and pending patent applications and if a determination is made to abandon a patent or a patent application, or that an issued patent or a patent application is deemed to no longer have significant economic value, the unamortized balance in deferred patent costs related to that patent is immediately expensed. On April 21, 2003, as previously discussed in Note 13, the Company completed a private placement, which resulted in a change of control for the company. The Company has also changed its business strategy which focused on development of ribozyme-based therapeutics and diagnostics to developing a new class of nucleic acid based therapeutics based on RNA interference. As a result of finalizing this change in strategic direction Table of Contents RIBOZYME PHARMACEUTICALS, INC. NOTES TO FINANCIAL STATEMENTS (Continued) during the second quarter ended June 30, 2003, the Company undertook a detailed review of its existing patent portfolio. As a result of this review, the Company has written off in the second quarter $447,000 related to abandoned patents. In addition, since the Company is no longer pursuing the development of ribozymes internally, the Company expensed approximately $4.9 million of capitalized patent costs related to this ribozyme technology. This expense will be reflected as a separate line item in the Company s statement of operations for the second quarter. Patent costs directly related to the Company s existing RNAi technology and chemistry technology relating to process development, manufacturing, stabilization and delivery of oligonucleotides continue to remain capitalized and will amortize over a shorter period due to the early stage of the Company s technology. The Company will continue to periodically review the estimated recoverability of the costs of these patents. If the Company determines that the estimated recoverability of the patent costs decreases significantly or that these patents or patent applications should be abandoned or have significantly reduced economic value, the Company will expense these costs. Due to the early stage of the technology, the Company intends to expense all future patent-related legal costs until the Company determines that the estimated recoverability of the associated legal costs is sufficiently probable, at which time such costs will be capitalized. Table of Contents REPORT OF INDEPENDENT AUDITORS To the Stockholders and Board of Directors Medizyme Pharmaceuticals, Ltd. We have audited the accompanying balance sheets of Medizyme Pharmaceuticals, Ltd. (a development stage company) as of December 31, 2000, and the related statements of operations, stockholders (deficit) equity, and cash flows for the year ended December 31, 2000. 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. We conducted our audit in accordance with auditing standards generally accepted in the United States. 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. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Medizyme Pharmaceuticals, Ltd. at December 31, 2000, and the results of its operations and its cash flows for the year ended December 31, 2000 in conformity with accounting principles generally accepted in the United States. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company has incurred significant operating losses since inception related to research, has insufficient working capital to meet budgeted cash requirements for the next year without additional financing and has a stockholders deficit. These conditions raise substantial doubt about the Company s ability to continue as a going concern. Management s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of these uncertainties. /s/ ERNST & YOUNG LLP Denver, Colorado January 23, 2003 See accompanying notes. See accompanying notes. See accompanying notes. See accompanying notes. Unaudited Interim Financial Statements Condensed balance sheet (unaudited) as of March 31, 2003 of Sirna Therapeutics, Inc. (formerly Ribozyme Pharmaceuticals, Inc.) F-1 Condensed statements of operations (unaudited) for the three-month periods ended March 31, 2002 and 2003 of Sirna Therapeutics, Inc. (formerly Ribozyme Pharmaceuticals, Inc.) F-2 Condensed statements of cashflows (unaudited) for the three-month periods ended March 31, 2002 and 2003 of Sirna Therapeutics, Inc. (formerly Ribozyme Pharmaceuticals, Inc.) F-3 Notes to condensed financial statements (unaudited) of Sirna Therapeutics, Inc. (formerly Ribozyme Pharmaceuticals, Inc.) F-4 Audited Financial Statements Report of Ernst & Young LLP F-9 Balance sheets as of December 31, 2001 and 2002 of Ribozyme Pharmaceuticals, Inc. (now known as Sirna Therapeutics, Inc.) F-10 Statements of operations for the years ended December 31, 2000, 2001 and 2002 of Ribozyme Pharmaceuticals, Inc. (now known as Sirna Therapeutics, Inc.) F-11 Statements of redeemable preferred stock and stockholders (deficit) equity of Ribozyme Pharmaceuticals, Inc. (now known as Sirna Therapeutics, Inc.) F-12 Statements of cashflows for the years ended December 31, 2000, 2001 and 2002 of Ribozyme Pharmaceuticals, Inc. (now known as Sirna Therapeutics, Inc.) F-14 Notes to financial statements of Ribozyme Pharmaceuticals, Inc. (now known as Sirna Therapeutics, Inc.) F-15 Report of Ernst & Young LLP. F-35 Balance sheets as of December 31, 2000, 2001 (unaudited) and 2002 (unaudited) of Medizyme Pharmaceuticals, Ltd. F-36 Statements of operations for the years ended December 31, 2000, 2001 (unaudited) and 2002 (unaudited) and for the period from inception to December 31, 2002 (unaudited) of Medizyme Pharmaceuticals, Ltd. F-37 Statement of stockholders (deficit) equity of Medizyme Pharmaceuticals, Ltd. F-38 Statements of cashflows for the years ended December 31, 2000, 2001 (unaudited) and 2002 (unaudited) and for the period from inception to December 31, 2002 (unaudited) of Medizyme Pharmaceuticals, Ltd. F-39 Notes to financial statements of Medizyme Pharmaceuticals, Ltd. Table of Contents MEDIZYME PHARMACEUTICALS, LTD. (A Development Stage Company) NOTES TO THE FINANCIAL STATEMENTS Information as of and for the years ended December 31, 2001 and 2002 are unaudited December 31, 2002 1. Organization and Basis of Presentation Medizyme Pharmaceuticals, Ltd. (the Company or Medizyme) was incorporated on December 21, 1999 in Bermuda. The Company is owned jointly by Elan International Services, Ltd. (EIS), a wholly-owned subsidiary of Elan Corporation plc (Elan), and Ribozyme Pharmaceuticals, Inc. (RPI), holding 19.9% (non-voting shares) and 80.1% of the shares, respectively. The primary objective of the Company is to carry on the business of the development, testing, registration, manufacturing, commercialization, and licensing of Products (as defined in the Subscription, Joint Development and Operating Agreement (JDOA) dated January 7, 2000 between Medizyme, EIS, RPI and others). The focus of the collaborative venture is to develop Products using the intellectual property of Elan, and RPI and the Medizyme technology pursuant to the JDOA. The Company s ability to continue as a going concern is entirely dependent upon the funds it receives from its shareholders in connection with the shareholders respective obligations to fund the Company s operations. The financial information at December 31, 2001 and 2002 and for the years then ended including the cumulative period from inception (December 21, 1999) to December 31, 2002 is unaudited but includes all adjustments (consisting of only normal recurring adjustments) that the Company considers necessary for a fair presentation of its financial position at such date and the operating results and cash flows for that period. Capital Requirements, Management s Plans and Basis of Presentation The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business. The Company incurred a net loss of $6,745,104 for the year ended December 31, 2002 and has an accumulated deficit of $28,434,780 at December 31, 2002. The Company relies upon funding from Elan and Ribozyme Pharmaceuticals to fund its expenses. Elan and Ribozyme Pharmaceuticals are currently in negotiations regarding the future of Medizyme and will likely cease operations during the second quarter of 2003. 2. Significant Accounting Policies The Company follows accounting principles generally accepted in the United States. Significant accounting policies are as follows: Research and Development Costs Research costs are charged as an expense of the period in which they are incurred. Development costs are deferred to future periods if certain criteria relating to future benefits are satisfied and if the costs do not exceed the expected future benefits. Use of Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the Table of Contents MEDIZYME PHARMACEUTICALS, LTD. (A Development Stage Company) NOTES TO THE FINANCIAL STATEMENTS (Continued) reported amount of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Comprehensive Income Comprehensive income (loss) approximates net loss for the period ended December 31, 2002, 2001 and 2000. 3. Related Party Transactions At the end of the period, the amount due to shareholders and companies related through common ownership represents costs for research and development that are subcontracted to RPI and Elan. Research and development expense of $1,729,069, $5,408,952 and $6,242,801 represents costs under such agreements for the years ended December 31, 2002, 2001 and 2000, respectively. These transactions are in the normal course of operations and are measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties. Further, the amount due to shareholders is unsecured, and interest free with no set terms of repayment. 4. License In January 2000, the Company paid a license fee to Elan Corporation plc in the amount of $15,000,000 to acquire rights to certain Elan technology. The licensed Elan technology, MEDIPAD , is a disposable continuous subcutaneous drug delivery device, which allows a patient to administer a drug at home. Medizyme was formed to develop multiple ribozyme based drug products targeted toward breast cancer application that used the MEDIPAD device as the drug delivery mechanism. Pursuant to the license agreement between the Company and Elan, the MEDIPAD device is intended for use in the delivery of any ribozyme drug developed by the Company targeting a gene believed responsible for certain breast cancers. In accordance with FASB 2, Accounting for Research and Development Costs, the cost of intangibles that are purchased from others for use in research and development activities and have alternative future uses (in research and development projects or otherwise) should be capitalized and amortized as intangible assets. Therefore, since the Company s license of the MEDIPAD device was intended for use with any ribozyme drug developed by the Company targeting a gene believed responsible for certain breast cancers, the license fee was capitalized in 2000 and is being amortized over the three-year term of the license agreement. 5. Shareholders Equity Preferred Shares In January 2000, the Company issued 6,000 non-voting convertible preference shares (Preferred Shares) for $1,250 per share with a par value of $1.00 each. 3,612 Preferred Shares were issued to RPI and 2,388 Preferred Shares were issued to EIS for net proceeds of $7,500,000. At any time after January 7, 2002, the holders of the Preferred Shares have the right to convert all, or a portion, of such Preferred Shares into common shares on a one-to-one basis. Upon liquidation of the Company, the holders of the Preferred Shares will be entitled to be paid out of the assets of the Company available for distribution to shareholders before any distribution or payment is made to the holders of any other classes of stock. Table of Contents MEDIZYME PHARMACEUTICALS, LTD. (A Development Stage Company) NOTES TO THE FINANCIAL STATEMENTS (Continued) Common Shares In January 2000, the Company issued 6,000 voting common shares to RPI for $1,250 per share with a par value of $1.00 each. The Company received net proceeds of $7,500,000 related to this issuance. Contributed Surplus Contributed surplus of $28,263,800, $26,142,862 and $19,220,647 at December 31, 2002, 2001 and 2000, respectively, represents the share premium of $14,988,000 on amounts initially contributed by shareholders, as well as additional amounts received from shareholders which represents capital contributions to fund the Company s operating costs. 6. Taxes Under current Bermuda law the Company is not required to pay any taxes in Bermuda on either income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that in the event of such taxes being imposed, the Company will be exempted from taxation until the year 2016. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000908754_polar_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000908754_polar_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ccfc8541a4f0dc19a42ad7972a031df6705baa1c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000908754_polar_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of Murdock common stock offered by this prospectus will be passed upon by Arenson & Zimmerman, PLC. James H. Arenson, a partner in Arenson & Zimmerman, PLC, holds $15,000 in principal amount of Polar s convertible debt and a warrant exercisable for 30,612 shares of Polar s common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000911534_trump_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000911534_trump_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0630233ac37bfaaf0468552007e15b6d5062b0b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000911534_trump_legal_matters.txt @@ -0,0 +1,2556 @@ +LEGAL MATTERS + + The validity of +the Resale Notes will be passed upon for the Issuers by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. In giving their opinion, LeBoeuf, Lamb, Greene & MacRae, +L.L.P. may rely on the opinion of Graham, Curtin & Sheridan, a Professional Association, with respect to matters relating to New Jersey law. + + + 188 + +Table of Contents + + +INDEPENDENT AUDITORS + + The financial +statements of Trump s Castle Associates, L.P. and Subsidiary and Trump Indiana, Inc., as of December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, and the financial statements of Trump Management +Services, LLC as of December 31, 2001 and for the two-month period ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, independent certified public accountants, as indicated in their report, which is +included herein. Arthur Andersen, which has ceased operations, has not consented to the inclusion of their report in this prospectus, and we have dispensed with the requirement to file their consent in reliance upon Rule 437a of the Securities Act. +Under most circumstances a registrant must obtain and file the consent of its accountants contemporaneously with the filing of any registration statement that includes audited financial statements. By granting such a consent, accounting firms become +exposed to liability under Section 11(a) of the Securities Act for any untrue statements of material fact in, or omissions of material facts from, such registration statement. Investors who bring a successful claim under Section 11(a) of the +Securities Act are entitled to recessionary damages. As a result of the criminal conviction against Arthur Andersen in connection with Enron Corporation, and the volume of civil lawsuits filed against it, Arthur Andersen may not have the ability to +withstand liability for prior audits. + + Effective June 3, 2002, +THCR Holdings appointed Ernst & Young LLP as our new independent auditors. The combined financial statements of Trump Casino Holdings, LLC as of December 31, 2002 and for the year then ended appearing in this prospectus and registration +statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting +and auditing. + + + 189 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + + +Page + + Trump Casino Holdings, LLC + + + + + Annual Financial Statements + + + + + Report of Independent Auditors + + + F-2 + + Combined Balance Sheets as of December 31, 2001 and 2002 + + + F-3 + + Combined Statements of Operations for the years ended December 31, 2000, 2001 and 2002 + + + F-4 + + Combined Statements of Capital for the years ended December 31, 2000, 2001 and 2002 + + + F-5 + + Combined Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 + + + F-6 + + Notes to Combined Financial Statements + + + F-7 + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000, 2001 and 2002 + + + F-26 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required formation is included +in the consolidated financial statements or notes thereto. + + + + + Interim Financial Statements + + + + + Condensed Consolidated Balance Sheets as of December 31, 2002 and March 31, 2003 (unaudited) + + + F-27 + + Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-28 + + Condensed Consolidated Statement of Capital for the three months ended March 31, 2003 (unaudited) + + + F-29 + + Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-30 + + Notes to Condensed Consolidated Financial Statements (unaudited) + + + F-31 + + Trump s Castle Associates, L.P. (now known as Trump Marina Associates, L.P.) and Subsidiary* + + + + + Report of Independent Auditors + + + F-36 + + Consolidated Balance Sheet as of December 31, 2001 + + + F-37 + + Consolidated Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-38 + + Consolidated Statements of Partners Capital for the years ended December 31, 2000 and 2001 + + + F-39 + + Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-40 + + Notes to Consolidated Financial Statements + + + F-41 + + Financial Statement Schedule + + + + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000 and 2001 + + + F-50 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required information is +included in the consolidated financial statements or notes thereto. + + + + + Trump Indiana, Inc.* + + + + + Report of Independent Auditors + + + F-51 + + Balance Sheet as of December 31, 2001 + + + F-52 + + Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-53 + + Statements of Capital for the years ended December 31, 2000 and 2001 + + + F-54 + + Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-55 + + Notes to Financial Statements + + + F-56 + + All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included +in the consolidated financial statements or notes thereto. + + + + + THCR Management Services, LLC* + + + + + Report of Independent Auditors + + + F-64 + + Balance Sheet as of December 31, 2001 + + + F-65 + + Statement of Operations for the two months ended December 31, 2001 + + + F-66 + + Statement of Cash Flows for the two months ended December 31, 2001 + + + F-67 + + Notes to Financial Statements + + + F-68 + +All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes +thereto. + + + + + +* + +Became a wholly-owned subsidiary of Trump Casino Holdings, LLC on March 25, 2003 pursuant to a corporate reorganization. See Note 1 to Combined Financial Statements of Trump Casino +Holdings, LLC. + + + F-1 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + Board of Directors + Trump Casino Holdings, LLC + + + We have audited the accompanying combined balance sheet of +Trump Casino Holdings, LLC as of December 31, 2002 and the related combined statements of operations, capital, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial +Statements. These financial statements and schedule are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. + + We conducted our audit in accordance with auditing standards generally +accepted in the United States. 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. + + In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Trump Casino Holdings, LLC at December 31, 2002 and the combined results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a +whole, present fairly in all material respects the information set forth therein. + + We also have audited, as to combination only, the accompanying combined balance sheet of Trump Casino Holdings, LLC as of December 31, 2001, and the related combined statements of operations, capital, and cash flows +for the two years then ended. As described in Note 1, Trump Casino Holdings, LLC was capitalized on March 25, 2003 as a holding company for three entities under common control; accordingly, its financial statements are presented as though the +combination of Trump s Castle Associates, L.P. and Subsidiary, Trump Indiana, Inc., and THCR Management Services, LLC occurred at the beginning of the period presented. We did not audit the financial statements of these three entities. Their +financial statements, which are presented separately herein, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those respective financial statements in their reports dated March 13, 2002, +which also are presented separately herein. In our opinion, these combined financial statements have been properly combined on the basis described in Note 1. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 +combined financial statements of Trump Casino Holdings, LLC, other than with respect to such combination and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements of Trump Casino +Holdings, LLC taken as whole or on the separate financial statements of any of its subsidiaries. + + /s/ ERNST & YOUNG LLP + + Philadelphia, Pennsylvania + March 25, 2003 + + + F-2 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED BALANCE SHEETS + (in thousands) + + + + +December 31, +2001 + + + +December 31, +2002 + + + + + +(See Note 1*) + + + + + +ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + + Cash and cash equivalents + + +$ +34,291 + + +$ +33,917 + + + Restricted cash + + + +4,800 + + + + + + + Trade receivables, net of allowance for doubtful accounts of $2,979 and $2,607, respectively + + + +12,984 + + + +9,872 + + + Other receivables + + + +2,342 + + + +2,884 + + + Inventories + + + +3,038 + + + +3,182 + + + Prepaid expenses and other current assets + + + +2,449 + + + +3,797 + + + Due from affiliates + + + +216 + + + +378 + + + + + + + + Total current assets + + + +60,120 + + + +54,030 + + + + + + + + PROPERTY AND EQUIPMENT + + + + + + + + + + + Land and land improvements + + + +92,379 + + + +92,379 + + + Buildings and building improvements + + + +424,031 + + + +425,027 + + + Riverboat and improvements + + + +34,159 + + + +34,239 + + + Furniture, fixtures and equipment + + + +81,897 + + + +102,014 + + + Construction in progress + + + +3,779 + + + +6,639 + + + + + + + + + + +636,245 + + + +660,298 + + + Less-Accumulated depreciation and amortization + + + +115,798 + + + +142,444 + + + + + + + + + + +520,447 + + + +517,854 + + + INVESTMENT IN BUFFINGTON HARBOR RIVERBOATS, LLC + + + +33,889 + + + +31,842 + + + OTHER ASSETS + + + +35,210 + + + +24,338 + + + + + + + + Total assets + + +$ +649,666 + + +$ +628,064 + + + + + + + +LIABILITIES AND EQUITY + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + + Current maturities of long-term debt + + +$ +12,952 + + +$ +7,712 + + + Trade accounts payable + + + +11,556 + + + +8,961 + + + Due to affiliates + + + +8,184 + + + +4,381 + + + Accrued payroll and related expenses + + + +8,017 + + + +8,597 + + + Accrued interest payable + + + +4,953 + + + +3,778 + + + Self insurance reserves + + + +3,444 + + + +2,892 + + + Other + + + +16,385 + + + +20,108 + + + + + + + + Total current liabilities + + + +65,491 + + + +56,429 + + + DUE TO (FROM) AFFILIATES-THCR HOLDINGS + + + +42,553 + + + +32,566 + + + LONG-TERM DEBT, LESS CURRENT MATURITIES + + + +464,493 + + + +487,242 + + + OTHER LONG-TERM LIABILITIES + + + +16,121 + + + +5,974 + + + + + + + + Total liabilities + + + +588,658 + + + +582,211 + + + CAPITAL + + + + + + + + + + + Contributed capital + + + +237,197 + + + +238,273 + + + Accumulated other comprehensive loss + + + +(372 +) + + +(938 +) + + Accumulated deficit + + + +(175,817 +) + + +(191,482 +) + + + + + + + Total capital + + + +61,008 + + + +45,853 + + + + + + + + Total liabilities and capital + + +$ +649,666 + + +$ +628,064 + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-3 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF OPERATIONS + (in thousands) + + + + +For the Years Ended December 31, + + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + REVENUES + + + + + + + + + + + + + + + Gaming + + +$ +386,541 + + +$ +390,104 + + +$ +410,645 + + + Rooms + + + +21,827 + + + +22,470 + + + +21,835 + + + Food and beverage + + + +36,971 + + + +35,069 + + + +35,601 + + + Management fees + + + + + + + + + + + +2,710 + + + Other + + + +11,449 + + + +12,042 + + + +12,335 + + + + + + + + + + Gross revenues + + + +456,788 + + + +459,685 + + + +483,126 + + + Less-Promotional allowances + + + +88,867 + + + +85,863 + + + +86,165 + + + + + + + + + + Net revenues + + + +367,921 + + + +373,822 + + + +396,961 + + + + + + + + + + COSTS AND EXPENSES + + + + + + + + + + + + + + + Gaming + + + +190,377 + + + +189,712 + + + +190,455 + + + Rooms + + + +6,311 + + + +5,745 + + + +6,246 + + + Food and beverage + + + +15,248 + + + +14,571 + + + +14,856 + + + General and administrative + + + +88,220 + + + +84,138 + + + +86,367 + + + General and administrative-related parties + + + +12,045 + + + +10,413 + + + +13,177 + + + Debt renegotiation costs + + + + + + + + + + + +1,629 + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + + + + + + + + + + +337,350 + + + +328,716 + + + +340,336 + + + + + + + + + + Income from operations + + + +30,571 + + + +45,106 + + + +56,625 + + + + + + + + + + NON-OPERATING INCOME (EXPENSE) + + + + + + + + + + + + + + + Interest income + + + +2,075 + + + +1,382 + + + +867 + + + Interest expense + + + +(45,993 +) + + +(48,085 +) + + +(51,361 +) + + Interest expense-related parties + + + +(16,457 +) + + +(17,600 +) + + +(19,367 +) + + Other non-operating income (expense) + + + +(218 +) + + +100 + + + +1,219 + + + + + + + + + + Non-operating expense, net + + + +(60,593 +) + + +(64,203 +) + + +(68,642 +) + + + + + + + + + Loss before income taxes and equity in loss from Buffington Harbor, LLC + + + +(30,022 +) + + +(19,097 +) + + +(12,017 +) + + Equity in loss from Buffington Harbor, LLC + + + +(3,134 +) + + +(2,808 +) + + +(2,448 +) + + Provision for income taxes + + + + + + + +(150 +) + + +(1,200 +) + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-4 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CAPITAL + (in thousands) + + + + +Contributed +Capital + + +Accumulated +Deficit + + + +Accumulated +Other +Comprehensive +Loss + + + +Total + + + + Balance at December 31, 1999 + + +$ +229,015 + +$ +(120,606 +) + +$ + + + +$ +108,409 + + + Capital contribution (See Note 1*) + + + +7,732 + + + + + + + + + + +7,732 + + + Net loss (See Note 1*) + + + + + + +(33,156 +) + + + + + + +(33,156 +) + + + + + + + + + + + Balance at December 31, 2000 (See Note 1*) + + + +236,747 + + +(153,762 +) + + + + + + +82,985 + + + Capital contribution (See Note 1*) + + + +450 + + + + + + + + + + +450 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss (See Note 1*) + + + + + + +(22,055 +) + + + + + + +(22,055 +) + + Adjustment for interest rate swap (See Note 1*) + + + + + + + + + + +(372 +) + + +(372 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(22,427 +) + + + + + + + + + + + Balance at December 31, 2001 (See Note 1*) + + + +237,197 + + +(175,817 +) + + +(372 +) + + +61,008 + + + Capital contribution + + + +1,076 + + + + + + + + + + +1,076 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss + + + + + + +(15,665 +) + + + + + + +(15,665 +) + + Adjustment for interest rate swap + + + + + + + + + + +(566 +) + + +(566 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(16,231 +) + + + + + + + + + + + Balance at December 31, 2002 + + +$ +238,273 + +$ +(191,482 +) + +$ +(938 +) + +$ +45,853 + + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + + See accompanying notes + + + F-5 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CASH FLOWS + (in thousands) + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + Adjustments to reconcile net loss to net cash flows provided by operating activities + + + + + + + + + + + + + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + Issuance of PIK debt in satisfaction of accrued interest + + + +15,188 + + + +17,368 + + + +17,805 + + + Amortization for City of Gary development agreement + + + +3,700 + + + +667 + + + + + + + Equity in loss from Buffington Harbor, LLC + + + +3,134 + + + +2,808 + + + +2,448 + + + Accretion of bond discount + + + +5,122 + + + +5,981 + + + +6,985 + + + Amortization of loan costs + + + +410 + + + +1,134 + + + +4,711 + + + Allocation of expenses from THCR Holdings + + + + + + + + + + + +1,076 + + + Provision of losses on receivables + + + +1,420 + + + +1,430 + + + +2,303 + + + Valuation allowance CRDA investments + + + +3,680 + + + +1,432 + + + +3,762 + + + (Increase) decrease in receivables + + + +(5,564 +) + + +(215 +) + + +1,903 + + + Decrease (increase) in inventories + + + +206 + + + +358 + + + +(144 +) + + (Increase) decrease in prepaid expenses and other current assets + + + +(28 +) + + +138 + + + +(1,605 +) + + (Increase) decrease in other assets + + + +(7,319 +) + + +(1,310 +) + + +1,646 + + + Decrease in due to affiliates + + + +(858 +) + + +(8,563 +) + + +(14,173 +) + + Increase (decrease) in current liabilities + + + +1,551 + + + +3,743 + + + +(5,011 +) + + Increase (decrease) in other long-term liabilities + + + +17 + + + +(7,164 +) + + +(4,711 +) + + + + + + + + + Net cash flows provided by operating activities + + + +12,652 + + + +19,889 + + + +28,936 + + + + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + + + + + + + Purchases of property and equipment, net + + + +(5,479 +) + + +(7,089 +) + + +(15,378 +) + + (Advances) repayment of note receivable + + + + + + + +(3,535 +) + + +3,535 + + + Investment in Buffington Harbor Riverboats, LLC + + + +(1,534 +) + + +(112 +) + + +(401 +) + + Purchases of CRDA investments + + + +(3,347 +) + + +(3,388 +) + + +(3,486 +) + + + + + + + + + Net cash flows used in investing activities + + + +(10,360 +) + + +(14,124 +) + + +(15,730 +) + + + + + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + + + + + + + Contributed capital + + + + + + + +450 + + + + + + + Repayment of other borrowings + + + +(7,675 +) + + +(29,118 +) + + +(91,323 +) + + Proceeds of other borrowings + + + +5,000 + + + +38,500 + + + +75,245 + + + Cost of issuing debt + + + +(290 +) + + +(4,168 +) + + +(2,302 +) + + + + + + + + + Net cash flows (used in) provided by financing activities + + + +(2,965 +) + + +5,664 + + + +(18,380 +) + + + + + + + + + Net (decrease) increase in cash and cash equivalents + + + +(673 +) + + +11,429 + + + +(5,174 +) + + CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR + + + +28,335 + + + +27,662 + + + +39,091 + + + + + + + + + + CASH AND CASH EQUIVALENTS AT END OF YEAR + + +$ +27,662 + + +$ +39,091 + + +$ +33,917 + + + + + + + + + + SUPPLEMENTAL INFORMATION: + + + + + + + + + + + + + + + Cash paid for interest + + +$ +38,921 + + +$ +39,043 + + +$ +41,452 + + + + + + + + + + Cash paid for income taxes + + +$ + + + +$ + + + +$ +75 + + + + + + + + + + Purchase of equipment under capitalized lease obligations + + +$ +4,156 + + +$ +7,293 + + +$ +8,342 + + + + + + + + + + Contribution of capital by and forgiveness of amount due to THCR Holdings + + +$ +7,732 + + +$ +450 + + +$ + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes + + + F-6 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS + + (1) Organization and Operations + + The accompanying combined financial statements include those of Trump Casino Holdings, a Delaware single member limited +liability company ( TCH ), and its subsidiary, Trump Casino Funding, Inc., a New Jersey corporation, ( TCF ). Its wholly-owned subsidiaries include (i) Trump Casino Funding, Inc.( Trump Casino Funding ), (ii) Trump +Marina Associates, L.P. ( Marina Associates ), (iii) Trump Marina, Inc., (iv) Trump Indiana, Inc. ( Trump Indiana ), (v) Trump Indiana Realty, L.L.C. and (vi) THCR Management Holdings, L.L.C. ( THCR Management +Holdings ). + + The sole member of Trump Casino Holdings is +THCR Holdings. THCR Holdings is owned approximately 63.4% by Trump Hotels & Casino Resorts, Inc. ( THCR ) as both a general and limited partner, and approximately 36.6% by Donald J. Trump as a limited partner. THCR is a publicly held +company whose common stock is traded on The New York Stock Exchange under the symbol DJT . + + On March 25, 2003, TCH was capitalized and simultaneously, Marina Associates, Trump Marina, Inc., Trump Indiana, Inc., Trump Indiana Realty, L.L.C., and +THCR Management Holdings became wholly owned subsidiaries of TCH pursuant to a corporate reorganization approved by THCR s Board of Directors. THCR Management Holdings has no operations and it owns 100% of THCR Management Services, LLC +( THCR Management ). THCR Management Holding s only asset, other than its investment in THCR Management, was $254,000 of cash which was advanced to THCR Management at December 31, 2002. As a result of this reorganization of entities +under common control, the accompanying combined financial statements present the combined financial statements of TCH as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002. + + The financial statements of (i) Trump Marina Associates, L.P. (formerly +Trump s Castle Associates, L.P.) as of December 31, 2001 and for each of the two years in the period then ended, (ii) Trump Indiana, Inc. as of December 31, 2001 and for each of the two years in the period then ended, and (iii) THCR Management +Services, LLC as of December 31, 2001 and for the two months then ended were audited by other auditors who have ceased operations. These entities constitute 100% of the combined assets of TCH at December 31, 2001 and combined revenues and combined +net loss of TCH for the years ended December 31, 2001 and 2000. + + Marina Associates owns and operates the Trump Marina Hotel Casino, ( Trump Marina ), a casino hotel located in the marina district of Atlantic City, New Jersey (the Marina District ). Trump Indiana owns and operates a +riverboat gaming facility operating in Buffington Harbor, on Lake Michigan, Indiana (the Trump Indiana Riverboat ). THCR Management Holdings is the sole member of THCR Management. THCR Management manages the day-to-day operations of Trump +29 Casino located in Coachella Valley, California (in the Palm Springs area) pursuant to a five year management agreement (the Management Agreement ) commencing on April 16, 2002, between THCR Management and the Twenty Nine Palms Band of +Luiseno Mission Indians, a federally recognized native American Tribe and the owner of Trump 29 Casino (the Tribe ). Trump Indiana Realty, LLC has no material assets or operations. + + TCH and TCF have no operations and their ability to service their debt is +dependent upon the successful operations of Trump Marina, Trump Indiana, and the management fees generated pursuant to the Trump 29 Management Agreement. + + + F-7 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS (Continued) + + + (2) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000925266_morgan_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000925266_morgan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4ddfb34d14bf8897db10ba2e936a523a0fbbecb2 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000925266_morgan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000938113_brigus_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000938113_brigus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7dc2113ec850402d4b433eab1829c1561330f2b6 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000938113_brigus_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the common shares offered hereby has been passed upon for us by Silicon Valley Law Group, San Jose, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000942307_dade_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000942307_dade_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a5a8bf2eff4a49a74d674811da5fca8c0c04e4ce --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000942307_dade_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Notes offered hereby will be passed on for us by Kirkland & Ellis, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0000944763_reable_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0000944763_reable_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9317dbdf272b73003d6cb164a8a191199db78cec --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0000944763_reable_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Winstead Sechrest & Minick P.C., Austin, Texas, will pass on the validity of the common stock offered by this prospectus for us. Brown Raysman Millstein Felder & Steiner LLP, New York, New York, has acted as counsel for the underwriters with regard to certain legal matters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001001258_asta_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001001258_asta_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3246af044f9be692965c0564dac7ef703a32d528 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001001258_asta_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters relating to this offering will be passed upon for us by Lowenstein Sandler PC, Roseland, New Jersey. The statements in this prospectus under "Risk Factors -- Government regulations may limit our ability to recover and enforce the collection of our receivables" and "Our Business -- Government Regulation" will be passed upon by Dreher Langer & Tomkies L.L.P., Columbus, Ohio, regulatory counsel to Asta. Certain legal matters relating to our common stock will be passed on for the underwriters by Pitney, Hardin, Kipp & Szuch, LLP, Florham Park, New Jersey. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001002517_nuance_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001002517_nuance_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3379c4b118a8f2ecebf5b0ae5205193c853dc30e --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001002517_nuance_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares registered hereby will be passed upon by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. Katharine A. Martin, one of our directors, is a member of Wilson, Sonsini, Goodrich & Rosati. See Certain Relationships and Securities Transactions above. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001003648_learning_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001003648_learning_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..da32341995d3190ff20156cd32cc18a25c044eb0 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001003648_learning_legal_matters.txt @@ -0,0 +1 @@ +(In thousands) 2003 $ 7,208 $ 238 2004 28,014 965 2005 27,335 934 2006 26,441 847 2007 24,765 641 Thereafter 166,779 2,632 The Closed Centers Only column in the table above represents the minimum lease payments in total for all closed centers. The Company has accrued as of January 3, 2003, $1.2 million in restructuring charges related to these lease payments. The Company expects to assign the remaining amounts to a third party or negotiate reductions with the landlord. Related Party Transactions For a discussion of related party transactions and a summary of certain other relationships involving the Company and its directors and executive officers, please see Certain Relationships and Related Party Transactions. Operational Improvements The Company continues steps to improve the profitability of its operations through pricing, more effective labor management and expense control and efforts aimed at boosting enrollment. These measures resulted in improvements in operating results for the third quarter and have resulted in additional improvements in operating results in the first and second periods of the fourth quarter. Contingencies During fiscal 2002, the Company decided not to pursue opening three new build-to-suit centers after leases for these centers had been signed with the developer of the centers. The Company was subsequently sued by the developer for breach of contract. This case was settled at the end of fiscal 2002, and a current liability was recorded on the balance sheet as of March 29, 2002 in the amount of $0.8 million, which was paid during first quarter 2003. The Company is primarily liable on approximately $1.0 million for lease assignments already negotiated in connection with certain lease terminations resulting from the fiscal 2001 restructuring program (see Note 12 of the Company s Notes to Consolidated Financial Statements unaudited). A subsidiary of the Company is primarily or contingently liable for many of the leases of Tutor Time s franchisees. In an effort to build its franchisee network, Tutor Time either leased the prospective site for a franchisee, with a subsequent sublease of the site to the franchisee, or provided a lease guarantee to the landlord for the benefit of the franchisee in exchange for a monthly lease guarantee fee payable by the franchisee that is based upon the monthly rent expense of the guaranteed lease. The payments the Company could be required to pay related to leases and guarantees aggregates $99.0 million and $15.7 million, respectively, in case of default by the franchisee. Should the Company be required to make payments under these leases, it may assume obligations for operating the center. Should the center not be economically viable, the Company will make provision for the lease termination at that time. The Company has taken over operations for a center previously operated by a franchisee as a result of a default under the franchisee s lease and intends to continue to operate this center. In addition, various legal actions and other claims are pending or could be asserted against the Company. Litigation is subject to many uncertainties; the outcome of individual litigated matters is not predictable with assurance, and it is reasonably possible that some of these matters may be decided unfavorably to the RATIO OF EARNINGS TO FIXED CHARGES The following table shows our ratios of earnings to fixed charges for the periods indicated. This information should be read in conjunction with the financial statements and the accompanying notes appearing elsewhere in this prospectus. 40 Weeks Ended Fiscal Year Ended Company. It is the opinion of management that the ultimate liability, if any, with respect to these matters will not materially affect the financial position, results of operations or cash flows of the Company. Quantitative and Qualitative Disclosure about Market Risk Market risk represents the risk of loss that may impact our consolidated financial position, results of operations or cash flow. The Company is exposed to market risk due to changes in interest rates and foreign currency exchange rates. Interest Rates. The Company has exposure to market risk for changes in interest rates related to its debt obligations. The Company does not have cash flow exposure due to rate changes on our 15% Subordinated Notes in the amount of $14 million at January 3, 2003. The Company has cash flow exposure on the revolving line of credit, with an outstanding balance of $12.6 million and its notes payable, with an outstanding balance of $3.8 million as of January 3, 2003. Accordingly, a 2% (200 basis points) change in the LIBOR rate or the prime rate would have resulted in interest expense changing by approximately $0.3 million for year to date 2003. Foreign Currency Exchange Rates. The Company s exposure to foreign currency exchange rates is limited to revenues for one company-owned center and franchise royalties for 11 franchised centers. Based upon the relative size of our foreign operations, the Company does not believe that the reasonably possible near-term change in the related exchange rate would have a material effect on its financial position, results of operations and cash flows. New Accounting Pronouncements SFAS No. 143, Accounting for Asset Retirement Obligations, was issued in August 2001, and addresses legal obligations (arising from laws, statutes, contracts, etc.) that an entity must satisfy when disposing of tangible, long-lived assets. The standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The Company is evaluating the impact this Statement will have on its consolidated financial statements and is anticipating the adoption of SFAS No. 143 in the first quarter of Fiscal 2004. SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002, was issued in April 2002, and rescinds FASB Statement No. 4, Reporting Gains and Losses from Extinguishments of Debt, and an amendment of that Statement, FASB Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This Statement also rescinds FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. This Statement amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The Company adopted this Statement during the first quarter of Fiscal 2003 which had no significant effect on the Company. SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, was issued in June 2002, and addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The Company is anticipating the adoption of SFAS No. 146 in the third quarter of Fiscal 2003. SFAS No. 147, Acquisitions of Certain Financial Institutions an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9, was issued in October 2002, and addresses FASB Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, and FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution Is Acquired in a Business Combination Accounted for by the Purchase Method, provided interpretive guidance on the application of the purchase method to acquisitions of financial institutions. Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both Statement 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with FASB Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. The Company adopted this Statement during the second quarter of Fiscal 2003 which had no significant effect on the Company. SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure an amendment of FASB Statement No. 123 (Issued 12/02), was issued in December 2002. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported. SFAS No. 148 is not expected to have a material effect on the Company s financial statements. In November 2002, the FASB released FASB Interpretation No. 45 (FIN 45), Guarantor s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others: an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34. FIN 45 establishes new disclosure and liability-recognition requirements for direct and indirect debt guarantees with specified characteristics. The initial measurement and recognition requirements of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. However, the disclosure requirements are effective for interim and annual financial statement periods ending after December 15, 2002. The Company has adopted the disclosure provisions and management does not expect the full adoption of FIN 45 to have a material impact on the Company s results of operations or financial position. On January 17, 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. The primary objective of the Interpretation is to provide guidance on the identification of, and financial reporting for, entities over which control is achieved through means other than voting rights; such entities are known as variable-interest entities. This Interpretation is effective for financial statements filed after January 31, 2003 and is not expected to have a material effect on the Company s condensed financial statements. Financial Statements and Supplementary Data The financial statements and supplementary data required for this prospectus are included in the financial statements set forth beginning on page F-1 of this prospectus. BUSINESS General Childtime Learning Centers, Inc. is one of the largest publicly traded for-profit providers of early childhood care and educational services in the United States. Childtime Learning Centers, Inc. conducts business through its wholly-owned subsidiary Childtime Childcare, Inc. and its other wholly-owned subsidiaries. The Company and its predecessors began operations in 1967. The Company operates in three business segments: Childtime Learning Centers, Tutor Time Learning Centers and Franchise Operations. The Company provides center-based educational services and child care to children between the ages of six weeks and 12 years under two distinct brand identities: Childtime Learning Centers ( Childtime ) and Tutor Time Childcare Learning Centers ( Tutor Time ). As of January 3, 2003, the Company operated a total of 467 centers system-wide under three major lines of business and had system-wide licensed capacity capable of serving over 50,000 children. The Company s three lines of business are: Childtime Learning Centers: 278 centers operated by the Company, consisting of: 266 Childtime centers and 12 Childtime-branded centers operated for third parties; Tutor Time Learning Centers: 58 Tutor Time centers operated by the Company; and Tutor Time Franchise Operations: 131 franchised Tutor Time centers. The Childtime and Tutor Time brands operate in largely distinct market segments. Tutor Time attracts a more affluent customer base with higher average incomes than the typical Childtime center. Childtime centers are, on average, smaller, less standardized in construction and appeal to parents who value a homey feel and more intimate experience for their child. Tutor Time centers are larger, more standardized in layout, and designed to appeal to parents who value a more structured educational and developmental experience. Both brands place emphasis on educational quality and content, with the Company s Curriculum Department developing proprietary content distinct to each brand. Because Tutor Time centers are typically larger than Childtime centers, they generally deliver the potential for higher economic returns per center. However, Tutor Time centers also require higher investment and are typically fitted with more expensive equipment and supplies (e.g., telephones, intercoms and security cameras in each room and children s computers). Childtime and Tutor Time corporate centers are located in the United States (in 27 states), with the exception of one Tutor Time center located in Canada. The vast majority of these centers are operated on leased premises, with typical lease terms ranging from 1 to 25 years; 51 of the Childtime centers are operated on Company-owned premises. The 12 Childtime centers the Company operates under management contracts are all located in the U.S., serving hospitals, corporations and the federal government. Under these contracts, the Company receives an annual operating fee and, in some cases, is eligible to receive incentives for improving revenues and/or managing costs. These contracts are typically up for renewal on an annual basis. Tutor Time franchise centers are also predominantly located in the U.S., with 120 centers operating in 17 states. An additional 11 centers are operated in Canada, Hong Kong, Indonesia, and the Philippines, for the most part under master franchise agreements. The Company currently guarantees leases for 66 of its franchise centers, including sites under development. The Company believes that Tutor Time is currently one of the largest franchisors of child care services based in the United States. In addition to its existing centers, the Company had 23 Tutor Time centers under development as of January 3, 2003, of which six are to be Company-operated centers and 17 are to be franchise centers. The majority of these centers are scheduled to open before June 2003, with the rest scheduled to open before June 2004. The Company acquired the assets of Tutor Time Learning Systems, Inc. on July 19, 2002, for an aggregate purchase price of approximately $22.8 million, including acquisition costs, plus the assumption of certain liabilities. The Company purchased substantially all of the operating assets and contract rights used by Tutor Time in its child care operations and, as a result, significantly increased its revenue base and the number of centers under its management. The strategic rationale for the acquisition was to improve the range of the Company s product offering and to enable the Company to enter the child care franchise business. Specifically, through the acquisition of Tutor Time, the Company acquired the ability to serve a different segment of the child care market and to broaden its prospective customer base. By catering to a more premium-priced clientele, the Company can operate and market its Tutor Time centers as a different and distinct brand. Furthermore, by operating Tutor Time as a separate brand, the Company will be able to franchise and operate this unique model, both domestically and internationally. The Company s strategy is to offer a nationally-recognized educational curriculum, within a stimulating environment in order to provide high quality child care and to maximize the development and preparation of children for school. With over 7,500 employees, the quality, skills, and motivation of our center staff is of paramount importance. The Company places a great deal of emphasis on the recruitment, selection and ongoing training of its child care center directors and area managers. Management seeks to improve both the revenue and profit performance of the Company s existing centers by placing strong emphasis on actions to increase enrollment and to manage costs. This is particularly important given the fixed-cost and labor-intensive nature of the business and its sensitivity to overall economic conditions. The Company s current initiatives include development of appropriate marketing programs, cost (particularly labor cost) management tools, high-quality training for pivotal operating roles (e.g., center directors and area managers), and multi-unit business management techniques. The Company also maintains an incentive plan that ties center director and area manager compensation directly to center performance. The Company will continue to seek opportunities to drive profitable growth. Management continues to see attractive growth opportunities in the development of new centers in the Company s core domestic corporate and franchise markets. In addition, we continue to receive strong interest from qualified parties in potentially attractive international markets. Going forward, we will consider acquisitions where there is a strong fit with the Company s existing operations, where management has confidence in the organization s ability to effectively manage the integration, and where the price can be justified on conservative expectations of future returns. The Company utilizes a 52 to 53 week fiscal year (generally comprised of 13 four-week periods), ending on the Friday closest to March 31. The fiscal years ended March 29, 2002, March 30, 2001 and March 31, 2000 all contained 52 weeks. The first quarter for fiscal 2002, 2001 and 2000 contained 16 weeks, while the remaining quarters for fiscal 2002, 2001 and 2000 each contained 12 weeks. Similarly, the first quarter of fiscal 2003 contained 16 weeks and the second quarter of fiscal 2003 contained 12 weeks. All significant inter-company transactions have been eliminated. Business Strategy The Company s business strategy is to: (1) focus on excellent operational execution and profitability for our corporate centers; (2) develop a culture of dedication to customer service and performance; (3) reinforce our value proposition to Tutor Time franchisees; (4) successfully complete the integration of Childtime s and Tutor Time s operations as quickly as possible; and (5) improve the Company s organizational leadership, institutional skills and capabilities. Management believes focus on these factors will help create value in the near-term, and re-position the company for profitable growth in the medium- to long-term. Excellent Operational Execution and Profitability for Corporate Centers Excellent operational execution for corporate centers is critical to the success of the Company. Market research shows that parents decision to enroll their child in a Childtime or Tutor Time center is based on a number of factors and typically involves an intense, focused buy decision. Parents make tradeoffs between price and perceived value, especially value in relation to our major national and local competitors, and a wide range of other options that can include nannies, home care, and frequently lower-cost locally-sponsored child care options. Happy children, satisfied parents, and positive word-of-mouth are the most critical tests of how well the Company is managing the business and its ability to capture a price premium. They are a reflection of the many factors that determine the overall quality of the program in any given center. Based on experience, the most important of these factors include: the skills and (often) the longevity of center directors and staff; the differentiation and quality of the educational offering; the condition of facilities; and the degree to which the Company is perceived as service-oriented and values-driven. The most notable areas that management is focused on to improve corporate operations are as follows: Tightened oversight of center operations by corporate and field staff with a combination of both child care and multi-unit management experience, supported by more timely, accurate and relevant data and analysis to manage the business Development of a number of modules to improve training for center directors, staff and field support personnel, not just in the areas of center management and curriculum, but also in financial management, marketing, customer service, and the technologies that can improve center and business management Development of new tools and approaches to focus center directors and area managers on the major value drivers of the business, primarily Improved marketing tools and techniques to drive enrollment, critical in a largely fixed/semi-fixed cost business New scheduling and labor management tools to optimize labor hours, by far the largest and typically the most under-managed cost item (often greater than 50% of total costs) Revised capital expenditure processes to improve oversight and effectiveness of facilities maintenance costs New performance management approaches to drive stronger ownership incentives for center directors and area managers Standardization and communication of best practice operating policies and procedures Revised recruitment practices to hire staff who have a higher likelihood of success and length of service (reduced staff turnover has the potential to save the Company millions of dollars in largely hidden costs) Ongoing focus on under-performing centers to determine the reasons for poor performance with appropriate action plans to turn around each center or remove it from the portfolio Improving the quality and differentiation of curriculum for both brands by improving content development and follow-through on curriculum delivery Improved Customer Service and Performance Culture The Company is taking steps to refocus all employees on providing timely and responsive customer service and on delivering a top-quality product to each employee s customer at all times whether that customer be children, parents, center staff, center directors, area managers, the corporate or franchise operations team, etc. This is being accomplished through dedicated customer-service training initiatives and through re-design of job descriptions, performance evaluation systems, and incentive plans. Improved Franchisee Relations and Value Proposition Franchising represents an important component of the Company s current Tutor Time business and an attractive growth option for the Company going forward. Relations with existing Tutor Time franchisees were severely strained as a result of Tutor Time Learning Systems, Inc. s financial distress and the Chapter 11 process. Repairing these relationships and earning the trust and cooperation of the franchisee community is a major priority for the Company s senior management team. To do this, the Company is focused on providing excellent support to franchisees through its franchise district management team, with additional support from key roles in the regional management structure, including the regional training managers and regional marketing support. In addition, the Education, Technology and Marketing Departments continue to take steps to improve value delivery and support. The Franchise Operations group is expanding its role to include business advisory and performance benchmarking. Successful Integration of Operations Since the acquisition of Tutor Time, management has focused on consolidating several back-office functions to its Michigan headquarters. This has included the corporate operations, finance and accounting functions, and to some degree the technology, legal, marketing, and real estate functions. Management has used the integration process to pick the best of both companies in terms of technology and accounting systems, operating policies and procedures, and management talent. Going forward, the Company will maintain an office in Florida focused mainly on franchise operations and education and training. This consolidation of operations has resulted in reduced costs while providing consistent information and services to the entire organization. Improved Organizational Leadership, Skills and Capabilities The Company has made a concerted effort to upgrade the overall level of management talent to capitalize on the growth opportunity presented with the acquisition of the Tutor Time brand. New hires include the CEO, CFO, Vice President of Human Resources, Vice President of Marketing, as well as a reorganization of and internal hires into key positions in the regional management teams. The Company also plans to hire a Chief Operating Officer as the reorganization and streamlining of operations proceeds. The new management team is focused on developing institutional skills and capabilities in critical areas to focus the organization on key value drivers including: high-impact marketing techniques to drive enrollment, labor and controllable cost management, training, curriculum development, capital expenditure management, action plans for management of under-performing centers, and overall business planning and strategy. Balance at December 31, 2001 4,469,600 $ Balance at June 30, 2002 4,469,600 $ In the years prior to the acquisition of Tutor Time, the Company had focused on expanding its Childtime brand through a number of smaller acquisitions and build-to-suit centers at the rate of approximately 30 to 40 centers per year. During fiscal 2001 and 2002, the Company shifted strategy to focus on improving the profitability of current operations, and significantly reduced the number of these smaller acquisitions. As a result, the Company closed 22 centers during fiscal 2002 (18 of which were included in its restructuring plan initiated at the end of fiscal 2001). Eight additional centers were closed by January 3, 2003, and three Tutor Time franchise centers that had reached the end of their contracted franchise terms were allowed to exit the system. With the acquisition of Tutor Time in July 2002, the Company acquired and accepted the contracts on 58 operating corporate centers, 124 operating franchise centers, and additional Tutor Time centers that were at various stages of development. In addition to the current development pipeline, the Company is actively researching new sites to add to the Tutor Time portfolio. Current plans are for a mix of franchise and corporate sites to be opened within existing franchise and corporate geographies. The Company will prioritize adding units in its existing markets in order to increase market concentration and to leverage administrative and advertising expenses. The Company continues to experience a large number of inquiries from qualified candidates interested in franchise opportunities, as well as ongoing demand from its existing base of franchisees. The majority of inquiries are for U.S.-based opportunities. The Company has also received inquiries for international opportunities, presenting an attractive long-term growth option for the Company. In choosing locations for new centers, the Company considers a number of factors, emphasizing suburban neighborhoods with growing populations of young families. Management looks for sites in proximity to newly developed or developing residential areas on heavily traveled local streets. The Company performs a detailed analysis of the demographics of the area surrounding the proposed site and focuses on several site selection criteria including: the percentage of children under age six; the population density within a three-mile radius surrounding a proposed site; and average household income. The Company also analyzes the percentage of the population consisting of college-educated, dual-income families, as well as the average home value in the target area. In addition to acquiring or building centers in residential areas, the Company had obtained contracts in the past with employers and office complex managers to operate centers in at-work locations. Historically, public agencies and hospitals have been the principal employers providing or otherwise arranging for child care services for their employees. A number of private sector employers have begun to offer this benefit, as they recognize that reduction of employee absenteeism due to a lack of reliable and available child care can significantly offset the cost to employers in offering such benefits. The Company s expansion activity is limited to child care centers in market areas showing strong growth potential and to sites which the Company believes it can conform to its standard facility and educational format. The Company utilizes prototype building designs in its build-to-suit centers. The Company continuously reviews its existing center portfolio in an effort to ensure all centers meet minimum performance standards. Centers become candidates for closure when they fail to meet certain demographic or financial criteria. Going forward, there are no assurances that the Company will be able to continue to develop or acquire new sites in a manner that will meet its requirements. Educational Programs The Company s educational programs stress the process of learning and discovery. The staff is trained to support children in their active explorations and to help them to become self-confident, independent and inquisitive learners. The Company believes in fostering all aspects of a child s development: social, emotional, physical and intellectual. The two primary means of meeting this goal are the use in each center of a nationally recognized educational curriculum and the center s ongoing dialogue with parents in providing a learning environment for their children that meets or exceeds their expectations as customers. In each Childtime center, the Company has historically utilized The Creative Curriculum For Early Childhood, a nationally recognized educational curriculum published by Teaching Strategies, Inc. and written by Diane Trister Dodge (a member of the Governing Board of the National Association for the Education of Young Children from 1990 to 1994) and Laura J. Colker. The Creative Curriculum provides a philosophy and a framework for development of appropriate curriculum, but it does not provide detailed daily lesson plans. Tutor Time centers in contrast have used an in-house proprietary curriculum developed by Dr. Victoria Folds, Tutor Time s Vice President of Education. Dr. Folds curriculum emphasizes developmentally appropriate activities, drawing on best practices from traditional, progressive and Montessori teaching approaches. As the two brands are integrated into one Company, Dr. Folds education team will continue to develop proprietary curriculum for Tutor Time, and is using the principles laid out in The Creative Curriculum to take over development of more detailed lesson plans and support materials for Childtime centers. Emphasis will be placed on keeping the materials for Childtime and Tutor Time distinct from each other and from competitor s offerings in the market. Children enrolled at a center are placed into groups according to their age. Each group has specific learning goals that enable the staff to develop planning activities and daily programs and to assess each child s growth and development. At designated times during the year, an informal developmental assessment is prepared for each child and reviewed with the child s parents. Generally speaking, the Company s classrooms under both brands are organized in seven levels following the sequential process of growth and development, from infancy through school-age: Infants (six weeks - twelve months). A homelike environment and positive caregiver interactions foster the infant s sense of trust and self-esteem. Daily routines (feeding, diapering and rocking) and sensory experiences are used to promote listening and language skills to help infants learn about the world around them. Play activities and interactions focus on the development of large muscles for sitting, crawling, standing and walking. Activities that develop small muscles for grasping, reaching, holding and picking up objects are also utilized on a routine basis. Young Toddler (1 - 2 years). Classroom space and materials are organized to support the young toddler s need to physically explore, discover and be independent. Caregivers provide comforting words and lap time to help toddlers deal with separation from parents. Toddlers are encouraged to participate in daily routines to develop self-help skills and self-esteem. Play activities with sensory experiences provide opportunities to help in the development of thinking skills, large and small muscles and assist in promoting communication skills. Stories, pictures and books are introduced to help toddlers experience reading as a pleasurable activity. Caregivers reinforce positive behaviors, set limits and are consistently available as a homebase to support the toddler s conflicting need for independence and comfort. Toddler (2 - 3 years). Classroom space and materials are organized to support the older toddler s increased need for independence in making simple decisions, engaging in pretend play and playing cooperatively with other children. Toddlers are supported in their self-help skills (dressing, feeding and toileting) and encouraged to help with daily routines in order to become familiar with the sequence of events to foster their self-esteem. Play activities provide opportunities to practice skills, increase communication about sensory experiences and promote listening and speaking skills. Indoor and outdoor activities focus on helping toddlers strengthen small muscles and aid in the development of hand-eye coordination and large muscles. Preschool 1 (3 - 4 years). Classroom space and materials are organized in distinct interest centers to support young preschoolers initiative to practice their new skills and express their ideas and feelings. These centers are set up to encourage preschoolers to select play activities, engage in hands-on exploration, participate in pretend play and develop the ability to play cooperatively. Small muscles and hand-eye coordination continue to be strengthened through art activities, sand and water play and by working with manipulative toys and blocks. The daily schedule includes many activities for large muscle development. Stories and books are used daily to increase familiarity with the meaning of letters and words (emergent literacy) and to foster reading as a pleasurable activity. Preschool 2 (4 - 5 years). Classroom organization and the daily schedule provide increased opportunities for independent and small group play in interest centers. Such group play supports older preschoolers developing ability to organize their own play, assign roles and tasks and work towards a common goal. Activities provide hands-on experiences. Caregiver interaction focuses on helping preschoolers organize the information they gather, develop an understanding of number concepts, reasoning and problem solving skills (matching, classifying and sequencing), while expanding listening and language skills. Independent and group activities with books and stories promote reading readiness. Caregivers create a print rich environment (signs, labels and charts) and provide opportunities for children to draw, paint and engage in writing activities. Children are increasingly involved in helping to set limits for positive and caring behaviors. Caregivers focus special attention in order to promote kindergarten readiness. Five Year Old or Kindergartner (5 - 6 years). Classroom organization, materials and activities support the five year-old s increased ability to understand written symbols (letters, numbers and some words) and create an interest in writing. Educational interest centers continue to provide opportunities for hands-on exploration to sharpen observation skills, explore cause and effect, share and play cooperatively with others, plan and carry out a task and engage in independent or group play for an extended period of time. Materials are provided to encourage representation, symbolic play and to practice drawing and writing. Activities are planned to help children learn to follow directions, recall and sequence events, understand measurement, recognize how materials can change, think creatively to solve problems, improve their coordination skills and use their bodies in challenging outdoor play tasks. Centers which offer a kindergarten program for transitioning children into first grade follow the local school district s specific goals and assessment requirements. School-ages (6 - 12 years). Classroom space, equipment and materials are organized to support school-agers sense of industry and competence and to accommodate the wide range of interests and abilities of six to twelve year-olds. The program provides opportunities for school-agers to pursue their interests, perfect coordination of large and small muscles and to learn to work with others. The environment is designed to engage children in activities (arts and crafts, cooking, dramatic play, music, dance, games and sports) they can pursue independently, with a friend, or as a group project. Caregiver integration focuses on helping children set reasonable goals and manageable tasks, guiding them to think about the consequences of their words and actions so as to foster a sense of community. Special time is allotted for children to complete their homework assignments. Ratio of earnings to fixed charges(1) NM NM NM NM 2.17 2.68 2.68 Through parent surveys, the Company continually assesses the quality of its education curriculum. These surveys provide the Company with feedback on parent satisfaction with their child s developmental growth and with the Company s curriculum, center director and overall quality of the center. Center directors also conduct both formal and informal parent interviews in order to ascertain parent satisfaction levels and address any concerns. Information gained from these interviews is forwarded to the Company s management for review. The Company also endeavors to provide an exit-survey to parents who stop utilizing its services. The Company continues to focus its efforts on obtaining accreditation for many of its centers by the National Association for the Education of Young Children ( NAEYC ) or the National Early Childhood Program Accreditation ( NECPA ). NAEYC and NECPA are national organizations which have established comprehensive criteria for providing quality child care. Both organizations have developed and implemented a voluntary and rigorous accreditation process through which child care providers have their programs formally evaluated by trained NAEYC or NECPA verifiers and the families served by the providers. Centers which earn such national accreditation status demonstrate a commitment to excellence by operating centers of the highest quality for the children they serve. The Company believes that the process of earning accreditation assists in the Company s efforts to continually improve its programs, training and facilities. The Company shares NAEYC s and NECPA s commitment to provide the highest quality child care and, thus, continues to pursue an aggressive accreditation schedule. Products and Services General. Subsequent to the end of fiscal 2002, the Company reorganized its corporate operations into one division with the Childtime learning center and Tutor Time learning center operations headed by a Director of Corporate Operations. The Director oversees regional teams, with each team comprised of a regional operations manager, finance manager and training manager. Reporting to the regional operations manager are area managers, with each area manager responsible for multiple learning centers. Each individual center has a dedicated center director and a staff generally ranging from 15 to 30 persons. The centers operate year-round, five days per week, generally opening at 6:30 a.m. and remaining open until 6:30 p.m. A child may be enrolled in any of a variety of program schedules, from a full-time, five-day-per-week plan to as little as two or three half-days a week. A child attending full-time typically spends approximately 9 hours a day, five days per week, at a center. The Company s current weekly tuition for full-day service typically ranges from approximately $100 to $300 depending on the location of the center, the age of the child, and whether it is a Childtime or Tutor Time center. Tuition is generally paid, in advance, on a weekly basis. The Company also charges additional registration and materials fees which vary by brand and location. The Company generally reviews its tuition rates at least once each year to determine whether rates at a particular center should be changed in light of that center s competitive environment and financial results. Our franchise operations are headed by Tutor Time s Vice President of Franchise Operations. The Vice President oversees District Franchise Managers, who in turn are the main point of contact between franchisees and the Company. The District Franchise Managers provide support and training to franchisees and their center staff, and also ensure that franchisee operations are in compliance with Company standards. Both the regional corporate operations teams and the franchise district managers can draw on additional resources within the Company to bring in expert advice on specific topics including marketing, curriculum, finance and business management, licensing, new center openings, state and federal grants, government relations, real estate and facilities management. Center Operations. Each center is managed by a director who is supervised by an area manager. The Company places a great deal of emphasis on the recruitment, selection and ongoing training of center directors. Center directors are hired by their respective area manager from a pool of candidates who have undergone an initial psychological profile screen, reference check, and criminal background check. All center directors are required by state regulations to have some minimum level of training, which is typically in the form of credit hours from a state approved training agency or an accredited educational institution. The Company prefers that potential directors have a bachelor s degree in early childhood education, child development or a health-related field plus a minimum of two years experience in licensed child care. Many directors are recruited from within the Company and have served as caregivers or assistant directors in one of the Company s centers. A center director has overall responsibility for the operations of a center including: ensuring that the center is operated in accordance with Company and state licensing standards and operating procedures; providing an educational, caring and safe environment for children and their parents; marketing the Company to parents and otherwise promoting the positive image of the Company in the community. The center directors receive a salary and bonus tied to the financial and operating performance of their center. Each center director is also responsible for hiring his or her staff, including caregivers. The center director assesses and collects tuition and fees. All funds received by each center are deposited in an account established by the Company in a local bank. All payroll and most other center expenses are paid directly by the Company s corporate office. Basic supplies are purchased by the centers pursuant to national vendor contracts negotiated by the corporate office to take advantage of volume buying discounts and to retain financial controls. Direct expenditures by the centers are limited to miscellaneous operating expenses. Area Supervision. An area manager hires the director of each of his or her centers and is supervised by a regional manager. Area managers also work very closely with other corporate staff members, such as the Vice President Human Resources, Director of Real Estate, Vice President Marketing, Corporate Controller or General Counsel, on such issues as center acquisition and marketing, personnel actions and financial planning. Additional duties of area managers are to facilitate communications between center directors and the corporate office, as well as among center directors, and to monitor cost control and revenue generation efforts and licensing compliance. Area managers typically spend 80% of their work time in the centers they supervise. Area managers receive a salary and bonus tied to the financial and operating performance of the centers under their supervision. Training. The Company believes that the skills and expertise of the director and staff at each center are among the most significant factors for parents selecting center-based child care programs. In order to enhance the quality of the staff at each center, the Company provides both externally and internally developed training programs for its personnel. It has developed training materials and manuals for its staff and conducts seminars for its area managers and directors on such subjects as interpersonal and business skills, basic financial concepts and marketing. All management personnel (including area managers, center directors and assistant directors) participate in periodic training programs or meetings and must comply with applicable state and local licensing regulations. Center staff is required to participate in orientation and training sessions. The Company is organized for its operations into regions, each of which has an on-site regional training manager to assist in the development and implementation of its training programs. These training programs are designed to prepare and enhance the skills of its caregivers to meet the Company s internal standards and applicable state licensing requirements. All new center directors are required to attend a one-week training course held at their respective region office within four weeks of their hire date. Safety. The Company is committed to the health and safety of the children in its care. To prevent unauthorized persons from entering the center, substantially all centers are equipped with front door security systems requiring card keys, security codes, or other forms of access control. In addition, most centers use a double door entrance and have a centrally monitored security system to protect the center after hours. Each day, children must be signed in and out by parents, legal guardians or an authorized designee of the parent or guardian. All centers have at least one staff member trained in first aid and CPR. Center staff members are trained to detect child neglect and abuse, and are required by law and company policy to immediately report all suspected instances. In the rare event that an employee is accused of child neglect or abuse, it is the Company s policy to place the employee on administrative leave pending the results of an independent state agency investigation, in which the Company cooperates fully. No assurances can be made that allegations of child neglect or abuse will not be made in the future. However, allegations of child neglect or abuse against an employee are rare, and in most cases, covered by the Company s general liability insurance. Since these incidents fall within the insurance policy limits, it is the Company s position that such occurrences will not materially affect the financial position, results of operations, or cash flow of the Company. Acquisitions of franchises: Goodwill recorded $ $ 852 Fair value of assets acquired PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY The following table sets forth the high and low sales prices of the Company s common stock for the periods indicated, as reported on The Nasdaq National Market System through April 4, 2003, and the high and low bid prices as reported on The Nasdaq SmallCap Market beginning October 11, 2002. These quotations represent prices between dealers and do not include retail mark-ups, mark-downs or other fees or commissions and may not represent actual transactions. Prices The Company maintains general liability insurance and appropriate umbrella policies in adequate amounts, as described under Insurance . Financial Planning; Budgeting and Cost Control. The Company has implemented a program of financial planning and cost control which seeks to maximize operational profit without sacrificing quality child care. This goal is accomplished by actively engaging the area manager and center director in the formulation and implementation of the budget for each center. The Company s operations are organized into regions, each of which includes an on-site regional finance manager. The regional finance manager is responsible for assisting the director and area manager in the budgeting process along with other financial functions. Directors are then responsible for implementing the approved budget and become primarily responsible for the financial performance of the center. In order to encourage profitable performance, the Company has implemented a financial incentive program for meeting or exceeding pre-approved budget goals. Facilities. Most of the Company s centers are freestanding structures leased or owned by the Company. The Company utilizes prototype buildings designed specifically for each state emphasizing energy efficiencies, lower maintenance costs and enhanced appearance. Depending on the state, these prototype designs for Childtime centers generally contain between 7,900 to 9,000 square feet in a one story, air-conditioned building; Tutor Time centers are typically larger with prototype centers averaging over 10,000 square feet. The interiors primarily consist of closed classrooms bordering a central hallway. Such a design accommodates the desire to allow children the freedom to explore their environment as well as the staff s need to be able to monitor activities in the classroom. The Company s centers contain classrooms, recreational areas, a kitchen and bathroom facilities and are designed to accommodate the grouping of children by age or development level. Two unique features of Tutor Time centers are the Tutor Towne Village and self-contained classrooms. The Tutor Towne Village is a common room outfitted with a post office, firehouse, and other facades that create a play and learning environment imitating a small town. Use of the room is purposefully integrated into the Tutor Time curriculum in a way that enables staff to teach children through guided socio-dramatic play. Classrooms are self-contained in that each classroom is designed to have its own areas for play, learning, eating, crafts and diaper changing so that teachers and children do not need to leave the room, except for other special activities such as use of playgrounds or the Tutor Towne Village . Childtime centers do not have the same level of standardization of features due to the varying age of centers and the fact that many were acquired. However, most centers have unique and appealing features in line with the educational and developmental philosophy of the Company. Room materials are chosen for their educational value, quality and versatility. The infant/ young toddler room features separate, sanitary diaper changing areas. Each facility has a playground designed to accommodate the full range of children attending the center, including an area specifically for toddlers. The playground is fenced in for security and organized to provide adequate supervision for every age group. Each center is equipped with a variety of audio-visual aids, educational supplies, games, toys, indoor and outdoor play equipment. In addition, most Tutor Time centers and some Childtime centers are equipped with personal computers and software designed for preschool and school age children. Tutor Time centers typically are equipped with security cameras and phones in each classroom. Virtually all of the centers are also equipped with vehicles for the transportation of children to and from elementary schools and for field trips. Van drivers carry cellular telephones in the event of a break down while on the road. As of January 3, 2003, the Company operated 324 Company-owned centers and franchised 131 centers. Aggregate licensed capacity for these centers was over 50,000 children. The capacity of centers differs from state to state because of various licensing requirements. Management Contracts. As of January 3, 2003, the Company also had contracts to manage 12 child care centers. Many of these centers are located on or near the premises of a specific employer and involve varying degrees of involvement from the employer, such as ownership of the premises, minimum enrollment guarantees, the assumption of financial responsibility for the ongoing operations of the center, other management arrangements, or any combination of the above. Historically, public agencies and hospitals have been the principal employers providing or otherwise arranging for child care services for their employees. Fiscal Quarter High Low Marketing The Company believes that the quality of a center s director, staff, center location, and consistent localized advertising and marketing are the key components to a successful center. The Company relies heavily on recommendations from current customers as a source of new enrollments. To encourage recommendations, the Company offers a referral bonus to parents and employees of the Company who successfully recommend the Company s services to others. In addition, the Company advertises through a variety of database direct marketing programs that target parents within a specified radius of each center. The Company also advertises through direct mail distribution of promotional material in residential areas surrounding a center and through listings in the Yellow Pages (directory-based and online) and maintains an internet web site. The Company will continue to promote its safe, secure facilities along with its respected curriculum and qualified staff through direct marketing campaigns timed around peak enrollment periods or to support specified programs. Seasonality Generally, the Company s accounting periods are organized into 13 four-week periods, with 4 four-week periods comprising the first fiscal quarter and 3 four-week periods comprising each of the second, third and fourth fiscal quarters. Consequently, the Company s revenues, gross profit and operating results for the first quarter are favorably impacted by the additional four weeks included in that quarter. Periodically, due to the Company s closing the fiscal year on the Friday closest to March 31, the Company will have a five-week period in the thirteenth period of its fiscal year. Due to the impact of summer vacation, in July and August of each year (the last month of the Company s first fiscal quarter and the first month of the Company s second fiscal quarter), the Company has historically experienced an enrollment decline. In addition, the Company typically experiences revenue declines in the months of November and December due to the impact of several major holidays. To partially offset these declines, the Company has successfully implemented and marketed both a summer camp program with a new theme and focus each year, as well as a December holiday camp. New enrollments are generally highest in September and January; accordingly, August and December are traditionally the best months to open new centers. However, with the exception of spring, the Company has demonstrated an ability to successfully open centers throughout the year because of enhanced pre-opening marketing efforts. Total enrollments (and, accordingly, the Company s results) are typically the strongest in the fourth quarter (which include the months of January, February and March). Competition The child care and preschool education industry is highly fragmented and competitive and has historically been dominated by small, local nursery schools and child care centers. The Company s competition consists principally of local nursery schools and child care centers (some of which are non-profit, including church-affiliated centers), providers of services that operate out of homes, and other proprietary multi-unit child care center providers, some of which are larger and may have substantially greater financial resources than the Company. Among the larger providers of for-profit child care and preschool education are KinderCare Learning Centers, Inc., La Petite Academy, Inc., Aramark/ Children s World, and Knowledge Universe, Inc. Bright Horizons Family Solutions, Inc. is the largest competitor in the at-work/management contract segment. Major competitors in the franchise segment include Goddard Schools, Primrose Schools, and Kiddie Academy. The Company believes it is able to compete favorably with these providers by offering a high quality level of child care services. This is especially true in competing against local nursery schools, child care centers and in-home providers where the Company is often at a price disadvantage, because these providers generally charge less for their services than the Company charges. Many church-affiliated and other non-profit child care centers have lower occupancy costs, than the Company and may receive donations or other funding to cover operating expenses. Consequently, operators of such centers may charge tuition rates that are less than the Company s rates. In addition, fees for home-based and not-for-profit care are normally lower than fees for William D. Davis 53 President and Chief Executive Officer and Director Frank M. Jerneycic 54 Chief Financial Officer and Treasurer Melanie de Vries 39 Vice President of Marketing Thomas G. Horton 40 Vice President and Interim Chief Operating Officer Scott W. Smith 45 Vice President of Human Resources Ira L. Young 43 Secretary and General Counsel Benjamin R. Jacobson 58 Chairman of the Board Jason K. Feld(b) 49 Director Paula L. Gavin(a)(b) 57 Director Kenneth Johnsson 51 Director George A. Kellner(a) 60 Director James J. Morgan(a) 60 Director Brett D. Shevack(b) center-based care, because these providers are not regulated and, thus, not required to satisfy the same health, safety, insurance or state regulations as the Company s centers. The Company competes by hiring and training quality center directors and by offering professionally-planned educational and recreational programs, well-equipped facilities, and trained staff and supervisory personnel. In addition, the Company also provides a range of enrichment programs, including foreign language, dance, music and karate. The Company also provides drop in service, and the transportation between the Company s child care centers and schools of children enrolled in the Company s before and after school program. Personnel As of January 3, 2003, the Company employed more than 7,500 persons (including part-time and substitute caregivers), of which 90 are employed at corporate headquarters in Michigan and in Florida, 16 are employed at the 5 regional offices and 33 are employed as area managers or franchise district managers. The remainder are employed at the Company s child care centers. Center employees include center directors, assistant directors, full-time and part-time teachers, caregivers, substitute caregivers, aides and other staff, including cooks and van drivers. All center directors, regional managers, area managers and most corporate supervisory personnel are salaried; all other employees are paid on an hourly basis. The Company does not have an agreement with any labor union and believes that its relations with its employees are good. The Company is also subject to the Fair Labor Standards Act, which governs minimum wages, overtime compensation and working conditions. A portion of the Company s personnel (estimated to be less than 1% as a percentage of total payroll expense) are paid at the federal minimum wage. Regulation Child care centers are subject to numerous state and local regulations and detailed state licensing requirements. Although these regulations vary from jurisdiction to jurisdiction, government agencies generally review, among other things, the adequacy of buildings and equipment, licensed capacity, the ratio of staff to children, staff training, record keeping, the dietary program, the daily curriculum and health and safety standards. In most jurisdictions, these agencies conduct scheduled and unscheduled inspections of centers, and licenses must be renewed periodically. In a few jurisdictions, new legislation or regulations have been enacted or are being considered which establish requirements for employee background checks or other clearance procedures for new employees of child care centers. Repeated failures by a center to comply with applicable regulations can subject it to state sanctions, which might include fines, corrective orders, being placed on probation or, in more serious cases, suspension or revocation of the center s license to operate. Management believes the Company is in substantial compliance with all material regulations applicable to its business. For the fiscal year ended March 29, 2002 and the first three quarters of fiscal year 2003 ended January 3, 2003, approximately 22% and 24%, respectively, of the Company s revenues were generated from federal and state child care assistance programs, primarily the Child Care and Development Block Grant and At-Risk Programs. These programs are typically designed to assist low-income families with child care expenses and are administered through various state agencies. Although no federal license is required at this time, there are minimum standards that must be met to qualify for participation in certain federal programs. There is no assurance that funding for such federal and state programs will continue at current levels and a significant reduction in such funding may have an adverse impact on the Company. There are certain tax incentives for parents utilizing child care programs. Section 21 of the Internal Revenue Code provides a federal income tax credit ranging from 20% to 30% of certain child care expenses for qualifying individuals (as defined therein). The fees paid to the Company for child care services by eligible taxpayers qualify for the tax credit, subject to the limitations of Section 21. In 2002, the amount of the qualifying child care expenses was limited to $2,400 for one child and $4,800 for two or more children. Therefore, the maximum credit ranged from $480 to $720 for one child and from $960 to $1,440 for two or more children. For 2003, the tax credit currently ranges from 20% to 35% of qualifying child care expenses and is limited to $3,000 for one child and $6,000 for two or more children. Therefore, the maximum credits ranges Arizona 22 0 15 California 34 5 24 Connecticut 0 2 5 Delaware 0 1 1 Florida 12 2 13 Georgia 15 0 2 Illinois 6 8 2 Indiana 0 0 1 Iowa 3 0 0 Kansas 0 2 0 Maryland/DC 14 0 0 Massachusetts 0 1 0 Michigan 18 16 1 Minnesota 0 0 8 Mississippi 1 0 0 Missouri 4 0 3 Nevada 7 0 0 New Jersey 6 2 8 New Mexico 1 0 0 * Includes 3 U.S. Government operating contracts with indefinite terms The Company currently leases its corporate offices in Farmington Hills, Michigan. This lease expired at December 31, 2002 and is being extended on a monthly basis through May 2003, at which time the headquarters will relocate to a new office space, consisting of approximately 20,000 square feet, in the same general metropolitan area. Legal Proceedings The Company is involved from time to time in routine litigation arising out of the ordinary course of its business, most of which is covered by general liability insurance. In management s opinion, none of the litigation in which the Company is currently involved will have a material effect on its financial condition, results of operations, or cash flows. (a) member of Compensation Committee (b) member of Audit Committee William D. Davis has served as the President and Chief Executive Officer of the Company since July 22, 2002, and as a Director since August 2002. Mr. Davis was formerly President and Chief Executive Officer of Tutor Time Learning Systems, Inc., from March 2002 until the Company s acquisition of Tutor Time in July 2002. Tutor Time filed Chapter 11 bankruptcy in May 2002. Prior to joining Tutor Time, Mr. Davis served as Chief Executive Officer of Waterbury Holdings, a holding company located in Burlington, Vermont, from March 1995 through January 1998. During his association with Waterbury Holdings, Mr. Davis held the position of Partner and Chief Executive Officer of Waterbury s affiliates, including McKenzie LLC, All Season s Kitchen LLC, Franklin County Cheese Corporation, Waterbury Fresh Foods LLC, Rondele LLC, and Frank Hahn Incorporated. In December 1998, Mr. Davis, along with other investors, purchased Rondele Foods LLC from Waterbury Holdings, and he became Chairman of the newly-formed company, Rondele Specialty Foods, based in Wausau, Wisconsin. Mr. Davis also served as the President and Chief Executive Officer of ChefExpress.Net Inc., an Internet-based virtual warehouse providing ingredients and specialty food, from January 2000 through June 2001. Mr. Davis is also a board member of Green Mountain Coffee Roasters Inc., where he serves as Chairman of the Audit Committee. Frank M. Jerneycic has served as the Chief Financial Officer and Treasurer since August 30, 2002. Mr. Jerneycic has served for the past six years as the Senior Vice President and Chief Financial Officer of Decision Consultants, Inc., a software services company located in Southfield, Michigan. Melanie de Vries has served as Vice President of Marketing since January 2003. Prior to joining the Company, Ms. de Vries spent a year and a half as the Senior Marketing officer for ForeSee Results, a start-up website measurement services company. Prior to that, Ms. de Vries spent seven years with Deloitte Touche LLP, where she served as the National Director of Marketing and Public Relations for the firm s Manufacturing Practice, National Director of Public Relations and Communications for Deloitte Consulting, and Director of Marketing for the Deloitte Touche Michigan Practice. Ms. de Vries holds a BA from the University of Michigan. Thomas G. Horton has served in the capacity of a Vice President and Interim Chief Operating Officer of the Company since September 2002. He previously served as a consultant and Director of Special Projects for the Company from July 2002 to September 2002 after having held the same position with Tutor Time Learning Systems, Inc., from March 2002 until the Company s acquisition of Tutor Time in July 2002. Mr. Horton was an engagement manager and later an associate principal with McKinsey Company in Montreal, Canada and Stamford, Connecticut from September 1995 to December 2001. Scott W. Smith has served as Vice President of Human Resources since May 1, 2002. Prior to joining Childtime, Mr. Smith was the Vice President of Human Resources for Glotel, PLC, a human capital solutions provider located in London, England, where he had responsibility for the startup of the Human Resources Department. Prior to that, Mr. Smith worked for Kelly Services, a temporary employment placement firm located in Troy, Michigan, for eight years, most recently serving as the Vice President of Human Resources. Mr. Smith holds a BS from Central Michigan University. Ira L. Young has served as General Counsel and Secretary of the Company since July 22, 2002. Prior to assuming this position with the Company, Mr. Young served as General Counsel of Tutor Time Learning Systems, Inc. from February 1999 and Corporate Secretary of Tutor Time from June 1999. Mr. Young joined Tutor Time as Litigation Counsel in March 1998, having previously served as an associate attorney with Mandel, Weisman Kirschner, of Boca Raton, Florida, since 1993. Benjamin R. Jacobson has served as a Director of the Company since February 1996 and as the Company s Chairman of the Board since December 2002. Since 1989, he has been the managing general partner of Jacobson Partners, a New York City based investment-banking partnership. Mr. Jacobson also serves as a board member for several privately held companies. Dr. Jason K. Feld has served as a Director of the Company since February 1996 and has been a Vice President of Assessment Technology Incorporated since 1986. Assessment Technology Incorporated is a private Tucson, Arizona based corporation that creates, distributes and supports the use of technology to promote learning and documents the effectiveness of educational programs on children. In addition to his past service as a faculty member at the University of Arizona, Dr. Feld has served on boards and committees for educational organizations. His work has been published in books, technical reports and research articles. Paula L. Gavin has served as a Director of the Company since October 2002 and is the President and Chief Executive Officer of the YMCA of Greater New York. While serving in that capacity, she has been responsible for the management and development of 20 branches and 200 YMCA program locations in New York City since 1990. Prior to that, Ms. Gavin was Vice President of Network Operations at AT T, where her responsibilities included business planning, finance, personnel and training for AT T s operations unit. Kenneth Johnsson has served as a Director of the Company since October 2002 and is a Tutor Time franchisee currently responsible for the operation of three Tutor Time centers. Prior to opening his first franchise, Mr. Johnsson held various sales and management positions with Strauss Paper Company located in Port Chester, New York. George A. Kellner has been a director of the Company since November 1995 and the Company s Chairman of the Board from November 1995 until August 2001 and served as a director of the Company s predecessor from July 1990 to November 1995. Since August 2001, Mr. Kellner has served as the Company s Vice Chairman of the Board. Mr. Kellner is Chief Executive Officer of Kellner, DiLeo Co., a private New York City based firm specializing in merger and convertible arbitrage, distressed and high-yield investing and special situations. Kellner, DiLeo Co. is a member firm of the New York and American Stock Exchanges. Mr. Kellner is a Trustee of Milton Academy and Bard College, Vice Chairman of Phoenix House, a member of the Board of Overseers at the NYU Stern School of Business, a member of the Advisory Council of the Department of Economics at Princeton University and a member of the Dormitory Authority of the State of New York. James J. Morgan has been a Director of the Company since January 2001. He has also served as the Interim President and Chief Executive Officer of the Company from January 2001 until August 2001 and again from March 2002 until July 22, 2002. Mr. Morgan has also served as the Company s Chairman of the Board from August 2001 until December 2002. Since January 2002, Mr. Morgan has been a partner of Jacobson Partners, having previously acted as an investor in Jacobson Partners performing consulting assignments for that entity. Benjamin Jacobson, the current Chairman of the Board of the Company, is the managing general partner of Jacobson Partners. Mr. Morgan retired in 1997 as President and Chief Executive Officer of Philip Morris Incorporated. Mr. Morgan also serves as a Director of Bertucci s Corporation, a full-service, casual dining, Italian restaurant chain headquartered in Maynard, Massachusetts and Conforma Clad, Inc., a manufacturer of specialized bearings and other industrial components located in New Albany, Indiana. Brett D. Shevack has served as a Director of the Company since October 2002 and is the Vice President of BBDO Worldwide, a premier global advertising agency. Prior to joining BBDO, Mr. Shevack was the President of the Wolf Group, an integrated advertising agency which acquired Partners Shevack, an agency founded by Mr. Shevack, in 1998. Board Compensation For the fiscal year ended March 28, 2003, the standard arrangement for compensation of directors was as follows: officers of the Company who were directors (including the non-executive Chairman of the Board) did not receive any additional compensation for services as a director. Directors who were not employees of the Company received directors fees of $4,000 per year, paid in quarterly installments, $1,500 for each Board meeting attended and $250 for each Committee meeting attended. Prior to October, 2002, the standard arrangement for compensation of directors provided for annual directors fees of $6,000 and per meeting fees of $500. Directors who are not employees of the Company are also participants in the Company s Director Stock Option Plan. Pursuant to such plan, options to purchase 2,500 shares are granted to each non-employee director, subject to availability, at each annual meeting at which they are elected or remain in office. Options for up to 75,000 shares are available for grant under the Director Stock Option Plan, each of which becomes fully vested and exercisable on the first anniversary of the date of grant. The exercise price of options granted under the Plan will equal the market price of the Common Stock at the time of grant. On October 16, 2002, as an inducement to their acceptance of their appointment to the Company s Board of Directors, each of Paula L. Gavin, Kenneth Johnsson and Brett D. Shevack were granted options to purchase 2,500 shares of the Company s common stock at $1.50 per share (the price per share, as reported on The Nasdaq SmallCap Market, at the close of business on such date). The options vest on the first anniversary of the grant date and expire in October 2007. Board Committees The Board of Directors of the Company currently has an Audit Committee and a Compensation Committee. The Board of Directors does not have a separate nominating committee. The duties of the Compensation Committee include recommending to the entire Board of Directors of the Company the compensation arrangements for senior management and directors of the Company and administration of the 1995 Stock Incentive Plan For Key Employees. During fiscal 2003, the Compensation Committee held one meeting. The current members of the Compensation Committee are Paula L. Gavin, James J. Morgan and George A. Kellner. Mr. Morgan is the Chairman of the Compensation Committee. The duties of the Audit Committee include reviewing the services provided by the Company s independent auditors, consulting with such auditors on audits and proposed audits, reviewing the need for internal auditing procedures and the adequacy of internal controls. During fiscal 2003, the Audit Committee held four meetings. The current members of the Audit Committee are Jason K. Feld, Paula L. Gavin and Brett D. Shevack. Mrs. Gavin is the Chairperson of the Audit Committee. (1) Represents relocation expenses reimbursed by the Company. (2) Appointment as interim officer, and related compensation, was pursuant to a consulting arrangement with the Company (see Consulting Agreements below). (3) Effective July 22, 2002, Mr. Morgan ceased serving as the Company s Interim President and Chief Executive Officer. (4) Includes option for 60,000 shares granted during fiscal 2001, with respect to which the expiration date was extended during fiscal 2002. (5) Includes compensation expense related to stock options granted below market price. (6) Effective August 30, 2002, Mr. Tylka ceased serving as the Company s Interim Chief Financial Officer and Treasurer. (7) Includes compensation expense related to stock options granted to Mr. Tylka on September 1, 2001. (8) Effective March 26, 2003, Ms. Danner ceased serving as the Company s Vice President of Corporate Operations. Discontinued operations before income tax (367 ) 11 161 Income tax (benefit) (136 ) 4 William D. Davis 0 85,000/150,000 / Frank M. Jerneycic 0 0/50,000 / Scott W. Smith 0 0/5,000 / James J. Morgan 0 110,000/0 / Leonard Tylka 0 26,600/3,400 / Karen R. Danner 0 0/0 / Incentive Bonus Plan During fiscal 2003, each of the executive officers of the Company, other than James J. Morgan and Leonard C. Tylka, participated in the Company s Standard Incentive Plan which would entitle the executive officers to receive a bonus upon the Company achieving certain earnings goals during fiscal 2003. These bonus arrangements were structured by the Company s Compensation Committee during fiscal 2003. The Company has not yet determined whether it achieved the objectives of the incentive formula and, accordingly, with respect to fiscal 2003, no bonuses have been paid to the Company s executive officers as of the date hereof. Consulting Agreements In January 2001, the Company entered into consulting agreements with each of James J. Morgan and Leonard C. Tylka. The agreement with Mr. Morgan has a six-month term starting January 16, 2001, unless mutually extended by the Company and Mr. Morgan. During the term, Mr. Morgan functioned as a consultant until January 29, 2001, at which time he was appointed Interim Chief Executive Officer and President of the Company. As compensation for his services, Mr. Morgan was to receive a $15,000 per month consulting fee, reimbursement of reasonable business expenses, and options to purchase 60,000 shares of the Company s common stock, at an exercise price of $7.00 per share. The options had a two-year term and vested at the rate of 10,000 shares per month, with the first 10,000 shares vesting on January 29, 2001. Pursuant to the consulting agreement, Mr. Morgan was appointed to the Board of Directors effective January 29, 2001, which appointment would continue after termination of his role as Interim Chief Executive Officer. In July 2001, the Company entered into a new consulting agreement with Mr. Morgan. Pursuant to the new arrangement, Mr. Morgan was appointed the Company s Chairman of the Board and ceased serving as Interim Chief Executive Officer and President, effective August 2001. As compensation for his services, Mr. Morgan received a $7,500 per month consulting fee, reimbursement of reasonable business expenses, and options to purchase 50,000 shares of the Company s common stock, at an exercise price of $11.00 per share. The options vest one year from the date of grant and expire September 2006. The options automatically vest upon a change of control of the Company. In addition, the expiration date for the previously granted option to acquire 60,000 shares of the Company s common stock was extended to September 2006. In March 2002, Mr. Morgan was reappointed as the Company s Interim Chief Executive Officer and President, positions he filled until July 22, 2002. Mr. Morgan s consulting arrangement ended in November 2002. Pursuant to the consulting agreement with Mr. Tylka, Mr. Tylka was appointed as the Company s Interim Chief Financial Officer effective as of January 29, 2001. For his services, Mr. Tylka was to receive an annual consulting fee in the amount of $150,000, payable monthly in arrears, and reimbursement of reasonable business expenses. Mr. Tylka s engagement as consultant was to continue until terminated by the Company s Chairman of the Board upon sixty days prior written notice. This consulting agreement replaced the consulting agreement with Mr. Tylka, entered into in May 1997, which provided Mr. Tylka with annual consulting fees of $25,000. In February 2002, the Company entered into a new consulting agreement with Mr. Tylka, extending his appointment as the Company s Interim Chief Financial Officer until June 30, 2002. Since June 30, 2002, Mr. Tylka s consulting arrangement had been extended on a month-to month basis until November 2002. For his services, Mr. Tylka received an annual consulting fee in the amount of $175,000, payable monthly in arrears, and reimbursement of reasonable business expenses. Mr. Tylka received a $10,000 severance payment from the Company upon the termination of his consulting arrangement. In connection with his consulting arrangement, in March 2001, Mr. Tylka was granted options to purchase 10,000 shares of the Company s common stock at a price of $7.97 per share. These options vest evenly over 3 years and expire in March 2007. In September 2001, Mr. Tylka was granted additional options to purchase 20,000 shares at $11.00 per share. These additional shares vest in September 2002 and expire in September 2006. Mr. Tylka s options automatically vest upon a change of control of the Company. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS In July 2000, the Company retained Jacobson Partners, of which Benjamin R. Jacobson, the Chairman of the Board of the Company, is the managing general partner, James J. Morgan, a director and former Chairman of the Board and Interim Chief Executive Officer of the Company, is a partner, and George A. Kellner, the Company s Vice Chairman of the Board, is a special advisor, to provide management and financial consulting services. As consideration for the provision of such services to the Company and its Board of Directors, Jacobson Partners is entitled to receive an annual fee of $250,000, plus reimbursement of reasonable out-of-pocket expenses. The agreement will continue in effect until terminated by either party upon six months prior written notice. As additional consideration for its services, the Company granted to Jacobson Partners, and its designees, two options to acquire, in the aggregate, up to 557,275 shares of the Company s common stock. As of March 29, 2002, options for 294,117 shares were exercised at a cost of $2,500,000. The options to acquire the remaining 263,158 shares expired July 2002. In addition, the 294,117 shares acquired by Jacobson Partners and its designees are subject to registration rights until July 2007. As part of its agreement with the Company, Jacobson Partners agreed that, until July 2002, neither it nor its designees would acquire additional shares of the Company s common stock (whether in the open market or in private transactions) (i) having an aggregate purchase price in excess of $2,500,000 or (ii) at the same time the Company would be engaged in a share repurchase agreement. During that two-year period, pursuant to a separate agreement with Childcare Associates and KD Partners II (Company shareholders controlled by Mr. Kellner), Jacobson Partners and its designees had the right to acquire Company shares owned by such entities to the extent investors in such entities wish to have their pro rata interest in the Company s common stock sold; provided that any shares so purchased by Jacobson Partners and its designees would be subject to an irrevocable voting proxy in favor of Mr. Kellner. All shares of the Common Stock acquired by Jacobson Partners and its designees during the first two years of the agreement, including shares purchased in the open market or in private transactions, are subject to registration rights until July 6, 2007. On June 26, 2002, in connection with the Company s acquisition of substantially all of the assets of Tutor Time Learning Systems, Inc., the Company entered into an investment advisory agreement with Jacobson Partners. Upon consummation of the acquisition, Jacobson Partners earned a fee consisting of a cash payment of $333,334 and the issuance of 175,438 shares of the Company s common stock. In July 2002, to provide a majority of the funding to finance the Company s acquisition of substantially all of the assets of Tutor Time Learning Systems, Inc., and to provide related working capital, the JP Acquisition Fund Group, a group of lenders organized by Jacobson Partners, loaned an aggregate of $14,000,000 to the Company. The loans are subject to a subordination agreement in favor of the Company s secured creditor, bear interest at 15% (of which only 7% is payable in cash unless certain conditions are met, with the rest payable in kind with the issuance of additional subordinated debt) and mature December 31, 2004. The terms of this subordinated loan arrangement were approved by a Special Committee of the Board of Directors. Although Jacobson Partners received no consideration for arranging this financing, lenders included JP Acquisition Fund II, L.P. and JP Acquisition Fund III, L.P., entities controlled and managed by affiliates of Jacobson Partners (for an aggregate of $10,497,154), Mr. Jacobson (for $115,703), trusts for the benefit of Mr. Jacobson s children (for an aggregate of $30,000), Mr. Kellner (for $174,429) and Mr. Morgan (for $225,000). Also in July 2002, certain members of the JP Acquisition Fund Group (the Optionees ) agreed to arrange for the Company to obtain a standby purchase commitment in connection with this rights offering. As consideration for such commitment, a Special Committee of the Board of Directors approved the grant to the Optionees of options to purchase, in the aggregate, up to 400,000 shares of common stock, until July 19, 2006, at an exercise price of $5.00 per share (approximately 171% of the five-day average of the daily closing prices of the common stock on The Nasdaq National Market System as of July 19, 2002, the date of the agreement). All shares acquired by the Optionees would be subject to registration rights, pursuant to which, until July 6, 2007, the Optionees would have the right to cause the Company to register, at the Company s expense, their shares of common stock, whenever the Company is otherwise registering shares (except in certain circumstances). The option grant to the Optionees has been approved by our shareholders. Revenues, net $ 222 $ 456 Operating expenses 377 523 Provision for doubtful accounts 4 1 Depreciation and amortization 4 23 Exit and closure expenses 354 Intangible asset impairment charges 10 Long lived fixed asset impairment charges CAPITALIZATION The following table shows our capitalization as of January 3, 2003. The table also shows our capitalization as adjusted for the completion of the rights offering, including application of net proceeds as described on page 18 under Use of Proceeds; Reason for this Rights Offering , at the subscription price of $[160.00] per Unit, assuming that we receive offering proceeds of $[16,000,000], less expenses. Capitalization as of January 3, 2003 Actual Adjustments As Adjusted * Less than 1%. (1) Beneficial ownership includes voting or investment power with respect to securities. Unless otherwise indicated, each person or entity named in this table has sole voting power and investment power, or shares voting power and investment power with his or her spouse, with respect to all shares of common stock listed as owned by that person. (2) All addresses are care of Childtime Learning Centers, Inc., 38345 West Ten Mile Road, Suite 100, Farmington Hills, Michigan 48335. (3) Ms. Danner ceased serving as the Company s Vice President of Corporate Operations effective March 26, 2003. (4) Consists of shares of common stock issuable pursuant to incentive stock options, granted under the Company s Key Employee Stock Option Plan, that are exercisable within 60 days after the Record Date. Pursuant to the incentive stock option agreement, Mr. Davis is obligated, each year, to purchase an amount of shares equal to one half of his annual cash bonus, if any, from the Company divided by the option exercise price of $3.50 per share, simultaneously with his receipt of such bonus; provided that Mr. Davis may not exercise options to purchase more than 40,160 shares in any calendar year except upon a change of control. (5) Includes 10,000 shares of common stock, issuable pursuant to stock options granted under the Company s Director Stock Option Plan, that are exercisable within 60 days after the Record Date. (6) Includes 250 shares of common stock with respect to which Mr. Feld shares voting and investing powers with his spouse. (7) Includes 792,595 shares of common stock beneficially owned by other members of the Jacobson Partners Group. Also includes 157,894 shares of common stock directly owned by Mr. Jacobson, which shares represent Mr. Jacobson s proportionate interest in the 175,438 shares originally issued to Jacobson Partners pursuant to the Fee Agreement dated June 27, 2002 between the Company and Jacobson Partners (the Fee Agreement ). Does not include (a) 2,895,000 shares beneficially owned by Mr. Kellner, a member of the Group, in which shares Mr. Jacobson disclaims beneficial ownership, and (b) 110,000 shares beneficially owned by Mr. Morgan, a member of the Group, in which shares Mr. Jacobson disclaims beneficial ownership. Mr. Jacobson is the managing partner of Jacobson Partners. Mr. Jacobson disclaims beneficial ownership of all shares not directly owned by him or held for his account. (8) Includes 2,427,373 shares of common stock owned by Childcare Associates and 437,627 shares of common stock owned by KD Partners II. Mr. Kellner is the managing partner of Childcare Associates and the managing partner of KD Special Situations Partners, the investment general partner of KD Partners II. Also includes 14,076 shares of common stock beneficially owned by Mr. Kellner as a result of his membership in the Jacobson Partners Group. Mr. Kellner disclaims beneficial ownership of all shares not directly owned by him or held for his account. (9) Includes 110,000 shares of common stock issuable pursuant to options, granted in connection with Mr. Morgan s consulting arrangement with the Company, that are exercisable within 60 days after the Record Date. Also includes 1,754 shares of common stock directly owned by Mr. Morgan, which shares represent Mr. Morgan s proportionate interest in the 175,438 shares originally issued to Jacobson Partners pursuant to the Fee Agreement. Does not include 3,860,453 shares beneficially owned by other members of the Jacobson Partners Group, in which shares Mr. Morgan disclaims beneficial ownership. Mr. Morgan is a partner of Jacobson Partners and a minority investor in funds included in the Jacobson Partners Group. (10) Consists of 26,600 shares issuable pursuant to options, granted in connection with Mr. Tylka s consulting arrangement with the Company, which are exercisable within 60 days after the Record Date. Mr. Tylka is a minority investor in Childcare Associates. Mr. Tylka disclaims beneficial ownership of the shares of common stock owned by such shareholder. (11) Effective August 30, 2002, Mr. Tylka ceased serving as the Company s Interim Chief Financial Officer and Treasurer. (12) Includes shares issuable pursuant to stock options, that are exercisable within 60 days after the Record Date, as described in the foregoing notes. (13) Based on the Amendment to Schedule 13D as filed by such holders with the Securities and Exchange Commission as of February 20, 2003. Consists of all shares of common stock beneficially owned by members of the Jacobson Partners Group, including George A. Kellner, Benjamin R. Jacobson and James J. Morgan, as reported on the Schedule 13D, as amended, filed by the Group. The Group is distinct from the JP Acquisition Fund Group, although there is significant overlap in their membership. Includes (i) 2,899,076 shares beneficially owned by Mr. Kellner, including the shares owned by Childcare Associates and KD Partners II (see note 14 below) and 10,000 shares issuable to Mr. Kellner pursuant to stock options, granted under the Company s Director Stock Option Plan, that are exercisable within 60 days after the Record Date, (ii) 110,000 shares issuable to Mr. Morgan pursuant to options, granted in connection with Mr. Morgan s consulting arrangement with the Company, that are Income (loss) before discontinued operations and cumulative effect of change in accounting principle (12,286 ) (1,511 ) (3,804 ) (341 ) 4,228 5,016 4,280 Discontinued operations, net of taxes (578 ) (56 ) (231 ) 7 101 80 exercisable within 60 days after the Record Date, and 5,074 shares beneficially owned by Mr. Morgan and (iii) 167,932 shares beneficially owned by Mr. Jacobson and 10,000 shares issuable to Mr. Jacobson pursuant to stock options, granted under the Company s Director Stock Option Plan, that are exercisable within 60 days after the Record Date. Mr. Jacobson is the managing partner of Jacobson Partners and Mr. Morgan is a partner of Jacobson Partners. Mr. Kellner, Mr. Jacobson and Mr. Morgan are all investors in or co-investors of JP Acquisition Fund II, L.P. and JP Acquisition Fund III, L.P. Mr. Kellner also serves as a special advisor to Jacobson Partners. (14) Mr. Kellner is the managing partner of Childcare Associates and the managing partner of KD Special Situations Partners, the investment general partner of KD Partners II. (15) Based on the Amendment to Schedule 13G as filed by such holder with the Securities and Exchange Commission as of December 31, 2002. (Dollar amounts in thousands) Long term debt (net of current portion) $ 17,249 $ $ Shareholders equity: Common stock: 20,000,000 shares authorized (40,000,000 shares, as adjusted (1)); 5,416,210 shares outstanding ( shares, as adjusted) 31,665 Retained Earnings (5,532 ) DESCRIPTION OF OUR CAPITAL STOCK Under our Restated Articles of Incorporation, as amended ( Restated Articles ), we are authorized to issue up to 40,000,000 shares of common stock, no par value per share, and 1,000,000 shares of preferred stock, no par value per share. As of the date of this prospectus, there were 5,416,210 shares of common stock issued and outstanding, and no shares of preferred stock outstanding. The following summary is qualified in its entirety by reference to our Restated Articles and our Restated Bylaws (the Bylaws ). A copy of our Restated Articles has been previously filed as an exhibit to Amendment No. 1 to our Registration Statement on Form S-1, filed on January 12, 1996. A copy of the most recent amendment to our Restated Articles has been previously filed as an exhibit to our Current Report on Form 8-K, filed on March 20, 2003. A copy of our Bylaws has been previously filed as an exhibit to our Quarterly Report on Form 10-Q for the fiscal quarter ended July 19, 2002. Each such filing is incorporated by reference into this registration statement of which this prospectus forms a part. Common Stock Holders of shares of our common stock have no pre-emptive, redemption, conversion or sinking fund rights. Holders of shares of our common stock are entitled to one vote per share on all matters submitted to a vote of holders of shares of common stock and do not have any cumulative voting rights. In the event of a liquidation, dissolution or winding-up of the Company, the holders of shares of our common stock are entitled to share equally and ratably in the assets of the Company, if any, remaining after the payment of all of our debt liabilities and the liquidation preference of any outstanding shares of preferred stock. The outstanding shares of common stock are, and the shares included in this rights offering will, when issued and, in the case of common shares included in the rights offering, upon payment of the related rights offering subscription price, be fully paid and nonassessable. Additional authorized but unissued shares of common stock may be issued by the Board of Directors of the Company without the approval of the shareholders. Holders of shares of our common stock participate ratably in such dividends and other distributions, if any, as may be declared by the Board of Directors out of funds legally available for such purposes, subject to the rights of any outstanding shares of preferred stock. As of March 28, 2003, we had outstanding options to acquire 1,046,903 shares of our common stock, including options granted to members of the JP Acquisition Fund Group, at exercise prices ranging from $1.15 to $18.28 per share with a weighted average exercise price of $5.94 per share and a weighted average remaining contractual life of 4.17 years. Preferred Stock The Board of Directors is permitted to provide for the issuance of the 1,000,000 authorized shares of preferred stock, without shareholder approval, in one of more series and to fix the designations, preferences, powers, and relative, participating, optional or other rights and restrictions thereof, including without limitation, the dividend rate, conversion rights, voting rights, redemption price and liquidation preference, to fix the number of shares constituting any such series and to increase and decrease the number of shares of such series. There are currently no shares of preferred stock issued and outstanding. We have no present plans to issue any preferred shares. Provisions of the Articles and Bylaws The Company has authorized the issuance of preferred stock in its Restated Articles. The issuance of preferred stock could be used, under certain circumstances, as a method of preventing a takeover of the Company and could permit the Board of Directors, without any action of the holders of shares of common stock, to issue shares of preferred stock which could have a detrimental effect on the rights of holders of shares of common stock, including the loss of voting control. Furthermore, anti-takeover provisions that could be included in the shares of preferred stock when issued may have a depressive effect on the market price of the Company s securities and may limit shareholders ability to receive a premium on their shares by discouraging takeover and tender offer bids. In addition, the Company has a classified Board of Directors so that one class of directors is elected at each annual meeting of shareholders for a full three-year term. With a classified Board of Directors, it will generally take the shareholders two annual meetings to elect a majority of the Board of Directors. Accordingly, the existence of authorized but unissued shares of capital stock of the Company, together with the classification of the Board of Directors, may discourage unsolicited takeover bids by third parties. Michigan Law Chapters 7A and 7B of the Michigan Business Corporation Act (the Act ) may affect attempts to acquire control of the Company. In general, under Chapter 7A, business combinations (defined to include, among other transactions, certain mergers, dispositions of assets or shares and recapitalizations) between covered Michigan business corporations or their subsidiaries and an interested shareholder (defined as the direct or indirect beneficial ownership of at least 10% of the voting power of a covered corporation s shares) can be consummated only if approved by at least 90% of the votes of each class of the corporation s shares entitled to vote and by at least two-thirds of such voting shares not held by the interested shareholder , or such shareholder s affiliates, unless five years have elapsed after the person involved became an interested shareholder and unless certain price and other conditions are satisfied. The Board of Directors may exempt business combinations with a particular interested shareholder by resolution adopted prior to the time the interested shareholder attained that status. In general, under Chapter 7B of the Act, an entity that acquires Control Shares of the Company may vote the Control Shares on any matter only if a majority of all shares, and of all non- Interested Shares , of each class of shares entitled to vote as a class, approve such voting rights. Interested Shares are shares owned by officers of the Company, employee-directors of the Company and the entity making the Control Share Acquisition . Control Shares are shares that, when added to shares already owned by an entity, would give the entity voting power in the election of directors over any of three thresholds: one-fifth, one-third and a majority. The effect of the statute is to condition the acquisition of voting control of a corporation on the approval of a majority of the pre-existing disinterested shareholders. The Board of Directors has the option of choosing to amend the Company s Articles of Incorporation or Bylaws before a Control Share Acquisition occurs to provide that Chapter 7B does not apply to the Company. Transfer Agent and Registrar The Transfer Agent and Registrar for the Company s common stock is Computershare Investor Services, LLC. DESCRIPTION OF THE SUBORDINATED NOTES The Subordinated Notes are to be issued under an Indenture, as supplemented from time to time (as so supplemented, the Indenture ), between the Company and U.S. Bank National Association, a national banking association, as trustee. The Indenture will be qualified under the Trust Indenture Act of 1939, as amended (the Trust Indenture Act ), and the Indenture will be subject to and governed by the Trust Indenture Act. The following description is a summary of the material provisions of the Indenture. It does not include all of the provisions of the Indenture nor does it restate the Indenture in its entirety. We urge you to read the Indenture because it defines your rights. The terms of the Subordinated Notes will include those stated in the Indenture and those made part of the Indenture by reference to the Trust Indenture Act. You may obtain a copy of the Indenture by contacting our Chief Financial Officer and Treasurer, at the address and telephone number provided in this prospectus. General The Subordinated Notes will be issued in denominations of $35 and integral multiples thereof. The maturity date (the Maturity Date ) of the Subordinated Notes is , 2008. The Subordinated Notes will be unsecured and subordinate, and rank junior in right of payment, to the extent and in the manner set forth in the Indenture, to all Senior Indebtedness (as defined below). See Subordination. We are a legal entity separate and distinct from our subsidiaries. Our principal subsidiaries are Childtime Childcare, Inc. and Tutor Time Learning Centers, LLC. Our right to participate in any distribution of assets of any subsidiary upon such subsidiary s liquidation or reorganization or otherwise is subject to the prior claims of creditors of the subsidiary, except to the extent we may be recognized as a creditor of that subsidiary. Accordingly, the Subordinated Notes will be effectively subordinated to all existing and future liabilities of our subsidiaries. The Indenture does not limit our ability to incur or issue other secured or unsecured debt, including Senior Indebtedness, or the incurrence of liabilities by our subsidiaries. See Subordination. Interest The Subordinated Notes will bear interest from the date of initial issuance at the annual rate of 15% of the principal amount thereof, until the principal thereof becomes due and payable on the Maturity Date. The amount of interest payable for any period will be computed on the basis of the actual number of days elapsed based on a 360-day year. In the event that any date on which interest is payable on the Subordinated Notes is not a Business Day, then payment of the interest payable on such date will be made on the next succeeding day that is a Business Day (including interest or other payment in respect of any such delay). Overdue interest and principal will bear interest on the amount thereof (to the extent permitted by law) at the rate per annum of 18% thereof, compounded quarterly. A Business Day is any day other than a Saturday, a Sunday, or a day on which banking institutions in the State of Michigan are authorized or required by law or executive order to remain closed. Interest on the Subordinated Notes will be payable quarterly in arrears in cash on March 31, June 30, September 30 and December 31 of each year, commencing on June 30, 2003 (each date on which interest is payable on the Notes being referred to herein as an Interest Payment Date ). Interest on overdue interest and principal will be payable in cash on demand. The Company may be prevented from making payments (including interest payments) on the Subordinated Notes if it is not in compliance with the covenants of the Senior Indebtedness, with the duration of such periods during which the Company is prevented from paying interest depending upon, among other things, the nature and duration of our non-compliance. See Subordination below and Risk Factors Risks Related to the Subordinated Notes We may be prohibited from making payments on the Subordinated Notes if we are not in compliance with the terms of our Senior Indebtedness. Payment and Paying Agents Payment of principal of and premium, if any, and any interest on the Subordinated Notes will be made in cash at the office of the trustee in Detroit, Michigan or at the office of such paying agent or paying agents as we may designate from time to time, except that at our option, payment of any interest may be made by check mailed to the address of the person entitled thereto as such address appears, at the close of business on the record date for such interest (except defaulted interest), in the register for the Subordinated Notes maintained by the Company or the trustee. We may at any time designate additional paying agents or rescind the designation of any paying agent; however, we will at all times be required to maintain a paying agent in each place of payment for the Subordinated Notes. Any monies deposited with the trustee or any paying agent, or then held by us in trust, for the payment of the principal or interest on any Subordinated Note and remaining unclaimed for two years after such principal or interest has become due and payable, will be repaid to us and the holder of such Subordinated Note will thereafter look, as a general unsecured creditor, only to us for payment of such amounts. Total shareholders equity 26,133 Optional Redemption Subject to the subordination provisions described below, the Subordinated Notes will be redeemable, in whole or in part, at our option, any time after the date of issuance of the Subordinated Notes, for cash at a redemption price equal to 100% of the outstanding principal amount of the Subordinated Notes, plus accrued interest thereon to the date of prepayment. Notice of any optional redemption will be mailed at least 15 days but not more than 60 days before the redemption date to each holder of the Subordinated Notes to be prepaid at its registered address. Unless we default in payment of the redemption price, on and after the redemption date interest ceases to accrue on the Subordinated Notes called for redemption. The Subordinated Notes are subject to significant subordination provisions which, among other things, prevent us from redeeming (upon a change of control, as described below, or otherwise) the Subordinated Notes until such time as the Senior Indebtedness has been repaid in full and satisfied in cash and the Bank One Credit Agreement, all commitments to lend or otherwise extend credit under the Bank One Credit Agreement and any and all letters of credit issued pursuant to such agreement, will have expired or been irrevocably terminated. See Subordination. Mandatory Redemption Subject to the subordination provisions described above in the immediately preceding paragraph, we will redeem all Subordinated Notes not previously redeemed by us upon the happening of any occurrence constituting a change of control. An event will be deemed to have triggered a change of control if: (i) any person or group within the meaning of Section 13(d)(3) of the Exchange Act of 1934, as amended (the Exchange Act ), together with any affiliates and associates of any thereof, other than JP Acquisition Fund II, L.P., JP Acquisition Fund III, L.P., JPAF, Limited Partnership, JPAF III, LLC, Jacobson Partners and the other members of the group referenced in the Schedule 13D originally filed on July 24, 2000, as amended from time to time (SEC File No. 005-48813), will beneficially own (within the meaning of Rule 13d-3 under the Exchange Act) at least a majority of the total voting power of all classes of capital stock of the Company entitled to vote generally in the election of directors of the Company, or (ii) the Company is liquidated or dissolved or our shareholders adopt a plan for the liquidation or dissolution of the Company. Upon a mandatory redemption, we will repurchase all of the Subordinated Notes outstanding within 60 days after such change of control at a purchase price equal to 100% of their outstanding principal amount, plus accrued and unpaid interest, if any, to the repurchase date. The redemption amount will be paid in cash. Notice of any mandatory redemption will be mailed at least 15 days but not more than 60 days before the redemption date to each holder of the Subordinated Notes to be prepaid at its registered address. Unless we default in payment of the redemption price, on or after the redemption date, interest ceases to accrue on such Subordinated Notes called for redemption. Events of Default The Indenture provides that any one or more of the following described events with respect to the Subordinated Notes constitutes an Event of Default (whatever the reason for such Event of Default and whether it will be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body): (1) failure for 30 days to pay any interest on the Subordinated Notes, when due; or (2) failure to pay any principal or premium, if any, on the Subordinated Notes when due whether at maturity, upon redemption, by declaration of acceleration of maturity or otherwise; or (3) failure to observe or perform certain other covenants, or the breach of any warranty, contained in the Indenture which continues for 30 days after written notice to us from the trustee or the holders of at least 25% in aggregate outstanding principal amount of the Subordinated Notes; or (4) certain events of bankruptcy, insolvency or reorganization of the Company or any Material Subsidiary (as defined in below), including the dissolution or winding up of the Company or any Material Subsidiary. The holders of a majority in aggregate outstanding principal amount of the Subordinated Notes have the right to direct the time, method and place of conducting any proceeding for any remedy available to the trustee. Subject to the subordination provisions described below, the trustee or the holders of not less than 25% in aggregate outstanding principal amount of the Subordinated Notes may, by written notice, declare the principal, and all accrued interest, due and payable immediately upon the occurrence and continuation of an Event of Default. The holders of a majority in aggregate outstanding principal amount of the Subordinated Notes may annul such declaration and waive the default if the default (other than the nonpayment of the principal of the Subordinated Notes which has become due solely by such acceleration) has been cured and a sum sufficient to pay all matured installments of interest and principal due otherwise than by acceleration has been deposited with the trustee. Notwithstanding the foregoing paragraph, until such time as all Senior Indebtedness has been paid in full in cash and the Bank One Credit Agreement, all commitments to lend or otherwise extend credit under the Bank One Credit Agreement and any letters of credit issued pursuant to such agreement, have irrevocably terminated, neither the trustee nor the holders of the Subordinated Notes will have the right to accelerate the maturity of the Subordinated Notes as a result of an Event of Default specified in clauses (1), (2) or (3) above. If an Event of Default specified in clause (4) above occurs, the principal of and accrued interest on all Subordinated Notes will become immediately due and payable without any declaration or other act on the part of the trustee or Noteholders. The holders of a majority in aggregate outstanding principal amount of the Subordinated Notes affected thereby may, on behalf of the holders of all the Subordinated Notes, waive any past default, except a default in the payment of principal of or premium, if any, or interest on the Subordinated Notes (unless such default has been cured and a sum sufficient to pay all matured installments of interest and premium, if any, and principal due otherwise than by acceleration has been deposited with the trustee) or a default in respect of a covenant or provision which under the Indenture cannot be modified or amended without the consent of the holder of each outstanding Subordinated Note. The Indenture requires that we file annually with the trustee an officers certificate as to the absence of certain defaults under the Indenture. The term Material Subsidiary means, as of any date, any subsidiary of ours (a) the value of whose assets, as such assets would appear on a consolidated balance sheet of such subsidiary and its consolidated subsidiaries prepared as of the end of the fiscal quarter next preceding such determination in accordance with generally accepted accounting principles, is at least 10% of the value of the assets of the Company and its consolidated subsidiaries, determined as aforesaid, or (b) which has revenues, as such revenues would appear on a consolidated income statement of such subsidiary and its consolidated subsidiaries prepared as of the end of the fiscal quarter next preceding such determination in accordance with generally accepted accounting principles, constituting at least 10% of the revenues of the Company and its consolidated subsidiaries, or (c) which has net income, as such net income would appear on a consolidated income statement of such subsidiary and its consolidated subsidiaries prepared as of the end of the fiscal quarter next preceding such determination in accordance with generally accepted accounting principles, constituting at least 10% of the Company s consolidated net income. Consolidation, Merger, Sale of Assets and Other Transactions The Indenture provides that we will not consolidate with or merge into any other person or convey, transfer or lease our properties and assets as an entirety or substantially as an entirety to any person, and we will not permit any person to consolidate with or merge into us or convey, transfer or lease its properties and assets as an entirety or substantially as an entirety to us, unless: (1) either we will be the continuing corporation, or the person (other than the Company) formed by such consolidation or into which the Company is merged or to which the properties and assets of the Company substantially as an entity are transferred or leased, will be a person organized under the laws of the United States or any State thereof or the District of Columbia, and such person expressly assumes, by execution and delivery of a supplemental indenture, our obligations under the Subordinated Notes and the Indenture; and (2) immediately after giving effect to such transaction, no Event of Default, and no event which, after notice or lapse of time or both, would become an Event of Default, will have occurred and be continuing. The general provisions of the Indenture do not afford holders of the Subordinated Notes protection in the event of a highly leveraged transaction or other transaction involving us that may adversely affect holders of the Subordinated Notes. Modification of the Indenture From time to time we and the trustee may, without the consent of the holders of the Subordinated Notes, amend, waive or supplement the Indenture for specified purposes, including, among other things, curing ambiguities, defects or inconsistencies (provided that any such action does not materially adversely affect the interests of the holders of Subordinated Notes), making any other change that does not adversely affect the rights of any holder of Subordinated Notes and qualifying, or maintaining the qualification of, the Indenture under the Trust Indenture Act. The Indenture contains provisions permitting us and the trustee, with the consent of the holders of a majority in aggregate principal amount of the Subordinated Notes, to modify the Indenture in a manner affecting the rights of the holders of the Subordinated Notes; provided that no such modification may, without the consent of the holders of each outstanding Subordinated Note so affected, (i) change the Maturity Date or reduce the principal amount of the Subordinated Notes or reduce the rate or extend the time of payment of interest thereon or reduce any amount payable upon redemption thereof or change any date on which the Subordinated Notes may be redeemed or (ii) reduce the percentage of principal amount of Subordinated Notes, the holders of which are required to consent to any such modification of the Indenture. Satisfaction and Discharge The Indenture provides that when, among other things, all the Subordinated Notes not previously delivered to the trustee for cancellation (i) have become due and payable or (ii) will become due and payable at maturity, or are to be called for redemption under arrangements satisfactory to the trustee, within one year, and we deposit or cause to be deposited with the trustee funds, in trust, for the purpose and in an amount sufficient to pay and discharge the entire indebtedness on the Subordinated Notes not previously delivered to the trustee for cancellation, for the principal and premium, if any, and interest to the date of maturity or redemption, as the case may be, then the Indenture will cease to be of further effect (except as to certain of our obligations under the Indenture, including our obligations to pay all other sums due pursuant to the Indenture and to provide the officers certificates and opinions of counsel described therein), and we will be deemed to have satisfied and discharged the Indenture. Subordination The Indenture provides that the Subordinated Notes issued thereunder and all indebtedness, obligations or liabilities of the Company to the holders of the Subordinated Notes (collectively, the Subordinated Indebtedness ) will be subordinate and junior in right of payment to all Senior Indebtedness of the Company to the extent provided in the Indenture. No payment or distribution of assets may be made by the Company on account of the Subordinated Indebtedness or on account of the purchase or redemption or acquisition of any Total capitalization $ 43,382 $ $ Subordinated Indebtedness if a default has occurred and continues with respect to any payment of principal of (or premium, if any) or interest on the Senior Indebtedness (a Senior Indebtedness Payment Default ). If an event of default other than a Senior Indebtedness Payment Default occurs and continues with respect to any Senior Indebtedness which entitles any holder thereof to accelerate the maturity of the Senior Indebtedness (a Senior Indebtedness Non-Payment Default ), no payment or distribution of assets of the Company may be made by the Company on account of the Subordinated Indebtedness or on account of the purchase or redemption or acquisition of any Subordinated Indebtedness for a period (the Payment Blockage Period ) commencing on the date the Company or the trustee receives notice from the holders of the Senior Indebtedness of the occurrence of such a default on the Senior Indebtedness until the earlier of (a) the expiration of 180 days from such date of receipt, (b) the default has been cured or waived or the Senior Indebtedness is discharged or (c) the holders of the Senior Indebtedness provide to the Company or the trustee written notice of termination of the Payment Blockage Period. Upon the expiration or termination of a Payment Blockage Period, the Company may resume making payments in respect of the Subordinated Indebtedness, provided, however, that no missed payments on the Subordinated Indebtedness may be made unless the Company delivers to Bank One (as defined below) contemporaneously with such missed payments a certificate of the chief financial officer of the Company certifying that no Senior Indebtedness Payment Default or Senior Indebtedness Non-Payment Default has occurred and is continuing or will have occurred and be continuing after such missed payments are made and that Childtime Childcare, Inc. and the Company will be in pro forma compliance with all financial covenants under the Bank One Credit Agreement after giving effect to such missed payments. Upon any payment or distribution of assets to creditors upon any liquidation, dissolution, winding up, reorganization, assignment for the benefit of creditors, marshaling of assets or any bankruptcy, insolvency, debt restructuring or similar proceedings in connection with any insolvency or bankruptcy proceeding of the Company, the holders of Senior Indebtedness will first be entitled to receive payment in full before the holders of the Subordinated Indebtedness will be entitled to receive or retain any payment in respect thereof. In addition to the above restrictions, the trustee and the holders of the Subordinated Indebtedness are also subject to certain significant restrictions concerning acceleration of maturity of the Subordinated Indebtedness upon the occurrence of an Event of Default while Senior Indebtedness remains outstanding. See Events of Default above. For example, in the event of the acceleration of the maturity of the Subordinated Indebtedness, the holders of all Senior Indebtedness outstanding at the time of such acceleration will first be entitled to receive payment in full before the holders of the Subordinated Indebtedness will be entitled to receive or retain any payment in respect of the Subordinated Indebtedness. Prior to the Maturity Date, we cannot make any payment, whether in cash, property or securities, with respect to the principal (including redemption payments) of or premium, if any, on the Subordinated Indebtedness until such time as the Senior Indebtedness has been repaid in full and satisfied in cash and the Bank One Credit Agreement, all commitments to lend or otherwise extend credit under the Bank One Credit Agreement and any and all letters of credit issued pursuant to such agreement, have expired or been irrevocably terminated, all in accordance with the terms of the Bank One Credit Agreement. The term Senior Indebtedness means all indebtedness, obligations and other liabilities of the Company or any of its subsidiaries, whether now existing or hereafter arising, whether direct or indirect, absolute or contingent and howsoever evidenced, under or in respect of the Bank One Credit Agreement, whether for principal, interest (including, without limitation, interest accruing after the filing of a petition initiating any proceeding under any state or federal bankruptcy law whether or not such interest is an allowable claim), reimbursement of amounts drawn under letters of credit issued or arranged for pursuant thereto, guarantees in respect thereof, and all charges, fees, expenses (including reasonable fees and expenses of counsel), premiums, indemnifications and other amounts in respect of the Bank One Credit Agreement incurred by or owing to Bank One and/or any other lender under the Bank One Credit Agreement or their representative, agent or trustee, and all other obligations of the Company or any of its subsidiaries incurred under or in respect of or relating to the Bank One Credit Agreement, including, without limitation, any interest rate protection obligations and in respect of premiums, indemnities or otherwise, and all indebtedness under the Bank One (In thousands) Cash flows from operating activities: Net loss $ (36,235 ) $ (2,585 ) $ (1,219 ) Adjustments to reconcile net income to net cash (used in) provided by operating activities of continuing operations: Extraordinary item gain on early extinguishment of debt (950 ) Change in revenue recognition cumulative effect on prior years 876 Depreciation and amortization 3,702 3,175 2,980 Amortization of credit facility fees 2,274 1,780 Provision for bad debts 2,674 579 1,043 Losses (gains) from facility actions and provisions for losses including impairment charges on leaseholds, equipment and intangible assets 19,436 (887 ) (2,253 ) Changes in operating assets and liabilities: Accounts, notes and other receivables (2,052 ) 83 1,010 Prepaid expenses and other current assets 78 (1,496 ) (187 ) Other assets 109 39 (18 ) Accounts and drafts payable 3,960 1,953 (303 ) Accrued expenses and other current assets 5,233 350 (3,335 ) Deferred franchise and related fees 242 Credit Agreement which is disallowed, avoided or subordinated pursuant to Section 548 of the Federal Bankruptcy Code or any applicable state fraudulent conveyance law. The term Bank One Credit Agreement means (a) the Amended and Restated Credit Agreement, dated as of January 31, 2002, as amended from time to time (the Childtime Credit Agreement ) between Childtime Childcare, Inc. and Bank One, together with all amendments, agreements, documents and instruments from time to time delivered in connection with the Childtime Credit Agreement (including, without limitation, all promissory notes, guaranty agreements, pledge agreements, security agreements, mortgages, deeds of trust, security deeds, collateral assignments and other security documents), and all agreements, devices and arrangements providing for payments calculated with reference to fluctuations of interest rates, exchange rates or forward rates (including without limitation any interest rate swap agreements, dollar denominated or cross-currency interest rate exchange agreements, forward currency exchange agreements, interest rate cap or collar protection agreements, forward rate currency or interest rate options, puts and warrants) entered into by Childtime Childcare, Inc. with Bank One, and as the Childtime Credit Agreement and such other agreements, documents, instruments, devices and arrangements may be amended, amended and restated, renewed, extended, restructured, supplemented or otherwise modified from time to time, and (b) any credit agreement, loan agreement or other agreement, document, instrument, device or arrangement refinancing, refunding or otherwise replacing the Childtime Credit Agreement or any other agreement deemed the Bank One Credit Agreement under clause (a) or (b) hereof, whether or not with the same representative lenders or holders, and irrespective of any changes in the terms and conditions thereof. Without limiting the generality of the foregoing, the term Bank One Credit Agreement will include any amendment, amendment and restatement, renewal, extension, restructuring, supplement or modification to the Bank One Credit Agreement, including any agreement (i) extending the maturity of any Indebtedness (as defined in the Bank One Credit Agreement) incurred thereunder or contemplated thereby, (ii) adding or deleting borrowers or guarantors thereunder, so long as borrowers and issuers include one or more of the Company and its Subsidiaries and their respective successors and assigns or (iii) increasing the amount of Indebtedness (as defined in the Bank One Credit Agreement) incurred thereunder or available to be borrowed thereunder. The term Bank One means Bank One, NA, with its main office in Chicago, Illinois, and successor by merger to Bank One, Michigan, a Michigan banking corporation, collectively with all of its successors and assigns under the Bank One Credit Agreement and its and their respective affiliates. Our right to participate in any distribution of assets of any subsidiary upon such subsidiary s liquidation or reorganization or otherwise, is subject to the prior claims of creditors of the subsidiary, except to the extent we may be recognized as a creditor of that subsidiary. Accordingly, the Subordinated Notes will be effectively subordinated to all existing and future liabilities of our subsidiaries. As of January 3, 2003, our Senior Indebtedness totaled $12.6 million. We expect from time to time to incur additional indebtedness constituting Senior Indebtedness. The Indenture places no limitation on the amount of additional Senior Indebtedness that we may incur or the amount of liabilities our subsidiaries may incur. Governing Law The Indenture and the Subordinated Notes will be governed by and construed in accordance with the laws of the State of New York. Information Concerning the Trustee Following the qualification of the Indenture under the Trust Indenture Act, the trustee will have and be subject to all the duties and responsibilities specified with respect to an indenture trustee under the Trust Indenture Act. Subject to such provisions, the trustee is under no obligation to exercise any of the powers vested in it by the Indenture at the request of any holder of the Subordinated Notes, unless offered reasonable indemnity by such holder against the costs, expenses and liabilities which might be incurred thereby. The trustee is not required to expend or risk its own funds or otherwise incur personal financial liability in the performance of its duties if the trustee reasonably believes that repayment or adequate indemnity is not reasonably assured to it. PLAN OF DISTRIBUTION On February 20, 2003, we entered into a Standby Securities Purchase Agreement with the JP Acquisition Fund Group, which further defines our rights and obligations, and the rights and obligations of the JP Acquisition Fund Group, with respect to the JP Acquisition Fund Group s participation in this rights offering. The Standby Securities Purchase Agreement obligates us to sell, and requires the JP Acquisition Fund Group to subscribe for and purchase from us, for a purchase price of $[160.00] per Unit any and all Units not subscribed for by our shareholders; provided, however, that the Standby Purchase Commitment of the JP Acquisition Fund Group is limited to the Standby Commitment Limit. Consequently, the JP Acquisition Fund Group will be required to purchase pursuant to the Standby Purchase Commitment up to a maximum of Units not purchased by our shareholders. Under the terms of the Standby Securities Purchase Agreement, we agreed to indemnify the JP Acquisition Fund Group against claims and liabilities arising out of or based upon any untrue statement or alleged untrue statement of any material fact contained in this prospectus, the registration statement of which it forms a part, any amendment or supplement thereto, or arising out of the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading. We also agreed to reimburse the JP Acquisition Fund Group and its members for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such actions or claims asserting liabilities against them. The Standby Securities Purchase Agreement may be terminated by the JP Acquisition Fund Group if we become insolvent or bankrupt or by either us or the JP Acquisition Fund Group if this offering is not consummated on or before July 18, 2003, through no fault of the JP Acquisition Fund Group. In addition, the Standby Securities Purchase Agreement may be terminated by us or the JP Acquisition Fund Group if the purchase of securities pursuant to the Standby Purchase Commitment is not consummated on or before July 28, 2003, through no fault of the terminating party. As consideration for agreeing to arrange for the Company to obtain a standby purchase commitment in connection with this rights offering, certain members of the JP Acquisition Fund Group received options to purchase shares of the Company s common stock. See Certain Relationships and Related Party Transactions. We are offering Units directly to you pursuant to this rights offering. We have not employed any brokers, dealers or underwriters in connection with the solicitation or exercise of subscription rights in this rights offering and no commissions, fees or discounts will be paid in connection with it. Certain of our officers and other employees may solicit responses from you, but such officers and other employees will not receive any commissions or compensation for such services other than their normal employment compensation. The JP Acquisition Group has acknowledged to us that the securities purchased pursuant to the Standby Purchase Commitment are being issued pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended (the Securities Act ), and are restricted securities. Each member of the JP Acquisition Group has represented and warranted to us that it is an accredited investor within the meaning of the rules under the Securities Act and that it is acquiring such securities for its own account as principal for investment and without a view to the distribution or sale thereof. The JP Acquisition Fund Group has advised us that it does not intend to resell any shares of common stock acquired in the offering, but rather intends to retain such shares for investment purposes, and that it does not currently have any plans or proposals with respect to any extraordinary corporate transactions involving the Company or any sale of its assets or any change in its Board of Directors, management, capitalization, dividend policy, charter or by-laws, or any other change in its business or corporate structure or with respect to the delisting or deregistration of any of its securities. The JP Acquisition Fund Group has also indicated to us that it has no present intention to take the Company private. The JP Acquisition Fund Group has also advised us, however, that any determination to retain its majority interest in the Company will be subject to its continuing evaluation of pertinent factors related to its investment in us. Depending upon the continuing assessment of these factors from time to time, the JP Acquisition Fund Group may change its present intentions and may determine to acquire additional shares of common stock (by means of open market or privately negotiated purchases or otherwise) or to dispose of some or all of the shares of common stock held by the JP Acquisition Fund Group and its members. FEDERAL INCOME TAX CONSIDERATIONS The following is a summary of the material United States federal income tax considerations and consequences of the receipt, exercise and/or lapse of subscription rights to purchase Units and of the purchase, ownership and disposition of the Units. This summary deals only with subscription rights and Units (and Subordinated Notes and shares of common stock constituting part of a Unit) held as capital assets by holders who acquire the subscription rights in the rights offering and who purchase the Units upon original issuance at the original offering price. This summary does not discuss the tax considerations applicable to subsequent purchasers. For purposes of this summary, U.S. holder means a beneficial owner of a subscription right or Unit (or Subordinated Notes or shares of common stock constituting part of a Unit) that is (1) an individual citizen or resident of the United States, (2) a corporation, or other entity taxable as a corporation, created or organized in or under the laws of the United States or any state thereof or the District of Columbia, or (3) a partnership, estate or trust treated, for United States federal income tax purposes, as a domestic partnership, estate or trust. This summary is based upon the Internal Revenue Code of 1986, as amended (the Code ), treasury regulations issued thereunder, Internal Revenue Service rulings and pronouncements and judicial decisions now in effect, all of which are subject to change, possibly with retroactive effect. This summary does not address all aspects of United States federal income taxation that may be relevant to holders in light of their particular circumstances, such as holders who are subject to special tax treatment (for example, (1) banks, regulated investment companies, insurance companies, dealers in securities or currencies, or tax-exempt organizations, (2) persons holding Units (or Subordinated Notes or shares of common stock constituting part of a Unit) as part of a straddle, hedge, conversion transaction or other integrated investment, or (3) persons whose functional currency is not the U.S. dollar), some of which may be subject to special rules, nor does it address United States federal taxes (other than income taxes), alternative minimum taxes or state, local or foreign taxes. Prospective investors that are not United States persons (within the meaning of Section 7701(a)(30) of the Code) are urged to consult their own tax advisors with respect to the United States federal income tax consequences of receiving subscription rights and an investment in Units, including the potential application of United States federal withholding taxes. This summary is not intended as tax advice, but rather represents our best attempt to describe certain United States federal income tax consequences that may apply to you based on current United States federal income tax law. This summary may in the end not describe the United States federal income tax consequences which are applicable to you because, among other reasons, no statutory, administrative or judicial authority directly addresses the treatment of the distribution of the subscription rights or rights substantially similar to the subscription rights for United States federal income tax purposes. No rulings will be obtained from the Internal Revenue Service with respect to any of the United States federal income tax consequences described below. Thus, no assurance can be given that the Internal Revenue Service or a court will agree with the tax consequences described herein. Prospective investors are urged to consult their own tax advisors with respect to the United States federal tax consequences of the receipt, exercise and/or lapse of subscription rights to purchase Units and of the purchase, ownership and disposition of Units in light of their own particular circumstances, as well as the effect of any state, local or foreign tax laws. Subscription Rights to Purchase Units We believe that the distribution of a subscription right to purchase a Unit will be treated for United States federal income tax purposes as the distribution of two separate rights, that is, (1) a distribution of the right to acquire Subordinated Notes, and (2) a distribution of the right to acquire shares of common stock. (For purposes of the following discussion, the right to acquire Subordinated Notes will be referred to as the debt right and the right to acquire shares of common stock will be referred to as the stock right. ) No assurance can be given, however, that our position will not be challenged by the Internal Revenue Service or, if so challenged, that the challenge will not be successful. If the distribution of a subscription right contemplated under this prospectus is not treated as the distribution of separate debt and stock rights, the federal income tax considerations and consequences of the rights offering to holders will be materially different than described below. The remainder of this discussion assumes that the distribution of a subscription right will be treated as the distribution of separate debt and stock rights. Distribution of Subscription Rights. Section 305(a) of the Code generally provides that gross income does not include the amount of any distribution by a corporation to its shareholders of stock or rights to acquire stock of that corporation. Section 305(b) and (c) of the Code and United States Treasury regulations thereunder set forth several exceptions to the general rule of Section 305(a). If one of the exceptions were to apply to the distribution of a stock right considered part of a subscription right, (1) the value of the stock right would be treated as a dividend (ordinary income) to the extent of our current or accumulated earnings and profits, if any, and (2) any value of the stock right considered part of a subscription right in excess of our earnings and profits would be treated first as a non-taxable return of capital to the extent of the U.S. holder s tax basis and then a gain from a sale or exchange of the holder s common stock. The exceptions generally apply to distributions which are designed to have the effect of distributing cash or property other than our common stock to some shareholders while increasing other shareholder s ownership of our common equity. Because the distribution of stock rights considered part of the subscription rights is being made to all our shareholders and no holder of our stock will receive a distribution of money or property in lieu of receiving stock rights or in exchange for not exercising the stock rights, it is unlikely that the distribution of stock rights considered part of the subscription rights could have such an effect. Accordingly, this discussion assumes that the exceptions of Section 305(b) and (c) to Section 305(a) do not apply to the distribution of a stock right considered part of a subscription right. Unlike the distribution of a stock right considered part of a subscription right, the distribution by us of a debt right considered part of a subscription right will be taxable to a U.S. holder in an amount equal to the fair market value (on the date of distribution) of such debt right. We expect that the fair market value of a debt right considered part of a subscription right will be $0.00. We believe that any value a subscription right may have is attributable solely to the stock right considered part of such subscription right. Thus, because (1) any value attributable to a subscription right as of the date of distribution will be attributable solely to the value of the stock right and (2) the distribution of a subscription right will be made with respect to our common stock, the distribution of a subscription right by us to a U.S. holder should be a non-taxable event. The remainder of this discussion assumes that this valuation of a debt right considered part of a subscription right will be respected for United States federal income tax purposes. Tax Basis of Subscription Rights. Except as provided in the following sentence, the tax basis of a subscription right will be zero. If, however, either (1) the fair market value (on the date of distribution) of the stock right considered part of the subscription right is 15% or more of the fair market value (on the date of distribution) of the shares of the common stock with respect to which the subscription right is distributed, or (2) the U.S. holder properly elects, in the holder s federal income tax return for the taxable year in which the holder receives the subscription right, to allocate part of the tax basis of such common stock to the subscription right, then, upon the exercise of the subscription right, the holder s tax basis in such common stock will be allocated between such common stock and the subscription right in proportion to the fair market values (on the date of distribution) of the common stock and the stock right considered part of the subscription right. We have not obtained an independent appraisal of the valuation of the shares of the common stock with respect to which subscription rights are distributed or the stock rights considered part of such subscription rights and, therefore, each U.S. holder individually must determine how the rule in the preceding sentence will apply in that holder s particular situation. For United States federal income tax purposes, the fair market value of property is the price at which the property would change hands between a willing buyer and a willing seller, where neither party is under a compulsion to buy or sell and both have reasonable knowledge of all the relevant facts. Expiration of Subscription Rights. A U.S. holder will not recognize any gain or loss upon the expiration of a subscription right, and no adjustment will be made to the tax basis, if any, of the shares of common stock with respect to which the right is distributed. SELECTED FINANCIAL INFORMATION The following table sets forth, for the periods indicated, selected data from our financial statements. This table should be read in conjunction with Management Discussion and Analysis of Financial Condition and Results of Operations , set forth below, and with our Consolidated Financial statements and related notes for the fiscal year ended March 29, 2002 and the 40 weeks ended January 3, 2003 appearing elsewhere in this prospectus. 40 Weeks Ended 52 Weeks Ended Exercise of Subscription Rights. A U.S. holder will not recognize gain or loss on the exercise of a subscription right. Units Purchased Pursuant to Exercise of Subscription Rights Allocation of Purchase Price for Units. A U.S. holder s purchase of a Unit will be treated as a purchase of Subordinated Notes and shares of common stock constituting the Unit. The purchase price of each Unit will be allocated between the Subordinated Notes and the shares of common stock constituting such Unit in proportion to their respective fair market values at the time of acquisition. We expect to report the fair market value of the shares of common stock as $[125.00] and the fair market value of the Subordinated Notes as $35. This position will be binding on each U.S. holder (but not on the Internal Revenue Service) unless such holder explicitly discloses a contrary position on a statement attached to its timely filed United States federal income tax return for the taxable year in which the Unit is acquired. Thus, absent such disclosure, a U.S. holder should allocate the purchase price for a Unit in accordance with the values reported by us. The remainder of this discussion assumes that this allocation of the purchase price of a Unit will be respected for United States federal income tax purposes. Allocation of Tax Basis in Units. A U.S. holder s aggregate initial tax basis in a Unit purchased pursuant to the exercise of a subscription right will equal (1) the purchase price paid for such Unit (that is, $[160.00]), plus (2) the holder s adjusted tax basis, if any, in the subscription right. The portion of the tax basis in a Unit attributable to the purchase price paid for such Unit will be allocated to the Subordinated Notes and shares of common stock in the same manner that the purchase price for the Unit was allocated to such notes and common stock as described immediately above in Allocation of Purchase Price for Units. Thus, $[125.00] and $35 of the tax basis attributable to the purchase price paid for a Unit will be allocated to the shares of common stock and Subordinated Notes, respectively. The portion of the tax basis in a Unit attributable to the subscription right as a result of the rule described in Subscription Rights to Purchase Units Tax Basis of Subscription Rights above, if any, should be allocated to the shares of common stock. Sale, Exchange or Other Disposition of Units. If a U.S. holder sells, exchanges or otherwise disposes of a Unit, the holder will be treated as having sold, exchanged or disposed of the Subordinated Notes and the shares of common stock that constitute such Unit. The treatment of the sale, exchange or other disposition of the Subordinated Notes and the shares of common stock are described under Subordinated Notes and Shares of Common Stock Constituting a Unit Subordinated Notes Sale, Exchange or Other Disposition of Subordinated Notes and Subordinated Notes and Shares of Common Stock Constituting a Unit Shares of Common Stock Sale, Exchange or Other Disposition of Shares of Common Stock below. Subordinated Notes and Shares of Common Stock Constituting a Unit Subordinated Notes Classification of Subordinated Notes. We intend to take the position that the Subordinated Notes will be classified for United States federal income tax purposes as indebtedness under current law. The remainder of this discussion assumes that the Subordinated Notes will be classified as indebtedness for United States federal income tax purposes. There can be no assurance, however, that an Internal Revenue Service challenge or a subsequent change in the tax laws will not affect such classification. Payment of Interest on Subordinated Notes. Interest on Subordinated Notes will generally be taxable to a U.S. holder as ordinary interest income at the time it is accrued or is received in accordance with the holder s method of accounting for United States federal income tax purposes. We intend to take the position that the Subordinated Notes do not have original issue discount or amortizable debt premium. No assurance can be given, however, that our position will not be challenged by the Internal Revenue Service or, if so challenged, that the challenge will not be successful. Holding Period of Subordinated Notes. The holding period of Subordinated Notes will begin on the date of exercise of the subscription right pursuant to which the notes are acquired. Sale, Exchange or Other Disposition of Subordinated Notes. Upon the sale, exchange or other disposition of Subordinated Notes constituting part of a Unit, a U.S. holder will recognize capital gain or loss equal to the difference between the amount realized on the sale, exchange or other disposition (other than amounts representing interest which will be treated as interest as described under Payment of Interest on Subordinated Notes above) and the holder s adjusted tax basis in the notes. A U.S. holder s adjusted tax basis in Subordinated Notes generally will equal the holder s initial tax basis determined as set forth under Units Purchased Pursuant to Exercise of Subscription Rights Allocation of Tax Basis in Units above, less any principal payments received by such holder. For certain non-corporate taxpayers (including individuals), the rate of taxation of capital gains will depend upon (1) the taxpayer s holding period in the capital asset (with preferential rates available for capital assets held for more than 12 months) and (2) the taxpayer s marginal tax rate for ordinary income. The deductibility of capital losses is subject to limitations. U.S. holders are urged to consult their tax advisors with respect to the rate of taxation of capital gains and the ability to deduct capital losses. Shares of Common Stock Dividends. Any dividend, whether paid in cash or in property (other than with additional shares of common stock or stock rights), will generally be taxable to a U.S. holder as ordinary dividend income, to the extent paid out of our current or accumulated earnings and profits, when received irrespective of such holder s method of accounting. The amount of each such dividend will equal the sum of the amount of cash and the fair market value of property received by the U.S. holder. To the extent a U.S. holder receives a dividend that exceeds our current or accumulated earnings and profits, the excess will be treated first as a non-taxable return of capital that reduces the holder s basis in its common stock to the extent of such basis and thereafter as taxable gain from the sale or exchange of common stock. In addition, such dividend generally will be eligible for the dividends received deduction if received by an otherwise qualifying corporate U.S. holder. Corporate U.S. holders of our shares of common stock otherwise entitled to the dividends received deduction should consider the minimum holding period requirements of Section 246(c) of the Code, the debt-financed portfolio stock rules of Section 246A of the Code, and the extraordinary dividend provisions of Section 1059 of the Code, the effects of which are to reduce or eliminate the benefit of the dividends received deduction with respect to our shares of common stock subject to such rules. Corporate U.S. holders of our shares of common stock should also consider whether any dividends received deduction allowed for dividends received on our shares of common stock may either cause or increase the holder s liability for the alternative minimum tax. Holding Period of Shares of Common Stock. The holding period of shares of common stock will begin on the date of exercise of the subscription right pursuant to which the shares are acquired. Sale, Exchange or Other Disposition of Shares of Common Stock. The sale, exchange or other disposition of shares of common stock constituting part of a Unit will result in the recognition of capital gain or loss to the U.S. holder in an amount equal to the difference between the amount realized and the holder s adjusted tax basis in the shares. For certain non-corporate taxpayers (including individuals), the rate of taxation of capital gains will depend upon (1) the taxpayer s holding period in the capital asset (with preferential rates available for capital assets held for more than 12 months) and (2) the taxpayer s marginal tax rate for ordinary income. The deductibility of capital losses is subject to limitations. U.S. holders are urged to consult their tax advisors with respect to the rate of taxation of capital gains and the ability to deduct capital losses. Backup Withholding and Information Reporting Backup withholding and information reporting requirements may apply to certain non-corporate U.S. holders with respect to (1) certain payments of principal and interest on Subordinated Notes, (2) payment of dividends on shares of common stock, and (3) payments of proceeds of the sale or other disposition of Subordinated Notes and shares of common stock. We, our agent, a broker, or any paying agent, as the case may be, will be required to withhold a tax equal to 30% (29% for 2004 and 2005, and 28% for 2006 through 2010) from any such payment if the U.S. holder fails to furnish or certify its correct taxpayer identification number to the payor in the manner required, fails to certify that the holder is exempt from backup withholding, or otherwise fails to comply with the applicable requirements of the backup withholding rules. Any amounts withheld under the backup withholding rules from a payment to a U.S. holder may be credited against such holder s United States federal income tax and may entitle such holder to a refund, provided that the required information is furnished to the Internal Revenue Service. United States Federal Income Tax Treatment of Non-U.S. Holders For purposes of the following discussion, we use the term non-U.S. holder to refer to a beneficial owner of a subscription right or Unit (or Subordinated Notes or shares of common stock constituting part of a Unit) that is (1) a nonresident alien individual, (2) a foreign corporation, or (3) a foreign estate. If you are an individual, you may be deemed to be a resident alien, as opposed to a nonresident alien, in any calendar year by virtue of being present in the United States for at least 31 days in that calendar year and for an aggregate of at least 183 days during a three-year period ending in that calendar year (counting for such purposes all of the days present in that year, one-third of the days present in the immediately preceding year, and one-sixth of the days present in the second preceding year). Resident aliens are generally subject to U.S. federal income tax as if they were U.S. citizens. The following discussion does not address all aspects of United States federal income taxation that may be relevant to a non-U.S. holder s particular facts and circumstances (including, for example, being a U.S. expatriate) nor does it address the tax consequences for the stockholders of a non-U.S. holder. If a foreign partnership holds subscription rights or Units (or Subordinated Notes or shares of common stock constituting a Unit), the tax treatment of the partnership and of its partners will generally depend upon the status of the partners and the activities of the partnership. If a foreign trust holds subscription rights or Units (or Subordinated Notes or shares of common stock constituting part of a Unit), the tax treatment of the trust and of its beneficiaries will generally depend upon the status of the beneficiaries, the activities of the trust and the classification of the trust as a foreign complex trust, foreign simple trust, or foreign grantor trust, as defined in applicable United States Treasury regulations. If a holder of subscription rights or Units (or Subordinated Notes or shares of common stock constituting a Unit) is a foreign partnership or trust, such holder and the partners or beneficiaries of such holder, as the case may be, should consult their tax advisors. Withholding Taxes on Non-U.S. Holders Distribution of Subscription Rights. The distribution of a subscription right by us to a non-U.S. holder is generally subject to United States federal withholding tax at the rate of 30%. We, however, may elect to not withhold on a distribution to the extent it represents a non-taxable distribution of a stock right. As indicated in Subscription Rights to Purchase Units Distribution of Subscription Rights above, we expect that the fair market value of the debt right considered part of a subscription right will be $0.00 and believe that any value a subscription right may have is attributable solely to the stock right considered part of such subscription right. Therefore, because any value attributable to a subscription right as of the date of distribution will be attributable solely to the value of the stock right, the distribution of a subscription right by us should represent a non-taxable distribution of a stock right for this purpose thereby permitting us to elect to not withhold on the distribution of a subscription right. We intend to elect to not withhold on the distribution of a subscription right. Payments of Principal and Interest on Subordinated Notes. Subject to the discussion under Backup Withholding and Information Reporting below, payments of principal and interest on Subordinated Notes by us or by any of our paying agents to any non-U.S. holder will not be subject to United States federal withholding tax, provided that, in the case of interest: (1) the non-U.S. holder does not own (actually or constructively) 10% or more of the total combined voting power of all classes of our stock entitled to vote, is not a controlled foreign corporation related (directly or indirectly) to us through stock ownership, and is not a bank receiving interest described in Section 881(c)(3)(A) of the Code; and (2) the non-U.S. holder fulfills certain certification statement requirements set forth under the Code. The certification statement requirements generally will be satisfied if the non-U.S. holder of Subordinated Notes certifies on Form W-8BEN, under penalties of perjury, that it is not a United States person and provides its name and address. The Form W-8BEN must be delivered pursuant to applicable procedures and be properly transmitted to the withholding agent, and none of the persons receiving the Form W-8BEN can have actual knowledge that the form is false. If Subordinated Notes are held through a foreign intermediary, the intermediary, as well as the beneficial owner, may need to satisfy certification requirements. Dividends on Shares of Common Stock. Unless an exception applies, dividends paid to a non-U.S. holder will be subject to United States federal withholding tax at a rate of 30%. The entire dividend is generally subject to withholding tax. Special rules apply, however, if a distribution is made that is greater than our current or accumulated earnings and profits as calculated for United States federal income tax purposes. In such a case, we may elect to withhold only on the portion of the distribution that is out of our earnings and profits (the remainder of the distribution would generally not be subject to withholding tax). Alternatively, we may withhold on the entire distribution. In that case, a non-U.S. holder would generally be entitled to obtain a refund or credit from the Internal Revenue Service for the withholding tax on the portion of the distribution that exceeds our earnings and profits. Reduction of or Exemption from Withholding Tax by Treaty. A reduced rate of or exemption from withholding tax may apply to interest on Subordinated Notes or dividends on shares of common stock paid to a non-U.S. holder if the holder is eligible for benefits under a tax treaty between the United States and the holder s country of residence. The particular withholding tax rate that would apply to a non-U.S. holder depends on the holder s tax status and on the particular tax treaty. The non-U.S. holder must generally provide the withholding agent a properly executed Form W-8BEN in order to claim such an exemption from withholding tax. The Form W-8BEN must be delivered pursuant to applicable procedures and be properly transmitted to the withholding agent, and none of the persons receiving the Form W-8BEN can have actual knowledge that the form is false. In addition, the non-U.S. holder may be required to provide a United States taxpayer identification number on the Form W-8BEN in order to qualify for an exemption. If Subordinated Notes or shares of common stock are held through a foreign intermediary, the intermediary, as well as the beneficial owner, may need to satisfy certification requirements. Income Effectively Connected to a United States Trade or Business. If interest on Subordinated Notes or dividends on shares of common stock paid to a non-U.S. holder are effectively connected with the conduct of the holder s trade or business in the United States, such interest or dividends (as the case may be) will be exempt from United States federal withholding tax (provided that, in the case of dividends, if an income tax treaty applies, such dividends are also attributable to a permanent establishment in the United States). The non-U.S. holder, however, will be subject to regular United States federal income tax on the interest or dividends (as the case may be) in the same manner as if it were a U.S. holder. In addition, if the non-U.S. holder is a foreign corporation, it may be subject to a branch profits tax equal to 30% (or a lower rate provided by an applicable treaty) of its effectively connected earnings and profits for the taxable year, subject to adjustments. The non-U.S. holder generally must provide the withholding agent a properly executed Form W-8ECI in order to claim this exemption from withholding tax. The Form W-8ECI must be delivered pursuant to applicable procedures and be properly transmitted to the withholding agent, and none of the persons receiving the Form W-8ECI can have actual knowledge that the form is false. If Subordinated Notes or shares of common stock are held through a foreign intermediary, the intermediary, as well as the beneficial owner, may need to satisfy certification requirements. The foregoing discussion does not deal with all aspects of United States federal withholding tax that may be relevant to investors holding subscription rights or Units (or Subordinated Notes or shares of common stock constituting part of a Unit) that are not United States persons. Furthermore, the rules regarding withholding are complex and vary depending on an investor s particular situation. Thus, we advise you to consult with your tax advisor regarding the application of and the methods for satisfying the withholding tax rules. Sale, Exchange or Other Disposition of Subordinated Notes and Shares of Common Stock A non-U.S. holder generally will not be subject to United States federal income tax on gain realized on the sale, exchange or other disposition of Subordinated Notes or shares of common stock, unless (1) the gain is effectively connected with a trade or business that the holder conducts in the United States, (2) the non-U.S. holder is an individual, is present in the United States for at least 183 days during the year in which he disposes of the notes or common shares (as the case may be), and certain other conditions are satisfied, or (3) in the case of the disposition of shares of common stock, the non-U.S. holder directly or indirectly holds (or held at any time within the shorter of the period the common stock was held or the five-year period before the disposition) more than 5% of our shares of common stock and we are (or have been at any such time) a United States real property holding corporation. Generally, a corporation is a United States real property holding corporation if the fair market value of its United States real property interests equals or exceeds 50% of the sum of the fair market value of its worldwide real property assets plus its other assets used or held for use in a trade or business. We do not believe that we are currently a United States real property holding corporation or that we will become one in the future. No assurance can be given, however, that we are not or will not become a United States real property holding corporation. If we are or were to become a United States real property holding corporation, gains realized by a non-U.S. holder which did not directly or indirectly own more than 5% of our common stock at any time during the shorter of the five-year period preceding the disposition or the holder s holding period generally would not be subject to United States federal income tax as a result of our status as a United States real property holding corporation, provided that our common stock was regularly traded on an established securities market. If the gain on the sale, exchange or other disposition of Subordinated Notes or shares of common stock is effectively connected with a trade or business that the non-U.S. holder conducts in the United States, such gain generally will be subject to United States federal income tax at the usual rates applicable to United States persons. In addition, if the non-U.S. holder is a foreign corporation, it may be subject to a branch profits tax equal to 30% (or a lower rate provided by an applicable treaty) of its effectively connected earnings and profits for the taxable year, subject to adjustments. For purposes of the branch profits tax, interest on Subordinated Notes, dividends on shares of common stock, and any gain recognized on the sale, exchange or other disposition of Subordinated Notes or shares of common stock will be included in the effectively connected earnings and profits of the non-U.S. holder if the interest, dividend or gain is effectively connected with the conduct by the holder of a trade or business in the United States. Backup Withholding and Information Reporting Backup withholding generally will not apply to interest on Subordinated Notes or dividends on shares of common stock if (1) the non-U.S. holder certifies that it is not a United States person, or (2) the holder otherwise establishes an exemption, provided that we or our paying agent do not have actual knowledge that the holder is a United States person. Payments on the sale, exchange or other disposition of Subordinated Notes or shares of common stock made to or through a foreign office of a broker or middleman generally will not be subject to information reporting or backup withholding. However, information reporting, but not backup withholding, may apply to those payments if the broker or middleman has certain connections to the United States, unless the broker or middleman has in its records documentary evidence that the beneficial owner is not a United States person and certain other conditions are met or the beneficial owner otherwise establishes an exemption. Backup withholding may apply to any payment that the broker or middleman is required to report if the broker has actual knowledge that the payee is a United States person. Payment of the proceeds of a sale, exchange or other disposition of Subordinated Notes or shares of common stock to or through the United States office of a United States or foreign broker will be subject to backup withholding and information reporting unless the non-U.S. holder certifies, under penalties of perjury, that it is not a United States person (and we or our paying agent not have actual knowledge that the beneficial owner is a United States person) or otherwise establishes an exemption. Any amounts withheld from a payment to a non-U.S. holder under the backup withholding rules will be allowed as a credit against that holder s United States federal income tax liability and may entitle the holder to a refund, provided that the holder furnishes the required information to the Internal Revenue Service. Certain Tax-Qualified Plan Considerations If the recipient of subscription rights to acquire Units is an employee benefit plan, Keogh plan, tax-sheltered annuity, individual retirement account or annuity, or Roth IRA, which is intended to satisfy Section 401(a), 403, 408 or 408A of the Code (each a Benefit Plan ), then the subscription rights may be exercised, and the Units purchased, by and under the Benefit Plan. If, however, the subscription rights are received by a Benefit Plan, but the Units are purchased outside of the Benefit Plan by a participant or beneficiary thereof pursuant to an exercise of subscription rights, then such purchase may be deemed to be a distribution from the Benefit Plan which may violate the terms of the Benefit Plan and/ or applicable provisions of the Code and may also give rise to early distribution penalty taxes and a disqualification of the tax-exempt status of the Benefit Plan. Similarly, if the subscription rights to purchase Units are received by a person other than a Benefit Plan, but the Units are purchased by the Benefit Plan pursuant to the exercise of such subscription rights, such purchase by the Benefit Plan may be deemed to be a contribution to the Benefit Plan which may violate the terms of the Benefit Plan and/ or applicable provisions of the Code and may also give rise to a disqualification of the tax-exempt status of the Benefit Plan. Holders should consult their own tax advisors with respect to the tax consequences of either a purchase of Units by a participant or beneficiary outside of a Benefit Plan pursuant to the exercise of subscription rights that are received by the Benefit Plan, or a purchase of Units by a Benefit Plan pursuant to the exercise of subscription rights that are received by a person other than the Benefit Plan. LEGAL MATTERS The validity of the shares of common stock and subordinated debt offered by this prospectus is being passed upon for the Company by Honigman Miller Schwartz and Cohn LLP, Detroit, Michigan. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001013240_icg_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001013240_icg_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bc972688f31398469ab352fb0cc83c4dee337f2 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001013240_icg_legal_matters.txt @@ -0,0 +1 @@ +cumulative effect of this change in accounting principle. In addition, the change in accounting principle resulted in an increase in revenue of $1 million for the year ended December 31, 2000. We recognize revenue at the amount expected to be realized, which includes billing and service adjustments. Valuation allowances for uncollectible accounts receivable are established through a charge to selling, general and administrative expenses or SG&A. We assess the adequacy of this reserve periodically, evaluating general factors such as the length of time individual receivables are past due, historical collection experience, the economic and competitive environment, and changes in the credit worthiness of customers. We also assess the ability of specific customers to meet their financial obligations and establish specific valuation allowances based on the amount we expect to collect from these customers, as considered necessary. If circumstances relating to specific customers change or economic conditions improve or worsen such that past collection experience and assessment of the economic environment are no longer relevant, the estimate of the recoverability of our trade receivables may change. We had, as of September 30, 2003, total accounts receivable outstanding of $119 million, including approximately $90.4 million from the Qwest agreement, and an allowance for uncollectible accounts receivable of $7 million. On October 2, 2003, the balance due from the Qwest agreement was collected in full. Operating Costs and Accrued Liabilities We lease certain network facilities, primarily circuits, from ILECs and CLECs to augment our owned infrastructure generally for a fixed monthly fee. We also use the facilities of other carriers for which we are billed on a usage basis. We issued a significant number of disconnect orders to ILECs and CLECs for leased circuits throughout 2001 as a result of our optimization of our network and associated operating cost structure, as well as the curtailment of our expansion plans. In addition, many of these providers changed our billing account numbers, or BANs, in an attempt to segregate our pre- and post-Chapter 11 petition billing activity. Disconnected services were frequently not reflected on a timely basis by these facilities providers on our invoices, resulting in inaccurate invoices and disputes, and the assignment of new BANs by these facilities providers frequently resulted in incorrect balances being carried forward on invoices. We dispute invoices for usage billings when the call record detail is not adequate to support such charges. As a result of these and other types of billing disputes, we are in settlement negotiations with certain providers. In determining the amount of such operating expenses and related accrued liabilities to reflect in our financial statements, we consider the adequacy of documentation of disconnect notices, compliance with prevailing contractual requirements for submitting such disconnect notices and disputes to the provider of the facilities, and compliance with our interconnection agreements with these carriers. Significant judgment is required in estimating the ultimate outcome of the dispute resolution process, as well as any other amounts that may be incurred to conclude the negotiations or settle any litigation. Property and Equipment Our property and equipment includes property and equipment in service, under construction or development, and held for sale. Pursuant to the adoption of fresh start reporting, we wrote down the value of our property and equipment by $392 million and the balance of our accumulated depreciation by $126 million immediately prior to emerging from bankruptcy. The total fresh start reporting value of the long-lived assets was generally allocated on a pro rata basis to the individual asset categories based on asset appraisals obtained in November 2001 and March 2002. The new property and equipment values are being depreciated over the remaining estimated useful lives of the assets. Property and equipment placed in service subsequent to the establishment of the fresh start reporting balance sheet is stated at historical cost. Costs associated directly with network construction, service installations and development of business support systems, including employee related costs, and interest expense incurred during the construction period, are capitalized. Depreciation is calculated on a straight-line basis over the assets' estimated useful lives, which are determined based on historical usage with consideration given to technological changes, trends in the industry and other economic factors that could impact the network architecture and asset utilization. Assets held for sale are stated at the estimated proceeds from the sale, less costs to sell. Equipment held under capital leases is stated at the lower of the fair value of the asset or the net present value of the minimum lease payments at the inception of the lease. Amortization of equipment held under capital leases is included in depreciation and amortization expense, and is calculated on a straight-line basis over the estimated useful lives of the assets, or the related lease term, whichever is shorter. We provide for the impairment of long-lived assets pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which requires that long-lived assets and certain identifiable intangibles held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of its assets may not be recoverable. An impairment loss is recognized when the assets' carrying value exceeds both the assets' estimated undiscounted future cash flows, excluding interest, and the assets' estimated fair value. Measurement of the impairment loss is then based on the estimated fair value of the assets. Considerable judgment is required to project such future cash flows and, if required, to estimate the fair value of the long-lived assets and the amount of the impairment. We recorded approximately $1.7 billion, $28 million and $0.6 million of provision for impairment of long-lived assets in 2000, 2001 and the 2002 Predecessor Period, respectively. We reviewed our long-lived asset balances for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," as of September 30, 2003. As a result of this review, management believes that the estimated fair value of our long-lived assets as of September 30, 2003, exceeds their carrying value. LIQUIDITY AND CAPITAL RESOURCES Qwest Transaction and Debt Prepayment As discussed above under "Recent Developments Qwest Transaction and Debt Prepayment," on October 2, 2003, Qwest paid us an aggregate of approximately $75.8 million in cash to terminate early its obligations under four separate dial-up data services agreements with us. Qwest also paid us approximately $31.0 million in cash as final payment for the Qwest dial-up data services provided and to be provided by us under the four agreements between June 30, 2003 and December 31, 2003. All of our obligations to provide services to Qwest under these agreements will terminate, by agreement, on December 31, 2003, which is expected to result in the loss of approximately 28% of our recurring communications revenue. To offset this significant high margin revenue loss, we must improve liquidity through various operating initiatives and the sale of certain non-strategic assets. In addition, we will need to obtain additional funding through debt or equity financing no later than the first quarter of 2004, unless sufficient asset sales occur first. There can be no certainty that we will solve the liquidity issue and continue as a going concern. We used approximately $81.2 million of the net proceeds from the Qwest transaction to prepay in full the aggregate balance outstanding under our secured notes and senior subordinated term loan. As a result of the prepayments, $42.1 million of cash held in a cash collateral account for the benefit of our secured lenders was released and became available to us for general operational purposes, and we are no longer subject to the restrictive debt covenants under the respective debt instruments. Selected Balance Sheet Data As of September 30, 2003 Impact of the Transactions on Liquidity To offset the significant future loss of the Qwest dial-up data services revenue, we have commenced several operating initiatives to increase sales and reduce operating expenses and capital expenditures. In addition, management is evaluating the possible sale of certain non-strategic assets. Each of these initiatives is described in further detail below. Initiatives to increase sales: We are in the process of significantly expanding our quota-bearing sales personnel within our corporate services line of business. As of September 30, 2003, the total number of quota-bearing sales personnel was 150. During the third quarter, we commenced a plan to increase our quota-bearing sales personnel to a total of approximately 250. Management anticipates that this sales force will be fully deployed by the second quarter of 2004. Initiatives to reduce operating and capital expenditures: Operating costs: Line costs: We are is aggressively eliminating those incremental direct operating costs that were incurred in support of the Qwest dial-up data services revenue and to re-configure the remaining transport network in a more cost-efficient manner. Network operating costs: As a result of the loss of the Qwest dial-up data services revenue, a significant amount of switching capacity within our network will be under-utilized. We intend to re-configure the switching network in a more cost-efficient manner through the consolidation of network traffic and the elimination of excess network facilities. Capital expenditures: We are aggressively managing our capital expenditures and will be deferring all capital expenditures unless such expenditures support near term revenue growth with high returns and short paybacks, or are required to maintain either the integrity of the network or services to existing customers. SG&A expenses: We continue to evaluate our SG&A expenses in the context of our existing and projected revenues and plans to reduce those SG&A expenses that are not critical to the support of sales initiatives or the support of services being provided to existing customers. Initiatives to sell non-strategic assets: We are evaluating the opportunity to increase our liquidity through the potential disposition of assets including excess network transport equipment, switches and other assets which are either not optimized or under-performing. There can be no assurance, however, that these operating initiatives and potential sales of assets will be successful in sufficiently improving our liquidity. Based upon our current projections, management believes that in addition to the foregoing operating initiatives and potential asset sales, we will need to borrow additional funds or acquire funds through equity financing in 2004, and by the first quarter of 2004 if sufficient asset sales do not occur first. Although management anticipates that our reduced debt burden and unencumbered asset base will enhance our ability to raise needed capital, there can be no assurance that financing will be available to us on acceptable terms, or at all. Such financing is contingent upon market conditions and our results of operations and other factors, and is therefore not assured. Other Liquidity Items Other debt totaling $22.6 million as of September 30, 2003 consisted primarily of notes issued to vendors and taxing authorities. The notes have annual interest rates that range from 4% to 10%, and a As Reported Subsequent to December 31, 2002, and primarily as a result of the transactions described below, our capital lease obligations, excluding interest, were modified. The total of such capital lease commitments declined from $96.6 million as of December 31, 2002, to $79.8 million at September 30, 2003, primarily due to the replacement of our capital lease with Southern California Edison Company, or SCE, which is described below. In addition, as a result of the prepayment of our senior notes and senior subordinated term loan in October 2003, our long-term debt obligations were reduced from $110.6 million as of December 31, 2002 to approximately $22.6 million as of October 7, 2003. Receipt of Qwest Transaction Funds(1) (1)Assumes that all aspects of the Transactions were complete as of close of business September 30, 2003. See reconciliation of 2003 "As Reported" and "Pro Forma" debt maturities under "Pro Forma Effect of the Qwest Transactions and Debt Prepayment" herein. We lease certain portions of our network from SCE. In the first nine months of 2003 we completed two transactions with SCE that changed the recorded amounts of assets under capitalized lease agreements and the related capital lease liability. In January 2003, we returned certain leased dark fiber to SCE, which resulted in corresponding $3.2 million reductions of property and equipment and capital lease obligations. Further, in May 2003, we agreed with SCE to return additional assets and to replace the previous contract, as amended, with new agreements. In connection with the May 2003 termination of the previous contract and execution of new licenses and leases, we recorded corresponding $11.4 million reductions of property and equipment and capital lease obligations. Capital Expenditures Capital expenditures, exclusive of amounts required to sustain network functionality, will be driven primarily by customer demand for our services. If customer demand for new services does not meet management's expectations, capital expenditures will be proportionally reduced. We anticipate that approximately $9 million will be required in the fourth quarter of 2003 for capital expenditures, $2.5 million of which is expected to be related to network infrastructure upgrades, enhancements to back office systems, and to sustain the current network functionality. We have significant capacity available on our data backbone, metropolitan and regional fiber networks, and in our modem banks. It is our objective to use this capacity to generate future revenue streams. Off Balance Sheet Financing We have no off balance sheet financing other than long term commitments for operating leases and rents as shown in the table of "Contractual Cash Commitments" above. Historical Cash Flow Information Net Cash Provided (Used) By Operating Activities Predecessor Company 2000, 2001 and 2002 Predecessor Period Our operating activities before reorganization items provided positive cash flow totaling $142 million, $74 million and $29 million in 2000, 2001 and from January 1, 2002 to October 11, 2002, which we sometimes refer to as the 2002 Predecessor Period, respectively. Prepayment of Secured Indebtedness(2) The 2002 Predecessor Period operating activities before reorganization items consisted of a net loss before reorganization items of $21 million and cash used by working capital of $24 million, offset by non-cash charges of $74 million. In 2001, operating activities before reorganization items consisted of a net loss before reorganization items of $99 million, offset by non-cash charges of $136 million and cash provided by working capital of $37 million. In 2000, operating activities before reorganization items consisted of a net loss before reorganization items of approximately $2.4 billion, offset by cash provided by working capital of $212 million and non-cash charges of $2.3 billion, comprised primarily of approximately $1.7 billion of provision for impairment of long-lived assets. Reorganization items used $20 million, $86 million and $31 million of cash in 2000, 2001 and the 2002 Predecessor Period, respectively. Reorganization items represent primarily reorganization income (expense), net, adjusted for non-cash items recognized during the bankruptcy process. These non-cash items were comprised primarily of fresh start reporting adjustments in the 2002 Predecessor Period, changes in liabilities subject to compromise and restructuring accruals, gains related to contract settlements, and a gain related to the write-off of deferred financing and offering costs in 2000. Predecessor Company Nine months ended September 30, 2002 The Predecessor Company's operating activities in the nine months ended September 30, 2002 provided $6.0 million of cash. Operating activities before reorganization items provided $31.9 million of cash, which consisted of net non-cash charges of $73.5 million, offset by a net loss before reorganization items of $19.9 million and net cash used by working capital of $21.7 million. Reorganization items used $25.9 million of cash, which consisted primarily of net reorganization expense of $34.4 million and net gain on negotiated settlements and disposal of long-lived assets of $3.6 million, offset by an increase in liabilities subject to compromise of $1.8 million and an increase in post-petition restructuring accruals of $10.3 million. Reorganized Company 2002 Reorganized Period The Reorganized Company's operating activities from October 12, 2002 to December 31, 2002, which we sometimes refer to as the 2002 Reorganized Period, provided positive cash flow totaling $4 million. Operating activities before reorganization items provided positive cash flow of $8 million, which was offset by a decrease in restructuring accruals of $4 million. The $8 million of cash provided by operating activities before reorganization items consisted of depreciation and amortization of $8 million and other non-cash charges of $3 million, offset by a net loss of $1 million and cash used by working capital of $2 million. Reorganized Company Nine months ended September 30, 2003 The Reorganized Company's operating activities in the nine months ended September 30, 2003 provided $5.9 million of cash. Operating activities before reorganization items provided $18.1 million of cash, which consisted of net income of $60.8 million and net non-cash charges of $39.3 million, offset by net cash used by working capital of $82.0 million. Net cash used by working capital consisted of an increase in receivables of $86.1 million, offset by a decrease in prepaid expenses of $1.1 million and increases in accounts payable and accrued liabilities of $0.9 million and deferred revenue of $2.1 million. Receivables increased due primarily to the $90.4 million due from Qwest as of September 30, 2003, pursuant to the Qwest agreement. This amount was paid in full by Qwest on October 2, 2003. Reorganization items, consisting of the change in post-petition restructuring accruals, used $12.1 million of cash. Pro Forma Net Cash Used By Investing Activities Predecessor Company 2000, 2001 and 2002 Predecessor Period Investing activities used $558 million, $18 million and $78 million in 2000, 2001 and the 2002 Predecessor Period, respectively. Net cash used by investing activities was primarily comprised of purchases of property and equipment, proceeds from dispositions of property, equipment and other assets, purchases and sales of short-term investments, and fluctuations in restricted cash and long-term deposit balances. Net cash used by investing activities includes cash expended for the acquisition of property, equipment and other assets of $596 million, $44 million and $37 million in 2000, 2001 and the 2002 Predecessor Period, respectively, which is net of the change in prepaid expenses, accounts payable and accrued liabilities related to the acquisition of property and equipment. Additionally, in accordance with the terms of the secured notes, on October 10, 2002, we transferred $45 million to a cash collateral account, which was classified as restricted cash in our balance sheet. Our capital expenditures (including assets acquired under capital leases) were $974 million, $92 million and $41 million in 2000, 2001 and the 2002 Predecessor Period, respectively. In 2000 and 2001, we acquired assets under capital leases and IRU agreements of $231 million and $51 million, respectively. No assets under capital leases or IRUs were acquired in the 2002 Predecessor Period. Predecessor Company Nine months ended September 30, 2002 The Predecessor Company's investing activities used $34.3 million of cash in the nine months ended September 30, 2002. Net cash used by investing activities was comprised primarily of capital expenditures of $41.3 million, proceeds of $3.4 million from the disposition of property, equipment and other assets, and a $3.3 million decrease in working capital balances attributable to capital expenditures. Reorganized Company 2002 Reorganized Period Investing activities in the 2002 Reorganized Period used $8 million, primarily comprised of purchases of property and equipment, offset by proceeds from decreases in long-term deposits and restricted cash, and proceeds from the disposition of property, equipment and other assets. Net cash used by investing activities includes cash expended for the acquisition of property, equipment and other assets of $11 million in 2002, which is net of the change in prepaid expenses, accounts payable and accrued liabilities related to the acquisition of property and equipment. Our 2002 Reorganized Period capital expenditures were $10 million. No assets under capital leases or IRUs were acquired in the 2002 Reorganized Period. Reorganized Company Nine months ended September 30, 2003 The Reorganized Company's investing activities used $25.0 million of cash in the nine months ended September 30, 2003, which was comprised primarily of $27.3 million of capital expenditures for network infrastructure upgrades, enhancements to back office systems and labor costs associated with the installation of new services. Offsetting the capital expenditures, restricted cash balances decreased $2.2 million. (in thousands of dollars) Assets: Cash 19,962 90,400 (39,027 ) 71,335 Restricted cash 48,886 (42,152 ) 6,734 Net Cash Provided (Used) By Financing Activities Predecessor Company 2000, 2001 and 2002 Predecessor Period Financing activities provided $528 million in 2000 and used $21 million and $11 million in 2001 and the 2002 Predecessor Period, respectively. Financing activities for the 2002 Predecessor Period include the receipt of new financing consisting of a $25 million senior subordinated term loan, which was used to pay down the outstanding principal balance of our secured notes to $59 million. We also made payments of $2 million for long-term debt issuance costs and $9 million for capital leases. Due to our then ongoing bankruptcy proceedings, our financing activities in 2001 were minimal. All pre-petition contractual debt and capital lease payments were suspended pursuant to our bankruptcy proceedings and subject to revised payment terms on a specific, case-by-case basis. We ceased the accretion of discounts and the accrual of interest on all unsecured debt subject to compromise as of our petition date. We continued to accrue and make interest payments on all fully secured long-term debt and capital lease obligations. During 2001, we made principal payments on capital leases of $17 million. In addition, we made $1 million in preferred stock dividend payments in 2001 as part of a settlement approved by the Bankruptcy Court. Net cash provided by financing activities in 2000 includes proceeds from our senior credit facility, our previously outstanding 8% Series A Convertible Preferred Stock, and the issuance of common stock in conjunction with the exercise of options and warrants and our employee stock purchase plan in the respective amounts of $95 million, $720 million and $17 million. These cash inflows were offset by principal payments on long-term debt, capital leases and IRUs and payments of long-term debt issuance costs and preferred dividends in the aggregate amount of $304 million. Predecessor Company Nine months ended September 30, 2002 The Predecessor Company's financing activities used $8.5 million of cash in the nine months ended September 30, 2002, which was comprised primarily of principal payments on capital lease obligations. Reorganized Company 2002 Reorganized Period Financing activities used $1 million in the 2002 Reorganized Period, consisting primarily of principal payments on long-term debt and capital leases. Reorganized Company Nine Months ended September 30, 2003 The Reorganized Company's financing activities used $11.7 million of cash in the nine months ended September 30, 2003, which included $7.1 million of principal payments on long-term debt and $4.6 million of principal payments on capital lease obligations. Supplemental Disclosure of Non-cash Investing and Financing Activities Our property and equipment and asset retirement obligations each increased by $2.5 million in the nine months ended September 30, 2003, as a result of our adoption of the provisions of SFAS 143 on January 1, 2003. In addition, in the first nine months of 2003, we renegotiated the contractual terms of certain capital lease obligations, as discussed further under "Liquidity and Capital Resources Capital Commitments Contractual Cash Commitments" herein, which resulted in a $14.6 million decrease in property and equipment and a corresponding decrease in capital lease obligations. Qwest revenue 30 %(1) 5 %(2) WorldCom revenue 10 % 13 % ISP #1 revenue 9 % 12 % ISP #2 revenue 7 % 9 % Top Four Customers revenue 56 %(1) (1)Communications revenue of the Reorganized Company is comparable to that of the Predecessor Company, except with respect to revenue recognition of certain deferred revenue. Due to the write-down of the deferred revenue balance in connection with the application of fresh start reporting, revenue was reduced by approximately $1 million per quarter. (2)Amounts represent percentages of Communications revenue. (3)Depreciation and amortization amounts of the Reorganized Company periods are not comparable to those of the Predecessor Company periods primarily due to the adoption of fresh start in October 2002. Pursuant to the adoption of fresh start, the Company wrote down the value of its property and equipment by $392 million, or 63%, and wrote off the $126 million balance of Communications revenue decreased $35.3 million, or 11%, for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002. The decrease for the nine-month period was due primarily to decreases of $14.7 million, $14.4 million and $23.1 million in corporate services, point-to-point broadband and reciprocal compensation revenue, respectively, offset by an increase in dial-up revenue of $17.0 million. In addition, to communications revenue, we had $75.8 million of early termination revenue in the nine months ended September 30, 2003. This amount was comprised of the Qwest early termination revenue, which was earned in consideration of the early termination of the Qwest dial-up data services agreements. Jeffrey R. Pearl 39 Interim Chief Executive Officer and Executive Vice President Sales and Marketing Richard E. Fish, Jr. 38 Executive Vice President and Chief Financial Officer Michael D. Kallet 50 Executive Vice President Operations and Chief Technology Officer Bernard L. Zuroff 48 Executive Vice President, General Counsel and Secretary John V. Colgan 58 Senior Vice President Finance and Controller William J. Connors(1)(2) 33 Director Timothy F. Price(1)(2) 50 Director John A. Scarpati(3) 52 Director Joseph R. Thornton(1)(2) Dial-Up Dial-up revenue is earned by providing PRI ports (one- and two-way) and managed modem RAS services to ISPs and other communication service companies. Dial-up revenue is comprised of (i) monthly recurring revenue, which includes fixed monthly service revenue and service revenue directly attributable to usage and (ii) non-recurring revenue, which includes installation revenue, billing adjustments and credits and other non-recurring items. Dial-up revenue increased 13% from $135.2 million in the nine months ended September 30, 2002, to $152.2 million in the nine months ended September 30, 2003. Dial-up revenue increased due primarily to the acquisition of a new customer, ISP #2, in late 2002. In addition, ISP #1 significantly increased its service levels for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002. Offsetting the above increases, revenue from WorldCom decreased significantly due to a 2003 settlement agreement, as discussed further under "Notes to Consolidated Financial Statements (Unaudited) Commitments and Contingencies". Dial-up revenue's contribution to communications revenue rose from 42% in the first nine months of 2002 to 54% in first nine months of 2003. As discussed above under "Liquidity and Capital Resources Qwest Transaction and Debt Repayment", on September 30, 2003, we entered into the Qwest agreement. Approximately $73.9 million of Qwest dial-up services revenue was included in dial-up revenue for the nine months ended September 30, 2003. The Qwest agreement calls for substantially all of the Qwest dial-up services to be disconnected from our network by December 31, 2003. Deferred revenue as of September 30, 2003 included approximately $6.4 million for the provision of Qwest dial-up data services between October 1, 2003 and December 31, 2003. Future revenue from the Qwest dial-up data services is expected to be eliminated by December 31, 2003, pursuant to the Qwest agreement. In addition, during the third quarter of 2003, ISP #1, which accounted for 9% of communications revenue in the nine months ended September 30, 2003, renegotiated its contract, as described under "Risk Factors A significant portion of our revenue is derived from a small number of large customers and we may not be able to retain them on profitable terms." Management anticipates that the renegotiation of contract terms will result in an approximately 30% reduction in revenue earned from ISP #1 in the future. Point-to-Point Broadband Point-to-point broadband revenue is generated primarily from service provided to IXCs and end-user business customers. This service provides dedicated bandwidth and offers DS1 to OC-192 capacity to connect: (i) long-haul carriers to local markets, large companies and other long-haul carrier facilities; and (ii) large companies to their long distance carrier facilities and other facilities. Point-to-point broadband revenue decreased 18% from $80.3 million in the first nine months of 2002 to $65.9 million in the first nine months of 2003. The decrease in the nine-month period in point-to-point broadband revenue was comprised of decreases in special access, switched access and SS7 revenues of 16%, 35% and 40%, respectively. Special access, switched access and SS7 revenue represented 92%, 4% and 4%, respectively, of total point-to-point broadband revenue in the first nine months of 2003. Special access revenue decreased primarily due to churn related to IXC customers reducing network capacity and a loss of end-users as a result of the economic downturn. Switched access and SS7 revenues decreased primarily due to the loss of customers. Point-to-point broadband revenue's contribution to communications revenue decreased from 25% in the first nine months of 2002 to 23% in the first nine months of 2003. 68,848 90,400 (81,179 ) 78,069 Trade receivables, net 112,023 (90,400 ) 21,623 Deferred financing costs, net of accumulated amortization of $1.1 million at September 30, 2003 2,285 (2,285 ) Other 226,096 226,096 Corporate Services Corporate services revenue includes: (i) local enhanced telephony, or Voice; (ii) DIA provided to businesses over our major metropolitan fiber optic networks or lines leased from the ILECs; and (iii) other business services. Other business services include carrier access billing service, or CABS, which is generated from the origination and termination of switched access traffic. Corporate services revenue decreased 27% from $55.6 million in the first nine months of 2002 to $40.9 million in the first nine months of 2003, due primarily to a $7.2 million, or 22%, decrease in monthly recurring revenue. The decrease in monthly recurring revenue for the nine-month period was due to a 12% decrease in the average billed line count, which was primarily due to customer churn, and a 12% decrease in the average monthly revenue per line. In addition, during the nine-month period, CABS revenue decreased $8.9 million, or 51%, due to rate reductions and reduced call volume. Corporate services revenue's contribution to communications revenue declined from 17% in the nine months ended September 30, 2002 to 14% in the nine months ended September 30, 2003. Reciprocal compensation Reciprocal compensation revenue is primarily earned pursuant to interconnection agreements with ILECs for the transport and termination of calls originated by ILEC customers, including Internet bound calls. Reciprocal compensation revenue decreased 46% from $49.8 million in the first nine months of 2002 to $26.6 million in the first nine months of 2003. Reciprocal compensation revenue included $12.3 million and $4.6 million from customer settlements in the nine months ended September 30, 2002 and 2003, respectively. Excluding revenue from customer settlements, reciprocal compensation revenue would have decreased 41% in the nine-month period, primarily due to contractual and regulated rate reductions. The Company anticipates that reciprocal compensation revenue will continue to decline in the future based on future negotiated and regulated rate reductions and the expiration of agreements currently in effect between us and the major ILECs. Reciprocal compensation's contribution to communications revenue decreased from 16% in the first nine months of 2002 to 9% in the first nine months of 2003. Operating costs Operating costs consist primarily of payments to ILECs, other CLECs, and long distance carriers for the use of network facilities to support local, special, switched access services and long distance services as well as internal network operating costs, right-of-way fees and other operating costs. Internal network operating costs include the cost of engineering and operations personnel dedicated to the operations and maintenance of the network. Total operating costs decreased 5% from $191.3 million in the first nine months of 2002 to $181.7 million in the first nine months of 2003. As a percentage of communications revenue, operating costs increased from 59% in the first nine months of 2002 to 64% in the first nine months of 2003. It is management's estimate that the variable gross margin on the Qwest dial-up data services revenue ranged from between 70% and 80%. Operating costs for the nine months ended September 30, 2002 reflected higher external line costs incurred as a result of our network footprint expansion. We initiated the expansion of our network to new markets in 2003 in order to serve our customers, particularly a new major ISP customer engaged in late 2002. The increase in external line costs was offset by a decrease in personnel expenses due to a reduction in headcount in the first nine months of 2003, as compared to the first nine months of 2002, which occurred as a result of two separate reductions in force initiated by the Company in the second quarter of 2002 and in the second quarter of 2003. In addition, network operations expenses decreased due primarily to the consolidation and closure of switch sites and reduction in repairs and maintenance expenses. Selling, general and administrative expenses Selling, general and administrative expenses, or SG&A expenses, increased 2% from $67.7 million in the first nine months of 2002 to $68.9 million in the first nine months of 2003. SG&A expenses represented 21% and 24% of communications revenue in the first nine months of 2002 and 2003, respectively. We initiated and completed two separate reductions in force in the second quarter of 2002 and in the second quarter of 2003. The reductions in force resulted in a 17% reduction in average headcount in the first nine months of 2003, as compared to the first nine months of 2002. As a result, personnel expenses, excluding severance expense, decreased 13% in the first nine months of 2003, as compared to the first nine months of 2002. Other significant fluctuations in SG&A expenses for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002, were as follows: Business taxes decreased in 2003 due primarily to lower assessed valuations and revised estimates calculated in the third quarter of 2003. Professional fees increased in 2003 due primarily to agency recruiting fees incurred to recruit marketing and sales professionals, accounting and legal fees incurred to comply with the provisions of the Sarbanes-Oxley Act of 2002, and legal and investment banker fees incurred to assist us with contract negotiations. The provision for doubtful accounts in 2003 decreased to $1.1 million from $4.0 million in 2002. Severance expenses increased in 2003 due primarily to the departure of Randall E. Curran, our former CEO, and due to the 2003 reductions in force. In the nine months ended September 30, 2002, severance expenses associated with the 2002 reduction in force were included in reorganization expenses in the accompanying statements of operations. Software maintenance expenses decreased in 2003 due primarily to the expiration of a significant software maintenance agreement and its replacement with less expensive maintenance agreements. Depreciation and amortization The Reorganized Company's depreciation and amortization expense was $31.2 million the first nine months of 2003. The average remaining useful life of property and equipment in service is approximately 6 years. The Predecessor Company's depreciation and amortization expense was $66.4 million in the first nine months of 2002. Pursuant to the adoption of fresh start reporting in October 2002, we wrote down the book value of our property and equipment by $392 million, or 63%, and wrote off the $126 million balance of accumulated depreciation. The total fresh start reporting value of the long-lived assets was allocated pro rata to the individual asset categories based on recent asset appraisals. The adjusted property and equipment values are being depreciated over the remaining useful lives of the assets. Other operating income, net Other operating expense (income), net, included a net loss (gain) on disposals of long-lived assets of ($0.7) million and $2.5 million in the first nine months of 2002 and 2003, respectively, as well as $0.3 million of SFAS 143 accretion expense in the first nine months of 2003 and provision for impairment of long-lived assets of $0.7 million in the first nine months of 2002. Interest expense The Reorganized Company incurred $18.3 million in interest expense in the first nine months of 2003, primarily on the secured notes, the senior subordinated term loan, other debt and capital leases. Interest expense in the nine-month period included $1.8 million of non-cash amortization of deferred financing costs and debt discount, as well as $2.5 million of non-cash accreted interest that is included in capital lease obligations. The Predecessor Company incurred $15.4 million in interest expense in the first nine months of 2002, primarily on the senior credit facility, which was refinanced on the effective date of our reorganization, and capital leases. Interest expense in the 2002 nine-month period included $0.5 million of non-cash amortization of deferred financing costs, as well as $2.9 million of non-cash accreted interest that was included in capital lease obligations. Contractual interest expense of $190 million was not recorded for the nine months ended September 30, 2002, due to the Predecessor Company's bankruptcy proceedings. Interest income The Reorganized Company's interest income of $0.6 million in the first nine months of 2003 was included in Interest Income in the condensed consolidated statement of operations. The Predecessor Company's interest income of $1.4 million in the first nine months of 2002 was considered earned as a result of the bankruptcy filing, and was therefore classified as a reorganization item, in accordance with the requirements of SOP 90-7. Reorganization expense, net The Predecessor Company recorded net reorganization expense of $34.4 million in the first nine months of 2002. Reorganization items in the 2003 quarterly period consisted of income and expenses associated with the bankruptcy proceedings that were not directly attributable to our ongoing operations and included legal and professional fees and net loss on negotiated settlements and disposal of long-lived assets. During the nine-month 2003 period, the largest component of net reorganization expense was contract termination expenses, which amounted to $23.4 million. Other significant reorganization items during the period included severance and employee retention costs, legal and professional fees, switch site closure costs and net gain on negotiated settlements and disposal of long-lived assets. Reorganization items also consisted during the period of income and expenses associated with the bankruptcy proceedings that were not directly attributable to our ongoing operations. Total revenue decreased $80 million, or 16%, for the year ended December 31, 2002, as compared to the year ended December 31, 2001. The decrease was due primarily to a $43 million decrease in point-to-point broadband revenue, a $41 million decrease in corporate services revenue and a $2.5 million decrease in reciprocal compensation revenue, offset by a $7 million increase in dial-up revenue. The general economic downturn and the severe downturn in the telecommunications industry have resulted in an oversupply of network infrastructure. In addition, the slowing economy has resulted in many of our customers ceasing operations, filing for bankruptcy protection, or cutting costs. The effects on us include higher levels of customer disconnections and increased pricing pressure on new and existing customer contracts. In addition, customers are taking longer to make buying decisions, thus lengthening the sales cycle. Dial-Up Dial-up revenue increased 4% from $178 million in 2001 to $185 million in 2002. For 2002 as compared to 2001, monthly recurring revenue increased 1% due to a 20% increase in the average number of billed lines offset by a 16% decrease in the average monthly revenue per line. The average monthly revenue per line decreased due primarily to contract renegotiations with major customers and a change in product mix. Dial-up revenue's contribution to total revenue rose from 36% in 2001 to 44% in 2002. Point-to-Point Broadband Point-to-point broadband revenue decreased 29% from $147 million in 2001 to $104 million in 2002. Special access, switched access and SS7 revenue represented 90%, 6% and 4%, respectively, of total point-to-point broadband revenue in 2002. The decrease in point-to-point broadband revenue was comprised of decreases in special access, switched access and SS7 revenues of 28%, 54% and 55%, respectively. Special access revenue decreased primarily due to churn related to IXC customers reducing network capacity and a loss of end-users as a result of the economic downturn. Switched access and SS7 revenues decreased primarily due to the loss of customers. Point-to-point broadband revenue's contribution to total revenue declined from 29% in 2001 to 25% in 2002. Corporate Services Corporate services revenue decreased 37% from $112 million in 2001 to $70 million in 2002. Recurring voice revenue decreased $32 million, or 43%, due primarily to a 40% decrease in the average number of billed lines, which was primarily due to customer churn, and a 4% decrease in the Total assets 409,252 (83,464 ) 325,788 average monthly revenue per line. Corporate services revenue was also impacted by a $5 million, or 95%, decrease in long-distance revenue as a result of our transition out of the long-distance business in the fourth quarter of 2001. Corporate services revenue's contribution to total revenue declined from 22% in 2001 to 17% in 2002. Reciprocal compensation Reciprocal compensation revenue decreased 4% from $64 million in 2001 to $61 million in 2002. Reciprocal compensation's contribution to total revenue increased from 13% in 2001 to 14% in 2002. Reciprocal compensation revenue includes $4 million and $13 million from customer settlements in 2001 and 2002, respectively. Excluding these settlements, reciprocal compensation revenue would have decreased 19% during 2002 primarily due to contractual and regulated rate reductions. We anticipate that reciprocal compensation revenue will continue to decline in the future based on future negotiated and regulated rate reductions and the expiration of agreements currently us and the major ILECs. We also anticipate that due to changes in the regulatory environment, reciprocal compensation revenue earned after 2003 will be significantly reduced. Operating costs Total operating costs decreased 29% from $352 million in 2001 to $250 million in 2002. As a percentage of revenue, operating costs also decreased from 70% in 2001 to 60% in 2002. Operating costs consist primarily of payments to ILECs, other CLECs and long distance carriers for the use of network facilities to support local, special, switched access services and long distance services as well as internal network operating costs, right-of-way fees and other operating costs. Internal network operating costs include the cost of engineering and operations personnel dedicated to the operations and maintenance of the network. In 2002, we continued to reduce excess network capacity and reconfigure our network for better performance. In addition, we reduced the number of our employees in 2002 by 16%. Selling, general and administrative expenses SG&A expenses decreased 5% from $94 million in 2001 to $90 million in 2002. SG&A expenses represented 19% and 21% of revenue in 2001 and 2002, respectively. SG&A expenses decreased primarily due to fewer employees, lower facilities costs achieved in connection with our consolidation of locations during the bankruptcy reorganization, and reduced real estate and personal property taxes achieved as a result of write-downs in the value of our property and equipment. Bad-debt expense Bad-debt expense decreased 63% from $14 million in 2001 to $5 million in 2002 due to improved collections and customer settlements. Depreciation and amortization Predecessor Company: Depreciation and amortization expense was $68 million and $66 million for 2001 and the 2002 Predecessor Period, respectively. Pursuant to the adoption of fresh start reporting in October 2002, we wrote down the book value of our property and equipment by $392 million, and the $126 million balance of the accumulated depreciation to zero. The total fresh start reporting value of the long-lived assets was allocated pro rata to the individual asset categories based on recent asset appraisals. The new property and equipment values are being depreciated over the remaining useful lives of the assets. Reorganized Company: Depreciation and amortization expense for the 2002 Reorganized Period was $8 million. This amount is lower than during 2001 and the 2002 Predecessor Period because of the significant write-downs from fresh start reporting. The average remaining useful life of our property and equipment in service at December 31, 2002, was approximately 6 years. Provision for impairment of long-lived assets Predecessor Company: Impairment charges of $28 million and $0.6 million were recorded in 2001 and the 2002 Predecessor Period, respectively, to reduce assets classified as held for sale to their fair value. Reorganized Company: We performed an analysis pursuant to the requirements of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," as of December 31, 2002, to determine if a provision for impairment of its long-lived assets was required. The analysis compared our estimate of future undiscounted cash flows that will be generated by the existing long-lived assets to their net book value of $231 million. The analysis indicated that no provision for impairment was required. Other, net operating costs and expenses Other, net operating costs and expenses decreased from $12 million in 2001 to $0.7 million in the 2002 Predecessor Period. Other, net operating costs and expenses in 2001 consisted primarily of the loss on disposal of long-lived assets. Interest expense Predecessor Company: Interest expense was $32 million and $17 million for 2001 and the 2002 Predecessor Period, respectively. Interest expense for 2001 includes $12 million relating to the Predecessor Company's debtor-in-possession revolving credit agreement, or the DIP Financing, with Chase Manhattan Bank, which originated on December 4, 2000. On November 7, 2001, the Predecessor Company terminated the DIP Financing without ever having drawn any amounts under this agreement. Contractual interest that was not recorded due to the bankruptcy proceedings totaled $249 million and $198 million in 2001 and the 2002 Predecessor Period, respectively. Reorganized Company: We incurred $6 million in interest expense after the bankruptcy reorganization. Interest expense was incurred primarily on the secured notes, the senior subordinated term loan, other debt and capital leases. Interest income Predecessor Company: Interest income of $7 million and $2 million in 2001 and the 2002 Predecessor Period, respectively, was considered earned as a result of the bankruptcy filing, and was therefore classified as a reorganization item in accordance with the requirements of SOP 90-7. The decrease in total interest income is attributable to the decrease in cash, cash equivalents and short-term investments resulting from the use of the Predecessor Company's cash balances in connection with its reorganization through the bankruptcy proceedings, and from generally lower interest rates and yields on its invested cash. Reorganized Company: Interest income of $0.2 million earned after the bankruptcy reorganization is included in Interest Income in the consolidated statement of operations. Reorganization income (expense), net We recorded net reorganization expense of $13 million and net reorganization income of approximately $4.4 billion for 2001 and the 2002 Predecessor Period, respectively. Reorganization items Total revenue decreased 16% to $500 million in 2001 compared to 2000. Dial-up revenues increased significantly to account for 36% of the revenue generated in 2001. The contribution of reciprocal compensation as a percent of total revenue decreased from 23% in 2000 to 13% in 2001. Dial-up Dial-up revenue increased 15% to $178 million in 2001 from $154 million in 2000. The increase was primarily attributable to a 2% increase in the average number of customer access ports and a significant reduction in service credits issued to customers in 2001, offset by a reduction in the average revenue per port due to product mix and price reductions. We issued $30 million of service credit to customers in the third and fourth quarters of 2000. Service levels significantly improved in early 2001. Point-to-point broadband Point-to-point broadband revenue, which includes switched access and SS7 revenues, decreased 12% to $147 million in 2001 from $167 million in 2000. The decrease was due primarily to a reduction of $12 million in switched access revenues due to reduced customer demand and a reduction of $12 million of revenue recognized in 2000 on a fiber optic lease agreement with a major IXC that did not recur in 2001. Special access, switched access and SS7 revenue represented 83%, 9% and 8%, respectively, of total point-to-point broadband revenue in 2001. Corporate services Corporate services revenue decreased 19% to $112 million in 2001 from $138 million in 2000. The decrease was primarily attributable to a 21% decrease in the average number of access lines, many of which were resale lines that generated a higher than average revenue per line but low margins, and a reduction in revenue due to the transitioning of long distance services to another carrier in late 2001. Reciprocal compensation Reciprocal compensation revenue declined 54% from $139 million in 2000 to $64 million in 2001. Reciprocal compensation revenue is primarily earned under interconnection agreements with ILECs for terminating local traffic but also includes revenue from transport and termination of other traffic for the ILECs. Reciprocal compensation is charged based on a rate per minute of use, or MOU. Reciprocal compensation MOUs decreased 9% in 2001 from 2000 as the number of ports and access lines decreased, and the average rate per MOU declined 52%. In 2000, we negotiated new interconnection agreements with several ILECs. These agreements fixed the recognition and receipt of compensation for terminating ISP traffic but at rates lower than we had historically received. Operating costs Total operating costs decreased 20% from $440 million in 2000 to $352 million in 2001. Operating costs decreased as a percentage of revenue from 74% in 2000 to 70% in 2001. Operating costs consist primarily of payments to ILECs, other CLECs and long distance carriers for the use of network facilities to support dial-up, voice, point-to-point broadband, switched access and long distance services as well as internal network operating costs, right-of-way fees and other operating costs. Internal network operating costs include the cost of engineering and operations personnel dedicated to the operations and maintenance of the network. Operating costs decreased as a percentage of revenue primarily due to termination of circuits that were not generating revenue. Selling, general and administrative expenses Total SG&A expenses decreased from $200 million in 2000 to $94 million in 2001, a 53% decrease. Selling, general and administrative expenses as a percentage of revenue decreased from 33% in 2000 to 19% in 2001. The decrease in SG&A expenses was attributable to decreases in salaries and benefits, travel and entertainment, marketing and professional fees as well as other expenses as a result of the Predecessor Company's restructuring process which commenced in the second half of 2000. These reductions included reducing the full-time employee count from 2,054 at December 31, 2000, to 1,368 at December 31, 2001, with the majority of the headcount reductions taking place in the first quarter of 2001. Liabilities and stockholders' equity: Secured Notes and Senior Subordinated Term Loan, net of discount of $3.9 million at September 30, 2003(2) 77,270 (77,270 ) Other debt 22,582 22,582 Capital lease obligations 79,768 79,768 Bad-debt expense Bad-debt expense decreased 83% from $85 million in 2000 to $14 million in 2001. The Predecessor Company recorded a provision for uncollectible accounts in 2000 of $29 million and $53 million in the third and fourth quarters of 2000, respectively. Of those amounts, $6 million and $13 million related to reciprocal compensation for the third and fourth quarters of 2000, respectively. This greater amount in the provision in 2000 was attributable to (i) customers in the ISP and Internet space that were unable to pay for service, (ii) the resolution of billing disputes, (iii) customers that stopped or deferred payments for services as the Predecessor Company entered bankruptcy and (iv) reduction in the resources that the Predecessor Company could afford to expend to enforce the payment of reciprocal compensation under the interconnection agreements. The decrease in the provision for uncollectible accounts in 2001 was attributable to significant improvement in the collection of current billings and past due accounts as well an improvement in customers' reactions to our reorganization and satisfactory settlements of account balances with major customers. Depreciation and amortization Depreciation and amortization decreased 79% from $319 million in 2000 to $68 million in 2001. The decrease was primarily due to the approximately $1.7 billion impairment charge to reduce tangible and intangible assets to their fair value as of December 31, 2000. The net book value of the tangible assets in service became the new cost basis for depreciation as of December 31, 2000. Provision for impairment of long-lived assets We recorded approximately $1.7 billion and $28 million of provision for impairment of long-lived assets in 2000 and 2001, respectively. Our impairment analysis as of December 31, 2000, indicated that there was a shortfall of undiscounted cash flows before interest compared to the carrying value of our long-lived tangible and intangible assets, and that impairment had occurred. For purposes of calculating the amount of the impairment we segregated our long-lived assets into three categories: intangible assets consisting primarily of goodwill, tangible assets to be disposed of and tangible assets to be utilized in ongoing operations. As a result of the analysis of shortfalls of cash flows to carrying values of assets, all intangibles, consisting primarily of goodwill relating to our acquisitions under the purchase method of accounting, were written off as of December 31, 2000, resulting in an impairment charge of $80 million. We determined that certain assets that would not be utilized under our business plan would be held for sale. These assets were comprised primarily of (i) assets under construction, for which the incremental capital required to place the asset in service was not available; and (ii) assets already in service that were not deemed necessary in the business plan. An impairment of $124 million was reflected in the financial statements for 2000 to reduce these assets to their fair value, which was based on existing appraisals or purchase offers, less cost to sell. Additional impairment charges of $28 million and $0.6 million were recorded in 2001 and the 2002 Predecessor Period, respectively, to reduce assets classified as held for sale to their fair value. The fair value of tangible assets to be utilized in ongoing operations was determined to be $550 million at December 31, 2000. This value was derived based on the following valuation techniques: (i) discounted cash flows; (ii) asset appraisal; and (iii) current market capitalization. In order to reduce tangible assets to be used in ongoing operations to the fair value of $550 million, we recorded an impairment charge as of December 31, 2000, of approximately $1.5 billion. No adjustment was made to recorded depreciation during the year ended December 31, 2000. The book value of the impaired assets at December 31, 2000, became the new cost basis of the assets. Subsequent depreciation of the new cost basis was calculated based on the remaining estimated useful life of the assets. Other, net operating costs and expenses Other, net operating costs and expenses increased from $4 million in 2000 to $12 million in 2001. Other, net operating costs and expenses consist primarily of the loss on disposal of long-lived assets. Interest expense Interest expense decreased from $234 million in 2000 to $32 million in 2001. The decrease in interest expense was a result of our bankruptcy filing. Interest was not accrued or paid and discounts were not accreted on all prepetition debt subject to compromise. Contractual interest that was not recorded due to the bankruptcy proceedings totaled $30 million for the period from November 14, 2000 through December 31, 2000, and $249 million in 2001. Included in interest expense for 2000 was $176 million of noncash interest. Additionally, interest expense was net of interest capitalized related to construction in progress of $7 million and $1 million during 2000 and 2001, respectively. We continued to accrue and make payments on all fully collateralized long-term debt and capital lease obligations not subject to compromise. Interest income Interest income decreased from $24 million in 2000 to $7 million in 2001. Interest income earned as a result of the bankruptcy filing of $1 million and $7 million in 2000 and 2001, respectively, was classified as reorganization expenses in accordance with the requirements of SOP 90-7. The decrease in total income was attributable to the decrease in cash, cash equivalents and short-term investments resulting from the use of our cash balances in connection with our reorganization under the bankruptcy proceedings and from generally lower interest rates and yields on our invested cash. Other expense, net Other expense, net changed from $15 million of expense in 2000 to $1.0 million of income in 2001. Other expense, net in 2001 consisted primarily of a net gain on the sale of investments. The 2000 amount related primarily to the loss on an investment, partially offset by a gain on a litigation settlement. Reorganization expense, net Reorganization expenses associated with the Predecessor Company's reorganization of $14 million and $54 million in 2001 and 2000, respectively, consist of costs associated with the bankruptcy proceedings that are not directly attributable to our ongoing operations. In 2001, reorganization items costs included a gain on settlement with major customers of $39 million and interest income earned as a result of the bankruptcy filing of $7 million, offset by severance and employee retention costs of $13 million, loss on equipment returned to vendors of $10 million, legal and professional fees of $17 million, switch site closure costs of $5 million, line cost termination expenses of $9 million and other expenses of $5 million. In 2000, these costs included $37 million for the write-off of deferred financing and offering costs, $10 million for severance and employee retention costs, $6 million in professional fees, $2 million in lease cancellation charges, offset by $1 million of interest income earned as a result of the bankruptcy filing. Accretion and preferred dividends on preferred securities of subsidiaries Accretion of costs and preferred dividends on preferred securities of subsidiaries decreased from $60 million in 2000 to $0 in 2001. The decrease was due to the bankruptcy proceedings. The accretion of the preferred dividends and amortization of offering costs on all preferred securities ceased as of the filing of our petition for bankruptcy on November 14, 2000. We fully accreted the discount and fully wrote off the offering costs totaling $10 million associated with the preferred stock subsequent to November 14, 2000. Such amounts are included in reorganization expenses in the accompanying consolidated statement of operations. Accretion and preferred dividends on preferred securities of subsidiaries recorded through November 14, 2000 for the year ended December 31, 2000 consist of the accretion of issuance costs, discount and preferred security dividend accruals for our then-outstanding preferred stock. Net income from discontinued operations Net income from discontinued operations was $4 million in 2000, which consisted of adjustments to the gain on the disposal of a subsidiary in 1999. Cumulative effect of change in accounting principle Cumulative effect of change in accounting principle for revenue from installation services of $7 million for 2000 was due to the change in accounting as a result of the adoption of SAB 101 on October 1, 2000, applied retroactively from January 1, 2000. Accretion and dividends of 8% Series A Convertible Preferred Stock to liquidation value and related dividends Accretion and dividends of 8% Series A Convertible Preferred Stock to liquidation value and related dividends was comprised of the dividends and the accretion to liquidation value of the 8% Series A Convertible Preferred Stock of $158 million during 2000. The decrease was due to the bankruptcy proceedings. Recording of the accretion and related dividends ceased as of November 14, 2000. Charge for beneficial conversion feature of 8% Series A Convertible Preferred Stock Charge for beneficial conversion of 8% Series A Convertible Preferred Stock during 2000 related to the charge to additional paid-in capital of $159 million of the proceeds of the 8% Series A Convertible Preferred Stock which was the intrinsic value of the beneficial conversion feature of the convertible preferred securities. The beneficial conversion feature was recognized immediately as a return to the preferred stockholders during 2000 as the 8% Series A Convertible Preferred Stock was immediately convertible into shares of our Predecessor Company's common stock. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of September 30, 2003, we were subject to market risks arising from changes in interest rates. Our primary interest rate exposure resulted from changes in LIBOR or the prime rate, which were used to determine the interest rate applicable to the principal balance outstanding from time to time on our secured notes. The weighted average interest rate applicable to the outstanding principal balance on the secured notes at September 30, 2003, was 7.5%. A hypothetical change in annual interest rate of 1% per annum applied to the outstanding principal balance on the secured notes on September 30, 2003, would have resulted in additional interest expense of $0.6 million. As explained under "Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources", we terminated the secured notes in October 2003. As a result, as of the date of this prospectus, our remaining debt was not subject to interest rate risk. Currently, we do not use derivative financial instruments to manage our interest rate risk. We invest our cash in short-term commercial paper, investment-grade corporate and government obligations and money market funds. In addition, we do not, in the normal course of business, use derivative financial instruments for trading or speculative purposes. BUSINESS OVERVIEW We are a facilities-based, nationwide communications provider focused on delivering data and voice services to corporate customers, ISPs and telecommunication carriers. We are a certified CLEC in most states and have interconnection agreements with every major local exchange carrier. Through our network of fiber optic cable, voice and data switches, data points of presence, and peering arrangements, we provide corporate services, point-to-point broadband services and dial-up services. We were organized as a Delaware corporation on April 11, 1996. As discussed above under "Recent Developments," we terminated early four Qwest dial-up data services agreements in exchange for a cash payment from Qwest of approximately $106.8 million, which amount included payment of approximately $31.0 million for dial-up data services provided and to be provided by us under the agreements during the six months ended December 31, 2003. Approximately $81.2 million of the proceeds from the Qwest transaction was used to prepay in full the outstanding indebtedness under our secured notes and senior subordinated term loan, and approximately $42.1 million of cash previously held in a cash collateral account for the benefit of our lenders was released to us. Although these transactions allowed us to reduce our future debt service payments and increased our available cash, our loss of the ongoing Qwest revenue and related cash flow from operating activities is expected to result in significant future losses and negative cash flow from operations. In an effort to offset the expected significant future losses and related liquidity concerns, we have commenced several operating initiatives to increase sales and reduce operating expenses and capital expenditures. These initiatives include increasing our sales force, reducing network operating costs, and delaying capital expenditures that do not support near-term revenue growth or are not required to maintain network integrity. There can be no assurance, however, that these operating initiatives, described in greater detail under "Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources Impact of the Transactions on Liquidity," will be successful in sufficiently improving our liquidity or increasing our operating revenues. BUSINESS STRATEGY Our goal is to be the leading provider of telecommunications services primarily to business users in the markets we serve and to other carriers. To achieve this goal, we are actively implementing the following strategies: Increase our market share within the corporate services sector by differentiating ourselves with IP telephony and converged services while continuing to offer traditional voice and data products; Leverage our existing fiber optic and local access networks; Reduce our network costs; and Dispose of non-strategic assets. Increase Our Market Share in Corporate Services Based on data obtained from Dun & Bradstreet reports, we estimate that aggregate annual wire line spending by medium to large size businesses in our addressable markets totals approximately $13 billion. While demand for voice services by these businesses has been relatively stable, we expect demand for data services in commercial applications to increase significantly over the next several years as businesses address their growing need for data connections, greater bandwidth and outsourcing Total debt and capital lease obligations 179,620 (77,270 ) 102,350 Other liabilities 87,720 87,720 Stockholders' equity 141,912 (6,194 ) 135,718 network and information technology infrastructure. Our corporate services product offerings, especially our voice and IP telephony converged services, have been designed to address this growing need. We believe that our IP telephony and converged services should be the solution of choice for our targeted businesses because of these services' compatibility with broadband, their power to integrate end user communications tools such as the personal computer and telephone, and their ability to be bundled with other services, such as long-distance, local access and dedicated Internet access. In order to reach these potential customers and increase our market share, we have increased our sales force from 96 sales professionals in July 2003 to 182 in November 2003. We have deployed skilled and market knowledgeable regional sales teams and an indirect sales channel that work with our seasoned sales leadership team to promote our corporate services product offerings. As a result of this sales force growth and our renewed focus, we are positioned to fulfill on our strategy through targeted sales and direct marketing to potential new customers and to our established CLEC customer base. Leverage Our Existing Network Assets Our network architecture supports the convergence of circuit switched or traditional public switched telephone network (PSTN) and packet switched IP technology. Our data network footprint covers approximately 75% of the U.S. population (as determined by U.S. Census population data reporting) and our local network currently serves 26 U.S. markets, including Austin, Akron, Atlanta, Birmingham, Charlotte, Cincinnati, Colorado Springs, Columbus, Cleveland, Corpus Christi, Dallas, Dayton, Denver, Fort Worth/Arlington, Houston, Irvine, Jersey City, Los Angeles, Louisville, Nashville, Oakland, Sacramento, San Antonio, San Diego, San Francisco and San Jose. We are also deploying voice services in five new markets: New York, Washington, DC, Boston, Chicago and Seattle. We intend to maximize the capability of our existing integrated fiber optic and local access networks to deliver voice, data and Internet access solutions that meet our customers' needs. By leveraging our existing network assets, we expect to be able to offer a full range of voice and data services to our target market quickly and with minimal capital investment. Reduce Our Network Costs We are focused on reducing our network costs and increasing network operational efficiencies. To achieve this, we are concentrating primarily on consolidating our switches and reducing the costs of network infrastructure we lease from IXCs and other LECs. Because of the breadth and depth of our transport network, we can migrate network traffic from one switch to another without reducing footprint coverage or service quality. We are targeting approximately 10 switches for removal from our network by mid to late 2004. The consolidation of switches is expected to result in reduced maintenance, utilities, leased infrastructure and personnel costs. Once an asset is identified for decommissioning, the remaining useful life of the asset is evaluated and depreciation expense adjusted accordingly. We have also established a team whose goal is to reduce the cost of our leased facilities by monitoring the usage of these facilities and eliminating those facilities that are not cost-effective. In addition, this team is monitoring the billing of leased facilities for accuracy. We anticipate eliminating, by the second quarter of 2004, approximately 30% of the leased network facilities infrastructure costs we incurred during the third quarter of 2003. Dispose of Non-Strategic Assets We are evaluating the opportunity to increase our liquidity through dispositions of non-strategic assets, including excess network transport equipment, switches and other assets that are either not optimized or are under-performing. The early retirement of our assets may result in accelerated depreciation expense and/or an impairment charge. TELECOMMUNICATIONS NETWORKS AND FACILITIES Combined Network Overview We have designed and built our local and regional fiber optic networks to serve geographic locations where we believe there are large numbers of potential customers. Our network architecture reflects a convergence of circuit switched technology used in our PSTN network, and packet switched technology, used in our IP network. Our network infrastructure allows us to quickly scale to meet customer demand, address network issues and control the costs and features of our product offerings. The key components of this network include transport, Class 5 digital switches, SS7 and IP. We have access to customer facilities, LEC and IXC facilities, and connectivity between our own switches. Our Class 5 digital switches placed in 31 markets across the country allow us to offer a wide range of voice and data services across a large network footprint. Our own SS7 network enables us to maintain and monitor certain critical aspects of our network without having to rely on an outside entity. Finally, our IP infrastructure allows us to route both data and IP voice services across our entire network. IP Network Our nationwide data network has been built to provide the nationwide bandwidth for all of our data services. Our data network operates at OC-48 capacity and interconnects our major network access points and points of presence. Our network is built with redundant self-healing paths and uses the latest in traffic routing technologies. A diagram showing the design of our IP network backbone is presented below: We have deployed softswitches to support some of our dial-up and all of our IP converged services. Softswitches are programmable central office switches built on standard computer platforms using standard protocols, which makes them less costly than traditional switches. Softswitches also offer flexible functionality, thereby promoting a flexible cost structure, which means that we will be able to support new customers and network growth over time without having to invest a large amount of capital to increase capacity. Our softswitches use the latest technology to ensure quality service. By using softswitches, we realize cost savings over traditional switches, reduce the load on our Class 5 switches, simplify administration, and maximize resource utilization. We provide connectivity from our network backbone to the rest of the Internet via a mixture of public and private peering connections. These connections are provided via numerous OC3, OC12 and Gigabit Ethernet connections in seven geographically diverse locations. Local Network Our network covers approximately 6,400 route miles and approximately 186,000 strand miles of owned and leased regional (intercity) and metropolitan (local or intracity) fiber. We offer service to approximately 5,200 buildings, either entirely through our facilities (on-net) or through the use of another carrier's facilities (off-net). The majority of our network is built utilizing Synchronous Optical Network, or SONET, ring architecture. In addition, we have been deploying DWDM, or dense wave division multiplexing, technology to enable us to further maximize the capacity of our fiber optic network. We extend SONET rings or point-to-point links from rings to each customer's premises over our own fiber optic cable, and in some cases using customer links obtained from ILECs. We then place necessary electronic equipment at a location near or in the customer's premises to terminate the link. We serve our customers from one or more central offices or hubs strategically positioned throughout our network. The central offices house the transmission, switching, and IP equipment needed to interconnect customers with each other, the long distance carriers, and other local exchange networks. As of September 30, 2003, we maintained approximately 140 collocations with other LECs. In addition, we maintain our own Signaling System 7, or SS7, network, which affords us increased control of our network, provides cost savings by eliminating the need to pay another entity for this function. SS7 is an architecture platform for performing out of band signaling in support of call establishment, billing, routing and information exchange functions in the PSTN. The following table sets forth information about our network, organized by market served, as of November 30, 2003: Total liabilities and stockholders' equity 409,252 (83,464 ) 325,788 Network Monitoring and Management Through our dedicated Network Operations Center, or NOC, located in Englewood, Colorado, our experienced team of technicians monitor, detect, isolate, and correct network problems 24 hours a day, 7 days a week, 365 days a year. The NOC is divided into three distinctive groups, each having responsibility for certain aspects of our network. Problems are sought to be identified and detected before they affect our customers. NOC technicians utilize a suite of operational support system (OSS) tools to monitor the network looking for potential issues and signal degradation as well as troubleshooting network events when there are outages. PRODUCT OFFERINGS We have three primary product offerings: Corporate Services, which includes IP telephony and converged services, voice and voice conferencing; and other business services, which includes carrier access billing service that is generated from the origination and termination of switched access traffic; Point-To-Point Broadband Services, which includes private line (formerly special access) DS1 to OC-192 capacity to connect (i) long-haul carriers to local markets, large companies and other long-haul carrier facilities and (ii) large companies to their long distance carrier and other facilities; and Dial-Up Data Services, which includes primary rate interface and remote access service. The latter two product offerings are focused on wholesale services to ISPs and other carriers, and the corporate services offerings are focused on retail services to businesses with voice, data, long distance and other ICG services requirements. The historical financial performance for each of our three primary product offerings is discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations." Corporate Services IP Telephony and Converged Services VoicePipe VoicePipe is an IP telephony communications solution that combines customers' voice and data communications and aggregates them onto a dedicated DS1-to-DS3 line. ICG launched VoicePipe in 24 markets in 2003 including the following cities: Austin, Akron, Atlanta, Birmingham, Charlotte, Cincinnati, Columbus, Cleveland, Colorado Springs, Corpus Christi, Dallas, Dayton, Denver, Houston, Irvine, Los Angeles, Louisville, Nashville, Oakland, Sacramento, San Antonio, San Diego, San Francisco and San Jose. By the end of the first quarter in 2004, ICG plans to complete its deployment of VoicePipe in the following five other markets: Boston, Chicago, New York, Seattle and Washington, D.C. VoicePipe is a managed service and provides businesses with a lower total cost of ownership solution when compared to traditional PBX or key phone systems, brings greater mobility to the workforce, and reduces the number of vendors required to provide local, long-distance and Internet access. In addition, VoicePipe requires no investment in a telephone system or PBX and works with both analog and certain IP phones. VoicePipe offers all of the traditional features and functionality of a PBX or key phone system with the upgraded feature of a web interface/portal for each user. The web interface/portal allows customers to manage their phone calls, voice mails, personal directories, "find me follow me," and a variety of other options all with the click of their mouse. We are targeting VoicePipe to businesses, particularly those with multiple locations. Remote workers and VoicePipe users with multiple locations can recognize added efficiencies and benefit from abbreviated dialing between locations, as well as reduced intrastate toll calling charges. During the third quarter of 2003, we installed VoicePipe on over 800 IP phones for our employees. The use of VoicePipe within ICG is expected to increase product knowledge and productivity within the sales, provisioning and client services organizations. Employees' daily usage of VoicePipe is also expected to further enhance our ability to deliver quality customer support. Since the introduction of VoicePipe in February 2003, we have increased its functionality, adding the ability to support more extensions, allowing for multiple locations, and adding remote user features. We anticipate continuing to enhance our VoicePipe functionality by adding more features in the near future, including the ability to integrate with other business software packages. The VoicePipe service can use one DS1 or faster facility for the last mile to the customer. VoicePipe distinguishes voice packets from data packets, and allocates bandwidth accordingly to prioritize voice traffic to ensure quality of service (QoS) and give customers the most efficient usage of their bandwidth. Customers are able to use the full DS1 bandwidth for data needs when phone call volume is low; however, when numerous phone calls are engaged, VoicePipe will automatically adjust the use of the bandwidth. The customer's communications travel to ICG's facilities and then onto the appropriate voice or data networks. VoicePipe voice calls are not routed over the public Internet like some Voice Over Internet Protocol (VoIP) services, but stay on our Multiple Protocol Label Switching (MPLS) enabled data backbone. The following diagram illustrates how traffic travels between the customer premise, the PSTN and the Internet using VoicePipe : VoicePipe Configuration iConverge iConverge combines high-speed Internet access and reliable voice services on a single DS1 line, allowing customers to choose how much bandwidth to dedicate to "always-on" Internet access versus voice service based on their business requirements. Additionally, customers have the ability to monitor their service on a secure web-based management center. iConverge represents a first step for businesses seeking to incorporate IP telephony solutions in the future since it interfaces with existing traditional telephone equipment. Small to medium size businesses can take advantage of the cost-saving benefits of convergence without sacrificing prior capital investment. iConverge features include local voice services, voicemail, long distance and e-mail. The following diagram illustrates how traffic travels between the customer premise, the PSTN and the Internet using iConverge : iConverge Configuration Dedicated Internet Access (DIA) DIA provides businesses a full-time high-speed dedicated Internet connection at bandwidth speeds varying from DS1 to DS3. We offer basic DIA, burstable DS3 enhanced service, which delivers Internet connectivity but with flexible bandwidth to accommodate peak demand, and NxT1, which allows customers a cost effective alternative by combining two to four DS1's to meet growing demand. Our DIA service offers high levels of customer service and network reliability at a competitive price. Our DIA service also comes with an industry-leading service level agreement that proactively provides invoice credits in the event of a network outage. Voice ICG's local voice service consists of basic local exchange lines and trunks with local calling, local toll calling and business-related voice line features (e.g., voicemail). Under our business strategy, sales of voice services will concentrate on customers with a minimum of 24 lines. We believe that we provide a more responsive service delivery alternative to existing providers, as well as excellent customer service and network reliability critical to meet customer expectations for voice applications. Our long distance service provides cost-effective intrastate, interstate, international and toll-free calling along with worldwide calling card access. Our long distance, which is available in all of our markets, uses our fiber optic network and regional switches to ensure quality transmissions and network efficiencies. We currently offer reservationless audio conferencing, which allows customers to initiate meetings at any time by telephone. In addition, we plan to launch a new audio and web combined service, or Voice+Web Conferencing, in the first quarter of 2004. Voice+Web Conferencing is an integrated service that will give users the ability to control phone and online meetings, run training seminars, and software applications as well as view websites simultaneously. Voice+Web Conferencing will be available on a nationwide basis, will be targeted to our existing local voice service customers, and is expected to integrate with VoicePipe . Point-to-Point Broadband We provide the following Point-to-Point Broadband services to a customer base that is comprised primarily of IXCs, ISPs and medium- to large-sized businesses. Private Line (formerly Special Access) We provide both Local and Intercity Private Line Services to IXCs, ISPs and medium to large end-user business customers. This involves providing a dedicated facility used to connect: (i) end user to end user (ii) end-users to long distance carrier facilities; (iii) long distance carrier facilities to local telephone company central offices; and (iv) different facilities of the same carrier. Private Line Services are offered at DS1, DS3, OC-3, OC-12, OC-48 and OC-192 capacities. Our Private Line Services are available within all of the company's fiber based metropolitan networks and on an intercity basis between ICG's metro areas. Dial-Up Data Services Our Dial-Up Data Services are offered on a wholesale basis to ISPs and enable the ISPs' subscribers to connect to the ISP and the Internet. It is not economically feasible for many ISPs to build and maintain their own networks, and consequently many prefer to outsource network facilities management in order to focus internal resources on their core ISP business. We offer Primary Rate Interface (PRI) ports and Remote Access Services (RAS) to ISPs to manage their Internet access requirements, ranging from connection to facilities to complete turnkey modem management. Our Dial-Up Data Services customers include some of the largest national and regional ISPs. We estimate that our combined voice and data network systems are serving approximately 5% of all Dial-Up Internet subscribers in the United States, based upon an industry average of ten end-users per port. ICG's Dial-Up Data Services are supported by our nationwide fiber optic backbone that connects to numerous public and private peering sites with major ISPs and IXCs. The network, in combination with certain leased long-haul assets, carries data traffic associated with our ISP business. The design of the physical network permits us to offer flexible, high-speed services to our customers. Currently, our network footprint has the capability to provide Dial-Up Data Services to over 75% of the nation's population (as determined by U.S. Census population data reporting). We provide the following Dial-Up Data products and services: Primary Rate Interface (PRI) PRI uses our network to route ISP end-user calls through an ICG phone number from the public switched network to the ISP-owned modem banks. The ISP's own RAS equipment is typically collocated at one of our central office facilities. PRI is billed at a fixed monthly rate per DS1. Remote Access Service (RAS) Unlike PRI, which requires the ISP to actively oversee their own data infrastructure, RAS is a turnkey Dial-Up Internet access service toward which many ISPs have migrated. RAS adds network management services as it "connects, sends and routes" customer data traffic. This service has the capability to route data directly over our network to the Internet, allowing the ISP to outsource its infrastructure and create a national footprint with minimal investment in fixed assets. RAS is offered with a variety of billing options including monthly port, hourly and per subscriber usage. (1)Excludes the Qwest early termination revenue. (2)Excludes the Qwest early termination revenue and the Qwest dial-up data services revenue. Marketing Traditionally, our marketing efforts have been limited to trade show and trade journal press given our focus on the wholesale sector. In 2003, our marketing efforts grew significantly to support the launch of VoicePipe in 24 markets. We undertook approximately a $1.5 million advertising campaign with the local and national business press, outdoor advertising as well as radio in some markets. The goal of the campaign was to build awareness of VoicePipe among business decision makers and to drive potential leads to our website for more information. We intend to continue to pursue tactics to help build our brand identity within the corporate services space by further segmenting and targeting decision makers and buyers through direct marketing. Sales Within the past six months we have nearly doubled our internal sales force from 96 sales professionals as of July 2003 to 182 as of November 2003, and intend to increase the number of sales professionals to 250 by the second quarter of 2004. Our sales force is led by a seasoned sales leadership team and is organized by highly skilled and market knowledgeable regional teams. We have also established an indirect sales force that targets value-added resellers who represent ICG. We have also increased the sales team's likelihood of success through expanded training programs and a dedicated sales engineering team. Direct Sales Our sales organization includes retail and wholesale direct sales teams. Of the 182 full-time sales professionals as of November 30, 2003, 18 were wholesale sales personnel, and the remaining were retail sales personnel. The responsibilities of the retail sales organization include both new sales activities and the ongoing management of existing customers. The wholesale organization focuses on national opportunities in the carrier and ISP market segments. Wholesale account managers' responsibilities include customer acquisition and revenue generation, relationship management and contract negotiation. Indirect Sales The direct sales force is complemented by an alternative sales channel that consists of third party sales partners and agents. This channel was developed to distribute our increasing number of products and services. We currently have distribution arrangements with a number of national, regional and local agents and agency firms, whose representatives market primarily our corporate services product offerings. This channel includes approximately 475 third party sales partners in markets throughout the United States. We expect to focus our efforts on high productivity sales partners, which we believe will result in a strong program with increased loyalty and production. Information System Infrastructure Our information system infrastructure is comprised of off the shelf packages together with applications developed specifically for ICG. Our multiyear OSS architecture plan emphasizes the deployment of off the shelf packages for common business and operations functions, integrated with workflow management and data bus technology. We use customized applications only for those functions not addressed by the commercial market if the application provides us with a strategic advantage. These information systems provide 24X7 real time access. Off the shelf packages support sales, order capture, service assurance, billing, network inventory, leased line cost management, accounting and finance, human resource management and customer support. In house expertise in enterprise process development, workflow management, and bus technology allows ICG to integrate these applications to meet the rapidly changing needs of the business. COMPETITION We participate in several sectors of the telecommunications services industry, all of which are highly competitive. Our Corporate Services product offerings such as voice, data, long distance and conferencing compete against CLECs, ILECs and IXCs. Services are difficult to differentiate between competitors; however, we believe ICG's products and services are distinguishable by the customer experience, price and the bundling of products. We have one of the largest deployments of an IP telephony solution by any facilities-based provider. Many LECs, IXCs, regional players and new entrants have all announced plans to introduce a VoIP or IP telephony service for businesses and have publicly acknowledged the demand for such a service. In addition to facing competition from these service providers, we compete Selected Statement of Operations and Cash Flow Data Nine months ended September 30, 2003 with equipment providers such as Cisco, Nortel and Ayava, who offer similar IP PBX solutions. These equipment providers deliver premised-based options, as opposed to a hosted network service platform. Our primary competitors for dial-up services include Level 3, WorldCom, Sprint, and the ILECs. Currently there is more capacity available to support dial-up services than there is demand for such services, creating significant pricing pressures. Furthermore, demand for these services is expected to decline. Dial-up services compete with and are losing market share to broadband services such as cable, DSL, and wireless. Our competitors for Point-to-Point Broadband services include all facilities based CLECs, ILECs and IXCs. Over the past two years, demand for Point-to-Point Broadband services from carriers has decreased due to the carriers' excess capacity and network grooming initiatives. This has resulted in reduced volume and prices of our Point-to-Point Broadband services. While strong competition currently exists in all sectors of the industry, we believe that we can effectively compete in the areas on which we have focused. Our competitive advantages are inherent in our products and services offered to existing and potential customers, particularly our IP telephony offering. We believe that the large business market for voice and data services provides the greatest opportunity for us to gain market share and significantly grow our revenue. We have increased our sales distribution channels and our regional and market team presence to compete more aggressively and gain market share. REGULATORY ACTIVITY The company's operations are impacted by rules and regulations promulgated and enforced on the federal, state and local levels. Specifically, the Federal Communications Commission has primary jurisdiction with respect to the company's interstate products and services. The various state utility commissions enforce rules relating to our local and intra state products and services and the municipal authorities regulate, among other things, the company's access to the public rights of way. In addition to internal resources, the company retains outside counsel and advisors to ensure appropriate compliance with all regulatory requirements. The company generally segregates its product offerings into three different categories. The first category, Corporate Services, includes products and services such as Direct Internet Access, Standard Business Lines and Long Distance. Our offerings in this service category encounter regulatory treatment such as reciprocal compensation, network interconnection, Unbundled Network Elements (UNEs), number portability and others. VoicePipe , our VoIP product, is also an element of our corporate services offerings. Currently, there are a number of uncertainties that exist with respect to the regulatory treatment of VoIP. Among those uncertainties are whether the conventional access charges regime is applicable to VoIP traffic and carrier obligations with respect to the Communications Assistance For Law Enforcement Act (CALEA), including enhanced 911 (E-911) services, and numerous consumer protection issues. The second category, Broadband Services, which includes our Private Lineproduct offerings, are significantly structured according to the application and collection of interstate and intrastate access charges for telecommunications traffic that both originates and terminates on our network. Both federal and state regulatory authorities have jurisdiction over the applicable access charges. The final category is Dial-Up Internet Access. While this particular offering is considered unregulated, the Primary Rate Interface or ISDN component, which is a material element of our Dial-Up service offerings, incurs some conventional regulatory oversight with respect to price discrimination, service quality and inter-carrier compensation. As Reported General Operational and Intercarrier Compensation Issues The Telecommunications Act generally requires RBOCs to provide interconnection and nondiscriminatory access to their local telecommunications networks and other essential facilities. Network access and interconnections are typically facilitated through written agreements between the parties, commonly known as interconnection agreements. Interconnection agreements are negotiated and enforced on a state-by-state basis. The negotiations involving each agreement are highly complex and can be contentious. Where the parties cannot reach agreement, we must petition the applicable state regulatory agency to arbitrate the disputed issues. Rulings of that particular agency are subject to judicial review by the appropriate state court and, with respect to certain issues, a federal district court. We have executed interconnection agreements with every Regional Bell Operating Company, or RBOC, and other smaller ILECs. Key issues that we face during negotiations include, but are not limited to: (i) "virtual-nxx" network deployment that affects the routing and rating of calls where the terminating party may not physically be in the local calling area of the originating party; (ii) Voice over Internet Protocol ("VoIP") issues, including whether VoIP traffic should have the same intercarrier compensation as switched access traffic; and (iii) various other technical and operational related issues. Reciprocal Compensation Reciprocal compensation historically has been an important source of revenue for us. In general, reciprocal compensation is the reimbursement of costs incurred by a carrier that terminates local telecommunications traffic originated on the network of another carrier. We maintain that reciprocal compensation is an appropriate regulatory mechanism, regardless of whether the telecommunications traffic is routed to a conventional end user or an ISP. Our position has been affirmed by a number of state utility commissions as a result of the arbitration of certain terms and conditions articulated in various RBOC interconnection agreements. While we did in fact prevail in a number of arbitrations, in the interest of gaining certainty with respect to the collection of reciprocal compensation, we have negotiated voluntary settlement agreements with certain RBOCs that provide for the payment of reciprocal compensation for both traditional voice, as well as Internet bound traffic. The majority of these reciprocal compensation settlement agreements have expired and in such cases, the parties' current interconnection agreements now govern reciprocal compensation issues. Our reciprocal compensation settlement agreement with SBC, however, remains in effect until May 31, 2004. In April 2001, the Federal Communications Commission, or FCC, in response to an opinion by the U.S. Court of Appeals for the District of Columbia Circuit, issued an order regarding reciprocal compensation for Internet bound traffic. The Order placed limits on the volume of reciprocal compensation eligible traffic, the recovery of reciprocal compensation in new markets entered after April 2001. The April 2001 Order has not had a material effect on those interconnection agreements (BellSouth Verizon and Qwest) that explicitly require the payment of reciprocal compensation on conventional voice traffic. Likewise, the April 2001 Order has not had a materially negative impact as it relates to the exchange of reciprocal compensation for Internet bound traffic for the aforementioned interconnection agreements, nor has it had any material impact on the negotiated reciprocal compensation settlement agreement with SBC. The FCC is expected to provide further guidance with respect to reciprocal compensation on Internet bound traffic prior to June 2004. Switched Access Switched access is the connection between a long distance carrier's POP and an end user's premises provided through the switching facilities of a LEC. Switched access associated with intrastate toll traffic is governed by our intrastate tariffs filed with respective state utility commissions. Likewise, switched access associated with interstate toll traffic may be governed by interstate switched access tariffs filed with the FCC. Qwest Transaction Historically, the FCC has regulated the access rates imposed by the RBOCs while the CLEC access rates have been less regulated. In May 2000, the FCC ordered a substantial reduction in RBOC per-minute access charges and an increase in the flat monthly charge paid by local residential service subscribers for access to interstate long distance service. The FCC also released an order effective in June 2001 that subjects CLECs' interstate switched access charges to regulation. Specifically, carriers were required to withdraw their interstate tariffs if their switched access rates exceeded rates established by the FCC. Because our switched access rates exceeded the rates established by the FCC, we withdrew our interstate access tariff in August 2001. Effective with that same order, our rates were reduced and will continue to decline through June 2004 to be in parity with the RBOC rates competing in each area. In addition, when a CLEC enters a new market its access charges may be no higher than the rates charged by the RBOC operating in the same market. This order does not affect rates subject to contracts that we have entered into with certain long distance carriers. The May 2000 RBOC access reform decision, as well as the CLEC access charge regulation have resulted in reductions in the per-minute rates we receive for switched access service in 2001 and 2002 and will result in further reductions through June 2004. Federal Regulation As a result of a previous order adopted by the FCC, carriers were classified for regulatory purposes as either dominant (i.e., generally RBOCs) or non-dominant (i.e., generally CLECs). With respect to most issues, we are considered a non-dominant carrier. Consequently, we enjoy a reduced regulatory compliance burden as compared to the RBOCs. Nevertheless, we must still comply with certain requirements of the Telecommunications Act, such as offering service on a non-discriminatory basis and at reasonable rates. Further, pursuant to our classification as a non-dominant carrier, we elected as of August 1, 2001 to withdraw our tariffs for our interstate product and service offerings. We are not subject to rate-of-return regulation in any jurisdiction, nor are we currently required to obtain FCC authorization for the installation, operation or maintenance of our fiber optic network facilities. Currently, we utilize certain ILEC network elements in order to provide service to our customers. These network elements include, but are not necessarily limited to, transport facilities, local loops and collocation. We would consider any change in policy that either limits or eliminates our ability to purchase the aforementioned network elements as an impairment to our ability to implement our network deployment strategies. During 2001, the FCC initiated a Triennial Review of UNEs to determine which of these elements the RBOCs must continue to provide under sections 251 and 252 of the 1996 Act. The FCC rendered a decision in this proceeding in August, 2003. In that decision the FCC maintained conventional local loops and local switching as a UNEs, but placed new limitations on transport and broadband local loops. The FCC also retained the UNE Platform (UNE-P), which is the combination of transport, local loops, switching and ancillary services that allows a carrier to deliver end-to-end services without owning any telecommunications facilities. We do not currently employ UNE-P, and we have only moderate deployment of UNE transport facilities and local loops. We do not expect these rulings to have a materially negative impact on our revenue or costs. State Regulation In general, state public utility commissions have regulatory jurisdiction over us with respect to local and other intrastate telecommunications services. To provide intrastate service (particularly local dial tone service), we generally must obtain a Certificate of Public Convenience and Necessity (CPCN) from Termination of Secured Indebtedness the state regulatory agency prior to offering service. Additionally, most states require us to file tariffs, which articulate the terms and conditions for services that are classified as regulated intrastate services. In some states, we may also be subject to various reporting and record-keeping requirements. Under the Telecommunications Act, state commissions continue to set regulatory requirements, including service quality standards and guidelines, for certificated providers of local and intrastate long distance services. Importantly, state regulatory authorities specify permissible terms and conditions (i.e., price) for interconnection with the RBOCs' telecommunications networks. Moreover, these same authorities regulate the provision of unbundled network elements by the RBOCs and enforce performance measurements and other material standards related to local competition and interconnection. In certain states, the utility commission has the authority to scrutinize the rates charged by CLECs for intrastate long distance and local services. We currently hold CPCNs (or their equivalents) to provide competitive local services in the following states: Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Utah, Vermont, Virginia, Washington, Washington, D.C., West Virginia, Wisconsin, and Wyoming. Additionally, the Company holds CPCNs (or their equivalents) to provide intrastate long distance services in the following states: Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, Washington, Washington D.C., West Virginia, Wisconsin and Wyoming. Local Government Authorizations Under the Telecommunications Act, municipalities typically obtain jurisdiction under applicable state law to control our access to municipally owned or controlled rights of way and to require us to obtain street opening and construction permits to install and expand our fiber-optic network. In addition, many municipalities require us to obtain licenses or franchises and to pay license or franchise fees, often based on a percentage of gross revenue or a certain amount per linear foot, in order to provide telecommunications services. However, in certain states, including California, Ohio and Colorado, current law limits the amount of such fees to be paid to local jurisdictions to actual costs incurred by the municipality for maintaining the public rights of way. There is no assurance that certain cities that currently do not impose fees will not seek to impose fees in the future nor is there any assurance that, following the expiration of existing franchises, the municipality will be obligated to renew a previous agreement or that previously agreed upon fees will remain at their current levels. The Telecommunications Act requires that local governmental authorities treat telecommunications carriers in a non-discriminatory and competitively neutral manner. The Act also mandates that any compensation received in exchange for access to the public rights of way be just and reasonable. Where a particular municipality has required unreasonable rights of way access fees, we historically have taken an aggressive position, up to and including litigation. However, due to many court rulings across the country in favor of carriers, we have been able to lessen our aggressive position and have instead worked to establish non-adversarial relationships with these municipalities. Nevertheless, if any of our existing franchise or license agreements are terminated prior to their expiration dates or are not renewed, and consequently we are forced to remove our facilities from the public rights of way, such termination could have a material adverse effect on us. Pro Forma VoIP Regulation There are an increasing number of federal, state, local and foreign laws and regulations pertaining to the Internet and telecommunications. In addition, a number of federal, state, local and foreign legislative and regulatory proposals are under consideration. Our ability and plans to provide telecommunication services at attractive rates arise in part from the fact VoIP services are not currently subject to the same regulation as traditional telephony. In fact, most VoIP providers have adopted the position that VoIP should not be subject to conventional telecommunications regulations, as these providers believe that VoIP is an information service, not a telecommunications service. Likewise, many traditional telecommunications service providers are advocating before the Federal Communications Commission (FCC) and several of the state utility commissions to regulate VoIP on the same or similar basis as traditional telephone services. There are numerous legal and regulatory proceedings in progress that address the regulatory treatment of VoIP. For example, a federal court invalidated a Minnesota Public Utilities Commission rule that applied traditional phone regulation to VoIP. Additionally, the California Public Utilities Commission recently initiated an inquiry regarding whether VoIP providers should be required to register as telecommunications services providers. We are actively monitoring the development of regulations and policy that could impact our VoIP offering. If the FCC or any state commission decides to regulate VoIP, they may impose surcharges, taxes or additional regulations upon providers of Internet telephony. These surcharges could include access charges payable to local exchange carriers to carry and terminate traffic, contributions to the universal service fund or other charges. We have voluntarily decided to comply with certain regulations with respect to CALEA and the provision of E-911 services, which could also create a significant financial burden. The imposition of any such additional fees, charges, taxes and regulations on VoIP services could materially increase our costs and may reduce or eliminate any competitive pricing advantage. EMPLOYEES As of November 30, 2003, we had 971 full-time employees. None of our employees are represented by a union or subject to a collective bargaining agreement. We believe that we generally offer compensation packages comparable to those of our competitors similar in size and capital structure. We believe that the successful implementation of our business strategy will depend upon our continued ability to attract and retain qualified employees. While we do not expect to add a significant number of new employees to the organization in the near future, we continue to reallocate the distribution of our workforce by adding sales professionals and reducing the number of employees in other areas. In fact, we have reduced the size of our workforce by approximately 15% since our emergence from bankruptcy in October 2002 to enhance our efficiency and cost structure. PROPERTIES Our real estate portfolio includes numerous properties for administrative, warehouse, equipment, collocation and POP sites. As of November 30, 2003, we had approximately 1,076,000 square feet of leased office, warehouse, and equipment space, including our approximately 240,000 square-foot corporate headquarters building located in Englewood, Colorado. We also had approximately 836,000 square feet of space leased throughout the United States, primarily in our switch sites. The lease on our corporate headquarters expires in January 2023, and the other leases expire in 2003 through 2016. Since November 2000, we have reduced our real estate portfolio by approximately 226 sites and 796,848 square feet by rejecting leases through the bankruptcy process and through lease expirations. We continue to evaluate our real estate needs, and will continue to carefully review our portfolio of leased locations for optimum use and cost savings opportunities. (in thousands of dollars) Revenue: Communications 285,581 (73,879 ) 211,702 Early termination 75,779 (75,779 ) LEGAL PROCEEDINGS On November 14, 2000, ICG and most of its subsidiaries filed voluntary petitions for protection under the Bankruptcy Code in the Delaware Bankruptcy Court (Joint Case Number 00-4238 (PJW)). The bankruptcy petition was filed in order to preserve cash and give us the opportunity to restructure our debt. Our Modified Plan was confirmed and became effective on October 10, 2002. The Bankruptcy Court continues to retain exclusive jurisdiction over all matters arising out of and related to our bankruptcy case, including, but not limited to, the resolution and disposition of pre-petition and administrative claims. We expect that these claims will be resolved not later than 2004, and that the Bankruptcy Court will enter a final decree shortly thereafter closing the Chapter 11 case. During the third and fourth quarters of 2000, certain former officers and we were served with fourteen lawsuits filed by various stockholders in the United States District Court for the District of Colorado. In October 2001, the Colorado District Court consolidated the various actions and appointed lead plaintiffs' counsel. In February 2002, lead plaintiffs' counsel filed a consolidated amended complaint. The amended complaint does not name ICG as a defendant. The amended complaint alleges violations of Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, and seeks class action certification under Rule 23 of the Federal Rules of Civil Procedure. The amended complaint seeks unspecified compensatory damages. Under section 510(b) of the Bankruptcy Code, all pre-petition securities claims against ICG were mandatorily subordinated and discharged upon the confirmation of the Modified Plan. Holders of pre-petition equity securities claims did not receive any recovery from us under the Modified Plan. We are a party to certain other litigation that has arisen in the ordinary course of business. In the opinion of management, the ultimate resolution of these matters will not have a material impact on our financial condition or results of operations. We are not involved in any administrative or judicial proceedings relative to an environmental matter. (1)Member of Audit Committee (2)Member of Compensation Committee (3)Chairman of Audit Committee and Compensation Committee The following sets forth certain biographical information, including present and past business experience, regarding our directors and executive officers. Jeffrey R. Pearl joined us in July 2003 as Executive Vice President Sales and Marketing, and was named interim Chief Executive Officer in November 2003 following the departure of Mr. Randall E. Curran. Prior to joining us, Mr. Pearl held a variety of executive sales positions with Qwest Communications, including Vice President of Sales where Mr. Pearl supervised a 1,500 person direct sales force from August 2000 to June 2003. Prior thereto, Mr. Pearl was Regional Vice President from November 1998 to August 2000. Prior to Qwest, Mr. Pearl held sales positions at Frontier Communications and WorldCom, Inc. Richard E. Fish, Jr. has served as our Executive Vice President and Chief Financial Officer since December 2000. Prior to this position, Mr. Fish was our Vice President of Finance from September 1999 to May 2000 and became Senior Vice President of Finance thereafter until he was appointed our Chief Financial Officer. Before joining us, Mr. Fish was Director-Access Management with AT&T Corporation from 1998 to 1999. AT&T acquired Teleport Communications Group, Inc. in 1998 where Mr. Fish was Director-Operations since 1994. Prior thereto, Mr. Fish was a manager with Arthur Andersen & Co., where he spent approximately seven years. Mr. Fish was serving as Senior Vice President of Finance at the time of our bankruptcy filing. Michael D. Kallet has served as our Executive Vice President Operations and Chief Technology Officer since July 1999. Mr. Kallet was also General Manager and Chief Operations Officer of ICG NetAhead, Inc., one of our former subsidiaries, from February 1999 to June 1999. Prior thereto, he was Senior Vice President of Products and Services of NETCOM On-Line Communication Services, Inc., one of our former subsidiaries since December 1995. Prior to joining NETCOM On-Line Communication Services, Inc., Mr. Kallet held several positions in the technology industry, including positions at IBM, Computer Support Corporation, Walker Interactive and Software Publishing Corporation (Harvard Graphics). Mr. Kallet was serving as Executive Vice President Operations and Chief Technology Officer at the time of our bankruptcy filing. Bernard L. Zuroff has served as our Executive Vice President, General Counsel and Secretary since October 2000. Prior to this position, Mr. Zuroff was Assistant General Counsel and Corporate Attorney since July 1996. Before joining us, he had 11 years of experience as an attorney with Gorsuch Kirgis, L.L.C., the Resolution Trust Company and Infotel, Inc. Mr. Zuroff was serving as Executive Vice President, General Counsel and Secretary at the time of our bankruptcy filing. John V. Colgan has served as our Senior Vice President Finance and Controller since July 1999. Since joining us in April 1994, Mr. Colgan has held a number of positions including Vice President of Financial Planning and Analysis and Senior Vice President of Finance for ICG Telecom Group, Inc., a subsidiary of the Company. Prior thereto, Mr. Colgan held several executive positions in the transportation and logistics industry, including positions with TLN, Inc., MNX, Inc. and Burlington Northern Motor Carriers, a subsidiary of Burlington Northern, Inc. Prior to joining Burlington Northern, Mr. Colgan was a senior manager at Arthur Andersen & Co. where he spent approximately ten years. Mr. Colgan was serving as Senior Vice President of Finance and Controller at the time of our bankruptcy filing. William J. Connors has served as our director since October 2002 and has been a member of our Board's Audit and Compensation Committees since joining. He is a Portfolio Manager for W. R. Huff Asset Management Co., L.L.C. and the Chief Investment Officer of WRH Partners Global Securities, LP. Mr. Connors has worked with the Huff group since 1992. Mr. Connors is also a member of the Board of Directors of Impsat Fiber Networks, Inc. Mr. Connors received his undergraduate degree in Applied Mathematics from Drew University and his MBA from Columbia University. Mr. Connors is a Chartered Financial Analyst. He joined our Board of Directors on October 10, 2002. Timothy F. Price has served as our director since October 2002 and has been a member of our Board's Audit and Compensation Committees since joining. He has also served as a managing member of Communications Advisory Group, L.L.C., a telecommunications consulting firm, since January 2001. Prior to joining Communications Advisory Group, L.L.C., Mr. Price served as an advisor to several venture capital firms and investment banks. From 1984 to December 1999, Mr. Price served in various capacities with MCI, Inc. and its subsidiary, MCI WorldCom Communications, a provider of business and residential communication services. His positions included President and Chief Operating Officer of MCI, Inc., and President and CEO of MCI WorldCom Communications. During his tenure with MCI, Mr. Price also served as President Business Markets, where he led the introduction of Network MCI Business and Proof Positive from MCI. Prior to this role, Mr. Price served as Senior Vice President Sales and held senior positions in MCI's paging and cellular telephony business. Prior to joining MCI, Mr. Price served as Vice President Marketing for Warner Amex Cable. In addition, Mr. Price has served on the Boards of Directors of both MCI and WorldCom, SHL Systemhouse, the National Alliance of Business, the Woodruff Foundation and the Corporate 100 of the John F. Kennedy Center for the Performing Arts. Mr. Price currently serves on the Board of Directors of Anchor Glass Container Corporation, a manufacturer of glass containers, Vanguard Car Rental and DecisionOne, a provider of information technology support services. He also serves on the Advisory Board of C&T Access Ventures. John A. Scarpati joined our Board of Directors on October 10, 2002, and has been Chairman of the Board's Audit and Compensation Committees since joining. Mr. Scarpati served as Chief Administrative Officer of Global Crossing Ltd., a telecommunications services provider of voice, data, video and conferencing products and services, from December 1999 to October 2000. Since leaving Global Crossing Ltd., Mr. Scarpati has been an independent consultant. From July 1998 to December 1999, Mr. Scarpati served in various capacities with AT&T, a communications services provider of voice, video and data communications, including Vice President and Chief Financial Officer for the AT&T Business Service Group and Senior Financial Officer for AT&T Local Network Services. From 1984 until 1998, Mr. Scarpati worked for Teleport Communications Group, Inc. in several financial roles including Senior Vice President and Chief Financial Officer. Mr. Scarpati also has served as Vice President Manager of Acquisitions at Merrill Lynch & Co., Inc. Mr. Scarpati served as an executive officer of Global Crossing within two years prior to its filing of a petition for relief under the federal bankruptcy laws in January 2002. Joseph R. Thornton joined our Board of Directors on October 10, 2002, and has been a member of the Board's Audit and Compensation Committees since joining. Mr. Thornton is counsel to W. R. Huff Asset Management Co., L.L.C., an independent investment management firm that specializes in the management of corporate high yield bonds, and has worked with the firm for more than ten years. Mr. Thornton received a BA degree in Economics, and JD and MBA degrees from the University of North Carolina at Chapel Hill. Mr. Thornton has served on the Boards of Directors of e.spire Communications and Uniflex, Inc. and as an observer to the Board of Price Communications. Mr. Thornton is a Chartered Financial Analyst. Mr. Thornton is also a member of the Board of Directors of Impsat Fiber Networks, Inc. There are no family relationships between any of our directors and executive officers. Election of Directors Our Board of Directors is divided into three separate classes of directors, designated Class I, Class II and Class III, respectively. At each annual meeting of stockholders, the term of one class of directors expires and successors to such directors are elected to serve three-year terms. The initial terms of the Class I, Class II and Class III directors expire at the 2003, 2004 and 2005 annual meetings of the stockholders, respectively. Pursuant to the Modified Plan and our Restated By-Laws, we are currently obligated to nominate for election (in connection with any meeting of or written consent solicited from our stockholders called for the purpose of electing directors) two individuals designated by Cerberus, two individuals designated by Huff and the individual acting as our Chief Executive Officer. The Chief Executive Officer is a Class I director, one designee of Cerberus and Huff, respectively, is a Class II director, and the other designee of Cerberus and Huff, respectively, is a Class III director. The election of directors is decided by the vote of the holders of a majority of the outstanding shares of all classes of the Company's stock entitled to vote, present in person or by proxy at the meeting, voting as a single class. In addition, Cerberus has the option to appoint one non-voting, non-participating observer to our Board of Directors. Director Compensation We compensate our non-employee directors with a cash payment of $26,000 per year. We also compensate our non-employee directors $1,000 in cash for attendance in person at meetings of our Board of Directors. In addition, the Chairmen of the Compensation and Audit Committees each receive an annual fee of $25,000 payable in quarterly installments. On February 10, 2003, all of our non-employee directors were granted options to purchase 10,000 shares of common stock under the Directors' Stock Option Plan at $9.12 per share. Such options fully vested on the date of grant. There are no other arrangements pursuant to which we compensate any of our non-employee directors. Compensation Committee Interlocks and Insider Participation None of our current executive officers has ever served as a member of the board of directors, or any committee thereof, of any other entity that has or has had one or more executive officers serving as a member of our Board of Directors, or any committee thereof. Total revenue 361,360 (149,658 ) 211,702 Operating costs and expenses: Operating costs 181,738 (18,470 ) 163,268 Selling, general and administrative expenses 68,908 68,908 Depreciation and amortization 31,233 31,233 Other expense, net 2,815 2,815 Since we emerged from bankruptcy on October 10, 2002, our Compensation Committee of our Board of Directors has consisted of our four non-employee directors: John A. Scarpati, who serves as Chairman, William J. Connors, Timothy F. Price and Joseph R. Thornton. From January 1, 2002 to October 10, 2002 (the effective date of our Modified Plan), the Compensation Committee consisted of William J. Laggett, Walter L. Threadgill, Leontis Teryazos and John U. Moorhead. None of the individuals serving on the Compensation Committee during fiscal year 2002 was an officer or employee of us or our subsidiaries during the fiscal year 2002, was an officer of us or our subsidiaries prior to the fiscal year 2002 or had any relationship that required disclosure under the caption "Certain Relationships and Related Transactions" contained in this prospectus. Executive Compensation and Other Benefits Summary of Cash and Certain Other Compensation The following table provides certain summary information concerning compensation paid or accrued by us and our subsidiaries, to or on behalf of Randall E. Curran, our former Chairman and Chief Executive Officer and the four other most highly compensated executive officers for the fiscal years ended December 31, 2002, December 31, 2001 and December 31, 2000. We have not maintained any long-term incentive plans, nor have we granted stock appreciation rights. On October 10, 2002, as part of the Modified Plan, certain members of senior management were granted options under the ICG Communications, Inc. Year 2002 Stock Option Plan. The persons named in the table are hereinafter referred to as our named executive officers. (1)For such persons for whom no amount is disclosed in this column, such amounts were less than 10% of the combined amount of the person's salary and bonus. However, in our Forms 10-K for fiscal years ended December 31, 2000 and 2001, respectively, all amounts for perquisites and other personal benefits were included in this column, regardless of amount. Further, amounts for 401(k) contributions which were previously included in this column are now reflected in the column "All Other Compensation." (2)The amounts shown in this column for Mr. Curran and Mr. Kallet represent bonuses earned pursuant to the terms of their respective employment agreements for our successful emergence from bankruptcy. (3)Consists of our contributions to 401(k) plan. (4)Incentive bonus earned in 2001 but paid in 2002. (5)Includes $6,111 for car allowance, $383,887 for taxable relocation expenses and $1,736 of non-taxable relocation expenses. (6)Includes $160,000 for retention bonus and $81,000 for incentive bonus earned in 2001 but paid in 2002. (7)Includes $40,630 incentive bonus and $40,000 retention bonus. (8)Such options were with respect to the old stock of the Predecessor Company, which options were cancelled as part of our Modified Plan. (9)Includes our contributions to 401(k) plan and 401(k) Wraparound Deferred Compensation Plan. (10)Includes $340,000 for retention bonus and $126,000 for incentive bonus earned in 2001 but paid in 2002. (11)Includes $3,712 in Company contributions to 401(k) plan and $1,610 in executive life insurance premiums. (12)Includes $283,462 in annual salary and $462 of retroactive salary that was paid in 2000. (13)Includes $122,020 incentive bonus and $85,000 retention bonus. (14)Taxable relocation expenses. (15)Includes $16,871 for our contributions to 401(k) plan and 401(k) Wraparound Deferred Compensation Plan, $1,610 for executive life insurance payments and $28,482 for distribution of amounts under our 401(k) Wraparound Deferred Compensation Plan. (16)Includes $1,780 for executive life insurance premium and $6,157 Company contributions to 401(k) plan. (17)Includes $52,000 for retention bonus and $66,000 for incentive bonus earned in 2001 but which was paid in 2002. (18)Consists of $38,837 incentive bonus and $13,000 retention bonus. (19)Consists of $80,000 retention bonus and $53,792 for incentive bonus which was earned in 2001 but paid in 2002. (20)Includes $59,070 incentive bonus and $20,000 retention bonus. (21)Includes $4,712 in accrued and unused vacation, $19,249 for distribution of amounts under our Wraparound Deferred Compensation Plan, and $12,648 for Company contributions to 401(k) plan and 401(k) Wraparound Deferred Compensation Plan. Randall E. Curran Richard E. Fish, Jr. 43,714 Michael D. Kallet 83,785 Bernard L. Zuroff 36,428 John V. Colgan 26,250 Executive Employment Agreements During the term of his employment with us, Mr. Curran's employment agreement provided for a month-to-month term at an annual base salary of $900,000. Subject to our achieving certain financial targets established by our Board, the agreement also provided for performance bonuses in an amount equal to 12 months' base salary at the rate then in effect based upon performance targets established at the discretion of our Board or the Compensation Committee. In addition, Mr. Curran was entitled to benefits that were generally provided to our senior executives, including reimbursement of reasonable out-of-pocket expenses incurred on our behalf. Pursuant to the terms of his employment agreement, Total operating costs and expenses 284,694 (18,470 ) 266,224 Mr. Curran received a lump-sum severance payment in an amount equal to 15 months of his base salary. Our employment agreements with Richard E. Fish, Jr., Michael D. Kallet, Bernard L. Zuroff, Robert Athey, John V. Colgan and James F. Smith provide for base salaries and such other benefits as are generally provided to our senior executives, including reimbursement of reasonable out-of-pocket expenses incurred on our behalf. These employment agreements may be terminated by us or by the employee with or without cause. If an agreement is terminated by us for any reason other than the employee's death, disability or for cause, or if there is a constructive dismissal (for example, the employee resigns because he or she is required to relocate to another state or country), the employee will receive an amount equal to 12 months salary at the rate then in effect. Fifty percent will be paid in a lump sum within 15 business days of termination and the remaining 50% is payable in 12 equal monthly installments commencing 30 days after termination. If the employee obtains new employment within such 12-month period, the severance is subject to mitigation on a dollar-for-dollar basis. If the employee's employment is terminated in the case of death, the employee's estate will receive an amount equal to three months' base salary. Messrs. Fish, Kallet, Zuroff, Athey, Colgan and Smith are subject to a ten-year confidentiality covenant and a one-year non-interference commitment following termination of employment. Directors Stock Option Plan Our Board of Directors has adopted, and the stockholders have approved, the Directors' Stock Option Plan, or the Directors Option Plan, pursuant to which each non-employee director has been granted options. The Directors' Option Plan provides for the granting of stock options as determined by a committee appointed by the Board of Directors. All of our non-employee directors are eligible to participate in the Directors' Option Plan. The Directors' Option Plan authorizes the grant of awards relating to an aggregate of 120,000 shares of our common stock. If any corporate transaction occurs which causes a change in our capitalization such as a reorganization, recapitalization, stock split, stock dividend, reverse stock split, share combination, merger, consolidation, acquisition of property or shares, separation, spinoff, stock rights offering, liquidation or similar event, the number and kind of shares of common stock available, or the number and kind and/or price of the shares of common stock subject to outstanding awards granted under the Directors' Option Plan, will be adjusted appropriately and equitably to prevent dilution or enlargement of the optionees' rights. Shares underlying awards will be counted against the 120,000 shares limitation and may be reused to the extent that an award expires, is terminated unexercised or forfeited, or shares of common stock are returned to our treasury as a result of any form of "cashless" exercise of options or tax withholding of shares permitted by the committee under the Directors' Option Plan. The Directors' Option Plan became effective as of February 10, 2003 and will continue until the Directors' Option Plan's tenth anniversary. In the event of a termination, the Directors' Option Plan will remain in effect so long as any awards remain outstanding. The committee administering the Directors' Option Plan may grant to directors non-qualified stock options, or NSOs. In fact, only NSOs may be granted to non-employee directors. The exercise price for any option granted under this Directors Option Plan must be at least equal to 100% of the fair market value of our common stock on the date the option is granted. NSOs will expire at times the committee determines at the time of grant; however, no award can be exercisable later than the tenth anniversary after the date of grant. Awards granted under the Directors' Option Plan are exercisable or payable at the times and subject to the restrictions and conditions the committee establishes. Each NSO will become vested according to the vesting schedule contained in the award agreement. If no vesting schedule is provided, the NSO will become 100% vested upon the grant date. Only upon exercise of the option will the holder have the rights of a stockholder with respect to the shares of our common stock subject to an award under the Directors' Option Plan. Except as otherwise provided in an award agreement, if a holder of an option grant dies or become disabled during the exercise period while still serving as a director, the NSO may be exercised by those entitled to do so (beneficiaries in the event of a death) within 18 months following the death or disability (provided that an exercise must occur within the exercise period), but not thereafter. Except as otherwise provided in the award agreement, if the service of a director is terminated within the exercise period for any reason other than for cause or death or disability, the director may exercise the NSO within 90 days following the date of termination (provided that an exercise must occur within the exercise period) but not thereafter. The NSO may be exercised only as to the shares of common stock as to which the NSO had become exercisable on or before the date of termination, death or disability. In the event the service of a director is terminated for cause, any NSO then held by the director, whether or not vested, will be cancelled and will become void, and the director will have no further interest in the NSO. The Directors' Option Plan is administered by a committee consisting of two or more members of the Board of Directors appointed by our Board of Directors. The members of the committee serve for a period decided in the sole discretion of the Board of Directors and may be removed from the committee at any time at the sole discretion of the Board of Directors. Currently, the committee members do not receive any compensation, although compensation is permissible, for administering the Directors' Option Plan, other than the standard fees as established from time to time by our Board of Directors for services by them on committees. The committee is comprised of those individuals deemed necessary by the Board of Directors, in its sole discretion, to comply with applicable securities and tax rules and regulations. The committee has full authority to decide all questions of interpretation and application of the provisions of the Directors Option Plan and its decisions are final and binding upon all employees in the Directors' Option Plan. Currently, Messrs. Connors, Price, Scarpati and Thornton serve on the committee which administers the Directors' Option Plan. ICG Communications, Inc. Year 2002 Stock Option Plan Our Board of Directors has adopted the ICG Communications, Inc. Year 2002 Stock Option Plan, or the 2002 Plan. The 2002 Plan provides for the granting of stock options as determined by a committee appointed by the Board of Directors. Employees of ICG or any of its parents or subsidiaries may be granted options; however, any such grants lie within the discretion of such committee. The 2002 Plan authorizes the grant of awards relating to an aggregate of 768,137 shares of common stock. If any corporate transaction occurs which causes a change in our capitalization such as a reorganization, recapitalization, stock split, stock dividend, reverse stock split, share combination, merger, consolidation, acquisition of property or shares, separation, spinoff, stock rights offering, liquidation or similar event, the number and kind of shares of common stock available, or the number and kind and/or price of the shares of common stock subject to outstanding awards granted under the 2002 Plan, will be adjusted appropriately and equitably to prevent dilution or enlargement of the optionees' rights. Shares underlying awards will be counted against the 768,137 shares limitation and may be reused to the extent that an award expires, is terminated unexercised or forfeited, or shares of common stock are returned to our treasury as a result of any form of "cashless" exercise of options or tax withholding of shares permitted by the committee under the 2002 Plan. The 2002 Plan became effective as of January 1, 2002, and is unlimited in duration. In the event of a termination, the 2002 Plan will remain in effect so long as any awards remain outstanding. The committee administering the 2002 Plan may grant to employees incentive stock options, or ISOs, NSOs or a combination of these options under the 2002 Plan. The exercise price for any ISO or NSO granted under this 2002 Plan must be at least equal to 100% of the fair market value of the common stock on the date the option is granted. ISOs and NSOs will expire at times the committee determines at the time of grant. No option can be exercisable later than the tenth anniversary after the grant (five years for ISOs granted to an employee who owns more than 10% of all of the voting power of all classes of stock). Awards granted under the 2002 Plan are exercisable or payable at the times and subject to the restrictions and conditions the committee establishes. The 2002 Plan is described as a non-cash equity based long-term incentive plan. Each ISO or NSO will become vested according to the vesting schedule contained in the option agreement. If no vesting schedule is provided, the ISO or NSO will become 33.3% vested on the first anniversary of the grant date, an additional 33.3% vested on the second anniversary of the grant date and an additional 33.4% on the third anniversary of the grant date, as long as the grantee is employed on each anniversary date. Options will become fully vested upon a change in control. Only upon exercise of the option will the holder have the rights of a stockholder with respect to the shares of common stock subject to an award under the 2002 Plan. With regard to ISOs and NSOs, if a grantee dies or becomes disabled during the exercise period while still employed, the option may be exercised by those entitled to do so (by beneficiary in the event of death) within 18 months following death or disability (provided than an exercise must occur within the exercise period), but not thereafter. To retain ISO treatment, however, any vested options must be exercised within 12 months of death or disability. If a grantee's employment is terminated (which means such employee is no longer employed by us or any subsidiary) within the exercise period for any reason other than for cause or death or disability, the grantee may exercise the option within 18 months following the date of termination (provided that an exercise must occur within the exercise period) but not thereafter. Any ISO exercised after 90 days, however, will be treated as an NSO. The ISO or NSO may be exercised only as to the shares of common stock as to which the ISO or NSO had become exercisable on or before the date of the termination, death or disability. All unvested options at the time of termination, death or disability will automatically terminate. In the event employment with us or any subsidiary is terminated for cause, any ISO or NSO then held by the employee will be cancelled and will become void, and he will have no further interest in the ISO or NSO. The 2002 Plan is administered by a committee consisting of two or more members of the Board of Directors appointed by our Board of Directors. The committee members do not receive any compensation for administering the 2002 Plan, although the 2002 Plan does not prohibit compensation, other than the standard fees as established from time to time by the Board of Directors for services by them on such committee. The committee is comprised of those individuals deemed necessary by the Board of Directors, in its sole discretion, to comply with applicable securities and tax rules and regulations. The committee has full authority to decide all questions of interpretation and application of the provisions of the 2002 Plan and its decisions are final and binding upon all employees in the 2002 Plan. The Board of Directors may amend, suspend or terminate the 2002 Plan at any time, provided that no amendment may materially adversely affect any outstanding award without consent of the holders. Any amendment that increase the number of shares of common stock available under the 2002 Plan or which changes the class of eligible employees requires the approval of our stockholders. Directors are generally considered to be "affiliates" of us under the rules and regulations promulgated under the Securities Act of 1933. Affiliates may not offer or sell the shares of common Commitments and contingencies (note 7) Stockholders' equity: Reorganized Company preferred stock, $0.001 par value, 10,000,000 shares authorized; 0 shares issued and outstanding Reorganized Company common stock, $0.01 par value, 100,000,000 shares authorized; 8,000,000 shares deemed issued and outstanding 80 Balances at September 30, 2003 8,000 $ Balances at December 31, 2001 (Predecessor Company) 53,707 537 922,040 (4,367,334 ) (3,444,757 ) Shares issued upon conversion of mandatorily redeemable preferred securities of subsidiary 1,538 15 36,940 36,955 Net income 4,367,334 4,367,334 Effect of reorganization and Fresh Start reporting (55,245 ) (552 ) 8,000 Balances at December 31, 2002 (Reorganized Company) $ 8,000 $ stock they acquire under the 2002 Plan, unless the offers and sales are made pursuant to an effective registration statement under the Securities Act of 1933 or pursuant to an appropriate exemption from the registration requirements of the Securities Act of 1933; or in accordance with the conditions and limitations contained in Rule 144 promulgated under the Securities Act of 1933. Any acceleration of the vesting or payment of awards under the 2002 Plan in the event of a change in control may cause part or all of the consideration involved to be treated as an "excess parachute payment" under the Internal Revenue Code, which may subject the holder to a 20% excise tax and which may not be deductible by ICG. ICG Communications, Inc. Year 2003 Stock Option Plan Our Board of Directors has adopted the ICG Communications, Inc. Year 2003 Stock Option Plan, or the 2003 Plan. The 2003 Plan provides for the granting of stock options as determined by a committee appointed by the Board of Directors. Employees of us or our parents or subsidiaries may be granted options; however, any such grants lie within the discretion of such committee. The 2003 Plan authorizes the grant of awards relating to an aggregate of 265,000 shares of our common stock. If any corporate transaction occurs which causes a change in our capitalization such as a reorganization, recapitalization, stock split, stock dividend, reverse stock split, share combination, merger, consolidation, acquisition of property or shares, separation, spinoff, stock rights offering, liquidation or similar event, the number and kind of shares of common stock available, or the number and kind and/or price of the shares of common stock subject to outstanding awards granted under the 2003 Plan, will be adjusted appropriately and equitably to prevent dilution or enlargement of the optionees' rights. Shares underlying awards will be counted against the 265,000 share limitation and may be reused to the extent that an award expires, is terminated unexercised or forfeited, or shares of common stock are returned to our treasury as a result of any form of "cashless" exercise of options or tax withholding of shares permitted by the committee under the 2003 Plan. The 2003 Plan became effective as of February 28, 2003, and, subject to stockholder approval of the 2003 Plan if such stockholder approval is required by law, will be unlimited in duration, but no ISO may be granted after 2003 Plan's tenth anniversary. In the event of a termination, the 2003 Plan will remain in effect so long as any awards remain outstanding. The committee administering the Plan may grant to employees ISOs, NSOs or a combination of these options under the Plan. The exercise price for any ISO granted under this Plan must be at least equal to the fair market value of the common stock on the date the option is granted (but special rules apply to the exercise price of ISOs granted to an employee who owns more than 10% of all the voting power of all classes of our stock or the stock of our parent or subsidiary). The exercise price for any NSO granted under this Plan may be at any price. ISOs and NSOs will expire at times the committee determines at the time of grant. No option can be exercisable later than the tenth anniversary after the grant (five years for ISOs granted to an employee who owns more than 10% of all of the voting power of all classes of stock). Awards granted under the 2003 Plan are exercisable or payable at the times and subject to the restrictions and conditions the committee establishes. The 2003 Plan is designed as a non-cash equity based long-term incentive plan. Each ISO or NSO will become vested according to the vesting schedule contained in the option agreement. If no vesting schedule is provided, the ISO or NSO will become 33.3% vested on the first anniversary of the grant date, an additional 33.3% vested on the second anniversary of the grant date and an additional 33.4% on the third anniversary of the grant date, as long as the grantee is employed on each anniversary date. Options will become fully vested upon a change in control. Only upon Operating income (loss) 76,666 (131,188 ) (54,522 ) exercise of the option will the holder have the rights of a stockholder with respect to the shares of common stock subject to an award under the 2003 Plan. With regard to ISOs, if a grantee dies or becomes disabled during the exercise period while still employed, or within the 90-day period referred to in the following sentence, the vested ISOs must be exercised by those entitled to do so (by a beneficiary in the event of death) within 18 months following the grantee's death or disability (provided that an exercise must occur within the exercise period), but not thereafter. To retain ISO treatment, however, any vested ISO must be exercised within 12 months of death or disability. If a grantee's employment is terminated (which means such employee is no longer employed by us or any subsidiary) within the exercise period for any reason other than for cause or death or disability, the grantee may exercise the ISO within 90 days following the date of the termination (provided that an exercise must occur within the exercise period), but not thereafter. With regard to NSOs, if a grantee dies or becomes disabled during the exercise period while still employed, the NSO may be exercised by those entitled to do so (by beneficiary in the event of death) within 18 months following death or disability (provided than an exercise must occur within the exercise period), but not thereafter. If a grantee's employment is terminated (which means such employee is no longer employed by us or any subsidiary) within the exercise period for any reason other than for cause or death or disability, the grantee may exercise the NSO within 18 months following the date of termination (provided that an exercise must occur within the exercise period) but not thereafter. The ISO or NSO may be exercised only as to the shares of common stock as to which the ISO or NSO had become exercisable on or before the date of the termination, death or disability. All unvested options at the time of termination, death or disability will automatically terminate. In the event employment with us or any subsidiary is terminated for cause, any ISO or NSO then held by the employee will be cancelled and will become void, and he will have no further interest in the ISO or NSO. The 2003 Plan is administered by a committee consisting of two or more members of the Board of Directors appointed by our Board of Directors. The members of the committee serve for a period decided in the sole discretion of the Board of Directors and may be removed from the committee at any time at the sole discretion of the Board of Directors. The committee members do not receive any compensation for administering the 2003 Plan, other than the standard fees as established from time to time by the Board of Directors for services by them on such committee. The committee is expected to be comprised of those individuals deemed necessary by the Board of Directors, in its sole discretion, to comply with applicable securities and tax rules and regulations. The committee has full authority to decide all questions of interpretation and application of the provisions of the 2003 Plan and its decisions are final and binding upon all employees in the 2003 Plan. The Board of Directors may amend, suspend or terminate the 2003 Plan at any time, provided that no amendment may materially adversely affect any outstanding award without consent of the holders. Limitation of Liability and Indemnification Our Amended and Restated Certificate of Incorporation eliminates the personal liability of our directors to us and our stockholders for monetary damages for breach of the directors' fiduciary duties to the fullest extent permissible by law. Our Amended and Restated Certificate of Incorporation and Restated By-Laws provide that we shall indemnify our officers and directors to the fullest extent permitted by law. We have also entered into agreements to indemnify our officers and directors that require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as officers or directors or other positions served at our request to the fullest extent not prohibited by law. CERTAIN RELATIONSHIPS AND RELATED-PARTY TRANSACTIONS Senior Subordinated Term Loan and Related Warrants Pursuant to the Modified Plan, Cerberus arranged our $25 million senior subordinated term loan, all of the proceeds of which were distributed pro rata to the holders of our pre-petition secured notes. The senior subordinated term loan, which was prepaid pursuant to its terms following the completion of the Qwest transaction, had the following terms: subordinated to the secured notes; secured by liens, which were junior to the liens securing the then-outstanding secured notes, on substantially all of our assets; 4-year maturity; and interest rate of 14% per annum. Madeleine L.L.C., a lender under the senior subordinated term loan, received warrants to purchase a total of 426,316 additional shares of common stock which are beneficially owned by Stephen Feinberg, a selling stockholder and the beneficial owner of more than 5% of our common stock. See "Description of Capital Stock Warrants" and "Security Ownership of Certain Beneficial Owners and Management." In addition, as a result of the Qwest transaction, we prepaid to Madeleine L.L.C. $22.5 million in principal and all accrued interest due to Madeleine L.L.C. under our senior subordinated term loan. See "Recent Developments Prepayment of Secured Notes and Senior Subordinated Term Loan." Nomination Rights to Board of Directors Our Restated By-Laws, which were adopted in connection with the Modified Plan, provide that under certain conditions that are currently satisfied Huff and Cerberus and their respective affiliates each have the right to require us to nominate two individuals for election to our Board of Directors. Further, Cerberus has the right to appoint one non-voting, non-participating observer to our Board of Directors. Accordingly, Cerberus required us to nominate Timothy F. Price and John A. Scarpati, and both were elected and currently serve as members of our Board of Directors. Huff required us to nominate William J. Connors and Joseph R. Thornton, and both were elected and currently serve as members of our Board of Directors. Mr. Connors and Mr. Thornton are both currently employed by Huff. Furthermore, in connection with the Modified Plan, we entered into a letter agreement with Huff, dated as of July 25, 2002, pursuant to which Huff will cause one or more of the individuals who were nominated for election to our Board of Directors by Huff, as described above, to resign from our Board of Directors upon a specified reduction in the percentage of our common stock that they control. See "Management Election of Directors." Registration Rights Agreement Madeleine L.L.C. and Huff entered into a registration rights agreement with us at the time of our emergence from bankruptcy which gives them certain registration rights with respect to the shares of our common stock owned by them. The registration statement of which this prospectus forms a part was filed by us because they exercised their rights to have their shares registered under the registration rights agreement. Under the terms of the registration rights agreement, the above holders are entitled to demand up to five total registrations with respect to our securities, provided the securities to be registered in any such registration either equal a minimum of $5,000,000 aggregate offering price to the public or the requested registration constitutes all of such holder's registrable securities. We are required to register all shares of our common stock currently owned or subsequently acquired by these holders. The registration rights agreement also provides these holders with unlimited "piggyback" registration rights for securities owned by them, which gives them the right to include the securities they own in registration statements in which we are registering securities for sale on our behalf or on behalf of other holders of our securities. Although we will be responsible for all expenses incurred in connection with any registration offered pursuant to the registration rights agreement, we will not be responsible for applicable underwriting discounts, selling commissions or stock transfer taxes incurred by the holders or for the expenses of more than one counsel for all such holders. The registration rights agreement also includes customary indemnification and contribution provisions. Indemnification Agreements In March of 2003, we entered into indemnification agreements with each of our directors. The indemnification agreements require us to indemnify our directors to the fullest extent permitted by law and require us to advance the expenses incurred by such directors as a result of any threatened claims or proceedings brought against them as to which they could be indemnified, subject to applicable law. See "Description of Capital Stock Limitation of Liability and Indemnification" and "Management Limitation of Liability and Indemnification" for more information regarding these agreements. *Less than one percent 1.The information regarding beneficial ownership of our common stock has been presented in accordance with the rules of the SEC and is not necessarily indicative of beneficial ownership for any other purpose. Under these rules, beneficial ownership of common stock includes any shares as to which a person, directly or indirectly, has or shares voting power or investment power and also any shares as to which a person has the right to acquire such voting or investment power within 60 days through the exercise of any stock option or other right. The percentage of beneficial ownership as to any person as of a particular date is calculated by dividing the number of shares beneficially owned by such person by the sum of the number of shares outstanding as of such date and the number of shares as to which such person has the right to acquire voting or investment power within 60 days. The number of shares of our common stock deemed outstanding on December 15, 2003 for purposes of calculating the percent of class owned was 8,000,000. As used in this registration statement, "voting power" is the power to vote or direct the voting of shares Other income (expenses): Interest expense (18,306 ) 7,584 (10,722 ) Other 2,439 2,439 and "investment power" is the power to dispose or direct the disposition of shares. Except as noted, each stockholder listed has sole voting and investment power with respect to the shares shown as beneficially owned by such stockholder. 2.Mr. Huff reports having sole voting and dispositive power over these shares, which are or will be upon issuance held, through accounts managed by W.R. Huff Asset Management Co., L.L.C. The amount reported includes 168,991 shares of common stock underlying warrants issued under the Modified Plan, 395,760 shares of common stock expected to be issued under the Modified Plan and 118,102 additional shares of common stock underlying warrants that are expected to be issued under the Modified Plan. 3.Stephen Feinberg has sole voting and dispositive power over all shares of ICG which have been or will be issued, in the aggregate, to Cerberus Partners, L.P., Cerberus International, Ltd., Cerberus Institutional Partners, L.P. and Madeleine L.L.C. Mr. Feinberg serves as the managing member of Cerberus Associates, L.L.C., the general partner of Cerberus Partners, L.P., and, through one or more intermediate entities, the investment manager for each of Cerberus International, Ltd., Cerberus Institutional Partners, L.P. and Madeleine L.L.C. The amount set forth herein includes 22,279 shares of our common stock and 4,110 shares of our common stock underlying warrants that may be issued pursuant to the Modified Plan, in the aggregate, to Cerberus Partners, L.P., Cerberus International, Ltd. and Cerberus Institutional Partners, L.P. They also include 680,870 shares of our common stock underlying warrants that have been issued to Madeleine L.L.C. pursuant to the Modified Plan. 4.Husic Capital Management, a California limited partnership and registered investment adviser, reports having sole voting and dispositive power over these shares as investment adviser to its investment advisory clients, none of which is reported to own individually more than 5% of our common stock. Each of Frank J. Husic & Co., as the sole general partner of Husic Capital Management, and Frank J. Husic, as the sole shareholder of the general partner, also report having sole voting and dispositive power over these shares by virtue of their relationship to Husic Capital Management. The principal business address of each of the general partner and Mr. Husic is reported to be 555 California Street, Suite 2900, San Francisco, California 94104. 5.All shares reported as beneficially owned represent shares that may be acquired within 60 days pursuant to the exercise of outstanding options granted under the ICG Communications, Inc. Year 2002 Stock Option Plan. 6.All shares reported as beneficially owned represent shares that may be acquired within 60 days pursuant to the exercise of outstanding options granted under the ICG Communications, Inc. Directors' Stock Option Plan. DESCRIPTION OF CAPITAL STOCK Since October 10, 2002, the effective date of our plan of reorganization, we have been governed by our Amended and Restated Certificate of Incorporation, which provides for 110,000,000 shares of authorized capital stock, consisting of 100,000,000 shares of common stock, par value $.01 per share, and 10,000,000 shares of preferred stock, par value $.001 per share. In accordance with Section 1123(a)(6) of the Bankruptcy Code, our Amended and Restated Certificate of Incorporation prohibits the issuance of any shares of non-voting securities. The following summary description of our capital stock is qualified in its entirety by reference to our Amended and Restated Certificate of Incorporation and Restated By-Laws, a copy of each of which is filed as an exhibit to the registration statement of which this prospectus is a part. Pursuant to the plan of reorganization, on October 10, 2002, (1) all then-outstanding shares of our pre-reorganization common stock were cancelled, as well as all unexercised options and warrants, and (2) we were instructed by the Bankruptcy Court to issue 8,00,000 shares of common stock to our pre-reorganization unsecured creditors as their allowed unsecured claims are approved. Common Stock We may issue up to 100,000,000 shares of our common stock. As of December 19, 2003, of the 8,000,000 shares of common stock to be issued to our unsecured creditors, 7,706,894 shares were issued and outstanding. We expect all claims to be settled and the remaining shares to be issued by the end of 2004. Our common stock has the following terms: The outstanding shares of our common stock are fully paid and non-assessable. Holders of common stock are entitled to one vote per share for each share held of record on all matters submitted to a vote of stockholders and are entitled to receive ratably such dividends as may be declared by our Board of Directors out of funds legally available therefor. After satisfaction of the dividend rights of holders of any outstanding preferred stock (and no shares of preferred stock were outstanding as of December 19, 2003), holders of common stock will be entitled to any dividend declared by our Board of Directors out of funds legally available for this purpose. However, it is not anticipated that any cash dividends will be paid on our common stock for the foreseeable future. Upon our liquidation, dissolution or winding up, holders of common stock will have the right to a ratable portion of assets remaining after payment of liabilities and any payments due to holders of then-outstanding preferred stock. The holders of common stock have no preemptive rights. The rights, preferences and privileges of holders of common stock may be adversely affected by the rights of the holders of shares of any series of preferred stock that we may designate and issue in the future. Preferred Stock We may issue up to 10,000,000 shares of preferred stock in one or more series. Our Board of Directors may issue such preferred stock, and designate the terms thereof (including with respect to voting rights, dividends, liquidation preferences and redemption and conversion rights), without the need for stockholder approval. There are no shares of preferred stock outstanding, and there are no agreements or understandings for the designation of any series of preferred stock or the issuance of shares thereunder. The existence of authorized but unissued preferred stock may enable our Board to render more difficult or to discourage an attempt to obtain control of us by means of a merger, tender offer, proxy contest or otherwise. Warrants We expect to issue warrants to purchase an aggregate of 1,473,684 shares of our common stock. Warrants to purchase an aggregate of 800,000 shares of common stock, of which 759,690 have been issued, are expected to be issued to our pre-reorganization unsecured creditors pursuant to the Modified Plan. Warrants to purchase an aggregate of 673,684 shares of common stock were issued as partial consideration for our senior subordinated term loan and in accordance with the Note and Warrant Purchase Agreement dated as of July 25, 2002 among us, Madeleine L.L.C. and Morgan Stanley & Co., Incorporated, referred to in this prospectus as the Note and Warrant Purchase Agreement. Modified Plan Warrants In accordance with the Warrant Agreement dated as of October 10, 2002 between us and American Stock Transfer & Trust Company, as warrant agent, as amended by Amendment No. 1 thereto, collectively referred to in this prospectus as the Warrant Agreement, we have issued warrants to purchase an aggregate of 759,690 shares of our common stock to our pre-reorganization unsecured creditors under the Modified Plan. The warrants may be exercised from the date of issuance until the later of (i) October 10, 2007 and (ii) the date that a registration statement covering the underlying common stock of the warrants becomes effective. No warrants to purchase fractional shares will be issued. The warrants are transferable pursuant to the terms of the Warrant Agreement. The Warrant Agreement, which is included as an exhibit to the registration statement of which this prospectus forms a part, details the procedures for issuance, distribution, exchange and transfer of the warrants. Prior to the exercise of their warrants, registered holders are not entitled to vote and are not deemed to be the holders of common stock for any purpose. The initial exercise price of the warrants is $9.12 per share of common stock. The number of shares purchasable or assets or property payable upon the exercise of each warrant and the exercise price of the warrants are subject to adjustment, on the terms and conditions contained in the Warrant Agreement, in the event of (i) the sale or issuance of additional shares of common stock without consideration or for a consideration per share less than the greater of $9.12, subject to adjustment, and the current market price in effect immediately prior to the issuance or sale; (ii) the declaration, order, payment or making of a dividend or other distribution (including any distribution of other or additional stock or other securities or property or options by way of dividend or spin-off, reclassification, recapitalization or similar corporate rearrangement) on the common stock other than (a) a dividend payable in additional shares of common stock or (b) a distribution of "poison pill" rights by us pursuant to a "poison pill" shareholder rights plan; (iii) the issuance, sale, granting or assuming of any options or shares of stock, indebtedness or other securities convertible into common stock, or the fixing of a record date for the determination of holders of any class of our securities entitled to receive any options or shares of stock, indebtedness or other securities convertible into common stock; (iv) the declaration or payment of any dividend on the common stock payable in common stock, or the subdivision of the outstanding shares of common stock into a greater number of shares of common stock (by reclassification or otherwise than by payment of a dividend in common stock); and (v) the combination or consolidation of the outstanding shares of common stock into a lesser number of shares of common stock, by reclassification or otherwise. As a result of these adjustments, a warrant holder will receive the economic terms of the warrant as if the warrant had been exercised immediately before the occurrence of the event that resulted in the adjustment. Payment of the aggregate exercise price for all shares of common stock being acquired upon exercise of a warrant may be made in United States dollars, by certified check or bank draft made payable to us, or by wire. In lieu of payment in cash of the aggregate exercise price and subject to applicable law, the holder of a warrant may (i) request that we pay the "spread" that will be delivered by us by delivering to such holder the number of shares of our common stock equal to (a) the product of the current market price per share of common stock (on the date of exercise), multiplied by the number of shares of common stock underlying the warrant being exercised, minus (b) the product of the exercise price, multiplied by the number of shares of common stock underlying the warrant being exercised, divided by (c) the current market price per share of common stock (as of the date of exercise); (ii) surrender to us for cancellation certificates representing shares of our common stock owned by the holder having a current market price (on the date of exercise) equal to the aggregate exercise price of the warrant being exercised; or (iii) if any of our secured notes are outstanding and held by the holder, cancel all or any part of the unpaid principal amount of such secured notes in an amount equal to the aggregate exercise price of the warrant being exercised. The shares of common stock (and our other securities) issuable upon exercise of a warrant (or upon conversion of any shares of common stock issued upon the exercise) constitute registrable securities under the Registration Rights Agreement dated as of October 10, 2002 among us and certain holders of registrable securities, which is included as an exhibit to the registration statement of which this prospectus forms a part and is referred to in this prospectus as the Registration Rights Agreement. Each holder of a warrant is entitled to all of the benefits afforded to a holder of registrable securities under the Registration Rights Agreement and each holder, by its acceptance of the warrant, is bound by the terms and conditions of the Registration Rights Agreement applicable to the holders of registrable securities. The shares of our common stock underlying the warrants held by the selling stockholders are being registered under the registration statement of which this prospectus forms a part. Note and Warrant Purchase Agreement Warrants Nominal Warrants As partial consideration for our senior subordinated term loan and in accordance with the Note and Warrant Purchase Agreement, we have also issued warrants, referred to in this prospectus as the Nominal Warrants, to purchase an aggregate of 473,684 shares of our common stock. The Nominal Warrants may be exercised from the date of issuance until the later of (i) July 25, 2007 and (ii) the date that a registration statement covering the underlying common stock of the Nominal Warrants becomes effective. No Nominal Warrants to purchase fractional shares will be issued. The Nominal Warrants are transferable pursuant to the terms of the Note and Warrant Purchase Agreement. The Note and Warrant Purchase Agreement, which is included as an exhibit to the registration statement of which this prospectus forms a part, details the procedures for issuance, distribution, exchange and transfer of the Nominal Warrants. Prior to the exercise of their Nominal Warrants, registered holders are not entitled to vote and are not deemed to be the holders of common stock for any purpose. The initial exercise price of the Nominal Warrants is $0.01 per share of common stock. The number of shares purchasable or assets or property payable upon the exercise of each Nominal Warrant and the exercise price of the Nominal Warrants are subject to adjustment, on the terms and conditions contained in the Note and Warrant Purchase Agreement, in the event of (i) the sale or issuance of additional shares of common stock without consideration or for a consideration per share less than the current market price of the common stock in effect immediately prior to the sale or issuance; (ii) the declaration, order, payment or making of a dividend or other distribution (including any distribution of other or additional stock or other securities or property or options by way of dividend or spin-off, reclassification, recapitalization or similar corporate rearrangement) on the common stock other than a dividend payable in additional shares of common stock; (iii) the issuance, sale, granting or assuming of any options or shares of stock, indebtedness or other securities convertible into common stock, or the fixing of a record date for the determination of holders of any class of our securities entitled to receive Total other expense, net (15,867 ) 7,584 (8,283 ) any options or shares of stock, indebtedness or other securities convertible into common stock; (iv) the declaration or payment of any dividend on the common stock payable in common stock, or the subdivision of the outstanding shares of common stock into a greater number of shares of common stock (by reclassification or otherwise than by payment of a dividend in common stock); and (v) the combination or consolidation of the outstanding shares of common stock into a lesser number of shares of common stock, by reclassification or otherwise. As a result of these adjustments, a Nominal Warrant holder will receive the economic terms of the Nominal Warrant as if the Nominal Warrant had been exercised immediately before the occurrence of the event that resulted in the adjustment. Payment of the aggregate exercise price for all shares of common stock being acquired upon exercise of a Nominal Warrant may be made in United States dollars, by certified check or bank draft made payable to us, or by wire. In lieu of payment in cash of the aggregate exercise price and subject to applicable law, the holder of a Nominal Warrant may (i) request that we pay the "spread" that will be delivered by us by delivering to such holder the number of shares of our common stock equal to (a) the product of the current market price per share of common stock (on the date of exercise), multiplied by the number of shares of common stock underlying the Nominal Warrant being exercised, minus (b) the product of the exercise price, multiplied by the number of shares of common stock underlying the Nominal Warrant being exercised, divided by (c) the current market price per share of common stock (as of the date of exercise); (ii) surrender to us for cancellation certificates representing shares of our common stock owned by the holder having a current market price on the date of exercise equal to the aggregate exercise price of the Nominal Warrant being exercised; or (iii) if any of our secured notes are outstanding and held by the holder, cancel all or any part of the unpaid principal amount of such secured notes in an amount equal to the aggregate exercise price of the Nominal Warrant being exercised. The shares of common stock (and our other securities) issuable upon exercise of a Nominal Warrant (or upon conversion of any shares of common stock issued upon such exercise) are registrable securities under the Registration Rights Agreement. Each holder of a Nominal Warrant is entitled to all of the benefits afforded to a holder of registrable securities under the Registration Rights Agreement and each holder of a Nominal Warrant is bound by the terms and conditions of the Registration Rights Agreement applicable to the holders of registrable securities. The shares of our common stock underlying the Nominal Warrants held by the selling stockholders are being registered under the registration statement of which this prospectus forms a part. Fee Warrants In addition, as partial consideration for our senior subordinated term loan and in accordance with the Note and Warrant Purchase Agreement, we have issued warrants, referred to in this prospectus as the Fee Warrants, to purchase an aggregate of 200,000 shares of our common stock. The Fee Warrants may be exercised from the date of issuance until the later of (i) July 25, 2007 and (ii) the date that a registration statement covering the underlying common stock of the Fee Warrants becomes effective. No Fee Warrant to purchase fractional shares will be issued. The Fee Warrants are transferable pursuant to the terms of the Note and Warrant Purchase Agreement. The Note and Warrant Purchase Agreement details the procedures for issuance, distribution, exchange and transfer of the Fee Warrants. Prior to the exercise of their Fee Warrants, the registered holders are not entitled to vote and are not deemed to be the holders of common stock for any purpose. The initial exercise price of the Fee Warrants is $9.12 per share of common stock. The number of shares purchasable or assets or property payable upon the exercise of the Fee Warrants and the exercise price of the Fee Warrants are subject to adjustment, on the terms and conditions contained in the Note and Warrant Purchase Agreement, in the event of (i) the sale or issuance of additional shares of common stock without consideration or for a consideration per share less than the greater of $9.12 per share, subject to adjustment, and the current market price in effect immediately prior to such issuance or sale; (ii) the declaration, order, payment or making of a dividend or other distribution (including any distribution of other or additional stock or other securities or property or options by way of dividend or spin-off, reclassification, recapitalization or similar corporate rearrangement) on the common stock other than (a) a dividend payable in additional shares of common stock or (b) a distribution of "poison pill" rights by us pursuant to a "poison pill" shareholders rights plan; (iii) the issuance, sale, granting or assuming of any options or shares of stock, indebtedness or other securities convertible into common stock, or the fixing of a record date for the determination of holders of any class of our securities entitled to receive any options or shares of stock, indebtedness or other securities convertible into common stock; (iv) the declaration or payment of any dividend on the common stock payable in common stock, or the subdivision of the outstanding shares of common stock into a greater number of shares of common stock (by reclassification or otherwise than by payment of a dividend in common stock); and (v) the combination or consolidation of the outstanding shares of common stock into a lesser number of shares of common stock, by reclassification or otherwise. As a result of these adjustments, a Fee Warrant holder will receive the economic terms of the Fee Warrant as if the Fee Warrant had been exercised immediately before the occurrence of the event that resulted in the adjustment. Payment of the aggregate exercise price for all shares of common stock being acquired upon exercise of a Fee Warrant may be made in United States dollars, by certified check or bank draft made payable to us, or by wire. In lieu of payment in cash of the aggregate exercise price and subject to applicable law, the holder of a Fee Warrant may (i) request that we pay the "spread" that will be delivered by us by delivering to such holder a number of shares of our common stock equal to (a) the product of the current market price per share of common stock (on the date of exercise), multiplied by the number of shares of common stock underlying the Fee Warrant being exercised, minus (b) the product of the exercise price, multiplied by the number of shares of common stock underlying the Fee Warrant being exercised, divided by (c) the current market price per share of common stock (as of the date of exercise); (ii) surrender to us for cancellation certificates representing shares of our common stock owned by the holder having a current market price (on the date of exercise) equal to the aggregate exercise price of the Fee Warrant being exercised; or (iii) if any of our secured notes are outstanding and held by the holder, cancel all or any part of the unpaid principal amount of such secured notes in an amount equal to the aggregate exercise price of theFee Warrant being exercised. The shares of common stock (and our other securities) issuable upon exercise of the Fee Warrants (or upon conversion of any shares of common stock issued upon such exercise) constitute registrable securities under the Registration Rights Agreement. The holders of the Fee Warrants are entitled to all of the benefits afforded to a holder of registrable securities under the Registration Rights Agreement and each holder of the Fee Warrants is bound by the terms and conditions of the Registration Rights Agreement applicable to the holders of registrable securities. The shares of our common stock underlying the Fee Warrants held by the selling stockholders are being registered under the registration statement of which this prospectus forms a part. Foreign Ownership Restrictions Under the Telecommunications Act of 1996, non-U.S. citizens or their representatives, foreign governments or their representatives, or corporations organized under the laws of a foreign country may not own, in the aggregate, more than 20% of a common carrier licensee or more than 25% of the parent of a common carrier licensee if the FCC determines that the public interest would be served by prohibiting this ownership. Additionally, the FCC's rules may under some conditions limit the size of investments by foreign telecommunications carriers in U.S. international carriers. Limitation of Liability and Indemnification Under Section 145 of the DGCL, a corporation may indemnify its directors, officers, employees and agents and its former directors, officers, employees and agents and those who serve, at the corporation's request, in such capacities with another enterprise, against expenses, including attorneys' fees, as well as judgments, fines and settlements in nonderivative lawsuits, actually and reasonably incurred in connection with the defense of any action, suit or proceeding in which they or any of them were or are made parties or are threatened to be made parties by reason of their serving or having served in such capacity. The DGCL provides, however, that such person must have acted in good faith and in a manner such person reasonably believed to be in, or not opposed to, the best interests of the corporation and, in the case of a criminal action, such person must have had no reasonable cause to believe his or her conduct was unlawful. In addition, the DGCL does not permit indemnification in an action or suit by or in the right of the corporation, where such person has been adjudged liable to the corporation, unless, and only to the extent that, a court determines that such person fairly and reasonably is entitled to indemnity for costs the court deems proper in light of liability adjudication. Indemnity is mandatory to the extent a claim, issue or matter has been successfully defended. Our Amended and Restated Certificate of Incorporation provides that none of our directors shall be personally liable for breach of fiduciary duty as a director, except as required by the DGCL. Any repeal or modification of such provision shall not adversely affect any right or protection, or any limitation of the liability of, our directors existing at, or arising out of facts or incidents occurring prior to, the effective date of such repeal or modification. Both our Amended and Restated Certificate of Incorporation and our Restated By-Laws contain provisions that further provide for the indemnification of directors and officers (and employees and agents) in accordance with and to the fullest extent permitted by the DGCL. In addition, we have entered into indemnification agreements with all of our directors which may, in certain cases, be broader than the specific indemnification provisions contained under current applicable law. The indemnification agreements may require us, among other things, to indemnify such directors against certain liabilities that may arise by reason of their status or service as directors, officers or employees of us and our subsidiaries and to advance the expenses incurred by such parties as a result of any threatened claims or proceedings brought against them as to which they could be indemnified. Anti-Takeover Effects of Various Provisions of Delaware Law and Our Amended and Restated Certificate of Incorporation and Restated By-Laws We are subject to the provisions of Section 203 of the DGCL. Subject to some exceptions, Section 203 prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction it attained that status with the approval of the board of directors or unless the business combination is approved in a prescribed manner. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to various exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of the corporation's voting stock. This statute could prohibit or delay the accomplishment of mergers or other takeover or change in control attempts and, accordingly, may discourage attempts to acquire us. In addition, various provisions of our Amended and Restated Certificate of Incorporation and our Restated By-Laws may be deemed to have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a stockholder might consider in its best interest, including those attempts that might result in a premium over the market price for the shares held by stockholders. Special Meeting of Stockholders. Our Restated By-Laws provide that special meetings of our stockholders may be called only by the Chairman of the Board of Directors, the Chief Executive Officer or a majority of the Board of Directors. Authorized But Unissued Shares. The authorized but unissued shares of common stock and preferred stock are available for future issuance without stockholder approval. These additional shares may be used for a variety of corporate purposes, including future public offerings to raise additional capital, corporate acquisitions and employee benefit plans. The existence of authorized but unissued shares of common stock and preferred stock could make more difficult or discourage an attempt to obtain control of us by means of a proxy context, tender offer, merger or otherwise. Classified Board of Directors. Our Board of Directors is composed of three separate classifications. At each annual meeting of stockholders after the initial classification, the successors to directors whose terms expire will be elected to serve a term of three years. This classification of directors may have the effect of delaying or preventing changes in our control. See "Management Election of Directors." The DGCL provides generally that the affirmative vote of a majority of the shares entitled to vote on any matter is required to amend a corporation's certificate of incorporation or bylaws, unless a corporation's certificate of incorporation or bylaws, as the case may be, requires a greater percentage. Registration Rights The selling stockholders and us entered into a registration rights agreement. Please refer to "Certain Relationships and Related-Party Transactions Registration Rights Agreement" for a description of this agreement. Transfer Agent and Registrar The transfer agent and registrar for our common stock is American Stock Transfer and Trust, New York, NY. LEGAL MATTERS For the purposes of this offering, our general counsel has given his opinion as to the validity of the shares of common stock offered by the selling stockholders under this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001016577_sunterra_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001016577_sunterra_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..789e99c0df1f6e01850d0a0c7dfeaada99a9e208 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001016577_sunterra_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Frederick C. Bauman, our Vice President, General Counsel and Secretary. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001022329_impsat_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001022329_impsat_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5ba11b1594e5556019d5572ed946d2d4099de99e --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001022329_impsat_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered hereby will be passed upon by Arnold Porter, Washington, D.C., U.S. counsel to IMPSAT Fiber Networks, Inc. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001026448_impac_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001026448_impac_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6b72dbd4400001a2c960fe8a406a086fb116c1bd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001026448_impac_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock being offered by us will be passed upon by Orrick, Herrington & Sutcliffe LLP, San Francisco, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001029893_radnor_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001029893_radnor_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..01a8645ee0fdd483573d13ed68a785a0f666b4f4 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001029893_radnor_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Duane Morris LLP, Philadelphia, Pennsylvania, will pass upon the validity of the issuance of the common stock offered hereby. Milbank, Tweed, Hadley & McCloy LLP, New York, New York, will pass upon certain legal matters in connection with this offering for the underwriters. Vincent F. Garrity, Jr., a member of our board of directors through March 4, 2002 and the beneficial owner of 4,612,074 shares of our common stock in his capacity as a trustee of the trusts created by Mr. Kennedy for the benefit of his children and others, is of counsel to Duane Morris LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001035748_callidus_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001035748_callidus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8e3f1cdc7623fa19e26f026b53cc4ab6b8e745fd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001035748_callidus_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of common stock offered hereby will be passed upon for Callidus by Davis Polk Wardwell, Menlo Park, California. Shearman Sterling LLP, Menlo Park, California, will pass upon certain legal matters in connection with this offering for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001050690_mercer_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001050690_mercer_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..669e7bfe760a3d215b588402fa1bc69c3f0f8114 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001050690_mercer_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the common stock will be passed upon for the Holding Company by Stevens & Lee, King of Prussia, Pennsylvania. Stevens & Lee has consented to the reference herein to its opinion. Certain legal matters will be passed upon for Sandler O'Neill & Partners, L.P. by Lord, Bissell & Brook, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001052163_anchor_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001052163_anchor_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..00aafa2c216ca5c101c3ef5f153a97c6935b175a --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001052163_anchor_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered by this prospectus will be passed upon for us by Schulte Roth & Zabel LLP, New York, New York. Certain legal matters in connection with the offering will be passed upon for the underwriter by Cahill Gordon & Reindel LLP, New York, New York. Cahill Gordon & Reindel LLP has performed legal services for us in the past and may do so in the future. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001061859_overnite_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001061859_overnite_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b3bb58e6a595468b2b297f8bcca5a4e4bff7e0e2 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001061859_overnite_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the validity of the shares of common stock offered hereby have been passed upon for us by Hunton & Williams LLP, Richmond, Virginia. The underwriters have been represented by Cravath, Swaine & Moore LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001062449_buffalo_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001062449_buffalo_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..11c0a40d3ea4014f12d76ad9597c480847cbc16d --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001062449_buffalo_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters 70 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001063239_accpac_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001063239_accpac_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1559882b0e4c2ed89e59e3d5422cc5bf4499c41a --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001063239_accpac_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Covington & Burling, San Francisco, California. The underwriters have been represented by Jones Day, Menlo Park, California. Covington & Burling has in the past provided, and may continue to provide, legal services to Computer Associates and its affiliates. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001063882_trump_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001063882_trump_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0630233ac37bfaaf0468552007e15b6d5062b0b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001063882_trump_legal_matters.txt @@ -0,0 +1,2556 @@ +LEGAL MATTERS + + The validity of +the Resale Notes will be passed upon for the Issuers by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. In giving their opinion, LeBoeuf, Lamb, Greene & MacRae, +L.L.P. may rely on the opinion of Graham, Curtin & Sheridan, a Professional Association, with respect to matters relating to New Jersey law. + + + 188 + +Table of Contents + + +INDEPENDENT AUDITORS + + The financial +statements of Trump s Castle Associates, L.P. and Subsidiary and Trump Indiana, Inc., as of December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, and the financial statements of Trump Management +Services, LLC as of December 31, 2001 and for the two-month period ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, independent certified public accountants, as indicated in their report, which is +included herein. Arthur Andersen, which has ceased operations, has not consented to the inclusion of their report in this prospectus, and we have dispensed with the requirement to file their consent in reliance upon Rule 437a of the Securities Act. +Under most circumstances a registrant must obtain and file the consent of its accountants contemporaneously with the filing of any registration statement that includes audited financial statements. By granting such a consent, accounting firms become +exposed to liability under Section 11(a) of the Securities Act for any untrue statements of material fact in, or omissions of material facts from, such registration statement. Investors who bring a successful claim under Section 11(a) of the +Securities Act are entitled to recessionary damages. As a result of the criminal conviction against Arthur Andersen in connection with Enron Corporation, and the volume of civil lawsuits filed against it, Arthur Andersen may not have the ability to +withstand liability for prior audits. + + Effective June 3, 2002, +THCR Holdings appointed Ernst & Young LLP as our new independent auditors. The combined financial statements of Trump Casino Holdings, LLC as of December 31, 2002 and for the year then ended appearing in this prospectus and registration +statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting +and auditing. + + + 189 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + + +Page + + Trump Casino Holdings, LLC + + + + + Annual Financial Statements + + + + + Report of Independent Auditors + + + F-2 + + Combined Balance Sheets as of December 31, 2001 and 2002 + + + F-3 + + Combined Statements of Operations for the years ended December 31, 2000, 2001 and 2002 + + + F-4 + + Combined Statements of Capital for the years ended December 31, 2000, 2001 and 2002 + + + F-5 + + Combined Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 + + + F-6 + + Notes to Combined Financial Statements + + + F-7 + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000, 2001 and 2002 + + + F-26 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required formation is included +in the consolidated financial statements or notes thereto. + + + + + Interim Financial Statements + + + + + Condensed Consolidated Balance Sheets as of December 31, 2002 and March 31, 2003 (unaudited) + + + F-27 + + Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-28 + + Condensed Consolidated Statement of Capital for the three months ended March 31, 2003 (unaudited) + + + F-29 + + Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-30 + + Notes to Condensed Consolidated Financial Statements (unaudited) + + + F-31 + + Trump s Castle Associates, L.P. (now known as Trump Marina Associates, L.P.) and Subsidiary* + + + + + Report of Independent Auditors + + + F-36 + + Consolidated Balance Sheet as of December 31, 2001 + + + F-37 + + Consolidated Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-38 + + Consolidated Statements of Partners Capital for the years ended December 31, 2000 and 2001 + + + F-39 + + Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-40 + + Notes to Consolidated Financial Statements + + + F-41 + + Financial Statement Schedule + + + + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000 and 2001 + + + F-50 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required information is +included in the consolidated financial statements or notes thereto. + + + + + Trump Indiana, Inc.* + + + + + Report of Independent Auditors + + + F-51 + + Balance Sheet as of December 31, 2001 + + + F-52 + + Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-53 + + Statements of Capital for the years ended December 31, 2000 and 2001 + + + F-54 + + Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-55 + + Notes to Financial Statements + + + F-56 + + All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included +in the consolidated financial statements or notes thereto. + + + + + THCR Management Services, LLC* + + + + + Report of Independent Auditors + + + F-64 + + Balance Sheet as of December 31, 2001 + + + F-65 + + Statement of Operations for the two months ended December 31, 2001 + + + F-66 + + Statement of Cash Flows for the two months ended December 31, 2001 + + + F-67 + + Notes to Financial Statements + + + F-68 + +All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes +thereto. + + + + + +* + +Became a wholly-owned subsidiary of Trump Casino Holdings, LLC on March 25, 2003 pursuant to a corporate reorganization. See Note 1 to Combined Financial Statements of Trump Casino +Holdings, LLC. + + + F-1 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + Board of Directors + Trump Casino Holdings, LLC + + + We have audited the accompanying combined balance sheet of +Trump Casino Holdings, LLC as of December 31, 2002 and the related combined statements of operations, capital, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial +Statements. These financial statements and schedule are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. + + We conducted our audit in accordance with auditing standards generally +accepted in the United States. 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. + + In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Trump Casino Holdings, LLC at December 31, 2002 and the combined results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a +whole, present fairly in all material respects the information set forth therein. + + We also have audited, as to combination only, the accompanying combined balance sheet of Trump Casino Holdings, LLC as of December 31, 2001, and the related combined statements of operations, capital, and cash flows +for the two years then ended. As described in Note 1, Trump Casino Holdings, LLC was capitalized on March 25, 2003 as a holding company for three entities under common control; accordingly, its financial statements are presented as though the +combination of Trump s Castle Associates, L.P. and Subsidiary, Trump Indiana, Inc., and THCR Management Services, LLC occurred at the beginning of the period presented. We did not audit the financial statements of these three entities. Their +financial statements, which are presented separately herein, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those respective financial statements in their reports dated March 13, 2002, +which also are presented separately herein. In our opinion, these combined financial statements have been properly combined on the basis described in Note 1. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 +combined financial statements of Trump Casino Holdings, LLC, other than with respect to such combination and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements of Trump Casino +Holdings, LLC taken as whole or on the separate financial statements of any of its subsidiaries. + + /s/ ERNST & YOUNG LLP + + Philadelphia, Pennsylvania + March 25, 2003 + + + F-2 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED BALANCE SHEETS + (in thousands) + + + + +December 31, +2001 + + + +December 31, +2002 + + + + + +(See Note 1*) + + + + + +ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + + Cash and cash equivalents + + +$ +34,291 + + +$ +33,917 + + + Restricted cash + + + +4,800 + + + + + + + Trade receivables, net of allowance for doubtful accounts of $2,979 and $2,607, respectively + + + +12,984 + + + +9,872 + + + Other receivables + + + +2,342 + + + +2,884 + + + Inventories + + + +3,038 + + + +3,182 + + + Prepaid expenses and other current assets + + + +2,449 + + + +3,797 + + + Due from affiliates + + + +216 + + + +378 + + + + + + + + Total current assets + + + +60,120 + + + +54,030 + + + + + + + + PROPERTY AND EQUIPMENT + + + + + + + + + + + Land and land improvements + + + +92,379 + + + +92,379 + + + Buildings and building improvements + + + +424,031 + + + +425,027 + + + Riverboat and improvements + + + +34,159 + + + +34,239 + + + Furniture, fixtures and equipment + + + +81,897 + + + +102,014 + + + Construction in progress + + + +3,779 + + + +6,639 + + + + + + + + + + +636,245 + + + +660,298 + + + Less-Accumulated depreciation and amortization + + + +115,798 + + + +142,444 + + + + + + + + + + +520,447 + + + +517,854 + + + INVESTMENT IN BUFFINGTON HARBOR RIVERBOATS, LLC + + + +33,889 + + + +31,842 + + + OTHER ASSETS + + + +35,210 + + + +24,338 + + + + + + + + Total assets + + +$ +649,666 + + +$ +628,064 + + + + + + + +LIABILITIES AND EQUITY + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + + Current maturities of long-term debt + + +$ +12,952 + + +$ +7,712 + + + Trade accounts payable + + + +11,556 + + + +8,961 + + + Due to affiliates + + + +8,184 + + + +4,381 + + + Accrued payroll and related expenses + + + +8,017 + + + +8,597 + + + Accrued interest payable + + + +4,953 + + + +3,778 + + + Self insurance reserves + + + +3,444 + + + +2,892 + + + Other + + + +16,385 + + + +20,108 + + + + + + + + Total current liabilities + + + +65,491 + + + +56,429 + + + DUE TO (FROM) AFFILIATES-THCR HOLDINGS + + + +42,553 + + + +32,566 + + + LONG-TERM DEBT, LESS CURRENT MATURITIES + + + +464,493 + + + +487,242 + + + OTHER LONG-TERM LIABILITIES + + + +16,121 + + + +5,974 + + + + + + + + Total liabilities + + + +588,658 + + + +582,211 + + + CAPITAL + + + + + + + + + + + Contributed capital + + + +237,197 + + + +238,273 + + + Accumulated other comprehensive loss + + + +(372 +) + + +(938 +) + + Accumulated deficit + + + +(175,817 +) + + +(191,482 +) + + + + + + + Total capital + + + +61,008 + + + +45,853 + + + + + + + + Total liabilities and capital + + +$ +649,666 + + +$ +628,064 + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-3 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF OPERATIONS + (in thousands) + + + + +For the Years Ended December 31, + + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + REVENUES + + + + + + + + + + + + + + + Gaming + + +$ +386,541 + + +$ +390,104 + + +$ +410,645 + + + Rooms + + + +21,827 + + + +22,470 + + + +21,835 + + + Food and beverage + + + +36,971 + + + +35,069 + + + +35,601 + + + Management fees + + + + + + + + + + + +2,710 + + + Other + + + +11,449 + + + +12,042 + + + +12,335 + + + + + + + + + + Gross revenues + + + +456,788 + + + +459,685 + + + +483,126 + + + Less-Promotional allowances + + + +88,867 + + + +85,863 + + + +86,165 + + + + + + + + + + Net revenues + + + +367,921 + + + +373,822 + + + +396,961 + + + + + + + + + + COSTS AND EXPENSES + + + + + + + + + + + + + + + Gaming + + + +190,377 + + + +189,712 + + + +190,455 + + + Rooms + + + +6,311 + + + +5,745 + + + +6,246 + + + Food and beverage + + + +15,248 + + + +14,571 + + + +14,856 + + + General and administrative + + + +88,220 + + + +84,138 + + + +86,367 + + + General and administrative-related parties + + + +12,045 + + + +10,413 + + + +13,177 + + + Debt renegotiation costs + + + + + + + + + + + +1,629 + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + + + + + + + + + + +337,350 + + + +328,716 + + + +340,336 + + + + + + + + + + Income from operations + + + +30,571 + + + +45,106 + + + +56,625 + + + + + + + + + + NON-OPERATING INCOME (EXPENSE) + + + + + + + + + + + + + + + Interest income + + + +2,075 + + + +1,382 + + + +867 + + + Interest expense + + + +(45,993 +) + + +(48,085 +) + + +(51,361 +) + + Interest expense-related parties + + + +(16,457 +) + + +(17,600 +) + + +(19,367 +) + + Other non-operating income (expense) + + + +(218 +) + + +100 + + + +1,219 + + + + + + + + + + Non-operating expense, net + + + +(60,593 +) + + +(64,203 +) + + +(68,642 +) + + + + + + + + + Loss before income taxes and equity in loss from Buffington Harbor, LLC + + + +(30,022 +) + + +(19,097 +) + + +(12,017 +) + + Equity in loss from Buffington Harbor, LLC + + + +(3,134 +) + + +(2,808 +) + + +(2,448 +) + + Provision for income taxes + + + + + + + +(150 +) + + +(1,200 +) + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-4 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CAPITAL + (in thousands) + + + + +Contributed +Capital + + +Accumulated +Deficit + + + +Accumulated +Other +Comprehensive +Loss + + + +Total + + + + Balance at December 31, 1999 + + +$ +229,015 + +$ +(120,606 +) + +$ + + + +$ +108,409 + + + Capital contribution (See Note 1*) + + + +7,732 + + + + + + + + + + +7,732 + + + Net loss (See Note 1*) + + + + + + +(33,156 +) + + + + + + +(33,156 +) + + + + + + + + + + + Balance at December 31, 2000 (See Note 1*) + + + +236,747 + + +(153,762 +) + + + + + + +82,985 + + + Capital contribution (See Note 1*) + + + +450 + + + + + + + + + + +450 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss (See Note 1*) + + + + + + +(22,055 +) + + + + + + +(22,055 +) + + Adjustment for interest rate swap (See Note 1*) + + + + + + + + + + +(372 +) + + +(372 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(22,427 +) + + + + + + + + + + + Balance at December 31, 2001 (See Note 1*) + + + +237,197 + + +(175,817 +) + + +(372 +) + + +61,008 + + + Capital contribution + + + +1,076 + + + + + + + + + + +1,076 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss + + + + + + +(15,665 +) + + + + + + +(15,665 +) + + Adjustment for interest rate swap + + + + + + + + + + +(566 +) + + +(566 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(16,231 +) + + + + + + + + + + + Balance at December 31, 2002 + + +$ +238,273 + +$ +(191,482 +) + +$ +(938 +) + +$ +45,853 + + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + + See accompanying notes + + + F-5 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CASH FLOWS + (in thousands) + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + Adjustments to reconcile net loss to net cash flows provided by operating activities + + + + + + + + + + + + + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + Issuance of PIK debt in satisfaction of accrued interest + + + +15,188 + + + +17,368 + + + +17,805 + + + Amortization for City of Gary development agreement + + + +3,700 + + + +667 + + + + + + + Equity in loss from Buffington Harbor, LLC + + + +3,134 + + + +2,808 + + + +2,448 + + + Accretion of bond discount + + + +5,122 + + + +5,981 + + + +6,985 + + + Amortization of loan costs + + + +410 + + + +1,134 + + + +4,711 + + + Allocation of expenses from THCR Holdings + + + + + + + + + + + +1,076 + + + Provision of losses on receivables + + + +1,420 + + + +1,430 + + + +2,303 + + + Valuation allowance CRDA investments + + + +3,680 + + + +1,432 + + + +3,762 + + + (Increase) decrease in receivables + + + +(5,564 +) + + +(215 +) + + +1,903 + + + Decrease (increase) in inventories + + + +206 + + + +358 + + + +(144 +) + + (Increase) decrease in prepaid expenses and other current assets + + + +(28 +) + + +138 + + + +(1,605 +) + + (Increase) decrease in other assets + + + +(7,319 +) + + +(1,310 +) + + +1,646 + + + Decrease in due to affiliates + + + +(858 +) + + +(8,563 +) + + +(14,173 +) + + Increase (decrease) in current liabilities + + + +1,551 + + + +3,743 + + + +(5,011 +) + + Increase (decrease) in other long-term liabilities + + + +17 + + + +(7,164 +) + + +(4,711 +) + + + + + + + + + Net cash flows provided by operating activities + + + +12,652 + + + +19,889 + + + +28,936 + + + + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + + + + + + + Purchases of property and equipment, net + + + +(5,479 +) + + +(7,089 +) + + +(15,378 +) + + (Advances) repayment of note receivable + + + + + + + +(3,535 +) + + +3,535 + + + Investment in Buffington Harbor Riverboats, LLC + + + +(1,534 +) + + +(112 +) + + +(401 +) + + Purchases of CRDA investments + + + +(3,347 +) + + +(3,388 +) + + +(3,486 +) + + + + + + + + + Net cash flows used in investing activities + + + +(10,360 +) + + +(14,124 +) + + +(15,730 +) + + + + + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + + + + + + + Contributed capital + + + + + + + +450 + + + + + + + Repayment of other borrowings + + + +(7,675 +) + + +(29,118 +) + + +(91,323 +) + + Proceeds of other borrowings + + + +5,000 + + + +38,500 + + + +75,245 + + + Cost of issuing debt + + + +(290 +) + + +(4,168 +) + + +(2,302 +) + + + + + + + + + Net cash flows (used in) provided by financing activities + + + +(2,965 +) + + +5,664 + + + +(18,380 +) + + + + + + + + + Net (decrease) increase in cash and cash equivalents + + + +(673 +) + + +11,429 + + + +(5,174 +) + + CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR + + + +28,335 + + + +27,662 + + + +39,091 + + + + + + + + + + CASH AND CASH EQUIVALENTS AT END OF YEAR + + +$ +27,662 + + +$ +39,091 + + +$ +33,917 + + + + + + + + + + SUPPLEMENTAL INFORMATION: + + + + + + + + + + + + + + + Cash paid for interest + + +$ +38,921 + + +$ +39,043 + + +$ +41,452 + + + + + + + + + + Cash paid for income taxes + + +$ + + + +$ + + + +$ +75 + + + + + + + + + + Purchase of equipment under capitalized lease obligations + + +$ +4,156 + + +$ +7,293 + + +$ +8,342 + + + + + + + + + + Contribution of capital by and forgiveness of amount due to THCR Holdings + + +$ +7,732 + + +$ +450 + + +$ + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes + + + F-6 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS + + (1) Organization and Operations + + The accompanying combined financial statements include those of Trump Casino Holdings, a Delaware single member limited +liability company ( TCH ), and its subsidiary, Trump Casino Funding, Inc., a New Jersey corporation, ( TCF ). Its wholly-owned subsidiaries include (i) Trump Casino Funding, Inc.( Trump Casino Funding ), (ii) Trump +Marina Associates, L.P. ( Marina Associates ), (iii) Trump Marina, Inc., (iv) Trump Indiana, Inc. ( Trump Indiana ), (v) Trump Indiana Realty, L.L.C. and (vi) THCR Management Holdings, L.L.C. ( THCR Management +Holdings ). + + The sole member of Trump Casino Holdings is +THCR Holdings. THCR Holdings is owned approximately 63.4% by Trump Hotels & Casino Resorts, Inc. ( THCR ) as both a general and limited partner, and approximately 36.6% by Donald J. Trump as a limited partner. THCR is a publicly held +company whose common stock is traded on The New York Stock Exchange under the symbol DJT . + + On March 25, 2003, TCH was capitalized and simultaneously, Marina Associates, Trump Marina, Inc., Trump Indiana, Inc., Trump Indiana Realty, L.L.C., and +THCR Management Holdings became wholly owned subsidiaries of TCH pursuant to a corporate reorganization approved by THCR s Board of Directors. THCR Management Holdings has no operations and it owns 100% of THCR Management Services, LLC +( THCR Management ). THCR Management Holding s only asset, other than its investment in THCR Management, was $254,000 of cash which was advanced to THCR Management at December 31, 2002. As a result of this reorganization of entities +under common control, the accompanying combined financial statements present the combined financial statements of TCH as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002. + + The financial statements of (i) Trump Marina Associates, L.P. (formerly +Trump s Castle Associates, L.P.) as of December 31, 2001 and for each of the two years in the period then ended, (ii) Trump Indiana, Inc. as of December 31, 2001 and for each of the two years in the period then ended, and (iii) THCR Management +Services, LLC as of December 31, 2001 and for the two months then ended were audited by other auditors who have ceased operations. These entities constitute 100% of the combined assets of TCH at December 31, 2001 and combined revenues and combined +net loss of TCH for the years ended December 31, 2001 and 2000. + + Marina Associates owns and operates the Trump Marina Hotel Casino, ( Trump Marina ), a casino hotel located in the marina district of Atlantic City, New Jersey (the Marina District ). Trump Indiana owns and operates a +riverboat gaming facility operating in Buffington Harbor, on Lake Michigan, Indiana (the Trump Indiana Riverboat ). THCR Management Holdings is the sole member of THCR Management. THCR Management manages the day-to-day operations of Trump +29 Casino located in Coachella Valley, California (in the Palm Springs area) pursuant to a five year management agreement (the Management Agreement ) commencing on April 16, 2002, between THCR Management and the Twenty Nine Palms Band of +Luiseno Mission Indians, a federally recognized native American Tribe and the owner of Trump 29 Casino (the Tribe ). Trump Indiana Realty, LLC has no material assets or operations. + + TCH and TCF have no operations and their ability to service their debt is +dependent upon the successful operations of Trump Marina, Trump Indiana, and the management fees generated pursuant to the Trump 29 Management Agreement. + + + F-7 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS (Continued) + + + (2) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001065002_resource_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001065002_resource_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e202fbd46b1f119adcb11df1b2d063e6e74f47c4 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001065002_resource_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters in this offering, including the legality of the common stock offered pursuant to this prospectus, will be passed upon for Resource Bankshares by Kaufman & Canoles, a Professional Corporation, Norfolk, Virginia. Certain matters in this offering will be passed upon for the underwriters by LeClair Ryan, A Professional Corporation, Richmond, Virginia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001069996_fednat_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001069996_fednat_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..eb7581a6e9f981936d8417680e46a333d96bda91 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001069996_fednat_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Broad and Cassel, a partnership including professional associations, Miami, Florida, is giving an opinion regarding the validity of the offered shares of common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001070154_sterling_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001070154_sterling_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2dac535dee897ad122ae532e1f08ba02ab84b5bd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001070154_sterling_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the common stock has been opined upon for Provident Bancorp by Luse Gorman Pomerenk & Schick, P.C., Washington, D.C., counsel to Provident Bancorp. Certain legal matters will be passed upon for Ryan Beck & Co. by Pitney, Hardin, Kipp & Szuch, LLP, Morristown, New Jersey. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001075343_ncric_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001075343_ncric_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2f30911b4afa0ec5343889a55f36edf797674904 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001075343_ncric_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Luse Gorman Pomerenk & Schick, P.C., Washington, D.C., counsel to NCRIC Group, Inc, will issue its opinion to us regarding the legality of the issuance of the common stock and the federal income tax consequences of the conversion. Certain legal matters will be passed upon for Sandler O'Neill & Partners, L.P. by Patton Boggs LLP, Washington, D.C. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001078337_white_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001078337_white_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8edb04bb3b37fc44c7c85ee1cf030a6e19744bec --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001078337_white_legal_matters.txt @@ -0,0 +1 @@ +Summary Financial and Operating Data The following summary statements of operations data and other data in fiscal 2000, 2001, and 2002 and the balance sheet data at the end of fiscal 2002 is derived from our financial statements, audited by KPMG LLP, included elsewhere in this prospectus. The summary statements of operations data and other data in fiscal 1998 and fiscal 1999 are derived from unaudited financial statements not included in this prospectus. The summary statements of operations data and other data for the three months ended May 4, 2002 and May 3, 2003, have been derived from our unaudited financial statements, included elsewhere in this prospectus, which have been prepared on the same basis as our audited financial statements and, in the opinion of management, contain all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results of operations for such periods. The summary store data for all fiscal periods presented have been derived from internal records of our operations. The historical results presented below are not necessarily indicative of the results to be expected for any future period. You should read the selected financial and operating data shown below in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements and related notes included elsewhere in this prospectus. Our fiscal year consists of 52 or 53 weeks, ends on the Saturday nearest to the last day of January, and is named for the calendar year ending closest to that date. All fiscal years presented consist of 52 weeks of operations, except fiscal 2000, which consisted of 53 weeks. You should read the information set forth below in conjunction with other sections of this prospectus, including "Selected Financial and Operating Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and our financial statements and related notes. Three Months Ended each of the last two fiscal years, our gross profit percentage exceeded 55% of our net sales and our average annual inventory turnover rate exceeded 5.0 times. Growth Strategy We believe we are well-positioned to capitalize on our distinctive brand identity, open an increasing number of stores, and pursue our goal of becoming a leading national chain in the women's apparel industry. Key elements of our growth strategy include the following: Open New Stores. We have demonstrated our ability to open new stores that provide compelling investment returns in new markets and geographic territories and across a variety of retail settings. We opened 16 stores in fiscal 2002 and ended the year with 92 stores. In fiscal 2003, we plan to open 22 stores and end the year with 111 stores. As of May 31, 2003, we have opened nine stores and have signed leases for an additional ten stores. In fiscal 2004, we plan to open 25 to 30 stores and have identified 35 potential store sites, 12 of which have been approved by our site selection committee. The average size of our stores has increased modestly over the past several years and, as of May 31, 2003, was 1,496 square feet. We plan to increase the size of our new store prototype to an average of 1,750 to 1,800 square feet. Based on our internal analysis, we believe the potential exists for at least 400 White House -- Black Market stores nationwide. Improve Store Productivity and Overall Profitability. We believe we can continue to increase our store sales productivity by implementing the following marketing and merchandising initiatives: We continuously review our merchandise offering to identify opportunities to increase sales productivity by increasing store-level inventory density, extending product lines or categories, and promoting additional wardrobe selling. To date, our direct marketing efforts have consisted of sending periodic mailings offering selected discounts to certain customers and hosting VIP parties in our stores. In the future, we plan to initiate a more efficient and measurable direct marketing program designed to communicate to a broader customer base on a more frequent basis and use more sophisticated marketing vehicles that better communicate our distinctive product offering. In order to enhance our value proposition and brand loyalty, we plan to initiate a customer loyalty program designed to reward our frequent customers with price discounts or other incentives. We are currently enhancing our point-of-sale and management information systems to facilitate more extensive customer data collection. We believe we have opportunities to further increase our operating margins in the future by leveraging store-level operating and corporate infrastructure costs over a larger sales base and capitalizing on enhanced purchasing power. Merchandising Our merchandising objective is to develop a distinctive brand identity in the women's apparel marketplace by offering our customer a unique assortment of quality, competitively priced, fashionable apparel and accessories in the classic and timeless colors of white and black. The key elements of our merchandise strategy to support this objective are as follows: offer our customer feminine, flattering, and stylish White House -- Black Market private brand merchandise; differentiate our merchandise by using a combination of market resources and key vendors that provide us with customized product designs; maintain a current merchandise profile by frequently introducing new styles and fabrications; Fiscal Year maintain an on-going dialogue with our customers and sales associates in order to better understand and anticipate fashion trends and design preferences; monitor our sourcing, delivery, and sell-through levels by item and style in order to effectively manage inventory turnover and reduce markdowns; facilitate the easy coordinating of outfits or wardrobing through our merchandise presentation and customer assistance in order to increase average dollars and units per transaction; and provide our customers with an attractive and intimate shopping environment differentiated by our distinctive merchandise offering, presentation, boutique-like store setting, and personalized customer service. Merchandise Organization and Process. Our merchandise organization is led by our Executive Vice President, Merchandising, Patricia Darrow-Smith. The merchandise group consists of six buyers who report to our General Merchandise Manager and one merchandise planner and four analysts who report to our Director of Planning and Allocation. Our buyers are responsible for trend identification, sourcing, buying, and pricing of each merchandise category. Our merchandise planners and analysts are responsible for overall inventory management, markdowns, and allocation of merchandise to individual stores. Our technical and quality assurance group consists of a technical designer and two assistant technical designers and is responsible for the quality, fit, color, and consistency of our products. Our merchandise calendar consists of four distinct selling seasons, supported by additional themes or collections developed by our merchandise group. These themes and collections are developed after considering market trends, seasonal fashions, and feedback from our customers. We collaborate with our vendors to design products to meet our color, style, fabrication, fit, and quality specifications. We currently do not employ an in-house design staff. Our merchandise planning group is responsible for merchandise allocation and utilizes an integrated allocation software system. The allocation process involves analysis of past sales performance by store and category, current trends, and seasonality, as well as consideration of collections and desired merchandise flow. Once our merchandise is in our stores, buyers monitor sales and trend data to make product and buying decisions, while analysts monitor sell-through, inventory levels and aging to determine replenishment, store transfers, and markdowns. Products. Our clothing is fashionable and contemporary and the fit is comfortable, yet styled to enhance the figure of the body-conscious woman. Sizes range from zero to 14, with the majority of our sales between sizes zero and eight. We utilize both natural and synthetic fabrics, including cotton, linen, tencel, microfibers, and matte jersey. Our apparel has unique textures and patterns, ranging from solids to prints, stripes, and color blocking. Our collections encourage wardrobe selling by offering coordinated styles, fabrics, texture, and fit within our white and black theme. In order to maintain a fresh look in our stores, we continually introduce new items and replenish our stores up to five times per week. While the designs, fabrications, and styles of our products are modified frequently, we believe our singular focus on our target customer and commitment to our white and black color palette reduce the risks inherent in changing color, fit, and finish trends. Our merchandise is competitively priced, with typical price ranges as follows: (i) bottoms from $58 to $98, (ii) tops from $28 to $68, (iii) sweaters from $48 to $88, and (iv) dresses from $88 to $128. In fiscal 2002, approximately 83% of our sales mix consisted of apparel categorized generally as sportswear, dresses, and outerwear. Accessories, including bags, scarves, shoes, belts, sunglasses, jewelry, and gifts, represented approximately 17% of our net sales in fiscal 2002. Product Sourcing. A key element of our merchandise strategy is to source our private brand merchandise from a wide variety of independent third-party vendors. While we have established relationships with more than 100 different vendors, we rely on five to seven core vendors. These vendors supply us with approximately one-third of our total purchases and collaborate with us for trend analysis and our private brand merchandise design. We believe that approximately 60% of our merchandise by dollar volume in fiscal 2002 was produced domestically by our vendors and their sources, with the balance manufactured by third parties, predominantly in Asia. Because our domestic sourcing has the inherent advantages of shorter lead times, more consistent delivery, smaller order quantities, and quicker response to changes in fashion and business trends, we have sought to source a significant amount of our merchandise from domestic vendors. As we grow, we expect to develop in-house design capabilities and source a portion of our product directly from third-party manufacturers. We plan, however, to maintain a balance between vendor-based and direct sourcing, in order to preserve flexibility and design creativity while increasing production capacity. We believe that this sourcing strategy will provide an opportunity to improve our gross profit percentage in the future. Marketing and Visual Merchandising We believe that the distinctive visual appeal of our stores, together with our high-visibility locations are integral to our marketing strategy. To date, our direct marketing efforts have consisted of sending periodic mailings to certain customers offering selected discounts and hosting VIP parties in our stores. We have developed a database of over 300,000 names gathered from our point-of-sale system and website. In the future, we plan to utilize a broader mix of channels and media, including direct mail, e-commerce, email, magazines, and billboard, in order to communicate to a broader customer base on a more frequent basis. We have recently added a Director of Branding to our merchandising group who is responsible for maintaining a consistent brand message through all channels visible to our customers. In order to enhance our value proposition and brand loyalty, we also plan to initiate a customer loyalty program designed to reward our best customers with price discounts, gifts, and other merchandise incentives. We are currently in the process of upgrading our point-of-sale and management information systems to accommodate more extensive customer data collection. We expect to introduce this new customer loyalty program in fiscal 2004. Retail Stores Store Design. Our stores are designed to highlight our distinctive merchandise and to reinforce our brand identity. White House -- Black Market stores are bright and open, with a clean, contemporary look. We feature signature elements such as chandeliers, columns, and archways, and utilize tile floors, painted wood fixtures, and textured white walls. Our relatively small stores have a warm and intimate boutique feel. Our merchandise is displayed by collection in a coordinated manner. Our merchandise display techniques are designed to facilitate wardrobe selling and make a clear statement about our merchandise focus for each season. Our store layout and merchandise presentation are consistent chain-wide, based on planning guidance established by our visual merchandising department. Our new merchandise collections are featured in our windows and at front-of-the-store displays and are changed frequently to highlight our current product focus. The average size of our stores has increased modestly over the past several years and, as of May 31, 2003, was 1,496 square feet. We plan to increase the size of our new store prototype to an average of 1,750 to 1,800 square feet. Market and Store Location Strategy. We locate our stores in mid- to large-sized metropolitan markets, generally with a minimum population of 500,000. Our stores are geographically dispersed between northern and southern climates and have proven to be similarly successful in all regions of the Lifestyle Centers Fashion-oriented centers near recreational destinations such as restaurants and movie theaters 50 1,592 Street Front Locations Street front locations in cities, towns, villages, and resort areas 21 1,537 Regional Malls Major malls, typically anchored by two or more full-line department stores 29 1,345 Our specific site selection criteria considers such factors as local demographics (including age, education, and income levels), population trends, traffic patterns, and site location visibility. We prefer to locate our stores near other retail stores and recreational destinations such as restaurants and movie theaters that appeal to our customers. We have a standardized and disciplined process to analyze and select our new markets and sites and to negotiate lease terms. Our site selection analysis is based on data provided by an independent market research firm. We use a commercial real estate consultant to identify and recommend potential sites. Final site approval is required by our real estate committee comprised of our Chief Executive Officer, Chief Financial Officer, Vice President of Store Operations, and two independent members of our Board. In the future, we plan to develop in-house real estate capabilities and are currently in the process of recruiting a Director of Real Estate. Our lease terms typically range from seven to ten years and approximately 30% of our leases contain one or more renewal options. Substantially all of our leases have percentage rent clauses which require the payment of additional rent based on the store's net sales in excess of a certain thresholds and approximately 15% of our leases have early cancellation clauses, which permit the lease to be terminated if certain sales levels are not met in specific periods. We actively review the performance of our existing stores to identify under-performing stores. Over the past three years we have closed a total of seven stores and plan to close three stores in fiscal 2003, one of which has already closed. During fiscal 2004, we intend to close one store and consolidate six of our white and black only single concept stores into three White House -- Black Market stores. In fiscal 2005, we plan to consolidate the remaining six single concept stores into three White House -- Black Market stores. Store Operations We believe our centralized merchandising and operating processes provide a consistent, chain-wide, "one-store experience" and enable our store managers and sales associates to focus on providing our customers with a high level of service and assistance. Our hiring, training, and compensation programs as well as our internal management and communication processes are designed to reinforce our service and selling-oriented culture. To accomplish this, we seek to hire personable and enthusiastic managers and sales associates, provide them with frequent feedback and training, and offer them performance-based compensation. Organization and Store Management. Our field operations are organized into ten districts. Each district is run by a district manager, typically responsible for eight to 12 stores and who reports to our Director of Store Operations. District managers are responsible for hiring and training store managers and assistant managers, providing consistency of merchandise presentation across our stores, communicating corporate information to the stores, and monitoring sales and profit performance. Store managers are responsible for hiring, training, and managing sales associates, visual merchandising, maintaining the cleanliness of our stores, and monitoring store performance. Our average store has one manager and three to six sales associates. We utilize part-time employees to provide us greater flexibility in managing payroll hours and expense. Our management process is based on frequent and open communication throughout all areas and levels of our organization. Senior management monitors store performance and other business trends through daily sales, profitability, and operating reports. District managers receive weekly store performance reports and have daily contact and weekly meetings with store operations executives. Our store managers also receive weekly store sales reports and monthly profitability and operating reports and meet regularly with their district managers. Hiring, Training, and Compensation. We seek to hire store managers who have experience with other women's apparel retailers or by promoting our assistant managers and sales associates. We compensate our district and store managers with a salary plus incentive bonuses based on sales performance. Our sales associates are paid on an hourly basis plus commissions on sales, receive additional incentives to encourage wardrobe selling, and receive discounts on merchandise to encourage them to wear our apparel and reflect our image on the selling floor. We believe our store and district managers have a low turnover rate due to our competitive compensation package and attractive work environment. Our district and store managers average 6.4 and 2.1 years experience, respectively, with us. Ten of our store managers also act as corporate trainers, conducting training programs for other store managers on an ongoing basis and new store associates prior to store openings. New store managers attend a week-long training session at our corporate headquarters covering store operations and financials, customer service, and corporate functions such as merchandising and distribution. Distribution We currently operate a 30,400 square foot distribution facility in Glen Burnie, Maryland, which also houses our corporate headquarters. In order to accommodate our current needs and planned growth, we have identified a site for a new 120,000 square foot central distribution and corporate headquarters facility in the greater Baltimore, Maryland area and have initiated discussions concerning lease terms. We expect this facility to be fully operational in late fiscal 2003 or early fiscal 2004 and to incorporate improved automation and scanning technology not currently utilized by us. We expect that our new distribution facility will have the capacity, without modification or enhancement, to service approximately 250 stores. We estimate that approximately 95% of our merchandise is currently pre-ticketed by our vendors, which allows us to process merchandise more quickly and reduce labor costs. Our merchandise is generally shipped to our stores within two days of receipt at the distribution center. We rely on third-party carriers to deliver our merchandise from our distribution facility to our stores. Each store receives three to five shipments per week and merchandise is available for sale in our stores the same day it is received. 2003 4 4 2004 12 11 2005 9 8 2006 11 5 2007 6 2 After 2007 58 70 Distribution Center and Corporate Headquarters. Our current distribution center and principal executive offices are located at 6711 Baymeadow Drive, Glen Burnie, Maryland 21060. The facility initially opened in November 1999 and currently consists of a distribution center and corporate and administrative headquarters that comprises approximately 30,400 square feet, consisting of approximately 19,400 square feet for distribution and approximately 11,000 square feet for corporate and administrative offices. Our lease on these premises expires in July 2009, but may be terminated early at our option in July 2004. As more fully described above under " Distribution," our existing distribution center and headquarters facility does not have adequate available space to accommodate our current needs and anticipated growth. We have identified and expect to lease a new distribution center and headquarters facility in Maryland to replace our existing facility, which we would attempt to sublet for the remainder of its lease term. Competition We compete with a variety of retailers including other specialty stores, department stores, mass merchandisers, and direct marketers. Our competitors include Ann Taylor, Anthropologie, Banana Republic, bebe, Cach , Chico's, Christopher & Banks, Coldwater Creek, J. Jill, and Talbots. We also compete with national and regional department stores, including Bloomingdale's, Marshall Field's, Neiman Marcus, Nordstrom, and Saks Fifth Avenue. The women's retail apparel industry is highly competitive and given relatively low barriers to entry, we expect competition in our markets to increase. The primary competitive factors in our markets include brand recognition, product quality, style, price, store location and ambiance, and customer service levels. Many of our competitors are considerably larger and have substantially greater financing, marketing, and other resources. We cannot assure you that we will be able to compete successfully with them in the future, particularly in new markets. Regulation of Imports A significant amount of the apparel and accessories we sell are manufactured outside of the United States. As a result, our business remains subject to the various risks of doing business abroad and to the imposition of United States customs duties. In the ordinary course of our business, we may from time to time be subject to claims by the United States Custom Service for tariffs, duties, and other charges. The pricing of imports from certain countries may also be affected by treaties, trade relations, U.S. government legislation, and decisions of multi-national organizations such as the World Trade Organization. Acts or decisions by any of these or similar institutions could change the pricing of imports in all categories, including apparel. We cannot predict or control the acts or decisions of these institutions. Because a significant amount of our merchandise is imported, we could be adversely affected by these acts or decisions. Intellectual Property and Proprietary Rights We believe that our trademarks and other proprietary rights are important to our success. This is particularly the case for the "White House -- Black Market" marks because the name "White House-- Black Market" is well known by our customers. Accordingly, we intend to maintain these marks and the related registrations and applications. We are not aware of any claims of infringement or other challenges to our rights to use these marks in any jurisdiction in which we currently operate. We have registered "White House -- Black Market" in the United States. Each of the registrations related to this name has a term of ten years and each is renewable indefinitely if the mark is still in use in commerce at the time of renewal. We also have additional trademark rights and applications. We have registered "White House -- Black Market" and "The White House Black Market" in certain jurisdictions outside the United States, including Australia, Bermuda, The European Community, Mexico and The Netherlands Antilles, and have applications for certain trademarks pending in various other foreign jurisdictions. The various applications in foreign jurisdictions have been made in order to provide us with the ability to expand our operations outside the United States if and when management determines such an expansion is viable and in the best interests of our stockholders. We take actions to establish and protect our trademarks and other proprietary rights, however we cannot assure you that others will not imitate our products or infringe on our intellectual property rights. In addition, we cannot assure you that others will not resist or seek to block the sale of our products as infringements of their trademark and proprietary rights. In certain jurisdictions, other entities may have rights to names that could limit our ability to expand in such jurisdictions. If we fail to obtain or perfect trademark, ownership, or license rights, it would limit our ability to expand into certain international markets or enter such markets with the White House -- Black Market name, and to capitalize on the value of our brand. Employees As of May 31, 2003, we employed 712 persons, approximately 50% of whom were full-time employees and approximately 50% of whom were part-time employees. The number of part-time employees fluctuates during peak selling periods. As of the above date, approximately 90% of our employees worked in our retail stores and in direct field supervision, 1% worked in our distribution center, and 9% worked in corporate headquarters. All employees receive discounts on the merchandise we sell. None of our employees are represented under a collective bargaining agreement, and we are not aware of any efforts or plans to organize any of our employees. We have never had a work stoppage and we consider our relations with our employees to be good. Legal Proceedings We are not a party to any litigation or other legal proceedings that we believe could reasonably be expected to have a material adverse effect on our business or financial condition. (1)Member of the audit committee (2)Member of the compensation committee (3)Member of the nominating and corporate governance committee Richard D. Sarmiento. Mr. Sarmiento founded White House -- Black Market in 1985 and has served as a director and as our President and Chief Executive Officer since our inception. Mr. Sarmiento has served as our Chairman since May 2003. Prior to founding White House -- Black Market, Mr. Sarmiento worked for the Hyatt Hotels Corporation. He received a B.A. from the University of Kansas. Patricia Darrow-Smith. Ms. Darrow-Smith is our Executive Vice President, Merchandising, and has served as our most senior merchandising executive since 1986. Ms. Darrow-Smith previously worked for the Hyatt Hotels Corporation. She received a B.A. from the College of Notre Dame of Maryland. Ms. Darrow-Smith is married to F. Michael Smith, our Vice President, Operations. Stephen L. Hirsch. Mr. Hirsch has served as our Vice President, Finance and Administration, and Chief Financial Officer since July 1999. From September 1996 to June 1999, Mr. Hirsch was Senior Vice President, Finance and Administration, and Chief Financial Officer of Pic 'N Pay Stores, Inc., a footwear and apparel retail chain that filed a voluntary petition for bankruptcy in 2000, approximately ten months following Mr. Hirsch's departure from the company. Mr. Hirsch holds a B.A. from the University of Maryland and a M.B.A. from the University of Baltimore. F. Michael Smith. Mr. Smith is our Vice President, Operations, and has served as our most senior operations executive since joining us in September 1990. Mr. Smith holds a B.A. from Drew University. Mr. Smith is married to Patricia Darrow-Smith, our Executive Vice President, Merchandising. Craig J. Foley. Mr. Foley has served as a director since January 1999. Mr. Foley has been affiliated with Phillips-Smith-Machens Venture Partners, a private equity investment firm, since April 1994 and has served as a general partner of Wickham Capital Partners, a private investment firm, since February 1994. Mr. Foley is also a director of Starbucks Corporation. Howard E. Goldstein. Mr. Goldstein has served as a director since January 1999. Mr. Goldstein is a general partner of INVESCO Private Capital, Inc., a private equity firm, where he has worked since 1984. (in thousands, except per share, store data, and other data) Statement of Operations Data: Net sales $ 24,328 $ 28,530 $ 37,721 $ 49,532 $ 66,956 $ 15,978 $ 19,905 Cost of goods sold(1) 11,641 13,501 17,676 21,884 28,271 6,901 8,600 Darryl Hartley-Leonard. Mr. Hartley-Leonard has served as a director since April 1999. Mr. Hartley-Leonard is Chief Executive Officer of PGI Inc., an event production and marketing company. Mr. Hartley-Leonard served as President, Chief Executive Officer and Chief Operating Officer of Hyatt Hotels Corporation from 1986 to 1994 and as Chairman from 1994 to 1996. Mr. Hartley-Leonard also serves as a director of Jones Lang LaSalle Incorporated, Brookdale Living Communities, and Evanston Northwestern Healthcare, and as a member of the board of trustees of LaSalle Hotel Properties. Sally Frame Kasaks. Ms. Kasaks has served as a director since May 1999. Ms. Kasaks has been President of ISTA, Inc., a marketing and retail consulting firm, since 1996. Prior to that, Ms. Kasaks served as Chairman and Chief Executive Officer at Ann Taylor Stores, Inc. from February 1992 to August 1996, President and Chief Executive Officer at Abercrombie & Fitch, a division of The Limited, Inc., from February 1989 to February 1992, and Chairman and Chief Executive Officer of The Talbots, Inc. from November 1985 to September 1988. Ms. Kasaks is also a director of Pacific Sunwear of California, Inc., Tuesday Morning Corporation, The Children's Place Retail Stores, Inc., Grupo Cortefiel, S.A., Coach, Inc., and Crane and Company. We are currently recruiting additional independent directors to serve on our board. We expect to add at least one independent director prior to completion of the offering. Board Composition Our articles of incorporation and bylaws currently authorize five directors. Upon completion of the offering, our amended and restated articles of incorporation and bylaws will provide that our board will be divided into three classes, Class I, Class II and Class III, with each class serving staggered three-year terms. The Class I directors, Mr. Goldstein and Ms. Kasaks, will stand for reelection at our 2004 annual meeting of stockholders. The Class II directors, Messrs. Foley and Hartley-Leonard, will stand for reelection at our 2005 annual meeting of stockholders. The Class III director, Mr. Sarmiento, will stand for reelection at our 2006 annual meeting of stockholders. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third of the directors. This staggered classification of the board of directors may have the effect of delaying or preventing changes in control or management. Board Committees Our board of directors has a compensation committee, an audit committee, and a nominating and corporate governance committee. Compensation Committee. Our compensation committee reviews and makes recommendations to the board regarding the compensation and benefits provided to all of our employees. As part of the foregoing, the compensation committee administers our 1999 Stock Option Plan and will administer our 2003 Stock Option Plan. The current members of the compensation committee are Messrs. Goldstein, Foley and Hartley-Leonard and Ms. Kasaks. A subcommittee of the compensation committee, the executive compensation subcommittee, reviews and makes recommendations to the board regarding the compensation and benefits provided executive officers and directors including stock compensation. The executive compensation subcommittee is comprised of Messrs. Goldstein and Foley. Audit Committee. Our audit committee reviews and monitors our internal accounting procedures and reviews the results and scope of the annual audit and other services provided by our independent accountants. The audit committee also consults with our management and our independent auditors prior to the presentation of financial statements to stockholders and, as appropriate, initiates inquiries into aspects of our financial affairs. The Audit Committee is also charged with overseeing our compliance with legal and regulatory requirements, including our disclosure controls and procedures. In addition, the audit committee is responsible for considering and approving the appointment of, and reviewing fee arrangements with, our independent auditors and approving any non-audit services provided by our independent auditors. The current members of the audit committee are Messrs. Foley and Goldstein. Nominating and Corporate Governance Committee. Our nominating and corporate governance committee makes recommendations to the board concerning nominations to the board, including nominations to fill a vacancy (including a vacancy created by an increase in the board of directors). The nominating and corporate governance committee will consider nominees for directors nominated by stockholders upon submission in writing to our corporate secretary of the names of such nominees in accordance with our bylaws. This committee is also charged with shaping corporate governance policies and practices and monitoring compliance with such policies. The current members of the nominating and corporate governance committee are Mr. Foley and Ms. Kasaks. Director Compensation Our non-employee directors receive a fee of $1,500 for attendance in person at each board meeting or board committee meeting and a fee of $500 for attendance by teleconference at such meetings. In addition, our directors are reimbursed for all reasonable out-of-pocket expenses incurred in connection with their attendance at board and board committee meetings. From time to time, certain directors who are not employees of White House -- Black Market have received grants of options to purchase shares of our common stock. In March 2002, we granted non-qualified options to purchase 3,077 shares of our common stock at an exercise price of $2.60 per share to each of Howard Goldstein, Craig Foley, and Darryl Hartley-Leonard. We granted non-qualified options to purchase 6,154 shares of our common stock to Sally Frame Kasaks in March 2002 at an exercise price of $2.60 per share. We plan to engage an independent consultant to advise us regarding compensation of our directors in the future. Compensation Committee Interlocks and Insider Participation During fiscal 2002, the compensation committee was comprised of Messrs. Goldstein and Hartley-Leonard and Ms. Kasaks. None of such persons serves, or has at any time served, as an officer or employee of White House -- Black Market. None of our executive officers has served as a member of the compensation committee, or other committee serving an equivalent function, of any other entity, one of whose executive officers served as a member of our compensation committee. Following the offering, our compensation committee will be comprised solely of non-employee independent directors. Indemnification and Limitation on Liability Our articles of incorporation provide that we will indemnify our current and former officers and directors against any and all liabilities and expenses incurred in connection with their services in such capacities to the maximum extent permitted by Maryland law, as from time to time amended. The articles of incorporation further provide that the right to indemnification also includes the right to be paid by us for expenses incurred in connection with any such proceeding in advance of its final disposition to the fullest extent permitted by Maryland law. Our articles of incorporation also provide that we may, by action of our board of directors, provide indemnification to any of our employees and agents and any other persons serving at our request as a director, officer, partner, trustee, employee, or agent of another corporation, partnership, joint venture, trust, or other enterprise to such extent and to such effect as is permitted by Maryland law and as our board of directors determines to be appropriate. We have the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee, or agent of White House -- Black Market, or is or was serving at our request as a director, officer, employee, or agent of another corporation, partnership, joint venture, trust, or other enterprise against any expense, liability, or loss incurred by such person in any such capacity or arising out of his status as such, whether or not we would have the power to indemnify such person against such liability under Maryland law. Our articles of incorporation authorize our board of directors to make further provision for indemnification of directors, officers, employees, and agents by bylaw, resolution, or agreement. We expect to enter into agreements with each of our directors and executive officers pursuant to which we have agreed to indemnify such persons to the maximum extent permitted by Maryland law. These agreements also require us to maintain directors' and officers' liability insurance for the benefit of each of these persons and to advance any expenses incurred by any such person in any proceeding in which such person is entitled to indemnification. No amendment, modification, or repeal of our articles of incorporation, nor the adoption of any additional provision of the articles of incorporation nor, to the fullest extent permitted by Maryland law, any amendment, modification, or repeal of law will eliminate or reduce the effect of the provisions in the articles of incorporation limiting liability or indemnifying certain persons or adversely affect any right or protection then existing thereunder in respect of any acts or omissions occurring prior to such amendment, modification, repeal, or adoption. The articles of incorporation further provide that a director will not be personally liable for monetary damages to us or our stockholders, except to the extent such exemption from liability or limitation thereof is not permitted under Maryland law. Maryland law does not permit the restriction or limitation of liability of directors and officers to the extent that: the director or officer received an improper benefit or profit in money, property, or services; or a judgment or other final adjudication adverse to the director or officer is entered in a proceeding based on a finding in the proceeding that the director's or officer's action, or failure to act, was the result of active and deliberate dishonesty and was material to the cause of action adjudicated in the proceeding. This limitation on liability applies to events occurring at the time the person serves as a director or officer, regardless of whether the person is a director or officer at the time of any proceeding in which liability is asserted. With respect to the indemnification of directors and officers for liabilities arising under the Securities Act, the SEC has opined that this indemnification is against public policy, as expressed in the Securities Act, and is therefore unenforceable. (1)Includes (i) $13,478 in premiums for life insurance of which Mr. Sarmiento is the beneficiary and (ii) $10,021 for a car allowance paid for Mr. Sarmiento by us. The balance of the other annual compensation is from reimbursements for medical expenses and matching contributions to our 401(k) plan. (2)Includes (i) $7,212 in premiums for life insurance of which Mr. Hirsch is the beneficiary, (ii) $7,917 for a car allowance paid to Mr. Hirsch by us, (iii) $1,844 for car insurance paid for Mr. Hirsch by us, and (iv) $6,460 for payment by us of medical expenses incurred by Mr. Hirsch. The balance of the other annual compensation is from matching contributions to our 401(k) plan. (3)Value of perquisites and other personal benefits for Ms. Darrow-Smith do not exceed the lesser of $50,000 or 10% of her total annual salary and bonus. (4)Includes (i) $7,896 in premiums for life insurance of which Mr. Smith is the beneficiary, (ii) $7,917 for a car allowance paid to Mr. Smith by us, and (iii) $7,175 for reimbursement by us of medical expenses incurred by Mr. Smith. The balance of the other annual compensation is from matching contributions to our 401(k) plan. Option Grants in Fiscal 2002 The following table provides information concerning grants of options to purchase our common stock that we made to our named executive officers during fiscal 2002. We did not grant stock appreciation rights to these individuals during fiscal 2002. All of the options were granted under our 1999 Stock Option Plan. The potential realizable value calculation assumes that the value of the common stock appreciates at the indicated annual rate (compounded annually) from the grant date until the expiration of the option term and is calculated in accordance with SEC rules. Potential realizable value does not represent our estimate or projections of future stock price performance. The (1)The options become exercisable in annual cumulative installments of 20%, commencing one year from the date of grant, with full vesting occurring on the 5th anniversary date of the date of grant. (2)The exercise price was determined by our board of directors on the date of grant taking into account the purchase price paid by investors for shares of our Class C common stock, the liquidation preferences and other rights, privileges, and preferences associated with the Class C common stock, and an evaluation by the board of directors of our revenue, operating history, and prospects. The exercise price may be paid in cash, in shares of our common stock valued at fair market value on the exercise date, or through a cashless exercise procedure involving a same-day sale of the purchased shares. (3)For purposes of calculating the potential realizable value at assumed annual rates of stock price appreciation, the revised, estimated fair market value of our common stock on the date of grant is $4.16 per share. Potential realizable values are computed by (i) multiplying the number of shares of common stock subject to a given option by the revised fair market value on the date of grant, (ii) assuming that the aggregate stock value derived from that calculation compounds annually for the entire term of the option and (iii) subtracting from that result the aggregate option exercise price. In May 2003, we granted options to purchase an aggregate of 80,615 shares of our common stock at a weighted average exercise price of $12.58 per share to certain employees and directors. Among the employees receiving these grants were Messrs. Sarmientio, Hirsch, and Smith, and Ms. Darrow-Smith, who each was granted options to purchase 13,231 shares. Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values The following table provides summary information regarding options held by our Chief Executive Officer and named executive officers in fiscal 2002. The value of unexercised in-the-money options at fiscal year end is calculated using the difference between the option exercise price and the estimated fair market value at May 3, 2003, which has been deemed to be $10.24 per share, multiplied by the number of shares underlying the option. An option is in-the-money if the fair market value of the common stock subject to the option is greater than the exercise price. The assumed initial public offering price of $13.00 per share is higher than the estimated fair market value at fiscal year end, and (1)The fair market value of our common stock at the end of fiscal 2002 was estimated by the board of directors on the basis of the purchase price paid by investors for shares of our Class C common stock (taking into account the liquidation preferences and other rights, privileges, and preferences associated with the Class C common stock) and an evaluation by the board of our revenue, operating history, and prospects. 1999 Stock Option Plan The 1999 Stock Option Plan (the "1999 Stock Option Plan") will be terminated as of the date of the completion of this offering. Such termination will not affect any option previously granted under the 1999 Stock Option Plan. Shares available for future issuance under the 1999 Stock Option Plan will be carried over to the 2003 Stock Option Plan described below. On May 21, 1999, we adopted our 1999 Stock Option Plan for the purpose of promoting our long-term growth and profitability by (i) providing key people with incentives to improve stockholder value and contribute to our growth and financial success, and (ii) enabling us to attract, retain, and reward talented and skilled persons for positions of substantial responsibility. Our stockholders approved the 1999 Stock Option Plan as of May 1999. We use stock options as a component of compensation for our officers and key employees. Shares Reserved. A maximum of 307,692 shares of common stock is available and reserved for issuance under the 1999 Stock Option Plan. The 1999 Stock Option Plan has been amended, subject to stockholder approval, to increase the number of shares available under the plan by 615,385 to a total of 923,077. Administration. The compensation committee of our board of directors administers the 1999 Stock Option Plan. The committee has the sole discretion to make all decisions and take all actions relating to the interpretation, administration, and operation of the 1999 Stock Option Plan. The committee has the discretion to determine who will receive options, what type of options will be issued, how many shares will be covered by the option, what the vesting requirements will be, if any, and what the other features, terms, and conditions of each option will be. The compensation committee may also reprice the exercise price of outstanding options to the then current fair market value of the underlying stock by accepting the surrender of outstanding options and substituting new options and modify outstanding awards in other ways. Eligibility. The committee may grant options to our full-time employees, officers, members of our board of directors, subcontractors, and outside consultants. Types of Award. The 1999 Stock Option Plan provides for the issuance of incentive stock options and non-statutory stock options to purchase shares of our common stock. Incentive stock options may be granted to employees and may qualify for favorable tax treatment under Section 422 of the Internal Revenue Code of 1986, as amended ("Code") if certain requirements are satisfied. Non-statutory stock options do not qualify for such favorable tax treatment. Exercise Price. The exercise price for options granted under the 1999 Stock Option Plan may not be less than 100% of the fair market value of our common stock on the option grant date. Transferability. Incentive stock options granted under the 1999 Stock Option Plan are not transferable by the optionee except by will or the laws of descent and distributions in the event of the optionee's death. The 1999 Stock Option Plan has been amended to allow transfer of nonstatutory stock options to certain family members and other transferees permitted by the compensation committee. Vesting and Exercise. Options vest (that is, become exercisable) at the time or times determined by the compensation committee. The Company may make or guarantee loans to assist grantees in exercising options and satisfying any related tax withholding obligations. In most cases, our options vest over the five-year period following the date of grant. Options generally expire ten years after they are granted, except that they generally expire earlier if the optionee's service terminates earlier. Payment of the exercise price may be made in cash or by any other means the compensation committee may prescribe, including, but not limited to, cashless exercise through a designated brokerage firm after our stock is registered. Merger or Sale. In the event of any proposed sale, merger, share exchange, consolidation, or other reorganization or business combination in which we are not the surviving corporation or in which nonvoting securities, cash, or securities of another corporation are received or if we sell all or substantially all of our assets, then the compensation committee will take such action as it deems appropriate and equitable, including without limitation accelerating or changing the exercise dates of any option, canceling the options and paying cash to the option holders, or causing a successor entity to replace the options with like options for other securities. Change in Capitalization. The number and price of shares covered by outstanding stock options and the number of shares authorized under the 1999 Stock Option Plan shall be proportionately adjusted, as determined appropriate and equitable by the compensation committee, to take into account any stock split, reverse stock split, stock dividend, recapitalization, combination or reclassification of shares, or similar event. Amendment or Termination. Our board may amend or terminate the 1999 Stock Option Plan at any time. If our board amends the 1999 Stock Option Plan, it does not need to ask for stockholder approval of the amendment unless such amendment increases the number of shares available under the 1999 Stock Option Plan or applicable law requires such approval. No amendment shall impair the rights of any optionee under an option previously granted without his or her consent. The 1999 Stock Option Plan will be terminated as of the date of the completion of this offering. Such termination will not affect any option previously granted under the 1999 Stock Option Plan. 2003 Stock Option Plan We have adopted The White House, Inc. 2003 Stock Option Plan (the "2003 Stock Option Plan") to replace the 1999 Stock Option Plan effective upon completion of the offering. The 2003 Stock Option Plan will serve the same purpose of promoting our long-term growth and profitability by (i) providing key people with incentives to improve stockholder value and contribute to our growth and financial success, and (ii) enabling us to attract, retain, and reward talented and skilled persons for positions of substantial responsibility. We have used stock options as a component of compensation for our officers and key employees. The differences from the 1999 Stock Option Plan include the following: Securities law requirements in the 2003 Stock Option Plan are changed to those applicable to a public company. The definition of "fair market value" of the common stock is changed to refer to the listed price on the Nasdaq Market. Unless otherwise determined by the Board, the Committee administering the 2003 Stock Option Plan is required to include solely "nonemployee directors" under Rule 16b-3 and "outside directors" under Code Section 162(m). The number of shares subject to options that may be issued to one employee in one year is limited to 61,538 in order to meet the exception for performance-based compensation under Code Section 162(m). Nonqualified options may have an exercise price lower than the fair market value of the common stock on the grant date. Any shares used to satisfy the exercise price under an option must have been held for at least six months. Stock appreciation rights may be issued under the 2003 Stock Option Plan. The requirement for optionees to sign a stockholders agreement and certain repurchase rights of the company at termination of employment are eliminated. Shares Reserved. A maximum of (i) 615,385 shares of common stock, plus (ii) a carryover of the shares available for future awards under the 1999 Stock Option Plan at the date of its termination and (iii) any shares subject to options, or portions of options, granted under the 1999 Stock Option Plan which are forfeited, surrendered or cancelled or otherwise expire or terminate after the date of termination of the 1999 Stock Option Plan without being exercised, will be available and reserved for issuance under the 2003 Stock Option Plan. Administration. Unless otherwise determined by the Board, the compensation committee of our board of directors will administer the 2003 Stock Option Plan. The committee has the sole discretion to make all decisions and take all actions relating to the interpretation, administration, and operation of the 2003 Stock Option Plan. The committee has the discretion to determine who will receive options, what type of options will be issued, how many shares will be covered by the option, what the vesting requirements will be (if any), and what the other features, terms, and conditions of each option will be. The compensation committee may also reprice the exercise price of outstanding options to the then current fair market value of the underlying stock by accepting the surrender of outstanding options and substituting new ones and modify outstanding awards in other ways. Eligibility. The committee may grant options to full-time employees, officers, members of our board of directors, subcontractors, and outside consultants of the Company or any subsidiary. The 2003 Stock Option Plan provides that no participant may receive options covering more than 61,538 shares in any one year. Types of Award. The 2003 Stock Option Plan provides for the issuance of incentive stock options and nonstatutory stock options to purchase shares of our common stock. Incentive stock options may be granted to employees and may qualify for favorable tax treatment under Code Section 422 if certain requirements are satisfied. Nonstatutory stock options do not qualify for such favorable tax treatment. Exercise Price. The exercise price for incentive stock options granted under the 2003 Stock Option Plan may not be less than 100% of the fair market value of our common stock on the option grant date. The price of nonstatutory stock options is determined by the committee. Transferability. Incentive stock options granted under the 2003 Stock Option Plan are not transferable by the optionee except by will or the laws of descent and distributions in the event of the optionee's death. Nonstatutory options may be transferred to certain family members and other transferees permitted by the compensation committee. Vesting and Exercise. Options vest, or, become exercisable, at the time or times determined by the compensation committee. The Company may make or guarantee loans to assist grantees in exercising options and satisfying any related tax withholding obligations. Payment of the exercise price may be made in cash or by any other means the compensation committee may prescribe, including, but not limited to, cashless exercise through a designated brokerage firm after our stock is registered. Stock Appreciation Rights ("SARs"). Under the 2003 Stock Option Plan, the committee may issue SARs which entitle the holder to receive at the time prescribed in the SAR in stock or cash, as determined by the committee, the excess of the value of the number of shares under the vested portion of the SAR over their base price stated in the SAR. SARs shall be subject to such restrictions and conditions as the committee prescribes. SARs may be issued on a free-standing basis or in tandem with stock options. Merger or Sale. In the event of any proposed sale, merger, share exchange, consolidation, or other reorganization or business combination in which we are not the surviving corporation or in which nonvoting securities, cash, or securities of another corporation are received or if we sell all or substantially all of our assets, then the compensation committee will take such action as it deems appropriate and equitable, including without limitation accelerating or changing the exercise dates of any option, canceling the options and paying cash to the option holders, or causing a successor entity to replace the options with like options for other securities. Change in Capitalization. The number and price of shares covered by outstanding stock options and the number of shares authorized under the 2003 Stock Option Plan shall be proportionately adjusted, as determined appropriate and equitable by the compensation committee, to take into account any stock split, reverse stock split, stock dividend, recapitalization, combination or reclassification of shares, or similar event. Amendment or Termination. Our board may amend or terminate the 2003 Stock Option Plan at any time. If our board amends the Plan, it does not need to ask for stockholder approval of the amendment unless such amendment increases the number of shares available under the 2003 Stock Option Plan or applicable law requires such approval. No amendment shall impair the rights of any optionee under an option previously granted without his or her consent. Employee Stock Purchase Plan Our board of directors has adopted an Employee Stock Purchase Plan, subject to stockholder approval. Purpose. The purpose of the Employee Stock Purchase Plan is to provide a means by which our employees may be given an opportunity to purchase our common stock through payroll deductions at a discounted price and upon terms that offer certain tax advantages. The rights to purchase common stock granted under the purchase plan are intended to qualify as options issued under an "employee stock purchase plan" as that term is defined by Section 423 of the Code. Administration. Our board of directors is responsible for administering the Employee Stock Purchase Plan and has the final power and sole discretion to construe and interpret the terms of the purchase plan and the rights granted under it. Our board of directors has the power, subject to the provisions of the purchase plan, to determine whether any subsidiary of ours is eligible to participate in the purchase plan, and also has the power to construe and interpret the plan and rights granted under it, and to establish, amend, and revoke rules and regulations for its administration. The board has delegated administration of the purchase plan to the compensation committee of the board. When the term "Board" is used in this section with respect to the purchase plan, it refers to the compensation committee, as well as to the board. Offerings. The purchase plan will be implemented by offerings of rights to all eligible employees from time to time pursuant to the provisions thereof. The first such offering will commence on the later of the first day of the month following the completion of this offering or the beginning of our fiscal month of August 2003 and end on the last day of our fiscal month of January 2004. However, in no event will the first offering period commence before a filing of a registration statement for the Plan with the SEC. Thereafter, offerings will be semi-annual (but can be changed to annual or quarterly) and will be for a duration of six months. At the discretion of the board, offerings may be divided into quarterly periods or combined into annual periods. Purchases of common stock will be made on the last date of each offering period during which the Nasdaq National Market is open for trading. Eligibility. Unless otherwise determined by the board, any employee who customarily works more than 20 hours per week and more than five months of the calendar year and who has been employed by us for at least 12 months (or such other period as determined by the board not in excess of two years) as of the first day of such offering period, is eligible to participate in that offering under the purchase plan. Notwithstanding the foregoing, no employee is eligible for the grant of any rights under the purchase plan if, immediately after such grant, the employee would own, directly or indirectly, stock possessing 5% or more of the total combined voting power or value of all classes of our stock (including any stock which such employee may purchase under all outstanding rights and options), nor will any employee be granted rights that would permit him or her to buy more than $25,000 worth of stock (determined at the fair market value of the shares at the time such rights are granted) under all employee stock purchase plans of the company in any calendar year. Participation in the Plan; Payroll Deductions. Eligible employees become participants in the purchase plan by delivering to us, prior to the first day of an offering period, an agreement authorizing payroll deductions in whole percentages of up to 10% of such employees' covered compensation (as defined in the purchase plan) during the offering period. A participant may not alter the amount of the payroll deduction during an offering period, but may discontinue participation and withdraw the accumulated payroll deductions prior to the end of the offering. All payroll deductions made for a participant are credited to his or her account under the purchase plan and deposited with our general funds. A participant may not make any additional payments into such account. Purchase Price. The purchase price per share at which shares are sold in an offering under the purchase plan must be the lower of (i) 85% of the closing price of a share of common stock on the Nasdaq National Market on the date of commencement of the offering (or in the event the stock was not traded on such date, the nearest prior business day on which trading of the common stock occurred on the Nasdaq National Market), or (ii) 85% of the closing price of a share of common stock on the Nasdaq National Market on the last date of the offering (or in the event the stock was not traded on such date, the nearest prior business day on which trading of the common stock occurred on the Nasdaq National Market). If the stock is not traded on the Nasdaq National Market, the committee shall determine the appropriate basis for establishing the price of the stock. The purchase price is paid with the amounts accumulated by each participant through his or her payroll deductions. Purchase of Stock. By executing an agreement to participate in the purchase plan, the employee is deemed to have been granted a qualified option to purchase a whole number of shares of common stock equal to the amount of his/her accumulated payroll deductions divided by the purchase price at which shares are sold in the offering. The maximum number of shares any employee may be granted the right to purchase in any one offering is 500 (or such other number approved by the committee before the respective offering period) shares and the maximum aggregate number of shares that may be purchased by all participants in any one offering is 25,000 shares (subject to adjustment for changes in the duration of offering periods and certain changes in capitalization) plus all unissued shares from prior offerings. If the aggregate number of shares to be purchased upon exercise of rights granted in the offering would exceed the maximum aggregate number, the board would make a pro rata allocation of shares available in a uniform and equitable manner. Unless the employee's participation is discontinued, his or her right to purchase shares is exercised automatically on the purchase date for the offering at the applicable purchase price. Withdrawal. While each participant in the purchase plan is required to sign an agreement authorizing payroll deductions, the participant may withdraw from a given offering by terminating his or her payroll deductions and by delivering to us a notice of withdrawal from the purchase plan. Such withdrawal may be elected at any time prior to the end of an offering. Upon withdrawal from an offering by the employee, we will distribute to the employee his or her accumulated payroll deductions, without interest, and such employee's interest in the offering will be automatically terminated. The employee is not entitled to again participate in such offering. An employee's withdrawal from an offering will not have any effect upon such employee's eligibility to participate in subsequent offerings under the purchase plan. Termination of Employment. Rights granted pursuant to any offering under the purchase plan terminate immediately upon cessation of an employee's employment for any reason, and we will distribute to such employee all of his or her accumulated payroll deductions, without interest. A leave of absence in excess of 90 days will be regarded as a termination of employment for purposes of the purchase plan unless return to employment is guaranteed by contract or applicable law. Restrictions of Transfer. Rights granted under the purchase plan are not transferable otherwise than by will or the laws of descent and distribution in the event of a participant's death, or by designation of a beneficiary in accordance with the terms of the purchase plan and, otherwise during the participant's lifetime, shall be exercisable only by the participant to whom such rights were granted. Duration, Amendment, and Termination. The board may suspend or terminate the purchase plan at any time. The purchase plan shall automatically terminate on the earlier of (i) the day prior to the tenth anniversary of the adoption of the plan, or (ii) the date that the maximum number of shares available under the purchase plan have been issued. The board may amend the purchase plan at any time. Any amendment of the purchase plan must be approved by the stockholders within 12 months of its adoption by the board if the amendment would (i) increase the maximum number of shares of common stock reserved for issuance under the purchase plan (except for adjustments upon certain changes in capitalization), or (ii) modify the requirements relating to eligibility for participation in the purchase plan. Rights granted before amendment or termination of the purchase plan will not be adversely altered or impaired by any amendment or termination of such plan without consent of the person to whom such rights were granted. Adjustment Provision. The purchase plan and outstanding rights may be appropriately and proportionally adjusted at the discretion of the Board as to classes and numbers of shares and purchase prices under current offerings in the event of changes to the common stock as a result of merger, reorganization, recapitalization, reclassification, stock split, reverse stock split, or other similar transaction. No adjustments shall be made for stock dividends. For this purpose, any distribution of common stock to stockholders in an amount aggregating 20% or more of the outstanding common stock shall be deemed a stock split and any distribution of common stock to stockholders in an amount aggregating less than 20% of the outstanding common stock shall be deemed a stock dividend. Effect of Certain Corporate Events. In the event of a dissolution, liquidation, or specified type of acquisition or merger of the company, the compensation committee shall take such action as it deems appropriate and equitable, which may include (i) a refund of payroll deductions in the offering, (ii) shortening the offering period, or (iii) providing that each participant in such offering will be entitled to receive for each share of common stock that such participant would have purchased on the purchase date the approximate cash, securities, and/or property that a holder of one share of common stock was entitled to receive upon and at the time of such transaction. Stock Subject to Purchase Plan. An aggregate of 200,000 shares of common stock has been reserved for future issuance under the purchase plan. Employment Agreements We plan to enter into employment agreements with Richard Sarmiento, Patricia Darrow-Smith, Michael Smith, and Stephen Hirsch prior to completion of the offering. We entered into an employment offer letter agreement with Stephen Hirsch on July 12, 1999. Mr. Hirsch's employment offer letter provides for the payment of (i) 12 months salary in the event Mr. Hirsch's employment is terminated within 12 months before or after a change of control of the Company and (ii) nine months salary in the event we terminate him without cause. The terms "cause" and "change of control" are defined in the offer letter. We plan to replace this employment offer letter agreement with an employment agreement prior to the offering. RELATED PARTY TRANSACTIONS In connection with the offering, we are required to make a distribution of $11.8 million to holders of our Class C common stock. The recipients of this distribution are Craig Foley and entities affiliated with Mr. Foley as well as entities affiliated with Howard Goldstein. The entities receiving the distribution are Phillips-Smith Specialty Retail Group III, L.P., Chancellor Private Capital Offshore Partners I, C.V., Chancellor Private Capital Offshore Partners II, L.P., Chancellor Private Capital Partners III, L.P., and Citiventure 96 Partnership, L.P. Each entity receiving the distribution is the beneficial owner of more than 5% of our outstanding common stock. The distribution amounts are proportionate to ownership of Class C shares. Messrs. Foley and Goldstein are members of our board of directors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations Amounts Distributable to Holders of Class C Common Stock." In January 2002, one of our non-employee stockholders negotiated a sale of certain of her Class A common shares to entities affiliated with Messrs. Foley and Goldstein, members of our board of directors. As part of this transaction, we agreed to exchange Class A common shares acquired by the entities for shares of Class C common stock, on a one-for-one basis. Accordingly, we issued 92,308 shares of Class C common stock to these entities in exchange for 92,308 shares of Class A common stock. Entities affiliated with Messrs. Foley and Goldstein paid $225,000 for the 92,308 shares of Class A common stock acquired. The Class A shares were subsequently exchanged for Class C shares on a share-for-share basis. We have from time to time retained the services of a company affiliated with a relative of Ms. Darrow-Smith to provide us with painting for certain of our stores. The total consideration paid by us for those services was approximately $9,000, $97,000, and $0 in fiscal 2000, 2001, and 2002, respectively. We believe that the transactions disclosed above were made on terms no less favorable to us than would have been obtained from unaffiliated third parties. Our policy is that all transactions between us and our executive officers, directors, and principal stockholders be on terms no less favorable to us than we could obtain from unaffiliated third parties or else be approved by our disinterested directors. *less than 1% Richard D. Sarmiento 58 Chairman, President, Chief Executive Officer, and Director Patricia Darrow-Smith 41 Executive Vice President, Merchandising Stephen L. Hirsch 50 Vice President, Finance and Administration, and Chief Financial Officer F. Michael Smith 47 Vice President, Operations Craig J. Foley(1)(2)(3) 59 Director Howard E. Goldstein(1)(2) 44 Director Darryl Hartley-Leonard(2) 58 Director Sally Frame Kasaks(2)(3) (1)Includes (i) 2,769 shares held by Mr. Sarmiento's spouse, (ii) 8,614 shares held by Mr. Sarmiento's children, and (iii) 1,046 shares subject to options currently exercisable or exercisable within 60 days of May 31, 2003. Mr. Sarmiento's address is 6711 Baymeadow Drive, Glen Burnie, Maryland 21060. (2)Represents (i) 190,887 shares held of record by Chancellor Private Capital Partners III, L.P., (ii) 841,971 shares held of record by Citiventure 96 Partnership, L.P., (iii) 25,398 shares held of record by Chancellor Private Capitol Offshore Partners I, C.V., (iv) 314,468 shares held of record by Chancellor Private Capital Offshore Partners II, L.P., and (v) 6,153 shares subject to options held by these entities that are currently exercisable or exercisable within 60 days of May 31, 2003. INVESCO Private Capital, Inc. is the sole investment manager of all of the foregoing funds and has full dispositive power with respect to shares held by them. Mr. Goldstein, one of our directors, is Managing Director of INVESCO Private Capital, Inc. Mr. Goldstein disclaims beneficial ownership of these shares except to the extent of his pecuniary interest in these entities. Mr. Goldstein's business address is c/o INVESCO Private Capital, Inc., 1166 Avenues of the Americas, 27th Floor, New York, New York 10036. (3)Represents (i) 958,397 shares held of record by Phillips-Smith Specialty Retail Group III, L.P., (ii) 26,299 shares held of record by Mr. Foley, and (iii) 6,153 shares subject to options held by Mr. Foley that are currently exercisable or exercisable within 60 days of May 31, 2003. Mr. Foley, one of our directors, is a principal of Phillips-Smith Specialty Retail Group III, L.P. Mr. Foley disclaims beneficial ownership of the shares not held of record by him except to the extent of his pecuniary interest in Phillips-Smith Specialty Retail Group III, L.P. Mr. Foley's address is 5080 Spectrum Drive, Suite 700 West, Dallas, Texas 75248. (4)Includes (i) 1,046 shares subject to options that are currently exercisable or exercisable within 60 days of May 31, 2003, and (ii) 477,969 shares beneficially owned by Ms. Darrow-Smith's spouse, F. Michael Smith. Ms. Darrow-Smith's address is 6711 Baymeadow Drive, Glen Burnie, Maryland 21060. (5)Includes (i) 1,046 shares subject to options that are currently exercisable or exercisable within 60 days of May 31, 2003, and (ii) 781,730 shares beneficially owned by Mr. Smith's spouse, Patricia Darrow-Smith. Mr. Smith's address is 6711 Baymeadow Drive, Glen Burnie, Maryland 21060. (6)Represents shares subject to options that are currently exercisable or exercisable within 60 days of May 31, 2003. (7)Includes 38,821 shares subject to options that are currently exercisable or exercisable within 60 days of May 31, 2003. Mr. Hirsch's address is 6711 Baymeadow Drive, Glen Burnie, Maryland 21060. (8)Includes (i) 116,030 shares held of record by Ms. Bernholz's spouse, Martin Bernholz, and (ii) 249,692 shares held of record by Ms. Bernholz. Ms. Bernholz's address is 6711 Baymeadow Drive, Glen Burnie, Maryland 21060. (9)Includes (i) 249,692 shares held of record by Mr. Bernholz's spouse, Anne Bernholz, and (ii) 116,030 shares held of record by Mr. Bernholz. Mr. Bernholz's address is 6711 Baymeadow Drive, Glen Burnie, Maryland 21060. Mr. Bernholz, who is an attorney, has been retained by the Company during the last three years to handle lease negotiations for the Company. He receives a monthly retainer of $3,500. (10)Includes 233,224 shares held of record by . Mr. Goldstein is a general partner of INVESCO Private Capital, Inc. which has sole voting and dispositive power over . Mr. Goldstein disclaims beneficial ownership of these shares except to the extent of his pecuniary interest in these entities. (11)Includes (i) 163,563 shares held of record by Phillips-Smith Specialty Retail Group, III L.P. and (ii) 2,023 shares beneficially owned by Mr. Foley. Mr. Foley is a principal of Phillips-Smith Specialty Retail Group, III L.P. Mr. Foley disclaims beneficial ownership of the shares not held of record by him except to the extent of his pecuniary interest in Phillips-Smith Specialty Retail Group III, L.P. (12)Includes 50,234 shares beneficially owned by Ms. Darrow-Smith's spouse, F. Michael Smith. (13)Includes 30,851 shares beneficially owned by Mr. Smith's spouse, Patricia Darrow-Smith. (14)Includes 233,224 shares held of record by . (15)Includes (i) 163,563 shares held of record by Phillips-Smith Specialty Retail Group, III L.P. and (ii) 2,023 shares beneficially owned by Mr. Foley. Mr. Foley is a principal of Phillips-Smith Specialty Retail Group, III L.P. Mr. Foley disclaims beneficial ownership of the shares not held of record by him except to the extent of his pecuniary interest in Phillips-Smith Specialty Retail Group III, L.P. (16)Includes shares beneficially owned by Ms. Bernholz's spouse, Martin J. Bernholz. (17)Includes shares beneficially owned by Mr. Bernholz's spouse, Anne Bernholz. (18)Assumes the underwriters' over-allotment option is not exercised. In the event that the underwriters' over-allotment option is exercised in full, the following persons will sell the additional number of shares and beneficially own the percentage of shares set forth after their respective names: (i) Richard D. Sarmiento (37,395, or 14.5%) (ii) Patricia Darrow-Smith (37,695, or 14.5%) (includes 14,342 shares beneficially owned by Ms. Darrow-Smith's spouse, F. Michael Smith, and 23,353 shares beneficially owned by Ms. Darrow-Smith), (iii) F. Michael Smith (37,695, or 14.5%) (includes 23,353 shares beneficially owned by Mr. Smith's spouse, Patricia Darrow-Smith, and 14,342 shares beneficially owned by Mr. Smith), (iv) entities affiliated with INVESCO Private Capital, Inc. (108,419, or 13.2%) (includes 108,419 shares held of record by ), (v) Phillips-Smith Specialty Retail Group III, L.P. (76,063, or 9.5%), (vi) Anne Bernholz (116,061, or 0%) (includes shares beneficially owned by Ms. Bernholz's spouse, Martin J. Bernholz, and shares beneficially owned by Ms. Bernholz), (vii) Martin J. Bernholz (116,061, or 0%) (includes shares beneficially owned by Mr. Bernholz's spouse, Anne Bernholz, and shares beneficially owned by Mr. Bernholz), (viii) Eric Ryan (41,255, or 1.2%), (ix) Roderick Ryan (20,754, or .5%), (x) Ayman Sabi (15,046, or 0%), and (xi) Nick Kahook (15,233, or 0%). Voting power after exercise of the over-allotment option will remain proportionate to ownership. DESCRIPTION OF CAPITAL STOCK General The following information describes our common stock and preferred stock and provisions of our articles of amendment and restatement and our bylaws as in effect upon the completion of the offering. This description is only a summary. You should also refer to the articles of amendment and restatement and our bylaws which have been filed with the SEC as exhibits to our registration statement, of which this prospectus forms a part. The descriptions of the common stock and preferred stock reflect changes to our capital structure that will occur upon the receipt of the requisite stockholder approvals and upon the completion of the offering in accordance with the terms of the proposed articles of amendment and articles of amendment and restatement. As of May 31, 2003, we had 44 stockholders of record. Upon the completion of the offering our authorized capital stock will consist of 25,000,000 shares of common stock, par value $0.01 per share, and 5,000,000 shares of preferred stock, par value $0.01 per share. Certain features of our articles of incorporation, as amended and restated, and bylaws may have the effect of delaying or preventing a change in control transaction. See "Risk Factors Risks Relating to the Offering We are subject to anti-takeover provisions which could affect the price of our common stock." Common Stock Holders of our common stock are entitled to one vote per share on all matters to be voted on by stockholders. There is no cumulative voting in the election of our directors, which means the holders of a majority of our outstanding common stock, subject to the rights of holders of our preferred stock, if any, can elect all the nominees standing for election. Subject to the prior rights of holders of preferred stock, if any, the holders of common stock are entitled to receive such dividends, if any, as may be declared from time to time by our board of directors in its discretion from funds legally available therefor. Upon our liquidation or dissolution, the remainder of our assets will be distributed ratably among the holders of common stock after payment of liabilities and the liquidation preferences of any outstanding shares of preferred stock. Our common stock has no preemptive or other subscription rights and there are no conversion rights or redemption or sinking fund provisions with respect to such shares. All of the outstanding shares of common stock are, and the shares to be sold in the offering will be, fully paid and nonassessable. Under Maryland law, a Maryland corporation generally cannot dissolve, amend its charter, merge, sell all or substantially all of its assets, engage in a share exchange, or engage in similar transactions outside the ordinary course of business, unless approved by the affirmative vote of stockholders holding at least two-thirds of the shares entitled to vote on the matter. However, a Maryland corporation may provide in its charter for approval of these matters by a lesser percentage but not less than a majority of all the votes entitled to be cast on the matter. Our charter provides for approval by a majority of all the votes entitled to be cast notwithstanding any provision of law requiring a greater percentage. Preferred Stock Effective upon the completion of the offering, we will have 5,000,000 shares of undesignated preferred stock authorized. Our board of directors has the authority to issue the preferred stock in one or more series and to fix the price, preferences, conversion or other rights, voting powers, restrictions, limitations to dividends, qualifications or terms or conditions, terms of redemption, redemption prices, liquidation preferences, and the number of shares constituting a series or the designation of such series, without any further vote or action by our stockholders. Our issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of delaying, deferring, or preventing a change in control of White House -- Black Market without further action by the stockholders and may adversely affect the market price of, and the voting and other rights of, the holders of common stock. We have no current plans to issue any shares of preferred stock. Business Combinations Maryland law prohibits certain "business combinations" (including a merger, consolidation, share exchange, or, in certain circumstances, an asset transfer or issuance or reclassification of equity securities) between a Maryland corporation and an "interested stockholder." Interested stockholders are all persons (i) who beneficially own 10% or more of the voting power of the corporation's shares or (ii) an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was an interested stockholder or an affiliate or an associate thereof. Such business combinations are prohibited for five years after the most recent date on which the interested stockholder became an interested stockholder. Thereafter, any such business combination must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least (i) 80% of the votes entitled to be cast by all holders of voting shares of the corporation, and (ii) 662/3% of the votes entitled to be cast by all holders of voting shares of the corporation other than voting shares held by the interested stockholder, or an affiliate or associate of the interested stockholder, with whom the business combination is to be effected, unless, among other things, the corporation's stockholders receive a minimum price (as defined in Maryland law) for their shares and the consideration is received in cash or in the same form as previously paid by the interested stockholder for its shares. These provisions of Maryland law do not apply, however, to business combinations that are approved or exempted by our board of directors prior to the time that the interested stockholder becomes an interested stockholder. Our board of directors has adopted an irrevocable resolution exempting Richard Sarmiento, Patricia Darrow-Smith and Michael Smith, and each of their respective existing and future affiliates from the provisions of the business combination statute. The board of directors has also adopted an irrevocable resolution exempting Phillips-Smith Specialty Retail Group III, L.P. and INVESCO Private Capital, Inc. and their respective existing and future affiliates and associates from the business combination statute up to the number of shares beneficially owned by them, respectively, immediately prior to the closing of the offering. Control Share Acquisitions Maryland law provides that "control shares" of a Maryland corporation acquired in a "control share acquisition" have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter, excluding shares of stock owned by the acquiror or by officers or directors who are employees of the corporation. Control shares are voting shares of stock which, if aggregated with all other shares of stock previously acquired by such a person, would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of voting power: (i) 10% or more but less than 331/3%; (ii) 331/3% or more but less than a majority; or (iii) a majority of all voting power. Control shares do not include shares of stock an acquiring person is entitled to vote as a result of having previously obtained stockholder approval in accordance with the control share act. A "control share acquisition" means, subject to certain exceptions, the acquisition of, ownership of, or the power to direct the exercise of voting power with respect to, control shares. A person who has made or proposes to make a control share acquisition, upon satisfaction of certain conditions (including an undertaking to pay expenses), may compel the board of directors to call a special meeting of stockholders to be held within 50 days of demand therefor to consider the voting rights of the shares. If no request for a meeting is made, the corporation may itself present the question at any stockholders' meeting. If voting rights are not approved at the meeting or if the acquiring person does not deliver an acquiring person statement as permitted by the statute, then, subject to certain conditions and limitations, the corporation may redeem any or all of the control shares (except those for which voting rights have previously been approved) for fair value determined, without regard to voting rights, as of the date of the last control share acquisition or of any meeting of stockholders at which the voting rights of such shares are considered and not approved. If voting rights for "control shares" are approved at a stockholders' meeting and the acquiror becomes entitled to vote a majority of the shares entitled to vote, all other stockholders may exercise appraisal rights. The fair value of the stock as determined for purposes of such appraisal rights may not be less than the highest price per share paid in the control share acquisition, and certain limitations and restrictions otherwise applicable to the exercise of dissenters' rights do not apply in the context of a "control share acquisition." A control share acquisition does not include any merger, consolidation or share exchange where we are a party to such transaction. Our amended and restated article of incorporation will provide that "control share acquisition" will not include any transaction by Richard Sarmiento, Patricia Darrow-Smith, Michael Smith, or their existing or future affiliates or associates. Additionally, the amendment will provide that a "control share acquisition" does not include any transaction which would otherwise constitute a "control share acquisition," up to the number of shares beneficially owned by them immediately prior to the effective time of the amendment, by either INVESCO Private Capital, Inc., or Phillips-Smith Specialty Retail Group III, L.P. or their existing or future affiliates. Certain Charter and Bylaw Provisions Our charter and bylaws will be amended and restated as of the closing of the offering and, as a result of such amendment and restatement, will contain several provisions that may make the acquisition of control of White House -- Black Market by means of a proxy fight, open market purchases, tender offer, or other method more difficult. The following is a summary of certain of these provisions. Forms of our charter and bylaws, as amended, are filed as exhibits to the registration statement filed with the Commission of which this prospectus is a part, and the following summary is qualified in its entirety by reference to such documents. Number of Directors. Our charter and bylaws provide that the number of directors shall be fixed from time to time by resolution adopted by a majority of the entire board of directors, but may not consist of fewer than three or such lesser number of stockholders. The size of our board of directors has initially been set at five members. Classified Board of Directors. Our charter divides the board of directors into three classes, with one class having a term of one year, one class having a term of two years, and one class having a term of three years. Each class is to be as nearly equal in number as possible. At each annual meeting of our stockholders, commencing with the annual meeting of stockholders to be held in fiscal 2004, directors will be elected to succeed those directors whose terms have expired, and each newly elected director will serve for a three-year term. The classification of directors and the provisions in the charter that limit the ability of stockholders to increase the size of the board of directors, together with the provisions in our charter described below that limit the ability of stockholders to remove directors and that permit the remaining directors to fill any vacancies on the board, will have the effect of making it more difficult for stockholders to change the composition of our board of directors. As a result, at least two annual meetings of stockholders may be required for our stockholders to change a majority of the directors, whether or not a change in the board of directors would be beneficial to us and our stockholders and whether or not a majority of our stockholders believes that such a change would be desirable. Removal of Directors and Filling Vacancies. Our charter and bylaws provide that a director may be removed by stockholders only "for cause" and with the approval of the holders of 80% of the total voting power of all of our outstanding securities then entitled to vote generally in the election of directors, voting together as a single class at a special meeting of stockholders called for that purpose. The charter and the bylaws provide that all vacancies on our board of directors, including those resulting from an increase in the number of directors, may be filled solely by a majority of the remaining directors even if they do not constitute a quorum. If the vacancy occurs as a result of the removal of a director, our stockholders may elect a successor at the meeting at which such removal occurs. Advance Notice Requirements for Stockholder Proposals and Director Nominations. Our bylaws establish advance notice procedures with regard to stockholder proposals and the nomination, other than by or at the direction of the board of directors or a committee thereof, of candidates for election as directors. These procedures require that a notice of stockholder proposals and stockholder nominations for the election of directors at any meeting of stockholders must be in writing, contain certain specified information, and be received by our corporate secretary not less than 90 nor more than 120 days prior to the meeting (or if less than ten days' notice or prior public disclosure of the date of the meeting is given, the notice of stockholder proposals or nominations must be in writing and received by the our corporate secretary no later than the close of business on the tenth day following the day on which notice of the meeting was mailed or public disclosure thereof was made, whichever occurs first). We may reject a stockholder proposal or nomination that is not made in accordance with such procedures. Limitations on Calling Stockholder Meetings. Our charter and bylaws provide that special meetings of stockholders can be called only by our chairman of the board of directors, our president, our board of directors, or by the corporate secretary at the request of holders of at least a majority of all votes entitled to be cast. These provisions may have the effect of delaying consideration of a stockholder proposal until the next annual meeting unless a special meeting is called by the board of directors, the chairman of the board, the president, or the corporate secretary upon the request of holders of a sufficient number of shares. Amendment of Certain Provisions of the Charter and Bylaws. Our charter provides that the affirmative vote of the holders of at least 80% of the aggregate combined voting power of all classes of capital stock entitled to vote thereon, voting as one class, is required to amend, repeal or adopt provisions inconsistent with certain provisions of the charter, including those provisions relating to the limitation on calling stockholder meetings, the number, election, and term of directors; the removal of directors; the amendment of our bylaws; and the provision governing applicability of the Maryland Control Share Act (Section 3-702 of the Maryland General Corporation Law). Our charter further provides that board of directors shall have the exclusive right to make, alter, amend or repeal our bylaws. These requirements will have the effect of making more difficult any amendment by our stockholders, even if a majority of our stockholders believe that such amendment would be in their best interests. Power to Reclassify Shares of our Stock. Our charter authorizes our board of directors to classify and reclassify any unissued stock and permits our board, without stockholder approval, to amend the charter to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class that we have authority to issue. Prior to issuance of shares of each class or series, the board is required by Maryland law and to set the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board could authorize the issuance of shares of preferred stock with terms and conditions that could have the effect of delaying, deferring or preventing a transaction or a change in control that might involve a premium price for holders of our common stock or otherwise be in their best interest. No shares of our preferred stock are presently outstanding and we have no present plans to issue any preferred stock. Registration Rights We have granted holders of 4,856,644 shares of our common stock demand and "piggyback" registration rights with respect to such shares. These rights may require us to file registration statements under the Securities Act covering all or a portion of our common stock issued to these holders or we may be required to include such shares of our common stock in a registration under the Securities Act that we initiate on our own behalf. The demand registration rights granted to these holders provide that upon request of holders of a majority of the common stock held by these persons, which request can be made at any time after the consummation of the offering, we may be required to use our best efforts to register all or a portion of such shares under the Securities Act on a Form S-1 registration statement. We are obligated to effect an unlimited number of such registrations on a Form S-1 registration statement, but we are only required to pay for the expenses of two such registrations and we are not required to effect any demand registration within 180 days after any other registration statement filed pursuant to the exercise of these demand registration rights or that was subject to the piggyback registration rights described below. These holders of common stock also have the right to request us to register such shares under the Securities Act on a Form S-3 registration statement, if and when we qualify to use this form of registration statement. There is no limit on the number of registrations on Form S-3 that such holders may request. In addition, each of these holders has certain piggyback registration rights. If we propose to register any common stock under the Securities Act for our own account (other than pursuant to an offering in connection with the registration of securities on the Form S-8 or any successor form, which covers securities issued under an employee benefit plan, or on the Form S-4 or any successor form, which covers securities issued in a business combination or a registered exchange offer), holders of piggyback rights may require that we include all or a portion of their common stock in such registration. In connection with any such offering, the managing underwriter thereof can limit the number of shares held by persons with piggyback registration rights to be included in such registration. We will be responsible for all expenses incurred in connection with the registration rights above, excluding underwriting discounts or commissions. Transfer Agent and Registrar The transfer agent and registrar for our common stock is Registrar and Transfer Company. Listing We have applied to list our shares of common stock on the Nasdaq National Market under the symbol "WHBK." SHARES ELIGIBLE FOR FUTURE SALE Prior to the offering, there has been no public market for our common stock. Future sales of substantial amounts of common stock in the public market could lower prevailing market prices. As described below, no shares currently outstanding (other than shares sold in the offering by the selling stockholders) will be available for sale immediately after the offering because of contractual restrictions on resale. Sales of substantial amounts of our common stock in the public market after the restrictions lapse could harm the prevailing market price and impair our ability to raise equity capital in the future. Upon completion of the offering, we will have 7,859,994 shares of common stock outstanding. Of these shares, the 3,119,292 shares sold in the offering, plus any shares issued upon exercise of the underwriters' over-allotment option, will be freely tradable without restriction under the Securities Act, unless purchased by our "affiliates" as that term is defined in Rule 144 under the Securities Act. In general, affiliates include officers, directors, and 10% stockholders. The remaining 4,740,742 shares outstanding are "restricted securities" within the meaning of Rule 144 and will be subject to the volume, manner of sale, and other limitations under Rule 144 (except that 370,940 of these shares may be sold without these limitations). Restricted securities may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144, 144(k), or 701 promulgated under the Securities Act, which are summarized below. Sales of the restricted securities in the public market, or the availability of such shares for sale, could adversely affect the market price of the common stock. All of our directors, officers, and securityholders have entered into lock-up agreements in connection with the offering generally providing that they will not offer, sell, contract to sell, or grant any option to purchase or otherwise dispose of our common stock or any securities exercisable for or convertible into our common stock owned by them for a period of 180 days after the date of this prospectus without the prior written consent of William Blair & Company, L.L.C. In determining whether to consent to a transaction prohibited by these restrictions, William Blair & Company, L.L.C. will take into account various factors, including the length of time before the lock-up expires, the number of shares requested to be sold, the anticipated manner and timing of sale, the potential impact of the sale on the market for the common stock, market conditions generally, the reason for the requested release, and whether the person requesting the release is one of our affiliates, executive officers or directors. Taking into account the lock-up agreements, and assuming William Blair & Company, L.L.C. does not release stockholders from these agreements, the number of restricted shares that will be available for sale in the public market under the provisions of Rule 144, 144(k), and 701 will be as follows: Beginning on the effective date of this prospectus, only the shares sold in the offering will be immediately available for sale in the public market. Beginning 180 days after the effective date, approximately all of our 4,740,742 restricted shares will be eligible for sale subject to the volume, manner of sale, and other limitations under Rule 144 (except that 370,940 of these shares may be sold without these limitations). In general, under Rule 144, after the expiration of the lock-up agreements, a person who has beneficially owned restricted securities for at least one year would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: one percent of the number of shares of common stock then outstanding, which will equal approximately 78,599 shares immediately after the offering; or the average weekly trading volume of the common stock during the four calendar weeks preceding the sale. Sales under Rule 144 are also subject to requirements with respect to manner of sale, notice, and the availability of current public information about us. Under Rule 144(k), a person who is not deemed to have been our affiliate at any time during the three months preceding a sale and who has beneficially owned the shares proposed to be sold for at least two years, is entitled to sell such shares without complying with the manner of sale, public information, volume limitation, or notice provisions of Rule 144. Rule 701 permits our employees, officers, directors, or consultants who purchased shares pursuant to a written compensatory plan or contract to resell such shares in reliance upon Rule 144 but without compliance with specific restrictions. Rule 701 provides that affiliates may sell their Rule 701 shares under Rule 144 without complying with the holding period requirement and that non-affiliates may sell such shares in reliance on Rule 144 without complying with the holding period, public information, volume limitation, or notice provisions of Rule 144. This offering will be underwritten on a firm commitment basis. In the underwriting agreement, the underwriters have agreed, subject to the terms and conditions set forth therein, to purchase the shares of common stock being sold pursuant to this prospectus at a price per share equal to the public offering price less the underwriting discount specified on the cover page of this prospectus. According to the terms of the underwriting agreement, the underwriters either will purchase all of the shares or none of them. In the event of default by any underwriter, in certain circumstances, the purchase commitments of the non-defaulting underwriters may be increased or the underwriting agreement may be terminated. In the underwriting agreement, we and the selling stockholders have made certain representations and warranties to the underwriters and have agreed to indemnify them and their controlling persons against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the underwriters may be required to make in respect thereof. The representatives of the underwriters have advised us and the selling stockholders that the underwriters propose to offer the common stock to the public initially at the public offering price set forth on the cover page of this prospectus and to selected dealers at such price less a concession of not more than $ per share. The underwriters may allow, and such dealers may re-allow, a concession not in excess of $ per share to certain other dealers. The underwriters will offer the shares subject to prior sale and subject to receipt and acceptance of the shares by the underwriters. The underwriters may reject any order to purchase shares in whole or in part. The underwriters expect that we and the selling stockholders will deliver the shares to the underwriters through the facilities of The Depository Trust Company in New York, New York on or about , 2003. At that time, the underwriters will pay us and the selling stockholders for the shares in immediately available funds. After commencement of the public offering, the representatives may change the public offering price and other selling terms. Certain of the selling stockholders have granted the underwriters an option, exercisable within 30 days after the date of this prospectus, to purchase up to an additional 467,894 shares of common stock at the same price per share to be paid by the underwriters for the other shares offered hereby solely for the purpose of covering over-allotments. If the underwriters purchase any such additional shares pursuant to this option, each of the underwriters will be committed to purchase such additional Public offering price $ $ $ Underwriting discount paid by us $ $ $ Underwriting discount paid by selling stockholders $ $ $ We estimate that our total expenses for the offering, excluding the underwriting discount, will be approximately $1,200,000. We, and each of our directors, executive officers, and stockholders, who in the aggregate beneficially own all of our outstanding shares of common stock, have agreed, subject to limited exceptions, for a period of 180 days after the date of this prospectus, not to, without the prior written consent of William Blair & Company, L.L.C.: directly or indirectly offer, sell, contract to sell, assign, transfer, encumber, pledge, grant an option to purchase, make any "short" sale, establish a "put equivalent position" within the meaning of Rule 16a-1(h) under the Exchange Act, or otherwise dispose of any shares of the Company's common stock, or any options or warrants to purchase any shares of common stock or any securities convertible into, exchangeable for, or that represent the right to receive shares of common stock ("common stock equivalents") held of record or beneficially owned (within the meaning of Rule 13d-3 under the Exchange Act); enter into any swap or other arrangement that transfers all or a portion of the economic consequences associated with the ownership of any common stock or common stock equivalent; or exercise any registration rights with respect to any common stock or common stock equivalent. This agreement does not extend to bona fide gifts to immediate family members of such persons who agree to be bound by such restrictions, or to limited partners or stockholders who agree to be bound by such restrictions. In determining whether to consent to a transaction prohibited by these restrictions, the underwriters will take into account various factors, including the length of time before the lock-up expires, the number of shares requested to be sold, the anticipated manner and timing of sale, the potential impact of the sale on the market for the common stock, market conditions generally, the reason for the requested release, and whether the person requesting the release is one of our affiliates, executive officers or directors. We may grant options and issue common stock under existing stock option plans and issue unregistered shares in connection with any outstanding convertible securities or options during the lock-up period. See "Shares Eligible for Future Sale." The representatives have informed us that the underwriters will not confirm, without client authorization, sales to their client accounts as to which they have discretionary authority. The representatives have also informed us that the underwriters intend to deliver all copies of this prospectus via hand delivery or through mail or courier services and only printed forms of the prospectus are intended to be used. In connection with the offering, the underwriters and other persons participating in the offering may engage in transactions which affect the market price of the common stock. These may include stabilizing and over-allotment transactions and purchases to cover syndicate short positions. Stabilizing transactions consist of bids or purchases for the purpose of pegging, fixing, or maintaining the price of the common stock. An over-allotment involves selling more shares of common stock in the offering than are specified on the cover page of this prospectus, which results in a syndicate short position. The short position may be either a covered short position or a naked short position. In a covered short position, the number of shares over-alloted by the underwriters is not greater than the number of shares that they may purchase in the over-allotment option. In a naked short position, the number of shares over-alloted is greater than the number of shares in the over-allotment option. The underwriters may cover this short position by purchasing common stock in the open market or by exercising all or part of their over-allotment option. In determining the source of shares to close out the short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which it may purchase shares through the over-allotment option. If underwriters sell more shares than could be covered by the over-allotment option, a naked short position, the position can only be closed out by buying shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there could be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering. In addition, the representatives may impose a penalty bid. This allows the representative to reclaim the selling concession allowed to an underwriter or selling group member if common stock sold by such underwriter or selling group member in the offering is repurchased by the representative in stabilizing or syndicate short covering transactions. These transactions, which may be effected on the Nasdaq National Market or otherwise, may stabilize, maintain, or otherwise affect the market price of the common stock and could cause the price to be higher than it would be without these transactions. The underwriters and other participants in the offering are not required to engage in any of these activities and may discontinue any of these activities at any time without notice. We, the selling stockholders, and the underwriters make no representation or prediction as to whether the underwriters will engage in such transactions or choose to discontinue any transactions engaged in or as to the direction or magnitude of any effect that these transactions may have on the price of the common stock. We have applied to list our common stock on the Nasdaq National Market under the symbol "WHBK." In the ordinary course of business, some of the underwriters and their affiliates have provided, and may in the future provide, investment banking, commercial banking, and other services to us for which they have received, and may in the future receive, customary fees or other compensation. Determination of Offering Price Prior to the offering, there has been no public market for the common stock. The initial public offering price for our common stock will be determined by negotiation between us and the representatives of the underwriters. The factors that will be considered in determining the initial public offering price are prevailing market and economic conditions, our revenue and earnings, market valuations of other companies engaged in activities similar to us, estimates of our business potential and prospects, the present state of our business operations, our management, and other factors deemed relevant. The estimated initial public offering price range on the cover of this preliminary prospectus is subject to change as a result of market conditions or other factors. LEGAL MATTERS Certain legal matters with respect to the validity of the common stock offered hereby will be passed on for us by Venable, Baetjer, Howard & Civiletti, LLP, Washington, D.C. Certain legal matters relating to the offering will be passed upon for the underwriters by Sonnenschein Nath & Rosenthal, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001080980_pats-inc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001080980_pats-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001080980_pats-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001080985_hollingshe_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001080985_hollingshe_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001080985_hollingshe_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001081014_audio_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001081014_audio_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001081014_audio_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001085810_precision_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001085810_precision_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001085810_precision_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001085811_ppi_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001085811_ppi_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001085811_ppi_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001088529_ivideonow_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001088529_ivideonow_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b4107b05654700fc45636f2e48a323c0970f6eb9 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001088529_ivideonow_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered through this prospectus will be passed on for 99 Cent Stuff by Sachs Sax Klein, Boca Raton, Florida and for the underwriter by Schneider Weinberger LLC, Boca Raton, Florida. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001099217_dds_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001099217_dds_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1ed739d15da1e4876a9f02c336e50f3c560a9e8e --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001099217_dds_legal_matters.txt @@ -0,0 +1,11307 @@ +LEGAL MATTERS + +Certain legal matters with respect to the validity of the issuance of the shares of Common Stock offered by this prospectus will be passed upon for us by Hodgson Russ LLP, Buffalo, New York, and by Woodburn & Wedge of Reno, Nevada. + +38 + +Back to Contents + +EXPERTS + +The consolidated financial statements + of DDS Holdings, Inc. (formerly Black Diamond Industries, Inc.) as of November + 14, 2002 and for the year ended October 31, 2002 and the period ended November + 14, 2002, included in this prospectus and the registration statement on Amendment + No. 1 to Form S-1, have been included in reliance on the report of Robert + Jarkow, CPA, + independent certified public accountant, given on the authority of said person + as an expert in accounting and auditing. The consolidated financial statements + of Fishtheworld Holdings, Inc and Subsidiary as of December 31, 2002 and + 2001 and for the years then ended and the consolidated financial statements + of DDS Technologies USA, Inc. (formerly Fishtheworld Holdings, Inc.) and + Subsidiary as of June 30, 2003 and for the periods from July 17, 2002 (inception) + through October 31, 2002, the two months ended December 31, 2002, the six + months ended June 30, 2003 and for the period from July 17, 2002 (inception) + through June 30, 2003, have been included in this prospectus and the registration + statement on Amendment + No. 1 to Form S-1, have been included in reliance on the report of Weinberg & Company, + P.A., independent certified public accountants, given us the authority of + said firm experts in accounting and auditing. + + + +39 + +Back to Contents + +INDEX TO FINANCIAL STATEMENTS + + PAGE + + F-1 + + CONDENSED CONSOLIDATED FINANCIAL + STATEMENTS OF DDS TECHNOLOGIES USA, INC. (FORMERLY FISHTHEWORLD HOLDINGS, + INC.) AND + SUBSIDIARY, AS OF SEPTEMBER 30, 2003 (unaudited) + + + + + + + + + +PAGE + +F-17 + +CONSOLIDATED FINANCIAL STATEMENTS OF DDS TECHNOLOGIES USA, INC. (FORMERLY FISHTHEWORLD HOLDINGS, INC.) AND SUBSIDIARY, AS OF JUNE 30, 2003 + + + + + + + + + +PAGE + +F-34 + +CONSOLIDATED FINANCIAL STATEMENTS + OF FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY AS OF DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + + + + + + + + + +PAGES + +F-44 + +CONSOLIDATED FINANCIAL STATEMENT + OF DDS HOLDINGS, INC. AND SUBSIDIARY AS OF NOVEMBER 14, 2002 + + + + + + + + + + + + + + + + + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + (A DEVELOPMENT COMPANY) + + CONDENSED CONSOLIDATED BALANCE SHEET + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + + + + + ASSETS + + + + + + + + + + + + + + CURRENT ASSETS + + + + + + + + + Cash + + $ + + 468,960 + + + + + Total Current Assets + + + + + + 468,960 + + + + + + + + + + + + + + FIXED ASSETS, NET + + + + 18,808 + + + + + LICENSE + + + + 4,700,000 + + + + + DEPOSITS AND OTHER + + + + 962,714 + + + + + + + + + + + + + + TOTAL ASSETS + + $ + + 6,150,482 + + + + + + + + + + + + + LIABILITIES AND STOCKHOLDERS' EQUITY + + + + + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + Accrued expenses + + $ + + 20,390 + + + + + Accrued professional fees + + + + 605,000 + + + + + Total Current Liabilities + + + + + + 625,390 + + + + + + + + + + + + + + STOCKHOLDERS' EQUITY + + + + + + + + + Preferred + stock, $.0001 par value, 1,000,000 shares authorized, no shares + + issued + and outstanding + + + + + + - + + + + + Common + stock, $.0001 par value, 25,000,000 shares authorized, 18,573,969 + + issued + and outstanding + + + + + + 1,857 + + + + + Additional paid-in capital + + + + 11,877,832 + + + + + Subscriptions receivable + + + + (1,000,000) + + + + + Deferred consulting expense + + + + (1,980,208) + + + + + Note receivable - related party + + + + (235,000) + + + + + Interest receivable - related + party + + + + (2,152) + + + + + Deficit accumulated during + development stage + + + + (3,137,237) + + + + + Total Stockholders' Equity + + + + + + 5,525,092 + + + + + + + + + + + + + + TOTAL LIABILITIES AND + STOCKHOLDERS' EQUITY + + $ + + 6,150,482 + + + + + + + + + + + + + + See accompanying notes to the condensed + consolidated financial statements + + + + + F-1 + + + +Back to Contents + + + + + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + (A DEVELOPMENT COMPANY) + + CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS + + (UNAUDITED) + + + + + + + + + + For the Three Months Ended September 30, 2003 + + + + For the Nine Months Ended September 30, 2003 + + + + For the Period From + + July 17, 2002 (Inception) Through September 30, 2002 + + + + For the Period From + + July 17, 2002 (Inception) Through September 30, 2003 + + + + + + + + + + + + + + + + REVENUES + $ + + - + $ + + - + $ + + - + $ + + - + + + + + + + + + + + + + + + + EXPENSES + + + + + + + + + + + + Professional fees + + 888,568 + + 2,130,102 + + 22,826 + + 2,455,320 + + + + Merger costs + + - + + 200,000 + + - + + 200,000 + + + + Salaries and related taxes + + 66,370 + + 136,802 + + - + + 136,802 + + + + General and administrative + + + 109,604 + + + 264,681 + + + 33,104 + + + 347,267 + + + + + Total Expenses + + + + 1,064,542 + + 2,731,585 + + 55,930 + + 3,139,389 + + + + + + + + + + + + + + + + INTEREST INCOME + + + 922 + + + 2,152 + + + - + + + 2,152 + + + + + + + + + + + + + + + + NET LOSS + $ + + (1,063,620) + $ + + (2,729,433) + $ + + (55,930) + $ + + (3,137,237) + + + + + + + + + + + + + + + + NET LOSS PER SHARE - BASIC + AND DILUTED + $ + + (0.06) + $ + + (0.16) + $ + + (0.01) + + + + + + + + + + + + + + + + + + WEIGHTED AVERAGE NUMBER OF + + SHARES OUTSTANDING - BASIC AND + + DILUTED + + + 18,392,410 + + + 16,793,985 + + + 10,767,255 + + + + + + + + + + + + + + + + + + + See accompanying notes to the condensed + consolidated financial statements + + + + + F-2 + + + + + +Back to Contents + + + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + (A DEVELOPMENT COMPANY) + + CONDENSED COSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY + + FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2003 + + (UNAUDITED) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common + +Shares + + + + Stock + + Amount + + + + Additional Paid-In Capital + + + + Subscriptions Receivable + + + + Deferred Consulting Expense + + + + Note Receivable Related Party + + + + Interest Receivable Related Party + + + + Accumulated Deficit + + + + Total + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + issued for cash at inception + + 10,767,255 + + $ + 1,077 + + $ + 957,328 + + $ + + + $ + + + + + + + + + + + + $ + 958,405 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + issued for license valued at $1.00 + +per share + + 3,500,000 + + + 350 + + + 3,499,650 + + + + + + + + + + + + + + + + + + 3,500,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + issued for cash in December 2002 at $1.00 per share + + 100,000 + + + 10 + + + 99,990 + + + + + + + + + + + + + + + + + + 100,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + issued for cash in January 2003 at $1.00 per share + + 200,000 + + + 20 + + + 199,980 + + + + + + + + + + + + + + + + + + 200,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common + stock issued for license in January 2003 + +at $1.00 per share + + 500,000 + + + 50 + + + 499,950 + + + + + + + + + + + + + + + + + + 500,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Note receivable - + related party in February 2003 + + + + + + + + + + + + + + + + + (235,000 + ) + + + + + + + + (235,000 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Interest + receivable - related party + + + + + + + + + + + + + + + + + + + + (2,152 + ) + + + + + (2,152 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + issued for cash in February, March + +and April 2003 at $1.00 per share + + 800,000 + + + 80 + + + 799,920 + + + + + + + + + + + + + + + + + + 800,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Recapitalization + for merger in April 2003 + + 429,000 + + + 43 + + + (43 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + See accompanying notes to the condensed + consolidated financial statements. + + + + + F-3 + + + + +Back to Contents + + + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + (A DEVELOPMENT COMPANY) + + CONDENSED COSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY + + FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH SEPTEMBER 30, 2003 + + (UNAUDITED) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common + +Shares + + + + Stock + + Amount + + + + Additional Pain-In Capital + + + + Subscriptions Receivable + + + + Deferred Consulting Expense + + + Note Receivable Related Party + + + + Interest Receivable Related Party + + + + Accumulated Deficit + + + + Total + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + issued for cash in + +May 2003 at $1.00 per share + + 100,000 + + + 10 + + + 99,990 + + + - + + + - + + - + + + - + + + - + + + 100,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + subscribed at $1.00 + +per share + + 1,500,000 + + + 150 + + + 1,499,850 + + + (1,500,000 + ) + + - + + - + + + - + + + - + + + - + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Collection of + subscription + + receivable in July 2003 + + - + + + - + + + - + + + 500,000 + + + - + + - + + + - + + + - + + + 500,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Warrants issued + for consulting + +expense in April 2003 + + - + + + - + + + 1,274,848 + + + - + + + (1,274,848 + ) + - + + + - + + + - + + + - + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + issued for cash in + +July and August 2003 at $3.50 + +per share, net + + 502,714 + + + 50 + + + 1,020,444 + + + - + + + - + + - + + + - + + + - + + + 1,020,494 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Warrants issued + with sale of + +common stock for cash in July + +and August 2003 + + - + + + - + + + 563,056 + + + - + + + - + + - + + + - + + + - + + + 563,056 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Common stock + issued for services + +in August and September 2003 + + 175,000 + + + 17 + + + 1,298,233 + + + - + + + (1,298,250 + ) + - + + + - + + + - + + + - + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Options issued + for consulting + +services in August 2003 + + - + + + - + + + 64,636 + + + - + + + (64,636 + ) + - + + + - + + + - + + + - + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Amortization of + deferred consulting + +expense + + - + + + - + + + - + + + - + + + 657,526 + + - + + + - + + + - + + + 657,526 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Net loss: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + July 17, 2002 + (inception) through + +December 31, 2002 + + - + + + - + + + - + + + - + + + - + + - + + + - + + + (407,804 + ) + + (407,804 + ) + + + + Nine months ended + September 30, + +2003 + + - + + + - + + + - + + + - + + + - + + - + + + - + + + (2,729,433 + ) + + (2,729,433 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + BALANCE, + SEPTEMBER 30, 2003 + + 18,573,969 + + $ + 1,857 + + $ + 11,877,832 + + $ + (1,000,000 + ) + $ + (1,980,208) + $ + (235,000 + ) + $ + (2,152 + ) + $ + (3,137,237 + ) + $ + 5,525,092 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + See accompanying + notes to the condensed consolidated financial statements. + + + + + F-4 + + + + +Back to Contents + + + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + (A DEVELOPMENT COMPANY) + + CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS + + (UNAUDITED) + + + + + + + + + For the Nine Months Ended + + September 30, 2003 + + + + For the Period From + + July 17, 2002 (Inception) Through September 30, 2002 + + + + For the Period From + + July 17, 2002 (Inception) Through + + September 30, 2003 + + + + + CASH FLOWS FROM OPERATING + ACTIVITIES: + + + + + + + + + + + + + + + + + Net loss + $ + (2,729,433) + $ + (55,930) + $ + (3,137,237) + + + + + Adjustments to reconcile net loss to net cash used in operating + activities: + + + + + + + + + + + + + + + + + + + Depreciation expense + + + + + 2,360 + + + - + + + 2,929 + + + + + Amortization of deferred consulting expense + + + + + 657,526 + + + - + + + 657,526 + + + + + Other non-cash expense + + + + + 4,112 + + + - + + + - + + + + + Changes in operating assets + and liabilities: + + + + + + + + + + + + + + + + + Security deposit and other + + + + + (1,847) + + + - + + + (6,824) + + + + + Accrued expenses + + + + + + 623,238 + + + + 35,939 + + + + 623,238 + + + + + Net Cash Used In Operating Activities + + + + + + (1,444,044) + + + + (19,991) + + + + (1,860,368) + + + + + + + + + + + + + + + + + + + + + + CASH FLOWS FROM INVESTING + ACTIVITIES: + + + + + + + + + + + + + + + + + Deposit on purchase of + machinery + + + (955,890) + + + - + + + (955,890) + + + + + Purchases of fixed assets + + + (4,761) + + + - + + + (21,737) + + + + + Acquisition of license + + + (200,000) + + + - + + + (700,000) + + + + + Note receivable - related + party + + + + (235,000) + + + + - + + + + (235,000) + + + + + Net Cash Used In Investing Activities + + + + + + (1,395,651) + + + + - + + + + (1,912,627) + + + + + + + + + + + + + + + + + + + + + + CASH FLOWS FROM FINANCING + ACTIVITIES: + + + + + + + + + + + + + + + + + Sales of common stock and + subscriptions received + + + + 3,183,550 + + + + 236,676 + + + + 4,241,955 + + + + + Net Cash Provided By Financing Activities + + + + + + 3,183,550 + + + + 236,676 + + + + 4,241,955 + + + + + + + + + + + + + + + + + + + + + + NET INCREASE IN CASH + + + 343,855 + + + 216,685 + + + 468,960 + + + + + + + + + + + + + + + + + + + + + + CASH - BEGINNING OF PERIOD + + + + 125,105 + + + + - + + + + - + + + + + + + + + + + + + + + + + + + + + + CASH - END OF PERIOD + $ + + 468,960 + $ + + 216,685 + $ + + 468,960 + + + + + + + + + + + + + + + + + + + + + + NON-CASH INVESTING AND + FINANCING ACTIVITIES: + + + + + + + + + + + + + + + + + + + + + + Common stock issued for + license valued at $1.00 per share + $ + + 500,000 + $ + + - + $ + + 4,000,000 + + + + + + + + + + + + + + + + + + + + + + Warrants issued for deferred + consulting services + $ + + 1,274,848 + $ + + - + $ + + 1,274,848 + + + + + + + + + + + + + + + + + + + + + + Common stock issued for + deferred consulting expenses + $ + + 1,298,250 + $ + + - + $ + + 1,298,250 + + + + + + + + + + + + + + + + + + + + + + Options issued for deferred + consulting services + $ + + 64,636 + $ + + - + $ + + 64,636 + + + + + + + + + + + + + + + + + + + + + + Common stock subscribed at + $1.00 per share + $ + + 1,500,000 + $ + + - + $ + + 1,500,000 + + + + + + + + + + See accompanying notes to the condensed + consolidated financial statements. + + + + + F-5 + + + + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + +NOTE 1 + + BACKGROUND AND +BASIS OF PRESENTATION + + + DDS + Technologies USA, Inc. (formerly Fishtheworld Holdings, Inc.) and subsidiary + (the "Company") is a development stage + company with no revenues since its inception on July 17, 2002. The Company + has been engaged in the process of obtaining the license rights and + exclusive marketing rights for a dry disaggregation system for North + America, Central America, the Caribbean (excluding Cuba), South America and + Africa. + + + + + Since its inception, the Company has been dependent upon + the receipt of capital investment to fund its continuing activities. In + addition to the normal risks associated with a new business venture, there + can be no assurance that the Company's product development will be + successfully completed or that it will be a commercial success. The + Company's ability to execute its business plan will depend on its ability to + obtain additional financing and achieve a profitable level of operations. + There can be no assurance that sufficient financing will be obtained. Nor + can the Company give any assurance that it will generate substantial + revenues or that its business operations will prove to be profitable. + + + + + On + November 14, 2002, Black Diamond Industries, Inc., ("Black Diamond") + a public Florida corporation, conducting no business other than to seek + a suitable acquisition partner, acquired all of the outstanding + shares of common stock of DDS Holdings, Inc., a Nevada company pursuant to + a securities exchange agreement dated October 27, 2002. Under the terms + of the + securities exchange agreement, the stockholders of DDS Holdings, Inc. agreed + to transfer all of the issued and outstanding shares of common stock in + exchange for an aggregate of 12,915,525 shares of common stock, or + approximately 93% of Black Diamond. Immediately prior to, and in conjunction + with the transaction, the sole director and officer and majority shareholder + of Black Diamond returned 13,564,350 shares of common stock to treasury. + + + + + In December 2002, the Company changed its name to DDS + Technologies USA, Inc. and reincorporated in the state of Delaware. + + + + + Under + a share exchange agreement entered into on April 4, 2003, Fishtheworld + Holdings, Inc. ("Fishtheworld") a public Florida + corporation conducting no business other than to seek a suitable acquisition + partner, acquired 88.5% of DDS Technologies USA, Inc. in exchange for + 15,367,255 shares of common stock or approximately 97% of the then issued + and outstanding shares of Fishtheworld. DDS Technologies USA, Inc. also paid + a cash consideration of $200,000 to the shareholders of Fishtheworld, which + has been accounted for as merger costs in the nine months ended September + 30, 2003 statement of operations. Immediately prior to the share exchange, + the majority shareholder of Fishtheworld returned 8,571,000 shares to + treasury and resigned as the sole director and officer of the company. The + members of the Board of Directors of the Company became members of the Board + of Directors of Fishtheworld. DDS Technologies USA, Inc. adopted the + December 31st year-end of Fishtheworld. + + F-6 + +Back to Contents + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + In May 2003, Fishtheworld changed its name to DDS + Technologies, USA, Inc. and reincorporated in the state of Nevada. + + + + Generally accepted accounting principles in the United + States of America require that a company whose stockholders retain a + majority interest in a business combination be treated as the acquirer for + accounting purposes. Since Black Diamond and Fishtheworld were public shells + and DDS Holdings, Inc. is a development stage company with no revenues, the + transactions were treated as recapitalizations of the Company. As a result + of the reincorporation, the Company's par value for its preferred and common + stock changed from $.001 to $.0001 per share. + + + + + +NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ORGANIZATION + + + (A) Principles of Consolidation + + + + + The accompanying condensed consolidated financial + statements include the accounts of DDS Technologies USA, Inc. and its wholly + owned subsidiary. All material intercompany accounts and transactions have + been eliminated. + + + + (B) License + + + + + The license is recorded at its acquisition cost as + described in Note 5. Under the terms of the agreement, the license has a + 20-year life, which expires in May 2022, and will be amortized over the + expiration term when the Company commences operations which generate + revenues. + + + + (C) Use of Estimates + + + + + The preparation of the condensed consolidated financial + statements in conformity with accounting principles generally accepted in + the United States of America requires management to make estimates and + assumptions that affect the reported amounts of assets and liabilities and + of contingent assets and liabilities at the date of the condensed + consolidated financial statements and the reported amounts of revenues and + expenses during the reporting period. Actual results could differ from those + estimates. + + + + (D) Loss Per Common Share + + + Net loss per common share (basic and diluted) is based on + the net loss divided by the weighted average number of common shares + outstanding during each period. Common stock equivalents were not included + in the calculation of diluted loss per share as their effect would be anti-dilutive. + + F-7 + +Back to Contents + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + (E) Interim Consolidated Financial Statements + + + + + + The + condensed consolidated financial statements as of September 30, 2003 + and for the three and nine months then ended, and for the + periods from July 17, 2002 (inception) through September 30, 2003 and + 2002, are unaudited. In the opinion of management, such condensed consolidated + financial statements include all adjustments (consisting of normal recurring + accruals) necessary for the fair presentation of the consolidated financial + position and the consolidated results of operations. The consolidated + results of operations for the periods presented are not necessarily + indicative of the results to be expected for the full year. The condensed + consolidated financial statements should be read in conjunction with the + Company's Annual Report Form 10-KSB as of December 31, 2002. + + + + (F) Stock-Based Compensation + + + + + The Company accounts for its stock-based employee + compensation plans using the intrinsic value based method, under which + compensation cost is measured as the excess of the stock's market price at + the grant date over the amount an employee must pay to acquire the stock. + Stock options and warrants issued to non-employees are accounted for using + the fair value based method, under which the expense is measured as the fair + value of the security at the date of grant based on the Black-Scholes + pricing model. + + + + (G) Recent Accounting Pronouncements + + + + + In + January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest + Entities", an interpretation of Accounting Research Bulletin ("ARB") No. 51, + "Consolidated Financial Statements". Interpretation No. 46 addresses + consolidation by business enterprises of variable interest entities, which + have one or both of the following characteristics: (i) the equity investment + at risk is not sufficient to permit the entity to finance its activities + without additional subordinated support from other parties, which is + provided through other interest that will absorb some or all of the expected + losses of the entity; (ii) the equity investors lack one or more of the + following essential characteristics of a controlling financial interest: + the direct or indirect ability to make decisions about the entities activities + through voting rights or similar rights; or the obligation to absorb the + expected losses of the entity if they occur, which makes it possible for + the + entity to finance its activities; the right to receive the expected residual + returns of the entity if they occur, which is the compensation for the risk + of absorbing the expected losses. + + + + Interpretation + No. 46 also requires expanded disclosures by the primary beneficiary (as + defined) of a variable interest entity and by an enterprise that holds a + significant variable interest in a variable interest entity but is not the + primary beneficiary. Interpretation No. 46 + + F-8 + +Back to Contents + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + applies + immediately to variable interest entities created after January 31, 2003, + and to variable interest entities in which an enterprise obtains an interest + after that date. It applies in the first fiscal year or interim period + beginning after June 15, 2003, to variable interest entities in which an + enterprise holds a variable interest that it acquired before February 1, + 2003. Interpretation No. 46 may be applied prospectively with a + cumulative-effect adjustment as of the date on which it is first applied or + by restating previously issued financial statements for one or more years + with a cumulative-effect adjustment as of the beginning of the first year + restated. + + + + In + June 2003, the FASB issued an Exposure Draft for a proposed Statement + of Financial Accounting Standards ("SFAS") entitled + "Qualifying Special Purpose Entities ("QSPE") and Isolation of Transferred + Assets", an amendment of SFAS No. 140 ("The Exposure Draft"). + The Exposure Draft is a proposal that is subject to change and as such, is + not yet + authoritative. If the proposal is enacted in its current form, it will amend + and clarify SFAS 140. The Exposure Draft would prohibit an entity from being + a QSPE if it enters into an agreement that obligated a transferor of + financial assets, its affiliates, or its agents to deliver additional cash + or other assets to fulfill the special-purposes entity's obligation to + beneficial interest holders. + + + + In + April 2003, the FASB issued SFAS No. 149, "Amendment + of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. + 149 amends and clarifies financial accounting and reporting for derivative + instruments, including certain derivative instruments embedded in other + contracts (collectively referred to as derivatives) and for hedging + activities under SFAS No. 133, "Accounting for Derivative Instruments and + Hedging Activities". The changes in SFAS No. 149 improve financial reporting + by requiring that contracts with comparable characteristics be accounted for + similarly. This statement is effective for contracts entered into or + modified after June 30, 2003 and all of its provisions should be applied + prospectively. + + + + In + May 2003, the FASB issued SFAS No. 150, "Accounting + For Certain Financial Instruments with Characteristics of both Liabilities + and Equity". SFAS No. 150 changes the accounting for certain financial + instruments with characteristics of both liabilities and equity that, under + previous pronouncements, issuers could account for as equity. The new + accounting guidance contained in SFAS No. 150 requires that those + instruments be classified as liabilities in the balance sheet. + + + + SFAS No. 150 affects the issuer's accounting for three + types of freestanding financial instruments. One type is mandatorily + redeemable shares, which the issuing company is obligated to buy back in + exchange for cash or other assets. A second type includes put options and + forward purchase contracts, which involves instruments that do or may + require the issuer to buy back some of its shares in exchange for cash or + other assets. The third type of + + F-9 + + + +Back to Contents + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + instruments that are liabilities under this + Statement is obligations that can be settled with shares, the monetary value + of which is fixed, tied solely or predominantly to a variable such as a + market index, or varies inversely with the value of the issuers' shares. SFAS No. 150 does not apply to features embedded in a financial instrument + that is not a derivative in its entirety. + + + + Most + of the provisions of Statement 150 are consistent with the existing definition + of liabilities in FASB Concepts Statement No. + 6, "Elements of Financial Statements". The remaining provisions + of this Statement are consistent with the FASB's proposal to revise that + definition + to encompass certain obligations that a reporting entity can or must settle + by issuing its own shares. This Statement shall be effective for financial + instruments entered into or modified after May 31, 2003 and otherwise shall + be effective at the beginning of the first interim period beginning after + June 15, 2003, except for mandatorily redeemable financial instruments of + a non-public entity, as to which the effective date is for fiscal periods + beginning after December 15, 2003. + + + + Management does not expect the implementation of these + recent pronouncements to have a material effect on the Company's + consolidated financial position or results of operations. + + + + + +NOTE 3 NOTE RECEIVABLE - RELATED PARTY + + + In February 2003 the Company entered into a $235,000 + short-term loan agreement with DDS Technologies LTD, a British corporation. + DDS Technologies LTD is a stockholder of the Company. The loan was for a + maximum period of ninety days to be repaid with interest at a rate of 1.57% + per annum. In the event that DDS Technologies LTD failed to repay the full + amount due within 120 days, the Company had the right to demand issuance of + shares of DDS Technologies LTD amounting to ten percent of their issued and + outstanding shares. The Company has not demanded payment on the note nor + have they demanded the issuance of shares of common stock of + DDS Technologies LTD. Both parties have agreed to + apply the amount due on the note to future purchases of equipment from DDS + Technologies LTD. As DDS Technologies LTD is a significant stockholder of + the Company, the note and interest receivable have been presented as a + component of stockholders' equity in the accompanying condensed consolidated + balance sheet at September 30, 2003. + + + + + +NOTE 4 LICENSE + + + On August 29, 2002, the Company (the licensee) entered + into an exclusive license agreement with DDS Technologies LTD. (the + licensor, a United Kingdom company). The initial license agreement, which + expires on May 28, 2022, provides for the exclusive North, South, Central + American and Caribbean (excluding Cuba) rights to the pending patent, + #02425336.1, which was filed with the European patent office on May 28, + 2002. The patent relates to the + + F-10 + +Back to Contents + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + Longitudinal + Micrometric Separator for Classifying Solid Particulate Materials. The terms + of the agreement required the Company to pay at the time of signing $500,000 + and 3,500,000 shares of the common stock of the Company, which were paid + during 2002. + + + + For the nine months ended September 30, 2003, the Company + paid an additional $200,000 and issued an additional 500,000 shares of + common stock valued at $1.00 per share to DDS Technologies LTD. for an + extension of the license to include Africa, subject to certain exceptions. + + + + In accordance with the agreement, the Company is required + to pay the licensor: (1) 49% of the net profits derived from the sale of + products embodying the technology, (2) 24% of the + net profits derived from the licensing and rental of products embodying the + technology, and (3) 49% of the net profits derived from the sale of + materials that are produced by machines embodying the technology and + subsequently sold for use in producing pharmaceuticals, additives, cosmetics + or other products. Additionally, the Company is required to pay 2% of the + net profits derived in (1) through (3) above to a charity designated by the + licensor. + + + + + +NOTE 5 DEPOSITS + + + The Company is negotiating + a purchase agreement with a limited liability Netherlands company, which + is a wholly + owned subsidiary of + DDS Technologies LTD. (See Notes 3 and 4). Pursuant to the draft agreement, + the Company will purchase machines, which embody technology described in + Note 4. The Company has advanced $995,890 as an initial deposit for the + purchase of the equipment. The Company expects to finalize the purchase + agreement in November 2003. + + + + + +NOTE 6 SUBSCRIPTION +RECEIVABLE + + + In April and June 2003, the Company signed various + subscription agreements for the sale of 1,500,000 shares of common stock at + $1.00 per share aggregating $1,500,000. On July 23, 2003, the Company + collected $500,000. + + + + + +NOTE 7 RELATED PARTY TRANSACTIONS + + + For the three and nine months ended September 30, 2003 + and for the period from July 17, 2002 (inception) through September 30, 2003 + the Company incurred consulting expenses of $133,000, $379,000 and $446,000, + respectively, from stockholders of the Company. Also see Notes 3, 4 and 5 + for additional related party transactions. + + + + F-11 + +Back to Contents + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + + NOTE 8 COMMON STOCK + + + + + In July and August 2003, the Company entered into stock + purchase agreements with several accredited investors for additional equity + capital. The Company raised a total of $1,759,500 ($1,583,550 net of + commissions, see Note 10). The agreements provide for the purchase of the + Company's common stock at $3.50 per share plus warrants equal to one-half of + the number of shares purchased. The warrants are exercisable at any time for + a period of 3 years at an exercise price of $7.00 per share. The total + shares issued were 502,714 and warrants for another 251,357 shares. The + warrants were valued using the Black-Scholes pricing model and resulted in a + fair value of $563,056. The net proceeds of $1,583,550 were allocated + between the fair value of the warrants issued with the common stock + ($563,056) and the common stock ($1,020,494). The Company granted + registration rights to the investors and is currently incurring penalties + (See Note 12(A)). + + + + + +NOTE 9 STOCK OPTIONS + + + The + Company has established a Stock Option Plan (the "Plan") to + attract, retain and motivate key employees, to provide an incentive for + them to achieve long-range performance goals and to enable + them to participate in the long-term growth of the Company. Options granted + under the Plan may include non-qualified stock options as well as incentive + stock option intended to qualify under Section 422A of the Internal Revenue + Code. The aggregate number of shares that may be issued under the Plan or + exercise of options must not exceed three million shares. Each stock option + agreement specifies when all or any installment of the option becomes + exercisable. + + + + In + May 2003, the Company granted stock options to an executive employee. + The Company applies Accounting Principles Board ("APB") + Opinion 25, Accounting for Stock Issued to Employees, and related + interpretations in accounting for option granted to employees. Under APB + Opinion 25, if the exercise price of the Company's employee stock options + equals or exceeds the market price of the underlying stock on the date of + grant, no compensation cost is recognized. For the option granted in May + 2003, the exercise price of each option equaled the market price of the + Company's stock on the date of grant and an option expires in 10 years. + + + + SFAS No. 123, Accounting for Stock-Based Compensation, as + amended by SFAS No. 148, Accounting for Stock-Based Compensation - + Transition and Disclosure, requires the Company to provide pro forma + information regarding net income and earnings per share for each period + presented as if compensation cost for the Company's stock options had been + determined in accordance with the fair value based method prescribed in SFAS + No. 123. The Company estimates the fair value of each stock option at the + grant date by using the Black-Scholes option pricing model with the + following weighted average assumptions used for the + + F-12 + +Back to Contents + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + grants in May + 2003; no dividend yield for all years; expected volatility of 74%; risk-free + interest rate of 3%, and an expected life of 5 years. + + + + Under the accounting provisions of SFAS No. 123, as + amended by SFAS No. 148, the Company's net loss and net loss per common + share for the nine months ended September 30, 2003 would have been as + follows: + + + + + + + + + Net loss + + As Reported + + $ + + (2,729,433) + + + + + + Pro Forma + + $ + + (3,215,276) + + + + + + + + + + + Net loss per common + + As Reported + + $ + + (0.16) + + + + share - basic and diluted + + Pro Forma + + $ + + (0.19) + + + + + + A summary of the status of the Company's option plans as + of September 30, 2003 and the changes during the period ending on that date + is presented below: + + + + + + + + + + + + Shares + + + Weighted Average Exercise Price + + + + + + + + + + + + Outstanding at inception + + + - + + $ + + - + + + + Granted + + + 600,000 + + $ + + 5.00 + + + + Forfeited + + + - + + $ + + - + + + + Outstanding at September 30, 2003 + + + 600,000 + + $ + + 5.00 + + + + + + + + + + + + Options exercisable at September 30, 2003 + + + 300,000 + $ + + 5.00 + + + + + + + + + + + + Weighted average fair value of options + granted to employees during the year + + $ + + 2.46 + + + + + + + + The following table summarizes + information about the stock options outstanding at September 30, 2003: + + + + + + + + + Options Outstanding + + Options Exercisable + + + + + Exercise Price + + Number Outstanding at September 30, 2003 + + Weighted Average Remaining Contractual Life + + Weighted Average Exercise Price + + Number Exercisable at September 30, 2003 + + Weighted Average Exercise Price + + + + + + + + + + + + + + + + + + + $ + 5.00 + + 600,000 + + 9.83 + $ + 5.00 + + 300,000 + $ + 5.00 + + + + +F-13 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + + NOTE 10 STOCK WARRANTS AND INVESTMENT BANKING AGREEMENT + + + + + On April 23, 2003, the Company entered into a one-year + agreement with a consulting company for investment banking and other related + services. Pursuant to this agreement, the Company issued to the consulting + company a stock purchase warrant exercisable for a period of five years to + acquire 500,000 shares of the Company's common stock at an exercise price of + $6.50 per share. The warrant was valued using the Black-Scholes pricing + model and resulted in a fair value of $1,274,848. The amount is being + amortized over the life of the agreement resulting in consulting expense of + $531,187 for the nine months ended September 30, 2003. The remaining + unamortized balance of $743,661 is presented in the accompanying condensed + consolidated balance sheet as a contra to equity which is included in + deferred consulting expense. + + + + The agreement also provides that when the consulting + company serves as a placement agent for the issuance and sale of securities, + the Company will pay 10% of the money raised and also issue warrants to + purchase common stock equal to 5% of the number of shares of common stock + sold. The exercise price of the warrants will be the same price that the + investors purchased the common stock for. In connection with the stock sold + in the quarter ended September 30, 2003, the Company paid a $175,950 + commission to the consulting company and issued stock purchase warrants + exercisable for three years to acquire 25,000 shares of the Company's common + stock at an exercise price of $7.00 per share. The warrants were valued + using the Black-Scholes pricing model and resulted in a fair value of + $56,002. There was no accounting effect for the issuance of the warrants as + there would have been an increase and decrease to additional paid-in capital + for the same amount (See Note 8). + + + + + +NOTE 11 AGREEMENTS + + + On August 14, 2003 the Company entered into a one-year + agreement with a marketing company. As part of the agreement, the marketing + company will be responsible to provide business advisory and various other + investment and marketing services. For these services, the Company is paying + monthly cash consideration of $5,000. In addition, the Company will issue + 10,000 shares of restricted common stock per quarter. The first 10,000 + shares were issued upon signing the agreement. Based on the per share price + on the date of the agreement, $26,000 was expensed to consulting fees for + the quarter and $26,000 was deferred. The Company further agreed to issue + 35,000 stock options per quarter with a strike price of $8.00 per share, + expiring 3 years from the date of grant. The Company estimates the fair + value of the stock options at the grant date by using the Black-Scholes + option-pricing model with the following weighted average assumptions: no + dividend yield for all years; expected volatility of 77%; risk-free interest + rate of 3% and an expected life of 3 years, resulting in a fair value of + $64,636. The amount is being amortized over the life of the agreement + resulting in consulting + + F-14 + +Back to Contents + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + expense of + $32,318 for the three months ended September 30, 2003. The remaining + unamortized balance of $32,318 is presented in the condensed consolidated + balance sheet as deferred consulting expense. + + + + On August 15, 2003 the Company entered into a six-month + agreement with an investment consulting company. As part of the agreement, + this consulting company will disseminate information about the Company to + its investors, brokerage firms and others in the financial community. As + compensation for these services, the Company paid cash consideration of + $10,000 upon signing and will pay $5,000 per month thereafter. In addition + the Company has issued 15,000 restricted shares of the Company's common + stock. Based on the per share price on date of agreement, the Company has + recognized $19,313 in consulting fee expense for the quarter and has + deferred $57,938 of expenses. + + + + On September 12, 2003 the Company entered into a one-year + agreement with a financial consulting firm. As part of the agreement, the + consulting firm will provide analytical review of the Company's financial + information and will assist the Company as its financial advisor and + investment banker. As compensation for these services, the Company has + issued 100,000 restricted shares of common stock. Based on the per share + price on the date of the agreement, the Company has recognized $32,250 in + consulting fee expense for the quarter and has deferred $741,750 of + expenses. + + + + On September 19, 2003 the Company entered into a one-year + agreement with an individual. As part of the agreement, the individual will + provide a list of names of potential investors as well as provide other + services for the Company. As compensation for these services the Company has + issued 50,000 shares of restricted common stock. Based on the per share + price on the date of the agreement, the Company has recognized $16,459 in + consulting fee expense and has deferred $378,541 of expenses. + + + + + +NOTE 12 CONTINGENCIES + + + (A) Contingencies + + + + + The Company granted registration rights to certain + investors in the July 2, 2003 private placement of securities. Under those + rights, if the Company does not file a registration statement within 45 days + of closing, the Company owes the investors an aggregate of approximately + $13,000 per month in penalties. The Company began incurring those penalties + on August 16, 2003 and, as of September 30, 2003, has accrued $19,500, which + are included in accrued expenses. + + F-15 + + + +Back to Contents + + + + DDS TECHNOLOGIES USA, INC. + + (FORMERLY FISHTHEWORLD HOLDINGS, INC.) + + AND SUBSIDIARY + + NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS + + AS OF SEPTEMBER 30, 2003 + + (UNAUDITED) + + (B) Litigation + + + + + + The Company is a defendant in a lawsuit whereby the + plaintiff contends that it is entitled to a commission for allegedly + procuring financing for a transaction. The Company filed a Motion to Dismiss + the plaintiff's complaint, which has not yet been set for hearing. The + plaintiff seeks damages totaling $175,584 plus interest from December 31, + 2002. The Company believes the suit is without merit and is vigorously + defending its position. In the opinion of management, this suit will not + have a material effect on the Company's consolidated financial position or + results of operations. + + + + + +NOTE 13 SUBSEQUENT EVENTS + + + In October 2003, the Company settled a contract dispute + with a consultant by issuing 60,000 shares of common stock. The settlement + value was $465,000 and was determined based on the closing price of the + Company's common stock on the settlement date. The amount is included in + accrued professional fees in the accompanying consolidated balance sheet at + September 30, 2003. + + + + On October 17, 2003, the Company entered into stock + purchase agreements with several accredited investors for the sale of common + stock. The Company raised a total of $5,426,018. The agreements called for + the purchase of Company shares at $6.00 per share plus warrants equal to + one-half of the number of shares purchased. The warrants are exercisable at + any time for a period of three years at a strike price of $8.00 per share. + The total shares issued were 904,334 shares and warrants for another 452,167 + shares. + + + + On October 31, 2003, the Company entered into an + employment agreement with its newly appointed president and chief executive + officer. For his services, he will be compensated with an initial annual + base salary of $150,000 and will be eligible to receive an annual bonus at + the discretion of the Board of Directors. Also, as part of the agreement, + the Company granted 400,000 options to the president with an exercise price + of $7.00 per share. These options vest over a three-year period. + + + + + +F-16 + +Back to Contents + +INDEPENDENT AUDITORS REPORT + +To the Board of Directors and shareholders of: + + DDS Technologies U.S.A., Inc. and Subsidiary + +We have audited the accompanying + consolidated balance sheet of DDS Technologies U.S.A., Inc. (formerly + Fishtheworld Holdings, Inc.) and Subsidiary as of June 30, 2003, and the + related statements of operations, stockholders equity and cash flows + for the periods from July 17, 2002 (inception) through October 31, 2002, + the two months ended December 31, 2002, the six months ended June 30, 2003 + and for the period from July 17, 2002 (inception) through June 30, 2003. + 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 audit. + +We conducted our audit in accordance + with generally accepted auditing standards in the United States of America. + 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 financial + statement presentation. We believe that our audit provides a reasonable basis + for our opinion. + +In our opinion, the consolidated + financial statements referred to above present fairly, in all material respects, + the consolidated financial position of DDS Technologies U.S.A., Inc. (formerly + Fishtheworld Holdings, Inc.) and Subsidiary as of June 30, 2003, and + the consolidated results of their operations, and their cash flows for the + periods from July 17, 2002 (inception) through October 31, 2002, the + two months ended December 31, 2002, the six months ended June 30, 2003 and + for the period from July 17, 2002 (inception) through June 30, 2003, in conformity + with accounting principles generally accepted in the United States of America. + +WEINBERG & COMPANY, P.A. + +Boca Raton, Florida + +August 22, 2003, except for Note 12, which is as of October 10, 2003 + +F-17 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +(A DEVELOPMENT STAGE COMPANY) + +CONSOLIDATED BALANCE SHEET + +AS OF JUNE 30, 2003 + +ASSETS + + + + + + + +CURRENT + ASSETS + + + + + + +Cash + + +$ +16,241 + + + + + + + + +Total + Current Assets + + + +16,241 + + + + + + + + +FIXED ASSETS, + NET + + + +15,130 + + +LICENSE + + + +4,700,000 + + +SECURITY DEPOSIT + AND OTHER + + + +6,824 + + + + + + + +TOTAL + ASSETS + + +$ +4,738,195 + + + + + + + +LIABILITIES + AND STOCKHOLDERS EQUITY + + + + + + + + +CURRENT LIABILITIES + + + + + +Accrued payroll taxes + +$ +6,900 + + +Accrued professional fees + + +660,286 + + +Accrued travel expenses + + +9,976 + + + + + + + + + + +Total + Current Liabilities + + + +677,162 + + + + + + + + + + +STOCKHOLDERS EQUITY + + + + + + +Preferred + stock, $.0001 par value, 1,000,000 shares authorized, no shares issued + and outstanding + + + + + + +Common + stock, $.0001 par value, 25,000,000 shares authorized, 17,896,255 issued + and outstanding + + + +1,790 + + +Additional + paid-in capital + + + +8,931,463 + + +Subscriptions + receivable + + + +(1,500,000 +) + +Deferred + consulting expense + + + +(1,062,373 +) + +Note + receivable related party + + + +(235,000 +) + +Interest + receivable related party + + + +(1,230 +) + +Deficit + accumulated during development stage + + + +(2,073,617 +) + + + + + + + + + +Total + Stockholders' Equity + + + +4,061,033 + + + + + + + +TOTAL + LIABILITIES AND STOCKHOLDERS EQUITY + + +$ +4,738,195 + + + + + + + + + + +See accompanying notes to the consolidated financial statements. + +F-18 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +(A DEVELOPMENT STAGE COMPANY) + +CONSOLIDATED STATEMENTS OF OPERATIONS + + + + For + the Six Months + + Ended June 30, 2003 + + + For + the Two Months + + Ended December 31, 2002 + + + For + the Period From + + July 17, 2002 (Inception) + + Through October 31, 2002 + + + For the + Period From + + July 17, 2002 (Inception) + + Through June 30, 2003 + + + + + + + + + + + + + + + + +REVENUES + + +$ + + + +$ + + + +$ + + + +$ + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +EXPENSES + + + + + + + + + + + + + + + + + + +Professional + fees + + + +1,241,534 + + + +167,983 + + + +157,235 + + + +1,566,752 + + +Merger + costs + + + +200,000 + + + + + + + + + + + +200,000 + + +Salaries + and related taxes + + + +70,432 + + + + + + + + + + + +70,432 + + +General + and administrative + + + +155,077 + + + +42,241 + + + +40,345 + + + +237,663 + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Total + Expenses + + + +1,667,043 + + + +210,224 + + + +197,580 + + + +2,074,847 + + + + + + + + + + + + + + + + + + + + +INTEREST + INCOME + + + +1,230 + + + + + + + + + + + +1,230 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +NET + LOSS + + +$ +(1,665,813 +) + +$ +(210,224 +) + +$ +(197,580 +) + +$ +(2,073,617 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +NET + LOSS PER SHARE BASIC AND DILUTED + + +$ +(0.10 +) + +$ +(0.02 +) + +$ +(0.02 +) + + + + + + + + + + + + + + + + + + + + +WEIGHTED + AVERAGE NUMBER OF SHARES OUTSTANDING BASIC AND DILUTED + + + +15,981,526 + + + +14,277,091 + + + +10,799,965 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +See accompanying notes to the consolidated financial statements. + +F-19 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +(A DEVELOPMENT STAGE COMPANY) + +CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY + +FOR THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH JUNE 30, 2003 + + + +Common Stock + + +Additional Paid-In + + Capital + + +Subscriptions + + Receivable + + +Deferred Consulting + + Expense + + +Note Receivable Related Party + + +Interest Receivable Related Party + + +Accumulated Deficit + + +Total + + + + +Shares + + + Amount + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Common + stock issued for cash at inception + + +10,767,255 + + +$ +1,077 + + +$ +957,328 + + +$ + + + +$ + + + + + + + + + + + + + + + +$ +958,405 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Common + stock issued for license valued at $1.00 per share + + +3,500,000 + + + +350 + + + +3,499,650 + + + + + + + + + + + + + + + + + + + + + + + +3,500,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Common + stock issued for cash in December 2002 at $1.00 per share + + +100,000 + + + +10 + + + +990 + + + + + + + + + + + + + + + + + + + + + + + +100,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Common + stock issued for cash in January 2003 at $1.00 per share + + +200,000 + + + +20 + + + +199,980 + + + + + + + + + + + + + + + + + + + + + + + +200,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Common + stock issued for license in January 2003 at $1.00 per share + + +500,000 + + + +50 + + + +499,950 + + + + + + + + + + + + + + + + + + + + + + + +500,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Note + receivable related party in February 2003 + + + + + + + + + + + + + + + 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THE PERIOD FROM JULY 17, 2002 (INCEPTION) THROUGH JUNE 30, 2003 + + + + + Common + Stock + + + Additional + Paid-In + + Capital + + + Subscriptions + + Receivable + + + Deferred + Consulting + + Expense + + + Note + Receivable Related Party + + + Interest + Receivable Related Party + + + Accumulated + Deficit + + + Total + + + + + + + + + + Shares + + + Amount + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Common + stock issued for cash in May 2003 at $1.00 per share + + +100,000 + + + +10 + + + +99,990 + + + + + + + + + + + + + + + + + + + + + + + +100,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Common + stock subscribed at $1.00 per share + + +1,500,000 + + + +150 + + + +1,499,850 + + + +(1,500,000 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Warrants + issued for consulting expense + + + + + + + + + + +1,274,848 + + + + + + + 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+$ +(1,062,373 +) + +$ +(235,000 +) + +$ +(1,230 +) + +$ +(2,073,617 +) + +$ +4,061,033 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +See accompanying notes to the consolidated financial statements. + +F-21 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +(A DEVELOPMENT STAGE COMPANY) + +CONSOLIDATED STATEMENTS OF CASH FLOWS + + + +For the Six Months Ended + +June 30, 2003 + + +For the Two Months Ended December 31, 2002 + + +For the Period From + + July 17, 2002 (Inception) Through October 31, 2002 + + +For the Period From + + July 17, 2002 (Inception) Through + + June 30, 2003 + + + + + + + + + + + + + + + + + + + + +CASH + FLOWS FROM OPERATING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Net loss + + +$ +(1,665,813 +) + +$ +(210,224 +) + +$ +(197,580 +) + +$ +(2,073,617 +) + +Adjustments + to reconcile net loss to net cash used in operating activities: + + + + + + + + + + + + + + + + + + +Depreciation + expense + + + +1,427 + + + +569 + + + + + + + +1,996 + + +Amortization + of deferred consulting expense + + + +212,475 + + + + + + + + + + + +212,475 + + +Other + non-cash expense + + + +4,112 + + + +(4,112 +) + + + + + + + + + +Changes + in operating assets and liabilities: + + + + + + + + + + + + + + + + + + +Due + from related party + + + + + + + +6,000 + + + +(6,000 +) + + + + + +Non-trade + receivable + + + + + + + +10,000 + + + +(10,000 +) + + + + + +Security + deposit and other + + + +(1,847 +) + + +(4,977 +) + + + + + + +(6,824 +) + +Accrued + expenses + + + +675,932 + + + +(35,939 +) + + +35,939 + + + +675,932 + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Net + Cash Used In Operating Activities + + + +(773,714 +) + + +(238,683 +) + + +(177,641 +) + + +(1,190,038 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +CASH + FLOWS FROM INVESTING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Purchases + of fixed assets + + + +(150 +) + + +(16,976 +) + + + + + + +(17,126 +) + +Acquisition + of license + + + +(200,000 +) + + + + + + +(500,000 +) + + +(700,000 +) + +Note + receivable related party + + + +(235,000 +) + + + + + + + + + + +(235,000 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + +Net + Cash Used In Investing Activities + + + +(435,150 +) + + +(16,976 +) + + +(500,000 +) + + +(952,126 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +CASH + FLOWS FROM FINANCING ACTIVITIES: + + + + + + + + + + + + + + + + + + +Sales + of common stock + + + +1,100,000 + + + +281,693 + + + +776,712 + + + +2,158,405 + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Net Cash Provided By Financing Activities + + +1,100,000 + + + +281,693 + + + +776,712 + + + +2,158,405 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +NET + INCREASE (DECREASE) IN CASH + + + +(108,864 +) + + +26,034 + + + +99,071 + + + +16,241 + + + + + + + + + + + + + + + + + + + + +CASH BEGINNING + OF PERIOD + + + +125,105 + + + +99,071 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +CASH END + OF PERIOD + + +$ +16,241 + + +$ +125,105 + + +$ +99,071 + + +$ +16,241 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Common + stock issued for license valued at $1.00 per share + + +$ +500,000 + + +$ + + + +$ +3,500,000 + + +$ +4,000,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + +See accompanying notes to the consolidated financial statements. + +F-22 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + NOTE 1 + BACKGROUND AND BASIS OF + PRESENTATION + + + + + +DDS Technologies USA, Inc. (formerly Fishtheworld Holdings, Inc.) and subsidiary (the Company ) is a development stage company with no revenues since its inception on July 17, 2002. The Company has been engaged in the process of obtaining the license rights and exclusive marketing rights for a dry disaggregation system for North America, Central America, the Caribbean (excluding Cuba), South America and Africa. + + + + + +Since its inception, the Company has been dependent upon the receipt of capital investment to fund its continuing activities. In addition to the normal risks associated with a new business venture, there can be no assurance that the Company's product development will be successfully completed or that it will be a commercial success. The Company's ability to execute its business plan will depend on its ability to obtain additional financing and achieve a profitable level of operations. There can be no assurance that sufficient financing will be obtained. Nor can the Company give any assurance that it will generate substantial revenues or that its business operations will prove to be profitable. + + + + + +On November 14, 2002, Black Diamond Industries, Inc., ( Black Diamond ) a public Florida corporation, conducting no business other than to seek a suitable acquisition partner, acquired all of the outstanding shares of common stock of DDS Holdings, Inc., a Nevada company pursuant to a securities exchange agreement dated October 27, 2002. Under the terms of the securities exchange agreement, the stockholders of DDS Holdings, Inc. agreed to transfer all of the issued and outstanding shares of common stock in exchange for an aggregate of 12,915,525 shares of common stock, or approximately 93% of Black Diamond. Immediately prior to, and in conjunction with the transaction, the sole director and officer and majority shareholder of Black +Diamond returned 13,564,350 shares of common stock to treasury. + + + + + +In December 2002, the Company changed its name to DDS Technologies USA, Inc. and reincorporated in the state of Delaware. + + + + + +Under a share exchange agreement entered into on April 4, 2003, Fishtheworld Holdings, Inc. ( Fishtheworld ) a public Florida corporation conducting no business other than to seek a suitable acquisition partner, acquired 88.5% of DDS Technologies USA, Inc. in exchange for 15,367,255 shares of common stock or approximately 97% of the then issued and outstanding shares of Fishtheworld. DDS Technologies USA, Inc. also paid a cash consideration of $200,000 to the shareholders of Fishtheworld, which has been accounted for as merger costs in the June 30, 2003 statement of operations. Immediately prior to the share exchange, the majority shareholder of Fishtheworld returned 8,571,000 shares to treasury and resigned as the sole director +and officer of the company. The members of the Board of Directors of the Company became members of the Board of Directors of Fishtheworld. DDS Technologies USA, Inc. adopted the December 31st year-end of Fishtheworld. + +F-23 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + +In May 2003, Fishtheworld changed + its name to DDS Technologies, USA, Inc. and reincorporated in the state + of Nevada. As a result of the reincorporation, the Company s par value + for its preferred +and common stock changed to $.0001 per share. + + + + + +Generally accepted accounting principles in the United States of +America require that a company whose stockholders retain a majority interest in a business combination be treated +as the acquirer for accounting purposes. Since Black Diamond and Fishtheworld were public shells and DDS Holdings, +Inc. is a development stage company with no revenues, the transactions were treated as recapitalizations of the Company. + + + + + NOTE 2 + SUMMARY OF SIGNIFICANT ACCOUNTING + POLICIES AND ORGANIZATION + + + + + +(A) Principles of Consolidation + + + + + +The accompanying consolidated financial statements include the accounts of DDS Technologies USA, Inc. and its wholly owned subsidiary. All material intercompany accounts and transactions have been eliminated. + + + + + +(B) Fair Value of Financial Instruments + + + + + +The carrying amounts of the Company s financial instruments, including cash, note receivable and accrued liabilities approximate fair value because of their short maturities. + + + + + +(C) Property and Equipment + + + + + +Office and computer equipment are recorded at cost and are depreciated using the straight-line method over their estimated life of five years. The cost of additions and betterments are capitalized, and repairs and maintenance costs are charged to operations in the periods incurred. When depreciable assets are retired or sold, the cost and related allowances for depreciation are removed from the accounts and the gain or loss is recognized. + + + + + +(D) License + + + + + +The license is recorded at its acquisition cost as described in Note 5. Under the terms of the agreement, the license has a 20-year life, which expires in May 2022, and will be amortized over the expiration term when the Company commences operations which generate revenues. + + + + + +(E) Use of Estimates + + + + + +The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. + +F-24 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + +(F) Impairment of Long-Lived Assets + + + + + +In August 2001, the Financial Accounting Standards Board ( FASB ) issued Statement of Financial Accounting Standards ( SFAS ) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ( Statement No. 144 ). This pronouncement superceded Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of ( Statement No. 121 ) and was required to be adopted on January 1, 2002. Statement No. 144 retained the fundamental provisions of Statement No. 121 as it related to assets to be held and used and assets to be sold. Statement No. 144 requires impairment losses to be recorded on assets to be held and +used by the Company when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of the assets. When an impairment loss is required for assets to be held and used by the Company, the related assets are adjusted to their estimated fair value. Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than a forced or liquidation sale. + + + + + +The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of current market yields as well as future events and conditions. Such future events and conditions include economic and market conditions, as well as availability of suitable financing to fund acquisition and development activities. The realization of the Company's revenue producing assets is dependent upon future uncertain events and conditions, and accordingly, the actual timing and amounts realized by the Company may be materially different from their estimated value. + + + + + +The Company's management believes there is no impairment of its long-lived assets as the estimate of future undiscounted cash flows exceeds the carrying amount of the assets. + + + + + +(G) Loss Per Common Share + + + + + +Net loss per common share (basic and diluted) is based on the net loss divided by the weighted average number of common shares outstanding during each period. Common stock equivalents were not included in the calculation of diluted loss per share as their effect would be anti-dilutive. + +F-25 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + +(H) Income Taxes + + + + + +Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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. + + + + + +(I) Stock-Based Compensation + + + + + +The Company accounts for its stock-based employee compensation plans using the intrinsic value based method, under which compensation cost is measured as the excess of the stock's market price at the grant date over the amount an employee must pay to acquire the stock. Stock options and warrants issued to non-employees are accounted for using the fair value based method, under which the expense is measured as the fair value of the security at the date of grant based on the Black-Scholes pricing model. + + + + + +(J) Recent Accounting Pronouncements + + + + + +In January 2003, The FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities , an interpretation of Accounting Research Bulletin ( ARB ) No. 51, Consolidated Financial Statements . Interpretation No. 46 addresses consolidation by business enterprises of variable interest entities, which have one or both of the following characteristics: (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated support from other parties, which is provided through other interest that will absorb some or all of the expected losses of the entity; (ii) the equity investors lack one or more of the following essential characteristics of a +controlling financial interest: the direct or indirect ability to make decisions about the entities activities through voting rights or similar rights; or the obligation to absorb the expected losses of the entity if they occur, which makes it possible for the entity to finance its activities; the right to receive the expected residual returns of the entity if they occur, which is the compensation for the risk of absorbing the expected losses. + + + + + +Interpretation No. 46 also requires expanded disclosures by the primary beneficiary (as defined) of a variable interest entity and by an enterprise that holds a significant variable interest in a variable interest entity but is not the primary beneficiary. Interpretation No. 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. Interpretation No. 46 may be applied prospectively with a cumulative-effect adjustment as +of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. + +F-26 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + +In June 2003, the FASB issued an Exposure Draft for a proposed SFAS entitled Qualifying Special Purpose Entities ( QSPE ) and Isolation of Transferred Assets , an amendment of SFAS No. 140 ( The Exposure Draft ). The Exposure Draft is a proposal that is subject to change and as such, is not yet authoritative. If the proposal is enacted in its current form, it will amend and clarify SFAS 140. The Exposure Draft would prohibit an entity from being a QSPE if it enters into an agreement that obligated a transferor of financial assets, its affiliates, or its agents to deliver additional cash or other assets to fulfill the special-purposes entity's obligation to beneficial interest holders. + + + + + +In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities . SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities . The changes in SFAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. This statement is effective for contracts entered into or modified after June 30, 2003 and all of its provisions should be applied +prospectively. + + + + + +In May 2003, the FASB issued SFAS No. 150, Accounting For Certain Financial Instruments with Characteristics of both Liabilities and Equity . SFAS No. 150 changes the accounting for certain financial instruments with characteristics of both liabilities and equity that, under previous pronouncements, issuers could account for as equity. The new accounting guidance contained in SFAS No. 150 requires that those instruments be classified as liabilities in the balance sheet. + + + + + +SFAS No. 150 affects the issuer s accounting for three types of freestanding financial instruments. One type is mandatorily redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets. A second type includes put options and forward purchase contracts, which involves instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets. The third type of instruments that are liabilities under this Statement is obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuers shares. SFAS No. 150 does not +apply to features embedded in a financial instrument that is not a derivative in its entirety. + +F-27 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + +Most of the provisions of Statement 150 are consistent with the existing definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements . The remaining provisions of this Statement are consistent with the FASB s proposal to revise that definition to encompass certain obligations that a reporting entity can or must settle by issuing its own shares. This Statement shall be effective for financial instruments entered into or modified after May 31, 2003 and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of a non-public entity, as to which the effective date is for fiscal periods +beginning after December 15, 2003. + + + + + +Management does not expect the implementation of these recent pronouncements to have a material effect on the Company's consolidated financial position or results of operations. + + + + + NOTE 3 + NOTE RECEIVABLE RELATED + PARTY + + + + + +In February 2003 the Company entered into a $235,000 short-term loan agreement with DDS Technologies LTD, a British corporation. DDS Technologies LTD is a stockholder of the Company. The loan was for a maximum period of ninety days to be repaid with interest at a rate of 1.57% per annum. In the event that DDS Technologies LTD failed to repay the full amount due within 120 days, the Company had the right to demand issuance of shares of DDS Technologies LTD amounting to ten percent of their issued and outstanding shares. The Company has not demanded payment on the note nor have they demanded the issuance of shares of common stock of DDS Technologies LTD. Both parties have agreed to apply the amount due on the note to future purchases of +equipment from DDS Technologies LTD. As DDS Technologies LTD is a significant stockholder of the Company, the note and interest receivable have been presented as a component of stockholders' equity in the accompanying consolidated balance sheet at June 30, 2003. + + + + + NOTE 4 + FIXED ASSETS + + + + + +As + of June 30, 2003, fixed assets consist of: + + + + + +Computer + equipment + + +$ +12,144 + + + +Office + equipment + + + +4,982 + + + + + + + + + + + + + +17,126 + + + +Less + accumulated depreciation + + + +(1,996 +) + + + + + + + + + + +$ +15,130 + + + + + + + + + + +Depreciation expense for the period from July 17, 2002 (inception) through October 31, 2002, the two months ended December 31, 2002 and the six months ended June 30, 2003, amounted to $0, $569 and $1,427, respectively. + +F-28 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + NOTE 5 + LICENSE + + + + + +On August 29, 2002, the Company (the licensee) entered into an exclusive license agreement with DDS Technologies LTD. (the licensor, a United Kingdom company). The initial license agreement, which expires on May 28, 2022, provides for the exclusive North, South, Central American and Caribbean (excluding Cuba) rights to the pending patent, #02425336.1, which was filed with the European patent office on May 28, 2002. The patent relates to the Longitudinal Micrometric Separator for Classifying Solid Particulate Materials. The terms of the agreement required the Company to pay at the time of signing $500,000 and 3,500,000 shares of the common stock of the Company, which were paid during 2002. + + + + + +For the six months ended June 30, 2003, the Company paid an additional $200,000 and issued an additional 500,000 shares of common stock valued at $1.00 per share to DDS Technologies LTD. for an extension of the license to include Africa, subject to certain exceptions. + + + + + +In accordance with the agreement, the Company is required to pay the licensor: (1) 49% of the net profits derived from the sale of products embodying the technology, (2) 24% of the net profits derived from the licensing and rental of products embodying the technology, and (3) 49% of the net profits derived from the sale of materials that are produced by machines embodying the technology and subsequently sold for use in producing pharmaceuticals, additives, cosmetics or other products. Additionally, the Company is required to pay 2% of the net profits derived in (1) through (3) above to a charity designated by the licensor. + + + + + NOTE 6 + SUBSCRIPTION RECEIVABLE + + + + + +In April and June 2003, the Company signed various subscription agreements for the sale of 1,500,000 shares of common stock at $1.00 per share aggregating $1,500,000 (See Note 12). + + + + + NOTE 7 + RELATED PARTY TRANSACTIONS + + + + + +For the six months ended June 30, 2003 and for the period from July 17, 2002 (inception) through June 30, 2003 the Company incurred consulting expenses of $246,000 and $313,000, respectively from stockholders of the Company. Also see Notes 3 and 5 for additional related party transactions. + +F-29 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + NOTE 8 + INCOME TAXES + + + + + +No provision for Federal and state income taxes has been recorded as the Company has start up costs and net operating loss carryforwards of approximately $2,074,000 to offset any future taxable income. Such carryforwards begin to expire in 2022. Under the Tax Reform Act of 1986, the amounts of and benefits from net operating losses and capital losses carried forward may be impaired or limited in certain circumstances. Events, which may cause limitations in the amount of net operating losses that the Company may utilize in any one year, include, but are not limited to, a cumulative ownership change of more than 50% over a three-year period. + + + + + +The deferred tax asset as of June 30, 2003, consisting primarily of the tax effect of net operating loss carryforwards amounted to approximately $705,000. The Company has provided a full valuation allowance on the deferred tax asset as of June 30, 2003 to reduce such deferred tax assets to zero, as it is management's belief that realization of such amounts is not considered more likely than not. + + + + + NOTE 9 + STOCK OPTIONS + + + + + +The Company has established a Stock Option Plan (the Plan ) to attract, retain and motivate key employees, to provide an incentive for them to achieve long-range performance goals and to enable them to participate in the long-term growth of the Company. Options granted under the Plan may include non-qualified stock options as well as incentive stock option intended to qualify under Section 422A of the Internal Revenue Code. The aggregate number of shares that may be issued under the Plan or exercise of options must not exceed three million shares. Each stock option agreement specifies when all or any installment of the option becomes exercisable. + + + + + +In May 2003, the Company granted stock options to an executive employee. The Company applies Accounting Principles Board ( APB ) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for option granted to employees. Under APB Opinion 25, if the exercise price of the Company's employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation cost is recognized. For the option granted in May 2003, the exercise price of each option equaled the market price of the Company's stock on the date of grant and an option expires in 10 years. + + + + + +SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure, requires the Company to provide pro forma information regarding net income and earnings per share for each period presented as if compensation cost for the Company's stock options had been determined in accordance with the fair value based method prescribed in SFAS No. 123. The Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option pricing model with the following weighted average assumptions used for the grants in May 2003; no dividend yield for all years; expected volatility of 74%; risk-free interest rate of 3%, and an expected life of 5 +years. + +F-30 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + +Under the accounting provisions of SFAS No. 123, as amended by SFAS No. 148, the Company's net loss and net loss per common share would have been as follows: + + + + + + + + + + + + + + + + + + + + For + the Six Months + + Ended June 30, 2003 + + + For + the Period From + + July 17, 2002 (Inception) + + Through June 30, 2003 + + + + + + + + + + + + + + +Net loss + +As Reported + +$ +(1,665,813 +) + +$ +(2,073,617 +) + + + + +Pro Forma + +$ +(2,151,656 +) + +$ +(2,559,460 +) + + + + + + + + + + + + + + + +Net loss per common + +As Reported + +$ +(.11 +) + +$ +(.15 +) + + +share basic + and diluted + + +Pro Forma + +$ +(.14 +) + +$ +(.19 +) + + + + + +A summary of the status of the Company s option plans as of June 30, 2003 and the changes during the period ending on that date is presented below: + + + + + + + + + + + + + +June 30, 2003 + +Shares + + +Weighted Average + + Exercise + Price + + + + + + + + + + + + +Outstanding + at inception + + + + + + +$ + + + + +Granted + + + +600,000 + + +$ +5.00 + + + +Forfeited + + + + + + +$ + + + + + + + + + + + + + +Outstanding + at June 30, 2003 + + + +600,000 + + +$ +5.00 + + + + + + + + + + + + +Options + exercisable at June 30, 2003 + + + +150,000 + + +$ +5.00 + + + + + + + + + + + + + + + + + + + + + + + +Weighted + average fair value of options granted to employees during the year + + +$ +2.46 + + + + + + + + + + + + + + + +F-31 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + +The following table summarizes information about the stock options outstanding at June 30, 2003: + + + + + + + + + + + + + + + + + + + + +Options Outstanding + +Options Exercisable + + + + + + + + + + Exercise + Price + + +Number + + Outstanding + at + + June 30, 2003 + +Weighted + Average + + Remaining + + Contractual Life + + Weighted + Average + + Exercise Price + +Number + Exercisable at + + June 30, 2003 + + Weighted + Average + + Exercise Price + + + + + + + + + + + + + + + + + + +$ +5.00 + + +600,000 + +9.83 + +$ +5.00 + +150,000 + +$ +5.00 + + + + + + NOTE 10 + STOCK WARRANTS + + + + + +On April 23, 2003, the Company entered into a one-year agreement with The Shemano Group, Inc. for investment banking and other related services. Pursuant to this agreement, the Company issued to the Shemano Group, Inc. a stock purchase warrant exercisable for a period of five years to acquire 500,000 shares of the Company's common stock at an exercise price of $6.50 per share. The warrant was valued using the Black-Scholes pricing model and resulted in a fair value of $1,274,848. The amount is being amortized over the life of the agreement resulting in consulting expense of $212,475 for the six months ended June 30, 2003. The remaining unamortized balance of $1,062,373 is presented in the accompanying condensed consolidated balance sheet as +deferred consulting expense. + + + + + NOTE 11 + COMMITMENT AND CONTINGENCIES + + + + + +(A) Lease Commitment + + + + + +The Company leases its office space under a non-cancelable operating lease agreement for a five-year term ending in December 2007. Minimum future lease payments for the next five years are as follows: + + + + + + + + + +Years Ending June 30 + + + + + + + + + + + + + +2004 + +$ +53,388 + + + +2005 + + +54,984 + + + +2006 + + +56,598 + + + +2007 + + +58,224 + + + +2008 + + +29,520 + + + + + + + + + + + +$ +252,714 + + + + + + + + + +F-32 + +Back to Contents + +DDS TECHNOLOGIES USA, INC. + +(FORMERLY FISHTHEWORLD HOLDINGS, INC.) + +AND SUBSIDIARY + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +AS OF JUNE 30, 2003 + + +Rent expense for the period from July 17, 2002 (inception) through October 31, 2002, the two months ended December 31, 2002 and the six months ended June 30, 2003, amounted to $0, $0 and $12,986, respectively. + + + + + +(B) Contingencies + + + + + +The Company granted registration rights to certain investors in the July 2, 2003 private placement of securities (See Note 12). Under those rights, if the Company does not file a registration statement within 45 days of closing, the Company owes the investors an aggregate of approximately $13,000 per month in penalties. The Company began incurring those penalties on August 16, 2003. + + + + + +(C) Litigation + + + + + +The Company is a defendant in a lawsuit whereby the plaintiff contends that it is entitled to a commission for allegedly procuring financing for a transaction. The Company filed a Motion to Dismiss the plaintiff's complaint, which has not yet been set for hearing. The plaintiff seeks damages totaling $175,584 plus interest from December 31, 2002. The Company believes the suit is without merit and is vigorously defending its position. In the opinion of management, this suit will not have a material effect on the Company's consolidated financial position or results of operations. + + + + + NOTE 12 + SUBSEQUENT EVENTS + + + + + +On July 23, 2003, the Company collected $500,000 in connection with the subscriptions receivable at June 30, 2003 (See Note 6). + + + + + +On July 2, 2003, the Company entered into stock purchase agreements with several accredited investors for additional equity capital. The Company raised a total of $1,372,000 during the initial phase. The agreement provides for the purchase of the Company's common stock at $3.50 per share plus warrants equal to one-half of the number of shares purchased. The warrants are exercisable at any time for a period of 3 years at an exercise price of $7.00 per share. The total shares issued were 392,000 and warrants for another 196,000 shares. The Company raised another $387,500 in August from additional investors under the same terms. The Company granted registration rights to the investors and is currently incurring penalties (See Note +11(B)). + + + + + +In October 2003, the Company settled a contract dispute with a consultant by issuing 60,000 shares of common stock. The settlement value was $465,000 and was determined based on the closing price of the Company's common stock on the settlement date. The amount is included in accrued professional fees in the accompanying consolidated balance sheet at June 30, 2003. + +F-33 + +Back to Contents + +INDEPENDENT AUDITOR S REPORT + +To the Board of Directors of: +Fishtheworld Holdings, Inc. and Subsidiary + +We have audited the accompanying + balance sheets of Fishtheworld Holdings, Inc. and Subsidiary as of December + 31, 2002 (consolidated) and 2001 and the related statements of operations, + changes in stockholders equity (deficiency) and cash flows for the years + then ended. 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. + +We conducted our audits in accordance + with auditing standards generally accepted in the United States of America. + Those standards require that we plan and perform the audits 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. + +In our opinion, the financial statements + referred to above present fairly in all material respects, the financial + position of Fishtheworld Holdings, Inc. and subsidiary as of December 31, + 2002 (consolidated) and 2001, and the results of their operations and their + cash flows for the years then ended in conformity with accounting principles + generally accepted in the United States of America. + +The accompanying financial statements + have been prepared assuming that the Company will continue as a going concern. + As discussed in Note 6 to the financial statements, the Company has a net + loss of $45,710 and a negative cash flow from operating activities of $26,049 + for the year ended December 31, 2002, and has a working capital deficiency + of $17,906 and a stockholders deficiency of $24,986 at December 31, 2002. + These matters raise substantial doubt about the Company s ability to continue + as a going concern. Management s plan in regards to these matters is also + described in Note 6. The financial statements do not include any adjustments + that might result from the outcome of this uncertainty. + +WEINBERG & COMPANY, P.A. + +Boca Raton, Florida +March 27, 2003 + +F-34 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +AS OF DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + +ASSETS + + + + + 2002 + + + 2001 + + + + + + + + + + +CURRENT ASSETS + + + + + + + + + +Cash + + +$ +422 + + +$ +1,891 + + +Accounts + Receivable + + + +88 + + + + + + +Inventory + + + +208 + + + + + + + + + + + + + + +TOTAL ASSETS + +$ +718 + + +$ +1,891 + + + + + + + + + + + + + + + + + + + + +LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIENCY) + + + + + + + + + + + + + + + + + + + + + + +CURRENT LIABILITIES + + + + + + + + + +Accounts + Payable And Accrued Expenses + + +$ +16,904 + + +$ + + + +Accrued + interest payable + + + +53 + + + + + + +Due + to related party + + + +1,667 + + + + + + + + + + + + + + + + + + + + +TOTAL CURRENT LIABILITIES + + +18,624 + + + + + + + + + + + + + + + + +LONG-TERM LIABILITIES + + + + + + + + + +Note + Payable Stockholder + + + +7,080 + + + + + + + + + + + + + + +TOTAL LIABILITIES + + +25,704 + + + + + + + + + + + + + + +STOCKHOLDERS EQUITY + (DEFICIENCY) + + + + + + + + + + +Common + Stock, $.001 par value, 100,000,000 shares authorized, 10,000,000 and 9,000,000 + issued and outstanding, respectively + + + +10,000 + + + +9,000 + + +Additional + paid-in capital + + + +18,033 + + + +200 + + +Deficit + + + +(53,019 +) + + +(7,309 +) + + + + + + + + + + + + + + + +Total + Stockholders Equity (Deficiency) + + + +(24,986 +) + + +1,891 + + + + + + + + + + +TOTAL + LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIENCY) + + +$ +718 + + +$ +1,891 + + + + + + + + + + + + + + + + +F-35 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY + +CONSOLIDATED STATEMENTS OF OPERATIONS + +FOR THE YEARS ENDED DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + + + +2002 + + +2001 + + + + + + + + + + +REVENUES NET + +$ +18 + + +$ +4,517 + + + + + + + + + + +OPERATING EXPENSES + + + + + + + + + +Professional + fees + + + +33,016 + + + + + + +General + and administrative + + + +9,660 + + + +2,877 + + +Executive + compensation + + + +3,000 + + + +3,000 + + + + + + + + + + + + + + + + +Total + Operating Expenses + + + +45,676 + + + +5,877 + + + + + + + + + + + + + + + + + + + + +LOSS FROM OPERATIONS + +$ +(45,658 +) + +$ +(1,360 +) + + + + + + + + + +OTHER INCOME (EXPENSE) + + + + + + + + + +Interest + income + + + +1 + + + + + + +Interest + expense + + + + +(53 +) + + + + + + + + + + + + + + + + + + + +Total Other Expenses + + +(52 +) + + + + + + + + + + + + + +NET LOSS + +$ +(45,710 +) + +$ +(1,360 +) + + + + + + + + + +NET + LOSS PER SHARE BASIC AND DILUTED + + +$ + + + +$ + + + + + + + + + + + +WEIGHTED + AVERAGE NUMBER OF SHARES OUTSTANDING BASIC AND DILUTED + + + +9,392,679 + + + +9,000,000 + + + + + + + + + + + + + + + + + + + + +F-36 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (DEFICIENCY) +FOR THE YEARS ENDED DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + + + + Common Stock + + + Additional + + Paid-In + + Capital + + + + + + + + + + + + + + + + + + + + + + + + + + + +Shares + + +Amount + + + + +Deficit + + +Total + + + + + + + + + + + + + + + + + + + +Balance, December 31, 2000 + +9,000,000 + + +$ +9,000 + + +$ +(2,800 +) + +$ +(5,349 +) + +$ +851 + + + + + + + + + + + + + + + + + + + + + + + +Contributed services compensation + + + + + + + + + +3,000 + + + + + + + +3,000 + + + + + + + + + + + + + + + + + + + + + + + +Net loss + + + + + + + + + + + + + +(1,360 +) + + +(1,360 +) + + + + + + + + + + + + + + + + + + + + + + +Distributions to stockholder + + + + + + + + + + + + + +(600 +) + + +(600 +) + + + + + + + + + + + + + + + + + + +Balance, December 31, 2001 + +9,000,000 + + + +9,000 + + + +200 + + + +(7,309 +) + + +1,891 + + + + + + + + + + + + + + + + + + + + + + + +Recapitalization of the Company + +1,000,000 + + + +1,000 + + + +(2,517 +) + + + + + + +(1,517 +) + + + + + + + + + + + + + + + + + + + + + + +Contributed capital + + + + + + + + + +17,350 + + + + + + + +17,350 + + + + + + + + + + + + + + + + + + + + + + + +Contributed services compensation + + + + + + + + + +3,000 + + + + + + + +3,000 + + + + + + + + + + + + + + + + + + + + + + + +Net loss + + + + + + + + + + + + + +(45,710 +) + + +(45,710 +) + + + + + + + + + + + + + + + + + + +BALANCE, DECEMBER 31, 2002 + +10,000,000 + + +$ +10,000 + + +$ +18,033 + + +$ +(53,019 +) + +$ +(24,986 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +F-37 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH FLOWS +FOR THE YEARS ENDED DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + + + +2002 + + +2001 + + + + + + + + + + +CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + +Net + loss + + +$ +(45,710 +) + +$ +(1,360 +) + +Adjustments + to reconcile net loss to net cash (used in) provided by operating activities: + + + + + + + + + + +Contributed services compensation + + +3,000 + + + +3,000 + + +Changes + in operating assets and liabilities: + + + + + + + + + + +(Increase) + decrease in: + + + + + + + + + + +Accounts + receivable + + + +(88 +) + + + + + +Inventory + + + +(208 +) + + + + + +Increase + (decrease) in: + + + + + + + + + + +Accounts + payable and accrued expenses + + + +16,904 + + + + + + +Accrued + interest payable + + + +53 + + + + + + + + + + + + + + + + +Net + Cash (Used In) Provided By Operating Activities + + + +(26,049 +) + + +1,640 + + + + + + + + + + +CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + +Cash received in acquisition of subsidiary + + +150 + + + + + + +Proceeds from additional capital contributed + + +17,350 + + + + + + + + + + + + + + + + + + + + +Net + Cash Provided By Investing Activities + + + +17,500 + + + + + + + + + + + + + + +CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + +Distributions + to stockholder + + + + + + + +(600 +) + +Proceeds + from note payable stockholder + + + +7,080 + + + + + + + + + + + + + + + + + + + + +Net + Cash Provided By (Used In) Financing Activities + + + +7,080 + + + +(600 +) + + + + + + + + + +NET (DECREASE) INCREASE IN CASH + + +(1,469 +) + + +1,040 + + + + + + + + + + + + +CASH BEGINNING OF YEAR + + +1,891 + + + +851 + + + + + + + + + + +CASH END OF YEAR + +$ +422 + + +$ +1,891 + + + + + + + + + + +F-38 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY +NOTES TO FINANCIAL STATEMENTS AS OF +DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + + + NOTE 1 + SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES + + + + + + + + +(A) Organization and Business Operations + + + + + +Fishtheworld Holdings, Inc. and Subsidiary (the Company ), formerly known as Fishtheworld.com, Inc., was incorporated in the State of Florida on July 13, 1998 for the purpose of providing fishing report services from around the world through the Company s website. The fishing guide locator allows users the ability to search for a fishing guide based on area, type of fish, fresh or salt water, lake, river, bay or ocean, spin or fly fishing, length or type of boat, number of people, and the cost structures associated with the trip. The Company contracts with local and regional independent service representatives and sales agents to locate and sell the guide listings and local advertising on its website. + + + + + +Under a share exchange agreement (the Agreement ) entered into on May 8, 2002, Asturias Industries, Inc., ( AI ), a reporting public company with no operations at that time, acquired 100% of the issued and outstanding Common Stock of the Company in exchange for 9,000,000 shares of Common Stock of AI. Immediately after the acquisition, there were 10,000,000 shares of AI outstanding. As a result of the exchange, the Company became a wholly owned subsidiary of AI and the shareholders of the Company became shareholders of 90% of AI. Generally accepted accounting principles in the United States of America require that the Company whose shareholders retain a majority interest in a business combination be treated as the acquirer +for accounting purposes. As a result, the exchange was treated as a recapitalization of the Company and the financial statements include the balance sheet of the accounting acquirer and the acquiree at historical cost as of December 31, 2002 and the statements of operations include the results of operations of the accounting acquirer for all periods presented and the results of operations of the acquiree from the date of merger and recapitalization. + + + + + +(B) Principles of Consolidation + + + + + +The accompanying consolidated financial statements for 2002 include the accounts of Fishtheworld Holdings, Inc. and its wholly owned subsidiary. All significant intercompany transactions and balances have been eliminated in consolidation. + + + + + +(C) Use of Estimates + + + + + +In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reported period. Actual results could differ from those estimates. + +F-39 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY +NOTES TO FINANCIAL STATEMENTS AS OF +DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + + + + (D) Inventory + + + + + + + + + + Inventory consists of deep drop + fishing lights held for sale. Inventory is stated at the lower of cost + or market value, as determined using the first in, first out method. + + + + + + + + + + At December 31, inventory consisted + of the following: + + + + + + + + + + + + + + +2002 + + +2001 + + + + + + + + + + + + +Finished goods + +$ +208 + + +$ + + + + + + + + + + + + + + + + + + + + + + +(E) Fair Value of Financial Instruments + + + + + +The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties other than in a forced sale or liquidation. The carrying amounts of the Company s trade and other receivables, accounts payable and accrued liabilities and due to related party approximates their fair value due to the short-term nature of these instruments. + + + + + +(F) Income Taxes + + + + + +Prior to the recapitalization of the Company on May 8, 2002 (See Note 1(A)), the Company, with the consent of its stockholder, had elected under the Internal Revenue Code to be an S Corporation. In lieu of corporation income taxes, the stockholder of an S Corporation is taxed on their proportionate share of the Company s taxable income. Therefore, no provision or liability for federal income taxes had been included in the financial statements for the year ended December 31, 2001 and for the period from January 1, 2002 through May 8, 2002. + + + + + +For the period subsequent to the recapitalization, May 9, 2002 to December 31, 2002, the Company accounts for income taxes under Statement of Financial Accounting Standards ( SFAS ) No. 109 Accounting for Income Taxes . Under SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The deferred tax asset arising from the Company s net operating loss +of approximately $40,000 has been fully offset by a valuation allowance. + + + + + +(G) Revenue Recognition + + + + + +The Company recognizes advertising revenues at the time the ad is placed on the Company s website. + +F-40 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY +NOTES TO FINANCIAL STATEMENTS AS OF +DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + + +(H) Loss Per Share + + + + + +Basic and diluted loss per common share for the years ended December 31, 2002 and 2001 are computed based upon the weighted average common shares outstanding. Diluted earnings per common share is computed based on the weighted average common shares and Common Stock equivalents outstanding. For 2002 and 2001, there were no Common Stock equivalents. + + + + + +(I) Website Development Expenses + + + + + +The Company follows the Emerging Issues Task Force Issue 00-2 Accounting for Web Site Development Costs in accounting for its website development expenses. Accordingly, costs that involve design of the web page and do not change the content are capitalized and amortized over their estimated useful life. Costs incurred in operating a website that have no future benefits are expenses in the current period. Costs incurred in operating the website which have a future benefit are capitalized in accordance with the AICPA s Statement of Position 98-1 and amortized over the respective future periods which are expected to benefit from the changes. As of December 31, 2002 and 2001, no website costs or expenses have been +capitalized. + + + + + +(J) Recent Accounting Pronouncements + + + + + +The Financial Accounting Standards Board ( FASB ) has recently issued several new Statements of Financial Accounting Standards. + + + + + +SFAS No. 143 Accounting for Asset Retirement Obligations establishes standards for the initial measurement and subsequent accounting for obligations associated with the sale, abandonment, or other type of disposal of long-lived tangible assets arising from the acquisition, construction, or development and/or normal operation of such assets. SFAS No. 143 is effective for fiscal years beginning after June 15, 2001, with earlier application encouraged. + + + + + +In August 2001, the FASB issued SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 replaces SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The FASB issued SFAS 144 to establish a single accounting model, based on the framework established in SFAS 121, as SFAS 121 did not address the accounting for a segment of a business accounted for as a discontinued operation under APB 30, Reporting The Results of Operations Reporting The Effects of Disposal of a Segment of a Business, and Extraordinary Unusual and Infrequently Occurring Events and Transactions. SFAS144 also resolves significant implementation issues +related to SFAS 121. Companies are required to adopt SFAS 144 for fiscal years beginning after December 15, 2001, but early adoption is permitted. We will adopt SFAS 144 as of the beginning of fiscal 2003. + +F-41 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY +NOTES TO FINANCIAL STATEMENTS AS OF +DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + + +In April 2002, the FASB issued SFAS No. 145 Rescission of FASB Statement Nos. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections . This statement rescinds SFAS 4, Reporting Gains and Losses from Extinguishment of Debt and an amendment of that statement, SFAS 64, Extinguishments of Debt Made to Satisfy Sinking Fund Requirements . The statements also rescinds SFAS 44, Accounting for Intangible Assets of Motor Carriers and amends SFAS 13- Accounting for Leases to eliminate an inconsistency between the required accounting for sale-leaseback transactions. SFAS 145 also amends other existing authoritative pronouncements to make various technical corrections, +clarify meanings, or describe their applicability under changed conditions. SFAS 145 is effective for fiscal years beginning after May 15, 2002 and to certain transactions occurring after that date. + + + + + +In July 2002, the FASB issued SFAS No. 146 Accounting for Costs Associated with Exit or Disposal Activities . This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including certain costs incurred in a restructuring) . SFAS 146 requires that a liability for a cost associated with exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of the entity s commitment to the exit plan. SFAS 146 is effective +for fiscal years beginning after December 31, 2002, with early application encouraged. + + + + + +In December 2002, the Financial Accounting Standards Board issued Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure an amendment of FASB Statement No. 123, ( SFAS 148 ). SFAS 148 amends FASB Statement No. 123, Accounting for Stock Based Compensation ( SFAS 123 ) and provides alternative methods for accounting for a change by registrants to the fair value method of accounting for stock-based compensation. Additionally, SFAS 148 amends the disclosure requirements of SFAS 123 to require disclosure in the significant accounting policy footnote of both annual and interim financial statements of the method of accounting for stock based-compensation and the related +pro forma disclosures when the intrinsic value method continues to be used. The statement is effective for fiscal years beginning after December 15, 2002, and disclosures are effective for the first fiscal quarter beginning after December 15, 2002. + + + + + +The adoption of these pronouncements is not expected to have a material effect on the Company s consolidated financial position or results of operations. + + + + +NOTE 2 + + DUE TO RELATED PARTY + + + + + +The amount due to related party represents advances made to the Company by an entity controlled by a stockholder of the Company. The amount is non-interest bearing, unsecured and due on demand. + + + + +NOTE 3 + NOTE PAYABLE STOCKHOLDER + + + + + +The Company has a note payable to a stockholder in the amount of $7,080 as of December 31, 2002. The stockholder consented to defer repayment on the outstanding balance until January 31, 2004. The note accrues interest at 6% per annum from November 11, 2000. As of December 31, 2002, $53 has been recorded as an expense and is included in accrued interest payable. + +F-42 + +Back to Contents + +FISHTHEWORLD HOLDINGS, INC. AND SUBSIDIARY +NOTES TO FINANCIAL STATEMENTS AS OF +DECEMBER 31, 2002 (CONSOLIDATED) AND 2001 + +NOTE 4 + COMMON STOCK + + + + + +The Company was originally authorized to issue 10,000,000 shares of Common Stock having a par value of $0.001. In May 2002, an amended Articles of Incorporation was filed with the State of Florida to increase its authorized shares of Common Stock to 100,000,000 shares. As of December 31, 2002, after the recapitalization discussed in Note 1(A), there are 10,000,000 shares issued and outstanding. + + + + +NOTE 5 + + CONTRIBUTED SERVICES + + + + + +During the years ended December 31, 2002 and 2001, the stockholder/officer of the Company contributed his services to the business which had a fair value of $3,000 and $3,000, respectively. Such contributed services have been reflected as additional paid-in capital in the statement of changes in stockholders equity. + + + + + NOTE 6 + GOING CONCERN + + + + + +The Company s financial statements as of and for the years ended December 31, 2002 and 2001 have been prepared on a going concern basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company incurred a net loss of $45,710 and a negative cash flow from operating activities of $26,049, and has a working capital deficiency of $17,906 and a stockholders deficiency of $24,986 as of December 31, 2002. The Company s working capital deficiency as of December 31, 2002 may not enable it to meet such objectives as presently structured. The financial statements do not include any adjustments that might result form the outcome of this +uncertainty. + + + + + +The ability of the Company to continue as a going concern is dependent on the Company s ability to raise additional capital, commence profitable operations and implement its business plan. Management believes the Company will become profitable with the commencement of additional revenue producing operations during 2003. + +F-43 + +Back to Contents + +ROBERT JARKOW +CERTIFIED PUBLIC ACCOUNTANT + +3111 North Andrews Avenue +Fort Lauderdale, Florida 33309 + +(954) 630-9070 + +INDEPENDENT AUDITOR S REPORT + +To the Board of Directors +DDS Holdings, Inc. + + I have audited the accompanying balance sheet of DDS Holdings, + Inc. and Subsidiary (a development stage company) as of November 14, 2002 + and the related statements of operations, shareholders equity, and cash + flows for the year ended October 31, 2002, and the period ending November + 14, 2002. These financial statements are the responsibility of the Company s + management. My responsibility is to express an opinion on these financial + statements based on my audits. + + I conducted my audits in accordance + with auditing standards generally accepted in the United States of America. + Those standards require that I 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. I believe + that my audit provides a reasonable basis for my opinion. + + In my opinion, the financial statements + referred to above present fairly, in all material respects, the financial + position of DDS Holdings, Inc. and Subsidiary (a development stage company) + as of November 14, 2002, and the results of its operations and cash flows + for year ended October 31, 2002, and the period ending November 14, 2002, + in conformity with accounting principles generally accepted in the United + States of America. + +November 10, 2002 + +F-44 + +Back to Contents + +DDS HOLDINGS, INC. and SUBSIDIARY +(A DEVELOPMENT STAGE COMPANY) +BALANCE SHEET + + November 14, 2002 + + ASSETS + + + + + + + + +Current Asset + + + + + +Cash + + +$ +256,564 + + + + + + + + +Total + current asset + + +$ +256,564 + + + + + + + + +License + + +4,000,000 + + + + + + + + + + + + +$ +4,256,564 + + + + + + + + + + + + + + + + + SHAREHOLDERS EQUITY + + + + + + + + +Preferred + stock-$.0001 par value; 10,000,000 Shares Authorized; + + no shares issued and outstanding + + +$ +-0- + + +Common + Stock-$.001 par value; 25,000,000 Shares authorized; + + 13,911,525 shares issued and outstanding + + + +4,324,563 + + +Deficit + accumulated during the development stage + + + +-67,999 + + + + + + + + + + +Total + shareholders equity + + + +4,256,564 + + + + + + + + + + + + +$ + 4,256,564 + + + + + + + + + + +The accompanying notes are an integral part of these financial statements. + +F-45 + +Back to Contents + +DDS HOLDINGS, INC. and SUBSIDIARY +(A DEVELOPMENT STAGE COMPANY) +STATEMENTS OF OPERATIONS + +Year Ended October 31, 2002 +Period Ended November 14, 2002 +Inception (June 11, 1998) to November 14, 2002 + + + + November 14, + + 2002 + + + October 31, + + 2002 + + + (Deficit) + + accumulated during + + the development stage + + + + + + + + + + + + + +Revenues + +$ +-0- + + +$ +-0- + + +$ +-0- + + +General + and administrative expenses + + + +2,507 + + + +62,975 + + + +67,999 + + + + + + + + + + + + + + + + + + + + + + + + + + + +Net + (loss) + + +$ +-2,507 + + +$ +-62,975 + + +$ +-67,999 + + + + + + + + + + + + + + + + +Net + (loss) per share-basic and diluted + + +$ +-0.0002 + + +$ +-0.0189 + + +$ +-0.0053 + + + + + + + + + + + + + + + + +Weighted + average number of shares outstanding during the period- diluted and undiluted + + + +12,866,848 + + + +3,328,136 + + + +12,866,848 + + +The accompanying notes are an integral part of these financial statements. + +F-46 + +Back to Contents + +DDS HOLDINGS, INC. and SUBSIDIARY +(A DEVELOPMENT STAGE COMPANY) +STATEMENT OF SHAREHOLDERS EQUITY + +Inception (June 11, 1998) to November 14, 2002 + + + +Common Stock + + + + + + + + + + + + + + + + + +Shares + + + Amount + + + (Deficit) + + accumulated during + + the development stage + + + + + + + + + + + + + + + + + +Balance October 31, 2002 + +9,445,629 + + +$ +1,845 + + +$ +-2,517 + + +Stock + sold for cash, net of costs + + +765,896 + + + +682,718 + + + + + +Stock + issued for license + + +3,500,000 + + + +3,500,000 + + + + + +Net + (loss) for the year ended October 31, 2002 + + + + + + + + + +-62,975 + + + + + + + + + + + + + + + +Balance October 31, 2002 + +13,711,525 + + + +4,184,563 + + + +-65,492 + + +Stock + sold for cash + + +200,000 + + + +200,000 + + + + + +Acquisition + of public shell + + + + + + +-60,000 + + + + + +Net + (loss) for period ended November 14, 2002 + + + + + + + + + +-2,507 + + + + + + + + + + + + + + + +Balance November 14,2002 + +13,911,525 + + +$ +4,324,563 + + +$ +-67,999 + + + + + + + + + + + + + + + + + + + + +The accompanying notes are an integral part of these financial statements. + +F-47 + +Back to Contents + +DDS HOLDINGS, INC. and SUBSIDIARY +(A DEVELOPMENT STAGE COMPANY) +STATEMENTS OF CASH FLOWS + +Year Ended October 31, 2002 +Period Ended November 14, 2002 +Inception (June 11, 1998) to November 14, 2002 + + +November 14, + + 2002 + + +October 31, + + 2002 + + +Cash Flows + + during the + + development stage + + + + + + + + + + + + + +Cash + flows from operating activities + + + + + + + + + + + + + + +Net + (loss) + + +-$ +2,507 + + +-$ +62,975 + + +-$ +67,999 + + + + + + + + + + + + +Net + cash (used) by operating activities + + + +-2,507 + + + +-62,975 + + + +-67,999 + + +Cash + flows from investing activities + + + + + + + + + + + + + + +Cash + paid for license + + + + + + + +-500,000 + + + +-500,000 + + + + + + + + + + + + +Net + cash (used) by investing activities + + + + + + + +-500,000 + + + +-500,000 + + +Cash + flows from financing activities + + + + + + + + + + + + + + +Sale + of common stock for cash + + + +200,000 + + + +681,896 + + + +884,563 + + +Acquisition + of public shell + + + +-40,000 + + + +-20,000 + + + +-60,000 + + + + + + + + + + + + +Net + cash provided by financing activities + + + +160,000 + + + +661,896 + + + +824,563 + + + + + + + + + + + + +Net + increase in cash + + + +157,493 + + + +98,921 + + + +256,564 + + +Cash-beginning + + + +99,071 + + + +150 + + + +-0- + + + + + + + + + + + + +Cash-ending + + +$ + 256,564 + + +$ + 99,071 + + +$ + 256,564 + + +Non-cash + investing activities + + Common stock issued for license + + + + + + +$ + 3,500,000 + + + +$ + 3,500,000 + + +F-48 + +Back to Contents + +DDS HOLDINGS, INC. and SUBSIDIARY +(A DEVELOPMENT STAGE COMPANY) + +NOTES TO FINANCIAL STATEMENTS +NOVEMBER 14, 2002 + +NOTE 1. PUBLIC ENTITY + + On November 14, 2002, an inactive + public shell corporation, Black Diamond Industries, Inc. (formed June 11, + 1998), with no assets or liabilities, was acquired by a privately held + company (formed July 17, 2002) which had no revenue and is in the development + stage. + + The owners of the private company + received 90% of the public entity in exchange for 100% of their stock in + the private company and the privately owned company became a subsidiary + of the public entity. The public company changed its name to DDS Holdings, + Inc. + + The transaction was accounted for + as a reverse acquisition, which is a capital transaction and not a business + combination. Accordingly, the recorded assets, liabilities, and operations + of the private company were carried forward at historical amounts and the + equity has been restated to give effect to the transaction from inception. + +NOTE 2. SUMMARY OF SIGNIFICANT + ACCOUNTING POLICIES + +Nature of Operations + + On August 29, 2002, the Company + acquired a license to market a technology know as Longitudinal Micrometric + Separator For Classifying Solid Particulate Materials . See Note 3. + + The license is for technology that + has recently been developed. Management has not yet determined the useful + life of the license. + + Operations to date have consisted + of acquisition of the license and the development of a marketing plan. + +Use of Estimates + + Use of estimates and assumptions + by management is required in the preparation of financial statements in + conformity with generally accepted accounting principles. Actual results + could differ from those estimates and assumptions. + +Cash Concentration + + The Company maintains its cash + in bank deposit accounts which may exceed the $100,000 federally insured + limits. + +F-49 + +Back to Contents + +Loss Per Share + + Loss per share is calculated by + dividing net loss by the average number of shares outstanding during the + period. + + At November 14, 2002 there are + no shares that would cause a dilution of loss per share. + +NOTE 3. LICENSE + + On August 29, 2002, the Company + (the licensee) entered into an agreement with DDS Technology, Ltd (the + licensor, a United Kingdom company) which is the owner of a European patent + application dated May 28, 2002. The agreement grants to the Company use + of the technology in the geographic area of North, Central, and South America, + (excluding Cuba) and the right of first refusal for other areas or should + either entity decide to sell their company. + + The technology is used to convert + discarded waste materials and residuals of the production of pharmaceutical, + cosmetic, and food production, using grain or other products, to produce + a stabilizing effect on the product. + + The agreement will expire on May + 28, 2022. The Company paid $500,000 cash plus 3,500,000 shares of its common + stock- valued at $1 per share- which was the fair market value of common + stock sold under Regulation D of the Securities and Exchange Act (see Note + 6.). + + The agreement also allows the licensor + to one member on the board of directors. + + The Company will pay: (1) 24% of + the net profits derived from the licensing and rental of the technology, + or (2) 49% of the net profits derived from the sale of materials that are + produced by machines utilizing the technology, and (3) 2% of the net profits + of the technology to a charity designated by the licensor. Net profit is + determined using generally accepted accounting principles of the United + States of America. + + This agreement can be terminated + by either party upon the others default if not corrected within 60 days. + + The laws of the United Kingdom + will govern until the Company becomes publicly traded, after which the + laws of the State of Florida will govern. + +NOTE 4. OPERATING FACILITIES + + On October 25, 2002, the Company entered into a five year lease for office space expiring on October 25, 2007 (with options expiring through 2013). Occupancy is anticipated be in January 2003. A security deposit of $5,000 due upon occupancy. Minimum lease commitments are as follows: 2003 is $32,060; 2004 is $33,031; 2005 is $34,003; 2006 is $34,974; 2007 is $35,946. + +F-50 + +Back to Contents + +NOTE 5. INCOME TAX + + At November 14, 2002, the Company + had net operating loss carryforwards, of approximately $68,000, available + to offset taxable income through 2017. The deferred tax benefit of the + net operating loss carryforwards, of approximately $10,000, has been fully + reserved for due to the uncertainty of its recognition. + + At November 14, 2002, there are + no items that give rise to deferred income taxes. + +NOTE 6. COMMON STOCK + + In July 2002, the Company began + a private placement offering of 2,500,000 shares of its common stock at + $1 per share. As of November 14, 2002, 965,896 shares have been sold. The + costs of \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001102741_stec-inc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001102741_stec-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1c71baeb4019e97e0fa7fe7122952be703ef50ea --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001102741_stec-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Squire, Sanders & Dempsey L.L.P., Los Angeles, California. Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California, is acting as counsel for the underwriters in connection with selected legal matters relating to the shares of common stock offered by this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001107573_msc-group_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001107573_msc-group_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..50b47bef633e3b3cde70583dde2efdb649c15a51 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001107573_msc-group_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Cassidy & Associates, Washington, D.C., has given its opinion as attorneys-at-law that the shares of common stock offered by the selling securityholders are fully paid, validly issued and non-assessable. James M. Cassidy, a principal of Cassidy & Associates, is the beneficial shareholder of 500,000 shares of the common stock of MSC Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001114084_intervideo_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001114084_intervideo_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7aa1790a8162fc9fd4821bcc75e79225142f6f04 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001114084_intervideo_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Wilson Sonsini Goodrich & Rosati, a professional corporation, Palo Alto, California, will pass for us on the validity of the common stock offered hereby. O Melveny & Myers LLP, Menlo Park, California, is acting as counsel for the underwriters in connection with selected legal matters relating to the shares of common stock offered by this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001121732_infinity_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001121732_infinity_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001121732_infinity_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001121734_custom_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001121734_custom_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001121734_custom_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001121735_pci-newco_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001121735_pci-newco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001121735_pci-newco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001121740_decrane_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001121740_decrane_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001121740_decrane_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001121741_decrane_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001121741_decrane_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001121741_decrane_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001121742_dah-ip_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001121742_dah-ip_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001121742_dah-ip_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001121743_dah-ip_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001121743_dah-ip_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001121743_dah-ip_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001121744_carl-f_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001121744_carl-f_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001121744_carl-f_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001126499_crystal_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001126499_crystal_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..baf643d942b44ea8f1be1023d1a43fbf5453bc3f --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001126499_crystal_legal_matters.txt @@ -0,0 +1 @@ +(1) We report our financial results on a fiscal year of 52 or 53 weeks ending on the Friday closest to June 30. All fiscal years were 52 weeks. (2) Fiscal 1999 and fiscal 2000 are presented as if we existed as a separate entity during those periods. (3) The net losses included unusual items of $86.7 million in fiscal 1999, $242.6 million in fiscal 2000 and $1.9 million in fiscal 2001. The unusual item in fiscal 1999 related to an exchange of shares between Old Seagate and some of our former employees in June 1999. The net losses included restructuring charges of $1.3 million in fiscal 2000 and $573,000 in fiscal 2001. These unusual items and restructuring charges are described in more detail in the notes to our financial statements and in Management s Discussion and Analysis of Financial Condition and Results of Operations Results of Operations . (4) On November 22, 2000, we became a majority owned subsidiary of New SAC. The purchase price under this transaction was allocated to our assets and liabilities based on their relative fair values on that date. As of June 27, 2003 Table of Contents implementation. The implementation process to date has involved greater than anticipated expenditures of technical, financial and management resources. While we initially anticipated that the remaining regional implementation would be completed by the end of fiscal 2003, we now believe that implementation may not be completed until the end of calendar 2003. Further difficulties may delay completion of the implementation even longer. We also anticipate that we will need to expend greater time, money and resources than we originally expected. If we continue to experience further difficulties in the implementation, this could: result in significant and unexpected increases in our operating expenses; complicate and prolong our internal data gathering and analysis processes; require us to restructure or develop our internal processes to adapt to the new system; result in extended work hours for our employees and the temporary use of outside resources, with a resulting increase in expenses, to resolve any software configuration issues or to process transactions manually until issues are resolved; result in the loss of management focus as attention paid to implementation is diverted from other issues; and cause disruption of our operations if the transition to the new enterprise resource planning system creates new or unexpected difficulties or if this system does not perform as expected. We may not be able to operate our business successfully as it grows, if we are unable to improve our internal systems, processes and controls. In order to operate our business successfully as it grows, we need to improve our internal systems, processes and controls. In order to achieve this, we are increasingly relying on technical systems such as sales prospects management systems, technical support systems, scheduling systems and order entry systems. If we have difficulty providing and managing our internal systems, processes and controls, these difficulties could disrupt existing customer relationships, causing us to lose customers, limit us to smaller deployments of our products or increase our technical support costs. We derive a material portion of our revenues from customers outside of North America, and our failure to address the difficulties associated with marketing, selling and supporting our products outside North America could cause our sales to decline. We have significant international operations including development facilities, sales personnel and customer support operations. Our primary product development facilities are located in Vancouver, Canada and Ipswich, England. We derived 26% of our total revenues in fiscal 2001, 2002 and 2003 from sales outside of North America. Our international operations are subject to certain inherent risks including: exchange rate fluctuations and the impact on pricing of our products and our expenses; increases in tariffs, duties, price controls, restrictions on foreign currencies or trade barriers imposed by foreign countries such as import and export restrictions; technical difficulties associated with product localization; lack of experience in certain geographic markets; longer payment cycles for sales in certain foreign countries; seasonal reductions in business activity in the summer months in Europe and certain other countries; Table of Contents the significant presence of some of our competitors in some international markets; potentially adverse tax consequences; management, staffing, legal and other costs of operating an enterprise spread over various countries; political instability in the countries where we are doing business; and fears concerning SARS or other travel or health risks that may adversely affect our ability to sell our products and services in any country in which the business sales culture encourages face-to-face interactions. These factors could have an adverse effect on our business, results of operations and financial condition. In addition, we intend to continue to invest resources to expand our sales and support operations into strategic international locations such as the People s Republic of China. If the revenues generated by these operations are not adequate to offset the expense of establishing these foreign operations, our business, results of operations and financial condition could be materially harmed. Our ability to pay dividends and engage in other transactions may be limited if we do not receive Comerica Bank California s consent because we are subject to limitations under our revolving line of credit. In October 2002, we executed an agreement with Comerica Bank California for a $15.0 million revolving line of credit. As of June 27, 2003 and the date of this document, we did not have any outstanding borrowings under the revolving line. Subject to limited exceptions, we are restricted in our ability to pay dividends by the covenants contained in our revolving loan agreement with Comerica. We are permitted to repurchase stock and/or pay cash dividends in an aggregate amount not to exceed $2.0 million during the term of the agreement, provided that we are not in default under the agreement and that a default would not occur immediately after payment of the dividend. We may be unable to repurchase stock or pay dividends in excess of those amounts if Comerica does not agree. The terms of the revolving line also require us, among other things, to maintain quarterly financial covenants related to liquidity, minimum tangible net worth and quarterly free cash flow. We are restricted from selling, leasing or otherwise disposing of any part of our business or property under most circumstances. In addition, the agreement places restrictions on entering into arrangements that will result in a change of control and restricts our ability to incur specified forms of indebtedness. We are also restricted from making some types of distributions or investments. We are also required to maintain at least an aggregate of $10.0 million in investment accounts with Comerica and some of its affiliates. We may not be able to engage in these types of transactions, such as the sale of debt securities, unless we obtain Comerica s consent. A potential acquirer, lender or other strategic party may be reluctant to enter into an arrangement with us that contemplates any of these transactions unless we obtain Comerica s consent. If we are unable to obtain consent or cannot obtain consent in a timely manner, the other party may not elect to proceed with a transaction that we believe to be in our stockholders best interests. We may be obligated to indemnify our customers if they are subject to third party claims and any indemnification obligation could hurt our results of operations and harm our reputation. Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. Existing or future United States federal or state laws, foreign laws or unfavorable judicial decisions may make these provisions ineffective. Because our products are used with enterprise software systems and databases, our liability Table of Contents could be substantial if we receive an unfavorable judgment. In addition, our insurance against product liability may not be adequate to cover a potential claim. We are a party to litigation, including an action commenced by Vedatech Corporation in the United Kingdom, which could cause us to incur expenses to defend ourselves, and in the event of an adverse judgment against us in any litigation, we may have to pay damages, which could affect our liquidity. In November 1997, Vedatech commenced an action in the Chancery Division of the High Court of Justice in the United Kingdom against Crystal Decisions (UK) Limited, our wholly owned subsidiary. The liability phase of the trial was completed in March 2002, and we prevailed on all claims except for a quantum meruit claim. The court ordered the parties to mediate the amount of that claim and we came to a mediated settlement with Vedatech in August 2002. The mediated settlement was not material to our operations and contained no continuing obligations. In September 2002, however, we received notice that Vedatech is seeking to set aside the settlement. In April 2003, we filed an action in the High Court of Justice seeking a declaration that the mediated settlement agreement is valid and binding. In October 2003, Vedatech filed an action against us, Crystal Decisions (UK) Limited and Susan J. Wolfe in the United States District Court, Northern District of California, San Jose Division, alleging that the August 2002 mediated settlement was induced by fraud and that the defendants engaged in negligent misrepresentation and unfair competition. Although we believe that Vedatech s basis for seeking to set aside our mediated settlement and its claims in the October 2003 complaint are meritless, the outcome cannot be determined at this time. If our mediated settlement were to be set aside, or we were to be found liable in the October 2003 action, a negative outcome could adversely affect our business, results of operations and financial condition. In addition to the foregoing, we are subject to other litigation in the ordinary course of our business. While we believe that the ultimate outcome of these matters will not have a material adverse effect on us, the outcome of these matters is not determinable and negative outcomes may adversely affect our business, results of operations and financial condition. Risks Related to our Relationship with New SAC and Seagate Technology that Will Impact Us if the Proposed Acquisition Does Not Occur If we are compelled to pay any indemnity claims by VERITAS, our assets could be depleted substantially. In a series of transactions that took place in November 2000, New SAC purchased the operating business of Old Seagate, including the business intelligence software business that we now operate. In a concurrent transaction, Old Seagate and Seagate Software Holdings, our former parent, were sold to VERITAS. In connection with these transactions, New SAC and certain of its affiliates, including us, agreed to indemnify VERITAS, Old Seagate and some of their affiliates for substantially all liabilities arising in connection with our operating assets. Although we have agreed with Seagate Technology and several of its affiliates on a methodology to allocate liability, our liability, like Seagate Technology s, is not capped. As a result, we continue to face possible liability for actions, events or circumstances arising or occurring both before and after the November 2000 transactions. Some areas of potential liability include: tax liabilities; obligations under federal, state and foreign pension and retirement benefit laws; and existing and future litigation. Table of Contents In the event that our indemnity obligations are triggered, we could experience a material adverse effect on our business and financial condition. Our directors may have conflicts of interest because of their ownership of capital stock of, and their board membership or employment with, New SAC and its other affiliates. Many of our directors own interests in our majority stockholder, New SAC, and some of them hold shares and options to purchase the capital stock of Seagate Technology. Ownership of New SAC or Seagate Technology could create, or appear to create, potential conflicts of interest when our directors are faced with decisions that could have different implications for us and for New SAC or its other affiliates. Some of our directors also serve on the boards of directors of New SAC, Certance Holdings, a removable tape storage company and an affiliate of New SAC, and Seagate Technology. Several of our directors also serve as officers of those entities, as well as other affiliates of New SAC. We expect that some of our directors will continue to spend a substantial portion of their time on the affairs of New SAC and Seagate Technology, for which those entities may pay our directors director fees or other compensation. In view of these overlapping relationships, conflicts of interest may exist or arise with respect to existing and future business dealings, including the relative commitment of time and energy by our directors to us and New SAC and Seagate Technology, potential acquisitions of businesses or properties and other business opportunities, the issuance of additional capital stock, the election of new or additional directors or the payment of dividends by us. We cannot assure you that any conflicts of interest will be resolved in our favor. Because New SAC controls our board of directors and owned 98.4% of our outstanding stock as of October 17, 2003, your ability to influence corporate matters is greatly limited. New SAC beneficially owned approximately 98.4% of our outstanding common stock as of October 17, 2003, and we expect New SAC to continue to own a substantial number of shares of the combined company after the acquisition. In addition, the shareholders of New SAC are parties to a shareholders agreement governing the ownership of New SAC s stock. These arrangements result in New SAC and the New SAC shareholders acting together with respect to matters submitted to our stockholders. Through its influence on our board of directors and as a majority stockholder, New SAC has the ability to determine the direction of our business, our operating budget, whether to pursue possible acquisitions, whether to pursue a sale of our company and other matters, including all matters submitted to our stockholders. For example, New SAC and its wholly owned subsidiary, Seagate Software (Cayman) Holdings, have delivered actions by written consent to Business Objects for the purpose of effecting the proposed acquisition, and the number of shares represented by those consents are sufficient to approve the proposed acquisition. Stockholders who are opposed to the merger would have appraisal rights as their remedy. New SAC and the shareholders of New SAC may be the largest single stockholder of the combined company after the acquisition is completed and for the foreseeable future and may decide not to enter into a transaction in which you would receive consideration for your Business Objects shares that is much higher than the cost to you or the then-current market price of those shares. In addition, New SAC and New SAC s shareholders could elect to sell a controlling interest in us and you may not have a right to participate in the sale. Any decision regarding their ownership of us or Business Objects that New SAC and its shareholders may make at some future time will be in their absolute discretion. Table of Contents FORWARD-LOOKING STATEMENTS This document, including the sections entitled Questions and Answers about the Recission Offer , Summary , Risk Factors , Management s Discussion and Analysis of Financial Condition and Results of Operations and Business , contains forward-looking statements. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements. These risks and other factors include those listed under Risk Factors and elsewhere in this document. In some cases, you can identify forward-looking statements by terminology such as may , will , should , expects , intends , plans , anticipates , believes , estimates , predicts , potential , continue or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks outlined under Risk Factors . These factors may cause our actual results to differ materially from any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this document to conform our prior statements to actual results. DIVIDEND POLICY We have never declared or paid any dividends on our capital stock. We currently expect to retain any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Subject to limited exceptions, we are restricted in our ability to pay dividends by the covenants contained in our revolving loan agreement with Comerica. We are permitted to repurchase stock and/or pay cash dividends in an aggregate amount not to exceed $2.0 million during the term of the Comerica agreement, provided that we are not in default under the agreement and that a default would not occur immediately after payment of the dividend. Table of Contents be assumed and instead will accelerate and become fully vested and exercisable and, to the extent not exercised as of the closing of the proposed acquisition, will terminate and be of no force and effect. Holders of our stock options at closing will not be entitled to receive any cash either in consideration for or upon exercise of their stock options. Consideration Table. The per share merger consideration to be paid to holders of our common stock and holders of Seagate Software (Cayman) Holdings common stock and the exchange ratio for our stock options will be determined shortly before the closing of the proposed acquisition and will depend on: the number of shares of our common stock and stock options outstanding as of the closing of the proposed acquisition; the proceeds that we receive from options exercised between July 18, 2003 and the closing of the proposed acquisition; and the average closing prices for Business Objects ADSs on the Nasdaq National Market for the 10 trading days ending on the third day prior to the closing of the proposed acquisition. The following table sets forth, by way of example, calculations of the common stock exchange ratio, the per share cash consideration and the option exchange ratio based on the following facts and assumptions: there were 76,225,451 shares of our common stock outstanding as of October 3, 2003, and, for the purposes of this analysis, it is assumed that no additional shares of our common stock will be issued prior to the closing of the proposed acquisition, other than upon the exercise of stock options; between July 18, 2003 and October 3, 2003, 118,646 of our stock options were exercised, resulting in aggregate cash proceeds of $490,028; all options granted under the United Kingdom sub-plan of our 1999 stock option plan and our 2000 stock option plan, and all options held by our nonemployee directors will be exercised in full prior to the closing, resulting in the issuance of an aggregate of 4,487,579 additional shares of our common stock and aggregate cash proceeds of $18,830,316; of the options granted under our 1999 stock option plan as of October 3, 2003, options exercisable for an aggregate of 8,007,323 shares of our common stock at a weighted average exercise price of $5.98 will not vest prior to the closing of the proposed acquisition (which, solely for such purpose, is assumed to occur on December 31, 2003), and options exercisable for an aggregate of 7,862,038 shares of our common stock at a weighted average exercise price of $5.98 will vest prior to the closing of the proposed acquisition; and the average closing price of Business Objects ADSs on Nasdaq National Market for the 10 trading days prior to and including the third trading day prior to the closing will be between $15.00 and $40.00 All Vested 1999 Plan No Vested 1999 Plan 10 Trading Day Average Price Options are Exercised Options are Exercised In addition to the 76,091,581 shares of common stock outstanding as of June 27, 2003, we may issue additional shares of common stock including: 17,828,827 shares of common stock issuable upon exercise of options outstanding at a weighted average exercise price of $4.62 per share as of June 27, 2003; 2,786,694 shares of common stock issuable upon exercise of options at a weighted average exercise price per share of $11.74 that we granted between June 28, 2003 and October 17, 2003; and a total of 6,394,333 shares of common stock available for future issuance under our various stock plans as of October 17, 2003, excluding the annual increases in the number of shares authorized under each of our stock plans beginning July 3, 2004. See Executive Compensation Incentive Plans for a description of how these annual increases are determined. The number of shares subject to outstanding options to acquire our common stock set forth above includes the following options that will become fully vested and exercisable before the closing of our proposed acquisition by Business Objects and terminate to the extent those options are not exercised before the effective time of the proposed acquisition. Options to purchase: 103,450 shares of our common stock at a weighted average exercise price per share of $4.00 per share that are issued and outstanding pursuant to our 2000 stock option plan that were granted to employees of Old Seagate; 649,312 shares our common stock at a weighted average exercise price per share of $4.00 per share that are issued and outstanding under the U.K. sub-plan to our 1999 stock option plan; and 3,742,917 shares of our common stock at a weighted average exercise price of $4.24 per share that are issued and outstanding under our 1999 stock option plan and held by our non-employee directors. We expect to record a dividend in connection with the vesting and exercisability of the options outstanding under the 2000 stock option plan. We do not expect the vesting and exercisability of the other options set forth above to result in compensation expense or a dividend. You should read this table together with the sections of this document entitled Selected Financial Data and Management s Discussion and Analysis of Financial Condition and Results of Operations and with our financial statements and related notes beginning on page F-1. (in thousands) Balance Sheet Data: Cash, cash equivalents and short-term investments $ 7,419 $ 3,621 $ 34,379 $ 71,451 $ 104,703 Restricted cash 2,019 Working capital (deficit) (11,163 ) 8,860 10,750 26,426 49,762 Total assets 79,820 72,545 105,126 136,846 208,698 Long-term liabilities 459 381 3,600 2,575 3,090 Total stockholders equity 2,883 23,113 35,609 41,452 75,756 Table of Contents MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read together with the audited consolidated financial statements and the notes thereto and other information included elsewhere in this document. Overview General We provide business intelligence software and services that enable the effective use and management of information within and among organizations. Our revenues are derived primarily from licensing fees for software products and, to a lesser extent, fees for services relating to these products, including maintenance, technical support, training and consulting. We sell our software products through two channels: directly to end user customers through our sales force and indirectly through resellers, original equipment manufacturers, systems integrators and distributors, including independent software vendors. Original equipment manufacturers, which are independent software vendors and hardware vendors, generally integrate our products with theirs or resell them with their products. Our other indirect vendors resell our software products to end user customers. We operate and report financial results on a fiscal year of 52 or 53 weeks ending on the Friday closest to June 30. Accordingly, fiscal 2001 ended on June 29, 2001, fiscal 2002 ended on June 28, 2002 and fiscal 2003 ended on June 27, 2003. Fiscal 2001, 2002 and 2003 were each comprised of 52 weeks. Sources of Revenues Licensing revenues. We generate licensing revenues from the sale of licenses to use our software products. We price our products on a per user, processor or concurrent user basis. We generally do not sell licenses for our products on a time or subscription basis. We currently operate with virtually no order backlog because our software products are typically delivered shortly after orders are received. Licensing revenues in any quarter are substantially dependent on orders booked and delivered in that quarter. Historically, we have recognized a substantial portion of our revenues in the last month of a quarter. As we sell more large-scale deployments of our products, orders may become larger and the impact of the longer sales cycle of these deployments may make our revenues harder to predict. Maintenance, support and services revenues. Our maintenance revenues are derived from selling rights to existing customers to receive product upgrades, when and if we make them available. Our maintenance agreements generally have a term of one year. Customers may renew their maintenance agreements for additional consecutive periods. Our technical support revenues are derived from fees charged to customers for post-sales efforts. We sell technical support services under several different programs generally on a 12-month basis, on a fee for use, fixed price or a per incident basis. Our professional services organization generates revenues for training and consulting to plan and execute the deployment of our products and accelerate end user adoption. In addition, we provide training to our customers employees to enhance their ability to utilize fully the features and functionality of the product purchased. We provide training and consulting services related to the use of our products and receive project- or time-based fees as a result. Costs of Revenues Our cost of licensing revenues consists primarily of materials, product packaging, distribution costs, related fulfillment personnel and third-party royalties. Our cost of maintenance, Table of Contents support and services revenues consists primarily of personnel and related overhead costs for technical support, training, consulting and the cost of materials delivered with product upgrades and enhancements. Prior to the end of fiscal 2002, our total cost of revenues also included the amortization of the fair value of developed technologies on our balance sheet that arose as the result of certain transactions described further under Change in Control of Crystal Decisions. Operating Expenses Sales and marketing expenses include salaries, benefits, commissions and bonuses earned by sales and marketing personnel, advertising, product promotional campaigns, promotional materials, travel, facilities and other overhead costs. Research and development expenses are expensed as incurred and consist primarily of personnel and related costs associated with development of new products, the enhancement and localization of existing products, quality assurance and testing, as well as facilities and other overhead costs. General and administrative expenses consist primarily of personnel costs for finance, legal and human resources, as well as other administrative costs. In May 2003, we pledged $1.0 million to the Community Foundation of Silicon Valley, which we accrued and expensed in fiscal 2003 and paid on June 30, 2003. We also agreed to match employee contributions to the Community Foundation of Silicon Valley up to 1% of our income before interest, taxes and amortization for the prior fiscal year. The maximum amount of our matching contribution in fiscal 2003 was approximately $220,000, which we accrued and expensed in fiscal 2003 and paid in July 2003. The maximum amount that we could pay under this matching plan for fiscal 2004 would be approximately $453,000. The Community Foundation of Silicon Valley is an independent, public benefit organization that provides grants to charitable groups in areas such as education, arts and cultural participation and neighborhoods and civic engagement. The Community Foundation of Silicon Valley also works with independent, public benefit organizations to provide grants that are used in communities outside of the San Francisco bay area. The Community Foundation of Silicon Valley awards grants equal to at least 5% of its endowment annually. Foreign Exchange We conduct the majority of our business and collect the majority of our revenues in U.S. dollars, which is the currency in which we report our financial results. We also earn approximately 20% of our revenues in currencies other than the U.S. dollar including the Euro, the British pound and the Canadian dollar. Our total revenues are affected by changes in the exchange rates for these currencies relative to the U.S. dollar. We incur a significant portion of our expenses in Canadian dollars. Our total expenses fluctuate according to the changes in the exchange rate of the Canadian dollar relative to the U.S. dollar. With the exception of our Canadian dollar expenses, the impact of fluctuations in foreign exchange rates on our net operating income is nominal as our foreign denominated expenses are substantially offset by our foreign denominated revenues. For fiscal 2003, a 10% increase in the exchange rate for the Canadian dollar would have increased our revenues by less than 1% but would have increased our expenses by approximately 4%. We recently implemented a partial hedging strategy for these exposures. We may experience substantial foreign exchange gains or losses due to the volatility of the Canadian dollar, to the extent our hedging activities are ineffective, or other currencies compared to the U.S. dollar. Critical Accounting Policies and Estimates Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States and form the basis for the following discussion and analysis of critical accounting policies and estimates. We make estimates and assumptions that Table of Contents All Vested 1999 Plan No Vested 1999 Plan 10 Trading Day Average Price Options are Exercised Options are Exercised Table of Contents affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities during the course of preparing these financial statements. On a regular basis, we evaluate our estimates and assumptions including those related to the recognition of revenues, allowance for doubtful accounts, contingent liabilities and income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable. These estimates form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates. The following critical accounting policies reflect the more significant estimates and assumptions we have used in the preparation of our financial statements: Recognition of Revenues We follow specific and detailed guidelines in measuring revenues; however, certain judgments and estimates affect the application of the policy. Revenues in any given period are difficult to predict and any shortfall in revenues or delay in recognizing revenues could cause our results of operations to vary significantly from quarter to quarter. We sell licenses for software products separately or with services as part of a bundled arrangement. We sell maintenance and technical support contracts with licenses in a bundled arrangement or separately as a contract renewal. We provide training and consulting services as part of a bundled arrangement or separately based on a project or time and materials basis. For each sales transaction, we determine whether evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection is probable. If any of these criteria are not met, we defer recognition of revenues until such time as all of the criteria are met. In bundled software arrangements that include rights to multiple software products and/or services, we recognize revenues using the residual method as prescribed by the Statement of Position 98-9 Modification of SOP No. 97-2 Software Revenue Recognition with Respect to Certain Transactions . Under the residual method, revenues are allocated to the undelivered elements based on vendor specific objective evidence of fair value of the undelivered elements and the residual amount of revenues are allocated to the delivered elements. Vendor specific objective evidence of the fair value of maintenance and technical support contracts is based on renewal rates as determined by the prices paid by our customers when maintenance is sold separately. Vendor specific objective evidence of fair value of training and consulting services is based upon daily rates as determined by the prices paid by our customers when these services are sold separately. For all bundled arrangements, we assess whether the service elements of the arrangement are essential to the functionality of the other elements of the arrangement. When services are considered essential or the arrangement involves customization or modification of the software, both the license and service revenues under the arrangement are recognized under the percentage of completion method of contract accounting, based on cost of labor inputs. We accrue expected losses, if any, with respect to consulting services once they become known. For those arrangements for which we have concluded that the service elements are not essential to the other elements of the arrangement, we use vendor specific objective evidence of fair value for the service elements to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. We recognize revenues allocable to maintenance and technical support contracts ratably over the term of the respective contracts, which is typically one year. Maintenance contracts include rights to unspecified software product enhancements and upgrades when and as we make them available. We recognize revenues allocable to training and consulting services as the services are performed. Table of Contents For sales to distributors and resellers, we recognize revenues upon the delivery of our products to these parties. We reserve an amount equal to our estimate of all products held by such parties which are subject to rights of return and resale contingencies. We consider several factors in determining these estimates including historical experience, level of inventory in the distribution channels, nature of the product, fixed or determinable fees and payment terms. We reduce our revenues and the related receivables by this estimate. For sales to original equipment manufacturers, we recognize revenues when the original equipment manufacturer reports sales that have occurred to an end user customer, provided that collection is probable. Some original equipment manufacturer arrangements include the payment of an upfront arrangement fee which is deferred and recognized either ratably over the contractual period or when the original equipment manufacturer reports sales that have occurred to an end user customer, in accordance with the contractual terms. If we determine, through royalty audits or other means, that an original equipment manufacturer did not report revenues accurately, we attempt to reconcile the discrepancies and, if appropriate, record additional revenues upon resolution. Deferred revenues represent amounts under license and service arrangements for which the earnings process has not been completed. These amounts relate primarily to provision of maintenance and technical support services with future deliverables and arrangements where specified customer acceptance has not yet occurred. Deferred revenues classified as long-term in nature represent revenues that will not be realized for more than 12 months after the date of the balance sheet. Allowance for Doubtful Accounts The allowance for doubtful accounts, which is netted against our accounts receivable on our balance sheets, totaled $2.1 million as of June 28, 2002 and $2.6 million as of June 27, 2003. The allowance for doubtful accounts represents estimated losses resulting from the inability of our customers to make required payments. We base our estimates on specific identification of probable bad debts based on collection efforts, aging of accounts receivable, our historical experience including bad write-offs and other factors. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, we may be required to record additional allowances. If the data we use to calculate the allowance does not reflect the future ability to collect outstanding receivables, we may be required to record additional allowances and the future results of our operations could be materially impacted. Our bad debt expenses are reflected in general and administrative expenses. Contingencies and Litigation We evaluate contingent liabilities including threatened or pending litigation in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies . We assess the likelihood of any adverse judgments or outcomes to a potential claim or legal proceeding, as well as potential ranges of probable losses, when the outcome of the claims or proceedings are probable and reasonably estimable. A determination of the amount of accrued liabilities required, if any, for these contingencies is made after analysis of each matter. Because of uncertainties related to these matters, we base our estimates on the information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Any revisions in the estimates of potential liabilities could have a material impact on our results of operations and financial position. Table of Contents Income Taxes We are subject to income taxes in both the United States and numerous foreign jurisdictions and we use estimates in determining our worldwide provision for income taxes. This process involves estimating actual current tax liabilities together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities which are recorded on the balance sheet. Our deferred tax assets consist primarily of net operating losses carried forward. We assess the likelihood that deferred tax assets will be recovered from future taxable income, and, a valuation allowance is recognized if it is more likely than not that some portion of the deferred tax assets will not be recognized. We provided a full valuation allowance against all of our deferred tax assets as of June 29, 2001 and June 28, 2002. During fiscal 2003, we released a portion of our valuation allowance against our deferred tax assets and have recorded current and long-term deferred tax assets at June 27, 2003. To the extent we establish any valuation allowance against our deferred tax assets or change this valuation allowance in a period, we reflect the impact in the provision for (benefit from) income taxes in our statements of operations. Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgment that could become subject to audit by tax authorities in the ordinary course of business. Stock-Based Compensation We measure compensation expense for the majority of our stock option plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees and related interpretations. The fair market value of our common stock on the date of grant is determined by the compensation committee of our board of directors. Because there has been no public market for our stock, the compensation committee determined the fair value of our common stock by considering a number of factors, including, but not limited to, contemporaneous valuations, our current financial performance and prospects for future growth and profitability, the status of product releases and product integration, the absence of a resale market for our common stock, the control position held by New SAC and comparisons to certain of our key valuation metrics with similar metrics for comparable publicly traded companies, including measures of market capitalization based on revenue multiples, price-to-earnings ratios and operating margins. We have elected not to apply fair value-based accounting provided under SFAS No. 123 Accounting for Stock-Based Compensation because it requires the use of option valuation models, which in our opinion, do not provide a reliable measure of the fair value of our employee stock options. As required by SFAS 123, as modified by SFAS No. 148 Accounting for Stock Based Compensation Transition and Disclosure an Amendment of FASB Statement No. 123, we provide pro forma disclosure of the effect of using the fair value-based method of measuring compensation expense. For purposes of the pro forma disclosure, we estimate the fair value of stock options issued to employees using the Black-Scholes option valuation model. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected life of options and our expected stock price volatility. Therefore, the estimated fair value of our employee stock options could vary significantly as a result of changes in the assumptions used. Change in Control of Crystal Decisions We became an indirect subsidiary of New SAC on November 22, 2000 when New SAC indirectly acquired 75,001,000 shares, or 99.7% of our common stock outstanding on that date, under the terms of a stock purchase agreement with Old Seagate and Seagate Software The purchase price paid by New SAC under the stock purchase agreement was fixed and no contingencies were identified that would have resulted in a change in the overall purchase price. However, in allocating the purchase price, New SAC recorded a full valuation allowance against deferred tax assets in accordance with Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes , or SFAS 109. The deferred tax assets subject to this valuation allowance were based on the excess of tax bases over the fair values of acquired property, plant and equipment and liabilities assumed, for which New SAC expected to receive tax deductions in U.S. federal and state returns in future periods based on their ability to generate taxable income in the United States. The following summarizes the impact of push down accounting on our results: Revenues. Deferred revenues were reduced by $1.3 million and revenues were reduced on a declining basis during the 12 months following the November 2000 transaction. Consequently, revenues were lower by $1.2 million for fiscal 2001 and $128,000 for fiscal 2002 than they would have been had the push down adjustments not occurred. There was no impact during fiscal 2003. Depreciation. Our long-lived tangible assets were reduced by $4.3 million on November 22, 2000. Consequently, we recorded $1.5 million less depreciation expense for each of fiscal 2001 and fiscal 2002 and $775,000 less for fiscal 2003 than we would have recorded had the push down adjustments not been made. Amortization. We recorded additional amortization expense of $3.3 million for fiscal 2001 and $5.6 million for fiscal 2002 from recording the incremental fair value of intangible assets pushed down to our financial statements on November 22, 2000. In-process research and development. We wrote off in-process research and development of $7.1 million as an expense in fiscal 2001. We did not have any similar expenses in fiscal 2002 or fiscal 2003. Elimination of intangible assets, net of deferred tax liability. We reduced intangible assets, net of deferred tax liability, by $9.1 million to zero at June 28, 2002. While we have adopted SFAS No. 142 Goodwill and Other Intangible Assets at the beginning of fiscal 2003, the non-amortization provisions and the impairment tests will not be applicable until such time as we have recorded goodwill and other intangible assets on our balance sheet. Licensing revenues $ 140,009 33 % $ 185,532 Percentage of total revenues 64 % 65 % Maintenance, support and services revenues $ 77,161 32 % $ 101,976 Percentage of total revenues 36 % 35 % Total revenues $ 217,170 32 % $ 287,508 The majority of our revenues were derived from licensing fees for our products and we anticipate that licensing fees will continue to represent the majority of our revenues for the foreseeable future. Our revenues have increased as a result of the continued delivery of new products, better sales training, the increased size and productivity of our sales force and our targeted marketing campaigns. Additionally, we continued to add new customers with our Crystal 8 and 9 product offerings, which included the release of Crystal Enterprise 8.5 in May Cost of licensing revenues $ 4,993 12 % $ 5,617 Percentage of licensing revenues 4 % 3 % Cost of maintenance, support and services revenues $ 46,377 21 % $ 56,313 Percentage of maintenance, support and services revenues 60 % 55 % Amortization of developed technologies $ 5,078 (100 )% $ Percentage of total revenues 2 % Total cost of revenues $ 56,448 10 % $ 61,930 Percentage of total revenues 26 % 22 % The absolute dollar increase in cost of licensing revenues was equally due to increased license volume and cost associated with new product releases. Cost of licensing revenues vary depending on the volume, distribution method and mix of software licenses shipped. Cost of maintenance, support and services revenues increased as we continued to expand our customer support and professional services organizations to meet the demands of our growing customer base. These costs included increases in salary and benefit costs of $7.4 million, additional overhead cost allocations associated with increased headcount of $4.0 million, a decrease in outside service costs of $933,000 and cost savings of $857,000 associated with travel and entertainment. Our overheads, which increased as the result of additional facilities and information technology costs, are generally allocated across departments based on headcount. Amortization of developed technologies for fiscal 2002 related to the fair value of developed technologies of $15.2 million pushed down to our financial statements as a result of the November 2000 transaction. There was no amortization during fiscal 2003 as a result of the Sales and marketing $ 94,449 15 % $ 108,470 Percentage of total revenues 43 % 38 % Research and development $ 30,515 37 % $ 41,924 Percentage of total revenues 14 % 15 % General and administrative $ 18,464 59 % $ 29,434 Percentage of total revenues 9 % 10 % Amortization of other intangible assets $ 2,358 (100 )% $ Percentage of total revenues 1 % Total operating expenses $ 145,786 23 % $ 179,828 Percentage of total revenues 67 % 63 % Sales and marketing. The increase in sales expenses in absolute dollars was primarily associated with increased salary and benefits expense of $8.7 million related to an overall increase in our sales force of approximately 60 people and the resultant higher total commissions. In addition, ancillary costs such as travel and entertainment increased by $2.1 million. Marketing expenses increased in absolute dollars of $1.1 million as the result of additional headcount in the department and the related costs associated with increased marketing campaigns and promotional material associated with major releases. The decrease in our sales and marketing expenses as a percentage of total revenues resulted primarily from increased productivity in our direct sales force in addition to a higher total percentage of sales through our indirect channels. Research and development. The increase in research and development expenses in absolute dollars primarily resulted from increased salary and benefits costs of $5.6 million associated with increased headcount. Expenses also increased by $945,000 as a result of incremental outsourcing costs for research and development related to final quality assurance testing for our products. In addition, as research and development headcount comprises approximately 25% of our headcount, allocations for increases in facilities and overhead costs accounted for $5.0 million of the increase. We expect research and development costs to increase in absolute dollars in future periods as we invest in new products and improvements to our existing products. (dollars in thousands) Provision for income taxes $ 3,300 $ 13,191 Effective tax rate 20 % 28 % The change in effective tax rate was due primarily to the effect of continuing growth in profitability, a decrease in available foreign research and development tax credits and utilization Licensing revenues $ 107,028 31 % $ 140,009 Percentage of total revenues 64 % 64 % Maintenance, support and services revenues $ 60,694 27 % $ 77,161 Percentage of total revenues 36 % 36 % Total revenues $ 167,722 29 % $ 217,170 Revenues from Ingram Micro accounted for $27.7 million, or 16% of total revenues, for fiscal 2001 and $21.0 million, or 10% of total revenues, for fiscal 2002. The primary reason for the decrease during fiscal 2002 was the transition of one of our products from the distributor channel to direct sales. No other customer accounted for 10% or more of our total revenues during fiscal 2001 or fiscal 2002. In fiscal 2001, our revenues were $123.5 million, or 74% of total revenues, from customers in North America, $31.8 million, or 19% of total revenues, from customers in Europe, the Middle East and Africa and $12.5 million, or 7% of total revenues, from customers in the Asia Pacific region. In fiscal 2002, our revenues were $159.8 million, or 74% of total revenues, from customers in North America, $41.8 million, or 19% of total revenues, from customers in Europe, the Middle East and Africa and $15.6 million, or 7% of total revenues, from customers in the Asia Pacific region. Licensing revenues. The increase in licensing revenues was primarily attributable to an increase in the size and productivity of our direct sales force. Our direct sales force continued to add new customers, while continuing to make additional sales to our existing customers. In addition, we increased revenues from indirect sales, primarily from original equipment manufacturers. All of our channels benefited from the releases of our Crystal 8 product suite throughout fiscal 2001 and fiscal 2002. Maintenance, support and services revenues. The absolute dollar increase in maintenance, support and services revenues was attributable to a higher cumulative installed customer base receiving maintenance. In addition, both consulting and technical support revenues increased as a result of new and existing agreements with our customers and the initiation of new pricing arrangements for these services. Cost of licensing revenues $ 5,504 (9 )% $ 4,993 Percentage of licensing revenues 5 % 4 % Cost of maintenance, support and services $ 41,996 10 % $ 46,377 Percentage of maintenance, support and services revenues 69 % 60 % Amortization of developed technologies $ 3,050 66 % $ 5,078 Percentage of total revenues 2 % 2 % Total cost of revenues $ 50,550 12 % $ 56,448 Percentage of total revenues 30 % 26 % We realized cost savings in cost of licensing revenues due to initiatives to reduce our production, fulfillment and shipping costs as a percentage of revenues. The absolute dollar increase in cost of maintenance, support and services revenues was the result of costs associated with increased headcount of $2.8 million and an increase in the use of external services to support our professional services organization of $2.1 million. The decline in cost of maintenance, support and services as a percentage of maintenance, support and services revenues was primarily attributable to the continued increase in maintenance revenues which had nominal associated costs, increased pricing for our technical support and cost control initiatives. At November 22, 2000, existing developed technologies were revalued and effective November 23, 2000, we began amortizing over 36 months the $15.2 million of developed technologies pushed down to our financial statements. The absolute dollar increase for fiscal 2002 was the result of amortization for fiscal 2001 being charged on a different and smaller intangible asset base up to and including the five months ended November 22, 2000. Gross Margin Our gross margin increased from 70% for fiscal 2001 to 74% for fiscal 2002. The increase in our gross margin was primarily attributable to an increase in the margins for maintenance, services and support from 31% in fiscal 2001 to 40% in fiscal 2002. Sales and marketing $ 73,888 28 % $ 94,449 Percentage of total revenues 44 % 43 % Research and development $ 29,236 4 % $ 30,515 Percentage of total revenues 17 % 14 % General and administrative $ 15,465 19 % $ 18,464 Percentage of total revenues 9 % 9 % Amortization of goodwill and other intangible assets $ 2,023 17 % $ 2,358 Percentage of total revenues 1 % 1 % Write-off of in-process research and development $ 7,073 (100 )% $ Percentage of total revenues 4 % Unusual items $ 1,851 (100 )% $ Percentage of total revenues 1 % Restructuring costs $ 573 (100 )% $ Percentage of total revenues Total operating expenses $ 130,109 12 % $ 145,786 Percentage of total revenues 78 % 67 % Sales and marketing. The absolute dollar increase in sales and marketing expenses was primarily associated with increased salary and benefits expense of $11.3 million related to an overall increase in our sales force headcount and $7.1 million related to higher total commissions associated with increased revenues. In support of our sales efforts, travel and entertainment costs increased by $1.1 million. The decrease as a percentage of revenues resulted from increased productivity of our sales force. Research and development. The absolute dollar increase was primarily associated with costs associated with increased headcount of $1.4 million, offset by targeted reductions in discretionary spending of $355,000. The decrease in research and development costs as a percentage of total revenues was the result of revenues increasing at a greater rate than research and development costs due to cost control measures. General and administrative. The increase in absolute dollars was primarily attributable to higher salary expense associated with our headcount growth of $755,000 and increased outside service costs of $1.9 million, which was offset in part by cost management initiatives. Amortization of goodwill and other intangible assets. At November 22, 2000, existing goodwill and other intangible assets were revalued and effective November 23, 2000, we began amortizing over 36 months the $7.1 million of assembled workforce pushed down to our financial statements. The absolute dollar increase was the result of amortization for fiscal 2001 being charged on a different and smaller intangible asset base up to and including the five months ended November 22, 2000. Write-off of in-process research and development. As part of the push down of the purchase price allocation of the November 2000 transaction, $7.1 million of in-process research and development was recorded. This amount, which was 4% of total revenues for fiscal 2001, was written off in its entirety in fiscal 2001 because the acquired technologies had not yet reached technological feasibility and there were no future alternative uses. We had no write-off of in-process research and development for fiscal 2002. Unusual items. Unusual items were comprised of non-cash compensation expense arising from the acceleration and net exercise of Old Seagate options to purchase 51,500 shares of Old (dollars in thousands) Provision for income taxes $ 1,183 $ 3,300 Effective tax rate 20 % The change in the effective tax rate was due primarily to our achievement of profitability and the absence of certain non-cash charges associated with the November 2000 transaction. In addition, the income tax provision for fiscal 2001 included benefits recorded during the period from July 1, 2000 to November 22, 2000 under the tax allocation agreement we had with Old Seagate. We provided a valuation allowance for fiscal 2001 and fiscal 2002 against the deferred tax assets arising primarily from temporary differences and net operating losses carried forward due to the uncertainty of their realizability. The effective rate used to record the income tax provision differed from the 35% U.S. federal statutory rate in fiscal 2001 due primarily to the fact that we operate in various foreign jurisdictions, as well as an increase in the valuation allowance for U.S. deferred tax assets arising subsequent to the termination of the tax allocation agreement on November 22, Table of Contents 2000 and non-deductible charges arising from push down accounting. Other significant items impacted by the above were the recognition of previously deferred revenues and an adjustment to the acquisition related intangible assets. The effective rate used to record the income tax provision differed from the 35% U.S. federal statutory rate in fiscal 2002 due primarily to the benefits of operating in various foreign jurisdictions, including the availability of research and development investment tax credits in Canada, an increase in the valuation allowance and the inclusion of a reconstituted net operating loss. The increase in the valuation allowance and the inclusion of a reconstituted net operating loss are the results of filing the U.S. federal and state income tax returns for the year ended June 29, 2001 and reflecting a final revised purchase price allocation schedule regarding the November 2000 transaction. Selected Quarterly Financial Data The table below shows our unaudited quarterly statements of operations data for each of the eight quarters in the period ended June 27, 2003. This information has been derived from our unaudited financial statements, which, in our opinion, have been prepared on the same basis as our audited financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the information for the quarters presented. The results of operations for any quarter are not necessarily indicative of the results of operations for any future period. Weighted average number of shares used in basic net income per share 75,445 75,490 75,620 75,848 75,895 75,950 76,008 76,061 Weighted average number of shares used in diluted net income per share 75,445 75,817 76,739 78,947 79,677 79,194 79,823 82,258 (in thousands) Net cash provided by operating activities $ 13,037 $ 41,069 $ 57,028 Net cash (used) in investing activities (9,594 ) (9,877 ) (27,538 ) Net cash provided by (used in) financing activities 27,810 5,294 (1,103 ) Table of Contents Operating Activities Our principal source of liquidity is our cash and available-for-sale securities, as well as the cash we generate from operations. For fiscal 2001, fiscal 2002 and fiscal 2003, we have generated more cash from our operating activities than we used. We earned more revenues year-over-year, including deferred revenues, and improved cash collections to 65 average days sales outstanding for fiscal 2003 from 68 days for fiscal 2002. In addition, we increased our gross margins and reduced our overall operating costs as a percentage of total revenues. In fiscal 2003, we began a extensive implementation of an enterprise resource planning system for our North America and Asia Pacific regions. The system included modules for use by our financial and administrative functional departments including human resources, payroll, project management, budgeting, order management, accounts receivable, accounts payable, general ledger and other financial functions. To date, we have incurred approximately $6.6 million of expenditures in connection with the implementation of our enterprise resource planning system. The implementation of the enterprise resource planning system and the adjustment of our procedures to adapt to the new system has been slower and more costly than we anticipated. We expect to implement the system in Europe in the first half of fiscal 2004 and expect to have the entire implementation completed by the end of calendar 2003. Investing Activities Prior to fiscal 2003, our investing activities consisted solely of the purchase of property and equipment to support the growth of our business. In fiscal 2001, investing activities were primarily for the purchase of leaseholds improvements, computers, furniture and office equipment. During fiscal 2002, investing activities were primarily for the purchase of computer equipment and costs related to the purchase and implementation of a global enterprise resource planning system. Our investing activities in fiscal 2003 included costs related to implementation of new systems, including our enterprise resource planning system, leasehold improvements and furniture related to the expansion of existing leased space and other computer purchases. We anticipate that our capital expenditures will be approximately $22 million for fiscal 2004. The majority of our capital expenditures are denominated in Canadian dollars. The amount we spend on capital expenditures will vary significantly depending on a number of factors including the timing of our facilities expansion, our information technology and telecommunications systems upgrades and build outs and our completion of our enterprise resource planning system implementation. Prior to fiscal 2003, we did not invest in securities with maturities of 90 days or more. In addition, prior to October 2001, the majority of our cash balances were managed for us by Old Seagate and Seagate Technology, and represented a net receivable balance on the consolidated financial statements, on which we earned interest. During fiscal 2003, we purchased $14.2 million of short-term investments and received $9.3 million on maturity of some of these investments. In addition, we purchased $3.3 million of long-term investments, which had not matured as of June 27, 2003. Financing Activities Prior to fiscal 2001, some of our working capital requirements were financed by borrowings from Old Seagate available under a revolving loan agreement that was subsequently amended on July 4, 2001 and renewed with Seagate Technology. The revolving loan agreement originally provided for maximum outstanding borrowings of up to $60.0 million, with the amount being reduced to $15.0 million on renewal. The revolving loan agreement expired on July 4, 2002 and was not renewed. There was no outstanding receivable or payable balance under this agreement upon its expiration. Total operating expenses 78 67 Operating leases $48,009 $ 8,361 $ 11,275 $ 8,141 $ 20,232 In May 2003, we agreed to pledge $1.0 million to the Community Foundation of Silicon Valley, which we accrued and expensed in fiscal 2003 and paid on June 30, 2003. We also agreed to match employee contributions to the Community Foundation of Silicon Valley up to 1% of our income before interest, taxes and amortization for the prior fiscal year. The amount accrued for our matching contribution in fiscal 2003 was approximately $220,000, which we expensed in fiscal 2003 and paid in July 2003. The maximum amount that we could pay under this matching plan for fiscal 2004 would be approximately $453,000. Certain shares issued and option grants made under our 1999 stock option plan to residents of California, Maryland and New York may not have complied with all applicable securities laws of those states. Accordingly, we are planning to make a rescission offer to these stockholders and optionees which will allow the holders to elect, during a limited period of time, to return their shares or options to us in return for a payment equal to their purchase price or 20% of their aggregate exercise price, plus any applicable interest. As of October 17, 2003 approximately 327,970 outstanding shares of our common stock and approximately 1,439,792 shares subject to outstanding options will be subject to the rescission offer. The shares and options had purchase and exercise prices ranging from $4.00 to $11.82 per share. We do not believe that the holders of these shares of our common stock and options to purchase our common stock will accept our offer because the prices at which we are offering to repurchase them are less than the estimated fair market value of the Business Objects ADSs and cash that our stockholders will receive and estimated fair market value of the options to acquire Business Objects ADSs our optionees will receive if Business Objects proposed acquisition of our company is completed. However, in the unlikely event that all of these persons accepted our offer, we would make total payments of approximately $3.4 million, which we would fund from our existing cash balances. Financing Agreements In October 2002, we executed an agreement with Comerica for a $15.0 million revolving line of credit. The revolving line provides for interest to be calculated at U.S. prime rate or LIBOR plus 2.5% per annum. Borrowings under the revolving line are limited to 80% of eligible accounts Table of Contents receivable, with an additional $2.0 million available in any month in which we maintain $15.0 million in our investment accounts with Comerica or some of its affiliates. On September 30, 2004, any outstanding principal and interest under the line of credit will be immediately due and payable. Upon notice to Comerica and without penalty, Crystal Decisions may terminate the agreement at any time provided that all obligations have been paid in full. The revolving line is collateralized by substantially all of our personal property, excluding our intellectual property. The agreement also required our U.S. and Canadian subsidiaries to pledge all of their assets in support of our obligations under the agreement. We pledged shares of most of our subsidiaries. The terms of the revolving line require us, among other things, to maintain the following quarterly financial covenants on a consolidated basis: a ratio of unrestricted cash and cash equivalents plus 80% of eligible accounts receivable to current liabilities less deferred revenue of at least 1.25 to 1.0; a tangible net worth of at least $28.0 million plus 50% of the net income for each quarter ending after October 1, 2002 plus 75% of the gross proceeds received by us from the sale of our equity securities; and positive free cash flow for the four quarter period then ended and positive free cash flow for at least two of the four quarters in such period. We are restricted from selling, leasing or otherwise disposing of any part of our business or property under most circumstances. In addition, the agreement places restrictions on entering into arrangements that will result in a change of control, places restrictions on our ability to pay dividends and restricts our ability to incur other forms of indebtedness. We are also restricted from making some types of distributions or investments. We are also required to maintain at least an aggregate of $10.0 million in investment accounts with Comerica and some of its affiliates. No amounts were outstanding under the revolving line at June 27, 2003 or as of the date of this document. As of June 27, 2003, we maintained $57.1 million of our cash equivalents balance with Comerica. Our Canadian subsidiary entered into a overdraft credit facility with The Bank of Nova Scotia during fiscal 2002 whereby The Bank of Nova Scotia will provide up to Canadian $2.0 million credit for certain overdrafts plus a foreign exchange forward trading line generally supporting notional contracts in the range of $4.0 million to $6.0 million. Any overdraft balances are subject to interest computed at the bank s prime lending rate payable monthly. During fiscal 2003, there were no balances outstanding under this agreement. On September 26, 2002, our Canadian subsidiary placed $2.0 million on deposit with The Bank of Nova Scotia as a general hypothecation to the overdraft credit facility and the foreign exchange line. The funds held and the interest earned thereon are classified as restricted cash on our balance sheet. Our future liquidity and capital requirements will depend on numerous factors, including: the amount and timing of our revenues; the extent to which our existing and new products gain market acceptance; the extent to which customers continue to renew maintenance agreements; the extent of required and planned capital expenditures required to support our current operations and growth; and available borrowings under future credit arrangements, if any. We believe that our current cash, cash equivalents, short-term investments and the cash generated from our operations, the overdraft agreement with The Bank of Nova Scotia, and the available borrowings under the line of credit with Comerica will be sufficient to meet our operating and capital requirements for at least the next 12 months. We anticipate that our capital Table of Contents expenditures will be approximately $22.0 million in fiscal 2004. We have no current plans, and we are not currently negotiating, to obtain additional financing. The factors described above will affect our future capital requirements and the adequacy of our available funds. If we need to raise funds in the future, we may be required to raise those funds through public or private financings, strategic relationships or other arrangements. We cannot assure you that the funding, if needed, will be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders and debt financing, if available, may involve restrictive covenants. Our failure to raise capital as and when needed could have a negative impact on our ability to pursue our business strategy and maintain profitability. Quantitative and Qualitative Disclosures About Market Risk Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign exchange rates. We do not hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. The investment of cash is regulated by our investment policy of which the primary objective is the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk. Among other selection criteria, our current investment policy states that all investments, with the exception of up to 20% of cash and cash equivalents, must be maintained in U.S. dollar denominated investment grade securities, with no maturities exceeding two years. We may hold up to 20% of cash and cash equivalents in investment grade non-U.S. denominated securities. In addition, our investment policy does not allow for investment in technology companies. We mitigate the effect of default risk by investing in only high credit quality securities and by using a portfolio manager to respond appropriately to a significant reduction in credit rating of any investment issuer, guarantor or depository. The portfolio includes only diversified marketable securities with active secondary or resale markets to ensure portfolio liquidity. Our investments in debt securities include money market funds, investment grade commercial paper, corporate bonds, government agency securities and other debt securities. The diversity of our portfolio helps us to achieve our investment objective. As of June 27, 2003, all of our cash, cash equivalents, short-term and long-term investments were classified as available-for-sale. While we are exposed to interest rate fluctuations in many countries, our interest income is most sensitive to fluctuations in the general level of U.S. interest rates. Declines in interest rates over time will reduce our interest income and we do not attempt to reduce or eliminate our exposure to interest rate risk through the use of derivative financial instruments due to the short-term nature of the investments. For fiscal 2002 and fiscal 2003, fluctuations in the U.S. interest rate did not have a material impact on our net interest income. Foreign Exchange Risk We conduct business on a global basis in international currencies. As such, we are exposed to adverse or beneficial movements in foreign exchange rates. The majority of our sales are denominated in U.S. dollars, the currency in which we report our financial statements; however, we do conduct a portion of our sales in currencies other than the U.S. dollar, including the British pound, euro, Canadian dollar and Japanese yen. We are also exposed to foreign exchange rate fluctuations as the financial results of our foreign subsidiaries are translated into U.S. dollars on consolidation. Commencing on March 29, Table of Contents 2003, all translation gains and losses will be included in the determination of net income and will no longer be recorded as an adjustment to accumulated other comprehensive income in stockholders equity. As exchange rates vary, these results, when translated, may vary from expectations and adversely or beneficially impact overall expected profitability. We also have exposure to foreign exchange rate fluctuations when we translate cash from one currency into another to fund operational requirements. In addition, we have exposure to the change in rates as the result of timing differences between expenses being incurred and paid. As exchange rates vary, we may experience a negative impact on financial results. We incur the majority of our research and development, customer support costs and administrative expenses in Canadian dollars and British pounds. For example, approximately 80% of our revenues were denominated in U.S. dollars, 6% in British pounds and less than 5% in Canadian dollars for fiscal 2003. Approximately 34% of our total expenses were denominated in U.S. dollars, 15% in British pounds and 40% in Canadian dollars in fiscal 2003. These percentages fluctuate with exchange rates, business operating changes and cash flow versus expense patterns. We have evaluated our exposure to these risks and have determined that our only significant operating exposure to foreign currencies at this time is to the Canadian dollar. The strengthening of the Canadian dollar has negatively affected and may continue to negatively affect our operating expenses and net income and we continue to have foreign currency risk from this source. For fiscal 2003, a 10% increase in the Canadian dollar relative to the U.S. dollar would have increased our revenues by less than 1% but would have increased our expenses by approximately 4%. We cannot predict the effect of exchange rate fluctuations upon our future results. We recently implemented a partial hedging strategy for exposure to fluctuations in the exchange rate of the Canadian dollar relative to the U.S. dollar. Although we recently have begun hedging, we cannot be sure that any hedging techniques we may implement will be successful or that our business, results of operations, financial condition and cash flows will not be adversely affected by exchange rate fluctuations. Table of Contents BUSINESS Crystal Decisions We provide business intelligence software and services that enable the effective use and management of information within and among organizations. We develop, market and support products that allow organizations of all sizes to access data from disparate systems, create useful, interactive information from that data through analysis and reporting and reliably deliver that information to the users that need it. Our products are designed to meet the needs of a wide range of end users, from non-technical users to sophisticated analysts and application developers. In addition, our products can be used to deliver reports to customers and suppliers of the organizations that use our products. Our products can serve as an information infrastructure that empowers users to extract more value from data that has already been captured by existing information technology systems in order to improve decision-making, lower overall information technology costs and enhance competitiveness. Our products are used by organizations of all sizes across almost all segments of the economy. As of June 27, 2003, we had delivered more than 15 million product licenses and had registered users in more than 170 countries. As a result, we have a diverse customer base that includes software developers, approximately 350 independent software vendors and numerous well established companies, such as Aetna, ADP, Citigroup, Coca-Cola, JP Morgan Chase Bank, Kraft Foods and Northrop Grumman. Industry Background Organizations of every size need to analyze and assess their performance quickly and effectively. As a result, every organization has a fundamental and widespread need for useful information. The burden on organizations to make more effective use of information is increasing rapidly in today s environment, which is characterized by increasing data volume, uncertain economic trends, increasing competition and heightened legislative and regulatory requirements for data collection, reporting and disclosure. Organizations have spent billions of dollars implementing software systems to efficiently capture, organize, store and protect data that measures their performance, including customer sales, expenses, inventory management and employee data. However, these transactional software systems were not primarily designed to facilitate easy access, viewing, manipulation and broad dissemination of data. Employees and customers often do not have access to the information within these systems. If they do, employees and customers do not typically have the ability to customize the information or analyze it from multiple perspectives. As a result, there is a basic need to access, analyze, understand and deliver information more effectively within and among organizations. A broad category of software known as business intelligence has been developed to help organizations address the need to transform the organizations growing amount of data into useful information. In 2003, IDC estimated that the market for business intelligence software would be $4.5 billion in 2007. Organizations have typically deployed business intelligence products that are custom developed or purchased as stand-alone products in a specific department or for an individual project. This approach has resulted in a proliferation of products and systems that are often not integrated with each other or existing enterprise systems and, as a result, only provide a fragmented view of the overall business. Many of these products and systems are costly and complex to maintain and support. In addition, many business intelligence products are designed primarily for sophisticated analytical users and are difficult for the non-technical user to master. Most non-technical users require intuitive and seamless access to data as part of their regular work tasks, regardless of where the data is stored in an organization. Table of Contents To allow broad user access to data within and among organizations and to maximize the organizations return on investment, a business intelligence product should meet a range of complex needs. A business intelligence product should integrate data from disparate systems and applications, scale to support large numbers of users and offer flexible reporting that is easy to use and provides a full range of presentation, formatting and interactivity. We believe there is a significant opportunity to provide organizations with a different approach to business intelligence software by focusing on the most common information and reporting needs. In order to accomplish this objective, we believe business intelligence products should serve as an underlying information infrastructure that allows every user to access information in a form appropriate for the user. The Crystal Decisions Solution We develop, market and support products that enable users to access data, add value to it through analysis and reporting and reliably manage and deliver the results within business applications or processes. Our business is driven by a primary guiding principle: to help organizations bring together their people and information to improve decision-making and performance. Our products focus first on solving the most common business intelligence need, which is for information reporting and delivery. To achieve our goals, we designed our products as a core reporting and analysis infrastructure for an organization s data systems and applications. Our products allow organizations to maximize the value of the data they have without requiring extensive re-engineering or creation of additional systems that cannot work with the existing transactional software systems. Our products offer the following benefits to our customers: Lower overall information technology costs through standardization. Our products have been designed to access data from, and integrate with, a wide range of existing transactional software, database and custom-built systems. Our products facilitate data access, analysis and reporting in a consistent, standardized manner. This standardization empowers more users to access more information in a more usable form and allows organizations to integrate functions and applications more easily. As a result, organizations can better use and increase the return on their existing information technology investments. We also believe that our products are able to lower the overall information technology purchase, maintenance and training costs for organizations by consolidating those data analysis and reporting systems into our single platform. Meet essential information management demands. We believe that information reporting, analysis and delivery are essential parts of almost every application in every organization. As organizations increasingly depend on using their information for most processes, the business intelligence infrastructure upon which they rely is subject to increased technological demands. We have developed our products to meet these demands and to be: scalable in terms of concurrent user volume, capacities, processing, throughput and use of hardware assets; reliable by providing high levels of uptime, high fault tolerance, disaster recovery and redundancy capability; high performance in terms of response and processing times for users and requests; manageable in terms of ease of deployment and cost of maintenance and ownership; flexible enough to be used in any size deployment; and extensible as organizational needs change over time. Table of Contents Address the information requirements of all users and organizations. Our products can be used by technical and non-technical staff to improve decision-making and enhance competitiveness. Our products are flexible enough to provide users with an appropriate level of interactivity and sophistication. We believe that our products create a complete and integrated reporting, analysis, query and information delivery infrastructure to satisfy the requirements of sophisticated analysts and technical users while also providing the ease of use necessary to appeal to non-technical users. To address the specific requirements of customers of all sizes and their projects, our products are available individually or together as an integrated suite. Ease of integration with existing systems. Our products are designed to be easy to deploy, customize and integrate into a customer s existing information technology environment and processes. As the needs of each customer are unique, our products are open and flexible enough to provide developers and systems integrators with the means to complete deployments on an organizational or departmental basis. As a result, our customers can use our products in the manner that best suits their requirements and generates value from their systems and software investments. Products We offer an integrated suite of business intelligence products that include: Crystal Reports Crystal Reports is an integrated software package for query, report design, application development and report publishing functions. Crystal Reports is used to generate data driven, highly formatted, interactive reports which are stored in a proprietary file format. Crystal Reports is designed in a range of versions to meet the needs of report authors, analysts and application developers. Crystal Reports allows these users to: access most types of structured data; format, design and process a variety of reports; and integrate these reports into .NET, Java, COM and other development environments. Reports can be published in a variety of formats including DHTML, RTF, Microsoft Excel, PDF and XML. Crystal Reports is deployed on the Windows operating system and is available in Simplified Chinese, English, French, German, Italian, Japanese, Korean and Spanish. To build a common business report, such as a sales report, a technical report author could use Crystal Reports to access relevant sales and customer databases, organize and format the appropriate information, such as customer name, sales amount, product selection and shipping dates. The report could include tables of information, graphs, maps and/or images, conditional formatting, advanced business logic and summarized calculations. The finished report could be viewed and used by any end user, who could navigate the report by page or by clicking on charts or summaries for more detail and could also print or e-mail the report. An application developer could use one of the reporting components embedded within Crystal Reports to include this sales report as a seamless part of another application, such as a sales management system. Crystal Analysis Crystal Analysis consists of software that includes functions for user ad hoc analysis, analytic reporting, analytic application development and online analytical processing for multi-dimensional data. We provide Crystal Analysis products in a range of client and server versions for a variety of users including non-technical users, analysts and developers. Our client-based analysis product provides powerful and guided data navigation and enables the creation of Table of Contents interactive report applications. Our analytic server product can be used to consolidate large amounts of data with complex business logic to facilitate sophisticated analysis by the end user. All Crystal Analysis components can integrate with Crystal Enterprise and Crystal Reports. Our client-based analysis product can be deployed on Windows. Our analytic server product can be deployed on servers using the Windows, Solaris, AIX, HP-UX and Linux operating systems. Crystal Analysis is available in English, French, German and Japanese. A business analyst could use the client-based Crystal Analysis product to access a large multidimensional data warehouse and track key information, such as product sales by region over time. The business analyst could simultaneously integrate key variables, such as margin and pipeline, and interactively explore sales results using different views of the data to identify trends in the information and forecast the impact of changes on the sales model or product mix. Crystal Enterprise Crystal Enterprise is infrastructure software that integrates our products and fosters efficient management and delivery of report information. It offers a customizable solution for providing interactive information to employees, customers and suppliers. Crystal Enterprise addresses a range of information management needs including the need for: a scalable, reliable platform to manage, process, store and deliver information to a large number of internal and external users; and standardized reporting, analysis and information delivery across multiple business applications. Crystal Enterprise can be deployed on servers using the Windows, Solaris and AIX operating systems. Almost any web-browser or standards-based application can serve as the Crystal Enterprise user interface. Crystal Enterprise is available in English, French, German and Japanese. A customer could use Crystal Enterprise to build, deploy and maintain a web-based sales information application or to deliver specific sales reports as part of a packaged customer relationship management system. Crystal Enterprise would store report content from Crystal Reports or Crystal Analysis, integrate with the customer s existing user security protocols and process reports on demand for any user. The user interface could be presented as a user-customized summary page with navigation, scheduling and viewing capabilities to enable easy use by any type of user. Crystal Applications Crystal Applications are software templates that provide reports, user interface components and data models to support common processes, such as performance management, sales force management, e-commerce and telecommunications billing analyses. These templates are built using our Crystal Enterprise platform and are functional examples of how our products can be combined to address specific issues. We believe that these templates help accelerate customer adoption and deployment of our products. A customer could customize, complete and deploy our performance management application template with Crystal Enterprise to provide a management scorecard to help track corporate performance against key metrics, such as number of new orders booked by month, days sales outstanding, customer shipments and sales representative turnover. Crystal Enterprise Partner Kits Our Crystal Enterprise partner kits are a series of software toolkits and packages that enable customers to integrate our products with those of other independent software vendors by Table of Contents providing an interface to the transactional software system s data structures and security regimes. Most kits include data access drivers, sample reports and data structures and may include special documentation, support and services. We currently offer packages for many transactional software systems including SAP R/3, SAP BW, Siebel CRM, PeopleSoft and Baan ERP. Services We believe that high quality, real time customer support is important to the successful marketing, sales and implementation of our products. Accordingly, in addition to offering our software products, we offer our customers a broad range of post-sale support services such as technical support, training and consulting. These services are designed to help us to optimize customer satisfaction and influence customers future purchasing decisions. We are committed to developing and sustaining long-term relationships with our customers and have dedicated substantial resources to customer service and support, including 476 dedicated staff members as of June 27, 2003. Maintenance We offer maintenance programs for most of our products, which generally consist of product enhancements and upgrades when and as we make them available. We generally sell maintenance in 12-month increments. Professional Services To speed end user adoption of our products, our professional services organization provides consulting and training to plan and execute their deployment. We have a dedicated team in North America and England who perform these services for us alone or in combination with other consultants, system integrators or value added resellers. Technical Support Our technical support services are designed to assist our customers to use our products to their full potential. We believe effective technical support during product evaluations and implementations benefits our customers and that post-sales support has been and will continue to be a means to achieve greater customer satisfaction. We provide a range of technical support services to match the needs of different organizations including fee-for-service offerings. We operate technical support groups that are located at various sites around the world, including North America and Europe. We also offer 24 hour, seven-day toll-free telephone services with some types of technical support packages. Strategic Relationships We have developed relationships with a wide range of technology vendors and service providers including industry leaders and influencers such as Microsoft and SAP. In many cases, we have integrated our products with those of the other party and our products are delivered with theirs. We believe these relationships generate new sales opportunities, increase our deployment capacity and enhance our products features. Microsoft We began our relationship with Microsoft in 1993. Microsoft currently integrates our products into its developer product suite, Visual Studio.NET and Business Solutions products. We receive advance notice of planned upgrades and improvements to Microsoft s products so that we can integrate our products before shipment. We have a full time staff at Microsoft s Redmond, Washington facilities. We also coordinate sales and marketing efforts where possible. Table of Contents Through its Business Solutions value-added reseller channel, Microsoft resells our products with its customer relationship management and enterprise resource planning products. SAP We have an original equipment manufacturer and reseller arrangement with SAP whereby SAP incorporates our Crystal Enterprise and Crystal Reports products into SAP s BW 3.0 product, its data warehouse product. We receive advance notice of planned upgrades and improvements to SAP s products so that we can integrate our products before shipment. We have full time staff at a site adjacent to SAP s Walldorf, Germany facility. Other Strategic Relationships We also have original equipment manufacturer relationships with approximately 350 independent software vendors. These companies sell and support our products and/or integrate our products into their applications. As a result of these relationships, we believe our customers may derive incremental value from the other applications by using our integrated reporting and analysis products without a separate deployment or integration cycle. We consider our relationships with these companies to be of strategic importance to us because they are generally industry leaders and influence adoption of products and technologies by customers. Customers As of June 27, 2003, we had delivered more than 15 million product licenses and had registered users in more than 170 countries. Our products are used by organizations of all sizes in almost every segment of the economy. As a result, we have a diverse customer base that includes a broad community of software developers and a number of well established companies. The following table lists some of our top 50 end user customers who purchased products and services directly from us by revenues we recognized from July 3, 1999 to June 27, 2003. Consumer/Retail The Coca-Cola Company Kraft Foods, Inc. Pepsi-Cola Company Safeway, Inc. Financial Services/Insurance Aetna Life Insurance Company Automatic Data Processing, Inc. Bank of America Citigroup, Inc. Insurance Corporation of British Columbia J.P. Morgan Chase Bank Morgan Stanley Co. Inc. R+V Allegemeine Versicherung AG Suntrust Banks, Inc. Healthcare/Pharmaceuticals Genentech, Inc. Johnson Johnson Pfizer Inc. Information and Other Technology Microsoft Corporation Seagate Technology Manufacturing/Industrials Air Products Chemicals Inc. The Boeing Company Ford Motor Company International Paper Company Northrop Grumman Corporation Toyota Motor Manufacturing North America, Inc. Trans-Canada Pipelines Limited Professional Services KPMG International Telecommunications AT T Corp. AT T Wireless Services, Inc. SBC Operations, Inc. Verizon Wireless We derived a substantial portion of our revenues from one distributor, Ingram Micro, during the last three fiscal years. As a percentage of our total revenues, Ingram Micro accounted for 16% in fiscal 2001, 10% in fiscal 2002 and less than 10% in fiscal 2003. No other customer or distributor accounted for 10% or more of our total revenues in fiscal 2001, fiscal 2002 or fiscal Table of Contents 2003. In fiscal 2001, our revenues were $123.5 million, or 74% of total revenues, from customers in North America, $31.8 million, or 19% of total revenues, from customers in Europe, the Middle East and Africa and $12.5 million, or 7% of total revenues, from customers the Asia Pacific region. In fiscal 2002, our revenues were $159.8 million, or 74% of total revenues, from customers in North America, $41.8 million, or 19% of total revenues, from customers in Europe, the Middle East and Africa and $15.6 million, or 7% of total revenues, from customers in the Asia Pacific region. In fiscal 2003, our revenues were $212.0 million, or 74% of total revenues, from customers in North America, $54.6 million, or 19% of total revenues, from customers in Europe, the Middle East and Africa and $20.9 million, or 7% of total revenues, from customers in the Asia Pacific region. See note 16 to our consolidated financial statements in this document for more information. Our customers often purchase licenses for a single location, department or division and may later expand their use of our products to other parts of their organizations. We believe we can sell additional licenses of our existing products to our existing customer base and also sell those customers new products as we expand our product line. Customer Case Study The following case study illustrates how one of our customers, Aetna, a health insurance and benefits provider, adopted our products to solve a business problem. Aetna s management needed to pull financial and operational data from disparate systems throughout the company, analyze that data quickly and present the resulting information in a form that would assist management in making effective business decisions. Aetna integrated our Crystal Enterprise 8.5 and Crystal Reports 8.5 products into its existing information systems, allowing Aetna to extract and present a unified view of financial and operational data from 50 different data sources that feed into its Microsoft SQL Server and IBM DB2 databases. Previously, in order for Aetna to tabulate monthly financial information from dozens of geographically dispersed offices, a full month was required using a combination of Microsoft Excel spreadsheets and Microsoft Word documents. With our products in place, Aetna was able to cut the time it takes to generate such monthly financial data from a full month to only 12 to 14 days. The reports created with our products present the information to Aetna s management in a unified, flexible view that can break down financial and operational information based on business units, geography or customer segments. Additionally, by providing Aetna s management with a one-company view of the organization, our software provides Aetna with a better view of the performance and profitability of its various products. Sales and Marketing We organize our sales and marketing programs by geographic regions, including North America, Japan, the Asia Pacific region and the European region, which includes the Middle East and Africa. In most cases, we sell our English language products. In some cases, we adapt certain products for foreign markets, including translation of documentation and user interfaces to local languages. To reach our customers, we utilize a direct sales force and indirect sales channels, such as our original equipment manufacturer relationships and a network of resellers and distributors. Our sales channels are supported by our pre-sales and technical specialists. Customers can also purchase some of our products by downloading them over the Internet. Direct Sales We sell our products primarily through a direct sales force that is comprised of field sales personnel, inside sales personnel, telesales personnel and our eStore staff. Our field sales force, consisting of customer account managers, professional service account coordinators and support Table of Contents managers, focus on mid-sized and large enterprises. Our inside sales force, consisting of customer account managers, professional services account coordinators and support managers, focus their efforts on small and mid-sized enterprises, with most selling conducted over the telephone. Our inside sales force most often contacts sales prospects who already use our Crystal Reports product. Our telesales group serves as a direct telephone link to customers who call our offices, affording us the opportunity to address customer issues and make additional sales. Our eStore provides us with an opportunity to test pricing and promotional strategies and conduct low-cost sales via the world wide web. Our direct sales force for North America is managed from our Vancouver, Canada offices. We also have a direct sales presence throughout the world managed from our offices in England, Japan and Singapore. Indirect Sales Our indirect revenues include sales to distributors, other resellers and original equipment manufacturers and as a percentage of total revenues were 37% in fiscal 2001, 33% in fiscal 2002 and 34% in fiscal 2003. We have established indirect sales channels through distributors and resellers, who primarily focus their sales efforts on small and mid-sized organizations. We sell our products through original equipment manufacturers that bundle our products with theirs. We have a sales team targeted at developing and maintaining our relationships with original equipment manufacturers. Marketing Our marketing activities consist of several key components: targeted print advertising in trade, technical and business publications; online advertising on our web site; cooperative marketing programs with original equipment manufacturers, distributors and other resellers; participation in seminars and tradeshows; direct mailings to both prospective and existing customers; and extensive public relations activities and programs to build relationships with key information technology community analysts and influencers. Our marketing groups produce, or oversee the production of, substantially all of our online and print product literature, brochures, advertising and similar marketing and promotional material. Research and Development Since our inception, we have devoted significant resources to the development of our products and technology. We believe that our future success depends in large part on continued innovation and rapid product development. We conduct a majority of our research and development operations in Vancouver, Canada and Ipswich, England. As of June 27, 2003, our research and development team consisted of 450 persons. We had research and development expenses of $29.2 million in fiscal 2001, $30.5 million in fiscal 2002 and $41.9 million in fiscal 2003. Our customers did not fund any of our research and development expenses in fiscal 2001, fiscal 2002 or fiscal 2003. We pursue our product development objectives by developing new software products and product enhancements internally, but may from time to time acquire products, technologies and businesses complementary to ours or form alliances with other companies. We recently began to outsource some of the final quality assurance testing for our products and anticipate that we may outsource other development functions in the future. Table of Contents Patents and Intellectual Property Rights Our success and ability to compete is dependent in part on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing upon the proprietary rights of others. We rely primarily on a combination of copyright, trade secret and trademark laws, confidentiality procedures, contractual provisions and other similar measures to protect our proprietary information. Due to the rapidly changing nature of applicable technologies, we believe that the improvement of existing products, reliance upon trade secrets and unpatented proprietary know-how and development of new products are generally more important than patent protection. As of June 27, 2003, we had two United States issued patents, eight patent applications pending in the United States and one foreign patent application pending. We also have an ongoing trademark registration program pursuant to which we register some of our product names, slogans and logos in the United States and in some foreign countries. We also use contractual provisions to protect our intellectual property rights. We license our software to be integrated or sold with the products of numerous independent software vendors, as well as licensing directly to end users. These license agreements, which address our technology, documentation and other proprietary information, include restrictions intended to protect and defend our intellectual property. These licenses are generally non-transferable and are typically perpetual. We also require all of our employees, contractors and many of those with whom we have business relationships to sign non-disclosure and confidentiality agreements. Our products also include third party software that we obtain the rights to use through license agreements. We use this software primarily to add features that we do not choose to develop internally. Competition The market for our products is highly competitive, rapidly evolving and subject to changing technology, customer needs and new product introductions. We compete principally with vendors of integrated query, reporting, analysis and information delivery software, such as Actuate, Brio Software, Business Objects, Cognos, Hummingbird, Information Builders and MicroStrategy. We also face or expect to face some competition from the SAS Institute and Informatica and expect increased competition from additional market entrants, including companies that specialize in the development, marketing and support of software products that assist users to access, analyze and interpret data to make business decisions. We also face competition from database and application vendors, such as Microsoft, Oracle, SAP and IBM, who offer reporting and analysis tools with their products. The competitive factors affecting the market for our products include: product functionality; performance and reliability; quality of customer support; ease of use and installation; availability and quality of consulting and implementation services; vendor reputation; demonstrable cost-effective benefits for users; price; sales and marketing capabilities; and financial stability of the software provider. We believe that we currently compete effectively with our competitors on the basis of these factors. Our ability to remain competitive will depend to a great extent upon our ongoing Balance at June 29, 2001 75,397,915 $ Table of Contents CAPITALIZATION The following table sets forth our capitalization as of June 27, 2003. As of June 27, 2003 Table of Contents performance in the areas of product development and customer support. To be successful in the future, we believe that we must respond promptly and effectively to the challenges of technological change and our competitors innovations by continually enhancing our product offerings. Performance in these areas will in turn depend upon our ability to attract and retain highly qualified technical personnel in a competitive market for experienced and talented software developers. Employees As of June 27, 2003, we had 1,769 full-time employees, including 618 in sales and marketing, 476 in services and support, 450 in research and development and 225 in general and administrative functions. None of our employees are represented by a labor union or are the subject of a collective bargaining agreement. We have never experienced a work stoppage and believe that our employee relations are good. We believe our future success will depend in large part upon our ability to attract and retain highly skilled managerial, product development, sales and marketing personnel. Properties Our principal executive offices are located in Palo Alto, California. Our properties consist of leased facilities for sales and marketing, research and development, services and support and administrative personnel. The majority of our facilities are occupied under leases that expire at various times through fiscal 2015. At June 27, 2003, our leased space approximated 362,000 square feet with approximately 220,000 square feet located in Canada, 61,000 square feet located in the United States, 60,000 square feet located in Europe and 21,000 square feet located in the Asia Pacific region. These figures exclude approximately 105,000 square feet of unoccupied space in Canada and approximately 3,000 square feet leased to others in the United States. We have continued to lease additional space in our Vancouver, Canada location and are currently in the process of building out unoccupied space in this location. We believe that our facilities are adequate for our current needs and that suitable additional or substitute space will be available as needed to accommodate expansion of our operations. Legal Proceedings In November 1997, Vedatech commenced an action in the Chancery Division of the High Court of Justice in the United Kingdom against Crystal Decisions (UK) Limited, our wholly owned subsidiary. The liability phase of the trial was completed in March 2002, and we prevailed on all claims except for a quantum meruit claim. The court ordered the parties to mediate the amount of that claim and we came to a mediated settlement with Vedatech in August 2002. The mediated settlement was not material to our operations and contained no continuing obligations. In September 2002, however, we received notice that Vedatech is seeking to set aside the settlement. In April 2003, we filed an action in the High Court of Justice seeking a declaration that the mediated settlement agreement is valid and binding. In October 2003, Vedatech filed an action against us, Crystal Decisions (UK) Limited and Susan J. Wolfe in the United States District Court, Northern District of California, San Jose Division, alleging that the August 2002 mediated settlement was induced by fraud and that the defendants engaged in negligent misrepresentation and unfair competition. Although we believe that Vedatech s basis for seeking to set aside our mediated settlement and its claims in the October 2003 complaint are meritless, the outcome cannot be determined at this time. If our mediated settlement were to be set aside, or we were to be found liable in the October 2003 action, a negative outcome could adversely affect our business, results of operations and financial condition. In addition to the foregoing, we are subject to other litigation in the ordinary course of our business. While we believe that the ultimate outcome of these matters will not have a material adverse effect on us, the outcome of these matters is not determinable and negative outcomes may adversely affect business, results of operations and our financial condition. Jonathan J. Judge 49 President, Chief Executive Officer and Director 2002 William G. Gibson 54 Chief Operating Officer 2000 Eric Patel 47 Chief Financial Officer 1999 Anthony L. Wind 41 Chief Technology Officer 2001 Andrew L. Handford 37 Vice President of Products and Research and Development 2001 Gregory B. Kerfoot 44 Chairman of the Board of Directors 1999 Fred D. Anderson 59 Director 2002 Robert L. Bailey 46 Director 2003 Justin T. Chang 36 Director 2001 Stephen J. Luczo 46 Director 1999 David J. Roux 46 Director 2001 John W. Thompson 54 Director 2001 Donald L. Waite 70 Director 1999 Jonathan J. Judge has served as our president and chief executive officer since October 2002 and a director since November 2002. From 1976 until he joined our company, Mr. Judge held various management positions with IBM, most recently as general manager of IBM s personal computing division. William G. Gibson has served as our chief operating officer since September 2000. From April 1998 to September 2000, Mr. Gibson served as the president, western region, of Rogers Wireless, Inc. From August 1997 to March 1998, Mr. Gibson served as vice president-business units at Lucent Technologies, Inc. Mr. Gibson served as vice president and general manager at Sprint PCS from April 1997 to August 1997. Mr. Gibson served as vice president and general manager of Ameritech Cellular and Paging from June 1993 to April 1997. Eric Patel has served as our chief financial officer since November 1999. From February 1997 to November 1999, Mr. Patel served in various capacities at University Games, a board game manufacturing company, the most recent of which was chief financial officer and vice president of operations and international sales and marketing. From May 1993 to November 1996, Mr. Patel served as director of strategy for Dreyers Ice Cream. Anthony L. Wind has served as our chief technology officer since July 2001. From December 1999 to July 2001, Mr. Wind served as our vice president of products and research and development. From February 1998 to December 1999, Mr. Wind served as our predecessor s vice president of products. Mr. Wind served as director of research and development for our predecessors from September 1994 to February 1998. Andrew L. Handford has served as our vice president of products and research and development since July 2001. From June 1999 to July 2001, Mr. Handford served as our director of product management. From July 1995 to June 1999, Mr. Handford held a series of management roles in our company and its predecessors. Gregory B. Kerfoot has served as a director since August 1999 and has served as the chairman of our board of directors since July 2002. Mr. Kerfoot served as our chief executive officer from August 2000 until October 2002, and as president from August 1999 to October Total stockholders equity 75,756 Table of Contents 2002. Mr. Kerfoot also served as our chief operating officer from August 1999 until August 2000. Mr. Kerfoot joined Old Seagate in May 1994 when Old Seagate acquired Crystal Computer Services. He continued as director of research and development for Crystal Computer Services. In May 1996, he was appointed president of Crystal Computer Services and later in 1996 was named executive vice president and general manager of Crystal Computer Services. From September 1997 to September 1999, Mr. Kerfoot served as the chief strategic officer for Seagate Software Holdings, as well as executive vice president and general manager of Seagate Software Holdings. Fred D. Anderson has served as a member of our board of directors since August 2002. Mr. Anderson is executive vice president and chief financial officer of Apple Computer, Inc., which he joined in April 1996. Mr. Anderson is also a member of the board of directors of 3Com Corporation. Robert L. Bailey has served as a member of our board of directors since April 2003. Mr. Bailey is the president and chief executive officer of PMC-Sierra, Inc. in which capacity he has served since July 1997. Mr. Bailey has served as a director for PMC-Sierra since October 1996 and as chairman of PMC-Sierra s board of directors from February 2000 to February 2003. Justin T. Chang has served as a member of our board of directors since February 2001. Mr. Chang is a partner of Texas Pacific Group and has been an executive of Texas Pacific Group since 1993. Prior to joining Texas Pacific Group, Mr. Chang was a financial analyst in the Merchant Banking Group and the Mergers and Acquisitions Group of Wasserstein Perella Co., Inc. Mr. Chang is also a member of the board of directors of ON Semiconductor. Stephen J. Luczo has served as a member of our board of directors since August 1999. Mr. Luczo served as the chairman of our board of directors from August 1999 to July 2002 and served as our chief executive officer from August 1999 to November 2000. Mr. Luczo became the chief executive officer and a director of Seagate Technology and New SAC in November 2000. From July 1998 to May 2000, he served as president and chief executive officer of Old Seagate and was a director of Old Seagate from July 1998 to November 2000. He joined Old Seagate in October 1993 as senior vice president, corporate development. In March 1995, he became Old Seagate s executive vice president, corporate development and chief operating officer of the software group. Mr. Luczo is a member of the Listed Company Advisory Committee of the New York Stock Exchange. David J. Roux has served as a member of our board of directors since February 2001. Mr. Roux is a managing member of Silver Lake Partners, a private equity firm he co-founded in January 1999. Since November 2000, Mr. Roux has served as chairman of New SAC and as a director of Seagate Technology. Mr. Roux is also currently serving as a director and Compensation Committee member of SubmitOrder.com, Inc. and a director of EConnections, Inc. From November 2000 until June 2002, Mr. Roux also served as chairman of Seagate Technology. From February 1998 to November 1998, he served as the chief executive officer and president of Liberate Technologies. From September 1994 until December 1998, Mr. Roux held various management positions with Oracle Corporation, most recently as executive vice president of corporate development. Before joining Oracle, Mr. Roux served as senior vice president, marketing and business development at Central Point Software from April 1992 to July 1994. Mr. Roux is a member of the boards of directors of Gartner, Inc. and VERITAS. John W. Thompson has served as a member of our board of directors since February 2001. Mr. Thompson has served as a director of Seagate Technology since November 2000. Mr. Thompson is chairman of the board of directors and chief executive officer of Symantec Corporation, which he joined in April 1999. From 1971 to April 1999, Mr. Thompson held various executive and management positions with IBM. Mr. Thompson is a member of the boards of directors of NiSource Inc. and United Parcel Service, Inc. Total capitalization $ 75,756 Table of Contents Donald L. Waite has served as a member of our board of directors since August 1999. Since November 2000, Mr. Waite has served as executive vice president and chief administrative officer of New SAC and Seagate Technology. Mr. Waite also serves as officer and/or director of several subsidiaries and affiliates of Seagate Technology. From March 1995 to November 2000, Mr. Waite served as executive vice president and chief administrative officer of Old Seagate. Mr. Waite also served as chief financial officer of Old Seagate from October 1983 to February 1998. Mr. Waite joined Old Seagate in 1983. Board Composition Our board of directors consists of nine members, each of whom is currently subject to election at our annual meeting of stockholders. Executive officers are elected by the board of directors on an annual basis and serve until their successors have been duly elected and qualified. There are no family relationships among any of our directors or executive officers. Committees of the Board of Directors Our board of directors has a nominating and corporate governance committee, an audit committee and a compensation committee. Each of our committees will have the composition and responsibilities described below: Nominating and Corporate Governance Committee Our nominating and corporate governance committee is comprised of Messrs. Chang, Kerfoot and Roux, each of whom is a nonmanagement member of our board of directors. The nominating and corporate governance committee is responsible for, among other things: recommending to our board of directors a slate of directors for nominating; developing and recommending to our board of directors a set of corporate governance principles applicable to our company; overseeing the process for evaluating our board of directors and management; evaluating the current composition, organization and governance of our board of directors and its committees, determining future requirements and making recommendations to our board of directors for approval; and reviewing and evaluating, at least annually, the performance of the nominating and corporate governance committee and its members, including the compliance of the nominating and corporate governance committee with its charter. Audit Committee Our audit committee is comprised of Messrs. Anderson, Bailey, Thompson and Waite, each of whom is a nonmanagement member of our board of directors. Messrs. Anderson, Bailey and Thompson are independent directors. Compensation Committee Our compensation committee is comprised of Messrs. Anderson, Luczo, Roux and Thompson, each of whom is a nonmanagement member of our board of directors. In accordance with our compensation committee charter, at least two members of the compensation committee are outside directors as that term is defined in Section 162(m) of the Internal Revenue Code of 1986, as amended, and at least two members are nonemployee directors within the meaning of Table of Contents Rule 16b-3 of the rules promulgated under the Securities Exchange Act of 1934, as amended. The compensation committee is responsible for, among other things: reviewing and making recommendations to our board of directors relating to the compensation policy for our employees, officers, directors and consultants; reviewing and making recommendations to our board of directors regarding all forms of compensation to be provided to our chief executive officer and all equity compensation grants to our officers; reviewing and making recommendations to our board of directors regarding general compensation goals and guidelines for our employees and the criteria by which bonuses to our employees are determined; making recommendations to our board of directors with respect to amendments to our benefit plans and changes to the number of shares reserved for issuance under our benefit plans; and producing an annual report on executive compensation for inclusion in our annual proxy statement. Director Compensation Beginning in June 2003, we began paying our directors cash compensation of $25,000 per year for their service as members of our board of directors. We began also paying the chairperson of our audit committee an additional $10,000 per year and the other members of that committee an additional $5,000 per year. We reimburse our directors for reasonable travel expenses in connection with attendance at board and committee meetings. Prior to June 2003, we did not pay any cash compensation to our directors, except for reimbursement for reasonable travel expenses in connection with attendance at board and committee meetings. Under our 1999 stock option plan, nonemployee directors are eligible to receive stock option grants at the discretion of the board of directors. In May 2003, we granted each of Messrs. Anderson, Chang, Luczo, Roux, Thompson and Waite an option to acquire 20,000 shares of our common stock at $8.00 per share. In May 2003, we granted Mr. Bailey an option to purchase 50,000 shares of our common stock at $8.00 per share. In August 2002, we granted Mr. Anderson an option to purchase 50,000 shares of our common stock at $5.50 per share. In May 2001, we granted each of Messrs. Chang, Roux and Thompson an option to purchase 50,000 shares of our common stock at $4.00 per share. In November 1999, we granted Mr. Luczo an option to purchase 275,000 shares and granted Mr. Waite an option to purchase 50,000 shares of our common stock at an exercise price of $4.00 per share. Each of the grants vest as to 25% of the shares at the first anniversary of grant and as to 1/48th of the shares monthly thereafter. Compensation Committee Interlocks and Insider Participation Our board of directors established its compensation committee in November 1999. Prior to establishing the compensation committee, our board of directors as a whole performed the functions delegated to the compensation committee. Mr. Luczo, a member of our board and compensation committee, is an executive officer of Seagate Technology. Mr. Luczo is also a former officer of our company. Mr. Roux, a member of our board and compensation committee, is a principal of Silver Lake Partners. In addition, we previously paid New SAC, of which Mr. Roux is a director and Mr. Luczo is a director and chairman and chief executive officer, management fees. These fees were discontinued in December 2002. Seagate Technology, of which Mr. Roux is a director and Mr. Luczo is a director and chairman and chief executive officer, provided various administrative services to us under several service agreements. In addition, we have licensed Seagate Technology some of our products. See Our Relationships and Arrangements with New SAC, Seagate Technology, our Officers and our Directors for more information about transactions between us and Mr. Luczo and Mr. Roux. Table of Contents SELECTED FINANCIAL DATA The selected financial data set forth below should be read together with Management s Discussion and Analysis of Financial Condition and Results of Operations and our financial statements and related notes. We have derived the statement of operations data for the fiscal years ended June 29, 2001, June 28, 2002 and June 27, 2003 and the balance sheet data as of June 28, 2002 and June 27, 2003 from the audited financial statements included elsewhere in this document. The statement of operations data for the fiscal years ended July 2, 1999 and June 30, 2000 and the balance sheet data as of July 2, 1999, June 30, 2000 and June 29, 2001 were derived from the audited financial statements that are not included in this document. Historical results are not necessarily indicative of results to be expected for future periods. Fiscal Years Ended (1) The stock options listed in the table represent options to purchase our common stock. See Option Grants in Fiscal 2003 for additional information regarding options to purchase our stock granted during fiscal 2003. (2) Includes $46,795 of cost of living allowances paid to Mr. Judge under his agreement. See Employment Contracts, Change-of-Control Arrangements and Separation Agreements for additional information regarding Mr. Judge s agreement. (3) Mr. Judge became our president and chief executive officer in October 2002 and is paid an annual base salary of $400,000 with a maximum bonus payout of $800,000. Mr. Judge s compensation for fiscal 2003 included amounts since joining us in October 2002. Mr. Judge s compensation includes amounts contributed by Mr. Judge to the group registered retirement savings plan in the amount of $3,387 for fiscal 2003. Included in Mr. Judge s Other Annual Compensation is the employer match made by us under the group registered retirement savings plan, which was $1,693 for fiscal 2003. See Employment Contracts, Change-of-Control Arrangements and Separation Agreements for additional information regarding Mr. Judge s agreement. (4) Mr. Kerfoot was our chief executive officer from August 2000 to October 2002, our president from August 1999 to October 2002 and our chief operating officer from August 1999 to August 2000. (5) Mr. Kerfoot donated his bonus to the Crystal Decisions Foundation, a non-profit charitable foundation. (6) Mr. Gibson s compensation for fiscal 2001 included amounts since joining us in September 2000 as our chief operating officer. (7) Mr. Patel s compensation includes amounts contributed by Mr. Patel to the group registered retirement savings plan in the amounts of $2,449 for fiscal 2001, $9,342 for fiscal 2002 and $9,635 for fiscal 2003. Included in Other Annual Compensation is the employer match made by us under the group registered retirement savings plan, of $1,225 for fiscal 2001, $2,017 for fiscal 2002 and $1,645 for fiscal 2003. Jonathan J. Judge 2,000,000 35.62 % $ 5.50 11/19/12 $ 6,917,841 $ 17,531,167 Gregory B. Kerfoot William G. Gibson 90,000 1.60 % 5.50 11/19/12 311,303 788,903 Eric Patel 56,250 1.00 % 5.50 11/19/12 194,564 493,064 Anthony L. Wind 56,250 1.00 % 5.50 11/19/12 194,564 493,064 Andrew L. Handford 100,000 1.78 % 5.50 11/19/12 345,892 876,558 All stock options granted to named executive officers in fiscal 2003 vest as to 25% of the shares subject to the option on the first anniversary of the vesting commencement date and as to 1/48th per month thereafter. Under our 1999 stock option plan, our board retains discretion to modify the terms of outstanding options. The percentage of total options granted was based on aggregate grants of options to purchase 5,614,225 shares of common stock to our employees, nonemployee directors and named executive officers in fiscal 2003. The foregoing options were granted to our named executive officers at an exercise price equal to the fair market value of our common stock on the grant date, as determined by the compensation committee of our board of directors. Because there is no public market for our stock, the compensation committee determined the fair market value of our common stock by considering a number of factors, including, but not limited to, contemporaneous valuations, our current financial performance and prospects for future growth and profitability, the status of product releases and product integration, the absence of a resale market for our common stock, the control position held by New SAC and comparisons of certain of our key metrics with similar metrics for comparable publicly traded companies, including measures of market capitalization based on revenue multiples, price-to-earnings ratios and operating margins. The table sets forth the hypothetical gains or option spreads that would exist for the options at the end of their respective 10-year terms based on assumed annualized rates of compound stock price appreciation of 5% and 10% from the dates the options were granted until the expiration of the 10-year option term. The disclosure of 5% and 10% assumed rates is required Jonathan J. Judge 2,000,000 $ $ 5,000,000 Gregory B. Kerfoot 2,758,332 541,668 10,981,245 2,093,755 William G. Gibson 358,332 331,668 1,412,495 1,162,505 Eric Patel 332,289 173,961 1,318,740 596,886 Anthony L. Wind 286,249 127,001 1,139,059 415,317 Andrew L. Handford 121,384 133,741 482,607 380,862 The value received is calculated as the market value of our common stock at the exercise date minus the exercise price. The value of unexercised in-the-money options is deemed to be the fair market value of our common stock at fiscal year end minus the exercise price. The fair market value of our common stock at June 27, 2003, as determined by the compensation committee of our board of directors, was $8.00 per share. The foregoing options were granted to our named executive officers at an exercise price equal to the fair market value of our common stock on the grant date, as determined by the compensation committee of our board of directors. Because there is no public market for our stock, the compensation committee determined the fair market value of our common stock by considering a number of factors, including, but not limited to, contemporaneous valuations, our current financial performance and prospects for future growth and profitability, the status of product releases and product integration, the absence of a resale market for our common stock, the control position held by New SAC and comparisons of certain of our key metrics with similar metrics for comparable publicly traded companies, including measures of market capitalization based on revenue multiples, price-to-earnings ratios and operating margins. Employment Contracts, Change-of-Control Arrangements and Separation Agreements In September 2002, we entered into an agreement with Mr. Judge in connection with Mr. Judge s employment as our president and chief executive officer. We agreed to pay Mr. Judge a base salary of $400,000 with additional performance-based bonus compensation of up to a maximum of $800,000 per year. Mr. Judge also received an option grant of 2,000,000 shares at a per share exercise price of $5.50 in November 2002. Mr. Judge s initial option vests as to 25% of the shares on the first anniversary of his employment with us and as to 1/48th of the total number of shares monthly thereafter. In addition, we agreed to recommend to our board of directors that the board grant Mr. Judge an option to purchase 250,000 shares of our stock upon successful completion of an initial public offering, as well as an option to purchase an additional 250,000 shares of stock upon completion of four successive quarters of attaining 100% of our revenues and profitability targets after completion of an initial public offering. These additional options will be granted at a fair market value to be determined by the board of directors on the date of grant and will be subject to four-year vesting from the date of grant. Mr. Judge also is entitled to health benefits as well as reimbursement for reasonable premium costs for a $1.0 million term life insurance policy, up to a maximum annual premium of Table of Contents $20,000. We agreed to provide Mr. Judge with coverage for typical relocation expenses, reasonable attorneys fees in connection with the negotiation of his letter agreement and reasonable annual tax and financial planning expenses. We have agreed to pay Mr. Judge a severance payment of $400,000 upon termination of his employment for any reason after five years as our employee. We have also agreed to assist Mr. Judge in establishing a Canadian immigrant trust. Mr. Judge agreed to place his Georgia residence in the trust during his employment with us for up to one day less than five years. In return, we agreed to pay or reimburse Mr. Judge for any Canadian departure taxes arising from his residence relating to the employment period of up to one day less than five years. If Mr. Judge is employed by us for at least five years, we have agreed to pay or reimburse him for any Canadian departure taxes related to his residence whenever the departure tax liability may arise, including following termination of his employment for any reason. However, if we terminate his employment without cause prior to his five-year employment anniversary, we will not be obligated to cover his Canadian departure taxes related to his residence. We refer to these payments as the residence tax payments. In the event that we terminate Mr. Judge for any reason other than cause or if he resigns as a result of involuntary termination on or before his one-year anniversary of employment with us, we have agreed to pay Mr. Judge, in lieu of any other severance other than the severance payment or the residence tax payments, if due, 1.5 times his base salary and target bonus for the year and to cover his COBRA premiums for the full period provided by law or provide up to $2,500 per month for the same period in reimbursement for healthcare premiums if COBRA is not available. In the event that this termination occurs after his one-year anniversary of his employment with us, we have agreed to pay him the sum of his base salary and target bonus for the year in addition to the coverage for the COBRA premiums discussed above. In the event that we terminate Mr. Judge for cause or if he voluntarily resigns other than pursuant to involuntary termination, we may elect, in our sole discretion, to provide him with the benefits described in this paragraph so that he will be subject to a non-compete agreement and so that he will sign a release of all claims against us, our directors and our employees. In the event of a change-of-control, we have agreed to provide Mr. Judge with immediate vesting of 50% of his then unvested shares with respect to his initial option grant of 2,000,000 shares and his pending grant of 250,000 options to be granted upon the successful completion of an initial public offering, as well as one additional year of vesting on any of his other options. In the event that he resigns within three months following a change-of-control in which he is not made the chief executive officer of the surviving entity, we have agreed to pay Mr. Judge, in lieu of any other severance other than the accelerated vesting described above and the severance and residence tax payments, if due, a lump sum cash payment equal to two times the sum of his base salary and target bonus. In the event of an involuntary termination or termination by us without cause within 12 months following a change-of-control, we have agreed to pay Mr. Judge, in lieu of any other severance other than the accelerated vesting and the severance and residence tax payments, if due, a lump sum cash payment equal to two times the sum of his base salary and target bonus for the year, as well as providing full acceleration of his initial option grant of 2,000,000 shares and his pending grant of 250,000 shares and acceleration of one year of vesting for all of his other options, if any. In August 2003, we entered into an amendment to his employment agreement with Mr. Judge that contemplates the proposed acquisition. Mr. Judge has relinquished his right to the 250,000 share option grants to be made to him upon the successful completion of an initial public offering and upon four consecutive quarters of achievement of revenue and profitability targets for two cash payments of $500,000, less applicable withholding taxes. Provided that Mr. Judge is an employee of the combined company upon the closing of the proposed acquisition and he executes a release of claims in our favor, the first $500,000 payment will be made upon the closing of the proposed acquisition. The second $500,000 payment will be made to Mr. Judge on Table of Contents his last day of employment with the combined company as long as he continues to be an employee of the combined company for a transition period of no more than six months following the closing of the proposed acquisition. In addition, upon the closing of the proposed acquisition, Mr. Judge will be entitled to receive all benefits due to him upon an involuntary termination without cause within 12 months following a change-of-control; provided, however, that for purposes of calculating any severance payments due to him, the lump sum of Mr. Judge s salary and target bonus will be deemed to equal $1.0 million per year. Provided that he executes a release of claims, Mr. Judge will be entitled to the payment of $2.0 million and the two $500,000 payments described above upon the closing of the proposed acquisition. In the event that he is terminated without cause or he resigns as a result of an involuntarily termination prior to the closing of the proposed acquisition if the proposed acquisition is completed subsequently, Mr. Judge will be entitled to the payment of $2.0 million, the two $500,000 payments and all the benefits that would be due to him upon an involuntary termination without cause within 12 months following a change-of-control described above provided that he executes a release of claims. If Mr. Judge is terminated without cause or he reigns as a result of an involuntary termination after the closing of the proposed acquisition but prior to the payment of the second $500,000 payment, Mr. Judge will receive the second $500,000 payment on his last day of employment with the combined company provided that he executes a release of claims. In July 2000, we entered into an agreement with Mr. Gibson in connection with Mr. Gibson s employment as our chief operating officer. We agreed that if we terminated Mr. Gibson s employment without just cause for which we have agreed to provide him written notice, we would pay him his then current base salary for one year, an amount equal to his bonus for the calendar year immediately preceding his termination and an allowance of 10% of his annual base salary in lieu of all other benefits. We would be required to pay these amounts to Mr. Gibson monthly over a one-year period. We are a party to management retention agreements with each of the members of our executive committee other than Mr. Judge including: William G. Gibson, chief operating officer, Andrew L. Handford, vice president of products and research and development, Eric Patel, chief financial officer, and Anthony L. Wind, chief technology officer. Under the management retention agreements each of the members of our executive committee will be entitled to: continued employment for a period of three months following the closing of the proposed acquisition by Business Objects; and accelerated vesting of options as a result of the proposed acquisition as follows: 50% of all unvested shares subject to each such option to acquire our common stock outstanding as of July 18, 2003 will become vested and exercisable upon the closing of the proposed acquisition; and the remaining 50% of all unvested shares subject to each option outstanding as of July 18, 2003 will become vested and exercisable on (i) the first anniversary of the closing of the proposed acquisition provided he continues in employment and (ii) his termination date if he is terminated without cause or resigns for good reason, as defined in the management retention agreements, within 12 months after the closing of the proposed acquisition and he executes a release of claims. The management retention agreements for Messrs. Gibson, Handford, Patel and Wind will provide that a termination will be: by the employer, without cause if we or our successor were to terminate the applicable officer s employment without cause (as such term is defined by the common law of British Columbia); or Table of Contents by the employee, for good reason if the applicable officer were to terminate the officer s employment for any of the following reasons: a significant reduction in the officer s duties (not including title) or responsibilities; provided, however, that a reduction of duties, position or responsibilities solely by virtue of us being acquired and being made part of a larger entity shall not constitute grounds for a termination for good reason; a reduction in the officer s base salary or target bonus opportunity (other than pursuant to a proportional reduction applying to all senior executives of us or our successor); a material reduction in kind or level of the officer s benefits (other than pursuant to a proportional reduction applying to all senior executives of us or our successor); and the relocation of his principal place of employment to a place outside of the Lower Mainland region of British Columbia; or any action by us that would constitute a constructive dismissal under the common law of British Columbia. The management retention agreements provide that if within 12 months of the closing of the proposed acquisition an officer is terminated without cause or resigns for good reason, or, in the case of Mr. Gibson, upon the expiration of his employment 11 months after the closing of the proposed acquisition, and the officer executes a release of claims in our favor, then the officer is entitled to receive: a lump sum payment of 12 months of the officer s base salary and 100% of the officer s target bonus, in each case, as in effect at the time of such termination and welfare benefits for up to 12 months following termination and in the case of Mr. Patel, continuation of certain health care benefits for up to 12 months; accelerated vesting of all of the officer s outstanding options that were in existence as of July 18, 2003; and reimbursement of reasonable expenses of up to $5,000 for individual executive outplacement services. The management retention agreement for Mr. Handford also provides that if Mr. Handford voluntarily terminates his employment without good reason within 15 months after the proposed acquisition and he executes a release of claims, then he is entitled to receive: a lump sum payment of 12 months of his base salary and 100% of his target bonus, in each case, as in effect at the time he entered into his management retention agreement, in the case of termination within six months, and at the time of such termination, in the case of termination between six and 15 months, together with welfare benefits for up to 12 months following termination; in the case of termination between nine and 15 months, accelerated vesting of all of his outstanding options that were in existence as of July 18, 2003; and reimbursement of reasonable expenses of up to $5,000 for individual executive outplacement services. In addition to the benefits listed above, the management retention agreements for Messrs. Gibson, Handford, Patel and Wind also provide that the officer s benefits will be increased such that his lump sum payment will be 18 months of his base pay and target bonus and his employee benefits, and in the case of Mr. Patel certain health care benefits, will continue (in thousands, except per share data) Statement of Operations Data: Revenues: Licensing $ 92,013 $ 74,182 $ 107,028 $ 140,009 $ 185,532 Maintenance, support and services 50,552 52,727 60,694 77,161 101,976 Table of Contents for 18 months if the officer agrees that for a period of 12 months after the termination of his employment not to: directly or indirectly, alone or as a partner, officer, director, lender, shareholder, employee, or consultant of any other person, firm or entity, render any services in Canada or the United States of any of the certain competitors of us with respect to business intelligence software or services; solicit directly, or assist anyone else in the solicitation of any employee to leave his or her employment with us or any person, firm or corporation in the habit of dealing with us; and in the event the officer provides services to any business intelligence software or services entity, solicit business or any orders for business intelligence software or services from any person or entity that has been a client of us or our successor within the 18 months preceding his termination of employment. The management retention agreements for Messrs. Gibson, Handford, Patel and Wind also provide for a reduction in the benefits payable to the officer under his management retention agreement to the extent his benefits, together with any other payments he is eligible to receive in connection with the proposed acquisition, would exceed 2.99 times his base amount, as such term is defined in Section 280G of the Internal Revenue Code of 1986, as amended, unless requisite stockholder approval is obtained in accordance with Section 280G of the Internal Revenue Code to exempt such benefits from the application of Section 280G of the Internal Revenue Code. Other than our agreements with Messrs. Judge, Gibson, Handford, Patel and Wind and we currently do not have change-of-control or separation agreements with any of the named executive officers nor do we have any employment agreements that require our named executive officers to provide services to us for any specific term. Incentive Plans 1999 Stock Option Plan Our board of directors adopted our 1999 stock option plan in August 1999 and reserved 22,500,000 shares of common stock for issuance under the 1999 plan. The 1999 plan was approved by our stockholders in August 1999. The 1999 plan provides for grants of incentive stock options to employees, including officers and employee directors and nonstatutory stock options to employees, consultants and nonemployee directors of our company, our parent and our respective subsidiaries. The purposes of our 1999 plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to our employees and consultants to perform future services and to promote the success of our business. At the direction of the board of directors, the compensation committee administers our 1999 plan and determines, among other things, the optionees and the terms of options granted, including the exercise price, number of shares subject to the option and the exercisability thereof. The term of the options granted under the 1999 plan is set forth in the option agreement. The term of an option may not exceed 10 years and, in the case of an incentive stock option granted to an optionee who owns more than 10% of the voting power of all the classes of stock of our company, parent or subsidiaries at the time of grant, the term of an option may not exceed five years. The exercise price for options granted under the 1999 plan is determined in the option agreement. However, in the case of options granted to an employee who owns stock representing more than 10% of the voting power of all classes of voting stock of our company, parent or subsidiaries, the exercise price may be no less than 110% of the fair market value of a share of our common stock at the time of the grant. For all other employees, the exercise price Table of Contents may not be less than fair market value of our common stock for an incentive stock option and may not be less than 85% of the fair market value for a nonstatutory stock option. Generally, options granted under the 1999 plan vest as to 25% of the shares subject to the option on the first anniversary of the vesting commencement date and as to 1/48th per month thereafter of the shares subject to the option. No incentive stock options may be granted to an optionee, which, when combined with all other incentive stock options becoming exercisable in any calendar year that are held by that person, would have an aggregate fair market value in excess of $100,000. In any fiscal year, we may not grant any employee options to purchase more than 5,000,000 shares. However, in connection with his or her initial employment, an employee may be granted options to purchase up to an additional 3,000,000 shares that will not count against the 5,000,000 share limit. In the event of a merger of our company or a sale of substantially all of our assets, any option which is not assumed or substituted by a successor will fully vest and then terminate after 15 days from the date that the notice is sent to the optionee informing the optionee of such vesting acceleration. The 1999 plan will terminate in August 2009, unless our board of directors terminates it sooner. Other than options held by nonemployee members of our board of directors or outstanding under the United Kingdom sub-plan of the 1999 plan, at the effective time of the proposed acquisition options then outstanding under the 1999 plan will become options to acquire Business Objects ADSs pursuant to an exchange ratio and adjustment to the per share exercise price determined at the effective time. Options held by nonemployee members of our board of directors or granted under the United Kingdom sub-plan will become fully exercisable prior to our proposed acquisition by Business Objects. Any of those options not exercised prior to the effective time of the proposed acquisition will terminate and will no longer be exercisable or represent the right to purchase Business Objects ADSs. As of October 17, 2003, we had issued 1,230,977 shares of common stock upon the exercise of options under the 1999 plan. In addition, there were 20,221,490 options to purchase shares of our common stock outstanding and 1,047,783 shares available for grant under the 1999 plan as of October 17, 2003. 2000 Stock Option Plan Our board of directors adopted our 2000 stock option plan in June 2000 and reserved 200,000 shares of common stock for issuance under the 2000 plan. Our stockholders approved the 2000 plan in June 2000. The 2000 plan provides for grants of incentive stock options to employees, including officers and employee directors, of our company, parent or subsidiaries and nonstatutory stock options to employees, consultants and nonemployee directors of our company, our parent and our respective subsidiaries. The purposes of our 2000 plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to our employees, consultants and nonemployee directors and to promote the success of our business. At the request of the board of directors, the compensation committee administers our 2000 plan and determines, among other things, the optionees and the terms of options granted, including the exercise price, number of shares subject to the option and the exercisability thereof. The term of the options granted under the 2000 plan is set forth in the option agreement. The term of an option may not exceed 10 years and, in the case of an incentive stock option granted to an optionee who owns more than 10% of the voting power of all of the classes of stock of our company, parents or subsidiaries at the time of grant, the term of an option may not exceed five years. The exercise price for options granted under the 2000 plan is determined in the option agreement. However, in the case of options granted to an employee who owns stock Total revenues 57,458 110,264 167,722 Cost of revenues: Licensing 1,656 4,084 5,740 Maintenance, support and services 17,048 24,712 41,760 Amortization of developed technologies Table of Contents representing more than 10% of the voting power of all classes of voting stock of our company, parent or subsidiaries, the exercise price may be no less than 110% of the fair market value of a share of our common stock at the time of the grant. For all other employees, the exercise price may not be less than fair market value of our common stock for an incentive stock option and may not be less than 85% of the fair market value for a nonstatutory stock option. Under the terms of the stock option agreements under which the outstanding stock options were granted, the options were granted at fair market value and become fully vested and exercisable immediately prior to a merger or sale of substantially all of our assets, or on the date upon which a registration statement related to an initial public offering is declared effective by the Securities and Exchange Commission. We expect to record a non-cash dividend upon vesting of these options at some time prior to the proposed acquisition, as all of the options under this plan have been granted to employees of our parent or a company under common control. The 2000 plan will terminate in June 2010, unless our board of directors terminates it sooner. Prior to our proposed acquisition by Business Objects, options outstanding under the 2000 plan will become fully exercisable. Any options not exercised at the effective time of the proposed acquisition will terminate and will no longer be exercisable or represent the right to receive an option to purchase Business Objects ADSs. As of October 17, 2003, we had granted options to purchase 161,450 shares of our common stock under the 2000 plan of which 103,450 options were outstanding; however, no shares have been issued upon the exercise of options under the 2000 plan. As of October 17, 2003, 96,550 shares remained available for grant under the 2000 plan. 2002 Stock Option Plan Our board of directors adopted our 2002 stock option plan in May 2002 and amended it in May 2003. A total of 5,000,000 shares of common stock have been reserved for issuance under our 2002 plan, together with an annual increase in the number of shares of common stock reserved under the plan beginning on the first day of our fiscal year, commencing July 3, 2004, in an amount equal to the lesser of: 7,500,000 shares of common stock; 5.0% of our outstanding shares of common stock on the last day of the prior fiscal year; or an amount determined by our board of directors. The 2002 plan provides for grants of incentive stock options to our employees including officers and employee directors of our company, parent or subsidiaries and nonstatutory stock options to employees, consultants and nonemployee directors. The purposes of our 2002 plan are to attract and retain the best available personnel, to provide additional incentive to our employees, consultants and nonemployee directors and to promote the success of our business. At the request of the board of directors, the compensation committee administers our 2002 plan and determines, among other things, the optionees and the terms of options granted, including the exercise price, number of shares subject to the option and the exercisability thereof. The term of the options granted under the 2002 plan is set forth in the option agreement. However, the term of an incentive stock option may not exceed 10 years and, in the case of an option granted to an optionee who owns more than 10% of the total combined voting power of all classes of stock of our company, parent or subsidiaries at the time of grant, the term of an option may not exceed five years. Options granted under the 2002 plan vest and become exercisable as set forth in each option agreement. With respect to any optionee who owns more than 10% of the total combined voting power of all classes of stock of our company, parent or subsidiaries, the exercise price of any stock option granted must be at least 110% of the fair market value of our common stock on the grant Table of Contents date. For all other employees, the exercise price may not be less than fair market value. However, for all employees, options may be granted with an exercise price of less than fair market value on the date of grant pursuant to a merger or other corporate transaction. No incentive stock options may be granted to an optionee, which, when combined with all other incentive stock options becoming exercisable in any calendar year that are held by that person, would have an aggregate fair market value in excess of $100,000. In any fiscal year, we may not grant any employee options to purchase more than 1,000,000 shares or 4,000,000 shares in the case of an employee s initial employment. In the event of a merger of our company or a sale of substantially all of the assets of our company, any option that is not assumed or substituted by a successor will fully vest and will terminate upon completion of the transaction. The 2002 stock option plan will terminate in May 2013, unless our board of directors terminates it sooner. As of October 17, 2003, we had not granted any options nor issued any shares of common stock upon the exercise of options granted under our 2002 plan and 5,000,000 shares remain available for grant under our 2002 plan. The 2002 plan will become effective only upon the effective date of a registration statement of a firm commitment underwritten initial public offering. Assuming the proposed acquisition is completed, we currently expect that the 2002 plan will not become effective. 2002 Director Option Plan Our board of directors adopted our 2002 director option plan in May 2002 and amended it in May 2003. We have reserved a total of 250,000 shares of common stock for issuance under the 2002 director option plan, together with an annual increase in the number of shares of common stock reserved under the plan beginning on the first day of our fiscal year commencing July 3, 2004 equal to the lesser of: 300,000 shares of common stock; 0.2% of the outstanding shares of our common stock on the last day of the prior fiscal year; or an amount determined by the board of directors. The option grants under the 2002 director option plan are automatic and nondiscretionary, and the exercise price of the options is 100% of the fair market value of our common stock on the grant date. Only nonemployee directors are eligible for grants under our 2002 director option plan. The 2002 director option plan provides for an initial grant to a new nonemployee director of an option to purchase 50,000 shares of common stock. Subsequent to the initial grants, each nonemployee director will be automatically granted an option to purchase 20,000 shares of common stock on the first meeting of our board of directors after our annual meeting of stockholders. So long as that director has been a member of our board of directors for six months or more at the time of our annual meeting. The term of the options granted under the 2002 director option plan is 10 years, but the options expire three months following the termination of the optionee s status as a director or 12 months if the termination is due to death or disability. The grants will become exercisable at a rate of 25% of the shares subject to the grant after the first anniversary of the date of grant and 1/48th of such shares per month commencing thereafter. Table of Contents In the event of a merger of the company or a sale of substantially all of the assets of the company, any option which is not assumed or substituted will fully vest and will terminate upon completion of the transaction. The 2002 director option plan will terminate in May 2013, unless our board of directors terminates it sooner. As of October 17, 2003, we had not granted any options nor issued any shares of common stock upon the exercise of options under our 2002 director option plan and 250,000 shares remain available for grant under our 2002 director option plan. The 2002 director option plan will become effective only upon the effective date of a registration statement of a firm commitment underwritten initial public offering. Assuming the proposed acquisition is completed, we currently expect that the 2002 director option plan will not become effective. Registered Retirement Savings Plan Our regular full- and part-time employees in Canada are entitled to participate in a group registered retirement savings plan that we sponsor. This plan is established by contractual arrangement between participating employees and the Royal Bank of Canada, who operates the plan. The plan is registered under Section 146 of the Income Tax Act (Canada) and provides that employees may contribute, on a pre-tax basis, funds for investment on their behalf by Royal Bank of Canada. We contribute, on behalf of each participating employee, fifty cents for every dollar that the employee contributes to his or her plan account, up to an annual maximum of Canadian $2,500 or 6% of the employee s annual salary, whichever is less. Employee participation in the plan is voluntary. We made matching contributions to the plan of an aggregate of Canadian $1.3 million in fiscal 2001, Canadian $1.5 million in fiscal 2002 and Canadian $1.7 million in fiscal 2003. 401(k) Plan Our employees in the United States are eligible to participate in the Seagate Technology 401(k) plan, if they have attained the age of 21 and have completed one month of service with us. The Seagate Technology 401(k) plan excludes from participation employees of affiliated employers, employees subject to collective bargaining agreements and nonresident alien employees. The Seagate Technology 401(k) plan is intended to qualify under Sections 401(a), 401(m) and 401(k) of the Internal Revenue Code of 1986, as amended, and the Seagate Technology 401(k) plan trust is intended to qualify under Section 501(a) of the Internal Revenue Code. All contributions to the Seagate Technology 401(k) plan by eligible employees, and the investment earnings thereon, are not taxable to these employees until withdrawn and are 100% vested immediately. Our eligible employees may elect to reduce their current compensation up to the maximum statutorily prescribed annual limit, and to have these salary reductions contributed on their behalf to the Seagate Technology 401(k) plan. In connection with the proposed acquisition, our employees who participated in Seagate Technology s 401(k) plan will be provided the opportunity to roll their Seagate Technology 401(k) plan interests into the Business Objects 401(k) plan, to the extent that the rollover is available under the terms of the Business Objects 401(k) plan and applicable law. After the closing of the proposed acquisition, our employees will no longer be eligible to make new contributions to Seagate Technology s 401(k) plan but generally may maintain their existing balances in the Seagate Technology 401(k) plan if they so choose. We made matching contributions to the Seagate Technology 401(k) plan of an aggregate of $295,000 in fiscal 2001, $367,000 in fiscal 2002 and $426,000 in fiscal 2003. Total revenues 142,565 126,909 167,722 217,170 287,508 Cost of revenues: Licensing 3,938 3,906 5,504 4,993 5,617 Maintenance, support and services 37,374 41,346 41,996 46,377 56,313 Amortization of developed technologies 4,545 198 3,050 5,078 Write-off of developed technologies 4,700 Table of Contents Limitations on Liability and Indemnification Matters We have adopted provisions in our certificate of incorporation that limit the liability of our directors and executive officers for monetary damages for breach of their fiduciary duties to the maximum extent permitted by Delaware law. Under Delaware law, a certificate of incorporation may provide that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors except liability for: any breach of their duty of loyalty to our company or our stockholders; acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law; or any transaction from which the director derived an improper personal benefit. The limits on a director s or officer s liability in our certificate of incorporation does not apply to liabilities arising under the federal securities laws and will not affect the availability of equitable remedies such as injunctive relief or rescission. Our certificate of incorporation, together with our bylaws, provide that we must indemnify our directors and officers and may indemnify our other employees and agents to the fullest extent permitted by law. Our bylaws also permit us to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in that capacity, regardless of whether our bylaws would otherwise permit indemnification. We believe that the indemnification provisions of our certificate of incorporation and bylaws are necessary to attract and retain qualified persons as directors and officers. We also maintain directors and officers liability insurance. We have entered and expect to continue to enter into agreements to indemnify our directors, executive officers and other employees as determined by the board of directors. These agreements provide for indemnification for related expenses including attorneys fees, judgments, fines and settlement amounts incurred by any of these individuals in any action or proceeding. We believe that these provisions and agreements are necessary to attract and retain qualified persons as our directors and executive officers. Messrs. Luczo, Roux, Thompson and Waite have entered into indemnification agreements with New SAC. In addition, Mr. Roux, one of our directors, has entered into an indemnification agreement with an affiliate of Silver Lake Partners. An affiliate of Silver Lake Partners also maintains directors and officers liability insurance that covers Mr. Roux s membership on our board. At present we are not aware of any pending litigation or proceeding involving any director, officer, employee or agent of our company in such person s capacity with our company where indemnification will be required or permitted. We are also not aware of any threatened litigation or proceeding that might result in a claim for indemnification. New SAC(1) 75,001,000 98.4% c/o M C Corporate Services Limited P.O. Box 309GT, Ugland House South Church Street George Town Grand Cayman, Cayman Islands Affiliates of Silver Lake Partners, L.P.(2) 75,001,000 98.4 c/o Silver Lake Partners, L.P. 2725 Sand Hill Road, Suite 150 Menlo Park, California 94025 TPG SAC Advisors III Corp.(3) 75,001,000 98.4 c/o Texas Pacific Group 301 Commerce Street, Suite 3300 Fort Worth, Texas 76102 * Less than one percent. (1) A wholly owned subsidiary of New SAC acquired 75,001,000 shares of our outstanding common stock in November 2000. Messrs. Luczo and Roux, in their capacities as directors of New SAC, and Mr. Waite, in his capacity as an officer of New SAC, may be deemed to have shared voting or dispositive power over these shares. Each of them disclaims this beneficial ownership. (2) Includes 75,001,000 shares of our common stock beneficially owned by New SAC, over which affiliates of Silver Lake Partners, L.P. may be deemed, as a result of their ownership of approximately 31.8% of New SAC s total outstanding shares, to have shared voting or dispositive power. The affiliates of Silver Lake Partners, L.P. are Silver Lake Partners Cayman, L.P., Silver Lake Investors Cayman, L.P. and Silver Lake Technology Investors Cayman, L.P. The sole general partner of each of Silver Lake Partners Cayman, L.P. and Silver Lake Investors Cayman, L.P. is Silver Lake Technology Associates Cayman, L.P. and the sole general partners of each of Silver Lake Technology Associates Cayman, L.P. and Silver Lake Technology Investors Cayman, L.P. is Silver Lake (Offshore) AIV GP LTD. The shareholders of Silver Lake (Offshore) AIV GP LTD are James A. Davidson, Glenn H. Hutchins, David J. Roux, Integral Capital Partners SLP LLC, Yolande Jun and Karl Schade. Ms. Jun and Mr. Schade are employees of an affiliate of Silver Lake Partners, L.P. All persons identified above disclaim beneficial ownership of these shares. (3) Includes 75,001,000 shares of our common stock beneficially owned by New SAC, over which affiliates of TPG SAC Advisors III Corp. may be deemed, as a result of their ownership of approximately 22.1% of New SAC s total outstanding shares, to have shared voting or dispositive power. TPG SAC Advisors III Corp. is the sole general partner of TPG SAC GenPar, L.P., which is the sole general partner of SAC Investments, L.P. The shareholders of TPG SAC Advisors III Corp. are David Bonderman, James G. Coulter, William S. Price, Justin T. Chang and John Marren. Each of them, however, disclaims beneficial ownership of these shares, except to extent of his pecuniary interest therein. (4) Includes 75,001,000 shares of our common stock beneficially owned by New SAC, over which affiliates of August Capital III, L.P., may be deemed, as a result of their ownership of 11.4% of New SAC s outstanding shares, to have shared voting or dispositive power. The members of August Capital Management III, L.L.C. may be deemed to have shared voting or dispositive power over those shares. August Capital Management III, L.L.C. is the general partner of August Capital III, L.P. The members of August Capital Management III, L.L.C. are Andrew S. Rapaport, John Johnston, David F. Marquardt and Andrew Anker. Each of them, however, disclaims beneficial ownership of these shares, except to the extent of his pecuniary interest therein. (5) Includes 2,000,000 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. Table of Contents (6) Includes 450,325 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. (7) Includes 373,356 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. (8) Includes 208,834 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. (9) Includes 571,770 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. (10) Includes 70,000 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. (11) Includes 50,000 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. (12) Represents 75,001,000 shares of common stock beneficially owned by New SAC to which Mr. Chang may be deemed, in his capacity as a principal of Texas Pacific Group, to have shared voting or dispositive power. Includes 70,000 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. TPG SAC Advisors III Corp., which owns approximately 22.1% of New SAC s total outstanding shares, is the sole general partner of TPG SAC GenPar, L.P., which is the sole general partner of SAC Investments, L.P. Mr. Chang is also a shareholder of TPG SAC Advisors III Corp., which is the sole general partner of TPG SAC GenPar, L.P., which is the sole general partner of SAC Investments, L.P., which owns approximately 22.1% of New SAC s total outstanding shares. Mr. Chang disclaims beneficial ownership of these shares, except to the extent of his pecuniary interest therein. (13) Includes 3,300,000 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. Mr. Kerfoot also owns 170,000 shares of New SAC, representing 1.5% of New SAC s total outstanding shares. (14) At October 17, 2003, we held repurchase rights on 3,230 shares. Also, includes 120,000 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. Includes 75,001,000 shares of common stock beneficially owned by New SAC to which Mr. Luczo may be deemed, in his capacity as the chief executive officer and director of New SAC, to have shared voting or dispositive power. Mr. Luczo disclaims beneficial ownership of these shares, except to the extent of his pecuniary interest therein. Mr. Luczo owns 556,904 shares of New SAC, representing 4.9% of New SAC s total outstanding shares. (15) Represents 75,001,000 shares of common stock beneficially owned by New SAC to which Mr. Roux may be deemed, in his capacity as a director of New SAC, to have shared voting or dispositive power. Mr. Roux disclaims beneficial ownership of these shares, except to the extent of his pecuniary interest therein. Includes 70,000 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. (16) Includes 42,917 shares of common stock that may be acquired upon the exercise of stock options exercisable within 60 days after October 17, 2003. Mr. Thompson owns 12,314 shares of New SAC, representing 0.1% of New SAC s total outstanding shares. (17) At October 17, 2003, we held repurchase rights on 1,043 shares. Includes 20,000 shares of common stock that may be acquired upon exercise of stock options exercisable within 60 days after October 17, 2003. Also includes 75,001,000 shares of common stock beneficially owned by New SAC to which Mr. Waite may be deemed, in his capacity as an officer of New SAC, to have shared voting or dispositive power. Mr. Waite disclaims beneficial ownership of these shares, except to the extent of his pecuniary interest therein. Mr. Waite owns 124,738 shares of New SAC, representing 1.1% of New SAC s total outstanding shares. (18) See notes 2 through 17. Table of Contents OUR RELATIONSHIPS AND ARRANGEMENTS WITH NEW SAC, SEAGATE TECHNOLOGY, OUR OFFICERS AND OUR DIRECTORS Transactions with Seagate Technology In December 2000, we signed a software license agreement with Old Seagate, whose obligations were assigned to Seagate Technology. Under the terms of the license agreement, we granted Seagate Technology a non-exclusive, non-transferable, perpetual license to use certain business intelligence products and receive related maintenance and support services for one year. The total value of the license agreement was $1.6 million. The license agreement was priced at an approximate 50% discount to our established list price. We recognized $1.5 million of the revenues from the license agreement in fiscal 2001 and the remaining $151,000 in fiscal 2002. We also earned consulting revenues of $327,000 in fiscal 2001 and $30,000 in fiscal 2002. The maintenance and support services related to the license agreement were renewed for one year during the three months ended December 28, 2001 and for an additional year in the three months ended March 28, 2003. Revenues from maintenance and support services are being recognized ratably over the term of the contract, which is one year. We recognized $282,000 in fiscal 2002 and $455,000 in fiscal 2003 in connection with these maintenance and support services. At June 27, 2003, there were no amounts in accounts receivable due from Seagate Technology as a result of the renewal of maintenance and support services. Historically, Old Seagate and Seagate Technology, either directly or indirectly, provided substantial administrative and financial services to us under a general services agreement between Seagate Software Holdings and Old Seagate dated June 28, 1997. During fiscal 2001, the general services agreement was replaced by the following agreements between us and Seagate Technology and its affiliates: a corporate services agreement, a payroll services agreement and a management services agreement. Under substantially the same terms as the general services agreement, Seagate Technology and its affiliates continued to provide various cash management, taxation, administrative, accounting and similar corporate and managerial services as requested by us. Seagate Software Holdings contributed its rights, and we assumed Seagate Software Holdings obligations under the general services agreement in connection with the asset contribution in fiscal 2000. Seagate Technology assumed Old Seagate s rights and obligations under the general services agreement in connection with the closing of the November 2000 transactions. For various corporate services performed on our behalf, Old Seagate and Seagate Technology charged us an aggregate of $1.2 million in fiscal 2001 and Seagate Technology charged us an aggregate of $865,000 in fiscal 2002 and an aggregate of $348,000 in fiscal 2003. The amounts we paid to Old Seagate and Seagate Technology represented a reasonable estimate of Old Seagate or Seagate Technology s direct and indirect costs incurred in performing services for us. The cost allocated to us was intended to be on a basis no less favorable than what we could obtain from an unaffiliated third party. We have audit rights with respect to the computation and analysis of service fees pursuant to the general services agreement and the agreements that replaced the general services agreement in fiscal 2001. In December 2002, we paid a non-recurring termination fee of $625,000 to Seagate Technology for the benefit of New SAC related to a previous consulting and advisory contract. Additionally, on July 4, 2000, we signed a revolving loan agreement with Seagate Technology on substantially the same terms and conditions as the prior agreement, which was dated July 4, 1998, between Seagate Software Holdings and Seagate Technology. In connection with the asset contribution, Seagate Software Holdings rights and obligations under the 1998 intercompany revolving loan agreement were contributed to and assumed by us. Under the revolving loan agreement, Seagate Technology financed some of our working capital requirements. The revolving loan agreement provided for maximum borrowings of up to Total cost of revenues 50,557 45,450 50,550 56,448 61,930 Table of Contents $60.0 million and expired on July 4, 2001. On July 4, 2001, we renewed this revolving loan agreement with Seagate Technology. The July 4, 2001 revolving loan agreement provided for maximum borrowings of up to $15.0 million and expired on July 4, 2002. We did not renew the revolving loan agreement and it expired on July 4, 2002. We had no receivables from Seagate Technology as of June 28, 2002 or June 27, 2003 under the revolving loan agreement. Borrowings from Old Seagate and Seagate Technology were used primarily to fund our operating activities. During fiscal 2001, there were $4.8 million of net repayments under the revolving loan agreement. In addition during fiscal 2001, Seagate Technology repaid $31.0 million of the loan receivable under the revolving loan agreement. During fiscal 2002, Seagate Technology made $3.4 million of net repayments under the revolving loan agreement. There were no borrowings from Seagate Technology or repayments to Seagate Technology during fiscal 2003. We were included in the consolidated federal and certain combined and consolidated foreign and state income tax returns of Old Seagate until November 22, 2000. Old Seagate and Seagate Software Holdings entered into a tax allocation agreement dated April 4, 1996 pursuant to which we computed hypothetical tax returns as if we were not joined in consolidated or combined returns with Old Seagate and assuming the maximum marginal federal corporate income tax rate. Generally, we were required to pay Old Seagate the positive amount of any hypothetical taxes. If the hypothetical tax returns showed entitlement to refunds, including any refunds attributable to a carryback, then Old Seagate would pay us the amount of any refunds. The amounts relating to the tax allocation agreement were included in the net intercompany revolving loan balance. The tax allocation agreement terminated upon the closing of the November 2000 transactions. We entered into a state tax allocation agreement with several New SAC affiliates effective as of November 23, 2000. Under the terms of the state tax allocation agreement, each entity that is included in any state unitary and combined return with the other New SAC affiliates must compute hypothetical tax returns, with certain modifications, as if the entity were not included in combined returns with the other New SAC affiliates. Each entity must pay the positive amount of any such hypothetical taxes. If the hypothetical tax returns show entitlement to refunds, including any refunds attributable to carrybacks, then the other New SAC affiliates will pay the entitled entities the amount of such refunds within 30 days of the close of the fiscal year in which the entitled entities otherwise would have been able to utilize the net operating losses or tax credits on a separate return filing basis. We have not been included in any state unitary and combined return with the other New SAC affiliates since June 30, 2001. As of June 27, 2003, there were no tax-related receivables due to us from certain New SAC affiliates. We occupy two facilities leased by Seagate Technology for which we pay Seagate Technology fair value rent and related costs in aggregate of approximately $340,000 per year. One of the subleases is expected to end in September 2003. Transactions with VERITAS VERITAS and a subsidiary of VERITAS Software Corporation entered into a three-year cross license and original equipment manufacturer agreement with Crystal Decisions, Corp., a wholly owned subsidiary, on May 28, 1999. Messrs. Luczo and Kerfoot were members of the board of directors of VERITAS at that time. The cross license agreement provided for the licensing of certain products between the parties. We recognized no revenues from VERITAS in fiscal 2001, fiscal 2002 or fiscal 2003. On June 21, 2002, the cross license agreement was terminated and we entered into two software license and services agreements with VERITAS Software Global Corporation. Messrs. Luczo and Roux were members of the board of directors of VERITAS at that time. Under one of the agreements, VERITAS granted us a perpetual, irrevocable, non-exclusive, non-transferable, worldwide license to use given products in specified amounts, solely in support of Table of Contents our internal business operations. The software license agreement provided for the purchase of annual maintenance and support, which was calculated as a percentage of the actual list price of the licensed software. In July 2002, we recorded approximately $622,000 as a prepaid expense related to the annual maintenance and support contract, which was being expensed ratably in fiscal 2003. In July 2003, the maintenance and support agreement was renewed for selected products of the software and we recorded approximately $111,000 as a prepaid expense, which is being expensed ratably in fiscal 2004. In a separate agreement, we granted VERITAS a perpetual software license to use given products in specified amounts and 18 months of maintenance and support services for no consideration. The fair value of the license and maintenance and support services was approximately $126,000. We recognized no revenues under this agreement. Sale of Seagate Technology Our majority stockholder is New SAC, an exempted limited liability company organized under the laws of the Cayman Islands. New SAC was formed by affiliates of Silver Lake Partners, Texas Pacific Group, August Capital, J.P. Morgan Partners LLC, investment partnerships of which the general partner, managing general partner or investment manager is affiliated with Goldman, Sachs Co. and other investors. Prior to November 22, 2000, we were a majority owned subsidiary of Seagate Software Holdings, a Delaware corporation and wholly owned subsidiary of Old Seagate. We became an indirect subsidiary of New SAC on November 22, 2000 when Seagate Software (Cayman) Holdings acquired 75,001,000 shares, or 99.7% of our common stock outstanding on that date, under the terms of a stock purchase agreement with Old Seagate and Seagate Software Holdings. Upon completion of the transaction, New SAC purchased all of the operating assets of Old Seagate and its consolidated subsidiaries for cash and borrowings of $1.84 billion, including transaction costs of $25.0 million. This included Old Seagate s rigid disc drive, storage area network, removable tape storage solutions businesses and operations, our common stock, and certain cash balances, but excluded the approximately 128 million shares of VERITAS common stock then held by Seagate Software Holdings and certain of Old Seagate s equity investments, which were subsequently transferred to VERITAS through a merger of a wholly owned subsidiary of VERITAS into Old Seagate. Messrs. Luczo, Kerfoot and Waite, who are members of our board of directors, each invested in the equity component of the financing for the November 2000 transaction with New SAC and each is a shareholder of New SAC. Mr. Luczo and Mr. Waite also participated in the financing of the transaction through the roll-over of a portion of their outstanding stock and options in Old Seagate to equity interests in New SAC and deferred compensation in a subsidiary of New SAC. In addition, Mr. Luczo and Mr. Waite entered into employment agreements with Seagate Technology (US) Holdings, Inc. Each employment agreement has a three-year term, subject to automatic successive one-year renewals thereafter. Under the employment agreements, Mr. Luczo was appointed and serves as chief executive officer of New SAC and Seagate Technology, and Mr. Waite was appointed and serves as executive vice president and chief administrative officer of New SAC, Seagate Technology and Seagate Software (Cayman) Holdings, as well as the president and chief operating officer of Certance Holdings. Mr. Luczo also became a director of New SAC and Seagate Technology and Certance Holdings and chief executive officer, president and chief operating officer of Seagate Software (Cayman) Holdings. Messrs. Luczo, Kerfoot and Waite also received shares of VERITAS common stock and cash to the extent of their outstanding common stock and options in Old Seagate, net of any amounts rolled over into equity and deferred compensation in New SAC and its affiliates. The per Table of Contents share amounts paid to these board members were the same as the amounts paid to other holders of Old Seagate common stock. In connection with the November 2000 transactions, New SAC and its affiliates, including us, agreed to assume and indemnify VERITAS and its affiliates for substantially all liabilities arising in connection with Old Seagate s and our operating assets and for selected tax liabilities. In return, VERITAS, Old Seagate and their affiliates agreed to indemnify New SAC and its affiliates, including us, for certain liabilities, including all taxes of Old Seagate for which New SAC and its affiliates are not obligated to indemnify VERITAS and its affiliates. VERITAS deposited $150 million in an escrow account. This amount will reduce these tax liabilities, including those of our company and our subsidiaries. To the extent any part of the $150 million is not utilized to satisfy these tax liabilities, it will be paid to the former stockholders of Old Seagate. In July 2002, we entered into a reimbursement agreement with Seagate Technology and its affiliates which allocates the respective liabilities and obligations of the parties under the indemnification agreement. Under the reimbursement agreement, if we and Seagate Technology became obligated to indemnify VERITAS or Old Seagate under the indemnification agreement, a subsidiary of Seagate Technology will be responsible for the first $125 million of the tax liabilities. Any amount in excess of the first $125 million will be allocated pro rata in accordance with the portion of the purchase price allocated to each entity in connection with the November 2000 transaction among various subsidiaries and affiliates Seagate Technology and us. For indemnification obligations other than tax liabilities, the parties agreed that the responsible entity will reimburse any entity that satisfies the obligation on its behalf. In connection with the agreement and plan of merger that we entered into on July 18, 2003 with Business Objects, we obtained from VERITAS a written release from our obligations to indemnify VERITAS for matters arising prior to the November 2000 transaction. The release will only become effective if the transaction with Business Objects is completed prior to March 31, 2004 and will not be of any force or effect unless and until the proposed acquisition is completed. In addition, on July 18, 2003, New SAC entered into a letter agreement with us whereby New SAC agreed to reimburse us for any claims arising prior to March 31, 2006 and related to tax matters under the reimbursement agreement or the indemnification agreement. The letter agreement will become effective only upon the closing of the proposed acquisition of our company by Business Objects and will not be of any force or effect if the proposed acquisition is not completed. New SAC Shareholders Agreement As of the date of the closing of the November 2000 transactions, our parent company, New SAC, entered into a shareholders agreement with its shareholders, certain members of our board of directors and specified members of Seagate Technology s management. The New SAC shareholders agreement will terminate in the event that 50% or more of New SAC s shares are sold or distributed to the public or are actively traded on a national securities exchange. Corporate Governance New SAC s board of directors consists of nine members, three of whom are designated by Silver Lake Partners, two of whom are designated by Texas Pacific Group, one of whom is an executive officer of New SAC whose appointment is reasonably acceptable to a majority of the directors, one of whom is an independent director proposed by Silver Lake Partners, approved by Texas Pacific Group and reasonably acceptable to a majority of the directors, one of whom is the chief executive officer of New SAC and one of whom is a director elected pursuant to the provisions of New SAC s governing documents. The consent of at least seven members of New SAC s board of directors is required before New SAC may voluntarily commence a bankruptcy Total revenues 100 100 Table of Contents proceeding, enter into a material business combination, sell a material amount of assets, enter into a material transaction with some of the shareholders of New SAC or any of its affiliates, authorize, issue or sell equity securities or options or warrants to purchase equity securities, pay dividends or redeem equity securities or amend its memorandum and articles of association. Accordingly, our ability to engage in some transactions requiring stockholder approval will effectively be limited without the consent of New SAC shareholders. In addition, the consent of eight directors is required to increase or decrease the size of New SAC s board, and the consent of seven directors is required for the exercise of the drag-along rights described below, and the consent of at least five directors, with no Seagate Technology management directors participating, is required to terminate the chief executive officer of New SAC or appoint his successor. Preemptive Rights The parties to the New SAC shareholders agreement have preemptive rights allowing them to acquire for cash, in proportion to their respective shareholdings in New SAC, additional securities proposed to be issued and sold by New SAC, excluding shares issued upon the exercise of outstanding options granted under employee benefit plans or similar arrangements. If a New SAC shareholder fails to exercise that shareholder s preemptive rights, New SAC has the right to sell these additional securities. Transfer Restrictions; Tag-Along Rights; Drag-Along Rights No party to the New SAC shareholders agreement is permitted to sell, transfer or otherwise dispose of any of New SAC s shares until the earlier of November 22, 2003 or 180 days after New SAC s initial public offering without the prior consent of both Silver Lake Partners and Texas Pacific Group, subject to specific exceptions. After the earlier of November 22, 2003 or 180 days after New SAC s initial public offering, each New SAC shareholder subject to the agreement will have a right of first offer to acquire any New SAC shares that another New SAC shareholder to the agreement proposes to sell or otherwise transfer, and any third party buyer will be subject to approval of New SAC s board of directors, excluding those directors affiliated with the transferring shareholder. In addition, each New SAC shareholder and member of Seagate Technology management who is a party to the New SAC shareholder s agreement has tag-along rights, which are the rights to include a proportionate number of shares, on the same terms and conditions, in any sale by another party to the agreement to a third party. Beginning after the earlier of November 22, 2003 or 180 days after New SAC s initial public offering, any New SAC shareholder holding a majority of the outstanding shares of New SAC will also have drag-along rights, meaning that if the shareholder receives an offer from a third party to purchase a majority of New SAC s outstanding shares or enter into a business combination, the shareholder will have the right to cause New SAC s other shareholders to join in the sale or business combination on the same terms and conditions. Registration Rights Subject to limitations specified in the New SAC shareholders agreement, New SAC agreed to include New SAC shares held by the New SAC shareholders in any public offering, other than New SAC s initial public offering by granting: to each shareholder to the agreement unlimited rights to participate in an offering initiated by New SAC; to all shareholders holding at least 20% of New SAC s outstanding shares three demand registrations; and to any single shareholder holding at least 10% of New SAC s outstanding shares one demand registration right with respect to that shareholder. Table of Contents In addition, subject to certain conditions, all New SAC shareholders may require New SAC to register New SAC shares they hold on Form S-3 without limits to the number of those registrations. New SAC agreed to pay all registration expenses relating to these registrations and to indemnify the selling shareholders. Distribution Upon Initial Public Offering of Certain Subsidiaries; New Shareholders Agreement At any time 190 days after the initial public offering of the shares of designated subsidiaries of New SAC, Silver Lake Partners or Texas Pacific Group, or both, can require that New SAC distribute to its shareholders the remaining shares New SAC holds of the newly public subsidiary s stock. Upon the distribution of a newly public subsidiary s shares, the newly public subsidiary is required to enter into a new agreement with the New SAC shareholders, on substantially the same terms as the New SAC shareholders agreement. In connection with our proposed acquisition by Business Objects, Silver Lake Partners and Texas Pacific Group have agreed not to exercise this right in the future with respect to the combined company. Instead, New SAC, New SAC s shareholders, certain Seagate Technology officers and some of our directors have entered into a new agreement with Business Objects that will only be effective upon the closing of the proposed acquisition. (1) As of October 17, 2003, we held the right to repurchase 3,230 of the 175,000 shares. Our repurchase right lapsed for 43,750 shares on October 22, 2000 and thereafter lapses at a rate of 1/48th per month of the shares subject to the option. (2) As of October 17, 2003, we held the right to repurchase 1,043 of the 50,000 shares. Our repurchase right lapsed for 12,500 shares on October 22, 2000 and thereafter lapses at a rate of 1/48th per month of the shares subject to the option. Table of Contents DESCRIPTION OF CAPITAL STOCK General We have 150,000,000 shares of $0.001 par value per share common stock authorized in our certificate of incorporation. We do not have any authorized preferred stock. Common Stock As of October 17, 2003, we had 76,231,727 shares of common stock outstanding that were held of record by approximately 300 stockholders. The holders of common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Subject to preferences that may be applicable to any outstanding preferred stock, the holders of common stock are entitled to receive ratably any dividends that may be declared from time to time by the board of directors out of funds legally available for that purpose. In the event of our liquidation, dissolution or winding up, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock then outstanding. The common stock has no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the common stock. Anti-Takeover Effects of Some Provisions of Delaware Law Certain provisions of Delaware law and our certificate of incorporation and bylaws could make the acquisition of our company through a tender offer, a proxy contest or other means more difficult and could make the removal of incumbent officers and directors more difficult. We expect these provisions to discourage certain types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of our company to first negotiate with our board of directors. We believe that the benefits provided by our ability to negotiate with the proponent of an unfriendly or unsolicited proposal outweigh the disadvantages of discouraging these proposals. We believe the negotiation of an unfriendly or unsolicited proposal could result in an improvement of its terms. Anti-Takeover Effects of Certain Provisions of Our Charter Documents Under Delaware law, a special meeting of stockholders may be called by the board of directors or by any other person authorized to do so in the certificate of incorporation or the bylaws. Our certificate of incorporation and bylaws provide that only a majority of our board of directors, the chairman of the board, the chief executive officer or president can call a special meeting of stockholders. Because our stockholders do not have the right to call a special meeting, a stockholder could not force stockholder consideration of a proposal over the opposition of the board of directors by calling a special meeting of stockholders prior to the time a majority of the board of directors believed or the chief executive officer believed the matter should be considered or until the next annual meeting provided that the requestor met the notice requirements. The restriction on the ability of stockholders to call a special meeting means that a proposal to replace the board also could be delayed until the next annual meeting. Table of Contents LEGAL MATTERS The validity of the common stock which we are offering to repurchase hereby will be passed upon for us by Wilson Sonsini Goodrich Rosati, Professional Corporation, Palo Alto, California. United States federal tax consequences relating to the Crystal Decisions merger will be passed upon for us and Seagate Software (Cayman) Holdings by Wilson Sonsini Goodrich Rosati, Professional Corporation, Palo Alto, California. Investment partnerships comprised of members of and persons associated with Wilson Sonsini Goodrich Rosati own an interest representing less than 1% of the capital commitments of Silver Lake Partners. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001131907_micromet_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001131907_micromet_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b48f56ac6e2518fe10ec8772389539d06f5a5151 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001131907_micromet_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Latham Watkins LLP, San Diego, California. As of the date of this prospectus, Latham Watkins LLP and certain of its attorneys hold shares of our preferred stock which will be converted into an aggregate of 8,154 shares of our common stock upon the closing of this offering. Certain legal matters in connection with this offering will be passed upon for the underwriters by Bingham McCutchen LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001137281_internatio_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001137281_internatio_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5726abba0bd7b761c635dfec6226ed8b51b5951b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001137281_internatio_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Stepp Law Group, Newport Beach, California, and Walkers Attorneys-At Law, Grand Cayman, Cayman Islands, will pass upon the legality of the ordinary shares offered by this prospectus. Stepp Law Group acts as our counsel on United States legal matters related to this prospectus. We are not aware of any material legal proceedings against IFG. We may be involved, from time to time, in various legal proceedings and claims incident to the normal conduct of our business. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001138268_grey-wolf_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001138268_grey-wolf_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..45ca0973a27bb4eb32d16f261d6adc84a1a74253 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001138268_grey-wolf_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the notes and the Abraxas common stock covered by this prospectus has been passed upon for Abraxas by Cox & Smith Incorporated, San Antonio, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001139665_xcel_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001139665_xcel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..170c587cf236663edf4afa234a294ae7c8191551 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001139665_xcel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Selected legal matters with respect to the validity of the common stock offered by this prospectus are being passed upon for us by Pillsbury Winthrop LLP, San Diego, California. An attorney of Pillsbury Winthrop LLP owns 2,000 shares of our Series C convertible preferred stock, which will be converted automatically into an equal number of shares of common stock upon the closing of this offering. An entity in which attorneys and former attorneys of Pillsbury Winthrop LLP are members owns an aggregate of 20,000 shares of our Series A convertible preferred stock, which will be converted automatically into an equal number of shares of common stock upon the closing of this offering. Selected legal matters in connection with this offering will be passed upon for the underwriters by Heller Ehrman White & McAuliffe LLP, San Diego, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001140184_ipayment_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001140184_ipayment_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..66f3fb2ff2c4b7a170318f40169204d93af89523 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001140184_ipayment_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered will be passed upon for us by White Case LLP, New York, New York. As of April 22, 2003, an individual affiliated with White Case LLP beneficially owned warrants to purchase an aggregate of 54,506 shares of our common stock. Various legal matters related to the sale of the common stock issued in this offering will be passed upon for the underwriters by Latham Watkins LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001159119_premcor_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001159119_premcor_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..662b778e1aca884c1378b300ec0f128fedc4670b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001159119_premcor_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of our common stock offered hereby and other legal matters will be passed upon for us by Stroock & Stroock & Lavan LLP, New York, New York. The validity of our common stock offered hereby will be passed upon for the underwriters by Davis Polk & Wardwell, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001160241_digitalnet_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001160241_digitalnet_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..22ae90cd5c2895b495028ad7a2f2eaa74cf406a7 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001160241_digitalnet_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of our common stock offered by this prospectus will be passed upon for DigitalNet by Fried, Frank, Harris, Shriver & Jacobson (a partnership including professional corporations), Washington, DC. The underwriters are being represented in connection with this offering by Cravath, Swaine & Moore LLP, New York, NY. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001161924_middlebroo_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001161924_middlebroo_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..13d4cc913732efcd4d7fbca3292b69c14ea0792e --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001161924_middlebroo_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by McCarter English, LLP. Certain legal matters in connection with the offering will be passed upon for the underwriters by Coudert Brothers LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001164722_aderis_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001164722_aderis_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..77d2754fa2d36f1fa0be278342dff58a9461f330 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001164722_aderis_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Latham Watkins LLP. Clifford Chance US LLP is counsel for the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001165880_montpelier_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001165880_montpelier_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7ebbf6fef1e28d5e1b02b5b0273a40b92113db52 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001165880_montpelier_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters as to U.S. law in connection with this offering will be passed upon for us by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York, and Cahill Gordon & Reindel, LLP, special tax counsel to the Company. Certain matters as to Bermuda law in connection with this offering will be passed upon for us by Conyers Dill & Pearman, Hamilton, Bermuda. Certain legal matters as to U.S. law in connection with this offering will be passed upon for the underwriters by Davis Polk & Wardwell. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001166720_ipc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001166720_ipc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5c01d9719e5e6147aba9c0f95cde475268df380d --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001166720_ipc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fried, Frank, Harris, Shriver Jacobson (a partnership including professional corporations), New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001168478_hewitt_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001168478_hewitt_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..96ce4294fd27ffa5cf99365bb89fa57707d1f6fc --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001168478_hewitt_legal_matters.txt @@ -0,0 +1,19099 @@ +LEGAL MATTERS + +McDermott, Will +& Emery, Chicago, Illinois, will pass upon the validity of the shares of class A common stock offered hereby. Legal matters relating to the offering will be passed upon for the underwriters by Cleary, Gottlieb, Steen & Hamilton, New York, +New York. + + +103 + +Table of Contents + + + +EXPERTS + +The combined and +consolidated financial statements of Hewitt Associates, Inc. and subsidiaries and its predecessor at September 30, 2002 and 2001, and for the years then ended, appearing in this prospectus and the related registration statement, have been audited by +Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing. + +The fiscal 2000 annual combined financial statements of Hewitt +Associates LLC and Affiliates included in this prospectus and the related registration statement have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their reports with respect thereto, and are included herein in +reliance upon the authority of such firm as experts in accounting and auditing in giving such reports. Arthur Andersen s audit report has not been re-issued in connection with this filing on Form S-1. We refer you to Risk +Factors Risks That Relate to Our Financial Results and Our Independent Public Accountants . + +The 2001 annual consolidated financial statements of the benefits consulting business of Bacon & Woodrow included in this prospectus and +the related registration statement have been audited by Smith & Williamson, independent auditors, as indicated in their reports with respect thereto, and are included herein in reliance upon the authority of such firm as experts in accounting +and auditing in giving such reports. + + +WHERE YOU CAN FIND MORE INFORMATION + +We have filed with the Securities and Exchange Commission a registration statement on Form S-1 (File Number 333- ) under the Securities Act of 1933 with respect +to the shares of class A common stock offered hereby. This prospectus does not contain all of the information set forth in the registration statement, certain portions of which are omitted as permitted by the rules and regulations of the Securities +and Exchange Commission. For further information pertaining to us and the class A common stock to be sold in the offering, reference is made to the registration statement, including the exhibits thereto and the financial statements, notes and +schedules filed as a part thereof. Statements contained in this prospectus regarding the contents of any contract or other document referred to herein or therein are not necessarily complete, and in each instance reference is made to the copy of +such contract or other document filed as an exhibit to the registration statement or such other document, each such statement being qualified in all respects by such reference. + +We are subject to the informational requirements of the Securities Exchange Act of 1934 and file reports, proxy +statements and other information with the Securities and Exchange Commission. Such reports, proxy statements and other information, as well as the registration statement and the exhibits and schedules thereto, may be inspected, without charge, at +the public reference facility maintained by the Securities and Exchange Commission at 450 Fifth Street, NW, Washington, D.C. 20549. Copies of such material may also be obtained from the Public Reference Section of the Securities and Exchange +Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. You may obtain information on the operation of the SEC public reference room in Washington, D.C. by calling the SEC at 1-800-SEC-0330. Such materials can also be +inspected on the Securities and Exchange Commission s website at www.sec.gov. + + +104 + +Table of Contents + +INDEX TO FINANCIAL STATEMENTS + + + + + Page + + Hewitt Associates LLC and Affiliates + + + + + Report of Ernst & Young LLP, Independent Auditors + + + F-2 + + Report of Arthur Andersen LLP, Independent Public Accountants + + + F-3 + + Combined and Consolidated Balance Sheets as of September 30, 2001 and 2002 + + + F-4 + + Combined and Consolidated Statements of Operations for the Fiscal Years ended September 30, 2000, +2001 and 2002 + + + F-6 + + Combined and Consolidated Statements of Stockholders Equity for the Fiscal Years ended +September 30, 2000, 2001 and 2002 + + + F-7 + + Combined and Consolidated Statements of Cash Flows for the Fiscal Years ended September 30, 2000, +2001 and 2002 + + + F-8 + + Notes to the Combined and Consolidated Financial Statements + + + F-10 + + Consolidated Balance Sheets as of September 30, 2002 and March 31, 2003 + + + F-33 + + Combined and Consolidated Statements of Operations for the three and six months ended March 31, +2002 and 2003 + + + F-34 + + Combined and Consolidated Statements of Cash Flows for the six months ended +March 31, 2002 and +2003 + + + F-35 + + Notes to the Combined and Consolidated Financial Statements + + + F-36 + + Benefits Consulting Business of Bacon & Woodrow + + + + + Report of Smith & Williamson, Independent Auditors + + + F-51 + + Consolidated Income Statement Before Partner Distributions for the year ended +September 30, +2001 + + + F-52 + + Consolidated Balance Sheet as of September 30, 2001 + + + F-53 + + Consolidated Statement of Cash Flows for the year ended September 30, 2001 + + + F-54 + + Consolidated Statement of Partners Balances for the year ended September 30, +2001 + + + F-55 + + Notes to the Consolidated Financial Statements + + + F-56 + + Consolidated Income Statement Before Partner Distributions for the six months ended March 31, +2002 + + + F-64 + + Consolidated Balance Sheets as of September 30, 2001 and March 31, 2002 + + + F-65 + + Consolidated Statement of Cash Flows for the six months ended March 31, 2002 + + + F-66 + + Notes to the Consolidated Financial Statements + + + F-67 + + + +Table of Contents + +REPORT OF INDEPENDENT AUDITORS + +To the Board of Directors and Stockholders of Hewitt Associates, Inc.: + +We have audited the accompanying combined and consolidated balance +sheets of Hewitt Associates, Inc. (a Delaware corporation) and subsidiaries and its predecessor (the Company ) as of September 30, 2001 and 2002, and the related combined and consolidated statements of operations, stockholders +equity and cash flows for each of the two years ended September 30, 2002. These combined and consolidated financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these combined and +consolidated financial statements based on our audits. The financial statements as of September 30, 2000 and for the year then ended were audited by other auditors who have ceased operations. The other auditors report dated March 8, 2002 +expressed an unqualified opinion on such statements. + +We +conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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. + +In our opinion, the combined and consolidated financial statements referred to above present fairly, in all material respects, the financial +position of the Company as of September 30, 2001 and 2002, and the results of their operations and their cash flows for each of the two years ended September 30, 2002, in conformity with accounting principles generally accepted in the United States +of America. + +/S/ ERNST & YOUNG LLP + +Chicago, Illinois +October 31, 2002 + + +F-2 + +Table of Contents + +REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS (1) + +To the Owners of Hewitt Associates LLC and Affiliates: + + +We have audited the accompanying combined balance sheet +of the companies as described in Note 1 (Hewitt Associates LLC and Affiliates), a group of Illinois limited liability companies, as of September 30, 2000 and the related combined statements of operations, changes in owners capital, and cash +flows for the years ended September 30, 1999 and 2000. 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. + +We conducted our audits in accordance with auditing standards generally +accepted in the United States. 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. + +In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of Hewitt Associates LLC and Affiliates as of September 30, 2000 and the results of their operations +and their cash flows for the years ended September 30, 1999 and 2000 in conformity with accounting principles generally accepted in the United States. + +/S/ ARTHUR ANDERSEN LLP + +Chicago, Illinois +March 8, 2002 + + + +(1) +This is a copy of the audit report for the years ended September 30, 1999 and 2000, previously issued by Arthur Andersen LLP. This audit report has not been reissued by Arthur +Andersen LLP in connection with this filing on Form S-1. The combined balance sheet as of September 30, 2000, the combined statements of operations, changes in owners capital and cash flows for the year ended September 30, 1999 referred to in +this report have not been included in the accompanying financial statements. + + +F-3 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +COMBINED AND CONSOLIDATED BALANCE SHEETS +(Dollars in thousands except share and per share amounts) + + + + + Combined September 30, 2001 + + + Consolidated September 30, 2002 + + ASSETS + + + + + + + + + Current Assets + + + + + + + + + Cash and cash equivalents + + + $ + + 60,606 + + + $ + + 136,450 + + Client receivables and unbilled work in process, less allowances +of $14,540 in 2001 and $16,160 +in 2002 + + + + + 367,798 + + + + + 394,184 + + Prepaid expenses and other current assets + + + + + 25,818 + + + + + 32,006 + + Deferred income taxes + + + + + + + + + + 16,976 + + + + + + + Total current assets + + + + + 454,222 + + + + + 579,616 + + + + + + + Non-Current Assets + + + + + + + + + Property and equipment, net + + + + + 164,550 + + + + + 249,613 + + Goodwill, net + + + + + 8,506 + + + + + 201,286 + + Intangible assets, net + + + + + 59,544 + + + + + 169,887 + + Due from related parties + + + + + + + + + + 3,468 + + Other assets + + + + + 14,535 + + + + + 15,476 + + + + + + + Total non-current assets + + + + + 247,135 + + + + + 639,730 + + + + + + + Total Assets + + + $ + + 701,357 + + + $ + + 1,219,346 + + + + + + + LIABILITIES + + + + + + + + + Current Liabilities + + + + + + + + + Accounts payable + + + $ + + 25,466 + + + $ + + 23,286 + + Accrued expenses + + + + + 87,245 + + + + + 180,946 + + Advanced billings to clients + + + + + 59,892 + + + + + 73,965 + + Current portion of long-term debt + + + + + 8,228 + + + + + 36,918 + + Current portion of capital lease obligations + + + + + 13,885 + + + + + 11,572 + + Employee deferred compensation and accrued profit sharing + + + + + 52,189 + + + + + 56,481 + + + + + + + Total current liabilities + + + + + 246,905 + + + + + 383,168 + + + + + + + Long-Term Liabilities + + + + + + + + + Debt, less current portion + + + + + 157,783 + + + + + 147,000 + + Capital lease obligations, less current portion + + + + + 14,663 + + + + + 88,913 + + Other long-term liabilities + + + + + 22,635 + + + + + 48,435 + + Deferred income taxes + + + + + + + + + + 19,265 + + + + + + + Total long-term liabilities + + + + + 195,081 + + + + + 303,613 + + + + + + + Total Liabilities + + + $ + + 441,986 + + + $ + + 686,781 + + + + + + + Commitments and Contingencies (Notes 15 and 19) + + + + + + + + + + + + + +F-4 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +COMBINED AND CONSOLIDATED BALANCE SHEETS (Continued) +(Dollars in thousands except share and per share amounts) + + + + + Combined September 30, 2001 + + + + Consolidated September 30, 2002 + + + + OWNERS CAPITAL AND STOCKHOLDERS +EQUITY + + + + + + + + + + + Owners Capital + + + + + + + + + + + Accumulated earnings and paid-in-capital + + + $ + + 260,138 + + + + + $ + + + + + + Accumulated other comprehensive loss + + + + + (767 + + ) + + + + + + + + + + + + + + Total owners capital + + + + + 259,371 + + + + + + + + + + + + + + + + Stockholders Equity + + + + + + + + + + + Preferred stock, par value $0.01 per share, 10,000,000 shares authorized + + + + + + + + + + + + + + + + Class A common stock, par value $0.01 per share, 750,000,000 shares authorized, 19,162,660 shares +issued and outstanding + + + + + + + + + + + + 192 + + + + Class B common stock, par value $0.01 per share, 200,000,000 shares authorized, 73,726,424 shares +issued and outstanding + + + + + + + + + + + + 737 + + + + Class C common stock, par value $0.01 per share, 50,000,000 shares authorized, 5,568,869 shares +issued and outstanding + + + + + + + + + + + + 56 + + + + Restricted stock units, 319,902 units issued and outstanding + + + + + + + + + + + + 6,078 + + + + Additional paid-in capital + + + + + + + + + + + + 615,377 + + + + Retained earnings (deficit) + + + + + + + + + + + + (22,691 + + ) + + Unearned compensation + + + + + + + + + + + + (83,375 + + ) + + Accumulated other comprehensive income + + + + + + + + + + + + 16,191 + + + + + + + + + Total stockholders equity + + + + + + + + + + + + 532,565 + + + + + + + + + Total Liabilities, Owners Capital and Stockholders Equity + + + $ + + 701,357 + + + + + $ + + 1,219,346 + + + + + + + + + + +The accompanying notes are an integral part of these financial statements. + + +F-5 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +COMBINED AND CONSOLIDATED STATEMENTS OF OPERATIONS (1) +(Dollars in thousands except share and per share amounts) + + + + + Year Ended September 30, + + + + + + 2000 + + + + 2001 + + + + 2002 (1) + + + + Revenues: + + + + + + + + + + + + + + + Revenue before reimbursements (net revenues) + + + $ + + 1,280,552 + + + + + $ + + 1,475,661 + + + + + $ + + 1,716,197 + + + + Reimbursements + + + + + 25,507 + + + + + + + 26,432 + + + + + + + 33,882 + + + + + + + + + + + Total revenues + + + + + 1,306,059 + + + + + + + 1,502,093 + + + + + + + 1,750,079 + + + + + + + + + + + Operating expenses: + + + + + + + + + + + + + + + Compensation and related expenses, excluding initial public offering restricted stock +awards + + + + + 715,336 + + + + + + + 838,085 + + + + + + + 1,014,529 + + + + Initial public offering restricted stock awards + + + + + + + + + + + + + + + + + + + 27,525 + + + + Reimbursable expenses + + + + + 25,507 + + + + + + + 26,432 + + + + + + + 33,882 + + + + Other operating expenses + + + + + 307,281 + + + + + + + 337,419 + + + + + + + 357,789 + + + + Selling, general and administrative expenses + + + + + 75,790 + + + + + + + 87,986 + + + + + + + 76,034 + + + + Non-recurring software charge + + + + + + + + + + + + 26,469 + + + + + + + + + + + + + + + + + + Total operating expenses + + + + + 1,123,914 + + + + + + + 1,316,391 + + + + + + + 1,509,759 + + + + + + + + + + + Operating income + + + + + 182,145 + + + 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5,570 + + + + + + + 44,431 + + + + + + + 75,844 + + + + Cash and cash equivalents, beginning of year + + + + + 10,605 + + + + + + + 16,175 + + + + + + + 60,606 + + + + + + + + + + + Cash and cash equivalents, end of year + + + $ + + 16,175 + + + + + $ + + 60,606 + + + + + $ + + 136,450 + + + + + + + + + + + + +F-8 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +COMBINED AND CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) +(Dollars in thousands) + + + + + Year Ended September 30, + + + + + + 2000 + + + + 2001 + + + + 2002 + + + + Change in client receivables and unbilled work in process: + + + + + + + + + + + + + + + Beginning of year client receivables and unbilled work in process + + + $ + + 301,895 + + + + + $ + + 377,536 + + + + + $ + + 367,798 + + + + Non-cash distribution of client receivables to Hewitt Holdings + + + + + + + + + + + + + + + + + + + (152,500 + + ) + + Fair value of acquired client receivables and work in process + + + + + + + + + + + + + + + + + + + 46,188 + + + + Effect of exchange rates on client receivables and unbilled work in process + + + + + (1,774 + + ) + + + + + 87 + + + + + + + 4,438 + + + + End of year client receivables and work in process + + + + + (377,536 + + ) + + + + + (367,798 + + ) + + + + + (394,184 + + ) + + + + + + + + + Change in client receivables and unbilled work in process + + + $ + + (77,415 + + ) + + + $ + + 9,825 + + + + + $ + + (128,260 + + ) + + Schedule of non-cash investing and financing activities: + + + + + + + + + + + + + + + Acquisition, cash paid, net of cash received: + + + + + + + + + + + + + + + Common stock issued in connection with acquisition + + + $ + + + + + + + $ + + + + + + + $ + + 219,240 + + + + Fair value of assets acquired + + + + + + + + + + + + + + + + + + + (142,406 + + ) + + Fair value of liabilities assumed + + + + + + + + + + + + + + + + + + + 100,403 + + + + Goodwill + + + + + + + + + + + + + + + + + + + (178,124 + + ) + + + + + + + + + + + + + Cash paid, net of cash received + + + + + + + + + + + + + + + + + + + (887 + + ) + + Real estate and equipment purchased under capital leases + + + + + 18,896 + + + + + + + 11,081 + + + + + + + 88,944 + + + + Software licenses purchased under long-term agreements + + + + + + + + + + + + + + + + + + + 18,148 + + + + Client receivables distributed to Hewitt Holdings + + + + + + + + + + + + + + + + + + + 152,500 + + + + Conversion of owner capital to common stock + + + + + + + + + + + + + + + + + + + 57,216 + + + + Accrued offering costs + + + $ + + + + + + + $ + + + + + + + $ + + 1,347 + + + + Supplementary disclosure of cash paid during the year: + + + + + + + + + + + + + + + Interest paid + + + $ + + 9,672 + + + + + $ + + 11,892 + + + + + $ + + 16,210 + + + + Income taxes paid + + + $ + + + + + + + $ + + + + + + + $ + + 33,647 + + + + + + +The accompanying notes are an integral part of these financial +statements. + + +F-9 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS + +For the Fiscal Years Ended September 30, 2000, 2001 and 2002 + +(Dollars in thousands except share and per share amounts) + +1. Description of Business + +Hewitt Associates, Inc., a Delaware corporation, and its subsidiaries (collectively, Hewitt or the Company ) provide human +resources outsourcing and consulting services. + +Prior to +May 31, 2002, the results of the Company included the combined results of three Illinois limited liability companies: Hewitt Associates LLC and subsidiaries, Hewitt Financial Services LLC and Sageo LLC (collectively, Hewitt Associates LLC and +Affiliates ). Hewitt Associates LLC and Affiliates was under the common control of Hewitt Holdings LLC ( Hewitt Holdings ). + +On May 31, 2002, the Company completed its transition to a corporate structure whereby Hewitt Holdings ownership interest in Hewitt Associates +LLC and Affiliates was transferred to Hewitt Associates, Inc. + +On June 5, 2002, the Company acquired the actuarial and benefits consulting business of Bacon & Woodrow in the United Kingdom. The results of operations for Bacon & Woodrow s actuarial and benefits consulting business +are included in the Company s results from the acquisition date. + +On June 27, 2002, the Company sold 11,150,000 shares of Class A common stock at $19.00 per share in its initial public offering. In July 2002, the underwriters exercised their over-allotment option to purchase an additional 1,672,500 +shares of the Company s Class A common stock at $19.00 per share. The combined transactions generated $219 million in net cash proceeds after offering expenses. + +2. Summary of Significant Accounting Policies + +The combined and consolidated financial statements are prepared on the accrual basis of accounting. +The significant accounting policies are summarized below: + +Principles of Combination and Consolidation + +The accompanying combined and consolidated financial statements reflect the operations of the Company and its majority-owned subsidiaries after elimination of intercompany accounts and transactions. Combined financial statements are +presented for periods prior to the transition to a corporate structure when the combined entities that now make up the Company were under common control. Upon consummation of the transition to a corporate structure, the affiliated companies of +Hewitt were transferred into the newly formed corporation, Hewitt Associates, Inc., and their results are presented on a consolidated basis. + +Revenue Recognition + +Revenues include fees primarily generated from outsourcing contracts and from consulting services provided to the Company s clients. + + +Under the Company s outsourcing contracts, which +typically have a three- to five-year term, clients pay an implementation fee and an ongoing service fee. In accordance with the Securities and Exchange Commission s Staff Accounting Bulletin No. 101, Revenue Recognition in Financial +Statements, the Company recognizes revenues for non-refundable, upfront implementation fees evenly over the period between the initiation of ongoing services through the end of the contract term (on a straight-line basis). Most indirect costs of +implementation are expensed as incurred. However, incremental direct costs of implementation are deferred and recognized as expense over the same period that deferred implementation fees are recognized. If a client terminates an outsourcing contract + + + +F-10 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +prematurely, both the deferred implementation revenues and related costs are recognized in the period in which the termination occurs. + +Revenues related to ongoing service fees and to services provided +outside the scope of outsourcing contracts are recognized as services are provided. Ongoing service fees are normally billed on a monthly basis, typically based on the number of plan participants or services. Services provided outside the scope of +outsourcing contracts are billed on a time-and-materials basis. + +Losses on outsourcing contracts are recognized during the period in which the loss becomes probable and the amount of the loss is reasonably estimable. Contract losses are determined to be the amount by which the estimated direct and +a portion of indirect costs of the contract exceed the estimated total revenues that will be generated by the contract. + +The Company s clients pay for consulting services either on a time-and-materials basis or on a fixed-fee basis. Revenues are recognized under +time-and-material based arrangements as services are provided. On fixed-fee engagements, revenues are recognized as the services are performed, which is measured by hours incurred in proportion to total hours estimated to complete a project. Losses +on consulting contracts are recognized during the period in which the loss becomes probable and the amount of the loss is reasonably estimable. Losses are determined to be the amount by which the estimated direct and indirect costs of the project +exceed the estimated total revenues that will be generated for the work. + +Revenues earned in excess of billings are recorded as unbilled work in progress. Billings in excess of revenues earned are recorded as advanced billings to clients, a deferred revenue liability, until services are rendered. + + +The Company considers the criteria established by Emerging +Issues Task Force ( EITF ) Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, in determining whether revenue should be recognized on a gross versus a net basis. In consideration of these criteria, the +Company recognizes revenue primarily on a gross basis. Factors considered in determining if gross or net recognition is appropriate include whether the Company is primarily responsible to the client for the services, changes the delivered product, +performs part of the service delivered, has discretion on vendor selection, or bears credit risk. In accordance with EITF Issue No. 01-14, Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses +Incurred, reimbursements received for out-of pocket expenses incurred are characterized as revenues and are shown as a separate component of total revenues. Similarly, related reimbursable expenses are also shown separately within operating +expenses. + +Income Before Taxes and Owner Distributions + +Prior to May 31, 2002, the Company operated as a group of affiliated +limited liability companies and recorded income before taxes and owner distributions in accordance with accounting principles generally accepted in the United States of America. Income before taxes and owner distributions is not comparable to net +income of a corporation because compensation and related expenses for services rendered by owners have not been reflected as expenses and the Company incurred no income taxes in its historical results prior to its transition to a corporate +structure. Results prior to May 31, 2002 do not reflect the financial position and results of operations that would have been reported had the Company operated as a corporation for all the periods presented. + +Income Taxes + +On May 31, 2002, the Company became subject to federal and state income taxes and began to apply the asset and +liability method described in Statement of Financial Accounting Standards ( SFAS ) No.109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for + + + +F-11 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their +respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using 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. Prior to May 31, 2002, the Company was not subject to income taxes because it operated as +a limited liability company. Taxes on income earned prior to May 31, 2002 were the responsibility of Hewitt Holdings owners. + +Foreign Currency Translation + +The Company s foreign operations use the local currency as their functional currency. Accordingly, assets and liabilities of foreign +subsidiaries are translated into U.S. Dollars at exchange rates in effect at year-end, while revenues and expenses are translated at average exchange rates prevailing during the year. Translation adjustments are reported as a component of +accumulated other comprehensive income (loss) in owners capital and stockholders equity. Gains or losses resulting from foreign exchange transactions, which have not been significant, are recorded in earnings. + +Earnings Per Share + +On May 31, 2002, the Company completed its transition to a corporate structure and began to report earnings per share +( EPS ) in accordance with SFAS No.128, Earnings Per Share. For the year ended September 30, 2002, loss per share was calculated based on the net loss incurred in the four-month period from May 31, 2002 through September 30, +2002. Prior to May 31, 2002, Hewitt was comprised of limited liability companies and did not have outstanding common stock from which to calculate earnings per share, nor did the Company s earnings include owner compensation or income taxes. As +such, the Company s historical income before taxes and owner distributions is not comparable to net income of a corporation. Therefore, historical earnings per share have not been presented for periods prior to May 31, 2002, and the combined +financial statements do not reflect the financial position and results of operations that would have been reported had the Company operated as a corporation for those periods. + +Use of Estimates + +The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of +America requires management to make estimates and assumptions that affect the amounts reported in the combined and consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, the accounting for contract and +project loss reserves, the allowance for doubtful accounts, depreciation and amortization, impairment, taxes and any contingencies. Although these estimates are based on management s best knowledge of current events and actions that the Company +may undertake in the future, actual results may be different from the estimates. + +Concentrations of Credit Risk + +The +Company s financial instruments that are exposed to concentrations of credit risk consist of cash equivalents, client receivables and unbilled work in process. Hewitt invests its cash equivalents in the highest rated money market investments +and continuously monitors the investment ratings. Concentrations of credit risk with respect to unbilled revenues and receivables are limited as no client makes up a significant portion of the Company s billings. Credit risk itself is limited +due to the Company s large number of Fortune 500 clients, its clients strong credit histories, and their dispersion across many different industries and geographic regions. For each of the years ended September 30, + + + +F-12 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +2000, 2001 and 2002, no single client represented ten percent or more of the Company s total revenues. + +Fair Value of Financial Instruments + +Cash and cash equivalents, marketable securities, client receivables, +and foreign exchange instruments are financial assets with carrying values that approximate fair value. Accounts payable, other accrued expenses and liabilities and the Company s variable rate debt are financial liabilities with carrying values +that approximate fair value. The fair value of the Company s $150,000 fixed rate senior term notes is estimated to be approximately $165 million at September 30, 2002 and was calculated by discounting the future cash flows of the senior term +notes at rates currently offered to the Company for similar debt instruments with comparable maturities. + +Cash and Cash Equivalents + +The Company defines cash and cash equivalents as cash and investments with original maturities of 90 days or less. At September 30, 2001 and 2002, cash and cash equivalents included cash in checking and money market accounts as well +as investment grade municipal debt obligations maturing in 90 days or less. + +Marketable Securities + +Marketable +securities represent available-for-sale securities and are classified on the balance sheet within other current assets at their fair market value. Unrealized gains or losses are reported as a component of accumulated other comprehensive income +(loss). Realized gains or losses are reported in other expenses, net on the combined and consolidated statements of operations. + +Hedging Transactions + +The Company does not enter into derivative transactions except in limited situations when there is a compelling economic reason or to mitigate risk +to the Company (See Note 9, Financial Instruments). The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 138, Accounting for Certain Derivative Instruments and Certain +Hedging Activities An Amendment of FASB Statement No. 133, in fiscal year 2001. + +All derivative instruments are reported in the combined and consolidated financial statements at fair value. Changes in the fair value of derivatives are recorded each period in earnings or other comprehensive +income (loss), depending on whether the derivative is designated and effective as part of a hedged transaction, and on the type of hedge transaction. Gains or losses on derivative instruments reported in other comprehensive income (loss) are +reclassified as earnings in the period in which earnings are affected by the underlying hedged item, and the ineffective portion of all hedges are recognized in earnings in the current period. The Company had no derivative instruments outstanding at +September 30, 2002. + +Property and Equipment + +Property and equipment are recorded at cost. Depreciation and +amortization are computed using the straight-line method over the estimated useful lives of the assets, which are as follows: + + + Asset Description + + + Asset Life + + Computer equipment + + + 3 to 5 years + + Telecommunications equipment + + + 5 years + + Furniture and equipment + + + 5 to 15 years + + Leasehold improvements + + + Lesser of estimated useful life or lease term + + + +F-13 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +Software Development Costs + + +Software development costs are accounted for in +accordance with the American Institute of Certified Public Accountants Statement of Position No. 98-1 ( SOP 98-1 ), Accounting for Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires the +capitalization of certain costs incurred in connection with developing or obtaining internal use software. The Company amortizes the software costs over periods ranging from three to five years. + +Long-Lived Assets + +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying +amount of an asset may not be recoverable. Recoverability of long-lived assets held for use are assessed by a comparison of the carrying amount of the asset to the estimated future undiscounted net cash flows expected to be generated by the asset. +If estimated future undiscounted net cash flows are less than the carrying amount of the asset, the asset is considered impaired and expense is recorded in an amount required to reduce the carrying amount of the asset to its fair value. + + +Stock-Based Compensation + +The Company applies Accounting Principles Board (APB) Opinion No. 25, +Accounting for Stock Issued to Employees, in accounting for its stock-based compensation plans, but provides the pro forma disclosures required by SFAS No. 123, Accounting for Stock-Based Compensation. The Company grants non-qualified +stock options at an exercise price equal to the fair market value of the Company s stock on the grant date. Since the stock options have no intrinsic value on the grant date, no compensation expense is recorded in connection with the stock +option grants. Generally, stock options vest 25 percent on each anniversary of the grant date, are fully vested four years from the grant date and have a term of ten years. Restricted stock awards, including restricted stock and restricted stock +units, are measured using the fair market value of the stock as of the grant date and recorded as unearned compensation on the balance sheet. As the restricted stock awards vest, the unearned compensation is amortized to compensation expense on a +straight-line basis. The shares are subject to forfeiture and restrictions on sale or transfer for six months to four years from the grant date. For purposes of calculating basic and diluted earnings per share, vested restricted stock awards and +exercised stock options are considered outstanding. Restricted stock awards vest on a cliff schedule so that restricted stock awards are not considered outstanding until the stated vesting date for earnings per share calculations. Under the treasury +stock method, unvested restricted stock awards and unexercised stock options with fair market values of the underlying stock greater than the stock options exercise prices are considered common stock equivalents for the purposes of calculating +diluted earnings per share for periods when there are positive earnings and the incremental effect would be dilutive. + +New Accounting Pronouncements + +In June 2001, the Financial Accounting Standards Board ( FASB ) issued SFAS No. 141, Business Combinations, and SFAS No. 142, +Goodwill and Other Intangible Assets. SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations, except for qualifying business combinations that were initiated prior to July 1, 2001. Under SFAS No. 142, +goodwill and intangible assets with indefinite lives are not amortized but are reviewed for impairment annually, or more frequently if indicators arise. For acquisitions made prior to July 1, 2001, Hewitt has adopted the provisions of SFAS No. 142 +as of October 1, 2002. The change is not expected to have a + + + +F-14 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +material effect on the Company s results. The acquisition of the benefits consulting business of Bacon & Woodrow occurred on June 5, 2002, +after the provisions of SFAS No. 141 and 142 went into effect. As such, in accordance with SFAS Nos. 141 and 142, goodwill recorded in the acquisition has not been amortized but will be reviewed for impairment at least annually or whenever +indicators of impairment exist. Other identifiable intangible assets have been recorded as described in Note 12. + +In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 replaces SFAS No. +121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The FASB issued SFAS No. 144 to establish a single accounting model based on the framework established in SFAS No. 121. The Company has +adopted SFAS No. 144 as of October 1, 2002, and believes that the adoption will not significantly impact its consolidated financial position or results of operations in fiscal 2003. + +In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB +Statement No. 13, and Technical Corrections. SFAS No. 145 eliminates the requirement under SFAS No. 4 to aggregate and classify all gains and losses from extinguishment of debt as an extraordinary item, net of related income tax effect. SFAS No. +145 also amends SFAS No. 13 to require that certain lease modifications with economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. In addition, SFAS No. 145 requires +reclassification of gains and losses in all prior periods presented in comparative financial statements related to debt extinguishments that do not meet the criteria for an extraordinary item in APB No. 30. SFAS No. 145 is effective for fiscal years +beginning after May 15, 2002 with early adoption encouraged. The Company adopted SFAS No. 145 on October 1, 2002, and the adoption did not have a material effect on the Company s financial position or results of operations. + +On July 30, 2002, the FASB issued SFAS No. 146, Accounting for Costs +Associated with Exit or Disposal Activities. The statement requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or a disposal plan. Examples +of costs covered by the statement include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. SFAS No. 146 is to be applied +prospectively to exit or disposal activities initiated after December 31, 2002. The Company is currently evaluating the requirements and impact of this statement on the Company s consolidated results of operations and financial position. + + + Reclassifications + +Certain prior year amounts have been reclassified to conform with the +current year presentation. + +3. Transition to a Corporate Structure + + +On May 31, 2002, the Company completed its transition +to a corporate structure in connection with its planned initial public offering. + +Prior to the transition to a corporate structure, the Company consisted of single-member limited liability companies, which were wholly owned by Hewitt Holdings. As such, owners capital represented the ownership +interests of Hewitt Holdings in the Company. Historically, distributions to and contributions from Hewitt Holdings were based on the capital requirements of the Company and of Hewitt Holdings and were subject to the discretion of the owners of +Hewitt Holdings. + +On March 1, 2002, Hewitt Associates, +Inc., a Delaware corporation, was formed as a subsidiary of Hewitt Holdings. Three classes of common stock were authorized. The holders of Class A, Class B and Class C common stock have one vote per share. All shares of Class B and Class C common +stock vote in accordance with a majority of the votes cast by the holders of Class B and Class C common stock as a group. + + +F-15 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +In May 2002, Hewitt +Associates LLC distributed $152,500 of accounts receivable and $55,000 of cash to Hewitt Holdings to fund a distribution to the owners of accumulated earnings in preparation for Hewitt Associates LLC and Affiliates transition to a corporate +structure. The $152,500 distribution of receivables to Hewitt Holdings was a one-time transaction that reduced cash collections in fiscal 2002 and therefore reduced our cash flows from operating activities. + +On May 31, 2002, Hewitt Holdings transferred all of its ownership +interests in Hewitt Associates LLC and Affiliates to Hewitt Associates, Inc., thereby making Hewitt Associates LLC and Affiliates a wholly-owned subsidiary of the Company. The capital in the business was converted and owners of the Company received +70,819,520 shares of the Company s Class B common stock. + +In connection with the transition to a corporate structure, the Company incurred a non-recurring compensation expense resulting from certain owners receiving more common stock than their proportional share of total capital, without +offset for those owners who received less than their proportional share in the issuance of the Class B common stock. The amount of this one-time charge was $17,843. As a result of owners becoming employees of the Company, the Company began to record +compensation expense. The Company incurred an additional non-recurring compensation expense resulting from the establishment of a vacation liability for these owners in the amount of $8,300. The Company also became subject to income taxes subsequent +to its transition to a corporate structure. As a result, the Company incurred a non-recurring income tax expense of $21,711 to initially record deferred tax assets and liabilities under the provisions of SFAS No. 109, Accounting for Income +Taxes. + +4. Initial Public Offering + +On June 27, 2002, the Company sold 11,150,000 shares of Class A common +stock at $19.00 per share in its initial public offering. The Company s gross proceeds from the offering were $211,850, before the underwriting discount of $14,829 and estimated offering expenses of approximately $7,276. + +In July 2002, the underwriters exercised their over-allotment option to +purchase an additional 1,672,500 shares of the Company s Class A common stock at $19.00 per share. The option exercise generated gross proceeds of $31,778 before the underwriting discount of $2,225. + +Of the $219,298 in net proceeds received in July 2002, $52,000 was used +to repay the outstanding balance on the Company s lines of credit. The remaining $167,298 is intended to be used for future working capital needs and for general corporate purposes. + +In connection with the initial public offering, the Company granted to employees restricted stock, restricted stock +units and non-qualified stock options on common stock. (See Note 18, Stock-Based Compensation Plans). + +5. Earnings Per Share + +In accordance with SFAS No. 128, Earnings Per Share, basic EPS is calculated by dividing net income by the weighted-average number of shares of common stock outstanding. Diluted EPS includes the components of basic EPS and +also gives effect to dilutive potential common stock equivalents. + +For the year ended September 30, 2002, loss per share was calculated based on the net loss incurred between May 31, 2002 and September 30, 2002, the period during which the Company operated as a corporation. As such, the loss per +share for the year ended September 30, 2002 is not indicative of the amount that would have been computed had the Company been a corporation for the + + + +F-16 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +entire year presented. During the period between May 31, 2002 and September 30, 2002, the Company also incurred several one-time charges totaling +$47,854 (see Note 3) related to the Company s transition to a corporate structure and $27,525 of compensation expense related to the initial public offering restricted stock award. Additionally, common stock has been weighted from the time of +the Company s transition to a corporate structure on May 31, 2002 and not from the beginning of the year. The following table presents computations of basic and diluted EPS in accordance with accounting principles generally accepted in the +United States of America. + + + Net income as reported for the full year + + + $ + + 190,373 + + + + Less net income through May 31, 2002 + + + + + 213,064 + + + + + + + Net loss from June 1, 2002 through September 30, 2002 + + + $ + + (22,691 + + ) + + + + + Weighted-average number of common stock for basic + + + + + 85,301,042 + + + + Incremental effect of dilutive common stock equivalents: + + + + + + + Unvested restricted stock awards + + + + + + + + + Unexercised stock options + + + + + + + + + + + + Weighted-average number of common stock for diluted + + + + + 85,301,042 + + + + + + + Earnings per share basic + + + $ + + (0.27 + + ) + + + + + Earnings per share diluted + + + $ + + (0.27 + + ) + + + + + +All of the +Company s restricted stock awards and stock options are excluded from diluted loss per share since their effect is antidilutive. + +6. Acquisition of Bacon & Woodrow + +On June 5, 2002, the Company acquired the benefits consulting business of Bacon & Woodrow ( Bacon & Woodrow ), a leading actuarial +and benefits consulting firm in the United Kingdom. The purchase price totaled $259,009 and was comprised of $219,240 of common stock, $38,882 in assumed net liabilities and $887 of acquisition-related costs. Bacon & Woodrow s results of +operations are included within the Company s historical results from the acquisition date of June 5, 2002. + +Pursuant to the purchase agreement, the former partners and employees of Bacon & Woodrow initially received an aggregate of 1,400,000 shares of +the Company s Series A mandatorily redeemable preferred stock which was redeemable for shares of the Company s common stock. Effective as of August 2, 2002, the Bacon & Woodrow former partners and employees elected to exchange their +shares of Series A preferred stock in exchange for 9,417,526 shares of common stock. Of the 9,417,526 shares of common stock issued, the former partners of Bacon & Woodrow received 2,906,904 shares of Class B common stock and 5,568,869 shares of +Class C common stock, and a trust for the benefit of the non-partner employees of Bacon & Woodrow received 941,753 shares of Class A common stock. + +The preliminary allocation of the $259,009 purchase price to acquired net assets resulted in the allocation of $178,124 to goodwill, $65,874 to +identifiable intangible assets (primarily customer relationships) with indefinite lives, $15,011 to identifiable intangible assets with estimated five-year lives, $61,521 to identifiable assets (which includes $40,445 of client receivables and +unbilled work in process), and $100,403 to assumed liabilities (which includes $22,687 of accounts payable and accrued expenses and $36,071 of short-term borrowings). The actual allocation of the purchase price will depend upon the final evaluation +of the fair value of the assets and liabilities of the benefits consulting business of Bacon & Woodrow. Consequently, the ultimate allocation of the purchase price could differ from that presented above. + + +F-17 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +Assuming only the +acquisition of the actuarial and benefits consulting business of Bacon & Woodrow occurred at the beginning of 2002 and 2001, pro forma net revenues would have been approximately $1,807 million in 2002 and $1,599 million in 2001; pro forma net +income would have been $215 million in 2002 and $207 million in 2001. These pro forma results, which are unaudited, give effect to the Company s incorporation and initial public offering on the dates such events actually occurred, on May 31, +2002 and June 27, 2002, respectively. Because the Company was a limited liability company during 2001 and for the first eight months of 2002, the pro forma effect of the acquisition on earnings per share is not meaningful. The pro forma results are +not necessarily indicative of what would have occurred if the acquisition had been consummated at the beginning of each year, nor are they necessarily indicative of future consolidated operating results. + +7. Client Receivables and Unbilled Work in Process + +Client receivables and unbilled work in process, net of allowances, for +work performed through September 30, 2001 and 2002, consisted of the following: + + + + + 2001 + + + 2002 + + Client receivables + + + $ + + 216,424 + + + $ + + 219,126 + + Unbilled work in process + + + + + 151,374 + + + + + 175,058 + + + + + + + + + $ + + 367,798 + + + $ + + 394,184 + + + + + + + +An analysis of the +activity in the client receivable and unbilled work in process allowances for the years ended September 30, 2001 and 2002, consisted of the following: + + + + + 2001 + + + + 2002 + + + + Balance at beginning of year + + + $ + + 9,426 + + + + + $ + + 14,540 + + + + Increase in allowances + + + + + 30,643 + + + + + + + 31,453 + + + + Use of allowances + + + + + (25,529 + + ) + + + + + (29,833 + + ) + + + + + + + Balance at end of year + + + $ + + 14,540 + + + + + $ + + 16,160 + + + + + + + + + +8. Marketable Securities + + +Marketable securities classified in other current +assets include equity securities which are classified as available-for-sale. Unrealized gains and losses on these investments have been included in accumulated other comprehensive income (loss) but as of September 30, 2001 and 2002, there were no +unrealized gains or losses. Realized gains or losses are classified in other expenses, net and for the years ended September 30, 2000, 2001 and 2002, realized gains on marketable securities were $4,175, $5,413 and $0, respectively. + +9. Financial Instruments + +The Company does not enter into derivative transactions except in +limited situations when there is a compelling reason to mitigate economic risk. On August 6, 2001, Hewitt purchased a 150 million foreign currency option to offset the foreign currency risk associated with its planned purchase of the benefits +consulting business of Bacon & Woodrow for common stock with a value of 140 million. (See Note 6, Acquisition of Bacon & Woodrow). The cost of the foreign currency option was $2,344, which was recorded as a current asset at September +30, 2001. This instrument did not qualify for the hedge accounting treatment under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, because SFAS No. 133 prohibits hedge accounting for a forecasted business +combination. The instrument was marked to the spot rate and resulting gains or losses were recognized currently in other expenses, net. For the years ended September 30, 2001 and 2002, the gain on the option was $1,309 and the loss was $3,653, +respectively. + + +F-18 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +10. Property and Equipment + + +As of September 30, 2001 and 2002, net property and +equipment, which includes assets under capital leases, consisted of the following: + + + + + 2001 + + + + 2002 + + + + Property and equipment: + + + + + + + + + + + Buildings + + + $ + + + + + + + $ + + 89,414 + + + + Computer equipment + + + + + 214,172 + + + + + + + 239,181 + + + + Telecommunications equipment + + + + + 96,745 + + + + + + + 100,634 + + + + Furniture and equipment + + + + + 91,598 + + + + + + + 84,347 + + + + Leasehold improvements + + + + + 64,761 + + + + + + + 70,034 + + + + + + + + + Total property and equipment + + + + + 467,276 + + + + + + + 583,610 + + + + Less accumulated depreciation + + + + + (302,726 + + ) + + + + + (333,997 + + ) + + + + + + + Property and equipment, net + + + $ + + 164,550 + + + + + $ + + 249,613 + + + + + + + + + +11. Goodwill + +As of September 30, 2001 and 2002, goodwill consisted of the following: + + + + + + 2001 + + + + 2002 + + + + Goodwill: + + + + + + + + + + + Purchased goodwill + + + $ + + 10,039 + + + + + $ + + 203,675 + + + + Accumulated amortization + + + + + (1,533 + + ) + + + + + (2,389 + + ) + + + + + + + Goodwill, net + + + $ + + 8,506 + + + + + $ + + 201,286 + + + + + + + + + +Goodwill +represents the excess of the purchase price and related costs over the value assigned to the net tangible and identifiable intangible assets of the businesses acquired. Goodwill acquired in acquisitions prior to July 1, 2001 has been amortized on a +straight-line basis over the periods of expected benefit, which range from five to fifteen years. + +As of October 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, for existing goodwill balances as of July +1, 2001. The acquisition of the benefits consulting business of Bacon & Woodrow occurred on June 5, 2002, after the provisions of SFAS No. 142 went into effect. As such, in accordance with SFAS No. 142, $178,124 of goodwill acquired in the +acquisition was not amortized. Under the provisions of SFAS No. 142, the Company will test all goodwill for potential impairment whenever indicators of impairment arise with reviews at least annually. + +12. Intangible Assets + +As of September 30, 2001 and 2002, intangible assets consisted of the +following: + + + + + 2001 + + + 2002 + + Intangible assets: + + + + + + + + + Capitalized software, net of accumulated amortization of $80,062 in 2001 and $93,945 in +2002 + + + $ + + 59,544 + + + $ + + 89,085 + + Contractual customer relationships + + + + + + + + + + 71,286 + + Trademarks, net of accumulated amortization of $680 + + + + + + + + + + 9,516 + + + + + + + Intangible assets, net + + + $ + + 59,544 + + + $ + + 169,887 + + + + + + + + +F-19 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +During the fourth +quarter of fiscal 2001, the Company recorded a $26,469 non-recurring charge related to the impairment of software that had been used in the Sageo business. It was determined that Sageo s principal service offering, which was a web-based +self-service benefits and administration business using the Company s back-end Total Benefit Administration and +Hewitt Associates Connections platforms, could be more efficiently managed and grown by fully integrating Sageo into Hewitt +Associates and by reducing Sageo s cost structure and leveraging the technology at Hewitt Associates. In the quarter ended September 30, 2001, the decision was made to transition Sageo s clients from Sageo s website to the Total +Benefit Administration web interface and discontinue the use of the Sageo software. At the same time, the Company wrote off +the remaining investment in the Sageo software, resulting in a $26,469, non-recurring charge, and terminated or redeployed the Sageo employees who were necessary only when Sageo was a stand-alone company. This charge was classified within the +results of the Outsourcing segment. + +In connection with the +June 5, 2002 acquisition of the benefits consulting business of Bacon & Woodrow, the Company acquired $65,874 of contractual customer relationships with indefinite lives, $5,538 in capitalized software and $9,473 of trademarks with five-year +lives. Under the provisions of SFAS No. 141, the Company will test for potential impairment whenever indicators of impairment arise with reviews at least annually. + +13. Other Assets + +As of September 30, 2001 and 2002, other assets consisted of the following: + + + + + 2001 + + + 2002 + + Other assets: + + + + + + + + + Prepaid long-term interest and service contracts + + + $ + + 7,923 + + + $ + + 8,729 + + Investments in affiliated companies + + + + + 6,612 + + + + + 6,747 + + + + + + + Other assets + + + $ + + 14,535 + + + $ + + 15,476 + + + + + + + +The Company has +several prepaid long-term maintenance contracts for maintenance on computer software systems that expire through June 2005. Benefits related to these long-term prepaid maintenance contracts are received over the contractual period, as designated. +The long-term portion of the prepaid interest relates to prepaid lease obligations of the Company. + +Investments in less than 50%-owned affiliated companies over which the Company has the ability to exercise significant influence are accounted for +using the equity method of accounting. + +14. Debt + +Debt at September 30, 2001 and 2002, consisted of the following: + + + + + + 2001 + + + 2002 + + Multi-currency line of credit and foreign debt + + + $ + + 9,761 + + + $ + + 33,918 + + Unsecured senior term notes + + + + + 156,250 + + + + + 150,000 + + + + + + + + + + + 166,011 + + + + + 183,918 + + Current portion + + + + + 8,228 + + + + + 36,918 + + + + + + + Long-term debt, less current portion + + + $ + + 157,783 + + + $ + + 147,000 + + + + + + + + +F-20 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +The principal +portion of long-term debt becomes due as follows: + + + Fiscal year ending: + + + + + + 2003 + + + $ + + 36,918 + + 2004 + + + + + 13,000 + + 2005 + + + + + 13,000 + + 2006 + + + + + 23,000 + + 2007 + + + + + 28,000 + + 2008 and thereafter + + + + + 70,000 + + + + + Total + + + $ + + 183,918 + + + + + +On September 27, +2002, the Company obtained two unsecured line of credit facilities. The 364-day facility expires on September 26, 2003, and provides for borrowings up to $70 million. The three-year facility expires on September 27, 2005, and provides for borrowings +up to $50 million. Borrowings under either facility accrue interest at LIBOR plus 52.5 to 72.5 basis points or the prime rate, at the Company s option. Quarterly facility fees ranging from 10 to 15 basis points are charged on the average daily +commitment under both facilities. If the aggregate utilization under both facilities exceeds 50% of the aggregate commitment, an additional utilization fee based on the aggregate utilization is assessed at a rate of 0.125% per annum. At September +30, 2002, there was no outstanding balance on either facility. + +On February 23, 1998, the Company obtained an unsecured multi-currency line of credit with banks permitting borrowings up to $10,000 at a multi-currency interbank interest rate plus 75 basis points, ranging from .75% to 5.21% as of +September 30, 2002. At September 30, 2001 and 2002, borrowings under the multi-currency line of credit were $7,736 and $5,972, respectively. Of the amounts outstanding at September 30, 2001 and 2002, $7,736 and $0, respectively, have been classified +as long-term debt. The drawn amounts are denominated in foreign currencies, and have been translated at the exchange rate in effect at year-end. In addition, Hewitt Bacon & Woodrow Ltd., the Company s U.K. subsidiary, has an unsecured line +of credit denominated in British Pound Sterling and provides for borrowings of up to 17 million. As of September 30, 2002, the outstanding balance was 15 million, equivalent to $23,529 with interest at a rate of 4.85%. Other +foreign debt outstanding at September 30, 2001 and 2002 totaled $2,025 and $4,417, respectively. + +On October 16, 2000, the Company issued unsecured senior term notes to various note holders in the amount of $25,000. Of this amount, $10,000 bears +interest at 7.65%, and is repayable on October 15, 2005; $15,000 bears interest at 7.90%, and is repayable on October 15, 2010. + +On July 7, 2000, the Company issued unsecured senior term notes to various note holders in the amount of $25,000. Of this amount, $15,000 bears +interest at 7.93%, and is repayable on June 30, 2007; $10,000 bears interest at 8.11%, and is repayable on June 30, 2010. + +On March 30, 2000, the Company issued $50,000 of unsecured senior term notes to various note holders. Of this amount, $15,000 bears interest at +7.94% and is repayable in annual installments beginning March 2003 through March 2007 and $35,000 bears interest at 8.08%, and is repayable in annual installments beginning March 2008 through March 2012. + +On May 30, 1996, the Company issued unsecured senior term notes to +various note holders in the amount of $50,000, bearing interest at 7.45%. The notes are repayable in annual installments beginning May 2004 through May 2008. + +On May 28, 1996, the Company obtained an unsecured seven-year term loan agreement with various banks in the amount of $30,000, bearing interest at +6.50%. The Company paid interest on a quarterly basis through June 30, 2002. On July 31, 1998, the Company also began to make monthly + + + +F-21 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +principal payments which continued through June 30, 2002. The amounts outstanding at September 30, 2001 and 2002 were $6,250 and $0, +respectively. + +Various debt agreements call for the +maintenance of specified financial ratios, among other restrictions. At September 30, 2001 and 2002, the Company was in compliance with all debt covenants. + +15. Lease Agreements + +The Company has obligations under long-term non-cancelable lease agreements, principally for office space, furniture and equipment, with terms +ranging from one to twenty years. Some of the leases are with related parties (See Note 16, Related Party Transactions). + +Capital Leases + +Capital lease obligations at September 30, 2001 and 2002, consisted of the following: + + + + + 2001 + + + 2002 + + Building capital leases + + + $ + + + + + $ + + 87,822 + + Computer and telecommunications equipment + + + + + 28,548 + + + + + 12,663 + + + + + + + + + + + 28,548 + + + + + 100,485 + + Current portion + + + + + 13,885 + + + + + 11,572 + + + + + + + Capital lease obligations, less current portion + + + $ + + 14,663 + + + $ + + 88,913 + + + + + + + +The Company s +two building capital leases are payable in monthly installments at 7.33% interest and expire in April 2017 and May 2017. + +The Company s computer and telecommunications equipment installment notes and capitalized leases are secured by the related equipment and are +payable typically over three to five years in monthly or quarterly installments and at various interest rates ranging from 5.50% to 7.97%. + +Capital Leases: + + + + + Third Party + + + Related Party + + + Total + + Fiscal year ending: + + + + + + + + + + + + 2003 + + + $ + + 11,375 + + + $ + + 197 + + + $ + + 11,572 + + 2004 + + + + + 5,175 + + + + + 715 + + + + + 5,890 + + 2005 + + + + + 2,360 + + + + + 829 + + + + + 3,189 + + 2006 + + + + + 2,668 + + + + + 953 + + + + + 3,621 + + 2007 + + + + + 3,002 + + + + + 1,087 + + + + + 4,089 + + 2008 and thereafter + + + + + 51,961 + + + + + 20,163 + + + + + 72,124 + + + + + + + + + Total minimum lease payments + + + $ + + 76,541 + + + $ + + 23,944 + + + $ + + 100,485 + + + + + + + + + +Operating Leases + + +The Company also has various third-party operating +leases for office space, furniture and equipment with terms ranging from one to twenty years. The Company has various office leases that grant a free rent period. The accompanying combined and consolidated statements of operations reflect all rent +expense on a straight-line basis over the term of the leases. + + + +F-22 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +The difference between straight-line basis rent and the amount paid has been recorded as accrued lease obligations. + +The following is a schedule by years of minimum future rental payments +required under operating leases which have an initial or remaining non-cancelable lease terms in excess of one year: + +Operating Leases: + + + + + Third Party + + + Related Party + + + Total + + Fiscal year ending: + + + + + + + + + + + + 2003 + + + $ + + 47,770 + + + $ + + 34,076 + + + $ + + 81,846 + + 2004 + + + + + 44,484 + + + + + 33,764 + + + + + 78,248 + + 2005 + + + + + 35,335 + + + + + 33,017 + + + + + 68,352 + + 2006 + + + + + 31,793 + + + + + 33,281 + + + + + 65,074 + + 2007 + + + + + 25,790 + + + + + 33,577 + + + + + 59,367 + + 2008 and thereafter + + + + + 124,479 + + + + + 331,390 + + + + + 455,869 + + + + + + + + + Total minimum lease payments + + + $ + + 309,651 + + + $ + + 499,105 + + + $ + + 808,756 + + + + + + + + + +Total rental +expense for operating leases amounted to $82,812 in 2000, $86,696 in 2001 and $103,958 in 2002. + +16. Related Party Transactions + +The Company has entered into real estate transactions as described below with Hewitt Holdings and its subsidiaries, Hewitt Properties I LLC, Hewitt Properties II LLC, Hewitt Properties III LLC, Hewitt Properties IV LLC, and +Hewitt Properties VII LLC, The Bayview Trust, and Overlook Associates (an equity method investment of Hewitt Holdings). The following leases were outstanding as of September 30, 2001 and 2002: + + + Holdings Property +Entities + + + Location + + + Commencement Date + + + Expiration Date + + Hewitt Holdings LLC + + + Rowayton, Connecticut + + + October 1994 + + + November 2001 + + Hewitt Properties I + + + Lincolnshire, Illinois + + + November 1998 + + + November 2018 + + Hewitt Properties II + + + Lincolnshire, Illinois + + + December 1999 + + + December 2019 + + Hewitt Properties III + + + Lincolnshire, Illinois + + + May 1999 + + + May 2014 + + Hewitt Properties IV + + + Orlando, Florida + + + March 2000 + + + March 2020 + + Hewitt Properties IV + + + The Woodlands, Texas + + + March 2000 + + + March 2020 + + Hewitt Properties VII + + + Norwalk, Connecticut + + + September 2001 + + + September 2011 + + The Bayview Trust + + + Newport Beach, California + + + June 2002 + + + May 2017 + + Overlook Associates + + + Lincolnshire, Illinois + + + * + + + * + +* +The Company has several leases with Overlook Associates, the first began in 1989 and the last expires in 2017. + +Total lease payments were $35,176 in 2000, $39,436 in 2001 and $40,053 +in 2002. The leases were entered into on terms comparable to those which could have been obtained on an arm s length basis. The historical cost of the real property owned by the Holdings property entities aggregates to $460,588 and $394,068 in +2001 and 2002, respectively. The investment in these properties were funded through capital contributions by Hewitt Holdings and third-party debt. Total outstanding debt + + + +F-23 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +owed to third parties by these related parties totaled $318,620 and $285,298 in 2001 and 2002, respectively. The debt is payable over periods that +range from three to eighteen years, and bears fixed interest rates that range from 5.58% to 7.93%. This debt is not reflected on the Company s balance sheet as the obligation represented by the debt is an obligation of Hewitt Holdings and its +related parties, and is not an obligation of the Company. Substantially all of the activities of the Hewitt Holdings property entities involve assets that are leased to the Company. The Company does not guarantee the debt related to these +properties. + +In April 2002, Hewitt Properties VII sold the +Norwalk, Connecticut property and the Company entered into a 15-year capital lease with the purchaser to lease the office space. The Company recorded a $65,000 increase to both property and long-term debt to record this long-term lease obligation. + + +In June 2002, the Company entered into a 15-year capital +lease with The Bayview Trust to lease office space in Newport Beach, California. The Company recorded a $23,944 increase to both property and long-term debt to record this long-term lease obligation. + +The combined and consolidated statements of operations include expenses +that have been allocated to the Company by Hewitt Holdings on a specific identification basis. Management believes these allocations and charges are reasonable and that such expenses would not have differed materially had the Company operated on a +stand-alone basis. + +17. Retirement Plans + +Employee 401(k) and Profit Sharing Plan + +The Company has a qualified 401(k) and profit sharing plan for its +eligible employees. Under the plan, Hewitt makes annual contributions equal to a percentage of participants total cash compensation and may make additional contributions in accordance with the terms of the plan. Additionally, employees may +make contributions in accordance with the terms of the plan, with a portion of those contributions matched by the Company. In 2000, 2001, and 2002, profit sharing plan expenses were $41,620, $58,547 and $66,005, respectively. + +Defined Benefit Plans + +With the acquisition of the actuarial and benefits consulting business +of Bacon & Woodrow, the Company acquired a defined benefit pension plan, which was closed to new entrants in 1998, to provide retirement benefits to eligible employees. The Company also has other defined benefit pension plans to provide benefits +to eligible employees. It is the Company s policy to fund the minimum annual contributions required by applicable regulations. + +Healthcare Plans + +The Company provides health benefits for retired employees and certain dependents when the employee becomes eligible for these benefits by +satisfying plan provisions which include certain age and service requirements. The health benefit plans covering substantially all U.S. and Canadian employees are contributory, with contributions reviewed annually and adjusted as appropriate. These +plans contain other cost-sharing features such as deductibles and coinsurance. The Company does not pre-fund these plans and has the right to modify or terminate any of these plans in the future. + + +F-24 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +The following tables +provide a reconciliation of the changes in the defined benefit and healthcare plans benefit obligations and fair value of assets for the years ended September 30, 2001 and 2002, and a statement of funded status as of September 30, 2001 and +2002. + + + + + Pension Benefits + + + + Health + Benefits + + + + + + 2002 + + + + 2001 + + + + 2002 + + + + Change in Benefit Obligation + + + + + + + + + + + + + + + Benefit obligation, beginning of year + + + $ + + 1,028 + + + + + $ + + 2,782 + + + + + $ + + 3,603 + + + + Acquisition of Bacon & Woodrow + + + + + 51,985 + + + + + + + + + + + + + + + + + + Service cost + + + + + 809 + + + + + + + 351 + + + + + + + 608 + + + + Interest cost + + + + + 1,113 + + + + + + + 201 + + + + + + + 336 + + + + Actuarial losses + + + + + 4,370 + + + + + + + 563 + + + + + + + 4,054 + + + + Benefit payments + + + + + (218 + + ) + + + + + (294 + + ) + + + + + (48 + + ) + + Changes in foreign exchange rates + + + + + 4,326 + + + + + + + + + + + + + + + + + + + + + + + + + Benefit obligation, end of year + + + $ + + 63,413 + + + + + $ + + 3,603 + + + + + $ + + 8,553 + + + + + + + + + + + Change in Plan Assets + + + + + + + + + + + + + + + Fair value of plan assets, beginning of year + + + $ + + + + + + + $ + + + + + + + $ + + + + + + Acquisition of Bacon & Woodrow + + + + + 39,796 + + + + + + + + + + + + + + + + + + Actual return on plan assets + + + + + (3,743 + + ) + + + + + + + + + + + + + + + + Employer contribution + + + + + 279 + + + + + + + 294 + + + + + + + 48 + + + + Benefit payments + + + + + (218 + + ) + + + + + (294 + + ) + + + + + (48 + + ) + + Changes in foreign exchange rates + + + + + 2,965 + + + + + + + + + + + + + + + + + + + + + + + + + Fair value of plan assets, end of year + + + $ + + 39,079 + + + + + $ + + + + + + + $ + + + + + + + + + + + + + Reconciliation of Accrued Obligation and Total Amount Recognized + + + + + + + + + + + + + + + Unfunded status + + + $ + + (24,334 + + ) + + + $ + + (3,603 + + ) + + + $ + + (8,553 + + ) + + Unrecognized net loss + + + + + 9,420 + + + + + + + 870 + + + + + + + 2,302 + + + + Unrecognized prior service cost + + + + + + + + + + + + + + + + + + + 2,554 + + + + Unrecognized transition obligation + + + + + + + + + + + + 558 + + + + + + + 525 + + + + + + + + + + + Net amount recognized, end of year + + + $ + + (14,914 + + ) + + + $ + + (2,175 + + ) + + + $ + + (3,172 + + ) + + + + + + + + + +The assumptions +used in the measurement of our benefit obligations as of June 30, 2001 and 2002 are as follows: + + + + + Pension Benefits + + + Health + Benefits + + + + 2002 + + + 2001 + + + 2002 + + Weighted-average assumptions: + + + + + + + + + Discount rate + + + 5.70% + + + 7.25% + + + 7.00% + + Expected return on plan assets + + + 6.50% + + + N/A + + + N/A + + Rate of compensation increase + + + 3.00% + + + N/A + + + N/A + + +The health plan +provides flat dollar credits based on years of service and age at retirement. There is a small group of grandfathered retirees who receive postretirement medical coverage at a percentage of cost. The liabilities for these retirees are valued +assuming a 12.0% health care cost trend rate for 2002. The rate was assumed to decrease gradually to 6.0% in 2014 and remain at that level thereafter. + + +F-25 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +The components of +net periodic benefit costs for the three years ended September 30, 2002 include: + + + + + Pension Benefits + + + + Health + Benefits + + + + 2002 + + + + 2000 + + + 2001 + + + 2002 + + Components of Net Periodic Benefit Cost + + + + + + + + + + + + + + + + Service cost + + + $ + + 809 + + + + + $ + + 298 + + + $ + + 351 + + + $ + + 608 + + Interest cost + + + + + 1,148 + + + + + + + 182 + + + + + 201 + + + + + 336 + + Expected return on plan assets + + + + + (1,041 + + ) + + + + + + + + + + + + + + + + + Amortization of: + + + + + + + + + + + + + + + + Unrecognized prior service cost + + + + + + + + + + + + + + + + + + + + + + + + Unrecognized loss + + + + + + + + + + + + + + + + + 1 + + + + + 68 + + Transition obligation + + + + + + + + + + + + 33 + + + + + 33 + + + + + 33 + + + + + + + + + + + Net periodic benefit cost + + + $ + + 916 + + + + + $ + + 513 + + + $ + + 586 + + + $ + + 1,045 + + + + + + + + + + + +The effect of a +one percentage point increase or decrease in the assumed health care cost trend rates on total service and interest costs and the postretirement benefit obligation are provided in the following table. + + + + + 2001 + + + + 2002 + + + + Effect of 1% Change in the Assumed Health Care Cost Trend Rates + + + + + + + + + + + Effect of 1% increase on: + + + + + + + + + + + Total of service and interest cost components + + + $ + + 2 + + + + + $ + + 2 + + + + Benefit obligation + + + + + 28 + + + + + + + 62 + + + + Effect of 1% decrease on + + + + + + + + + + + Total of service and interest cost components + + + $ + + (2 + + ) + + + $ + + (2 + + ) + + Benefit obligation + + + + + (26 + + ) + + + + + (57 + + ) + + +18. Stock-Based Compensation +Plan + +In 2002, the Company adopted the Hewitt Global +Stock and Incentive Compensation Plan (the Plan ) for associates and directors. The incentive compensation plan is administered by the Compensation and Leadership Committee of the Board of Directors of Hewitt Associates, Inc. (the + Committee ). Under the Plan, associates and directors may receive awards of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units +and cash-based awards. As of September 30, 2002, only restricted stock and restricted stock units and non-qualified stock options have been granted. A total of 25,000,000 shares of Class A common stock has been reserved for issuance under the plan. +As of September 30, 2002, there were 15,196,092 shares available for grant under the plan. + +Restricted Stock and Restricted Stock Units + +In connection with the initial public offering, the Company granted 5,789,908 shares of Class A restricted stock and restricted stock units to employees. The restricted stock and restricted stock units have substantially the same +terms, except the holders of restricted stock units do not have voting rights. The one-time initial public offering-related awards were valued at $110,141 on the grant date (a weighted price of $19.02 per share) and 37% will be amortized on a +straight-line basis as non-cash compensation expense from the grant date to December 31, 2002 and 63% will be amortized on a straight-line basis as non-cash compensation expense over four years following the grant date. For the year ended September +30, 2002, compensation expense for the initial public offering restricted stock + + + +F-26 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +awards was $27,525 representing amortization between the offering date, June 27, 2002, and September 30, 2002 and applicable payroll taxes. The +remaining $83,375 of unearned compensation is recorded within stockholders equity and will be amortized as the awards vest. + +Stock Options + +The Committee may grant both incentive stock options and non-qualified stock options to purchase shares of Class A common stock. Subject to the +terms and provisions of the plan, stock options may be granted to participants in such number, and upon such terms, as determined by the Committee, provided that incentive stock options may not be granted to directors. The stock option price is +determined by the Committee, provided that for stock options issued to participants in the United States, the stock option price should not be less than 100% of the fair market value of the underlying shares on the date the stock option is granted +and no stock option should be exercisable later than the tenth anniversary of its grant. The non-qualified stock options granted in conjunction with the Company s initial public offering vest over a period of four years and expire in ten years. +The following table summarizes stock option activity during 2002: + + + + + Shares + + + + Weighted-Average Exercise Price + + Outstanding at September 30, 2001 + + + + + + + + + + + + Granted + + + 4,106,703 + + + + + $ + + 19.29 + + Exercised + + + + + + + + + + + + Forfeited + + + (17,700 + + ) + + + + + 19.00 + + + + + + + Outstanding at September 30, 2002 + + + 4,089,003 + + + + + $ + + 19.29 + + + + + + + +The following +table summarizes information about stock options outstanding at September 30, 2002. There were no exercisable options as of September 30, 2002. + + + + + Outstanding Options + + + + Number + Outstanding + + + Weighted- + Average Exercise Price + + + Weighted- + Average + Term (Years) + + Range of exercise prices: + + + + + + + + + + $19.00 + + + 3,843,013 + + + $ + + 19.00 + + + 9.6 + + $23.50-$28.00 + + + 245,990 + + + + + 23.87 + + + 9.7 + + + + + + + + + + + 4,089,003 + + + $ + + 19.29 + + + 9.7 + + + + + + + + + +Pursuant to SFAS +No. 123, Accounting for Stock-Based Compensation, the Company has elected to account for its employee stock option plans under APB No. 25, Accounting for Stock Issued to Employees, which recognizes expense based on the intrinsic value +at the measurement date. Because stock options have been issued with exercise prices equal to the fair market value of the underlying stock at the measurement date, no compensation cost has resulted. Pro forma information regarding net income and +earnings per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method. The fair value for these stock options was estimated at the date of grant using a +Black-Scholes option pricing model with the following weighted-average assumptions: + + + + + 2002 + + Expected volatility + + + 35% + + Risk-free interest rate + + + 3.81%-4.19% + + Expected life (years) + + + 4 + + Dividend yield + + + 0% + + + +F-27 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +The weighted-average +estimated fair market value of employee stock options granted during 2002 was $6.50 per share. These stock options were granted at exercise prices equal to the current fair market value of the underlying stock. + +For purposes of pro forma disclosures, the estimated fair value of the +stock options is amortized to compensation expense over the stock options vesting period. The Company s pro forma net income (loss) and earnings (loss) per share would have been as follows: + + + + + 2002 + + + + Net income: + + + + + + + As reported + + + $ + + 190,373 + + + + Stock option compensation expense, net of tax + + + + + (1,130 + + ) + + + + + Adjusted net income + + + $ + + 189,243 + + + + Net loss applicable to common stockholders +(from June 1, 2002 through September 30, +2002): + + + + + + + As reported + + + $ + + (22,691 + + ) + + Stock option compensation expense, net of tax + + + + + (1,130 + + ) + + + + + Adjusted net loss applicable to common stockholders + + + $ + + (23,821 + + ) + + Net loss per share as reported basic and diluted: + + + + + + + As reported + + + $ + + (0.27 + + ) + + Adjusted net loss per share + + + $ + + (0.28 + + ) + + +19. Legal Proceedings + + +The Company is occasionally subject to lawsuits and +claims arising in the normal conduct of business. Management does not expect the outcome of any pending claim to have a material adverse affect on the business, financial condition or results of operations. + +20. Other Comprehensive Income (Loss) + +Accumulated other comprehensive income (loss) consists of the following +components: + + + + + Foreign + Currency Translation + Adjustment + + + + Minimum + Pension + Liability + + + + Net + Unrealized + Gains (Losses) + + + + Accumulated + Other + Comprehensive + Income (Loss) + + + + As of September 30, 1999 + + + $ + + 235 + + + + + $ + + + + + + + $ + + + + + + + $ + + 235 + + + + Other comprehensive income (loss) + + + + + (763 + + ) + + + + + + + + + + + + 2,191 + + + + + + + 1,428 + + + + + + + + + + + + + As of September 30, 2000 + + + + + (528 + + ) + + + + + + + + + + + + 2,191 + + + + + + + 1,663 + + + + Other comprehensive income (loss) + + + + + (239 + + ) + + + + + + + + + + + + (2,191 + + ) + + + + + (2,430 + + ) + + + + + + + + + + + As of September 30, 2001 + + + + + (767 + + ) + + + + + + + + + + + + + + + + + + + (767 + + ) + + Other comprehensive income (loss) + + + + + 17,648 + + + + + + + (690 + + ) + + + + + + + + + + + + 16,958 + + + + + + + + + + + + + As of September 30, 2002 + + + $ + + 16,881 + + + + + $ + + (690 + + ) + + + $ + + + + + + + $ + + 16,191 + + + + + + + + + + + + + +21. Income Taxes + + +Prior to the Company s transition to a corporate +structure, no provision for income taxes was made as the liability for such taxes were that of the former owners. As a result of the Company s transition to a corporate structure on May 31, 2002, a tax expense of $21,711 was recognized related +to deferred tax assets and liabilities recorded in accordance with the provisions of SFAS No. 109, + + + +F-28 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + +Accounting for Income Taxes, arising from temporary differences between the book and tax basis of the Company s assets and liabilities at +the date of transition. + +Subsequent to transition, the +Company s provision for income taxes aggregated $11,342 ($33,053 income tax expense less the $21,711 tax expense related to the transition to a corporate structure) and consisted of the following: + + + + + Current + + + Deferred + + + + Total + + U.S. Federal + + + $ + + 25,740 + + + $ + + (16,108 + + ) + + + $ + + 9,632 + + State and local + + + + + 4,808 + + + + + (3,314 + + ) + + + + + 1,494 + + Foreign + + + + + 216 + + + + + + + + + + + + 216 + + + + + + + + + + + $ + + 30,764 + + + $ + + (19,422 + + ) + + + $ + + 11,342 + + + + + + + + + +At September 30, +2002, the Company had income taxes receivable of $2,091. Income tax expense for the period subsequent to transition differed from the amounts computed by applying the U.S. federal income tax rate of 35% to income before taxes ($10,361 for the period +June 1, 2002 through September 30, 2002) as a result of the following: + + + Provision for taxes at U.S. federal statutory rate + + + $ + + 3,626 + + Increase in income taxes resulting from: + + + + + + Costs of transition to corporate structure + + + + + 4,530 + + State and local income taxes, net of federal income tax benefit + + + + + 972 + + Nondeductible expenses + + + + + 592 + + Foreign earnings taxed at varying rates and foreign losses not tax effected + + + + + 1,401 + + Other + + + + + 221 + + + + + + + $ + + 11,342 + + + + + +The tax effects of +temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below: + + + Deferred tax assets: + + + + + + + Accrued expenses + + + $ + + 23,910 + + + + Foreign tax loss carryforwards + + + + + 27,859 + + + + Other + + + + + 3,176 + + + + + + + + + + + 54,945 + + + + Valuation allowance + + + + + (27,859 + + ) + + + + + + + $ + + 27,086 + + + + + + + Deferred tax liabilities: + + + + + + + Compensation and benefits + + + $ + + 15,805 + + + + Income deferred for tax purposes + + + + + 2,282 + + + + Goodwill amortization + + + + + 1,460 + + + + Depreciation and amortization + + + + + 5,583 + + + + Other + + + + + 4,245 + + + + + + + + + $ + + 29,375 + + + + + + + + +F-29 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +In assessing the +realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation +of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this +assessment. In order to fully realize the deferred tax asset, the Company will need to generate future taxable income prior to the expiration of the foreign net operating loss carryforwards which expire in 2003 through 2017. Foreign taxable loss for +the four-month period ended September 30, 2002 was $21,477 and consolidated taxable income for the same four month period was $26,457. Based upon the level of historical taxable income and projections for future taxable income over the periods +during which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at September 30, 2002. The amount of +the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. + +22. Segments and Geographic Data + +Under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company has determined that it has two +reportable segments based on similarities among the operating units including homogeneity of services, service delivery methods and use of technology. The two segments are outsourcing and consulting. + + + + + +Outsourcing Hewitt applies benefits and human resources expertise and employs its integrated technology systems to administer its clients human resource programs. +Benefits outsourcing includes the administration of health and welfare (such as medical) plans, defined contribution (such as 401(k)) plans and defined benefit (such as pension) plans. Hewitt assumes and automates the resource-intensive processes +required to administer its clients benefit programs, and provides on-line tools and information that support decision-making and transactions by its clients and their employees. With the information and tools that Hewitt provides, Hewitt +helps its clients to optimize the return on their investments in their benefit programs. Hewitt has built on its experience in benefits outsourcing to offer employers the ability to outsource a wide range of human resource activities using its human +resources business process outsourcing ( HR BPO ) solution. + + + + + +Consulting Hewitt provides actuarial services and a wide array of other consulting services covering the design, implementation, communication and operation of health and +welfare, compensation and retirement plans, and broader human resources programs and processes. + +Hewitt operates many of the administrative and support functions of its business through the use of centralized shared service operations to provide +an economical and effective means of supporting the outsourcing and consulting segment businesses. These shared services include information systems, human resources, general office support and space management, overall corporate management, finance +and legal services. Additionally, Hewitt utilizes a client development group that markets the entire spectrum of its services and devotes resources to maintaining existing client relationships. The compensation and related expenses, other operating +expenses, and selling, general and administrative expenses of the administrative and marketing functions are not allocated to the business segment, rather, they are included in unallocated shared costs. The costs of information systems and human +resources, however, are allocated to the outsourcing and consulting segments based on a specific indentification basis or based on usage and headcount. + +The accounting policies of the operating segments are the same as those described in Note 2, Summary of Significant Accounting Policies. + + + +F-30 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + +The table below +presents information about the Company s reportable segments for the periods presented: + + + + + Year Ended September 30, + + + + 2000 + + + 2001 + + + 2002 + + Outsourcing (1) + + + + + + + + + + + + Revenues before reimbursements (net revenues) + + + $ + + 802,683 + + + $ + + 951,884 + + + $ + + 1,115,462 + + Segment income before the non-recurring software charge (2) + + + + + 137,716 + + + + + 164,425 + + + + + 272,702 + + Segment income (2) + + + + + 137,716 + + + + + 137,956 + + + + + 272,702 + + Net client receivables and work in process + + + + + + + + 213,438 + + + + + 193,996 + + Consulting (3) + + + + + + + + + + + + Revenues before reimbursements (net revenues) + + + $ + + 477,869 + + + $ + + 523,777 + + + $ + + 600,735 + + Segment income (2) + + + + + 151,060 + + + + + 168,766 + + + + + 161,787 + + Net client receivables and work in process + + + + + + + + 154,360 + + + + + 200,188 + + Total Company + + + + + + + + + + + + Revenues before reimbursements (net revenues) + + + $ + + 1,280,552 + + + $ + + 1,475,661 + + + $ + + 1,716,197 + + Reimbursements + + + + + 25,507 + + + + + 26,432 + + + + + 33,882 + + + + + + + + + Total revenues + + + $ + + 1,306,059 + + + $ + + 1,502,093 + + + $ + + 1,750,079 + + + + + + + + + Segment income before the non-recurring software charge (2) + + + $ + + 288,776 + + + $ + + 333,191 + + + $ + + 434,489 + + Non-recurring software charge + + + + + + + + + + 26,469 + + + + + + + + + + + + + + Segment income (2) + + + + + 288,776 + + + + + 306,722 + + + + + 434,489 + + Charges not recorded at the segment level: + + + + + + + + + + + + One-time charges (4) + + + + + + + + + + + + + + + 26,143 + + Initial public offering restricted stock awards (5) + + + + + + + + + + + + + + + 27,525 + + Unallocated shared costs (2) + + + + + 106,631 + + + + + 121,020 + + + + + 140,501 + + + + + + + + + Operating income (2) + + + $ + + 182,145 + + + $ + + 185,702 + + + $ + + 240,320 + + + + + + + + + Net client receivables and work in process + + + + + + $ + + 367,798 + + + $ + + 394,184 + + Assets not reported by segment + + + + + + + + 333,559 + + + + + 825,162 + + + + + + + + + + Total assets + + + + + + $ + + 701,357 + + + $ + + 1,219,346 + + + + + + + + + +(1) + The fiscal years 2000 and 2001 Outsourcing results include the results of Sageo prior to the decision to transition Sageo clients from Sageo s website to the Total +Benefit Administration web interface and the Sageo employees who were directly involved in supporting clients were transferred +to Hewitt. In the year ended September 30, 2001, stand-alone company expenses were eliminated and Sageo website development spending ceased. Sageo contributed $0 and + + + +F-31 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + + + +$10,342 of Outsourcing net revenues and reduced segment income by $20,628 and $73,462 for the years ended September 30, 2000 and 2001, respectively. + +(2) +Prior to May 31, 2002, owners were compensated through distributions of income. In connection with the Company s transition to a corporate structure on May 31, 2002, +owners who worked in the business became employees and the Company began to record their compensation as compensation and related expenses in arriving at segment income. + +(3) +On June 5, 2002, the Company acquired the benefits consulting business of Bacon & Woodrow. As such, the results of Bacon & Woodrow have been included in the +Company s Consulting segment s results from the acquisition date of June 5, 2002 through September 30, 2002. + +(4) +In connection with the Company s transition to a corporate structure, the following one-time charges were incurred: a) $8,300 of non-recurring compensation expense +related to the establishment of a vacation liability for its former owners and b) $17,843 of non-recurring compensation expense resulting from certain owners receiving more common stock than their proportional share of total capital, without offset +for those owners who receive less than their proportional share of stock. + +(5) +Compensation expense of $27,525 related to the amortization of initial public offering restricted stock awards. + +Revenues and long-lived assets for the years ended September 30 are +indicated below. Revenues are attributed to geographic areas based on the country where the associates perform the services. Long-lived assets include net property and equipment and intangible assets, such as capitalized software. + + + + + Year Ended September 30, + + + + 2000 + + + 2001 + + + 2002 + + Revenues + + + + + + + + + + + + United States + + + $ + + 1,202,190 + + + $ + + 1,380,991 + + + $ + + 1,571,747 + + All Other Countries + + + + + 103,869 + + + + + 121,102 + + + + + 178,332 + + + + + + + + + Total + + + $ + + 1,306,059 + + + $ + + 1,502,093 + + + $ + + 1,750,079 + + + + + + + + + Long-Lived Assets + + + + + + + + + + + + United States + + + + + + $ + + 220,977 + + + $ + + 320,038 + + All Other Countries + + + + + + + + 19,546 + + + + + 309,477 + + + + + + + + + + Total + + + + + + $ + + 240,523 + + + $ + + 629,515 + + + + + + + + + + +The Company s +revenues attributable to areas outside the United States are influenced by fluctuations in exchange rates of foreign currencies, foreign economic conditions, and other factors associated with foreign trade. + +23. Regulated Subsidiary + +Hewitt Financial Services LLC, a registered U.S. broker-dealer +subsidiary, which is subject to the Securities and Exchange Commission s Uniform Net Capital Rule , has elected to compute its net capital in accordance with the Alternative Standard of that rule. As of September 30, 2001 +and 2002, Hewitt Financial Services LLC had regulatory net capital, as defined, of $742 and $1,641, respectively, which exceeded the amounts required by $737 and $1,636, respectively. + + +F-32 + +Table of Contents + + +HEWITT ASSOCIATES, +INC. + + +CONSOLIDATED BALANCE SHEETS +(Dollars in thousands except for share and per share amounts) + + + + + + March 31, 2003 + + + + September 30, 2002 + + + + + + (Unaudited) + + + + + + + ASSETS + + + + + + + + + + + Current Assets + + + + + + + + + + + Cash and cash equivalents + + + $ + + 149,195 + + + + + $ + + 136,450 + + + + Client receivables and unbilled work in process, less allowances of $15,255 at +March 31, 2003 and $16,160 at September 30, 2002 + + + + + 412,552 + + + + + + + 394,184 + + + + Prepaid expenses and other current assets + + + + + 40,523 + + + + + + + 35,474 + + + + Deferred income taxes, net + + + + + 16,973 + + + + + + + 16,976 + + + + + + + + + Total current assets + + + + + 619,243 + + + + + + + 583,084 + + + + + + + + + Non-Current Assets + + + + + + + + + + + Property and equipment, net + + + + + 231,198 + + + + + + + 249,613 + + + + Goodwill, net + + + + + 217,400 + + + + + + + 201,286 + + + + Intangible assets, net + + + + + 167,571 + + + + + + + 169,887 + + + + Other assets, net + + + + + 17,063 + + + + + + + 15,476 + + + + + + + + + Total non-current assets + + + + + 633,232 + + + + + + + 636,262 + + + + + + + + + Total Assets + + + $ + + 1,252,475 + + + + + $ + + 1,219,346 + + + + + + + + + LIABILITIES + + + + + + + + + + + Current Liabilities + + + + + + + + + + + Accounts payable + + + $ + + 15,340 + + + + + $ + + 23,286 + + + + Accrued expenses + + + + + 182,335 + + + + + + + 180,946 + + + + Advanced billings to clients + + + + + 84,893 + + + + + + + 73,965 + + + + Current portion of long-term debt + + + + + 32,817 + + + + + + + 36,918 + + + + Current portion of capital lease obligations + + + + + 10,385 + + + + + + + 11,572 + + + + Employee deferred compensation and accrued profit sharing + + + + + 25,722 + + + + + + + 56,481 + + + + + + + + + Total current liabilities + + + + + 351,492 + + + + + + + 383,168 + + + + + + + + + Long-Term Liabilities + + + + + + + + + + + Debt , less current portion + + + + + 144,000 + + + + + + + 147,000 + + + + Capital lease obligations, less current portion + + + + + 84,959 + + + + + + + 88,913 + + + + Other long-term liabilities + + + + + 41,475 + + + + + + + 48,435 + + + + Deferred income taxes, net + + + + + 19,265 + + + + + + + 19,265 + + + + + + + + + Total long-term liabilities + + + + + 289,699 + + + + + + + 303,613 + + + + + + + + + Total Liabilities + + + $ + + 641,191 + + + + + $ + + 686,781 + + + + + + + + + Commitments and Contingencies (Note 10) + + + + + + + + + + + STOCKHOLDERS EQUITY + + + + + + + + + + + Stockholders Equity + + + + + + + + + + + Preferred stock, par value $0.01 per share, 10,000,000 shares authorized + + + $ + + + + + + + $ + + + + + + Class A common stock, par value $0.01 per share, 750,000,000 shares authorized, 19,209,636 and +19,162,660 shares issued and outstanding as of March 31, 2003 and September 30, 2002, respectively + + + + + 192 + + + + + + + 192 + + + + Class B common stock, par value $0.01 per share, 200,000,000 shares authorized, 73,726,424 shares +issued and outstanding as of March 31, 2003 and September 30, 2002 + + + + + 737 + + + + + + + 737 + + + + Class C common stock, par value $0.01 per share, 50,000,000 shares authorized, 5,568,869 shares +issued and outstanding as of March 31, 2003 and September 30, 2002 + + + + + 56 + + + + + + + 56 + + + + Restricted stock units, 227,025 and 319,902 units issued and outstanding as of +March 31, 2003 and September 30, 2002, respectively + + + + + 4,784 + + + + + + + 6,078 + + + + Additional paid-in capital + + + + + 625,724 + + + + + + + 615,377 + + + + Retained earnings (deficit) + + + + + 15,574 + + + + + + + (22,691 + + ) + + Unearned compensation + + + + + (55,338 + + ) + + + + + (83,375 + + ) + + Accumulated other comprehensive income + + + + + 19,555 + + + + + + + 16,191 + + + + + + + + + Total stockholders equity + + + + + 611,284 + + + + + + + 532,565 + + + + + + + + + Total Liabilities and Stockholders Equity + + + $ + + 1,252,475 + + + + + $ + + 1,219,346 + + + + + + + + + +The accompanying +notes are an integral part of these statements. + + +F-33 + +Table of Contents + + +HEWITT ASSOCIATES, +INC. + + +CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS (1) +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + + + + Three Months Ended + March 31, + + + + Six Months Ended + March 31, + + + + + + 2003 + + + + 2002 + + + + 2003 + + + + 2002 + + + + Revenues: + + + + + + + + + + + + + + + + + + + Revenue before reimbursements (net revenues) + + + $ + + 478,056 + + + + + $ + + 408,703 + + + + + $ + + 958,375 + + + + + $ + + 812,777 + + + + Reimbursements + + + + + 13,928 + + + + + + + 6,667 + + + + + + + 27,534 + + + + + + + 13,470 + + + + + + + + + + + + + Total revenues + + + + + 491,984 + + + + + + + 415,370 + + + + + + + 985,909 + + + + + + + 826,247 + + + + + + + + + + + + + Operating expenses: + + + + + + + + + + + + + + + + + + + Compensation and related expenses, excluding initial public offering restricted stock +awards (1) + + + + + 311,238 + + + + + + + 223,874 + + + + + + + 622,777 + + + + + + + 441,276 + + + + Initial public offering restricted stock awards + + + + + 4,659 + + + + + + + + + + + + + + 29,544 + + + + + + + + + + + Reimbursable expenses + + + + + 13,928 + + + + + + + 6,667 + + + + + + + 27,534 + + + + + + + 13,470 + + + + Other operating expenses + + + + + 94,098 + + + + + + + 86,723 + + + + + + + 188,511 + + + + + + + 174,335 + + + + Selling, general and administrative expenses + + + + + 24,316 + + + + + + + 21,253 + + + + + + + 43,752 + + + + + + + 34,793 + + + + + + + + + + + + + Total operating expenses + + + + + 448,239 + + + + + + + 338,517 + + + + + + + 912,118 + + + + + + + 663,874 + + + + + + + + + + + + + Operating income (1) + + + + + 43,745 + + + + + + + 76,853 + + + + + + + 73,791 + + + + + + + 162,373 + + + + Other expenses, net: + + + + + + + + + + + + + + + + + + + Interest expense + + + + + (4,881 + + ) + + + + + (3,429 + + ) + + + + + (10,198 + + ) + + + + + (7,062 + + ) + + Interest income + + + + + 457 + + + + + + + 495 + + + + + + + 1,100 + + + + + + + 1,126 + + + + Other income (expense), net + + + + + 440 + + + + + + + (2,084 + + ) + + + + + 164 + + + + + + + (2,943 + + ) + + + + + + + + + + + Total other expenses, net + + + + + (3,984 + + ) + + + + + (5,018 + + ) + + + + + (8,934 + + ) + + + + + (8,879 + + ) + + + + + + + + + + + Income before taxes and owner distributions + + + + + + + $ + + 71,835 + + + + + + + + + $ + + 153,494 + + + + + + + + + + + + + + + + + Income before income taxes + + + + + 39,761 + + + + + + + + + + + 64,857 + + + + + + + + + Provision for income taxes (1) + + + + + 16,254 + + + + + + + + + + + 26,591 + + + + + + + + + + + + + + + + + + + + + + + Net income + + + $ + + 23,507 + + + + + + + + + $ + + 38,266 + + + + + + + + + + + + + + + + + + + + + + + Earnings per share: + + + + + + + + + + + + + + + + + + + Basic + + + $ + + 0.25 + + + + + + + + + $ + + 0.41 + + + + + + + + + Diluted + + + $ + + 0.24 + + + + + + + + + $ + + 0.40 + + + + + + + + + Weighted average shares: + + + + + + + + + + + + + + + + + + + Basic + + + + + 95,127,936 + + + + + + + + + + + 94,096,400 + + + + + + + + + Diluted + + + + + 97,069,525 + + + + + + + + + + + 96,804,889 + + + + + + + + +(1) +In connection with the Company s transition to a corporate structure on May 31, 2002, owners who worked in the business became employees and the Company began to record +their compensation in compensation and related expenses and the Company became subject to corporate income taxes. As such, owner compensation expenses and corporate income taxes were recorded in the current year quarter and six month period but not +in the prior year quarter and six month period. Additionally, on June 5, 2002, the Company acquired the actuarial and benefits consulting business of Bacon & Woodrow and their results are included in the Company s results from the +acquisition date of June 5, 2002. + +The +accompanying notes are an integral part of these statements. + + +F-34 + +Table of Contents + + +HEWITT ASSOCIATES, +INC. + + +CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS +(Unaudited) +(Dollars in thousands) + + + + + Six Months Ended + March 31, + + + + + + 2003 + + + + 2002 + + + + Cash flows from operating activities: + + + + + + + + + + + Income before taxes and owner distributions + + + + + + + $ + + 153,494 + + + + Net income + + + $ + + 38,266 + + + + + + + + + Adjustments to reconcile income before taxes and owner distributions and +net income to net cash provided by operating activities: + + + + + + + + + + + Depreciation + + + + + 38,993 + + + + + + + 34,668 + + + + Amortization + + + + + 15,955 + + + + + + + 12,285 + + + + Initial public offering restricted stock awards (Note 11) + + + + + 26,889 + + + + + + + + + + + Deferred income taxes + + + + + 3 + + + + + + + + + + + Changes in operating assets and liabilities: + + + + + + + + + + + Client receivables and unbilled work in process + + + + + (12,766 + + ) + + + + + 15,554 + + + + Prepaid expenses and other current assets + + + + + 1,016 + + + + + + + (1,615 + + ) + + Accounts payable + + + + + (9,403 + + ) + + + + + (11,446 + + ) + + Accrued expenses + + + + + 8,910 + + + + + + + 23,165 + + + + Advanced billings to clients + + + + + 10,790 + + + + + + + 10,952 + + + + Employee deferred compensation and accrued profit sharing + + + + + (30,939 + + ) + + + + + (23,063 + + ) + + Other long-term liabilities + + + + + 399 + + + + + + + (472 + + ) + + + + + + + Net cash provided by operating activities + + + + + 88,113 + + + + + + + 213,522 + + + + Cash flows from investing activities: + + + + + + + + + + + Additions to property and equipment + + + + + (19,192 + + ) + + + + + (15,825 + + ) + + Cash paid for acquisition, net of cash received + + + + + (6,846 + + ) + + + + + + + + + Increase in other assets + + + + + (31,299 + + ) + + + + + (13,165 + + ) + + + + + + + Net cash used in investing activities + + + + + (57,337 + + ) + + + + + (28,990 + + ) + + Cash flows from financing activities: + + + + + + + + + + + Capital distributions, net + + + + + + + + + + + + (177,810 + + ) + + Proceeds from the exercise of stock options + + + + + 252 + + + + + + + + + + + Short-term borrowings + + + + + 529 + + + + + + + + + + + Repayments of long-term debt + + + + + (13,269 + + ) + + + + + (4,375 + + ) + + Repayments of capital lease obligations + + + + + (5,141 + + ) + + + + + (6,939 + + ) + + Payment of accrued offering costs + + + + + (797 + + ) + + + + + + + + + + + + + + Net cash used in financing activities + + + + + (18,426 + + ) + + + + + (189,124 + + ) + + Effect of exchange rate changes on cash and cash equivalents + + + + + 395 + + + + + + + 327 + + + + + + + + + Net increase (decrease) in cash and cash equivalents + + + + + 12,745 + + + + + + + (4,265 + + ) + + Cash and cash equivalents, beginning of period + + + + + 136,450 + + + + + + + 60,606 + + + + + + + + + Cash and cash equivalents, end of period + + + $ + + 149,195 + + + + + $ + + 56,341 + + + + + + + + + Supplementary disclosure of cash paid during the period: + + + + + + + + + + + Interest paid + + + $ + + 10,198 + + + + + $ + + 4,777 + + + + Income taxes paid + + + $ + + 4,356 + + + + + $ + + + + + + +The accompanying +notes are an integral part of these statements. + + +F-35 + +Table of Contents + + +HEWITT ASSOCIATES, +INC. + + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in +thousands except for share and per share amounts) + + +1. Description of Business: + +Hewitt Associates, Inc., a Delaware corporation, and its subsidiaries ( Hewitt or the Company ) provide human resources +outsourcing and consulting services. + +Prior to May 31, +2002, the results of the Company included the combined results of three Illinois limited liability companies: Hewitt Associates LLC and subsidiaries, Hewitt Financial Services LLC, and Sageo LLC (collectively, Hewitt Associates LLC and +Affiliates ). Hewitt Associates LLC and Affiliates was under the control of Hewitt Holdings LLC ( Hewitt Holdings ). + +On May 31, 2002, the Company completed its transition to a corporate structure whereby Hewitt Holdings ownership interests in Hewitt +Associates LLC and Affiliates were transferred to Hewitt Holdings newly formed and then wholly-owned subsidiary, Hewitt Associates, Inc. + +On June 5, 2002, the Company acquired the actuarial and benefits consulting business of Bacon & Woodrow in the United Kingdom. The results of +operations for Bacon & Woodrow s actuarial and benefits consulting business are included in the Company s results from the acquisition date. + +On June 27, 2002, the Company sold 11,150,000 shares of Class A common stock at $19.00 per share in its initial public offering. In July 2002, the +underwriters exercised their over-allotment option to purchase an additional 1,672,500 shares of the Company s Class A common stock at $19.00 per share. The combined transactions generated $218,502 in net cash proceeds after offering expenses. + + +2. Summary of Significant Accounting Policies: + + +Basis of Presentation + +The accompanying unaudited interim consolidated and combined financial +statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q. In the opinion of management, these financial statements include all adjustments necessary to present +fairly the financial position, results of operations, and cash flows as of March 31, 2003, and for all periods presented. All adjustments made have been of a normal and recurring nature. Certain information and footnote disclosures normally included +in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The Company believes that the disclosures included are adequate and provide a fair +presentation of interim period results. Interim financial statements are not necessarily indicative of the financial position or operating results for an entire year. It is suggested that these interim financial statements be read in conjunction +with the audited financial statements and the notes thereto, together with Management s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company s Form 10-K for the fiscal year ended September 30, +2002, as filed with the Securities and Exchange Commission. Certain previously reported amounts have been reclassified to conform to the current period presentation. + +The consolidated and combined financial statements are prepared on the accrual basis of accounting. The significant +accounting policies are summarized below: + +Principles of Consolidation +and Combination + +The accompanying consolidated and +combined financial statements reflect the operations of the Company and its majority owned subsidiaries after elimination of intercompany accounts and + + + +F-36 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +transactions. Combined financial statements are presented for periods prior to the transition to a corporate structure when the combined entities that +now make up the Company were under common control. Upon consummation of the transition to a corporate structure, the affiliated companies of Hewitt were transferred into the newly formed corporation, Hewitt Associates, Inc., and their results are +presented on a consolidated basis. + +Revenue Recognition + + +Revenues include fees generated from outsourcing +contracts and from consulting services provided to the Company s clients. + +Under the Company s outsourcing contracts, which typically have a three- to five-year term, clients generally pay an implementation fee and an ongoing service fee. In accordance with the Securities and Exchange +Commission s Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, the Company recognizes revenues for non-refundable, upfront implementation fees evenly over the period between the initiation of ongoing +services through the end of the contract term (on a straight-line basis). Most indirect costs of implementation are expensed as incurred. However, incremental direct costs of implementation are deferred and recognized as expense over the same period +that deferred implementation fees are recognized. If a client terminates an outsourcing contract prematurely, both the deferred implementation revenues and related costs are recognized in the period in which the termination occurs. + +Revenues related to ongoing service fees and to services provided +outside the scope of outsourcing contracts are recognized as services are provided. Ongoing service fees are normally billed on a monthly basis and are typically based on the number of plan participants or services. Services provided outside the +scope of outsourcing contracts are billed on a time-and-materials or a fixed fee basis. + +Losses on outsourcing contracts are recognized during the period in which the loss becomes probable and the amount of the loss is reasonably estimable. Contract losses are determined to be the amount by which +the estimated direct and a portion of indirect costs of the contract exceed the estimated total revenues that will be generated by the contract. + +The Company s clients pay for consulting services either on a time-and-materials or a fixed-fee basis. Revenues are recognized under +time-and-material based arrangements as services are provided. On fixed-fee engagements, revenues are recognized as the services are performed, which is measured by hours incurred in proportion to total hours estimated to complete a project. Losses +on consulting agreements are recognized during the period in which the loss becomes probable and the amount of the loss is reasonably estimable. Losses are determined to be the amount by which the estimated direct and indirect costs of the project +exceed the estimated total revenues that will be generated for the work. + +Revenues earned in excess of billings are recorded as unbilled work in progress. Billings in excess of revenues earned are recorded as advanced billings to clients, a deferred revenue liability, until services are rendered. + + + +F-37 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +The Company considers the criteria established by Emerging Issues Task Force ( EITF ) Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, in determining whether revenue should be +recognized on a gross versus a net basis. In consideration of these criteria, the Company recognizes revenue primarily on a gross basis. Factors considered in determining if gross or net recognition is appropriate include whether the Company is +primarily responsible to the client for the services, changes the delivered product, performs part of the service delivered, has discretion on vendor selection, or bears credit risk. In accordance with EITF Issue No. 01-14, Income Statement +Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred, reimbursements received for out-of pocket expenses incurred are characterized as revenues and are shown as a +separate component of total revenues. Similarly, related reimbursable expenses are also shown separately within operating expenses. + +Performance-Based Compensation + +The Company s compensation program includes a performance-based +component that is determined by management. Performance-based compensation is discretionary and is based on individual, team, and total Company performance. Performance-based compensation is paid once per fiscal year after the Company s annual +operating results are finalized. The amount of expense for performance-based compensation recognized at interim and annual reporting dates involves judgment, is based on our quarterly and annual results as compared to our internal targets, and takes +into account other factors, including industry-wide results and the general economic environment. Annual performance-based compensation levels may vary from current expectations as a result of changes in the actual performance of the individual, +team, or Company. As such, accrued amounts are subject to change in future periods if actual future performance varies from performance levels anticipated in prior interim periods. + +Goodwill and Other Intangible Assets + +On October 1, 2002, the Company adopted Statement of Financial Accounting Standards ( SFAS ) No. 142, Goodwill and Other Intangible +Assets, for acquisitions made prior to July 1, 2001. The Company evaluates its goodwill for impairment whenever indicators of impairment exist with reviews at least annually. The evaluation is based upon a comparison of the estimated fair value +of the reporting unit to which the goodwill has been assigned to the sum of the carrying value of the assets and liabilities of that reporting unit. The fair values used in this evaluation is estimated based upon discounted future cash flow +projections for the reporting unit. + +Income Before Taxes and Owner +Distributions + +Prior to May 31, 2002, the Company +operated as a group of affiliated limited liability companies and recorded income before taxes and owner distributions in accordance with accounting principles generally accepted in the United States of America. Income before taxes and owner +distributions is not comparable to net income of a corporation because compensation and related expenses for services rendered by owners have not been reflected as expenses and the Company incurred no income taxes in its historical results prior to +its transition to a corporate structure. Results prior to May 31, 2002, do not reflect the financial position and results of operations that would have been reported had the Company operated as a corporation for all the periods presented. + + + +F-38 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +Income +Taxes + +On May 31, 2002, the Company became subject to +federal and state income taxes and began to apply the asset and liability method described in Statement of Financial Accounting Standards ( SFAS ) No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are +recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax +assets and liabilities are measured using 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. Prior to May 31, 2002, the Company was not subject to income taxes because it operated as a limited liability company. Taxes on income earned prior to May 31, 2002, +were the responsibility of Hewitt Holdings owners. + +Earnings Per +Share + +On May 31, 2002, the Company completed its +transition to a corporate structure and began to report earnings per share in accordance with SFAS No. 128, Earnings Per Share. Prior to May 31, 2002, Hewitt was comprised of limited liability companies and did not have outstanding common +stock from which to calculate earnings per share, nor did the Company s earnings include owner compensation or income taxes. As such, the Company s historical income before taxes and owner distributions is not comparable to net income of a +corporation. Therefore, historical earnings per share have not been presented for periods prior to May 31, 2002, and the consolidated and combined +financial statements do not reflect the financial position and results of operations that would have been reported had the Company operated as a corporation for those periods. + +Use of Estimates + +The preparation of financial statements and related disclosures in conformity with accounting principles generally +accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated and combined financial statements and accompanying notes. Estimates are used for, but not limited to, +the accounting for contract and project loss reserves, performance-based compensation, the allowance for doubtful accounts, depreciation and amortization, impairment, taxes, and any contingencies. Although these estimates are based on +management s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates. + +Stock-Based Compensation + +The Company applies the intrinsic value method for accounting for stock-based compensation as outlined in Accounting Principles Board +( APB ) Opinion No. 25, Accounting for Stock Issued to Employees and provides the pro forma disclosures required by SFAS No. 123, Accounting for Stock-Based Compensation as amended by SFAS No. 148, Accounting for +Stock-Based Compensation Transition and Disclosure. + +Restricted stock awards, including restricted stock and restricted stock units, are measured using the fair market value of the stock as of the grant date and are recorded as unearned compensation on the balance sheet. As the +restricted stock awards vest, the unearned compensation is amortized to + + + +F-39 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +compensation expense on a straight-line basis. Employer payroll taxes are also recorded as expense when they become due over the vesting period. The +shares are subject to forfeiture and restrictions on sale or transfer for six months to four years from the grant date. For purposes of calculating basic and diluted earnings per share, vested restricted stock awards and exercised stock options are +considered outstanding. Restricted stock awards vest on a cliff schedule so that restricted stock awards are not considered outstanding until the stated vesting date for earnings per share calculations. Under the treasury stock method, unvested +restricted stock awards and unexercised stock options with fair market values of the underlying stock greater than the stock options exercise prices are considered common stock equivalents for the purposes of calculating diluted earnings per +share for periods when there are positive earnings and the incremental effect would be dilutive. + +The Company also grants nonqualified stock options at an exercise price equal to the fair market value of the Company s stock on the grant date. Since the stock options have no intrinsic value on the grant +date, no compensation expense is recorded in connection with the stock option grants. Generally, stock options vest 25 percent on each anniversary of the grant date, are fully vested four years from the grant date and have a term of ten years. + + +For purposes of pro forma disclosures, the estimated fair +value of the stock options is amortized to compensation expense over the stock options vesting period. The Company s pro forma net income and earnings per share would have been as follows: + + + + + Three Months + Ended March 31, 2003 + + + + Six Months + Ended March 31, 2003 + + + + Net income: + + + + + + + + + + + As reported + + + $ + + 23,507 + + + + + $ + + 38,266 + + + + Stock option compensation expense, net of tax + + + + + (1,079 + + ) + + + + + (2,122 + + ) + + + + + + + Adjusted net income + + + $ + + 22,428 + + + + + $ + + 36,144 + + + + + + + + + Net income per share as reported basic: + + + + + + + + + + + As reported + + + $ + + 0.25 + + + + + $ + + 0.41 + + + + Adjusted net income per share + + + $ + + 0.24 + + + + + $ + + 0.38 + + + + Net income per share as reported diluted: + + + + + + + + + + + As reported + + + $ + + 0.24 + + + + + $ + + 0.40 + + + + Adjusted net income per share + + + $ + + 0.23 + + + + + $ + + 0.37 + + + + +New Accounting Pronouncements + + +In November 2002, the FASB s Emerging Issues +Task Force reached a consensus on EITF No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. EITF No. 00-21 addresses the accounting treatment for arrangements that provide the delivery or performance of multiple +products or services where the delivery of a product, system or performance of services may occur at different points in time or over different periods of time. EITF No. 00-21 requires the separation of the multiple deliverables that meet certain +requirements into individual units of accounting that are accounted for separately under the appropriate authoritative accounting literature. EITF No. 00-21 is applicable to revenue arrangements entered into in fiscal periods beginning after +June 15, 2003. The Company is currently evaluating the requirements and impact of this issue on its consolidated results of operations and financial position. + + +F-40 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +In January 2003, the FASB issued FASB Interpretation No. 46 ( FIN No. 46 ), Consolidation of Variable Interest Entities, to expand upon and strengthen existing accounting guidance that addresses when a company should +include in its financial statements the assets, liabilities and activities of another entity. Until now, a company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting +interests. FIN No. 46 changes that by requiring a variable interest entity, as defined, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity s activities or entitled to +receive a majority of the entity s residual returns or both. The Company does not expect the adoption of FIN No. 46 to have a material impact on its consolidated financial statements. + +3. Transition to a Corporate Structure + +On May 31, 2002, the Company completed its transition to a corporate structure in connection with its planned initial +public offering. + +Prior to the transition to a corporate +structure, the Company consisted of single-member limited liability companies, which were wholly owned by Hewitt Holdings. As such, owners capital represented the ownership interests of Hewitt Holdings in the Company. Historically, +distributions to and contributions from Hewitt Holdings were based on the capital requirements of the Company and of Hewitt Holdings, and were subject to the discretion of the owners of Hewitt Holdings. + +On March 1, 2002, Hewitt Associates, Inc., a Delaware corporation, was +formed as a subsidiary of Hewitt Holdings. Three classes of common stock were authorized. The holders of Class A, Class B, and Class C common stock have one vote per share. All shares of Class B and Class C common stock are voted in accordance with +a majority of the votes cast by the holders of Class B and Class C common stock as a group. + +On May 31, 2002, Hewitt Holdings transferred all of its ownership interests in Hewitt Associates LLC and Affiliates to Hewitt Associates, Inc., thereby making Hewitt Associates LLC and Affiliates a wholly-owned +subsidiary of the Company. The capital in the business was converted and Hewitt Holdings received 70,819,520 shares of the Company s Class B common stock. + +4. Initial Public Offering + +On June 27, 2002, the Company sold 11,150,000 shares of Class A common stock at $19.00 per share in its initial public offering. The Company s +gross proceeds from the offering were $211,850, before the underwriting discount of $14,829 and offering expenses of $8,072. In July 2002, the underwriters exercised their over-allotment option to purchase an additional 1,672,500 shares of the +Company s Class A common stock at $19.00 per share. The option exercise generated gross proceeds of $31,778 before the underwriting discount of $2,225. + +Of the $218,502 in net proceeds received in July 2002, $52,000 was used to repay the outstanding balance on the Company s lines of credit, +$8,341 was used to pay income taxes resulting from the Company s transition to a corporate structure, and the balance was used for general corporate purposes and working capital. + +In connection with the initial public offering, the Company granted to employees restricted stock, restricted stock +units, and nonqualified stock options on common stock. (See Note 11, Stock-Based Compensation Plan, for additional information). + + +F-41 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +5. Earnings Per Share + +In accordance with SFAS No. 128, Earnings Per Share, basic earnings per share is calculated by dividing net income by the weighted-average number of shares of common stock outstanding. Diluted earnings per share includes the +components of basic earnings per share and also gives effect to dilutive potential common stock equivalents. + +The following table presents computations of basic and diluted earnings per share in accordance with accounting principles generally accepted in the +United States of America for the three and six months ended March 31, 2003. + + + + + Three Months + Ended March 31, 2003 + + + Six Months Ended March 31, 2003 + + Net income as reported + + + $ + + 23,507 + + + $ + + 38,266 + + + + + + + Weighted-average number of common stock for basic + + + + + 95,127,936 + + + + + 94,096,400 + + Incremental effect of dilutive common stock equivalents: + + + + + + + + + Unvested restricted stock awards + + + + + 1,124,709 + + + + + 1,827,082 + + Unexercised in-the-money stock options + + + + + 816,880 + + + + + 881,407 + + + + + + + Weighted-average number of common stock for diluted + + + + + 97,069,525 + + + + + 96,804,889 + + + + + + + Earnings per share basic + + + $ + + 0.25 + + + $ + + 0.41 + + + + + + + Earnings per share diluted + + + $ + + 0.24 + + + $ + + 0.40 + + + + + + + +6. Other +Comprehensive Income + +The following table presents the +pre-tax, tax and after-tax components of the Company s other comprehensive income for the periods presented: + + + + + Three Months Ended + March 31, + + + Six Months Ended + March 31, + + + + 2003 + + + + 2002 + + + 2003 + + + 2002 + + Income before owner distributions and taxes + + + + + + + $ + + 71,835 + + + + + + $ + + 153,494 + + Net Income + + + $ + + 23,507 + + + + + + + + $ + + 38,266 + + + + + + Other comprehensive income (loss): + + + + + + + + + + + + + + + + Foreign currency translation adjustments + + + + + (2,882 + + ) + + + + + 27 + + + + + 3,364 + + + + + 47 + + + + + + + + + + + Total comprehensive income + + + $ + + 20,625 + + + + + $ + + 71,862 + + + $ + + 41,630 + + + $ + + 153,541 + + + + + + + + + + + +The change in the +foreign currency translation during the three months ended March 31, 2003, as compared to the six months ended March 31, 2003, was primarily due to a decrease in the value of the U.S. Dollar relative to the British Pound Sterling. + +7. Acquisition of Bacon & Woodrow + +On June 5, 2002, the Company acquired the actuarial and benefits +consulting business of Bacon & Woodrow ( Bacon & Woodrow ) in the United Kingdom. The purchase price totaled $259,009, and + + + +F-42 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +was comprised of $219,240 of common stock, $38,882 in assumed net liabilities, and $887 of acquisition-related costs. Bacon & Woodrow s +results of operations are included within the Company s historical results from the acquisition date of June 5, 2002. + +Pursuant to the purchase agreement, the former partners and employees of Bacon & Woodrow initially received an aggregate of 1,400,000 shares of +the Company s Series A mandatorily redeemable preferred stock which was redeemable for shares of the Company s common stock. Effective August 2, 2002, the Bacon & Woodrow former partners and employees elected to exchange their shares +of Series A preferred stock for common stock. Of the 9,417,526 shares of common stock issued, the former partners of Bacon & Woodrow received 2,906,904 shares of Class B common stock and 5,568,869 shares of Class C common stock, and a trust for +the benefit of the non-partner employees of Bacon & Woodrow received 941,753 shares of Class A common stock. + +The preliminary allocation of the $259,009 purchase price to acquired net assets resulted in the allocation of $178,124 to goodwill, $65,874 to +identifiable intangible assets (primarily customer relationships) with indefinite lives, $15,011 to identifiable intangible assets with estimated five-year lives, $61,521 to identifiable assets (which includes $40,445 of client receivables and +unbilled work in process), and $100,403 to assumed liabilities (which includes $22,687 of accounts payable and accrued expenses and $36,071 of short term borrowings). The actual allocation of the purchase price will depend upon the final evaluation +of the fair value of the assets and liabilities of the benefits consulting business of Bacon & Woodrow. Consequently, the ultimate allocation of the purchase price could differ from that presented above. + +Assuming the acquisition of the actuarial and benefits consulting +business of Bacon & Woodrow occurred on October 1, 2001, pro forma net revenues for the three and six months ended March 31, 2002 would have been approximately $443,000 and $880,000, respectively, and pro forma income before taxes and owner +distributions would have been approximately $36,000 and $80,000, respectively. These pro forma results, which are unaudited, give effect to the Company s incorporation and initial public offering on the dates such events actually occurred, on +May 31, 2002 and June 27, 2002, respectively. Because the Company was a limited liability company for the first eight months of fiscal 2002, the pro forma effect of the acquisition on earnings per share is not meaningful. The pro forma results +are not necessarily indicative of what would have occurred if the acquisition had been consummated on October 1, 2001, nor are they necessarily indicative of future consolidated operating results. + +8. Related Party Transactions + +The Company has entered into real estate transactions with Hewitt +Holdings and its subsidiaries. Except for two capital leases recorded in fiscal 2002, totaling $86,958 at March 31, 2003, the remaining office space leases are operating leases. The investments in the properties owned by these related parties were +funded through capital contributions by Hewitt Holdings and third-party debt. This debt is not reflected on the Company s balance sheet as the obligation represented by the debt is an obligation of these related parties, and is not an +obligation of, nor guaranteed by, the Company. + +The +combined and consolidated statements of operations include expenses that have been allocated to the Company by Hewitt Holdings on a specific identification basis for the period prior to + + + +F-43 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +incorporation only. Management believes these allocations and charges are reasonable and that such expenses would not have differed materially had the +Company operated on a stand-alone basis. + +9. Client Receivables and Unbilled Work in Process + +Client receivables and unbilled work in process, net of allowances, for work performed through March 31, 2003 and September 30, 2002, consisted +of the following: + + + + + March 31, 2003 + + + September 30, 2002 + + Client receivables + + + $ + + 233,525 + + + $ + + 219,126 + + Unbilled work in process + + + + + 179,027 + + + + + 175,058 + + + + + + + + + $ + + 412,552 + + + $ + + 394,184 + + + + + + + +10. Legal Proceedings + +The Company is occasionally subject to lawsuits and claims arising in the normal conduct of business. Management does not expect the outcome of any pending claim to have a material adverse affect on the business, financial condition +or results of operations of the Company. + +11. Stock-Based Compensation Plan + +In 2002, the Company adopted the Hewitt Associates, Inc. Global Stock and Incentive Compensation Plan (the Plan ) for employees and directors. The Plan is administered by the Compensation and Leadership Committee +of the Board of Directors of the Company (the Committee ). Under the Plan, employees and directors may receive awards of nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, +performance units, and cash-based awards, and employees can also receive incentive stock options. As of March 31, 2003, only restricted stock and restricted stock units and nonqualified stock options have been granted. A total of 25,000,000 +shares of Class A common stock has been reserved for issuance under the Plan. As of March 31, 2003, there were 15,228,884 shares available for grant under the Plan. + +Restricted Stock and Restricted Stock Units + +In connection with the initial public offering, the Company granted 5,789,908 shares of Class A restricted stock and +restricted stock units at $19.03 per weighted share to employees. The restricted stock and restricted stock units have substantially the same terms, except the holders of restricted stock units do not have voting rights. + +During the three and six months ended March 31, 2003, $4,659 and +$29,544, respectively, of compensation and payroll tax expense was recorded for the initial public offering-related awards. Also, on December 31, 2002, 1,967,843 shares of restricted stock vested and 91,458 of restricted stock units vested and were +converted to Class A common stock. + +As of March 31, 2003, +the remaining $55,338 of unearned compensation within stockholders equity is related to the unvested initial public offering stock awards and will be amortized as the awards vest through June 27, 2006 adjusted for payroll taxes and +forfeitures. + + +F-44 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +Stock +Options + +The Committee may grant both incentive stock +options and nonqualified stock options to purchase shares of Class A common stock. Subject to the terms and provisions of the Plan, options may be granted to participants in such number, and upon such terms, as determined by the Committee, provided +that incentive stock options may not be granted to non-employee directors. The option price is determined by the Committee, provided that for options issued to participants in the United States, the option price may not be less than 100% of the fair +market value of the shares on the date the option is granted and no option may be exercisable later than the tenth anniversary of its grant. The nonqualified stock options granted in conjunction with the Company s initial public offering vest +over a period of four years. + +The following table +summarizes stock option activity during the six months ended March 31, 2003: + + + + + Shares + + + + Weighted-Average Exercise Price + + Outstanding at September 30, 2002 + + + 4,089,003 + + + + + $ + + 19.29 + + Granted + + + 48,987 + + + + + + + 32.39 + + Exercised + + + (13,255 + + ) + + + + + 19.00 + + Forfeited + + + (20,750 + + ) + + + + + 19.30 + + + + + + + + + Outstanding at March 31, 2003 + + + 4,103,985 + + + + + $ + + 19.45 + + + + + + + + + +The following +table summarizes information about stock options outstanding at March 31, 2003. + + + + + Outstanding Options + + + Options Exercisable + + + + Number + Outstanding + + + Weighted-Average Exercise Price + + + Weighted- + Average + Term (Years) + + + Number + Vested + + + Weighted-Average Exercise Price + + Range of exercise prices: + + + + + + + + + + + + + + + $19.00 + + + 3,811,108 + + + $ + + 19.00 + + + 9.1 + + + 92,700 + + + $ + + 19.00 + + $23.50-$28.00 + + + 244,390 + + + + + 23.88 + + + 9.2 + + + 2,945 + + + + + 23.50 + + $32.45 + + + 48,487 + + + + + 32.45 + + + 9.7 + + + + + + + + + + + + + + + + + + + + + + + + + + 4,103,985 + + + $ + + 19.45 + + + 9.1 + + + 95,645 + + + $ + + 19.14 + + + + + + + + + + + + + + + + +The +weighted-average estimated fair market value of employee stock options granted during the six months ended March 31, 2003, was $10.74 per share. These stock options were granted at exercise prices equal to the then current fair market value of the +underlying stock. + + +12. Goodwill and Intangible Assets + +In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized but +instead tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values. The Company fully adopted the +provisions of SFAS No. 142 effective October 1, 2002. + + +F-45 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +Under SFAS No. 142, the Company is required to perform transitional impairment tests for its goodwill and certain intangible assets as of the date of adoption. During the three months ended December 31, 2002, no impairments were +recognized as a result of the intangible asset transitional impairment testing that was performed. The transitional impairment test for goodwill was completed during the three months ended March 31, 2003, and compared the fair values of the +Company s reporting units to their respective carrying values. No impairment was recognized as a result of the goodwill transitional impairment testing. + +The following is a summary of income before taxes and owner distributions for the three and six months ended March 31, 2002, as adjusted to +remove the amortization of goodwill: + + + + + Three Months + Ended March 31, 2002 + + + Six Months + Ended March 31, 2002 + + Income before taxes and owner distributions: + + + + + + + + + As reported + + + $ + + 71,835 + + + $ + + 153,494 + + Goodwill amortization + + + + + 218 + + + + + 416 + + + + + + + Adjusted income before taxes and owner distributions + + + $ + + 72,053 + + + $ + + 153,910 + + + + + + + +The following is a +summary of changes in the carrying amount of goodwill by segment for the six months ended March 31, 2003: + + + + + Outsourcing Segment + + + Consulting Segment + + + Total + + Balance at September 30, 2002 + + + $ + + + + + $ + + 201,286 + + + $ + + 201,286 + + Additions + + + + + + + + + + 13,560 + + + + + 13,560 + + Changes in foreign exchange rates + + + + + + + + + + 2,554 + + + + + 2,554 + + + + + + + + + Balance at March 31, 2003 + + + $ + + + + + $ + + 217,400 + + + $ + + 217,400 + + + + + + + + + +Goodwill additions +during the six months ended March 31, 2003, resulted from an acquisition of the remaining interest in a joint venture investment in The Netherlands and an adjustment to the purchase price allocation related to another acquisition in Switzerland. + + +Intangible assets with definite useful lives are amortized +over their respective estimated useful lives. Effective October 1, 2002, intangible assets with indefinite useful lives are not amortized but instead tested for impairment at least annually. + + +F-46 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +The following is a summary of intangible assets at March 31, 2003 and September 30, 2002: + + + + + March 31, 2003 + + + September 30, 2002 + + + + Gross Carrying Amount + + + Accumulated Amortization + + + Total + + + Gross Carrying Amount + + + Accumulated Amortization + + + Total + + Definite useful lives + + + + + + + + + + + + + + + + + + + + + Capitalized software + + + $ + + 194,898 + + + $ + + 107,777 + + + $ + + 87,121 + + + $ + + 183,030 + + + $ + + 93,945 + + + $ + + 89,085 + + Trademarks + + + + + 10,272 + + + + + 1,712 + + + + + 8,560 + + + + + 10,196 + + + + + 680 + + + + + 9,516 + + + + + + + + + + + + + + + Total + + + $ + + 205,170 + + + $ + + 109,489 + + + $ + + 95,681 + + + $ + + 193,226 + + + $ + + 94,625 + + + $ + + 98,601 + + + + + + + + + + + + + + + + + + Indefinite useful life + + + + + + + + + + + + + + + + + + + + + Contractual customer relationships + + + + + + + + + $ + + 71,890 + + + + + + + + + $ + + 71,286 + + + + + + + + + + + + + + + + + + + Total intangible assets + + + + + + + + + $ + + 167,571 + + + + + + + + + $ + + 169,887 + + + + + + + + + + + + + + + + + + + +Amortization +expense related to capitalized software was $7,911 and $6,366 for the three months ended March 31, 2003 and 2002, respectively, and $14,948 and $12,285, respectively, for the six months ended March 31, 2003 and 2002. Amortization expense +related to trademarks was $498 and $0 for the three months ended March 31, 2003 and 2002, respectively, and $1,007 and $0, respectively, for the six months ended March 31, 2003 and 2002. Estimated amortization expense related to intangible assets +with definite lives at September 30, 2002, for each of the years in the five-year period ending September 30, 2007 and thereafter is as follows: + + + + + 2003 + + + 2004 + + + 2005 + + + 2006 + + + 2007 + + + 2008 and thereafter + + + Total + + Fiscal year ending: + + + + + + + + + + + + + + + + + + + + + + + + Estimated intangibles amortization expense + + + $ + + 29,645 + + + $ + + 26,240 + + + $ + + 19,396 + + + $ + + 14,375 + + + $ + + 8,041 + + + $ + + 904 + + + $ + + 98,601 + + +13. Segment Data + +Under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company has determined that it has two reportable segments based on similarities among the operating units including homogeneity of +services, service delivery methods, and use of technology. The two segments are Outsourcing and Consulting. + + + + + +Outsourcing Hewitt applies benefits and human resources expertise and employs its integrated technology systems to administer its clients human resource programs. +Benefits outsourcing includes the administration of health and welfare (such as medical) plans, defined contribution (such as 401(k)) plans, and defined benefit (such as pension) plans. Hewitt assumes and automates the resource-intensive processes +required to administer its clients benefit programs, and provides on-line tools and information that support decision-making and transactions by its clients and their employees. With the information and tools that Hewitt provides, Hewitt helps +its clients to optimize the return on their investments in their benefit programs. Hewitt has built on its experience in benefits outsourcing and human resource expertise to offer employers the ability to outsource a wide range of human resource +activities using its human resources business process outsourcing ( HR BPO ) solution. + + +F-47 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + + + + + +Consulting Hewitt provides a wide array of consulting and actuarial services covering the design, implementation, communication and operation of health and welfare, +compensation and retirement plans, and broader human resources programs and processes. + +Hewitt operates many of the administrative and support functions of its business through the use of centralized shared service operations to provide +an economical and effective means of supporting the outsourcing and consulting businesses. These shared services include information systems, human resources, general office support and space management, overall corporate management, finance and +legal services. Additionally, Hewitt utilizes a client development group that markets the entire spectrum of its services and devotes resources to maintaining existing client relationships. The compensation and related expenses, other operating +expenses, and selling, general and administrative expenses of the administrative and marketing functions are not allocated to the business segments, rather, they are included in unallocated shared costs. The costs of information systems and human +resources, however, are allocated to the outsourcing and consulting segments on a specific identification basis or based on usage and headcount. + +The table below presents information about the Company s reportable segments for the periods presented: + + + Business Segments + + + Three Months Ended + March 31, + + + Six Months Ended + March 31, + + + + 2003 + + + 2002 + + + 2003 + + + 2002 + + Outsourcing + + + + + + + + + + + + + + + Revenues before reimbursements (net revenues) + + + $ + + 295,919 + + + $ + + 275,081 + + + $ + + 604,092 + + + $ + + 551,104 + + Segment income (1) + + + + + 53,334 + + + + + 63,672 + + + + + 122,047 + + + + + 139,679 + + Consulting (2) + + + + + + + + + + + + + + + Revenues before reimbursements (net revenues) + + + $ + + 182,137 + + + $ + + 133,622 + + + $ + + 354,283 + + + $ + + 261,673 + + Segment income (1) + + + + + 39,977 + + + + + 44,513 + + + + + 66,178 + + + + + 82,692 + + Total Company + + + + + + + + + + + + + + + Revenues before reimbursements (net revenues) + + + $ + + 478,056 + + + $ + + 408,703 + + + $ + + 958,375 + + + $ + + 812,777 + + Reimbursements + + + + + 13,928 + + + + + 6,667 + + + + + 27,534 + + + + + 13,470 + + + + + + + + + + + Total revenues + + + $ + + 491,984 + + + $ + + 415,370 + + + $ + + 985,909 + + + $ + + 826,247 + + + + + + + + + + + Segment income (1) + + + $ + + 93,311 + + + $ + + 108,185 + + + $ + + 188,225 + + + $ + + 222,371 + + Charges not recorded at the Segment level: + + + + + + + + + + + + + + + Initial public offering restricted stock awards (3) + + + + + 4,659 + + + + + + + + + + 29,544 + + + + + + + Unallocated shared costs (1) + + + + + 44,907 + + + + + 31,332 + + + + + 84,890 + + + + + 59,998 + + + + + + + + + + + Operating income (1) + + + $ + + 43,745 + + + $ + + 76,853 + + + $ + + 73,791 + + + $ + + 162,373 + + + + + + + + + + +(1) +Prior to May 31, 2002, owners were compensated through distributions of income. In connection with the Company s transition to a corporate structure on May 31, 2002, +owners who worked in the business became employees and the Company began to record their compensation in compensation and related expenses in arriving at segment income. + + +F-48 + +Table of Contents + +HEWITT ASSOCIATES, INC. + +NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (continued) +MARCH 31, 2003 AND 2002 +(Unaudited) +(Dollars in thousands except for share and per share amounts) + + +(2) +On June 5, 2002, the Company acquired the actuarial and benefits consulting business of Bacon & Woodrow. As such, the results of Bacon & Woodrow have been included in +the Company s Consulting segment results from the acquisition date of June 5, 2002. + +(3) +Compensation expense of $4,659 and $29,544 for the three and six months ended March 31, 2003, respectively, related to the amortization of the initial public offering +restricted stock awards. + +14. Subsequent Events + +The Company has entered into a non-binding letter of intent to purchase a benefits administration and actuarial business. The transaction is expected to close in June 2003. The letter of intent specifies that the Company will pay +cash to purchase selected contract rights and obligations, tangible assets and also assume certain real estate lease obligations. + +The Company has also entered into an agreement to purchase a developer and marketer of human resource management, payroll processing and time and +attendance software products and services. The transaction is subject to regulatory approval, and is expected to close in June 2003. The purchase price will consist of approximately $43 million in cash plus the potential for additional +performance-based consideration of up to $30 million payable through 2006. + + +F-49 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +REPORT AND CONSOLIDATED FINANCIAL STATEMENTS +AS OF AND FOR THE YEAR ENDED SEPTEMBER 30, 2001 + +Smith & Williamson +No 1 Riding House Street +London +W1A 3AS + + +F-50 + +Table of Contents + +INDEPENDENT AUDITOR S REPORT + +To the Partners of Bacon & Woodrow. + +We have audited the accompanying consolidated balance sheet of the benefits consulting business of Bacon & Woodrow +as at September 30, 2001, and the consolidated income statement before partner distributions and the consolidated statement of cash flows and the consolidated statement of partners balances for the year then ended. These financial +statements are the responsibility of the partners of Bacon & Woodrow. Our responsibility is to express an opinion on these financial statements based on our audit. + +We conducted our audit in accordance with auditing standards generally accepted in the United States of America. +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. + +In our +opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the benefits consulting business of Bacon & Woodrow as of September 30, 2001 and the results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. + +/s/ Smith & Williamson + +London, England +16 May 2002 + + +F-51 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +CONSOLIDATED INCOME STATEMENT BEFORE PARTNER DISTRIBUTIONS + +For the year ended September 30, 2001 +(In thousands of U.S. Dollars) + + + REVENUES + + + + + + + Revenues before reimbursements (net revenues) + + + $ + + 122,883 + + + + Reimbursements + + + + + 2,492 + + + + + + + Total Revenues + + + + + 125,375 + + + + OPERATING EXPENSES + + + + + + + Personnel expenses + + + + + 65,670 + + + + Reimbursable expenses + + + + + 2,492 + + + + Selling, general and administrative expenses + + + + + 13,963 + + + + Other operating expenses + + + + + 14,334 + + + + + + + Total Operating Expenses + + + + + 96,459 + + + + + + + OPERATING INCOME + + + + + 28,916 + + + + Other Income (Expense) + + + + + + + Interest income + + + + + 414 + + + + Interest expense + + + + + (51 + + ) + + Other income + + + + + 247 + + + + + + + + + + + 610 + + + + + + + PARTNERSHIP INCOME BEFORE TAXES + + + + + 29,526 + + + + Provision for corporate taxes + + + + + (121 + + ) + + + + + PARTNERSHIP INCOME BEFORE PARTNER DISTRIBUTIONS + + + $ + + 29,405 + + + + + + + + + +The accompanying notes to the Consolidated Financial Statements are an +integral part of these statements. + + +F-52 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +CONSOLIDATED BALANCE SHEET +As of September 30, 2001 +(In thousands of U.S. Dollars) + + + ASSETS + + + + + + CURRENT ASSETS + + + + + + Cash and cash equivalents + + + $ + + 1,531 + + Client receivables, net of reserves of $586 + + + + + 19,260 + + Work in process, net of reserves of $591 + + + + + 21,008 + + Other receivables + + + + + 2,287 + + Prepaid expenses and other assets + + + + + 4,546 + + + + + Total Current Assets + + + + + 48,632 + + + + + NON-CURRENT ASSETS + + + + + + Property and equipment, net + + + + + 9,823 + + Investments + + + + + 103 + + + + + Total Non-Current Assets + + + + + 9,926 + + + + + TOTAL ASSETS + + + $ + + 58,558 + + + + + LIABILITIES + + + + + + CURRENT LIABILITIES + + + + + + Accounts payable + + + $ + + 1,555 + + Accrued expenses + + + + + 11,702 + + Corporate taxes payable + + + + + 181 + + Annuities payable within one year + + + + + 1,546 + + Provision for onerous property leases + + + + + 207 + + + + + Total Current Liabilities + + + + + 15,191 + + + + + NON-CURRENT LIABILITIES + + + + + + Annuities payable + + + + + 35,557 + + Deferred corporate taxes + + + + + 13 + + Provision for onerous property leases + + + + + 1,177 + + + + + Total Non-Current Liabilities + + + + + 36,747 + + + + + CAPITAL + + + + + + Partners balances + + + + + 6,620 + + + + + TOTAL LIABILITIES AND CAPITAL + + + $ + + 58,558 + + + + + + +The accompanying notes to the Consolidated Financial Statements are an integral part of these statements. + + +F-53 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +CONSOLIDATED STATEMENT OF CASH FLOWS +For the year ended September 30, 2001 +(In thousands of U.S. Dollars) + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + Partnership income before partner distributions + + + $ + + 29,405 + + + + Demerger adjustment + + + + + 2,477 + + + + + + + Partnership income before distributions net of demerger adjustment + + + + + 31,882 + + + + + + + + + Adjustments to reconcile partnership income before distributions net of demerger adjustment to net +cash provided by operating activities: + + + + + + + Depreciation and amortisation + + + + + 4,013 + + + + Increase in net client receivables + + + + + (3,646 + + ) + + Increase in work in process + + + + + (3,018 + + ) + + Increase in other receivables, prepaid expenses and other assets + + + + + (1,665 + + ) + + Decrease in annuities payable + + + + + (1,052 + + ) + + Decrease in accounts payable + + + + + (46 + + ) + + Increase in accrued expenses + + + + + 2,839 + + + + Decrease in taxes payable + + + + + (50 + + ) + + + + + Total Adjustments + + + + + (2,625 + + ) + + + + + Net cash provided by operating activities + + + + + 29,257 + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + Proceeds from sales of property and equipment + + + + + 61 + + + + Additions to investments + + + + + (17 + + ) + + Additions to property and equipment + + + + + (4,442 + + ) + + + + + Net cash used in investing activities + + + + + (4,398 + + ) + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + Transfer of Insurance business assets + + + + + 6,791 + + + + Amounts paid to and on behalf of Partners + + + + + (32,089 + + ) + + + + + Net cash used in financing activities + + + + + (25,298 + + ) + + + + + Effect of exchange rate changes on cash + + + + + 169 + + + + + + + NET DECREASE IN CASH AND CASH EQUIVALENTS + + + $ + + (270 + + ) + + CASH AND CASH EQUIVALENTS, beginning of year + + + $ + + 1,801 + + + + + + + CASH AND CASH EQUIVALENTS, end of year + + + $ + + 1,531 + + + + + + + +The accompanying notes to the +Consolidated Financial Statements are an integral part of these statements. + + +F-54 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +CONSOLIDATED STATEMENT OF PARTNERS BALANCES +For the year ended September 30, 2001 + +(In thousands of U.S. Dollars) + + + Partners balances at October 1, 2000 + + + $ + + (84 + + ) + + Partnership income + + + + + 29,405 + + + + Transfer of Insurance business assets + + + + + 6,791 + + + + Demerger adjustment + + + + + 2,477 + + + + + + + + + + + 38,589 + + + + Distributions to Partners + + + + + (23,410 + + ) + + Taxes paid on behalf of Partners + + + + + (8,679 + + ) + + Effect of exchange rates + + + + + 120 + + + + + + + Partners balances at September 30, 2001 + + + $ + + 6,620 + + + + + + + + + +The accompanying notes to the Consolidated Financial Statements are an integral part of +these statements. + + +F-55 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +For the year ended September 30, 2001 +(in thousands of U.S. Dollars) + +1. BASIS OF PREPARATION AND PRINCIPLES OF CONSOLIDATION + +Basis of preparation + +The normal accounting year of Bacon & Woodrow is April 30. These accounts for the Benefits Consulting business of Bacon & Woodrow have been prepared by combining the carved out results for the seven month period from October +1, 2000 to April 30, 2001 with the actual results for the five month period to September 30, 2001, after making the adjustments referred to below. These accounts therefore represent the fiscal year ended September 30, 2001. + + + +1. +Under the terms of a Demerger and Business Transfer Agreement dated December 20, 2000 the Insurance business carried on by certain Partners of Bacon & Woodrow was +effectively transferred to Deloitte & Touche at May 1, 2001. Certain assets and liabilities were transferred to Deloitte & Touche at that date and a number of Partners and staff became Partners or employees of Deloitte & Touche. + + +The effects of the demerger +have been removed from these financial statements using the methodology prescribed in the Securities and Exchange Commission s Staff Accounting Bulletin Topic 1B. The principle assumptions used are as follows: + + + +i) +All of the income and direct expenses associated with the Insurance business for the period from October 1, 2000 to April 30, 2001, including the results of the firm s +subsidiary companies transferred to Deloitte & Touche, have been removed from the income statement. + + + +ii) +All central overheads of the firm for that period have been allocated to the continuing business or to the Insurance business using, in management s opinion, reasonable +methods. Costs have been allocated based on specific identification wherever possible and remaining unassigned costs have been allocated based on the most relevant cost driver for the category of expense (for example, headcount, usage, volume of +transactions). The costs that have been attributed to the Insurance business have been excluded from the income statement. + + + +iii) +The income statement recognises 100% of the income or expenditure stream that relates to any asset that remained with Bacon & Woodrow after the demerger had been +completed. + + + +2. +At September 30, 2001, Bacon & Woodrow held 25% of the issued share capital of Combined Actuarial Performance Services Limited. This holding was disposed of in December +2001 and, accordingly, the investment and any related income has been excluded from these financial statements. + + + +3. +The current Partnership Deed entitles certain current partners to an annuity following their retirement. A liability of $15,068 has been recognized in these financial +statements for annuities payable to current partners, although these obligations will cease to exist as a result of some restructuring to be undertaken in advance of the transaction with Hewitt Associates. + +Principles of consolidation + +The consolidated financial statements include the accounts of the +Benefits Consulting business of Bacon & Woodrow, a partnership of consulting actuaries whose principal place of business is in London, England, and its controlled subsidiary companies. Pursuant to SFAS No. 94, Consolidation of All +Majority-Owned Subsidiaries, control is exercised through board representation and long-term majority interest in the subsidiaries stock. + + +F-56 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the year ended September 30, 2001 +(in thousands of U.S. Dollars) + + +Bacon & Woodrow s share of earnings or losses of associates, in which at least 20% and not more than 50% of the voting securities is owned, +is included in the consolidating operating results using the equity method of accounting. All other investments are accounted for under the cost method and all significant interfirm transactions and profits have been eliminated. + +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES + + +Revenue recognition + +Revenues are recognised under time-and-material arrangements as +services are provided. Revenue represents the net of: + + + +(i) +Net revenues, being invoices raised for services, net of U.K. value added tax; and + + + +(ii) +Reimbursements, being invoices raised for disbursements, net of U.K. value added tax. + +Translation of non-U.S. currency amounts + +The net assets and operations of entities outside the United States are translated into U.S. dollars using appropriate +rates. Assets and liabilities are translated at year-end exchange rates and income and expense items are translated at average exchange rates. + +Annuities + +Under the terms of the Bacon & Woodrow Partnership Deed, certain Partners admitted to the partnership prior to May 2, 1996 are entitled to +receive cash annuities after their retirement from the partnership. These entitlements ceased to accrue on May 1, 1997. The accrued entitlements at that date are subject to adjustment in deferment and payment in line with the pension increases +awarded by the Bacon & Woodrow Staff Pension Fund. The partnership s liability for these payments is unfunded. + +The full liability for annuity payments to retired partners (net of contributions receivable from former partners) and current partners, discounted +using the firm s cost of borrowing is included as a liability on the balance sheet. Amounts expected to be payable within 12 months of the balance sheet date are included in current liabilities. The balance of the estimated liability is +included as a non-current liability. + +The resultant annual +charge to the income statement is included in personnel expenses. + +Property and equipment + +Depreciation on property and equipment has been calculated so as to write down assets on a straight-line basis over their expected useful lives, which are considered to be: + + + Leasehold improvements + + + Over the lesser of the useful life or term of the lease + + Computer equipment + + + 3 years + + Furniture, fixtures, fittings and other equipment + + + 3 5 years + + +Computer software +development expenditures have been accounted for in accordance with SOP 98-1, Accounting for Costs of Computer Software Developed or Obtained for Internal Use. + + +F-57 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the year ended September 30, 2001 +(in thousands of U.S. Dollars) + + +Investments + +Investments in which Bacon & Woodrow has the ability to exercise significant influence are accounted for under the equity method. + +Work in process + +Work in process is shown at its estimated net realisable value. Unbilled disbursements have also been included at their +estimated net realisable value. + +Use of estimates + +Preparation of financial statements in conformity with generally +accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the +reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Estimates are used when accounting for revenue, allowances for uncollectable receivables, investments in affiliates, depreciation +and amortisation, employee benefits plans and taxes. + +Provision for +taxation + +The provision for tax shown in the financial +statements represents the corporate taxes payable by certain subsidiary companies. No provision has been made in these financial statements for the personal income taxes payable by the partners of Bacon & Woodrow. + +Recently issued accounting standards + +The management of Bacon & Woodrow does not believe that any +recently issued, but not yet effective, accounting standards if currently adopted would have a material effect on these financial statements. + +Concentrations of credit risk + +Financial instruments that subject the partnership and its subsidiaries to credit risk consist primarily of accounts receivable and unbilled +revenues. Concentrations of credit risk are limited due to the large number of clients of the partnership and their dispersion across many different industries. Provision is made against client receivables and work in process when management becomes +aware that an amount is likely to be irrecoverable. + +Cash and cash +equivalents + +Cash and cash equivalents consist +principally of amounts held on deposit at one bank. + +Lines of credit + + +The partnership has an unused line of credit of $11 +million at September 30, 2001. + + +F-58 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the year ended September 30, 2001 +(in thousands of U.S. Dollars) + + +Long-lived assets + +The partnership and its subsidiaries identify and record impairment on long-lived assets when events and circumstances indicate that such assets +have been impaired. The recoverability of long-lived assets is evaluated periodically and impairment, if any, is recognised on the basis of expected discounted cash flows. + +3. PROVISION FOR ONEROUS PROPERTY LEASES + + + Provision at September 30, 2001 + + + $ + + 1,384 + + + + + +Bacon & +Woodrow has long term lease commitments on a number of properties that are surplus to current operating requirements. Each of the buildings has been, or is available to be, sub-let to a third party. A provision of $1,384, representing the +partnership s estimated undiscounted liability, net of estimated rental income, has been recognised for future onerous property lease costs that are expected to be incurred between 2001 and 2016. + +4. PREPAID EXPENSES AND OTHER ASSETS + + + Prepaid rent and service charges + + + $ + + 1,432 + + Prepaid rates + + + + + 619 + + Prepaid professional indemnity insurance + + + + + 1,118 + + Other assets + + + + + 1,377 + + + + + + + $ + + 4,546 + + + + + +5. ACCRUED EXPENSES + + + Value Added Tax + + + $ + + 1,364 + + Payroll taxes + + + + + 3,088 + + Accrued compensation + + + + + 3,840 + + Other accrued expenses + + + + + 3,410 + + + + + + + $ + + 11,702 + + + + + +6. TAXES + + +Taxes relating to the income of the partnership are +the responsibility of the individual partners and accordingly no provision is made in these financial statements for that liability. + +Certain U.K. corporate taxes are payable by group companies as follows; + + + Provision at October 1, 2000 + + + $ + + 231 + + + + Corporate taxes paid in the year + + + + + (171 + + ) + + Corporate taxes accrued on the results for the year + + + + + 121 + + + + + + + Provision at September 30, 2001 + + + $ + + 181 + + + + + + + +Deferred corporate +taxes in certain group companies reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured + + + +F-59 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the year ended September 30, 2001 +(in thousands of U.S. Dollars) + + +using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. The group s deferred tax liabilities +are as follows; + + + Deferred tax liabilities + + + + + + Property and equipment + + + $ + + 13 + + + + + Total Deferred Tax Liabilities at September 30, 2001 + + + $ + + 13 + + + + + +7. PARTNERS BALANCES + +Partners balances at September 30, 2001 represent undistributed earnings and the income tax thereon. Amounts are expected to be paid out to current partners, and to the relevant tax authorities on behalf of current partners, in +one or more installments on or prior to April 30, 2002. The Demerger Adjustment included in the Consolidated Statements of Partners Balances and Cash Flows represents the difference between the cash impact and the accounting effect of the +transfer of the Insurance business as described in Note 1. + +8. PROPERTY AND EQUIPMENT + + + + + Leasehold improvements + + + + Furniture, fixtures and fittings + + + + Computer equipment + + + + Other equipment + + + + +Total + + + + Cost at September 30, 2001 + + + $ + + 4,208 + + + + + $ + + 5,719 + + + + + $ + + 17,345 + + + + + $ + + 1,852 + + + + + $ + + 29,124 + + + + Depreciation at September 30, 2001 + + + + + (1,983 + + ) + + + + + (3,201 + + ) + + + + + (12,722 + + ) + + + + + (1,395 + + ) + + + + + (19,301 + + ) + + + + + + + + + + + + + Net Book Value at September 30, 2001 + + + $ + + 2,225 + + + + + $ + + 2,518 + + + + + $ + + 4,623 + + + + + $ + + 457 + + + + + $ + + 9,823 + + + + + + + + + + + + + + + +9. INVESTMENTS + +The partnership of Bacon & Woodrow owns 100% of the share capital of Bacon & Woodrow Limited, Bacon & Woodrow Properties Company and a dormant company, 55 East Street Limited. + + +F-60 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the year ended September 30, 2001 +(in thousands of U.S. Dollars) + + +The Bacon & Woodrow Limited group includes the following subsidiary and affiliated companies: + + + Company + + + Activity + + + Proportion of ordinary shares held % + + Bacon & Woodrow Consulting Ltd + + + Computer Software and Consultancy Services + + + 100 + + Bacon & Woodrow Investment Services Ltd + + + Consultancy Services + + + 100 + + Bacon & Woodrow Partnerships Ltd + + + Holding Company + + + 100 + + Bacon & Woodrow Service Company Ltd + + + Provision of staff to Bacon & Woodrow + + + 100 + + Cockman, Consultants & Partners Ltd + + + Holder of property lease + + + 100 + + Pensions Central Library Ltd + + + Provision of occupational pension scheme information + + + 100 + + PFA Systems Ltd + + + Computer Software and Consultancy Services + + + 100 + + Triskel Communications Ltd + + + Communication Services + + + 100 + + Bacon Woodrow & Legris Ltd + + + Actuarial Services + + + 33 + + Bacon & Woodrow Investment Consulting Limited + + + Investment Services + + + 100 + + Executive Remuneration Review Ltd + + + Remuneration Consultancy Services + + + 50 + + Kerr Henderson Bacon & Woodrow Ltd + + + Actuarial Services + + + 50 + + Bacon & Woodrow Associates Ltd + + + Dormant + + + 100 + + Bacon & Woodrow Financial Services Ltd + + + Dormant + + + 100 + + Bacon & Woodrow Insurance Consulting Ltd + + + Dormant + + + 100 + + Bacon & Woodrow Pension Administration Services Ltd + + + Dormant + + + 100 + + Bacon & Woodrow Trustees Ltd + + + Dormant + + + 100 + + PFA Administration Services Ltd + + + Dormant + + + 100 + + +In addition, Bacon +& Woodrow Partnerships Limited is a corporate partner in Bacon & Woodrow Guernsey Practice (15%) and in Delany, Bacon & Woodrow (30%) and accounts for the relevant shares of profit based on the equity method of accounting. + + +On May 1, 2001, as part of the transfer of the Insurance +business Bacon & Woodrow disposed of its interest in Bacon & Woodrow SARL and Bacon & Woodrow Ltd disposed of its interests in Bacon & Woodrow London Market Services Ltd, Bacon & Woodrow BV, Bacon & Woodrow GmbH and Bacon +& Woodrow SARL. The effects of these transactions have been excluded from these financial statements. + +10. LEASE COMMITMENTS + +The Bacon & Woodrow group has various non-cancellable operating lease agreements for office space, with various renewal options and terms that extend to 2023. One lease for a building that is still under +construction has not yet commenced and accordingly the lease start date has been estimated in the schedule below. Rental expense (net of sublease income of $270) was $5,052 in fiscal 2001. Future minimum rental commitments under these leases (in +thousands of U.S. Dollars) as of September 30, 2001 are as follows; + + + Year to September 30, 2002 + + + $ + + 5,217 + + 2003 + + + + + 5,276 + + 2004 + + + + + 6,115 + + 2005 + + + + + 8,615 + + 2006 + + + + + 8,496 + + Thereafter + + + + + 90,153 + + + + + Total + + + $ + + 123,872 + + + + + + +F-61 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the year ended September 30, 2001 +(in thousands of U.S. Dollars) + + +Total minimum rental commitments have not been reduced for future minimum sublease rentals. + +11. WORK IN PROCESS + + + Work in process + + + $ + + 20,316 + + + + Unbilled disbursements + + + + + 1,283 + + + + + + + + + $ + + 21,599 + + + + Less provision against net realisable value + + + + + (591 + + ) + + + + + Work in process September 30, 2001 + + + $ + + 21,008 + + + + + + + +12. COMMITMENTS AND CONTINGENCIES + +At September 30, 2001 the firm is involved in various legal proceedings, claims and litigation arising in the ordinary course of business. Based on its current assessment, management believes that the firm s financial +statements include adequate provision for estimated costs and losses that may ultimately be incurred with regard to such matters. + +13. SUBSEQUENT EVENT + +Bacon & Woodrow expects to enter into a definitive agreement to sell its Benefits Consulting business to Hewitt Associates, Inc. +( Hewitt ). The transaction is expected to close in June 2002. Pursuant to the agreement, the former partners and employees of Bacon & Woodrow will receive an aggregate of 1.4 million shares of Hewitt s series A preferred stock +which may be exchanged for shares of Hewitt s common stock valued at 140 million ($204 million), and Hewitt will assume approximately 16.5 million ($24 million) of Bacon & Woodrow s liabilities in excess of assets. The +foregoing amounts are based on a May 9, 2002 exchange rate of 1.46 U.S. Dollars per British Pound Sterling. Commencing five trading days following the 25th day after the consummation of Hewitt s proposed initial public offering +( offering ), the former partners and employees of Bacon & Woodrow will be entitled to put their shares of series A preferred stock, and commencing 60 days after consummation of the offering Hewitt will have the right to call Bacon +& Woodrow s shares of series A preferred stock, in exchange for shares of Hewitt s common stock based on the average closing price per share for Hewitt s class A common stock on the New York Stock Exchange for the five trading +days following the 25th day after the consummation of the offering. The actual applicable exchange rate from U.S. Dollars to British Pounds Sterling will be based on the average exchange rate for the same five trading day period. In exchange for +their shares of series A preferred stock, the former partners of Bacon & Woodrow will receive shares of Hewitt class B common stock and Hewitt class C common stock, and the non-partner employees of Bacon & Woodrow will receive shares of +Hewitt class A common stock. + +14. PROFIT SHARING +AND RETIREMENT PLANS + +Bacon & Woodrow operates a +Performance Related Bonus (PRB) scheme for all permanent employees in the U.K. The annual bonus is determined by management and amounted to $5,542 in fiscal 2001. + +Bacon & Woodrow maintains a contributory Defined Contribution employee retirement plan and a non-contributory +Defined Benefit employee retirement plan, which was closed to new entrants in 1998. The Bacon & Woodrow Staff Pension Scheme in which the employees participate is administered on a Bacon & Woodrow group basis and total contributions are +assessed by a qualified actuary on the cost of providing pensions across all participating companies. + + +F-62 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the year ended September 30, 2001 +(in thousands of U.S. Dollars) + + +The following schedules provide information concerning the Defined Benefit pension plan. + + + Changes in projected benefit obligation + + + + + + + Projected benefit obligation, beginning of year + + + $ + + 43,551 + + + + Service cost + + + + + 2,186 + + + + Interest cost + + + + + 2,528 + + + + Expenses + + + + + (101 + + ) + + Actuarial gain + + + + + (4,217 + + ) + + Benefits paid + + + + + (780 + + ) + + Foreign exchange movements + + + + + (266 + + ) + + + + + Projected benefit obligation, end of year + + + $ + + 42,901 + + + + + + + Funded status + + + + + + + Plan assets at market value at September 30, 2001 + + + $ + + 38,231 + + + + Projected benefit obligation + + + + + (42,901 + + ) + + + + + PBO in excess of plan assets + + + $ + + (4,670 + + ) + + + + + Unrecognised net loss on assets + + + $ + + (9,713 + + ) + + Unrecognised net asset at transition + + + + + 5,072 + + + + Accrued pension expense + + + + + (29 + + ) + + + + + + + $ + + (4,670 + + ) + + + + + Components of pension expense + + + + + + + Service cost + + + $ + + 2,186 + + + + Interest cost + + + + + 2,528 + + + + Expected return on plan assets + + + + + (3,694 + + ) + + Amortisation of transition obligation + + + + + (217 + + ) + + + + + Total + + + $ + + 803 + + + + + + + Assumptions + + + + + + + Asset return + + + + + 7.50% + + + + Discount rate + + + + + 6.00% + + + + + +F-63 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +CONSOLIDATED INCOME STATEMENT BEFORE PARTNER DISTRIBUTIONS + +For the six months ended March 31, 2002 +(Unaudited) +(in thousands of U.S. Dollars) + + + REVENUES + + + + + + + Revenues before reimbursements (net revenues) + + + $ + + 66,681 + + + + Reimbursements + + + + + 1,867 + + + + + + + Total Revenues + + + + + 68,548 + + + + OPERATING EXPENSES + + + + + + + Personnel expenses + + + + + 36,639 + + + + Reimbursable expenses + + + + + 1,867 + + + + Selling, general and administrative expenses + + + + + 7,270 + + + + Other operating expenses + + + + + 8,474 + + + + + + + Total Operating Expenses + + + + + 54,250 + + + + + + + OPERATING INCOME + + + + + 14,298 + + + + Other Income (Expense) + + + + + + + Interest income + + + + + 97 + + + + Interest expense + + + + + (82 + + ) + + Other income + + + + + 75 + + + + + + + + + + + 90 + + + + + + + PARTNERSHIP INCOME BEFORE TAXES + + + + + 14,388 + + + + Provision for corporate taxes + + + + + + + + + + + + PARTNERSHIP INCOME BEFORE PARTNER DISTRIBUTIONS + + + $ + + 14,388 + + + + + + + + +The accompanying notes to the Consolidated Financial Statements are an integral part of these statements. + + +F-64 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +CONSOLIDATED BALANCE SHEET +As of September 30, 2001 and March 31, 2002 +(in thousands of U.S. Dollars) + + + + + September 30, + 2001 + + + March 31, 2002 + + + + + + + + (Unaudited) + + + + ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + Cash and cash equivalents + + + $ + + 1,531 + + + $ + + 1,126 + + + + Client receivables, net of reserves of $586 and $192, respectively + + + + + 19,260 + + + + + 19,217 + + + + Work in process, net of reserves of $591 and $950, respectively + + + + + 21,008 + + + + + 19,012 + + + + Other receivables + + + + + 2,287 + + + + + 1,365 + + + + Prepaid expenses & other assets + + + + + 4,546 + + + + + 2,366 + + + + + + + + + Total Current Assets + + + + + 48,632 + + + + + 43,086 + + + + + + + + + NON-CURRENT ASSETS + + + + + + + + + + Property and equipment, net + + + + + 9,823 + + + + + 11,170 + + + + Investments + + + + + 103 + + + + + 78 + + + + + + + + + Total Non-Current Assets + + + + + 9,926 + + + + + 11,248 + + + + + + + + + TOTAL ASSETS + + + $ + + 58,558 + + + $ + + 54,334 + + + + + + + + + LIABILITIES + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + Short-term debt + + + $ + + + + + $ + + 27,008 + + + + Accounts payable + + + + + 1,555 + + + + + 356 + + + + Accrued expenses + + + + + 11,702 + + + + + 11,160 + + + + Corporate taxes payable + + + + + 181 + + + + + 95 + + + + Annuities payable within one year + + + + + 1,546 + + + + + 1,498 + + + + Provision for onerous property leases + + + + + 207 + + + + + 168 + + + + + + + + + Total Current Liabilities + + + + + 15,191 + + + + + 40,285 + + + + + + + + + NON-CURRENT LIABILITIES + + + + + + + + + + Annuities payable + + + + + 35,557 + + + + + 34,839 + + + + Deferred corporate taxes + + + + + 13 + + + + + 13 + + + + Provision for onerous property leases + + + + + 1,177 + + + + + 1,074 + + + + + + + + + Total Non-Current Liabilities + + + + + 36,747 + + + + + 35,926 + + + + + + + + + CAPITAL + + + + + + + + + + Partners balances + + + + + 6,620 + + + + + (21,877 + + ) + + + + + + + TOTAL LIABILITIES AND CAPITAL + + + $ + + 58,558 + + + $ + + 54,334 + + + + + + + + + +The accompanying +notes to the Consolidated Financial Statements are an integral part of these statements. + + +F-65 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +CONSOLIDATED STATEMENT OF CASH FLOWS +For the six months ended March 31, 2002 +(Unaudited) +(in thousands of U.S. Dollars) + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + Partnership income before partner distributions + + + $ + + 14,388 + + + + Adjustments to reconcile partnership income before partner distributions to net cash provided by +operating activities + + + + + + + Depreciation and amortisation + + + + + 2,056 + + + + Profit on part-disposal of Bacon Woodrow & Legris + + + + + (39 + + ) + + Decrease in net client receivables + + + + + 43 + + + + Decrease in work in process + + + + + 1,996 + + + + Decrease in other receivables, prepaid expenses and other assets + + + + + 3,102 + + + + Decrease in accounts payable + + + + + (1,199 + + ) + + Decrease in accrued expenses + + + + + (685 + + ) + + Decrease in annuities payable + + + + + (767 + + ) + + Decrease in taxes payable + + + + + (86 + + ) + + + + + Total Adjustments + + + + + 4,421 + + + + + + + Net cash provided by operating activities + + + + + 18,809 + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + Proceeds from part-disposal of Bacon Woodrow & Legris + + + + + 43 + + + + Sales of investments + + + + + 22 + + + + Additions to property and equipment + + + + + (3,731 + + ) + + + + + Net cash used in investing activities + + + + + (3,666 + + ) + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + Borrowings of short-term debt + + + + + 27,008 + + + + Amounts paid to and on behalf of Partners + + + + + (43,267 + + ) + + Tax provision + + + + + 213 + + + + CAPS dividend + + + + + 55 + + + + + + + Net cash used in financing activities + + + + + (15,991 + + ) + + + + + Effect of exchange rates + + + + + 443 + + + + + + + NET DECREASE IN CASH AND CASH EQUIVALENTS + + + $ + + (405 + + ) + + CASH AND CASH EQUIVALENTS, beginning of period + + + + + 1,531 + + + + + + + CASH AND CASH EQUIVALENTS, end of period + + + $ + + 1,126 + + + + + + + + +The accompanying notes to the Consolidated Financial Statements are an integral part of these statements. + + +F-66 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the six months ended March 31, 2002 +(Unaudited) +(in thousands of U.S. Dollars) + +1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION + + +Basis of Presentation + +The consolidated financial statements include the accounts of the +Benefits Consulting business of Bacon & Woodrow and its active subsidiaries, Bacon & Woodrow Limited and Bacon & Woodrow Properties Company. The consolidated financial results are unaudited and should be read in conjunction with the +annual consolidated financial statements of the partnership. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States by Bacon & Woodrow s management and +reflect all adjustments, that in the opinion of management, are necessary for a fair presentation of the interim period presented. Interim period operating results may not be indicative of the operating results for a full year. + +Principles of consolidation + +The consolidated financial statements include the accounts of the +Benefits Consulting business of Bacon & Woodrow, a partnership of consulting actuaries whose principal place of business is in London, England, and its controlled subsidiary companies. Pursuant to SFAS No. 94, Consolidation of All +Majority-Owned Subsidiaries, control is exercised through board representation and long-term majority interest in the subsidiaries stock. + +Bacon & Woodrow s share of earnings or losses of associates, in which at least 20% and not more than 50% of the voting securities is owned, +is included in the consolidating operating results using the equity method of accounting. All other investments are accounted for under the cost method and all significant interfirm transactions and profits have been eliminated. + +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES + + +Revenue recognition + +Revenues are recognised under time-and-material arrangements as +services are provided. Revenue represents the net of: + + + +(i) + +Net revenues, being invoices raised for services, net of U.K. value added tax; and + + + +(ii) + +Reimbursements, being invoices raised for disbursements, net of U.K. value added tax. + +Annuities + +Under the terms of the Bacon & Woodrow Partnership Deed, certain Partners admitted to the partnership prior to May 2, 1996 are entitled to +receive cash annuities after their retirement from the partnership. These entitlements ceased to accrue on May 1, 1997. The accrued entitlements at that date are subject to adjustment in deferment and payment in line with pension increases awarded +by the Bacon & Woodrow Staff Pension Fund. The partnership s liability for these payments is unfunded. + +The full liability for annuity payments to retired partners (net of contributions receivable from former partners) and current partners, discounted +using the firm s cost of borrowing is included as a liability on the balance sheet. Amounts expected to be payable within 12 months of the balance sheet date are included in current liabilities. The balance of the estimated liability is +included as a non-current liability. + +The resultant charge +to the income statement is included in personnel expenses. + + +F-67 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the six months ended March 31, 2002 +(Unaudited) +(in thousands of U.S. Dollars) + + +Translation of non-U.S. currency amounts + +The net assets and operations of entities outside the United States are translated into U.S. dollars using appropriate rates. Assets and liabilities are translated at period-end exchange rates and income and expense items are +translated at average exchange rates. + +Work in process + +Work in process is shown at its estimated net realisable value. +Unbilled disbursements have also been included at their estimated net realisable value. + +Provision for taxation + +The +provision for tax shown in the financial statements represents the corporate taxes payable by certain subsidiary companies. No provision has been made in these financial statements for the personal income taxes payable by the partners of Bacon & +Woodrow. + +Recently issued accounting standards + +In March 2002, the FASB issued Emerging Issues Task Force (EITF) Issue +No. 01-14, Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred. EITF 01-14 requires that reimbursements received for out-of-pocket expenses incurred should be characterised as revenues in +the statement of operations. Bacon & Woodrow has adopted EITF 01-14 during the quarter ended March 31, 2002 and has, accordingly, restated revenue for all periods reported. Previously the cost of out-of-pocket expense reimbursements was +classified as an offset against revenue. + +3. PROVISION FOR ONEROUS PROPERTY LEASES + + + Provision at March 31, 2002 + + + $ + + 1,241 + + + + + +Bacon & +Woodrow has long term lease commitments on a number of properties that are surplus to current operating requirements. Each of the buildings has been, or is available to be, sub-let to a third party. A provision of $1,241 representing the +partnership s estimated undiscounted liability, net of estimated rental income, has been recognised for future onerous property lease costs that are expected to be incurred between 2002 and 2016. + +4. TAXES + +Taxes relating to the income of the partnership are the responsibility +of the individual partners and accordingly no provision is made in these financial statements for that liability. + +Certain U.K. corporate taxes amounting to $95 at March 31, 2002 are payable by group companies. + + +F-68 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the six months ended March 31, 2002 +(Unaudited) +(in thousands of U.S. Dollars) + + +Deferred corporate taxes in certain group companies reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws +that will be in effect when such differences are expected to reverse. The group s deferred tax liabilities total $13 at March 31, 2002. + +5. PARTNERS BALANCES + +Partners balances at March 31, 2002 represent undistributed earnings and the income tax thereon. Under the terms of the Bacon & Woodrow +Partnership Deed profit is recognised on a different basis from the basis adopted in these financial statements. As a UK partnership Bacon & Woodrow is not required to comply with accounting principles generally accepted in the United States +and, in particular, the liability to pay annuities to retired partners described in Note 2 above is not recognised by the partnership in the annual accounts prepared for the partners. The balance at March 31, 2002 shown in these financial statements +is made up as follows: + + + Undistributed earnings and income tax thereon + + + $ + + 330 + + + + Liability for unfunded annuities and other US GAAP adjustments + + + + + (22,207 + + ) + + + + + Balance at March 31, 2002 + + + $ + + (21,877 + + ) + + + + + +In the six months +to March 31, 2002 the partnership has sought to increase the proportion of its working capital that is financed by third parties and has, in consequence, reduced the financing provided by partners + +6. SHORT TERM DEBT + +At March 31, 2002 the partnership has short-term sterling facilities +totaling $28.5 million from one bank. Borrowings under these facilities at March 31, 2002 amounted to $27.0 million. The facilities are repayable; on demand and are subject to an annual commitment fee. The weighted average interest rate in the +period was approximately 4.9%. + +7. COMMITMENTS +AND CONTINGENCIES + +At March 31, 2002 the firm is +involved in various legal proceedings, claims and litigation arising in the ordinary course of business. Based on its current assessment, management believes that the firm s financial statements include adequate provision for estimated costs +and losses that may ultimately be incurred with regard to such matters. + +8. SUBSEQUENT EVENT + +Bacon & Woodrow expects to enter into a definitive agreement to sell its benefits consulting business to Hewitt Associates, Inc. ( Hewitt ). The transaction is expected to close in June 2002. Pursuant to the agreement, +the former partners and employees of Bacon & Woodrow will receive an aggregate of 1.4 million shares of Hewitt s series A preferred stock which may be exchanged for shares of Hewitt s common stock valued at 140 million ($204 +million), and Hewitt will assume approximately 16.5 million ($24 million) of Bacon & Woodrow s liabilities in excess of assets. The + + + +F-69 + +Table of Contents + +BENEFITS CONSULTING BUSINESS OF BACON & WOODROW + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + +For the six months ended March 31, 2002 +(Unaudited) +(in thousands of U.S. Dollars) + + +foregoing amounts are based on a May 9, 2002 exchange rate of 1.46 U.S. Dollars per British Pound Sterling. Commencing five trading days following the +25th day after the consummation of Hewitt s proposed initial public offering ( offering ), the former partners and employees of Bacon & Woodrow will be entitled to put their shares of series A preferred stock, and commencing 60 +days after consummation of the offering Hewitt will have the right to call Bacon & Woodrow s shares of series A preferred stock, in exchange for shares of Hewitt s common stock based on the average closing price per share for +Hewitt s class A common stock on the New York Stock Exchange for the five trading days following the 25th day after the consummation of the offering. The actual applicable exchange rate from U.S. Dollars to British Pounds Sterling will be based +on the average exchange rate for the same five trading day period. In exchange for their shares of series A preferred stock, the former partners of Bacon & Woodrow will receive shares of Hewitt class B common stock and Hewitt class C common +stock, and the non-partner employees of Bacon & Woodrow will receive shares of Hewitt class A common stock. + + +F-70 + +Table of Contents + + +No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is +an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date. + + + +TABLE OF CONTENTS + + + + + Page \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001169358_inveresk_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001169358_inveresk_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0a60373fc296e79e05e417989b532b5e1e5efa94 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001169358_inveresk_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Clifford Chance US LLP, New York, New York. Certain legal matters in connection with the offering will be passed upon for the underwriters by Coudert Brothers LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001173495_orbitz-inc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001173495_orbitz-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..92bd0cd24988d21c82eccb961e62dc14e7e18e2a --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001173495_orbitz-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Latham & Watkins LLP, Chicago, Illinois, and for the underwriters by Sullivan & Cromwell LLP, New York, New York. Certain legal matters have been passed upon for the selling stockholders by Jones Day, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001174735_accredited_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001174735_accredited_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..beda427ea135bd24328736d987eab1c411d62d2c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001174735_accredited_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Gray Cary Ware & Freidenrich LLP in San Diego, California will pass upon the validity of the shares of common stock offered by this prospectus and certain other legal matters for us. Kirkpatrick & Lockhart LLP in Washington, D.C. will pass upon certain regulatory matters for us. Brobeck, Phleger & Harrison LLP in Irvine, California will pass upon certain legal matters for the underwriters. Cooley Godward LLP will pass upon certain legal matters for the selling stockholders. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001176435_99-cent_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001176435_99-cent_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b4107b05654700fc45636f2e48a323c0970f6eb9 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001176435_99-cent_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered through this prospectus will be passed on for 99 Cent Stuff by Sachs Sax Klein, Boca Raton, Florida and for the underwriter by Schneider Weinberger LLC, Boca Raton, Florida. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001177293_perpetual_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001177293_perpetual_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a2084211961feccd26c36583b5baf5408d0aa5ca --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001177293_perpetual_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters relating to the validity of the Trust Units and Rights will be passed upon for us by Gowling Lafleur Henderson LLP, 1400, 700 2nd Street South West, Calgary, Alberta, T2P 4V5 and for the Dealer Managers by Stikeman Elliott, 4300, 888 3rd Street South West, Calgary, Alberta, T2P 5C5. Certain legal matters pertaining to United States securities law will be passed upon for us by Carter Ledyard Milburn LLP, 2 Wall Street, New York, New York, 10005 and for the Dealer Managers by White Case LLP, 1155 Avenue of the Americas, New York, New York, 10036 2787. Carter Ledyard Milburn LLP and Stikeman Elliott as well as Felesky Flynn LLP, 3400, 350 7th Avenue South West, Calgary, Alberta, T2P 3N9 have passed upon certain income tax considerations discussed herein. As of the date hereof, the counsel, partners and associates, as a group, of each of Gowling Lafleur Henderson LLP, Stikeman Elliott, Carter Ledyard Milburn LLP, White Case LLP and Felesky Flynn LLP owned, directly or indirectly, less than 1% of the issued and outstanding PRL Common Shares and will receive less than 1% of the Dividend Units and Rights. As at December 4, 2002 Scotia Capital Inc. owned directly or indirectly, less than 1% of the issued and outstanding PRL Common Shares and will receive less than 1% of the Dividend Units and Rights. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001183920_dade_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001183920_dade_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a5a8bf2eff4a49a74d674811da5fca8c0c04e4ce --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001183920_dade_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Notes offered hereby will be passed on for us by Kirkland & Ellis, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001191119_nii_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001191119_nii_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001191119_nii_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001194410_blue_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001194410_blue_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2a8cf80c373e752804b48c2a0f999095ceeed98c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001194410_blue_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes and the guarantees under New York State law are being passed upon on behalf of the issuers and the guarantors by Akin Gump Strauss Hauer & Feld LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001194424_republic_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001194424_republic_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2a8cf80c373e752804b48c2a0f999095ceeed98c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001194424_republic_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes and the guarantees under New York State law are being passed upon on behalf of the issuers and the guarantors by Akin Gump Strauss Hauer & Feld LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001194426_n-t_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001194426_n-t_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2a8cf80c373e752804b48c2a0f999095ceeed98c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001194426_n-t_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes and the guarantees under New York State law are being passed upon on behalf of the issuers and the guarantors by Akin Gump Strauss Hauer & Feld LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001195933_infinity_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001195933_infinity_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ebdcb08f4bfd40b2c7fe3327c5af5a667b7326d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001195933_infinity_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters in connection with the offering will be passed upon for us by Keating, Muething & Klekamp, P.L.L. and for the underwriters by Dewey Ballantine LLP. Dewey Ballantine LLP will rely upon the opinion of Keating, Muething & Klekamp, P.L.L. as to matters governed by the laws of the State of Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200022_integrated_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200022_integrated_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..853d053aaca47db75a999f02b25071584ef7b485 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200022_integrated_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by us will be passed upon for us by Gersten, Savage, Kaplowitz, Wolf & Marcus, LLP, New York, New York which has acted as our counsel in connection with this offering. Certain matters will be passed upon for the underwriters by Mayer, Brown, Rowe & Maw, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200713_nextel_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200713_nextel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200713_nextel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200714_nii_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200714_nii_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200714_nii_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200715_mccaw_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200715_mccaw_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200715_mccaw_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200716_airfone_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200716_airfone_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200716_airfone_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200718_nextel_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200718_nextel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200718_nextel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200745_nextel_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200745_nextel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200745_nextel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200748_nextel_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200748_nextel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200748_nextel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200752_nextel_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200752_nextel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200752_nextel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200755_comunicaci_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200755_comunicaci_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200755_comunicaci_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200758_sistemas_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200758_sistemas_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200758_sistemas_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200760_radiophone_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200760_radiophone_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200760_radiophone_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200765_prestadora_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200765_prestadora_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200765_prestadora_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200769_fonotransp_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200769_fonotransp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200769_fonotransp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200772_servicios_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200772_servicios_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200772_servicios_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200774_nextel-de_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200774_nextel-de_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200774_nextel-de_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200775_teletransp_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200775_teletransp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200775_teletransp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200776_servicios_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200776_servicios_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200776_servicios_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200777_multifon_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200777_multifon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200777_multifon_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200778_nextel-sa_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200778_nextel-sa_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200778_nextel-sa_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200779_nextel_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200779_nextel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200779_nextel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200781_promobile_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200781_promobile_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200781_promobile_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200785_telemobile_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200785_telemobile_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200785_telemobile_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200787_master_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200787_master_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200787_master_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200789_transnet_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200789_transnet_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200789_transnet_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200790_nextel_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200790_nextel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200790_nextel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001200793_telecomuni_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001200793_telecomuni_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..786d088423c2139d04b4ec8cb1ae794aafa021d8 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001200793_telecomuni_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain U.S. legal matters regarding the common stock of NII Holdings being issued pursuant to this prospectus and the guarantees of the notes issued by NII Holdings (Cayman), Ltd. being offered pursuant to this prospectus of Nextel International (Services), Ltd, NII Funding Corp., McCaw International (Brazil), Ltd., Airfone Holdings, Inc., Nextel International (Mexico), Ltd., Nextel International (Peru) LLC, and Nextel International Uruguay, Inc., will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. Certain matters under the laws of the Cayman Islands relating to the notes and the guarantees of the notes by Nextel International (Peru) LLC and Nextel International (Indonesia) LLC will be passed upon by Maples and Calder, Grand Cayman, Cayman Islands. Certain matters under the laws of Peru relating to the guarantees of the notes by Nextel del Peru, S.A. and Transnet del Peru, S.R.L. will be passed upon by Miranda Amado, Lima, Peru. Certain matters under the laws of Mexico relating to the guarantees of the notes by Comunicaciones Nextel de Mexico, S.A. de C.V., Sistemas de Comunicaciones Troncales, S.A. de C.V., Radiophone, S.A. de C.V., Prestadora de Servicios de Radiocomunicacion, S.A. de C.V., Fonotransportes Nacionales, S.A. de C.V., Servicios Protel, S.A. de C.V., Nextel de Mexico, S.A. de C.V. Teletransportes Integrales, S.A. de C.V., Servicios de Radiocomunicacion Movil de Mexico, S.A. de C.V., and Multifon, S.A. de C.V. will be passed upon by Gallastegui y Lozano, D.F., Mexico, Mexico. Certain matters under the laws of Brazil relating to the guarantees by Nextel S.A., Nextel Telecomunicacoes Ltda., Promobile Telecomunicacoes Ltda., Telemobile Telecomunicacoes Ltda., Master-Tec Telecomunicacoes Industria e Comercio de Produtos Electronicos Ltda., and Telecomunicacoes Brastel S/C Ltda, will be passed upon by Pinheiro Neto Advogados, S o Paulo, Brazil. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001209807_converse_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001209807_converse_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..835a2bf7abb872b1db9451e17881ed9927181b1f --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001209807_converse_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock being offered will be passed upon for us by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. Jeffrey D. Saper, a member of Wilson Sonsini Goodrich & Rosati serves as one of our directors. The validity of our common stock offered hereby will be passed upon for the underwriters by Davis Polk & Wardwell, New York, New York. As of the date of this prospectus, investment partnerships composed of certain current and former members of and persons associated with Wilson Sonsini Goodrich & Rosati and certain members of Wilson Sonsini Goodrich & Rosati beneficially owned an aggregate of 100,000 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001214299_telkom-sa_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001214299_telkom-sa_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..650dba0d8622335577fb34ee66db4bf2f0a331f2 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001214299_telkom-sa_legal_matters.txt @@ -0,0 +1,42279 @@ +LEGAL MATTERS + +The validity of the issuance of the ordinary shares and ADSs offered hereby will be passed upon for Telkom by Paul, + +Hastings, Janofsky & Walker LLP, New York, New York, United States counsel to Telkom, with respect to matters of New + +York law and United States federal law, and by Werksmans Inc., South African counsel to Telkom, with respect to matters + +of South African law. Legal matters relating to the ordinary shares and ADSs offered hereby will be passed upon for the + +underwriters by Freshfields Bruckhaus Deringer, United States counsel to the underwriters with respect to matters of New + +York law and United States federal law, and Deneys Reitz Inc. and Chuene, Kwinana & Motsatse Inc., South African + +counsel to the underwriters with respect to matters of South African law. In addition, certain legal matters relating to New + +York law and United States law will be passed upon for the Government of the Republic of South Africa by Skadden, Arps, + +Slate, Meagher & Flom LLP, United States counsel to the Government, and certain legal matters relating to South African + +law will be passed upon for the Government of the Republic of South Africa by Edward Nathan & Friedland (Proprietary) + +Limited, South African counsel to the Government. + +205 + +EXPERTS + +The consolidated financial statements of the Telkom Group as of March 31, 2002, 2001 and 2000 and for each of the + +three years in the period ended March 31, 2002, appearing in this prospectus and the US registration statement have been + +audited by Ernst & Young, Registered Accountants and Auditors, Chartered Accountants (SA), as set forth in their report on + +page F48 of this prospectus, and are included in reliance upon the authority of such firm as experts in accounting and + +auditing in giving the report. + +The audited financial statements of Vodacom as of March 31, 2002, 2001 and 2000 and for each of the three years in the + +period ended March 31, 2002 included in this prospectus have been so included in reliance on the report on page F115 of + +this prospectus, which contains an explanatory paragraph concerning certain restatements and adjustments as described in + +note 44 of the consolidated financial statements, of PricewaterhouseCoopers Inc. and Deloitte & Touche, Registered + +Accountants and Auditors, Chartered Accountants (SA), given on the authority of such firms as experts in auditing and + +accounting. + +Ernst & Young have reported that they have applied limited procedures in accordance with professional standards for a + +review of the unaudited condensed consolidated financial statements of the Telkom Group as of September 30, 2002 and for + +each of the six month periods ended September 30, 2002 and 2001 appearing in this prospectus and the US registration + +statement. However, their separate reports included on page F2 of this prospectus state that they did not audit and they do + +not express an opinion on those financial statements. Accordingly, the degree of reliance on their reports on such + +information should be restricted considering the limited nature of the review procedures applied. The independent auditors + +are not subject to the liability provisions of Section 11 of the US Securities Act of 1933 for their reports on the unaudited + +condensed consolidated financial statements because that report is not a "report"- or a "part"- of the US registration + +statement prepared or certified by the auditors within the meaning of Sections 7 and 11 of the US Securities Act of 1933. + +In addition, with respect to the unaudited condensed consolidated financial statements of Vodacom as of September 30, + +2002 and for each of the six-month periods ended September 30, 2002 and 2001 included in this prospectus and the + +US registration statement, PricewaterhouseCoopers Inc. and Deloitte & Touche reported that they have applied limited + +procedures in accordance with professional standards for a review of such information. However, their separate report + +thereon, dated December 12, 2002, appearing herein state that they did not audit and they do not express an opinion on the + +unaudited condensed consolidated financial statements. Accordingly, the degree of reliance on their report on such + +unaudited condensed consolidated financial statements should be restricted in light of the limited nature of the review + +procedures applied. Furthermore, PricewaterhouseCoopers Inc. and Deloitte & Touche are not subject to the liability + +provisions of Section 11 of the US Securities Act of 1933 for their report on the unaudited condensed consolidated financial + +statements because that report is not "a report"- or "a part"- of the US registration statement prepared or certified by + +PricewaterhouseCoopers Inc. and Deloitte & Touche within the meaning of Sections 7 and 11 of the US Securities Act + +of 1933. + +206 + +EXPENSES RELATING TO THE GLOBAL OFFERING + +Set forth below is an itemization of the total expenses, excluding underwriting discounts and commissions, that are + +expected to be incurred in connection with the offer and sale of securities. With the exception of the JSE listing and + +inspection fee, the US Securities and Exchange Commission registration fee and the New York Stock Exchange listing fee, + +all amounts are estimates. Telkom currently estimates that it will pay R137,000,000 of legal fees and expenses, accounting + +fees and expenses, financial advisory fees and other fees and expenses in connection with the offering and the Government + +of the Republic of South Africa will pay the remainder of the fees and expenses. + +JSE listing and inspection fee . . . . . . . . . . . . . . . . . . . . . . . . + +R620,000 + +US Securities and Exchange Commission registration fee . . . . . . . . . + +183,960 + +NASD filing fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +275,000 + +New York Stock Exchange listing fee . . . . . . . . . . . . . . . . . . . + +1,969,872 + +Printing and engraving expenses . . . . . . . . . . . . . . . . . . . . . . + +27,000,000 + +Legal fees and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . + +93,000,000 + +Accounting fees and expenses . . . . . . . . . . . . . . . . . . . . . . . + +80,000,000 + +Financial advisory fees . . . . . . . . . . . . . . . . . . . . . . . . . . . + +27,000,000 + +Other fees and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . + +10,000,000 + +Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +R240,048,832 + +207 + +ENFORCEMENT OF CIVIL LIABILITIES + +Telkom is incorporated in the Republic of South Africa. Substantially all of the members of Telkom's board of directors + +and officers, and certain experts named herein, reside outside of the United States. Substantially all of the assets of these + +persons and all of our assets are located outside the United States. As a result, it may not be possible for you to effect + +service of legal process within the United States or elsewhere outside of the Republic of South Africa upon most of + +Telkom's directors or officers, including with respect to matters arising under US federal securities laws or applicable state + +securities laws. + +Moreover, it may not be possible for investors to enforce against these persons or us a judgment obtained in a United + +States court predicated upon the civil liability provisions of the federal securities or other laws of the United States or any + +state thereof. A foreign judgment is not directly enforceable in South Africa, but constitutes a cause of action which will be + +enforced by South African courts provided that: + +- the court which pronounced the judgment had jurisdiction to entertain the case; + +- the judgment is final and conclusive; + +- the recognition and enforcement of the judgment by South African courts would not be contrary to public policy, + +including observance of the rules of natural justice which require that the documents initiating the foreign + +proceedings were properly served on the defendant and that the defendant was given the right to be heard and + +represented by counsel in a free and fair trial before an impartial tribunal; + +- the judgment was not obtained by fraudulent means; + +- the judgment does not involve the enforcement of penal or revenue laws, which relate to income of the State derived + +from taxation and other sources; + +- the judgment is not for the payment of multiple or punitive damages; and + +- the enforcement of the judgment is not precluded by the provisions of the South African Protection of Businesses Act, + +99 of 1978. + +The South African Protection of Businesses Act, 99 of 1978, prohibits the enforcement in the Republic of South Africa + +of a foreign judgment, except with the permission of the South African Minister of Trade and Industry, and limits the + +recovery of multiple or punitive damages that have been awarded by a non-South African court, irrespective of whether + +or not the South African Minister of Trade and Industry has consented. In addition, the South African Protection of + +Businesses Act, 99 of 1978, provides that in determining whether or not a foreign judgment is recognizable or enforceable + +in the Republic of South Africa, the person against whom the judgment was given will not be regarded as having submitted + +to the jurisdiction of the foreign court by reason only of the fact that such person appeared in the proceedings in question + +for the purposes of contesting the jurisdiction of the court, protecting or obtaining property, applying for dismissal or stay + +of proceedings pending arbitration, or for the institution of new proceedings. Such person will also not be regarded as + +having submitted to the jurisdiction of the foreign court if that person did business within the area of the court, unless at the + +same time as when the events giving rise to the liability or relevant proceedings occurred, that person conducted a + +permanent business establishment within that area. + +South African courts cannot inquire into the merits of a foreign judgment and cannot act as a court of appeal or review + +over the foreign court. South African courts will usually implement their own procedural laws and the capacity of the + +parties to contract will be determined in accordance with South African law. It is doubtful whether an original action based + +on United States federal securities laws can be brought before South African courts. A plaintiff who is not resident in South + +Africa may be required to provide security for costs in the event of proceedings being initiated in South Africa. + +Furthermore the Rules of the High Court of South Africa require that documents executed outside South Africa must be + +authenticated for the purpose of use in South Africa. + +It is possible for an investor to bring an action against Telkom in a South African civil court to enforce rights under + +United States federal securities laws. These laws will not be enforced if they are penal or revenue or taxation laws or laws + +which are contrary to South African public policy. It is not possible therefore for an investor to seek to impose criminal + +liability on us in a South African court arising from a violation of United States federal securities laws. + +208 + +WHERE YOU CAN FIND MORE INFORMATION + +We have filed with the SEC a registration statement on Form F1 under the Securities Act (SEC File No. 333- ). + +This prospectus does not contain all of the information set forth in the registration statement, parts of which have been + +omitted in accordance with the rules and regulations of the SEC. For further information about us and the ordinary shares + +and the ADSs, please refer to the registration statement and exhibits, which you may obtain as described below. + +Upon completion of the global offering, we will be subject to the informational requirements of the Securities Exchange + +Act of 1934 as they apply to a foreign private issuer, and will file reports and other information with the SEC. As a foreign + +private issuer, we will be exempt from Exchange Act rules regarding the content and furnishing of proxy statements to + +shareholders and rules relating to short swing profits reporting and liability. + +Our SEC filings are available to the public over the internet at the SEC's website at http://www.sec.gov You may also + +read and copy any document we file at the public reference facilities of the SEC located at 450 Fifth Street, N.W., + +Washington, DC 20549. You may obtain more information concerning the operation of the Public Reference Section of the + +SEC by calling the SEC at 1-800-SEC-0330. In addition, upon the listing of our ADSs on the New York Stock Exchange, + +the reports and other information we file with the SEC will also be available for reading and copying at the offices of the + +New York Stock Exchange, 11 Wall Street, New York, New York 10005, United States. We also maintain an internet site at + +http://www.telkom.co.za. Our website and the information contained therein or connected thereto shall not be deemed to be + +incorporated into this prospectus or the registration statement of which it forms a part. + +209 + +DOCUMENTS AVAILABLE FOR INSPECTION + +Copies of the following documents are available for inspection at our registered office during normal business hours + +from the date of this prospectus until the closing of the global offering: + +- Telkom's audited consolidated financial statements as of and for the past three financial years ended March 31, 2002; + +- Telkom's new memorandum and articles of association; + +- the memorandum and articles of association of Telkom Directory Services and Swiftnet; + +- the new shareholders' agreements, referred to in "Relationship with Major Shareholders and Related Transactions - + +Shareholder arrangements"- beginning on page 156 of this prospectus; + +- the material contracts referred to in "Additional Information - Material contracts"- beginning on page 212 of this + +prospectus; + +- summaries of the service agreements of executive directors and executive officers; + +- the trust deed constituting the Khulisa Share Administration Trust; + +- the trust deed constituting the Diabo Share Trust; + +- the review report and report of Ernst & Young, Chartered Accountants (SA) referred to on pages F2 and F48, + +respectively, and the joint review report and report of PricewaterhouseCoopers Inc. and Deloitte & Touche, Chartered + +Accountants (SA), referred to on pages F25 and F115, respectively, of this prospectus; + +- the written consent of the reporting accountants to the issue of the prospectus including their reports in the form and + +context in which they are included herein; and + +- the written consents of the advisors referred to under "Corporate Information and Advisors"- to their names being + +included in this prospectus in the capacities stated. + +h2d + +210 + +210 + +ADDITIONAL INFORMATION + +Telkom's ownership and legal corporate structure as of the date of this prospectus + +Subsidiaries: + +Joint venture: + +Investments: + +Note: 1 Immediately following the global offering: + + + + the Government will own the one class A ordinary share and approximately 42% of Telkom's issued and outstanding ordinary share + +capital, or 38% if the underwriters exercise their over-allotment option in full; and + + + + Thintana Communications will own the one class B ordinary share and approximately 30% of Telkom's issued and outstanding + +ordinary share capital. + +Note: 2 Dormant entities. + +Vodacom's ownership and legal corporate structure as of the date of this prospectus + +Vodacom Group (Proprietary) Limited + +Vodacom + +(Proprietary) + +Limited + +Vodacom + +International Holdings + +(Proprietary) + +Limited + +Vodacom Service + +Provider Company + +(Proprietary) + +Limited + +Vodacom + +International + +Limited (Mauritius) + +) + +Vodacom Tanzania + +Limited + +Vodacom Congo + +(R.D.C.) S.P.R.L. + +Vodacom + +Mozambique + +(VM S.A.R.L.) + +Vodacom Lesotho + +(Proprietary) + +Limited + +100% + +100% + +100% + +100% + +65% + +51% + +98% + +88.3% + +Telkom SA Limited + +Vodafone Group plc + +VenFin Limited + +50% + +35% + +15% + +Telkom Directory + +Services (Proprietary) + +Limited + +Swiftnet + +(Proprietary) + +Limited + +Intekom + +(Proprietary) + +Limited + +Telkom + +Communications + +International + +2 + +(Proprietary) + +Limited + +Q-Trunk + +(Proprietary) + +Limited + +2 + +Telkom SA Limited + +Rascom + +: + +1.18% + +New Skies + +: + +0.89% + +Inmarsat + +: + +0.30% + +100% + +64.9% + +100% + +100% + +100% + +Vodacom Group + +(Proprietary) + +Limited + +50% + +Government of the Republic of + +South Africa + +Thintana Communications + +LLC + +Ucingo Investments + +(Proprietary) Limited + +67% + +1 + +30% + +1 + +3% + +211 + +211 + +Additional information with respect to our subsidiaries + +Details of our subsidiaries, but not our Vodacom joint venture, are as follows: + +Date and + +place of + +Length of + +incorporation + +Percentage + +time + +and date of + +Issued + +held, directly + +business + +Name and + +becoming a + +share + +or indirectly, + +Principal + +has been + +registration number + +subsidiary + +capital + +by Telkom + +business + +conducted + +Telkom Directory Services + +April 29, 1992 + +R100,000 divided into + +64.9% + +Provide services required + +10 years + +(Pty) Ltd (registration no: + +Republic of + +100,000 ordinary shares + +for the production of + +1992/002329/07) + +South Africa + +of R1.00 each + +telephone directories + +Swiftnet (Pty) Ltd + +November 23, 1994 + +R50,000,000 was divided + +100% + +Render telecommunications + +8 years + +(registration no: + +Republic of + +into 5,000,000 ordinary + +services enabling customers + +1994/009541/07) + +South Africa + +shares of R1.00 each and + +access to our switched + +45,000,000 preference + +data network by means + +shares of R1.00 each + +of fixed portable radio lines + +Telkom Communications + +May 21, 1999 + +US$ 2 divided into + +100% + +Dormant + +3 years + +International (Pty) Ltd + +Mauritius + +2 ordinary shares of + +(registration no: + +US$1 each + +22372/5013) + +Intekom (Pty) Ltd + +October 11, 1996 + +R100,000 divided into + +100% + +Hold and license to + +4.5 years + +(registration no: + +Republic of + +10,000,000 ordinary shares + +Telkom certain intellectual + +1996/013862/07) + +South Africa + +of R0.01 each + +property rights + +Q-Trunk (Pty) Ltd + +April 18, 1994 + +R10,001,000 divided into + +100% + +Dormant + +8 years + +(registration no: + +Republic of + +10,001,000 ordinary shares + +1994/02728/07) + +South Africa + +of R1.00 each + +Prior to becoming dormant in 2001, the main business and object of: + + Telkom Communications International was to carry on the business of investments and to acquire and hold securities + +of all kinds; + + Q-Trunk was to provide a radio trunking service to the public as a network operator. + +The following is a summary of certain provisions of the articles of association of Swiftnet and Telkom Directory + +Services, Telkom's operating subsidiaries. + +Directors + +The directors of Swiftnet and Telkom Directory Services are not obliged to hold any qualification shares. + +The directors of Telkom Directory Services are entitled to such remuneration as the shareholders in a general meeting + +may from time to time determine, which remuneration shall be divided among the directors in such proportions as they may + +agree, or in default of such agreement, equally, except that in the event any director has held office for less than a year, such + +director shall only rank in such determination in the proportion to the period during which he or she has actually held + +office. + +The directors of each of the companies may, with the approval of a disinterested quorum of directors, hold any other + +office or place of profit in the company, except that of auditor, or any subsidiary of the company in conjunction with his + +office of director, for such period and on such terms as to remuneration, in addition to the remuneration to which he may be + +entitled as a director, and otherwise as a disinterested quorum of directors may determine. + +Any director who serves on any executive or other committee or devotes special attention to the business of the company + +or goes or resides outside the Republic of South Africa for the purposes of the company or otherwise performs or binds + +himself or herself to perform services which, in the opinion of the directors, are outside the scope of the ordinary duties of + +a director, may be paid such extra remuneration or allowances as a disinterested quorum of directors may determine. + +The remuneration of a director appointed to any position or executive office shall be determined by a disinterested + +quorum of directors, shall be in addition to or in substitution for any ordinary remuneration as a director of the company + +and may consist of a salary or a commission on profits or dividends or both. + +212 + +Borrowing powers + +The directors may from time to time borrow for the purposes of the company such amounts as they think fit or secure + +the payment or repayment of such amounts as they think fit, whether by the creation and issue of debentures, secured or + +unsecured, whether outright or as security for any debt, liability or obligation of the company or of any third party, + +mortgage or charge upon all or any of the property or assets of the company, including its uncalled or unpaid capital, make + +such regulations regarding the transfer of debentures and all matters incidental to debentures, provided that the total amount + +owing by the company in respect of money so raised, borrowed or secured shall not exceed the amount authorized by + +Telkom, once Telkom's shares are listed on any stock exchange. + +Property acquisitions + +Neither Telkom, nor any of its subsidiaries have, in the three years preceding the date of this prospectus acquired, nor do + +they propose to acquire or have any option to acquire any securities in, or the business undertakings of, any other company + +or business enterprise or any immovable property or other property in the nature of a fixed asset, the purchase price of + +which is material, as contemplated by the South African Companies Act, 61 of 1973. + +Property disposals + +Details of all disposals by Telkom and by its subsidiaries, but not our Vodacom joint venture, of any securities in any + +other company or any business undertaking or any enterprise or any immovable property or other property in the nature of a + +fixed asset, the purchase price of which is material, as contemplated in the South African Companies Act, 61 of 1973, + +which have occurred in the three years preceding the date of this prospectus or which are to occur are as follows: + + pursuant to a purchase agreement, dated March 18, 2000, between Telkom and debis Fleet Management (Proprietary) + +Limited, Telkom sold its fleet management division, as a going concern, to debis Fleet Management effective March 31, + +2000. The purchase price was R753,286,368, which was paid to Telkom in cash on March 31, 2000. The address of + +debis Fleet Management is 123 Wierda Road, Zwartkop, Centurion, South Africa. The beneficial shareholder of debis + +Fleet Management is Daimler Chrysler Services (debis) AG of debis House, am Potsdamer Platz, Eichornstrabe 3, + +10785 Berlin, Germany; and + + on September 1, 2002, we issued an information memorandum inviting potential investors to provide to us by + +November 2002, preliminary submissions to purchase a substantial portion of our fixed line property portfolio and + +lease that property back to us. This transaction is expected to involve over 1,400 properties ranging from warehouses + +and exchange buildings to our national network operations center and is intended to further our strategy of focusing + +on our core business. We are currently reviewing the bids we have received to date after having completed a due + +diligence process. + +Material contracts + +Particulars of all material contracts within the meaning of the South African Companies Act, 61 of 1973, and the JSE + +Listings Requirements entered into by Telkom or any of its subsidiaries, but not our Vodacom joint venture, within the two + +years preceding the date of this prospectus, other than in the ordinary course of the business carried on by Telkom or any of + +its subsidiaries, or any other contract entered into at any time that contains an obligation or settlement that is significant to + +Telkom or any of its subsidiaries, as of the date of this prospectus, are as follows: + + the registration rights agreement referred to under "Relationship with Major Shareholders and Other Related + +Transactions Shareholder arrangements Registration rights agreement" on page 161 of this prospectus; + + the existing and new strategic services agreements between Telkom, Thintana Communications, SBC International + +Management Services Inc. and Telkom Management Services SDN Berhad referred to under "Relationship with + +Major Shareholders and Related Transactions Shareholder arrangements Strategic services agreement" beginning + +on page 160 of this prospectus; + + agreement, dated July 31, 2000, between Telkom and Telecommunications Facilities Management Company + +(Proprietary) Limited or TFMC, pursuant to which Telkom appoints TFMC to manage, administer and maintain all of + +its properties; + + exclusive facilities management services agreement, dated March 31, 2001, between Telkom and Systems + +Applications Projects (Africa) (Proprietary) Limited or SAP Africa, pursuant to which SAP Africa grants Telkom a + +license to use specified software to establish, operate and administer a central web-based market for use by Telkom, + +its employees and business parties, for purposes of buying or selling products and/or services; + + the Vodacom joint venture agreement referred to under "Relationship with Major Shareholders and Related + +Transactions" beginning on page 156 of this prospectus; + +213 + + multiparty implementation agreement, dated September 30,1993, between Telkom, Vodacom (Proprietary) Limited, + +Mobile Telephone Networks (Proprietary) Limited or MTN, the Postmaster General and the Government of the + +Republic of South Africa, which relates to the implementation of the national cellular telecommunications licenses + +issued to Vodacom and MTN; + + interconnection agreement, dated February 16, 1994 between Telkom and Vodacom (Proprietary) Limited, as + +amended on August 22, 1996, January 12, 1998, July 21, 1998 and September 4, 2001, relating to the interconnection + +of their respective telecommunications networks and the conveyance of messages to and from their respective + +networks to the intended destination of such messages; + + interconnection agreement, dated February 16, 1994 between Telkom and MTN, as amended on August 22, 1996, + +January 12, 1998, July 21, 1998 and September 14, 2001, relating to the interconnection of their respective + +telecommunications networks and the conveyance of messages to and from their respective networks to the intended + +destination of such messages; + + interconnection agreement, dated August 31, 2001, between Telkom and Cell C, as amended on September 18, 2001, + +relating to the interconnection of their respective telecommunications networks and the conveyance of messages to + +and from their respective networks to the intended destination; + + terms and conditions of the bonds listed on the Bond Exchange of South Africa under ticker code "TK01", as set out + +in an offering circular issued by Telkom; + + terms and conditions of the bonds listed on the Bond Exchange of South Africa under ticker code "TL08", as set out + +in an offering circular issued by Telkom; + + terms and conditions of the bonds listed on the Bond Exchange of South Africa under ticker code "TL03", as set out + +in an offering circular issued by Telkom; + + terms and conditions of the bonds listed on the Bond Exchange of South Africa under ticker code "TL06", as set out + +in an offering circular issued by Telkom, dated October 29, 2001; + + terms and conditions of the bonds listed on the Bond Exchange of South Africa under ticker code "TL20" as set out + +in the placing document issued by Telkom; + + terms and conditions of the zero coupon loan stock PP02 as set out in a private placing circular issued by Telkom; + + terms and conditions of the zero coupon loan stock PP03 as set out in a zero coupon note issued by Telkom; and + + terms and conditions of the Telkom EuroBond 2000 listed on the London Stock Exchange, as set out in the offering + +circular issued by Telkom. + +Royalty agreements + +Details of existing or proposed contracts relating to material royalties and technical fees payable by Telkom or any of its + +subsidiaries, but not our Vodacom joint venture, are as follows: + +Date of agreement + +Parties + +Product or services + +Royalty/Technical fee + +February 28, 2000 + +Telkom and Safika Technology + +Right to use FLOWTHRU + +Service fee of 20% of purchase price + +Holdings (Proprietary) Limited + +AND I-CARE software + +in year 1, 50% in year 2 and 100% + +t/a Safika BEA + +in year 3, based on minimum purchase + +price prior to April 30, 2000 of + +US$2 million + +December 18, 1998 + +Telkom and Systems Applications + +Use of software, third party + +Initial cost of R45,194,765 with + +Products (Southern Africa) + +database and network access + +service fee of 15% of original fee + +(Proprietary) Limited and + +per annum + +Vodacom + +April 28, 1999 + +Telkom and AMDOCS, Inc. and + +License to use billing system + +Assessed annual commitment of + +Persetel Q-Data Africa + +and related software products + +R23 million + +(Proprietary) Limited + +and related customization + +services and maintenance + +Extension of agreement + +Telkom and IBM South Africa + +License agreement for use of + +R10,896,556, subject to foreign + +from March 31, 2001 + +(Proprietary) Limited + +proprietary software of IBM or + +exchange increases and consumer + +Group 80 Main Frame Equipment + +price increases + +and Enterprise Administered + +System/390 software + +214 + +Date of agreement + +Parties + +Product or services + +Royalty/Technical fee + +March 1, 2000 + +Telkom and EMC Computer Systems + +Right to use software, including + +License and maintenance fee for year + +(Proprietary) Limited + +Microcode and Film-ware for + +ended March 31, 2002 was + +internal enterprise network to + +R13,554,329 and payment is in terms + +support host computers, network + +of a quote basis + +devices and application systems + +September 1, 1999 + +Telkom and Oracle Corporation + +License and maintenance + +License and service fee of R24,105,998 + +(South Africa) (Proprietary) Limited + +agreement for the use of Oracle + +for year ended March 31, 2002 + +network software for data + +management, development, + +administration and sales analysis + +August 1, 1999 + +Telkom and Novell Ireland + +License and service fee for use + +Currently annual commitment + +Software Limited + +of Novell software + +of R15,103,869 + +Commissions paid in respect of underwriting + +Details of the consideration paid within the preceding three years as commission to any person for subscribing or + +agreeing to subscribe or procuring or agreeing to procure subscriptions for securities in Telkom are as follows: + +Commission + +paid in year + +ended + +Description + +Name of + +Address of + +Amount + +Commission + +March 31, + +of security + +underwriter + +underwriter + +underwritten + +paid + +(ZAR) + +(ZAR) + +2002 + +Telkom bond TL03 + +Joint Lead Manager + +87 Maude Street + +2,300,000,000 + +1,581,250 + +Deutsche Bank AG + +Sandown, Sandton + +South Africa + +Joint Lead Manager + +2 Fredman Drive + +Rand Merchant Bank, + +Sandown + +a division of FirstRand + +South Africa + +Bank Limited + +Senior Co-Lead Manager + +138 West Street + +Merrill Lynch South Africa + +Sandown, Sandton + +(Proprietary) Limited + +South Africa + +2002 + +Telkom bond TL06 + +Lead Manager + +3 Simmonds Street + +1,500,000,000 + +750,000 + +Standard Corporate + +Johannesburg + +and Merchant Bank, + +South Africa + +a division of The Standard + +Bank of South Africa + +Limited + +Co-Lead Manager + +100 Grayston Drive + +Investec Bank Limited + +Sandown, Sandton + +South Africa + +Co-Lead Manager + +1 Fricker Road + +JP Morgan Securities + +Illovo + +South Africa + +Johannesburg + +(Proprietary) Limited + +South Africa + +Joint Manager + +135 Rivonia Road + +Nedcor Bank Limited + +Sandown, Sandton + +South Africa + +Joint Manager + +1 Newton Avenue + +Nedcor Investment + +Killarney + +Bank Limited + +Johannesburg + +(Proprietary) + +South Africa + +Joint Manager + +61 Central Street + +Wipcapital + +Houghton + +(Proprietary) Limited + +Johannesburg + +South Africa + +215 + +Commission + +paid in year + +ended + +Description + +Name of + +Address of + +Amount + +Commission + +March 31, + +of security + +underwriter + +underwriter + +underwritten + +paid + +(ZAR) + +(ZAR) + +2001 + +Telkom bond TL03 + +Joint Lead Manager + +87 Maude Street + +2,700,000,000 + +1,856,250 + +Deutsche Bank AG + +Sandown, Sandton + +South Africa + +Joint Lead Managers + +2 Fredman Drive + +Rand Merchant Bank, + +Sandown, Sandton + +a division of FirstRand + +South Africa + +Bank Limited + +Senior Co-Lead Manager + +138 West Street + +Merrill Lynch South Africa + +Sandown, Sandton + +(Proprietary) Limited + +South Africa + +2002 + +Telkom Euro bond + +Salomon Brothers + +111 Buckingham + +3,150,000,000 + +3,150,000 + +International Limited + +Palace Road + +London, SW1B OSB + +United Kingdom + +Dresdner Bank AG + +London Branch + +ABN Amro Bank NV + +Commerzbank AG + +Credit Agricole Indosuez + +Credit Suisse First Boston + +(Europe) Limited + +Deutsche Bank AG + +Commission + +paid in year + +ended + +Description + +Name of + +Address of + +Amount + +Commission + +March 31, + +of security + +underwriter + +underwriter + +underwritten + +paid + +(ZAR) + +(ZAR) + +2000 + +Telkom bond TL08 + +Joint Lead Managers + +3 Simmonds Street + +1,500,000,000 + +1,687,500 + +Standard Corporate + +Johannesburg + +and Merchant Bank, + +South Africa + +a division of The Standard + +Bank of South Africa + +Limited + +Joint Lead Managers + +1 Fricker Road + +JP Morgan Securities + +Illovo + +South Africa + +Johannesburg + +(Proprietary) Limited + +South Africa + +Senior Co-Lead Manager + +87 Maude Street + +Deutsche Bank AG + +Sandown, Sandton + +South Africa + +Joint Manager + +2 Fredman Drive + +Rand Merchant Bank, + +Sandown, Sandton + +a division of FirstRand + +South Africa + +Bank Limited + +Joint Manager + +2 Maude Street + +African Merchant Bank + +Sandown, Sandton + +Limited + +South Africa + +The directors of the underwriters in the above table that are companies incorporated in the Republic of South Africa are + +as follows: + +FirstRand Bank Limited: + + M Brogan, R Williams, M King, A Vahed, V Bartlett, G Ferreira, L Dippenaar, J Burger, J Gafney, P Goss, P Harris, + +S Maharaj, D Falck, R Spilg. + +216 + +Merrill Lynch South Africa (Proprietary) Limited: + + M Borkum, H Borkum, A Hare, M Marks, B Henderson, C Phillips, Y Ramaih, S Ermotti, A Horowitz. + +The Standard Bank of South Africa Limited: + + D Hawton, C Strauss, E Theron, E Mackay, D Band, J Maree, E Bradley, D Cooper, R Plumbridge, R Andersen, + +S Macozoma, R Menell, C Stals, M Ruck, P Prinsloo. + +Investec Bank Limited: + + D Jowell, B Kantor, S Abrahams, R Berkowitz, A Leith, P Thomas, G Burger, R Forlee, S Hackner, D Kuper, + +B Tapnack, R Upton, M Nkosi, M Mason, I Kantor, D Lawrence, H Herman, R Mokate, D Nurek, M Malungani, + +D Motsepe, F Titi. + +J P Morgan Securities South Africa (Proprietary) Limited: + + J Coulter, M Horton, W Evans. + +Nedbank Limited: + + C Liebenberg, M Katz, S Morris, A Routledge, R Laubscher, M Levett, D Muller, J de Blanche, B Hore, P Joubert, + +W Clewlow, J Magwaza, M Mkhwanazi, M Ndlovu, J Roberts, J Sutcliffe, T Nyasulu, I Botha, T Boardman, + +C Savage, B Davison, B Figaji, P Nhleko, R Cottrell, D Nicholas. + +Nedcor Investment Bank Limited: + + G Richardson, S Morris, R Laubscher, J Bestbier, B Davison, P Lane, W Ross, M Davis, P Joubert, R Cottrell, + +C Liebenberg, A Routledge, M Katz, R van Wyk, L Porter, I Botha, E Molobi, P Nhleko, N Dennis, S Pityana. + +Wipcapital (Proprietary) Limited: + + G Serobe, D Tennick. + +AMB Holdings Limited: + + B Vundla, J Chalsty, R Rumboll, W Winckler, J Meyers, Z Lusengo, D Baloyi, A Moosa, A Jammine, A Sprague, + +O Maubane, C Vosloo, R Dow. + +Directors of Vodacom + +The only material loan made by Telkom or any of its subsidiaries is to Vodacom. See "Management's Discussion and + +Analysis of Financial Condition and Results of Operations Funding sources" beginning on page 81 of this prospectus. + +Vodacom's directors are Wendy Luhabe, Alan Knott-Craig, Andrew Mthembu, Leon Crouse, Shameel Aziz-Joosub, Sizwe + +Nxasana, Philip Williams, Josua Malherbe, Hans Kuropatwa, Edward Langston, Shawn McKenzie and Chian Khai Tan. + +Telkom company selected five-year historical financial information + +The following five year selected historical financial information is required by the South African Companies Act, 61 of + +1973 and sets forth the unaudited profit of Telkom, excluding its subsidiaries and Vodacom joint venture, before and after + +tax for each of the five years ended March 31, 2002 and the unaudited total assets and liabilities as of March 31, 2002. This + +unaudited historical financial information has been derived from Telkom's annual financial statements prepared in + +accordance with South African generally accepted accounting principles and required by the South African Companies Act, + +61 of 1973, as of and for each of the five years ended March 31, 2002 with certain adjustments made for purposes of + +converting those amounts to the corresponding amounts under IAS. For purposes of this presentation, Telkom's investments + +in subsidiaries and the Vodacom joint venture are reflected using the cost method of accounting in accordance with IAS 27, + +paragraph 29, and IAS 31, paragraph 42, respectively. This unaudited selected historical financial information is not + +required by the US securities and exchange commission's rules and regulations and is not in accordance with US GAAP. + +Year ended March 31, + +1998 + +1999 + +2000 + +2001 + +2002 + +(unaudited) + +(ZAR millions) + +Income statement data + +Profit before tax . . . . . . . . . + +3,012 + +1,822 + +889 + +1,677 + +489 + +Profit after tax . . . . . . . . . . + +2,123 + +1,391 + +711 + +1,373 + +262 + +Balance sheet data as of + +March 31, 2002 + +Total assets . . . . . . . . . . . . + +48,514 + +Total liabilities . . . . . . . . . . + +34,555 + +F1 + +INDEX TO FINANCIAL STATEMENTS + +Page + +Condensed Consolidated Interim Financial Statements of Telkom SA Limited + +Review Report of the Independent Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +F2 + +Condensed Consolidated Income Statements for the six months ended September 30, 2002 and 2001 . . . . . . . + +F3 + +Condensed Consolidated Balance Sheets at March 31, 2002 and September 30, 2002 . . . . . . . . . . . . . . . . + +F4 + +Condensed Consolidated Statements of Changes in Equity for the six months ended September 30, 2002 and 2001 + +F5 + +Condensed Consolidated Cash Flow Statements for the six months ended September 30, 2002 and 2001 . . . . . + +F6 + +Notes to the Condensed Consolidated Interim Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . + +F7 + +Condensed Consolidated Interim Financial Statements of Vodacom Group (Proprietary) Limited + +Review Report of the Independent Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +F25 + +Condensed Consolidated Income Statements for the six months ended September 30, 2002 and 2001 . . . . . . . + +F26 + +Condensed Consolidated Balance Sheets at March 31, 2002 and September 30, 2002 . . . . . . . . . . . . . . . . + +F27 + +Condensed Consolidated Statements of Changes in Equity for the six months ended September 30, 2002 and 2001 + +F28 + +Condensed Consolidated Cash Flow Statements for the six months ended September 30, 2002 and 2001 . . . . . + +F29 + +Notes to the Condensed Consolidated Interim Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . + +F30 + +Consolidated Financial Statements of Telkom SA Limited + +Report of the Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +F48 + +Consolidated Income Statements for the three years ended March 31, 2002 . . . . . . . . . . . . . . . . . . . . . + +F49 + +Consolidated Balance Sheets at March 31, 2002, 2001 and 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +F50 + +Consolidated Statements of Changes in Equity for the three years ended March 31, 2002 . . . . . . . . . . . . . . + +F51 + +Consolidated Cash Flow Statements for the three years ended March 31, 2002 . . . . . . . . . . . . . . . . . . . + +F52 + +Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +F53 + +Consolidated Financial Statements of Vodacom Group (Proprietary) Limited + +Report of the Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +F115 + +Consolidated Income Statements for the three years ended March 31, 2002 . . . . . . . . . . . . . . . . . . . . . + +F116 + +Consolidated Balance Sheets at March 31, 2002, 2001 and 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +F117 + +Consolidated Statements of Changes in Equity for the three years ended March 31, 2002 . . . . . . . . . . . . . . + +F118 + +Consolidated Cash Flow Statements for the three years ended March 31, 2002 . . . . . . . . . . . . . . . . . . . + +F119 + +Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +F120 + +F2 + +REVIEW REPORT OF THE INDEPENDENT ACCOUNTANTS + +to the Shareholders of Telkom SA Limited + +We have reviewed the accompanying condensed consolidated balance sheet of Telkom SA Limited and its subsidiaries as of + +September 30, 2002, and the related condensed consolidated statements of income, shareholders' equity and cash flows for + +the six-month periods ended September 30, 2002 and 2001 set out on pages F3 to F24. These condensed consolidated + +interim financial statements are the responsibility of the Company's directors. We were furnished with the report of other + +accountants on their reviews of the interim information of Vodacom Group (Proprietary) Limited, a 50% joint venture, + +which statements reflect total assets constituting 15.9% in September 2002 and total revenues constituting 21.6% in + +September 2002 and 18.4% in September 2001 of the related consolidated totals. + +We conducted our reviews in accordance with standards established by the American Institute of Certified Public + +Accountants. A review of interim financial information consists principally of applying analytical procedures to financial + +data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than + +an audit conducted in accordance with auditing standards generally accepted in the United States of America, which will be + +performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. + +Accordingly we do not express such an opinion. + +Based on our reviews and the report of other accountants, we are not aware of any material modifications that should be + +made to the accompanying condensed consolidated interim financial statements for them to be in conformity with + +International Accounting Standard 34 Interim Financial Reporting. + +We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated + +balance sheet of Telkom SA Limited as of March 31, 2002, and the related consolidated statements of income, + +shareholders' equity, and cash flows for the year then ended and in our report dated December 10, 2002, we expressed, + +based on our audit and the report of other auditors, an unqualified opinion on those consolidated financial statements as + +well as drew attention to Telkom SA Limited's change in accounting policy for financial instruments to conform with + +International Accounting Standards 39 Financial Instruments: Recognition and measurement. In our opinion, the + +information set forth in the accompanying condensed consolidated balance sheet as of March 31, 2002, is fairly stated, in + +all material respects, in relation to the consolidated balance sheet from which it has been derived. + +International Accounting Standards vary in certain significant respects from accounting principles generally accepted in the + +United States of America. Application of accounting principles generally accepted in the United States of America would + +have affected the consolidated shareholders' equity as of September 30, 2002, and the consolidated results of operations for + +each of the six-month periods ended September 30, 2002 and September 30, 2001 to the extent summarized in Note 21 to + +the unaudited condensed consolidated interim financial statements. + +ERNST & YOUNG + +Registered Accountants and Auditors + +Chartered Accountants (SA) + +Pretoria + +December 12, 2002 + + Chartered Accountants (SA) + + Telephone (011) 772-3000 + +Wanderers Office Park + +Telefax + +(011) 772-4000 + +52 Corlett Drive, Illovo + +Docex + +123 Randburg + +PO Box 2322 + +www.ey.com/southafrica + +Johannesburg 2000 + +TELKOM SA LIMITED + +CONDENSED CONSOLIDATED INCOME STATEMENTS + +for the six months ended September 30, 2002 and 2001 + +September + +September + +2001 + +2002 + +Note + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +Operating revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3 + +16,523 + +18,316 + +Operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +14,355 + +15,505 + +Employee expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,590 + +3,707 + +Payments to other operators . . . . . . . . . . . . . . . . . . . . . . . + +2,654 + +3,105 + +Selling, general and administrative expenses . . . . . . . . . . . . . . + +3,794 + +3,795 + +Services rendered . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,091 + +1,108 + +Operating leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +583 + +684 + +Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . + +2,643 + +3,106 + +Operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,168 + +2,811 + +Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +306 + +152 + +Profit before finance charges . . . . . . . . . . . . . . . . . . . . . . . + +2,474 + +2,963 + +Finance charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,845) + +(1,779) + +Profit before tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +629 + +1,184 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(206) + +(456) + +Profit after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +423 + +728 + +Minority interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(52) + +(84) + +Net profit for the period . . . . . . . . . . . . . . . . . . . . . . . . . . + +371 + +644 + +Basic and diluted earnings per share (cents) . . . . . . . . . . . . . . + +8 + +66.6 + +115.6 + +F3 + +F4 + +TELKOM SA LIMITED + +CONDENSED CONSOLIDATED BALANCE SHEETS + +at March 31, 2002 and September 30, 2002 + +March + +September + +2002 + +2002 + +(Audited) + +(Unaudited) + +Rm + +Rm + +ASSETS + +Non-current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . + +44,240 + +43,386 + +Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . + +41,918 + +41,172 + +Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +530 + +442 + +Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +780 + +867 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,012 + +905 + +Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +10,968 + +11,195 + +Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +624 + +887 + +Trade receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,720 + +6,163 + +Income tax receivable . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,081 + +237 + +Other financial assets . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,819 + +2,823 + +Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . + +724 + +1,085 + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +55,208 + +54,581 + +EQUITY AND LIABILITIES + +Capital and reserves . . . . . . . . . . . . . . . . . . . . . . . . . . + +16,832 + +17,475 + +Share capital and premium . . . . . . . . . . . . . . . . . . . . . . . + +8,293 + +8,293 + +Share issue expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(44) + +Non-distributable reserves . . . . . . . . . . . . . . . . . . . . . . . . + +134 + +112 + +Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +8,449 + +9,070 + +Minority interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +133 + +214 + +Non-current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . + +25,597 + +21,340 + +Interest-bearing debt . . . . . . . . . . . . . . . . . . . . . . . . . . . + +21,505 + +17,097 + +Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,028 + +1,047 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +463 + +523 + +Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,601 + +2,673 + +Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12,646 + +15,552 + +Trade and other payables . . . . . . . . . . . . . . . . . . . . . . . . + +7,391 + +6,025 + +Current portion of interest-bearing debt . . . . . . . . . . . . . . . . . + +2,041 + +5,953 + +Current portion of finance leases . . . . . . . . . . . . . . . . . . . . + +5 + +5 + +Deferred income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +958 + +838 + +Income tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . + +193 + +76 + +Current portion of provisions . . . . . . . . . . . . . . . . . . . . . . + +1,236 + +1,291 + +Credit facilities utilized . . . . . . . . . . . . . . . . . . . . . . . . . + +822 + +1,364 + +Total equity and liabilities . . . . . . . . . . . . . . . . . . . . . . . + +55,208 + +54,581 + +TELKOM SA LIMITED + +CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY + +for the six months ended September 30, 2002 and 2001 + +Share Share + +Preliminary + +Non- + +Retained + +Total + +capital + +premium + +listing costs + + distributable + +earnings + +reserves + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Balance at March 31, 2001 (Audited) + +5,570 + +2,723 + +6,679 + +14,972 + +Adoption of IAS39 . . . . . . . . . . + +45 + +584 + +629 + +Restated Balance at March 31, 2001 + +(Audited) . . . . . . . . . . . . . . . + +5,570 + +2,723 + +45 + +7,263 + +15,601 + +Net profit for the period . . . . . . . + +371 + +371 + +Transfer to non-distributable reserve . + +11 + +(11) + +Share issue expenses . . . . . . . . . + +(32) + +(32) + +Foreign currency reserves (net of tax) + +8 + +8 + +Balance at September 30, 2001 + +(Unaudited) . . . . . . . . . . . . . + +5,570 + +2,723 + +(32) + +64 + +7,623 + +15,948 + +Balance at March 31, 2002 (Audited) + +5,570 + +2,723 + +(44) + +134 + +8,449 + +16,832 + +Net profit for the period . . . . . . . + +644 + +644 + +Transfer to non-distributable reserve . + +23 + +(23) + +Fair value adjustment . . . . . . . . . + +(22) + +(22) + +Foreign currency reserves (net of tax) + +(23) + +(23) + +Share issue expenses reversal . . . . + +44 + +44 + +Balance at September 30, 2002 + +(Unaudited) . . . . . . . . . . . . . + +5,570 + +2,723 + +112 + +9,070 + +17,475 + +F5 + +F6 + +TELKOM SA LIMITED + +CONDENSED CONSOLIDATED CASH FLOW STATEMENTS + +for the six months ended September 30, 2002 and 2001 + +September + +September + +2001 + +2002 + +Note + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +Operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,301 + +3,462 + +Cash receipts from customers . . . . . . . . . . . . . . . . . . . . . . . . + +16,548 + +18,021 + +Cash paid to suppliers and employees . . . . . . . . . . . . . . . . . . . + +(11,963) + +(13,980) + +Cash generated from operations . . . . . . . . . . . . . . . . . . . . . . + +4,585 + +4,041 + +Income from investments . . . . . . . . . . . . . . . . . . . . . . . . . . + +246 + +152 + +Finance charges paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(957) + +(1,168) + +Taxation (paid)/refunded . . . . . . . . . . . . . . . . . . . . . . . . . . + +(573) + +437 + +Investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(3,653) + +(2,453) + +Proceeds on disposal of property, plant and equipment . . . . . . . . . . + +13 + +2 + +Additions to property, plant and equipment . . . . . . . . . . . . . . . . + +(3,641) + +(2,346) + +Additions to other investments . . . . . . . . . . . . . . . . . . . . . . . + +(3) + +(109) + +Purchase of minority interests . . . . . . . . . . . . . . . . . . . . . . . + +14 + +(22) + +Financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(973) + +(1,178) + +Loans raised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +7,444 + +7,599 + +Loans repaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(9,182) + +(8,614) + +Finance lease . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +(Increase)/decrease in interest-bearing investments . . . . . . . . . . . . + +765 + +(165) + +Net decrease in net cash and cash equivalents . . . . . . . . . . . . . . . + +(1,325) + +(169) + +Net cash and cash equivalents at beginning of the period . . . . . . . . . + +867 + +(98) + +Effect of foreign exchange rate differences . . . . . . . . . . . . . . . . . + +2 + +(12) + +Net cash and cash equivalents at end of the period . . . . . . . . . . . + +9 + +(456) + +(279) + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +1. + +BASIS OF PREPARATION + +The condensed consolidated balance sheet of the Telkom SA Limited Group ("Group") as at September 30, 2002 and + +the condensed consolidated income statements, statements of changes in equity and cash flows for the six months + +ended September 30, 2001 and 2002 are unaudited. For purposes of the interim financial statements, certain + +information and disclosures normally included in financial statements prepared in accordance with generally accepted + +accounting principles have been condensed or omitted. The March 31, 2002 balance sheet was derived from the + +audited group consolidated financial statements prepared in accordance with International Accounting Standards (IAS). + +These unaudited financial statements should be read in conjunction with the audited IAS consolidated financial + +statements for the three years ended March 31, 2002. + +All adjustments of a normal recurring nature, necessary for the fair presentation of the condensed consolidated interim + +financial statements have been included herein. The results of the interim periods are not necessarily indicative of the + +results for the entire year. + +2. + +ACCOUNTING POLICIES + +The condensed consolidated interim financial statements have been prepared in accordance with and comply with + +IAS 34 Interim Financial Reporting. + +The preparation of the condensed consolidated interim financial statements requires the Group's management to make + +estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent + +assets and liabilities at the date of the condensed consolidated interim financial statements, and the reported amounts + +of revenues and expenses during the reporting period. Actual results could differ from those estimates. + +The accounting policies of the Group applied in the presentation of the accompanying unaudited condensed + +consolidated interim financial statements for the six months ended September 30, 2001 and 2002 are consistent with + +those applied in the financial statements for the year ended March 31, 2002. + +September + +September + +2001 + +2002 + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +3. + +OPERATING REVENUE + +Operating Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . + +16,523 + +18,316 + +Fixed Line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +13,473 + +14,355 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,050 + +3,961 + +Fixed Line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +13,473 + +14,355 + +Subscriptions, connections and other usage . . . . . . . . . . . . . + +2,208 + +2,239 + +Traffic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +8,495 + +8,911 + +National (local and long distance) . . . . . . . . . . . . . . . . + +4,371 + +4,510 + +Fixed-to-mobile . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,508 + +3,770 + +International (outgoing) . . . . . . . . . . . . . . . . . . . . . . + +616 + +631 + +Interconnection . . . . . . . . . . . . . . . . . . . . . . . . . . . + +626 + +825 + +Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,786 + +1,996 + +Directories and other . . . . . . . . . . . . . . . . . . . . . . . . + +358 + +384 + +4. + +IMPAIRMENT LOSSES . . . . . . . . . . . . . . . . . . . . . . + +16 + +The Group impaired the goodwill arising on the acquisition of 40% of Swiftnet (Proprietary) Limited as a result of the + +current performance of that company. + +F7 + +F8 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +September + +September + +2001 + +2002 + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +5. + +RESTRUCTURING COSTS . . . . . . . . . . . . . . . . . . . . . + +195 + +169 + +Telkom has continued to incur restructuring costs, as a result of + +a plan to reduce the workforce. 498 employees were affected + +(September 30, 2001: 1,102). + +March + +September + +2002 + +2002 + +(Audited) + +(Unaudited) + +6. + +NUMBER OF SHARES IN ISSUE + +557,031,819 ordinary shares of R10 each. + +7. + +NET ASSET VALUE PER SHARE (cents) . . . . . . . . . . . . . + +3,021.7 + +3,137.2 + +The calculation of net asset value per share is based on + +net assets of R17,475 million as at September 30, 2002 + +(March 31, 2002: R16,832 million) and + +557,031,819 (March 31, 2002: 557,031,819) issued shares. + +September + +September + +2001 + +2002 + +(Unaudited) + +(Unaudited) + +8. + +BASIC AND DILUTED EARNINGS PER SHARE (cents) . . . . + +66.6 + +115.6 + +The calculation of basic and diluted earnings per share is based + +on net profit of R644 million ( September 30, 2001: R371 million) + +and 557,031,819 (September 30, 2001: 557,031,819) issued shares. + +There are no dilution factors at present, as a result basic and + +diluted earnings per share are equal. + +September + +September + +2001 + +2002 + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +9. + +NET CASH AND CASH EQUIVALENTS . . . . . . . . . . . . . + +(456) + +(279) + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +270 + +1,085 + +Credit facilities utilized . . . . . . . . . . . . . . . . . . . . . . . . + +(726) + +(1,364) + +Unutilized banking facilities . . . . . . . . . . . . . . . . . . . . . + +R2,2 billion + +R2,2 billion + +The general banking facilities have no specific maturity date, but are + +subject to annual review. The facilities are in place to ensure + +continuing liquidity. + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +September + +September + +2001 + +2002 + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +10. + +ADDITIONS TO PROPERTY, PLANT AND EQUIPMENT + +Additions: + +Land and buildings . . . . . . . . . . . . . . . . . . . . . . . . . + +145 + +100 + +Network equipment . . . . . . . . . . . . . . . . . . . . . . . . . + +2,377 + +1,463 + +Furniture and office equipment . . . . . . . . . . . . . . . . . . . + +10 + +7 + +Data Processing equipment . . . . . . . . . . . . . . . . . . . . . + +472 + +148 + +Under construction . . . . . . . . . . . . . . . . . . . . . . . . . + +615 + +616 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +22 + +12 + +3,641 + +2,346 + +11. + +MOVEMENT IN INVENTORIES + +The majority of the group's inventories are purchased from foreign + +countries, that require a lead time of approximately three months + +before receipt in South Africa. Telkom Group practice is to place + +most of its orders during the first six months of the year. Our + +inventory level therefore decreases towards the end of the year. + +March + +September + +2002 + +2002 + +(Audited) + +(Unaudited) + +Rm + +Rm + +12. + +INTEREST BEARING DEBT + +Current portion of interest bearing debt + +Local debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,002 + +5,892 + +Foreign debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +39 + +61 + +Total current portion of interest bearing debt . . . . . . . . . . . + +2,041 + +5,953 + +Long term portion of interest bearing debt + +Local debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +16,010 + +11,011 + +Foreign debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,495 + +6,086 + +Total long term portion of interest bearing debt . . . . . . . . . . + +21,505 + +17,097 + +Movements in borrowings for the six month period ended September 30, 2002 + +Interest bearing debt in the form of commercial paper bills decreased from R2.5 billion to R1.7 billion as set out in + +Note 13 below. An additional credit facility of R148 million was extended and taken up by the Group with an + +additional loan of R79 million raised from the minority shareholders and a revolving credit of R32 million granted. + +F9 + +F10 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +13. + +ISSUES AND REPAYMENT OF INTEREST BEARING DEBT + +For the six month period ended September 30, 2002 + +New issue: + + The issuing of an extended credit facility to Vodacom Congo (R.D.C.) S.P.R.L. for R150 million. + +Repayment of debt + +The following local debt was repaid in the period under review: + + R803,6 million repayment of Commercial Paper Bills. + + R200 million repayment of locally registered debt instruments (PP01). + +Refinancing of current portion of interest bearing debt + +The refinancing of R5.9 billion of current portion of interest bearing + +debt will depend on the market circumstances at the time of + +repayment. Management believes that sufficient funding facilities + +will be available at the date of refinancing. + +14. + +PURCHASE OF MINORITY INTEREST + +On May 16, 2001, an additional 40% of Swiftnet (Proprietary) Limited was acquired for R22 million, bringing the + +Group's shareholding to 100% (See Note 4). + +March + +September + +2002 + +2002 + +(Audited) + +(Unaudited) + +Rm + +Rm + +15. + +CONTINGENCIES + +Third parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +65 + +29 + +Guarantee of employee housing loans . . . . . . . . . . . . . . . . . + +208 + +175 + +Third parties + +These amounts represent sundry disputes against third parties that are not individually significant and that the company + +does not envisage settling. + +Guarantee of employee housing loans + +Telkom guarantees to settle a certain portion of employees' housing loans. The amount guaranteed differs depending + +on factors such as employment period and salary rates. When an employee leaves the employment of Telkom, any + +housing debt guaranteed by Telkom is settled before any payment can be made over to the employee. + +The maximum amount of the guarantee in the event of default is disclosed above. + +Supplier dispute + +Expenditure of R594 million was incurred in the 2000 and 2001 financial year for the development and the installation + +of an integrated end-to-end customer assurance and activation system by Telcordia. In the 2001 financial year, the + +agreement with Telcordia was terminated and Telkom wrote off R119 million of this investment in the fixed-line + +business. Following an assessment of the viability of the assets related to the Telcordia initiative, Telkom wrote off the + +balance of these assets of R346 million in the 2002 financial year. During March 2001, the dispute was taken to + +arbitration, where Telcordia was seeking approximately $130 million plus interest at a rate of 15.5% per year for + +money outstanding and damages. In September 2002, a partial ruling was issued by the arbitrator in favour of + +Telcordia. The arbitration proceedings and any liability are not, however, expected to be finalized until late 2003 or + +early 2004. Telkom's provision of R373 million, for its estimate of probable liabilities, including interest, was + +recognized at September 30, 2002 (March 31, 2002: R375 million). + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +15. + +CONTINGENCIES (continued) + +Vodacom Congo (R.D.C.) S.P.R.L. + +The Group has a 51% equity interest through Vodacom in Vodacom Congo (R.D.C.) S.P.R.L. ("Vodacom Congo"), + +which commenced business on December 11, 2001. This investment is governed by a shareholders' agreement which + +provides the minority shareholder certain protective and participating rights. In terms of IAS 31 "Accounting for + +interest in Joint Ventures", Vodacom Congo may not be consolidated as a subsidiary as it is considered to be a joint + +venture and has been proportionally consolidated in the financial statements at March 31, 2002 and September 30, + +2002. Vodacom in terms of the shareholders' agreement is ultimately responsible for the funding of the operations of + +Vodacom Congo for the first three years. The shareholders' agreement also gives Vodacom the right to appoint + +management and the majority of the Board of the company. Vodacom also has a separate management agreement to + +manage the company on a day-to-day basis. Currently Vodacom Congo is incurring losses which are expected to + +increase in the foreseeable future. The 49% portion attributable to the joint venture partner of the liabilities and losses + +were as follows: + +March + +September + +2002 + +2002 + +(Audited) + +(Unaudited) + +Rm + +Rm + +Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(19) + +(87) + +Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(30) + +(384) + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +440 + +714 + +Preference shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(368) + +(368) + +Accordingly, the Group exposure is 50% of the above amounts. + +Furthermore, the following guarantees were approved/issued + +by Vodacom in respect of Vodacom Congo: + +Euro + +US$ + +September 30, 2002: + +Details + +Beneficiary + +m + +m + +Approved not issued + +Guarantees not yet + +ABSA Bank + +4 + +issued + +Limited + +March 31, 2002: + +Approved and issued + +Guarantee Alcatel + +ABSA Bank + +32.6 + +29.8 + +C.I.T., Alcatel Space + +Limited + +Industries and Alcatel + +Altech Telecoms (Pty) + +Ltd ("Alcatel") + +Approved not issued + +Guarantees not yet + +ABSA Bank + +51.2 + +issued + +Limited + +Accordingly, the Group exposure is 50% of the above amounts. + +16. + +COMMITMENTS + +Capital commitments authorized not committed . . . . . . . . . . + +6,680 + +3,877 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,847 + +3,049 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,833 + +828 + +Capital commitments authorized and committed . . . . . . . . . + +810 + +2,793 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +85 + +1,852 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +725 + +941 + +Management expects these commitments will be financed mainly from internally generated cash. + +F11 + +F12 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +September + +September + +2001 + +2002 + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +17. + +SEGMENT INFORMATION + +for the six months ended September 30, 2002 and 2001 + +The intercompany transactions are reflected as net and + +are thus eliminated against segment results. + +Business segments + +Consolidated revenue . . . . . . . . . . . . . . . . . . . . . . . . . + +16,523 + +18,316 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +13,658 + +14,563 + +To external customers . . . . . . . . . . . . . . . . . . . . . . . . + +13,473 + +14,355 + +Intercompany . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +185 + +208 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,762 + +4,720 + +To external customers . . . . . . . . . . . . . . . . . . . . . . . . + +3,050 + +3,961 + +Intercompany . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +712 + +759 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(897) + +(967) + +Segment operating profit . . . . . . . . . . . . . . . . . . . . . . . + +2,168 + +2,811 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,415 + +1,894 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +787 + +920 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(34) + +(3) + +Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . + +306 + +152 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +327 + +183 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +8 + +8 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(29) + +(39) + +Finance charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,845 + +1,779 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,812 + +1,660 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +62 + +158 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(29) + +(39) + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +206 + +456 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(17) + +194 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +223 + +262 + +Depreciation and amortization . . . . . . . . . . . . . . . . . . . + +2,643 + +3,106 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,159 + +2,511 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +484 + +595 + +Impairment loss/asset write-offs . . . . . . . . . . . . . . . . . . . + +16 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +16 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +March + +September + +2002 + +2002 + +(Audited) + +(Unaudited) + +Rm + +Rm + +17. + +SEGMENT INFORMATION (continued) + +at March 31, 2002 and September 30, 2002 + +Consolidated assets . . . . . . . . . . . . . . . . . . . . . . . . . . + +50,528 + +50,654 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +43,588 + +42,629 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +7,531 + +8,442 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(591) + +(417) + +Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +780 + +867 + +Financial assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,819 + +2,823 + +Tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,081 + +237 + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +55,208 + +54,581 + +Consolidated liabilities . . . . . . . . . . . . . . . . . . . . . . . . + +13,471 + +12,714 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +10,804 + +8,991 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,408 + +4,247 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(741) + +(524) + +Interest-bearing debt . . . . . . . . . . . . . . . . . . . . . . . . . . + +24,579 + +24,102 + +Tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +193 + +76 + +Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +38,243 + +36,892 + +September + +September + +2001 + +2002 + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +Other segment information + +Capital expenditure for property, plant and equipment . . . . . . + +3,641 + +2,346 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,630 + +1,487 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,011 + +859 + +F13 + +F14 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +September + +September + +2001 + +2002 + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +18. + +RELATED PARTY TRANSACTIONS + +With Joint Venture (Vodacom 50% share) + +Income + +186 + +208 + +Expenses + +712 + +759 + +Interest received + +19 + +20 + +With shareholders + +Thintana Communications LLC Management fees + +141 + +115 + +Government Revenue + +774 + +888 + +March + +September + +2002 + +2002 + +(Audited) + +(Unaudited) + +Rm + +Rm + +Related Party Balances + +With Joint Venture (Vodacom) + +Trade receivables + +16 + +41 + +Trade payables + +166 + +272 + +With shareholders + +Government Trade receivables + +170 + +134 + +Employees Other receivables + +119 + +170 + +With affiliate directors + +March 31, 2002 + +Mr. E Molobi, the Chairman of the Board of Directors on September 30, 2001 had the following interests as Chief + +Executive Officer of Kagiso Trust investments (Proprietary) Limited: + + A 25% holding by Kagiso Trust Investments (Proprietary) Limited in BUA Telecoms, a company that is a vendor to + +the Group. + + A 25% holding by Kagiso Trust Investments (Proprietary) Limited in debis Fleet Management (Proprietary) + +Limited, a fleet management company to which the Group has outsourced its vehicle fleet. + + A 50.1% holding by Kagiso Trust Investments (Proprietary) Limited in Kagiso Treasury Services (Proprietary) + +Limited who manages Telkom's treasury function. + +September 30, 2002 + +Mr. E Molobi resigned as a director of Telkom on July 11, 2002, and is no longer the Chairman of the Board of + +Directors at September 30, 2002. + +19. + +NEGATIVE WORKING CAPITAL RATIO + +For the interim period ended September 30, 2002 and the financial year ended March 31, 2002, the Telkom SA + +Limited Group had a negative working capital ratio. A negative working capital ratio arises when the Group's current + +liabilities are greater than the current assets. Current liabilities will be financed from operating cash flows, new + +borrowings and credit facilities. + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +20. + +SUBSEQUENT EVENTS + +Taxation + +The South African Revenue Services ("SARS") indicated, in an assessment dated August 28, 2002, that they are + +disallowing the treatment of certain income in Telkom's 1998 income tax return. The dispute related to the first time + +application in fiscal year ended 1998 of Section 32 ("S32") of the Income Tax Act, 1962, which allows revenue + +generated by transmitting messages internationally to be only partly included in determining taxable income, and the + +deferral of unbilled revenues for tax purposes. + +On December 10, 2002, SARS agreed with Telkom's practice of claiming S32 of the Income Tax Act, 1962, for all + +years up to and including March 2001. Telkom has not claimed S32 in respect of the 2002 financial year. SARS, + +however, disallowed Telkom's practice of deferring certain unbilled revenue from taxable income. + +The impact of the disallowance of unbilled revenue, which has been recognized as an additional income tax provision + +in the Income Statement for the year ended March 31, 2002, is as follows: + +Rm + +Reversal of tax receivable . . . . . . . . . . . . . . . . . . + +(218) + +Reversal of deferred taxation . . . . . . . . . . . . . . . . + +186 + +Reversal of interest accrued . . . . . . . . . . . . . . . . . + +(100) + +Tax effect of interest reversal . . . . . . . . . . . . . . . . + +30 + +(102) + +In connection with the filing of its tax return for the 2001 fiscal year, Telkom revised the basis of its calculation and + +increased its estimate of the S32 benefit used for the preparation of the March 31, 2001 financial statements by an + +amount of R92 million. The revision has been recognized as a change in estimate and reflected as a reduction of the + +income tax provision for the year ended March 31, 2002. + +The tax impact of the above is reflected in the determination of the tax provision for the fiscal year ended March 31, + +2002. + +Other + +The directors are not aware of any other matter or circumstance arising since the end of the financial period, not + +otherwise dealt with in the condensed consolidated interim financial statements, which significantly affects the + +financial position of the Group and the results of its operations. + +21. + +US GAAP INFORMATION + +Differences between International Accounting Standards and US Generally Accepted Accounting Principles + +The condensed consolidated interim financial statements of Telkom SA Ltd have been prepared in accordance with + +International Accounting Standards ("IAS"), which differ in certain respects from generally accepted accounting + +principles in the United States ("US GAAP"). Application of US GAAP would have affected the unaudited + +consolidated balance sheet as of September 30, 2002 and unaudited consolidated net income for the six month periods + +ended September 30, 2001 and 2002 to the extent described below. A description of the material differences between + +IAS and US GAAP as they relate to Telkom SA Limited and subsidiaries ("the Group"), as well as its equity + +accounted investment in Vodacom, are discussed in further detail below. + +*The United States Dollar (USD) amounts shown in the footnotes have been translated at September 30, 2002 and for + +the six month period ended September 30, 2002 from South African Rand ("ZAR") only as a matter of arithmetic + +computation at the South African exchange rate of ZAR10.535 = USD 1, the buying rate on September 30, 2002, the + +date of our most recent balance sheet included in this reconciliation. These amounts are unaudited and are included + +for the convenience of the reader only. Such translation should not be construed as a representation that the South + +African Rand amounts have been or could be converted into US Dollars at this or any other rate. + +The accompanying unaudited condensed consolidated interim financial statements should be read in conjunction with + +the audited consolidated financial statements of Telkom SA Limited and subsidiaries for the year ended March 31, + +2002. + +The accounting policies of the company applied in the presentation of the reconciliations of shareholders equity as of + +September 30, 2002 and net income for the six month periods ended September 30, 2001 and 2002 are consistent with + +those applied in the audited financial statements referred to above, except for the application of SFAS 142, "Goodwill + +and Other Intangible Assets", effective as of April 1, 2002. + +F15 + +F16 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +Net income and equity in accordance with US GAAP differences + +The following schedule illustrates the significant adjustments to reconcile net income in accordance with IAS to the + +amounts determined in accordance with US GAAP for the six month periods ended September 30, 2001 and 2002. + +September 30, + +September 30, *September 30, + +2001 + +2002 + +2002 + +(Unaudited) + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +US$m + +Net income according to IAS . . . . . . . . . . . . . . . . . . . . + +371 + +644 + +61 + +US GAAP adjustments Telkom: + +(a) Revenue recognition . . . . . . . . . . . . . . . . . . . . . . . + +(3) + +42 + +4 + +(b) Sale and leaseback transaction . . . . . . . . . . . . . . . . . . + +48 + +50 + +5 + +(c) Share issue expenses . . . . . . . . . . . . . . . . . . . . . . . + +(32) + +44 + +4 + +(d) Derivative financial instruments . . . . . . . . . . . . . . . . . + +46 + +38 + +4 + +(e) Goodwill and amortization . . . . . . . . . . . . . . . . . . . . + +16 + +2 + +(e) Goodwill impairment . . . . . . . . . . . . . . . . . . . . . . . + +(16) + +(2) + +(h) Tax effect of reconciling differences . . . . . . . . . . . . . . . + +(34) + +(49) + +(4) + +(h) Additional distribution tax retained earnings . . . . . . . . . . + +11 + +(19) + +(2) + +(h) Capital gains tax Vodacom income . . . . . . . . . . . . . . . + +(25) + +(2) + +US GAAP adjustments Vodacom: + +(d) Derivative financial instruments . . . . . . . . . . . . . . . . . + +13 + +2 + +(e) Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1) + +24 + +2 + +(f) Joint venture accounting . . . . . . . . . . . . . . . . . . . . . + +8 + +(g) Deferred bonus incentive scheme . . . . . . . . . . . . . . . . + +5 + +(14) + +(1) + +(h) Tax effect of reconciling differences . . . . . . . . . . . . . . . + +(5) + +4 + +Net income as per US GAAP before cumulative effect of change + +in accounting principles . . . . . . . . . . . . . . . . . . . . . . + +427 + +741 + +71 + +(d) + +Cumulative effect of a change in accounting principle reflecting + +the application of SFAS 133 Telkom (net of tax of R29m) . . + +48 + +(d) + +Cumulative effect of a change in accounting principle reflecting + +the application of SFAS 133 Vodacom (net of tax of R3m) . . + +6 + +(e) + +Cumulative effect of change in accounting principle reflecting + +the application of SFAS 142 (net of tax of Nil) . . . . . . . . . + +16 + +2 + +Net income according to US GAAP . . . . . . . . . . . . . . . . + +481 + +757 + +73 + +Basic and diluted earnings per share + +The basic and diluted earnings per share do not differ, as there are + +no potentially dilutive securities. + +557,031,819 issued shares + +Basic and diluted earnings per share before cumulative effect of + +change in accounting principle (cents) . . . . . . . . . . . . . . . . + +76.4 + +132.9 + +12.9 + +Basic and diluted earnings per share for cumulative effect of . . . . + +change in accounting principle (cents) . . . . . . . . . . . . . . . . + +10 + +3 + +Basic and diluted earnings per share (cents) . . . . . . . . . . . . . + +86.4 + +135.9 + +12.9 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +The following is a reconciliation of the material adjustments necessary to reconcile shareholders' equity in accordance with + +IAS to the amounts in accordance with US GAAP as at March 31, 2002 and September 30, 2002. + +March 31, + +September 30, *September 30, + +2002 + +2002 + +2002 + +(Audited) + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +US$m + +Shareholders' equity according to IAS . . . . . . . . . . . + +16,832 + +17,475 + +1,659 + +US GAAP adjustments Telkom: + +(a) Revenue recognition . . . . . . . . . . . . . . . . . . . . + +(1,105) + +(1,063) + +(101) + +(b) Sale and leaseback transaction . . . . . . . . . . . . . . . + +(277) + +(227) + +(22) + +(d) + +Derivative financial instruments fair value hedges at + +adoption of FAS133 . . . . . . . . . . . . . . . . . . . . + +(34) + +(28) + +(3) + +(e) Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . + +15 + +31 + +3 + +(h) Tax effect of reconciling differences . . . . . . . . . . . . + +535 + +498 + +47 + +(h) Additional distribution tax retained earnings . . . . . . + +(423) + +(442) + +(42) + +(h) Capital gains tax Vodacom income . . . . . . . . . . . + +(43) + +(68) + +(6) + +US GAAP adjustments Vodacom: + +(e) Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . + +15 + +34 + +3 + +(f) Joint venture accounting . . . . . . . . . . . . . . . . . . + +(g) Deferred bonus incentive scheme . . . . . . . . . . . . . + +29 + +15 + +1 + +(h) Tax effect of reconciling differences . . . . . . . . . . . . + +(9) + +(5) + +Shareholders' equity according to US GAAP . . . . . . . + +15,535 + +16,220 + +1,539 + +Comprehensive income + +Under US GAAP, SFAS 130 "Reporting Comprehensive Income" requires that certain items be recognized as a separate + +component of equity under the caption "Accumulated Other Comprehensive income". Additionally the standard requires + +that companies present comprehensive income, which is a combination of net income and changes in a company's + +accumulated other comprehensive income accounts. Changes in the Group's accumulated other comprehensive accounts are + +reflected under non-distributable reserves. + +Non- + +Retained earnings + +distributable + +Balance + +reserves + +Rm + +Rm + +Rm + +Total March 31, 2001 (audited) . . . . . . . . . . . . . . . . + +5,438 + +45 + +5,483 + +Net income per US GAAP for the period ended + +September 30, 2001 (unaudited) . . . . . . . . . . . . . . . . + +481 + +5,919 + +Foreign currency translation adjustment (unaudited) . . . . . . + +12 + +12 + +Transitional adjustment on application of SFAS 133 to net income + +for the period ended September 30, 2001 (net of tax of R262 m) + +(unaudited) + +. . . . . . . . . . . . . . . . . . . . . . . . . . . . + +440 + +Release of transitional adjustment in application of SFAS 133 to + +net income for the six month period September 30, 2001 (net of + +tax of R19 m) (unaudited) . . . . . . . . . . . . . . . . . . . . + +(34) + +406 + +Increase in fair value of investment (unaudited) . . . . . . . . + +45 + +Total September 30, 2001 (unaudited) . . . . . . . . . . . . + +5,919 + +463 + +6,382 + +F17 + +F18 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +Non- + +Retained + +distributable, + +Balance + +earnings + +reserves + +Rm + +Rm + +Rm + +Total March 31, 2002 (audited) . . . . . . . . . . . . . . . . + +6,755 + +487 + +7,242 + +Net income per US GAAP for the six month period ended + +September 30, 2002 (unaudited) . . . . . . . . . . . . . . . . + +757 + +7,512 + +Foreign currency translation adjustment (unaudited) . . . . . . + +(28) + +36 + +Release of transitional adjustment on application of SFAS 133 to + +net income for the six month period ended September 30, 2002 + +net of tax R13m (unaudited) . . . . . . . . . . . . . . . . . . + +(22) + +351 + +Decrease in fair value of investment (unaudited) . . . . . . . . + +(22) + +28 + +Total September 30, 2002 (unaudited) . . . . . . . . . . . . + +7,512 + +415 + +7,927 + +Movement in shareholders' equity in accordance with + +US GAAP + +March 31, + +September 30 + +September 30, + +2002 + +2002 + +2002 + +(Audited) + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +US$m + +Balance April 1 . . . . . . . . . . . . . . . . . . . . . . . . . + +13,776 + +15,535 + +1,474 + +Net income for the period . . . . . . . . . . . . . . . . . . . . + +1,317 + +757 + +72 + +Foreign currency reserves . . . . . . . . . . . . . . . . . . . . + +64 + +(28) + +(3) + +Fair value adjustments derivatives . . . . . . . . . . . . . . + +373 + +(22) + +(2) + +Decrease in fair value of investment . . . . . . . . . . . . . . + +5 + +(22) + +(2) + +Balance March 31, 2002 and September 30, 2002 . . . . . . . + +15,535 + +16,220 + +1,539 + +(a) + +Revenue recognition + +The Staff of the US Securities and Exchange Commission issued Staff Accounting Bulletin 101 (SAB 101) that + +addresses revenue recognition under US GAAP. Under this guidance, revenue earned from access, installation- + +activation and similar fees should be recognized over the estimated life of the customer relationship. Also, SAB 101 + +permits, but does not require, companies to defer costs directly associated with such revenue and to also recognize + +these costs over the life of the customer relationship. Under IAS the Group recognizes this revenue and related costs + +when the services are provided and the related costs are incurred. + +In accordance with US GAAP, revenue earned from installation and activation is deferred and recognized over the + +expected period of the customer relationship. The expected period of the customer relationship is 8 years + +(2001 8.5 years) for telephony voice customers and 4 years (2001 4 years) for data customers. The Group + +recognizes installation and activation costs, excluding those costs that are capitalized as an integral part of the network, + +in the period incurred. These adjustments resulted in a decrease of R3m and an increase of R42m to income for the + +six month periods ended September 30, 2001 and 2002, respectively. + +(b) + +Sale and lease-back + +Telkom outsourced its entire fleet of vehicles as well as the maintenance, fueling, insurance, tracking and other + +services to debis through a sale and lease-back agreement. The lease-back was in the form of a master service level + +agreement covering a period of five years providing, subject to Telkom's requirements, for the annual lease contracts + +for each vehicle under the agreement. + +Under the provisions of IAS 17, the Group recorded a gain from a transaction that had transferred substantially all of + +the risks and rewards incidental to ownership of the vehicles to debis as the criteria for profit recognition had been + +satisfied. The Group recognized a gain in the amount of R463m in 2000 and accounted for the lease-backs as operating + +leases. + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +Under US GAAP, SFAS 13, as amended by SFAS 28, the Group determined that while the terms of the agreement + +provide that the assets underlying the lease-back would be subject to annual lease contract, renewable based upon + +Telkom's vehicle requirements and cancelable under certain terms, debis' right of first refusal to provide all of the + +Group's requirements during the five year term represents an economic compulsion to renew the leases. Accordingly, + +the Group concluded, that since the lease-back covers substantially all the assets that were sold under the contract for + +substantially all their remaining useful lives, deferral of the related gain and recognition over the term of the related + +agreements was appropriate. + +Based on the requirements of SFAS 13, a selected portion of the vehicle leases would be treated as finance leases due + +to the fact that when analyzed on a vehicle by vehicle basis, the present value of the minimum lease payments of + +certain individual vehicles exceed 90% of the fair value of these vehicles or the lease term represents more than 75% + +of the remaining economic life of the vehicles. Accordingly, the full gain realized through the sale of the vehicles has + +been reversed and the proceeds from the sale has been treated as an obligation. Rental payments have been applied to + +interest expense on the obligation as well as to reduce the principal amount of the obligation. The resulting capital + +lease assets are being depreciated over their remaining useful lives. + +(c) + +Share issue expenses + +Under IAS, external costs directly attributable to the issue of new shares are shown as a deduction, in equity. + +This is only allowed under US GAAP however, when the proposed listing has not been delayed more than 90 days + +after incurring these costs. In 2002, Telkom's IPO was postponed more than 90 days. Therefore the costs incurred + +through September 30, 2001 related to the IPO of R32m have been expensed for US GAAP purposes. For IAS + +purposes, during the September 2002 period a decision was made to expense the IPO costs previously capitalized to + +the value of R44m. + +The Board resolved to write off previously capitalized share issue expenses as Telkom does not intend to issue new + +shares as part of its initial public offering. + +(d) + +Derivative financial instruments + +SFAS 133 Fair value adjustments + +The Group adopted IAS 39 and SFAS 133 on April 1, 2001. Upon adoption of IAS 39, the difference between previous + +carrying amounts and the fair value of derivatives, which prior to the adoption of IAS 39 had been designated as cash + +flow hedges or fair value hedges but which do not qualify for hedge accounting under IAS 39, is recognized as an + +adjustment to the opening balance of retained earnings in the financial year IAS 39 is initially applied. Changes in the + +fair value of derivatives subsequent to April 1, 2001 are recorded in the income statement as they do not qualify for + +hedge accounting. + +Under US GAAP, in accordance with SFAS 133, the company is required to recognize all derivatives on the balance + +sheet at fair value. The SFAS 133 transitional adjustments (at April 1, 2001) are recorded differently than those + +recorded under IAS 39. For pre-existing hedge relationships that would be considered cash flow type hedges, the + +transitional adjustment should be reported in Other Comprehensive Income as a cumulative effect of the accounting + +change. Any transition adjustment reported as a cumulative effect adjustment in Other Comprehensive Income will + +subsequently be reclassified into earnings in a manner consistent with the earnings effect of the hedged transaction. For + +pre-existing hedge relationships that would be considered fair value type hedges, the company adjusted the carrying + +values of the hedged item to its fair value, but only to the extent of an offsetting transition adjustment from the + +previously designated hedging instrument. For the six month periods ended September 30, 2001 and 2002, the Group + +amortized R6m and R6m respectively of the adjustments to the hedged debt instruments into earnings. The hedged + +asset or liability is subsequently accounted for in a manner consistent with the appropriate accounting for such assets + +and liabilities. For both cash flow and fair value hedges any portion of the derivative that is considered ineffective at + +transition is reported in income as a cumulative effect of an accounting change. + +Upon adoption on April 1, 2001, the Group recorded an adjustment to other comprehensive income of R440m (net of + +tax of R262m) representing the fair value adjustment of derivatives for which the pre-existing hedge relationships + +would be considered cash flow type hedges. For the six month periods ended September 30, 2001 and 2002, + +subsequent to the adoption date, the Group reclassified from other comprehensive income into earnings R34m (net of + +tax of R19m) and R22m (net of tax of R13m) respectively as the hedged transaction impacted earnings. Upon + +adoption, the Group also recorded an adjustment of R45m to increase the carrying value of a hedged debt instrument + +that was the hedged item in what would be considered a fair value type hedge. The fair value adjustment to the hedged + +item is limited to the extent of an off-setting fair value adjustment to the hedging instrument. Upon adoption, the + +Group recorded, a cumulative effect of change in accounting principal, R54m (net of tax of R33m) representing the + +ineffective portion of adjustments to record derivatives at fair value. + +F19 + +F20 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +(e) + +Goodwill + +Under IAS, goodwill arising on the acquisition of a foreign entity is treated as an asset of the Group and translated at + +the foreign exchange rate in effect at transaction date. In accordance with IAS the Group amortizes goodwill and other + +intangibles on a straight line basis over the anticipated period of benefits. + +Under US GAAP, goodwill arising on the acquisition of a foreign entity is translated at the actual exchange rate at the + +end of the period. Furthermore, under US GAAP with effect from July 1, 2001 goodwill and intangibles with infinite + +lives are not amortized for business combinations completed after June 30, 2001. For previously recorded goodwill and + +intangibles with infinite lives, amortization ceases on March 31, 2002. + +The Group has adopted SFAS 142 "Accounting for Goodwill and Other Intangibles" effective April 1, 2002. The + +Group completed the initial step of a transitional impairment test on all goodwill and indefinite lived intangible assets + +as of April 1, 2002 within six months of adoption of SFAS 142. + +Management determined that an impairment of R16m existed with respect to the step acquisition of the minority + +interest of Swiftnet which has been recognized as a cumulative effect of accounting change in the 2003 fiscal year. The + +impairment loss has been reflected in operating loss in the IAS income statement. + +Had Telkom applied SFAS 142 for the six months ended September 30, 2001, the pro forma effects on earnings + +would have been as follows (in millions of ZAR, except per share amounts): + +Income before cumulative effect of accounting change . . . . . . . . . . . . . . . . . . . . + +425 + +Net income according to US GAAP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +479 + +Basic and diluted per share income before cumulative effect of accounting change (cents) . + +76.3 + +Basic and diluted net income per share (cents) . . . . . . . . . . . . . . . . . . . . . . . . . + +85.9 + +(f) + +Joint venture accounting + +Under IAS, investments qualifying as joint ventures are accounted for under the proportionate consolidation method of + +accounting. Under the proportionate consolidation method, the venturer records its share of each of the assets, + +liabilities, income and expenses of the jointly controlled entity on a line-by-line basis with similar items in the + +venturer's financial statements. + +The venturer continues to record its total share of the losses in excess of the net investment in the joint venture. + +However for US GAAP purposes where the joint ventures are equity accounted, losses are only recognized up to the + +net investment in the joint venture, unless the investor has committed to continue providing financial support to the + +investee. For the 6 month period ended September 30, 2001, in accordance with IAS, the Group proportionately + +consolidated losses of R8m, that was in excess of the Group's net investment in the joint venture. Under US GAAP + +these losses are not recorded for reasons previously stated. + +Vodacom equity accounted earnings + +Under IAS, the Group's interests in joint ventures are proportionally consolidated. Under US GAAP, interest in joint + +ventures not meeting the criteria for accommodation under item 17 of Form 20-F should be reflected in the + +consolidated financial statements using the equity method. The following table sets out the restated abbreviated income + +statement and balance sheet of the Group joint venture company, Vodacom after US GAAP adjustments: + +September 30, + +September 30, *September 30, + +2001 + +2002 + +2002 + +(Unaudited) + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +US$m + +Income statements as per US GAAP + +Operating income . . . . . . . . . . . . . . . . . . . . . + +1,585 + +1,849 + +176 + +Income after financial items . . . . . . . . . . . . . . . + +1,504 + +1,562 + +149 + +Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(583) + +(628) + +(60) + +Minority interests . . . . . . . . . . . . . . . . . . . . . + +(96) + +(9) + +Net income before accounting changes . . . . . . . . . + +921 + +838 + +80 + +Change in accounting policy . . . . . . . . . . . . . . . + +11 + +Net income for the period . . . . . . . . . . . . . . . . + +932 + +838 + +80 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +March 31, + +September 30, *September 30, + +2002 + +2002 + +2002 + +(Audited) + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +US$m + +Balance sheets as per US GAAP + +Non-current assets . . . . . . . . . . . . . . . . . . . . + +11,429 + +11,830 + +1,123 + +Current assets . . . . . . . . . . . . . . . . . . . . . . . + +3,990 + +5,404 + +513 + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . + +15,419 + +17,234 + +1,636 + +Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,874 + +5,654 + +537 + +Minority interests . . . . . . . . . . . . . . . . . . . . . + +11 + +102 + +9 + +Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . + +10,534 + +11,478 + +1,090 + +Total equity and liabilities . . . . . . . . . . . . . . . . + +15,419 + +17,234 + +1,636 + +(g) + +Deferred bonus incentive scheme + +Under IAS, the total value of deferred bonus entitlements as calculated at the end of each financial period are provided + +for in full on the balance sheet date, based on the net present value of expected future cash flows. Under US GAAP, + +compensation cost should be recognized over the service period or the vesting period if the service period is not + +defined, based upon the undiscounted value of the entitlements. + +(h) + +Income taxes + +Deferred tax benefits and liabilities are calculated, when applicable, for the differences between IAS and US GAAP. + +Telkom is taxed at a corporate tax rate of 30% on taxable income. Telkom incurs an additional Secondary Tax on + +Companies (STC) at a rate of 12.50% on any dividends distributed to shareholders. The dividend tax is payable if and + +only when dividends are distributed. Neither the Company nor the shareholders receive any future tax benefits as a + +result of additional tax on dividends paid. As required under IAS, Telkom will recognize the tax effects of dividends + +when distributed in the future. Under US GAAP, consistent with the requirements of EITF 95-9, the company + +measures its income tax expense, including the tax effect of temporary differences, using the tax rate that includes the + +dividend tax. STC is calculated on retained income after the 1992 fiscal year after deducting the effects of certain + +capital transactions as defined. + +With respect to the Group's investment in Vodacom SFAS 109 requires that deferred taxes be recognized for the effect + +of the excess of the amount of financial reporting over the tax basis of such investment. According to South African tax + +law, the Group would be required to pay tax at a rate of 37.78% on any increase in the appreciation in the value of its + +investment since October 1, 2001. As such, deferred taxes have been recognized on the Group's share of the + +undistributed earnings of Vodacom since October 1, 2001. + +Deferred tax + +The tax effects of the US GAAP adjustments relating to Telkom's operations have been calculated based on a tax rate + +of 37.78%. + +(i) + +Employee benefits + +There is a difference in treatment of the transitional asset/liability on adoption of the statements under IAS and US + +GAAP. In terms of FAS 87, this is amortized on a straight line basis over the remaining lifetime of the fund at that + +time. In terms of IAS 19, if this is a "liability" or deficit, this is either recognized immediately or alternatively + +amortized over a period of 5 years. In the event of a net asset arising, the full amount is recognized immediately. The + +effects of these differences have been immaterial to the reconciliation. + +Furthermore, IAS 19 determines that the employer limits the extent of any asset recognized on the balance sheet by the + +employer to the true economic benefit available, whereas FAS 87 does not. To the extent that the "expense" calculated + +under FAS 87 is less than the actual contribution made, an asset will build up in the company accounts. IAS 19 + +recognizes the SA legislative position on surplus in allowing the limitation of the extent of any asset recognized to + +such as is available for the economic benefit of the employer. As no surplus has been apportioned to the employer, in + +terms of IAS 19, the asset is limited to zero. This has the impact of adjusting the expense recognized in the income + +statement to the employer's actual contribution for the period concerned. + +F21 + +F22 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +The disclosure of the retirement fund and pension fund unrecognized asset would be as follows under US GAAP: + +March 31, + +September 30, *September 30, + +2002 + +2002 + +2002 + +(Audited) + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +US$m + +Telkom retirement fund + +Present value of the funded obligation . . . . . . . . . . + +3,055 + +2,823 + +268 + +Fair value of plan asset . . . . . . . . . . . . . . . . . . + +(3,805) + +(3,609) + +(343) + +Funded status . . . . . . . . . . . . . . . . . . . . . . . + +(750) + +(786) + +(75) + +Unrecognized net actuarial gain . . . . . . . . . . . . . + +437 + +366 + +35 + +Unrecognized surplus . . . . . . . . . . . . . . . . . . . + +(313) + +(420) + +(40) + +March 31, + +September 30, *September 30, + +2002 + +2002 + +2002 + +(Audited) + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +US$m + +Telkom pension fund + +Present value of the funded obligation . . . . . . . . . . + +113 + +124 + +12 + +Fair value of plan asset . . . . . . . . . . . . . . . . . . + +(190) + +(213) + +(20) + +Funded status . . . . . . . . . . . . . . . . . . . . . . . + +(77) + +(89) + +(8) + +Unrecognized net actuarial gain . . . . . . . . . . . . . + +53 + +52 + +4 + +Unrecognized surplus . . . . . . . . . . . . . . . . . . . + +(24) + +(37) + +(4) + +Additional US GAAP disclosures + +Restructuring + +During the six-month periods ended September 31, 2001 and 2002, the Group had recognized the cost of restructuring + +charges associated with management's plan to reduce the size of its work force to a comparable level for world-class + +telecommunication companies. The plan involved the termination of employees, which the Group expects to be + +substantially completed within a period of 12 months. + +The 2002 plan affects 498 employees who ceased their service for the six month period to September 30, 2002 and + +1,248 employees who will cease their services during 2002/2003 and were still employed by the Group at + +September 30, 2002. These employees include operating personnel and product development and corporate staff. + +The following table provides a roll forward of restructuring provisions recognized by the Group for the year ended + +March 31, 2002 and for the six-month period ended September 30, 2002. + +March 31, + +September 30, *September 30, + +2002 + +2002 + +2002 + +(Audited) + +(Unaudited) + +(Unaudited) + +Rm + +Rm + +US$m + +Restructuring provision beginning of period . . . . . . + +35 + +3 + +Workforce reduction payments . . . . . . . . . . . . . . + +(338) + +(169) + +(16) + +Increase in provision . . . . . . . . . . . . . . . . . . . + +373 + +244 + +23 + +Restructuring provision end of period . . . . . . . . . + +35 + +110 + +10 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +Recently issued accounting standards + +SFAS 142 addresses the initial and ongoing financial accounting and reporting for acquired goodwill and other + +intangible assets. SFAS 142 requires that goodwill be separately disclosed from other intangible assets in the balance + +sheet, and no longer be amortized but tested for impairment at least annually (or more frequently if impairment + +indicators arise). SFAS 142 is effective for financial statements for periods beginning on or after December 15, 2001. + +Additionally, the amortization provisions of SFAS 142 are applicable to goodwill arising in all business acquisitions + +consummated after June 30, 2001 regardless of the adoption date of SFAS 142. Accordingly, goodwill arising from the + +increased investment in Telkom Directory Services is not subject to amortization. + +The Group has adopted SFAS 142 on April 1, 2002. The Group has completed the initial step of a transitional + +impairment test on adoption of SFAS 142. An impairment charge of R16m related to the investment in one of the + +subsidiaries Swiftnet was recognized as a result of the adoption of SFAS 142. This impairment loss has been reflected + +in operating loss in the IAS income statement. + +In August 2001, the FASB issued SFAS 143, "Accounting for Obligations Associated with the Retirement of Long- + +Lived Assets." SFAS 143 addresses financial accounting and reporting for the retirement obligation of an asset. This + +statement states that companies should recognize the asset retirement cost, at their fair value, as part of the cost of the + +asset and classify the accrued amount as a liability in the consolidated balance sheet. The asset retirement liability is + +then accredited to the ultimate payout as interest expense. The initial measurement of the liability would be + +subsequently updated for revised estimates of the discounted cash outflows. The Statement will be effective for fiscal + +years beginning after June 15, 2002. The Group does not expect the application of SFAS 143 to have a material effect + +on its US GAAP earnings and position. + +In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." + +SFAS 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived + +assets to be disposed. The Statement will be effective for fiscal years beginning after December 15, 2001. The Group + +does not expect the application of SFAS 144 to have a material effect on its US GAAP earnings and position. + +In April 2002, the FASB issued SFAS 145 "Rescission of SFAS 4, 44, and 64, Amendment of SFAS 13, and Technical + +Corrections". This Statement rescinds SFAS 4 "Reporting Gains and Losses from Extinguishment of Debt", and an + +amendment of that Statement, SFAS 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". + +SFAS 144 also rescinds SFAS 44, "Accounting for Intangible Assets of Motor Carriers". SFAS 144 amends SFAS 13, + +Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions + +and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback + +transactions. This Statement also amends other existing authoritative pronouncements to make various technical + +corrections, clarify meanings, or describe their applicability under changed conditions. The Group does not expect the + +application of SFAS 145 to have a material effect on its US GAAP earnings and financial position. + +In 2002, the FASB issued SFAS 146 "Accounting for Costs Associated with Exit or Disposal Activities". This + +Statement addresses the financial accounting and reporting for costs associated with exit or disposal activities and + +nullifies EITF Issue No 94.3 "Liability Recognition for Certain Employees termination Benefits and Other Costs to + +Exit an Activity (including Certain Costs Incurred in a Restructuring)". SFAS 146 requires that a liability for a cost + +associated with an exit or disposal activity be recognized when the liability is incurred. This liability does not arise + +when the Company has only committed to a plan, the fundamental criteria of EITF 94-3. In addition, fair value is the + +objective for initial measurement of the liability. This standard is effective for exit or disposal activities that are + +initiated after December 31, 2002, with early application encouraged. The Group does not expect the application of + +SFAS 146 to have a material effect on its US GAAP earnings and financial position. + +In November 2002, the Emerging Issues Task Force reached a final consensus related to Revenue Arrangements with + +Multiple Deliverables (EITF 00-21). The consensus requires that revenue arrangements with multiple deliverables + +should be divided into separate units of accounting if (a) a delivered item has value to the customer on a stand alone + +basis, (b) there is objective and reliable evidence of the fair value of the undelivered item and (c) if the arrangement + +includes a general right of return, delivery or performance of the undelivered items is considered probable and + +substantially in the control of the vendor. Arrangement consideration should be allocated among the separate units of + +accounting based on their relative fair value and appropriate revenue recognition criteria would be applied to each + +separate unit of accounting. The Group has not yet determined what effect, if any, EITF 00-21 would have on revenue + +and net income determined in accordance with US GAAP. The Task Force agreed the effective date for the consensus + +will be for all revenue arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption + +permitted. + +The Group will adopt EITF 00-21 for their fiscal year beginning April 1, 2004. + +F23 + +F24 + +TELKOM SA LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +US GAAP INFORMATION (continued) + +Recently issued accounting standards (continued) + +In December 2002, the FASB issued Statements of Financial Accounting Standards No 148, "Accounting for Stock- + +Based Compensation Transition and Disclosure an amendment of FAS 123". Under FAS 148, the statement provides + +alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based + +employee compensation. In addition, this statement amends the disclosure requirements of Statement 123 to require + +prominent disclosure on both annual and interim financial statements about the method of accounting for stock-based + +employee compensation and the effect of the method used on reported results. The amendments to Statement 123 in + +paragraphs 2(a)-2(e) of this statement shall be effective for financial statements for fiscal years ending after December 15, + +2002. Earlier application of the transition provisions in paragraphs 2(a)-2(d) is permitted for entities with a fiscal year + +ending prior to December 15, 2002, provided that financial statements for the 2002 fiscal year have not been issued as + +of the date this Statement is issued. Early application of the disclosure provisions in paragraph 2(e) is encouraged. The + +Group has determined that this statement will have no impact on its financial statements for the periods presented as it + +does not have any stock based compensation plans. + +In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure + +Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others an interpretation of FASB + +Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34" ("FIN 45"). This interpretation elaborates + +on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under + +certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a + +guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This interpretation does + +not prescribe a specific approach for subsequently measuring the guarantor's recognized liability over the term of the + +related guarantee. This interpretation also incorporates, without change, the guidance in FASB Interpretation No. 34, + +Disclosure of Indirect Guarantees of Indebtedness of Others, which is being superseded. The initial recognition and + +initial measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or + +modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. The disclosure requirements in this + +Interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The + +interpretive guidance incorporated without change from Interpretation 34 continues to be required for financial + +statements for fiscal years ending after June 15, 1981 the effective date of Interpretation 34. The Group is currently + +evaluating the impact of recognizing the fair value of certain guarantees that it has issued. + +In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities an + +interpretation of ARB No. 51 " ("FIN 46"). This interpretation of Accounting Research Bulletin No. 51. Consolidated + +Financial Statements, addresses consolidation by business enterprises of variable interest entities which have one or + +both of the following characteristics: + +1. + +The equity investment at risk is not sufficient to permit the entity to finance its activities without additional + +subordinated financial support from other parties, which is provided through other interests that will absorb some + +or all of the expected losses of the entity. + +2. + +The equity investors lack one or more of the following essential characteristics of a controlling financial interest: + +a. + +The direct or indirect ability to make decisions about the entity's activities through voting rights or similar + +rights. + +b. + +The obligation to absorb the expected losses of the entity if they occur, which makes it possible for the entity + +to finance its activities. + +c. + +The right to receive the expected residual returns of the entity if they occur, which is the compensation for the + +risk of absorbing the expected losses. + +This Interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable + +interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim + +period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it + +acquired before February 1, 2003. The Interpretation applies to public enterprises as of the beginning of the applicable + +interim or annual period, and it applies to nonpublic enterprises as of the end of the applicable annual period. + +This Interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first + +applied or by restating previously issued financial statements for one or more years with a cumulative-effect + +adjustment as of the beginning of the first year restated. The Group is still evaluating the impact of this interpretation + +on its financial statements. + +F25 + +P.O.Box: + +35296 + +P.O.Box: + +11007 + +MENLO PARK 0102 + +HATFIELD 0028 + +Tel: + +(012) 429 0000 + +Tel: + +(012) 482 0000 + +Fax: + +(012) 429 0100 + +Fax: + +(012) 460 3633 + +REVIEW REPORT OF THE INDEPENDENT ACCOUNTANTS + +to the Members of Vodacom Group (Proprietary) Limited + +We have reviewed the accompanying condensed consolidated balance sheet of Vodacom Group (Proprietary) Limited and + +its subsidiaries ("the Group") as at September 30, 2002, and the related condensed consolidated statements of income, + +shareholders' equity and cash flows for the six month periods ended September 30, 2002 and 2001 set out on pages F26 + +to F47. These condensed consolidated interim financial statements are the responsibility of the Company's directors. Our + +responsibility is to issue a report on the interim financial information based on our review. + +We conducted our review in accordance with standards established by the American Institute of Certified Public + +Accountants. Those standards require that we plan and perform the review to obtain moderate assurance that the interim + +financial information is free of material misstatement. A review of the interim financial information consists principally of + +applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting + +matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in + +the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken + +as a whole. We have not performed an audit and, accordingly we do not express such an opinion. + +Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed + +consolidated interim financial statements for them to be in conformity with International Accounting Standards 34 Interim + +Financial Reporting. + +We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated + +balance sheet of the Group as of March 31, 2002, and the related consolidated statements of income, shareholders' equity, + +and cash flows for the year then ended, and in our report dated June 11, 2002, except for note 44, as to which the date is + +October 15, 2002, we expressed, based on our audit, an unqualified opinion on those consolidated financial statements as + +well as drew attention to the Group's change in accounting policy for financial instruments to conform with International + +Accounting Standards 39 Financial Instruments: Recognition and measurement and to certain restatements regarding the + +consolidated financial statements of the Group as issued previously. + +In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of March 31, 2002, + +is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. + +International Accounting Standards vary in certain significant respects from accounting principles generally accepted in the + +United States of America. Application of accounting principles generally accepted in the United States of America would + +have affected the consolidated shareholders' equity as of September 30, 2002 and 2001 and the consolidated net profit for + +each of the six month periods ended September 30, 2002 and September 30, 2001 to the extent summarized in Note 20 to + +the unaudited condensed consolidated interim financial statements. + +Registered Accountants and Auditors + +Registered Accountants and Auditors + +Chartered Accountants (SA) + +Chartered Accountants (SA) + +Pretoria + +Pretoria + +December 12, 2002 + +December 12, 2002 + +A complete list of partners is available from any of our offices + +Joint auditors + +PricewaterhouseCoopers Inc + +Chartered Accountants (SA) + +Registered Accountants and Auditors + +(Registration no 1998/012055/21) + +Deloitte & Touche Chartered Accountants (SA) + +Registered Accountants and Auditors + +F26 + +VODACOM GROUP (PROPRIETARY) LIMITED + +CONDENSED CONSOLIDATED INCOME STATEMENTS + +for the six months ended September 30, 2002 and 2001 + +For the six months ended + +September 30, + +2001 + +2002 + +Rm + +Rm + +Notes + +(unaudited) + +(unaudited) + +Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4 + +7,522.2 + +9,440.8 + +Direct network operating cost . . . . . . . . . . . . . . . . . . . . . . . . + +(3,931.4) + +(5,320.6) + +Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(863.4) + +(1,084.8) + +Other operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1.7 + +8.3 + +Staff expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(506.9) + +(501.7) + +Marketing and advertising expenses . . . . . . . . . . . . . . . . . . . . + +(307.9) + +(364.8) + +General administration expenses . . . . . . . . . . . . . . . . . . . . . . + +(260.9) + +(234.4) + +Amortization of intangible assets . . . . . . . . . . . . . . . . . . . . . . + +(103.8) + +(104.6) + +Integration costs, disposals of operations and impairment costs . . . . . . + +5 + +25.5 + +Profit from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,575.1 + +1,838.2 + +Interest and dividends received . . . . . . . . . . . . . . . . . . . . . . . + +16.7 + +15.6 + +Finance costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(123.1) + +(315.3) + +Profit before taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,468.7 + +1,538.5 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(445.1) + +(524.7) + +Profit after taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,023.6 + +1,013.8 + +Minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(15.7) + +(95.7) + +Net profit from ordinary activities . . . . . . . . . . . . . . . . . . . . + +1,007.9 + +918.1 + +For the six months ended + +September 30, + +2001 + +2002 + +R + +R + +Note + +(unaudited) + +(unaudited) + +Basic and diluted earnings per share . . . . . . . . . . . . . . . . . . . + +8 + +100 790 + +91 810 + +F27 + +VODACOM GROUP (PROPRIETARY) LIMITED + +CONDENSED CONSOLIDATED BALANCE SHEETS + +at March 31, 2002 and at September 30, 2002 + +March 31, + +September 30, + +2002 + +2002 + +(Restated) + +Rm + +Rm + +Notes + +(audited) + +(unaudited) + +ASSETS + +Non-current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +11,213.3 + +11,868.5 + +Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . + +9 + +9,896.6 + +10,447.1 + +Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +796.3 + +682.6 + +Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +22.7 + +165.4 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +497.7 + +573.4 + +Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,145.3 + +5,450.7 + +Foreign currency derivatives . . . . . . . . . . . . . . . . . . . . . . . + +215.6 + +22.6 + +Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +306.0 + +382.1 + +Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,845.9 + +3,234.5 + +Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . + +58.6 + +247.5 + +Bank and cash balances . . . . . . . . . . . . . . . . . . . . . . . . . + +719.2 + +1,564.0 + +Total assets + +15,358.6 + +17,319.2 + +EQUITY AND LIABILITIES + +Capital and reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,463.8 + +6,337.0 + +Ordinary share capital . . . . . . . . . . . . . . . . . . . . . . . . . . + +6 + +Non-distributable reserves . . . . . . . . . . . . . . . . . . . . . . . . + +106.1 + +59.9 + +Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,357.7 + +6,277.1 + +Minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +10.6 + +102.3 + +Non-current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,894.4 + +2,800.2 + +Interest bearing debt . . . . . . . . . . . . . . . . . . . . . . . . . . . + +10 + +780.2 + +1,591.9 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +926.2 + +1,045.5 + +Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +188.0 + +162.8 + +Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +7,989.8 + +8,079.7 + +Shareholder loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +920.0 + +920.0 + +Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,201.7 + +3,473.7 + +Taxation payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +351.6 + +113.4 + +Non-interest bearing debt . . . . . . . . . . . . . . . . . . . . . . . . + +4.3 + +4.3 + +Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +319.5 + +285.8 + +Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +600.0 + +Short-term interest bearing debt . . . . . . . . . . . . . . . . . . . . . + +10 + +1,015.9 + +554.0 + +Bank overdrafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,576.8 + +2,728.5 + +Total equity and liabilities + +15,358.6 + +17,319.2 + +F28 + +VODACOM GROUP (PROPRIETARY) LIMITED + +CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY + +for the six months ended September 30, 2002 and 2001 + +Share capital + +Retained + +Non- + +Total + +and premium + +earnings + +distributable + +reserves + +Rm + +Rm + +Rm + +Rm + +BALANCE AT MARCH 31, 2001 AUDITED (RESTATED) + +3,593.2 + +(2.3) + +3,590.9 + +Net profit for the period . . . . . . . . . . . . . . . . + +1,007.9 + +1,007.9 + +Net gains and losses not recognized in the + +income statement + +Foreign currency translation reserve . . . . . . . . + +17.5 + +17.5 + +BALANCE AT SEPTEMBER 31, 2001 UNAUDITED + +4,601.1 + +15.2 + +4,616.3 + +BALANCE AT MARCH 31, 2002 AUDITED (RESTATED) + +5,357.7 + +106.1 + +5,463.8 + +Net profit for the period . . . . . . . . . . . . . . . . + +918.1 + +918.1 + +Contingency reserve . . . . . . . . . . . . . . . . . . + +1.3 + +(1.3) + +Net gains and losses not recognized in the income + +statement + +Foreign currency translation reserve . . . . . . . . + +(54.1) + +(54.1) + +Foreign currency translation reserve + + deferred taxation . . . . . . . . . . . . . . . . . + +9.2 + +9.2 + +BALANCE AT SEPTEMBER 30, 2002 UNAUDITED + +6,277.1 + +59.9 + +6,337.0 + +VODACOM GROUP (PROPRIETARY) LIMITED + +CONDENSED CONSOLIDATED CASH FLOW STATEMENTS + +for the six months ended September 30, 2002 and 2001 + +For the six months ended + +September 30, + +2001 + +2002 + +Rm + +Rm + +Notes + +(unaudited) + +(unaudited) + +CASH FLOW FROM OPERATING ACTIVITIES + +Cash receipts from customers . . . . . . . . . . . . . . . . . . . . . . + +7,090.8 + +9,009.8 + +Cash paid to suppliers and employees . . . . . . . . . . . . . . . . . . + +(4,150.8) + +(5,838.0) + +CASH GENERATED FROM OPERATIONS . . . . . . . . . . . . . . + +2,940.0 + +3,171.8 + +Finance costs paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(148.4) + +(242.1) + +Interest income received . . . . . . . . . . . . . . . . . . . . . . . . . + +16.7 + +15.6 + +Taxation paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(931.1) + +(707.9) + +Dividends paid shareholders . . . . . . . . . . . . . . . . . . . . . . + +11 + +(480.0) + +(600.0) + +NET CASH FLOWS FROM OPERATING ACTIVITIES . . . . . . . . . + +1,397.2 + +1,637.4 + +CASH FLOW FROM INVESTING ACTIVITIES + +Additions to property, plant and equipment . . . . . . . . . . . . . . . + +(2,022.1) + +(2,081.3) + +Proceeds on disposal of property, plant and equipment . . . . . . . . . + +24.2 + +4.6 + +Loans to minority shareholders . . . . . . . . . . . . . . . . . . . . . + +(153.9) + +Short-term investment . . . . . . . . . . . . . . . . . . . . . . . . . . + +(172.9) + +Other investing activities . . . . . . . . . . . . . . . . . . . . . . . . . + +(14.9) + +(11.9) + +NET CASH FLOWS UTILIZED IN INVESTING ACTIVITIES . . . . . + +(2,012.8) + +(2,415.4) + +CASH FLOW FROM FINANCING ACTIVITIES + +Interest bearing debt incurred . . . . . . . . . . . . . . . . . . . . . . + +11.1 + +336.4 + +Funding received from minority shareholders . . . . . . . . . . . . . . + +157.8 + +NET CASH FLOWS FROM FINANCING ACTIVITIES . . . . . . . . . + +11.1 + +494.2 + +NET DECREASE IN CASH AND CASH EQUIVALENTS . . . . . . + +(604.5) + +(283.8) + +Cash and cash equivalents at the beginning of the period . . . . . . . . + +(796.1) + +(857.6) + +Effect of foreign exchange rate changes . . . . . . . . . . . . . . . . . + +4.5 + +(23.1) + +CASH AND CASH EQUIVALENTS AT THE END OF THE PERIOD + +12 + +(1,396.1) + +(1,164.5) + +F29 + +F30 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS + +for the six months ended September 30, 2002 and 2001 + +1. + +NATURE OF OPERATIONS + +The Group is primarily an integrated mobile telecommunication and data communication business located in South + +Africa but does also have businesses in other African countries. + +2. + +BASIS OF PRESENTATION + +The condensed consolidated balance sheet of the Group as at September 30, 2002 and the condensed consolidated + +income statements, statements of changes in equity and cash flows for the six months ended September 30, 2002 and + +2001 are unaudited. These condensed consolidated financial statements are prepared in accordance with IAS 34: + +"Interim Financial Reporting". These unaudited financial statements should be read in conjunction with the audited + +consolidated financial statements for the three years ended March 31, 2002. + +The results of interim periods are not necessarily indicative of the results for the entire year. + +3. + +ACCOUNTING POLICIES + +The condensed consolidated financial statements have been prepared on the historic cost basis. The accounting policies + +applied are consistent with those of the previous year. + +The preparation of the condensed consolidated financial statements requires the Group's management to make + +estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets + +and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenues and + +expenses during the reporting period. Actual results could differ from these estimates. The accounting policies are + +consistent with those used in the financial statements for the year ended March 31, 2002. + +For the six months ended + +September 30, + +2001 + +2002 + +Rm + +Rm + +(unaudited) + +(unaudited) + +4. + +REVENUE + +Airtime and access . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,438.4 + +5,061.3 + +Interconnect revenue . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,917.8 + +2,554.9 + +Equipment sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +751.2 + +1,305.3 + +International airtime . . . . . . . . . . . . . . . . . . . . . . . . . . + +225.3 + +342.6 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +189.5 + +176.7 + +7,522.2 + +9,440.8 + +5. + +INTEGRATION COSTS, DISPOSALS OF OPERATIONS AND + +IMPAIRMENT COSTS + +Satellite phones reversal of onerous contract (Note 5.1) . . . . . . + +45.5 + +Management fees paid to Telkom SA Limited in respect of the + +Delareyville earth station . . . . . . . . . . . . . . . . . . . . . . . + +(20.0) + +25.5 + +5.1 + +Globalstar Southern Africa (Proprietary) Limited + +Vodacom Group (Proprietary) Limited acquired 100% of the share capital of Globalstar Southern Africa + +(Proprietary) Limited with effect from August 1, 2000. The principal nature of the business of the company is + +that of a provider of wholesale satellite airtime to cellular networks in Southern Africa. During the 2001 + +financial year the total goodwill on acquisition of R24.7 million and the total net asset value of the company was + +impaired by R102.5 million, as no satellite license was issued by the Independent Communications Authority of + +South Africa and the international satellite company Globalstar Limited Partnership, a United States listed + +company, was expected to go into Chapter 11 bankruptcy. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +5.1 + +Globalstar Southern Africa (Proprietary) Limited (continued) + +During the year ended March 31, 2001, a provision was made to reflect a contractual obligation of R45.5 million + +to purchase satellite phones. Since a satellite licence was not issued to Globalstar Southern Africa (Proprietary) + +Limited, these phones could not be utilized. The provision was reversed during the period ended September 30, + +2001 as the Group was subsequently released from this contractual obligation. + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +R + +R + +(audited) + +(unaudited) + +6. + +ORDINARY SHARE CAPITAL + +10,000 ordinary shares of 1 cent each . . . . . . . . . . . . . . . . . + +100 + +100 + +7. + +NET ASSET VALUE PER SHARE + +The calculation of net asset value per ordinary share is based on net assets + +of R6,337.0 million (March 31, 2002: R5,463.8 million) and 10,000 + +issued ordinary shares (March 31, 2002: 10,000) . . . . . . . . . . . + +546,380 + +633,700 + +For the six months ended + +September 30, + +2001 + +2002 + +R + +R + +(unaudited) + +(unaudited) + +8. + +BASIC AND DILUTED EARNINGS PER SHARE + +The calculation of basic earnings per ordinary share is based on earnings + +of R918.1 million (September 30, 2001: R1,007.9 million) and + +10,000 issued ordinary shares (September 30, 2001: 10,000) . . . . . + +100,790 + +91,810 + +Due to no dilution factors being present, basic earnings per share equals + +diluted earnings per share. + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +9. + +ADDITIONS TO PROPERTY, PLANT AND EQUIPMENT + +Land and buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . + +339.6 + +0.8 + +Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,050.3 + +1,492.4 + +Information services . . . . . . . . . . . . . . . . . . . . . . . . . . + +476.4 + +175.9 + +Community services . . . . . . . . . . . . . . . . . . . . . . . . . . + +9.5 + +4.1 + +Motor vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +20.5 + +10.3 + +Furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +39.2 + +7.0 + +Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +15.9 + +6.1 + +Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . + +94.2 + +13.5 + +Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +39.7 + +8.0 + +4,085.3 + +1,718.1 + +F31 + +F32 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +10. INTEREST BEARING DEBT + +As at March 31, 2002 + +As at September 30, 2002 + +Current Long-term + +Total + +Current + +Long-term + +Total + +portion + +portion + +portion + +portion + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +(audited) + +(audited) + +(audited) (unaudited) (unaudited) (unaudited) + +Finance leases . . . . . . . . . + +10.4 + +780.2 + +790.6 + +10.3 + +783.8 + +794.1 + +Funding loans . . . . . . . . . + +440.0 + +440.0 + +457.9 + +808.1 + +1,266.0 + +Other short-term loans . . . . . + +565.5 + +565.5 + +85.8 + +85.8 + +1,015.9 + +780.2 + +1,796.1 + +554.0 + +1,591.9 + +2,145.9 + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +10.1 + +Finance leases + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . . . . . + +502.4 + +503.8 + +The finance leases are collateralised by various land and buildings + +with a book value of R438.1 million (March 31, 2002: + +R443.0 million), bear interest at effective interest rates of between + +13.51% and 16.93% and are repayable between 2 and 10 years. + +Vodacom Service Provider Company (Proprietary) Limited . . . + +288. + +2 + +290.3 + +The finance leases are collateralised by various land and buildings + +with a book value of R276.5 million (March 31, 2002: + +R279.4 million), and bear interest at a variable nominal interest rate + +of 13.76% compounded monthly. Payments are made every six + +months in arrear and commenced on March 1, 2002. The finance + +leases expire on September 1, 2011. + +Less: Current portion of finance leases: + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . . + +(7.1) + +(10.3) + +Vodacom Service Provider Company (Proprietary) Limited + +(3.3) + +(10.4) + +(10.3) + +Long-term portion of finance leases . . . . . . . . . . . . . . . + +780.2 + +783.8 + +The fair value of the Group's finance lease liability is R794.1 million (March 31, 2002: R790.6 million). + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +10. INTEREST BEARING DEBT (continued) + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +10.2 + +Funding loans + +Commerzbank AG . . . . . . . . . . . . . . . . . . . . . . . . . . . + +200.0 + +200.0 + +The R200 million loan is uncollateralised, bears interest at a fixed + +rate of 13.7% NACQ (Nominal Amount Compounded Quarterly) + +and is repayable on March 17, 2003. + +Crdit Agricole Indosuez . . . . . . . . . . . . . . . . . . . . . . . + +200.0 + +200.0 + +The loan is uncollateralised, bears interest at a fixed rate of 14.0% + +NACQ and is repayable on March 17, 2003. + +Caspian Construction Company Limited and Planatel + +Communications Limited . . . . . . . . . . . . . . . . . . . . . . . + +40.0 + +92.6 + +The shareholder loans of $18.4 million (March 31, 2002: $3.4 million) + +are subordinated and bear no interest from 1 April 2002 + +(March 31, 2002: LIBOR plus 1%), and are available for repayment, + +subject to 60% shareholders' approval. + +The drawn portion of the project finance totalling $45.0 million to + +Vodacom Tanzania Limited are collateralised by a charge over 51% + +of the shares, the licence and the company's tangible and intangible + +assets. The loans bear interest based on the denomination of the debt + +between 5.5% and 13.0% per annum and will be fully repaid by + +March 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +474.8 + +The extended credit facility of $28.3 million to Vodacom Congo + +(R.D.C.) S.P.R.L is partly secured by guarantees and cash deposits, + +bears interest at EURIBOR plus 1.75% and is repayable on + +April 1, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +298.6 + +Less: Current portion of funding loans: + +Commerzbank AG . . . . . . . . . . . . . . . . . . . . . . . + +(200.0) + +(200.0) + +Crdit Agricole Indosuez . . . . . . . . . . . . . . . . . . . . + +(200.0) + +(200.0) + +Project finance to Vodacom Tanzania Limited . . . . . . . . . + +(57.9) + +Caspian Construction Company Limited and Planatel + +Communications Limited . . . . . . . . . . . . . . . . . . . . + +(40.0) + +(440.0) + +(457.9) + +Long-term portion of funding loans . . . . . . . . . . . . . . . . . + +808.1 + +The fair value of the Group's funding loan liability is R1,264.3 million (March 31, 2002: R444.6 million). + +F33 + +F34 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +10. INTEREST BEARING DEBT (continued) + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +10.3 + +Other short-term loans + +Standard Bank of London Limited . . . . . . . . . . . . . . . . . . + +539.4 + +The loan of $47.2 million is uncollateralised, bears interest at + +LIBOR plus 1.5% and is repayable by June 30, 2002. This loan + +is supported by a letter of comfort. + +Various loans to Vodacom (Proprietary) Limited . . . . . . . . . . + +26.1 + +21.3 + +ABSA Bank Limited . . . . . . . . . . . . . . . . . . . . . . . . . + +64.5 + +This loan is collateralised through guarantees issued and bears + +interest at an all in rate of 3%. This loan was replaced by a + +revolving credit facility on November 12, 2002, which bears interest + +at LIBOR plus 1.5% and is available until December 31, 2004 . . . + +565.5 + +85.8 + +10.4 Repayment of interest bearing debt + +2003 + +2004 + +2005 + +2006 + +2007 + +Total + +onwards + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Finance leases + +Vodacom (Proprietary) Limited + +10.3 + +16.2 + +27.3 + +43.6 + +406.4 + +503.8 + +Vodacom Service Provider + +Company (Proprietary) Limited + +3.7 + +9.5 + +16.6 + +260.5 + +290.3 + +Funding loans + +Commerzbank AG . . . . . + +200.0 + +200.0 + +Crdit Agricole Indosuez . . + +200.0 + +200.0 + +Other short-term loans . . . + +85.8 + +85.8 + +Vodacom Tanzania Limited . + +57.9 + +75.1 + +94.7 + +117.6 + +222.1 + +567.4 + +Vodacom Congo (R.D.C.) + +S.P.R.L.. . . . . . . . . . . + +298.6 + +298.6 + +554.0 + +393.6 + +131.5 + +177.8 + +889.0 + +2,145.9 + +11. + +DIVIDENDS PAID + +During the period under review, the dividend to the amount of R600.0 million (September 30, 2001: R480.0 million) + +was paid to ordinary shareholders. + +For the six months ended + +September 30, + +2001 + +2002 + +Rm + +Rm + +(unaudited) + +(unaudited) + +12. + +CASH AND CASH EQUIVALENTS AT END OF PERIOD + +Bank and cash balances . . . . . . . . . . . . . . . . . . . . . . . . . . . + +56.8 + +1,564.0 + +Bank overdrafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,452.9) + +(2,728.5) + +(1,396.1) + +(1,164.5) + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +13. + +DISPOSAL/(ACQUISITION) OF SUBSIDIARIES + +There were no acquisitions or disposals during the periods covered by the condensed consolidated financial + +statements. + +14. CONTINGENT LIABILITIES + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +14.1 + +Globalstar Southern Africa (Proprietary) Limited + +The functionality of the Gateway assets is under dispute and + +Globalstar Southern Africa (Proprietary) Limited and Vodafone + +Satellite Services Limited do not recognize the liability to + +Globalstar LP. . . . . . . . . . . . . . . . . . . . . . . . . . . + +15.0 + +15.0 + +14.2 Legal matters . . . . . . . . . . . . . . . . . . . . . . . . . . + +5.0 + +14.3 + +Vodacom Congo (R.D.C.) S.P.R.L. + +The Group has a 51% equity interest in Vodacom Congo (R.D.C.) S.P.R.L. ("Vodacom Congo"), which + +commenced business on December 11, 2001. This investment is governed by a shareholders' agreement which + +provides the minority shareholder certain protective and participating rights. In terms of IAS 31: "Accounting for + +interest in Joint Ventures", Vodacom Congo may not be consolidated as a subsidiary as it is considered to be a + +joint venture and has been proportionally consolidated in the financial statements at March 31, 2002 and + +September 30, 2002. + +The Group, in terms of the shareholders' agreement, is however ultimately responsible for the funding of the + +operations of Vodacom Congo for the first three years. The shareholders' agreement also gives the Group the + +right to appoint management and the majority of the Board of the company. The Group also has a separate + +management agreement to manage the company on a day-to-day basis. Currently Vodacom Congo is incurring + +losses which are expected to increase in the foreseeable future. The 49% portion attributable to the joint venture + +partner of the liabilities and losses were as follows: + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(19.3) + +(87.3) + +Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . + +(29.7) + +(383.8) + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . + +440.3 + +714.4 + +Preference shares . . . . . . . . . . . . . . . . . . . . . . . . + +(368.1) + +(368.1) + +Furthermore, the following guarantees were approved by the Group in respect of Vodacom Congo but are as yet + +not issued: + +Company + +Details + +Beneficiary + +Euro + +US$ + +Mil + +Mil + +September 30, 2002 + +Approved not issued + +Guarantees not yet issued + +ABSA Bank Limited + +4.0 + +March 31, 2002 + +Approved and issued + +Guarantee Alcatel + +ABSA Bank Limited + +32.6 + +29.8 + +C.I.T. Alcatel + +Space Industries + +and Alcatel Altech + +Telecoms (Pty) Ltd + +("Alcatel") + +Approved not issued + +Guarantees not yet issued + +ABSA Bank Limited + +51.2 + +F35 + +F36 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +14. + +CONTINGENT LIABILITIES (continued) + +14.4 + +Negative working capital ratio + +For the interim period ended September 30, 2002, and the financial year ended March 31, 2002, the Group had a + +negative working capital ratio. A negative working capital ratio arises when the Group's current liabilities are + +greater than the current assets. The Group's management believes that based on its operating cash flow, it will be + +able to meet liabilities as they arise and it is in compliance with any covenants in borrowing agreements. + +15. + +UNDRAWN BORROWING FACILITIES AND GUARANTEES + +The Group has Rand denominated credit facilities totalling R3,095.0 million with R1,973.7 million unutilized at + +September 30, 2002. The facilities are uncommitted and can also be utilized for foreign loans and are subject to review + +at various dates (usually on an annual basis). Vodacom Tanzania Limited has project funding facilities of $65.0 million + +of which $20.0 million are unutilized at September 30, 2002. Vodacom Congo (R.D.C.) S.P.R.L. has bridging facilities + +of Euro 35.8 million of which Euro 6.7 million are unutilized at September 30, 2002. Foreign currency term facilities + +are predominantly US dollar based, at various maturities and are utilized for bridging and short-term working capital + +needs. + +Companies within the Group have provided the following guarantees: + +Company + +Details + +Beneficiary + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +Vodacom (Proprietary) Limited + +All guarantees less than R0.2 million Various + +1.9 + +2.1 + +in terms of various lease agreements + +Vodacom (Proprietary) Limited + +Electricity supply + +Eskom + +1.0 + +1.0 + +Vodacom (Proprietary) Limited * Standby letters of credit + +Alcatel CIT + +299.9 + +345.6 + +Vodacom Service Provider + +All guarantees less than R0.1 million Various + +0.4 + +0.4 + +Company (Proprietary) Limited + +in terms of various lease agreements + +Vodacom Service Provider + +Electricity supply + +Midrand Town + +1.0 + +1.0 + +Company (Proprietary) Limited + +Council + +Vodacom Group (Proprietary) + +Guarantee for the obligations of + +ABSA Bank + +338.3 + +Limited ** + +Vodacom Congo (R.D.C.) S.P.R.L. + +Vodacom Group (Proprietary) + +Letter of credit issued for obligations Alcatel CIT + +112.8 + +Limited + +of Vodacom Congo (R.D.C.) S.P.R.L. + +Vodacom Group (Proprietary) + +Letter of credit issued for obligations Alcatel Space + +23.7 + +Limited + +of Vodacom Congo (R.D.C.) S.P.R.L. Industries + +Vodacom Group (Proprietary) + +Guarantee in respect of receipt by + +SA Insurance + +9.5 + +Limited + +independent intermediaries of + +Association for + +premiums on behalf of short-term + +benefit of + +insurers and Lloyd's underwriters, + +insurers + +and relating to short-term insurance + +business carried on in the Republic of + +South Africa + +304.2 + +834.4 + +* + +Amounts drawn on the standby letters of credit amounting to R nil (March 31, 2002: R98.4 million) are included as liabilities + +in the balance sheet. + +** + +Amounts drawn on the guarantee issued amounting to R298.6 million are included as liabilities in the balance + +sheet. + +Vodacom (Proprietary) Limited provides an unlimited guarantee for borrowings entered into by Vodacom Group + +(Proprietary) Limited. + +F37 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +16. COMMITMENTS + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +16.1 Capital Commitments + +(audited) + +(unaudited) + +Commitments for orders in respect of existing contracts: + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . . + +1,005.2 + +1,222.2 + +Vodacom Congo (R.D.C.) S.P.R.L. . . . . . . . . . . . . . . + +303.7 + +444.2 + +Vodacom Tanzania Limited . . . . . . . . . . . . . . . . . . + +78.9 + +166.8 + +Vodacom Service Provider Company (Proprietary) Limited . + +59.9 + +18.9 + +Vodacom International Holdings (Proprietary) Limited . . . + +2.2 + +Vodacom Group (Proprietary) Limited . . . . . . . . . . . . + +0.3 + +Vodacom Lesotho (Proprietary) Limited . . . . . . . . . . . + +30.2 + +1,450.2 + +1,882.3 + +Commitments not yet contracted for: + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . . + +805.5 + +1,483.7 + +Vodacom Congo (R.D.C.) S.P.R.L. . . . . . . . . . . . . . . + +16.0 + +79.6 + +Vodacom Service Provider Company (Proprietary) Limited . + +15.9 + +51.4 + +Vodacom Tanzania Limited . . . . . . . . . . . . . . . . . . + +10.3 + +Vodacom Lesotho (Proprietary) Limited . . . . . . . . . . . + +1.9 + +36.6 + +Vodacom Group (Proprietary) Limited . . . . . . . . . . . . + +3.7 + +849.6 + +1,655.0 + +The capital expenditure of the Group will be financed from internal cash generation, extended supplier credit and + +bank credit. + +16.2 + +License fees + +Network operators in the Group pay monthly license fees based on their net operational income as defined in the + +license agreement. Net operational income is defined as the total invoiced revenue of the license excluding + +discounts, Value Added Taxation and other direct taxes derived from customers of the licensee for the provision + +to them of the service, less net interconnect fees and bad debts actually incurred. + +17. + +EVENTS SUBSEQUENT TO THE PERIOD + +The directors are not aware of any matter or circumstance arising since the end of the financial period, not otherwise + +dealt with in the condensed consolidated financial statements, which significantly affects the position of the Group and + +the results of its operations. + +F38 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +18. RELATED PARTY TRANSACTIONS + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +18.1 + +Balances with Related Parties + +Included in accounts receivable: + +Telkom SA Limited Interconnect . . . . . . . . . . . . . . + +529.4 + +332.1 + +Telkom SA Limited Other . . . . . . . . . . . . . . . . . + +14.1 + +Vodafone Group plc . . . . . . . . . . . . . . . . . . . . . + +1.6 + +0.3 + +Included in accounts payable: + +Telkom SA Limited . . . . . . . . . . . . . . . . . . . . . . + +78.2 + +31.6 + +Telkom SA Limited Other . . . . . . . . . . . . . . . . . + +3.0 + +0.5 + +Vodafone Group plc . . . . . . . . . . . . . . . . . . . . . + +1.9 + +For the six months ended + +September 30, + +2001 + +2002 + +Rm + +Rm + +(unaudited) + +(unaudited) + +18.2 + +Transactions with Related Parties + +Telkom SA Limited . . . . . . . . . . . . . . . . . . . . . . . + +1,018.5 + +1,062.1 + +Interconnect income . . . . . . . . . . . . . . . . . . . . . + +1,421.9 + +1,497.8 + +Customer billing . . . . . . . . . . . . . . . . . . . . . . . + +4.1 + +19.9 + +Interest paid commercial . . . . . . . . . . . . . . . . . . + +0.3 + +Lease of transmission lines . . . . . . . . . . . . . . . . . . + +(174.7) + +(214.6) + +Interconnect fees . . . . . . . . . . . . . . . . . . . . . . . + +(158.6) + +(163.9) + +Interest payments on shareholder loan . . . . . . . . . . . . + +(37.0) + +(40.4) + +Vodago prepaid costs . . . . . . . . . . . . . . . . . . . . . + +(4.9) + +Telephone landline usage . . . . . . . . . . . . . . . . . . . + +(16.9) + +(9.6) + +Installation of transmission lines . . . . . . . . . . . . . . . + +(16.0) + +(15.9) + +Site costs . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(4.3) + +(6.6) + +Vodafone Group plc . . . . . . . . . . . . . . . . . . . . . . . + +(14.5) + +(23.7) + +Roaming income (transacted within the Vodafone Group) . . + +11.0 + +11.9 + +Roaming expense (transacted within the Vodafone Group) . + +(15.5) + +(24.7) + +Interest payments on shareholder loan . . . . . . . . . . . . + +(10.0) + +(10.9) + +Vodafone Holdings (SA) (Proprietary) Limited + +Interest payments on shareholder loan . . . . . . . . . . . . + +(13.3) + +(14.5) + +VenFin Finansieringskorporasie (Proprietary) Limited . . . . . + +(30.8) + +(28.5) + +Interest payments on shareholder loan . . . . . . . . . . . . + +(10.0) + +(10.9) + +Interest payments on money market . . . . . . . . . . . . . + +(20.8) + +(17.6) + +Descarte Investments No. 8 (Proprietary) Limited . . . . . . . + +(3.7) + +(4.0) + +Interest payments on shareholder loan . . . . . . . . . . . . + +(3.7) + +(4.0) + +Transactions with related parties are priced at prevailing market rates. + +F39 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +19. + +SEGMENTAL INFORMATION + +The Group is primarily an integrated mobile telecommunication and data communication business located in South + +Africa but does have businesses in other African countries. The primary reporting format therefore comprises the + +business segments of the Group. During the period under review, the Group did not experience any pressures relating + +to the potential seasonality and cyclicality of its operations. + +For the six months ended + +Unallocated + +Networks + +Service + +Other + +Elimi- + +Total + +September 30, 2001 + +providers + +nations + +(unaudited) + +BUSINESS SEGMENTS + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Segment revenue + +6,356.4 + +3,350.6 + +120.0 + +(2,304.8) + +7,522.2 + +External + +4,158.3 + +3,257.5 + +106.4 + +7,522.2 + +Inter-segment + +2,198.1 + +93.1 + +13.6 + +(2,304.8) + +Segment profit/(loss) from + +operations + +(2.3) + +1,539.7 + +135.6 + +(0.4) + +(97.5) + +1,575.1 + +Interest and dividends received + +16.7 + +Finance costs + +(123.1) + +Profit before taxation + +1,468.7 + +Included in segment profit/(loss) + +from operations: + +Depreciation and amortization + +(1.1) + +(823.3) + +(44.9) + +(0.4) + +(97.6) + +(967.3) + +Property, plant and equipment + +(1.1) + +(819.9) + +(42.1) + +(0.4) + +(863.5) + +Intangible assets + +(3.4) + +(2.8) + +(97.6) + +(103.8) + +Bad debts written off + +(11.2) + +(54.8) + +(66.0) + +Integration costs, disposals of + +operations and impairment costs + +(20.0) + +45.5 + +25.5 + +For the six months ended + +Unallocated + +Networks + +Service + +Other + +Elimi- + +Total + +September 30, 2002 + +providers + +nations + +(unaudited) + +BUSINESS SEGMENTS + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Segment revenue + +8,198.3 + +4,209.4 + +52.0 + +(3,018.9) + +9,440.8 + +External + +5,331.8 + +4,071.9 + +37.1 + +9,440.8 + +Inter-segment + +2,866.5 + +137.5 + +14.9 + +(3,018.9) + +Segment profit/(loss) from + +operations: + +17.6 + +1,750.2 + +192.1 + +(29.0) + +(92.7) + +1,838.2 + +Interest and dividends received + +15.6 + +Finance costs + +(315.3) + +Profit before taxation + +1,538.5 + +Included in segment profit/(loss) + +from operations + +Depreciation and amortization + +(1.4) + +(1,039.3) + +(55.7) + +(0.5) + +(92.5) + +(1,189.4) + +Property, plant and equipment + +(1.4) + +(1,030.1) + +(52.9) + +(0.4) + +(1,084.8) + +Intangible assets + +(9.2) + +(2.8) + +(0.1) + +(92.5) + +(104.6) + +Bad debts written off + +(3.6) + +(17.4) + +(21.0) + +F40 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +20. + +US GAAP INFORMATION + +The financial statements have been prepared in accordance with International Accounting Standards ("IAS") which + +differs in certain respects from Generally Accepted Accounting Principles in the United States ("US GAAP"). The + +effect of applying US GAAP principles to net profit and shareholders' equity is set out below along with an + +explanation of applicable differences between IAS and US GAAP: + +For the six months ended + +September 30, + +2001 + +2002 + +Rm + +Rm + +Notes + +(unaudited) + +(unaudited) + +Net profit as reported in accordance with IAS . . . . . . . . . . . + +1,007.9 + +918.1 + +Items increasing/(decreasing) net profit: + +Deferred bonus incentive scheme . . . . . . . . . . . . . . . . . . + +(a) + +10.4 + +(27.8) + +Goodwill non-amortization . . . . . . . . . . . . . . . . . . . . + +(b) + +49.2 + +Goodwill translation differences on amortization . . . . . . . . . + +(c) + +(0.6) + +(1.7) + +Derivative financial instruments reclassification of transition + +adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(e) + +25.3 + +3.9 + +Income tax rate difference . . . . . . . . . . . . . . . . . . . . . + +(f) + +(124.2) + +(112.2) + +Income tax effect of US GAAP adjustments . . . . . . . . . . . . + +(g) + +(13.4) + +9.0 + +Joint Venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(i) + +16.0 + +Net profit in accordance with US GAAP before cumulative effect of + +change in accounting policy . . . . . . . . . . . . . . . . . . . . . . + +921.4 + +838.5 + +Change in accounting policy upon adoption of SFAS 133: + +Derivative financial instruments transition adjustments . . . . + +(e) + +17.2 + +Income tax effect on above . . . . . . . . . . . . . . . . . . . . + +(g) + +(6.5) + +Net profit in accordance with US GAAP after cumulative effect of + +change in accounting policy . . . . . . . . . . . . . . . . . . . . . . + +932.1 + +838.5 + +As at + +As at + +September 30, + +September 30, + +2001 + +2002 + +Rm + +Rm + +Notes + +(unaudited) + +(unaudited) + +Shareholders' equity as reported in accordance with IAS . . . . . + +4,616.3 + +6,337.0 + +Items increasing/(decreasing) shareholders' equity: + +Deferred bonus incentive scheme . . . . . . . . . . . . . . . . . . + +(a) + +47.4 + +30.1 + +Goodwill non-amortization . . . . . . . . . . . . . . . . . . . . + +(b) + +51.1 + +Goodwill translation differences on accumulated amortization . + +(c) + +(0.9) + +(6.0) + +Goodwill accumulated translation differences . . . . . . . . . . + +(c) + +8.0 + +20.5 + +Income tax rate difference . . . . . . . . . . . . . . . . . . . . . + +(f) + +(552.0) + +(767.4) + +Income tax effect of US GAAP adjustments . . . . . . . . . . . . + +(g) + +(17.8) + +(11.3) + +Joint Venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(i) + +96.0 + +Shareholders' equity in accordance with US GAAP . . . . . . . . . + +4,197.0 + +5,654.0 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +20. + +US GAAP INFORMATION (continued) + +Movements in shareholders' equity in accordance with US GAAP + +Rm + +Balance at March 31, 2001 (audited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,195.0 + +Net profit for the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +932.1 + +Dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +Foreign currency translation reserve adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . + +20.9 + +Cumulative effect adjustment of adoption of SFAS 133 . . . . . . . . . . . . . . . . . . . . . . . + +64.8 + +Gain on derivatives reclassified to earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(15.8) + +Balance at September 30, 2001 (unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,197.0 + +Net profit for the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,187.5 + +Dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(600.0) + +Foreign currency translation reserve adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . + +106.1 + +Gain on derivatives reclassified to earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(16.6) + +Balance at March 31, 2002 (audited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,874.0 + +Net profit for the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +838.5 + +Dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +Foreign currency translation reserve adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(56.1) + +Gain on derivatives reclassified to earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(2.4) + +Balance at September 30, 2002 (unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,654.0 + +Summary of differences between International Accounting Standards and accounting principles generally + +accepted in the US. + +A summary of the principal differences and additional disclosures applicable to the Group are set forth below: + +(a) + +Deferred bonus incentive scheme + +Under IAS, the total value of deferred bonus entitlements as calculated at the end of each financial period is + +based on the net present value of expected future cash payments as determined under the bonus formula over the + +vesting period. + +Under US GAAP, in accordance with FIN 28 : "Accounting for Stock Appreciation Rights and Other Variable + +Stock Option Awards Plans and Interpretation of APB Opinions No. 15 and 25", compensation cost is recognized + +over the service period or the vesting period if the service period is not defined, based upon the undiscounted + +value of the entitlements. + +(b) + +Goodwill non-amortization + +Under IAS, goodwill and intangible assets arising in business combinations are amortized over their estimated + +useful lives. + +Under US GAAP, accounting for goodwill was substantially the same as IAS until the adoption of SFAS 142 + +"Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses the initial and ongoing financial + +accounting and reporting for acquired goodwill and other intangible assets. It requires that goodwill no longer be + +amortized but tested for impairment annually or more frequently if impairment indicators arise. + +The amortization provisions of SFAS 142 are applicable to goodwill arising in business combinations + +consummated after June 30, 2001 and consequently in the year ended March 31, 2002 goodwill arising from the + +investment in Vodacom Congo (R.D.C.) S.P.R.L. is not amortized. + +The Group adopted SFAS 142 with effect from April 1, 2002. From that date all goodwill is no longer + +amortized. + +The Group has carried out the initial impairment testing of goodwill required by SFAS 142 before the first + +interim reporting period as at September 30, 2002 based on the April 1, 2002 goodwill balance and determined + +that no impairment needed to be recognized upon the adoption of SFAS 142. + +F41 + +F42 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +20. + +US GAAP INFORMATION (continued) + +(c) + +Goodwill translation of goodwill arising on the acquisition of a foreign entity + +Under IAS, goodwill arising on the acquisition of a foreign entity is treated as an asset of the Group and + +translated at the foreign exchange rate ruling at the transaction date based on the historical rate. + +Under US GAAP, goodwill arising on the acquisition of Vodacom Congo (R.D.C.) S.P.R.L. and Vodacom + +Tanzania Limited is translated at the actual exchange rate at the end of the period. The resulting foreign + +exchange transaction gain or loss increases or decreases the net investment in Vodacom Congo (R.D.C.) S.P.R.L. + +and Vodacom Tanzania Limited. + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +A reconciliation of goodwill for South African and foreign entities + +reported under IAS on the balance sheet to the approximate amounts + +determined under US GAAP is as follows: + +Included in total goodwill reported under IAS . . . . . . . . . + +342.9 + +295.6 + +Goodwill not amortized under US GAAP . . . . . . . . . . + +1.9 + +51.1 + +Goodwill income tax rate change . . . . . . . . . . . . . + +20.1 + +20.1 + +Translation difference on amortization . . . . . . . . . . . . + +(4.3) + +(6.0) + +Translation difference on goodwill balance . . . . . . . . . + +31.7 + +20.5 + +As adjusted under US GAAP . . . . . . . . . . . . . . . . . . + +392.3 + +381.3 + +(d) + +Income taxes additional temporary differences + +Under IAS, no deferred tax liability was recognized in respect of intangible assets acquired other than in a + +business combination where there was a difference at the date of acquisition between the assigned values and the + +tax bases of the assets. + +Under US GAAP, a deferred tax liability (and corresponding increase in assets acquired) is recognized for all + +temporary differences between the assigned values and the tax bases of intangible assets acquired. The recording + +of such deferred tax liability has no net impact on net income or shareholder's equity as determined under US + +GAAP as the decrease in income tax expense is off-set by a corresponding increase in amortization (Note 20f). + +(e) + +Derivative financial instruments + +The Group adopted IAS 39 and SFAS 133: Accounting for Derivative Instruments and Hedging Activities + +("SFAS 133") on April 1, 2001. + +Under IAS, upon adoption of IAS 39, the difference between previous carrying amounts and the fair value of + +derivatives, which prior to the adoption of IAS 39 had been designated as either fair value or cash flow hedges + +but do not qualify as hedges under IAS 39, is recognized as an adjustment of the opening balance of retained + +earnings at the beginning of the financial year IAS 39 is initially applied. Changes in fair value of derivatives + +acquired after April 1, 2001 are recorded in the income statement. + +Under US GAAP, upon adoption of SFAS 133, the difference between previous carrying amounts and fair value + +of derivatives, which prior to the adoption of SFAS 133 had been cash flow type hedges but do not qualify as + +hedges under SFAS 133, is recognized as a cumulative effect adjustment of other comprehensive income in the + +year SFAS 133 is initially applied. This amount is subsequently released into earnings in the same period or + +periods during which the hedged transaction affects earnings. During the six month period ended September 30, + +2002 R3.9 million (2001: R26.0 million) was released into earnings. The difference between previous carrying + +amounts and fair value of derivatives, which prior to the adoption of SFAS 133 had been fair value type hedges, + +is recognized as a cumulative effect adjustment in earnings. Changes in fair value of derivatives acquired after + +April 1, 2001 are recorded in the income statement. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +20. + +US GAAP INFORMATION (continued) + +(f) + +Income tax rate differences + +The tax rate in South Africa varies depending on whether income is distributed. The income tax rate is 30% but + +upon distribution an additional tax (Secondary Tax on Companies or "STC") of 12.5% is due based on the + +amount of the dividends net of the STC liability. + +In conformity with IAS, Vodacom reflects the STC as a component of the income tax charge for the period in + +which dividends are declared. IAS also requires that deferred tax be provided for at the undistributed rate of 30%. + +For the purpose of US GAAP, Vodacom believes that under SFAS No. 109: "Accounting for Income Taxes" + +("SFAS 109") temporary differences should be tax effected using the tax rate that will apply when income is + +distributed, i.e. an effective rate of 37.78% including STC. The use of the higher rate not only affects the + +measurement of deferred tax assets and liabilities, and hence the tax charge for any period, but because + +temporary differences in a business combination need to be tax effected at the higher rate there is a consequent + +effect on the amount of goodwill recognized in a business combination under US GAAP. + +Vodacom has therefore computed the STC that would become payable upon distribution of relevant undistributed + +earnings and accrued that amount as an additional liability. + +(g) + +Deferred taxation + +The tax effects of the US GAAP adjustments have been calculated based on the enacted tax rate of 37.78% + +(2001: 37.78%, March 31, 2002: 37.78%). + +A reconciliation of the deferred tax balances under IAS to the approximate amounts determined under + +US GAAP, where materially different, are as follows: + +As at + +As at + +March 31, + +September 30, + +2002 + +2002 + +Rm + +Rm + +(audited) + +(unaudited) + +Net deferred tax liabilities: + +As reported under IAS . . . . . . . . . . . . . . . . . . . . . + +428.5 + +472.0 + +Additional temporary differences . . . . . . . . . . . . . . . + +62.2 + +54.8 + +Income tax rate difference . . . . . . . . . . . . . . . . . + +675.3 + +787.5 + +Tax effect of US GAAP adjustments . . . . . . . . . . . . . + +21.8 + +11.3 + +As adjusted under US GAAP . . . . . . . . . . . . . . . . . . + +1,187.8 + +1,325.6 + +Under IAS, deferred tax assets on deductible temporary differences are only recognized to the extent that it is + +probable that the future taxable profit will allow the deferred tax asset to be recovered. + +Under US GAAP, deferred tax assets are recognized on all temporary differences. A valuation allowance is + +recognized if it is more likely than not that the asset will not be recovered. For US GAAP, an additional deferred + +tax asset and a corresponding valuation adjustment allowance of R67.3 million (March 31, 2002: R31.0 million) + +have no effect on the net shareholder's equity for the year. + +(h) + +Capitalized interest + +Under IAS, interest cost incurred during the construction period is expensed as incurred. + +Under US GAAP, interest cost incurred during the construction period (i.e. period of time necessary to bring a + +constructed fixed asset to the condition and location necessary for its intended use) is capitalized. The capitalized + +interest is recorded as part of the asset to which it relates and is amortized over the asset's estimated useful life. + +Capitalized interest was nil for the six months ended September 30, 2002 and 2001 as the effect of capitalising + +interest, as compared with the effect of expensing interest, was not material. + +F43 + +F44 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +20. + +US GAAP INFORMATION (continued) + +(i) + +Joint ventures + +Under IAS, investments qualifying as joint ventures are accounted for under the proportionate consolidation + +method of accounting. Under the proportionate consolidation method, the venturer records its share of each of + +the assets, liabilities, income and expenses of the jointly controlled entity on a line-by-line basis with similar + +items in the venturer's financial statements. The venturer continues to record its share of losses in excess of its + +net investment of the joint venture. + +Under US GAAP, joint ventures are accounted for under the equity method of accounting. Under the equity + +method, an investment in a joint venture is shown in the balance sheet of an investor as a single amount. + +Likewise, an investor's share of earnings or losses from its investment is ordinarily shown in its income + +statement as a single amount. An investor discontinues applying the equity method when its net investment + +(including net advances) is reduced to zero. + +For the six months ended September 30, 2001, in accordance with IAS, the Group proportionately consolidated + +losses to the value of R16.0 million, that was in excess of the Group's net investment in the joint venture. Under + +US GAAP these losses are not considered in calculating net income as the value of the investment was reduced + +to zero. Upon disposal of the investment in Vodacom World Online (Proprietary) Limited in 2002, the gain on + +the sale was less based on a different basis in the net investment. + +(j) + +Comprehensive income + +Comprehensive income under US GAAP and accumulated other comprehensive income balances under US + +GAAP are summarised as follows: + +For the six months ended + +September, 30 + +2001 + +2002 + +Rm + +Rm + +(unaudited) + +(unaudited) + +Net income under US GAAP . . . . . . . . . . . . . . . . . . + +932.1 + +838.5 + +Other comprehensive income/(loss): + +Foreign currency translation adjustment . . . . . . . . . . . + +20.9 + +(56.1) + +Cumulative effect adjustment of adoption of SFAS 133 . . . + +64. + +8 + +Gain on derivatives reclassified to earnings . . . . . . . . + +(15.8) + +(2.4) + +Other comprehensive income/(loss) . . . . . . . . . . . . . . . + +69.9 + +(58.5) + +Comprehensive income . . . . . . . . . . . . . . . . . . . . . + +1,002.0 + +780.0 + +Accumulated other comprehensive income balances: + +Cumulative foreign currency translation adjustments . . . . + +23.2 + +73.2 + +Cumulative effect adjustment of adoption of SFAS 133 . . . + +49.0 + +30.0 + +(k) + +Impairment of assets + +Under IAS, the Group is required to annually assess whether there are any indications that an asset may be + +impaired. Should there be such an indicator, the asset must be tested for impairment. An impairment loss must + +be recognized in the statement of operations, should an assets carrying amount exceed its recoverable amount. + +The impairment loss is the difference between the assets carrying amount and its recoverable value. The + +recoverable amount is the higher of the assets net selling price or its value in use. Value in use is the future cash + +flows to be derived from the particular asset, discounted to present value using a pre-tax market determined rate + +that reflects the current assessment of the time value of money and the risks specific to the asset. The reversal of + +an impairment loss in subsequent periods is permitted when there has been a change in economic conditions or + +the expected use of the asset. + +Under US GAAP, for assets other than goodwill, the Group is required to test for impairment whenever there is + +an indication of impairment in accordance with the FASB Statement of Financial Accounting Standards No. 144 + +"Accounting for the Impairment or Disposal of Long-lived Assets ("SFAS 144"). For assets to be held and used, + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +20. + +US GAAP INFORMATION (continued) + +(k) + +Impairment of assets (continued) + +impairment is first measured by reference to undiscounted cash flows. If there is no impairment by reference to + +undiscounted cash flows, no further action is required but the useful life of the asset must be reconsidered. If + +impairment exists the Group must measure impairment by comparing the assets fair value to its carrying value. + +Fair value is either market value (if an active market for the asset exists) or the sum of discounted future cash + +flows. The discount rate reflects the risk that is specific to that asset. For assets to be disposed of, the loss + +recognized is the excess of the assets carrying amount over its fair value less costs to sell. The reversal of + +previously recognized impairment losses is prohibited. + +During the same period in 2001 the Group recognized a loss of R45.5 million in respect of a onerous contract + +(Note 5) in accordance with paragraph 8 of SFAS 5: "Accounting for Contingencies" ("SFAS 5"). Subsequent to + +the issuance of the 2001 financial statements, it became clear that the other party to the contract was prepared to + +waive its right to supply satellite phones and instead was prepared to enter into a revised contract to supply + +mobile phones. Accordingly, management determined that, based on the change in circumstances arising from + +the willingness of the other party to revise the contract, the Group would no longer incur a loss under the + +contract and therefore reversed the loss previously provided for. The reversal of the provision, based on a change + +in circumstances, is not the recovery of impaired assets but rather it represents the reversal in a subsequent + +period of provision for an estimated loss. + +The Group currently has no material GAAP difference for impairment of assets. + +(l) + +Revenue recognition + +Under IAS, the Group recognizes activation fee revenue and costs up to the amount of the related activation + +revenue immediately upon activation of a new customer. Any excess costs incurred are recognized up front upon + +activation of a new customer. + +Under US GAAP, activation fee revenues and costs up to the amount of activation revenue would be deferred + +and recognized over the customer relationship period. + +The Group has not presented the deferral of activation fees in the above US GAAP reconciliation, as there is no + +net income impact. + +(m) + +Recent accounting pronouncements + +In July 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting + +Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and + +intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if + +impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite + +lives will continue to be amortized over their useful lives. + +The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. + +With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Group adopted SFAS 142 + +effective April 1, 2002. The Group has evaluated the effect that the adoption of the provisions of SFAS 142 will + +have on its results of operations and financial position (Note 20b). + +In August 2001, the FASB issued Statement of Financial Accounting Standards No. 143, "Accounting for + +Obligations, Associated with the Retirement of Long-Lived Assets" ("SFAS 143"). SFAS 143 establishes + +accounting standards for recognition and measurement of a liability at fair value for an asset retirement + +obligation and an addition to the associated asset retirement cost. The accretion of interest expense each period + +is subsequently recorded as an expense and added to the liability. FAS 143 is effective for fiscal years beginning + +after June 15, 2002. The Group expects that the adoption of SFAS 143 will not have a material impact on its + +results of operations and financial position. + +In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the + +Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 addresses financial accounting and + +reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. This Statement + +supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived + +Assets to be disposed of" ("SFAS 121"). However, this Statement retains the fundamental provisions of SFAS 121 + +for recognition and measurement of the (a) impairment of long-lived assets to be held and used and (b) long- + +lived assets to be disposed of by sale. The Group adopted SFAS 144 effective April 1, 2002 (Note 20k). + +The adoption of SFAS 144 has no material impact on its results of operations and financial position. + +F45 + +F46 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (continued) + +for the six months ended September 30, 2002 and 2001 + +20. + +US GAAP INFORMATION (continued) + +(m) + +Recent accounting pronouncements (continued) + +In April 2002, the FASB issued Statements of Accounting Standards No. 145, "Rescission of SFAS Nos. 4, 44 + +and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002" ("SFAS 145"). SFAS 145 rescinds + +SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," SFAS No. 44, "Accounting for + +Intangible Assets of Motor Carriers", and SFAS 64, "Extinguishments of Debt made to satisfy Sinking-Fund + +requirements". As a result, gains and losses from extinguishment of debt will no longer be classified as + +extraordinary items unless they meet the criteria of unusual or infrequent as described in Accounting Principles + +Boards Opinion 30, "Reporting the Results of Operations Reporting the Effects of Disposal of a Segment of a + +Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". In addition, SFAS 145 + +amends SFAS 13, "Accounting for Leases", to eliminate an inconsistency between the required accounting for + +sale-leaseback transactions and the required accounting for certain lease modifications that have economic + +effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing authoritative + +pronouncements to make various technical corrections, clarify meanings, or describe their applicability under + +changed conditions. SFAS 145 is effective for fiscal years beginning after May 15, 2002. The Group is currently + +evaluating the impact that the adoption of SFAS 145 will have on its results of operations and financial position. + +However, the Group does not believe that the adoption of SFAS 145 will have a material impact on its results of + +operations and financial position. + +In June 2002, the FASB issued Statement of Accounting Standards No. 146, "Accounting for Costs Associated + +with Exit or Disposal Activities" ("SFAS 146"). This Statement addresses financial accounting and reporting for + +costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, + +"Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including + +Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS 146 eliminates the definition and requirements + +for recognition of exit costs in EITF 94-3. SFAS 146 requires that a liability for a cost associated with an exit or + +disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as + +defined in EITF 94-3 was recognized at the date of an entity's commitment to an exit plan. SFAS 146 also + +concluded that an entity's commitment to a plan, by itself, does not create a present obligation to others that + +meets the definition of a liability. SFAS 146 also establishes that fair value is the objective for initial + +measurement of the liability. SFAS 146 is effective for exit or disposal activities initiated after December 31, + +2002. The Group is currently evaluating the impact that the adoption of SFAS 146 will have on its results of + +operations and financial position. However, the Group does not believe that the adoption of SFAS 146 will have + +a material impact on its results of operations and financial position. + +In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions" ("SFAS 147"). + +This Statement removes acquisitions of financial institutions from the scope of Statement 72 and Interpretation 9 + +and requires that those transactions be accounted for in accordance with SFAS No. 141, Business Combinations + +("SFAS 141" and SFAS 142. In addition, this Statement amends SFAS 144, to include in its scope long-term + +customer-relationship intangible assets of financial institutions such as depositor and borrower relationship + +intangible assets and credit card holders intangible assets. SFAS 147 is effective for acquisitions where the date + +of acquisition is on or after October 1, 2002.. The Group expects that the adoption of this Statement will not + +have a material impact on its results of operations and financial position. + +In November 2002, the Emerging Issues Task Force reached a final consensus related to Revenue Arrangements + +with Multiple Deliverables (EITF 00-21). The consensus requires that revenue arrangements with multiple + +deliverables should be divided into separate units of accounting if (a) a delivered item has value to the customer + +on stand alone basis, (b) there is objective and reliable evidence of the fair value of the undelivered item + +and (c) if the arrangement includes a general right of return, delivery or performance of the undelivered items is + +considered probable and substantially in the control of the vendor. Arrangement consideration should be + +allocated among the separate units of accounting based on their relative fair value and appropriate revenue + +recognition criteria would be applied to each separate unit of accounting. The Group has not yet determined + +what effect, if any, EITF 00-21 would have on revenue and net income determined in accordance with + +US GAAP. The Task Force agreed the effective date for the consensus will be for all revenue arrangements + +entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. The Group will adopt + +EITF 00-21 for their fiscal year beginning April 1, 2004. + +F47 + +In December 2002, the FASB issued Statements of Financial Accounting Standards No 148, "Accounting for + +Stock-Based Compensation Transition and Disclosure an amendment of FAS 123". Under FAS 148, the + +statement provides alternative methods of transition for a voluntary change to the fair value based method of + +accounting for stock-based employee compensation. In addition, this statement amends the disclosure + +requirements of Statement 123 to require prominent disclosure on both annual and interim financial statements + +about the method of accounting for stock-based employee compensation and the effect of the method used on + +reported results. The amendments to Statement 123 in paragraphs 2(a)-2(e) of this statement shall be effective + +for financial statements for fiscal years ending after December 15, 2002. Earlier application of the transition + +provisions in paragraphs 2(a)-2(d) is permitted for entities with a fiscal year ending prior to December 15, 2002, + +provided that financial statements for the 2002 fiscal year have not been issued as of the date this Statement is + +issued. Early application of the disclosure provisions in paragraph 2(e) is encouraged. The Group has determined + +that this statement will have no impact on its financial statements for the periods presented as it does not have + +any stock based compensation plans. + +In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure + +Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others an interpretation of FASB + +Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34" ("FIN 45"). This interpretation + +elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its + +obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at + +the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. + +This interpretation does not prescribe a specific approach for subsequently measuring the guarantor's recognized + +liability over the term of the related guarantee. This interpretation also incorporates, without change, the + +guidance in FASB Interpretation No. 34, Disclosure of Indirect Guarantees of Indebtedness of Others, which is + +being superseded. The initial recognition and initial measurement provisions of this interpretation are applicable + +on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's + +fiscal year-end. The disclosure requirements in this Interpretation are effective for financial statements of interim + +or annual periods ending after December 15, 2002. The interpretive guidance incorporated without change from + +Interpretation 34 continues to be required for financial statements for fiscal years ending after June 15, 1981 + +the effective date of Interpretation 34. The Group is currently evaluating the impact of recognizing the fair value + +of certain guarantees that it has issued. + +In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities an + +interpretation of ARB No. 51 " ("FIN 46"). This interpretation of Accounting Research Bulletin No. 51. + +Consolidated Financial Statements, addresses consolidation by business enterprises of variable interest entities + +which have one or both of the following characteristics: + +1. + +The equity investment at risk is not sufficient to permit the entity to finance its activities without additional + +subordinated financial support from other parties, which is provided through other interests that will absorb + +some or all of the expected losses of the entity. + +2. + +The equity investors lack one or more of the following essential characteristics of a controlling financial + +interest: + +a. + +The direct or indirect ability to make decisions about the entity's activities through voting rights or + +similar rights. + +b. + +The obligation to absorb the expected losses of the entity if they occur, which makes it possible for the + +entity to finance its activities. + +c. + +The right to receive the expected residual returns of the entity if they occur, which is the compensation + +for the risk of absorbing the expected losses. + +This Interpretation applies immediately to variable interest entities created after January 31, 2003, and to + +variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year + +or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a + +variable interest that it acquired before February 1, 2003. The Interpretation applies to public enterprises as of + +the beginning of the applicable interim or annual period, and it applies to nonpublic enterprises as of the end of + +the applicable annual period. + +This Interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it + +is first applied or by restating previously issued financial statements for one or more years with a cumulative- + +effect adjustment as of the beginning of the first year restated. The Group is still evaluating the impact of this + +interpretation on its financial statements. + +F48 + +REPORT OF THE INDEPENDENT AUDITORS + +to the Shareholders of Telkom SA Limited + +We have audited the accompanying consolidated balance sheets of Telkom SA Limited and subsidiaries as of March 31, + +2002, 2001 and 2000, and the related consolidated statements of income, shareholders' equity, and cash flows for each of + +the three years in the period ended March 31, 2002 set out on pages F49 to F114. These financial statements are the + +responsibility of the Company's directors. Our responsibility is to express an opinion on these financial statements based on + +our audits. We did not audit the financial statements of Vodacom Group (Proprietary) Limited, a 50% joint venture, which + +statements reflect total assets constituting 14% in March 2002, 12% in 2001 and 10% in 2000, and total revenues + +constituting 24% in March 2002, 21% in 2001 and 18% in 2000 of the related consolidated totals. Those statements were + +audited by other auditors, whose report, which has been furnished to us, without qualifying, draws attention to the fact that + +there were certain restatements and adjustments regarding the consolidated financial statements of the Vodacom Group + +(Proprietary) Limited as issued previously. Our opinion, insofar as it relates to the amounts included for Vodacom + +Group (Proprietary) Limited, is based solely on the report of the other auditors. + +We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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. + +In our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above + +present fairly, in all material respects, the consolidated financial position of Telkom SA Limited at March 31, 2002, 2001 + +and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period + +ended March 31, 2002, in conformity with International Accounting Standards and in the manner required by the + +Companies Act in South Africa. + +International Accounting Standards vary in certain significant respects from accounting principles generally accepted in the + +United States of America. Application of accounting principles generally accepted in the United States of America would + +have affected the consolidated shareholders' equity as of March 31, 2002, 2001 and the consolidated results of operations + +for each of the two years in the period ended March 31, 2002 to the extent summarized in Note 41 to the consolidated + +financial statements. + +Without qualifying our opinion above we draw attention to Note 20 to the consolidated financial statements. In 2002 + +Telkom SA Limited changed its accounting policy for financial instruments to conform with International Accounting + +Standard 39 Financial Instruments: Recognition and measurement. + +ERNST & YOUNG + +Registered Accountants and Auditors + +Chartered Accountants (SA) + +Pretoria + +December 10, 2002 + + Chartered Accountants (SA) + + Telephone (011) 772-3000 + +Wanderers Office Park + +Telefax + +(011) 772-4000 + +52 Corlett Drive, Illovo + +Docex + +123 Randburg + +PO Box 2322 + +www.ey.com/southafrica + +Johannesburg 2000 + +TELKOM SA LIMITED + +CONSOLIDATED INCOME STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Note + +Rm + +Rm + +Rm + +Operating revenue . . . . . . . . . . . . . . . . . . . . . . . . . + +3 + +27,113 + +31,352 + +34,197 + +Operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . + +4 + +23,231 + +26,427 + +29,984 + +Employee expenses . . . . . . . . . . . . . . . . . . . . . . . . . . + +7,713 + +6,590 + +7,166 + +Payments to other operators . . . . . . . . . . . . . . . . . . . . . + +4,241 + +4,983 + +5,762 + +Selling, general and administrative expenses . . . . . . . . . . . . + +5,324 + +6,971 + +8,237 + +Services rendered . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,439 + +1,539 + +2,194 + +Operating leases . . . . . . . . . . . . . . . . . . . . . . . . . . . + +340 + +1,292 + +1,217 + +Depreciation and amortization . . . . . . . . . . . . . . . . . . . . + +4,174 + +5,052 + +5,408 + +Operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,882 + +4,925 + +4,213 + +Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . + +5 + +641 + +617 + +490 + +Profit before finance charges . . . . . . . . . . . . . . . . . . . . + +4,523 + +5,542 + +4,703 + +Finance charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +6 + +2,482 + +3,137 + +2,550 + +Profit before tax . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,041 + +2,405 + +2,153 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +7 + +501 + +715 + +873 + +Profit after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,540 + +1,690 + +1,280 + +Minority interests . . . . . . . . . . . . . . . . . . . . . . . . . . . + +13 + +68 + +59 + +Net profit for the year . . . . . . . . . . . . . . . . . . . . . . . . + +1,527 + +1,622 + +1,221 + +Basic and diluted earnings per share (cents) . . . . . . . . . . . . . + +8 + +274.1 + +291.2 + +219.2 + +F49 + +F50 + +TELKOM SA LIMITED + +CONSOLIDATED BALANCE SHEETS + +at March 31, 2002 + +2000 + +2001 + +2002 + +Note + +Rm + +Rm + +Rm + +ASSETS + +Non-current assets . . . . . . . . . . . . . . . . . . . . . . . . . + +36,266 + +40,863 + +44,240 + +Property, plant and equipment . . . . . . . . . . . . . . . . . . . . + +9 + +34,110 + +38,704 + +41,918 + +Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . + +10 + +470 + +415 + +530 + +Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +11 + +389 + +576 + +780 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12 + +1,297 + +1,168 + +1,012 + +Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +11,010 + +12,674 + +10,968 + +Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +13 + +1,187 + +861 + +624 + +Trade receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . + +14 + +5,427 + +5,852 + +5,720 + +Income tax receivable . . . . . . . . . . . . . . . . . . . . . . . . + +15 + +1,259 + +1,294 + +1,081 + +Other financial assets . . . . . . . . . . . . . . . . . . . . . . . . . + +16 + +1,184 + +2,866 + +2,819 + +Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . + +17 + +1,953 + +1,801 + +724 + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +47,276 + +53,537 + +55,208 + +EQUITY AND LIABILITIES + +Capital and reserves . . . . . . . . . . . . . . . . . . . . . . . . + +13,350 + +14,972 + +16,832 + +Share capital and premium . . . . . . . . . . . . . . . . . . . . . . + +18 + +8,293 + +8,293 + +8,293 + +Share issue expenses . . . . . . . . . . . . . . . . . . . . . . . . . + +18 + +(44) + +Non-distributable reserves . . . . . . . . . . . . . . . . . . . . . . + +19 + +134 + +Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . + +20 + +5,057 + +6,679 + +8,449 + +Minority interests . . . . . . . . . . . . . . . . . . . . . . . . . . + +47 + +116 + +133 + +Non-current liabilities . . . . . . . . . . . . . . . . . . . . . . . . + +19,508 + +23,002 + +25,597 + +Interest bearing debt . . . . . . . . . . . . . . . . . . . . . . . . . + +21 + +15,149 + +18,991 + +21,505 + +Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +22 + +779 + +852 + +1,028 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12 + +228 + +315 + +463 + +Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +23 + +3,352 + +2,844 + +2,601 + +Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . + +14,371 + +15,447 + +12,646 + +Trade and other payables . . . . . . . . . . . . . . . . . . . . . . . + +24 + +5,882 + +6,141 + +7,391 + +Current portion of interest bearing debt . . . . . . . . . . . . . . . + +21 + +5,320 + +5,491 + +2,041 + +Current portion of finance leases . . . . . . . . . . . . . . . . . . . + +22 + +5 + +Deferred income . . . . . . . . . . . . . . . . . . . . . . . . . . . + +970 + +1,142 + +958 + +Income tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . + +317 + +499 + +193 + +Current portion of provisions . . . . . . . . . . . . . . . . . . . . + +23 + +1,156 + +1,240 + +1,236 + +Credit facilities utilized . . . . . . . . . . . . . . . . . . . . . . . . + +17 + +726 + +934 + +822 + +Total equity and liabilities . . . . . . . . . . . . . . . . . . . . . + +47,276 + +53,537 + +55,208 + +F51 + +TELKOM SA LIMITED + +CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY + +for the three years ended March 31, 2002 + +Preliminary + +Non- + +Share + +Share + +listing distributable + +Retained + +capital + +premium + +costs + +reserves + +earnings + +Total + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Balance at April 1, 1999 . . . . . . + +5,570 + +2,723 + +3,862 + +12,155 + +Net profit for the year . . . . . . . . + +1,527 + +1,527 + +Dividends declared . . . . . . . . . + +(332) + +(332) + +Balance at March 31, 2000 . . . . . + +5,570 + +2,723 + +5,057 + +13,350 + +Net profit for the year . . . . . . . . + +1,622 + +1,622 + +Balance at March 31, 2001 . . . . . + +5,570 + +2,723 + +6,679 + +14,972 + +Adoption of IAS 39 . . . . . . . . . + +45 + +584 + +629 + +Restated balance . . . . . . . . . . + +5,570 + +2,723 + +45 + +7,263 + +15,601 + +Net profit for the year . . . . . . . . + +1,221 + +1,221 + +Transfer to non-distributable reserves + +35 + +(35) + +Fair value adjustment . . . . . . . . + +5 + +5 + +Foreign currency reserves (net of + +tax of R10m) (Note 19) . . . . . . . + +49 + +49 + +Share issue expenses (Note 18) . . . + +(44) + +(44) + +Balance at March 31, 2002 . . . . . + +5,570 + +2,723 + +(44) + +134 + +8,449 + +16,832 + +F52 + +TELKOM SA LIMITED + +CONSOLIDATED CASH FLOW STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Note + +Rm + +Rm + +Rm + +Operating activities . . . . . . . . . . . . . . . . . . . . . . . + +4,917 + +6,165 + +8,171 + +Cash receipts from customers . . . . . . . . . . . . . . . . . . . + +26,010 + +31,072 + +34,053 + +Cash paid to suppliers and employees . . . . . . . . . . . . . . + +(19,683) + +(21,240) + +(22,448) + +Cash generated from operations . . . . . . . . . . . . . . . . . + +29 + +6,327 + +9,832 + +11,605 + +Income from investments . . . . . . . . . . . . . . . . . . . . . + +498 + +582 + +506 + +Finance charges paid . . . . . . . . . . . . . . . . . . . . . . . + +30 + +(1,271) + +(3,927) + +(3,026) + +Taxation paid . . . . . . . . . . . . . . . . . . . . . . . . . . . + +31 + +(257) + +(322) + +(914) + +Operating cash flow . . . . . . . . . . . . . . . . . . . . . . . . + +5,297 + +6,165 + +8,171 + +Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . + +(380) + +Investing activities . . . . . . . . . . . . . . . . . . . . . . . . + +(9,107) + +(9,964) + +(9,294) + +Expenditure to maintain operations + +Proceeds on disposal of property, plant and equipment . . . . . + +898 + +230 + +139 + +Proceeds on disposal of subsidiaries and joint ventures . . . . . + +32 + +26 + +13 + +Additions to property, plant and equipment . . . . . . . . . . . + +(9,461) + +(9,889) + +(9,004) + +Intangible assets acquired . . . . . . . . . . . . . . . . . . . . . + +(5) + +(97) + +Proceeds on disposal of other investments . . . . . . . . . . . . + +12 + +Additions to other investments . . . . . . . . . . . . . . . . . . + +(255) + +(260) + +(119) + +Expenditure to expand operations + +Purchase of subsidiaries and minority interests . . . . . . . . . + +33 + +(410) + +(57) + +(182) + +Disposal of division . . . . . . . . . . . . . . . . . . . . . . . . + +34 + +100 + +Preliminary listing costs . . . . . . . . . . . . . . . . . . . . . + +(44) + +Financing activities . . . . . . . . . . . . . . . . . . . . . . . + +5,051 + +3,439 + +110 + +Loans raised . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +6,141 + +9,713 + +14,286 + +Loans repaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(732) + +(5,661) + +(15,041) + +(Increase)/Decrease in interest-bearing investments . . . . . . . + +(358) + +(613) + +865 + +Net increase/(decrease) in net cash and cash equivalents . . . + +861 + +(360) + +(1,013) + +Net cash and cash equivalents at beginning of the year . . . + +366 + +1,227 + +867 + +Effect of foreign exchange rate differences . . . . . . . . . . + +48 + +Net cash and cash equivalents at end of the year . . . . . . . + +17 + +1,227 + +867 + +(98) + +F53 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +1. + +OVERVIEW OF BUSINESS ACTIVITIES + +Telkom SA Limited ("Telkom") is a limited liability company incorporated in the Republic of South Africa ("South + +Africa"). The company, its subsidiaries and joint ventures ("the Group") is the leading provider of fixed-line voice and + +data communications services in South Africa and mobile communications services through Vodacom Group + +(Proprietary) Limited ("Vodacom") in South Africa and certain other African countries. The Group's services and + +products include: fixed line telephony, including domestic, prepaid, international, public payphone and carrier services, + +as well as enhanced services, customer premises equipment sales and directory services; mobile telephony through + +Vodacom; data communications using fibre connections, including data transmission, data networking and leased lines + +and related services; and e-commerce, including internet access service provider, application service provider, hosting, + +data storage, e-mail and security services. + +2. + +SIGNIFICANT ACCOUNTING POLICIES + +Basis of preparation + +Over the recent years a process has been underway to harmonize South African Statements of Generally Accepted + +Accounting Practice ("SA GAAP") with International Accounting Standards ("IAS"). At September 30, 2002 that + +process was essentially complete with there being no material differences in matters of principle between IAS + +and SA GAAP, there are however differences in the effective dates of IAS and SA GAAP. + +For the accounting periods up to, and including March 2002, the Group has prepared annual financial statements, as + +required by the South African Companies Act, in accordance with SA GAAP. + +The financial statements are prepared on the historical cost basis, with the exception of financial instruments, which + +are measured at fair value, in conformity with IAS. IAS were applied in full for the first time, in these financial + +statements, as the primary accounting basis. Where adjustments arising from this change could be reasonably + +determined, opening retained earnings for the earliest period presented were accordingly adjusted, with the exception + +of the adjustment arising on the adoption of IAS 39, which was accounted for on April 1, 2001. + +The preparation of financial statements requires the use of estimates and assumptions that affect the reported amounts + +of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the + +reported amounts of revenue and expenses during the reporting period. Although these estimates are based on + +management's best knowledge of current events and actions that the Group may undertake in the future, actual results + +ultimately may differ from those estimates. + +Basis of consolidation + +The consolidated financial statements include those of Telkom SA Limited, its subsidiaries and joint ventures. Joint + +ventures are accounted for using the proportionate consolidation method. Non-consolidated subsidiaries and joint + +ventures are carried at cost. Intra-Group transactions are eliminated on consolidation. Business combinations are + +accounted for using the purchase method of accounting. On acquisition of a subsidiary or joint venture, any excess of + +the purchase price over the fair value of the net assets is recognized as goodwill on acquisition. Minority interests are + +calculated on the fair value of assets and liabilities. + +Intangible assets + +Intangible assets, including goodwill, are stated at cost and amortized on a straight-line basis over the anticipated + +period of benefit. Amortization commences when the asset is available for its intended use. + +The expected useful lives assigned to intangible assets are: + +Years + +Licences + +5 to 20 + +Goodwill + +3 to 20 + +Trademarks, copyrights and other + +3 to 5 + +Property, plant and equipment + +Freehold land is stated at cost and is not depreciated. + +F54 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2. + +SIGNIFICANT ACCOUNTING POLICIES (continued) + +Property, plant and equipment ("PPE") is stated at historical cost less accumulated depreciation. Depreciation is + +charged from the date of commissioning on a straight-line basis over the estimated useful life. Assets under + +construction represents software, network and support equipment and includes all direct expenditure but excludes + +abnormal wastage. + +The expected useful lives assigned to groups of property, plant and equipment are: + +Years + +Buildings + +40 to 50 + +Buildings held under finance lease + +25 + +Network equipment + +Cables + +10 to 28 + +Switching equipment + +5 to 15 + +Transmission equipment + +15 + +Other + +2 to 15 + +Support equipment + +5 to 10 + +Furniture and office equipment + +3 to 10 + +Data processing equipment and software + +3 to 5 + +Other + +5 to 10 + +Repairs and maintenance + +The Group expenses all costs associated with the repair and maintenance of its telecommunications network. + +Borrowing costs + +Financing costs directly associated with the acquisition or construction of assets that require more than three months to + +complete and place in service are capitalized at interest rates relating to loans specifically raised for that purpose, or at + +the weighted average borrowing rate where the general pool of Group borrowings was utilized. Other borrowing costs + +are expensed as incurred. + +Inventories + +Inventories are stated at the lower of cost, determined on a weighted average basis, or estimated net realisable value. + +Impairment of assets + +The Group regularly reviews its assets and financial instruments for any indication of impairment. With respect to long + +lived assets, the Group recognizes impairment when indicators including changes in technological, market, economic, + +legal and operating environments occur and result in changes in the extent to which such assets will be used in the + +future. + +The impairment of network assets is measured using the present value of projected cash flows covering the remaining + +useful lives of the network. Impairments of other assets are determined using the net realizable value. + +Impairment losses are recognized when the carrying value exceeds the estimated recoverable amount. + +Financial instruments + +Recognition + +All financial instruments are initially recognized at cost, including transaction costs, when the Group becomes a party + +to their contractual arrangements. Gains and losses arising on changes in fair value of these instruments are recognized + +in income in the period they occur, except for those classified as "available-for-sale" which are taken directly to equity. + +Subsequent to initial recognition, financial assets classified as "available-for-sale" are measured at fair value and those + +classified as "held to maturity" at amortized cost. Receivables, loans advanced, interest-bearing borrowings and other + +financial liabilities are measured at amortized cost where a maturity date exists, or at cost if no maturity date exists. + +Amortized cost is calculated on the effective interest rate method. + +Fair value adjustments on unlisted investments are made if the value can be determined in terms of IAS 39. + +F55 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2. + +SIGNIFICANT ACCOUNTING POLICIES (continued) + +Derecognition + +On derecognition of a financial asset or liability, the difference between the consideration and the carrying amount on + +the trade date is included in income. + +Trade and other receivables + +Trade receivables are recognized and carried at original invoice amount less an allowance for uncollectables. Based on + +historical performance with the fixed-line business, an allowance of 2% is raised for debt outstanding for less than + +30 days. For debts older than 30 days an allowance of 10% is used, increasing to 100% for debts in excess of + +120 days. Bad debts are written-off when the collection process has been exhausted. + +The mobile businesses's policy for determining the allowance for doubtful accounts in full (unless arrangements have + +been made with the debtors for payment) is as follows: + +All amounts outstanding for 120 days and more as well as any specific retailers, dealers or subscribers outstanding for + +less than 120 days, where there is deemed to be a significant risk of non-payment. In addition, if accounts receivable + +balances are handed over for collection to the legal department, they are written off in full regardless of days + +outstanding. Hand over to the legal department is determined on a case by case basis, but usually occurs after amounts + +have been outstanding for 90 days for individual subscribers and after 150 days for all other accounts receivables. + +Bills of exchange and promissory notes held to maturity are measured at amortized cost using the effective interest rate + +method. Those that do not have a fixed maturity are carried at the fair value of the consideration given. + +Cash and cash equivalents + +Cash and cash equivalents comprise cash on hand, deposits held on call and term deposits with maturity of less than + +three months. + +Derivative financial instruments + +Effective April 1, 2001, all derivative financial instruments are measured at fair value subsequent to initial recognition + +with gains and losses taken to income. The fair value of forward exchange contracts is calculated by reference to + +current forward exchange rates for contracts with similar maturity profiles. The fair values of interest rate swap + +contracts are determined as the difference in the present value of the future net interest cash flows. The fair value of + +currency swaps is determined with reference to the present value of expected future cash flows. The Group's derivative + +transactions, while providing effective economic hedges under the risk management policies, do not qualify for hedge + +accounting under the specific rules of IAS 39. Upon initial application of IAS 39, the Group recorded the fair value of + +the existing forward contracts on the balance sheet and the corresponding gain was recognized as an adjustment to the + +opening balance of retained earnings. + +Prior to April 1, 2001, the Group entered into foreign exchange forward contracts to hedge the Group's exposure to + +fluctuations in foreign currency exchange rates on specific transactions. Up to March 31, 2001, gains and losses due to + +changes in spot rates on forward contracts designated as hedges of identifiable foreign currency firm commitments + +were deferred and included in the measurement of the related foreign currency transactions. Gains and losses due to + +changes in spot rates on forward contracts designated as hedges of existing assets and liabilities were recorded to the + +income statement to offset the currency gain or loss from the instrument being hedged. The portion of the premium + +paid or received relating to the firm commitment period was included in the measurement of the basis of the related + +foreign currency transaction when recorded. Any remaining premium was amortized over the life of the foreign + +exchange contract to the income statement. Foreign exchange contract costs incurred in covering currency loans are + +expensed over the period of the contract and are included in finance costs. + +Prior to April 1, 2001, the Group entered into interest rate swap agreements in order to manage interest rate exposure. + +The net interest paid or received on the swaps was recognized as interest expense. + +Prior to April 1, 2001, the Group entered into cross-currency interest rate swap agreements in order to manage + +exposures to interest rates and fluctuations in foreign currency exchange rates. The net interest paid or received on the + +swaps was recognized as interest expense. Gains and losses due to changes in spot rates on the contracts used for + +hedging were recorded to the income statement to offset the currency gain or loss from the instrument being hedged. + +F56 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2. + +SIGNIFICANT ACCOUNTING POLICIES (continued) + +Sale and buy back transactions + +Securities sold under sale and buy back agreements are carried at amortized cost. Associated finance charges are taken + +to income. + +Securities purchased under sale and buy back agreements are not recognized in the financial statements but a + +receivable is raised for the consideration provided. The receivable is classified as a held for trading investment, and is + +carried at fair value with adjustments taken to income. + +Bridge liquidity transactions + +New bonds issued are measured at amortized cost based on the yield to maturity of the new issue. + +Bonds are derecognized when the obligation specified in the contract is discharged. The difference between the + +carrying value of the bond and the amount paid to extinguish the obligation is included in income. + +Bonds issued where Telkom is a buyer and seller of last resort are carried at amortized cost. The Group does not + +actively trade in bonds. + +Foreign currencies + +The functional currency of the Group is the South African Rand. + +Transactions denominated in foreign currencies are translated at the rate of exchange at the transaction date. Monetary + +items denominated in foreign currencies are translated at the rate of exchange at the balance sheet date. Realized and + +unrealized profits and losses on foreign exchange are included in finance charges. + +Assets and liabilities of foreign entities are translated at the foreign exchange rates ruling at the balance sheet date. + +Income, expenditure and cash flow items are translated at the actual foreign exchange rate or average foreign exchange + +rates for the period. Exchange differences on consolidation are classified as part of the foreign currency translation + +reserve, until disposal of the investment. Any fair value adjustments arising on the acquisition of a foreign entity are + +recorded in the Group and translated at the foreign exchange rates on transaction date. + +Deferred taxation + +Deferred taxation is accounted for using the balance sheet liability method at current rates in respect of temporary + +differences. Deferred tax assets are recognized to the extent that future taxable profits are expected to be available for + +set-off. + +Employee benefits + +Short-term employee benefits + +The cost of all short-term employee benefits is recognized during the period employees render services. + +Leave benefits + +Holiday leave is accumulated over the period that the leave accrues and is subject to a cap. Sick leave is accumulated + +on days accrued and is also subject to a cap. + +Post-employment benefits + +The Group provides defined benefit and defined contribution plans for the benefit of employees. These plans are + +funded by the employees and the Group, taking into account recommendations of the independent actuaries. The post- + +retirement medical liability is unfunded. + +Defined contribution plans + +The Group's funding of the defined contribution plans is charged to the income statement in the same period as the + +related service is provided. + +Defined benefit plans + +The Group provides defined benefit plans for pension, medical aid costs, and telephone rebates to qualifying + +employees. The Group's net obligation in respect of defined benefits is calculated separately for each plan by + +estimating the amount of future benefits earned in return for services rendered. + +F57 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2. + +SIGNIFICANT ACCOUNTING POLICIES (continued) + +The amount recognized in the balance sheet represents the present value of the defined benefit obligations, calculated + +using the projected unit credit method, as adjusted for unrecognized actuarial gains and losses, unrecognized past + +service costs and reduced by the fair value of plan assets. The amount of any surplus recognized is limited to + +unrecognized actuarial losses and past service costs plus the present value of available refunds and reductions in future + +contributions to the plan. To the extent that there is uncertainty as to the entitlement to the surplus, no asset is + +recognized. + +Actuarial gains and losses are recognized as income or expense when the cumulative unrecognized gains and losses for + +each individual plan exceed 10% of the greater of the present value of the Group's obligation or the fair value of plan + +assets. These gains or losses are amortized on a straight line basis over ten years. + +Past service costs are recognized immediately to the extent that the benefits are vested, otherwise they are recognized + +on a straight line basis over the average period the benefits become vested. + +Termination benefits + +Termination benefits are payable when employment is terminated before the normal retirement age or when an + +employee accepts voluntary redundancy in exchange for benefits. Termination benefits are accounted for in terms of + +the policy for provisions. + +Provisions + +Provisions are recognized when, and only when, the Group has a present obligation (legal or constructive) as a result + +of a past event and it is probable (i.e. more likely than not) that an outflow of resources will be required to settle the + +obligation, and a reliable estimate can be made of the amount of the obligation. Provisions are reviewed at each + +balance sheet date and adjusted to reflect the current best estimate. Where the effect of time value of money is + +material, the amount of a provision is the present value of the expenditures expected to be required to settle the + +obligation. + +Revenue + +Revenue for services is stated at amounts invoiced to customers and excludes Value-Added Tax. + +The Group provides fixed-line communication services, mobile communication services, directory services and + +communication-related products. The Group provides such services to business, residential, payphone and mobile + +customers. Revenue, which excludes Value-Added Tax, represents the value of fixed consideration that has been + +received or is receivable. + +Revenue is recognized when there is evidence of an arrangement, collectability is reasonably assured, and the delivery + +of the product or service has occurred. In certain circumstances revenue is split into separately identifiable components + +and recognized when the related components are delivered in order to reflect the substance of the transaction. The + +value of components is determined using verifiable objective evidence. The Group does not provide customers with the + +right to a refund. + +Products and services + +Subscriptions + +The Group provides telephone and data communication services under postpaid and prepaid payment arrangements. + +Revenue includes fees for installation and activation. Installation and activation-related fees are recognized as revenue + +upon activation. Costs incurred on first time installations that form an integral part of the network are capitalized and + +depreciated over the life of the network. All other installation and activation costs are expensed as incurred. + +Postpaid and prepaid service arrangements include subscription fees, typically monthly fees, which are recognized + +over the subscription period on a pro rata basis. The terms and conditions of certain products allow the carry over of + +unused minutes; revenue related to the carry over of unused minutes is deferred until usage or expiration. + +F58 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2. + +SIGNIFICANT ACCOUNTING POLICIES (continued) + +Airtime, traffic and value-added services + +Prepaid service revenue collected in advance is deferred and recognized based on actual usage or upon expiration of + +the usage period or whatever comes first. Payphone service revenue is recognized when the service is provided. + +Community phone revenue collected in advance is deferred and recognized based on actual usage or upon expiration + +of the usage period. Interconnection revenue for call termination, call transit, and network usage are recognized in the + +period the traffic occurs. Revenue related to local, long distance, network-to-network, roaming and international call + +connection services is recognized when the call is placed or the connection provided. Revenue related to products and + +value-added services is recognized upon delivery of the product or service. + +Telkom provides incentives to its retail payphone card distributors as trade discounts. Incentives are based on sales + +volume and value. Revenue for retail payphone cards is recorded as traffic revenues, net of these discounts as the cards + +are used. + +Equipment sales + +Sales of communication equipment are recognized upon delivery to the customer. + +Directory services + +Revenue related to published directory services is recognized on a pro rata basis over the period in which the + +publication expires, which is generally 12 months. Telephone-based directory service revenue is recognized when the + +service is provided. + +Other + +Dividends from investments are recognized on the date that the dividend is declared. Interest is recognized on a time + +proportion basis taking into account the principal amount outstanding and the effective interest rate. + +Incentives + +Vodacom pays incentives to service providers and dealers for new activations, retention of existing customers and + +reaching specified sales targets. These incentives are expensed as incurred. + +Vodacom also pays distribution incentives to service providers and dealers for exclusivity, distribution assets and + +distribution subsidies, which are deferred and expensed over the contractual relationship period. + +Leases + +Operating lease payments are recognized as an expense in the income statement on a straight-line basis over the + +lease term. + +Assets acquired in terms of finance leases are capitalized at the lower of fair value or the present value of the minimum + +lease payments at inception of the lease and depreciated over the lesser of the useful life of the asset or the lease term. + +Lease finance costs are charged against income over the term of the lease using the effective interest rate method. + +Segmental reporting + +The Group is managed in two business segments: Fixed-line and Mobile. The basis of segment reporting is + +representative of the Group's internal reporting structure, which is in accordance with International Accounting + +Standards. The Group's two segments operate mainly in South Africa but the mobile segment has businesses in certain + +other African countries. + +The Fixed-line business segment provides local telephony, domestic and international long distance services as well as + +leased lines, data transmission, directory services and internet access. + +The Mobile business segment provides mobile telephony services as well as the sale of mobile equipment. + +Inter-segment sales are accounted for in the same way as sales to third parties at current market prices. + +Marketing + +Marketing costs are recognized as an expense as incurred. + +F59 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +3. + +OPERATING REVENUE + +27,113 + +31,352 + +34,197 + +Operating revenue + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +23,530 + +26,100 + +27,606 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,583 + +5,252 + +6,591 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +23,530 + +26,100 + +27,606 + +Subscriptions, connections and other usage . . . . . . . . . . . . . . . . + +4,085 + +4,197 + +4,410 + +Traffic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +14,991 + +16,409 + +17,168 + +Domestic (local and long distance) . . . . . . . . . . . . . . . . . . . + +8,153 + +8,280 + +8,670 + +Fixed-to-mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,325 + +6,845 + +7,323 + +International (outgoing) . . . . . . . . . . . . . . . . . . . . . . . . . + +1,513 + +1,284 + +1,175 + +Interconnection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,228 + +1,706 + +1,645 + +Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,602 + +3,150 + +3,729 + +Directories and other . . . . . . . . . . . . . . . . . . . . . . . . . . . + +624 + +638 + +654 + +4. + +OPERATING EXPENSES + +23,231 + +26,427 + +29,984 + +Operating expenses comprise: + +Employee expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +7,713 + +6,590 + +7,166 + +Salaries and wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,062 + +3,691 + +3,731 + +Pension and retirement funds . . . . . . . . . . . . . . . . . . . . . . . + +129 + +128 + +81 + +Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +129 + +128 + +119 + +Curtailment gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(38) + +Defined contribution expense . . . . . . . . . . . . . . . . . . . . . . . + +486 + +468 + +505 + +Post-retirement medical aid . . . . . . . . . . . . . . . . . . . . . . . . + +354 + +(27) + +228 + +Current service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . + +42 + +50 + +14 + +Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +266 + +348 + +224 + +Actuarial loss/(gain) . . . . . . . . . . . . . . . . . . . . . . . . . . + +15 + +(16) + +(5) + +Settlement (gain)/loss . . . . . . . . . . . . . . . . . . . . . . . . . . + +(86) + +11 + +Curtailment loss/(gain) . . . . . . . . . . . . . . . . . . . . . . . . . + +31 + +(323) + +(16) + +Medical aid contributions . . . . . . . . . . . . . . . . . . . . . . . . . + +248 + +383 + +379 + +Sick leave and telephone rebates . . . . . . . . . . . . . . . . . . . . . + +135 + +12 + +(5) + +Current service cost/(gain) . . . . . . . . . . . . . . . . . . . . . . . + +126 + +3 + +(15) + +Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +9 + +9 + +10 + +Other benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,996 + +1,803 + +1,874 + +Restructuring expense . . . . . . . . . . . . . . . . . . . . . . . . . . . + +303 + +132 + +373 + +Curtailment loss/(gain) + +The curtailment loss/(gain) resulted from a material reduction in the + +number of employees covered by the defined benefit plan, as well as a + +change in benefit under the plan. This, in turn, resulted in a required + +adjustment to the present value of the obligation. + +Settlement (gain)/loss + +The settlement (gain)/loss resulted from a transaction between the group + +and members of the defined benefit plan. The members were offered a + +lump sum in exchange for their right to receive specified post-employment + +benefits. + +Payments to other operators . . . . . . . . . . . . . . . . . . . . . . + +4,241 + +4,983 + +5,762 + +F60 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +4. + +OPERATING EXPENSES (continued) + +Selling, general and administrative expenses . . . . . . . . . . . . . + +5,324 + +6,971 + +8,237 + +Selling and administrative expenses . . . . . . . . . . . . . . . . . . . + +3,170 + +4,053 + +4,995 + +Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,065 + +2,076 + +2,202 + +Marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +582 + +592 + +617 + +Property, plant and equipment impairment losses (Note 9) . . . . . . . . + +279 + +445 + +Impairment provisions raised . . . . . . . . . . . . . . . . . . . . . . + +119 + +398 + +Write-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +160 + +47 + +Profit on disposal of property, plant and equipment . . . . . . . . . . . + +(493) + +(29) + +(22) + +Services rendered . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,439 + +1,539 + +2,194 + +Facilities management, security and other . . . . . . . . . . . . . . . . + +984 + +1,222 + +1,786 + +Consultancy services . . . . . . . . . . . . . . . . . . . . . . . . . . . + +445 + +290 + +382 + +Auditors' remuneration . . . . . . . . . . . . . . . . . . . . . . . . . . + +10 + +27 + +26 + +Audit fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +8 + +13 + +15 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +14 + +11 + +Operating leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +340 + +1,292 + +1,217 + +Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +239 + +297 + +316 + +Transmission and data lines . . . . . . . . . . . . . . . . . . . . . . . . + +7 + +5 + +Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +54 + +56 + +59 + +Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +40 + +934 + +842 + +Depreciation of property, plant and equipment . . . . . . . . . . . . + +4,138 + +4,920 + +5,283 + +Freehold buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +155 + +197 + +190 + +Leasehold buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +20 + +20 + +22 + +Network equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,766 + +3,367 + +3,324 + +Support equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +309 + +406 + +365 + +Furniture and office equipment . . . . . . . . . . . . . . . . . . . . . . + +27 + +34 + +44 + +Data processing equipment and software . . . . . . . . . . . . . . . . . + +678 + +817 + +1,262 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +183 + +79 + +76 + +Amortization of intangible assets . . . . . . . . . . . . . . . . . . . . + +36 + +132 + +125 + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +18 + +75 + +66 + +Trademarks, copyrights and other . . . . . . . . . . . . . . . . . . . . . + +16 + +55 + +53 + +Licenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +2 + +6 + +5. + +INVESTMENT INCOME + +641 + +617 + +490 + +6. + +FINANCE CHARGES + +2,482 + +3,137 + +2,550 + +Interest payable and loan discount amortized . . . . . . . . . . . . . + +2,107 + +2,560 + +2,550 + +Local loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,342 + +2,173 + +2,690 + +Foreign loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +137 + +559 + +599 + +Less: Finance costs capitalized . . . . . . . . . . . . . . . . . . . . . . + +(332) + +(160) + +(104) + +Foreign exchange (gains)/losses . . . . . . . . . . . . . . . . . . . . . . + +(40) + +(12) + +2,401 + +Fair value adjustments on derivative instruments . . . . . . . . . . . . . + +(3,036) + +Hedging costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +375 + +577 + +Capitalization rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +14.48% + +13.01% + +13.48% + +F61 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +7. + +TAXATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +501 + +715 + +873 + +South African normal company taxation . . . . . . . . . . . . . . + +318 + +470 + +787 + +Current tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +317 + +471 + +581 + +Underprovision/(overprovision) based on assessment . . . . . . . + +1 + +(1) + +206 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +132 + +214 + +48 + +Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +138 + +224 + +326 + +Overprovision for prior year based on assessment . . . . . . . . . + +(6) + +(10) + +(278) + +Secondary Tax on Companies . . . . . . . . . . . . . . . . . . . . + +50 + +29 + +37 + +Foreign tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1 + +2 + +1 + +Reconciliation of taxation rate . . . . . . . . . . . . . . . . . . . . + +% + +% + +% + +Effective rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +24.5 + +29.8 + +40.5 + +South African normal rate of taxation . . . . . . . . . . . . . . . . . + +30.0 + +30.0 + +30.0 + +Adjusted for: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(5.5) + +(0.2) + +10.5 + +Exempt income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(24.1) + +(15.5) + +0.1 + +Disallowable expenditure . . . . . . . . . . . . . . . . . . . . . . . + +16.5 + +13.2 + +12.3 + +Temporary differences in joint venture . . . . . . . . . . . . . . . . + +(0.6) + +(0.2) + +(0.4) + +Tax losses not utilized . . . . . . . . . . . . . . . . . . . . . . . . . + +1.0 + +1.1 + +- + +Secondary Tax on Companies . . . . . . . . . . . . . . . . . . . . . + +2.5 + +1.3 + +1.7 + +Underprovision for prior years . . . . . . . . . . . . . . . . . . . . . + +(0.8) + +(0.1) + +(3.2) + +The change in the effective rate for 2002 was primarily due to non-deductible losses relative to a supplier dispute, and + +the change in tax regime whereby certain income was no longer exempt from tax. + +8. + +EARNINGS AND DIVIDEND PER SHARE + +Basic and diluted earnings per share + +The calculation of earnings per share is based on net profit for the year (earnings) of Rm 1,221 (2001: Rm 1,622, + +2000: Rm 1,527) and ordinary shares in issue of 557,031,819 (2001: 557,031,819, 2000: 557,031,819). + +Dividend per share + +The calculation of the dividend per ordinary share is based on a declared ordinary dividend of R Nil (2001: R Nil, + +2000: Rm 332) and 557,031,819 (2001: 557,031,819, 2000: 557,031,819) ordinary shares issued. + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Basic and diluted earnings per share (cents) . . . . . . . . . . . . . . + +274.1 + +291.2 + +219.2 + +Dividend per share (cents) . . . . . . . . . . . . . . . . . . . . . . . . + +59.6 - + +- + +F62 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +9. + +PROPERTY, PLANT AND EQUIPMENT + +2002 + +2001 + +Accumulated + +Carrying + +Accumulated + +Carrying + +Cost depreciation + +value + +Cost depreciation + +value + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Freehold land and buildings . . . . + +3,548 + +(829) + +2,719 + +3,226 + +(641) + +2,585 + +Leasehold buildings . . . . . . . . + +758 + +(141) + +617 + +608 + +(120) + +488 + +Network equipment . . . . . . . . + +50,448 + +(20,032) + +30,416 + +46,904 + +(19,348) + +27,556 + +Support equipment . . . . . . . . + +3,090 + +(1,634) + +1,456 + +2,874 + +(1,432) + +1,442 + +Furniture and office equipment . . + +392 + +(167) + +225 + +333 + +(125) + +208 + +Data processing equipment and + +software . . . . . . . . . . . . . . + +7,217 + +(3,677) + +3,540 + +6,513 + +(2,748) + +3,765 + +Under construction . . . . . . . . + +2,700 + +2,700 + +2,408 + +2,408 + +Other . . . . . . . . . . . . . . . . + +496 + +(251) + +245 + +556 + +(304) + +252 + +68,649 + +(26,731) + +41,918 + +63,422 + +(24,718) + +38,704 + +2000 + + Accumulated + +Carrying + +Cost depreciation + +value + +Rm + +Rm + +Rm + +Freehold land and buildings . . . . . . . . . . . . . . . . . . . . . . . . . + +2,714 + +(448) + +2,266 + +Leasehold buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +570 + +(102) + +468 + +Network equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +39,709 + +(16,232) + +23,477 + +Support equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,342 + +(1,035) + +1,307 + +Furniture and office equipment . . . . . . . . . . . . . . . . . . . . . . . . + +286 + +(84) + +202 + +Data processing equipment and software . . . . . . . . . . . . . . . . . . . + +5,098 + +(2,186) + +2,912 + +Under construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,229 + +3,229 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +450 + +(201) + +249 + +54,398 + +(20,288) + +34,110 + +Carrying + + Foreign + + Carrying + +value at + + currency Impairment + + value at + +beginning + + translation + +and + + Deprecia- + +end of + +of year + + Additions + + Transfers + + reserve + + write-offs + + Disposals + +tion + +year + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +2002 + +Freehold land and + +buildings . . . . . . + +2,585 + +1 + +324 + +(1) + +(190) + +2,719 + +Leasehold buildings + +488 + +47 + +104 + +(22) + +617 + +Network equipment + +27,556 + +1,719 + +4,479 + +65 + +(12) + +(67) + +(3,324) + +30,416 + +Support equipment . + +1,442 + +379 + +(365) + +1,456 + +Furniture and office + +equipment . . . . . + +208 + +67 + +(6) + +(44) + +225 + +Data processing + +equipment and + +software . . . . . . + +3,765 + +337 + +935 + +(219) + +(16) + +(1,262) + +3,540 + +Under construction + +2,408 + +6,727 + +(6,221) + +(214) + +2,700 + +Other . . . . . . . . + +252 + +106 + +1 + +(38) + +(76) + +245 + +38,704 + +9,004 + +66 + +(445) + +(128) + +(5,283) + +41,918 + +F63 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +9. + +PROPERTY, PLANT AND EQUIPMENT (continued) + +Carrying + +Carrying + +value at + +Business + + Impairment + +value at + +beginning + +combina- + +and + +Deprecia- + +end of + +of year + +Additions + +tions + +Transfers + + write-offs + +Disposals + +tion + +year + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +2001 + +Freehold land and + +buildings . . . . . . + +2,266 + +- + +- + +536 + +- + +(20) + +(197) + +2,585 + +Leasehold buildings + +468 + +55 + +- + +- + +- + +(15) + +(20) + +488 + +Network equipment + +23,477 + +1,235 + +116 + +6,269 + +(160) + +(14) + +(3,367) + +27,556 + +Support equipment . + +1,307 + +85 + +- + +463 + +- + +(7) + +(406) + +1,442 + +Furniture and office + +equipment . . . . . + +202 + +18 + +- + +29 + +- + +(7) + +(34) + +208 + +Data processing + +equipment and + +software . . . . . . + +2,912 + +224 + +- + +1,482 + +- + +(36) + +(817) + +3,765 + +Under construction + +3,229 + +8,181 + +- + +(8,811) + +(119) + +(72) + +- + +2,408 + +Other . . . . . . . . + +249 + +91 + +- + +32 + +- + +(41) + +(79) + +252 + +34,110 + +9,889 + +116 + +(279) + +(212) + +(4,920) + +38,704 + + Carrying + + Carrying + + value at + + value at + + beginning + + Business + + Deprecia- + + end of + + of year + + Additions combinations + + Transfers + + Disposals + +tion + +year + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm Rm + +2000 + +Freehold land and buildings . . . + +1,557 + +8 + +- + +856 + +- + +(155) + +2,266 + +Leasehold buildings . . . . . . . + +493 + +3 + +- + +- + +(8) + +(20) + +468 + +Network equipment . . . . . . . + +20,219 + +409 + +- + +5,708 + +(93) + +(2,766) + +23,477 + +Support equipment . . . . . . . . + +980 + +61 + +- + +575 + +- + +(309) + +1,307 + +Furniture and office equipment . + +181 + +7 + +- + +49 + +(8) + +(27) + +202 + +Data processing equipment and + +software . . . . . . . . . . . . . + +1,928 + +158 + +- + +1,520 + +(16) + +(678) + +2,912 + +Under construction . . . . . . . . + +3,229 + +8,760 + +- + +(8,760) + +- + +- + +3,229 + +Other . . . . . . . . . . . . . . . + +598 + +55 + +18 + +52 + +(291) + +(183) + +249 + +29,185 + +9,461 + +18 + +- + +(416) + +(4,138) + +34,110 + +F64 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +9. PROPERTY, PLANT AND EQUIPMENT (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +The average time taken to construct assets varies between three and four months. + +Impairment and write-off of assets . . . . . . . . . . . . . . . . . . . . + +- + +279 + +445 + +Assets under construction . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +119 + +214 + +Assets relating to information technology development that, due to a + +supplier dispute, are not re-usable, have been impaired in full . . . . . + +- + +119 + +179 + +Certain information technology support system development found not + +to be economically viable, resulted in a full write-off . . . . . . . . . . + +- + +- + +35 + +Data processing equipment and software . . . . . . . . . . . . . . . . . . + +- + +- + +219 + +Assets relating to information technology development that, due to a + +supplier dispute, are not re-usable, have been impaired in full . . . . . + +- + +- + +167 + +The Group implemented a new billing system during 2002. The carrying + +value of the previous billing system was impaired in full . . . . . . . . + +- + +- + +52 + +Network equipment + +Network equipment written-off in full . . . . . . . . . . . . . . . . . . + +- + +160 + +12 + +10. INTANGIBLE ASSETS + +2002 + +2001 + + Accumulated + + Carrying + + Accumulated + +Carrying + +Cost amortization + +value + +Cost amortization + +value + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Goodwill . . . . . . . . . . . . + +493 + +(185) + +308 + +299 + +(119) + +180 + +Trademarks, copyrights and other + +274 + +(127) + +147 + +277 + +(74) + +203 + +Licences . . . . . . . . . . . . + +104 + +(29) + +75 + +54 + +(22) + +32 + +871 + +(341) + +530 + +630 + +(215) + +415 + +2000 + + Accumulated + + Carrying + +Cost amortization + +value + +Rm + +Rm + +Rm + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +231 + +(44) + +187 + +Trademarks, copyrights and other . . . . . . . . . . . . . . . . . . . . . . + +270 + +(19) + +251 + +Licences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +52 + +(20) + +32 + +553 + +(83) + +470 + +F65 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +10. + +INTANGIBLE ASSETS (continued) + +The carrying amounts of intangible assets can be reconciled as follows: + + Carrying + +Foreign + + value at + + currency + +Carrying + + beginning + + translation + +value at + + of year + + Additions + + Disposals + + reserve Amortization + + end of year + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +2002 + +Goodwill . . . . . . . . . + +180 + +194 + +(66) + +308 + +Trademarks, copyrights and + +other . . . . . . . . . . . . + +203 + +(3) + +(53) + +147 + +Licences . . . . . . . . . . + +32 + +48 + +(8) + +9 + +(6) + +75 + +415 + +242 + +(11) + +9 + +(125) + +530 + +Carrying + +value at + + Carrying + +beginning + +Business + + value at + +of year combinations Amortization + + end of year + +Rm + +Rm + +Rm + +Rm + +2001 + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . + +187 + +68 + +(75) + +180 + +Trademarks, copyrights and other . . . . . . . . . . . . . + +251 + +7 + +(55) + +203 + +Licences . . . . . . . . . . . . . . . . . . . . . . . . . . + +32 + +2 + +(2) + +32 + +470 + +77 + +(132) + +415 + +Carrying + +value at + + Carrying + +beginning + +Business + + value at + +of year + + Additions combinations Amortization + + end of year + +Rm + +Rm + +Rm + +Rm + +Rm + +2000 + +Goodwill . . . . . . . . . . . . . . . . . . + +31 + +174 + +(18) + +187 + +Trademarks, copyrights and other . . . . . + +29 + +4 + +234 + +(16) + +251 + +Licences . . . . . . . . . . . . . . . . . . + +33 + +1 + +(2) + +32 + +93 + +5 + +408 + +(36) + +470 + +F66 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +11. INVESTMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +389 + +576 + +780 + +Participating interests + +Unlisted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +114 + +102 + +102 + +Intelsat + +1.158069% (2001: 1.160425%, 2000: 1.161013%) share in International + +Telecommunications Satellite Organization, headquartered in + +Washington DC, USA at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +104 + +92 + +92 + +Directors' valuation: R264.4 million (2001: R152.3 million, 2000: R118.6 million) + +Inmarsat + +0.30186% (2001: 0.30186%, 2000: 0.30186%) share in International Mobile + +Satellite Services Organization, headquartered in London, United Kingdom, + +at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +9 + +9 + +9 + +Directors' valuation: R26.4 million (2001: R17.8 million, 2000: R13.1million) + +Rascom + +1.180595% (2001: 1.530%, 2000: 3.280705%) share in Regional African Satellite + +Communications Organization, headquartered in Abidjan, Ivory Coast, at cost . . + +1 + +1 + +1 + +Directors' valuation: R1.8 million (2001: R1.8 million, 2000: R1.5 million). + +A reliable fair value could not be determined for unlisted investments. The + +directors' valuations are based on the Group's interest in the entities' net asset + +values translated at year-end exchange rates. + +Investment initially held for disposal . . . . . . . . . . . . . . . . . . . . . . . . + +61 + +- + +- + +Film Fun Holdings (Proprietary) Limited + +100% shareholding, at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +26 + +- + +- + +Loans granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +35 + +- + +- + +Film Fun Holdings (Proprietary) Limited was not consolidated in Group results as + +they were acquired with a view to disposal in 2000. + +Joint ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +- + +- + +Vodacom World Online + +Joint venture loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +- + +- + +Listed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +27 + +27 + +77 + +New Skies N.V. + +0.889184% (2001: 1.157712%, 2000: 1.157712%) share in New Skies + +Satellite N.V., headquartered in The Hague, Netherlands at fair value + +(2001 and 2000, at cost) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +27 + +27 + +77 + +Market value: R77.0 million (2001: R72.0 million, 2000: Directors' valuation + +R54.8 million). + +Other investments + +Cost and valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +185 + +447 + +601 + +Linked insurance policies Coronation fund manager . . . . . . . . . . . . . . . + +- + +- + +211 + +Linked insurance policies Investec fund manager . . . . . . . . . . . . . . . . + +- + +- + +33 + +Ordinary shares Listed Investec fund manager . . . . . . . . . . . . . . . . . + +- + +- + +75 + +Other money markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +240 + +Government stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +1 + +Unlisted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +185 + +447 + +41 + +Included in other investments is R560m (2001: R440m, 2000: R180m) that will be used to fund the post-retirement + +medical aid liability. These investments have been made through a cell captive that has been consolidated in full. + +F67 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +12. DEFERRED TAXATION + +1,069 + +853 + +549 + +Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . + +1,201 + +1,069 + +853 + +Adoption of IAS 39 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(250) + +Income statement movements . . . . . . . . . . . . . . . . . . . . . + +(132) + +(216) + +(48) + +Temporary differences . . . . . . . . . . . . . . . . . . . . . . . . + +(138) + +(224) + +(326) + +Underprovision prior year based on assessment . . . . . . . . . . . + +6 + +8 + +278 + +Foreign equity revaluation . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(6) + +The balance comprises: . . . . . . . . . . . . . . . . . . . . . . . . + +1,069 + +853 + +549 + +Capital allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(371) + +(786) + +(1,579) + +Provisions and allowances . . . . . . . . . . . . . . . . . . . . . . . . + +774 + +601 + +806 + +Tax losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +666 + +1,038 + +1,322 + +Deferred tax balance is made up as follows: . . . . . . . . . . . . . + +1,069 + +853 + +549 + +Deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,297 + +1,168 + +1,012 + +Deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . + +(228) + +(315) + +(463) + +Tax losses available for set-off against future taxable profits . . . . + +2,394 + +3,719 + +4,637 + +Under South African tax legislation, tax losses for companies + +continuing to do business, do not expire. + +13. INVENTORIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,187 + +861 + +624 + +Installation and maintenance material . . . . . . . . . . . . . . . . . . + +895 + +532 + +336 + +Network equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . + +135 + +62 + +49 + +Merchandise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +157 + +267 + +239 + +14. TRADE RECEIVABLES . . . . . . . . . . . . . . . . . . . . . . . + +5,427 + +5,852 + +5,720 + +Trade debtors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,078 + +4,857 + +4,858 + +Gross trade debtors . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,624 + +5,343 + +5,501 + +Provision for doubtful debts . . . . . . . . . . . . . . . . . . . . . + +(546) + +(486) + +(643) + +Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +347 + +607 + +695 + +Other receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +388 + +167 + +F68 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +15. INCOME TAX RECEIVABLE . . . . . . . . . . . . . . . . . . . . . . . + +1,259 + +1,294 + +1,081 + +Tax receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,116 + +1,116 + +899 + +Interest accrued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +143 + +178 + +182 + +Income tax receivable relates to an over-payment of estimated tax in respect + +of the 1998 and 1999 tax years. A refund of R844 million was received + +subsequent to year-end. + +16. OTHER FINANCIAL ASSETS . . . . . . . . . . . . . . . . . . . . . . + +1,184 + +2,866 + +2,819 + +Repurchase agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +276 + +782 + +100 + +Bills of exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +86 + +193 + +10 + +Derivative instruments (Note 27) . . . . . . . . . . . . . . . . . . . . . . . + +822 + +1,891 + +2,709 + +Repurchase agreements + +The Group actively manages a portfolio of sale and buy back repurchase + +agreements in the South African capital and money markets, with a view to + +generating additional investment income on the favourable interest rates + +provided on these transactions. Interest received from the borrower is based + +on the current market-related yield required for South African Government + +and Telkom bonds. + +2002 + +Maturity period + +Yield + +7 days + +13.30% . . . . . . . . . . . . . . . . . . . . + +46 + +5 days + +13.02% 13.30% . . . . . . . . . . . . . + +54 + +100 + +2001 + +Maturity period + +Yield + +7 days + +11.30% 12.40% . . . . . . . . . . . . . + +348 + +3 days + +11.92% 13.30% . . . . . . . . . . . . . + +434 + +782 + +2000 + +Maturity period + +Yield + +3 days + +13.43% 14.26% . . . . . . . . . . . . . + +276 + +Due to the short-term nature of these transactions and the fact that the transactions are initiated based on market- + +related interest rates, the carrying value approximates the fair value. Collateral in the form of publicly tradable bonds + +has been delivered in respect of the above transactions. + +The terms and conditions of these transactions are governed by signed International Securities Market Association + +("ISMA") agreements with all counter parties and the regulations of the Bond Exchange of South Africa ("BESA"). + +The fair value of such bonds has been derived with reference to BESA quoted prices. + +F69 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +17. NET CASH AND CASH EQUIVALENTS . . . . . . . . . . . . . . . . + +1,227 + +867 + +(98) + +Cash and bank balances . . . . . . . . . . . . . . . . . . . . . . . . . . . + +874 + +306 + +723 + +Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,079 + +1,495 1 + +Cash shown as current assets . . . . . . . . . . . . . . . . . . . . . . . . . + +1,953 + +1,801 + +724 + +Credit facilities utilized . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(726) + +(934) + +(822) + +Undrawn borrowing facilities + +General banking facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,154 + +The general banking facilities have no specific maturity date but are + +subject to annual review. The facilities are in place to ensure liquidity. + +18. + +SHARE CAPITAL + +Authorised and issued share capital and share premium are made up + +as follows: + +Authorised + +1,000,000,000 (2001: 1,000,000,000, 2000: 1,000,000,000) ordinary shares + +of R10 each . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +10,000 + +10,000 + +10,000 + +Issued and fully paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +8,293 + +8,293 + +8,293 + +557,031,819 (2001: 557,031,819, 2000: 557,031,819) ordinary shares + +of R10 each . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,570 + +5,570 + +5,570 + +Share premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,723 + +2,723 + +2,723 + +Share issue expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(44) + +Share issue expenses represent costs incurred by the Group in preparation + +for the initial public offering. These costs are to be written-off against + +proceeds of a separate share issue by the Group on date of listing. + +19. NON-DISTRIBUTABLE RESERVES . . . . . . . . . . . . . . . . . . . + +- + +- + +134 + +Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Adoption of IAS 39 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +45 + +Movement during year . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +89 + +Foreign currency translation reserve (net of tax of R10m) . . . . . . . . + +- + +- + +49 + +Fair value adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +5 + +Life Fund reserve (Cell Captive) . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +35 + +The balance comprises: . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +134 + +Foreign currency translation reserve . . . . . . . . . . . . . . . . . . . . . + +- + +- + +49 + +Fair value adjustment to investments . . . . . . . . . . . . . . . . . . . . . + +- + +- + +50 + +Cell Captive reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +35 + +The Group has two cell captives, one used as an investment vehicle and the other for short-term insurance. The + +earnings from the cell captives are transferred to non-distributable reserves. + +F70 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +20. + +RETAINED EARNINGS + +Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,057 + +6,679 + +8,449 + +Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . + +3,862 + +5,057 + +6,679 + +Adoption of IAS 39 . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +584 + +Retained earnings for the year . . . . . . . . . . . . . . . . . . . . . . + +1,195 + +1,622 + +1,186 + +Profit per income statement . . . . . . . . . . . . . . . . . . . . . . . + +1,527 + +1,622 + +1,221 + +Dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(332) + +- + +- + +Transfer to non-distributable reserves . . . . . . . . . . . . . . . . . . + +- + +- + +(35) + +The balance comprises: . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,057 + +6,679 + +8,449 + +Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,483 + +4,856 + +5,660 + +Joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,335 + +1,754 + +2,678 + +Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +239 + +69 + +111 + +Adoption of IAS 39 + +On 1 April 2001 the Group prospectively adopted IAS 39 Financial + +Instruments: Recognition and Measurement. In accordance with IAS 39, + +adjustments have been made to reserves on the date of adoption, while + +comparative amounts have not been restated. + +Increase in opening retained earnings + +Gross . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +834 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(250) + +Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +584 + +21. INTEREST BEARING DEBT . . . . . . . . . . . . . . . . . . . . . . + +15,149 + +18,991 + +21,505 + +(Excluding finance lease and credit facilities utilized) + +(a)Local debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +15,584 + +14,923 + +18,012 + +Locally registered Telkom debt instruments . . . . . . . . . . . . . . . + +7,958 + +11,292 + +15,101 + +Name, maturity, rate p.a., nominal value: + +TK01, 2008, 10%, R4 594m (2001: R4 829m, 2000: R4 699m) . . . . . . + +3,453 + +3,666 + +3,552 + +TL08, 2004, 13%, R3 500m (2001: R3 500m, 2000: R3 500m) . . . . . . + +3,122 + +3,191 + +3,272 + +TL03, 2003, 10.75%, R5 000m (2001: R2 700m, 2000: Nil) . . . . . . . + +- + +2,669 + +4,985 + +TL06, 2006, 10.5%, R1 455m (2001: Nil, 2000: Nil) . . . . . . . . . . . + +- + +- + +1,435 + +TL20, 2020, 6%, R2 500m (2001: R2 500m, 2000: R2 500m) . . . . . . + +1,091 + +1,104 + +1,119 + +PP01, 2002, 12.5%, R200m (2001: R200m, 2000: R200m) . . . . . . . . + +192 + +196 + +200 + +PP02, 2010, 0%, R430m (2001: R430m, 2000: R430m) . . . . . . . . . . + +100 + +115 + +132 + +PP03, 2010, 0%, R1 350m (2001: R1 350m, 2000: Nil) . . . . . . . . . . + +351 + +406 + +Local bonds + +The local Telkom bonds are unsecured, but contain a number of restrictive + +covenants, which limit Telkom's ability to create encumbrances on revenues + +or assets, and to secure any indebtedness without securing the outstanding + +bonds equally and rateably with such indebtedness. + +Telkom is a buyer or seller of last resort in the Telkom bond TK01. + +To eliminate the resultant exposure Telkom sells or buys Government bonds. + +The objective of the hedging relationship is to eliminate price risk whereby + +value changes on the TK01 transactions are in total offset by value changes + +in the government stock. + +Telkom switching certificates 2008, 10.20% to 15.94% . . . . . . . . . . . + +120 + +120 + +- + +Revolving repurchase agreements . . . . . . . . . . . . . . . . . . . . . + +192 + +421 + +21 + +F71 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +21. + +INTEREST BEARING DEBT (continued) + +Commercial paper bills . . . . . . . . . . . . . . . . . . . . . . . . . . + +6,702 + +2,888 + +2,387 + +2002 2005, 10.09% to 15.13%, R2 962m (2001: R3 699m, 2000: R7 868m). + +Interest bearing long-term loans . . . . . . . . . . . . . . . . . . . . . + +610 + +200 + +221 + +Commerzbank AG (unsecured) . . . . . . . . . . . . . . . . . . . . . . . + +175 + +100 + +100 + +13.7% NACQ, repayable March 17, 2003. + +Credit Agricole Indosuez (unsecured) . . . . . . . . . . . . . . . . . . . + +100 + +100 + +100 + +14.0% NACQ, repayable on March 17, 2003. + +RMB Corporate Finance . . . . . . . . . . . . . . . . . . . . . . . . . . + +335 + +- + +- + +An option agreement between Vodacom Group (Proprietary) Limited and + +RMB Corporate Finance (Proprietary) Limited for the purchase of shares + +in Teljoy Holdings Limited lapsed on April 3, 2000 and the amount due + +was repaid on April 17, 2000. + +Vodacom Tanzania Limited + +The shareholder's loan is uncollaterised, bears interest at LIBOR plus 1% + +and no repayment terms have been determined. . . . . . . . . . . . . . . + +- + +- + +21 + +Short-term loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +282 + +Interest free long-term loans . . . . . . . . . . . . . . . . . . . . . . . + +2 + +2 + +- + +Sekha-Metsi Consortium Limited (unsecured) + +(b)Foreign debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,885 + +9,559 + +5,534 + +United States Dollar + +2002 2003, 3.83%, $4m (2001: $596m, 2000: $598m) . . . . . . . . . + +4,655 + +5,368 + +42 + +Euro + +2002 2005, 0.10% 7.125%, 514m (2001: 519m, 2000: 24m) . . . . . + +126 + +3,786 + +5,133 + +South African Rand + +2009, 10.56%, R359m (2001: R373m, 2000: Nil) . . . . . . . . . . . . . + +- + +359 + +359 + +This is shown as foreign debt since the loans are held with foreign lenders. + +This credit facility is guaranteed, with both agreements containing + +restrictive financial covenants, setting required levels for net debt to net + +worth and net income to net financing charges. + +Loans denominated in other currencies . . . . . . . . . . . . . . . . . . . + +104 + +46 + +- + +Less: Current portion of interest bearing debt . . . . . . . . . . . . . + +(5,320) + +(5,491) + +(2,041) + +Local debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(5,003) + +(2,191) + +(2,002) + +Locally registered Telkom debt instruments . . . . . . . . . . . . . . . + +- + +- + +(200) + +Commercial paper bills . . . . . . . . . . . . . . . . . . . . . . . . . . + +(4,401) + +(1,770) + +(1,278) + +Revolving repurchase agreements . . . . . . . . . . . . . . . . . . . . + +(192) + +(421) + +(21) + +Long-term loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(410) + +- + +(221) + +Short-term loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(282) + +Foreign debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(317) + +(3,300) + +(39) + +Total debt (including finance leases Note 22) . . . . . . . . . . . . . . + +21,248 + +25,334 + +24,579 + +Gross interest bearing debt . . . . . . . . . . . . . . . . . . . . . . . . . + +25,041 + +30,362 + +29,082 + +Discount on debt instruments issued . . . . . . . . . . . . . . . . . . . . + +(3,793) + +(5,028) + +(4,503) + +F72 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +2002 + +2002 + +Year repayable + +Total + +Total + +Foreign + +Local + +Total + +Rm + +Rm + +Rm + +Rm + +Rm + +21. + +INTEREST BEARING DEBT (continued) + +Repayment of interest bearing debt + +2000/2001 . . . . . . . . . . . . . . . . . + +5,320 - - - + +- + +2001/2002 . . . . . . . . . . . . . . . . . + +5,212 + +5,491 + +- + +- + +- + +2002/2003 . . . . . . . . . . . . . . . . . + +1,975 + +2,445 + +40 + +1,925 + +1,965 + +2003/2004 . . . . . . . . . . . . . . . . . + +112 + +3,802 + +18 + +5,054 + +5,072 + +2004/2005 . . . . . . . . . . . . . . . . . + +4,270 + +4,956 + +4 + +4,951 + +4,955 + +2005/2006 . . . . . . . . . . . . . . . . . + +2 + +3,848 + +5,002 + +276 + +5,278 + +Thereafter . . . . . . . . . . . . . . . . . + +8,150 + +9,820 + +470 + +11,342 + +11,812 + +25,041 + +30,362 + +5,534 + +23,548 + +29,082 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Included in long and short-term debt is: + +Guaranteed debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,937 + +3,954 + +4,088 + +By South African Government . . . . . . . . . . . . . . . . . . . . . . . . + +3,868 + +3,907 + +3,729 + +By South African Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . + +69 + +47 + +359 + +The Company may issue or re-issue locally registered debt instruments in + +terms of the Post Office Amendment Act 85 of 1991. These borrowing + +powers are set out in the Company's articles of association. + +Revolving repurchase agreements + +The Group actively manages a portfolio of sale and buy back repurchase + +agreements in the South African capital and money markets with a view to + +financing short-term liquidity gaps. Interest paid by the Group is based on + +the current market-related yield required for South African Government + +and Telkom bonds. + +2002 + +Maturity period + +Yield + +13 days + +13.10% . . . . . . . . . . . . . . . . . . . + +1 + +5 days + +13.02% 13.30% . . . . . . . . . . . . . + +20 + +21 + +2001 + +Maturity period + +Yield + +7 days + +12.40% . . . . . . . . . . . . . . . . . . . + +3 + +3 days + +12.12% 12.48% . . . . . . . . . . . . . + +418 + +421 + +2000 + +Maturity period + +Yield + +7 days + +14.15% . . . . . . . . . . . . . . . . . . . + +11 + +3 days + +13.84% 14.27% . . . . . . . . . . . . . + +181 + +192 + +F73 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +21. + +INTEREST BEARING DEBT (continued) + +Due to the short-term nature of these transactions and the fact that the transactions are initiated based on market- + +related interest rates, the carrying value approximates the fair value. + +Collateral in the form of publicly tradable bonds has been received in respect of the above transactions. + +The terms and conditions of these transactions are governed by signed ISMA agreements with all counter parties and + +the regulations of the Bond Exchange of South Africa (BESA). The fair value of such bonds has been derived with + +reference to BESA quoted prices. + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +22. FINANCE LEASES . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +779 + +852 + +1,028 + +Total finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +779 + +852 + +1,033 + +The finance leases are secured by land and buildings with a book value of + +R617m (2001: R488m, 2000: R468m). These amounts are repayable between + +periods of 5 and 17 years. Interest rates vary between 13.44% and 14.69%. + +Less: Current portion of finance leases . . . . . . . . . . . . . . . . . + +- + +- + +(5) + +23. PROVISIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,352 + +2,844 + +2,601 + +Leave pay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +493 + +450 + +463 + +Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . + +537 + +493 + +450 + +Charged to income . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +158 + +108 + +136 + +Leave utilized or paid . . . . . . . . . . . . . . . . . . . . . . . . . . + +(202) + +(151) + +(123) + +Medical aid liability (Note 28) . . . . . . . . . . . . . . . . . . . . . . + +2,464 + +2,183 + +2,154 + +Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . + +2,217 + +2,464 + +2,183 + +Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +266 + +348 + +224 + +Current service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +42 + +50 + +14 + +Actuarial loss/(gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . + +15 + +(16) + +(5) + +Settlement and curtailment loss/(gain) . . . . . . . . . . . . . . . . . . + +31 + +(409) + +(5) + +Termination settlement . . . . . . . . . . . . . . . . . . . . . . . . . . + +(118) + +(144) + +Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(107) + +(136) + +(113) + +Retirement and Pension Fund deficits (Note 28) . . . . . . . . . . . . + +1,097 + +985 + +759 + +Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . + +1,208 + +1,097 + +985 + +Repayment of the deficit . . . . . . . . . . . . . . . . . . . . . . . . . + +(240) + +(240) + +(307) + +Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +129 + +128 + +119 + +Curtailment gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(38) + +Sick leave . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +330 + +332 + +315 + +Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . + +205 + +330 + +332 + +Net charge to income . . . . . . . . . . . . . . . . . . . . . . . . . . . + +125 + +2 + +(17) + +Telephone rebates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +124 + +134 + +146 + +Balance at beginning of the year . . . . . . . . . . . . . . . . . . . . . + +114 + +124 + +134 + +Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +9 + +9 + +10 + +Current service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1 + +1 + +2 + +Short-term portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,156) + +(1,240) + +(1,236) + +Leave pay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(480) + +(450) + +(463) + +Medical benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(218) + +(200) + +(200) + +Retirement and Pension Fund deficit . . . . . . . . . . . . . . . . . . . + +(128) + +(258) + +(258) + +Sick leave . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(330) + +(332) + +(315) + +F74 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +23. + +PROVISIONS (continued) + +Leave pay benefits + +In terms of the Group's policy, employees are entitled to accumulate vested leave benefits not taken within a leave + +cycle. This is reviewed annually and is in accordance with legislation. + +Sick leave + +Sick leave provision is determined in accordance with the Group's policy. This takes into account the possibility of + +production loss for the Group, due to the inability of an employee to render services for an extended period due to + +illness. + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +24. TRADE AND OTHER PAYABLES . . . . . . . . . . . . . . . . . . . + +5,882 + +6,141 + +7,391 + +Trade payables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,981 + +3,851 + +4,877 + +Finance cost accrued . . . . . . . . . . . . . . . . . . . . . . . . . . . + +274 + +578 + +1,126 + +Deferred exchange gains . . . . . . . . . . . . . . . . . . . . . . . . . + +936 + +894 + +- + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +691 + +818 + +1,388 + +25. + +COMMITMENTS + +Capital commitments authorized . . . . . . . . . . . . . . . . . . . . + +10,351 + +11,028 + +7,490 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +8,733 + +9,201 + +4,932 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,618 + +1,827 + +2,558 + +Commitments against authorized capital expenditure . . . . . . . . + +2,271 + +1,311 + +810 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,939 + +503 + +85 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +332 + +808 + +725 + +Authorised capital expenditure not yet committed . . . . . . . . . . + +8,080 + +9,717 + +6,680 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +6,794 + +8,698 + +4,847 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,286 + +1,019 + +1,833 + +Management expects these commitments will be financed mainly from internally generated cash. + +Operating lease commitments + + Between + +Within one + +and + +Over + +Total + + one year + + five years + + five years + +Rm + +Rm + +Rm + +Rm + +2002 + +Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . + +737 + +208 + +310 + +219 + +Transmission and data lines . . . . . . . . . . . . . . . . . + +1,101 + +183 + +735 + +183 + +Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . + +809 + +809 + +- + +- + +Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . + +35 + +17 + +18 + +- + +2,682 + +1,217 + +1,063 + +402 + +Vehicle leases + +Telkom has entered into a lease agreement for its vehicles. The master lease agreement is for a period of five years and + +expires on March 31, 2005. As there is no minimum usage clause in the master lease agreement, only the lease + +payments for the next year have been disclosed. The leases of individual vehicles are renewed annually. + +F75 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +25. + +COMMITMENTS (continued) + +Finance lease commitments + + Between + +Within one + +and + +Over + +Total + + one year + + five years + + five years + +Rm + +Rm + +Rm + +Rm + +Buildings + +2002 + +Lease payments . . . . . . . . . . . . . . . . . . . . . . . + +2,550 + +54 + +292 + +2,204 + +Finance charges . . . . . . . . . . . . . . . . . . . . . . . + +(1,517) + +(88) + +(393) + +(1,036) + +Minimum lease payments . . . . . . . . . . . . . . . . . . + +1,033 + +(34) + +(101) + +1,168 + +Present value of the liability . . . . . . . . . . . . . . . . . + +1,026 + +Finance charges capitalized . . . . . . . . . . . . . . . . . + +7 + +Liability as disclosed in Note 22 . . . . . . . . . . . . . . . + +1,033 + +2001 + +Lease payments . . . . . . . . . . . . . . . . . . . . . . . + +2,452 + +49 + +264 + +2,139 + +Finance charges . . . . . . . . . . . . . . . . . . . . . . . + +(1,600) + +(83) + +(377) + +(1,140) + +Minimum lease payments . . . . . . . . . . . . . . . . . . + +852 + +(34) + +(113) + +999 + +Present value of the liability . . . . . . . . . . . . . . . . . + +845 + +Finance charges capitalized . . . . . . . . . . . . . . . . . + +7 + +Liability as disclosed in Note 22 . . . . . . . . . . . . . . . + +852 + +2000 + +Lease payments . . . . . . . . . . . . . . . . . . . . . . . + +2,458 + +45 + +202 + +2,211 + +Finance charges . . . . . . . . . . . . . . . . . . . . . . . + +(1,679) + +(79) + +(359) + +(1,241) + +Minimum lease payments . . . . . . . . . . . . . . . . . . + +779 + +(34) + +(157) + +970 + +Present value of the liability . . . . . . . . . . . . . . . . . + +772 + +Finance charges capitalized . . . . . . . . . . . . . . . . . + +7 + +Liability as disclosed in Note 22 . . . . . . . . . . . . . . . + +779 + +Finance charges accruing on the Group's building leases exceed the lease payments for the next five years. Minimum + +lease payments have been limited to R Nil in 2001 and 2002. For purposes of 2002, R5 million is the only minimum + +lease payment as reflected in Note 22. + +F76 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +26. + +CONTINGENCIES + +Third parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +35 + +184 + +65 + +Guarantee of employee housing loans . . . . . . . . . . . . . . . . . . . . + +262 + +178 + +208 + +Third parties + +These amounts represent sundry disputes against third parties that are not individually significant and that the company + +does not intend to settle. + +Guarantee of employee housing loans + +Telkom guarantees to settle a certain portion of employees' housing loans. The amount guaranteed differs depending + +on factors such as employment period and salary rates. When an employee leaves the employment of the Group, any + +housing debt guaranteed by Telkom is settled before any payment can be made over to the employee. + +The maximum amount of the guarantee in the event of the default is as disclosed above. + +Supplier dispute + +Expenditure of R594 million was incurred in the 2000 and 2001 financial year for the development and installation of + +an integrated end-to-end customer assurance and activation system by Telcordia. In the 2001 financial year, the + +agreement with Telcordia was terminated and in that year, Telkom wrote off R119 million of this investment in the + +fixed-line business. Following an assessment of the viability of the assets related to the Telcordia initiative, Telkom + +wrote off the balance of these assets of R346m in financial year 2002. During March 2001, the dispute was taken to + +arbitration, where Telcordia was seeking approximately $130 million plus interest at a rate of 15.5% per year for + +money outstanding and damages. In September 2002, a partial ruling was issued by the arbitrator in favour of + +Telcordia. The arbitration proceedings and any liability are not, however, expected to be finalized until late 2003 or + +early 2004. Telkom's provision of R375 million for its estimate of probable liabilities, including interest, was + +recognized at March 31, 2002. + +Site restoration costs + +The Group has no legal or constructive obligation to incur site restoration costs. Restoration of sites after + +decommissioning of assets are done on a case by case merit. No sites have been identified that would require material + +restoration to be performed. + +Vodacom Congo (R.D.C.) S.P.R.L. + +The Group has a 51% equity interest through Vodacom in Vodacom Congo (R.D.C.) S.P.R.L., ("Vodacom Congo"), + +which commenced business on December 11, 2001. + +Vodacom, in terms of the shareholders' agreement, is ultimately responsible for the funding of the operations of + +Vodacom Congo. Currently Vodacom Congo is incurring losses which are expected to increase into the foreseeable + +future. The 49% portion attributable to the other joint venture partner in respect of the liabilities and losses as at + +March 31, 2002 were as follows: + +Rm + +Losses + +(19.3) + +Liabilities + +(29.7) + +Accordingly, the Group exposure is 50% of the above amounts. + +F77 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +26. + +CONTINGENCIES (continued) + +Furthermore, the following guarantees were approved/issued by Vodacom in respect of Vodacom Congo subsequent to + +the balance sheet date: + +Euro + +US$ + +Details + +Beneficiary + +Date issued + +m + +m + +Approved and issued + +Guarantee Alcatel C.I.T., + +ABSA Bank Limited + +May 8, 2002 + +32.6 + +29.8 + +Alcatel Space Industries and + +Alcatel Altech Telecoms + +(Pty) Ltd ("Alcatel") + +Approved not issued + +Guarantees not yet issued + +ABSA Bank Limited + +51.2 + +Negative working capital ratio + +For each of the financial years ended 2002, 2001 and 2000 the Group had a negative working capital ratio. A negative + +working capital ratio arises when current liabilities are greater than the current assets. Current liabilities will be + +financed from operating cash flows, new borrowings and credit facilities. + +27. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT + +Exposure to continuously changing market conditions has highlighted the importance of financial risk management as + +an element of control for the Group. Treasury policies, risk limits and control procedures are continuously monitored + +by the Board of Directors. + +The Group holds or issues financial instruments to finance its operations, for the temporary investment of short-term + +funds and to manage currency and interest rate risks. In addition, financial instruments like trade receivables and + +payables, arise directly from the Group's operations. + +The Group finances its operations primarily by a mixture of issued share capital, retained profit, long-term and short- + +term loans. The Group uses derivative financial instruments to manage its exposure to market risks from changes in + +interest and foreign exchange rates. The Group does not speculate in derivative instruments. + +Interest rate risk management + +Interest rate risk arises from the repricing of the Group's forward cover and floating rate debt as well as new + +borrowings and refinancing. + +The Group's policy is to manage interest cost through the utilization of a mix of fixed and variable rate debt. In order + +to manage this mix in a cost efficient manner, the Group makes use of interest rate derivatives as approved in terms of + +Group policy. Fixed rate debt represents approximately 86.20% (2001: 62.66%, 2000: 63.13%) of the total + +consolidated debt, after taking the instruments listed below into consideration. The debt profile of mainly fixed rate + +debt has been maintained to limit the Group's exposure to interest rate increases given the size of the Group's debt + +portfolio. All financial instruments that reprice within one year are deemed to be floating rate debt. + +F78 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +27. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +Interest rate repricing profile for interest bearing debt: + +Floating rate + +Fixed rate + +0 -1 year + +2 -5 years + +> 5 years + +Total + +Rm + +Rm + +Rm + +Rm + +Rm + +2002 + +Borrowings . . . . . . . . . + +3,392 + +407 + +14,714 + +6,066 + +24,579 + +Percentage of borrowings . . + + 13.80% + + 1.66% + + 59.86% + + 24.68% + + 100.00% + +2001 + +Borrowings . . . . . . . . . + +9,460 + +1 + +9,809 + +6,064 + +25,334 + +Percentage of borrowings . . + + 37.34% + + 0.00% + + 38.72% + + 23.94% + + 100.00% + +2000 + +Borrowings . . . . . . . . . + +7,835 + +4,477 + +3,538 + +5,398 + +21,248 + +Percentage of borrowings . . + + 36.88% + + 21.07% + + 16.65% + + 25.40% + + 100.00% + +Borrowings do not include credit facilities utilized of R822m (2001: R934m, 2000: R726m), they are floating rate debt. + +The effective interest rate for the year was 13.48% (2001: 13.01%, 2000: 14.48%). At March 31, 2002 the Group did + +not have a significant interest rate risk exposure on financial assets. + +In order to hedge specific exposures in the interest rate repricing profile of existing borrowings and anticipated peak + +additional borrowings, the Group makes use of interest rate derivatives as approved in terms of Group policy. + +F79 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +27. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +The tables below summarise the interest rate hedges outstanding as at: + + Notional + +Weighted + +Average + +Average + + amount + +average + +Capped + +maturity + + Currency + +m + + coupon rate + + interest rate + +March 31, 2002 + +Interest rate swaps + +Pay fixed + +0 1 year + +ZAR + +1,300 + +12.19% + +1 5 years + +ZAR + +150 + +12.92% + +> 5 years + +ZAR + +1,000 + +14.67% + +Receive fixed + +1 5 years + +ZAR + +74 + +16.00% + +March 31, 2001 + +Interest rate swaps + +Pay fixed + +0 1 year + +USD + +70 + +6.30% + +1 5 years + +ZAR + +1,450 + +12.27% + +> 5 years + +ZAR + +1,000 + +14.67% + +Receive fixed + +1 5 years + +ZAR + +74 + +16.00% + +Caps + +0 1 year + +USD + +30 + +7.00% + +March 31, 2000 + +Interest rate swaps + +Pay fixed + +0 1 year + +CHF + +17 + +2.23% + +1 5 years + +USD + +70 + +6.30% + +1 5 years + +ZAR + +1,350 + +12.32% + +> 5 years + +ZAR + +1,000 + +14.67% + +Receive fixed + +0 1 year + +FFR + +50 + +4.15% + +0 1 year + +GBP + +1 + +7.25% + +> 5 years + +ZAR + +25 + +14.60% + +> 5 years + +ZAR + +71 + +16.00% + +Caps + +0 1 year + +USD + +70 + +5.83% + +1 5 years + +USD + +30 + +7.00% + +The interest rate swaps cover refinancing price risk on the commercial paper bill programme. + +Credit risk management + +The risk arises from derivative contracts entered into with international financial institutions with a rating of A1 or + +better. The accounting loss the company would incur if no amounts were recovered at March 31, 2002 is + +R2,683 million. No collateral is required when entering into derivative contracts. Credit limits are reviewed on a yearly + +basis or when information becomes available in the market. The Group limits its exposure to any counterparty and + +exposures are monitored daily. The Group expects that all counterparties will meet their obligations. Credit limits are + +set on an individual entity basis. + +Trade debtors comprise a large and widespread customer base, covering residential, business and corporate customer + +profiles. Credit checks are performed on all customers on application for new services, and on an ongoing basis where + +appropriate. + +F80 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +27. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +Liquidity risk management + +The Group is exposed to liquidity risk as a result of uncertain debtor related cash flows as well as capital commitments + +of the Group. Liquidity risk is primarily managed by the Corporate Finance division in accordance with policies and + +guidelines formulated by the Operating Committee. In terms of its borrowing requirements, the Group ensures that + +sufficient facilities exist to meet its immediate obligations. In terms of its long-term liquidity risk, the Operating + +Committee maintains a reasonable balance between the period assets generate funds and the period the respective + +assets are funded. Short-term liquidity gaps may be funded through sale and buy back transactions. + +Foreign currency exchange rate risk management + +The Group manages its foreign currency exchange rate risk by hedging, on a portfolio basis, all identifiable exposures + +via various financial instruments suitable to the Group's risk exposure. + +Cross currency swaps and forward exchange contracts have been entered into to reduce the foreign currency exposure + +on the Group's operations and liabilities. The Group also enters into forward foreign exchange contracts to hedge + +interest expense and purchase and sale commitments denominated in foreign currencies (principally US Dollars and + +Euro). The purpose of the Group's foreign currency hedging activities is to protect the Group from the risk that the + +eventual net flows will be adversely affected by changes in exchange rates. + +The tables below reflect the currency and interest rate exposure of liabilities. Foreign currency debt is translated at the + +year-end exchange rates: + +Liabilities + +2002 + +Fixed rate + +Floating + +Interest free + +Total + +Currency + +Rm + +Rm + +Rm + +Rm + +ZAR . . . . . . . . . . . . . . . . . . . . . . . . . . . + +16,190 + +4,016 + +11,762 + +31,968 + +USD . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +63 + +351 + +414 + +EUR . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,998 + +135 + +675 + +5,808 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +53 + +53 + +21,188 + +4,214 + +12,841 + +38,243 + +2001 + +Fixed rate + +Floating + +Interest free + +Total + +Currency + +Rm + +Rm + +Rm + +Rm + +ZAR . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12,344 + +4,722 + +11,359 + +28,425 + +USD . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +5,370 + +379 + +5,749 + +EUR . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,530 + +256 + +411 + +4,197 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +46 + +21 + +67 + +15,874 + +10,394 + +12,170 + +38,438 + +2000 + + Fixed rate + + Floating + + Interest free + +Total + +Currency + +Rm + +Rm + +Rm + +Rm + +ZAR . . . . . . . . . . . . . . . . . . . . . . . . . . . + + 13,338 + + 3,674 + + 11,574 + + 28,586 + +USD . . . . . . . . . . . . . . . . . . . . . . . . . . . + +75 + + 4,657 + +218 + +4,950 + +EUR . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +126 + +1 + +127 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +104 + +112 + +216 + +13,413 + +8,561 + +11,905 + +33,879 + +Assets + +There is no material foreign currency exposure for assets. + +F81 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +27. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +Forward exchange contracts + +The following contracts relate to specific items on the balance sheet or foreign commitments not yet due. Foreign + +commitments not yet due consist of capital expenditure ordered but not yet received and future interest payments and + +loans denominated in foreign currency. + +2002 + +Average maturity + +0 1 year + +1 5 years + +> 5 years + +currency + +Foreign + +Local + +Foreign + +Local + +Foreign + +Local + + currency + + currency + + currency + + currency + + currency + + currency + +notional + +amount + +notional + +amount + +notional + +amount + +amount + +amount + +amount + +m + +Rm + +m + +Rm + +m + +Rm + +Purchases + +United States Dollar . + +447 + +4,836 + +61 + +596 + +- + +- + +Pound Sterling . . . . + +6 + +108 + +2 + +26 + +- + +- + +Euro . . . . . . . . . + +169 + +1,692 + +62 + +489 + +- + +- + +Swedish Krona . . . . + +18 + +21 + +- + +- + +- + +- + +Australian Dollar . . + +1 + +2 + +- + +- + +- + +- + +Japanese Yen . . . . . + +34 3 + +- + +- + +- + +- + +6,662 + +1,111 + +- + +Sales + +United States Dollar . + +175 + +1,790 + +35 + +318 + +25 + +275 + +Pound Sterling . . . . + +3 + +45 + +- + +- + +- + +- + +Euro . . . . . . . . . + +41 + +410 + +- + +- + +- + +- + +2,245 + +318 + +275 + +2001 + +Average maturity + +0 1 year + +1 5 years + +> 5 years + +currency + +Foreign + +Local + +Foreign + +Local + +Foreign + +Local + +currency + +currency + +currency + +currency + +currency + +currency + +notional + +amount + +notional + +amount + +notional + +amount + +amount + +amount + +amount + +m + +Rm + +m + +Rm + +m + +Rm + +Purchases + +United States Dollar . + +1,173 + +8,802 + +87 + +802 + +- + +- + +Pound Sterling . . . . + +11 + +122 + +- + +- + +- + +- + +Euro . . . . . . . . . + +158 + +1,028 + +65 536 + +- + +- + +Deutsche Mark . . . . + +129 + +216 + +- + +- + +- + +- + +Swiss Franc . . . . . + +5 + +23 + +- + +- + +- + +- + +French Franc . . . . . + +51 + +51 + +- + +- + +- + +- + +Australian Dollar . . + +9 + +39 + +- + +- + +- + +- + +Japanese Yen . . . . . + +80 + +6 + +- + +- + +- + +- + +10,287 + +1,338 + +- + +Sales + +United States Dollar . + +295 + +2,300 + +35 + +307 + +34 + +364 + +Pound Sterling . . . . + +2 + +28 + +- + +- + +- + +- + +Euro . . . . . . . . . + +62 + +390 + +- + +- + +- + +- + +Deutsche Mark . . . . + +13 + +41 + +- + +- + +- + +- + +French Franc . . . . . + +43 + +47 + +- + +- + +- + +- + +Australian Dollar . . + +8 + +32 + +- + +- + +- + +- + +2,838 + +307 + +364 + +F82 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +27. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +2000 + +Average maturity + +0 1 year + +1 5 years + +> 5 years + +currency + +Foreign + +Local + +Foreign + +Local + +Foreign + +Local + +currency + +currency + +currency + +currency + +currency + +currency + +notional + +amount + +notional + +amount + +notional + +amount + +amount + +amount + +amount + +m + +Rm + +m + +Rm + +m + +Rm + +Purchases + +United States Dollar . + +1,404 + +9,155 + +380 + +2,692 + +20 + +213 + +Pound Sterling . . . . + +21 + +323 + +- + +- + +- + +- + +Euro . . . . . . . . . + +55 + +360 + +1 + +7 + +- + +- + +Deutsche Mark . . . . + +167 + +318 + +4 + +14 + +- + +- + +Swiss Franc . . . . . + +11 + +32 + +5 + +14 + +- + +- + +French Franc . . . . . + +665 + +240 + +3 + +- + +- + +- + +Australian Dollar . . + +7 + +22 + +- + +- + +- + +- + +Japanese Yen . . . . . + +141 + +9 + +- + +- + +- + +- + +Italian Lira . . . . . . + +16,418 + +56 + +- + +- + +- + +- + +Swedish Krone . . . . + +59 + +44 + +- + +- + +- + +- + +Spanish Peseta . . . . + +895 + +36 + +- + +- + +- + +- + +Canadian Dollar . . . - + +1 + +- + +- + +- + +- + +10,596 + +2,727 + +213 + +Sales + +United States Dollar . + +276 + +1,803 + +35 + +271 + +43 + +446 + +Pound Sterling . . . . + +1 + +12 + +- + +- + +- + +- + +Euro . . . . . . . . . + +20 + +123 + +- + +- + +- + +- + +Deutsche Mark . . . . + +18 + +58 + +- + +- + +- + +- + +Swiss Franc . . . . . + +- + +1 + +- + +- + +- + +- + +French Franc . . . . . + +67 + +37 + +- + +- + +- + +- + +Australian Dollar . . + +4 + +9 + +- + +- + +- + +- + +Swedish Krone . . . . + +1 + +1 + +- + +- + +- + +- + +Japanese Yen . . . . . + +14 + +1 + +- + +- + +- + +- + +Italian Lira . . . . . . + +2,432 + +8 + +- + +- + +- + +- + +Spanish Peseta . . . . + +443 + +17 + +- + +- + +- + +- + +2,070 + +271 + +446 + +Currency swaps + +Average + +Receive + +Average + +Pay + +Average + +maturity + +coupon + +coupon + +2002 + +Receive floating/pay floating . . . . . . + +0 - 1 year + +220m USD + +LIBOR + +1,400m ZAR JIBAR + +Receive floating/pay floating . . . . . . + +0 - 1 year + +1,990m ZAR + +JIBAR + +220m USD + +LIBOR + +Receive fixed/pay fixed . . . . . . . . . + + 2 - 5 years + +350m EUR + + 7.125% + +2,177m ZAR + +15.895% + +Receive fixed/pay floating . . . . . . . + + 2 - 5 years + +100m EUR + + 7.125% + +630m ZAR + +JIBAR + +2001 + +Receive floating/pay floating . . . . . . + + 1 - 5 years + +220m USD + +LIBOR + +1,400m ZAR + +JIBAR + +Receive fixed/pay fixed . . . . . . . . . + + 2 - 5 years + +350m EUR + +7.125% + +2,177m ZAR + +15.895% + +Receive fixed/pay floating . . . . . . . + + 2 - 5 years + +100m EUR + +7.125% + +630m ZAR + +JIBAR + +2000 + +Receive floating/pay floating . . . . . . + + 2 - 5 years + +220m USD + +LIBOR + +1,400m ZAR + +JIBAR + +F83 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +27. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +Fair values of financial instruments + +The estimated fair values have been determined using available market information and appropriate valuation methods + +as outlined below: + +2000 + +2001 + +2002 + + Carrying + + Fair value + + Carrying + + Fair value + + Carrying + + Fair value + +amount + +amount + +amount + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Assets + +Cash . . . . . . . . . . . . . . . + +1,953 + +1,953 + +1,801 + +1,801 + +724 + +724 + +Trade and other receivables . . . + + 5,427 + +5,427 + +5,852 + +5,852 + + 5,720 + + 5,720 + +Repurchase agreements . . . . . + +276 + +276 + +782 + +782 + +100 + +100 + +Bills of exchange . . . . . . . . 86 + +86 + +193 + +193 + +10 + +10 + +Investments . . . . . . . . . . . + +2 + +2 + +27 + +72 + +637 + +637 + +7,744 + +7,744 + +8,655 + +8,700 + +7,191 + +7,191 + +Liabilities + +Interest bearing debt . . . . . . . + +21,248 + +21,920 + +25,334 + +26,552 + +24,579 + +25,267 + +Trade and other payables . . . . + +5,882 + +5,882 + +6,141 + +6,141 + +7,391 + +7,391 + +Credit facilities utilized . . . . . + +726 + +726 + +934 + +934 + +822 + +822 + +27,856 + +28,528 + +32,409 + +33,627 + +32,792 + +33,480 + +Derivatives (Note 16) + +Currency swaps . . . . . . . . . + +- + +- + +699 + +699 + +2,411 + +2,411 + +Interest rate derivatives . . . . . + +- + +10 + +- + +(177) + +(72) + +(72) + +Foreign exchange derivatives . . + +822 + +73 + +1,192 + +748 + +370 + +370 + +822 + +83 + +1,891 + +1,270 + +2,709 + +2,709 + +The fair values of debtors, bank balances, repurchase agreements and other liquid funds, creditors and accruals, + +approximate their carrying amount due to the short-term maturities of these instruments. + +The fair values of borrowings are based on quoted prices or, where such prices are not available, the expected future + +payments discounted at market interest rates. + +The fair values of derivatives are determined using quoted prices or discounted cash flow analysis. These amounts + +reflect the approximate values of the net derivatives position at the balance sheet date. The fair value of investments are + +based on quoted prices. + +There were unlisted investments as of March 31, 2002, 2001 and 2000 with carrying values of R143m, R549m, and + +R387m, respectively, for which the fair value is not practicably determinable (Note 11). + +There is no single appropriate or workable method to select a single estimate of fair value because the range of + +reasonable fair value estimates is significant and the probabilities of the various estimates cannot be reasonably + +assessed. As a result, the usefulness of a single estimate of fair value is negated. Consequently, fair value cannot be + +reliably measured. + +Exchange rate table (closing rates): + +2000 + +2001 + +2002 + +R + +R + +R + +United States Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . + +6.586 + +8.003 + +11.440 + +Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +6.307 + +7.061 + +9.996 + +F84 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +28. + +EMPLOYEE BENEFITS + +The Group provides benefits for all its permanent employees through the Telkom Pension Fund, the Telkom + +Retirement Fund and the Vodacom Group Pension Fund. Membership is compulsory. In addition certain retired + +employees of Telkom SA Limited receive a telephone rebate and medical aid. All of the liabilities are actuarially + +determined and valuations performed at intervals not exceeding three years. Actuarial calculations are performed in the + +periods between valuations. + +At March 31, 2002, the Group employed 42,208 employees (2001: 46,735, 2000: 51,971). + +The Telkom Pension Fund + +The Telkom Pension Fund is a defined benefit fund that was created in terms of the Post Office Amendment Act 85 of + +1991. All employees who were members of the Government Service Pension Fund and Temporary Employees Pension + +Fund were transferred to a newly established Telkom Pension Fund. The deficits that existed in the aforementioned + +State Funds were transferred to the Telkom Pension Fund. Legislation also made provision that Telkom would + +guarantee the financial obligations of the Telkom Pension Fund. The South African Government guaranteed the + +actuarially valued deficit of the Telkom Pension Fund at September 20, 1991, plus interest as determined by the State + +Actuary. The most recent statutory valuation of the Telkom Pension Fund was performed at March 31, 2000. + +With effect from July 1, 1995, the Telkom Pension Fund was closed to new members. The funded status of the Telkom + +Pension Fund is disclosed below: + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Telkom Pension Fund + +Deficit (originated in terms of the legislation) + +Present value of the obligation . . . . . . . . . . . . . . . . . . . . . + +245 + +197 + +167 + +Fair value of the assets . . . . . . . . . . . . . . . . . . . . . . . . . . + +(201) + +(157) + +(150) + +Actuarial calculation/valuation deficit . . . . . . . . . . . . . . . . . + +44 + +40 + +17 + +Principal actuarial assumptions were as follows: + +ROI for post-retirement investment portfolios . . . . . . . . . . . . % + +13.0 + +13.0 + +13.0 + +Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % + +15.0 + +15.0 + +15.0 + +Expected return on plan assets . . . . . . . . . . . . . . . . . . . . % + +10.0 + +10.0 + +10.0 + +Salary inflation rate . . . . . . . . . . . . . . . . . . . . . . . . . . % + +7.5 + +7.5 + +7.5 + +Funding level: + +Actuarial calculation/valuation . . . . . . . . . . . . . . . . . . . . % + +82.0 + +88.3 + +91.0 + +The number of employees registered under the + +Telkom Pension Fund Plan . . . . . . . . . . . . . . . . . . . . . . . + +542 + +537 + +448 + +The Telkom Retirement Fund + +The Telkom Retirement Fund was established on July 1, 1995 as a defined contribution plan. Existing employees were + +given the option to either remain in the Telkom Pension Fund or to be transferred to the Telkom Retirement Fund. All + +pensioners of the Telkom Pension Fund and employees who retired after July 1, 1995 were transferred to the Telkom + +Retirement Fund. At the same time the proportionate share of the deficit relating to the transferring employees and + +pensioners was transferred to the Telkom Retirement Fund. Upon the transfer the Government ceased to guarantee the + +deficit in the Telkom Retirement Fund. Subsequent to July 1, 1995 further transfers of existing employees occurred. + +The Telkom Retirement Fund is governed by the Pension Funds Act, Act No. 24 of 1956. In terms of section 37A of + +this Act, the pension benefits payable to the pensioners cannot be reduced. + +The Telkom Retirement Fund is a defined contribution fund with regards to in-service members and a defined benefit + +fund with regards to pensioners. The Group guarantees the initial pensions on retirement date. The most recent + +statutory actuarial valuation of the Telkom Retirement Fund was performed on March 31, 2000. + +F85 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +28. + +EMPLOYEE BENEFITS (continued) + +The funded status of the Telkom Retirement Fund is discussed below: + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Telkom Retirement Fund + +Deficit (originated on transfer from Telkom Pension Fund + +on July 1, 1995 and transfers thereafter) + +Actuarial calculation/valuation . . . . . . . . . . . . . . . . . . . . . + +1,053 + +945 + +742 + +The number of in service employees registered under + +the Telkom Retirement Fund . . . . . . . . . . . . . . . . . . . . . . + +48,722 + +43,202 + +38,927 + +Company contributions. Refer Note 4. + +Telkom Retirement Fund + +Pensioners + +Present value of the funded obligation . . . . . . . . . . . . . . . . . + +2,332 + +2,586 + +3,055 + +Fair value of the plan asset . . . . . . . . . . . . . . . . . . . . . . . + +(2,923) + +(2,979) + +(3,805) + +Funded status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(591) + +(393) + +(750) + +Unrecognized net actuarial gain . . . . . . . . . . . . . . . . . . . . . + +591 + +223 + +460 + +Unrecognized surplus . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(170) + +(290) + +The surplus is not recognized due to the legal status of surpluses + +in South Africa. + +Included in the fair value of plan assets is: + +Office buildings occupied by Telkom . . . . . . . . . . . . . . . . . . + + 111 + + 111 + + 111 + +Telkom bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12 + +7 + +63 + +Principal actuarial assumptions were as follows: + +Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % + +13.5 + +12.5 + +12.2 + +Expected return on plan assets . . . . . . . . . . . . . . . . . . . . % + +14.0 + +14.0 + +14.0 + +Pension increase allowance . . . . . . . . . . . . . . . . . . . . . . % + +7.1 + +6.1 + +5.9 + +The number of pensioners registered under the Telkom Retirement Fund + + 12,098 + + 12,301 + + 13,963 + +Vodacom Group Pension Fund + +All eligible employees of the jointly controlled entity and its wholly-owned subsidiaries are members of the Vodacom + +Group Pension Fund, a defined contribution pension scheme, administered by ABSA Consultants and Actuaries + +(Proprietary) Limited. The Group's share of the contribution to the pension fund amounted to R21m (2001: R21m, + +2000: R15m). The Group's share of Vodacom employees at March 31, 2002 were 2,177 (2001: 2,136, 2000: 2,046). + +The fund is governed by the Pension Funds Act of 1956. + +Medical benefits + +Telkom SA Limited makes certain contributions to medical aid funds in respect of current and retired employees. The + +scheme is a defined benefit plan. The expense in respect of current employees' medical aid is disclosed in Note 4. + +The amounts due in respect of post-retirement medical benefits to current and retired employees have been actuarially + +determined and provided for as set out in Note 23. The Group has terminated future post-retirement medical benefits + +in respect of employees joining after July 1, 2000. + +There are three major categories of members entitled to the post retirement medical aid: pensioners who retired before + +1994 ("Pre-94"); those who retired after 1994 ("Post-94"); and the in-service members. The post-94 and the in-service + +members' liability is subject to a Rand cap, which increases annually with the average salary increase. + +Eligible employees must be employed by Telkom until retirement age to qualify for the post-retirement medical aid. + +The most recent valuation of the benefit was performed at March 31, 2001. + +The Company has allocated certain investments to fund for this liability as set out in Note 11. These investments do + +not qualify as plan assets. + +F86 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +28. + +EMPLOYEE BENEFITS (continued) + +Telephone rebates + +Telkom SA Limited provides telephone rebates to its pensioners. The most recent valuation was performed in January + +2000. Eligible employees must be employed by Telkom until retirement age to qualify for the telephone rebates. The + +scheme is a defined benefit plan. + +The funded status of the post-retirement liabilities is disclosed below: + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Medical aid liability + +Present value of the unfunded obligation . . . . . . . . . . . . . . . . + +2,818 + +1,791 + +1,886 + +Unrecognized actuarial (loss)/gain . . . . . . . . . . . . . . . . . . . + +(354) + +392 + +268 + +Liability as disclosed in the balance sheet (Note 23) . . . . . . . . . . + +2,464 + +2,183 + +2,154 + +Principal actuarial assumptions were as follows: + +Salary inflation rate . . . . . . . . . . . . . . . . . . . . . . . . . . % + +7.5 + +7.5 + +7.5 + +Medical inflation rate . . . . . . . . . . . . . . . . . . . . . . . . . % + +10.5 + +10.5 + +10.5 + +Withdrawal rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . % + +30.0 + +30.0 + +30.0 + +Actual retirement age . . . . . . . . . . . . . . . . . . . . . . . . . . + +65 + +65 + +65 + +Average retirement age . . . . . . . . . . . . . . . . . . . . . . . . . + +63 + +63 + +63 + +Average number of members . . . . . . . . . . . . . . . . . . . . . . + + 38,452 + + 32,616 + + 32,013 + +Average number of pensioners . . . . . . . . . . . . . . . . . . . . . + +9,237 + + 8,588 + + 8,180 + +Telephone rebate + +Present value of the unfunded obligation . . . . . . . . . . . . . . . . + +124 + +134 + +146 + +Principal actuarial assumptions were as follows: + +Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % + +15.0 + +15.0 + +15.0 + +CPI inflation rate . . . . . . . . . . . . . . . . . . . . . . . . . . . % + +9.5 + +9.5 + +9.5 + +Actual retirement age . . . . . . . . . . . . . . . . . . . . . . . . . . + +65 + +65 + +65 + +Average retirement age . . . . . . . . . . . . . . . . . . . . . . . . . + +63 + +63 + +63 + +Average number of members . . . . . . . . . . . . . . . . . . . . . . + +28,740 + +28,740 + +28,740 + +Average number of pensioners . . . . . . . . . . . . . . . . . . . . . + +12,305 + +12,305 + +12,305 + +29. RECONCILIATION OF PROFIT AFTER TAXATION TO CASH GENERATED FROM OPERATIONS + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +6,327 + +9,832 + +11,605 + +Profit after taxation . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,540 + +1,690 + +1,280 + +Finance charges . . . . . . . . . . . . . . . . . . . . . . . . Note 6 + +2,482 + +3,137 + +2,550 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . Note 7 + +501 + +715 + +873 + +Investment income . . . . . . . . . . . . . . . . . . . . . . . Note 5 + +(641) + +(617) + +(490) + +Non-cash items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,784 + +4,691 + +5,713 + +Depreciation and amortization . . . . . . . . . . . . . . . . Note 4 + +4,174 + +5,052 + +5,408 + +Increase/(Decrease) in provisions . . . . . . . . . . . . . . . . . . + +186 + +(611) + +(110) + +Profit on disposal of property, plant and equipment . . . . Note 4 + +(493) + +(29) + +(22) + +Write-off of property, plant and equipment . . . . . . . . . Note 4 + +- + +160 + +47 + +Impairment of property, plant and equipment . . . . . . . . Note 4 + +- + +119 + +398 + +Profit on disposal of subsidiaries and joint ventures . . . . Note 32 + +(18) + +- + +(8) + +Profit on disposal of division . . . . . . . . . . . . . . . . Note 34 + +(65) + +- + +- + +(Decrease)/Increase in working capital . . . . . . . . . . . . . . . + +(1,339) + +216 + +1,679 + +Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +126 + +398 + +246 + +Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,103) + +(280) + +(144) + +Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(362) + +98 + +1,577 + +F87 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +30. FINANCE CHARGES PAID + +1,271 + +3,927 + +3,026 + +Finance charges per income statement . . . . . . . . . . . . . . . . . + +2,482 + +3,137 + +2,550 + +Non-cash items . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,211) + +790 + +476 + +Movements in interest accruals . . . . . . . . . . . . . . . . . . . + +(208) + +(304) + +(548) + +Cost of forward exchange contracts amortized . . . . . . . . . . . + +11 + +(160) + +- + +Net discount amortized . . . . . . . . . . . . . . . . . . . . . . . + +(659) + +(591) + +(663) + +Fair value adjustment . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +1,332 + +Unrealized (gain)/loss . . . . . . . . . . . . . . . . . . . . . . . . + +(355) + +1,845 + +- + +IAS 39 application adjustment . . . . . . . . . . . . . . . . . . . + +- + +- + +355 + +31. TAXATION PAID + +257 + +322 + +914 + +Net asset at beginning of year . . . . . . . . . . . . . . . . . . . . . + +(911) + +(942) + +(795) + +Liability of joint venture acquired . . . . . . . . . . . . . . . . . . . + +- + +3 + +- + +Interest accrual on tax receivable . . . . . . . . . . . . . . . . . . . + +(143) + +(35) + +(4) + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +369 + +501 + +825 + +Net asset at end of year . . . . . . . . . . . . . . . . . . . . . . . . + +942 + +795 + +888 + +32. + +DISPOSAL OF SUBSIDIARIES AND JOINT VENTURES + +The Group's 50% joint venture company, Vodacom, disposed of the following: + + on February 27, 2002, its 51% interest in Vodacom Sport & Entertainment (Proprietary) Limited; + + on November 30, 2001, its 40% interest in Vodacom World Online (Proprietary) Limited; + + on March 31, 2002, its 100% interest in Film Fun Holdings (Proprietary) Limited, Teljoy Botswana (Proprietary) + +Limited and Africell Cellular Services (Proprietary) Limited; and + + during 2000, 10% of Vodacom World Online (Proprietary) Limited. + +These disposals were effected in order to dispose of non-core operations. + +2000 + +2002 + +Rm + +Rm + +Aggregate carrying value of net assets disposed of: + +8 + +38 + +Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . + +1 + +36 + +Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +3 + +Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . + +11 + +121 + +Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(4) + +(167) + +Intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +11 + +Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +5 + +Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +14 + +Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . + +- + +15 + +Minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(2) + +Profit on disposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +18 + +8 + +Disposal proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . + +26 + +44 + +Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . + +- + +(15) + +Net cash consideration . . . . . . . . . . . . . . . . . . . . . . . . . + +26 + +29 + +Settlement method + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +26 + +29 + +Current receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +16 + +Net cash inflow from disposals . . . . . . . . . . . . . . . . . . . . + +26 + +13 + +Current receivables + +R4.5m was settled in cash by the new owner on May 15, 2002. The remaining amount of R11m is to be settled in two + +equal instalments on August 31, 2002 and August 31, 2003. + +F88 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +33. PURCHASE OF SUBSIDIARIES, JOINT VENTURES AND MINORITY SHAREHOLDERS' INTERESTS + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Acquisitions: + +The following acquisitions were made: By the company: + + on October 11, 2001, an additional 10% of Telkom Directory Services + +(Proprietary) Limited, bringing the Group's shareholding to 64.9% . . . . . + +- + +- + +160 + + on May 16, 2001, an additional 40% of Swiftnet (Proprietary) Limited, + +bringing the Group's shareholding to 100% . . . . . . . . . . . . . . . . . + +- + +- + +22 + +By the Group's 50% joint venture, Vodacom: + + on August 1, 2000, 100% of Globalstar Southern Africa (Proprietary) Limited + +- + +46 + +- + + on July 14, 2000, an additional 14% of Vodacom Tanzania Limited, bringing + +Vodacom's shareholding to 65%. . . . . . . . . . . . . . . . . . . . . . . . + +- + +11 + +- + +Vodacom Tanzania Limited was treated as a joint venture and proportionally + +consolidated at 51% in 2000. In 2001, it was consolidated in full. + +During 2000, subsequent to the disposal of the internet division (Note 34), + +Vodacom acquired 50% of Vodacom World Online (Proprietary) Limited . . . + +60 + +- + +- + +During 2000 Vodacom acquired 50% of GSM cellular (Proprietary) Limited, + +bringing the total shareholding to 100% . . . . . . . . . . . . . . . . . . . . . + +36 + +- + +- + +Change in accounting treatment: + +In January 2000, 100% of Film Fun Holdings (Proprietary) Limited trading + +as Teljoy Television was acquired with a view to its subsequent disposal. + +Due to a change in intention this investment was consolidated in full in 2001 . + +314 + +- + +- + +Vodacom Sport & Entertainment (Proprietary) Limited was treated as a joint + +venture and proportionately consolidated at 50% in 2000. In 2001 it was + +consolidated in full. + +410 + +57 + +182 + +F89 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +33. + +PURCHASE OF SUBSIDIARIES, JOINT VENTURES AND MINORITY SHAREHOLDERS' INTERESTS + +(continued) + +2000 + +2001 + +Rm + +Rm + +The aggregate fair value of assets acquired and liabilities assumed on the + +purchase of subsidiaries and joint ventures were as follows: + +Aggregate fair value + +Net assets acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +311 + +1 + +Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +18 + +116 + +Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +234 + +9 + +Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +3 + +Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +17 + +12 + +Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +124 + +18 + +Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +75 + +10 + +Shareholders' loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(79) + +Interest bearing debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(10) + +Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(157) + +(75) + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(3) + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +174 + +68 + +Minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(2) + +Purchase price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +485 + +67 + +Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(75) + +(10) + +Cash consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +410 + +57 + +34. + +DISPOSAL OF DIVISION + +During 2000 Vodacom disposed of the Vodacom Internet Company which was a division of Vodacom Group + +(Proprietary) Limited. + +2000 + +Rm + +Carrying value + +Net assets disposed of . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +47 + +Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3 + +Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1 + +Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +54 + +Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12 + +Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(23) + +Profit on disposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +65 + +Disposal proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +112 + +Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(12) + +Cash consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +100 + +F90 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +35. + +SEGMENT INFORMATION + +The inter-company transactions are reflected as net and are thus eliminated against segment results. + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Business segment + +Consolidated revenue . . . . . . . . . . . . . . . . . . . . . . . . . + +27,113 + +31,352 + +34,197 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +23,838 + +26,439 + +27,976 + +To external customers . . . . . . . . . . . . . . . . . . . . . . . . + +23,530 + +26,100 + +27,606 + +Inter-company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +308 + +339 + +370 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,786 + +6,638 + +8,075 + +To external customers . . . . . . . . . . . . . . . . . . . . . . . . + +3,583 + +5,252 + +6,591 + +Inter-company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,203 + +1,386 + +1,484 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,511) + +(1,725) + +(1,854) + +Consolidated operating profit . . . . . . . . . . . . . . . . . . . . + +3,882 + +4,925 + +4,213 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,555 + +3,759 + +2,447 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,182 + +1,277 + +1,816 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +145 + +(111) + +(50) + +Consolidated investment income . . . . . . . . . . . . . . . . . . . + +641 + +617 + +490 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +785 + +900 + +817 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +16 + +13 + +16 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(160) + +(296) + +(343) + +Consolidated finance charges . . . . . . . . . . . . . . . . . . . . + +2,482 + +3,137 + +2,550 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,299 + +2,941 + +2,557 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +284 + +252 + +36 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(101) + +(56) + +(43) + +Consolidated taxation . . . . . . . . . . . . . . . . . . . . . . . . + +501 + +715 + +873 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +244 + +332 + +278 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +257 + +383 + +595 + +Consolidated assets . . . . . . . . . . . . . . . . . . . . . . . . . . + +44,444 + +48,801 + +50,528 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +39,900 + +42,943 + +43,588 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,857 + +6,164 + +7,531 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(313) + +(306) + +(591) + +Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +389 + +576 + +780 + +Financial assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,184 + +2,866 + +2,819 + +Tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,259 + +1,294 + +1,081 + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +47,276 + +53,537 + +55,208 + +Consolidated liabilities . . . . . . . . . . . . . . . . . . . . . . . . + +12,314 + +12,616 + +13,471 + +Fixed-line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +10,675 + +9,812 + +10,804 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,952 + +3,110 + +3,408 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(313) + +(306) + +(741) + +Interest-bearing debt . . . . . . . . . . . . . . . . . . . . . . . . . . + +21,248 + +25,334 + +24,579 + +Tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +317 + +499 + +193 + +Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +33,879 + +38,449 + +38,243 + +F91 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +35. + +SEGMENT INFORMATION (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Other segment information + +Capital expenditure for property, plant and equipment . . . . . . . + +9,461 + +9,889 + +9,004 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +8,468 + +8,297 + +6,962 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +993 + +1,592 + +2,042 + +Capital expenditure for intangible assets Mobile . . . . . . . . . + +5 + +- + +97 + +Depreciation and amortization . . . . . . . . . . . . . . . . . . . . + +4,174 + +5,052 + +5,408 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,625 + +4,234 + +4,373 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +549 + +818 + +1,035 + +Impairment loss/asset write-offs . . . . . . . . . . . . . . . . . . . + +- + +279 + +445 + +Fixed line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +230 + +445 + +Mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +49 + +- + +Geographical segment + +Consolidated revenue . . . . . . . . . . . . . . . . . . . . . . . . + +27,113 + +31,352 + +34,197 + +South Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +27,094 + +31,318 + +33,830 + +Other African countries . . . . . . . . . . . . . . . . . . . . . . . . + +19 + +92 + +370 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(58) + +(3) + +Consolidated operating profit . . . . . . . . . . . . . . . . . . . + +3,882 + +4,925 + +4,213 + +South Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,879 + +4,940 + +4,175 + +Other African countries . . . . . . . . . . . . . . . . . . . . . . . . + +3 + +(16) + +41 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1 + +(3) + +Consolidated assets + +South Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +47,246 + +53,293 + +54,367 + +Other African countries . . . . . . . . . . . . . . . . . . . . . . . . + +36 + +235 + +894 + +Elimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(6) + +9 + +(53) + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +47,276 + +53,537 + +55,208 + +"South Africa", which is also the country of domicile for Telkom SA Limited, comprises the segment information + +relating to Telkom SA Limited and its subsidiaries as well as Vodacom's South African-based mobile communications + +network, the segment information of its service providers and its other business segments. "Other African countries" + +comprises only Vodacom's mobile communications networks in Tanzania, Lesotho and the Democratic Republic of the + +Congo. + +F92 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +36. + +RELATED PARTIES + +Balances with related parties not disclosed elsewhere + +With joint venture: + +Vodacom Group (Proprietary) Limited + +Trade receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . + +25 + +25 + +41 + +Trade payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(241) + +(265) + +(272) + +Related party transactions with Vodacom + +Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(308) + +(377) + +(370) + +Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,203 + +1,386 + +1,484 + +Interest received . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(51) + +(39) + +(36) + +With shareholder: + +Thintana Communications LLC + +Management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . + +260 + +260 + +219 + +Government + +Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,014 + +1,213 + +1,382 + +Trade receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . + +333 + +172 + +134 + +Employees + +Other receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . + +186 + +165 + +170 + +With affiliate of director: + +Note 25 regarding vehicle lease and note 37 regarding the Group's treasury function. + +F93 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +37. + +DIRECTORS' INTEREST + +Mr E Molobi, the Chairman of the Board of directors at March 31, 2002, has the following interests as Chief Executive + +Officer for Kagiso Trust Investments (Proprietary) Limited: + + a 25% holding by Kagiso Trust Investments (Proprietary) Limited in BUA Telecoms, a company that is a vendor to + +the Group; + + a 25% holding by Kagiso Trust Investments (Proprietary) Limited in Debis Fleet Management (Proprietary) Limited, + +a fleet management company to whom the Group has outsourced its vehicle fleet; and + + a 50,1% holding by Kagiso Trust Investments (Proprietary) Limited in Kagiso Treasury Services (Proprietary) + +Limited, who manages the Group's Treasury function. + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Directors' emoluments . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +3 + +3 + +Executive + + For other services . . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +2 + +2 + +Non-executive + + For services as directors . . . . . . . . . . . . . . . . . . . . . + +- + +1 + +1 + +Emoluments per director: + + Fringe and + + Remuneration + + Performance + +other + + Total 2001 + +Fees + +* + +bonus + +benefits Total 2002 + +R + +R + +R + +R + +R + +R + +Non-executive directors + +Eric Molobi . . . . . . . . + +24,090 + +17,856 + +- + +- + +130,000 + +147,856 + +Dikgang Moseneke . . . . + +200,000 + +- + +- + +- + +70,000 + +70,000 + +Wendy Luhabe . . . . . . + +31,350 + +52,690 + +- + +- + +- + +52,690 + +Wendy Lucas Bull . . . . . + +21,780 + +56,320 + +- + +- + +- + +56,320 + +Richard Menell . . . . . . + +10,890 + +47,560 + +- + +- + +- + +47,560 + +Colin Smith . . . . . . . . + +- + +50,560 + +- + +- + +- + +50,560 + +Tlhalefeng Sekano . . . . + +- + +24,232 + +- + +- + +- + +24,232 + +Charles Valkin . . . . . . . + +25,330 + +51,730 + +- + +- + +- + +51,730 + +Peter Moyo . . . . . . . . + +- + +35,312 + +- + +- + +- + +35,312 + +Diliza Mji . . . . . . . . . + +25,080 + +52,190 + +- + +- + +- + +52,190 + +Sindy Zilwa . . . . . . . . + +- + +13,258 + +- + +- + +- + +13,258 + +Tan Sri Dato' Ir. Muhammad + +Radzi Mansor . . . . . . . + +- + +66,340 + +- + +- + +- + +66,340 + +338,520 + +468,048 + +200,000 + +668,048 + +Executive directors + +Sizwe Nxasana . . . . . . + +1,872,000 + +1,375,441 + +447,000 + +536,000 + +2,358,441* + +Total emoluments + + Paid by Telkom . . . . + +2,210,520 + +468,048 + +1,375,441 + +447,000 + +736,000 + +3,026,489 + +* Included in remuneration is pension contribution for S. Nxasana of R156 000. + +In the year ended March 31, 2002 R7,0m was paid to SBC Communications for services rendered by Thomas Barry. + +In the year ended March 31, 2002 R3,6m was paid to Telkom Malaysia for services rendered by Shanmugan + +Manickam. + +F94 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +38. INTEREST IN SIGNIFICANT SUBSIDIARIES + +Interest in + +Issued share capital + +issued ordinary + +share capital + +Country of + +2000 + +2001 + +2002 + +2000 + +2001 + +2002 + +incorporation + +% + +% + +% + +Directory advertising + +Telkom Directory Services (Proprietary) + +Limited . . . . . . . . . . . . . . . . . . . + +RSA + +R100 000 + +R100 000 + +R100 000 + +54.9 + +54.9 + +64.9 + +Data application services + +Swiftnet (Proprietary) Limited . . . . . . . + +RSA + +R50 000 000 + +R50 000 000 + +R50 000 000 + +60 + +60 + +100 + +The aggregate net profit of the two + +subsidiaries is R117,2 (2001: R33,6, + +2000: R143,2). + +Vodacom has interests in the following + +companies: + +Cellular network operators + +Vodacom (Proprietary) Limited . . . . . . . + +RSA + +R100 + +R100 + +R100 + +100 + +100 + +100 + +Vodacom Lesotho (Proprietary) Limited . . + +LES + +- + +M4,180 + +M4,180 + +- + +88.3 + +88.3 + +Vodacom Tanzania Limited . . . . . . . . . + +TZN + +- + +US$100 + +US$100 + +- + +65 + +65 + +Service providers + +Vodacom Service Provider Holding + +Company (Proprietary) Limited (INV) . . . + +RSA + +R1 020 + +R1 020 + +R1 020 + +100 + +100 + +100 + +Vodacom Service Provider Company + +(Proprietary) Limited (C) . . . . . . . . . . + +RSA + +R20 + +R20 + +R20 + +100 + +100 + +100 + +Globalstar Southern Africa (Proprietary) + +Limited (S) * . . . . . . . . . . . . . . . . + +RSA + +- + +R100 + +R100 + +- + +100 + +100 + +Vodac (Proprietary) Limited * . . . . . . . + +RSA + +R1 + +R1 + +R1 + +100 + +100 + +100 + +GSM Cellular (Proprietary) Limited * . . . + +RSA + +R1 200 + +R1 200 + +R1 200 + +100 + +100 + +100 + +Other + +Teljoy Holdings Limited (INV) . . . . . . . + +RSA + +R1 160 000 + +R158 999 + +R158 999 + +100 + +100 + +100 + +Film Fun (Holdings) (Proprietary) Limited + +(TV) . . . . . . . . . . . . . . . . . . . . . + +RSA + +R100 + +R100 + +- + +100 + +100 + +- + +Vodacom Sport & Entertainment + +(Proprietary) Limited (SE) . . . . . . . . . + +RSA + +- + +R100 + +- + +- + +51 + +- + +Vodacom Equipment Company + +(Proprietary) Limited * . . . . . . . . . . . + +RSA + +R100 + +R100 + +R100 + +100 + +100 + +100 + +Vodacare (Proprietary) Limited * . . . . . . + +RSA + +R100 + +R100 + +R100 + +100 + +100 + +100 + +Vodacom International Holdings + +(Proprietary) Limited (INV) . . . . . . . . . + +RSA + +- + +- + +R100 + +- + +- + +100 + +Vodacom International Limited (INV) . . . + +MAU + +- + +- + +US$100 + +- + +- + +100 + +* Dormant at March 31, 2002. + +Country of incorporation: RSA Republic of South Africa; TZN Tanzania; LES Lesotho; MAU Mauritius. + +Nature of business: C Cellular; S Satellite; SE Sport and entertainment contracts manager; TV Television and related rental + +services; INV Investment holding company. + +F95 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +39. + +INVESTMENTS IN JOINT VENTURES + +Vodacom Group (Proprietary) Limited + +Telkom owns 5,000 shares of 1 cent each at cost. This amounts to a 50% shareholding in Vodacom Group (Proprietary) + +Limited. + +The Group's proportionate share of Vodacom's assets and liabilities is as follows: + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,932 + +6,171 + +7,679 + +Non-current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,538 + +4,436 + +5,607 + +Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,394 + +1,735 + +2,072 + +Total liabilities and reserves . . . . . . . . . . . . . . . . . . . . . . + +(4,396) + +(5,711) + +(7,219) + +Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,335) + +(1,753) + +(2,732) + +Minority interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1 + +6 + +(5) + +Non-current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . + +(657) + +(806) + +(949) + +Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(2,405) + +(3,158) + +(3,533) + +Loan from joint venture partners . . . . . . . . . . . . . . . . . . . + +536 + +460 + +460 + +The Group's proportionate share of revenue and expense is + +as follows: + +Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,786 + +6,638 + +8,075 + +Net operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . + +(3,588) + +(5,349) + +(6,243) + +Profit before net financing charges . . . . . . . . . . . . . . . . . . . + +1,198 + +1,289 + +1,832 + +Net financing charges . . . . . . . . . . . . . . . . . . . . . . . . . . + +(284) + +(252) + +(36) + +Net income before taxation . . . . . . . . . . . . . . . . . . . . . . . + +914 + +1,037 + +1,796 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(257) + +(383) + +(595) + +Profit after taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +657 + +654 + +1,201 + +Minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5 + +(15) + +657 + +659 + +1,186 + +The Group's proportionate share of cash flow: + +Cash flow from operating activities . . . . . . . . . . . . . . . . . . . + +1,171 + +1,805 + +1,908 + +Cash flow from investing activities . . . . . . . . . . . . . . . . . . . + +(1,669) + +(1,426) + +(2,272) + +Cash flow from financing activities . . . . . . . . . . . . . . . . . . . + +323 + +(519) + +285 + +Net decrease in cash and cash equivalents . . . . . . . . . . . . . . . + +(175) + +(140) + +(79) + +Effect of exchange rate on cash and cash equivalents . . . . . . . . . . + +48 + +Cash and cash equivalents at beginning of year . . . . . . . . . . . . . + +(82) + +(258) + +(398) + +Cash and cash equivalents at end of year . . . . . . . . . . . . . . . . + +(257) + +(398) + +(429) + +Vodacom's joint ventures during 2002 included Vodacom World Online (Proprietary) Limited and Vodacom Congo. + +Effective November 30, 2001, Vodacom disposed of the interest in Vodacom World Online (Proprietary) Limited. + +Details of the disposal are presented in Note 32. The Group acquired its interest in Vodacom Congo on + +December 11, 2001. + +F96 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +40. + +SUBSEQUENT EVENTS + +Property portfolio + +In September 2002, Telkom issued an information memorandum inviting potential investors to provide, by November + +2002, preliminary submissions to purchase a substantial portion of Telkom's portfolio and enter into a sale and + +leaseback transaction. This transaction is intended to further the strategy of focusing on core businesses and increasing + +the return on assets. + +Telcordia matter + +Note 26. + +2% Share scheme + +On the date of the initial public offering, the Government of the Republic of South Africa will transfer 2% of its + +shareholding in the Company to a trust for the benefit of past and present employees. + +Taxation + +The South African Revenue Services ("SARS") indicated, in an assessment dated August 28, 2002, that they are + +disallowing the treatment of certain income in Telkom's 1998 income tax return. The dispute related to the first time + +application in fiscal year ended 1998 of Section 32 ("S32") of the Income Tax Act, 1962, which allows revenue + +generated by transmitting messages internationally to be only partly included in determining taxable income, and the + +deferral of unbilled revenues for tax purposes. + +On December 10, 2002, SARS agreed with Telkom's practice of claiming S32 of the Income Tax Act, 1962, for all + +years up to and including March 2001. Telkom has not claimed S32 in respect of the 2002 financial year. SARS, + +however, disallowed Telkom's practice of deferring certain unbilled revenue from taxable income. + +The impact of the disallowance of unbilled revenue, which has been recognized as an additional income tax provision + +in the Income Statement for the year ended March 31, 2002, is as follows: + +Rm + +Reversal of tax receivable . . . . . . . . . . . . . + +(218) + +Reversal of deferred taxation . . . . . . . . . . . + +186 + +Reversal of interest accrued . . . . . . . . . . . . + +(100) + +Tax effect of interest reversal . . . . . . . . . . . + +30 + +(102) + +In connection with the filing of its tax return for the 2001 fiscal year, Telkom revised the basis of its calculation and + +increased its estimate of the S32 benefit used for the preparation of the March 31, 2001 financial statements by an + +amount of R92 million. The revision has been recognized as a change in estimate and reflected as a reduction of the + +income tax provision for the year ended March 31, 2002. + +F97 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION + +Differences between International Accounting Standards and US Generally Accepted Accounting Principles + +The consolidated financial statements of Telkom SA Limited have been prepared in accordance with International + +Accounting Standards ("IAS"), which differ in certain respects from generally accepted accounting principles in the + +United States ("US GAAP"). Application of US GAAP would have affected the balance sheet as of March 31, 2002 + +and 2001 and net income for each of the two years in the periods ended March 31, 2002 to the extent described below. + +A description of the material differences between IAS and US GAAP as they relate to the Group, as well as its equity + +accounted investment in Vodacom, are discussed in further detail below. + +*The United States Dollar (USD) amounts shown in the footnotes have been translated at March 31, 2002 and for the + +year ended March 31, 2002 from South African Rand ("ZAR") only as a matter of arithmetic computation at the + +South African exchange rate of ZAR10.535 = USD1, the buying rate on September 30, 2002, the last business day + +prior to the date of our most recent balance sheet included in this submission. These amounts are unaudited and are + +included for the convenience of the reader only. Such translation should not be construed as a representation that the + +South African Rand amounts have been or could be converted into US Dollars at this or any other rate. + +Net income and equity in accordance with US GAAP differences + +The following schedule illustrates the significant adjustments to reconcile net income in accordance with IAS to the + +amounts determined in accordance with US GAAP for each of the two years ended March 31, 2002 and 2001: + +March 31, + +March 31, + +*March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Net income according to IAS . . . . . . . . . . . . . . . . . . . . . . . + +1,622 + +1,221 + +116 + +US GAAP adjustments Telkom: + +(a) Revenue recognition . . . . . . . . . . . . . . . . . . . . . . . . . . + +(26) + +29 + +3 + +(b) Sale and leaseback transaction . . . . . . . . . . . . . . . . . . . . . + +91 + +95 + +9 + +(c) Share issue expenses . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(44) + +(4) + +(d) Derivative financial instruments . . . . . . . . . . . . . . . . . . . . + +- + +90 + +9 + +(e) Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +15 + +1 + +(h) Tax effect of reconciling differences . . . . . . . . . . . . . . . . . + +(24) + +(81) + +(8) + +(h) Additional distribution tax retained earnings . . . . . . . . . . . . + +(90) + +(3) + +- + +(h) Capital gains tax Vodacom income . . . . . . . . . . . . . . . . . + +- + +(43) + +(4) + +US GAAP adjustments Vodacom: + +(d) Derivative financial instruments . . . . . . . . . . . . . . . . . . . . + +- + +26 + +2 + +(e) Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(1) + +- + +(f) Joint venture accounting . . . . . . . . . . . . . . . . . . . . . . . . + +22 + +(40) + +(4) + +(g) Deferred bonus incentive scheme . . . . . . . . . . . . . . . . . . . + +4 + +10 + +1 + +(h) Tax effect of reconciling differences . . . . . . . . . . . . . . . . . + +(1) + +(11) + +(1) + +Net income as per US GAAP before cumulative + +effect of change in accounting principle . . . . . . . . . . . . . . . . . + +1,598 + +1,263 + +120 + +(d) + +Cumulative effect of a change in accounting principle + +reflecting the application of SFAS 133 Telkom + +(net of tax of R30m) . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +48 + +4 + +(d) + +Cumulative effect of a change in accounting principle + +reflecting the application of SFAS 133 Vodacom (net of tax of R3m) + +- + +6 + +1 + +Net income according to US GAAP . . . . . . . . . . . . . . . . . . . + +1,598 + +1,317 + +125 + +Basic and diluted EPS + +The basic and diluted EPS do not differ, as there are no potentially dilutive + +securities. + +557,031,819 issued shares (cents) + +Basic and diluted earnings per share before cumulative effect of change in + +accounting principle + +286.9 + + 226.7 + +21.4 + +Basic and diluted earnings per share for cumulative effect of change in + +accounting principle + +- + +9.8 + +1 + +Basic and diluted earnings per share . . . . . . . . . . . . . . . . . . . . + +286.9 + +236.5 + +22.4 + +F98 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +The following is a reconciliation of the material adjustments necessary to reconcile shareholders' equity in accordance + +with IAS to the amounts in accordance with US GAAP as at March 31, 2002 and 2001: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Shareholders' equity according to IAS . . . . . . . . . . . . . . . . . + +14,972 + +16,832 + +1,598 + +US GAAP adjustments Telkom: + +(a) Revenue recognition . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,134) + +(1,105) + +(105) + +(b) Sale and leaseback transaction . . . . . . . . . . . . . . . . . . . . + +(372) + +(277) + +(26) + +(d) Derivative financial instruments . . . . . . . . . . . . . . . . . . . + +- + +(34) + +(3) + +(e) Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +15 + +1 + +(h) Tax effect of reconciling differences . . . . . . . . . . . . . . . . . + +569 + +535 + +51 + +(h) Additional distribution tax retained earnings . . . . . . . . . . . . + +(360) + +(423) + +(40) + +(h) Capital gains tax Vodacom income . . . . . . . . . . . . . . . . + +- + +(43) + +(4) + +(i) Fair value adjustment of investment . . . . . . . . . . . . . . . . . . + +45 + +- + +- + +US GAAP adjustments Vodacom: + +(e) Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2 + +15 + +1 + +(f) Joint venture accounting . . . . . . . . . . . . . . . . . . . . . . . . + +40 + +- + +- + +(g) Deferred bonus incentive scheme . . . . . . . . . . . . . . . . . . . + +19 + +29 + +3 + +(h) Tax effect of reconciling differences . . . . . . . . . . . . . . . . . + +(5) + +(9) + +(1) + +Shareholders' equity according to US GAAP . . . . . . . . . . . . . + +13,776 + +15,535 + +1,475 + +Comprehensive income + +Under US GAAP, SFAS 130 "Reporting Comprehensive Income" requires that certain items be recognized as a + +separate component of equity under the caption "Accumulated Other Comprehensive income". Additionally the + +standard requires that companies present comprehensive income, which is a combination of net income and changes in + +a company's accumulated other comprehensive income accounts. Changes in the Group's accumulated other + +comprehensive income is reflected under non-distributable reserves. + +Other + +Retained + +comprehensive + +earnings + +income + +Balance + +Rm + +Rm + +Rm + +Total April 1, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,840 + +- + +3,840 + +Net income per US GAAP . . . . . . . . . . . . . . . . . . . . . . . + +1,598 + +- + +5,438 + +Increase in fair value of listed investment . . . . . . . . . . . . . . . . + +- + +45 + +45 + +Total March 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,438 + +45 + +5,483 + +Net income per US GAAP . . . . . . . . . . . . . . . . . . . . . . . + +1,317 + +- + +6,755 + +Foreign currency translation adjustment . . . . . . . . . . . . . . . . + +- + +64 + +64 + +Increase in fair value of listed investment . . . . . . . . . . . . . . . . + +- + +5 + +50 + +Transitional adjustment on application of SFAS 133 (net of tax of R262m) + +- + +440 + +- + +Release of transitional adjustment on application of SFAS 133 to net + +income for 12-month period (net of tax of R38m) . . . . . . . . . . . + +- + +(67) + +373 + +Total March 31, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . + +6,755 + +487 + +7,242 + +F99 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +Movement in shareholders' equity in accordance with US GAAP + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Shareholders' equity according to US GAAP + +Balance April 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12,133 + +13,776 + +1,308 + +Net income for year . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,598 + +1,317 + +125 + +Foreign currency reserves . . . . . . . . . . . . . . . . . . . . . . . . + +- + +64 + +6 + +Fair value adjustments derivatives . . . . . . . . . . . . . . . . . . . + +- + +373 + +35 + +Fair value adjustments investments . . . . . . . . . . . . . . . . . . + +45 + +5 + +1 + +Balance March 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +13,776 + +15,535 + +1,475 + +US GAAP income statement, balance sheet and cash flow statement + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Income statements as per US GAAP + +Net revenue per IAS accounts . . . . . . . . . . . . . . . . . . . . . + +31,352 + +34,197 + +3,246 + +Net revenue per US GAAP . . . . . . . . . . . . . . . . . . . . . + +26,413 + +27,947 + +2,653 + +Operating income per IAS accounts . . . . . . . . . . . . . . . . . . + +4,925 + +4,213 + +400 + +Operating income per US GAAP . . . . . . . . . . . . . . . . . . + +3,716 + +2,498 + +237 + +Income after financial items per IAS accounts . . . . . . . . . . . . + +2,405 + +2,153 + +204 + +Income after financial items per US GAAP . . . . . . . . . . . . + +1,433 + +618 + +58 + +Equity accounted earnings per US GAAP . . . . . . . . . . . . . + +684 + +1,177 + +112 + +Taxes per IAS accounts . . . . . . . . . . . . . . . . . . . . . . . . + +715 + +873 + +83 + +Taxes per US GAAP . . . . . . . . . . . . . . . . . . . . . . . . . + +446 + +434 + +41 + +Minority interests per IAS accounts . . . . . . . . . . . . . . . . . . + +68 + +59 + +6 + +Minority interests per US GAAP . . . . . . . . . . . . . . . . . . + +73 + +44 + +4 + +Net income per IAS accounts . . . . . . . . . . . . . . . . . . . . . + +1,622 + +1,221 + +116 + +Net income per US GAAP . . . . . . . . . . . . . . . . . . . . . . + +1,598 + +1,317 + +125 + +Balance sheets as per US GAAP + +Non-current assets per IAS accounts . . . . . . . . . . . . . . . . . + +40,863 + +44,240 + +4,199 + +Non-current assets per US GAAP . . . . . . . . . . . . . . . . . . + +38,444 + +41,714 + +3,960 + +Current assets per IAS accounts . . . . . . . . . . . . . . . . . . . . + +12,674 + +10,968 + +1,041 + +Current assets per US GAAP . . . . . . . . . . . . . . . . . . . . + +11,080 + +9,229 + +876 + +Total assets per US GAAP . . . . . . . . . . . . . . . . . . . . . . . + +49,524 + +50,943 + +4,836 + +Equity per IAS accounts . . . . . . . . . . . . . . . . . . . . . . . . + +14,972 + +16,832 + +1,598 + +Equity per US GAAP . . . . . . . . . . . . . . . . . . . . . . . . + +13,776 + +15,535 + +1,475 + +Minority interests per IAS accounts . . . . . . . . . . . . . . . . . . + +116 + +133 + +13 + +Minority interests per US GAAP . . . . . . . . . . . . . . . . . . + +122 + +128 + +12 + +Long-term liabilities per IAS accounts . . . . . . . . . . . . . . . . + +23,009 + +25,597 + +2,430 + +Long-term liabilities per US GAAP . . . . . . . . . . . . . . . . . + +22,212 + +24,649 + +2,340 + +Current liabilities per IAS accounts . . . . . . . . . . . . . . . . . . + +15,447 + +12,646 + +1,200 + +Current liabilities per US GAAP . . . . . . . . . . . . . . . . . . + +13,414 + +10,631 + +1,009 + +Total equity and liabilities per US GAAP . . . . . . . . . . . . . . . + +49,524 + +50,943 + +4,836 + +F100 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Cash flow as per US GAAP + +Cash flow from operating activities . . . . . . . . . . . . . . . . . . . + +5,875 + +7,099 + +674 + +Cash generated from operations . . . . . . . . . . . . . . . . . . . . . + +7,455 + +7,959 + +755 + +Income from investments . . . . . . . . . . . . . . . . . . . . . . . . + +444 + +459 + +44 + +Dividends received . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +240 + +23 + +Net financing charges paid . . . . . . . . . . . . . . . . . . . . . . . . + +(1,983) + +(1,416) + +(134) + +Taxation paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(41) + +(143) + +(14) + +Cash flow from investing activities . . . . . . . . . . . . . . . . . . . + +(8,112) + +(7,128) + +(677) + +Cash flow from financing activities . . . . . . . . . . . . . . . . . . . + +2,017 + +(905) + +(86) + +Net decrease in net cash and cash equivalents . . . . . . . . . . . . . + +(220) + +(934) + +(89) + +Net cash and cash equivalents at beginning of year . . . . . . . . . . + +1,485 + +1,265 + +120 + +Net cash and cash equivalents at end of year . . . . . . . . . . . . . + +1,265 + +331 + +31 + +(a) + +Revenue recognition + +The Staff of the US Securities and Exchange Commission issued Staff Accounting Bulletin 101 ("SAB 101") that + +addresses revenue recognition under US GAAP. Under this guidance, revenue earned from access, installation- + +activation and similar fees should be recognized over the estimated life of the customer relationship. Also, + +SAB 101 permits, but does not require, companies to defer costs directly associated with such revenue and to also + +recognize these costs over the life of the customer relationship. Under IAS the Group recognizes this revenue + +and related costs when the services are provided and the related costs are incurred. + +In accordance with the US GAAP, revenue earned from installation and activation is deferred and recognized over + +the expected period of the customer relationship. The expected period of the customer relationship is 5 years + +(2001 8,5 years) for telephony voice customers and 4 years (2001 4 years) for data customers. + +The Group recognizes installation and activation costs, excluding those costs that are capitalized as an integral + +part of the network, in the period incurred. These adjustments resulted in a decrease of R26m to income and + +increase to income of R29m in 2001 and 2002, respectively. + +(b) + +Sale and lease-back + +As discussed in Note 25 on March 31, 2000, the company outsourced its entire fleet of vehicles as well as the + +maintenance, fueling, insurance, tracking and other services to debis through a sale and lease-back agreement. The + +lease-back was in the form of a master service level agreement covering a period of five years providing, subject + +to the company's requirements, for the annual lease contracts for each vehicle under the agreement. + +Under the provisions of IAS 17, the Group recorded a gain from a transaction that had transferred substantially all + +of the risks and rewards incidental to ownership of the vehicles to debis as the criteria for profit recognition had + +been satisfied. The Group recognized a gain in the amount of R463m in 2000 and accounted for the lease-backs as + +operating leases. + +Under US GAAP, SFAS 13, as amended by SFAS 28, the Group determined that while the terms of the agreement + +provide that the assets underlying the lease-back would be subject to annual lease contract, renewable based upon + +the company's vehicle requirements and cancelable under certain terms, debis' right of first refusal to provide all + +of the Group's requirements during the five-year term represents an economic compulsion to renew the leases. + +Accordingly, the Group concluded that since the lease-back cover substantially all the assets that were sold under + +the contract for substantially all their remaining useful lives, deferral of the related gain and recognition over the + +terms of the related agreements was appropriate. + +F101 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +(b) + +Sale and lease-back + +Based on the requirements of SFAS 13, a selected portion of the vehicle leases would be treated as finance leases + +due to the fact that when analyzed on a vehicle by vehicle basis, the present value of the minimum lease payments + +of certain individual vehicles exceed 90% of the fair value of these vehicles or the lease term represents more than + +75% of the remaining economic life of the vehicles. Accordingly, the full gain realized through the sale of the + +vehicles has been reversed and the proceeds from the sale has been treated as an obligation. Rental payments have + +been applied to interest expense on the obligation as well as to reduce the principal amount of the obligation. The + +resulting capital lease assets are being depreciated over their remaining useful lives. + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Retained earnings opening balance profit reversal . . . . . . . . + +(463) + +(372) + +(35) + +Recognition of profit income . . . . . . . . . . . . . . . . . . . + +93 + +93 + +9 + +Depreciation adjustment . . . . . . . . . . . . . . . . . . . . . . + +(20) + +(9) + +(1) + +Finance costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(2) + +(1) + +- + +Add back: Lease expense . . . . . . . . . . . . . . . . . . . . . . + +20 + +12 + +1 + +Net impact on income statement per period . . . . . . . . . . . . + +91 + +95 + +9 + +Retained earnings ending balance . . . . . . . . . . . . . . . . . + +(372) + +(277) + +(26) + +Balance sheet + +Capital lease assets + +April 1, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +29 + +- + +- + +Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(20) + +- + +- + +March 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +9 + +1 + +Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(9) + +(1) + +March 31, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Capital lease liability . . . . . . . . . . . . . . . . . . . . . . . + +11 + +- + +- + +(c) + +Share issue expenses + +Under IAS, external costs directly attributable to the issue of new shares are shown as a deduction, net of tax in + +equity. This is only allowed under US GAAP however, when the proposed listing has not been delayed more than + +90 days after incurring these costs. In 2002, Telkom's IPO was postponed more than 90 days. Therefore the costs + +incurred through March 31, 2002 related to the IPO of R44m have been expensed. + +(d) + +Derivative financial instruments + +SFAS133 Fair value adjustments + +The Group adopted IAS 39 and SFAS 133 on April 1, 2001. Upon adoption of IAS 39, the difference between + +previous carrying amounts and the fair value of derivatives, which prior to the adoption of IAS 39 had been + +designated as cash flow hedges or fair value hedges but which do not qualify for hedge accounting under IAS 39, + +is recognized as an adjustment to the opening balance of retained earnings in the financial year IAS 39 is initially + +applied. Changes in the fair value of derivatives subsequent to April 1, 2001 are recorded in the income statement + +as they do not qualify for hedge accounting. + +F102 + +TELKOM SA LIMITED + +NOTES TO THE CONSO1LIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +(d) + +Derivative financial instruments (continued) + +Under US GAAP, in accordance with SFAS 133, the company is required to recognize all derivatives on the + +balance sheet at fair value. The SFAS 133 transitional adjustments (at April 1, 2001) are recorded differently than + +those recorded under IAS 39. For pre-existing hedge relationships that would be considered cash flow type + +hedges, the transitional adjustment should be reported in OCI as a cumulative effect of the accounting change. + +Any transition adjustment reported as a cumulative effect adjustment in OCI will subsequently be reclassified into + +earnings in a manner consistent with the earnings effect of the hedged transaction. For pre-existing hedge + +relationships that would be considered fair value type hedges, the company adjusted the carrying values of the + +hedged item to its fair value, but only to the extent of an offsetting transition adjustment from the previously + +designated hedging instrument. The hedged asset or liability is subsequently accounted for in a manner consistent + +with the appropriate accounting for such assets and liabilities. For both cash flow and fair value hedges any + +portion of the derivative that is considered ineffective at transition is reported in income as a cumulative effect of + +an accounting change. + +Upon adoption on April 1, 2001, the Group recorded an adjustment to other comprehensive income of R440m (net + +of tax of R262m) representing the fair value adjustment of derivatives for which the pre-existing hedge + +relationships would be considered cash flow type hedges. In the 2002 fiscal year, subsequent to the adoption date, + +the Group reclassified from other comprehensive income into earnings R67m (net of tax of R38m) as the hedged + +transaction impacted earnings. Upon adoption, the Group also recorded an adjustment of R45m to increase the + +carrying value of a hedged debt instrument that was the hedged item in what would be considered a fair value type + +hedge. The fair value adjustment to the hedged item is limited to the extent of an off-setting fair value adjustment + +to the hedging instrument. In the 2002 fiscal year, the Group amortized R11m of the adjustment to the hedged + +debt instrument into earnings. Upon adoption, the Group recorded a cumulative effect of change in accounting + +principle, R54m (net of tax of R33m) representing the ineffective portion of adjustments to record derivatives at + +fair value. + +(e) + +Goodwill + +Under IAS, goodwill arising on the acquisition of a foreign entity is treated as an asset of the Group and translated + +at the foreign exchange rate in effect at transaction date. In accordance with IAS the Group amortizes goodwill + +and other intangibles on a straight-line basis over the anticipated benefit period. + +Under US GAAP, goodwill arising on the acquisition of a foreign entity is translated at the actual exchange rate at + +the end of the period. Furthermore, under US GAAP with effect from July 1, 2001 goodwill and other intangibles + +with infinite lives are not amortized for business combinations completed after June 30, 2001. For previously + +recorded goodwill and intangibles with infinite lives, amortization ceases on March 31, 2002. + +The Group is required to adopt SFAS 142 "Accounting for Goodwill and Other Intangibles" effective April 1, + +2002. The Group is required to complete the initial step of a transitional impairment test on all goodwill and + +indefinite lived intangible assets as of April 1, 2002 within six months of adoption of SFAS 142. Subsequent + +impairment losses will be reflected in operating income or loss in the income statement. + +Management determined that an impairment of R16m existed with respect to the step acquisition of the minority + +interest of Swiftnet which will be recognized as a cumulative effect of accounting change in the 2003 fiscal year. + +(f) + +Joint venture accounting + +Under IAS, investments qualifying as joint ventures are accounted for under the proportionate consolidation + +method of accounting. Under the proportionate consolidation method, the venturer records its share of each of the + +assets, liabilities, income and expenses of the jointly controlled entity on a line-by-line basis with similar items in + +the venturer's financial statements. + +The venturer continues to record its total share of the losses in excess of the net investment in the joint venture. + +However for US GAAP purposes where the joint ventures are equity accounted, losses are only recognized up to + +the net investment in the joint venture, unless the investor has committed to continue providing financial support + +to the investee. + +F103 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +(f) + +Joint venture accounting (continued) + +In 2001 and 2002, in accordance with IAS, the Group proportionately consolidated losses of R22m and R18m, + +respectively, that were in excess of the Group's net investment in the joint venture. Under US GAAP these losses + +are not recorded for reasons previously stated. The investment was disposed in 2002 and the gain on the sale for + +IAS purposes was calculated based on a lower investment balance, resulting in excess gain of R40m compared + +with US GAAP. + +Vodacom equity accounted earnings + +Under IAS, the Group's interests in joint ventures are proportionally consolidated. Under US GAAP, interest in + +joint ventures not meeting the criteria for accommodation under item 17 of Form 20-F should be reflected in the + +consolidated financial statements using the equity method. The following table sets out the restated abbreviated + +income statement and balance sheet of the Group joint venture company, Vodacom, after US GAAP adjustments: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Income statements as per US GAAP + +Operating income . . . . . . . . . . . . . . . . . . . . . . . . . + +2,604 + +3,641 + +346 + +Income after financial items . . . . . . . . . . . . . . . . . . . + +2,126 + +3,585 + +340 + +Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(886) + +(1,446) + +(137) + +Minority interests . . . . . . . . . . . . . . . . . . . . . . . . . + +9 + +(30) + +(3) + +Net income before accounting changes . . . . . . . . . . . . . . + +1,249 + +2,109 + +200 + +Change in accounting policy . . . . . . . . . . . . . . . . . . . + +- + +11 + +1 + +Net income for year . . . . . . . . . . . . . . . . . . . . . . . . + +1,249 + +2,120 + +201 + +Balance sheets as per US GAAP + +Non-current assets . . . . . . . . . . . . . . . . . . . . . . . . . + +8,974 + +11,429 + +1,085 + +Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,465 + +3,990 + +379 + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12,439 + +15,419 + +1,464 + +Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3,195 + +4,874 + +463 + +Minority interests . . . . . . . . . . . . . . . . . . . . . . . . . + +(11) + +11 + +1 + +Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +9,255 + +10,534 + +1,000 + +Total equity and liabilities . . . . . . . . . . . . . . . . . . . . + +12,439 + +15,419 + +1,464 + +(g) + +Deferred bonus incentive scheme + +Under IAS, the total value of deferred bonus entitlements as calculated at the end of each financial period are + +provided for in full on the balance sheet date, based on the net present value of expected future cash flows. Under + +US GAAP, compensation cost should be recognized over the service period or the vesting period if the service + +period is not defined, based on the undiscounted value of the entitlements. + +F104 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +(h) + +Income taxes + +Deferred tax benefits and liabilities are calculated, when applicable, for the differences between IAS and + +US GAAP. + +Telkom is taxed at a corporate tax rate of 30% on taxable income. Telkom incurs an additional Secondary Tax on + +Companies ("STC") at a rate of 12.5% on any dividends distributed to shareholders. The dividend tax is payable if + +and only when dividends are distributed. Neither the Company nor the shareholders receive any future tax benefits + +as a result of additional tax on dividends paid. As required under IAS, Telkom will recognize the tax effects of + +dividends when distributed in future. Under US GAAP, consistent with the requirements of EITF 95-9, the + +company measures its income tax expense, including the tax effect of temporary differences, using the tax rate + +that includes the dividend tax. STC is calculated on retained income after the 1992 fiscal year after deducting the + +net gains from certain capital transactions as defined and after giving credit for dividends received from Vodacom + +and other subsidiaries for which the Group had paid the related STC tax. The following is the reconciliation of the + +tax expense computed using the statutory tax rate of 30% to the effective rate of 70% (31% 2001): + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Income before tax per US GAAP . . . . . . . . . . . . . . . . . + +1,433 + +618 + +59 + +Expected income tax expense at statutory rate of 30% . . . . . . + +430 + +186 + +18 + +Adjustments due to STC on retained income . . . . . . . . . . . + +94 + +26 + +2 + +Exempt income . . . . . . . . . . . . . . . . . . . . . . . . . . + +(375) + +(1) + +- + +Unutilized tax losses . . . . . . . . . . . . . . . . . . . . . . . + +7 + +(11) + +(1) + +Disallowable expenses . . . . . . . . . . . . . . . . . . . . . . + +296 + +264 + +25 + +Temporary differences in joint venture . . . . . . . . . . . . . . + +(6) + +(11) + +(1) + +Under provision for prior year . . . . . . . . . . . . . . . . . . + +- + +(62) + +(6) + +Adjustment on possible CGT Vodacom earnings . . . . . . . . + +- + +43 + +4 + +Effective tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +446 + +434 + +41 + +With respect to the Group's investment in Vodacom SFAS109 requires that deferred taxes be recognized for the + +effect of the excess of the amount of financial reporting over the tax basis of such investment. According to South + +African tax law, the Group would be required to pay tax at a rate of 37.78% on any increase in the appreciation in + +the value of its investment since October 1, 2001. As such, deferred taxes have been recognized on the Group's + +share of the undistributed earnings of Vodacom since October 1, 2001. + +F105 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +Deferred tax + +The tax effects of the US GAAP adjustments relating to Telkom's operations have been calculated based on a tax + +rate of 37.78%. + +A reconciliation of the deferred tax balances under IAS to the amounts determined under US GAAP where + +materially different is as follows: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Net deferred tax asset per IAS . . . . . . . . . . . . . . . . . . . + +853 + +549 + +52 + +Additional distribution tax . . . . . . . . . . . . . . . . . . . . . + +(360) + +(423) + +(40) + +CGT on equity investee . . . . . . . . . . . . . . . . . . . . . . . + +- + +(43) + +(4) + +Tax effect of US GAAP adjustments . . . . . . . . . . . . . . . . + +569 + +535 + +51 + +Net deferred tax asset per US GAAP . . . . . . . . . . . . . . . . + +1,062 + +618 + +59 + +(i) + +Employee benefits + +There is a difference in treatment of the transitional asset/liability on adoption of the statements under IAS and + +US GAAP. In terms of FAS 87, this is amortized on a straight-line basis over the remaining lifetime of the fund + +effective from April 1, 1989. In terms of IAS 19, if this is a "liability" or deficit, this is either recognized + +immediately or alternatively amortized over a period of five years. In the event of an asset arising, the full amount + +is recognized immediately. + +Furthermore, IAS 19 determines that the employer limits the extent of any asset recognized on the balance sheet + +by the employer to the true economic benefit available, whereas FAS 87 does not. To the extent that the "expense" + +calculated under FAS 87 is lower than the actual contribution made, an asset will build up in the company + +accounts. IAS 19 does in fact recognize the SA legislative position on surplus in allowing the limitation of the + +extent of any asset recognized to such as is available for the economic benefit of the employer. As no surplus has + +been apportioned to the employer, in terms of IAS 19, the asset is limited to zero. This has the impact of adjusting + +the expense coming through the income statement to the employer's actual contribution for the period concerned. + +The effect of these differences has been immaterial to the US GAAP reconciliation. + +F106 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +The disclosure of the retirement fund and pension fund unrecognized asset would be as follows under US GAAP: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Telkom retirement fund + +Present value of the funded obligation . . . . . . . . . . . . . . . + +2,586 + +3,055 + +290 + +Fair value of plan asset . . . . . . . . . . . . . . . . . . . . . . . + +(2,979) + +(3,805) + +(361) + +Funded status . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(393) + +(750) + +(71) + +Unrecognized net actuarial gain . . . . . . . . . . . . . . . . . . + +214 + +437 + +41 + +Unrecognized surplus . . . . . . . . . . . . . . . . . . . . . . . . + +(179) + +(313) + +(30) + +Telkom pension fund + +Present value of the funded obligation . . . . . . . . . . . . . . . + +137 + +113 + +11 + +Fair value of plan asset . . . . . . . . . . . . . . . . . . . . . . . + +(185) + +(190) + +(18) + +Funded status . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(48) + +(77) + +(7) + +Unrecognized net actuarial gain . . . . . . . . . . . . . . . . . . + +48 + +53 + +5 + +Unrecognized surplus . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(24) + +(2) + +Additional US GAAP disclosures + +Concentration of risks + +The Group is party to collective bargaining agreements with unions covering the employment terms and conditions of + +a significant part of their employees. Approximately 35% of the company employees are members of the Alliance of + +Telkom Union and 37% of the company employees are members of the Communication Workers Union. These + +employees are bound to follow the decisions of the Union. The Group has an excellent working relationship with the + +unions and to date, there have been no significant disruptions to operations due to union activities. + +The company has various commercial contracts with suppliers of goods and services which at a high level can be + +classified into IT, Network, Commercial (inclusive of outsourced entities), Training and other. The contracts are on a + +three monthly basis assessed by means of a formal risk assessment model in order to determine relevant risk exposure. + +Risk exposure is evaluated against the following criteria: + + the value of the contract/company spend to date; + + impact of supplier/service provider of key strategic initiatives of the company; + + level/intensity of associated maintenance/support received from technology suppliers; + + the period that a specific technology is already introduced into the network; + + the extent of customization by the company on standard technical functionality provided by supplier/service + +provider; + + level of foreign exposure in currency associated with the product/service offering; and + + inherent business and financial risk associated with a supplier. + +The Group is currently the sole holder of the license to provide public switched telephony services within South Africa + +and therefore the customer base is diverse and spread across the country. Telkom has embarked on a process of signing + +long-term contracts with significant customers. + +There is a concentration of credit risk relating to the significant number of derivative contracts entered into with + +international financial institutions with a rating of A1 or better and where derivative fair market values in favour of + +Telkom with an individual institution represents at least 20% of the total value of all derivative contracts in favour of + +Telkom. The accounting loss the Company would incur if no amounts were recovered at March 31, 2002 is R2,6bn. + +The concentration developed due to the significant depreciation of the Rand since the transactions were entered into. It + +is the intention of management to reduce this concentration. No further transactions will be entered into with the + +affected counter-parties until a diverse group of counter-parties is restored. Options to reduce the significant + +concentration are continuously being evaluated. + +F107 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +There has been no indication of a significant change in any factors since the reporting date that would significantly + +impact estimates made by management in the most recent set of financial statements. + +Restructuring + +During the two years ended March 31, 2002, the Group had recognized the cost of restructuring charges associated + +with management's plan to reduce the size of its work force to a comparable level for world-class telecommunication + +companies. The plan involved the termination of employees, which the Group expects to be substantially completed + +within a period of 12 months. + +The 2002 plan affects 748 employees who will cease their services during 2002/2003 and were still employed by the + +Group at year-end. These employees include operating personnel and product development and corporate staff. + +For the periods April 1, 1999 to March 31, 2002 1670 employees have been affected by this process. + +The following table provides a roll forward of restructuring provisions recognized by the Group during the two-year + +period ended March 31, 2002: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Restructuring provision beginning of year . . . . . . . . . . . . . . + +- + +- + +- + +Increase in provision . . . . . . . . . . . . . . . . . . . . . . . . . . . + +132 + +373 + +35 + +Workforce reduction payments . . . . . . . . . . . . . . . . . . . . . + +(132) + +(338) + +(32) + +Restructuring provision end of year . . . . . . . . . . . . . . . . . . + +- + +35 + +3 + +As part of the Company's realignment initiatives it reached agreement with Telecommunication Facilities Management + +Company ("TFMC") on July 31, 2000 to outsource the following two business units: + +Facilities Infrastructure and Operations Services (FIO); and Property Asset Management and Development Services + +(PAMDEV). + +Telkom also outsourced and sold its fleet consisting of 18,686 vehicles, as well as workshops and other equipment, + +as a going concern, to debis Fleet Management. The Agreement entered into by Telkom and debis Fleet Management + +on March 31, 2000 is effective for a period of five years. + +Restrictions on dividend payouts + +The following is a reconciliation of retained earnings per US GAAP to the amount of unrestricted retained earnings: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Retained earnings per US GAAP . . . . . . . . . . . . . . . . . . . . + +5,438 + +6,755 + +641 + +Share of retained earnings in significant investee . . . . . . . . . . . . + +(1,754) + +(2,678) + +(254) + +Cell Captive investment . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(35) + +(3) + +Unrestricted retained earnings under US GAAP . . . . . . . . . . . . + +3,684 + +4,042 + +384 + +All distributable earnings are available for distribution based on the Group's dividend policy. The Board of Directors of + +Telkom decides on an annual basis the amount of earnings to be reinvested in the operations and the amount of any + +remaining funds that are available for distribution to shareholders. + +F108 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +Retained earnings of our investee, Vodacom is restricted, since we require the consent of other shareholders in order to + +require Vodacom to declare dividends. Restricted retained earnings included in the March 31, 2002 balance amount + +to R2,678m. + +Telkom has invested funds in a Cell Captive which will be used to fund future post-retirement medical aid costs. These + +funds will be used for that purpose only and are therefore not distributable. + +Leases + +The Group leases certain buildings, vehicles and equipment. The bulk of the lease terms negotiated for equipment- + +related premises are ten years with other leases signed for five years and three years. The bulk of non-equipment- + +related premises are for three to ten years. The majority of the leases normally contain an option clause entitling + +Telkom to renew the lease agreements for a period usually equal to the main lease term. + +The minimum lease payments under these agreements are subject to annual escalations, which range from 8% to 12%. + +Penalties in terms of lease agreements are only payable should Telkom vacate a premises and negotiate to terminate + +the lease agreement prior to the expiry date, in which case a settlement payment will be negotiated in accordance with + +the market conditions and location of the premises. Lease agreements are not signed for any contingency purposes. + +Future minimum lease payments under operating leases are included in Note 25. + +As discussed above, at March 31, 2000 the Group entered into a sale and leaseback of its vehicle fleet with debis, part + +of which is being accounted for under US GAAP as capital leases. While no minimum usage clause exists in this + +contract as presented in Note 25, the Group is deemed to be economically compelled under US GAAP to renew such + +leases based upon their historical requirements and contractual obligations to source any such requirements during the + +contract period from debis. + +F109 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +In accordance with the agreement the Group is not allowed to lease any similar vehicles as those specified in the + +contract from any other service provider during the five-year period. + +The current contract does not have a forced renewal option. Any continued involvement after March 31, 2005 will be + +renegotiated at the time of expiry of the current contract. The contract is structured to have no lease increases on + +vehicles that are continually leased from debis. If a vehicle is however replaced by a new similar vehicle the lease + +payment is increased with a percentage increase based on the South African Consumer Price Index at the time. The + +operating commitments at March 31, 2002 are as follows: + +Buildings + +Equipment + +Vehicles + +Total + +Rm + +Rm + +Rm + +Rm + +2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +184 + +17 + +809 + +1,010 + +2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +103 + +18 + +810 + +931 + +2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +66 + +- + +825 + +891 + +2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +56 + +- + +- + +56 + +2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +57 + +- + +- + +57 + +> 5 years . . . . . . . . . . . . . . . . . . . . . . . . . + +217 + +- + +- + +217 + +Total . . . . . . . . . . . . . . . . . . . . . . . . . . . + +683 + +35 + +2,444 + +3,162 + +The finance lease commitments at March 31, 2002 are as follows: + +Buildings + +Equipment + +Vehicles + +Total + +Rm + +Rm + +Rm + +Rm + +2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +54 + +- + +- + +54 + +2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +60 + +- + +- + +60 + +2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +66 + +- + +- + +66 + +2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +72 + +- + +- + +72 + +2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . + +79 + +- + +- + +79 + +> 5 years . . . . . . . . . . . . . . . . . . . . . . . . . + +1,823 + +- + +- + +1,823 + +Total . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,154 + +- + +- + +2,154 + +Investments + +The pertinent rights and privileges of the various securities outstanding have been disclosed in the financial statements. + +The Group requires no collateral or other security on repurchase agreements or securities lending transactions. + +Pensions + +For purposes of US GAAP, pension costs for defined benefit plans are accounted for in accordance with SFAS 87 + +"Employers' Accounting for Pensions" and the disclosure is presented in accordance with SFAS 132 "Employers + +Disclosures about Pensions and Other Post-retirement Benefits". Presented below are the disclosures required by + +US GAAP that are different from that provided under IAS. Except as described below, the plan liabilities and assets + +are the same under US GAAP as IAS. The difference in the balance sheet and income statements amounts are + +attributable to how and when the respective standards were implemented. + +F110 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +The net periodic pension costs includes the following components: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Service cost on benefits earned: + +Interest cost on projected benefit obligations . . . . . . . . . . . . . . + +285 + +324 + +31 + +Expected return on plan assets . . . . . . . . . . . . . . . . . . . . . + +(436) + +(444) + +(42) + +Amortization of transitional obligation . . . . . . . . . . . . . . . . . + +1 + +- + +- + +Amortization of unrecognized net gain . . . . . . . . . . . . . . . . . + +(20) + +Net periodic pension costs . . . . . . . . . . . . . . . . . . . . . . . . + +(170) + +(120) + +(11) + +The status of the pension plan is as follows: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Benefit obligation: + +At beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,332 + +2,586 + +245 + +Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +285 + +324 + +31 + +Benefits paid and net cash flow . . . . . . . . . . . . . . . . . . . . . + +(106) + +145 + +14 + +Actuarial gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +75 + +- + +- + +Benefit obligation at end of year . . . . . . . . . . . . . . . . . . . . + +2,586 + +3,055 + +290 + +Plan assets at fair value: + +At beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,924 + +2,980 + +283 + +Expected return on plan assets (2001 actual return) . . . . . . . . . . + +(323) + +444 + +42 + +Net cash flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +379 + +381 + +36 + +Plan assets at fair value at end of year . . . . . . . . . . . . . . . . . + +2,980 + +3,805 + +361 + +There is no difference in the benefit obligation at March 31, 2002 between US GAAP and IAS. + +Healthcare costs + +In addition to the Group's defined benefit pension plan, the Group sponsors a defined benefit healthcare plan that + +provides post-retirement medical benefits to full-time employees who have worked for the Company and joined before + +June 30, 2000. All employees joining after June 30, 2000 do not qualify for any post-retirement health care subsidies. + +The plan is contributory, with retiree contributions adjusted annually. The Group's policy is to fund the cost of medical + +benefits in amounts determined at the discretion of management. + +The contribution liability is calculated as the present value of the future contributions after retirement. The Rand cap + +on the subsidy applicable to active members and post-1994 continuation members has been assumed to escalate at + +salary inflation. + +F111 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +The assumed future investment returns has a significant effect on the amounts reported. A one-percentage-point change + +in the assumed healthcare cost trend rate would have the following effects: + +One-percentage- + +point movement + +Impact on total of service and interest cost components in 2002 . . . . . . . . . . . . . . . + +R26m + +Impact on post-retirement benefit obligation as of 2002 . . . . . . . . . . . . . . . . . . . . + +R294m + +Statement of income classification items + +US GAAP requires the disclosure of certain income statement items: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Revenues from other services . . . . . . . . . . . . . . . . . . . . . . + +(20,658) + +(21,520) + +(2,043) + +Income from rentals . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(593) + +(599) + +(57) + +Net sales of tangible products . . . . . . . . . . . . . . . . . . . . . . + +(131) + +(120) + +(12) + +Income from Government . . . . . . . . . . . . . . . . . . . . . . . . + +(891) + +(1,288) + +(122) + +Income from related parties . . . . . . . . . . . . . . . . . . . . . . . + +(4,140) + +(4,420) + +(419) + +Total operating revenue . . . . . . . . . . . . . . . . . . . . . . . . . + +(26,413) + +(27,947) + +(2,653) + +Total revenue from services . . . . . . . . . . . . . . . . . . . . . . + +(26,282) + +(27,827) + +(2,641) + +- Subscription and connection . . . . . . . . . . . . . . . . . . . . . . + +(4,055) + +(4,283) + +(407) + +- Domestic (local and long distance) . . . . . . . . . . . . . . . . . . + +(8,280) + +(8,670) + +(823) + +- Fixed to mobile . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(6,845) + +(7,323) + +(695) + +- International outgoing . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,284) + +(1,175) + +(111) + +- Interconnection . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,855) + +(1,798) + +(171) + +- Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(3,312) + +(3,891) + +(369) + +- Directories and other . . . . . . . . . . . . . . . . . . . . . . . . . + +(651) + +(687) + +(65) + +Revenue from product sales . . . . . . . . . . . . . . . . . . . . . . + +(131) + +(120) + +(12) + +Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(26,413) + +(27,947) + +(2,653) + +Costs of services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +13,478 + +13,780 + +1,308 + +Cost of tangible products sold . . . . . . . . . . . . . . . . . . . . . . + +232 + +232 + +22 + +Other operating expenses and SG&A . . . . . . . . . . . . . . . . . . + +8, 987 + +11,437 + +1,086 + +Total operating expense . . . . . . . . . . . . . . . . . . . . . . . . . + +22,697 + +25,449 + +2,416 + +Dividends received . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(240) + +(300) + +(28) + +Net interest and amortization of debt discount and expense . . . . . . + +2,070 + +1,830 + +174 + +F112 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +Statement of balance sheet classification items + +US GAAP requires the disclosure of certain balance sheet items: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Trade receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4,184 + +4,038 + +383 + +Receivables from dividends and interest . . . . . . . . . . . . . . . . + +295 + +303 + +29 + +Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +103 + +124 + +12 + +Other receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +444 + +252 + +24 + +Total receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,026 + +4,717 + +448 + +Amounts payable for advisory, management and service fee . . . . . . + +(9) + +(23) + +(2) + +Amounts payable to controlled companies . . . . . . . . . . . . . . . + +(582) + +(566) + +(54) + +Amounts payable to affiliates . . . . . . . . . . . . . . . . . . . . . . + +(100) + +(150) + +(14) + +Trade creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(902) + +(1,666) + +(158) + +Restructuring liability . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(35) + +(3) + +Other amounts payable . . . . . . . . . . . . . . . . . . . . . . . . . + +(3,505) + +(3,438) + +(327) + +Total payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(5,098) + +(5,878) + +(558) + +Allowances + +The following allowances, discounts and finance charges have been netted off against balance sheet items as disclosed + +in the IAS financial statements for Telkom: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Gross accounts receivable . . . . . . . . . . . . . . . . . . . . . . . + +5,392 + +5,236 + +497 + +Provision for bad debts . . . . . . . . . . . . . . . . . . . . . . . . . + +(366) + +(519) + +(49) + +Closing balance accounts receivable . . . . . . . . . . . . . . . . . . + +5,026 + +4,717 + +448 + +Provision for bad debts + +Opening balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +493 + +366 + +35 + +Movement in provision . . . . . . . . . . . . . . . . . . . . . . . . . + +671 + +965 + +91 + +Write-off against provision . . . . . . . . . . . . . . . . . . . . . . . + +(798) + +(812) + +(77) + +Closing balance bad debts provision . . . . . . . . . . . . . . . . . . + +366 + +519 + +49 + +Gross inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +714 + +465 + +44 + +Provision for obsolete stock deducted . . . . . . . . . . . . . . . . . . + +(52) + +(40) + +(4) + +Closing balance inventory . . . . . . . . . . . . . . . . . . . . . . . . + +662 + +425 + +40 + +Provision for obsolete stock + +Opening balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +112 + +52 + +5 + +Movement in provision . . . . . . . . . . . . . . . . . . . . . . . . . + +105 + +84 + +8 + +Write-off against provision . . . . . . . . . . . . . . . . . . . . . . . + +(165) + +(96) + +(9) + +Closing balance inventory . . . . . . . . . . . . . . . . . . . . . . . . + +52 + +40 + +4 + +F113 + +TELKOM SA LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +US GAAP INFORMATION (continued) + +Acquisitions of minority interests + +On April 1, 2001, the Group acquired the remaining 40% interest in Swiftnet for R22 million. The transaction has been + +accounted for as a step acquisition of minority interest in accordance with APB Opinion No. 16. Because the minority + +interest was carried at zero on the Group's consolidated financial statements, the Group has allocated the entire + +purchase price to goodwill which is being amortized over a period of five years. + +On October 11, 2001, the Group acquired an additional 10% interest in Telkom Directory Services for R160 million. + +The transaction has been accounted for as a step acquisition of minority interest in accordance with SFAS 141. The + +excess of the purchase price over the proportionate net book value acquired, comprising principally of working capital + +and debt, of R125 million has been allocated to goodwill. SFAS 141 considers goodwill as a non-amortizing asset, but + +requires such asset to be subject to an annual impairment test. + +Had the step acquisition of minority interest described above been completed at the beginning of each of the two fixed + +years in the period ended March 31, 2002, Telkom's pro forma results of operations would have been as follows: + +March 31, + +March 31, + +March 31, + +2001 + +2002 + +2002 + +Rm + +Rm + +US$m + +Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +26,413 + +27,947 + +2,653 + +Income before cumulative effect of change in accounting principles . . + +1,600 + +1,272 + +121 + +Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,600 + +1,326 + +126 + +Basic and diluted earnings per share (cents) . . . . . . . . . . . . . . + +287 + +238 + +23 + +Adoption of new accounting standards + +Effective April 1, 2001, the Group adopted SFAS133 "Accounting for Derivative Instruments and Hedging Activities", + +as amended. The effects of adoption of the standard have been included in the reconciliation of net income and + +shareholders' equity above and described in note (e) thereto. The Group also adopted SFAS 141 "Accounting for + +Business Combinations" for all acquisitions consummated after June 30, 2001. + +Recently issued accounting standards + +Under US GAAP, accounting for goodwill and intangible assets was substantially the same as IAS until the adoption + +of SFAS 141 and SFAS 142: "Goodwill and Other Intangible Assets". SFAS 141 is effective for all business + +acquisitions consummated after June 30, 2001. SFAS 141 requires all business combinations consummated after + +June 30, 2001 to be accounted for under the purchase method. SFAS 141 also sets forth guidelines for applying the + +purchase method of accounting in the determination of intangible assets, including goodwill, acquired in a business + +combination. + +SFAS 142 addresses the initial and ongoing financial accounting and reporting for acquired goodwill and other + +intangible assets. SFAS 142 requires that goodwill be separately disclosed from other intangible assets in the balance + +sheet, and no longer be amortized but tested for impairment at least annually (or more frequently if impairment + +indicators arise). SFAS 142 is effective for financial statements for periods beginning on or after December 15, 2001. + +Additionally, the amortization provisions of SFAS 142 are applicable to goodwill arising in all business acquisitions + +consummated after June 30, 2001 regardless of the adoption date of SFAS 142. Accordingly, goodwill arising from the + +increased investment in Telkom Directory Services is not subject to amortization. + +The Group has adopted SFAS 142 on April 1, 2002. The Group is required to complete the initial step of a transitional + +impairment test within six months of adoption of SFAS 142. Management has completed the financial assessment of + +goodwill for impairment and determined that an impairment of R16 million existed with respect to the step acquisition + +of the minority interest in Swiftnet, which will be recognized as a cumulative effect of accounting change in fiscal + +2003. Subsequent impairment losses will be reflected in operating income or loss in the income statement. + +F114 + +In August 2001, the FASB issued SFAS 143, "Accounting for Obligations Associated with the Retirement of + +Long-Lived Assets". SFAS 143 addresses financial accounting and reporting for the retirement obligation of an asset. + +This statement states that companies should recognize the asset retirement cost, at their fair value, as part of the cost of + +the asset and classify the accrued amount as a liability in the consolidated balance sheet. The asset retirement liability + +is then accreted to the ultimate payout as interest expense. The initial measurement of the liability would be + +subsequently updated for revised estimates of the discounted cash outflows. The Statement will be effective for fiscal + +years beginning after June 15, 2002. The Group does not expect the application of SFAS 143 to have a material effect + +on its US GAAP earnings and position. + +In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". + +SFAS 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived + +assets to be disposed. The Statement will be effective for fiscal years beginning after December 15, 2001. The Group + +does not expect the application of SFAS 144 to have a material effect on its US GAAP earnings and position. + +In April 2002, the FASB issued SFAS 145 "Rescission of SFAS 4, 44, and 64, Amendment of SFAS. 13, and Technical + +Corrections". This Statement rescinds SFAS 4 "Reporting Gains and Losses from Extinguishment of Debt", and an + +amendment of that Statement, SFAS 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". + +SFAS144 also rescinds SFAS 44, "Accounting for Intangible Assets of Motor Carriers". SFAS 144 amends SFAS 13, + +"Accounting for Leases", to eliminate an inconsistency between the required accounting for sale-leaseback transactions + +and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback + +transactions. This Statement also amends other existing authoritative pronouncements to make various technical + +corrections, clarify meanings, or describe their applicability under changed conditions. The Group does not expect the + +application of SFAS 145 to have a material effect on its US GAAP earnings and financial position. + +In 2002, the FASB issued SFAS 146 "Accounting for Costs Associated with Exit or Disposal Activities". This + +Statement addresses the financial accounting and reporting for costs associated with exit or disposal activities and + +nullifies EITF Issue No 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to + +Exit an Activity (including Certain Costs Incurred in a Restructuring)". SFAS 146 requires that a liability for a cost + +associated with an exit or disposal activity be recognized when the liability is incurred. This liability does not arise + +when the Company has only committed to a plan, the fundamental criteria of EITF 94-3. In addition, fair value is the + +objective for initial measurement of the liability. This standard is effective for exit or disposal activities that are + +initiated after December 31, 2002, with early application encouraged. The Group does not expect the application of + +SFAS 146 to have a material effect on its US GAAP earnings and financial position. + +In November 2002, the Emerging Issues Task Force reached a final consensus related to Revenue Arrangements with + +Multiple Deliveries (EITF 00-21). The consensus requires that revenue arrangements with multiple deliverables should + +be divided into separate units of accounting if (a) a delivered item has value to the customer on a stand alone basis, + +(b) there is objective and reliable evidence of the fair value of the undelivered item and (c) if the arrangement includes + +a general right of return, delivery or performance of the undelivered items is considered probable and substantially in + +the control of the vendor. Arrangement consideration should be allocated among the separate units of accounting based + +on their relative fair value and appropriate revenue recognition criteria would be applied to each separate unit of + +accounting. The Group has not yet determined what effect, if any, EITF 00-21 would have on revenue and net income + +determined in accordance with US GAAP. The Task Force agreed the effective date for the consensus will be for all + +revenue arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. + +Telkom will adopt EITF 00-21 for their fiscal year beginning April 1, 2004. + +F115 + +180 + + Box + +35296 + +BOX + +11007 + +MENLO PARK 0102 + +HATFIELD 0028 + +Tel + +(012) + +429 0000 + +Tel + +(012) 482 0000 + +Fax + +(012) + +429 0100 + +Fax + +(012) 460 3633 + +REPORT OF THE INDEPENDENT AUDITORS + +to the members of Vodacom Group (Proprietary) Limited + +We have audited the accompanying consolidated balance sheets of Vodacom Group (Proprietary) Limited and subsidiaries + +("the Group") as of March 31, 2000, 2001 and 2002 and the related consolidated statements of income, changes in equity + +and cash flows for each of the three years in the period ended March 31, 2002 set out in pages F116 to F183. 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. + +We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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. + +In our opinion, the consolidated financial statements, referred to above, present fairly, in all material respects, the financial + +position of the Group as at March 31, 2000, 2001 and 2002, and the results of their operations and their cash flows for each + +of the three years in the period ended March 31, 2002, in conformity with International Accounting Standards and in the + +manner required by the Companies Act in South Africa. + +Without qualifying our opinion above we draw attention to Note 44 containing certain restatements and adjustments + +regarding the consolidated financial statements of the Group as issued previously. + +Furthermore, as discussed in Note 24 to the financial statements, in 2002 the Group changed its accounting policy for + +financial instruments to conform to International Accounting Standards 39 Financial Instruments: Recognition and + +measurement. In addition, International Accounting Standards vary in certain significant respects from accounting principles + +generally accepted in the United States of America. The application of the latter would have affected the determination of + +net profit for each of the two years in the period ended March 31, 2002 and the determination of shareholders' equity at + +March 31, 2001 and March 31, 2002, to the extent summarised in Note 45 to the consolidated financial statements. + +Registered Accountants and Auditors + +Registered Accountants and Auditors + +Chartered Accountants (SA) + +Chartered Accountants (SA) + +Pretoria + +Pretoria + +June 11, 2002, except for Note 44 for + +June 11, 2002, except for Note 44 for + +which the date is October 15, 2002 + +which the date is October 15, 2002 + +A complete list of partners is available from any of our offices + +Joint auditors + +PricewaterhouseCoopers Inc + +Chartered Accountants (SA) + +Registered Accountants and Auditors + +(Registration no 1998/012055/21) + +Deloitte & Touche Chartered Accountants (SA) + +Registered Accountants and Auditors + +F116 + +VODACOM GROUP (PROPRIETARY) LIMITED + +CONSOLIDATED INCOME STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Notes + +(Restated) + +(Restated) + +(Restated) + +Rm + +Rm + +Rm + +Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1 + +9,571.6 + +13,276.4 + +16,150.7 + +Direct network operating cost . . . . . . . . . . . . . . . . + +(4,701.4) + +(6,916.4) + +(8,464.6) + +Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . + +(1,025.3) + +(1,364.1) + +(1,857.3) + +Other operating income . . . . . . . . . . . . . . . . . . . + +14. + +5 + +48. + +5 + +29.2 + +Staff expenses . . . . . . . . . . . . . . . . . . . . . . . . + +(648.6) + +(950.6) + +(1,135.2) + +Marketing and advertising expenses . . . . . . . . . . . . . + +(596.5) + +(514.6) + +(542.0) + +General administration expenses . . . . . . . . . . . . . . . + +(306.7) + +(541.1) + +(403.4) + +Amortization of intangible assets . . . . . . . . . . . . . . + +2 + +(73.6) + +(271.5) + +(212.7) + +Integration costs, disposals of operations and impairments . + +3 + +129. + +3 + +(213.2) + +56.4 + +Profit from operations . . . . . . . . . . . . . . . . . . . + +4 + +2,363.3 + +2,553.4 + +3,621.1 + +Interest and dividends received . . . . . . . . . . . . . . . + +6 + +32. + +0 + +25. + +4 + +32.0 + +Net finance costs . . . . . . . . . . . . . . . . . . . . . . . + +7 + +(567.2) + +(504.5) + +(59.8) + +Profit before taxation . . . . . . . . . . . . . . . . . . . . + +1,828.1 + +2,074.3 + +3,593.3 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +8 + +(513.6) + +(765.7) + +(1,190.7) + +Profit after taxation . . . . . . . . . . . . . . . . . . . . . + +1,314.5 + +1,308.6 + +2,402.6 + +Minority interest . . . . . . . . . . . . . . . . . . . . . . . + +0. + +5 + +9. + +2 + +(29.6) + +Net profit from ordinary activities . . . . . . . . . . . . . + +33 + +1,315.0 + +1,317.8 + +2,373.0 + +2000 + +2001 + +2002 + +(Restated) + +(Restated) + +(Restated) + +R + +R + +R + +Basic and diluted earnings per share . . . . . . . . . . . + +33 + +131 500 + +131 780 + +237 300 + +VODACOM GROUP (PROPRIETARY) LIMITED + +CONSOLIDATED BALANCE SHEETS + +at March 31, 2002 + +2000 + +2001 + +2002 + +Notes + +(Restated) + +(Restated) + +(Restated) + +Rm + +Rm + +Rm + +ASSETS + +Non-current assets . . . . . . . . . . . . . . . . . . . . . + +7,076.2 + +8,871.6 + +11,213.3 + +Property, plant and equipment . . . . . . . . . . . . . . . + +9 + +5,854.1 + +7,696.2 + +9,896.6 + +Intangible assets . . . . . . . . . . . . . . . . . . . . . . + +10 + +939.0 + +822.9 + +796.3 + +Investments . . . . . . . . . . . . . . . . . . . . . . . . + +11 + +15.7 + +13.4 + +22.7 + +Acquired business held for sale . . . . . . . . . . . . . . + +12 + +121.6 + +- + +- + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . + +13 + +145.8 + +339.1 + +497.7 + +Current assets . . . . . . . . . . . . . . . . . . . . . . . . + +2,787.6 + +3,470.2 + +4,145.3 + +Foreign currency derivatives . . . . . . . . . . . . . . . + +39 + +12.7 + +0.8 + +215.6 + +Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . + +14 + +222.1 + +398.4 + +306.0 + +Accounts receivable . . . . . . . . . . . . . . . . . . . . + +15 + +1,616.7 + +2,273.4 + +2,845.9 + +Short-term investments . . . . . . . . . . . . . . . . . . + +11 + +- + +- + +58.6 + +Bank and cash balances . . . . . . . . . . . . . . . . . . + +32 + +936.1 + +797.6 + +719.2 + +Total assets . . . . . . . . . . . . . . . . . . . . . . . . . + +9,863.8 + +12,341.8 + +15,358.6 + +EQUITY AND LIABILITIES + +Capital and reserves . . . . . . . . . . . . . . . . . . . . + +2,671.1 + +3,506.0 + +5,463.8 + +Ordinary share capital . . . . . . . . . . . . . . . . . . . + +16 + +- + +- + +- + +Non-distributable reserves . . . . . . . . . . . . . . . . . + +17 + +0.6 + +(2.3) + +106.1 + +Retained earnings . . . . . . . . . . . . . . . . . . . . . + +2,670.5 + +3,508.3 + +5,357.7 + +Minority interest . . . . . . . . . . . . . . . . . . . . . . + +18 + +(2.2) + +(11.4) + +10.6 + +Non-current liabilities . . . . . . . . . . . . . . . . . . . + +1,311.5 + +1,580.2 + +1,894.4 + +Interest bearing debt . . . . . . . . . . . . . . . . . . . . + +19 + +817.2 + +896.1 + +780.2 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . + +13 + +455.6 + +607.5 + +926.2 + +Provisions . . . . . . . . . . . . . . . . . . . . . . . . . + +23 + +38.7 + +76.6 + +188.0 + +Current liabilities . . . . . . . . . . . . . . . . . . . . . . + +5,883.4 + +7,267.0 + +7,989.8 + +Shareholder loans . . . . . . . . . . . . . . . . . . . . . + +20 + +1,070.0 + +920.0 + +920.0 + +Accounts payable . . . . . . . . . . . . . . . . . . . . . + +21 + +1,754.7 + +3,152.8 + +3,201.7 + +Taxation payable . . . . . . . . . . . . . . . . . . . . . . + +560.1 + +810.0 + +351.6 + +Non-interest bearing debt . . . . . . . . . . . . . . . . . + +22 + +4.3 + +32.4 + +4.3 + +Provisions . . . . . . . . . . . . . . . . . . . . . . . . . + +23 + +198.7 + +273.8 + +319.5 + +Dividends payable . . . . . . . . . . . . . . . . . . . . . + +0.1 + +483.8 + +600.0 + +Short-term interest bearing debt . . . . . . . . . . . . . . + +19 + +844.4 + +0.5 + +1,015.9 + +Bank overdraft and other short-term debt . . . . . . . . . + +32 + +1,451.1 + +1,593.7 + +1,576.8 + +Total equity and liabilities . . . . . . . . . . . . . . . . . + +9,863.8 + +12,341.8 + +15,358.6 + +COMMITMENTS AND CONTINGENT LIABILITIES . . + +34 - 36 + +F117 + +F118 + +VODACOM GROUP (PROPRIETARY) LIMITED + +CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY + +for the three years ended March 31, 2002 + +Share capital + +Retained + +Non- + +Total + +and premium + +earnings distributable + +reserves + +(Restated) + +(Restated) + +(Restated) + +(Restated) + +Rm + +Rm + +Rm + +Rm + +BALANCE AT APRIL 1, 1999 . . . . . . . . . . . . . . + +- + +1,355.5 + +- + +1,355.5 + +Net profit for year . . . . . . . . . . . . . . . . . . . + +- + +1,315.0 + +- + +1,315.0 + +Net gains and losses not recognized in the income + +statement (Note 17) + +Foreign currency translation reserve . . . . . . . . . + +- + +- + +0. + +6 + +0.6 + +BALANCE AT MARCH 31, 2000 . . . . . . . . . . . . + +- + +2,670.5 + +0. + +6 + +2,671.1 + +Net profit for year . . . . . . . . . . . . . . . . . . . + +- + +1,317.8 + +- + +1,317.8 + +Dividends declared . . . . . . . . . . . . . . . . . . . + +- + +(480.0) + +- + +(480.0) + +Net gains and losses not recognized in the income + +statement (Note 17) + +Foreign currency translation reserve . . . . . . . . . + +- + +- + +(2.9) + +(2.9) + +BALANCE AT MARCH 31, 2001 . . . . . . . . . . . . + +- + +3,508.3 + +(2.3) + +3,506.0 + +Change in accounting policy (Note 24) . . . . . . . . + +- + +84.9 + +- + +84.9 + +BALANCE AT MARCH 31, 2001 RESTATED . . . . + +- + +3,593.2 + +(2.3) + +3,590.9 + +Net profit for year . . . . . . . . . . . . . . . . . . . + +- + +2,373.0 + +- + +2,373.0 + +Dividends declared . . . . . . . . . . . . . . . . . . . + +- + +(600.0) + +- + +(600.0) + +Contingency reserve . . . . . . . . . . . . . . . . . . + +- + +(8.5) + +8.5 + +- + +Net gains and losses not recognized in the income + +statement (Note 17) + +Foreign currency translation reserve . . . . . . . . . + +- + +- + +119.8 + +119.8 + +Foreign currency translation reserve + + deferred taxation . . . . . . . . . . . . . . . . . . + +- + +- + +(19.9) + +(19.9) + +BALANCE AT MARCH 31, 2002 . . . . . . . . . . . . + +- + +5,357.7 + +106.1 + +5,463.8 + +VODACOM GROUP (PROPRIETARY) LIMITED + +CONSOLIDATED CASH FLOW STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Notes + +(Restated) + +(Restated) + +(Restated) + +Rm + +Rm + +Rm + +CASH FLOW FROM OPERATING ACTIVITIES + +Cash receipts from customers . . . . . . . . . . . . . . . . + +9,619.1 + +12,664.8 + +15,583.1 + +Cash paid to suppliers and employees . . . . . . . . . . . . + +(6,437.1) + +(8,001.2) + +(9,395.0) + +CASH GENERATED FROM OPERATIONS . . . . . . . + +25 + +3,182.0 + +4,663.6 + +6,188.1 + +Finance costs paid . . . . . . . . . . . . . . . . . . . . . . + +26 + +(554.3) + +(497.9) + +(374.1) + +Interest income received . . . . . . . . . . . . . . . . . . . + +31.3 + +25.4 + +26.5 + +Taxation paid . . . . . . . . . . . . . . . . . . . . . . . . . + +27 + +(318.3) + +(567.6) + +(1,539.1) + +Integration costs . . . . . . . . . . . . . . . . . . . . . . . + +- + +(13.7) + +- + +Dividends paid shareholders . . . . . . . . . . . . . . . . + +- + +- + +(480.0) + +Dividends paid minority shareholders in subsidiaries . . . + +- + +- + +(6.3) + +Dividends received . . . . . . . . . . . . . . . . . . . . . . + +0.7 + +- + +- + +NET CASH FLOWS FROM OPERATING ACTIVITIES . . + +2,341.4 + +3,609.8 + +3,815.1 + +CASH FLOW FROM INVESTING ACTIVITIES + +Additions to property, plant and equipment . . . . . . . . . + +28 + +(2,693.2) + +(2,834.9) + +(4,409.1) + +Proceeds on disposal of property, plant and equipment . . . + +61.7 + +83.0 + +92.4 + +Acquisition of intangible assets . . . . . . . . . . . . . . . + +10 + +(10.5) + +- + +(193.7) + +Disposal of subsidiaries . . . . . . . . . . . . . . . . . . . + +29 + +- + +- + +1.7 + +Acquisition of subsidiaries . . . . . . . . . . . . . . . . . . + +29 + +(699.3) + +(113.8) + +(0.1) + +Disposal of joint ventures . . . . . . . . . . . . . . . . . . + +30 + +51.8 + +- + +23.3 + +Acquisition of joint ventures . . . . . . . . . . . . . . . . . + +30 + +(120.7) + +- + +- + +Disposal/(Acquisition) of other investments . . . . . . . . . + +(126.1) + +18.0 + +- + +Other investing activities . . . . . . . . . . . . . . . . . . . + +(1.0) + +(4.9) + +(57.8) + +Disposal of internet division . . . . . . . . . . . . . . . . . + +31 + +199.8 + +- + +- + +NET CASH FLOWS UTILIZED IN INVESTING ACTIVITIES + +(3,337.5) + +(2,852.6) + +(4,543.3) + +CASH FLOW FROM FINANCING ACTIVITIES + +Shareholder loans repaid . . . . . . . . . . . . . . . . . . . + +- + +(150.0) + +- + +Interest bearing debt incurred . . . . . . . . . . . . . . . . + +1,120.6 + +- + +570.6 + +Interest bearing debt repaid . . . . . . . . . . . . . . . . . + +(459.4) + +(847.4) + +- + +Non-interest bearing debt repaid . . . . . . . . . . . . . . . + +- + +(16.9) + +- + +Finance lease capital repaid . . . . . . . . . . . . . . . . . + +(15.1) + +(23.9) + +- + +NET CASH FLOWS FROM/(UTILIZED) IN FINANCING + +ACTIVITIES . . . . . . . . . . . . . . . . . . . . . . . . . . + +646.1 + +(1,038.2) + +570.6 + +NET DECREASE IN CASH AND CASH EQUIVALENTS + +(350.0) + +(281.0) + +(157.6) + +Cash and cash equivalents at beginning of year . . . . . . . + +(164.5) + +(515.0) + +(796.1) + +Effect of foreign exchange rate changes . . . . . . . . . . . + +(0.5) + +(0.1) + +96.1 + +CASH AND CASH EQUIVALENTS AT END OF YEAR . + +32 + +(515.0) + +(796.1) + +(857.6) + +F119 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +BASIS OF PREPARATION + +These consolidated annual financial statements have been prepared in accordance with International Accounting Standards + +and have been prepared on the historical cost basis, unless otherwise indicated. The consolidated annual financial + +statements have been presented in South African Rands, as this is the currency in which the majority of the Group's + +transactions are denominated. + +The principal accounting policies are consistent in all material respects with those applied in the previous period, except + +where disclosed elsewhere. + +Certain restatements and adjustments were effected to these financial statements from those previously issued by the Group. + +Those restatements and adjustments that had a material effect on the financial statements are disclosed in Note 44. + +The following are the principal accounting policies adopted by the Group in the preparation of these consolidated annual + +financial statements: + +ACCOUNTING POLICIES + +1. + +CONSOLIDATION + +1. + +1 + +Basis of consolidation + +The consolidated annual financial statements include the consolidated financial position, results of operations + +and cash flows of Vodacom Group (Proprietary) Limited and its subsidiaries, both foreign and domestic, up to + +March 31, 2002. + +Joint ventures are included using the proportionate consolidation method, whereby the Group's share of the + +assets, liabilities, income, expenses and cash flows of joint ventures are combined on a line-by-line basis with + +similar items in the consolidated annual financial statements. + +Subsidiaries and joint ventures where control is intended to be temporary, as they are acquired and held + +exclusively with a view to their subsequent disposal in the near future or the subsidiary or joint venture is + +operating under severe long-term restrictions, which significantly impairs its ability to transfer funds, are not + +consolidated, or proportionately consolidated. Such subsidiaries and joint ventures are accounted for as + +investments in terms of the accounting policy for Financial Instruments. The Group, however, does not + +speculate in the acquisition and disposal of investments. + +Minority interests in the consolidated balance sheet and income statement are separately presented. + +Goodwill, on the acquisition of subsidiaries and joint ventures is accounted for in accordance with the Group's + +accounting policy for Intangible Assets set out below. + +1.2 + +Business combinations + +Acquisitions in a business combination + +Business combination acquisitions are accounted for using the purchase method of accounting, whereby the + +acquisition is accounted for at its cost plus any costs directly attributable to the acquisition. Cost represents + +the cash or cash equivalents paid or the fair value, at the date of the acquisition, of the purchase + +consideration. Business combinations include the acquisition of subsidiaries and joint ventures. + +On acquisition, the identifiable assets and liabilities of the relevant subsidiaries or joint ventures are + +measured based upon the Group's interest in their fair value at the date of acquisition. + +Disposals in a business combination + +On subsequent disposal, the profit or loss on disposal is the difference between the selling price and the fair + +value of net assets and liabilities disposed of, adjusted for any related goodwill to the extent that it has not + +been amortized in the consolidated income statement in accordance with the Group's accounting policies. + +1.3 + +Subsidiaries + +Subsidiaries are those entities controlled by the Group. Control is presumed to exist where the Group has an + +interest of more than one-half of the voting rights and the power to control the financial and operating activities + +of the entities so as to obtain benefits from its activities. All subsidiaries are consolidated. + +F120 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +1. + +CONSOLIDATION (continued) + +1.3 + +Subsidiaries (continued) + +Inter-company balances and transactions, and resulting unrealized profits between Group companies, are + +eliminated in full on consolidation. + +Where necessary, accounting policies of subsidiaries are adjusted to ensure that the consolidated annual + +financial statements are prepared using uniform accounting policies. + +Investments in subsidiaries are consolidated from the date on which the Group has power to exercise control, + +up to the date on which power to exercise control ceases. + +1.4 + +Joint ventures + +Joint ventures, for the purpose of these consolidated annual financial statements, are those entities in which the + +Group has joint control through a contractual arrangement with one or more other venturers. + +Investments in joint ventures are proportionately consolidated from the date on which the Group has power to + +exercise joint control, up to the date on which power to exercise joint control ceases. + +The Group's proportionate share of inter-company balances and transactions, and resulting unrealized profit or + +losses, between Group companies and jointly controlled entities are eliminated on consolidation. + +2. + +PROPERTY, PLANT AND EQUIPMENT + +Property, plant and equipment are stated at cost less accumulated depreciation and any accumulated impairment + +losses. Land is not depreciated and is recorded at cost. + +Cost of property, plant and equipment includes all directly attributable expenditure incurred in the acquisition, + +establishment and installation of such assets so as to bring them to a working condition for their intended use. + +Interest costs are not capitalized. + +Depreciation is calculated so as to write off the cost of property, plant and equipment on a straight-line basis, over + +their estimated useful lives to its estimated residual value. Depreciation commences when the asset is ready for its + +intended use (in the case of infrastructure assets this is deemed to be the date of acceptance). The estimated useful + +lives of depreciable property, plant and equipment are as follows: + +General purpose buildings + +50 years + +Special purpose buildings + +15 years + +Infrastructure + + - GSM + +8 years + +- Value added services equipment + +8 years + +- Value added services software + +3 years + +Community services + +- Containers + +5 years + +- Cellular equipment + +2 years + +Information services + +- Equipment + +4 years + +- Software + +3 years + +SIM centre + +4 years + +Office automation + +2 3 years + +Other assets + +- Motor vehicles + +4 years + +- Furniture and fittings + +5 years + +- Office equipment + +4 years + +General purpose buildings are classified as owner-occupied. They are therefore held at cost and depreciated as + +property, plant and equipment, and not regarded as investment properties. + +Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets or, + +where shorter, the term of the relevant lease if there is no reasonable certainty that the Group will obtain ownership + +by the end of the lease term. + +F121 + +F122 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2. + +PROPERTY, PLANT AND EQUIPMENT (continued) + +Maintenance and repairs, which neither materially add to the value of the assets nor appreciably prolong their useful + +lives, are recognized as an expense in the period incurred. Minor plant and equipment items are also recognized as an + +expense in the period incurred. + +Profits or losses on the retirement or disposal of property, plant and equipment, determined as the difference between + +the actual proceeds and the carrying amount of the assets, are recognized in the consolidated income statement in the + +period in which they occur. + +3. + +INTANGIBLE ASSETS + +Intangible assets are stated at cost less accumulated amortization and accumulated impairment losses, if any. The + +residual value of intangible assets is assumed to be zero. Intangible assets are amortized to the consolidated income + +statement on a straight-line basis over their estimated useful lives, which are reviewed on an annual basis. + +Amortization commences when the intangible asset is available for use. The estimated useful lives of intangible + +assets are currently as follows: + +Licences + +- Mobile + +5 - 20 years + +Other intangible assets + +- Contract mobile customers + +5 years + +- Internet customer related + +3 years + +- Trademarks + +5 years + +- Goodwill + +(Note 3.4) + +The following are the main categories of intangible assets: + +3.1 + +Licences + +Licences, which are acquired to yield an enduring benefit, are capitalized at cost and amortized from the date + +of commencement of usage rights over the duration of the licence agreement. + +3.2 + +Customer bases + +Cost of contract customer bases represents the purchase price on the acquisition of mobile or internet customer + +bases. Customer bases are amortized on a straight-line basis over their estimated useful lives. + +3.3 + +Trademarks and brands + +Purchased trademarks and brands are capitalized at cost and amortized over their estimated useful lives. + +Expenditure incurred to develop, maintain and renew trademarks and brands internally is recognized as an + +expense in the period incurred. + +3.4 + +Goodwill + +Goodwill represents the excess of the cost of the acquisition of a subsidiary or joint venture, over the Group's + +interest in the fair value of identifiable assets and liabilities at the date of acquisition, and is carried at cost less + +accumulated amortization and accumulated impairment losses, if any. Goodwill is amortized on a straight-line + +basis over its estimated useful life, not exceeding 20 years. + +4. + +INVENTORY + +Inventory is stated at the lower of cost and net realisable value. Cost is determined by the first-in-first-out method and + +comprises all costs of purchase, costs of conversion and other costs incurred in bringing it to its present location and + +condition. Net realisable value represents the estimated selling price in the ordinary course of business less all + +estimated costs to completion and the estimated costs necessary to make the sale. + +The amount of any write-down of inventory to net realisable value and all losses of inventory is recognized as an + +expense in the period the write-down or loss occurs. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +5. + +FOREIGN CURRENCIES + +5.1 + +Transactions and balances + +Foreign currency transactions are translated, on initial recognition, at the foreign exchange rate ruling at the + +date of the transaction. + +Monetary assets and liabilities denominated in foreign currencies are translated at the foreign exchange rate + +ruling at settlement date or balance sheet date whichever occurs first. Exchange differences on the settlement or + +translation of monetary assets or liabilities are included in finance costs in the period in which they arise. + +5.2 + +Foreign entities + +The annual financial statements of foreign entities are translated into South African Rands for incorporation + +into the consolidated annual financial statements. Assets and liabilities are translated at the foreign exchange + +rates ruling at balance sheet date. Income, expenditure and cash flow items are translated at the actual foreign + +exchange rate or average foreign exchange rates for the period. + +Gains and losses on the translation of equity loans to foreign entities that are intended to be permanent are + +recognized in equity. + +All resulting unrealized exchange differences are classified as equity. On disposal, the cumulative amounts of + +unrealized exchange differences that have been deferred are recognized in the consolidated income statement as + +part of the gain or loss on disposal. + +Goodwill adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities + +of the Group and translated at the foreign exchange rates ruling at transaction date. + +5.3 + +Foreign currency hedges + +Foreign currency hedges are dealt with in the Financial Instruments accounting policy. + +6. + +TAXATION + +6.1 + +Current taxation + +The charge for current taxation is based on the results for the period and is adjusted for items that are non- + +assessable or disallowed. Current taxation is measured at the amount expected to be paid, using taxation rates + +and laws that have been enacted or substantively enacted by the balance sheet date. + +6.2 + +Deferred taxation + +Deferred taxation is provided using the balance sheet liability method for all temporary differences arising + +between the carrying amounts of assets and liabilities, on the consolidated balance sheet, and their respective + +taxation bases. Deferred taxation is not provided on differences relating to goodwill for which amortization is + +not deductible for taxation purposes nor on the initial recognition of assets or liabilities, which is not a business + +combination and, at the time of the transaction, affects neither accounting nor taxable profit or loss. + +Deferred taxation liabilities are recognized for taxable temporary differences associated with investments in + +subsidiaries and joint ventures, except where the Group is able to control the timing of the reversal of the + +temporary differences and it is probable that it will not reverse in the foreseeable future. + +Deferred taxation assets are recognized to the extent that it is probable that future taxable profit will be + +available against which the associated unused taxation losses or credits and deductible temporary differences + +can be utilized. + +Provision for taxation, which could arise if undistributed retained profit of certain subsidiaries is remitted, is + +only made where a decision has been taken to remit such retained profits. + +6.3 + +Secondary Taxation on Companies + +Secondary Taxation on Companies (STC) is provided for at a rate of 12.5% on the amount of the net dividend + +declared by Vodacom Group (Proprietary) Limited. It is recorded as a tax expense when dividends are declared. + +F123 + +F124 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +7. + +EMPLOYEE BENEFITS + +7.1 + +Post-employment benefits + +The Group provides defined contribution funds for the benefit of employees, the assets of which are held in + +separate funds. The funds are funded by payments from employees and the Group. Contributions to the fund + +are recognized as an expense in the period in which the employee renders the related service. + +The Group has no liability for contributions to the medical aid of retired employees. + +7.2 + +Short-term and long-term benefits + +The cost of all short-term employee benefits, such as salaries, employee entitlements to leave pay, bonuses, + +medical aid and other contributions, are recognized during the period in which the employee renders the related + +service. The Group recognizes the expected cost of bonuses only when the Group has a present legal or + +constructive obligation to make such payment and a reliable estimate can be made. + +7.3 + +Accumulative termination benefits + +Accumulative termination benefits are payable whenever: + +- an employee's employment is terminated before the normal retirement date; or + +- an employee accepts voluntary redundancy. + +The Group recognizes termination benefits when it is constructively obliged to either terminate the employment + +of current employees according to a detailed formal plan without possibility of withdrawal or to provide + +termination benefits as a result of an offer made to encourage voluntary redundancy. If the benefits fall due + +more than 12 months after balance sheet date, they are discounted to present value. In the case of an offer to + +encourage voluntary redundancy and if the amount can be reasonably estimated, the measurement of + +termination benefits is based on the number of employees expected to accept the offer. + +7.4 + +Compensation benefits + +Employees of the wholly-owned subsidiaries, including executive directors, are eligible for compensation + +benefits in the form of a Deferred Bonus Incentive Scheme. Periodically, a number of entitlements are issued to + +employees, the value of which depends on the seniority of the employee. Benefits of eligible employees arising + +from the entitlements are determined with reference to the present value per entitlement, which is determined + +annually based on profits as per the audited consolidated annual financial statements of Vodacom Group + +(Proprietary) Limited. + +The fair value of the entitlements is calculated as the difference in the entitlement value at balance sheet date + +and the value at which the entitlements were issued, multiplied by the number of entitlements allocated to a + +participant. Any change in entitlement value is recorded in the income statement based on the present value of + +the expected future cash out flows and recorded as a liability in the balance sheet. Participating employees are + +entitled to cash in the entitlements over a six-year period. + +8. + +REVENUE RECOGNITION + +Revenue, which excludes Value-Added Taxation and sales between Group companies, represents the invoiced value + +of goods and services supplied by the Group. The Group measures revenue at the fair value of the consideration + +received or receivable. Revenue is recognized only when it is probable that the economic benefits associated with a + +transaction will flow to the Group and the amount of revenue, and associated costs incurred or to be incurred, can be + +measured reliably. If necessary, revenue is split into separately identifiable components. + +The main categories of revenue and bases of recognition for the Group are: + +8.1 + +Contract products + +These contracts may include a subsidised handset, 24-month service, activation, SIM-card and a user manual. + +Revenue is recognized as follows: + +- The loss on the subsidised handset which includes the costs of the handset, the SIM-card and manual, is + + recognized upon activation by the customer. + +- Activation fee revenue received from the customer is recognized upon activation by the customer. + +- Monthly access revenue received from the customer is recognized in the period in which the service is + + delivered. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +8. + +REVENUE RECOGNITION (continued) + +8.1 + +Contract products (continued) + +Airtime revenue is recognized on the usage basis. The terms and conditions of the bundled airtime products + +allow the carry over of unused minutes and accumulation to a maximum of five times the monthly + +allocation. The unused airtime is deferred in full. + +Deferred revenue related to unused airtime is recognized when utilized by the customer. Upon termination + +of the customer contract, all deferred revenue for unused airtime is recognized in income. + +Any other costs incurred as a result of a new customer, are expensed upon activation as this is treated as a + +customer acquisition cost. + +8.2 + +Prepaid products + +Airtime + +Upon purchase of a airtime voucher the customer receives the right to make outgoing calls. Revenue is + +recognized as the voucher is utilized by the customer. All airtime vouchers have an expiry date where any + +activated vouchers with deferred revenue related to unused minutes are recognized upon expiration since the + +Group has no remaining service obligation and the unused airtime is not refundable. + +Remaining elements of prepaid packages + +When a handset is sold with a prepaid package, all the costs, which include the costs of the handset, the + +SIM-card and manual, together with the subsidy, is treated as a customer acquisition cost and the loss is + +recognized upon activation by the customer. The cost of a package sold without a handset is also treated as a + +customer acquisition cost. + +The residual revenue related to the remaining elements of the prepaid packages are not separable since no + +objective evidence of fair value exists. The Group currently recognizes this residual amount upon activation. + +8.3 + +Equipment sales + +All equipment sales are recognized only when delivery and acceptance has taken place. Equipment sales to + +third party service providers are recognized when delivery is accepted. No rights of return exist on sales to + +third party service providers. + +8.4 + +Other revenue and income + +Interconnect income + +Interconnect income is recognized on the usage basis. + +Dividends + +Dividends from investments are recognized when the right to receive payment has been established. + +Interest + +Interest is recognized on a time proportion basis with reference to the principal amount receivable and the + +effective interest rate applicable. + +9. + +LEASES + +9.1 + +Lease classification + +Leases involving property, plant and equipment whereby the lessor provides finance to the lessee with the asset + +as security, and where the lessee assumes the significant risks and rewards of ownership of those leased assets, + +are classified as finance leases. + +Leases of property, plant and equipment to the lessee, under which the lessor effectively retains the significant + +risks and rewards of ownership of those leased assets, are classified as operating leases. + +9.2 + +Group as lessee + +Finance leases + +Lessee finance leases are capitalized, as property, plant and equipment, at their cash equivalent cost and a + +corresponding finance lease liability is raised. The cash equivalent cost is the lower of fair value or the + +present value of the minimum lease payments, at inception of the lease. Such assets are depreciated in terms + +of the accounting policy on property, plant and equipment stated above. + +F125 + +F126 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +9. + +LEASES (continued) + +9.2 + +Group as lessee (continued) + + + +Finance leases (continued) + +Lease payments are allocated between lease finance costs and a capital reduction of the finance lease liability. + +Lease finance costs are allocated to the consolidated income statement over the term of the lease using the + +effective interest rate method, so as to produce a constant periodic rate of return on the remaining balance of + +the liability for each period. + +Operating leases + +Lessee operating lease rental payments are expensed in the consolidated income statement on a straight-line + +basis over the lease term. + +When an operating lease is terminated before the lease term has expired any payment to the lessor that is + +required, by way of penalty, is recognized as an expense in the period in which termination takes place. + +10. + +DERIVATIVE INSTRUMENTS + +Prior to April 1, 2001, the Group entered into foreign exchange forward contracts to hedge the Group's exposure to + +fluctuations in foreign currency exchange rates on specific transactions. Up to March 31, 2001, gains and losses on + +forward contracts designated as hedges of identifiable foreign currency firm commitments were deferred and included + +in the measurement of the related foreign currency transactions. + +The portion of the premium paid or received relating to the commitment period was included in the measurement of + +the basis of the related foreign currency transaction when recorded. Any remaining premium was amortized over the + +remaining life of the forward contract. + +Foreign exchange contract costs incurred in covering foreign currency loans are expensed over the period of the + +contract and are included in finance costs. + +Effective April 1, 2001, the Group adopted IAS 39: Financial Instruments: Recognition and Measurement (Revised + +2000) ("IAS 39"), which requires that all derivative instruments be recorded on the balance sheet at fair value. + +Changes in the fair value of forward contracts are recorded each period in current earnings, as the forward contracts + +do not qualify as hedges under IAS 39. Upon initial application of IAS 39, the Group recorded the fair value of the + +existing forward contracts on the balance sheet and the corresponding gain was recognized as an adjustment of the + +opening balance of retained earnings. + +Prior to April 1, 2001, the Group entered into interest rate swap agreements in order to manage interest rate exposure. + +The net interest paid or received on the swaps was recognized as interest expense. Gains resulting from the early + +termination of interest rate swap agreements were deferred and amortized as adjustments to interest expense over the + +remaining period originally covered by the terminated swap. + +Effective April 1, 2001 interest rate swaps are fair valued and recorded on the balance sheet in accordance with IAS 39. + +The Group does not use financial instruments for trading or speculative purposes. + +11. + +FINANCIAL INSTRUMENTS OTHER THAN DERIVATIVES + +11.1 + +Initial recognition and measurement + +All financial instruments, other than derivatives which are dealt with above, are recognized on the consolidated + +balance sheet. Financial instruments are initially recognized when the Group becomes party to the contractual + +terms of the instruments and are measured at cost, which is the fair value of the consideration given (financial + +asset) or received (financial liability or equity instrument) for it. Financial liabilities and equity instruments + +issued by the Group are classified at initial recognition as debt or equity or compounded instruments in terms + +of IAS 32 on the basis of their contractual terms. Transaction costs are included in the initial measurement of + +the financial instrument. Subsequent to initial recognition, these instruments are measured as set out below. + +11.2 + +Financial assets + +The Group's principal financial assets are investments, foreign currency assets, receivables and bank and cash + +balances: + +Investments + +Investments in equity instruments, excluding those in subsidiaries and joint ventures, are classified as + +available for sale and are stated at fair value. Gains and losses from changes in fair value of available for + +sale financial assets are recognized directly in equity until the financial asset is disposed of or it is + +determined to be impaired, at which time the cumulative gain or loss previously recognized in equity is + +included in the consolidated income statement. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +11. + +FINANCIAL INSTRUMENTS OTHER THAN DERIVATIVES (continued) + +11.2 + +Financial assets (continued) + + + +Investments (continued) + +Investments acquired principally for the purpose of generating a profit from the short-term fluctuations in + +price, are classified as held for trading and are recorded and measured at fair value. Gains and losses on + +these investments are recorded in the consolidated income statement. + +Interest bearing investments, including investments in finance leases, are stated at original investment less + +principal payments, and amortizations, and less accumulated impairment. + +Receivables + +Receivables originated by the Group are stated at their cost less a provision for doubtful debts. An estimate + +of doubtful debts is made based on a review of all outstanding amounts at balance sheet date. Bad debts are + +written off during the period in which they are identified. + +The Group's policy for determining the allowance for doubtful accounts in full (unless arrangements have + +been made with the debtor for payment) is as follows: + +- All amounts outstanding for 120 days and more. + +- Any specific retailers, dealers or subscribers outstanding for less than 120 days, where there is deemed + +to be a significant risk of non-payment. + +In addition, if accounts receivable balances are handed over for collection, they are written off in full + +regardless of days outstanding. The hand over of outstanding debt is determined on a case by case basis, + +but usually occurs after amounts have been outstanding for 90 days for individual subscribers and after + +150 days for all other accounts receivables. + +The Group invoices its independent service providers and dealers (agents) for the revenue billed by them on + +behalf of the Group. The Group, within its contractual arrangements with its agents, pays them + +administrative fees. The Group receives in cash, the net amount equal to the gross revenue earned less the + +administrative fees payable to the agents. + +Bank and cash balances + +The accounting policy for bank and cash balances is dealt with under cash and cash equivalents set out + +below. + +11.3 + +Financial liabilities + +The Group's principal financial liabilities are shareholder loans, interest bearing debt, non-interest bearing + +debt, accounts payable, dividends payable, provisions and bank borrowings and other short-term debt: + +Shareholder loans + +Shareholder loans are recognized at the original proceeds received less principal payments. + +Interest bearing debt + +Interest bearing debt, including finance lease obligations, is recognized at amortized cost, namely original + +debt less principal payments and amortizations. The accounting policy for finance lease obligations is dealt + +with under leases set out above. + +Accounts payable + +Accounts payable are stated at their cost. + +Dividends payable + +Dividends payable are stated at amounts declared. + +Bank borrowings and other short-term debt + +The accounting policy for bank borrowings and other short-term debt is dealt with under cash and cash + +equivalents set out below. + +11.4 + +Equity instruments + +The Group's principal equity instrument is ordinary share capital, which is recorded at original cost. + +F127 + +F128 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +11. + +FINANCIAL INSTRUMENTS OTHER THAN DERIVATIVES (continued) + +11.5 + +De-recognition + +Financial assets (or a portion thereof) are de-recognized when the Group realises the rights to the benefits + +specified in the contract, the rights expire or the Group surrenders or otherwise loses control of the contractual + +rights that comprise the financial asset. On de-recognition, the difference between the carrying amount of the + +financial asset and proceeds receivable and any prior adjustment to reflect fair value that had been reported in + +equity are included in the consolidated income statement. + +Financial liabilities (or a portion thereof) are de-recognized when the obligation specified in the contract is + +discharged, cancelled or expire. On de-recognition, the difference between the carrying amount of the financial + +liability, including related unamortized costs and amounts paid for it are included in the consolidated income + +statement. + +11.6 + +Fair value methods and assumptions + +The fair value of financial instruments traded in an organised financial market are measured at the applicable + +quoted prices. + +The fair value of financial instruments not traded in an organised financial market, is determined using a + +variety of methods and assumptions that are based on market conditions and risk existing at balance sheet + +date, including independent appraisals and discounted cash flow methods. + +The carrying amounts of financial assets and liabilities with a maturity of less than one year are assumed to + +approximate their fair value. + +11.7 + +Offset + +Where a legally enforceable right of offset exists for recognized financial assets and financial liabilities, and + +there is an intention to settle the liability and realise the asset simultaneously, or to settle on a net basis, all + +related financial effects are offset. + +12. + +PROVISIONS + +Provisions are recognized when the Group has a present legal or constructive obligation resulting from past events, + +for which it is probable that an outflow of resources embodying economic benefits will be required to settle the + +obligation and a reliable estimate of the amount of the obligation can be made. A past event is deemed to give rise to + +a present obligation if, taking into account the available evidence, it is more likely than not that a present obligation + +exists at balance sheet date. + +The amount recognized as a provision, is the best estimate of the expenditure required to settle the present obligation + +at balance sheet date, taking into account risks and uncertainties surrounding the provision. + +13. + +IMPAIRMENT OF ASSETS + +The carrying amounts of assets, mentioned in the accounting policy notes, are assessed at each balance sheet date to + +determine whether there is any indication of impairment. If any such indication exists, the Group estimates the + +recoverable amount of the asset, being the higher of the asset's net selling price and its value in use. An impairment + +loss is recognized if the recoverable amount of an asset is less than its carrying amount. The impairment loss is + +recognized as an expense in the consolidated income statement immediately. + +The net selling price represents the amount obtainable from the sale of an asset in an arm's length transaction + +between knowledgeable, willing parties, less costs of disposal. + +The value in use of an asset represents the expected future cash flows, from continuing use and disposal that are + +discounted to their present value using an appropriate pre-tax discount rate that reflects current market assessments of + +the time value of money and the risks specific to the asset. + +For an asset that does not generate cash inflows largely independent of those from other assets, the recoverable + +amount is determined for the cash-generating unit to which the asset belongs. An impairment loss is recognized + +whenever the recoverable amount of a cash-generating unit is less than its carrying amount. The impairment loss is + +allocated to reduce the carrying amount of the assets of the cash-generating unit, first to goodwill in respect of the + +cash generating unit, if any, and then to the other assets on a pro rata basis based on their carrying amounts. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +13. + +IMPAIRMENT OF ASSETS (continued) + +A previously recognized impairment loss is reversed if there has been a change in the estimates used to determine the + +recoverable amount, however not to an amount higher than the carrying amount that would have been determined + +had no impairment loss been recognized in prior periods. + +After the recognition of an impairment loss, any depreciation or amortization charge for the asset is adjusted for + +future periods to allocate the asset's revised carrying amount, less its estimated residual value, on a systematic basis + +over its remaining useful life. + +For goodwill, a recognized impairment loss is not reversed, unless the impairment loss was caused by a specific + +external event of an exceptional nature that is not expected to recur and the increase relates clearly to the reversal of + +the effect of that event. + +14. + +CASH AND CASH EQUIVALENTS + +For the purpose of the consolidated cash flow statement, cash and cash equivalents comprise cash on hand, deposits + +held on call, net of bank borrowings, all of which are available for use by the Group unless otherwise stated. Cash on + +hand is measured at its face value. Deposits held on call are classified as loans originated by the company and carried + +at amortized cost. Due to the short-term nature of these, the amortized cost approximates its fair value. + +Bank borrowings, consisting of interest bearing short-term bank loans repayable on demand and overdrafts are + +recorded at the proceeds received, net of direct issue costs. Finance costs, including premiums payable on settlement + +or redemption, are accounted for on an accrual basis and are added to the carrying amount of the instrument to the + +extent that they are not settled in the period in which they arise. + +15. + +EXPENSES + +Marketing and advertising costs are expensed as they are incurred. Prepaid costs related to annual events + +sponsorships are written-off over the duration of the event. + +16. + +INCENTIVES + +Incentives paid to service providers and dealers for new activations, retention of existing customers and reaching + +specified sales targets are expensed as incurred. + +Distribution incentives paid to service providers and dealers for exclusivity, distribution assets and distribution + +subsidies are deferred and expensed over the contractual relationship period. + +17. + +DISCONTINUING OPERATIONS + +Discontinuing operations are significant, distinguishable components of an enterprise that have been sold, abandoned + +or are the subject of formal plans for disposal or discontinuance. + +The profit or loss on the sale or abandonment of a discontinuing operation is determined from the earlier of the + +enterprise entering into a binding sale agreement for substantially all of the assets attributable to the discontinuing + +operation, or, the approval and announcement of a detailed, formal plan of discontinuance by the board of directors. + +18. + +USE OF ESTIMATES + +The preparation of financial statements in accordance with Generally Accepted Accounting Principles require the use + +of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent + +assets and liabilities on the date of the financial statements and the reported amounts of revenues and expenses during + +the reporting period. + +Although these estimates are based on management's best knowledge of current events and actions they may + +undertake in the future, actual results ultimately may differ from those estimates. + +19. + +COMPARATIVES + +Certain comparative figures have been reclassified, where required or necessary, in accordance with current period + +classifications and presentation. + +F129 + +F130 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +1. + +REVENUE + +Airtime and access . . . . . . . . . . . . . . . . . . . . . . . . . . + +5,320.1 + +7,255.1 + +9,486.5 + +Interconnect revenue . . . . . . . . . . . . . . . . . . . . . . . . . + +2,582.9 + +3,260.1 + +4,300.9 + +Equipment sales . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,275.0 + +2,042.3 + +1,627.4 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +101.6 + +458.9 + +434.8 + +International airtime . . . . . . . . . . . . . . . . . . . . . . . . . + +292.0 + +260.0 + +301.1 + +9,571.6 + +13,276.4 + +16,150.7 + +2. + +AMORTIZATION OF INTANGIBLE ASSETS + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(35.8) + +(150.1) + +(98.9) + +Licences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(6.7) + +(7.2) + +(9.4) + +Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(6.3) + +(16.8) + +(7.1) + +Customer bases . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(24.8) + +(97.4) + +(97.3) + +(73.6) + +(271.5) + +(212.7) + +3. + +INTEGRATION COSTS, DISPOSALS OF OPERATIONS AND + +IMPAIRMENTS + +Globalstar Southern Africa (Proprietary) Limited excluding + +goodwill of R24.7 million for 2001 (Note 3.1) . . . . . . . . . . . + +- + +(148.0) + +37.7 + +Impairment of property, plant and equipment . . . . . . . . . . . + +- + +(97.7) + +- + +Impairment of shareholder loan . . . . . . . . . . . . . . . . . . + +- + +(4.8) + +- + +Satellite phones onerous contract . . . . . . . . . . . . . . . . + +- + +(45.5) + +45.5 + +Recoupment of Gateway assets accrual (Note 36) . . . . . . . . + +- + +- + +15.0 + +Management fees paid to Telkom SA Limited in respect of the + +Delareyville earth station (Note 36) . . . . . . . . . . . . . . . . + +- + +- + +(22.8) + +Capital gain on disposal of discontinued operations (Note 5) . . . . + +129.3 + +1.6 + +19.0 + +Joycell Shops (Proprietary) Limited and Yellow Lizard Web + +Design (Proprietary) Limited . . . . . . . . . . . . . . . . . . . + +- + +1.6 + +2.7 + +Vodacom Sport & Entertainment (Proprietary) Limited . . . . . + +- + +- + +40.0 + +Film Fun (Holdings) (Proprietary) Limited . . . . . . . . . . . . + +- + +- + +(53.8) + +Vodacom World Online (Proprietary) Limited (Note 5.1) . . . . + +129.3 + +- + +30.1 + +Write-off of investment in GSM Companies . . . . . . . . . . . . . + +- + +- + +(0.3) + +Vodacom Service Provider Company (Proprietary) Limited + +Integration costs (Note 3.2) . . . . . . . . . . . . . . . . . . . . . + +- + +(36.5) + +- + +Film Fun (Holdings) (Proprietary) Limited, trading as Teljoy + +Integration costs (Note 3.3) . . . . . . . . . . . . . . . . . . . . . + +- + +(30.3) + +- + +129.3 + +(213.2) + +56.4 + +3.1 + +Globalstar Southern Africa (Proprietary) Limited + +Vodacom Group (Proprietary) Limited acquired 100% of the share capital of Globalstar Southern Africa + +(Proprietary) Limited with effect from August 1, 2000. The principal nature of the business of the company is + +that of a provider of wholesale satellite airtime to cellular networks in Southern Africa. During the 2001 + +financial year the total goodwill on acquisition of R24.7 million (disclosed as part of the Goodwill amortization + + - Notes 2 and 10) and the total net asset value of the company was impaired by R102.5 million, as no satellite + +license was issued by the Independent Communications Authority of South Africa and the international satellite + +company Globalstar Limited Partnership, a United States listed company, was expected to go into Chapter 11 + +bankruptcy. + +During the year ended March 31, 2001, a provision was made to reflect a contractual obligation of + +R45.5 million to purchase satellite phones. Since a satellite licence was not issued to Globalstar Southern + +Africa (Proprietary) Limited, these phones could not be utilized. The provision was reversed during the year + +ended March 31, 2002 as the Group was subsequently released from this contractual obligation, and a + +recoupment of R15.0 million was made on certain of the Gateway assets that were impaired in 2001. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +3. + +INTEGRATION COSTS, DISPOSALS OF OPERATIONS AND IMPAIRMENTS (continued) + +3.2 + +Vodacom Service Provider Company (Proprietary) Limited + +On July 1, 2000 the businesses of GSM Cellular (Proprietary) Limited and Vodac (Proprietary) Limited were + +integrated with the business of Teljoy Cellular Services (Proprietary) Limited. Effective July 1, 2000, Teljoy + +Cellular Services (Proprietary) Limited changed its name to Vodacom Service Provider Company (Proprietary) + +Limited. + +The activities of Vodacare (Proprietary) Limited and Vodacom Equipment Company (Proprietary) Limited were + +also integrated into Vodacom Service Provider Company (Proprietary) Limited on November 1, 2000. + +3.3 + +Film Fun (Holdings) Proprietary Limited + +Film Fun (Holdings) Proprietary Limited, trading as Teljoy was acquired as part of the Teljoy Holdings + +Limited Group during January 2000. Non-profitable branches were closed during the 2001 financial year and + +the billing system, which was not operational, was written-off. + +4. + +PROFIT FROM OPERATIONS + +The profit from operations (including integration costs, disposals of operations and impairments (Note 3)) is arrived + +at after taking the following income/(expenditure) into account: + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Net profit/(loss) on disposal of property, plant and equipment . . . + +(9.6) + +0.4 + +3.4 + +Loss on disposal of property, plant and equipment . . . . . . . . + +(9.8) + +(8.2) + +(2.6) + +Profit on disposal of property, plant and equipment . . . . . . . . + +0.2 + +8.6 + +6.0 + +Depreciation of property, plant and equipment (Note 9) . . . . . . + +(1,025.3) + +(1,364.1) + +(1,857.3) + +Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(9.5) + +(10.5) + +(12.7) + +Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(790.8) + +(1,008.1) + +(1,388.5) + +Information services . . . . . . . . . . . . . . . . . . . . . . . . + +(128.3) + +(177.9) + +(332.1) + +Community services . . . . . . . . . . . . . . . . . . . . . . . . + +(7.2) + +(7.4) + +(11.1) + +Motor vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.2) + +(6.7) + +(19.6) + +Furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(2.5) + +(4.1) + +(16.3) + +Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.7) + +(2.3) + +(14.3) + +Leasehold improvements . . . . . . . . . . . . . . . . . . . . . + +(1.6) + +(2.9) + +(31.0) + +Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(82.5) + +(144.2) + +(31.7) + +Auditors' remuneration . . . . . . . . . . . . . . . . . . . . . . . . + +(3.6) + +(9.4) + +(7.3) + +Current year audit fees . . . . . . . . . . . . . . . . . . . . . . . + +(2.4) + +(4.5) + +(5.3) + +Prior year under provision of audit fees . . . . . . . . . . . . . . + +- + +(0.4) + +- + +Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(0.1) + +(0.1) + +(0.1) + +Other services . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.1) + +(4.4) + +(1.9) + +Consultancy services . . . . . . . . . . . . . . . . . . . . . . . . . + +(35.1) + +(35.4) + +(84.9) + +Administrative fees . . . . . . . . . . . . . . . . . . . . . . . . + +(9.3) + +(9.4) + +(22.5) + +Managerial fees . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.4) + +(1.5) + +(3.5) + +Secretarial fees . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(0.1) + +Technical fees . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(24.4) + +(24.5) + +(58.8) + +Operating lease rentals . . . . . . . . . . . . . . . . . . . . . . . . + +(378.8) + +(471.5) + +(474.2) + +GSM transmission and data lines . . . . . . . . . . . . . . . . . + +(301.0) + +(332.3) + +(336.0) + +Office accommodation . . . . . . . . . . . . . . . . . . . . . . . + +(40.7) + +(66.8) + +(79.7) + +Other accommodation . . . . . . . . . . . . . . . . . . . . . . . + +(32.1) + +(54.3) + +(49.4) + +Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . + +(5.0) + +(13.1) + +(7.6) + +Motor vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(5.0) + +(1.5) + +F131 + +F132 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +4. + +PROFIT FROM OPERATIONS (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Payment to other operators . . . . . . . . . . . . . . . . . . . . . . + +(391.2) + +(821.8) + +(1,378.1) + +Licence fees (Note 35.4) . . . . . . . . . . . . . . . . . . . . . . . + +(271.2) + +(328.8) + +(384.4) + +License fee GSM . . . . . . . . . . . . . . . . . . . . . . . . + +(271.0) + +(328.8) + +(384.4) + +License fee C450 . . . . . . . . . . . . . . . . . . . . . . . . + +(0.2) + +- + +- + +Foreign exchange losses . . . . . . . . . . . . . . . . . . . . . . . + +- + +(0.1) + +(11.2) + +Directors' remuneration . . . . . . . . . . . . . . . . . . . . . . . + +(14.1) + +(17.4) + +(25.8) + +Executive directors fees as directors: salaries . . . . . . . . . . + +(4.5) + +(5.6) + +(8.3) + +Executive directors fees as directors: bonuses . . . . . . . . . + +(8.5) + +(11.3) + +(16.9) + +Non-executive directors fees as directors . . . . . . . . . . . . + +(1.1) + +(0.5) + +(0.6) + +Directors' remuneration and emoluments paid by: . . . . . . . . . + +(14.1) + +(17.4) + +(25.8) + +Vodacom Group (Proprietary) Limited . . . . . . . . . . . . . . + +(8.8) + +(11.3) + +(16.2) + +Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(5.3) + +(6.1) + +(9.6) + +Staff expenses pension and provident fund contributions . . . . . + +(29.8) + +(42.5) + +(43.9) + +Pension fund contributions . . . . . . . . . . . . . . . . . . . . + +(29.8) + +(42.5) + +(42.8) + +Provident fund contributions . . . . . . . . . . . . . . . . . . . + +- + +- + +(1.1) + +Bad debts written-off . . . . . . . . . . . . . . . . . . . . . . . . . + +(16.5) + +(107.4) + +(111.2) + +Decrease/(Increase) in provision for bad debts . . . . . . . . . . . + +(5.4) + +(49.0) + +64.9 + +The headcount of the Group at March 31, 2002 was 4,353 + +(2001: 4,272, 2000: 4,091). + +5. + +DISCONTINUED OPERATIONS + +5.1 + +Vodacom World Online (Proprietary) Limited + +On June 1, 1999, the Group disposed of the Vodacom Internet Division, which formed part of Vodacom + +(Proprietary) Limited for an amount of R265.4 million to Vodacom World Online (Proprietary) Limited, a 50% + +joint venture of Vodacom (Proprietary) Limited and World Online (Note 31). The Group realized a capital gain + +of R123.3 million on this transaction, consisting of profits of R246.6 million less a deferred gain of + +R123.3 million reflecting Vodacom's continued 50% interest in the assets contributed. On March 31, 2000, the + +Group disposed of 10% of the shareholding in Vodacom World Online (Proprietary) Limited. A profit of + +R54.3 million arose, being the proceeds of the disposal of R51.1 million less the realization of the shareholder + +loans of R25.0 million, net liabilities of R3.2 million and deferred profit on the sale of the Internet Division by + +Vodacom (Proprietary) Ltd of R25.0 million. + +On November 9, 2001, the Group entered into a sale agreement to dispose of its 40% interest in the joint + +venture company of Vodacom World Online (Proprietary) Limited to Tiscali International BV, the other party to + +the joint venture. The company carried out the Group's internet service provider operations. The disposal was + +completed on November 30, 2001, on which date control of Vodacom World Online (Proprietary) Limited + +passed to Tiscali International BV. A profit of R30.1 million arose on the disposal of Vodacom World Online + +(Proprietary) Limited, being the proceeds of disposal R31.8 million less the realization of the shareholder's + +loan of R134.9 million, net liabilities of R34.9 million and deferred profit of R98.3 million on the sale of the + +internet division by Vodacom (Proprietary) Limited in the 2000 financial year (Note 30.2(b)) now realized. + +No tax charge or credit arose from the transaction. The results were deconsolidated from November 30, 2001. + +The Group's consolidated capital gain of R129.3 million on these disposals as disclosed in Note 3, arose from + +the R123.3 million from the sale of the Internet Division, which was subsequently reduced with subscriber + +base costs not capitalized of R48.3 million and the gain of R54.3 million from the disposal of its 10% + +shareholdings in Vodacom World Online (Proprietary) Limited. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +5. + +DISCONTINUED OPERATIONS (continued) + +5.2 + +Vodacom Sport & Entertainment (Proprietary) Limited + +On September 1, 2001, the Group entered into a sale agreement to dispose of its 51% interest in Vodacom Sport + +& Entertainment (Proprietary) Limited to South African Investments Limited ("SAIL"). The company carried out + +the Group's sport and entertainment marketing operations. The disposal was completed on February 27, 2002, on + +which date control of Vodacom Sport & Entertainment (Proprietary) Limited passed to SAIL. The results were + +deconsolidated from February 28, 2002. A profit of R40.0 million arose on the disposal of Vodacom Sport & + +Entertainment (Proprietary) Limited, being the proceeds of disposal less the carrying amount of the subsidiary's + +net assets (Note 29.1(a)). No tax charge or credit arose from the transaction. + +5.3 + +Film Fun (Holdings) (Proprietary) Limited, Teljoy Botswana (Proprietary) Limited and Africell Cellular + +Services (Proprietary) Limited + +The 100% shareholding in Film Fun (Holdings) (Proprietary) Limited, Teljoy Botswana (Proprietary) Limited + +and Africell Cellular Services (Proprietary) Limited was sold to a management consortium for R9.0 million. + +These disposals were effected in order to dispose of non-core operations. A loss of R53.8 million was realized, + +being the proceeds of disposal less the carrying amount of the subsidiary's net assets (Note 29.1(b)). The sale + +agreements were signed on March 27, 2002. The results were deconsolidated from March 31, 2002. The goodwill + +associated with the entities was allocated on the initial acquisition of the Teljoy Group on January 31, 2000. + +5.4 + +Results and cash flows + +The results and cash flows of Vodacom Sport & Entertainment (Proprietary) Limited (VSE), Vodacom World + +Online (Proprietary) Limited (VWOL), Film Fun (Holdings) (Proprietary) Limited (FFH), which have been + +included in the consolidated financial statements, were as follows: + +VSE + +VWOL + +Internet + +division + +Rm + +Rm + +Rm + +2000 + +Income statement + +Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +26.0 + +37.1 + +7.0 + +Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . + +(20.9) + +(68.8) + +(11.9) + +Net investment income . . . . . . . . . . . . . . . . . . . . + +1.0 + +1.0 + +16.2 + +Profit/(Loss) before taxation . . . . . . . . . . . . . . . . . . + +6.1 + +(30.7) + +11.3 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(2.2) + +- + +1.7 + +Profit/(Loss) after taxation . . . . . . . . . . . . . . . . . . . + +3.9 + +(30.7) + +13.0 + +Cash flow statement + +Net cash flows from operating activities . . . . . . . . . . . + +9.5 + +(11.1) + +11.4 + +Net cash flows from investing activities . . . . . . . . . . . . + +(1.2) + +(142.1) + +192.2 + +Net cash flows from financing activities . . . . . . . . . . . . + +- + +157.7 + +- + +Net increase in cash and cash equivalents . . . . . . . . . . . + +8.3 + +4.5 + +203.6 + +VSE + +VWOL + +FFH + +Rm + +Rm + +Rm + +2001 + +Income statement + +Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +48.9 + +43.0 + +215.2 + +Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . + +(32.3) + +(55.1) + +(218.1) + +Profit/(Loss) before taxation . . . . . . . . . . . . . . . . . . + +16.6 + +(12.1) + +(2.9) + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(6.0) + +- + +4.5 + +Profit/(Loss) after taxation . . . . . . . . . . . . . . . . . . . + +10.6 + +(12.1) + +1.6 + +Cash flow statement + +Net cash flows from operating activities . . . . . . . . . . . + +(5.4) + +(9.1) + +29.8 + +Net cash flows from investing activities . . . . . . . . . . . . + +(0.8) + +(5.8) + +(17.5) + +Net cash flows from financing activities . . . . . . . . . . . . + +- + +4.0 + +48.4 + +Net (decrease)/increase in cash and cash equivalents . . . . . + +(6.2) + +(10.9) + +60.7 + +F133 + +F134 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +5. + +DISCONTINUED OPERATIONS (continued) + +VSE + +VWOL + +FFH + +Rm + +Rm + +Rm + +5.4 + +Results and cash flows (continued) + +2002 + +Income statement + +Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +52.8 + +36.1 + +160.7 + +Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . + +(38.0) + +(56.0) + +(148.0) + +Profit/(Loss) before taxation . . . . . . . . . . . . . . . . . . + +14.8 + +(19.9) + +12.7 + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(4.3) + +- + +(0.1) + +Profit/(Loss) after taxation . . . . . . . . . . . . . . . . . . . + +10.5 + +(19.9) + +12.6 + +Cash flow statement + +Net cash flows from operating activities . . . . . . . . . . . + +(2.8) + +1.4 + +54.2 + +Net cash flows from investing activities . . . . . . . . . . . . + +(2.6) + +- + +(0.3) + +Net cash flows from financing activities . . . . . . . . . . . . + +- + +4.8 + +(129.4) + +Net (decrease)/increase in cash and cash equivalents . . . . . + +(5.4) + +6.2 + +(75.5) + +The assets and liabilities related to the entities discontinued are + +detailed in Notes 29 and 30. + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +6. + +INTEREST AND DIVIDENDS RECEIVED + +Interest received banks and loans . . . . . . . . . . . . . . . . . + +31.3 + +25.4 + +27.7 + +Dividends received unlisted investments . . . . . . . . . . . . . . + +0.7 + +- + +4.3 + +32.0 + +25.4 + +32.0 + +7. + +NET FINANCE COSTS + +Shareholder loans . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(202.1) + +(157.9) + +(144.2) + +Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(61.2) + +(60.8) + +(98.9) + +Funding loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(69.8) + +(65.7) + +(87.2) + +Bank and other interest . . . . . . . . . . . . . . . . . . . . . . . . + +(99.4) + +(162.9) + +(86.1) + +Gain/(Loss) on forward exchange contracts and liability + +revaluations (Note 7.1) . . . . . . . . . . . . . . . . . . . . . . . . + +(133.7) + +(56.1) + +347.4 + +Interest rate swaps . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.0) + +(1.1) + +4.3 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4.9 + +(567.2) + +(504.5) + +(59.8) + +7.1 + +Gain/(Loss) on forward exchange contracts and liability + +revaluations + +Gain on foreign liability revaluation . . . . . . . . . . . . . . + +- + +- + +18.3 + +Loss on foreign liability revaluation . . . . . . . . . . . . . . + +(247.8) + +Gain on foreign exchange contract revaluation . . . . . . . . + +- + +- + +778.4 + +Loss on foreign exchange contract revaluation . . . . . . . . + +- + +- + +(199.0) + +Realized foreign exchange gains . . . . . . . . . . . . . . . + +- + +2.3 + +2.5 + +Realized foreign exchange losses . . . . . . . . . . . . . . . + +- + +- + +(5.0) + +Foreign exchange premiums . . . . . . . . . . . . . . . . . . + +(133.7) + +(58.4) + +- + +(133.7) + +(56.1) + +347.4 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +8. + +TAXATION + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +South African normal taxation . . . . . . . . . . . . . . . . . . . . + +(556.2) + +(748.3) + +(1,001.7) + +Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(562.9) + +(763.8) + +(1,022.9) + +Prior year over provision . . . . . . . . . . . . . . . . . . . . . + +6.7 + +15.5 + +21.2 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +45.4 + +45.6 + +(82.7) + +Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +28.5 + +50.3 + +(79.7) + +Prior year under/(over) provision . . . . . . . . . . . . . . . . . + +16.1 + +(4.7) + +(3.0) + +Rate change . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +0.8 + +- + +- + +Secondary Taxation on Companies . . . . . . . . . . . . . . . . . + +(1.0) + +(60.5) + +(74.5) + +Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.0) + +(60.5) + +(75.5) + +Prior year over provision . . . . . . . . . . . . . . . . . . . . . + +- + +- + +1.0 + +Foreign taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.8) + +(2.5) + +(2.5) + +Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.8) + +(2.4) + +(3.7) + +Prior year over/(under) provision . . . . . . . . . . . . . . . . . + +- + +(0.1) + +1.2 + +Foreign deferred taxation current year . . . . . . . . . . . . . . . + +- + +- + +(29.3) + +(513.6) + +(765.7) + +(1,190.7) + +2000 + +2000 + +2001 + +2001 + +2002 + +2002 + +Rm + +% + +Rm + +% + +Rm + +% + +Reconciliation of rate of taxation + +Normal taxation on profit before taxation . . . . . + +548.4 + +30.0 + +622.3 + +30.0 + +1,075.2 + +30.0 + +Adjusted for: + +Exempt income . . . . . . . . . . . . . . . . . . . + +(1.9) + +(0.1) + +(0.1) + +- + +(1.3) + +- + +Disallowable expenditure . . . . . . . . . . . . . + +13.5 + +0.7 + +63.1 + +3.0 + +58.1 + +1.7 + +Prior year over provision . . . . . . . . . . . . . . + +(24.7) + +(1.4) + +(3.9) + +(0.2) + +(19.4) + +(0.5) + +Unutilized assessed loss . . . . . . . . . . . . . . + +- + +- + +42.8 + +2.1 + +21.9 + +0.6 + +Utilization of assessed loss . . . . . . . . . . . . + +7.6 + +(0.4) + +(2.2) + +(0.1) + +(0.6) + +(0.1) + +Foreign taxation rate differences . . . . . . . . . . + +- + +- + +- + +- + +14.1 + +0.4 + +Secondary Taxation on Companies . . . . . . . . + +1.0 + +0.1 + +60.5 + +2.9 + +74.5 + +2.1 + +Realization of deferred tax provided on customer + +base . . . . . . . . . . . . . . . . . . . . . . . . . + +(4.9) + +(0.3) + +(20.8) + +(1.0) + +(20.8) + +(0.6) + +Temporary differences in subsidiaries not + +provided for . . . . . . . . . . . . . . . . . . . . + +(25.4) + +(1.3) + +4.0 + +0.2 + +(11.0) + +(0.3) + +Globalstar Southern Africa (Proprietary) + +Limited . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +- + +(4.1) + +(0.1) + +Vodacom Tanzania Limited . . . . . . . . . . . + +- + +- + +4.0 + +0.2 + +- + +- + +Other . . . . . . . . . . . . . . . . . . . . . . . + +(25.4) + +(1.3) + +- + +- + +(6.9) + +(0.2) + +513.6 + +28.1 + +765.7 + +36.9 + +1,190.7 + +33.3 + +F135 + +F136 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +9. + +PROPERTY, PLANT AND EQUIPMENT + +Cost Accumulated + + Net book + + depreciation + +value + +2000 + +Rm + +Rm + +Rm + +Land and buildings . . . . . . . . . . . . . . . . . . . . . . . . . . + +384.7 + +(15.7) + +369.0 + +Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +6,868.3 + +(1,997.6) + +4,870.7 + +Information services . . . . . . . . . . . . . . . . . . . . . . . . . + +603.8 + +(293.6) + +310.2 + +Community services . . . . . . . . . . . . . . . . . . . . . . . . . + +61.6 + +(41.2) + +20.4 + +Motor vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +6.7 + +(2.3) + +4.4 + +Furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +20.8 + +(11.1) + +9.7 + +Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . + +13.9 + +(6.3) + +7.6 + +Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . + +6.3 + +(1.8) + +4.5 + +Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +458.9 + +(201.3) + +257.6 + +8,425.0 + +(2,570.9) + +5,854.1 + +Cost Accumulated + + Net book + + depreciation + + value + +2001 + +Rm + +Rm + +Rm + +Land and buildings . . . . . . . . . . . . . . . . . . . . . . . . . . + +456.6 + +(21.4) + +435.2 + +Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +9,428.6 + +(3,005.4) + +6,423.2 + +Information services . . . . . . . . . . . . . . . . . . . . . . . . . + +932.1 + +(471.4) + +460.7 + +Community services . . . . . . . . . . . . . . . . . . . . . . . . . + +80.1 + +(48.6) + +31.5 + +Motor vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +15.0 + +(6.2) + +8.8 + +Furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +46.5 + +(31.6) + +14.9 + +Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . + +21.0 + +(13.1) + +7.9 + +Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . + +11.2 + +(6.3) + +4.9 + +Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +757.7 + +(448.6) + +309.1 + +11,748.8 + +(4,052.6) + +7,696.2 + +Cost Accumulated + + Net book + + depreciation + + value + +2002 + +Rm + +Rm + +Rm + +Land and buildings . . . . . . . . . . . . . . . . . . . . . . . . . . + +795.7 + +(34.0) + +761.7 + +Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12,559.1 + +(4,393.9) + +8,165.2 + +Information services . . . . . . . . . . . . . . . . . . . . . . . . . + +1,606.3 + +(936.6) + +669.7 + +Community services . . . . . . . . . . . . . . . . . . . . . . . . . + +85.2 + +(55.6) + +29.6 + +Motor vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +67.0 + +(25.8) + +41.2 + +Furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +96.7 + +(48.6) + +48.1 + +Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . + +69.0 + +(42.6) + +26.4 + +Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . + +196.6 + +(76.1) + +120.5 + +Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +56.2 + +(22.0) + +34.2 + +15,531.8 + +(5,635.2) + +9,896.6 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +9. + +PROPERTY, PLANT AND EQUIPMENT (continued) + +2000 + + Land and + + Infra- + + Information + + Community + +Motor + + Furniture + +Office + + Leasehold + +Other + +Total + + buildings + + structure + +services + +services + +vehicles + + equipment + + improvements + +assets + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Opening balance . + +390.1 + + 4,024.4 + +234.0 + +13.3 + +3.4 + +10.5 + +5.6 + +1.3 + +218.4 4,901.0 + +Additions . . . . . + +6.3 + + 1,637.1 + +217.8 + +14.3 + +2.2 + +2.0 + +3.1 + +2.5 + +136.7 2,022.0 + +Disposals . . . . . + +(18.0) + +(0.1) + +(12.5) + +- + +- + +- + +- + +- + +(40.6) + + (71.2) + +Depreciation . . . + +(9.5) + +(790.8) + +(128.3) + +(7.2) + +(1.2) + +(2.5) + +(1.7) + +(1.6) + +(82.5) (1,025.3) + +Business + +combinations . . . + +0.1 + +0.1 + +(0.8) + +- + +- + +(0.3) + +0.6 + +2.3 + +25.6 + + 27.6 + +Closing balance . . + +369.0 + +4,870.7 + +310.2 + +20.4 + +4.4 + +9.7 + +7.6 + +4.5 + +257.6 5,854.1 + +2001 + + Land and + + Infra- + + Information + + Community + +Motor + + Furniture + +Office + + Leasehold + + Other + +Total + + buildings + + structure + + services + +services + + vehicles + + equipment + + improvements + +assets + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Opening balance . + +369.0 + +4,870.7 + +310.2 + +20.4 + +4.4 + +9.7 + +7.6 + +4.5 + +257.6 5,854.1 + +Additions . . . . . + +109.7 + +2,562.8 + +331.6 + +18.5 + +11.2 + +9.3 + +9.8 + +5.0 + +126.3 3,184.2 + +Disposals . . . . . + +(33.0) + +- + +(3.2) + +- + +(0.1) + +- + +(11.9) + +(1.7) + +(55.6) + + (105.5) + +Depreciation . . . + +(10.5) + +(1,008.1) + +(177.9) + +(7.4) + +(6.7) + +(4.1) + +(2.3) + +(2.9) + +(144.2) (1,364.1) + +Impairment and + +business + +combinations . . . + +- + +(2.2) + +- + +- + +- + +- + +4.7 + +- + +125. + +0 + +127.5 + +Closing balance . . + +435.2 + +6,423.2 + +460.7 + +31.5 + +8.8 + +14.9 + +7.9 + +4.9 + +309.1 7,696.2 + +2002 + + Land and + + Infra- + + Information + + Community + +Motor + + Furniture + +Office + + Leasehold + + Other + + Total + + buildings + + structure + +services + +services + +vehicles + + equipment + + improvements + +assets + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Opening balance + +as previously + +reported . . . . . . + +435.2 + +6,423.2 + +460.7 + +31.5 + +8.8 + +14.9 + +7.9 + +4.9 + +309.1 7,696.2 + +Asset category + +transfers . . . . . . + +- + +- + +95.6 + +- + +- + +- + +(0.1) + +(0.1) + +(95.4) + +- + +Restated opening + +balance . . . . . . + +435.2 + +6,423.2 + +556.3 + +31.5 + +8.8 + +14.9 + +7.8 + +4.8 + +213.7 7,696.2 + +Additions . . . . . + +339.6 + +3,050.3 + +476.4 + +9.5 + +20.5 + +39.2 + +15.9 + +94.2 + +39.7 4,085.3 + +Disposals . . . . . + +(0.5) + +(48.4) + +(17.5) + +(0.3) + +(0.1) + +(4.1) + +(0.1) + +(0.1) + +(17.8) + + (88.9) + +Foreign currency + +translation . . . . . + +0.1 + +128.9 + +0.7 + +- + +1.5 + +0.5 + +0.1 + +1.0 + +- + + 132.8 + +Depreciation . . . + +(12.7) + +(1,388.5) + +(332.1) + +(11.1) + +(19.6) + +(16.3) + +(14.3) + +(31.0) + +(31.7) (1,857.3) + +Other . . . . . . . + +- + +- + +(0.1) + +- + +- + +(0.1) + +- + +- + +1.3 + +1.1 + +Business + +combinations . . . + +- + +- + +(12.2) + +- + +(0.2) + +(4.4) + +(1.0) + +- + +(54.8) + +(72.6) + +Asset category + +transfers . . . . . . + +- + +(0.3) + +(1.8) + +- + +30.3 + +18.4 + +18.0 + +51.6 + +(116.2) + +- + +Closing balance . . + +761.7 + +8,165.2 + +669.7 + +29.6 + +41.2 + +48.1 + +26.4 + +120.5 + +34.2 9,896.6 + +F137 + +F138 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +9. + +PROPERTY, PLANT AND EQUIPMENT (continued) + +2000 + +2001 + +2002 + +Net book + +Net book + +Net book + +value + +value + +value + +Rm + +Rm + +Rm + +Freehold land and buildings + +Portions 859, 847, 827, the remaining extent of Portion 45 (a portion of + +Portion 9), and Portion 828 (a portion of Portion 9) of farm + +Randjesfontein No. 405, Registration division J.R., Province of Gauteng + +- + +32.4 + +43 Kwale Road, Dar es Salaam, Tanzania . . . . . . . . . . . . . . . . + +- + +6.8 + +Stand 172 Sandton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +0.5 + +0.5 + +- + +Sectional Plan No. 33/1981, High Level Road, Sea Point, Cape Town . + +0.1 + +- + +- + +Stand 200 Chelmsfordville . . . . . . . . . . . . . . . . . . . . . . . . + +0.1 + +0.1 + +0.1 + +0.7 + +0.6 + +39.3 + +Leasehold land and buildings + +Portion 827 and 828 of farm Randjesfontein No. 405 . . . . . . . . . . + +- + +- + +279.4 + +Portion 769 of farm Randjesfontein No. 405 . . . . . . . . . . . . . . . + +154.8 + +155.9 + +164.8 + +Stand 34083 Bellville, City of Tygerberg . . . . . . . . . . . . . . . . . + +112.6 + +111.1 + +109.5 + +Erven 5259 and 5260 Montague Gardens . . . . . . . . . . . . . . . . . + +- + +99.6 + +98.1 + +Holding 350 Erand Agricultural Holdings Ext. 1 . . . . . . . . . . . . . + +70.6 + +66.4 + +62.2 + +Holding 188 Erand Agricultural Holdings Ext. 1 . . . . . . . . . . . . . + +7.8 + +- + +- + +Stand 207 Erand Agricultural Holdings Ext. 28 . . . . . . . . . . . . . + +- + +- + +6.8 + +Portion 45 of Randjesfontein No. 405, and Holding 202 Erand + +Agricultural Holdings Ext. 1 . . . . . . . . . . . . . . . . . . . . . . . + +7.8 + +- + +- + +Holding 359 Erand Agricultural Holdings Ext. 1 . . . . . . . . . . . . . + +9.9 + +1.6 + +1.6 + +Erand 189 Agricultural Holdings Ext. . . . . . . . . . . . . . . . . . . . + +4.8 + +- + +- + +368.3 + +434.6 + +722.4 + +Total freehold and leasehold land and buildings . . . . . . . . . . . . . + +369.0 + +435.2 + +761.7 + +Debt is collateralised over leasehold land and buildings and the fair value of the lease liability is R790.6 million + +(2001: R496.6 million, 2000: R417.9 million). + +10. + +INTANGIBLE ASSETS + +Cost + +Accumulated + +Net book + +amortization + +value + +Rm + +Rm + +Rm + +2000 + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +462.0 + +(88.2) + +373.8 + +Licences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +104.1 + +(40.4) + +63.7 + +Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +51.9 + +(7.4) + +44.5 + +Customer bases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +486.8 + +(29.8) + +457.0 + +1,104.8 + +(165.8) + +939.0 + +Cost + +Accumulated + +Net book + +amortization + +value + +Rm + +Rm + +Rm + +2001 + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +597.4 + +(238.3) + +359.1 + +Licences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +108.8 + +(47.6) + +61.2 + +Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +67.2 + +(24.2) + +43.0 + +Customer bases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +486.9 + +(127.3) + +359.6 + +1,260.3 + +(437.4) + +822.9 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +10. + +INTANGIBLE ASSETS (continued) + +Cost + +Accumulated + +Net book + +amortization + +value + +Rm + +Rm + +Rm + +2002 + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +669.4 + +(326.5) + +342.9 + +Licences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +221.3 + +(56.9) + +164.4 + +Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +51.5 + +(24.8) + +26.7 + +Customer bases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +486.9 + +(224.6) + +262.3 + +1,429.1 + +(632.8) + +796.3 + +Reconciliation + +Opening net + +Additions + +Foreign + +Business Amortization + +Closing net + +book value + +currency combination + + book value + +translation + +2000 + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Goodwill . . . . . . . . . + +61.4 + +0.5 + +- + +347.7 + +(35.8) + +373.8 + +Licences . . . . . . . . . + +67.6 + +2.5 + +- + +0.3 + +(6.7) + +63.7 + +Trademarks . . . . . . . + +18.0 + +- + +- + +32.8 + +(6.3) + +44.5 + +Customer bases . . . . . + +39.8 + +7.5 + +- + +434.5 + +(24.8) + +457.0 + +186.8 + +10.5 + +- + +815.3 + +(73.6) + +939.0 + +Reconciliation + +Opening net + + Additions + +Foreign + +Business Amortization + +Closing net + +book value + +currency combination + + book value + +translation + +2001 + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Goodwill . . . . . . . . . + +373.8 + +- + +- + +135.4 + +(150.1) + +359.1 + +Licences . . . . . . . . . + +63.7 + +- + +1.5 + +3.2 + +(7.2) + +61.2 + +Trademarks . . . . . . . + +44.5 + +- + +- + +15.3 + +(16.8) + +43.0 + +Customer bases . . . . . + +457.0 + +- + +- + +- + +(97.4) + +359.6 + +939.0 + +- + +1.5 + +153.9 + +(271.5) + +822.9 + +Reconciliation + +Opening net + + Additions + +Foreign + +Business Amortization + +Closing net + + book value + +currency combination + + book value + +translation + +2002 + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Goodwill . . . . . . . . . + +359.1 + +98.5 + +- + +(15.8) + +(98.9) + +342.9 + +Licences . . . . . . . . . + +61.2 + +95.2 + +17.5 + +(0.1) + +(9.4) + +164.4 + +Trademarks . . . . . . . + +43.0 + +- + +- + +(9.2) + +(7.1) + +26.7 + +Customer bases . . . . . + +359.6 + +- + +- + +- + +(97.3) + +262.3 + +822.9 + +193.7 + +17.5 + +(25.1) + +(212.7) + +796.3 + +F139 + +F140 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +11. + +INVESTMENTS + +Held for trading + +Money market investments (Note 11.1) . . . . . . . . . . . . . . . . + +- + +- + +65.0 + +Less: Short-term portion of investments (Note 11.2) . . . . . . . . . + +- + +- + +(58.6) + +Available for sale + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +0.9 + +0.9 + +- + +Originating loans + +South African Investments Limited . . . . . . . . . . . . . . . . . . + +- + +- + +11.8 + +Long-term portion of the note receivable issued as part of the + +consideration for the disposal of Vodacom Sport & Entertainment + +(Proprietary) Limited. Interest is charged on this amount receivable + +at the prime lending rate minus one percent per annum from the + +transaction date. + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +5.9 + +1.3 + +0.5 + +Investment in joint venture loan Vodacom World Online + +(Proprietary) Limited . . . . . . . . . . . . . . . . . . . . . . . . . . + +4.0 + +- + +- + +Loan to Planatel Communication Limited and Caspian + +Construction Company Limited . . . . . . . . . . . . . . . . . . . . + +4.9 + +11.2 + +4.0 + +15.7 + +13.4 + +22.7 + +11.1 + +Money market investments + +Maturity + +Interest + + Market + +period + +rate + +value + +2002 + +Rm + +Details of the maturity periods and interest rates of the + +money market investments at year-end are as follows: + +0 - 6 months + +9.1% 9.6% + +36.2 + +6 - 12 months + +10.0% 11.1% + +18.4 + +Over 12 months + +9.7% 12.0% + +10.4 + +65.0 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +11.2 + +Short-term portion of investments + +Money market investment (Note 11.1) . . . . . . . . . . . . . + +- + +- + +54.6 + +Short-term loans. The amounts were repaid in full in May 2002 + +- + +- + +4.0 + +- + +- + +58.6 + +12. + +ACQUIRED BUSINESS HELD FOR SALE + +Film Fun (Holdings) (Proprietary) Limited: + +Shares at cost less provisions and amounts written-off . . . . . . . . + +51.6 + +- + +- + +Loans granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +70.0 + +- + +- + +121.6 + +- + +- + +The investments relate to the acquisition of Film Fun (Holdings) (Proprietary) Limited, trading as Teljoy, during + +January 2000, and is in connection with the television and rental segments of the Teljoy Holdings Group. + +Management's original intention was to sell the investment in the near future (Note 29.2). + +These loans were interest free and had no fixed repayment terms. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +13. + +DEFERRED TAXATION + +Deferred taxation asset . . . . . . . . . . . . . . . . . . . . . . . . . + +145.8 + +339.1 + +497.7 + +Deferred taxation liability . . . . . . . . . . . . . . . . . . . . . . . + +(455.6) + +(607.5) + +(926.2) + +(309.8) + +(268.4) + +(428.5) + +13.1 + +Components + +Capital allowances . . . . . . . . . . . . . . . . . . . . . . . . + +(315.5) + +(497.7) + +(822.9) + +Foreign equity revaluation reserve . . . . . . . . . . . . . . . + +- + +- + +(17.9) + +Assessed losses . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +107.2 + +295.9 + +Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +145.8 + +227.6 + +160.8 + +Prepayments and other allowances . . . . . . . . . . . . . . . + +(5.1) + +4.3 + +41.0 + +Acquisition of customer base . . . . . . . . . . . . . . . . . . + +(135.0) + +(109.8) + +(77.5) + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(7.9) + +(309.8) + +(268.4) + +(428.5) + +13.2 + +Reconciliation + +Balance at beginning of year . . . . . . . . . . . . . . . . . . + +(219.4) + +(309.8) + +(268.4) + +Income statement (expense)/income . . . . . . . . . . . . . . + +44.6 + +45.6 + +(112.0) + +Foreign equity revaluation reserve . . . . . . . . . . . . . . . + +- + +- + +(19.9) + +Movement due to IAS 39 adjustment . . . . . . . . . . . . . . + +- + +- + +(36.5) + +Business combinations + +Acquisition of customer base . . . . . . . . . . . . . . . . . + +(130.3) + +(4.5) + +2.7 + +Foreign exchange differences on consolidation + +of foreign subsidiaries . . . . . . . . . . . . . . . . . . . . + +- + +- + +7.2 + +Disposal of subsidiaries . . . . . . . . . . . . . . . . . . . . + +(5.5) + +0. + +3 + +(1.6) + +Rate change . . . . . . . . . . . . . . . . . . . . . . . . . . . + +0.8 + +- + +- + +Balance at end of year . . . . . . . . . . . . . . . . . . . . . . + +(309.8) + +(268.4) + +(428.5) + +Utilization of assessed losses + +Opening assessed loss . . . . . . . . . . . . . . . . . . . . . . + +25.3 + +- + +439.3 + +Current year assessed loss created/(utilized) . . . . . . . . . . + +(25.3) + +439.3 + +682.4 + +Closing assessed loss . . . . . . . . . . . . . . . . . . . . . . + +- + +439.3 + +1,121.7 + +Disposal of subsidiaries and joint venture . . . . . . . . . . . + +- + +- + +(53.3) + +Utilized to reduce deferred taxation . . . . . . . . . . . . . . . + +- + +(357.4) + +(986.3) + +Assessed losses available to reduce deferred taxation . . . . . + +- + +81.9 + +82.1 + +There are unused tax losses to the value of R82.1 million (2001: R81.9 million, 2000: nil) available to reduce + +the net deferred taxation liability. The effect of this would be a reduction in the net deferred taxation liability to + +R403.9 million (2001: R243.8 million, R2000: R309.8 million). A deferred tax asset was not recognized for the + +abovementioned unused tax losses as uncertainty existed at year-end on whether future taxable profits would be + +available to utilise the asset against. The recognition of the future taxable profits relating to the unrecognized + +deferred tax asset will be re-assessed in the next financial period. + +F141 + +F142 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +14. + +INVENTORY + +Finished goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +218.3 + +392.1 + +305.3 + +Other inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3.8 + +6.3 + +0.7 + +222.1 + +398.4 + +306.0 + +15. + +ACCOUNTS RECEIVABLE + +Trade debtors (net of allowance for doubtful accounts of + +R77.0 million (2001: R141.9 million, 2000: R92.9 million) . . . . . + +1,502.7 + +2,041.5 + +2,461.4 + +Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +114.0 + +174.0 + +262.5 + +Value-added taxation . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +57.9 + +31.3 + +Advances made to employees for education and travel . . . . . . . . + +- + +- + +10.2 + +South African Investments Limited short-term portion of the note + +receivable issued as consideration for the disposal of Vodacom Sport + +& Entertainment (Proprietary) Limited. Interest is charged on this + +amount receivable at the prime lending rate minus 1% per annum + +from the transaction date . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +11.8 + +Disposal of Film Fun (Holdings) (Proprietary) Limited . . . . . . . . + +- + +- + +9.0 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +59.7 + +1,616.7 + +2,273.4 + +2,845.9 + +2000 + +2001 + +2002 + +R + +R + +R + +16. + +ORDINARY SHARE CAPITAL + +Authorised + +100,000 ordinary shares of 1 cent each . . . . . . . . . . . . . . . + +1,000 + +1,000 + +1,000 + +Issued + +10,000 ordinary shares of 1 cent each . . . . . . . . . . . . . . . . + +100 + +100 + +100 + +Unissued share capital is not under the control of the Board of Directors. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +17. + +NON-DISTRIBUTABLE RESERVES + +Foreign currency translation reserve . . . . . . . . . . . . . . . . . . + +0.6 + +(2.3) + +117.5 + +Deferred taxation on foreign currency translation reserve . . . . . . + +- + +- + +(19.9) + +Contingency reserve . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +8.5 + +0.6 + +(2.3) + +106.1 + +Reconciliation + +Balance at the beginning of the year . . . . . . . . . . . . . . . . . . + +- + +0.6 + +(2.3) + +Foreign currency translation reserve . . . . . . . . . . . . . . . . . . + +0.6 + +(2.9) + +99.9 + +Foreign currency translation . . . . . . . . . . . . . . . . . . . . . + +0.6 + +(2.9) + +119.8 + +Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(19.9) + +Other non-distributable reserves: + +Transferred from distributable reserves contingency reserve . . . . + +- + +- + +8.5 + +Balance at the end of the year . . . . . . . . . . . . . . . . . . . . . + +0.6 + +(2.3) + +106.1 + +Deferred taxation on the foreign currency translation reserve relates + +only to the translation of equity loans to subsidiaries. + +18. + +MINORITY INTEREST + +Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(2.2) + +(11.4) + +10.6 + +Debit balances reflected in 2001 and 2000 result from losses incurred by certain subsidiaries who have a binding + +obligation to fund their percentage of the losses. + +19. + +INTEREST BEARING DEBT + +2001 + +2001 + +2001 + +2002 + +2002 + +2002 + +Current + +Long-term + +Total + +Current + +Long-term + +Total + +portion + +portion + +portion + +portion + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Finance leases . . . . . . + +0.5 + +496.1 + +496.6 + +10.4 + +780.2 + +790.6 + +Funding loans . . . . . . + +- + +400.0 + +400.0 + +440.0 + +- + +440.0 + +Other short-term loans . . + +- + +- + +- + +565.5 + +- + +565.5 + +0.5 + +896.1 + +896.6 + +1,015.9 + +780.2 + +1,796.1 + +2000 + +2000 + +2000 + +Current + +Long-term + +Total + +portion + +portion + +Rm + +Rm + +Rm + +Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +0.7 + +417.2 + +417.9 + +Funding loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +820.0 + +400.0 + +1,220.0 + +Other short-term loans . . . . . . . . . . . . . . . . . . . . . . . . . + +23.7 + +- + +23.7 + +844.4 + +817.2 + +1,661.6 + +F143 + +F144 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +19. + +INTEREST BEARING DEBT (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +19.1 + +Finance leases + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . . . . . + +416.6 + +495.7 + +502.4 + +The finance leases are collateralised by various land and + +buildings with a book value of R443.0 million (2001: + +R444.9 million, 2000: R363.5 million), bear interest at effective + +interest rates of between 13.85% and 14.69% and are repayable + +between 5 and 13 years. + +Vodacom Service Provider Company (Proprietary) Limited . . . + +- + +- + +288.2 + +The finance leases are collateralised by various land and + +buildings with a book value of R279.4 million, and bear interest + +at a variable nominal interest rate of 13.76% compounded + +monthly. Payments are made every six months in arrear and + +commenced on March 1, 2002. + +The finance lease expires on September 1, 2011. + +Vodacare (Proprietary) Limited . . . . . . . . . . . . . . . . . . + +0.4 + +- + +- + +The finances leases have been paid up in conjunction with the + +merger of the company into Vodacom Service Provider + +Company + +(Proprietary) Limited. + +Teljoy Holdings Limited . . . . . . . . . . . . . . . . . . . . . + +0.9 + +0.9 + +- + +The finance lease bears interest at an effective interest rate + +of 14.5% and is repayable by March 2004. + +Less: Current portion of finance leases: + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . + +- + +- + +(7.1) + +Vodacom Service Provider Company (Proprietary) Limited + +- + +(3.3) + +Vodacare (Proprietary) Limited . . . . . . . . . . . . . . + +(0.4) + +- + +- + +Teljoy Holdings Limited . . . . . . . . . . . . . . . . . . + +(0.3) + +(0.5) + +- + +(0.7) + +(0.5) + +(10.4) + +Long-term portion of finance leases . . . . . . . . . . . . . . . + +417.2 + +496.1 + +780.2 + +The fair value of the Group's finance lease liability is + +R790.6 million (2001: R496.6 million, 2000: R417.9 million). + +19.2 + +Funding loans + +Commerzbank AG . . . . . . . . . . . . . . . . . . . . . . . . + +350.0 + +200.0 + +200.0 + +The R200 million loan is uncollateralised, bears interest at a + +fixed rate of 13.7% NACQ (Nominal Amount Compounded + +Quarterly) and is repayable on March 17, 2003. The + +R150 million loan was uncollateralised, bore interest at a + +fixed rate of 14.9% NACM (Nominal Amount Compounded + +Monthly) and was repaid on May 21, 2000. + +Crdit Agricole Indosuez . . . . . . . . . . . . . . . . . . . . . + +200.0 + +200.0 + +200.0 + +The loan is uncollateralised, bears interest at a fixed rate of 14%. + +NACQ and is repayable on March 17, 2003. + +RMB Corporate Finance (Proprietary) Limited . . . . . . . . . + +670.0 + +- + +- + +Second instalment paid by Vodacom Group (Proprietary) + +Limited to RMB Corporate Finance (Proprietary) Limited on + +April 17, 2002 for the purchase of shares in Teljoy Holdings + +Limited. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +19. + +INTEREST BEARING DEBT (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +19.2 + +Funding loans (continued) + +Vodacom Tanzania Limited . . . . . . . . . . . . . . . . . . . + +- + +- + +40.0 + +The shareholders' loans from Planetel Communications Limited + +and Caspian Construction Company Limited are + +uncollateralised, bear interest at LIBOR plus 1% and are + +repayable when at least 60% of the shareholders with voting + +powers agree on repayment. + +Less: Current portion of funding loans: + +Commerzbank AG . . . . . . . . . . . . . . . . . . . . + +(150.0) + +(200.0) + +Crdit Agricole Indosuez . . . . . . . . . . . . . . . . . + +(200.0) + +RMB Corporate Finance (Proprietary) Limited . . . . . + +(670.0) + +Vodacom Tanzania Limited . . . . . . . . . . . . . . . . + +(40.0) + +(820.0) + +(440.0) + +Long-term portion of funding loans . . . . . . . . . . . . . . . + +400.0 + +400.0 + +- + +The fair value of the Group's funding loan liability is + +R444.6 million (2001: R413.9 million, 2000: R1,217.9 million). + +19.3 + +Other short-term loans + +Vodacom Tanzania Limited . . . . . . . . . . . . . . . . . . . + +- + +- + +539.4 + +The loan of $47.2 million from Standard Bank of London is + +uncollateralised, bears interest at an effective interest rate of + +LIBOR rate plus 1.5% and is repayable by June 30, 2002. + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . . . . + +23.7 + +- + +26.1 + +23.7 + +- + +565.5 + +The fair value of the Group's short-term loans is R565.5 million + +(2001: nil, 2000: R23.7 million). + +19.4 + +Repayment of interest bearing debt + +2003 + +2004 + +2005 + +2006 + +2007 + +Total + +onwards + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Finance leases + +Vodacom (Proprietary) + +Limited . . . . . . . . . . . + +7.1 + +(5.7) + +8.7 + +20.4 + +471.9 + +502.4 + +Vodacom Service Provider + +Company (Proprietary) + +Limited . . . . . . . . . . . + +3.3 + +(2.4) + +1.5 + +6.6 + +279.2 + +288.2 + +Funding loans + +Commerzbank AG . . . . . + + 200.0 + +- + +- + +- + +- + +200.0 + +Crdit Agricole Indosuez . + + 200.0 + +- + +- + +- + +- + +200.0 + +Other short-term loans . . . + + 565.5 + +- + +- + +- + +- + +565.5 + +Vodacom Tanzania Limited + +40.0 + +- + +- + +- + +- + +40.0 + + 1,015.9 + +(8.1) + +10.2 + +27.0 + +751.1 + + 1,796.1 + +F145 + +F146 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +20. + +SHAREHOLDER LOANS + +Telkom SA Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +535.0 + +460.0 + +460.0 + +Vodafone Group Plc . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +171.6 + +124.3 + +124.3 + +Vodafone Holdings (SA) (Proprietary) Limited . . . . . . . . . . . . . . + +165.5 + +165.5 + +165.5 + +VenFin Finansieringskorporasie (Proprietary) Limited . . . . . . . . . . + +144.4 + +124.2 + +124.2 + +Descarte Investments No. 8 (Proprietary) Limited . . . . . . . . . . . . + +53.5 + +46.0 + +46.0 + + 1,070.0 + +920.0 + +920.0 + +The shareholder loans are uncollateralised and bear interest at a rate of + +prime plus 2% (2000, 2001 and 2002). The average effective interest rate + +per annum during the year was 15.69% (2001: 17.16%, 2000: 18.81%). + +The loans are repayable on demand of all the shareholders by no later + +than March 31, 2019. The shareholders have deferred their right to claim + +or accept payment of the amounts owing to them in favour of all other + +creditors in the event of the liquidation of Vodacom Group (Proprietary) + +Limited or similar events. + +21. + +ACCOUNTS PAYABLE + +Trade creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +482.3 + +1,423.7 + +2,030.0 + +Income charged in advance . . . . . . . . . . . . . . . . . . . . . . . . + +470.3 + +782.6 + +602.5 + +Capital expenditure creditors . . . . . . . . . . . . . . . . . . . . . . . + +421.6 + +664.8 + +457.8 + +Value-added taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +11.0 + +45.5 + +16.3 + +Interest accrual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +22.3 + +28.9 + +5.7 + +Sundry accounts payable and accruals . . . . . . . . . . . . . . . . . . + +347.2 + +207.3 + +89.4 + +1,754.7 + +3,152.8 + +3,201.7 + +22. + +NON-INTEREST BEARING DEBT + +Vodacom Tanzania Limited . . . . . . . . . . . . . . . . . . . . . . . . + +28.1 + +- + +Shareholders' loans from Planatel Communication Limited of + +R15.3 million, and from Caspian Construction Company Limited of + +R12.8 million, respectively. These loans are uncollateralised and no + +repayment terms have been determined. + +During the 2002 financial year the terms of these loans were amended + +and as of April 1, 2002 they bear interest. + +Vodacom Lesotho (Proprietary) Limited . . . . . . . . . . . . . . . . . + +4.3 + +4.3 + +4.3 + +The shareholder's loan is uncollateralised and no repayment terms + +have been determined. + +The fair value of the Group's non-interest bearing debt liabilities + +could not be readily determined. + +4.3 + +32.4 + +4.3 + +23. + +PROVISIONS + +Deferred bonus incentive provision . . . . . . . . . . . . . . . . . . . . + +123.8 + +214.4 + +311.4 + +Bonus provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +48.1 + +66.0 + +95.8 + +Leave pay provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +27.0 + +33.6 + +44.6 + +Warranty provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +15.8 + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +38.5 + +36.4 + +39.9 + +237.4 + +350.4 + +507.5 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +23. + +PROVISIONS (continued) + +Reconciliation + +Deferred Bonus + +Leave pay + + Warranty + +Other + +2000 + + bonus + +provision + + provision + + provision + +incentive + +provision + +Rm + +Rm + +Rm + +Rm + +Rm + +Balance at beginning of year . . . . . + +46.9 + +39.6 + +14.3 + +- + +15.0 + +Provision created . . . . . . . . . . . + +76.9 + +39.3 + +12.7 + +- + +23.5 + +Provision utilized . . . . . . . . . . . + +- + +(30.8) + +- + +- + +- + +Balance at end of year . . . . . . . . + +123.8 + +48.1 + +27.0 + +- + +38.5 + +Reconciliation + +Deferred Bonus + +Leave pay + + Warranty + +Other + +2001 + + bonus + + provision + +provision + + provision + +incentive + +provision + +Rm + +Rm + +Rm + +Rm + +Rm + +Balance at beginning of year . . . . . + +123.8 + +48.1 + +27.0 + +- + +38.5 + +Provision created . . . . . . . . . . . + +133.4 + +48.1 + +13.1 + +- + +69.5 + +Provision utilized . . . . . . . . . . . + +(42.8) + +(30.2) + +(6.5) + +- + +(71.6) + +Balance at end of year . . . . . . . . + +214.4 + +66.0 + +33.6 + +- + +36.4 + +Reconciliation + +Deferred Bonus + +Leave pay + +Warranty + +Other + +2002 + +bonus + +provision + +provision + +provision + +incentive + +provision + +Rm + +Rm + +Rm + +Rm + +Rm + +Balance at beginning of year . . . . . + +214.4 + +66.0 + +33.6 + +- + +36.4 + +Provision created . . . . . . . . . . . + +161.8 + +112.0 + +19.5 + +53.8 + +84.0 + +Provision utilized . . . . . . . . . . . + +(64.8) + +(82.2) + +(8.5) + +(38.0) + +(80.5) + +Balance at end of year . . . . . . . . + +311.4 + +95.8 + +44.6 + +15.8 + +39.9 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Timing of provisions + +Within one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +198.7 + +273.8 + +319.5 + +After one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +38.7 + +76.6 + +188.0 + +237.4 + +350.4 + +507.5 + +23.1 + +Deferred bonus incentive provision + +The deferred bonus incentive provision represents the present value of bonus entitlements at balance sheet date. + +The value of the bonus entitlements are determined based on the audited consolidated financial statements of + +Vodacom Group (Proprietary) Limited. Periodically, a number of entitlements are issued to employees, the + +value of which depends on the level of the employee. + +The participating rights of employees vest in two equal portions after three and six years, respectively, and + +employees are entitled to cash in their entitlements within one year after the participating rights have vested. + +The provision created represents the present value of the expected future cash out flows of the entitlement + +value at balance sheet date less the value at which the entitlements were issued, multiplied by the number of + +entitlements allocated to a participant. + +The provision is utilized when eligible employees receive the value of vested entitlements. + +F147 + +F148 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +23. + +PROVISIONS (continued) + +23.2 + +Bonus provision + +The bonus provision consists of a profit based performance bonus. The performance bonus is payable at the + +sole discretion of the shareholders in May each year to Level 1 4 employees and payable bi-annually in + +December and May to Level 5 and 6 employees. The maximum bonus payable is determined by applying a + +specific formula based on Vodacom Group (Proprietary) Limited's consolidated profit and the employee's + +achievement of performance targets. The employee must be in service on May 31, to qualify for the bonus. + +23.3 + +Leave pay provision + +The leave pay provision relates to vested leave pay to which employees may become entitled upon leaving the + +employment of the Group. The provision arises as employees render a service that increases their entitlement + +to future compensated leave. The provision is utilized when employees who are entitled to leave pay, leave the + +employment of the Group or when the accrued leave due to an employee, is utilized. + +23.4 + +Warranty provision + +During the 2002 financial year, the warranty provision was created to cover manufacturing defects in the + +second year of warranty on handsets sold to customers. + +24. + +CHANGE IN ACCOUNTING POLICY + +The Group changed its accounting policy for foreign exchange contracts and other financial instruments due to the + +adoption of International Accounting Standard 39 Financial Instruments: Recognition and Measurement during + +the year ended March 31, 2002. Under the new policy, the Group elected not to apply hedge accounting to foreign + +exchange contracts and therefore all fair value adjustments are recognized in the income statement in the period in + +which they occur. + +Interest rate swaps are also recorded and measured at fair value. All changes in fair value are recognized in the + +income statement in the period in which they occur. + +These changes have had the effect of increasing net profit for the year and retained profit at the beginning of the year, + +and have been applied prospectively: + +Net profit + + Retained + + earnings + +Rm + +Rm + +Gross effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +352.3 + +121.4 + +Foreign exchange contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +347.4 + +104.2 + +Derivatives interest rate swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +4.9 + +17.2 + +Taxation effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(105.7) + +(36.5) + +Foreign exchange contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(104.2) + +(31.3) + +Interest rate swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.5) + +(5.2) + +246.6 + +84.9 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +25. + +CASH GENERATED FROM OPERATIONS + +Profit from operations . . . . . . . . . . . . . . . . . . . . . . . . + +2,363.3 + +2,553.4 + +3,621.1 + +Adjusted for: + +Depreciation of property, plant and equipment . . . . . . . . . . . . + +1,025.3 + +1,364.1 + +1,857.3 + +Net loss/(profit) on disposal of property, plant and equipment . . . . + +9.6 + +(0.4) + +(3.4) + +Revaluation of equity investment . . . . . . . . . . . . . . . . . . . + +- + +- + +8.9 + +Recoupment of Gateway asset accrual . . . . . . . . . . . . . . . . . + +- + +- + +(15.0) + +Bad debts written-off . . . . . . . . . . . . . . . . . . . . . . . . . . + +16.5 + +107.4 + +111.2 + +Capital (profit)/loss on disposal of subsidiaries . . . . . . . . . . . . + +(129.3) + +213.2 + +(16.3) + +GSM investment write-off . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +0.3 + +Impairment of assets . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(1.0) + +Amortization of intangible assets . . . . . . . . . . . . . . . . . . . + +73.6 + +271.5 + +212.7 + +Cash flow from operations before working capital changes . . . . . . + +3,359.0 + +4,509.2 + +5,775.8 + +Decrease/(Increase) in accounts receivable . . . . . . . . . . . . . . + +40.5 + +(718.9) + +(264.5) + +(Increase)/Decrease in inventory . . . . . . . . . . . . . . . . . . . . + +(42.3) + +(162.5) + +93.3 + +(Decrease)/Increase in accounts payable and provisions . . . . . . . + +(175.2) + +1,035.8 + +583.5 + +Cash generated from operations . . . . . . . . . . . . . . . . . . . . + +3,182.0 + +4,663.6 + +6,188.1 + +26. + +FINANCE COSTS PAID + +Shareholder loans . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(202.1) + +(157.9) + +(144.2) + +Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(61.2) + +(60.8) + +(98.9) + +Funding loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(69.8) + +(65.7) + +(87.2) + +Bank and other interest . . . . . . . . . . . . . . . . . . . . . . . . + +(99.4) + +(162.9) + +(81.2) + +Interest accrual at beginning of year . . . . . . . . . . . . . . . . . . + +(9.4) + +(22.3) + +(28.9) + +Interest accrual at end of year . . . . . . . . . . . . . . . . . . . . . + +22.3 + +28.9 + +5.7 + +(419.6) + +(440.7) + +(434.7) + +(Loss)/Gain on forward exchange contracts and liability revaluations + +(133.7) + +(56.1) + +347.4 + +Unrealized losses on revaluation of foreign exchange contracts . . . + +- + +- + +(220.4) + +Unrealized losses on spot rate revaluation of creditor . . . . . . . . . + +- + +- + +(41.0) + +Unrealized gain on interest rate swap revaluation . . . . . . . . . . . + +- + +- + +2.2 + +Other non-cash flow items . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(31.9) + +Interest rate swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(1.0) + +(1.1) + +4.3 + +(554.3) + +(497.9) + +(374.1) + +27. + +TAXATION PAID + +Taxation per the income statement . . . . . . . . . . . . . . . . . . . + +(513.6) + +(765.7) + +(1,190.7) + +Taxation payable at beginning of year . . . . . . . . . . . . . . . . . + +(288.6) + +(560.1) + +(810.0) + +Taxation payable at end of year . . . . . . . . . . . . . . . . . . . . + +560.1 + +810.0 + +351.6 + +Deferred taxation at beginning of year . . . . . . . . . . . . . . . . + +(219.4) + +(309.8) + +(268.4) + +Deferred taxation at end of year . . . . . . . . . . . . . . . . . . . . + +309.8 + +268.4 + +428.5 + +Business combination . . . . . . . . . . . . . . . . . . . . . . . . . + +(166.6) + +(10.4) + +(0.9) + +Movement due to IAS 39 adjustment . . . . . . . . . . . . . . . . . + +- + +- + +(36.5) + +Movement due to revaluation of equity loans . . . . . . . . . . . . . + +- + +- + +(19.9) + +Exchange difference on consolidation of foreign subsidiary . . . . . + +- + +- + +7.2 + +(318.3) + +(567.6) + +(1,539.1) + +F149 + +F150 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +28. + +ADDITIONS TO PROPERTY, PLANT AND EQUIPMENT + +Additions to property, plant and equipment (Note 9) . . . . . . . + +2,022.0 + +3,184.2 + +4,085.3 + +Less: Property, plant and equipment acquired in business + +combinations . . . . . . . . . . . . . . . . . . . . . . . . . + +(3.1) - - + +Vodacom (Proprietary) Limited finance leases . . . . . . . . . . . + +(10.4) + +(106.3) - + +Vodacom Service Provider Company (Proprietary) + +Limited finance leases . . . . . . . . . . . . . . . . . . . . . . . + + - - (282.2) + +Increase/(Decrease) in capex-related creditors . . . . . . . . . . . + +684.7 + +(243.0) + +606.0 + +2,693.2 + +2,834.9 + +4,409.1 + +29. + +DISPOSAL/(ACQUISITION) OF SUBSIDIARIES + +Disposals of subsidiaries + +Vodacom Sport & Entertainment (Proprietary) Limited + +(Note 29.1(a)) . . . . . . . . . . . . . . . . . . . . . . . . . . . + + - - 17.9 + +Film Fun (Holdings) (Proprietary) Limited (Note 29.1(b)) . . . . + + - - (16.2) + + - - 1.7 + +Acquisition of subsidiaries + +Vodacom International Holdings (Proprietary) Limited and + +Vodacom International Limited (Note 29.2(a)) . . . . . . . . . . . + + - + + - + +(0.1) + +Globalstar Southern Africa (Proprietary) Limited (Note 29.2(b)) . + +- + +(91.1) + +- + +GSM Cellular (Proprietary) Limited (Note 29.2(c)) . . . . . . . . + +(71.4) + + - - + +Vodacom Sport & Entertainment (Proprietary) Limited + +(Note 29.2(d)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +7.9 + +- + +Teljoy Holdings Limited (Note 29.2(e)) . . . . . . . . . . . . . . + +(627.9) + +- + +- + +Film Fun (Holdings) (Proprietary) Limited (Note 29.2(e)) . . . . + +- + +(8.5) + +- + +Vodacom Tanzania Limited (Note 29.2(f)) . . . . . . . . . . . . . + +- + +(28.9) + +- + +Vodacom Tanzania Limited (Note 29.2(g)) . . . . . . . . . . . . . + +- + +6.8 + +- + +(699.3) + +(113.8) + +(0.1) + + VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +29. + +DISPOSAL/(ACQUISITION) OF SUBSIDIARIES (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +29.1 + +Subsidiaries disposed + +(a) + +Vodacom Sport and & Entertainment (Proprietary) Limited + +On February 27, 2002, the Group disposed of its 51% + +interest in Vodacom Sport and & Entertainment + +(Proprietary) Limited. The fair value of the assets and + +liabilities disposed were as follows: + +Carrying amount of net assets disposed of . . . . . . . + +9.8 + +Property, plant and equipment . . . . . . . . . . . . + +1.3 + +Investments . . . . . . . . . . . . . . . . . . . . . . + +2.7 + +Inventory . . . . . . . . . . . . . . . . . . . . . . . + +0.5 + +Accounts receivable . . . . . . . . . . . . . . . . . + +228.6 + +Deferred taxation . . . . . . . . . . . . . . . . . . . + +1.6 + +Cash and cash equivalents . . . . . . . . . . . . . . + +4.6 + +Accounts payable . . . . . . . . . . . . . . . . . . . + +(227.9) + +Taxation payable . . . . . . . . . . . . . . . . . . . + +(0.4) + +Value-added-tax payable . . . . . . . . . . . . . . . + +(1.2) + +Minority interest . . . . . . . . . . . . . . . . . . . . + +(4.8) + +Capital gain on disposal . . . . . . . . . . . . . . . . . + +40.0 + +Selling price . . . . . . . . . . . . . . . . . . . . . . . + +45.0 + +Cash and cash equivalents . . . . . . . . . . . . . . . + +(4.6) + +Cash consideration . . . . . . . . . . . . . . . . . . . + +40.4 + +Less: Amount receivable . . . . . . . . . . . . . . . . + +(22.5) + +17.9 + +Selling price satisfied by: . . . . . . . . . . . . . . . + +45.0 + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . + +22.5 + +Deferred consideration to be settled in two equal + +instalments on August 31, 2002 and August 31, 2003. + +The amount receivable is reflected under investments + +and accounts receivable as a note receivable + +(Notes 11 and 14) . . . . . . . . . . . . . . . . . . . . + +22.5 + +F151 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +29. + +DISPOSAL/(ACQUISITION) OF SUBSIDIARIES (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +29.1 Subsidiaries disposed + +(a) Vodacom Sport and & Entertainment (Proprietary) Limited + +On February 27, 2002, the Group disposed of its 51% + +interest in Vodacom Sport and & Entertainment + +(Proprietary) Limited. The fair value of the assets and + +liabilities disposed were as follows: + +Carrying amount of net assets disposed of . . . . . . . + +9.8 + +Property, plant and equipment . . . . . . . . . . . . + +1.3 + +Investments . . . . . . . . . . . . . . . . . . . . . . + +2.7 + +Inventory . . . . . . . . . . . . . . . . . . . . . . . + +0.5 + +Accounts receivable . . . . . . . . . . . . . . . . . + +228.6 + +Deferred taxation . . . . . . . . . . . . . . . . . . . + +1.6 + +Cash and cash equivalents . . . . . . . . . . . . . . + +4.6 + +Accounts payable . . . . . . . . . . . . . . . . . . . + +(227.9) + +Taxation payable . . . . . . . . . . . . . . . . . . . + +(0.4) + +Value-added-tax payable . . . . . . . . . . . . . . . + +(1.2) + +Minority interest . . . . . . . . . . . . . . . . . . . . + +(4.8) + +Capital gain on disposal . . . . . . . . . . . . . . . . . + +40.0 + +Selling price . . . . . . . . . . . . . . . . . . . . . . . + +45.0 + +Cash and cash equivalents . . . . . . . . . . . . . . . + +(4.6) + +Cash consideration . . . . . . . . . . . . . . . . . . . + +40.4 + +Less: Amount receivable . . . . . . . . . . . . . . . . + +(22.5) + +17.9 + +Selling price satisfied by: . . . . . . . . . . . . . . . + +45.0 + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . + +22.5 + +Deferred consideration to be settled in two equal + +instalments on August 31, 2002 and August 31, 2003. + +The amount receivable is reflected under investments + +and accounts receivable as a note receivable + +(Notes 11 and 14) . . . . . . . . . . . . . . . . . . . . + +22.5 + +F151 + +F152 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +29. + +DISPOSAL/(ACQUISITION) OF SUBSIDIARIES (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +29.1 + +Subsidiaries disposed (continued) + +(b) + +Film Fun (Holdings) (Proprietary) Limited + +On March 31, 2002, the Group disposed of it's interest + +in Film Fun (Holdings) (Proprietary) Limited, Africell + +Cellular Services (Proprietary) Limited and Teljoy + +(Botswana) (Proprietary) Limited. The fair value of the + +assets and liabilities disposed were as follows: + +Carrying amount of net assets disposed of . . . . . . . + + - + + - + +62.8 + +Property, plant and equipment . . . . . . . . . . . . + + - + + - + +64.7 + +Loan Teljoy Holdings Limited . . . . . . . . . . . + + - + + - + +28.0 + +Goodwill . . . . . . . . . . . . . . . . . . . . . . . + + - + + - + +15.9 + +Cash and cash equivalents . . . . . . . . . . . . . . + + - + + - + +16.2 + +Accounts receivable . . . . . . . . . . . . . . . . . + +- - + +7.2 + +Inventory . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +5.3 + +Shareholding in subsidiaries . . . . . . . . . . . . . + +- + +- + +4.2 + +Investments . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +3.3 + +Taxation receivable . . . . . . . . . . . . . . . . . . + +- + +- + +1.1 + +Accounts payable . . . . . . . . . . . . . . . . . . . + +- + +- + +(64.2) + +Provision for licences . . . . . . . . . . . . . . . . + +- + +- + +(25.0) + +Deferred taxation . . . . . . . . . . . . . . . . . . . + +- + +- + +(2.7) + +Non-distributable reserve . . . . . . . . . . . . . . . + +- + +- + +(0.2) + +Trademark . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +9.0 + +Capital loss on disposal . . . . . . . . . . . . . . . . . + +- + +- + +(53.8) + +Selling price . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +9.0 + +Cash and cash equivalents . . . . . . . . . . . . . . . + +- + +- + +(16.2) + +Cash consideration . . . . . . . . . . . . . . . . . . . + +- + +- + +(7.2) + +Less: Amount receivable . . . . . . . . . . . . . . . . + +- + +- + +(9.0) + +- + +- + +(16.2) + +Selling price satisfied by: . . . . . . . . . . . . . . . . + +- + +- + +9.0 + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Deferred consideration . . . . . . . . . . . . . . . . + +- + +- + +9.0 + +The deferred consideration was settled in cash by the + +new owners on May 15, 2002. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +29. + +DISPOSAL/(ACQUISITION) OF SUBSIDIARIES (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +29.2 + +Subsidiaries acquired + +(a) + +Vodacom International Holdings (Proprietary) + +Limited and Vodacom International Limited + +Both companies became operational from April 1, 2001. + +Vodacom Group (Proprietary) Limited holds 100% of the + +issued share capital of Vodacom International Holdings + +(Proprietary) Limited, who in turn holds 100% of the + +issued share capital of Vodacom International Limited, a + +company based in Mauritius. The fair value of the share + +capital acquired is as follows: + +Share capital . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +(0.1) + +(b) + +Globalstar Southern Africa (Proprietary) Limited + +During the 2001 financial year the Group acquired 100% + +of Globalstar Southern Africa (Proprietary) Limited. The + +fair value of the assets acquired and liabilities assumed + +were as follows: + +Fair value of net assets acquired . . . . . . . . . . . . + +- + +(43.5) + +- + +Property, plant and equipment . . . . . . . . . . . . + +- + +96.6 + +- + +Inventory . . . . . . . . . . . . . . . . . . . . . . . + +- + +0.7 + +- + +Accounts receivable . . . . . . . . . . . . . . . . . + +- + +1.9 + +- + +Cash and cash equivalents . . . . . . . . . . . . . . + +- + +10.0 + +- + +Shareholder loans . . . . . . . . . . . . . . . . . . . + +- + +(33.0) + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . + +- + +(32.7) + +- + +Goodwill (amortized over five years) . . . . . . . . . . + +- + +(24.6) + +- + +Shareholder loans . . . . . . . . . . . . . . . . . . . . + +- + +(33.0) + +- + +Purchase price . . . . . . . . . . . . . . . . . . . . . . + +- + +(101.1) + +- + +Cash and cash equivalents . . . . . . . . . . . . . . . + +- + +10.0 + +- + +Cash consideration . . . . . . . . . . . . . . . . . . . + +- + +(91.1) + +- + +(c) + +GSM Cellular (Proprietary) Limited + +During the 2000 financial year the Group acquired an + +additional 50% of GSM Cellular (Proprietary) Limited to + +take the total shareholding to 100% and resulted in the + +company being treated as a subsidiary. + +Fair value of net assets acquired . . . . . . . . . . . . + +(38.9) + +- + +- + +Long-term loans . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Property, plant and equipment . . . . . . . . . . . . + +8.1 + +- + +- + +Inventory . . . . . . . . . . . . . . . . . . . . . . . + +7.8 + +- + +- + +Accounts receivable . . . . . . . . . . . . . . . . . + +27.2 + +- + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . + +(54.3) + +- + +- + +Short-term loans . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . + +3.9 + +- + +- + +Customer base . . . . . . . . . . . . . . . . . . . . + +66.0 + +- + +- + +Deferred taxation customer base . . . . . . . . . . + +(19.8) + +- + +- + +Goodwill (amortized over five years) . . . . . . . . . . + +(36.4) + +- + +- + +Purchase price . . . . . . . . . . . . . . . . . . . . . . + +(75.3) + +- + +- + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . + +3.9 + +- + +- + +Cash consideration . . . . . . . . . . . . . . . . . . . + +(71.4) + +- + +- + +F153 + +F154 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +29. + +DISPOSAL/(ACQUISITION) OF SUBSIDIARIES (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +29.2 + +Subsidiaries acquired (continued) + +(d) + +Vodacom Sport and & Entertainment (Proprietary) Limited + +During the financial year ended March 31, 2000, Vodacom + +Sport & Entertainment (Proprietary) Limited was treated + +as a joint venture and proportionately consolidated at + +51%, but from the 2001 financial year, it was consolidated + +in full. + +The adjustments that were made are as follows: + +Fair value of net assets acquired . . . . . . . . . . . . . + +- + +(1.0) + +- + +Property, plant and equipment . . . . . . . . . . . . . + +- + +0.9 + +- + +Deferred taxation . . . . . . . . . . . . . . . . . . . . + +- + +0.3 + +- + +Investments . . . . . . . . . . . . . . . . . . . . . . . + +- + +0.1 + +- + +Accounts receivable . . . . . . . . . . . . . . . . . . . + +- + +9.3 + +- + +Cash and cash equivalents . . . . . . . . . . . . . . . + +- + +7.9 + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . . + +- + +(15.0) + +- + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(2.5) + +- + +Net assets acquired . . . . . . . . . . . . . . . . . . . . + +- + +8.9 + +- + +Cash consideration . . . . . . . . . . . . . . . . . . . . . + +- + +7.9 + +- + +(e) + +Teljoy Holdings Limited + +During the 2000 financial year the Group acquired 100% of + +Teljoy Holdings Limited. Included in this acquisition, the + +Group acquired 100% of of Film Fun (Holdings) + +(Proprietary) Limited trading as Teljoy. The investment was + +consolidated from the 2001 financial year (Note 12). The fair + +value of the assets acquired and liabilities assumed were as + +follows: + +Fair value of net assets acquired . . . . . . . . . . . . . + +(449.1) + +(19.2) + +- + +Long-term loans . . . . . . . . . . . . . . . . . . . . . + +(0.6) + +(20.4) + +- + +Minority interest . . . . . . . . . . . . . . . . . . . . + +(0.8) + +- + +- + +Deferred taxation . . . . . . . . . . . . . . . . . . . . + +(5.5) + +- + +- + +Property, plant and equipment . . . . . . . . . . . . . + +27.6 + +126.9 + +- + +Intangible assets . . . . . . . . . . . . . . . . . . . . . + +33.2 + +0.3 + +- + +Investments . . . . . . . . . . . . . . . . . . . . . . . + +11.0 + +0.3 + +- + +Inventory . . . . . . . . . . . . . . . . . . . . . . . . + +26.1 + +12.9 + +- + +Accounts receivable . . . . . . . . . . . . . . . . . . . + +207.4 + +17.2 + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . . + +(239.8) + +(46.7) + +- + +Cash and cash equivalents . . . . . . . . . . . . . . . + +132.5 + +(8.4) + +- + +Customer base . . . . . . . . . . . . . . . . . . . . . + +368.5 + +- + +- + +Deferred taxation customer base . . . . . . . . . . . + +(110.5) + +- + +- + +Trademark . . . . . . . . . . . . . . . . . . . . . . . . + +- + +15.0 + +- + +Deferred taxation trademark . . . . . . . . . . . . . + +- + +(4.5) + +- + +Shareholder loans . . . . . . . . . . . . . . . . . . . . + +- + +(70.0) + +- + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +(3.4) + +- + +Goodwill (amortized over five years) . . . . . . . . . . . + +(311.3) + +(26.6) + +- + +Purchase price (2001: previously accounted for under + +investing activities) . . . . . . . . . . . . . . . . . . . . + +(760.4) + +(45.8) + +- + +Cash and cash equivalents . . . . . . . . . . . . . . . . . + +132.5 + +- + +- + +Net cash-flow on acquisition of wholly-owned subsidiary + +54.3 + +- - + +Cash consideration . . . . . . . . . . . . . . . . . . . . . + +(627.9) + +(8.5) + +- + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +29. + +DISPOSAL/(ACQUISITION) OF SUBSIDIARIES (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +29.2 + +Subsidiaries acquired (continued) + +(f) + +Vodacom Tanzania Limited + +On July 14, 2000, the Group acquired an additional 14% + +of Vodacom Tanzania Limited. The fair value of the assets + +acquired and liabilities assumed were as follows: + +Fair value of net assets acquired . . . . . . . . . . . . . + +- + +9.6 + +- + +Property, plant and equipment . . . . . . . . . . . . . + +- + +6.7 + +- + +Intangible assets . . . . . . . . . . . . . . . . . . . . . + +- + +6.8 + +- + +Inventory . . . . . . . . . . . . . . . . . . . . . . . . + +- + +10.2 + +- + +Accounts receivable . . . . . . . . . . . . . . . . . . . + +- + +6.8 + +- + +Cash and cash equivalents . . . . . . . . . . . . . . . + +- + +2.7 + +- + +Shareholder loans . . . . . . . . . . . . . . . . . . . . + +- + +(39.2) + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . . + +- + +(3.6) + +- + +Minority interest . . . . . . . . . . . . . . . . . . . . . . + +- + +(3.4) + +- + +Investments previously recognized . . . . . . . . . . . . + +- + +(4.9) + +- + +Goodwill (amortized over five years) . . . . . . . . . . . + +- + +(30.2) + +- + +Cash consideration . . . . . . . . . . . . . . . . . . . . . + +- + +(28.9) + +- + +(g) + +Vodacom Tanzania Limited + +During the financial year ended March 31, 2000, Vodacom + +Tanzania Limited was treated as a joint venture and + +proportionately consolidated at 51%, but from the 2001 + +financial year, it was consolidated in full as the change in + +shareholding changed the nature of the investment. The + +additional percentage acquired resulted in Vodacom + +Group (Proprietary) Limited obtaining control. The + +adjustments that were made are as follows: + +Fair value of net assets acquired . . . . . . . . . . . . . + +- + +(1.0) + +- + +Property, plant and equipment . . . . . . . . . . . . . + +- + +0.7 + +- + +Intangible assets . . . . . . . . . . . . . . . . . . . . . + +- + +3.2 + +- + +Investments . . . . . . . . . . . . . . . . . . . . . . . + +- + +4.7 + +- + +Accounts receivable . . . . . . . . . . . . . . . . . . . + +- + +0.4 + +- + +Cash and cash equivalents . . . . . . . . . . . . . . . + +- + +6.8 + +- + +Non-distributable reserve . . . . . . . . . . . . . . . . + +- + +0.1 + +- + +Shareholder loans . . . . . . . . . . . . . . . . . . . . + +- + +(16.0) + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . . + +- + +(0.9) + +- + +Net assets acquired . . . . . . . . . . . . . . . . . . . . + +- + +7.8 + +- + +Cash consideration . . . . . . . . . . . . . . . . . . . . . + +- + +6.8 + +- + +F155 + +F156 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +30. + +(ACQUISITION)/DISPOSAL OF JOINT VENTURES + +Disposal of joint ventures + +Joint ventures disposed Vodacom World Online (Proprietary) + +Limited (Note 30.2) . . . . . . . . . . . . . . . . . . . . . . . . . + +51.8 + +- + +23.3 + +Acquisition of joint ventures + +Joint ventures acquired Vodacom World Online (Proprietary) + +Limited (Note 30.1) . . . . . . . . . . . . . . . . . . . . . . . . . + +(120.7) + +- + +- + +Vodacom Congo (R.D.C.) S.P.R.L. . . . . . . . . . . . . . . . . . + +- + +- + +- + +During the 2002 financial year Vodacom Congo (R.D.C.) S.P.R.L. + +was formed and financed by the Group and accordingly it had no + +cash effect on the Group's cash flow . . . . . . . . . . . . . . . . . + +(120.7) + +- + +- + +30.1 + +Joint ventures acquired + +(a) + +Vodacom World Online (Proprietary) Limited + +During the 2000 financial year, subsequent to the disposal + +of the Internet Division (Note 31), the Group acquired + +50% of Vodacom World Online (Proprietary) Limited. + +Fair value of net assets acquired . . . . . . . . . . . . . + +(9.4) + +- + +- + +Long-term loans . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Property, plant and equipment . . . . . . . . . . . . . + +3.1 + +- + +- + +Investments . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Inventory . . . . . . . . . . . . . . . . . . . . . . . . + +0.4 + +- + +- + +Accounts receivable . . . . . . . . . . . . . . . . . . + +16.9 + +- + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . + +(23.0) + +- + +- + +Short-term loans . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . + +12.0 + +- + +- + +Goodwill (amortized over three years) . . . . . . . . . . + +(123.3) + +- + +- + +Purchase price . . . . . . . . . . . . . . . . . . . . . . + +(132.7) + +- + +- + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +12.0 + +- + +- + +Cash consideration . . . . . . . . . . . . . . . . . . . . + +(120.7) + +- + +- + +30.2 + +Joint ventures disposed + +(a) + +Vodacom World Online (Proprietary) Limited + +During the 2000 financial year, subsequent to the + +acquisition described above, the Group disposed of 10% + +of the joint venture in Vodacom World Online + +(Proprietary) Limited. + +Carrying amount of net liabilities disposed of . . . . . . + +(3.2) + +- + +- + +Property, plant and equipment . . . . . . . . . . . . . + +2.0 + +- + +- + +Accounts receivable . . . . . . . . . . . . . . . . . . + +3.7 + +- + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . + +(8.2) + +- + +- + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . + +(0.7) + +- + +- + +Capital gain on disposal . . . . . . . . . . . . . . . . . + +54.3 + +- + +- + +Selling price . . . . . . . . . . . . . . . . . . . . . . . . + +51.1 + +- + +- + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +0.7 + +- + +- + +Cash consideration . . . . . . . . . . . . . . . . . . . . + +51.8 + +- + +- + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +30. + +(ACQUISITION)/DISPOSAL OF JOINT VENTURES (continued) + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +30.2 + +Joint ventures disposed (continued) + +(b) + +Vodacom World Online (Proprietary) Limited + +On November 30, 2001, the Group disposed of its 40% + +joint venture shareholding in Vodacom World Online + +(Proprietary) Limited. The fair value of the assets and + +liabilities disposed were as follows: + +Carrying amount of net assets disposed . . . . . . . . + +- + +- + +1.7 + +Property, plant and equipment . . . . . . . . . . . . + +- + +- + +6.7 + +Intangibles . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Inventory . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +0.6 + +Accounts receivable . . . . . . . . . . . . . . . . . + +- + +- + +6.6 + +Taxation payable . . . . . . . . . . . . . . . . . . . + +- + +- + +(0.1) + +Cash and cash equivalents . . . . . . . . . . . . . . + +- + +- + +8.5 + +Accounts payable . . . . . . . . . . . . . . . . . . . + +- + +- + +(20.6) + +Capital gain on disposal . . . . . . . . . . . . . . . . . + +- + +- + +30.1 + +Selling price . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +31.8 + +Cash and cash equivalents . . . . . . . . . . . . . . . + +- + +- + +(8.5) + +Cash consideration . . . . . . . . . . . . . . . . . . . + +- + +- + +23.3 + +31. + +DISPOSAL OF INTERNET DIVISION + +Division disposed . . . . . . . . . . . . . . . . . . . . . . . . . . + +199.8 + +- + +- + +31.1 + +Disposal of Internet division + +During the 2000 financial year the group disposed of the + +Vodacom Internet division of Vodacom (Proprietary) Limited. + +Carrying amount of net assets disposed of . . . . . . . . . + +18.8 + +- + +- + +Long-term loans . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Property, plant and equipment . . . . . . . . . . . . + +6.6 + +- + +- + +Inventory . . . . . . . . . . . . . . . . . . . . . . . + +0.9 + +- + +- + +Accounts receivable . . . . . . . . . . . . . . . . . + +33.7 + +- + +- + +Accounts payable . . . . . . . . . . . . . . . . . . . + +(46.4) + +- + +- + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . + +24.0 + +- + +- + +Short-term loans . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Capital gain on disposal . . . . . . . . . . . . . . . . . + +246.6 + +- + +- + +Realized (Note 5.1) . . . . . . . . . . . . . . . . . . + +123.3 + +- + +- + +Deferred (Note 5.1) . . . . . . . . . . . . . . . . . . + +123.3 + +- + +- + +Selling price . . . . . . . . . . . . . . . . . . . . . . . + +265.4 + +- + +- + +Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(24.0) + +- + +- + +Cash flow included in capital gain . . . . . . . . . . . + +(41.6) + +- + +- + +Cash consideration . . . . . . . . . . . . . . . . . . . + +199.8 + +- + +- + +32. + +CASH AND CASH EQUIVALENTS AT END OF YEAR + +Bank and cash balances . . . . . . . . . . . . . . . . . . . . . . . + +936.1 + +797.6 + +719.2 + +Bank overdrafts and other short term debt . . . . . . . . . . . . . + +(1,451.1) + +(1,593.7) + +(1,576.8) + +(515.0) + +(796.1) + +(857.6) + +F157 + +F158 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +R + +R + +R + +33. + +EARNINGS AND DIVIDEND PER SHARE + +33.1 + +Basic and diluted earnings per share + +The calculation of basic earnings per ordinary share is based + +on earnings of R2,373.0 million (2001: R1,317.8 million, + +2000: R1,315.0 million) and 10,000 issued ordinary shares + +(2001: 10,000; 2000: 10, 000) . . . . . . . . . . . . . . . . + +131,500 + +131,780 + +237,300 + +Due to no dilution factors being present, basic earnings per + +share equals diluted earnings per share. + +33.2 + +Dividend per share + +The calculation of the dividend per ordinary share is based on + +a declared ordinary dividend of R600.0 million (2001: + +R480.0 million, 2000: nil) and 10,000 issued ordinary shares + +(2001: 10,000; 2000: 10,000). The dividends were declared + +as follows: + +Declared March 21, 2002 and payable June 28, 2002 (Final) + +- + +- + +60,000 + +Declared March 15, 2001 and payable June 29, 2001 (Final) + +- + + 48,000 + +- + +- + + 48,000 + +60,000 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +34. + +CAPITAL COMMITMENTS + +Commitments for orders in respect of existing contracts: + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . . . . + +657.7 + +1,272.1 + +1,005.2 + +Vodacom Congo (R.D.C.) S.P.R.L (Euro30.4 million at R9.99) + +- + +- + +303.7 + +Vodacom Tanzania Limited (US$6.9 million at R11.44) . . . . + +- + +47.5 + +78.9 + +Vodacom Service Provider Company (Proprietary) Limited . . + +- + +290.8 + +59.9 + +Vodacom International Holdings (Proprietary) Limited . . . . . + +- + +- + +2.2 + +Vodacom Group (Proprietary) Limited . . . . . . . . . . . . . + +- + +- + +0.3 + +Vodacare (Proprietary) Limited . . . . . . . . . . . . . . . . . + +5.3 + +- + +- + +Vodacom Lesotho (Proprietary) Limited . . . . . . . . . . . . + +- + +5.1 + +- + +663.0 + +1,615.5 + +1,450.2 + +Commitments not yet contracted for: + +Vodacom (Proprietary) Limited . . . . . . . . . . . . . . . . . + +3,460.9 + +2,871.9 + +805.5 + +Vodacom Congo (R.D.C.) S.P.R.L (US$1.4 million at R11.44) . + +- + +- + +16.0 + +Vodacom Service Provider Company (Proprietary) Limited . . + +- + +250.8 + +15.9 + +Vodacom Tanzania Limited (US$0.9 million at R11.44) . . . . + +- + +484.5 + +10.3 + +Vodacom Lesotho (Proprietary) Limited . . . . . . . . . . . . + +16.2 + +23.5 + +1.9 + +Vodacom Group (Proprietary) Limited . . . . . . . . . . . . . + +3.8 + +2.7 + +- + +Vodac (Proprietary) Limited . . . . . . . . . . . . . . . . . . . + +18.5 + +- + +- + +GSM (Proprietary) Limited . . . . . . . . . . . . . . . . . . . + +5.9 + +- + +- + +Teljoy Holdings Limited . . . . . . . . . . . . . . . . . . . . . + +2.7 + +- + +- + +Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +32.9 + +- + +3,508.0 + +3,666.3 + +849.6 + +The capital expenditure of the Group will be financed from internal cash generation, extended supplier credit and + +bank credit. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +35. + +OTHER COMMITMENTS + +Operating leases . . . . . . . . . . . . . . . . . . . . . . . . . . + +2,780.6 + +3,749.3 + +2,313.7 + +Sports and marketing contracts . . . . . . . . . . . . . . . . . . . + +154. + +5 + +388.8 + +321.1 + +Finance lease building . . . . . . . . . . . . . . . . . . . . . . . + +890.3 + +496.6 + +93.5 + +3,825.4 + +4,634.7 + +2,728.3 + +Within Between two + +After + +Total + +one year and five years + +five years + +Rm + +Rm + +Rm + +Rm + +35.1 + +Operating leases + +Transmission and data lines GSM . . . . . . . + +366.9 + +1,467.8 + +366.9 + +2,201.6 + +Office equipment . . . . . . . . . . . . . . . . + +0.4 + +1.1 + +- + +1.5 + +Other operating leases . . . . . . . . . . . . . + +47.2 + +56.8 + +6.6 + +110.6 + +414.5 + +1,525.7 + +373.5 + +2,313.7 + +35.2 Sports and marketing contracts . . . . . . . + +189.9 + +131.2 + +- + +321.1 + +35.3 Finance lease building . . . . . . . . . . . . . + +93.5 + +- + +- + +93.5 + +35.4 + +License fees + +Network operators in the Group pay monthly license fees based on their net operational income as defined in + +the license agreement. Net operational income is defined as the total invoiced revenue of the licensee excluding + +discounts, Value-Added Taxation and other direct taxes derived from customers of the licensee for the + +provision to them of the service, less net interconnect fees and bad debts actually incurred. + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +36. + +CONTINGENT LIABILITIES + +36.1 + +Globalstar Southern Africa (Proprietary) Limited + +An invoice amounting to R34.0 million was raised and issued + +to Globalstar Southern Africa (Proprietary) Limited on May 22, + +2001, for services rendered at the earth station in Delareyville, + +over a period of 26 months. The invoice was under dispute as + +no formal agreement was in place with the supplier, Telkom + +SA Limited, for those services rendered. Globalstar Southern + +Africa (Proprietary) Limited and Telkom SA Limited reached + +an agreement during the course of the year whereby an invoice + +of R22.8 million, inclusive of VAT, was issued and paid in + +December 2001 (Note 3) . . . . . . . . . . . . . . . . . . . . + +- + +34.0 + +- + +The functionality of the Gateway assets is under dispute and + +Globalstar Southern Africa (Proprietary) Limited and Vodafone + +Satellite Services Limited do not recognize the liability to + +Globalstar LP. This amount has been written back to income as + +the success of this claim is deemed to be remote (Note 3) . . . + +- + +- + +15.0 + +36.2 Legal matters . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +5.0 + +F159 + +F160 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +36. + +CONTINGENT LIABILITIES (continued) + +36.3 + +Vodacom Congo (R.D.C.) S.P.R.L. + +The Group has a 51% equity interest in Vodacom Congo (R.D.C.) S.P.R.L., ("Vodacom Congo"), which + +commenced business on December 11, 2001. This investment is governed by a shareholders' agreement which + +provides the minority shareholder certain protective and participating rights. In terms of IAS 31: "Accounting + +for interest in Joint Ventures", Vodacom Congo may not be consolidated as a subsidiary as it is considered to + +be a joint venture and has been proportionally consolidated in the financial statements at March 31, 2002. + +The Group, in terms of the shareholders' agreement, is however ultimately responsible for the funding of the + +operations of Vodacom Congo. The shareholders' agreement also gives the Group the right to appoint + +management and the majority of the board of the company. The Group also has a management agreement to + +manage the company on a day-to-day basis. Currently Vodacom Congo is incurring losses which are expected + +to increase into the foreseeable future. The 49% portion attributable to the joint venture partner of the liabilities + +and losses as at March 31, 2002 were as follows: + +2002 + +Rm + +Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(19.3) + +Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(29.7) + +Furthermore, the following guarantees were approved/issued by the Group in respect of Vodacom Congo + +subsequent to the balance sheet date: + +Company + +Details + +Beneficiary + +Date + +Euro + +US$ + +issued + +Mil + +Mil + +Approved and issued: + +Congo (R.D.C.) S.P.R.L. Guarantee Alcatel C.I.T. + +ABSA Bank + +May 8, 2002 + +32.6 + +29.8 + +Alcatel Space Industries + +Limited + +and Alcatel Altech Telecoms + +(Pty) Ltd. ("Alcatel") + +Approved not issued: + +Congo (R.D.C.) S.P.R.L. Guarantees not yet issued + +ABSA Bank + +- + +51.2 + +Limited + +36.4 + +Negative working capital ratio + +For financial years ended 2000, 2001 and 2002 the Group had a negative working capital ratio. A negative + +working capital ratio arises when the Group's current liabilities are greater than the current assets. The Group's + +management believes that based on its operating cash flow, it will be able to meet liabilities as they arise and + +that it is in compliance with all covenants contained in borrowing agreements. + +37. + +RETIREMENT BENEFITS + +All eligible employees of the Group and wholly-owned subsidiaries are members of the Vodacom Group Pension + +Fund, a defined contribution pension scheme. Executive employees of the Group company and wholly-owned + +subsidiaries also have the option to be members to the Vodacom Group Executive Provident Fund, a defined + +contribution provident scheme. Both schemes are administered by ABSA Consultants and Actuaries (Proprietary) + +Limited. Current contributions to the pension fund amounted to R42.8 million (2001: R42.5 million, 2000: + +R29.8 million). Current contributions to the provident fund amounted to R1.1 million (2001: nil, 2000: nil). + +South African funds are governed by the Pension Funds Act of 1956. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +38. + +RELATED PARTY TRANSACTIONS + +38.1 + +Balances with related parties (not disclosed elsewhere) + +Included in accounts receivable: + +Telkom SA Limited interconnect . . . . . . . . . . + +481.0 + +516.4 + +529.4 + +Telkom SA Limited other . . . . . . . . . . . . . . + +- + +13.8 + +14.1 + +Vodafone Group Plc . . . . . . . . . . . . . . . . . . + +15.7 + +1.0 + +1.6 + +Included in accounts payable: + +Telkom SA Limited . . . . . . . . . . . . . . . . . . + +50.4 + +50.1 + +78.2 + +Telkom SA Limited other . . . . . . . . . . . . . . + +- + +- + +3.0 + +Vodafone Group plc . . . . . . . . . . . . . . . . . . + +11.6 + +0.8 + +- + +38.2 + +Transactions with related parties + +Telkom SA Limited . . . . . . . . . . . . . . . . . . + +1,689.4 + +1,939.3 + +2,154.6 + +Interconnect income . . . . . . . . . . . . . . . . + +2,405.9 + +2,729.1 + +2,942.5 + +Customer billing . . . . . . . . . . . . . . . . . . + +- + +43.4 + +24.1 + +Interest paid commercial . . . . . . . . . . . . . + +- + +- + +0.4 + +Lease of transmission lines . . . . . . . . . . . . . + +(287.5) + +(321.1) + +(336.0) + +Interconnect fees . . . . . . . . . . . . . . . . . . + +(276.5) + +(297.0) + +(305.7) + +Interest payments on shareholder loan . . . . . . . + +(101.1) + +(78.9) + +(72.1) + +Telephone landline usage . . . . . . . . . . . . . . + +(11.7) + +(20.4) + +(34.6) + +Installation of transmission lines . . . . . . . . . . + +(36.4) + +(34.3) + +(32.7) + +Management fees . . . . . . . . . . . . . . . . . . + +- + +- + +(20.0) + +Site costs . . . . . . . . . . . . . . . . . . . . . . + +(3.3) + +(6.5) + +(11.3) + +Shareholder loan repayment . . . . . . . . . . . . + +- + +(75.0) + +- + +Vodafone Group Plc . . . . . . . . . . . . . . . . . . + +(28.6) + +(70.2) + +(25.5) + +Roaming income (transacted within the + +Vodafone Group) . . . . . . . . . . . . . . . . . . + +18.9 + +24.1 + +27.4 + +Roaming expense (transacted within the + +Vodafone Group) . . . . . . . . . . . . . . . . . . + +(15.1) + +(24.6) + +(33.4) + +Interest payments on shareholder loan . . . . . . . + +(32.4) + +(22.4) + +(19.5) + +Shareholder loan repayment . . . . . . . . . . . . + +- + +(47.3) + +- + +Vodafone Holdings (SA) (Proprietary) Limited: + +Interest payments on shareholder loan . . . . . . . . + +(31.2) + +(27.3) + +(26.0) + +VenFin Finansieringskorporasie (Proprietary) Limited + +(27.3) + +(81.1) + +(56.8) + +Interest payments on shareholder loan . . . . . . . + +(27.3) + +(21.3) + +(19.5) + +Interest payments on overdraft account . . . . . . + +- + +(39.6) + +(37.3) + +Shareholder loan repayment . . . . . . . . . . . . + +- + +(20.2) + +- + +Descarte Investments No. 8 (Proprietary) Limited . . + +(10.1) + +(15.4) + +(7.2) + +Interest payments on shareholder loan . . . . . . . + +(10.1) + +(7.9) + +(7.2) + +Shareholder loan repayment . . . . . . . . . . . . + +- + +(7.5) + +- + +Transactions with related parties are priced at prevailing market rates. + +39. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT + +The Group purchases or issues financial instruments in order to finance its operations and to manage the interest rate + +and currency risks that arise from those operations and from its sources of finance. Various financial balances for + +example trade debtors, trade creditors, accruals and prepayments, and provisions, arise directly from the Group's + +operations. Changing market conditions expose the Group to various financial risks and have highlighted the + +importance of financial risk management as an element of control for the Group. Principal financial risks faced in the + +normal course of the Group's business are foreign currency rate risk, interest rates risk, credit risk, and liquidity risk. + +F161 + +F162 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +39. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +The Group finances its operations through a mixture of retained profits, bank borrowings and long-term loans. Long- + +term financing is arranged locally by the South African entities. A treasury division within Vodacom Group + +(Proprietary) Limited has been established to provide treasury related services within the Group, including co- + +ordinating access to domestic and international financial markets, and the managing of various financial risks relating + +to the Group's operations. + +The Group utilises derivative instruments, the objective of which is to reduce exposure to fluctuations in foreign + +currency rates and interest rates, and to manage the liquidity of cash resources within the Group. Trading in + +derivative instruments for speculative purposes is strictly prohibited. + +Group treasury policies, risk limits, and control procedures are continuously monitored by management and the board + +of directors, through the Audit Committee, the objective being to minimise exposure to foreign currency, interest rate, + +credit risk and liquidity risk. These risks are managed within an approved treasury policy. + +39.1 + +Foreign currency management + +The Group enters into foreign exchange contracts to buy specified amounts of various foreign currencies in the + +future at a predetermined exchange rate. The contracts are entered into in order to manage the Group's + +exposure to fluctuations in foreign currency exchange rates on specific transactions. The contracts are matched + +with anticipated future cash flows in foreign currencies primarily from purchases of capital equipment. The + +Group's policy is to enter into foreign exchange contracts for 100% of the committed net foreign currency + +payments. + +The Group has entered into numerous foreign exchange contracts to cover foreign capital commitments in + +respect of future imports of GSM infrastructure. The total value of foreign exchange contracts at year-end was: + +Forward contracts to buy foreign currency + +Foreign Forward value + +Fair value + +contract value + +Mil + +Rm + +Rm + +2000 + +United States Dollar . . . . . . . . . . . . . . . . . . + +87.6 + +576.7 + +7.3 + +Deutschmark . . . . . . . . . . . . . . . . . . . . . . + +188.3 + +615.3 + +(2.0) + +Euro . . . . . . . . . . . . . . . . . . . . . . . . . . + +26.4 + +167.4 + +1.8 + +Pound Sterling . . . . . . . . . . . . . . . . . . . . . + +2.5 + +26.2 + +(0.4) + +Swedish Krona . . . . . . . . . . . . . . . . . . . . + +1.1 + +0.8 + +- + +1,386.4 + +6.7 + +2001 + +United States Dollar . . . . . . . . . . . . . . . . . . + +130.2 + +995.0 + +68.4 + +Deutschmark . . . . . . . . . . . . . . . . . . . . . . + +90.2 + +322.7 + +8.9 + +Euro . . . . . . . . . . . . . . . . . . . . . . . . . . + +41.3 + +300.2 + +(0.1) + +Pound Sterling . . . . . . . . . . . . . . . . . . . . . + +0.9 + +10.9 + +0.1 + +Swedish Krona . . . . . . . . . . . . . . . . . . . . + +1.7 + +1.3 + +- + +Swiss Franc . . . . . . . . . . . . . . . . . . . . . . + +0.1 + +0.6 + +- + +1,630.7 + +77.3 + +2002 + +United States Dollar . . . . . . . . . . . . . . . . . . + +102.6 + +1,099.4 + +119.0 + +Euro . . . . . . . . . . . . . . . . . . . . . . . . . . + +134.8 + +1,285.6 + +95.7 + +Pound Sterling . . . . . . . . . . . . . . . . . . . . . + +0.2 + +2.6 + +(0.1) + +2,387.6 + +214.6 + +Forward value represents the foreign contract value multiplied by the contracted forward contract rate. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +39. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +39.1 + +Foreign currency management (continued) + +Forward contracts to sell foreign currency + +Foreign + +Forward value + +Fair value + +contract value + +Mil + +Rm + +Rm + +2000 + +United States Dollar . . . . . . . . . . . . . . . . . . + +1.9 + +11.9 + +(0.1) + +Euro . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Deutschmark . . . . . . . . . . . . . . . . . . . . . . + +0.6 + +2.0 + +- + +13.9 + +(0.1) + +2001 + +United States Dollar . . . . . . . . . . . . . . . . . . + +1.6 + +12.4 + +(0.6) + +Euro . . . . . . . . . . . . . . . . . . . . . . . . . . + +1.2 + +9.3 + +- + +Deutschmark . . . . . . . . . . . . . . . . . . . . . . + +14.0 + +52.1 + +0.3 + +73.8 + +(0.3) + +2002 + +United States Dollar . . . . . . . . . . . . . . . . . . + +3.6 + +42.7 + +0.7 + +Euro . . . . . . . . . . . . . . . . . . . . . . . . . . + +6.1 + +63.3 + +0.3 + +Pound Sterling . . . . . . . . . . . . . . . . . . . . . + +0.1 + +1.0 + +- + +107.0 + +1.0 + +Forward value represents the foreign contract value multiplied by the contracted forward contract rate. + +39.2 + +Interest rate risk management + +The Group has entered into interest rate swap contracts that entitle, or oblige, it to receive interest at fixed rate + +on notional principal amounts and entitle, or oblige, it to pay interest at floating rates on the same notional + +principal amounts. The interest rate swaps allow the Group to swap long-term debt from fixed rates into + +floating rates that are lower, or higher, than those available if it had borrowed at fixed floating rates directly. + +Under the interest rates swaps, the Group agrees with other parties to exchange, at specified quarterly intervals, + +the difference between fixed rate and floating rate interest amounts calculated by reference to the agreed + +notional principal amounts. + +At balance sheet dates the Group had two interest rate swaps: + +Vodacom Group (Proprietary) Limited the Group swapped its fixed interest rate of 14.9% (2001: 14.9%, + +2000: 14.9%) NACQ (Nominal Amount Compounded Quarterly) for a floating rate, linked to the + +BA (Banker's Acceptance) rate plus margin of 2.00%. + +Vodacom (Proprietary) Limited the Company swapped its fixed interest rate of 20.1% (2001: 20.1%, + +2000: 20.1%) NACQ (Nominal Amount Compounded Quarterly) for a floating rate linked to the + +BA (Banker's Acceptance) rate plus margin of 2.25%. + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Fair value of interest rate swap asset . . . . . . . + +11.7 + +17.2 + +9.4 + +The fair value of the interest rate swap asset is represented by a notional principal amount of R148.8 million + +(2001: R146.9 million, 2000: R142.8 million) at a floating interest rate of between 12.1% and 12.6% + +(2001: 12.6%, 2000: 11.8%). + +39.3 + +Credit risk management + +Financial assets, which potentially subject the Group to concentrations of credit risk, consist principally of cash, + +short-term deposits and trade receivables. The Group's cash and cash equivalents and short-term deposits are + +placed with high credit quality financial institutions. Trade receivables are presented net of an allowance for + +doubtful receivables. Credit risk with respect to trade receivables is limited due to the large number of customers + +comprising the Group's customer base and stringent credit approval processes for contracted subscribers. + +The Group does not have any significant exposure to any individual customer or counter-party, except + +commercially to Telkom SA Limited (the Group's largest shareholder), Mobile Telecommunications Network + +(Proprietary) Limited, the Group's largest competitor, and Cell-C (Proprietary) Limited, the country's third + +network operator. + +F163 + +F164 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +39. + +FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued) + +39.3 + +Credit risk management (continued) + +With respect to the forward exchange contracts, the Group's exposure is on the full amount of the foreign + +currency payable on settlement. The Group minimises such risk by limiting the counter-parties to a group of + +major international banks and does not expect to incur any losses as a result of non-performance by these + +counter-parties. The positions in respect of these counter-parties are closely monitored. + +The carrying amounts of financial assets included in the consolidated balance sheet represent the Group's + +exposure to credit risk in relation to these assets. The credit exposure of forward exchange contracts is + +represented by the fair value of the contracts. + +39.4 + +Liquidity risk management + +The Group is exposed to liquidity risk as a result of uncertain debtor related cash flows as well as capital + +commitments of the Group. In terms of its borrowing requirements, the Group ensures that adequate funds in + +all currencies are available to meet its expected and unexpected financial commitments through utilization of + +undrawn borrowing facilities (Note 40). In terms of its long-term liquidity risk, a reasonable balance is + +maintained between the period over which assets generate funds and the period over which the respective + +assets are funded. + +39.5 + +Fair value of financial instruments + +At balance sheet date, the carrying amounts of cash and short-term deposits, accounts receivables, accounts + +payable and accrued expenses and short-term debt approximated their fair values due to the short-term + +maturities of these assets and liabilities. + +The fair value of forward exchange contracts and interest rate swaps are determined, using quoted prices or, + +where such prices are not available, discounted cash flow analysis is used. These amounts reflect the + +approximate values of the derivative positions at balance sheet date. + +40. + +UNDRAWN BORROWING FACILITIES AND GUARANTEES + +The Group has a twelve-month revolving credit facility of R3,327.6 million with R1,913.1 million unutilized at + +March 31, 2002. The facilities expiring within one year are of a general banking nature and thus subject to review at + +various dates (usually on an annual basis), and it is expected that this profile will continue relative to core working + +capital and seasonal peak borrowing requirements. Foreign currency term facilities are predominantly US Dollar- + +based, at various maturities and are utilized for bridging and short-term working capital needs. All other loans with + +external financial institutions are linked to the prime overdraft rate. + +Companies within the Group have provided the following guarantees: + +Company + +Details + +Beneficiary + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Vodacom (Proprietary) + +All guarantees less than R0.2 million Various + +1.9 + +1.9 + +1.9 + +Limited + +in terms of various lease agreements + +Vodacom (Proprietary) + +Electricity supply + +Eskom + +1.0 + +1.0 + +1.0 + +Limited + +Vodacom (Proprietary) + +Standby letters of credit * + +Alcatel CIT + +153.2 + +36.2 + +299.9 + +Limited + +Vodacom Service + +All guarantees less than R0.1 million Various + +0.4 + +0.4 + +0.4 + +Provider Company + +in terms of various lease agreements + +(Proprietary) Limited + +Vodacom Service + +Electricity supply + +Midrand Town + +1.0 + +1.0 + +1.0 + +Provider Company + +Council + +(Proprietary) Limited + +157.5 + +40.5 + +304.2 + +* Amounts drawn on the standby letters of credit amounting to R98.4 million for 2002 and R13.7 million for 2001 are + +included as liabilities in the balance sheet. + +Vodacom Group (Proprietary) Limited has provided a letter of support to the Standard Bank Group for credit + +facilities comprising short-term loans of US$15 million and US$32 million provided to Vodacom Tanzania Limited. + +Vodacom (Proprietary) Limited provides an unlimited guarantee for borrowings entered into by Vodacom Group + +(Proprietary) Limited. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +SEGMENTAL INFORMATION + +The Group is primarily an integrated mobile telecommunication and data communication business located in South + +Africa but does have businesses in other African countries. The primary reporting format therefore comprises the + +business segments of the Group. + +Unallo- + +Networks + +Service Other + +Elimi- + +Total + +cated + +providers + +nations + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +2000 + +BUSINESS SEGMENTS + +Segment revenue . . . . . . . . + +80.1 + +8,213.7 + +4,245.8 + +26.4 + +(2,994.4) + +9,571.6 + +External . . . . . . . . . . . + +- + +5,345.3 + +4,218.0 + +8.3 + +- + +9,571.6 + +Inter-segment . . . . . . . . + +80.1 + +2,868.4 + +27.8 + +18.1 + +(2,994.4) + +- + +Segment profit/(loss) from + +operations . . . . . . . . . . . + +36.2 + +2,328.9 + +80.0 + +5.1 + +(86.9) + +2,363.3 + +Interest and dividends received + +32.0 + +Finance costs . . . . . . . . . . + +(567.2) + +Profit before taxation . . . . . . + +1,828.1 + +Included in segment profit/(loss) + +from operations + +Depreciation and amortization . + +(0.8) + +(1,004.3) + +(71.9) + +(0.2) + +(21.7) + +(1,098.9) + +Property, plant and equipment + +(0.8) + +(997.6) + +(26.7) + +(0.2) + +- + +(1,025.3) + +Intangible assets . . . . . . . + +- + +(6.7) + +(45.2) + +- + +(21.7) + +(73.6) + +Bad debts written-off . . . . . . + +- + +- + +(16.5) + +- + +- + +(16.5) + +Integration costs, disposals of + +operations and impairments . . + +- + +- + +- + +- + +129.3 + +129.3 + +Capital expenditure . . . . . . . + +(6.2) + +(1,966.1) + +(59.1) + +(1.1) + +- + +(2,032.5) + +Assets . . . . . . . . . . . . . . + +3,281.6 + +7,644.9 + +1,519.4 + +20.0 + +(2,747.9) + +9,863.8 + +Segment assets . . . . . . . . + +3,281.6 + +7,644.9 + +1,519.4 + +20.0 + +(2,747.9) + +9,718.0 + +Deferred taxation assets . . . + +- + +- + +- + +- + +- + +145.8 + +Liabilities . . . . . . . . . . . . + +(2,367.1) + +(4,087.1) + +(895.5) + +(15.7) + +1,186.2 + +(7,194.9) + +Segment liabilities . . . . . . + +(2,367.1) + +(4,087.1) + +(895.5) + +(15.7) + +1,186.2 + +(6,179.2) + +Deferred tax liabilities . . . . + +- + +- + +- + +- + +- + +(455.6) + +Taxation liabilities . . . . . . + +- + +- + +- + +- + +- + +(560.1) + +Dividends payable . . . . . . + +- + +- + +- + +- + +- + +- + +F165 + +F166 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +SEGMENTAL INFORMATION (continued) + +Unallo- + +Networks + +Service Other + +Elimi- + +Total + +cated + + providers + + nations + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +2001 + +BUSINESS SEGMENTS + +Segment revenue . . . . . . . . + +106.3 + +10,728.2 + +6,554.3 + +332.7 + +(4,445.1) + +13,276.4 + +External . . . . . . . . . . . + +6,553.2 + +6,417.3 + +305.9 + +- + +13,276.4 + +Inter-segment . . . . . . . . + +106.3 + +4,175.0 + +137.0 + +26.8 + +(4,445.1) + +- + +Segment (loss)/profit from + +operations . . . . . . . . . . . + +(182.8) + +2,755.4 + +13.1 + +(55.9) + +23.6 + +2,553.4 + +Interest and dividends received + +25.4 + +Finance costs . . . . . . . . . . + +(504.5) + +Profit before taxation . . . . . . + +2,074.3 + +Included in segment (loss)/profit + +from operations + +Depreciation and amortization . + +(2.1) + +(1,287.5) + +(92.0) + +(53.8) + +(200.2) + +(1,635.6) + +Property, plant and equipment + +(2.1) + +(1,280.4) + +(35.2) + +(46.4) + +- + +(1,364.1) + +Intangible assets . . . . . . . + +- + +(7.1) + +(56.8) + +(7.4) + +(200.2) + +(271.5) + +Bad debts written-off . . . . . . + +- + +- + +(107.4) + +- + +- + +(107.4) + +Integration costs, disposals of + +operations and impairments . . + +(165.0) + +(50.3) + +(173.4) + +(42.1) + +217.6 + +(213.2) + +Capital expenditure . . . . . . . + +(5.3) + +(3,096.4) + +(80.4) + +(33.5) + +31.4 + +(3,184.2) + +Assets . . . . . . . . . . . . . . + +3,292.8 + +9,831.3 + +1,557.7 + +262.1 + +(2,941.2) + +12,341.8 + +Segment assets . . . . . . . . + +3,292.8 + +9,831.3 + +1,557.7 + +262.1 + +(2,941.2) + +12,002.7 + +Deferred taxation asset . . . + +- + +- + +- + +- + +- + +339.1 + +Liabilities . . . . . . . . . . . . + +(1,418.2) + +(5,423.2) + +(1,313.5) + +(107.8) + +1,316.8 + +(8,847.2) + +Segment liabilities . . . . . . + +(1,418.2) + +(5,423.2) + +(1,313.5) + +(107.8) + +1,316.8 + +(6,945.9) + +Deferred taxation liability . . + +- + +- + +- + +- + +- + +(607.5) + +Taxation liability . . . . . . . + +- + +- + +- + +- + +- + +(810.0) + +Dividends payable . . . . . . + +- + +- + +- + +- + +- + +(483.8) + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +SEGMENTAL INFORMATION (continued) + +Unallo- + +Networks + +Service Other + +Elimi- + +Total + +cated + +providers + +nations + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +2002 + +BUSINESS SEGMENTS + +Segment revenue . . . . . . . . + +- + +13,898.2 + +7,121.4 + +311.6 + +(5,180.5) + +16,150.7 + +External . . . . . . . . . . . + +- + +9,001.4 + +6,900.1 + +249.2 + +- + +16,150.7 + +Inter-segment . . . . . . . . + +- + +4,896.8 + +221.3 + +62.4 + +(5,180.5) + +- + +Segment (loss)/profit + +from operations . . . . . . . . + +(85.0) + +3,446.2 + +343.6 + +(32.6) + +(51.1) + +3,621.1 + +Interest and dividends received + +32.0 + +Finance costs . . . . . . . . . . + +(59.8) + +Profit before taxation . . . . . . + +3,593.3 + +Included in segment (loss)/profit + +from operations + +Depreciation and amortization . + +(2.3) + +(1,774.0) + +(66.3) + +(31.9) + +(195.5) + +(2,070.0) + +Property, plant and equipment + +(2.3) + +(1,762.6) + +(60.7) + +(31.7) + +- + +(1,857.3) + +Intangible assets . . . . . . . + +- + +(11.4) + +(5.6) + +(0.2) + +(195.5) + +(212.7) + +Bad debts written-off . . . . . . + +- + +- + +(111.2) + +- + +- + +(111.2) + +Integration costs, disposals of + +operations and impairments . . + +(109.9) + +45.5 + +(3.5) + +(20.0) + +144.3 + +56.4 + +Capital expenditure . . . . . . . + +(36.1) + +(3,660.2) + +(562.4) + +(21.7) + +1.4 + +(4,279.0) + +Assets . . . . . . . . . . . . . . + +4,737.3 + +12,976.0 + +2,466.5 + +679.7 + +(5,998.6) + +15,358.6 + +Segment assets . . . . . . . . + +4,737.3 + +12,976.0 + +2,466.5 + +679.7 + +(5,998.6) + +14,860.9 + +Deferred taxation assets . . . + +- + +- + +- + +- + +- + +497.7 + +Liabilities . . . . . . . . . . . . + +(2,427.0) + +(6,389.1) + +(2,103.7) + +(139.8) + +3,053.2 + +(9,884.2) + +Segment liabilities . . . . . . + +(2,427.0) + +(6,389.1) + +(2,103.7) + +(139.8) + +3,053.2 + +(8,006.4) + +Deferred tax liabilities . . . . + +- + +- + +- + +- + +- + +(926.2) + +Taxation liabilities . . . . . . + +- + +- + +- + +- + +- + +(351.6) + +Dividends payable . . . . . . + +- + +- + +- + +- + +- + +(600.0) + +"Unallocated" comprises the reporting relevant to Vodacom Group (Proprietary) Limited the parent company in the + +Group, which is primarily an investment holding company, but also offers combined administrative and shared- + +function services to companies within the Group. + +"Networks" comprise services provided by cellular networks within South Africa and other African countries. + +Services offered by the companies include the standard voice telecommunication services of cellular networks as well + +as data communication services through the cellular network, including short message servicing ("SMS") and + +wireless application protocol ("WAP"). + +"Service providers" comprise services provided by cellular telecommunication, satellite telecommunication and + +Internet service providers within South Africa. Cellular and satellite telecommunication service providers purchase + +bulk airtime from their respective networks and sell this on to their customer base. Internet service providers provide + +their customer base access to the World Wide Web. The internet service provider was disposed on November 30, 2001. + +"Other" comprises of other business lines of the Group, including the providing of promotion and event services as + +well as providing television rental and related rental services, neither of which fall within the Group's strategic focus + +nor do they constitute a separately reportable segment. The promotion and event service business, and the rental + +service business were disposed on February 27, 2002 and March 31, 2002, respectively. + +F167 + +F168 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +SEGMENTAL INFORMATION (continued) + +South Africa + +Other African + +Eliminations + +Total + +countries + +Rm + +Rm + +Rm + +Rm + +2000 + +GEOGRAPHICAL SEGMENTS + +Segment revenue . . . . . . . . . . . . . + +9,539.3 + +38.0 + +(5.7) + +9,571.6 + +External . . . . . . . . . . . . . . . . + +9,533.6 + +38.0 + +- + +9,571.6 + +Inter-segment . . . . . . . . . . . . . + +5.7 + +- + +(5.7) + +- + +Segment profit/(loss) from operations . . + +2,357.1 + +6.2 + +- + +2,363.3 + +Interest and dividends received . . . . . + +32.0 + +Finance costs . . . . . . . . . . . . . . . + +(567.2) + +Profit before taxation . . . . . . . . . . . + +1,828.1 + +Included in segment profit/(loss) from + +operations + +Depreciation and amortization . . . . . . + +(1,091.8) + +(7.1) + +- + +(1,098.9) + +Property, plant and equipment . . . . . + +(1,018.2) + +(7.1) + +- + +(1,025.3) + +Intangible assets . . . . . . . . . . . . + +(73.6) + +- + +- + +(73.6) + +Bad debts written-off . . . . . . . . . . . + +(16.5) + +- + +- + +(16.5) + +Integration costs, disposals of operations + +and impairments . . . . . . . . . . . . . + +129.3 + +- + +- + +129.3 + +Capital expenditure . . . . . . . . . . . . + +(2,011.1) + +(21.4) + +- + +(2,032.5) + +Assets . . . . . . . . . . . . . . . . . . . + +9,656.7 + +72.8 + +(11.5) + +9,863.8 + +Segment assets . . . . . . . . . . . . . + +9,656.7 + +72.8 + +(11.5) + +9,718.0 + +Deferred tax assets . . . . . . . . . . + +- + +- + +- + +145.8 + +Liabilities . . . . . . . . . . . . . . . . . + +(6,175.2) + +(15.5) + +11.5 + +(7,194.9) + +Segment liabilities . . . . . . . . . . . + +(6,175.2) + +(15.5) + +11.5 + +(6,179.2) + +Deferred taxation liabilities . . . . . . + +- + +- + +- + +(455.6) + +Taxation liabilities . . . . . . . . . . . + +- + +- + +- + +(560.1) + +Dividends payable . . . . . . . . . . . + +- + +- + +- + +- + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +SEGMENTAL INFORMATION (continued) + +South Africa + +Other African + +Eliminations + +Total + +countries + +Rm + +Rm + +Rm + +Rm + +2001 + +GEOGRAPHICAL SEGMENTS + +Segment revenue . . . . . . . . . . . . . + +13,208.0 + +184.4 + +(116.0) + +13,276.4 + +External . . . . . . . . . . . . . . . . + +13,092.0 + +184.4 + +- + +13,276.4 + +Inter-segment . . . . . . . . . . . . . + +116.0 + +- + +(116.0) + +- + +Segment profit/(loss) from operations . . + +2,583.3 + +(31.6) + +1.7 + +2,553.4 + +Interest and dividends received . . . . . + +25.4 + +Finance costs . . . . . . . . . . . . . . . + +(504.5) + +Profit before taxation . . . . . . . . . . . + +2,074.3 + +Included in segment profit/(loss) + +from operations + +Depreciation and amortization . . . . . . + +(1,596.6) + +(34.7) + +(4.3) + +(1,635.6) + +Property, plant and equipment . . . . . + +(1,329.8) + +(34.3) + +- + +(1,364.1) + +Intangible assets . . . . . . . . . . . . + +(266.8) + +(0.4) + +(4.3) + +(271.5) + +Bad debts written-off . . . . . . . . . . . + +(107.4) + +- + +- + +(107.4) + +Integration costs, disposals of operations + +and impairments . . . . . . . . . . . . . + +(213.2) + +- + +- + +(213.2) + +Capital expenditure . . . . . . . . . . . . + +(2,861.6) + +(354.0) + +31.4 + +(3,184.2) + +Assets . . . . . . . . . . . . . . . . . . . + +11,515.3 + +470.2 + +17.2 + +12,341.8 + +Segment assets . . . . . . . . . . . . . + +11,515.3 + +470.2 + +17.2 + +12,002.7 + +Deferred taxation asset . . . . . . . . + +- + +- + +- + +339.1 + +Liabilities . . . . . . . . . . . . . . . . . + +(6,525.8) + +(396.4) + +(23.7) + +(8,847.2) + +Segment liabilities . . . . . . . . . . . + +(6,525.8) + +(396.4) + +(23.7) + +(6,945.9) + +Deferred taxation liability . . . . . . . + +- + +- + +- + +(607.5) + +Taxation liability . . . . . . . . . . . . + +- + +- + +- + +(810.0) + +Dividends payable . . . . . . . . . . . + +- + +- + +- + +(483.8) + +F169 + +F170 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +41. + +SEGMENTAL INFORMATION (continued) + +South Africa + +Other African + +Eliminations + +Total + +countries + +Rm + +Rm + +Rm + +Rm + +2002 + +GEOGRAPHICAL SEGMENTS + +Segment revenue . . . . . . . . . . . . . + +15,415.4 + +740.4 + +(5.1) + +16,150.7 + +External . . . . . . . . . . . . . . . . + +15,410.3 + +740.4 + +- + +16,150.7 + +Inter-segment . . . . . . . . . . . . . + +5.1 + +- + +(5.1) + +- + +Segment profit/(loss) from operations . . + +3,545.7 + +81.5 + +(6.1) + +3,621.1 + +Interest and dividends received . . . . . + +32.0 + +Finance costs . . . . . . . . . . . . . . . + +(59.8) + +Profit before taxation . . . . . . . . . . . + +3,593.3 + +Included in segment profit/(loss) + +from operations + +Depreciation and amortization . . . . . . + +(1,939.2) + +(124.7) + +(6.1) + +(2,070.0) + +Property, plant and equipment . . . . . + +(1,737.2) + +(120.1) + +- + +(1,857.3) + +Intangible assets . . . . . . . . . . . . + +(202.0) + +(4.6) + +(6.1) + +(212.7) + +Bad debts written-off . . . . . . . . . . . + +(111.2) + +- + +- + +(111.2) + +Integration costs, disposals of operations + +and impairments . . . . . . . . . . . . . + +56.4 + +- + +- + +56.4 + +Capital expenditure . . . . . . . . . . . . + +(3,292.0) + +(988.4) + +1.4 + +(4,279.0) + +Assets . . . . . . . . . . . . . . . . . . . + +13,179.1 + +1,787.5 + +(105.7) + +15,358.6 + +Segment assets . . . . . . . . . . . . . + +13,179.1 + +1,787.5 + +(105.7) + +14,860.9 + +Deferred tax assets . . . . . . . . . . + +- + +- + +- + +497.7 + +Liabilities . . . . . . . . . . . . . . . . . + +(7,152.6) + +(945.1) + +91.3 + +(9,884.2) + +Segment liabilities . . . . . . . . . . . + +(7,152.6) + +(945.1) + +91.3 + +(8,006.4) + +Deferred taxation liabilities . . . . . . + +- + +- + +- + +(926.2) + +Taxation liabilities . . . . . . . . . . . + +- + +- + +- + +(351.6) + +Dividends payable . . . . . . . . . . . + +- + +- + +- + +(600.0) + +"South Africa", which is also the home country of the parent, comprises the segment information relating to the + +South African-based cellular network as well as all the segment information of the service providers and other + +business segments. "Other African countries" comprise of only cellular networks and are located in Tanzania, + +Lesotho and the Democratic Republic of Congo. + +ACCOUNTING POLICIES AND BASIS OF PREPARATION + +Segment information is prepared in conformity with accounting policies adopted for preparing and presenting the + +consolidated financial statements. + +Segment revenue excludes value-added taxation and includes inter-Group revenue. Net revenue represents segment + +revenue from which inter-Group revenue has been eliminated. Sales between segments are made on a commercial + +basis. Segment profit/(loss) from operations represents segment revenue less segment operating expenses. Segment + +expenses include direct and operating expenses. Integration costs, disposals or operations and impairments, + +depreciation and amortization have been allocated to the segments to which they relate. + +The segment assets and liabilities comprise all assets and liabilities of the different segments including those relating + +to operating, investing and financing activities. Unallocated assets and liabilities comprise of deferred taxation and + +other unallocatable balances. + +Capital expenditure in property, plant and equipment and intangible assets have been allocated to the segments to + +which they relate. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +42. + +INTEREST IN SUBSIDIARIES + +The information discloses interests in subsidiaries material to the financial position of the Group. + +The interest in the ordinary share capital is representative of the voting power. + +Issued share capital + +Interest in issued + +ordinary share capital + +Country of + +incorporation + +2000 + +2001 + +2002 + +2000 + +2001 + +2002 + +% + +% + +% + +Cellular network operators + +Vodacom (Proprietary) Limited . + +RSA + +R100 + +R100 + +R100 + +100 + +100 + +100 + +Vodacom Lesotho (Proprietary) + +Limited . . . . . . . . . . . . . . + +LES + +- + +M4,180 + +M4,180 + +- + +88,3 + +88,3 + +Vodacom Tanzania Limited . . . + +TZN + +- + +US$100 + +US$100 + +- + +65 + +65 + +Service providers + +Vodacom Service Provider + +Holding Company (Proprietary) + +Limited (INV) . . . . . . . . . . + +RSA + +R1,020 + +R1,020 + +R1,020 + +100 + +100 + +100 + +Vodacom Service Provider + +Company (Proprietary) + +Limited (C) . . . . . . . . . . . . + +RSA + +R20 + +R20 + +R20 + +100 + +100 + +100 + +Globalstar Southern Africa + +(Proprietary) Limited (S) * . . . . + +RSA + +- + +R100 + +R100 + +- + +100 + +100 + +Vodac (Proprietary) Limited * . . + +RSA + +R1 + +R1 + +R1 + +100 + +100 + +100 + +GSM Cellular (Proprietary) + +Limited * . . . . . . . . . . . . . + +RSA + +R1,200 + +R1,200 + +R1,200 + +100 + +100 + +100 + +Other + +Teljoy Holdings Limited (INV) . + +RSA + +R1,160,000 + +R158,999 + +R158,999 + +100 + +100 + +100 + +Film Fun (Holdings) + +(Proprietary) Limited (TV) . . . . + +RSA + +R100 + +R100 + +- + +100 + +100 + +- + +Vodacom Sport & Entertainment + +(Proprietary) Limited (SE) . . . . + +RSA + +- + +R100 + +- + +- + +51 + +- + +Vodacom Equipment Company + +(Proprietary) Limited * . . . . . . + +RSA + +R100 + +R100 + +R100 + +100 + +100 + +100 + +Vodacare (Proprietary) Limited * + +RSA + +R100 + +R100 + +R100 + +100 + +100 + +100 + +Vodacom International + +Holdings (Proprietary) + +Limited (INV) . . . . . . . . . . + +RSA + +- + +- + +R100 + +- + +- + +100 + +Vodacom International + +Limited (INV) . . . . . . . . . . + +MAU + +- + +- + +US$100 + +- + +- + +100 + +* Dormant at March 31, 2002. + +RSA Republic of South Africa; TZN Tanzania; LES Lesotho; MAU Mauritius; C Cellular; S Satellite; + +SE Sport and entertainment contracts manager; TV Television and related rental services; INV Investment + +holding company. + +F171 + +F172 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +43. + +INTEREST IN JOINT VENTURES + +The Group's joint ventures during the 2002 financial year included Vodacom World Online (Proprietary) Limited and + +Vodacom Congo (R.D.C.) S.P.R.L. Effective November 30, 2001, the Group disposed of the interest in Vodacom + +World Online (Proprietary) Limited. Details of the disposal are presented in Note 30 to the consolidated financial + +statements. + +The Group acquired its interest in Vodacom Congo (R.D.C.) S.P.R.L. on December 11, 2001. + +2001 + +2002 + +2002 + +Vodacom + +Vodacom Vodacom + +World + +Congo (R.D.C.) + +World + +Online + +S.P.R.L. + +Online + + + +(Proprietary) (Proprietary) + +Limited + +Limited + +Interest held . . . . . . . . . . . . . . . . . . . . . . . . . + +40% + +51% + +40% + +Rm + +Rm + +Rm + +The Group's proportionate share of assets and liabilities: + +Property, plant and equipment . . . . . . . . . . . . . . . . + +9.9 + +87.0 + +- + +Intangible assets . . . . . . . . . . . . . . . . . . . . . . . + +38.4 + +216.5 + +- + +Current assets . . . . . . . . . . . . . . . . . . . . . . . . + +4.9 + +154.9 + +- + +53.2 + +458.4 + +- + +Long-term liabilities . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Current liabilities . . . . . . . . . . . . . . . . . . . . . . . + +(22.2) + +(30.9) + +- + +Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . + +31.0 + +427.5 + +- + +The Group's proportionate share of revenue and expenditure: + +Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . + +43.0 + +5.7 + +36.1 + +Loss before taxation . . . . . . . . . . . . . . . . . . . . . + +(45.0) + +(20.1) + +(19.9) + +Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +- + +- + +Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(45.0) + +(20.1) + +(19.9) + +The Group's proportionate share of cash flows: + +Net cash flows from operating activities . . . . . . . . . . . + +(9.1) + +(72.3) + +1.4 + +Net cash flows from investing activities . . . . . . . . . . . + +(5.8) + +(275.8) + +- + +Net cash flows from financing activities . . . . . . . . . . . + +4.0 + +388.0 + +4.8 + +Net cash flow . . . . . . . . . . . . . . . . . . . . . . . . . + +(10.9) + +39.9 + +6.2 + +The Group's proportionate share of contingent liabilities + +and capital commitments: + +Contingent liabilities (Note 36) . . . . . . . . . . . . . . . + +- + +- + +- + +Capital commitments . . . . . . . . . . . . . . . . . . . . . + +0.2 + +319.7 + +- + +In terms of a shareholders agreement, the Group's joint venture partner in Vodacom Congo (R.D.C.) S.P.R.L., + +Congolese Wireless Network S.P.R.L. ("CWN") has a put option which comes into effect 3 years after the + +commencement date, December 1, 2001, and for a maximum of five years thereafter. In terms of the option, + +CWN shall be entitled to put to Vodacom International Limited such numbers of shares in and claims on loan account + +against Vodacom Congo (R.D.C.) S.P.R.L. as constitute 19% of the entire issued share capital of that company. + +CWN can exercise this option in a maximum of three tranches and each tranche must consist of at least 5% of the + +entire issued share capital of Vodacom Congo (R.D.C.) S.P.R.L. The option price will be the fair market value of + +the related shares. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +43. + +INTEREST IN JOINT VENTURES (continued) + +2000 + +Vodacom + +Vodacom + +Vodacom + +Vodacom + +Total + +Tanzania + +Lesotho + +World Sport + +and + +Limited + +Limited + +Online Entertain- + +(Proprietary) ment + +Limited (Proprietary) + +Limited + +Interest held . . . . . . . . . . . . . . . + +51% + +88.3% + +50% / 40% + +51% + +Rm + +Rm + +Rm + +Rm + +Rm + +The Group's proportionate share of + +assets and liabilities: + +Property, plant and equipment . . . . . . + +0.4 + +3.8 + +3.2 + +0.5 + +7.9 + +Intangible assets . . . . . . . . . . . . . + +1.7 + +0.1 + +28.5 + +- + +30.3 + +Investments . . . . . . . . . . . . . . . + +2.5 + +- + +- + +0.1 + +2.6 + +Current assets . . . . . . . . . . . . . . + +3.8 + +12.0 + +11.2 + +9.1 + +36.1 + +8.4 + +15.9 + +42.9 + +9.7 + +76.9 + +Long-term liabilities . . . . . . . . . . . + +- + +(7.3) + +- + +- + +(7.3) + +Current liabilities . . . . . . . . . . . . + +(0.5) + +(7.7) + +(13.2) + +(9.3) + +(30.7) + +Net assets . . . . . . . . . . . . . . . . + +7.9 + +0.9 + +29.7 + +0.4 + +38.9 + +The Group's proportionate share of + +revenue and expenditure: + +Revenue . . . . . . . . . . . . . . . . . + +- + +33.5 + +18.5 + +13.3 + +65.3 + +(Loss)/Profit before taxation . . . . . . . + +(0.5) + +7.0 + +(32.4) + +3.1 + +(22.8) + +Taxation . . . . . . . . . . . . . . . . . + +- + +(0.6) + +- + +(1.1) + +(1.7) + +Net (loss)/profit . . . . . . . . . . . . . + +(0.5) + +6.4 + +(32.4) + +2.0 + +(24.5) + +The Group's proportionate share of + +cash flows: + +Net cash flows from operating activities . + +- + +(0.2) + +0.4 + +0.5 + +0.7 + +Net cash flows from investing activities . + +(0.4) + +(16.1) + +(6.1) + +(0.6) + +(23.2) + +Net cash flows from financing activities . + +(6.0) + +9.2 + +63.1 + +- + +66.3 + +Net cash flow . . . . . . . . . . . . . . + +(6.4) + +(7.1) + +57.4 + +(0.1) + +43.8 + +The Group's proportionate share of + +contingent liabilities and capital + +commitments: + +Contingent liabilities . . . . . . . . . . . + +- + +- + +- + +- + +- + +Capital commitments . . . . . . . . . . + +- + +8.8 + +- + +- + +8.8 + +F173 + +F174 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +44. + +RESTATEMENT OF THE FINANCIAL STATEMENTS ISSUED PREVIOUSLY + +2000 + +2001 + +2002 + +Rm + +Rm + +Rm + +Net profit as previously disclosed . . . . . . . . . . . . . . + +1,359.0 + +1,361.7 + +2,337.6 + +Restatements and adjustments . . . . . . . . . . . . . . . . + +(44.0) + +(43.9) + +35.4 + +Net profit as restated . . . . . . . . . . . . . . . . . . . . . + +1,315.0 + +1,317.8 + +2,373.0 + +The summary of differences on restatements are set forth below and in Note 44.1 to Note 44.8: + +Balance as + +Share- Intangible + +Goodwill + +Hedge Deferred + +Unused + +Joint + +Other Balance as + +previously holder + +assets + +accounting + +bonus + +airtime venture + +restated + +reported loans + +incentives + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Rm + +Reconciliation 2000 + +Income statement + +Profit before taxation . . . . . + +1,896.3 + +- + +(11.0) + +- + +- + +36.1 + +(93.3) + +- + +- + +1,828.1 + +Taxation . . . . . . . . . . . . + +(537.8) + +- + +7.0 + +- + +- + +(10.8) + +28.0 + +- + +- + +(513.6) + +Minority interest . . . . . . . + +0.5 + +- + +- + +- + +- + +- + +- + +- + +- + +0.5 + +Net profit . . . . . . . . . . . + +1,359.0 + +- + +(4.0) + +- + +- + +25.3 + +(65.3) + +- + +- + +1,315.0 + +Balance sheet + +Capital and reserves . . . . . + +(3,770.3) + +1,070.0 + +4.0 + +- + +- + +(40.1) + +65.3 + +- + +- + +(2,671.1) + +Minority interest . . . . . . . + +(2.1) + +- + +- + +- + +- + +- + +- + +- + +4.3 + +2.2 + +Liabilities . . . . . . . . . . . + +(5,949.6) + +(1,070.0) + +(135.0) + +- + +- + +57.3 + +(93.3) + +- + +(4.3) + +(7,194.9) + +Assets . . . . . . . . . . . . . + +9,722.0 + +- + +131.0 + +- + +- + +(17.2) + +28.0 + +- + +- + +9,863.8 + +Reconciliation 2001 + +Income statement + +Profit before taxation . . . . . + +2,168.3 + +- + +(26.0) + +- + +(52.6) + +(28.3) + +12.9 + +- + +- + +2,074.3 + +Taxation . . . . . . . . . . . . + +(815.8) + +- + +29.7 + +- + +15.8 + +8.5 + +(3.9) + +- + +- + +(765.7) + +Minority interest . . . . . . . + +9.2 + +- + +- + +- + +- + +- + +- + +- + +- + +9.2 + +Net profit . . . . . . . . . . . + +1,361.7 + +- + +3.7 + +- + +(36.8) + +(19.8) + +9.0 + +- + +- + +1,317.8 + +Balance sheet + +Capital and reserves . . . . . + +(4,635.6) + +920.0 + +0.3 + +- + +173.3 + +(20.3) + +56.3 + +- + +- + +(3,506.0) + +Minority interest . . . . . . . + +7.1 + +- + +- + +- + +- + +- + +- + +- + +4.3 + +11.4 + +Liabilities . . . . . . . . . . . + +(7,732.6) + +(920.0) + +(109.8) + +- + +(29.1) + +29.0 + +(80.4) + +- + +(4.3) + +(8,847.2) + +Assets . . . . . . . . . . . . . + +12,361.1 + +- + +109.5 + +- + +(144.2) + +(8.7) + +24.1 + +- + +- + +12,341.8 + +Reconciliation 2002 + +Income statement + +Profit before taxation . . . . . + +3,589.3 + +- + +(29.4) + +0.2 + +39.3 + +8.6 + +(38.1) + +19.2 + +4.2 + +3,593.3 + +Taxation . . . . . . . . . . . . + +(1,227.0) + +- + +29.7 + +- + +(2.2) + +(2.6) + +11.4 + +- + +- + +(1,190.7) + +Minority interest . . . . . . . + +(24.7) + +- + +- + +- + +- + +- + +- + +(4.9) + +- + +(29.6) + +Net profit . . . . . . . . . . . + +2,337.6 + +- + +0.3 + +0.2 + +37.1 + +6.0 + +(26.7) + +14.3 + +4.2 + +2,373.0 + +Balance sheet + +Capital and reserves . . . . . + +(6,518.8) + +920.0 + +(0.3) + +28.5 + +22.3 + +(26.2) + +83.0 + +27.7 + +- + +(5,463.8) + +Minority interest . . . . . . . + +(417.7) + +- + +- + +- + +- + +- + +- + +362.8 + +44.3 + +(10.6) + +Liabilities . . . . . . . . . . . + +(8,819.2) + +(920.0) + +(77.5) + +- + +28.1 + +37.5 + +(118.5) + +29.7 + +(44.3) + +(9,884.2) + +Assets . . . . . . . . . . . . . + +15,755.7 + +- + +77.8 + +(28.5) + +(50.4) + +(11.3) + +35.5 + +(420.2) + +- + +15,358.6 + +44.1 + +Shareholder loans + +Shareholder loans, previously disclosed under shareholders' equity, were reclassified and are now included as a + +component of long-current liabilities for all periods presented. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +44. + +RESTATEMENT OF THE FINANCIAL STATEMENTS ISSUED PREVIOUSLY (continued) + +44.2 + +Intangible assets + +Previously the excess of the cost of an acquisition of a subsidiary over the Group's interest in the fair value of + +identifiable assets and liabilities at the date of certain acquisitions, was classified as goodwill. However, a + +portion of the excess previously classified as goodwill, related to customer bases and trademarks that have now + +been recorded as separate components of intangible assets. + +The amortization periods for the goodwill previously recorded and the separate components now disclosed are + +materially the same. + +Deferred taxation was raised on the customer bases and trademarks, with a corresponding adjustment to + +goodwill. + +44.3 + +Goodwill + +Acquired goodwill in the financial statements of Vodacom Congo (R.D.C) S.P.R.L. was converted at the + +average rate per month in the income statement and the closing rate in the balance sheet. This goodwill has + +now been translated at the historic rate on the date of acquisition, in accordance with the Group's accounting + +policy, which results in a different amortization charge. + +44.4 + +Hedge accounting + +During the 2001 financial year, qualifying assets were capitalized at the spot rate ruling on the order date + +together with the fair value movements on the related forward exchange contracts between the order date and + +acceptance date of the asset. The forward exchange contracts were recorded at fair value at order date and + +revalued to fair value at each reporting date of the asset. Where the assets had not been accepted at the + +reporting date, the fair value adjustments on the forward exchange contracts were deferred into equity and + +capitalized upon the asset acceptance date. The underlying liabilities were recorded at fair value on acceptance + +date and were also revalued at each reporting date. These subsequent fair value adjustments were expensed as + +incurred. + +The method previously applied in measuring the value of forward exchange contracts in the 2001 financial year + +has been amended to correspond with the treatment applied during all years prior to the 2001 financial year. + +During these years qualifying assets were capitalized at the spot rate ruling on the order date together with the + +unamortized premiums on the forward exchange contract between the order date and acceptance date of the + +qualifying asset. Unamortized premiums after the acceptance date of the asset were expensed over the + +remaining period of the forward exchange contract. The underlying liabilities were recorded at the forward + +exchange rate on acceptance date. These subsequent fair value adjustments were expensed as incurred. + +The 2002 year impact is a result of adoption of IAS 39 (Note 24). + +44.5 + +Deferred bonus incentive scheme + +The fair value of the entitlements were previously calculated as the difference in the entitlement value at + +balance sheet date and the value at which the entitlements were originally issued, multiplied by the number of + +entitlements allocated to a participant. This increase in entitlement value, previously expensed in full to the + +income statement and provided for in the balance sheet, is now based on the present value of the expected + +future cash out flows and recorded as a liability in the balance sheet. + +Details of the incentive scheme is set out in Note 23.1. + +44.6 + +Unused minutes on bundled airtime packages + +Revenue on bundled airtime products was previously recognized on the percentage of completion basis. The + +terms and conditions of the Group's bundled airtime products allow the carry over of unused minutes and + +accumulation thereof to a maximum of five times the monthly allocation of minutes. An assessment was made + +of the extent of minutes carried over that would ultimately be used and the related revenue was deferred. + +Deferred revenue related to unused airtime was recognized when utilized by the customer. + +Currently the revenue on carry-over minutes, as explained above, is deferred and only recognized when used by + +the customer or upon termination of the customer contract. + +44.7 + +Joint venture + +Vodacom Congo (R.D.C) S.P.R.L. was previously accounted for as a subsidiary. After reassessment the + +company was deconsolidated and accounted for as a joint venture. + +F175 + +F176 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +44. + +RESTATEMENT OF THE FINANCIAL STATEMENTS ISSUED PREVIOUSLY (continued) + +44.8 + +Other + +A deemed dividend on the liquidation of a subsidiary was previously credited directly against the retained + +earnings instead of being recognized in the income statement. + +Furthermore, certain amounts previously disclosed under minority interest have been reclassified to interest- + +and non-interest-bearing liabilities. + +45. + +US GAAP INFORMATION + +The financial statements have been prepared in accordance with International Accounting Standards ("IAS") which + +differs in certain respects from Generally Accepted Accounting Principles in the United States ("US GAAP"). The + +effect of applying US GAAP principles to net profit and shareholders' equity is set out below along with an + +explanation of applicable differences between IAS and US GAAP: + +Notes + +2001 + +2002 + +Rm + +Rm + +Net profit as reported in accordance with IAS . . . . . . . . + +1,317.8 + +2,373.0 + +Items increasing/(decreasing) net profit: + +Deferred bonus incentive scheme . . . . . . . . . . . . . . . . + +(a) + +7.0 + +20.9 + +Goodwill non-amortization . . . . . . . . . . . . . . . . . . + +(b) + +- + +1.9 + +Goodwill translation differences + +on accumulated amortization . . . . . . . . . . . . . . . . . . + +(c) + +(0.3) + +(4.0) + +Derivative financial instruments + +reclassification of transition adjustments . . . . . . . . . . . . + +(e) + +- + +52.0 + +Income tax rate differences . . . . . . . . . . . . . . . . . . + +(f) + +(118.3) + +(227.4) + +Income tax effect of US GAAP adjustments . . . . . . . . . . + +(g) + +(2.6) + +(27.5) + +Joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(i) + +45.0 + +(80.0) + +Net profit in accordance with US GAAP before + +cumulative effect of change in accounting policy . . . . . . . . + +1,248.6 + +2,108.9 + +Change in accounting policy upon adoption of SFAS 133 + +Derivative financial instruments transition adjustments . . . + +(e) + +- + +17.2 + +Income tax effect on above . . . . . . . . . . . . . . . . . . . + +(g) + +- + +(6.5) + +Net profit in accordance with US GAAP after cumulative + +effect of change in accounting policy . . . . . . . . . . . . . . + +1,248.6 + +2,119.6 + +Shareholders' equity as reported in accordance with IAS . + +3,506.0 + +5,463.8 + +Items increasing/(decreasing) shareholders' equity: + +Deferred bonus incentive scheme . . . . . . . . . . . . . . . . + +(a) + +37.0 + +57.9 + +Goodwill non-amortization . . . . . . . . . . . . . . . . . . + +(b) + +- + +1.9 + +Goodwill translation differences + +on accumulated amortization . . . . . . . . . . . . . . . . . . + +(c) + +(0.3) + +(4.3) + +Goodwill accumulated translation differences . . . . . . . . + +(c) + +4.6 + +31.7 + +Income tax rate differences . . . . . . . . . . . . . . . . . . + +(f) + +(418.4) + +(655.2) + +Income tax effect of US GAAP adjustments . . . . . . . . . . + +(f) + +(13.9) + +(21.8) + +Joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . + +(h) + +80.0 + +- + +Shareholders' equity in accordance with US GAAP . . . . . . + +3,195.0 + +4,874.0 + +Movements in shareholders' equity in + +accordance with US GAAP + +Balance at beginning of period . . . . . . . . . . . . . . . . . + +2,424.7 + +3,195.0 + +Net profit for period . . . . . . . . . . . . . . . . . . . . . . . + +1,248.6 + +2,119.6 + +Dividends declared . . . . . . . . . . . . . . . . . . . . . . . + +(480.0) + +(600.0) + +Foreign currency translation reserve adjustment . . . . . . . . + +1.7 + +127.0 + +Cumulative effect adjustment of adoption of SFAS 133, + +net of taxation . . . . . . . . . . . . . . . . . . . . . . . . . . + +- + +64.8 + +Gain on derivatives reclassified to earnings, net of taxation . + +- + +(32.4) + +Balance at end of period . . . . . . . . . . . . . . . . . . . . . + +3,195.0 + +4,874.0 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +45. + +US GAAP INFORMATION (continued) + +Summary of differences between International Accounting Standards and accounting principles generally + +accepted in the US. + +A summary of the principal differences and additional disclosures applicable to the Group are set forth below: + +(a) + +Deferred bonus incentive scheme + +Under IAS, the total value of deferred bonus entitlements as calculated at the end of each financial period is + +based on the net present value of expected future cash payments as determined under the bonus formula over the + +vesting period. + +Under US GAAP, in accordance with FIN 28: "Accounting for Stock Appreciation Rights and Other Variable + +Stock Option Awards Plans and Interpretation of APB Opinions No. 15 and 25", compensation cost is recognized + +over the service period or the vesting period if the service period is not defined, based upon the undiscounted + +value of the entitlements. + +(b) + +Goodwill non-amortization + +Under IAS, goodwill and intangible assets arising in business combinations are amortized over their estimated + +useful lives. + +Under US GAAP, accounting for goodwill and intangible assets was substantially the same as IAS until the + +adoption of SFAS No. 141: "Business Combinations" ("SFAS 141") and SFAS No. 142: "Goodwill and Other + +Intangible Assets" ("SFAS 142"). SFAS 141 is effective for all business acquisitions consummated after June 30, + +2001. SFAS 141 requires all business combinations consummated after June 30, 2001 to be accounted for under + +the purchase method. SFAS 141 also sets forth guidelines for applying the purchase method of accounting in the + +determination of intangible assets, including goodwill, acquired in a business combination. + +SFAS 142 addresses the initial and ongoing financial accounting and reporting for acquired goodwill and other + +intangible assets. SFAS 142 requires that goodwill be separately disclosed from other intangible assets in the + +balance sheet, and no longer be amortized but tested for impairment at least annually (or more frequently if + +impairment indicators arise). SFAS 142 is effective for financial statements for periods beginning on or after + +December 15, 2001. Additionally, the amortization provisions of SFAS 142 are applicable to goodwill arising in + +all business acquisitions consummated after June 30, 2001 regardless of the adoption date of SFAS 142. + +Accordingly, goodwill arising from the investment in Vodacom Congo (R.D.C.) S.P.R.L. is not subject to + +amortization. + +The Group will adopt SFAS 142 on April 1, 2002. The Group is required to complete the initial step of a + +transitional impairment test within six months of adoption of SFAS 142. However, management does not believe + +that a material adjustment will be necessary upon completion of this initial assessment. Subsequent impairment + +losses will be reflected in operating income or loss in the income statement. + +F177 + +F178 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +45. + +US GAAP INFORMATION (continued) + +(c) + +Goodwill translation of goodwill arising on the acquisition of a foreign entity + +Under IAS, goodwill arising on the acquisition of a foreign entity is treated as an asset of the Group and + +translated at the foreign exchange rate ruling at the transaction date based on the historical rate. + +Under US GAAP, goodwill arising on the acquisition of Vodacom Congo (R.D.C) S.P.R.L. and Vodacom + +Tanzania Limited is translated at the actual exchange rate at the end of the period. The resulting foreign + +exchange transaction gain or loss increases or decreases the net investment in Vodacom Congo (R.D.C.) S.P.R.L. + +and Vodacom Tanzania Limited. + +2001 + +2002 + +Rm + +Rm + +A reconciliation of goodwill for South African and foreign entities reported + +under IAS on the balance sheet to the approximate amounts determined + +under US GAAP is as follows: + +Included in total goodwill reported under IAS . . . . . . . . . . . . . . . + +359.1 + +342.9 + +Goodwill not amortized under US GAAP . . . . . . . . . . . . . . . . . + +- + +1.9 + +Additional goodwill income tax rate change . . . . . . . . . . . . . . . + +28.5 + +20.1 + +Translation difference on amortization . . . . . . . . . . . . . . . . . . . + +(0.3) + +(4.3) + +Translation difference on goodwill balance . . . . . . . . . . . . . . . . + +4.6 + +31.7 + +As adjusted under US GAAP . . . . . . . . . . . . . . . . . . . . . . . . + +391.9 + +392.3 + +(d) + +Income taxes additional temporary differences + +Under IAS, no deferred tax liability was recognized in respect of intangible assets acquired, other than in a + +business combination, where there was a difference at the date of acquisition between the assigned values and + +the tax bases of the assets. + +Under US GAAP, a deferred tax liability (and corresponding increase in assets acquired) is recognized for all + +temporary differences between the assigned values and the tax bases of intangible assets acquired. The recording + +of such deferred tax liability has no net impact on net income or shareholder's equity as determined under + +US GAAP as the decrease in income tax expense is off-set by a corresponding increase in amortization + +(Note 45(f)). + +(e) + +Derivative financial instruments + +The Group adopted IAS 39 and SFAS 133: "Accounting for Derivative Instruments and Hedging Activities" + +("SFAS 133") on April 1, 2001. + +Under IAS, upon adoption of IAS 39, the difference between previous carrying amounts and the fair value of + +derivatives, which prior to the adoption of IAS 39 had been designated as either fair value or cash flow hedges + +but do not qualify as hedges under IAS 39, is recognized as an adjustment of the opening balance of retained + +earnings at the beginning of the financial year IAS 39 is initially applied. Changes in fair value of derivatives + +acquired after April 1, 2001 are recorded in the income statement. + +Under US GAAP, upon adoption of SFAS 133, the difference between previous carrying amounts and fair value + +of derivatives, which prior to the adoption of SFAS 133 had been cash flow type hedges but do not qualify as + +hedges under SFAS 133, is recognized as a cumulative effect adjustment of other comprehensive income in the + +year SFAS 133 is initially applied. This amount is subsequently released into earnings in the same period or + +periods during which the hedged transaction affects earnings. During the year ended March 31, 2002 + +R52.0 million before taxation was released into earnings. The difference between previous carrying amounts + +and fair value of derivatives, which prior to the adoption of SFAS 133 had been fair value type hedges, is + +recognized as a cumulative effect adjustment in earnings. Changes in fair value of derivatives acquired after + +April 1, 2001 are recorded in the income statement. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +45. + +US GAAP INFORMATION (continued) + +(f) + +Income tax rate differences + +The tax rate in South Africa varies depending on whether income is distributed. The income tax rate is 30% but + +upon distribution an additional tax (Secondary Tax on Companies or "STC") of 12.5% is due based on the + +amount of the dividends net of the STC credit for dividends received during a dividend cycle. + +In conformity with IAS, Vodacom reflects the STC as a component of the income tax change for the period in + +which dividends are declared, IAS also requires that deferred tax be provided for at the undistributed rate + +of 30%. + +For the purpose of US GAAP, Vodacom believes that under SFAS No. 109: "Accounting for Income Taxes" + +("SFAS 109") temporary differences should be tax effected using the tax rate that will apply when income is + +distributed, i.e. an effective rate of 37.78% including STC. + +Vodacom has therefore computed the estimated STC that would become payable upon distribution of relevant + +undistributed earnings and accrued that amount as additional liability for US GAAP purposes. + +The use of the higher rate not only affects the measurement of deferred tax assets and liabilities, and hence the + +tax charge for any period, but because temporary differences in a business combination need to be tax effected at + +the higher rate there is a consequent effect on the amount of goodwill recognized in a business combination + +under US GAAP. + +(g) + +Deferred taxation + +The tax effects of the US GAAP adjustments have been calculated based on the enacted tax rate of 37.78% + +(2001: 37.78%). + +A reconciliation of the deferred tax balances under IAS to the approximate amounts determined under + +US GAAP, where materially different, are as follows: + +2001 + +2002 + +Rm + +Rm + +Net deferred tax liabilities: + +As reported under IAS . . . . . . . . . . . . . . . . . . . . . . . . . . . + +268.4 + +428.5 + +Additional temporary differences (Note 45(d)) . . . . . . . . . . . . . . . + +35.3 + +62.2 + +Income tax rate differences . . . . . . . . . . . . . . . . . . . . . . . . + +446.9 + +675.3 + +Tax effect of US GAAP adjustments . . . . . . . . . . . . . . . . . . . . + +13.9 + +21.8 + +As adjusted under US GAAP . . . . . . . . . . . . . . . . . . . . . . . . + +764.5 + +1,187.8 + +Under IAS, deferred tax assets on deductible temporary differences are only recognized to the extent that it is + +probable that the future taxable profit will allow the deferred tax asset to be recovered. + +Under US GAAP, deferred tax assets are recognized on all temporary differences. A valuation allowance is + +recognized if it is more likely than not that the asset will not be recovered. For US GAAP purposes, an + +additional deferred tax asset and a corresponding valuation adjustment allowance of R31.0 million + +(2001: R31.0 million) have no effect on the net shareholders' equity for the year. + +(h) + +Capitalized interest + +Under IAS, interest cost incurred during the construction period is expensed as incurred. + +Under US GAAP, interest cost incurred during the construction period (i.e. period of time necessary to bring a + +constructed fixed asset to the condition and location necessary for its intended use) is capitalized. The capitalized + +interest is recorded as part of the asset to which it relates and is amortized over the asset's estimated useful life. + +Capitalized interest was nil for the years ended March 31, 2002 and 2001 as the effect of capitalising interest, as + +compared with the effect of expensing interest, was not material. + +F179 + +F180 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +45. + +US GAAP INFORMATION (continued) + +(i) + +Joint ventures + +Under IAS, investments qualifying as joint ventures are accounted for under the proportionate consolidation + +method of accounting. Under the proportionate consolidation method, the venturer records its share of each of + +the assets, liabilities, income and expenses of the jointly controlled entity on a line-by-line basis with similar + +items in the venturer's financial statements. The venturer continues to record its share of losses in excess of its + +net investment of the joint venture. + +Under US GAAP, joint ventures are accounted for under the equity method of accounting. Under the equity + +method, an investment in a joint venture is shown in the balance sheet of an investor as a single amount. + +Likewise, an investor's share of earnings or losses from its investment is ordinarily shown in its income + +statement as a single amount. An investor discontinues applying the equity method when its net investment + +(including net advances) is reduced to zero. + +In 2001 and 2000, in accordance with IAS, the Group proportionately consolidated losses to the value of + +R45.0 million and R35.0 million, respectively, that was in excess of the Group's net investment in the joint + +venture. Under US GAAP these losses are not considered in calculating net income as the value of the + +investment was reduced to zero. Upon disposal of the investment in Vodacom World Online (Proprietary) + +Limited in 2002, the gain on the sale was less based on a different basis in the net investment. + +Under IAS Vodacom World Online (Proprietary) Limited was proportionately consolidated in 2001 and 2002 and + +Vodacom Congo (R.D.C.) S.P.R.L. in 2002. The summarised financial statement information for Vodacom World + +Online (Proprietary) Limited and Vodacom Congo (R.D.C.) S.P.R.L. relating to Vodacom's pro rata interest is + +set out in Note 43. Vodacom World Online (Proprietary) Limited was disposed of in November 2001. + +(j) + +Comprehensive income + +Comprehensive income under US GAAP and accumulated other comprehensive income balances under + +US GAAP are summarised as follows: + +2001 + +2002 + +Rm + +Rm + +Net income under US GAAP . . . . . . . . . . . . . . . . . . . . . . . . + +1,248.6 + +2,119.6 + +Other comprehensive income: + +Foreign currency translation adjustment . . . . . . . . . . . . . . . . . . + +1.7 + +127.0 + +Cumulative effect adjustment of adoption of SFAS 133 . . . . . . . . . . + +- + +64.8 + +Gain on derivatives reclassified to earnings . . . . . . . . . . . . . . . + +- + +(32.4) + +Other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . + +1.7 + +159.4 + +Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . + +1,250.3 + +2,279.0 + +Accumulated other comprehensive income balances: + +Cumulative foreign currency translation adjustments . . . . . . . . . . . + +2.3 + +129.3 + +Cumulative effect adjustment of adoption of SFAS 133 . . . . . . . . . . + +- + +32.4 + +(k) + +Impairment of assets + +Under IAS the Group is required to annually assess whether there are any indications that an asset may be + +impaired. Should there be such an indicator, the asset must be tested for impairment. An impairment loss must + +be recognized in the statement of operations, should an assets carrying amount exceed its recoverable amount. + +The impairment loss is the difference between the assets carrying amount and its recoverable value. The + +recoverable amount is the higher of the assets net selling price or its value in use. Value in use is the future cash + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +45. + +US GAAP INFORMATION (continued) + +(k) + +Impairment of assets (continued) + +flows to be derived from the particular asset, discounted to present value using a pre-tax market determined rate + +that reflects the current assessment of the time value of money and the risks specific to the asset. The reversal of + +an impairment loss in subsequent periods is permitted when there has been a change in economic conditions or + +the expected use of the asset. + +Under US GAAP the Group is required to test for impairment whenever there is an indication of impairment. + +For assets to be held and used, impairment is first measured by reference to undiscounted cash flows. If there is + +no impairment by reference to undiscounted cash flows, no further action is required but the useful life of the + +asset must be reconsidered. If impairment exists the Group must measure impairment by comparing the assets + +fair value to its carrying value. Fair value is either market value (if an active market for the asset exists) or the + +sum of discounted future cash flows. The discount rate reflects the risk that is specific to that asset. For assets to + +be disposed of, the loss recognized is the excess of the assets carrying amount over its fair value less costs to + +sell. The reversal of previously recognized impairment losses is prohibited. + +During 2001, the Group recognized an impairment loss in accordance with IAS amounting to R97.7 million. No + +part of that impairment loss was subsequently reversed. + +During the same period in the Group recognized a loss of R45.5 million in respect of a onerous contract (Note 3) + +in accordance with paragraph 8 of SFAS 5: "Accounting for Contingencies" ("SFAS 5"). Subsequent to the + +issuance of the 2001 financial statements, it became clear that the other party to the contract was prepared to + +waive its right to supply satellite phones and instead was prepared to enter into a revised contract to supply + +mobile phones. Accordingly, management determined that, based on the change in circumstances arising from + +the willingness of the other party to revise the contract, the Group would no longer incur a loss under the + +contract and therefore reversed the loss previously provided for. The reversal of the provision, based on a change + +in circumstances, is not the recovery of impaired assets but rather it represents the reversal in a subsequent + +period of provision for an estimated loss. + +The Group currently has no material GAAP difference for impairment of assets. + +(l) + +Revenue recognition + +Under IAS the Group recognizes activation fee revenue and costs up to the amount of the related activation + +revenue immediately upon activation of a new customer. Any excess costs incurred are recognized up front upon + +activation of a new customer. + +Under US GAAP activation fee revenues and costs up to the amount of activation revenue would be deferred and + +recognized over the customer relationship period. + +The Group has not presented the deferral of activation fees in the above US GAAP reconciliation, as there is no + +material impact. + +(m) + +Recent accounting pronouncements + +In July 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting + +Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and + +intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if + +impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite + +lives will continue to be amortized over their useful lives. + +The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. + +With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Group adopted SFAS 142 + +effective April 1, 2002. The Group has evaluated the effect that the adoption of the provisions of SFAS 142 will + +have on its results of operations and financial position. + +F181 + +F182 + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +45. + +US GAAP INFORMATION (continued) + +(m) + +Recent accounting pronouncements (continued) + +In August 2001, the FASB issued Statement of Financial Accounting Standards No. 143, "Accounting for + +Obligations, Associated with the Retirement of Long-Lived Assets" ("SFAS 143"). SFAS 143 establishes + +accounting standards for recognition and measurement of a liability at fair value for an asset retirement + +obligation and an addition to the associated asset retirement cost. The accretion of interest expense each period + +is subsequently recorded as an expense and added to the liability. SFAS 143 is effective for fiscal years + +beginning after June 15, 2002. The Group expects determined that the adoption of SFAS 143 will not have a + +material impact on its results of operations and financial position. + +In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the + +Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 addresses financial accounting and + +reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. This statement + +supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived + +Assets to be disposed of" ("SFAS 121"). However, this statement retains the fundamental provisions of SFAS + +121 for recognition and measurement of the: (a) impairment of long-lived assets to be held and used and + +(b) long-lived assets to be disposed of by sale. The Group adopted SFAS 144 effective April 1, 2002 + +(Note 45(j)). The Group expects that the adoption of SFAS 144 will not have a material impact on its results of + +operations and financial position. + +In November 2001, the Emerging Issues Task Force reached a consensus on "Accounting for Consideration + +Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)" ("EITF 01-09"). The purpose + +of Issue 01-09 is to address the accounting for consideration given by a vendor to a customer including both a + +reseller of the vendor's products and an entity that purchases the vendor's products from a reseller. The Task + +Force reached a consensus that cash consideration (including a sales incentive) given by a vendor to a customer + +is presumed to be a reduction of the selling price of the vendor's products or services and therefore, should be + +characterized as reduction of revenue when recognized in the vendor's income statement. That presumption is + +overcome and the consideration should be characterised as cost incurred if both the following conditions are + +met: (a) The vendor received or will receive, an identifiable benefit in exchange for the consideration and (b) the + +vendor can reasonably estimate the fair value of he benefit identified under condition (a). The EITF should be + +applied no later than in financial statements for annual or interim periods beginning after December 15, 2001. + +The Group expects that the adoption of EITF 01-09 will not have a material impact on its results of operations + +and financial position. + +In April 2002, the FASB issued Statements of Accounting Standards No. 145, "Rescission of SFAS Nos. 4, 44 + +and 64, Amendment of SFAS 13, and Technical Corrections as of "April 2002" ("SFAS 145"). SFAS 145 + +rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt", SFAS No. 44, "Accounting + +for Intangible Assets of Motor Carriers", and SFAS 64, "Extinguishments of Debt made to satisfy Sinking-Fund + +requirements". As a result, gains and losses from extinguishment of debt will no longer be classified as + +extraordinary items unless they meet the criteria of unusual or infrequent as described in Accounting Principles + +Boards Opinion 30, "Reporting the Results of Operations Reporting the Effects of Disposal of a Segment of a + +Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". In addition, + +SFAS 145 amends SFAS 13, "Accounting for Leases", to eliminate an inconsistency between the required + +accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have + +economic effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing + +authoritative pronouncements to make various technical corrections, clarify meanings, or describe their + +applicability under changed conditions. SFAS 145 is effective for fiscal years beginning after May 15, 2002. + +The Group is currently evaluating the impact that the adoption of SFAS 145 will have on its results of operations + +and financial position. However, the Group does not believe that the adoption of SFAS 145 will have a material + +impact on its results of operations and financial position. + +VODACOM GROUP (PROPRIETARY) LIMITED + +NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS + +for the three years ended March 31, 2002 + +45. + +US GAAP INFORMATION (continued) + +(m) + +Recent accounting pronouncements (continued) + +In June 2002, the FASB issued Statement of Accounting Standards No. 146, "Accounting for Costs Associated + +with Exit or Disposal Activities". This Statement addresses financial accounting and reporting for costs + +associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability + +Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain + +Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS 146 eliminates the definition and requirements for + +recognition of exit costs in EITF 94-3. SFAS 146 requires that a liability for a cost associated with an exit or + +disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as + +defined in EITF 94-3 was recognized at the date of an entity's commitment to an exit plan. SFAS 146 also + +concluded that an entity's commitment to a plan, by itself, does not create a present obligation to others that + +meets the definition of a liability. SFAS 146 also establishes that fair value is the objective for initial + +measurement of the liability. The Group is currently evaluating the impact that the adoption of SFAS 146 will + +have on its results of operations and financial position. However, the Group does not believe that the adoption of + +SFAS 146 will have a material impact on its results of operations and financial position. + +F183 + +A1 + +REPUBLIC OF SOUTH AFRICA + +The following information on the Republic of South Africa is intended as a general summary and has been extracted + +from publicly available documents, and has not been prepared or independently verified by us or our advisers or the + +underwriters or any of their respective affiliates or advisers: + +Introduction + +In 1994, South Africa held its first fully democratic national elections, culminating in the election of Mr. Nelson + +Mandela as President of South Africa, then the leader of the African National Congress and the anti-apartheid movement in + +South Africa. In June 1999, South Africa held its second fully democratic national elections, culminating in the election of + +Mr. Thabo Mbeki as President of South Africa. + +The Constitution states that South Africa is "founded on a commitment to achieve equality, to promote and protect + +human dignity and to advance human rights and freedoms." It enshrines the principles of the supremacy of the rule of law, + +universal adult suffrage, regular elections and multi-party democracy. The Constitution's Bill of Rights is one of the world's + +broadest, guaranteeing property rights, freedom of speech, movement and political activity and giving those accused of + +crimes many legal protections, including the right to a speedy trial and the right to remain silent. Among other things, the + +Bill of Rights enshrines the right to adequate housing, food, water, education and healthcare and prohibits discrimination on + +the basis of race, gender, sexual orientation, age, pregnancy or marital status. + +South Africa must address a legacy of great divisions within the population, largely along racial lines, which have taken + +a heavy toll on human development and the economy. This toll is evidenced by the chronically high unemployment rate + +(which some estimates put at 30% 40% of the economically active population) and the widely divergent nature of the + +economy, in which vast sections of the population suffer tremendous inadequacies in areas such as housing, sanitation, + +healthcare and education, while a small minority enjoys the benefits associated with a highly developed society. Faced with + +these challenges, the Government of the Republic of South Africa adopted a three year budgetary framework for social and + +economic policy as a basis for the design of Government programs to address such inadequacies at the national, provincial + +and local levels. The National Government has expressed its commitment to implementing these policies within a + +framework of fiscal discipline to ensure sustainable economic growth. + +Private sector confidence, cooperation between labor and management and reduced levels of political and criminal + +violence are expected to continue to be important determinants of being able to achieve sustainable economic growth in + +South Africa, with the long-term aim of creating jobs for all economically active South Africans. A dramatic increase in job + +opportunities will not be easily or rapidly obtained, and unemployment is unfortunately likely to remain a feature of the + +South African economy in the near future. + +Despite these challenges, South Africa has the most developed economy in sub-Saharan Africa, with a GDP equal to + +more than seven times that of its six immediate neighbors combined. + +The major strengths of the South African economy are its strong physical and economic infrastructure, its abundant + +natural resources, particularly gold, and a wide variety of other minerals including coal and uranium oxide, and its growing + +manufacturing sector. + +Geography and population + +The Republic of South Africa is the southernmost country on the African continent, bordered on the northwest by + +Namibia and Botswana; on the northeast by Zimbabwe, Mozambique and Swaziland; on the east and south by the Indian + +Ocean; and on the west by the Atlantic Ocean. Lesotho forms an enclave in the northeastern part of the country. The + +Republic of South Africa covers an area of approximately 1.2 million square kilometers and comprises nine provinces: + +Gauteng, Limpopo (previously Northern Province), Mpumalanga, North-West Province, Free State, Eastern Cape, Northern + +Cape, Western Cape and KwaZulu-Natal. + +The country has three capitals: Cape Town is the legislative capital, Pretoria is the executive capital and Bloemfontein is + +the judicial capital. The estimated population as of mid-year 2002 was approximately 45.4 million people according to + +Statistics South Africa. Major regions in South Africa include the Western Cape, with approximately 2.1 million people; + +KwaZulu-Natal with approximately 8.9 million people, including Durban, the country's leading port; Eastern Cape with + +approximately 6.7 million people, which includes Port Elizabeth, an industrial city and major port; and Gauteng with + +approximately 7.8 million people. This area includes Johannesburg, the main financial center, Pretoria and Soweto, a + +township outside Johannesburg, which is one of the largest communities in South Africa with estimates placing the + +population at over a million people. + +A2 + +According to Statistics South Africa, as of mid year 1999 approximately 55% of the population lived in urban areas. The + +most densely populated parts of South Africa are the four major industrialised areas: the Pretoria/Witwatersrand/Vereeniging + +area of Gauteng Province, the Durban/Pinetown/Pietermaritzburg area of KwaZulu-Natal Province, the Cape Peninsula + +area of the Western Cape Province and the Port Elizabeth/Uitenhage area of the Eastern Cape Province. + +Among the black population there are numerous ethnic groups. There are 11 official languages in South Africa. Until + +recently, whites dominated the nonwhite majority population under the political system of racial segregation known as + +apartheid. Legalized apartheid ended in the early 1990s, but South Africa is still recovering from the racial inequalities in + +economic power, opportunity and lifestyle. The end of apartheid led to the lifting of trade and other sanctions against South + +Africa imposed by the international community. It also led to a total reorganization of the South African Government, + +which since 1994 has been a nonracial democracy based on majority rule. + +Government and politics + +The twentieth century produced several fundamental governmental changes in South Africa. In 1910, the Union of South + +Africa was formed as a largely autonomous dominion of Britain. In 1961, South Africa became a republic and left the + +Commonwealth. A new constitution in 1984 established a three-house parliament with white, colored and Asian houses, but + +excluded the black majority altogether. Lengthy constitutional negotiations in the early 1990s led to the implementation of + +an interim constitution in April 1994. The interim constitution was designed to encourage the sharing of power between + +major parties with cabinet representation proportionate to their electoral strength. This was effectively a compromise + +intended to provide continuity in Government until the adoption of a new constitution. + +In December 1996, the parliament passed the Constitution of the Republic of South Africa, 1996, which came into force + +on February 4, 1997. The Constitution enshrines the principles of an open and democratic society and also established a + +relatively strong central Government and nine provincial governments. + +The president is elected by the majority party in parliament to a five year term. The president appoints both the sole + +deputy president and all members of the cabinet, without regard to party representation in the parliament. + +Ultimately, legislative authority vests in a parliament, which consists of two houses, the National Assembly and the + +National Council of Provinces. The National Assembly allows for 400 members elected under a list proportional + +representation system. The National Council of Provinces consists of ten members from each of the nine provinces, who + +are elected by the members of the provincial legislature. Each of the nine provinces has a provincial legislature and the + +Constitution contains a schedule which contains a list of matters over which the provincial legislatures have concurrent + +competence with the national legislature as well as certain issues over which the provincial legislatures have exclusive + +jurisdiction. + +The judiciary is structured according to a formal court system comprising a hierarchy of courts, with the highest court in + +the land in matters relating to the interpretation, protection and enforcement of the provisions of the Constitution being the + +Constitutional court and in relation to non-constitutional matters, the Supreme Court of Appeal. The independence of the + +judiciary is entrenched in the Constitution. + +On June 2, 1999, South Africa held its second fully democratic national election. Most of South Africa's major political + +parties participated in the elections, which were ultimately won by the African National Congress, led by Thabo Mbeki, + +which won nearly two thirds of the legislative seats. + +Economy + +Economic overview + +South Africa has a highly developed financial system and legal infrastructure at the core of its economy. However, it + +faces many challenges in order to overcome substantial inequalities among its population pursuant to social and economic + +development. Large parts of the population do not have access to adequate education, healthcare, housing or basic services + +in certain areas. + +In the years prior to South Africa's first democratic elections in 1994, the economy suffered from the country's political + +isolation, economic sanctions and poor economic growth. During the apartheid period, the Government of the Republic of + +South Africa professed to follow the capitalist system, although its own economic policies were in many respects + +interventionist and a large portion of the economy was owned and controlled by the state, while its racial policies + +compromised fundamental elements of capitalism such as the free movement of labor. International sanctions imposed + +because of the Government's apartheid policies were increasingly damaging in the late 1980s but ended in the early 1990s + +as the apartheid era came to a close. + +When the African National Congress came to power it was feared that it would pursue socialist policies. In practice, + +however, its economic policies have been geared to maximizing economic growth and attracting foreign investment. In + +recent years, the economy has benefited from stable political conditions through a transition to a nonracial democracy, + +normalization of its international financial and trading relations and improving economic fundamentals resulting from + +prudent monetary and fiscal policies. + +The Government's macroeconomic strategy for growth, employment and redistribution is based on promoting the free + +market and financial and fiscal discipline and aims at economic growth, job creation and the development and distribution + +of basic services to all South Africans. Some of the key elements of this strategy include reducing the budget deficit, + +restructuring and privatizing certain state assets, the further relaxation of foreign exchange controls, the maintenance of + +positive real interest rates and sound monetary policy and the introduction of tax incentives for foreign direct investments. + +Economic indicators + +The table below summarizes the main economic indicators for the Republic of South Africa: + +Year ended December 31, + +1998 + +1999 + +2000 + +2001 + +Economic summary + +Real GDP growth rate (%) . . . . . . . . . . . . . + +0.8 + +2.1 + +3.4 + +2.2 + +Current account (ZAR billions) . . . . . . . . . . + +(12.9) + +(3.9) + +(3.7) + +(1.7) + +Current account as a percentage of GDP (%) . . . + +(1.7) + +(0.5) + +(0.4) + +(0.2) + +Gold and gross foreign reserves (ZAR billion) . . + +31.6 + +45.4 + +57.0 + +90.6 + +Rand per Dollar average (ZAR . . . . . . . . . . + +5.53 + +6.11 + +6.94 + +8.60 + +Rand per Dollar at year end (ZAR) . . . . . . . . + +5.90 + +6.14 + +7.57 + +12.00 + +Rand per Pound Sterling average (ZAR . . . . . + +9.16 + +9.89 + +10.49 + +12.39 + +Rand per Pound Sterling at year end (ZAR) . . . . + +9.75 + +9.92 + +11.28 + +16.61 + +Prime lending rate at year end (percentage) . . . . + +23.00 + +15.50 + +14.50 + +13.00 + +Inflation rate (headline CPI, annual average + +year on year change) (percentage) . . . . . . . . . + +6.9 + +5.2 + +5.3 + +5.7 + +Gross domestic product + +The South African economy is the largest and most sophisticated on the African continent. The per capita GDP in South + +Africa was $2,623 in 2001, which ranks South Africa alongside other middle-income countries such as Chile, Mexico, + +Hungary, Thailand and Malaysia. Economic growth has in the past years begun to recover in response to substantial easing + +of the monetary policy by the Reserve Bank after the emerging market crisis and an improvement in prospects for world + +growth and commodity prices. GDP rose 2.1% in 1999, 3.4% in 2000 and 2.2% in 2001, compared to average annual + +growth of 0.7% from 1980 through 1990. + +South Africa is changing economically from a producer of raw materials to an industrial nation that produces both raw + +materials and commercial products. The nation's manufacturing, commerce and services have been built extensively on the + +foundations of mining and farming. The manufacturing sector accounted for the largest portion of the GDP at 19.8% in + +2001. Industries making the biggest contributions to manufacturing output were food, motor vehicles, iron and steel and + +fabricated metal industry. The financial services sector accounted for 19.0% of GDP in 2001, general Government services + +accounted for 14.3% of GDP in 2001 and wholesale and retail trade, catering and accommodation accounted for 13.9% of + +GDP in 2001. Mining still plays an important, albeit it, a diminishing role in the economy, both directly and indirectly as a + +result of manufacturing output devoted to the beneficiation of minerals. Mining accounted for 6.0% of GDP in 2001, while + +agriculture accounted for only 4.3% of GDP in 2001. + +The modern industrial and commercial economy gives a minority of the population, including most whites a standard of + +living equivalent to that in Western Europe, but for many who are wholly or partially excluded from the economy, incomes + +and lifestyles are characteristic of developing countries. There are marked variations in economic production among + +different geographic areas in South Africa. Sources estimate 40% of GDP is produced in Gauteng Province alone, while + +minimal commercial activity and poor infrastructure characterize the so called former black states. + +Monetary and fiscal policy and inflation + +Monetary policy is the sole responsibility of the Reserve Bank, the independence of which is safeguarded by the + +Constitution. The Reserve Bank's stated priority is financial stability. Monetary policy settings are guided principally by + +inflation targets determined by the South African Ministry of Finance. + +Headline consumer price index inflation was reduced to 5.7% in 2001 from 6.9% in 1998, while the CPIX inflation rate + +was reduced to 6.6% from 7.0%. This was mainly due to increased trade liberalization in an international deflationary + +environment. It is in this context of more competitive product markets and fiscal restraint that the Reserve Bank has set a + +3% to 6% average inflation target for the headline consumer price index excluding the impact of changes in interest rates in + +metropolitan and other urban areas for 2002. + +The fiscal deficit was cut to 1.4% of GDP in fiscal 2001/2002 data from 2.0% of GDP in fiscal 2000/2001. As of + +March 31, 2002, the total debt of the South African Government stood at R425 billion, or 42.9% of 2001/2002 GDP. + +A3 + +A4 + +Foreign trade and current account + +South Africa subscribed to the General Agreement on Tariffs and Trade reached in 1993 and proposed that it be awarded + +developing country status. This was not accepted, but the United States backed a proposal that South Africa be treated as an + +economy in transition, a status similar to that of the former communist countries of Eastern Europe. In negotiations with + +the European Union, South Africa has been treated as a developing country for the purpose of trade preferences in + +EU markets, but it has been denied participation in the Lome Convention agreements between the EU and 70 African, + +Caribbean and Pacific states because South Africa's export capacity and the size of its economy threaten those states. + +South Africa's current account deficit decreased to R1.7 billion, representing 0.2% of GDP in 2001 from R3.7 billion, + +representing 0.4% of GDP in 1999. This was largely due to improved trade performance supported by an undervalued real + +exchange rate. South Africa's total foreign debt was $36.9 billion, representing 29.3% of GDP, and its foreign currency + +denominated foreign debt was $24.9 billion, representing 21.5% of GDP, as of December 31, 2001 compared to total + +foreign debt of $38.9 billion, representing 29.9% of GDP, and foreign currency denominated foreign debt of $23.9 billion, + +representing 18.5% of GDP, as of December 31, 1999. Gold and foreign exchange reserves of the South African Reserve + +Bank were R91.0 billion as of December 31, 2001, with the net open forward position of the bank being $4.8 billion. This + +has subsequently been reduced to $1.7 billion as of August, 2002. + +Currency exchange + +The South African Reserve Bank in Pretoria, founded in 1920, is responsible for formulating and implementing + +monetary policy, overseeing the banking system and issuing the currency. Between January 1997 and December 2001, the + +Rand has depreciated at an average annual rate of 15% against the Dollar, 13% against the UK pound sterling, 7% against + +the Euro, 13% against the Japanese Yen. This is primarily due to two events. The first was the emerging markets crisis in + +1997 and 1998, which resulted in significant depreciation in the currencies of emerging markets globally. The second was + +the deteriorating political situation in Zimbabwe, one of South Africa's neighbors, during the course of 2000. These events + +were followed by a rapid fall in the US NASDAQ and a concurrent flight to quality, including the sell off of all emerging + +market securities, including South African securities. During 2001 the Rand fell a further 25% against the $. This was + +largely the result of a deteriorating outlook for global growth which pushed the current account back into deficit during + +2002. The events surrounding September 11 in the US also brought a flight to quality back into focus. The net result was + +significant downward pressure on the currency during this period. During 2002, the Rand appreciated by 8% against the + +Dollar and 2% against the UK pound sterling. + +There are a number of exchange control regulations that provide for restrictions on exporting capital from the Common + +Monetary Area consisting of the Republic of South Africa, the Republic of Namibia, and the Kingdoms of Lesotho and + +Swaziland. Transactions between South African residents, including corporations, and between residents and non-residents + +of the Common Monetary Area are subject to these exchange control regulations which are enforced by the South African + +Reserve Bank. + +The present exchange control system in South Africa is used principally to control capital movements. South African + +companies are generally not permitted to export capital from South Africa, hold foreign currency or maintain foreign bank + +accounts without the approval of the South African exchange control authorities or within authorities granted to authorized + +dealers in foreign exchanges. The South African authorities have expressed a commitment to a phased liberalization of + +exchange controls. Exchange controls were partially relaxed in 1996 and further relaxations occurred since then. The stated + +objective of the authorities is to reach a point where there is equality of treatment between residents and non-residents in + +relation to inflows and outflows of capital. Unlimited outward transfers of capital are not permitted at this stage, but the + +emphasis of regulation is expected to increasingly be on the positive aspects of prudential financial supervision. Authorized + +dealers in foreign exchange may, against the production of suitable documentary evidence, provide foreign exchange or + +hedging instruments to South African residents in respect of fixed and ascertained foreign exchange commitments or + +accruals covering transactions permissible pursuant to exchange control. + +Labor and employment + +According to Statistics South Africa, the rate of unemployment in South Africa in 2001 was 29.5%. Unemployment is + +much higher among the black population than other groups, and lowest among whites and Asians. Due to the inadequate + +education and training opportunities available to blacks, the South African labor force has a high proportion of lower + +skilled workers. The Government is attempting to reduce the unemployment figures through the introduction of programs + +such as the South African Skills Development Act, 1999, which requires employers to contribute an amount equal to 1% of + +their monthly payroll to a fund which is utilized for skills enhancement and job creation. + +Approximately 20% of the economically active population in South Africa was unionized in 2001. There are well- + +developed collective bargaining structures in place and many of the unions have affiliated themselves with trade union + +federations such as the Congress of South African Trade Unions and the National Council of Trade Unions. A number of + +the trade unions and their leaderships have close links to various political parties. Similarly, many employers have become + +affiliated with the employers organizations and federations of these organizations for the purposes of collective bargaining + +with trade unions. The South African National Economic Development and Labour Council is a further forum which + +facilitates discussion between the South African Government, business and organized labor on various issues relating to the + +economy. + +The South African Labour Relations Act, 1995, governs relations between employees and employers. The Labour + +Relations Act provides for more expansive rights of union organization, wider power to strike, the establishment of + +workplace forums and the protection of employees from unfair dismissal. It also promotes the decentralization of decision + +making to workplace and company levels, while centralizing the major collective bargaining issues at industry sector levels. + +The Labour Relations Act essentially seeks to establish simpler and more effective procedures for arbitration, conciliation + +and mediation. The Labour Relations Act also affords benefits to employees. The introduction of the Commission for + +Conciliation, Mediation and Arbitration, to which disputes must be referred prior to industrial action, significantly raises the + +prospects of having labor disputes resolved. + +Organized labor represented by the trade union federations is opposed to the privatization of state assets and consequent + +reduction in staff numbers. This viewpoint has led to past protest action and the possibility of future disruption to + +productivity. + +Three other important statutes which enhance the rights of employees in South Africa are: + + the South African Basic Conditions of Employment Act, 1997, which increased the minimum labor standards + +applicable in South Africa and extended the categories of employees to whom the minimum standard legislation is + +applicable; + + the South African Employment Equity Act, 1998, which obliges all employers, other than exempted small employers, + +to implement affirmative action measures designed to ensure that suitably qualified persons from previously + +disadvantaged groups have equal employment opportunities; and + + the Occupational Health and Safety Act, 1993, designed to prevent illnesses and accidents by imposing duties on the + +employer to remove or mitigate hazards to health and safety. + +A5 + +B1 + +EXTRACTS FROM TELKOM'S NEW MEMORANDUM AND + +ARTICLES OF ASSOCIATION + +21. DIRECTORS + +21.1 Subject to the provisions of the Act, the number of directors shall be 11 (eleven). + +21.2 + +The Class B Shareholder shall be entitled to appoint directors based upon the percentage of the issued ordinary + +shares owned by the Class B Shareholder at the time of such appointment as provided below: + +21.2.1 + +while the Class B Shareholder owns at least 25% (twenty-five percent) of the issued ordinary shares, the + +Class B Shareholder shall be entitled to appoint 5 (five) directors, including 2 (two) executive directors; + +21.2.2 + +while the Class B Shareholder owns at least 20% (twenty percent), but less than 25% (twenty-five + +percent), of the issued ordinary shares, the Class B Shareholder shall be entitled to appoint 4 (four) + +directors, including 2 (two) executive directors; + +21.2.3 + +while the Class B Shareholder owns at least 15% (fifteen percent), but less than 20% (twenty percent), of + +the issued ordinary shares, the Class B Shareholder shall be entitled to appoint 3 (three) directors, + +including 2 (two) executive directors; + +21.2.4 + +while the Class B Shareholder owns at least 10% (ten percent), but less than 15% (fifteen percent), of the + +issued ordinary shares, the Class B Shareholder shall be entitled to appoint 2 (two) directors, including + +2 (two) executive directors; and + +21.2.5 + +while the Class B Shareholder owns at least 5% (five percent), but less than 10% (ten percent), of the + +issued ordinary shares, the Class B Shareholder shall be entitled to appoint 1 (one) director, who may be + +an executive director. + +21.3 + +The Class A Shareholder shall be entitled to appoint directors based upon the percentage of the issued ordinary + +shares owned by the Class A Shareholder at the time of such appointment as provided below: + +21.3.1 + +while the Class A Shareholder owns at least 25% (twenty-five percent) of the issued ordinary shares, the + +Class A Shareholder shall be entitled to appoint 5 (five) directors, including 2 (two) executive directors; + +21.3.2 + +while the Class A Shareholder owns at least 20% (twenty percent), but less than 25% (twenty-five + +percent), of the issued ordinary shares, the Class A Shareholder shall be entitled to appoint 4 (four) + +directors, including 1 (one) executive director; + +21.3.3 + +while the Class A Shareholder owns at least 15% (fifteen percent), but less than 20% (twenty percent), of + +the issued ordinary shares, the Class A Shareholder shall be entitled to appoint 3 (three) non-executive + +directors; + +21.3.4 + +while the Class A Shareholder owns at least 10% (ten percent), but less than 15% (fifteen percent), of the + +issued ordinary shares, the Class A Shareholder shall be entitled to appoint 2 (two) non-executive + +directors; and + +21.3.5 + +while the Class A Shareholder owns at least 5% (five percent), but less than 10% (ten percent), of the + +issued ordinary shares, the Class A Shareholder shall be entitled to appoint 1 (one) non-executive + +director. + +21.4 + +Subject to articles 34 and 37, a general meeting shall have the power, from time to time, to appoint such number + +of directors (the "ordinary directors") not appointed pursuant to article 21.2 or article 21.3 provided that the total + +number of directors shall not at any time exceed the maximum number fixed by or in accordance with these + +articles, and provided further that a general meeting shall not be entitled to fill a vacancy of a Class A director or + +a Class B director. + +21.5 + +The Class A Shareholder shall have the power to remove or replace any Class A director at any time, with or + +without cause. The Class A Shareholder shall have the exclusive power to fill a vacancy created by the removal + +or resignation of any Class A director. + +21.6 + +The Class B Shareholder shall have the power to remove or replace any Class B director at any time, with or + +without cause. The Class B Shareholder shall have the exclusive power to fill any vacancy created by the + +resignation or removal of any Class B director. + +21.7 + +The appointment or removal of a Class A director or Class B director in terms of this article 21 shall be made by + +written notice to the company, signed by or on behalf of the Class A Shareholder or Class B Shareholder, as the + +case may be, and shall be operative as soon as the written notice is received at the office. + +21.8 + +The continuing directors may act, notwithstanding any vacancy in their number. If, and for so long as, the + +number of continuing directors is reduced below the minimum number of directors required to act as such for + +the time being, the continuing directors may act only to: + +21.8.1 increase the number of directors to the required minimum; or + +B2 + +21.8.2 + +summon a general meeting, provided that if there is no director able or willing to act, then any member + +may convene a general meeting for that purpose. + +21.9 Neither a director nor an alternate director shall be obliged to hold any qualification shares. + +21.10 + +Subject to article 30.4, the remuneration of the directors for their services as such shall be determined from time + +to time by the directors, taking into account the recommendations of the remuneration committee which shall + +be appointed by the directors. + +21.11 + +Subject to article 30.4, the directors shall be paid all travelling, subsistence and other expenses properly incurred + +by them in the execution of their duties in or about the business of the company and in attending general + +meetings of directors or of committees of the directors and which are authorised or ratified by the directors. + +21.12 + +Any director who: + +21.12.1 serves on any executive or other committee; or + +21.12.2 devotes special attention to the business of the company; or + +21.12.3 goes or resides outside the Republic for the purpose of the company; or + +21.12.4 + +otherwise performs or binds himself to perform services which, in the opinion of the directors, are + +outside the scope of the ordinary duties of a director, + +may be paid such extra remuneration or allowances in addition to or in substitution of the remuneration to which + +he may be entitled as a director, as the directors, excluding the director in question, may from time to time + +determine." + +24. CLASS A RESERVED MATTERS + +24.1 + +For so long as the Class A Shareholder shall be a significant shareholder, and if and to the extent that any of the + +following actions are not within the scope of the exclusive powers and authority delegated to the operating + +committee, none of the following actions shall be taken by or in respect of the company or any subsidiary of the + +company (as applicable) unless the action in question is (i) authorised by the board and (ii) the authorising + +resolution of the board shall have received the affirmative vote of at least 2 (two) Class A directors: + +24.1.1 + +approval or amendment by the company of the strategic objectives of the company or (to the extent + +legally permissible) the strategic objectives of any subsidiary of the company; + +24.1.2 + +any determination of or amendment to the management structure of the company or the schedule of + +authorizations, provided that approval thereof shall not be unreasonably withheld; + +24.1.3 + +any determination (including any amendment) made by the board (a) at any time before May 8, 2004 + +with respect to the scope or revocation of the exclusive powers and authority of the operating committee + +or the HRRC or (b) at any time before, on or after May 8, 2004 with respect to the countermanding, + +amending or supplementing of any decision or action made or taken by the operating committee or the + +HRRC before that date pursuant to their respective exclusive powers and authority; + +24.1.4 + +formation of any committee of, or the delegation of any authority to such committee by, the board, other + +than as expressly set out in these articles; + +24.1.5 any increase or reduction in the issued share capital of the company or any subsidiary of the company; + +24.1.6 + +any issue, conversion or allotment by the company of shares or other authorised shares, securities + +convertible into shares or securities of the company or any issue, conversion or allotment by any + +subsidiary of the company of any shares or authorised shares, securities convertible into shares or + +securities of that subsidiary; + +24.1.7 + +approving or making of the dividend policy from time to time including the declaration or distribution of + +any dividends by the company or any subsidiary of the company; + +24.1.8 any material change in the business of the company or of any subsidiary of the company; + +24.1.9 + +incurring, creating or assuming by the company of any indebtedness which would cause the debt/equity + +ratio of the company, or of the company on a consolidated basis, to exceed 1.00; + +24.1.10 + +any merger or consolidation involving the company where the aggregate of the payments and other + +consideration given by the parties to such transaction exceeds, or any transfer of assets or liabilities of + +the company or any subsidiary of the company where the sale price of such assets exceeds, in either case + +5% (five percent) of the company's gross revenues in the financial year immediately preceding the + +financial year in which such transaction occurs; + +24.1.11 + +execution, renewal, amendment or termination of any contract (for the avoidance of doubt, not including + +the company's licences) between the company or any subsidiary of the company and any member or any + +affiliate of such member who owns, directly or indirectly, in excess of 10% (ten percent) of the total + +issued ordinary shares of the company, unless the Class A Shareholder or any of its affiliates have an + +interest in the contract in question which conflicts with the company's or the applicable subsidiary's + +interest; + +24.1.12 establishment by the company of any direct or indirect subsidiary; + +24.1.13 any change to the name under which the company or any subsidiary of the company does business; + +24.1.14 any change in the company's financial year or tax year; + +24.1.15 any winding up or liquidation of the company or any subsidiary of the company; + +24.1.16 + +after May 7, 2004 and, subject to article 39.4, insofar as the Act requires any such appointment to be + +made by the directors, appointment of the company's auditors; + +24.1.17 + +materially altering the terms of any employee share ownership scheme approved by a general meeting; + +and + +24.1.18 + +any change or proposal to the shareholders for a change in the number of directors making up the board + +at any time. + +24.2 + +For so long as the Class A Shareholder shall be a significant shareholder, and if and to the extent that any of the + +actions set forth in this article 24 are within the exclusive powers and authority conferred upon the operating + +committee, none of such actions shall be taken by or in respect of the company or any subsidiary of the company + +(as applicable) unless (a) authorised by the operating committee and (b) the authorising resolution of the + +operating committee shall have received the affirmative vote of at least 1 (one) operating committee member + +appointed by the Class A Shareholder. + +24.3 + +Notwithstanding anything to the contrary anywhere else in these articles the provisions of articles 24.1, 24.2 and 25 + +shall in any event fall away and be of no further force or effect at the end of 8 (eight) years from the listing date." + +25. ADDITIONAL CLASS A RESERVED MATTERS + +The Class A reserved matters enumerated in article 24 shall also include, as additional Class A reserved matters, the + +approval or amendment by the company of any business plans and annual budgets and (to the extent legally + +permissible) any business plans or budgets or their equivalent of any subsidiary of the company, subject to the + +following: + +25.1 such matters shall be included only if the Class A Shareholder is a significant shareholder; and + +25.2 + +such matters shall not be included unless and until written notice permitting them to be included is given to the + +company by the Class A Shareholder and the Class B Shareholder." + +26. CLASS B RESERVED MATTERS + +26.1 + +For so long as the Class B Shareholder shall be a significant shareholder, and if and to the extent that any of the + +following actions are not within the scope of the exclusive powers and authority delegated to the operating + +committee, none of the following actions shall be taken by or in respect of the company or any subsidiary of the + +company (as applicable) unless the action in question is (i) authorised by the board and (ii) the authorising + +resolution of the board shall have received the affirmative vote of a majority of all the Class B directors: + +26.1.1 + +approval or amendment by the company of any business plan or any annual budget or the company's + +strategic objectives, or (to the extent legally permissible) any business plans or budgets or their + +equivalent of any subsidiary of the company or of the strategic objectives of any subsidiary of the + +company; + +26.1.2 + +any determination of or amendment to the management structure of the company or the schedule of + +authorizations; + +26.1.3 + +any determination (including any amendment) made by the board (a) at any time before May, 8 2004 + +with respect to the scope or revocation of the exclusive powers and authority of the operating committee + +or the HRRC or (b) at any time before, on or after May 8, 2004 with respect to the countermanding, + +amending or supplementing of any decision or action made or taken by the operating committee or the + +HRRC before that date pursuant to their respective exclusive powers and authority; + +26.1.4 + +formation of any committee of, or the delegation of any authority to such committee by, the board, other + +than as expressly set out in these articles; + +26.1.5 + +appointment, dismissal and replacement of members of the company's management provided to the + +company by the Class B Shareholder, or by any other person at the Class B Shareholder's instance but + +with the company's consent, but only where the appointment, dismissal or replacement is to be made by + +the company in breach of or otherwise than in accordance with the requirements of the strategic services + +agreement; + +26.1.6 + +establishing any new, or materially amending any existing, employee compensation policies or pension, + +retirement, death benefit, medical aid or other employee benefit or welfare plans, or materially altering + +the terms of any employee share ownership scheme approved by a general meeting if not specifically + +authorised in an annual budget; + +26.1.7 + +any increase or reduction in the issued share capital of the company or any subsidiary of the company; + +B3 + +B4 + +26.1.8 + +any issue, conversion or allotment by the company of shares or other authorised shares, securities + +convertible into shares or other securities of the company or any issue, conversion or allotment by any + +subsidiary of the company of any shares, securities convertible into shares or other securities of that + +subsidiary; + +26.1.9 + +approving or making of the dividend policy from time to time including the declaration or distribution + +of any dividends or other distributions by the company or any subsidiary of the company; + +26.1.10 + +approval of the annual financial statements, and any other publicly released financial statements, of the + +company or any subsidiary of the company; + +26.1.11 any change in the financial year or tax year of the company or any subsidiary of the company; + +26.1.12 + +any material change in the accounting policies of the company or any subsidiary of the company other + +than changes which bring the company's accounting policies in conformity with IAS or its licences; + +26.1.13 + +any material change in the business of the company or any subsidiary of the company or + +commencement of any new business by the company or any subsidiary of the company; + +26.1.14 + +incurring, creating or assuming by the company or any subsidiary of the company of any indebtedness + +if the debt/equity ratio of the company, or of the company on a consolidated basis, or of any individual + +subsidiary of the company, as applicable, exceeds (or would as a result thereof exceed) 1.00; + +26.1.15 + +the granting by the company or any subsidiary of the company of any guarantee or encumbrance not + +specifically authorised in an annual budget where such guarantees or encumbrances would exceed in + +the aggregate R50,000,000 (fifty million Rands) during any financial year; + +26.1.16 + +the company or any subsidiary of the company entering into any single transaction, contract or + +commitment (or series of related transactions, contracts or commitments), or waiving, terminating, + +modifying or amending any rights of the company or any subsidiary of the company in connection with + +or under any transactions, contracts or commitments (or series of related transactions, contracts or + +commitments), including, without limitation, for the acquisition or disposal of any property or assets, if + +such transaction, contract or commitment (or series of related transactions, contracts or commitments) + +requires payments or other consideration by the parties thereto with an aggregate value in excess of: + +26.1.16.1 R100,000,000 (one hundred million Rands) until May 7, 2004; and + +26.1.16.2 R200,000,000 (two hundred million Rands) thereafter, + +unless the Class B Shareholder or any of its affiliates have a material interest in the transaction, + +contract or commitment (or series of related transactions, contracts or commitments) in question which + +conflicts with the company's or the applicable subsidiary's interest; + +26.1.17 + +any transfer of, or any agreement to transfer, amend, terminate or renew the licences or any other + +telecommunication or broadcasting licence which may at any time be held by the company or any + +subsidiary of the company; + +26.1.18 + +the company or any subsidiary of the company commencing or settling any litigation, arbitration or + +other similar proceeding where: + +26.1.18.1 + +the aggregate of the claims by all parties involved exceeds R50,000,000 (fifty million + +Rands); or + +26.1.18.2 + +the dispute involves or relates to any competitor of the company or of any subsidiary of the + +company, or involves or relates to the government; or + +26.1.18.3 + +there is a reasonable likelihood that the outcome of such proceeding could otherwise have a + +material effect (whether adverse or positive) on the business, financial condition or prospects + +of the company or any subsidiary of the company, + +unless the Class B Shareholder or any of its affiliates are parties to such litigation, arbitration or other + +similar proceeding and have an interest therein which conflicts with the company's or the applicable + +subsidiary's interest; + +26.1.19 + +execution, renewal, amendment or termination of any contract (for the avoidance of doubt, not + +including the licences) between the company or any subsidiary of the company, on the one hand, and + +any member who owns, directly or indirectly, in excess of 10% (ten percent) of the total issued + +ordinary shares of the company or any affiliate of such member (or any officer or director of such + +member or affiliate or person which owns more than 10% (ten percent) of the issued ordinary shares of + +such member or affiliate), on the other hand, unless in relation to any such contract (but excluding the + +strategic services agreement) the Class B Shareholder or any of its affiliates have a material interest + +therein which conflicts with the company's or the applicable subsidiary's interest; + +26.1.20 + +establishment by the company or any subsidiary of the company of any direct or indirect subsidiary or + +any joint venture, partnership or similar arrangement; + +26.1.21 any change to the name under which the company or any subsidiary of the company does business; + +26.1.22 + +either of the following: + +26.1.22.1 + +any merger or consolidation involving the company or any subsidiary of the company where + +the aggregate of the payments and other consideration given by the parties to such + +transaction exceeds, or any transfer of assets or liabilities of the company or any subsidiary + +of the company (in one or a series of related transactions) where the value of the transferred + +assets or liabilities exceeds, in either case R50,000,000 (fifty million Rands); or + +26.1.22.2 + +if the company has received written notice from the Class A Shareholder and the Class B + +Shareholder that article 26.1.22.1 is no longer effective, then any merger or consolidation + +involving the company or any subsidiary of the company where the aggregate of the + +payments and other consideration given by the parties to such transaction exceeds, or any + +transfer of assets or liabilities of the company or any subsidiary of the company (in one or a + +series of related transactions) where the value of the transferred assets or liabilities exceeds, + +in either case 5% (five percent) of the company's gross revenues in the financial year + +immediately preceding the financial year in which such transaction occurs, + +unless the Class B Shareholder or any of its affiliates have a material interest in any such merger or + +consolidation which conflicts with the company's or the applicable subsidiary's interest; + +26.1.23 any winding up or liquidation of the company or any subsidiary of the company; + +26.1.24 + +the company or any subsidiary of the company entering into any agreement having the effect of + +restricting the business or activities which the company or any subsidiary of the company may conduct; + +26.1.25 + +after May 7, 2004, and, subject to article 39.4, insofar as the Act requires any such appointment to be + +made by the directors, appointment of the company's auditors; and + +26.1.26 + +any change or proposal to the shareholders for a change in the number of directors making up the board + +at any time. + +26.2 + +For so long as the Class B Shareholder shall be a significant shareholder, and if and to the extent that any of the + +actions set forth in this article 26 are within the exclusive powers and scope of authority conferred upon the + +operating committee, none of such actions shall be taken by or in respect of the company or any subsidiary of + +the company (as applicable) unless (a) authorised by the operating committee and (b) the authorising resolution + +of the operating committee shall have received the affirmative vote of at least 1 (one) operating committee + +member appointed by the Class B Shareholder. + +26.3 + +The Class B reserved matters enumerated in this article 26 shall not include those reserved matters set forth in + +articles 26.1.2, 26.1.3, 26.1.4, 26.1.6, 26.1.16, 26.1.18, 26.1.20 and 26.1.22.1 if the company receives written + +notice to that effect from the Class A Shareholder and the Class B Shareholder pursuant to their obligation to + +give such notice at the end of any period of time in terms of any shareholders' agreement between them if and + +after Thintana Communications LLC (as the holder of the Class B Share at or immediately after the date of + +registration of the special resolution adopting these articles) transfers the Class B Share to a transferee permitted + +by any such shareholders' agreement. + +26.4 + +Notwithstanding anything to the contrary anywhere else in these articles, the provisions of articles 26.1, 26.2 + +and 26.3 shall in any event fall away and be of no further force or effect at the end of 8 (eight) years from the + +listing date." + +36. OPERATING COMMITTEE + +The Company shall have an operating committee until May 7, 2004, which shall be constituted in accordance with, + +and be subject to the following provisions: + +36.1 + +Membership + +36.1.1 + +The operating committee shall consist of 5 (five) voting members and 4 (four) ex officio non-voting + +members, made up as follows: + +36.1.1.1 + +the CEO, 2 (two) Class A Shareholder voting opco appointees and 2 (two) Class B + +Shareholder voting opco appointees, all as ex officio voting members; and + +36.1.1.2 + +2 (two) Class A Shareholder non-voting opco appointees and 2 (two) Class B Shareholder + +non-voting opco appointees, all as non-voting members. + +36.1.2 + +The Class A Shareholder shall, while it is a significant shareholder, be entitled to appoint the 2 (two) + +Class A Shareholder voting opco appointees and the 2 (two) Class A Shareholder non-voting opco + +appointees (all of whom shall be known as the "Class A opco appointees") and 1 (one) or more + +alternates to each of them (which alternates may also be Class A opco appointees) and shall have the + +power to remove and to replace and fill any vacancies in respect of, any of the members and alternate + +members so appointed by the Class A Shareholder, provided that if at any time the Class A Shareholder + +ceases to be a significant shareholder the board shall be entitled, as if it were the Class A Shareholder, to + +make all the appointments to the operating committee that the Class A Shareholder would have been able + +to make in terms of this article 36.1.2 had it not ceased to be a significant shareholder. + +B5 + +B6 + +36.1.3 + +The Class B Shareholder shall, while it is a significant shareholder, be entitled to appoint the 2 (two) + +Class B Shareholder voting opco appointees and the 2 (two) Class B Shareholder non-voting opco + +appointees (all of whom shall be known as the "Class B opco appointees") and 1 (one) or more + +alternates to each of them (which alternates may also be Class B opco appointees) and shall have the + +power to remove and to replace and fill any vacancies in respect of, any of the members and alternate + +members so appointed by the Class B Shareholder, provided that if at any time the Class B Shareholder + +ceases to be a significant shareholder the board shall be entitled, as if it were the Class B Shareholder, to + +make all the appointments to the operating committee that the Class B Shareholder would have been able + +to make in terms of this article 36.1.3 had it not ceased to be a significant shareholder. + +36.1.4 The CEO shall be the chairperson of the operating committee. + +36.1.5 + +Any appointment or removal by the Class A Shareholder or the Class B Shareholder in terms of + +article 36.1 shall be made by written notice to the company, signed by or on behalf of the Class A + +Shareholder or Class B Shareholder, as the case may be, and shall be operative as soon as the written + +notice is received at the office. + +36.2 + +Powers of the Operating Committee + +36.2.1 + +Subject to article 36.2.2, the operating committee shall have the exclusive power and authority to: + +36.2.1.1 + +implement any business plan or annual budget; and implement (in conformity with any business + +plan or annual budget) all issues and matters relating to achievement of the company's + +obligations under the licenses, including, without limitation, network expansion, equipment + +procurement, tariff setting and packaging, customer service and marketing; + +36.2.1.2 + +prepare, review and recommend to the board business plans and any amendment of the business + +plans as provided in article 36.13 and each and any business plan of any subsidiary of the + +company and any amendment of such business plans; + +36.2.1.3 + +prepare, review and recommend to the board the annual budgets and any amendment of the + +annual budgets and all budgets of each subsidiary of the company and any amendment of such + +budgets, and approve such annual budget and budgets (and amendments) to the extent provided + +in article 36.12; + +36.2.1.4 implement the management structure and recommend to the board any amendment thereto; + +36.2.1.5 review and recommend to the board any amendment to the schedule of authorizations; and + +36.2.1.6 + +delegate authority to, and direct members of, the company's management with respect to any + +matters that are within the authority of the operating committee pursuant to this article 36.2. + +36.2.2 + +The operating committee's exclusive powers and authority set out in article 36.2.1 shall be revocable in + +whole or in part at any time by the board as a board reserved matter in accordance with articles 24 + +and 26. + +36.2.3 + +The board may also determine as a board reserved matter in accordance with articles 24 and 26, to + +countermand, amend or supplement any decisions or actions made or taken by the operating committee + +pursuant to its exclusive powers and authority set out in article 36.2.1. + +36.3 + +Term of the Operating Committee + +36.3.1 + +Unless determined otherwise by the board as a board reserved matter in accordance with articles 24 + +and 26, the operating committee shall terminate and cease to exist after May, 7 2004 and all the powers + +and any authority held by it at that date shall revert to the board. However, the board may determine, as a + +board reserved matter in accordance with articles 24 and 26, to extend the term of the operating + +committee or to re-establish the operating committee, in each case with such authority as the board may + +determine as a reserved matter in accordance with articles 24 and 26. + +36.4 + +Meetings of the operating committee + +36.4.1 + +Number of Meetings and Voting + +The operating committee may meet for the dispatch of business, adjourn and otherwise regulate its + +meetings as it thinks fit, provided that the operating committee shall meet at least once every month. + +36.4.2 + +Quorum + +The quorum necessary for the transaction of the business of the operating committee shall be at least + +3 (three) voting members (or their alternates); provided, that notwithstanding that a quorum may be + +present at any meeting of the operating committee, no action shall be taken at any such meeting (other + +than a decision to dissolve or adjourn such meeting) unless the CEO (or his alternate) is present, and at + +least 1 (one) of the Class A Shareholder voting opco appointees (or their alternates) and 1 (one) of the + +Class B Shareholder voting opco appointees (or their alternates) are present. If the CEO (or his alternate) + +is not present at a meeting of the operating committee otherwise duly constituted, the meeting shall be + +dissolved or adjourned for at least 24 (twenty four) hours, and if such meeting is so adjourned then the + +presence of the CEO (or his alternate) shall not be required to take any action at any resulting adjourned + +meeting. If none of the Class A Shareholder voting opco appointees (or their alternates) or none of the + +Class B Shareholder voting opco appointees (or their alternates) are present at a meeting of the operating + +committee otherwise duly constituted, the meeting shall be dissolved or adjourned for at least 24 (twenty + +four) hours and if the meeting is so adjourned then the presence of a Class A Shareholder voting opco + +appointee (or his alternate) or Class B Shareholder voting opco appointee (or his alternate), as the case + +may be, shall not be required to take any action at any resulting adjourned meeting. + +36.4.3 + +Convening a Meeting + +Either the CEO, a Class A Shareholder voting opco appointee or a Class B Shareholder voting opco + +appointee may convene a meeting of the operating committee at any time. At the request of the CEO, a + +Class A Shareholder voting opco appointee or a Class B Shareholder voting opco appointee the secretary + +of the company shall convene a meeting. + +36.4.4 + +Notice for Meetings + +The operating committee shall determine the number of days notice to be given for operating committee + +meetings (and the adjournment thereof) and the form and the medium for giving any such notice. + +36.4.5 + +Dissolution and Adjournment of Meetings + +The chairperson of the operating committee may, with the unanimous consent of any meeting at which a + +quorum is present (and shall if so directed by the meeting), dissolve any meeting of the operating + +committee or adjourn and give notice accordingly of any meeting of the operating committee from time + +to time and from place to place. Should a quorum not be present at any meeting of the operating + +committee within 30 (thirty) minutes after the appointed time, the chairperson of the meeting shall: + +36.4.5.1 + +adjourn such meeting, subject to article 36.4.2, to such time and such place as the meeting shall + +determine; or + +36.4.5.2 dissolve such meeting. + +36.4.6 + +Business at Adjourned Meetings + +No business shall be transacted at the resumption of any adjourned meeting of the operating committee + +other than the business left unfinished at the meeting from which the adjournment took place. + +36.5 + +Chairperson of operating committee Meetings + +The CEO shall act as the chairperson of meetings of the operating committee; provided, that if at any meeting + +the CEO is not present in person within 5 (five) minutes after the time appointed for holding the meeting, the + +voting members present shall elect a person to be chairperson of the meeting. The CEO shall not be considered + +present in person at the meeting (for the purpose of acting as chairperson of the meeting only) by virtue of his + +alternate being present at the meeting. + +36.6 + +Voting + +All matters put to a vote at any meeting of the operating committee shall be approved only by an affirmative vote + +of a majority of the members of such committee, and in the event of an equality of votes on any matter to be + +considered by the operating committee, the Class A Shareholder voting opco appointee present at the meeting, or + +if there is more than 1 (one) any one of them as they may decide as and when the equality of votes occurs, shall + +have a casting vote. + +36.7 + +Minutes + +36.7.1 + +The operating committee shall cause minutes to be kept, which shall include the following particulars: + +36.7.1.1 + +the names of the voting members and non-voting members present (or, as the case may be, their + +alternates) at each meeting of the operating committee; and + +36.7.1.2 + +all resolutions proposed and passed or not passed and such other proceedings at each meeting + +as the operating committee thinks fit. + +36.7.2 + +The secretary of the company shall act as secretary of the operating committee; provided, that if at any + +meeting the secretary of the company is not present in person within 5 (five) minutes after the time + +appointed for holding the meeting or if the voting members present otherwise determine, the voting + +members present shall elect a person to be the secretary for the meeting. + +36.7.3 + +Signing of the Minutes + +The minutes of each meeting of the operating committee shall be signed by: + +36.7.3.1 the chairperson of the meeting or by the chairperson of the next succeeding meeting; and + +36.7.3.2 + +any 1 (one) of the Class B opco appointees who was present at the meeting at which the + +proceedings took place. + +B7 + +B8 + +36.7.4 + +Extract from Minutes + +Any extract from or copy of the minutes of a meeting of the operating committee purporting to be signed by: + +36.7.4.1 any 1 (one) of the Class B opco appointees; and + +36.7.4.2 + +the chairperson of the meeting or by any voting member of the operating committee or by the + +secretary of such meeting, + +shall be prima facie proof of the contents of the minutes. + +36.8 + +Committee meetings by Conference Call + +The operating committee may meet by telephone or video conference if all members can hear all other members. + +A member of the operating committee who participates in a meeting of the operating committee by either of + +those means shall be considered present at the meeting for all purposes. + +36.9 + +Attendees + +The board, the Class A Shareholder and the Class B Shareholder may from time to time designate + +representatives who may attend any and all meetings of the operating committee. The number of representatives + +whom the board, the Class A Shareholder or the Class B Shareholder may so designate for attendance at any + +meeting of the operating committee shall not exceed 3 (three). Such representatives may be designated by the + +board, the Class A Shareholder or the Class B Shareholder, as the case may be, for attendance at any meeting by + +notice to the operating committee at any time prior to the commencement of the meeting. Any such + +representatives who attend a meeting of the operating committee shall be entitled to address the operating + +committee at the request of any member thereof with respect to any matter on the agenda for the applicable + +meeting but shall not be entitled to vote. + +36.10 + +Written Resolutions of the operating committee + +36.10.1 + +Authority + +A duly minuted resolution in writing signed by all the voting members of the operating committee or, + +as the case may be, their respective alternates, shall be as valid and effectual as a resolution passed at a + +meeting of the operating committee duly called and constituted. + +36.10.2 + +Requirements for Written Resolutions + +Any such written resolution may consist of 1 (one) or more documents signed by 1 (one) or more + +voting members of the operating committee (or as the case may be, their respective alternates), shall + +have regard to the provisions of section 242(2) of the Act and shall be delivered to the secretary of the + +company without delay and be recorded by him or her in the company's minute book for the operating + +committee. + +36.10.3 + +Date of Approval + +Each such written resolution shall be deemed to have been passed on the day it was signed by the last + +voting member, unless a statement to the contrary is made in the resolution. + +36.10.4 + +Confirmation of Written Resolution + +A written resolution, which is not signed by all the voting members of the operating committee, shall + +be inoperative until confirmed by a meeting of the operating committee. + +36.11 + +Reports to the Board + +The chairperson of the operating committee shall report on all action and activities taken by the operating + +committee and on the current operations and status of the company at each meeting of the board. + +36.12 + +Annual Budgets + +36.12.1 + +Until the date on which the operating committee terminates in terms of article 36.3.1, or its authority + +under article 36.2.1.3 in respect of the annual budget is revoked pursuant to article 36.2.2, the following + +provisions shall apply: + +36.12.1.1 + +The operating committee shall, not later than 1 (one) month prior to the commencement of + +each financial year of the company, cause to be prepared in accordance with article 36.12.1.3 + +below a proposed annual budget, which shall be approved as provided in article 36.12.1.4 + +below. Each such proposed annual budget shall include with respect to the company and its + +subsidiaries for such financial year: + +(i) budgeted capital and operating expenditures; + +(ii) a budgeted income statement; + +(iii) a budgeted balance sheet; + +(iv) budgeted borrowings and repayment of borrowings; and + +(v) a budgeted cash flow statement. + +36.12.1.2 + +Each annual budget shall generally be prepared with such detail as is commercially + +reasonable and customary for a business which is similar in size to the company's business. + +36.12.1.3 + +Each annual budget shall be prepared by or under the direction of such manager or managers + +as determined by the operating committee from time to time. The operating committee shall + +engage in early consultation with the board and shall give due consideration to the views of + +the board with respect to the preparation of each annual budget. + +36.12.1.4 + +The board shall consider, and shall act upon (i.e., approve or disapprove), as a board + +reserved matter in accordance with articles 25 and 26, any annual budget approved by the + +operating committee and presented to the board by the operating committee, within 10 (ten) + +days after each director receives a copy of the proposed annual budget. If the board does not + +approve the proposed annual budget presented to it, then the operating committee shall + +prepare a second proposed annual budget for the same financial year for submission to the + +board for approval, which may be the same as the first proposal; provided, that in connection + +with the preparation of such second proposed annual budget, the operating committee shall + +consult with the board and shall give due consideration to the reasons expressed by the + +board for rejecting the operating committee's first proposal for such annual budget. The + +board shall consider and shall approve or disapprove as a board reserved matter in + +accordance with articles 25 and 26, the second proposed annual budget for such financial + +year presented by the operating committee to the board within 10 (ten) days after each + +director receives a copy of the second proposed annual budget. If the board fails to approve + +the second proposed annual budget, then the operating committee shall thereafter be + +permitted to adopt an annual budget for such financial year in its discretion, except that + +budgeting capital expenditures and budgeted total operating expenses for such financial year + +shall not be more than 120% (one hundred twenty percent) of the amounts projected for + +such items in the business plan for such financial year. + +36.12.1.5 + +The operating committee may amend annual budgets subject to compliance with the + +procedures detailed in article 36.12.1.4 above. + +36.12.2 + +After the date on which the operating committee terminates in terms of article 36.3.1, or its authority + +under article 36.2.1.3 in respect of the annual budget is revoked pursuant to article 36.2.2, the board in + +its discretion may adopt and amend the annual budget as a board reserved matter in accordance with + +articles 25 and 26. + +36.13 + +Business plan + +36.13.1 + +Until the date on which the operating committee terminates in terms of article 36.3.1, or its authority + +under article 36.2.1.2 in respect of the business plan is revoked pursuant to article 36.2.2: + +36.13.1.1 + +The operating committee shall review the business plan of the company from time to time + +and in any event on an annual basis at least 1 (one) month prior to the commencement of + +each financial year of the company. The board may amend the business plan (and may adopt + +other business plans, and amend such other business plans) from time to time, as a board + +reserved matter in accordance with articles 25 and 26, only upon the recommendation of the + +operating committee. + +36.13.1.2 + +If at any time the board shall fail to adopt a business plan or approve any amendment to the + +business plan recommended by the operating committee, then the procedures set forth in + +article 36.12.1.4 (but excluding the last sentence) shall apply mutatis mutandis, provided that + +if the board fails to approve the second of any proposed business plan recommended to it by + +the operating committee, then the operating committee shall thereafter be permitted to adopt + +a business plan for the financial year in question in its discretion, subject to the provisions of + +article 36.13.3. + +36.13.2 + +After the date on which the operating committee terminates in terms of article 36.3.1, or its authority + +under article 36.2.1.2 in respect of the business plan is revoked pursuant to article 36.2.2, the board in + +its discretion may adopt and amend business plans as a board reserved matter in accordance with + +articles 25 and 26. + +36.13.3 + +The foregoing provisions of this article 36.13 notwithstanding, if the annual budget for any financial + +year which is approved in accordance with these articles is inconsistent with any business plan with + +respect to such financial year, then such business plan shall be deemed automatically amended with + +respect to such financial year as appropriate to take into account the effects of the annual budget so + +approved (and, if applicable, as so amended). + +36.14 + +Dissolution of the Operating Committee + +If at any time there shall cease to be a Class B Share in existence, the provisions of this article 36 shall cease to + +be of any further force or effect." + +43. LIMITATION ON SHARE OWNERSHIP + +43.1 + +The purpose of this article 43 is to prevent any person or persons acting in concert, other than an exempt + +shareholder, from owning, directly or indirectly, more than 15% (fifteen percent) of the issued shares of any + +class of shares in the company." + +B9 + +As to United States Law + +Paul, Hastings, Janofsky & Walker + +LLP + +75 East 55th Street + +New York, NY 10022 + +As to South African Law + +Huntley Mdlulwa Inc. + +1st Floor, Sabvest House + +46A Wierda Valley + +Sandton, 2196 + +Suite 356 + +Private Bag X6 + +Benmore, 2010 + +As to South African Law + +Maponya Inc. + +2nd Floor + +Sanlam Centre + +Pretoria, 0002 + +P O Box 13659 + +The Tramshed, Pretoria, 0126 + +As to South African Law + +Qunta, Inc. + +20th Floor, ABSA Centre + +2 Riebeeck Street + +Cape Town, 8001 + +P O Box 3713 + +Cape Town, 8000 + +As to South African Law + +Werksmans Inc. + +155, 5th Street + +Sandown 2196 + +Private Bag 10015 + +Sandton, 2146 + +As to South African Law + +Nalane Manaka Attorneys + +14th Floor + +Sanlam Centre Building + +Jeppe and von Weilligh Streets + +Johannesburg, 2001 + +P O Box 2787 + +Johannesburg, 2000 + +As to South African Law + +Mukwevho Adekeye Incorporated + +Saddle Drive + +Woodmead Office Park + +Woodmead, 2157 + +P O Box 1049 + +Gallo Manor, 2052 + +As to South African Law + +Acting as corporate law advisers and consultants to + +the Government of South Africa + +on a number of matters relating to the global + +offering but not including preparation of + +the prospectus + +Edward Nathan & Friedland (Proprietary) Limited + +4th Floor, The Forum + +3 Maude Street, Sandown, 2196 + +P O Box 783347, Sandton, 2146 + +As to United States Law + +Freshfields Bruckhaus + +Deringer + +65 Fleet Street + +London, EC4Y 1HS + +As to South African Law + +Chuene, Kwinana & Motsatse Inc. + +1st Floor, The Galleries + +163 Jan Smuts Avenue + +Parkwood, 2193 + +P O Box 3523 + +Parklands, 2121 + +As to South African Law + +Deneys Reitz Inc. + +82 Maude Street + +Sandton, 2196 + +P O Box 784903 + +Sandton, 2146 + +UBS Warburg Corporate Finance (South Africa) (Proprietary) Limited + +(Registration number 1994/008363/07), + +a subsidiary of UBS AG + +64 Wierda Road East + +Wierda Valley, Sandton, 2196 + +P O Box 652863, Benmore, 2010 + +AMB Holdings Limited + +Registration number 1995/003054/06 + +15th Floor, The Forum + +Maude Street, Sandton, 2196 + +P O Box 786833, Sandton, 2146 + +CORPORATE INFORMATION AND ADVISORS + +LEGAL ADVISORS TO TELKOM SA LIMITED + +LEGAL ADVISORS TO THE UNDERWRITERS + +FINANCIAL ADVISORS TO TELKOM SA LIMITED + +LEGAL ADVISORS TO + +THE GOVERNMENT OF THE REPUBLIC OF SOUTH AFRICA + +As to United States Law + +Skadden, Arps, Slate, Meagher & Flom LLP + +One Canada Square + +Canary Wharf + +London, E14 5DS + +PRINTED BY INCE (PTY) LTD + +INDEPENDENT AUDITORS + +For Telkom SA Limited + +Ernst & Young + +52 Corlett Drive + +Illovo, 2196 + +P O Box 2322 + +Johannesburg, 2000 + +For Vodacom Group (Proprietary) Limited + +PricewaterhouseCoopers, Inc. + +232 Ida Street + +Menlo Park, 0107 + +P O Box 35296 + +Menlo Park, 0102 + +Deloitte & Touche + +221 Waterkloof Road + +Waterkloof + +Pretoria, 0181 + +P O Box 11007 + +Hatfield, 0028 + +JOINT GLOBAL CO-ORDINATORS + +Deutsche Bank AG London + +Winchester House + +1 Great Winchester Street + +London, EC2N 2DB + +J.P. Morgan Securities Ltd. + +60 Victoria Embankment + +London, EC4Y OJP + +COMMERCIAL BANKERS + +ABSA Bank Limited + +Registration number 1986/004794/06 + +ABSA Tower East + +170 Main Street + +Johannesburg, 2001 + +P O Box 7735 + +Johannesburg, 2000 + +REGISTERED AND HEAD OFFICE + +OF TELKOM SA LIMITED + +Telkom Towers North + +152 Proes Street + +Pretoria, 0002 + +Private Bag X881 + +Pretoria, 0001 + +COMPANY SECRETARY + +Vincent Vikimpi Mashale + +(B Comm (Hons)) + +Telkom Towers North + +152 Proes Street + +Pretoria, 0002 + +Private Bag X881 + +Pretoria, 0001 + +TRANSFER SECRETARY + +Computershare Investor Services Limited + +Registration number 1958/003546/06 + +70 Marshall Street + +Johannesburg, 2001 + +P O Box 61051, Marshalltown, 2107 + +JOINT GLOBAL CO-ORDINATORS CONSORTIUM MEMBERS + +Standard Corporate and Merchant + +Bank + +(A division of The Standard Bank of + +South Africa Limited) + +Registration number 1962/000738/06 + +3 Simmonds Street + +Johannesburg, 2001 + +P O Box 61344 + +Marshalltown, 2017 + +African Harvest Capital + +(Proprietary) Limited + +Registration number + +1998/001469/07 + +3rd Floor + +Sanclare Building + +21 Dreyer Street + +Claremont, 7700, Cape Town + +Private Bag X9936 + +Sandton, 2146 + +Wipcapital (Proprietary) Limited + +Registration number 1997/021195/07 + +61 Central Street + +Houghton, 2198 + +Postnet Suite 104 + +Private Bag X2600 + +Houghton, 2041 + +Through and including the 25th day after the date of this prospectus, all dealers effecting transactions in these + +securities, whether or not participating in this global offering, may be required to deliver a prospectus. This is in + +addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold + +allotments or subscriptions. + +ordinary shares in the form of ordinary shares + +or American Depositary Shares + +TELKOM SA LIMITED + +PROSPECTUS + +Deutsche Bank Securities + +JPMorgan + +Prospectus dated , 2003 + +II-1 + +PART II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +ITEM 6 + +INDEMNIFICATION OF DIRECTORS AND OFFICERS + +Telkom's articles of association upon the listing of its ordinary shares on the JSE Securities Exchange, South Africa + +will provide as follows: + +"Every director, alternate director, operating committee member, alternate operating committee member, manager, + +secretary and other office of the company shall be indemnified out of the company's funds against all liability + +incurred by him in defending any proceedings (whether civil or criminal) arising out of any actual or alleged + +negligence, default, breach of duty of trust on his part in relation to the company in which judgment is given in his + +favor or in which he is acquitted or in connection with any matter in which relief is granted to him by the court + +in terms of the Act." + +Telkom and the Government of the Republic of South Africa have agreed to indemnify the Underwriters and to + +provide contribution in circumstances where indemnification is unavailable pursuant to the agreement. + +Telkom has purchased Directors and Officers' Liability Insurance. + +Directors of Telkom who are also employees of subsidiaries of Telkom may be entitled to indemnification from + +such subsidiaries for certain liabilities and expenses incurred as a result of serving as directors of Telkom. Directors of + +Telkom who are also employees of shareholders of Telkom may be entitled to indemnification from such shareholders + +for certain liabilities and expenses incurred as a result of serving as directors of Telkom. + +ITEM 7 + +RECENT SALES OF UNREGISTERED SECURITIES + +The following sets forth the date of sale and title and amount of securities sold within the last three years that were + +not registered by Telkom: + + R1,500,000,000 aggregate principal amount of 13% unsecured local bonds due May 31, 2004, issued on + +November 30, 1998 and July 29, 1999. The offering was underwritten by Standard Corporate and Merchant + +Bank, a division of The Standard Bank of South Africa Limited, JP Morgan Securities South Africa (Proprietary) + +Limited, Deutsche Bank AG, Rand Merchant Bank and African Merchant Bank. The aggregate underwriting + +commission paid was R1,687,500. The offering was exempt under Regulation S of the Securities Act of 1933. + + R2,300,000 aggregate principal amount of 10.75% unsecured local bonds due September 30, 2003, issued on + +March 15, 2001, June 26, 2001 and July 24, 2001. The offering was underwritten by Deutsche Bank AG and + +Rand Merchant Bank, a division of FirstRand Bank Limited, joint lead managers, and Merrill Lynch South + +Africa, senior co-lead manager. The aggregate underwriting commission paid was R1,581,250. The offering was + +exempt under Regulation S of the Securities Act of 1933. + + R1,500,000,000 aggregate principal amount of 10.5% unsecured local bonds due October 31, 2006, issued on + +October 31, 2001. The offering was underwritten by Standard Corporate and Merchant Bank, a division of The + +Standard Bank of South Africa Limited, lead underwriter, Investec Bank Limited and JP Morgan Securities + +South Africa (Proprietary) Limited and, co-lead managers, and Nedcor Investment Bank (Proprietary) Limited + +and Wipcapital (Proprietary) Limited, joint managers. The underwriting commission was R750,000. The offering + +was exempt under Regulation S of the Securities Act of 1933. + +II-2 + +ITEM 8 + +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES + +(A) EXHIBITS + +Exhibit number + +Description + +1.1 + +Form of Underwriting Agreement. (1) + + + +3.1 + +Memorandum and Articles of Association of Telkom SA Limited. (3) + +4.1 + +Form of Ordinary Share Certificate. (3) + +4.2 + +Deposit Agreement, among Telkom SA Limited, the The Bank of New York, as Depositary and + +Owners and Beneficial Owners of American Depositary Receipts issued thereunder, including the + +form of American Depositary Receipt. (2) + +5.1 + +Opinion of Werksmans Inc., South African counsel to the Registrant. (1) + +5.2 + +Opinion of Emmet, Marvin & Martin, LLP, United States, Counsel to the Depositary. (2) + +10.1 + +Strategic Services Agreement, dated January 16, 2003, among Telkom SA Limited, Thintana + +Communications, SBC International Management Services Inc. and Telekom Management Services + +SDN Berhad. (3) + +10.2 + +Strategic Services Agreement, dated May 14, 1997, among Telkom SA Limited, Thintana + +Communications LLC, SBC International Management Services Inc. and Telekom Management + +Services SDN Berhad. (3) + +10.3 + +Agreement dated, July 31, 2000, between Telkom SA Limited and Telecommunication Facilities + +Management Company (Proprietary) Limited. (3) + +10.4 + +Exclusive Facilities Management Services Agreement, dated March 31, 2001, between Telkom SA + +Limited and Systems Applications Projects (Africa) (Proprietary) Limited. (3) + +10.5 + +Multiparty Implementation Agreement, dated September 30, 1993, among Telkom SA Limited, + +Vodacom Group (Proprietary) Limited, Mobile Telephone Network (Proprietary) Limited, the + +Postmaster General and the Government of the Republic of South Africa. (3) + +10.6 + +Interconnection Agreement, dated February 16, 1994, among Telkom SA Limited and + +Vodacom Group (Proprietary) Limited, as amended by agreements among Telkom SA Limited, + +Vodacom Group Proprietary Limited and MTN on August 22, 1996, January 12, 1998, July 21, 1998, + +and September 4, 2001. (3) + +10.7 + +Interconnection Agreement, dated February 16, 1994, between Telkom SA Limited and MTN, as + +amended by agreements among Telkom SA Limited, Vodacom Group (Proprietary) Limited, and + +MTN on August 22, 1996, January 12, 1998, July 21, 1998 and September 14, 2001. (3) + +10.8 + +Interconnection Agreement, dated August 31, 2001, between Telkom SA Limited and Cell C, as + +amended by agreement among Telkom SA Limited, Vodacom Group (Proprietary) Limited and + +Cell C, dated September 18, 2001. (3) + +10.9 + +Joint Venture Agreement, dated March 31, 1995, between Telkom SA Limited, Vodafone Group plc, + +Rembrant Group Limited, Vodacom Group, Vodacom, Vodac and Vodafone Holdings (SA) + +(Proprietary) Limited. (3) + +10.10 + +Shareholders' Agreement, dated January 16, 2003, between the Minister for Communications of the + +Government of the Republic of South Africa and Thintana Communications LLC. (3) + +10.11 + +Registration Rights Agreement, dated January 16, 2003, among the Minister for Communications of + +the Government of the Republic of South Africa, Thintana Communications LLC and Telkom SA + +Limited. (3) + +21.1 + +Subsidiaries of the Registrant. (3) + +23.1(a) + +Consent of Ernst & Young related to their report, dated December 12, 2002. (1) + +23.1(b) + +Consent of Ernst & Young related to their report, dated December 10, 2002. (1) + +23.2(a) + +Consent of Deloitte & Touche and PricewaterhouseCoopers Inc. related to their report, dated + +June 11, 2002, except for Note 44 which the date is October 15, 2002. (1) + +23.2(b) + +Consent of Deloitte & Touche and PricewaterhouseCoopers Inc. related to their report dated + +December 12, 2002. (1) + +23.3 + +Consent of Werksmans Inc. (included in Exhibit 5.1). (1) + +23.4 + +Consent of Emmet, Marvin & Martin, LLP (included in Exhibit 5.2). (2) + +24.1 + +Power of Attorney of Directors and Officers of the Registrant. (3) + +(1) Filed herewith. + +(2) Incorporated by reference to the Registration Statement on Form F-6 submitted to the Securities and Exchange Commission on November 8, + +2002 with respect to American Depositary Shares representing the ordinary shares. + +(3) Previously filed. + +II-3 + +(B) + +FINANCIAL STATEMENT SCHEDULES + +Not Applicable. + +ITEM 9 + +UNDERTAKINGS + +The undersigned registrant hereby undertakes to provide to the underwriters at the closing specified in the + +underwriting agreements certificates in such denominations and registered in such names as required by the + +underwriters to permit prompt delivery to each purchaser. + +Insofar 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 Act 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. + +The undersigned registrant hereby undertakes that: + + For purposes of determining any liability under the Securities Act of 1933, the information omitted from the + +form of prospectus filed as part of this registration statement in reliance on Rule 430A and contained in a form + +of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be + +deemed to be part of this registration statement as of the time it is declared effective. + + For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment + +that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities + +offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering + +thereof. + +II-4 + +SIGNATURES + +Pursuant to the requirements of the Securities Act of 1933, the Registrant certifies that it has reasonable grounds to + +believe that it meets all of the requirements for filing on Form F-1 and has duly caused this \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001216462_republic_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001216462_republic_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2a8cf80c373e752804b48c2a0f999095ceeed98c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001216462_republic_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes and the guarantees under New York State law are being passed upon on behalf of the issuers and the guarantors by Akin Gump Strauss Hauer & Feld LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001216640_sandia_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001216640_sandia_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..45ca0973a27bb4eb32d16f261d6adc84a1a74253 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001216640_sandia_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the notes and the Abraxas common stock covered by this prospectus has been passed upon for Abraxas by Cox & Smith Incorporated, San Antonio, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001217490_wamsutter_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001217490_wamsutter_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..45ca0973a27bb4eb32d16f261d6adc84a1a74253 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001217490_wamsutter_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the notes and the Abraxas common stock covered by this prospectus has been passed upon for Abraxas by Cox & Smith Incorporated, San Antonio, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001217492_western_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001217492_western_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..45ca0973a27bb4eb32d16f261d6adc84a1a74253 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001217492_western_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the notes and the Abraxas common stock covered by this prospectus has been passed upon for Abraxas by Cox & Smith Incorporated, San Antonio, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001217497_east-side_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001217497_east-side_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..45ca0973a27bb4eb32d16f261d6adc84a1a74253 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001217497_east-side_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the notes and the Abraxas common stock covered by this prospectus has been passed upon for Abraxas by Cox & Smith Incorporated, San Antonio, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001218320_woodbridge_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001218320_woodbridge_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..49ddfa029b567ffcbe8571e7e18af2e24d0fc4c2 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001218320_woodbridge_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the investment notes will be passed upon for us by Stearns Weaver Miller Weissler Alhadeff Sitterson, P.A., Miami, Florida. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001220606_icon_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001220606_icon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffe37102da6644131c28564ff5340762ab64105e --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001220606_icon_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters Greene Radovsky Maloney & Share LLP provided us with an opinion on the legality of the securities offered in this prospectus and the tax matters set forth under "FEDERAL INCOME TAX CONSEQUENCES." Additional Information A registration statement under the Securities Act has been filed with the Securities and Exchange Commission, Washington, D.C., with respect to the shares. This prospectus, which forms a part of the registration statement, contains information concerning Fund Ten and includes a copy of the Operating Agreement to be utilized by Fund Ten, but it does not contain all the information set forth in the registration statement and its exhibits. The information omitted may be examined at the public reference room of the Securities and Exchange Commission located at 450 Fifth Street, N.W., Washington, D.C. 20549 (202-942-8090), without charge, and copies may be obtained from that office upon payment of the fee prescribed by the rules and regulations of the Securities and Exchange Commission. Additionally, it can be viewed via the web site of the Securities and Exchange Commission at www.sec.gov. Fund Ten will file periodic reports with the Securities and Exchange Commission, copies of which will be available on our website at www.iconcapital.com. Tabular Information Concerning Prior Public Programs Exhibit B contains prior performance and investment information for our previous publicly offered income-oriented programs: Series A; Series B; Series C, Series D; Series E; L.P. Six; L.P. Seven; Eight A; Eight B; and Nine. Table I through V of Exhibit B contain unaudited information relating to experience in raising and investing funds, the compensation paid to us and our affiliates, the operating results of, and sales or dispositions of investments by most of these prior public programs. PURCHASERS OF SHARES WILL NOT ACQUIRE ANY OWNERSHIP INTEREST IN ANY OF THE PRIOR PUBLIC PROGRAMS AND SHOULD NOT ASSUME THAT THE RESULTS OF ANY OF THE PRIOR PUBLIC PROGRAMS WILL BE INDICATIVE OF THE FUTURE RESULTS OF FUND TEN. MOREOVER, THE OPERATING RESULTS FOR THE PRIOR PUBLIC PROGRAMS SHOULD NOT BE CONSIDERED INDICATIVE OF FUTURE RESULTS OF THE PRIOR PUBLIC PROGRAMS NOR OF WHETHER THE PRIOR PUBLIC PROGRAMS WILL ACHIEVE THEIR INVESTMENT OBJECTIVES. FUTURE RESULTS AND THE 80 ACHIEVEMENT OF INVESTMENT OBJECTIVES WILL IN LARGE PART DEPEND ON FACTS WHICH WE CANNOT DETERMINE, INCLUDING THE RESIDUAL VALUE OF EQUIPMENT HELD BY THESE PRIOR PUBLIC PROGRAMS. Balance Sheets The audited consolidated balance sheet of ICON Capital Corp. and Subsidiary as of March 31, 2003 and the audited balance sheet of Fund Ten as of April 30, 2003 are included in this prospectus. Notwithstanding the inclusion of our balance sheet in this prospectus, by purchasing shares, you should be aware that you are not purchasing an interest in ICON Capital Corp., its subsidiaries, or in any of our affiliates or in any of other businesses we sponsor and manage. Sales Material In addition to this prospectus, we may use sales material in connection with the offering of shares. In some jurisdictions sales material may not be available. This material will include information relating to this offering, to us and to our affiliates, and may include brochures, articles and publications about equipment leasing. If required by regulatory agencies, we will use only sales material that they have approved. The offering of shares, however, is made only by means of this prospectus. Although the information contained in sales material does not conflict with any of the information contained in this prospectus, the material does not purport to be complete and should not be considered as a part of this prospectus or the registration statement of which this prospectus is a part, or as incorporated in them by reference or as forming the basis of this offering of the shares. 81 Glossary The following terms used in this prospectus shall have the meanings set forth below: "Affiliate" means: (i) any person or entity, directly or indirectly controlling, controlled by or under common control with another person or entity; (ii) any person or entity owning or controlling 10% or more of the outstanding voting securities or beneficial interests of another entity; or (iii) any officer, director, member or partner of an entity; and (iv) if such person is an officer, director, member or partner, any other business entity for which the person acts in such capacity. However, affiliates shall not include a person or entity who is a partner in a partnership, member of a limited liability company or joint venturer in a joint venture with Fund Ten if such person or entity is not otherwise an affiliate. "Dealer-Manager" means ICON Securities Corp., an affiliate of ours, who will act as the manager of this offering of shares. "First Cash Distributions" means cash distributions members receive in any month on their unreturned capital, up to the lesser of: (i) 0.42% of their unreturned capital; or (ii) the 5-year US Treasury bill rate (divided by 12) on the first business day of the month of the distribution. "Formation Fee" means the fee payable to us in connection with the selection and acquisition of equipment for Fund Ten which is acquired with the offering proceeds. "Fund Ten" means ICON Income Fund Ten, LLC, a Delaware limited liability company. "Gross Rental Payments" means the total amount of rental payments paid, whether directly to Fund Ten or pledged or assigned, by lessees of equipment from Fund Ten. "Growth Leases" means equipment leases which will generate little or no current cash flow for Fund Ten because the rental payments will be paid directly to the lender that lent Fund Ten a portion of the purchase price of the equipment. "ICON Capital Corp." means the Connecticut corporation which serves as the manager of Fund Ten, and is referred to in this prospectus as "we." "Income Leases" means equipment leases which are expected to provide current cash flow to Fund Ten, as none of the cash flow from the leases have been pledged or assigned. "Lessee" means the party which is leasing the equipment from the owner of the equipment. "Leverage" means the use of debt in the acquisition of equipment. "Liquidation Period" means the phase after the operating period during which Fund Ten will sell its assets; however, if we believe it would benefit members for Fund Ten's cash flow to be reinvested in equipment during the liquidation period, Fund Ten may do so. "Management Fee" means the fee payable to us from Fund Ten for actively managing the leasing of its equipment portfolio. "Maximum Offering" means the offering of 100,000 shares of Fund Ten. "Member" means a holder of at least one share and who has been admitted to Fund Ten as a member. 82 "Minimum Offering" means the offering of 5,000 shares of Fund Ten, which must be achieved before Fund Ten can begin operations or accept any subscriptions for shares. "Non-Recourse Debt" means debt for which the lender can only look to those assets of Fund Ten acquired with the debt as a source for repayment of the loan obligation in the event of default. "O&O Expense Allowance" means an allowance payable to us, the dealer-manager, or both, for expenses incurred in organizing Fund Ten as well as expenses relating to this offering of shares. "Operating Agreement" means the Operating Agreement of Fund Ten, as it may be amended from time to time. "Operating Period" means the time frame during which Fund Ten will purchase equipment, which period is anticipated to last 5 years commencing with the completion of the offering but which may be extended at our discretion for an additional 3 years. "Payout" means the point in time when members have received total cash distributions equal to the amount of their investment plus an 8% cumulative annual return, compounded daily, on their unreturned investment. "Publicly Traded Partnership" means a limited liability company or other unincorporated business association that is taxed as a corporation rather than a partnership. "Recourse Debt" means debt for which the lender can look to all of the assets of Fund Ten as a source for repayment of the loan obligation in the event of default. "Redemption" means the purchase of shares from a member by Fund Ten. "Reinvestment" means the use of cash generated from Fund Ten's initial equipment purchases to acquire additional items of equipment. "Reinvestment Acquisition Fee" means a fee payable to us in connection with the acquisition of equipment for Fund Ten, but only commencing 6 months after the closing of the offering and provided that all of the offering proceeds have been either invested in equipment, used to pay organizational and offering expenses or committed to reserves. "Re-Leasing Fee" means the fee payable to us in connection with re-leasing Fund Ten's equipment portfolio during the operating period. "Re-Sale Fee" means the fee payable to us in connection with the sale of Fund Ten's equipment portfolio, but not payable with respect to any equipment acquired during the liquidation period. "Residual Value" means the value of an item of equipment upon the maturity of its lease. "Sales Commission" means a commission paid to selling dealers, who are not affiliated with us, for selling shares. "Selling Dealer" means brokers unaffiliated with us who will be selling shares in this offering. "Shares" means ownership interests in Fund Ten, which entitled the holder to the rights described in the prospectus and in the Operating Agreement. "Underwriting Fees" means the fee payable to ICON Securities Corp., the dealer-manager of this offering and an affiliate of ours, in connection with the sale of shares. 83 INDEX TO FINANCIAL STATEMENTS ICON Income Fund Ten, LLC Audited Balance Sheet--April 30, 2003 ...................................... 85 Independent Auditors' Report ........................................... 86 Balance Sheet at April 30, 2003 ........................................ 87 Notes to Balance Sheet ................................................. 88 ICON Capital Corp. and Subsidiary Audited Balance Sheet--March 31, 2003 ...................................... 89 Independent Auditors' Report ........................................... 90 Balance Sheet at March 31, 2003 ........................................ 91 Notes to Balance Sheet ................................................. 92 84 ICON Income Fund Ten, LLC (A Delaware Limited Liability Company) Balance Sheet April 30, 2003 (With Independent Auditor's Report Thereon) 85 Independent Auditor's Report The Members ICON Income Fund Ten, LLC We have audited the accompanying balance sheet of ICON Income Fund Ten, LLC (a Delaware limited liability company) as of April 30, 2003. The balance sheet is the responsibility of the Company's management. Our responsibility is to express an opinion on the balance sheet based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the balance sheet is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the balance sheet. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall balance sheet presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the balance sheet referred to above presents fairly, in all material respects, the financial position of ICON Income Fund Ten, LLC as of April 30, 2003, in conformity with accounting principles generally accepted in the United States of America. /s/Hays & Company LLP May 9, 2003 New York, New York 86 ICON Income Fund Ten, LLC (A Delaware Limited Liability Company) Balance Sheet April 30, 2003 ASSETS Cash $1,000 ------ $1,000 ====== LIABILITIES AND MEMBERS' EQUITY Commitments and Contingencies Members' equity Manager $1,000 Additional members -- ------ $1,000 ====== See accompanying notes to balance sheet 87 ICON Income Fund Ten, LLC (A Delaware Limited Liability Company) Notes to Balance Sheet April 30, 2003 (1) The Limited Liability Company ICON Income Fund Ten, LLC (the "LLC") was formed on January 2, 2003 as a Delaware Limited Liability Company. The initial capitalization of the LLC was $1,000. The LLC will continue until December 31, 2023, unless terminated sooner. The LLC intends to offer member interest units on a "best efforts" basis to the general public with the intention of raising up to $150,000,000 of capital. With the funds raised, the LLC intends to invest in equipment subject to leases and in residual ownership rights in leased equipment. The manager of the LLC is ICON Capital Corp. (the "Manager"), a Connecticut corporation. The Manager will acquire the assets and manage the business of the LLC. (2) Capital Contribution The Manager has made an initial capital contribution of $1,000 to the LLC. (3) Commitment and Contingencies The LLC will not apply for ruling from the Internal Revenue Service; however, in the opinion of counsel the LLC will be classified as a partnership for U.S. Federal income tax purposes and not as an association taxable as a corporation. In the absence of a ruling, there cannot be any assurance that the LLC will not be classified by the Internal Revenue Service as an association taxable as a corporation. 88 ICON CAPITAL CORP. AND SUBSIDIARY Consolidated Balance Sheet March 31, 2003 (With Independent Auditor's Report Thereon) 89 INDEPENDENT AUDITOR'S REPORT The Board of Directors ICON Capital Corp. We have audited the accompanying consolidated balance sheet of ICON Capital Corp. and subsidiary as of March 31, 2003. This consolidated balance sheet is the responsibility of the Company's management. Our responsibility is to express an opinion on this consolidated balance sheet based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the balance sheet is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the balance sheet. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall balance sheet presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated balance sheet referred to above presents fairly, in all material respects, the consolidated financial position of ICON Capital Corp. and subsidiary as of March 31, 2003, in conformity with accounting principles generally accepted in the United States of America. /s/Hays & Company LLP May 6, 2003 New York, New York 90 ICON CAPITAL CORP. AND SUBSIDIARY CONSOLIDATED BALANCE SHEET MARCH 31, 2003 ASSETS Cash and cash equivalents $ 177,309 Receivables from managed Funds (Note 3) 996,393 Loans receivable - related parties (Note 3) 88,424 Prepaid expenses and other assets, net (Note 4) 230,562 Deferred charges (Note 2 (d)) 196,158 Fixed assets and leasehold improvements, less accumulated depreciation and amortization of $2,307,874 (Note 2(e)) 1,036,226 ---------- Total assets $2,725,072 ========== LIABILITIES AND STOCKHOLDER'S EQUITY Liabilities: Accounts payable and accrued expenses $ 459,320 Capitalized lease obligations (Note 6) 607,911 Deferred state income taxes (Note 2(f)) 51,602 Deferred gain on sale of furniture and fixtures (Note 6) 96,670 ---------- Total liabilities 1,215,503 ---------- Commitments and contingencies (Notes 3, 5 and 6) Stockholder's equity: Common stock: no par value; $10 stated value; authorized 3,000 shares; issued and outstanding 1,500 shares 15,000 Additional paid-in capital 739,400 Retained earnings 755,169 ---------- Total stockholder's equity 1,509,569 ---------- Total liabilities and stockholder's equity $2,725,072 ========== See accompanying notes to consolidated balance sheet. 91 ICON CAPITAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED BALANCE SHEET MARCH 31, 2003 (1) Organization ICON Capital Corp. (the "Company") is a wholly owned subsidiary of ICON Holdings Corp. ("Holdings" or "Parent"). The primary activity of the Company is the development, marketing and management of publicly registered equipment leasing Funds in the United States of America. On March 31, 2003, Holdings transferred all of the outstanding shares of its wholly-owned subsidiary, ICON Securities Corp., to the Company. As a result of this transfer between entities under common control, the consolidated balance sheet of the Company reflects this transfer as if it had occurred as of April 1, 2002. The Company is the general partner of six publicly owned Partnerships and the manager of one publicly owned Limited Liability Company as follows: ICON Cash Flow Partners, L.P., Series D ("ICON Cash Flow D"), ICON Cash Flow Partners, L.P., Series E ("ICON Cash Flow E"), ICON Cash Flow Partners L.P. Six ("ICON Cash Flow Six"), ICON Cash Flow Partners L.P. Seven ("ICON Cash Flow Seven"), ICON Income Fund Eight A L.P. ("ICON Eight A"), ICON Income Fund Eight B L.P. ("ICON Eight B") and ICON Income Fund Nine, LLC ("ICON Fund Nine") (collectively the "Funds"), which are publicly registered equipment leasing Funds. In addition, the Company is the manager of one fund currently in the process of registration, ICON Income Fund Ten, LLC. The Funds were formed for the purpose of acquiring equipment and leasing such equipment to third parties. The Company earns fees from the Funds from the sales proceeds of units. Additionally, the Company also earns acquisition and management fees during the Funds' operating lives and shares in each Fund's cash distributions. ICON Securities Corp. is a registered broker-dealer and a member of the National Association of Securities Dealers, Inc. whose primary business activity is to underwrite and sell units in the Funds. The following table identifies pertinent offering information of the Funds:
Date of First Date Gross Proceeds Closing Offering Closed Raised ------- --------------- ------ ICON Cash Flow D September 13, 1991 June 5, 1992 $ 40,000,000 ICON Cash Flow E June 5, 1992 July 31, 1993 61,041,151 ICON Cash Flow Six March 31, 1994 November 8, 1995 38,385,712 ICON Cash Flow Seven January 19, 1996 September 16,1998 99,999,683 ICON Eight A October 14, 1998 May 17, 2000 75,000,000 ICON Eight B May 25, 2000 October 17, 2001 75,000,000 ICON Fund Nine December 18, 2001 April 30, 2003 99,743,474 ------------- $489,170,020
92 ICON CAPITAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED BALANCE SHEET - CONTINUED MARCH 31, 2003 ICON Fund Nine was formed on July 11, 2001 with an initial capital contribution of $1,000 and began offering its units on December 18, 2001. The offering period for ICON Fund Nine ended on April 30, 2003. (2) Significant Accounting Policies (a) Basis of Accounting and Presentation The Company's consolidated balance sheet has been prepared on the historical cost basis of accounting using the accrual basis. (b) Consolidation The consolidated balance sheet includes the accounts of the Company and its wholly-owned subsidiary. All inter-company accounts and transactions have been eliminated in consolidation. (c) Investments in Funds The Company accounts for its interests in the Funds following the cost method of accounting, which approximates the equity method of accounting, based on the allocation and distribution provisions of the individual Fund agreements. (d) Deferred Charges Under the terms of the Funds' agreements, the Company is entitled to fees for organizing and offering the units of the Funds from the gross proceeds raised, subject to certain limitations, based on the number of investment units sold. The costs of organizing and offering are capitalized and amortized over the Fund offering period. The unamortized balance of these costs is reflected on the consolidated balance sheet as deferred charges. (e) Fixed Assets and Leasehold Improvements Fixed assets, which consists primarily of assets recorded under capitalized leases, are recorded at cost and are being amortized and depreciated over three to five years using the straight-line method. Leasehold improvements are also recorded at cost and are being amortized over the estimated useful lives of the improvements, or the term of the lease, if shorter, using the straight-line method. (f) Income Taxes The Company and ICON Securities Corp. are included in the consolidated federal income tax return of Holdings and combined income tax returns of Holdings in states where combined returns are required or permitted. It is the policy of Holdings to allocate a tax provision or benefit to its subsidiaries based on the amount of tax that would have been determined on a separate company basis. In other states, the Company files its own separate returns. 93 ICON CAPITAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED BALANCE SHEET - CONTINUED MARCH 31, 2003 The Company accounts for its state deferred income taxes following the liability method as provided for in Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes." (g) Use of Estimates The preparation of a balance sheet in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet. Actual results could differ from those estimates. (3) Related Party Transactions The Company earns fees from the Funds for the organization and offering of each Fund and for the underwriting, acquisition, management and administration of their investments. The balance sheet item "Receivables from managed Funds" relates to such fees, which have been earned by the Company but not paid by the Funds as of March 31, 2003. Substantially all of such amounts were collected subsequent to March 31, 2003. The Company historically made cash advances to its Parent to cover its allocated general and administrative expenses and its allocated portion of income taxes. During the year ended March 31, 2003, the Company began to make all of its general and administrative disbursements directly. It is anticipated that the Company will, in the future, continue to advance monies to Holdings for income taxes. It is expected that all future advances to Holdings, which result from these cash advances, will be realized by applying such amounts against future income taxes payable by the Company to Holdings. From time-to-time, the Company advances funds to its affiliates and related parties. Notes bearing interest at 11.5% per annum support these advances. The balance of these advances outstanding at March 31, 2003 was $88,424. (4) Prepaid Expenses and Other Assets Prepaid expenses and other assets consist principally of unamortized insurance costs and security deposits. (5) Income Taxes Holdings files a consolidated federal income tax return and combined state income tax returns in certain states which include the operating results of the Company and its subsidiary. The Company's allocable share of the consolidated federal tax expense and combined state tax expense is reflected on the books of the Company as on a separate company basis. 94 ICON CAPITAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED BALANCE SHEET - CONTINUED MARCH 31, 2003 The Company files separate state income tax returns in all other states in which it is required to file. Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. The Company's share of current and deferred federal tax obligations and its share of current and deferred combined state tax obligations are recorded as reductions of receivables from Holdings. Deferred federal and state income taxes included in such receivables were $12,879 at March 31, 2003. Of the $10,976 of deferred state income taxes for 2003, none related to states where the Company filed separate tax returns. (6) Sale-Leaseback and Lease Obligations In July 1998, the Company entered into an agreement to sell a portion of its fixed assets to 1998-A, for $1,500,000 based upon a third party appraisal. 1998-A simultaneously leased the fixed assets back to the Company. Under the lease, the Company agreed to pay 60 equal monthly installments of $31,255 with the first payment due August 1998. The lease contains an option for the Company to purchase the assets at the end of the term for one dollar ($1.00). The Company treated the transaction as a sale of assets and recorded a deferred gain on sale in the amount of $966,522. The deferred gain is being amortized against depreciation expense on a straight-line basis over the remaining useful life of the assets sold. The capital lease obligation is included in the March 31, 2003 consolidated balance sheet as "Capitalized lease obligations." During the year ended March 31, 2003, the Company entered into new capital leases for equipment aggregating $6,687. 95 ICON CAPITAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED BALANCE SHEET - CONTINUED MARCH 31, 2003 The repayment schedule of the various obligations under all capitalized leases, payable in monthly installments, are as follows: Fiscal Year Ending March 31, Amount --------- ------ 2004 $ 381,891 2005 179,940 2006 71,109 2007 53,375 ---------- Total 686,315 Less: amounts representing interest 78,404 ---------- Total $ 607,911 ========== The Company is obligated under operating leases for office space through the year 2008 as follows: Fiscal Year Ending March 31, Amount --------- ------ 2004 $1,332,271 2005 1,119,950 2006 727,666 2007 380,250 2008 158,438 ---------- Total $3,718,575 ========== 96 EXHIBIT A AMENDED AND RESTATED OPERATING AGREEMENT OF ICON INCOME FUND TEN, LLC AMENDED AND RESTATED OPERATING AGREEMENT OF ICON INCOME FUND TEN, LLC TABLE OF CONTENTS Section 1. ESTABLISHMENT OF COMPANY......................................................1 Section 2. NAME, PRINCIPAL OFFICE AND ADDRESS............................................1 2.1 Legal Name and Address........................................................1 2.2 Address of Members............................................................1 Section 3. PURPOSES AND POWERS...........................................................1 3.1 Purposes......................................................................1 3.2 Types of Equipment............................................................2 3.3 Powers........................................................................2 Section 4. TERM..........................................................................3 Section 5. MEMBERS AND CAPITAL...........................................................3 5.1 Manager.......................................................................3 5.2 Members.......................................................................3 5.3 Company Capital...............................................................4 5.4 Capital Accounts..............................................................5 5.5 Additional Capital Contributions..............................................6 5.6 Loans by Members..............................................................6 5.7 No Right to Return of Capital.................................................6 Section 6. MANAGER.......................................................................6 6.1 Extent of Powers and Duties...................................................6 6.2 Limitations on the Exercise of Powers of Manager..............................9 6.3 Limitation on Liability of Manager and its Affiliates; Indemnification.......11 6.4 Compensation of Manager and its Affiliates...................................12 6.5 Other Interests of the Manager and its Affiliates............................16 Section 7. POWERS AND LIABILITIES OF MEMBERS............................................17 7.1 Absence of Control Over Company Business.....................................17 7.2 Limited Liability............................................................17 Section 8. DISTRIBUTIONS AND ALLOCATIONS................................................18 8.1 Distribution of Cash.........................................................18 8.2 Allocations of Profits and Losses............................................18 8.3 Tax Allocations: Code Section 704(c); Revaluations...........................21 8.4 Distributions and Allocations Among the Members..............................22 8.5 Compliance with NASAA Guidelines Regarding Front-End Fees....................23 8.6 Return of Uninvested Capital Contribution....................................23 8.7 Members' Return of Investment in the Company.................................23 8.8 No Distributions in Kind.....................................................23 8.9 Company Entitled to Withhold.................................................23 Section 9. WITHDRAWAL OF MANAGER........................................................24 9.1 Voluntary Withdrawal.........................................................24 9.2 Involuntary Withdrawal.......................................................24 9.3 Consequences of Withdrawal...................................................24 9.4 Continuation of Company Business.............................................26 Section 10. TRANSFER OF SHARES...........................................................26 10.1 Withdrawal of a Non-Manager Member...........................................26
i 10.2 Assignment...................................................................26 10.3 Substitution.................................................................27 10.4 Status of an Assigning Member................................................28 10.5 Limited Right of Presentment for Redemption of Shares........................28 Section 11. DISSOLUTION AND WINDING-UP...................................................29 11.1 Events Causing Dissolution...................................................29 11.2 Winding Up of the Company; Capital Contribution by the Manager Upon Dissolution ............................................................29 11.3 Application of Liquidation Proceeds Upon Dissolution.........................30 Section 12. FISCAL MATTERS and reports...................................................31 12.1 Title to Property and Bank Accounts..........................................31 12.2 Maintenance of and Access to Basic Company Documents.........................31 12.3 Financial Books and Accounting...............................................32 12.4 Fiscal Year..................................................................32 12.5 Reports......................................................................32 12.6 Tax Returns and Tax Information..............................................35 12.7 Accounting Decisions.........................................................35 12.8 Federal Tax Elections........................................................35 12.9 Tax Matters Partner..........................................................35 12.10 Reports to State Authorities.................................................37 Section 13. MEETINGS AND VOTING RIGHTS OF THE MEMBERS....................................37 13.1 Meetings of the Members......................................................37 13.2 Voting Rights of the Members.................................................38 13.3 Limitations on Action by the Members.........................................38 Section 14. AMENDMENTS...................................................................39 14.1 Amendments by the Manager....................................................39 14.2 Amendments with the Consent of the Majority Interest.........................39 Section 15. POWER OF ATTORNEY............................................................40 15.1 Appointment of Attorney-in-Fact..............................................40 15.2 Amendments to Agreement and Certificate of Limited Liability Company.........40 15.3 Power Coupled With an Interest...............................................41 Section 16. GENERAL PROVISIONS...........................................................41 16.1 Notices, Approvals and Consents..............................................41 16.2 Further Assurances...........................................................42 16.3 Captions.....................................................................42 16.4 Binding Effect...............................................................42 16.5 Severability.................................................................42 16.6 Integration..................................................................42 16.7 Applicable Law...............................................................43 16.8 Counterparts.................................................................43 16.9 Creditors....................................................................43 16.10 Interpretation...............................................................43 16.11 Successors and Assigns.......................................................43 16.12 Waiver of Action for Partition...............................................43 Section 17. DEFINITIONS..................................................................43
ii AMENDED AND RESTATED OPERATING AGREEMENT OF ICON INCOME FUND TEN, LLC This Amended and Restated Operating Agreement of ICON Income Fund Ten, LLC, is executed as of the ____ day of May, 2003, by its manager, ICON Capital Corp., a Connecticut corporation, pursuant to Section 14 hereof. WITNESSETH: WHEREAS, ICON Income Fund Ten, LLC, a Delaware limited liability company (the "Company") was formed as a Delaware limited liability company pursuant to a Certificate of Limited Liability Company filed on January 2, 2003, 2001 under and pursuant to the Delaware Act. WHEREAS, the Manager, being the sole Member as of the date hereof, wishes to amend this Agreement pursuant to Section 14; and NOW, THEREFORE this Agreement is amended and restated to read in full as follows: \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001221842_gracechurc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001221842_gracechurc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9ce0735644cf0f83ff2bcf4080903fe8cd2e581c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001221842_gracechurc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Matters of English law relating to the validity of the issuance of the notes and matters of U.S. law will be passed upon for the issuer by Clifford Chance LLP, London, England. Weil, Gotshal & Manges has acted as counsel to the underwriters with respect to the offering of the notes pursuant to this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001223389_conns-inc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001223389_conns-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..dbc55e6025e25282c65363ba0ba019e1f8efc84b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001223389_conns-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Winstead Sechrest & Minick P.C., Dallas, Texas, will pass upon the legality of the shares of common stock offered by this prospectus. Alston & Bird LLP will pass upon legal matters for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001224374_chimera_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001224374_chimera_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a5a8bf2eff4a49a74d674811da5fca8c0c04e4ce --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001224374_chimera_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Notes offered hereby will be passed on for us by Kirkland & Ellis, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001224375_syva-co_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001224375_syva-co_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a5a8bf2eff4a49a74d674811da5fca8c0c04e4ce --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001224375_syva-co_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Notes offered hereby will be passed on for us by Kirkland & Ellis, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001224376_syva_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001224376_syva_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a5a8bf2eff4a49a74d674811da5fca8c0c04e4ce --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001224376_syva_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Notes offered hereby will be passed on for us by Kirkland & Ellis, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001224377_syva_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001224377_syva_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a5a8bf2eff4a49a74d674811da5fca8c0c04e4ce --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001224377_syva_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Notes offered hereby will be passed on for us by Kirkland & Ellis, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001224378_dade_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001224378_dade_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a5a8bf2eff4a49a74d674811da5fca8c0c04e4ce --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001224378_dade_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Notes offered hereby will be passed on for us by Kirkland & Ellis, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001224379_dade_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001224379_dade_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a5a8bf2eff4a49a74d674811da5fca8c0c04e4ce --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001224379_dade_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Notes offered hereby will be passed on for us by Kirkland & Ellis, New York, New York 10022. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001226308_dts-inc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001226308_dts-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..caae3ec2368a3c6227d6a02de0d9d79607641d5d --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001226308_dts-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Heller Ehrman White McAuliffe LLP, San Diego, California and for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001226932_trump_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001226932_trump_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0630233ac37bfaaf0468552007e15b6d5062b0b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001226932_trump_legal_matters.txt @@ -0,0 +1,2556 @@ +LEGAL MATTERS + + The validity of +the Resale Notes will be passed upon for the Issuers by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. In giving their opinion, LeBoeuf, Lamb, Greene & MacRae, +L.L.P. may rely on the opinion of Graham, Curtin & Sheridan, a Professional Association, with respect to matters relating to New Jersey law. + + + 188 + +Table of Contents + + +INDEPENDENT AUDITORS + + The financial +statements of Trump s Castle Associates, L.P. and Subsidiary and Trump Indiana, Inc., as of December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, and the financial statements of Trump Management +Services, LLC as of December 31, 2001 and for the two-month period ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, independent certified public accountants, as indicated in their report, which is +included herein. Arthur Andersen, which has ceased operations, has not consented to the inclusion of their report in this prospectus, and we have dispensed with the requirement to file their consent in reliance upon Rule 437a of the Securities Act. +Under most circumstances a registrant must obtain and file the consent of its accountants contemporaneously with the filing of any registration statement that includes audited financial statements. By granting such a consent, accounting firms become +exposed to liability under Section 11(a) of the Securities Act for any untrue statements of material fact in, or omissions of material facts from, such registration statement. Investors who bring a successful claim under Section 11(a) of the +Securities Act are entitled to recessionary damages. As a result of the criminal conviction against Arthur Andersen in connection with Enron Corporation, and the volume of civil lawsuits filed against it, Arthur Andersen may not have the ability to +withstand liability for prior audits. + + Effective June 3, 2002, +THCR Holdings appointed Ernst & Young LLP as our new independent auditors. The combined financial statements of Trump Casino Holdings, LLC as of December 31, 2002 and for the year then ended appearing in this prospectus and registration +statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting +and auditing. + + + 189 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + + +Page + + Trump Casino Holdings, LLC + + + + + Annual Financial Statements + + + + + Report of Independent Auditors + + + F-2 + + Combined Balance Sheets as of December 31, 2001 and 2002 + + + F-3 + + Combined Statements of Operations for the years ended December 31, 2000, 2001 and 2002 + + + F-4 + + Combined Statements of Capital for the years ended December 31, 2000, 2001 and 2002 + + + F-5 + + Combined Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 + + + F-6 + + Notes to Combined Financial Statements + + + F-7 + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000, 2001 and 2002 + + + F-26 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required formation is included +in the consolidated financial statements or notes thereto. + + + + + Interim Financial Statements + + + + + Condensed Consolidated Balance Sheets as of December 31, 2002 and March 31, 2003 (unaudited) + + + F-27 + + Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-28 + + Condensed Consolidated Statement of Capital for the three months ended March 31, 2003 (unaudited) + + + F-29 + + Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-30 + + Notes to Condensed Consolidated Financial Statements (unaudited) + + + F-31 + + Trump s Castle Associates, L.P. (now known as Trump Marina Associates, L.P.) and Subsidiary* + + + + + Report of Independent Auditors + + + F-36 + + Consolidated Balance Sheet as of December 31, 2001 + + + F-37 + + Consolidated Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-38 + + Consolidated Statements of Partners Capital for the years ended December 31, 2000 and 2001 + + + F-39 + + Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-40 + + Notes to Consolidated Financial Statements + + + F-41 + + Financial Statement Schedule + + + + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000 and 2001 + + + F-50 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required information is +included in the consolidated financial statements or notes thereto. + + + + + Trump Indiana, Inc.* + + + + + Report of Independent Auditors + + + F-51 + + Balance Sheet as of December 31, 2001 + + + F-52 + + Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-53 + + Statements of Capital for the years ended December 31, 2000 and 2001 + + + F-54 + + Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-55 + + Notes to Financial Statements + + + F-56 + + All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included +in the consolidated financial statements or notes thereto. + + + + + THCR Management Services, LLC* + + + + + Report of Independent Auditors + + + F-64 + + Balance Sheet as of December 31, 2001 + + + F-65 + + Statement of Operations for the two months ended December 31, 2001 + + + F-66 + + Statement of Cash Flows for the two months ended December 31, 2001 + + + F-67 + + Notes to Financial Statements + + + F-68 + +All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes +thereto. + + + + + +* + +Became a wholly-owned subsidiary of Trump Casino Holdings, LLC on March 25, 2003 pursuant to a corporate reorganization. See Note 1 to Combined Financial Statements of Trump Casino +Holdings, LLC. + + + F-1 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + Board of Directors + Trump Casino Holdings, LLC + + + We have audited the accompanying combined balance sheet of +Trump Casino Holdings, LLC as of December 31, 2002 and the related combined statements of operations, capital, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial +Statements. These financial statements and schedule are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. + + We conducted our audit in accordance with auditing standards generally +accepted in the United States. 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. + + In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Trump Casino Holdings, LLC at December 31, 2002 and the combined results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a +whole, present fairly in all material respects the information set forth therein. + + We also have audited, as to combination only, the accompanying combined balance sheet of Trump Casino Holdings, LLC as of December 31, 2001, and the related combined statements of operations, capital, and cash flows +for the two years then ended. As described in Note 1, Trump Casino Holdings, LLC was capitalized on March 25, 2003 as a holding company for three entities under common control; accordingly, its financial statements are presented as though the +combination of Trump s Castle Associates, L.P. and Subsidiary, Trump Indiana, Inc., and THCR Management Services, LLC occurred at the beginning of the period presented. We did not audit the financial statements of these three entities. Their +financial statements, which are presented separately herein, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those respective financial statements in their reports dated March 13, 2002, +which also are presented separately herein. In our opinion, these combined financial statements have been properly combined on the basis described in Note 1. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 +combined financial statements of Trump Casino Holdings, LLC, other than with respect to such combination and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements of Trump Casino +Holdings, LLC taken as whole or on the separate financial statements of any of its subsidiaries. + + /s/ ERNST & YOUNG LLP + + Philadelphia, Pennsylvania + March 25, 2003 + + + F-2 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED BALANCE SHEETS + (in thousands) + + + + +December 31, +2001 + + + +December 31, +2002 + + + + + +(See Note 1*) + + + + + +ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + + Cash and cash equivalents + + +$ +34,291 + + +$ +33,917 + + + Restricted cash + + + +4,800 + + + + + + + Trade receivables, net of allowance for doubtful accounts of $2,979 and $2,607, respectively + + + +12,984 + + + +9,872 + + + Other receivables + + + +2,342 + + + +2,884 + + + Inventories + + + +3,038 + + + +3,182 + + + Prepaid expenses and other current assets + + + +2,449 + + + +3,797 + + + Due from affiliates + + + +216 + + + +378 + + + + + + + + Total current assets + + + +60,120 + + + +54,030 + + + + + + + + PROPERTY AND EQUIPMENT + + + + + + + + + + + Land and land improvements + + + +92,379 + + + +92,379 + + + Buildings and building improvements + + + +424,031 + + + +425,027 + + + Riverboat and improvements + + + +34,159 + + + +34,239 + + + Furniture, fixtures and equipment + + + +81,897 + + + +102,014 + + + Construction in progress + + + +3,779 + + + +6,639 + + + + + + + + + + +636,245 + + + +660,298 + + + Less-Accumulated depreciation and amortization + + + +115,798 + + + +142,444 + + + + + + + + + + +520,447 + + + +517,854 + + + INVESTMENT IN BUFFINGTON HARBOR RIVERBOATS, LLC + + + +33,889 + + + +31,842 + + + OTHER ASSETS + + + +35,210 + + + +24,338 + + + + + + + + Total assets + + +$ +649,666 + + +$ +628,064 + + + + + + + +LIABILITIES AND EQUITY + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + + Current maturities of long-term debt + + +$ +12,952 + + +$ +7,712 + + + Trade accounts payable + + + +11,556 + + + +8,961 + + + Due to affiliates + + + +8,184 + + + +4,381 + + + Accrued payroll and related expenses + + + +8,017 + + + +8,597 + + + Accrued interest payable + + + +4,953 + + + +3,778 + + + Self insurance reserves + + + +3,444 + + + +2,892 + + + Other + + + +16,385 + + + +20,108 + + + + + + + + Total current liabilities + + + +65,491 + + + +56,429 + + + DUE TO (FROM) AFFILIATES-THCR HOLDINGS + + + +42,553 + + + +32,566 + + + LONG-TERM DEBT, LESS CURRENT MATURITIES + + + +464,493 + + + +487,242 + + + OTHER LONG-TERM LIABILITIES + + + +16,121 + + + +5,974 + + + + + + + + Total liabilities + + + +588,658 + + + +582,211 + + + CAPITAL + + + + + + + + + + + Contributed capital + + + +237,197 + + + +238,273 + + + Accumulated other comprehensive loss + + + +(372 +) + + +(938 +) + + Accumulated deficit + + + +(175,817 +) + + +(191,482 +) + + + + + + + Total capital + + + +61,008 + + + +45,853 + + + + + + + + Total liabilities and capital + + +$ +649,666 + + +$ +628,064 + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-3 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF OPERATIONS + (in thousands) + + + + +For the Years Ended December 31, + + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + REVENUES + + + + + + + + + + + + + + + Gaming + + +$ +386,541 + + +$ +390,104 + + +$ +410,645 + + + Rooms + + + +21,827 + + + +22,470 + + + +21,835 + + + Food and beverage + + + +36,971 + + + +35,069 + + + +35,601 + + + Management fees + + + + + + + + + + + +2,710 + + + Other + + + +11,449 + + + +12,042 + + + +12,335 + + + + + + + + + + Gross revenues + + + +456,788 + + + +459,685 + + + +483,126 + + + Less-Promotional allowances + + + +88,867 + + + +85,863 + + + +86,165 + + + + + + + + + + Net revenues + + + +367,921 + + + +373,822 + + + +396,961 + + + + + + + + + + COSTS AND EXPENSES + + + + + + + + + + + + + + + Gaming + + + +190,377 + + + +189,712 + + + +190,455 + + + Rooms + + + +6,311 + + + +5,745 + + + +6,246 + + + Food and beverage + + + +15,248 + + + +14,571 + + + +14,856 + + + General and administrative + + + +88,220 + + + +84,138 + + + +86,367 + + + General and administrative-related parties + + + +12,045 + + + +10,413 + + + +13,177 + + + Debt renegotiation costs + + + + + + + + + + + +1,629 + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + + + + + + + + + + +337,350 + + + +328,716 + + + +340,336 + + + + + + + + + + Income from operations + + + +30,571 + + + +45,106 + + + +56,625 + + + + + + + + + + NON-OPERATING INCOME (EXPENSE) + + + + + + + + + + + + + + + Interest income + + + +2,075 + + + +1,382 + + + +867 + + + Interest expense + + + +(45,993 +) + + +(48,085 +) + + +(51,361 +) + + Interest expense-related parties + + + +(16,457 +) + + +(17,600 +) + + +(19,367 +) + + Other non-operating income (expense) + + + +(218 +) + + +100 + + + +1,219 + + + + + + + + + + Non-operating expense, net + + + +(60,593 +) + + +(64,203 +) + + +(68,642 +) + + + + + + + + + Loss before income taxes and equity in loss from Buffington Harbor, LLC + + + +(30,022 +) + + +(19,097 +) + + +(12,017 +) + + Equity in loss from Buffington Harbor, LLC + + + +(3,134 +) + + +(2,808 +) + + +(2,448 +) + + Provision for income taxes + + + + + + + +(150 +) + + +(1,200 +) + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-4 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CAPITAL + (in thousands) + + + + +Contributed +Capital + + +Accumulated +Deficit + + + +Accumulated +Other +Comprehensive +Loss + + + +Total + + + + Balance at December 31, 1999 + + +$ +229,015 + +$ +(120,606 +) + +$ + + + +$ +108,409 + + + Capital contribution (See Note 1*) + + + +7,732 + + + + + + + + + + +7,732 + + + Net loss (See Note 1*) + + + + + + +(33,156 +) + + + + + + +(33,156 +) + + + + + + + + + + + Balance at December 31, 2000 (See Note 1*) + + + +236,747 + + +(153,762 +) + + + + + + +82,985 + + + Capital contribution (See Note 1*) + + + +450 + + + + + + + + + + +450 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss (See Note 1*) + + + + + + +(22,055 +) + + + + + + +(22,055 +) + + Adjustment for interest rate swap (See Note 1*) + + + + + + + + + + +(372 +) + + +(372 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(22,427 +) + + + + + + + + + + + Balance at December 31, 2001 (See Note 1*) + + + +237,197 + + +(175,817 +) + + +(372 +) + + +61,008 + + + Capital contribution + + + +1,076 + + + + + + + + + + +1,076 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss + + + + + + +(15,665 +) + + + + + + +(15,665 +) + + Adjustment for interest rate swap + + + + + + + + + + +(566 +) + + +(566 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(16,231 +) + + + + + + + + + + + Balance at December 31, 2002 + + +$ +238,273 + +$ +(191,482 +) + +$ +(938 +) + +$ +45,853 + + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + + See accompanying notes + + + F-5 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CASH FLOWS + (in thousands) + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + Adjustments to reconcile net loss to net cash flows provided by operating activities + + + + + + + + + + + + + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + Issuance of PIK debt in satisfaction of accrued interest + + + +15,188 + + + +17,368 + + + +17,805 + + + Amortization for City of Gary development agreement + + + +3,700 + + + +667 + + + + + + + Equity in loss from Buffington Harbor, LLC + + + +3,134 + + + +2,808 + + + +2,448 + + + Accretion of bond discount + + + +5,122 + + + +5,981 + + + +6,985 + + + Amortization of loan costs + + + +410 + + + +1,134 + + + +4,711 + + + Allocation of expenses from THCR Holdings + + + + + + + + + + + +1,076 + + + Provision of losses on receivables + + + +1,420 + + + +1,430 + + + +2,303 + + + Valuation allowance CRDA investments + + + +3,680 + + + +1,432 + + + +3,762 + + + (Increase) decrease in receivables + + + +(5,564 +) + + +(215 +) + + +1,903 + + + Decrease (increase) in inventories + + + +206 + + + +358 + + + +(144 +) + + (Increase) decrease in prepaid expenses and other current assets + + + +(28 +) + + +138 + + + +(1,605 +) + + (Increase) decrease in other assets + + + +(7,319 +) + + +(1,310 +) + + +1,646 + + + Decrease in due to affiliates + + + +(858 +) + + +(8,563 +) + + +(14,173 +) + + Increase (decrease) in current liabilities + + + +1,551 + + + +3,743 + + + +(5,011 +) + + Increase (decrease) in other long-term liabilities + + + +17 + + + +(7,164 +) + + +(4,711 +) + + + + + + + + + Net cash flows provided by operating activities + + + +12,652 + + + +19,889 + + + +28,936 + + + + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + + + + + + + Purchases of property and equipment, net + + + +(5,479 +) + + +(7,089 +) + + +(15,378 +) + + (Advances) repayment of note receivable + + + + + + + +(3,535 +) + + +3,535 + + + Investment in Buffington Harbor Riverboats, LLC + + + +(1,534 +) + + +(112 +) + + +(401 +) + + Purchases of CRDA investments + + + +(3,347 +) + + +(3,388 +) + + +(3,486 +) + + + + + + + + + Net cash flows used in investing activities + + + +(10,360 +) + + +(14,124 +) + + +(15,730 +) + + + + + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + + + + + + + Contributed capital + + + + + + + +450 + + + + + + + Repayment of other borrowings + + + +(7,675 +) + + +(29,118 +) + + +(91,323 +) + + Proceeds of other borrowings + + + +5,000 + + + +38,500 + + + +75,245 + + + Cost of issuing debt + + + +(290 +) + + +(4,168 +) + + +(2,302 +) + + + + + + + + + Net cash flows (used in) provided by financing activities + + + +(2,965 +) + + +5,664 + + + +(18,380 +) + + + + + + + + + Net (decrease) increase in cash and cash equivalents + + + +(673 +) + + +11,429 + + + +(5,174 +) + + CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR + + + +28,335 + + + +27,662 + + + +39,091 + + + + + + + + + + CASH AND CASH EQUIVALENTS AT END OF YEAR + + +$ +27,662 + + +$ +39,091 + + +$ +33,917 + + + + + + + + + + SUPPLEMENTAL INFORMATION: + + + + + + + + + + + + + + + Cash paid for interest + + +$ +38,921 + + +$ +39,043 + + +$ +41,452 + + + + + + + + + + Cash paid for income taxes + + +$ + + + +$ + + + +$ +75 + + + + + + + + + + Purchase of equipment under capitalized lease obligations + + +$ +4,156 + + +$ +7,293 + + +$ +8,342 + + + + + + + + + + Contribution of capital by and forgiveness of amount due to THCR Holdings + + +$ +7,732 + + +$ +450 + + +$ + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes + + + F-6 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS + + (1) Organization and Operations + + The accompanying combined financial statements include those of Trump Casino Holdings, a Delaware single member limited +liability company ( TCH ), and its subsidiary, Trump Casino Funding, Inc., a New Jersey corporation, ( TCF ). Its wholly-owned subsidiaries include (i) Trump Casino Funding, Inc.( Trump Casino Funding ), (ii) Trump +Marina Associates, L.P. ( Marina Associates ), (iii) Trump Marina, Inc., (iv) Trump Indiana, Inc. ( Trump Indiana ), (v) Trump Indiana Realty, L.L.C. and (vi) THCR Management Holdings, L.L.C. ( THCR Management +Holdings ). + + The sole member of Trump Casino Holdings is +THCR Holdings. THCR Holdings is owned approximately 63.4% by Trump Hotels & Casino Resorts, Inc. ( THCR ) as both a general and limited partner, and approximately 36.6% by Donald J. Trump as a limited partner. THCR is a publicly held +company whose common stock is traded on The New York Stock Exchange under the symbol DJT . + + On March 25, 2003, TCH was capitalized and simultaneously, Marina Associates, Trump Marina, Inc., Trump Indiana, Inc., Trump Indiana Realty, L.L.C., and +THCR Management Holdings became wholly owned subsidiaries of TCH pursuant to a corporate reorganization approved by THCR s Board of Directors. THCR Management Holdings has no operations and it owns 100% of THCR Management Services, LLC +( THCR Management ). THCR Management Holding s only asset, other than its investment in THCR Management, was $254,000 of cash which was advanced to THCR Management at December 31, 2002. As a result of this reorganization of entities +under common control, the accompanying combined financial statements present the combined financial statements of TCH as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002. + + The financial statements of (i) Trump Marina Associates, L.P. (formerly +Trump s Castle Associates, L.P.) as of December 31, 2001 and for each of the two years in the period then ended, (ii) Trump Indiana, Inc. as of December 31, 2001 and for each of the two years in the period then ended, and (iii) THCR Management +Services, LLC as of December 31, 2001 and for the two months then ended were audited by other auditors who have ceased operations. These entities constitute 100% of the combined assets of TCH at December 31, 2001 and combined revenues and combined +net loss of TCH for the years ended December 31, 2001 and 2000. + + Marina Associates owns and operates the Trump Marina Hotel Casino, ( Trump Marina ), a casino hotel located in the marina district of Atlantic City, New Jersey (the Marina District ). Trump Indiana owns and operates a +riverboat gaming facility operating in Buffington Harbor, on Lake Michigan, Indiana (the Trump Indiana Riverboat ). THCR Management Holdings is the sole member of THCR Management. THCR Management manages the day-to-day operations of Trump +29 Casino located in Coachella Valley, California (in the Palm Springs area) pursuant to a five year management agreement (the Management Agreement ) commencing on April 16, 2002, between THCR Management and the Twenty Nine Palms Band of +Luiseno Mission Indians, a federally recognized native American Tribe and the owner of Trump 29 Casino (the Tribe ). Trump Indiana Realty, LLC has no material assets or operations. + + TCH and TCF have no operations and their ability to service their debt is +dependent upon the successful operations of Trump Marina, Trump Indiana, and the management fees generated pursuant to the Trump 29 Management Agreement. + + + F-7 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS (Continued) + + + (2) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001226933_trump_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001226933_trump_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0630233ac37bfaaf0468552007e15b6d5062b0b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001226933_trump_legal_matters.txt @@ -0,0 +1,2556 @@ +LEGAL MATTERS + + The validity of +the Resale Notes will be passed upon for the Issuers by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. In giving their opinion, LeBoeuf, Lamb, Greene & MacRae, +L.L.P. may rely on the opinion of Graham, Curtin & Sheridan, a Professional Association, with respect to matters relating to New Jersey law. + + + 188 + +Table of Contents + + +INDEPENDENT AUDITORS + + The financial +statements of Trump s Castle Associates, L.P. and Subsidiary and Trump Indiana, Inc., as of December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, and the financial statements of Trump Management +Services, LLC as of December 31, 2001 and for the two-month period ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, independent certified public accountants, as indicated in their report, which is +included herein. Arthur Andersen, which has ceased operations, has not consented to the inclusion of their report in this prospectus, and we have dispensed with the requirement to file their consent in reliance upon Rule 437a of the Securities Act. +Under most circumstances a registrant must obtain and file the consent of its accountants contemporaneously with the filing of any registration statement that includes audited financial statements. By granting such a consent, accounting firms become +exposed to liability under Section 11(a) of the Securities Act for any untrue statements of material fact in, or omissions of material facts from, such registration statement. Investors who bring a successful claim under Section 11(a) of the +Securities Act are entitled to recessionary damages. As a result of the criminal conviction against Arthur Andersen in connection with Enron Corporation, and the volume of civil lawsuits filed against it, Arthur Andersen may not have the ability to +withstand liability for prior audits. + + Effective June 3, 2002, +THCR Holdings appointed Ernst & Young LLP as our new independent auditors. The combined financial statements of Trump Casino Holdings, LLC as of December 31, 2002 and for the year then ended appearing in this prospectus and registration +statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting +and auditing. + + + 189 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + + +Page + + Trump Casino Holdings, LLC + + + + + Annual Financial Statements + + + + + Report of Independent Auditors + + + F-2 + + Combined Balance Sheets as of December 31, 2001 and 2002 + + + F-3 + + Combined Statements of Operations for the years ended December 31, 2000, 2001 and 2002 + + + F-4 + + Combined Statements of Capital for the years ended December 31, 2000, 2001 and 2002 + + + F-5 + + Combined Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 + + + F-6 + + Notes to Combined Financial Statements + + + F-7 + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000, 2001 and 2002 + + + F-26 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required formation is included +in the consolidated financial statements or notes thereto. + + + + + Interim Financial Statements + + + + + Condensed Consolidated Balance Sheets as of December 31, 2002 and March 31, 2003 (unaudited) + + + F-27 + + Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-28 + + Condensed Consolidated Statement of Capital for the three months ended March 31, 2003 (unaudited) + + + F-29 + + Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-30 + + Notes to Condensed Consolidated Financial Statements (unaudited) + + + F-31 + + Trump s Castle Associates, L.P. (now known as Trump Marina Associates, L.P.) and Subsidiary* + + + + + Report of Independent Auditors + + + F-36 + + Consolidated Balance Sheet as of December 31, 2001 + + + F-37 + + Consolidated Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-38 + + Consolidated Statements of Partners Capital for the years ended December 31, 2000 and 2001 + + + F-39 + + Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-40 + + Notes to Consolidated Financial Statements + + + F-41 + + Financial Statement Schedule + + + + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000 and 2001 + + + F-50 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required information is +included in the consolidated financial statements or notes thereto. + + + + + Trump Indiana, Inc.* + + + + + Report of Independent Auditors + + + F-51 + + Balance Sheet as of December 31, 2001 + + + F-52 + + Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-53 + + Statements of Capital for the years ended December 31, 2000 and 2001 + + + F-54 + + Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-55 + + Notes to Financial Statements + + + F-56 + + All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included +in the consolidated financial statements or notes thereto. + + + + + THCR Management Services, LLC* + + + + + Report of Independent Auditors + + + F-64 + + Balance Sheet as of December 31, 2001 + + + F-65 + + Statement of Operations for the two months ended December 31, 2001 + + + F-66 + + Statement of Cash Flows for the two months ended December 31, 2001 + + + F-67 + + Notes to Financial Statements + + + F-68 + +All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes +thereto. + + + + + +* + +Became a wholly-owned subsidiary of Trump Casino Holdings, LLC on March 25, 2003 pursuant to a corporate reorganization. See Note 1 to Combined Financial Statements of Trump Casino +Holdings, LLC. + + + F-1 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + Board of Directors + Trump Casino Holdings, LLC + + + We have audited the accompanying combined balance sheet of +Trump Casino Holdings, LLC as of December 31, 2002 and the related combined statements of operations, capital, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial +Statements. These financial statements and schedule are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. + + We conducted our audit in accordance with auditing standards generally +accepted in the United States. 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. + + In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Trump Casino Holdings, LLC at December 31, 2002 and the combined results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a +whole, present fairly in all material respects the information set forth therein. + + We also have audited, as to combination only, the accompanying combined balance sheet of Trump Casino Holdings, LLC as of December 31, 2001, and the related combined statements of operations, capital, and cash flows +for the two years then ended. As described in Note 1, Trump Casino Holdings, LLC was capitalized on March 25, 2003 as a holding company for three entities under common control; accordingly, its financial statements are presented as though the +combination of Trump s Castle Associates, L.P. and Subsidiary, Trump Indiana, Inc., and THCR Management Services, LLC occurred at the beginning of the period presented. We did not audit the financial statements of these three entities. Their +financial statements, which are presented separately herein, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those respective financial statements in their reports dated March 13, 2002, +which also are presented separately herein. In our opinion, these combined financial statements have been properly combined on the basis described in Note 1. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 +combined financial statements of Trump Casino Holdings, LLC, other than with respect to such combination and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements of Trump Casino +Holdings, LLC taken as whole or on the separate financial statements of any of its subsidiaries. + + /s/ ERNST & YOUNG LLP + + Philadelphia, Pennsylvania + March 25, 2003 + + + F-2 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED BALANCE SHEETS + (in thousands) + + + + +December 31, +2001 + + + +December 31, +2002 + + + + + +(See Note 1*) + + + + + +ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + + Cash and cash equivalents + + +$ +34,291 + + +$ +33,917 + + + Restricted cash + + + +4,800 + + + + + + + Trade receivables, net of allowance for doubtful accounts of $2,979 and $2,607, respectively + + + +12,984 + + + +9,872 + + + Other receivables + + + +2,342 + + + +2,884 + + + Inventories + + + +3,038 + + + +3,182 + + + Prepaid expenses and other current assets + + + +2,449 + + + +3,797 + + + Due from affiliates + + + +216 + + + +378 + + + + + + + + Total current assets + + + +60,120 + + + +54,030 + + + + + + + + PROPERTY AND EQUIPMENT + + + + + + + + + + + Land and land improvements + + + +92,379 + + + +92,379 + + + Buildings and building improvements + + + +424,031 + + + +425,027 + + + Riverboat and improvements + + + +34,159 + + + +34,239 + + + Furniture, fixtures and equipment + + + +81,897 + + + +102,014 + + + Construction in progress + + + +3,779 + + + +6,639 + + + + + + + + + + +636,245 + + + +660,298 + + + Less-Accumulated depreciation and amortization + + + +115,798 + + + +142,444 + + + + + + + + + + +520,447 + + + +517,854 + + + INVESTMENT IN BUFFINGTON HARBOR RIVERBOATS, LLC + + + +33,889 + + + +31,842 + + + OTHER ASSETS + + + +35,210 + + + +24,338 + + + + + + + + Total assets + + +$ +649,666 + + +$ +628,064 + + + + + + + +LIABILITIES AND EQUITY + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + + Current maturities of long-term debt + + +$ +12,952 + + +$ +7,712 + + + Trade accounts payable + + + +11,556 + + + +8,961 + + + Due to affiliates + + + +8,184 + + + +4,381 + + + Accrued payroll and related expenses + + + +8,017 + + + +8,597 + + + Accrued interest payable + + + +4,953 + + + +3,778 + + + Self insurance reserves + + + +3,444 + + + +2,892 + + + Other + + + +16,385 + + + +20,108 + + + + + + + + Total current liabilities + + + +65,491 + + + +56,429 + + + DUE TO (FROM) AFFILIATES-THCR HOLDINGS + + + +42,553 + + + +32,566 + + + LONG-TERM DEBT, LESS CURRENT MATURITIES + + + +464,493 + + + +487,242 + + + OTHER LONG-TERM LIABILITIES + + + +16,121 + + + +5,974 + + + + + + + + Total liabilities + + + +588,658 + + + +582,211 + + + CAPITAL + + + + + + + + + + + Contributed capital + + + +237,197 + + + +238,273 + + + Accumulated other comprehensive loss + + + +(372 +) + + +(938 +) + + Accumulated deficit + + + +(175,817 +) + + +(191,482 +) + + + + + + + Total capital + + + +61,008 + + + +45,853 + + + + + + + + Total liabilities and capital + + +$ +649,666 + + +$ +628,064 + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-3 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF OPERATIONS + (in thousands) + + + + +For the Years Ended December 31, + + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + REVENUES + + + + + + + + + + + + + + + Gaming + + +$ +386,541 + + +$ +390,104 + + +$ +410,645 + + + Rooms + + + +21,827 + + + +22,470 + + + +21,835 + + + Food and beverage + + + +36,971 + + + +35,069 + + + +35,601 + + + Management fees + + + + + + + + + + + +2,710 + + + Other + + + +11,449 + + + +12,042 + + + +12,335 + + + + + + + + + + Gross revenues + + + +456,788 + + + +459,685 + + + +483,126 + + + Less-Promotional allowances + + + +88,867 + + + +85,863 + + + +86,165 + + + + + + + + + + Net revenues + + + +367,921 + + + +373,822 + + + +396,961 + + + + + + + + + + COSTS AND EXPENSES + + + + + + + + + + + + + + + Gaming + + + +190,377 + + + +189,712 + + + +190,455 + + + Rooms + + + +6,311 + + + +5,745 + + + +6,246 + + + Food and beverage + + + +15,248 + + + +14,571 + + + +14,856 + + + General and administrative + + + +88,220 + + + +84,138 + + + +86,367 + + + General and administrative-related parties + + + +12,045 + + + +10,413 + + + +13,177 + + + Debt renegotiation costs + + + + + + + + + + + +1,629 + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + + + + + + + + + + +337,350 + + + +328,716 + + + +340,336 + + + + + + + + + + Income from operations + + + +30,571 + + + +45,106 + + + +56,625 + + + + + + + + + + NON-OPERATING INCOME (EXPENSE) + + + + + + + + + + + + + + + Interest income + + + +2,075 + + + +1,382 + + + +867 + + + Interest expense + + + +(45,993 +) + + +(48,085 +) + + +(51,361 +) + + Interest expense-related parties + + + +(16,457 +) + + +(17,600 +) + + +(19,367 +) + + Other non-operating income (expense) + + + +(218 +) + + +100 + + + +1,219 + + + + + + + + + + Non-operating expense, net + + + +(60,593 +) + + +(64,203 +) + + +(68,642 +) + + + + + + + + + Loss before income taxes and equity in loss from Buffington Harbor, LLC + + + +(30,022 +) + + +(19,097 +) + + +(12,017 +) + + Equity in loss from Buffington Harbor, LLC + + + +(3,134 +) + + +(2,808 +) + + +(2,448 +) + + Provision for income taxes + + + + + + + +(150 +) + + +(1,200 +) + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-4 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CAPITAL + (in thousands) + + + + +Contributed +Capital + + +Accumulated +Deficit + + + +Accumulated +Other +Comprehensive +Loss + + + +Total + + + + Balance at December 31, 1999 + + +$ +229,015 + +$ +(120,606 +) + +$ + + + +$ +108,409 + + + Capital contribution (See Note 1*) + + + +7,732 + + + + + + + + + + +7,732 + + + Net loss (See Note 1*) + + + + + + +(33,156 +) + + + + + + +(33,156 +) + + + + + + + + + + + Balance at December 31, 2000 (See Note 1*) + + + +236,747 + + +(153,762 +) + + + + + + +82,985 + + + Capital contribution (See Note 1*) + + + +450 + + + + + + + + + + +450 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss (See Note 1*) + + + + + + +(22,055 +) + + + + + + +(22,055 +) + + Adjustment for interest rate swap (See Note 1*) + + + + + + + + + + +(372 +) + + +(372 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(22,427 +) + + + + + + + + + + + Balance at December 31, 2001 (See Note 1*) + + + +237,197 + + +(175,817 +) + + +(372 +) + + +61,008 + + + Capital contribution + + + +1,076 + + + + + + + + + + +1,076 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss + + + + + + +(15,665 +) + + + + + + +(15,665 +) + + Adjustment for interest rate swap + + + + + + + + + + +(566 +) + + +(566 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(16,231 +) + + + + + + + + + + + Balance at December 31, 2002 + + +$ +238,273 + +$ +(191,482 +) + +$ +(938 +) + +$ +45,853 + + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + + See accompanying notes + + + F-5 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CASH FLOWS + (in thousands) + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + Adjustments to reconcile net loss to net cash flows provided by operating activities + + + + + + + + + + + + + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + Issuance of PIK debt in satisfaction of accrued interest + + + +15,188 + + + +17,368 + + + +17,805 + + + Amortization for City of Gary development agreement + + + +3,700 + + + +667 + + + + + + + Equity in loss from Buffington Harbor, LLC + + + +3,134 + + + +2,808 + + + +2,448 + + + Accretion of bond discount + + + +5,122 + + + +5,981 + + + +6,985 + + + Amortization of loan costs + + + +410 + + + +1,134 + + + +4,711 + + + Allocation of expenses from THCR Holdings + + + + + + + + + + + +1,076 + + + Provision of losses on receivables + + + +1,420 + + + +1,430 + + + +2,303 + + + Valuation allowance CRDA investments + + + +3,680 + + + +1,432 + + + +3,762 + + + (Increase) decrease in receivables + + + +(5,564 +) + + +(215 +) + + +1,903 + + + Decrease (increase) in inventories + + + +206 + + + +358 + + + +(144 +) + + (Increase) decrease in prepaid expenses and other current assets + + + +(28 +) + + +138 + + + +(1,605 +) + + (Increase) decrease in other assets + + + +(7,319 +) + + +(1,310 +) + + +1,646 + + + Decrease in due to affiliates + + + +(858 +) + + +(8,563 +) + + +(14,173 +) + + Increase (decrease) in current liabilities + + + +1,551 + + + +3,743 + + + +(5,011 +) + + Increase (decrease) in other long-term liabilities + + + +17 + + + +(7,164 +) + + +(4,711 +) + + + + + + + + + Net cash flows provided by operating activities + + + +12,652 + + + +19,889 + + + +28,936 + + + + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + + + + + + + Purchases of property and equipment, net + + + +(5,479 +) + + +(7,089 +) + + +(15,378 +) + + (Advances) repayment of note receivable + + + + + + + +(3,535 +) + + +3,535 + + + Investment in Buffington Harbor Riverboats, LLC + + + +(1,534 +) + + +(112 +) + + +(401 +) + + Purchases of CRDA investments + + + +(3,347 +) + + +(3,388 +) + + +(3,486 +) + + + + + + + + + Net cash flows used in investing activities + + + +(10,360 +) + + +(14,124 +) + + +(15,730 +) + + + + + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + + + + + + + Contributed capital + + + + + + + +450 + + + + + + + Repayment of other borrowings + + + +(7,675 +) + + +(29,118 +) + + +(91,323 +) + + Proceeds of other borrowings + + + +5,000 + + + +38,500 + + + +75,245 + + + Cost of issuing debt + + + +(290 +) + + +(4,168 +) + + +(2,302 +) + + + + + + + + + Net cash flows (used in) provided by financing activities + + + +(2,965 +) + + +5,664 + + + +(18,380 +) + + + + + + + + + Net (decrease) increase in cash and cash equivalents + + + +(673 +) + + +11,429 + + + +(5,174 +) + + CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR + + + +28,335 + + + +27,662 + + + +39,091 + + + + + + + + + + CASH AND CASH EQUIVALENTS AT END OF YEAR + + +$ +27,662 + + +$ +39,091 + + +$ +33,917 + + + + + + + + + + SUPPLEMENTAL INFORMATION: + + + + + + + + + + + + + + + Cash paid for interest + + +$ +38,921 + + +$ +39,043 + + +$ +41,452 + + + + + + + + + + Cash paid for income taxes + + +$ + + + +$ + + + +$ +75 + + + + + + + + + + Purchase of equipment under capitalized lease obligations + + +$ +4,156 + + +$ +7,293 + + +$ +8,342 + + + + + + + + + + Contribution of capital by and forgiveness of amount due to THCR Holdings + + +$ +7,732 + + +$ +450 + + +$ + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes + + + F-6 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS + + (1) Organization and Operations + + The accompanying combined financial statements include those of Trump Casino Holdings, a Delaware single member limited +liability company ( TCH ), and its subsidiary, Trump Casino Funding, Inc., a New Jersey corporation, ( TCF ). Its wholly-owned subsidiaries include (i) Trump Casino Funding, Inc.( Trump Casino Funding ), (ii) Trump +Marina Associates, L.P. ( Marina Associates ), (iii) Trump Marina, Inc., (iv) Trump Indiana, Inc. ( Trump Indiana ), (v) Trump Indiana Realty, L.L.C. and (vi) THCR Management Holdings, L.L.C. ( THCR Management +Holdings ). + + The sole member of Trump Casino Holdings is +THCR Holdings. THCR Holdings is owned approximately 63.4% by Trump Hotels & Casino Resorts, Inc. ( THCR ) as both a general and limited partner, and approximately 36.6% by Donald J. Trump as a limited partner. THCR is a publicly held +company whose common stock is traded on The New York Stock Exchange under the symbol DJT . + + On March 25, 2003, TCH was capitalized and simultaneously, Marina Associates, Trump Marina, Inc., Trump Indiana, Inc., Trump Indiana Realty, L.L.C., and +THCR Management Holdings became wholly owned subsidiaries of TCH pursuant to a corporate reorganization approved by THCR s Board of Directors. THCR Management Holdings has no operations and it owns 100% of THCR Management Services, LLC +( THCR Management ). THCR Management Holding s only asset, other than its investment in THCR Management, was $254,000 of cash which was advanced to THCR Management at December 31, 2002. As a result of this reorganization of entities +under common control, the accompanying combined financial statements present the combined financial statements of TCH as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002. + + The financial statements of (i) Trump Marina Associates, L.P. (formerly +Trump s Castle Associates, L.P.) as of December 31, 2001 and for each of the two years in the period then ended, (ii) Trump Indiana, Inc. as of December 31, 2001 and for each of the two years in the period then ended, and (iii) THCR Management +Services, LLC as of December 31, 2001 and for the two months then ended were audited by other auditors who have ceased operations. These entities constitute 100% of the combined assets of TCH at December 31, 2001 and combined revenues and combined +net loss of TCH for the years ended December 31, 2001 and 2000. + + Marina Associates owns and operates the Trump Marina Hotel Casino, ( Trump Marina ), a casino hotel located in the marina district of Atlantic City, New Jersey (the Marina District ). Trump Indiana owns and operates a +riverboat gaming facility operating in Buffington Harbor, on Lake Michigan, Indiana (the Trump Indiana Riverboat ). THCR Management Holdings is the sole member of THCR Management. THCR Management manages the day-to-day operations of Trump +29 Casino located in Coachella Valley, California (in the Palm Springs area) pursuant to a five year management agreement (the Management Agreement ) commencing on April 16, 2002, between THCR Management and the Twenty Nine Palms Band of +Luiseno Mission Indians, a federally recognized native American Tribe and the owner of Trump 29 Casino (the Tribe ). Trump Indiana Realty, LLC has no material assets or operations. + + TCH and TCF have no operations and their ability to service their debt is +dependent upon the successful operations of Trump Marina, Trump Indiana, and the management fees generated pursuant to the Trump 29 Management Agreement. + + + F-7 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS (Continued) + + + (2) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001229966_trump_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001229966_trump_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0630233ac37bfaaf0468552007e15b6d5062b0b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001229966_trump_legal_matters.txt @@ -0,0 +1,2556 @@ +LEGAL MATTERS + + The validity of +the Resale Notes will be passed upon for the Issuers by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. In giving their opinion, LeBoeuf, Lamb, Greene & MacRae, +L.L.P. may rely on the opinion of Graham, Curtin & Sheridan, a Professional Association, with respect to matters relating to New Jersey law. + + + 188 + +Table of Contents + + +INDEPENDENT AUDITORS + + The financial +statements of Trump s Castle Associates, L.P. and Subsidiary and Trump Indiana, Inc., as of December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, and the financial statements of Trump Management +Services, LLC as of December 31, 2001 and for the two-month period ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, independent certified public accountants, as indicated in their report, which is +included herein. Arthur Andersen, which has ceased operations, has not consented to the inclusion of their report in this prospectus, and we have dispensed with the requirement to file their consent in reliance upon Rule 437a of the Securities Act. +Under most circumstances a registrant must obtain and file the consent of its accountants contemporaneously with the filing of any registration statement that includes audited financial statements. By granting such a consent, accounting firms become +exposed to liability under Section 11(a) of the Securities Act for any untrue statements of material fact in, or omissions of material facts from, such registration statement. Investors who bring a successful claim under Section 11(a) of the +Securities Act are entitled to recessionary damages. As a result of the criminal conviction against Arthur Andersen in connection with Enron Corporation, and the volume of civil lawsuits filed against it, Arthur Andersen may not have the ability to +withstand liability for prior audits. + + Effective June 3, 2002, +THCR Holdings appointed Ernst & Young LLP as our new independent auditors. The combined financial statements of Trump Casino Holdings, LLC as of December 31, 2002 and for the year then ended appearing in this prospectus and registration +statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting +and auditing. + + + 189 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + + +Page + + Trump Casino Holdings, LLC + + + + + Annual Financial Statements + + + + + Report of Independent Auditors + + + F-2 + + Combined Balance Sheets as of December 31, 2001 and 2002 + + + F-3 + + Combined Statements of Operations for the years ended December 31, 2000, 2001 and 2002 + + + F-4 + + Combined Statements of Capital for the years ended December 31, 2000, 2001 and 2002 + + + F-5 + + Combined Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 + + + F-6 + + Notes to Combined Financial Statements + + + F-7 + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000, 2001 and 2002 + + + F-26 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required formation is included +in the consolidated financial statements or notes thereto. + + + + + Interim Financial Statements + + + + + Condensed Consolidated Balance Sheets as of December 31, 2002 and March 31, 2003 (unaudited) + + + F-27 + + Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-28 + + Condensed Consolidated Statement of Capital for the three months ended March 31, 2003 (unaudited) + + + F-29 + + Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-30 + + Notes to Condensed Consolidated Financial Statements (unaudited) + + + F-31 + + Trump s Castle Associates, L.P. (now known as Trump Marina Associates, L.P.) and Subsidiary* + + + + + Report of Independent Auditors + + + F-36 + + Consolidated Balance Sheet as of December 31, 2001 + + + F-37 + + Consolidated Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-38 + + Consolidated Statements of Partners Capital for the years ended December 31, 2000 and 2001 + + + F-39 + + Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-40 + + Notes to Consolidated Financial Statements + + + F-41 + + Financial Statement Schedule + + + + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000 and 2001 + + + F-50 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required information is +included in the consolidated financial statements or notes thereto. + + + + + Trump Indiana, Inc.* + + + + + Report of Independent Auditors + + + F-51 + + Balance Sheet as of December 31, 2001 + + + F-52 + + Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-53 + + Statements of Capital for the years ended December 31, 2000 and 2001 + + + F-54 + + Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-55 + + Notes to Financial Statements + + + F-56 + + All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included +in the consolidated financial statements or notes thereto. + + + + + THCR Management Services, LLC* + + + + + Report of Independent Auditors + + + F-64 + + Balance Sheet as of December 31, 2001 + + + F-65 + + Statement of Operations for the two months ended December 31, 2001 + + + F-66 + + Statement of Cash Flows for the two months ended December 31, 2001 + + + F-67 + + Notes to Financial Statements + + + F-68 + +All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes +thereto. + + + + + +* + +Became a wholly-owned subsidiary of Trump Casino Holdings, LLC on March 25, 2003 pursuant to a corporate reorganization. See Note 1 to Combined Financial Statements of Trump Casino +Holdings, LLC. + + + F-1 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + Board of Directors + Trump Casino Holdings, LLC + + + We have audited the accompanying combined balance sheet of +Trump Casino Holdings, LLC as of December 31, 2002 and the related combined statements of operations, capital, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial +Statements. These financial statements and schedule are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. + + We conducted our audit in accordance with auditing standards generally +accepted in the United States. 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. + + In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Trump Casino Holdings, LLC at December 31, 2002 and the combined results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a +whole, present fairly in all material respects the information set forth therein. + + We also have audited, as to combination only, the accompanying combined balance sheet of Trump Casino Holdings, LLC as of December 31, 2001, and the related combined statements of operations, capital, and cash flows +for the two years then ended. As described in Note 1, Trump Casino Holdings, LLC was capitalized on March 25, 2003 as a holding company for three entities under common control; accordingly, its financial statements are presented as though the +combination of Trump s Castle Associates, L.P. and Subsidiary, Trump Indiana, Inc., and THCR Management Services, LLC occurred at the beginning of the period presented. We did not audit the financial statements of these three entities. Their +financial statements, which are presented separately herein, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those respective financial statements in their reports dated March 13, 2002, +which also are presented separately herein. In our opinion, these combined financial statements have been properly combined on the basis described in Note 1. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 +combined financial statements of Trump Casino Holdings, LLC, other than with respect to such combination and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements of Trump Casino +Holdings, LLC taken as whole or on the separate financial statements of any of its subsidiaries. + + /s/ ERNST & YOUNG LLP + + Philadelphia, Pennsylvania + March 25, 2003 + + + F-2 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED BALANCE SHEETS + (in thousands) + + + + +December 31, +2001 + + + +December 31, +2002 + + + + + +(See Note 1*) + + + + + +ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + + Cash and cash equivalents + + +$ +34,291 + + +$ +33,917 + + + Restricted cash + + + +4,800 + + + + + + + Trade receivables, net of allowance for doubtful accounts of $2,979 and $2,607, respectively + + + +12,984 + + + +9,872 + + + Other receivables + + + +2,342 + + + +2,884 + + + Inventories + + + +3,038 + + + +3,182 + + + Prepaid expenses and other current assets + + + +2,449 + + + +3,797 + + + Due from affiliates + + + +216 + + + +378 + + + + + + + + Total current assets + + + +60,120 + + + +54,030 + + + + + + + + PROPERTY AND EQUIPMENT + + + + + + + + + + + Land and land improvements + + + +92,379 + + + +92,379 + + + Buildings and building improvements + + + +424,031 + + + +425,027 + + + Riverboat and improvements + + + +34,159 + + + +34,239 + + + Furniture, fixtures and equipment + + + +81,897 + + + +102,014 + + + Construction in progress + + + +3,779 + + + +6,639 + + + + + + + + + + +636,245 + + + +660,298 + + + Less-Accumulated depreciation and amortization + + + +115,798 + + + +142,444 + + + + + + + + + + +520,447 + + + +517,854 + + + INVESTMENT IN BUFFINGTON HARBOR RIVERBOATS, LLC + + + +33,889 + + + +31,842 + + + OTHER ASSETS + + + +35,210 + + + +24,338 + + + + + + + + Total assets + + +$ +649,666 + + +$ +628,064 + + + + + + + +LIABILITIES AND EQUITY + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + + Current maturities of long-term debt + + +$ +12,952 + + +$ +7,712 + + + Trade accounts payable + + + +11,556 + + + +8,961 + + + Due to affiliates + + + +8,184 + + + +4,381 + + + Accrued payroll and related expenses + + + +8,017 + + + +8,597 + + + Accrued interest payable + + + +4,953 + + + +3,778 + + + Self insurance reserves + + + +3,444 + + + +2,892 + + + Other + + + +16,385 + + + +20,108 + + + + + + + + Total current liabilities + + + +65,491 + + + +56,429 + + + DUE TO (FROM) AFFILIATES-THCR HOLDINGS + + + +42,553 + + + +32,566 + + + LONG-TERM DEBT, LESS CURRENT MATURITIES + + + +464,493 + + + +487,242 + + + OTHER LONG-TERM LIABILITIES + + + +16,121 + + + +5,974 + + + + + + + + Total liabilities + + + +588,658 + + + +582,211 + + + CAPITAL + + + + + + + + + + + Contributed capital + + + +237,197 + + + +238,273 + + + Accumulated other comprehensive loss + + + +(372 +) + + +(938 +) + + Accumulated deficit + + + +(175,817 +) + + +(191,482 +) + + + + + + + Total capital + + + +61,008 + + + +45,853 + + + + + + + + Total liabilities and capital + + +$ +649,666 + + +$ +628,064 + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-3 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF OPERATIONS + (in thousands) + + + + +For the Years Ended December 31, + + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + REVENUES + + + + + + + + + + + + + + + Gaming + + +$ +386,541 + + +$ +390,104 + + +$ +410,645 + + + Rooms + + + +21,827 + + + +22,470 + + + +21,835 + + + Food and beverage + + + +36,971 + + + +35,069 + + + +35,601 + + + Management fees + + + + + + + + + + + +2,710 + + + Other + + + +11,449 + + + +12,042 + + + +12,335 + + + + + + + + + + Gross revenues + + + +456,788 + + + +459,685 + + + +483,126 + + + Less-Promotional allowances + + + +88,867 + + + +85,863 + + + +86,165 + + + + + + + + + + Net revenues + + + +367,921 + + + +373,822 + + + +396,961 + + + + + + + + + + COSTS AND EXPENSES + + + + + + + + + + + + + + + Gaming + + + +190,377 + + + +189,712 + + + +190,455 + + + Rooms + + + +6,311 + + + +5,745 + + + +6,246 + + + Food and beverage + + + +15,248 + + + +14,571 + + + +14,856 + + + General and administrative + + + +88,220 + + + +84,138 + + + +86,367 + + + General and administrative-related parties + + + +12,045 + + + +10,413 + + + +13,177 + + + Debt renegotiation costs + + + + + + + + + + + +1,629 + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + + + + + + + + + + +337,350 + + + +328,716 + + + +340,336 + + + + + + + + + + Income from operations + + + +30,571 + + + +45,106 + + + +56,625 + + + + + + + + + + NON-OPERATING INCOME (EXPENSE) + + + + + + + + + + + + + + + Interest income + + + +2,075 + + + +1,382 + + + +867 + + + Interest expense + + + +(45,993 +) + + +(48,085 +) + + +(51,361 +) + + Interest expense-related parties + + + +(16,457 +) + + +(17,600 +) + + +(19,367 +) + + Other non-operating income (expense) + + + +(218 +) + + +100 + + + +1,219 + + + + + + + + + + Non-operating expense, net + + + +(60,593 +) + + +(64,203 +) + + +(68,642 +) + + + + + + + + + Loss before income taxes and equity in loss from Buffington Harbor, LLC + + + +(30,022 +) + + +(19,097 +) + + +(12,017 +) + + Equity in loss from Buffington Harbor, LLC + + + +(3,134 +) + + +(2,808 +) + + +(2,448 +) + + Provision for income taxes + + + + + + + +(150 +) + + +(1,200 +) + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-4 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CAPITAL + (in thousands) + + + + +Contributed +Capital + + +Accumulated +Deficit + + + +Accumulated +Other +Comprehensive +Loss + + + +Total + + + + Balance at December 31, 1999 + + +$ +229,015 + +$ +(120,606 +) + +$ + + + +$ +108,409 + + + Capital contribution (See Note 1*) + + + +7,732 + + + + + + + + + + +7,732 + + + Net loss (See Note 1*) + + + + + + +(33,156 +) + + + + + + +(33,156 +) + + + + + + + + + + + Balance at December 31, 2000 (See Note 1*) + + + +236,747 + + +(153,762 +) + + + + + + +82,985 + + + Capital contribution (See Note 1*) + + + +450 + + + + + + + + + + +450 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss (See Note 1*) + + + + + + +(22,055 +) + + + + + + +(22,055 +) + + Adjustment for interest rate swap (See Note 1*) + + + + + + + + + + +(372 +) + + +(372 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(22,427 +) + + + + + + + + + + + Balance at December 31, 2001 (See Note 1*) + + + +237,197 + + +(175,817 +) + + +(372 +) + + +61,008 + + + Capital contribution + + + +1,076 + + + + + + + + + + +1,076 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss + + + + + + +(15,665 +) + + + + + + +(15,665 +) + + Adjustment for interest rate swap + + + + + + + + + + +(566 +) + + +(566 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(16,231 +) + + + + + + + + + + + Balance at December 31, 2002 + + +$ +238,273 + +$ +(191,482 +) + +$ +(938 +) + +$ +45,853 + + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + + See accompanying notes + + + F-5 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CASH FLOWS + (in thousands) + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + Adjustments to reconcile net loss to net cash flows provided by operating activities + + + + + + + + + + + + + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + Issuance of PIK debt in satisfaction of accrued interest + + + +15,188 + + + +17,368 + + + +17,805 + + + Amortization for City of Gary development agreement + + + +3,700 + + + +667 + + + + + + + Equity in loss from Buffington Harbor, LLC + + + +3,134 + + + +2,808 + + + +2,448 + + + Accretion of bond discount + + + +5,122 + + + +5,981 + + + +6,985 + + + Amortization of loan costs + + + +410 + + + +1,134 + + + +4,711 + + + Allocation of expenses from THCR Holdings + + + + + + + + + + + +1,076 + + + Provision of losses on receivables + + + +1,420 + + + +1,430 + + + +2,303 + + + Valuation allowance CRDA investments + + + +3,680 + + + +1,432 + + + +3,762 + + + (Increase) decrease in receivables + + + +(5,564 +) + + +(215 +) + + +1,903 + + + Decrease (increase) in inventories + + + +206 + + + +358 + + + +(144 +) + + (Increase) decrease in prepaid expenses and other current assets + + + +(28 +) + + +138 + + + +(1,605 +) + + (Increase) decrease in other assets + + + +(7,319 +) + + +(1,310 +) + + +1,646 + + + Decrease in due to affiliates + + + +(858 +) + + +(8,563 +) + + +(14,173 +) + + Increase (decrease) in current liabilities + + + +1,551 + + + +3,743 + + + +(5,011 +) + + Increase (decrease) in other long-term liabilities + + + +17 + + + +(7,164 +) + + +(4,711 +) + + + + + + + + + Net cash flows provided by operating activities + + + +12,652 + + + +19,889 + + + +28,936 + + + + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + + + + + + + Purchases of property and equipment, net + + + +(5,479 +) + + +(7,089 +) + + +(15,378 +) + + (Advances) repayment of note receivable + + + + + + + +(3,535 +) + + +3,535 + + + Investment in Buffington Harbor Riverboats, LLC + + + +(1,534 +) + + +(112 +) + + +(401 +) + + Purchases of CRDA investments + + + +(3,347 +) + + +(3,388 +) + + +(3,486 +) + + + + + + + + + Net cash flows used in investing activities + + + +(10,360 +) + + +(14,124 +) + + +(15,730 +) + + + + + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + + + + + + + Contributed capital + + + + + + + +450 + + + + + + + Repayment of other borrowings + + + +(7,675 +) + + +(29,118 +) + + +(91,323 +) + + Proceeds of other borrowings + + + +5,000 + + + +38,500 + + + +75,245 + + + Cost of issuing debt + + + +(290 +) + + +(4,168 +) + + +(2,302 +) + + + + + + + + + Net cash flows (used in) provided by financing activities + + + +(2,965 +) + + +5,664 + + + +(18,380 +) + + + + + + + + + Net (decrease) increase in cash and cash equivalents + + + +(673 +) + + +11,429 + + + +(5,174 +) + + CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR + + + +28,335 + + + +27,662 + + + +39,091 + + + + + + + + + + CASH AND CASH EQUIVALENTS AT END OF YEAR + + +$ +27,662 + + +$ +39,091 + + +$ +33,917 + + + + + + + + + + SUPPLEMENTAL INFORMATION: + + + + + + + + + + + + + + + Cash paid for interest + + +$ +38,921 + + +$ +39,043 + + +$ +41,452 + + + + + + + + + + Cash paid for income taxes + + +$ + + + +$ + + + +$ +75 + + + + + + + + + + Purchase of equipment under capitalized lease obligations + + +$ +4,156 + + +$ +7,293 + + +$ +8,342 + + + + + + + + + + Contribution of capital by and forgiveness of amount due to THCR Holdings + + +$ +7,732 + + +$ +450 + + +$ + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes + + + F-6 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS + + (1) Organization and Operations + + The accompanying combined financial statements include those of Trump Casino Holdings, a Delaware single member limited +liability company ( TCH ), and its subsidiary, Trump Casino Funding, Inc., a New Jersey corporation, ( TCF ). Its wholly-owned subsidiaries include (i) Trump Casino Funding, Inc.( Trump Casino Funding ), (ii) Trump +Marina Associates, L.P. ( Marina Associates ), (iii) Trump Marina, Inc., (iv) Trump Indiana, Inc. ( Trump Indiana ), (v) Trump Indiana Realty, L.L.C. and (vi) THCR Management Holdings, L.L.C. ( THCR Management +Holdings ). + + The sole member of Trump Casino Holdings is +THCR Holdings. THCR Holdings is owned approximately 63.4% by Trump Hotels & Casino Resorts, Inc. ( THCR ) as both a general and limited partner, and approximately 36.6% by Donald J. Trump as a limited partner. THCR is a publicly held +company whose common stock is traded on The New York Stock Exchange under the symbol DJT . + + On March 25, 2003, TCH was capitalized and simultaneously, Marina Associates, Trump Marina, Inc., Trump Indiana, Inc., Trump Indiana Realty, L.L.C., and +THCR Management Holdings became wholly owned subsidiaries of TCH pursuant to a corporate reorganization approved by THCR s Board of Directors. THCR Management Holdings has no operations and it owns 100% of THCR Management Services, LLC +( THCR Management ). THCR Management Holding s only asset, other than its investment in THCR Management, was $254,000 of cash which was advanced to THCR Management at December 31, 2002. As a result of this reorganization of entities +under common control, the accompanying combined financial statements present the combined financial statements of TCH as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002. + + The financial statements of (i) Trump Marina Associates, L.P. (formerly +Trump s Castle Associates, L.P.) as of December 31, 2001 and for each of the two years in the period then ended, (ii) Trump Indiana, Inc. as of December 31, 2001 and for each of the two years in the period then ended, and (iii) THCR Management +Services, LLC as of December 31, 2001 and for the two months then ended were audited by other auditors who have ceased operations. These entities constitute 100% of the combined assets of TCH at December 31, 2001 and combined revenues and combined +net loss of TCH for the years ended December 31, 2001 and 2000. + + Marina Associates owns and operates the Trump Marina Hotel Casino, ( Trump Marina ), a casino hotel located in the marina district of Atlantic City, New Jersey (the Marina District ). Trump Indiana owns and operates a +riverboat gaming facility operating in Buffington Harbor, on Lake Michigan, Indiana (the Trump Indiana Riverboat ). THCR Management Holdings is the sole member of THCR Management. THCR Management manages the day-to-day operations of Trump +29 Casino located in Coachella Valley, California (in the Palm Springs area) pursuant to a five year management agreement (the Management Agreement ) commencing on April 16, 2002, between THCR Management and the Twenty Nine Palms Band of +Luiseno Mission Indians, a federally recognized native American Tribe and the owner of Trump 29 Casino (the Tribe ). Trump Indiana Realty, LLC has no material assets or operations. + + TCH and TCF have no operations and their ability to service their debt is +dependent upon the successful operations of Trump Marina, Trump Indiana, and the management fees generated pursuant to the Trump 29 Management Agreement. + + + F-7 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS (Continued) + + + (2) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001229970_trump_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001229970_trump_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0630233ac37bfaaf0468552007e15b6d5062b0b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001229970_trump_legal_matters.txt @@ -0,0 +1,2556 @@ +LEGAL MATTERS + + The validity of +the Resale Notes will be passed upon for the Issuers by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. In giving their opinion, LeBoeuf, Lamb, Greene & MacRae, +L.L.P. may rely on the opinion of Graham, Curtin & Sheridan, a Professional Association, with respect to matters relating to New Jersey law. + + + 188 + +Table of Contents + + +INDEPENDENT AUDITORS + + The financial +statements of Trump s Castle Associates, L.P. and Subsidiary and Trump Indiana, Inc., as of December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, and the financial statements of Trump Management +Services, LLC as of December 31, 2001 and for the two-month period ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, independent certified public accountants, as indicated in their report, which is +included herein. Arthur Andersen, which has ceased operations, has not consented to the inclusion of their report in this prospectus, and we have dispensed with the requirement to file their consent in reliance upon Rule 437a of the Securities Act. +Under most circumstances a registrant must obtain and file the consent of its accountants contemporaneously with the filing of any registration statement that includes audited financial statements. By granting such a consent, accounting firms become +exposed to liability under Section 11(a) of the Securities Act for any untrue statements of material fact in, or omissions of material facts from, such registration statement. Investors who bring a successful claim under Section 11(a) of the +Securities Act are entitled to recessionary damages. As a result of the criminal conviction against Arthur Andersen in connection with Enron Corporation, and the volume of civil lawsuits filed against it, Arthur Andersen may not have the ability to +withstand liability for prior audits. + + Effective June 3, 2002, +THCR Holdings appointed Ernst & Young LLP as our new independent auditors. The combined financial statements of Trump Casino Holdings, LLC as of December 31, 2002 and for the year then ended appearing in this prospectus and registration +statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting +and auditing. + + + 189 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + + +Page + + Trump Casino Holdings, LLC + + + + + Annual Financial Statements + + + + + Report of Independent Auditors + + + F-2 + + Combined Balance Sheets as of December 31, 2001 and 2002 + + + F-3 + + Combined Statements of Operations for the years ended December 31, 2000, 2001 and 2002 + + + F-4 + + Combined Statements of Capital for the years ended December 31, 2000, 2001 and 2002 + + + F-5 + + Combined Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 + + + F-6 + + Notes to Combined Financial Statements + + + F-7 + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000, 2001 and 2002 + + + F-26 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required formation is included +in the consolidated financial statements or notes thereto. + + + + + Interim Financial Statements + + + + + Condensed Consolidated Balance Sheets as of December 31, 2002 and March 31, 2003 (unaudited) + + + F-27 + + Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-28 + + Condensed Consolidated Statement of Capital for the three months ended March 31, 2003 (unaudited) + + + F-29 + + Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-30 + + Notes to Condensed Consolidated Financial Statements (unaudited) + + + F-31 + + Trump s Castle Associates, L.P. (now known as Trump Marina Associates, L.P.) and Subsidiary* + + + + + Report of Independent Auditors + + + F-36 + + Consolidated Balance Sheet as of December 31, 2001 + + + F-37 + + Consolidated Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-38 + + Consolidated Statements of Partners Capital for the years ended December 31, 2000 and 2001 + + + F-39 + + Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-40 + + Notes to Consolidated Financial Statements + + + F-41 + + Financial Statement Schedule + + + + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000 and 2001 + + + F-50 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required information is +included in the consolidated financial statements or notes thereto. + + + + + Trump Indiana, Inc.* + + + + + Report of Independent Auditors + + + F-51 + + Balance Sheet as of December 31, 2001 + + + F-52 + + Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-53 + + Statements of Capital for the years ended December 31, 2000 and 2001 + + + F-54 + + Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-55 + + Notes to Financial Statements + + + F-56 + + All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included +in the consolidated financial statements or notes thereto. + + + + + THCR Management Services, LLC* + + + + + Report of Independent Auditors + + + F-64 + + Balance Sheet as of December 31, 2001 + + + F-65 + + Statement of Operations for the two months ended December 31, 2001 + + + F-66 + + Statement of Cash Flows for the two months ended December 31, 2001 + + + F-67 + + Notes to Financial Statements + + + F-68 + +All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes +thereto. + + + + + +* + +Became a wholly-owned subsidiary of Trump Casino Holdings, LLC on March 25, 2003 pursuant to a corporate reorganization. See Note 1 to Combined Financial Statements of Trump Casino +Holdings, LLC. + + + F-1 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + Board of Directors + Trump Casino Holdings, LLC + + + We have audited the accompanying combined balance sheet of +Trump Casino Holdings, LLC as of December 31, 2002 and the related combined statements of operations, capital, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial +Statements. These financial statements and schedule are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. + + We conducted our audit in accordance with auditing standards generally +accepted in the United States. 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. + + In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Trump Casino Holdings, LLC at December 31, 2002 and the combined results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a +whole, present fairly in all material respects the information set forth therein. + + We also have audited, as to combination only, the accompanying combined balance sheet of Trump Casino Holdings, LLC as of December 31, 2001, and the related combined statements of operations, capital, and cash flows +for the two years then ended. As described in Note 1, Trump Casino Holdings, LLC was capitalized on March 25, 2003 as a holding company for three entities under common control; accordingly, its financial statements are presented as though the +combination of Trump s Castle Associates, L.P. and Subsidiary, Trump Indiana, Inc., and THCR Management Services, LLC occurred at the beginning of the period presented. We did not audit the financial statements of these three entities. Their +financial statements, which are presented separately herein, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those respective financial statements in their reports dated March 13, 2002, +which also are presented separately herein. In our opinion, these combined financial statements have been properly combined on the basis described in Note 1. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 +combined financial statements of Trump Casino Holdings, LLC, other than with respect to such combination and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements of Trump Casino +Holdings, LLC taken as whole or on the separate financial statements of any of its subsidiaries. + + /s/ ERNST & YOUNG LLP + + Philadelphia, Pennsylvania + March 25, 2003 + + + F-2 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED BALANCE SHEETS + (in thousands) + + + + +December 31, +2001 + + + +December 31, +2002 + + + + + +(See Note 1*) + + + + + +ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + + Cash and cash equivalents + + +$ +34,291 + + +$ +33,917 + + + Restricted cash + + + +4,800 + + + + + + + Trade receivables, net of allowance for doubtful accounts of $2,979 and $2,607, respectively + + + +12,984 + + + +9,872 + + + Other receivables + + + +2,342 + + + +2,884 + + + Inventories + + + +3,038 + + + +3,182 + + + Prepaid expenses and other current assets + + + +2,449 + + + +3,797 + + + Due from affiliates + + + +216 + + + +378 + + + + + + + + Total current assets + + + +60,120 + + + +54,030 + + + + + + + + PROPERTY AND EQUIPMENT + + + + + + + + + + + Land and land improvements + + + +92,379 + + + +92,379 + + + Buildings and building improvements + + + +424,031 + + + +425,027 + + + Riverboat and improvements + + + +34,159 + + + +34,239 + + + Furniture, fixtures and equipment + + + +81,897 + + + +102,014 + + + Construction in progress + + + +3,779 + + + +6,639 + + + + + + + + + + +636,245 + + + +660,298 + + + Less-Accumulated depreciation and amortization + + + +115,798 + + + +142,444 + + + + + + + + + + +520,447 + + + +517,854 + + + INVESTMENT IN BUFFINGTON HARBOR RIVERBOATS, LLC + + + +33,889 + + + +31,842 + + + OTHER ASSETS + + + +35,210 + + + +24,338 + + + + + + + + Total assets + + +$ +649,666 + + +$ +628,064 + + + + + + + +LIABILITIES AND EQUITY + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + + Current maturities of long-term debt + + +$ +12,952 + + +$ +7,712 + + + Trade accounts payable + + + +11,556 + + + +8,961 + + + Due to affiliates + + + +8,184 + + + +4,381 + + + Accrued payroll and related expenses + + + +8,017 + + + +8,597 + + + Accrued interest payable + + + +4,953 + + + +3,778 + + + Self insurance reserves + + + +3,444 + + + +2,892 + + + Other + + + +16,385 + + + +20,108 + + + + + + + + Total current liabilities + + + +65,491 + + + +56,429 + + + DUE TO (FROM) AFFILIATES-THCR HOLDINGS + + + +42,553 + + + +32,566 + + + LONG-TERM DEBT, LESS CURRENT MATURITIES + + + +464,493 + + + +487,242 + + + OTHER LONG-TERM LIABILITIES + + + +16,121 + + + +5,974 + + + + + + + + Total liabilities + + + +588,658 + + + +582,211 + + + CAPITAL + + + + + + + + + + + Contributed capital + + + +237,197 + + + +238,273 + + + Accumulated other comprehensive loss + + + +(372 +) + + +(938 +) + + Accumulated deficit + + + +(175,817 +) + + +(191,482 +) + + + + + + + Total capital + + + +61,008 + + + +45,853 + + + + + + + + Total liabilities and capital + + +$ +649,666 + + +$ +628,064 + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-3 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF OPERATIONS + (in thousands) + + + + +For the Years Ended December 31, + + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + REVENUES + + + + + + + + + + + + + + + Gaming + + +$ +386,541 + + +$ +390,104 + + +$ +410,645 + + + Rooms + + + +21,827 + + + +22,470 + + + +21,835 + + + Food and beverage + + + +36,971 + + + +35,069 + + + +35,601 + + + Management fees + + + + + + + + + + + +2,710 + + + Other + + + +11,449 + + + +12,042 + + + +12,335 + + + + + + + + + + Gross revenues + + + +456,788 + + + +459,685 + + + +483,126 + + + Less-Promotional allowances + + + +88,867 + + + +85,863 + + + +86,165 + + + + + + + + + + Net revenues + + + +367,921 + + + +373,822 + + + +396,961 + + + + + + + + + + COSTS AND EXPENSES + + + + + + + + + + + + + + + Gaming + + + +190,377 + + + +189,712 + + + +190,455 + + + Rooms + + + +6,311 + + + +5,745 + + + +6,246 + + + Food and beverage + + + +15,248 + + + +14,571 + + + +14,856 + + + General and administrative + + + +88,220 + + + +84,138 + + + +86,367 + + + General and administrative-related parties + + + +12,045 + + + +10,413 + + + +13,177 + + + Debt renegotiation costs + + + + + + + + + + + +1,629 + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + + + + + + + + + + +337,350 + + + +328,716 + + + +340,336 + + + + + + + + + + Income from operations + + + +30,571 + + + +45,106 + + + +56,625 + + + + + + + + + + NON-OPERATING INCOME (EXPENSE) + + + + + + + + + + + + + + + Interest income + + + +2,075 + + + +1,382 + + + +867 + + + Interest expense + + + +(45,993 +) + + +(48,085 +) + + +(51,361 +) + + Interest expense-related parties + + + +(16,457 +) + + +(17,600 +) + + +(19,367 +) + + Other non-operating income (expense) + + + +(218 +) + + +100 + + + +1,219 + + + + + + + + + + Non-operating expense, net + + + +(60,593 +) + + +(64,203 +) + + +(68,642 +) + + + + + + + + + Loss before income taxes and equity in loss from Buffington Harbor, LLC + + + +(30,022 +) + + +(19,097 +) + + +(12,017 +) + + Equity in loss from Buffington Harbor, LLC + + + +(3,134 +) + + +(2,808 +) + + +(2,448 +) + + Provision for income taxes + + + + + + + +(150 +) + + +(1,200 +) + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-4 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CAPITAL + (in thousands) + + + + +Contributed +Capital + + +Accumulated +Deficit + + + +Accumulated +Other +Comprehensive +Loss + + + +Total + + + + Balance at December 31, 1999 + + +$ +229,015 + +$ +(120,606 +) + +$ + + + +$ +108,409 + + + Capital contribution (See Note 1*) + + + +7,732 + + + + + + + + + + +7,732 + + + Net loss (See Note 1*) + + + + + + +(33,156 +) + + + + + + +(33,156 +) + + + + + + + + + + + Balance at December 31, 2000 (See Note 1*) + + + +236,747 + + +(153,762 +) + + + + + + +82,985 + + + Capital contribution (See Note 1*) + + + +450 + + + + + + + + + + +450 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss (See Note 1*) + + + + + + +(22,055 +) + + + + + + +(22,055 +) + + Adjustment for interest rate swap (See Note 1*) + + + + + + + + + + +(372 +) + + +(372 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(22,427 +) + + + + + + + + + + + Balance at December 31, 2001 (See Note 1*) + + + +237,197 + + +(175,817 +) + + +(372 +) + + +61,008 + + + Capital contribution + + + +1,076 + + + + + + + + + + +1,076 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss + + + + + + +(15,665 +) + + + + + + +(15,665 +) + + Adjustment for interest rate swap + + + + + + + + + + +(566 +) + + +(566 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(16,231 +) + + + + + + + + + + + Balance at December 31, 2002 + + +$ +238,273 + +$ +(191,482 +) + +$ +(938 +) + +$ +45,853 + + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + + See accompanying notes + + + F-5 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CASH FLOWS + (in thousands) + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + Adjustments to reconcile net loss to net cash flows provided by operating activities + + + + + + + + + + + + + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + Issuance of PIK debt in satisfaction of accrued interest + + + +15,188 + + + +17,368 + + + +17,805 + + + Amortization for City of Gary development agreement + + + +3,700 + + + +667 + + + + + + + Equity in loss from Buffington Harbor, LLC + + + +3,134 + + + +2,808 + + + +2,448 + + + Accretion of bond discount + + + +5,122 + + + +5,981 + + + +6,985 + + + Amortization of loan costs + + + +410 + + + +1,134 + + + +4,711 + + + Allocation of expenses from THCR Holdings + + + + + + + + + + + +1,076 + + + Provision of losses on receivables + + + +1,420 + + + +1,430 + + + +2,303 + + + Valuation allowance CRDA investments + + + +3,680 + + + +1,432 + + + +3,762 + + + (Increase) decrease in receivables + + + +(5,564 +) + + +(215 +) + + +1,903 + + + Decrease (increase) in inventories + + + +206 + + + +358 + + + +(144 +) + + (Increase) decrease in prepaid expenses and other current assets + + + +(28 +) + + +138 + + + +(1,605 +) + + (Increase) decrease in other assets + + + +(7,319 +) + + +(1,310 +) + + +1,646 + + + Decrease in due to affiliates + + + +(858 +) + + +(8,563 +) + + +(14,173 +) + + Increase (decrease) in current liabilities + + + +1,551 + + + +3,743 + + + +(5,011 +) + + Increase (decrease) in other long-term liabilities + + + +17 + + + +(7,164 +) + + +(4,711 +) + + + + + + + + + Net cash flows provided by operating activities + + + +12,652 + + + +19,889 + + + +28,936 + + + + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + + + + + + + Purchases of property and equipment, net + + + +(5,479 +) + + +(7,089 +) + + +(15,378 +) + + (Advances) repayment of note receivable + + + + + + + +(3,535 +) + + +3,535 + + + Investment in Buffington Harbor Riverboats, LLC + + + +(1,534 +) + + +(112 +) + + +(401 +) + + Purchases of CRDA investments + + + +(3,347 +) + + +(3,388 +) + + +(3,486 +) + + + + + + + + + Net cash flows used in investing activities + + + +(10,360 +) + + +(14,124 +) + + +(15,730 +) + + + + + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + + + + + + + Contributed capital + + + + + + + +450 + + + + + + + Repayment of other borrowings + + + +(7,675 +) + + +(29,118 +) + + +(91,323 +) + + Proceeds of other borrowings + + + +5,000 + + + +38,500 + + + +75,245 + + + Cost of issuing debt + + + +(290 +) + + +(4,168 +) + + +(2,302 +) + + + + + + + + + Net cash flows (used in) provided by financing activities + + + +(2,965 +) + + +5,664 + + + +(18,380 +) + + + + + + + + + Net (decrease) increase in cash and cash equivalents + + + +(673 +) + + +11,429 + + + +(5,174 +) + + CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR + + + +28,335 + + + +27,662 + + + +39,091 + + + + + + + + + + CASH AND CASH EQUIVALENTS AT END OF YEAR + + +$ +27,662 + + +$ +39,091 + + +$ +33,917 + + + + + + + + + + SUPPLEMENTAL INFORMATION: + + + + + + + + + + + + + + + Cash paid for interest + + +$ +38,921 + + +$ +39,043 + + +$ +41,452 + + + + + + + + + + Cash paid for income taxes + + +$ + + + +$ + + + +$ +75 + + + + + + + + + + Purchase of equipment under capitalized lease obligations + + +$ +4,156 + + +$ +7,293 + + +$ +8,342 + + + + + + + + + + Contribution of capital by and forgiveness of amount due to THCR Holdings + + +$ +7,732 + + +$ +450 + + +$ + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes + + + F-6 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS + + (1) Organization and Operations + + The accompanying combined financial statements include those of Trump Casino Holdings, a Delaware single member limited +liability company ( TCH ), and its subsidiary, Trump Casino Funding, Inc., a New Jersey corporation, ( TCF ). Its wholly-owned subsidiaries include (i) Trump Casino Funding, Inc.( Trump Casino Funding ), (ii) Trump +Marina Associates, L.P. ( Marina Associates ), (iii) Trump Marina, Inc., (iv) Trump Indiana, Inc. ( Trump Indiana ), (v) Trump Indiana Realty, L.L.C. and (vi) THCR Management Holdings, L.L.C. ( THCR Management +Holdings ). + + The sole member of Trump Casino Holdings is +THCR Holdings. THCR Holdings is owned approximately 63.4% by Trump Hotels & Casino Resorts, Inc. ( THCR ) as both a general and limited partner, and approximately 36.6% by Donald J. Trump as a limited partner. THCR is a publicly held +company whose common stock is traded on The New York Stock Exchange under the symbol DJT . + + On March 25, 2003, TCH was capitalized and simultaneously, Marina Associates, Trump Marina, Inc., Trump Indiana, Inc., Trump Indiana Realty, L.L.C., and +THCR Management Holdings became wholly owned subsidiaries of TCH pursuant to a corporate reorganization approved by THCR s Board of Directors. THCR Management Holdings has no operations and it owns 100% of THCR Management Services, LLC +( THCR Management ). THCR Management Holding s only asset, other than its investment in THCR Management, was $254,000 of cash which was advanced to THCR Management at December 31, 2002. As a result of this reorganization of entities +under common control, the accompanying combined financial statements present the combined financial statements of TCH as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002. + + The financial statements of (i) Trump Marina Associates, L.P. (formerly +Trump s Castle Associates, L.P.) as of December 31, 2001 and for each of the two years in the period then ended, (ii) Trump Indiana, Inc. as of December 31, 2001 and for each of the two years in the period then ended, and (iii) THCR Management +Services, LLC as of December 31, 2001 and for the two months then ended were audited by other auditors who have ceased operations. These entities constitute 100% of the combined assets of TCH at December 31, 2001 and combined revenues and combined +net loss of TCH for the years ended December 31, 2001 and 2000. + + Marina Associates owns and operates the Trump Marina Hotel Casino, ( Trump Marina ), a casino hotel located in the marina district of Atlantic City, New Jersey (the Marina District ). Trump Indiana owns and operates a +riverboat gaming facility operating in Buffington Harbor, on Lake Michigan, Indiana (the Trump Indiana Riverboat ). THCR Management Holdings is the sole member of THCR Management. THCR Management manages the day-to-day operations of Trump +29 Casino located in Coachella Valley, California (in the Palm Springs area) pursuant to a five year management agreement (the Management Agreement ) commencing on April 16, 2002, between THCR Management and the Twenty Nine Palms Band of +Luiseno Mission Indians, a federally recognized native American Tribe and the owner of Trump 29 Casino (the Tribe ). Trump Indiana Realty, LLC has no material assets or operations. + + TCH and TCF have no operations and their ability to service their debt is +dependent upon the successful operations of Trump Marina, Trump Indiana, and the management fees generated pursuant to the Trump 29 Management Agreement. + + + F-7 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS (Continued) + + + (2) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001229973_thcr_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001229973_thcr_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0630233ac37bfaaf0468552007e15b6d5062b0b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001229973_thcr_legal_matters.txt @@ -0,0 +1,2556 @@ +LEGAL MATTERS + + The validity of +the Resale Notes will be passed upon for the Issuers by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. In giving their opinion, LeBoeuf, Lamb, Greene & MacRae, +L.L.P. may rely on the opinion of Graham, Curtin & Sheridan, a Professional Association, with respect to matters relating to New Jersey law. + + + 188 + +Table of Contents + + +INDEPENDENT AUDITORS + + The financial +statements of Trump s Castle Associates, L.P. and Subsidiary and Trump Indiana, Inc., as of December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, and the financial statements of Trump Management +Services, LLC as of December 31, 2001 and for the two-month period ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, independent certified public accountants, as indicated in their report, which is +included herein. Arthur Andersen, which has ceased operations, has not consented to the inclusion of their report in this prospectus, and we have dispensed with the requirement to file their consent in reliance upon Rule 437a of the Securities Act. +Under most circumstances a registrant must obtain and file the consent of its accountants contemporaneously with the filing of any registration statement that includes audited financial statements. By granting such a consent, accounting firms become +exposed to liability under Section 11(a) of the Securities Act for any untrue statements of material fact in, or omissions of material facts from, such registration statement. Investors who bring a successful claim under Section 11(a) of the +Securities Act are entitled to recessionary damages. As a result of the criminal conviction against Arthur Andersen in connection with Enron Corporation, and the volume of civil lawsuits filed against it, Arthur Andersen may not have the ability to +withstand liability for prior audits. + + Effective June 3, 2002, +THCR Holdings appointed Ernst & Young LLP as our new independent auditors. The combined financial statements of Trump Casino Holdings, LLC as of December 31, 2002 and for the year then ended appearing in this prospectus and registration +statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting +and auditing. + + + 189 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + + +Page + + Trump Casino Holdings, LLC + + + + + Annual Financial Statements + + + + + Report of Independent Auditors + + + F-2 + + Combined Balance Sheets as of December 31, 2001 and 2002 + + + F-3 + + Combined Statements of Operations for the years ended December 31, 2000, 2001 and 2002 + + + F-4 + + Combined Statements of Capital for the years ended December 31, 2000, 2001 and 2002 + + + F-5 + + Combined Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 + + + F-6 + + Notes to Combined Financial Statements + + + F-7 + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000, 2001 and 2002 + + + F-26 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required formation is included +in the consolidated financial statements or notes thereto. + + + + + Interim Financial Statements + + + + + Condensed Consolidated Balance Sheets as of December 31, 2002 and March 31, 2003 (unaudited) + + + F-27 + + Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-28 + + Condensed Consolidated Statement of Capital for the three months ended March 31, 2003 (unaudited) + + + F-29 + + Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-30 + + Notes to Condensed Consolidated Financial Statements (unaudited) + + + F-31 + + Trump s Castle Associates, L.P. (now known as Trump Marina Associates, L.P.) and Subsidiary* + + + + + Report of Independent Auditors + + + F-36 + + Consolidated Balance Sheet as of December 31, 2001 + + + F-37 + + Consolidated Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-38 + + Consolidated Statements of Partners Capital for the years ended December 31, 2000 and 2001 + + + F-39 + + Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-40 + + Notes to Consolidated Financial Statements + + + F-41 + + Financial Statement Schedule + + + + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000 and 2001 + + + F-50 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required information is +included in the consolidated financial statements or notes thereto. + + + + + Trump Indiana, Inc.* + + + + + Report of Independent Auditors + + + F-51 + + Balance Sheet as of December 31, 2001 + + + F-52 + + Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-53 + + Statements of Capital for the years ended December 31, 2000 and 2001 + + + F-54 + + Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-55 + + Notes to Financial Statements + + + F-56 + + All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included +in the consolidated financial statements or notes thereto. + + + + + THCR Management Services, LLC* + + + + + Report of Independent Auditors + + + F-64 + + Balance Sheet as of December 31, 2001 + + + F-65 + + Statement of Operations for the two months ended December 31, 2001 + + + F-66 + + Statement of Cash Flows for the two months ended December 31, 2001 + + + F-67 + + Notes to Financial Statements + + + F-68 + +All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes +thereto. + + + + + +* + +Became a wholly-owned subsidiary of Trump Casino Holdings, LLC on March 25, 2003 pursuant to a corporate reorganization. See Note 1 to Combined Financial Statements of Trump Casino +Holdings, LLC. + + + F-1 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + Board of Directors + Trump Casino Holdings, LLC + + + We have audited the accompanying combined balance sheet of +Trump Casino Holdings, LLC as of December 31, 2002 and the related combined statements of operations, capital, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial +Statements. These financial statements and schedule are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. + + We conducted our audit in accordance with auditing standards generally +accepted in the United States. 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. + + In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Trump Casino Holdings, LLC at December 31, 2002 and the combined results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a +whole, present fairly in all material respects the information set forth therein. + + We also have audited, as to combination only, the accompanying combined balance sheet of Trump Casino Holdings, LLC as of December 31, 2001, and the related combined statements of operations, capital, and cash flows +for the two years then ended. As described in Note 1, Trump Casino Holdings, LLC was capitalized on March 25, 2003 as a holding company for three entities under common control; accordingly, its financial statements are presented as though the +combination of Trump s Castle Associates, L.P. and Subsidiary, Trump Indiana, Inc., and THCR Management Services, LLC occurred at the beginning of the period presented. We did not audit the financial statements of these three entities. Their +financial statements, which are presented separately herein, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those respective financial statements in their reports dated March 13, 2002, +which also are presented separately herein. In our opinion, these combined financial statements have been properly combined on the basis described in Note 1. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 +combined financial statements of Trump Casino Holdings, LLC, other than with respect to such combination and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements of Trump Casino +Holdings, LLC taken as whole or on the separate financial statements of any of its subsidiaries. + + /s/ ERNST & YOUNG LLP + + Philadelphia, Pennsylvania + March 25, 2003 + + + F-2 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED BALANCE SHEETS + (in thousands) + + + + +December 31, +2001 + + + +December 31, +2002 + + + + + +(See Note 1*) + + + + + +ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + + Cash and cash equivalents + + +$ +34,291 + + +$ +33,917 + + + Restricted cash + + + +4,800 + + + + + + + Trade receivables, net of allowance for doubtful accounts of $2,979 and $2,607, respectively + + + +12,984 + + + +9,872 + + + Other receivables + + + +2,342 + + + +2,884 + + + Inventories + + + +3,038 + + + +3,182 + + + Prepaid expenses and other current assets + + + +2,449 + + + +3,797 + + + Due from affiliates + + + +216 + + + +378 + + + + + + + + Total current assets + + + +60,120 + + + +54,030 + + + + + + + + PROPERTY AND EQUIPMENT + + + + + + + + + + + Land and land improvements + + + +92,379 + + + +92,379 + + + Buildings and building improvements + + + +424,031 + + + +425,027 + + + Riverboat and improvements + + + +34,159 + + + +34,239 + + + Furniture, fixtures and equipment + + + +81,897 + + + +102,014 + + + Construction in progress + + + +3,779 + + + +6,639 + + + + + + + + + + +636,245 + + + +660,298 + + + Less-Accumulated depreciation and amortization + + + +115,798 + + + +142,444 + + + + + + + + + + +520,447 + + + +517,854 + + + INVESTMENT IN BUFFINGTON HARBOR RIVERBOATS, LLC + + + +33,889 + + + +31,842 + + + OTHER ASSETS + + + +35,210 + + + +24,338 + + + + + + + + Total assets + + +$ +649,666 + + +$ +628,064 + + + + + + + +LIABILITIES AND EQUITY + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + + Current maturities of long-term debt + + +$ +12,952 + + +$ +7,712 + + + Trade accounts payable + + + +11,556 + + + +8,961 + + + Due to affiliates + + + +8,184 + + + +4,381 + + + Accrued payroll and related expenses + + + +8,017 + + + +8,597 + + + Accrued interest payable + + + +4,953 + + + +3,778 + + + Self insurance reserves + + + +3,444 + + + +2,892 + + + Other + + + +16,385 + + + +20,108 + + + + + + + + Total current liabilities + + + +65,491 + + + +56,429 + + + DUE TO (FROM) AFFILIATES-THCR HOLDINGS + + + +42,553 + + + +32,566 + + + LONG-TERM DEBT, LESS CURRENT MATURITIES + + + +464,493 + + + +487,242 + + + OTHER LONG-TERM LIABILITIES + + + +16,121 + + + +5,974 + + + + + + + + Total liabilities + + + +588,658 + + + +582,211 + + + CAPITAL + + + + + + + + + + + Contributed capital + + + +237,197 + + + +238,273 + + + Accumulated other comprehensive loss + + + +(372 +) + + +(938 +) + + Accumulated deficit + + + +(175,817 +) + + +(191,482 +) + + + + + + + Total capital + + + +61,008 + + + +45,853 + + + + + + + + Total liabilities and capital + + +$ +649,666 + + +$ +628,064 + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-3 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF OPERATIONS + (in thousands) + + + + +For the Years Ended December 31, + + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + REVENUES + + + + + + + + + + + + + + + Gaming + + +$ +386,541 + + +$ +390,104 + + +$ +410,645 + + + Rooms + + + +21,827 + + + +22,470 + + + +21,835 + + + Food and beverage + + + +36,971 + + + +35,069 + + + +35,601 + + + Management fees + + + + + + + + + + + +2,710 + + + Other + + + +11,449 + + + +12,042 + + + +12,335 + + + + + + + + + + Gross revenues + + + +456,788 + + + +459,685 + + + +483,126 + + + Less-Promotional allowances + + + +88,867 + + + +85,863 + + + +86,165 + + + + + + + + + + Net revenues + + + +367,921 + + + +373,822 + + + +396,961 + + + + + + + + + + COSTS AND EXPENSES + + + + + + + + + + + + + + + Gaming + + + +190,377 + + + +189,712 + + + +190,455 + + + Rooms + + + +6,311 + + + +5,745 + + + +6,246 + + + Food and beverage + + + +15,248 + + + +14,571 + + + +14,856 + + + General and administrative + + + +88,220 + + + +84,138 + + + +86,367 + + + General and administrative-related parties + + + +12,045 + + + +10,413 + + + +13,177 + + + Debt renegotiation costs + + + + + + + + + + + +1,629 + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + + + + + + + + + + +337,350 + + + +328,716 + + + +340,336 + + + + + + + + + + Income from operations + + + +30,571 + + + +45,106 + + + +56,625 + + + + + + + + + + NON-OPERATING INCOME (EXPENSE) + + + + + + + + + + + + + + + Interest income + + + +2,075 + + + +1,382 + + + +867 + + + Interest expense + + + +(45,993 +) + + +(48,085 +) + + +(51,361 +) + + Interest expense-related parties + + + +(16,457 +) + + +(17,600 +) + + +(19,367 +) + + Other non-operating income (expense) + + + +(218 +) + + +100 + + + +1,219 + + + + + + + + + + Non-operating expense, net + + + +(60,593 +) + + +(64,203 +) + + +(68,642 +) + + + + + + + + + Loss before income taxes and equity in loss from Buffington Harbor, LLC + + + +(30,022 +) + + +(19,097 +) + + +(12,017 +) + + Equity in loss from Buffington Harbor, LLC + + + +(3,134 +) + + +(2,808 +) + + +(2,448 +) + + Provision for income taxes + + + + + + + +(150 +) + + +(1,200 +) + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-4 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CAPITAL + (in thousands) + + + + +Contributed +Capital + + +Accumulated +Deficit + + + +Accumulated +Other +Comprehensive +Loss + + + +Total + + + + Balance at December 31, 1999 + + +$ +229,015 + +$ +(120,606 +) + +$ + + + +$ +108,409 + + + Capital contribution (See Note 1*) + + + +7,732 + + + + + + + + + + +7,732 + + + Net loss (See Note 1*) + + + + + + +(33,156 +) + + + + + + +(33,156 +) + + + + + + + + + + + Balance at December 31, 2000 (See Note 1*) + + + +236,747 + + +(153,762 +) + + + + + + +82,985 + + + Capital contribution (See Note 1*) + + + +450 + + + + + + + + + + +450 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss (See Note 1*) + + + + + + +(22,055 +) + + + + + + +(22,055 +) + + Adjustment for interest rate swap (See Note 1*) + + + + + + + + + + +(372 +) + + +(372 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(22,427 +) + + + + + + + + + + + Balance at December 31, 2001 (See Note 1*) + + + +237,197 + + +(175,817 +) + + +(372 +) + + +61,008 + + + Capital contribution + + + +1,076 + + + + + + + + + + +1,076 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss + + + + + + +(15,665 +) + + + + + + +(15,665 +) + + Adjustment for interest rate swap + + + + + + + + + + +(566 +) + + +(566 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(16,231 +) + + + + + + + + + + + Balance at December 31, 2002 + + +$ +238,273 + +$ +(191,482 +) + +$ +(938 +) + +$ +45,853 + + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + + See accompanying notes + + + F-5 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CASH FLOWS + (in thousands) + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + Adjustments to reconcile net loss to net cash flows provided by operating activities + + + + + + + + + + + + + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + Issuance of PIK debt in satisfaction of accrued interest + + + +15,188 + + + +17,368 + + + +17,805 + + + Amortization for City of Gary development agreement + + + +3,700 + + + +667 + + + + + + + Equity in loss from Buffington Harbor, LLC + + + +3,134 + + + +2,808 + + + +2,448 + + + Accretion of bond discount + + + +5,122 + + + +5,981 + + + +6,985 + + + Amortization of loan costs + + + +410 + + + +1,134 + + + +4,711 + + + Allocation of expenses from THCR Holdings + + + + + + + + + + + +1,076 + + + Provision of losses on receivables + + + +1,420 + + + +1,430 + + + +2,303 + + + Valuation allowance CRDA investments + + + +3,680 + + + +1,432 + + + +3,762 + + + (Increase) decrease in receivables + + + +(5,564 +) + + +(215 +) + + +1,903 + + + Decrease (increase) in inventories + + + +206 + + + +358 + + + +(144 +) + + (Increase) decrease in prepaid expenses and other current assets + + + +(28 +) + + +138 + + + +(1,605 +) + + (Increase) decrease in other assets + + + +(7,319 +) + + +(1,310 +) + + +1,646 + + + Decrease in due to affiliates + + + +(858 +) + + +(8,563 +) + + +(14,173 +) + + Increase (decrease) in current liabilities + + + +1,551 + + + +3,743 + + + +(5,011 +) + + Increase (decrease) in other long-term liabilities + + + +17 + + + +(7,164 +) + + +(4,711 +) + + + + + + + + + Net cash flows provided by operating activities + + + +12,652 + + + +19,889 + + + +28,936 + + + + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + + + + + + + Purchases of property and equipment, net + + + +(5,479 +) + + +(7,089 +) + + +(15,378 +) + + (Advances) repayment of note receivable + + + + + + + +(3,535 +) + + +3,535 + + + Investment in Buffington Harbor Riverboats, LLC + + + +(1,534 +) + + +(112 +) + + +(401 +) + + Purchases of CRDA investments + + + +(3,347 +) + + +(3,388 +) + + +(3,486 +) + + + + + + + + + Net cash flows used in investing activities + + + +(10,360 +) + + +(14,124 +) + + +(15,730 +) + + + + + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + + + + + + + Contributed capital + + + + + + + +450 + + + + + + + Repayment of other borrowings + + + +(7,675 +) + + +(29,118 +) + + +(91,323 +) + + Proceeds of other borrowings + + + +5,000 + + + +38,500 + + + +75,245 + + + Cost of issuing debt + + + +(290 +) + + +(4,168 +) + + +(2,302 +) + + + + + + + + + Net cash flows (used in) provided by financing activities + + + +(2,965 +) + + +5,664 + + + +(18,380 +) + + + + + + + + + Net (decrease) increase in cash and cash equivalents + + + +(673 +) + + +11,429 + + + +(5,174 +) + + CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR + + + +28,335 + + + +27,662 + + + +39,091 + + + + + + + + + + CASH AND CASH EQUIVALENTS AT END OF YEAR + + +$ +27,662 + + +$ +39,091 + + +$ +33,917 + + + + + + + + + + SUPPLEMENTAL INFORMATION: + + + + + + + + + + + + + + + Cash paid for interest + + +$ +38,921 + + +$ +39,043 + + +$ +41,452 + + + + + + + + + + Cash paid for income taxes + + +$ + + + +$ + + + +$ +75 + + + + + + + + + + Purchase of equipment under capitalized lease obligations + + +$ +4,156 + + +$ +7,293 + + +$ +8,342 + + + + + + + + + + Contribution of capital by and forgiveness of amount due to THCR Holdings + + +$ +7,732 + + +$ +450 + + +$ + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes + + + F-6 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS + + (1) Organization and Operations + + The accompanying combined financial statements include those of Trump Casino Holdings, a Delaware single member limited +liability company ( TCH ), and its subsidiary, Trump Casino Funding, Inc., a New Jersey corporation, ( TCF ). Its wholly-owned subsidiaries include (i) Trump Casino Funding, Inc.( Trump Casino Funding ), (ii) Trump +Marina Associates, L.P. ( Marina Associates ), (iii) Trump Marina, Inc., (iv) Trump Indiana, Inc. ( Trump Indiana ), (v) Trump Indiana Realty, L.L.C. and (vi) THCR Management Holdings, L.L.C. ( THCR Management +Holdings ). + + The sole member of Trump Casino Holdings is +THCR Holdings. THCR Holdings is owned approximately 63.4% by Trump Hotels & Casino Resorts, Inc. ( THCR ) as both a general and limited partner, and approximately 36.6% by Donald J. Trump as a limited partner. THCR is a publicly held +company whose common stock is traded on The New York Stock Exchange under the symbol DJT . + + On March 25, 2003, TCH was capitalized and simultaneously, Marina Associates, Trump Marina, Inc., Trump Indiana, Inc., Trump Indiana Realty, L.L.C., and +THCR Management Holdings became wholly owned subsidiaries of TCH pursuant to a corporate reorganization approved by THCR s Board of Directors. THCR Management Holdings has no operations and it owns 100% of THCR Management Services, LLC +( THCR Management ). THCR Management Holding s only asset, other than its investment in THCR Management, was $254,000 of cash which was advanced to THCR Management at December 31, 2002. As a result of this reorganization of entities +under common control, the accompanying combined financial statements present the combined financial statements of TCH as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002. + + The financial statements of (i) Trump Marina Associates, L.P. (formerly +Trump s Castle Associates, L.P.) as of December 31, 2001 and for each of the two years in the period then ended, (ii) Trump Indiana, Inc. as of December 31, 2001 and for each of the two years in the period then ended, and (iii) THCR Management +Services, LLC as of December 31, 2001 and for the two months then ended were audited by other auditors who have ceased operations. These entities constitute 100% of the combined assets of TCH at December 31, 2001 and combined revenues and combined +net loss of TCH for the years ended December 31, 2001 and 2000. + + Marina Associates owns and operates the Trump Marina Hotel Casino, ( Trump Marina ), a casino hotel located in the marina district of Atlantic City, New Jersey (the Marina District ). Trump Indiana owns and operates a +riverboat gaming facility operating in Buffington Harbor, on Lake Michigan, Indiana (the Trump Indiana Riverboat ). THCR Management Holdings is the sole member of THCR Management. THCR Management manages the day-to-day operations of Trump +29 Casino located in Coachella Valley, California (in the Palm Springs area) pursuant to a five year management agreement (the Management Agreement ) commencing on April 16, 2002, between THCR Management and the Twenty Nine Palms Band of +Luiseno Mission Indians, a federally recognized native American Tribe and the owner of Trump 29 Casino (the Tribe ). Trump Indiana Realty, LLC has no material assets or operations. + + TCH and TCF have no operations and their ability to service their debt is +dependent upon the successful operations of Trump Marina, Trump Indiana, and the management fees generated pursuant to the Trump 29 Management Agreement. + + + F-7 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS (Continued) + + + (2) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001229975_thcr_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001229975_thcr_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0630233ac37bfaaf0468552007e15b6d5062b0b --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001229975_thcr_legal_matters.txt @@ -0,0 +1,2556 @@ +LEGAL MATTERS + + The validity of +the Resale Notes will be passed upon for the Issuers by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. In giving their opinion, LeBoeuf, Lamb, Greene & MacRae, +L.L.P. may rely on the opinion of Graham, Curtin & Sheridan, a Professional Association, with respect to matters relating to New Jersey law. + + + 188 + +Table of Contents + + +INDEPENDENT AUDITORS + + The financial +statements of Trump s Castle Associates, L.P. and Subsidiary and Trump Indiana, Inc., as of December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, and the financial statements of Trump Management +Services, LLC as of December 31, 2001 and for the two-month period ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, independent certified public accountants, as indicated in their report, which is +included herein. Arthur Andersen, which has ceased operations, has not consented to the inclusion of their report in this prospectus, and we have dispensed with the requirement to file their consent in reliance upon Rule 437a of the Securities Act. +Under most circumstances a registrant must obtain and file the consent of its accountants contemporaneously with the filing of any registration statement that includes audited financial statements. By granting such a consent, accounting firms become +exposed to liability under Section 11(a) of the Securities Act for any untrue statements of material fact in, or omissions of material facts from, such registration statement. Investors who bring a successful claim under Section 11(a) of the +Securities Act are entitled to recessionary damages. As a result of the criminal conviction against Arthur Andersen in connection with Enron Corporation, and the volume of civil lawsuits filed against it, Arthur Andersen may not have the ability to +withstand liability for prior audits. + + Effective June 3, 2002, +THCR Holdings appointed Ernst & Young LLP as our new independent auditors. The combined financial statements of Trump Casino Holdings, LLC as of December 31, 2002 and for the year then ended appearing in this prospectus and registration +statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting +and auditing. + + + 189 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + + +Page + + Trump Casino Holdings, LLC + + + + + Annual Financial Statements + + + + + Report of Independent Auditors + + + F-2 + + Combined Balance Sheets as of December 31, 2001 and 2002 + + + F-3 + + Combined Statements of Operations for the years ended December 31, 2000, 2001 and 2002 + + + F-4 + + Combined Statements of Capital for the years ended December 31, 2000, 2001 and 2002 + + + F-5 + + Combined Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 + + + F-6 + + Notes to Combined Financial Statements + + + F-7 + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000, 2001 and 2002 + + + F-26 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required formation is included +in the consolidated financial statements or notes thereto. + + + + + Interim Financial Statements + + + + + Condensed Consolidated Balance Sheets as of December 31, 2002 and March 31, 2003 (unaudited) + + + F-27 + + Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-28 + + Condensed Consolidated Statement of Capital for the three months ended March 31, 2003 (unaudited) + + + F-29 + + Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2003 (unaudited) + + + F-30 + + Notes to Condensed Consolidated Financial Statements (unaudited) + + + F-31 + + Trump s Castle Associates, L.P. (now known as Trump Marina Associates, L.P.) and Subsidiary* + + + + + Report of Independent Auditors + + + F-36 + + Consolidated Balance Sheet as of December 31, 2001 + + + F-37 + + Consolidated Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-38 + + Consolidated Statements of Partners Capital for the years ended December 31, 2000 and 2001 + + + F-39 + + Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-40 + + Notes to Consolidated Financial Statements + + + F-41 + + Financial Statement Schedule + + + + + Schedule II Valuation and Qualifying Accounts for the years ended December 31, 2000 and 2001 + + + F-50 + + Other Schedules are omitted for the reason that they are not required or are not applicable, or the required information is +included in the consolidated financial statements or notes thereto. + + + + + Trump Indiana, Inc.* + + + + + Report of Independent Auditors + + + F-51 + + Balance Sheet as of December 31, 2001 + + + F-52 + + Statements of Operations for the years ended December 31, 2000 and 2001 + + + F-53 + + Statements of Capital for the years ended December 31, 2000 and 2001 + + + F-54 + + Statements of Cash Flows for the years ended December 31, 2000 and 2001 + + + F-55 + + Notes to Financial Statements + + + F-56 + + All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included +in the consolidated financial statements or notes thereto. + + + + + THCR Management Services, LLC* + + + + + Report of Independent Auditors + + + F-64 + + Balance Sheet as of December 31, 2001 + + + F-65 + + Statement of Operations for the two months ended December 31, 2001 + + + F-66 + + Statement of Cash Flows for the two months ended December 31, 2001 + + + F-67 + + Notes to Financial Statements + + + F-68 + +All Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes +thereto. + + + + + +* + +Became a wholly-owned subsidiary of Trump Casino Holdings, LLC on March 25, 2003 pursuant to a corporate reorganization. See Note 1 to Combined Financial Statements of Trump Casino +Holdings, LLC. + + + F-1 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + Board of Directors + Trump Casino Holdings, LLC + + + We have audited the accompanying combined balance sheet of +Trump Casino Holdings, LLC as of December 31, 2002 and the related combined statements of operations, capital, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial +Statements. These financial statements and schedule are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. + + We conducted our audit in accordance with auditing standards generally +accepted in the United States. 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. + + In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Trump Casino Holdings, LLC at December 31, 2002 and the combined results of its operations and its cash +flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a +whole, present fairly in all material respects the information set forth therein. + + We also have audited, as to combination only, the accompanying combined balance sheet of Trump Casino Holdings, LLC as of December 31, 2001, and the related combined statements of operations, capital, and cash flows +for the two years then ended. As described in Note 1, Trump Casino Holdings, LLC was capitalized on March 25, 2003 as a holding company for three entities under common control; accordingly, its financial statements are presented as though the +combination of Trump s Castle Associates, L.P. and Subsidiary, Trump Indiana, Inc., and THCR Management Services, LLC occurred at the beginning of the period presented. We did not audit the financial statements of these three entities. Their +financial statements, which are presented separately herein, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those respective financial statements in their reports dated March 13, 2002, +which also are presented separately herein. In our opinion, these combined financial statements have been properly combined on the basis described in Note 1. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 +combined financial statements of Trump Casino Holdings, LLC, other than with respect to such combination and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements of Trump Casino +Holdings, LLC taken as whole or on the separate financial statements of any of its subsidiaries. + + /s/ ERNST & YOUNG LLP + + Philadelphia, Pennsylvania + March 25, 2003 + + + F-2 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED BALANCE SHEETS + (in thousands) + + + + +December 31, +2001 + + + +December 31, +2002 + + + + + +(See Note 1*) + + + + + +ASSETS + + + + + + + + + + CURRENT ASSETS + + + + + + + + + + + Cash and cash equivalents + + +$ +34,291 + + +$ +33,917 + + + Restricted cash + + + +4,800 + + + + + + + Trade receivables, net of allowance for doubtful accounts of $2,979 and $2,607, respectively + + + +12,984 + + + +9,872 + + + Other receivables + + + +2,342 + + + +2,884 + + + Inventories + + + +3,038 + + + +3,182 + + + Prepaid expenses and other current assets + + + +2,449 + + + +3,797 + + + Due from affiliates + + + +216 + + + +378 + + + + + + + + Total current assets + + + +60,120 + + + +54,030 + + + + + + + + PROPERTY AND EQUIPMENT + + + + + + + + + + + Land and land improvements + + + +92,379 + + + +92,379 + + + Buildings and building improvements + + + +424,031 + + + +425,027 + + + Riverboat and improvements + + + +34,159 + + + +34,239 + + + Furniture, fixtures and equipment + + + +81,897 + + + +102,014 + + + Construction in progress + + + +3,779 + + + +6,639 + + + + + + + + + + +636,245 + + + +660,298 + + + Less-Accumulated depreciation and amortization + + + +115,798 + + + +142,444 + + + + + + + + + + +520,447 + + + +517,854 + + + INVESTMENT IN BUFFINGTON HARBOR RIVERBOATS, LLC + + + +33,889 + + + +31,842 + + + OTHER ASSETS + + + +35,210 + + + +24,338 + + + + + + + + Total assets + + +$ +649,666 + + +$ +628,064 + + + + + + + +LIABILITIES AND EQUITY + + + + + + + + + + CURRENT LIABILITIES + + + + + + + + + + + Current maturities of long-term debt + + +$ +12,952 + + +$ +7,712 + + + Trade accounts payable + + + +11,556 + + + +8,961 + + + Due to affiliates + + + +8,184 + + + +4,381 + + + Accrued payroll and related expenses + + + +8,017 + + + +8,597 + + + Accrued interest payable + + + +4,953 + + + +3,778 + + + Self insurance reserves + + + +3,444 + + + +2,892 + + + Other + + + +16,385 + + + +20,108 + + + + + + + + Total current liabilities + + + +65,491 + + + +56,429 + + + DUE TO (FROM) AFFILIATES-THCR HOLDINGS + + + +42,553 + + + +32,566 + + + LONG-TERM DEBT, LESS CURRENT MATURITIES + + + +464,493 + + + +487,242 + + + OTHER LONG-TERM LIABILITIES + + + +16,121 + + + +5,974 + + + + + + + + Total liabilities + + + +588,658 + + + +582,211 + + + CAPITAL + + + + + + + + + + + Contributed capital + + + +237,197 + + + +238,273 + + + Accumulated other comprehensive loss + + + +(372 +) + + +(938 +) + + Accumulated deficit + + + +(175,817 +) + + +(191,482 +) + + + + + + + Total capital + + + +61,008 + + + +45,853 + + + + + + + + Total liabilities and capital + + +$ +649,666 + + +$ +628,064 + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-3 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF OPERATIONS + (in thousands) + + + + +For the Years Ended December 31, + + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + REVENUES + + + + + + + + + + + + + + + Gaming + + +$ +386,541 + + +$ +390,104 + + +$ +410,645 + + + Rooms + + + +21,827 + + + +22,470 + + + +21,835 + + + Food and beverage + + + +36,971 + + + +35,069 + + + +35,601 + + + Management fees + + + + + + + + + + + +2,710 + + + Other + + + +11,449 + + + +12,042 + + + +12,335 + + + + + + + + + + Gross revenues + + + +456,788 + + + +459,685 + + + +483,126 + + + Less-Promotional allowances + + + +88,867 + + + +85,863 + + + +86,165 + + + + + + + + + + Net revenues + + + +367,921 + + + +373,822 + + + +396,961 + + + + + + + + + + COSTS AND EXPENSES + + + + + + + + + + + + + + + Gaming + + + +190,377 + + + +189,712 + + + +190,455 + + + Rooms + + + +6,311 + + + +5,745 + + + +6,246 + + + Food and beverage + + + +15,248 + + + +14,571 + + + +14,856 + + + General and administrative + + + +88,220 + + + +84,138 + + + +86,367 + + + General and administrative-related parties + + + +12,045 + + + +10,413 + + + +13,177 + + + Debt renegotiation costs + + + + + + + + + + + +1,629 + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + + + + + + + + + + +337,350 + + + +328,716 + + + +340,336 + + + + + + + + + + Income from operations + + + +30,571 + + + +45,106 + + + +56,625 + + + + + + + + + + NON-OPERATING INCOME (EXPENSE) + + + + + + + + + + + + + + + Interest income + + + +2,075 + + + +1,382 + + + +867 + + + Interest expense + + + +(45,993 +) + + +(48,085 +) + + +(51,361 +) + + Interest expense-related parties + + + +(16,457 +) + + +(17,600 +) + + +(19,367 +) + + Other non-operating income (expense) + + + +(218 +) + + +100 + + + +1,219 + + + + + + + + + + Non-operating expense, net + + + +(60,593 +) + + +(64,203 +) + + +(68,642 +) + + + + + + + + + Loss before income taxes and equity in loss from Buffington Harbor, LLC + + + +(30,022 +) + + +(19,097 +) + + +(12,017 +) + + Equity in loss from Buffington Harbor, LLC + + + +(3,134 +) + + +(2,808 +) + + +(2,448 +) + + Provision for income taxes + + + + + + + +(150 +) + + +(1,200 +) + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes. + + + F-4 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CAPITAL + (in thousands) + + + + +Contributed +Capital + + +Accumulated +Deficit + + + +Accumulated +Other +Comprehensive +Loss + + + +Total + + + + Balance at December 31, 1999 + + +$ +229,015 + +$ +(120,606 +) + +$ + + + +$ +108,409 + + + Capital contribution (See Note 1*) + + + +7,732 + + + + + + + + + + +7,732 + + + Net loss (See Note 1*) + + + + + + +(33,156 +) + + + + + + +(33,156 +) + + + + + + + + + + + Balance at December 31, 2000 (See Note 1*) + + + +236,747 + + +(153,762 +) + + + + + + +82,985 + + + Capital contribution (See Note 1*) + + + +450 + + + + + + + + + + +450 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss (See Note 1*) + + + + + + +(22,055 +) + + + + + + +(22,055 +) + + Adjustment for interest rate swap (See Note 1*) + + + + + + + + + + +(372 +) + + +(372 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(22,427 +) + + + + + + + + + + + Balance at December 31, 2001 (See Note 1*) + + + +237,197 + + +(175,817 +) + + +(372 +) + + +61,008 + + + Capital contribution + + + +1,076 + + + + + + + + + + +1,076 + + + Comprehensive Loss: + + + + + + + + + + + + + + + + + + Net loss + + + + + + +(15,665 +) + + + + + + +(15,665 +) + + Adjustment for interest rate swap + + + + + + + + + + +(566 +) + + +(566 +) + + + + + + + + + + + Total comprehensive loss + + + + + + + + + + + + + + +(16,231 +) + + + + + + + + + + + Balance at December 31, 2002 + + +$ +238,273 + +$ +(191,482 +) + +$ +(938 +) + +$ +45,853 + + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + + See accompanying notes + + + F-5 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + COMBINED STATEMENTS OF CASH FLOWS + (in thousands) + + + + +2000 + + + +2001 + + + +2002 + + + + + +(See Note 1*) + + +(See Note 1*) + + + + + + CASH FLOWS FROM OPERATING ACTIVITIES + + + + + + + + + + + + + + + Net loss + + +$ +(33,156 +) + +$ +(22,055 +) + +$ +(15,665 +) + + Adjustments to reconcile net loss to net cash flows provided by operating activities + + + + + + + + + + + + + + + Depreciation and amortization + + + +25,149 + + + +24,137 + + + +27,606 + + + Issuance of PIK debt in satisfaction of accrued interest + + + +15,188 + + + +17,368 + + + +17,805 + + + Amortization for City of Gary development agreement + + + +3,700 + + + +667 + + + + + + + Equity in loss from Buffington Harbor, LLC + + + +3,134 + + + +2,808 + + + +2,448 + + + Accretion of bond discount + + + +5,122 + + + +5,981 + + + +6,985 + + + Amortization of loan costs + + + +410 + + + +1,134 + + + +4,711 + + + Allocation of expenses from THCR Holdings + + + + + + + + + + + +1,076 + + + Provision of losses on receivables + + + +1,420 + + + +1,430 + + + +2,303 + + + Valuation allowance CRDA investments + + + +3,680 + + + +1,432 + + + +3,762 + + + (Increase) decrease in receivables + + + +(5,564 +) + + +(215 +) + + +1,903 + + + Decrease (increase) in inventories + + + +206 + + + +358 + + + +(144 +) + + (Increase) decrease in prepaid expenses and other current assets + + + +(28 +) + + +138 + + + +(1,605 +) + + (Increase) decrease in other assets + + + +(7,319 +) + + +(1,310 +) + + +1,646 + + + Decrease in due to affiliates + + + +(858 +) + + +(8,563 +) + + +(14,173 +) + + Increase (decrease) in current liabilities + + + +1,551 + + + +3,743 + + + +(5,011 +) + + Increase (decrease) in other long-term liabilities + + + +17 + + + +(7,164 +) + + +(4,711 +) + + + + + + + + + Net cash flows provided by operating activities + + + +12,652 + + + +19,889 + + + +28,936 + + + + + + + + + + CASH FLOWS FROM INVESTING ACTIVITIES + + + + + + + + + + + + + + + Purchases of property and equipment, net + + + +(5,479 +) + + +(7,089 +) + + +(15,378 +) + + (Advances) repayment of note receivable + + + + + + + +(3,535 +) + + +3,535 + + + Investment in Buffington Harbor Riverboats, LLC + + + +(1,534 +) + + +(112 +) + + +(401 +) + + Purchases of CRDA investments + + + +(3,347 +) + + +(3,388 +) + + +(3,486 +) + + + + + + + + + Net cash flows used in investing activities + + + +(10,360 +) + + +(14,124 +) + + +(15,730 +) + + + + + + + + + CASH FLOWS FROM FINANCING ACTIVITIES + + + + + + + + + + + + + + + Contributed capital + + + + + + + +450 + + + + + + + Repayment of other borrowings + + + +(7,675 +) + + +(29,118 +) + + +(91,323 +) + + Proceeds of other borrowings + + + +5,000 + + + +38,500 + + + +75,245 + + + Cost of issuing debt + + + +(290 +) + + +(4,168 +) + + +(2,302 +) + + + + + + + + + Net cash flows (used in) provided by financing activities + + + +(2,965 +) + + +5,664 + + + +(18,380 +) + + + + + + + + + Net (decrease) increase in cash and cash equivalents + + + +(673 +) + + +11,429 + + + +(5,174 +) + + CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR + + + +28,335 + + + +27,662 + + + +39,091 + + + + + + + + + + CASH AND CASH EQUIVALENTS AT END OF YEAR + + +$ +27,662 + + +$ +39,091 + + +$ +33,917 + + + + + + + + + + SUPPLEMENTAL INFORMATION: + + + + + + + + + + + + + + + Cash paid for interest + + +$ +38,921 + + +$ +39,043 + + +$ +41,452 + + + + + + + + + + Cash paid for income taxes + + +$ + + + +$ + + + +$ +75 + + + + + + + + + + Purchase of equipment under capitalized lease obligations + + +$ +4,156 + + +$ +7,293 + + +$ +8,342 + + + + + + + + + + Contribution of capital by and forgiveness of amount due to THCR Holdings + + +$ +7,732 + + +$ +450 + + +$ + + + + + + + + + + +* + +As more fully explained in Note 1, the combined financial statements of TCH were audited for 2002, and as to combination only for 2001 and 2000. For 2001 and 2000, the underlying +components were audited by previous auditors who have ceased operations. + + See accompanying notes + + + F-6 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS + + (1) Organization and Operations + + The accompanying combined financial statements include those of Trump Casino Holdings, a Delaware single member limited +liability company ( TCH ), and its subsidiary, Trump Casino Funding, Inc., a New Jersey corporation, ( TCF ). Its wholly-owned subsidiaries include (i) Trump Casino Funding, Inc.( Trump Casino Funding ), (ii) Trump +Marina Associates, L.P. ( Marina Associates ), (iii) Trump Marina, Inc., (iv) Trump Indiana, Inc. ( Trump Indiana ), (v) Trump Indiana Realty, L.L.C. and (vi) THCR Management Holdings, L.L.C. ( THCR Management +Holdings ). + + The sole member of Trump Casino Holdings is +THCR Holdings. THCR Holdings is owned approximately 63.4% by Trump Hotels & Casino Resorts, Inc. ( THCR ) as both a general and limited partner, and approximately 36.6% by Donald J. Trump as a limited partner. THCR is a publicly held +company whose common stock is traded on The New York Stock Exchange under the symbol DJT . + + On March 25, 2003, TCH was capitalized and simultaneously, Marina Associates, Trump Marina, Inc., Trump Indiana, Inc., Trump Indiana Realty, L.L.C., and +THCR Management Holdings became wholly owned subsidiaries of TCH pursuant to a corporate reorganization approved by THCR s Board of Directors. THCR Management Holdings has no operations and it owns 100% of THCR Management Services, LLC +( THCR Management ). THCR Management Holding s only asset, other than its investment in THCR Management, was $254,000 of cash which was advanced to THCR Management at December 31, 2002. As a result of this reorganization of entities +under common control, the accompanying combined financial statements present the combined financial statements of TCH as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002. + + The financial statements of (i) Trump Marina Associates, L.P. (formerly +Trump s Castle Associates, L.P.) as of December 31, 2001 and for each of the two years in the period then ended, (ii) Trump Indiana, Inc. as of December 31, 2001 and for each of the two years in the period then ended, and (iii) THCR Management +Services, LLC as of December 31, 2001 and for the two months then ended were audited by other auditors who have ceased operations. These entities constitute 100% of the combined assets of TCH at December 31, 2001 and combined revenues and combined +net loss of TCH for the years ended December 31, 2001 and 2000. + + Marina Associates owns and operates the Trump Marina Hotel Casino, ( Trump Marina ), a casino hotel located in the marina district of Atlantic City, New Jersey (the Marina District ). Trump Indiana owns and operates a +riverboat gaming facility operating in Buffington Harbor, on Lake Michigan, Indiana (the Trump Indiana Riverboat ). THCR Management Holdings is the sole member of THCR Management. THCR Management manages the day-to-day operations of Trump +29 Casino located in Coachella Valley, California (in the Palm Springs area) pursuant to a five year management agreement (the Management Agreement ) commencing on April 16, 2002, between THCR Management and the Twenty Nine Palms Band of +Luiseno Mission Indians, a federally recognized native American Tribe and the owner of Trump 29 Casino (the Tribe ). Trump Indiana Realty, LLC has no material assets or operations. + + TCH and TCF have no operations and their ability to service their debt is +dependent upon the successful operations of Trump Marina, Trump Indiana, and the management fees generated pursuant to the Trump 29 Management Agreement. + + + F-7 + +Table of Contents + + TRUMP CASINO HOLDINGS, LLC + + NOTES TO COMBINED FINANCIAL STATEMENTS (Continued) + + + (2) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001231868_cleveland_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001231868_cleveland_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..01629492658420f81a0f6239a87d13ff927db32a --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001231868_cleveland_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Jones Day, Cleveland, Ohio will pass upon the validity of the issuance of the shares being sold in this offering. Certain legal matters will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001232298_gracechurc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001232298_gracechurc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9ce0735644cf0f83ff2bcf4080903fe8cd2e581c --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001232298_gracechurc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Matters of English law relating to the validity of the issuance of the notes and matters of U.S. law will be passed upon for the issuer by Clifford Chance LLP, London, England. Weil, Gotshal & Manges has acted as counsel to the underwriters with respect to the offering of the notes pursuant to this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001233426_nationshea_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001233426_nationshea_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..594216b39202db6c4b9716fc373f27cce1192b68 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001233426_nationshea_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the securities offered in this prospectus are being passed upon for us by Klehr, Harrison, Harvey, Branzburg & Ellers LLP, Philadelphia, Pennsylvania. Graubard Miller, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001236038_redenvelop_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001236038_redenvelop_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..aeefe6e7d9f0f43d46c67b49f95010a1cf4bb11e --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001236038_redenvelop_legal_matters.txt @@ -0,0 +1 @@ +Table of Contents enter our market with little difficulty and can launch new websites at a relatively low cost. We currently or potentially compete with a variety of other companies, including: other online retailers, such as Amazon.com major department stores such as Macy s and Bloomingdale s physical and online stores and catalog retailers that sell popular gift items such as Pottery Barn, Brookstone, Sharper Image, Tiffany s, Harry David, J Crew and 1-800-Flowers Internet portals and online service providers that feature shopping services, such as AOL, Yahoo! and Lycos Many of our traditional store-based, catalog-based and online competitors have longer operating histories, larger customer or user bases, greater brand recognition and significantly greater resources, particularly financial and marketing resources. Many of these competitors can devote substantially more resources to website development and catalog retailing than we can. In addition, large, well-established and well-financed entities may join with online competitors in the future. Our competitors may be able to secure products from vendors on more favorable terms, offer popular products to which we do not have access, fulfill customer orders more efficiently and adopt more aggressive pricing or inventory availability policies than we can. The U.S. retail industry, the specialty retail industry in particular, and the online commerce sector are highly competitive, dynamic in nature and have undergone significant changes over the past several years and will likely continue to undergo significant changes. Our ability to anticipate and respond successfully to these changes is critical to our long-term growth and we cannot assure you that we will anticipate and respond successfully to changes in the retail industry and online commerce sectors. If we are unable to maintain or increase our market share or compete effectively in the retail gift market, our business, financial condition and operating results would be adversely affected. Intellectual Property We believe that our registered trademark, RedEnvelope, and the brand name recognition that we have developed are of significant value. We strive to preserve the quality of our brand name and protect our trademark and other intellectual property rights to ensure that the value of our proprietary rights is maintained. We rely on various intellectual property laws and contractual restrictions to protect our proprietary rights. These include copyright and trade secret laws and confidentiality, invention assignment and nondisclosure agreements with our employees, contractors, suppliers and strategic partners. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our intellectual property without our authorization. In addition, we pursue the registration of our trademarks and service marks in the U.S. and internationally. However, effective intellectual property protection may not be available in every country in which our products and services are made or will be made available online. If we are unable to protect or preserve the value of our intellectual property for any reason, our business would be harmed. We also rely on technologies that we license from third parties. These licenses may not continue to be available to us on commercially reasonable terms, or at all, in the future. As a result, we may be required to develop or obtain substitute technology of lower quality or at greater cost, which could materially adversely affect our business, operating results and financial condition. Further, third parties may claim infringement by us with respect to our use of current or future technologies, whether developed by RedEnvelope or licensed from other parties. In addition, third parties may claim that the sale of one or more of our product offerings infringes their intellectual property rights. We expect that participants in our markets will be increasingly subject to infringement claims as the number of services and competitors in our industry segment grows. Any such claim, with or without merit, could be time consuming, result in costly litigation, cause service upgrade delays, cause us to discontinue use of a particular technology or the availability of a particular product offering, require us to pay monetary damages or enter into royalty or licensing agreements. Such royalty or licensing agreements might not be available on terms acceptable to us or at all. As a result, any such claim of infringement against us could have a material adverse effect upon our business, operating results and financial condition. We are currently a defendant in a lawsuit Table of Contents As of June 29, 2003 Table of Contents alleging infringement by us of patents held by a third party. For additional information on this lawsuit, see Business Legal Proceedings, and for additional information regarding the risks related to intellectual property, see Risk Factors. Government Regulation Our services are subject to federal, state and local consumer laws and regulations including consumer protection laws, user privacy laws and regulations prohibiting unfair and deceptive trade practices. In particular, under federal and state financial privacy laws and regulations, in certain circumstances we must provide notice to our customers of our policies on sharing non-public information with third parties, must provide advance notice of any changes to our privacy policies and, with limited exceptions, must give consumers the right to prevent sharing of their non-public personal information with unaffiliated third parties. In addition, a recently enacted California law requires that we promptly notify our customers who are California residents in the event that certain types of personal information provided to us by them are not encrypted and are obtained by unauthorized individuals, such as computer hackers. Further, the growth of online commerce could result in more stringent consumer protection laws that impose additional compliance burdens on online companies. These consumer protection laws could result in substantial compliance costs and could interfere with the conduct of our business. Moreover, there is currently great uncertainty whether or how existing laws governing issues such as property ownership, intellectual property issues, sales and other taxes, libel and personal privacy apply to the Internet and commercial online services. These issues may take years to resolve. For example, tax authorities in a number of states, as well as a Congressional advisory commission, are currently reviewing the appropriate tax treatment of companies engaged in online commerce, and new state tax regulations may subject us to additional state sales and income taxes. New legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business or the application of existing laws and regulations to the Internet and online commerce could result in significant additional costs to or taxes on our business. These costs and taxes could have an adverse effect on our cash flows and results of operations. Further, there is a possibility that we could be subject to significant fines or other payments for any past failures to comply with these requirements. In addition, because our website is accessible over the Internet in multiple states and other countries, other jurisdictions may claim that we are required to qualify to do business in that jurisdiction. We are qualified to do business only in California and Ohio at present. Our failure to qualify in a jurisdiction where we are required to do so could subject us to taxes and penalties. It could also hamper our ability to enforce contracts in those jurisdictions. The application of laws or regulations from jurisdictions whose laws do not currently apply to our business could have a material adverse effect on our business, operating results and financial condition. For a discussion of these and other risks related to government regulation, see Risk Factors. Employees As of June 29, 2003, we employed approximately 107 people, approximately 92% of whom were full time. We have never had a work stoppage, and none of our employees is represented by a labor union. We consider our employee relationships to be positive. If we are unable to retain our key employees or if we are unable to maintain adequate staffing of qualified employees, particularly during peak sales seasons, our business would be affected adversely. For a discussion of these and other risks related to our employees, see Risk Factors. Facilities We lease approximately 16,500 square feet of office space for our corporate headquarters in San Francisco, California, and we lease and operate an approximately 200,000 square foot warehouse and distribution facility in Lockbourne, Ohio. We also lease and operate an approximately 13,000 square foot customer service center in San Diego, California, which houses our call center. We believe these facilities will be sufficient for our needs for at least the next twelve months. Pro Forma As Actual Pro Forma(2) Adjusted(3) Table of Contents Our information technology systems are housed in a leased third-party facility in Santa Clara, California. Currently, we use 28 servers to run our website which are configured for high availability and large volumes of Internet traffic and are located in our leased third-party facility. Data is stored in a database that runs on a redundant server and storage array. We also have standby servers that provide for additional capacity as necessary. The facility housing our servers provides redundant HVAC, power and Internet connectivity. For a discussion of the risks related to disruption in services at our third-party facility in Santa Clara and other facility-related risks, See Risk Factors. Legal Proceedings By its letter dated March 9, 2000, Red Letter Days Plc, a United Kingdom company (Red Letter Days), asserted trademark rights in the United Kingdom in the marks RED LETTER, RED LETTER DAYS and the image of a red envelope. Red Letter Days offers experiential gifts in the United Kingdom. The letter claimed that if we were to use our name and the REDENVELOPE service mark in the United Kingdom in connection with retail sales of gifts, it would infringe Red Letter Days trademark rights. We have made a number of attempts to reach an amicable resolution of this dispute, but Red Letter Days has declined, to date, to enter into settlement negotiations. Red Letter Days has opposed our applications to register the REDENVELOPE and RedEnvelope stylized logo marks (Red Envelope Marks) in the United Kingdom and the European Community. Red Letter Days oppositions to our United Kingdom and European Community trademark applications are pending. Evidentiary submissions are being made by the parties in connection with those opposition proceedings and a decision is not expected for several months. The sole issue to be decided in the opposition proceedings is whether the RedEnvelope Marks are entitled to registration in the stated jurisdictions. Even if an opposition is successful in preventing the subject trademark from being registered, that decision by the registration authorities does not prevent the applicant from using the mark in that jurisdiction. In order to prevent us from using the RedEnvelope mark in the United Kingdom or European Community or to obtain any other equitable relief or monetary relief, Red Letter Days would need to bring a lawsuit against us in the appropriate jurisdiction. To the best of our knowledge, no such lawsuit has been filed. We opposed Red Letter Days application to register the RED LETTER mark in the United Kingdom, based on the descriptiveness of the RED LETTER mark as applied to the services of Red Letter Days. The United Kingdom trademark office has denied our opposition and has approved the registration of the Red Letter Days mark in the United Kingdom. This decision did not address a comparison of the REDENVELOPE and RED LETTER marks. In a letter dated May 23, 2003, counsel for Activ8Now, LLC offered us a license to U.S. Patents 6,557,006 and 6,535,889 and certain patent applications. In a letter dated July 10, 2003, Activ8Now asserted that we were using the patented technology of Activ8Now. In a letter dated September 3, 2003 and in response to an inquiry from our counsel, counsel for Activ8Now reasserted that certain of Activ8Now s patents covered certain aspects of our website operations and provided their analysis of how such Activ8Now patented technologies apply to our website operations, and again offered to license such patents to us. That letter is currently under review by our counsel. On September 5, 2003, our counsel discovered that Activ8Now had filed suit against RedEnvelope in the United States District Court for the Northern District of Georgia on September 3, 2003 alleging infringement of the two patents referenced above arising out of certain aspects of our website operations, and seeking the following relief: actual damages for the alleged infringement (including interest) in an unspecified amount, but no less than a reasonable royalty amount; permanent injunctive relief from further alleged acts of infringement; costs and reasonable attorney s fees related to the lawsuit; and triple damages in the event that Activ8Now can show infringement that was willful and intentional. Counsel for RedEnvelope is in the process of evaluating the merits of this claim and we intend to pursue any and all available defenses to these allegations vigorously. We currently believe that this lawsuit will not have a material, adverse effect on us. However, because this litigation matter is in its early stages, we do not have sufficient information to assess whether the allegations could lead to liability on the part of RedEnvelope or the amount of potential damages. We cannot guarantee that this lawsuit will not result in costly settlement arrangements, royalty payments, statutory damages, significant attorney s fees and/or require us to modify our website or our methods of conducting business. For a discussion of the risks related to claims of intellectual property infringement, see Risk Factors. (1) Member of the Compensation Committee (2) Member of the Audit Committee Alison L. May has served as the President, Chief Executive Officer and a member of our Board of Directors since April 2002. Prior to joining RedEnvelope, from March 2001 to April 2002, Ms. May served as the Chief Operating Officer at Gymboree Corporation, a children s specialty retailer. Ms. May held the positions of President and Business Consultant at ALM Consulting from February 2000 to March 2001. From January 1997 to February 2000, Ms. May served as the Chief Operating Officer at Esprit de Corp., a clothing retailer. Ms. May served as the President and Chief Financial Officer of Patagonia, Inc., an outdoor clothing and equipment retailer, from December 1991 to April 1996. Ms. May holds an MBA in Finance from the University of Southern California and a BA in Spanish, Education and History from Purdue University. Hilary Billings has served as Brand Strategist of RedEnvelope since April 2003. She has served as a member of our Board of Directors since July 1999 and served as Chief Marketing Officer and Chairman of the Board from February 2000 to April 2003. She also served as Chief Executive Officer of RedEnvelope from June 1999 to February 2000 and Chief Merchandising Officer from May 1999 to June 1999. From July 1997 to May 1999, Ms. Billings was a Senior Vice President of Brand Design at Starwood Hotels and Resorts where she helped develop the W Hotels brand. Before joining Starwood, Ms. Billings was a Vice President of Product Development with Pottery Barn catalog and retail group from 1995 to 1997. Ms. Billings has served as a member of the Board of Directors at Peet s Coffee and Tea, Inc., a coffee and tea retailer, since January 2002. Ms. Billings holds a BA from Brown University. Eric C. Wong has served as Chief Financial Officer of RedEnvelope since April 2003. Prior to that, Mr. Wong served as our Vice President of Finance from February 2003 to April 2003 and as our Director of Finance from November 2002 to February 2003. From February 2000 to July 2002, Mr. Wong served as the Director of Finance at Network Associates, Inc., an enterprise software company. From December 1997 to February 2000, Mr. Wong served as a Finance Manager at Sanmina Corporation, an electronics manufacturer. Mr. Wong is a certified public accountant and received a BA in Economics from the University of California at Santa Cruz. Table of Contents Pamela A. Knox has served as our Senior Vice President of Marketing since May 2003. Prior to joining RedEnvelope, from October 2000 to May 2003, Ms. Knox served as a Senior Vice President and the Chief Marketing Officer at 1-800-Flowers.com, an online flower retailer. From March 1997 to March 2000, Ms. Knox served as Vice President, Marketing Delivery Group at Citibank, N.A., a financial services company. Ms. Knox received a BA in Government from Wheaton College and an MBA from the University of California at Los Angeles. John W. Roberts has served as our Senior Vice President of Information Technology and Operations since July 2003 and our Vice President of Information Technology and Operations from March 2003 to July 2003. Prior to joining RedEnvelope, from July 2002 to March 2003, Mr. Roberts served as Vice President of Information Technology at Bridgespan, Inc., a mortgage services company. From November 2000 to June 2002, Mr. Roberts served as a Senior Director and Chief Information Officer at DiCarta, Inc., an enterprise software company. Mr. Roberts also served as a Director of Information Technology Operations at Webvan Group, Inc., an online retail grocer, from January 1998 to August 2000. Mr. Roberts received a BA in English from San Francisco State University and an MS in Systems Management from the University of Denver. Kristine N. Dang has served as General Merchandising Manager at RedEnvelope since April 2003. Prior to that, Ms Dang served as the Vice President of Merchandising at RedEnvelope from March 2000 to April 2003 and served as the Director of Merchandising at RedEnvelope from July 1998 to March 2000. Prior to joining RedEnvelope, from April 1997 to June 1998, Ms. Dang served as an Assistant Buyer at Williams-Sonoma, Inc., a specialty home furnishing retailer. Ms. Dang studied fashion design at San Francisco State University. Kristel D. Craven has served as our Vice President of Logistics since July 2003 and our Vice President of Customer Experience from August 2002 to July 2003. Prior to joining RedEnvelope, from November 1998 to June 2002, Ms. Craven served as the Director of Wholesale Operations at Esprit de Corp., a clothing retailer. Ms. Craven also served as a Customer Service Operations Manager at Patagonia, Inc., an outdoor clothing and equipment retailer, from April 1995 to October 1998, a Dealer Service Manager at Patagonia from July 1993 to March 1995 and a Wholesale Shipping Manager at Patagonia from 1990 to June 1993. Kathy M. Herzog has served as our Vice President of Planning since April 2003 and served as our Director of Merchandise Planning from January 2002 to April 2003. Prior to joining RedEnvelope, from August 2001 to December 2001, Ms. Herzog served as a Project Manager with GlobalNetXchange, a retail technology company. Ms. Herzog also served as the Director of Planning at Bluelight.com L.L.C., an online retail unit of Kmart Corporation, from January 2001 to July 2001. From March 2000 to December 2000, Ms. Herzog served as a Group Manager at Escalate, Inc., a retail software company. Ms. Herzog also served as a Project Manager at Williams-Sonoma, Inc., a specialty home furnishing retailer, from February 1999 to February 2000, a Planning and Inventory Manager at Williams-Sonoma, Inc. from March 1998 to January 1999 and a Senior Planner at Williams-Sonoma, Inc. from August 1996 to February 1998. Ms. Herzog holds a BA in Business Marketing from Pacific Lutheran University and an MBA in Business Management from Pacific Lutheran University. Michael Moritz has served as a member of our Board of Directors since July 1999 and as Chairman of the Board since April 2003. Since 1988, Mr. Moritz has served as a general partner at Sequoia Capital, a venture capital firm. Mr. Moritz has served as a member of the board of directors of Saba Software, a provider of human capital development and management solutions, since August 1998. Since July 1993, Mr. Moritz has also served as a member of the board of directors of Flextronics International Ltd., a contract electronics manufacturer. Mr. Moritz received an MA from Christ Church, University of Oxford. Michael E. Dunn has served as a member of our Board of Directors since August 2000. Mr. Dunn served as the President of Prophet Brand Strategy, Inc., a brand consulting firm, since June 1998 and has served as President and Chief Executive Officer of Prophet Brand Strategy since January 2000. From March 1994 to May 1998, Mr. Dunn served as the Chief Executive Officer of Context Integration, a (in thousands) Balance Sheet Data: Cash and equivalents $ 4,748 $ 4,748 $ 32,472 Working capital 5,662 5,662 33,386 Total assets 18,792 18,792 46,516 Capital lease obligations 1,634 1,634 1,634 Total indebtedness Mandatorily redeemable convertible preferred stock 82,556 Stockholders equity (deficit) $ (72,564 ) $ 9,992 $ 37,716 Table of Contents systems integrator. Mr. Dunn received a BA in Economics from Haverford College and an MBA/MA in Business and Asian Studies from the University of California at Berkeley. Scott Galloway has served as a member of our Board of Directors since June 2002. Mr. Galloway also served as a Director of RedEnvelope from September 1997 to August 2000 and the Chairman of the Board of RedEnvelope from September 1997 to February 2000. From December 1999 to January 2002, Mr. Galloway served as the Chief Executive Officer and Chairman of the Board at Brand Farm, an e-commerce incubator. Mr. Galloway served as the Chief Executive Officer of Prophet Brand Strategy, Inc., a brand consulting firm, from June 1992 to January 2000. Mr. Galloway received an MBA from the University of California at Berkeley and a BA in Economics from the University of California at Los Angeles. Charles Heilbronn has served as a member of our Board of Directors since October 2002. Since 1987, Mr. Heilbronn has held the position of Vice President and General Counsel at Chanel Limited, a luxury goods company marketing women s clothing, leather goods, fragrances and cosmetics, fine jewelry and watches. Mr. Heilbronn received a Master in Law from Universite de Paris V, Law School and an LLM from New York University Law School. Daniel R. Lyle has served as a member of our Board of Directors since July 2003. Mr. Lyle served as a partner at PricewaterhouseCoopers LLP from 1982 to June 2003. Mr. Lyle received a BA in Economics from California State University, Northridge and an MBA from the University of California at Los Angeles. Jacqueline A. Macdonald has served as a member of our Board of Directors since March 1999. Since August 1995, Ms. Macdonald has served as a partner at Sippl Macdonald Ventures L.P., a venture capital firm. Ms. Macdonald received an MBA from Harvard University and a BS in Industrial Engineering from Stanford University. Claire Gruppo resigned from our Board of Directors effective August 2003 and, as a result, we currently have one vacancy on our Board of Directors. To fill this vacancy, Karen Edwards has agreed to join our Board of Directors as soon as practicable following the completion of this offering. From January 1996 to October 2001, Ms. Edwards served as Vice President, Worldwide Marketing with Yahoo! Inc. Ms. Edwards received a BA in Communications from Stanford University and an MBA from Harvard University. Additionally, as soon as practicable following the completion of this offering, Jacqueline Macdonald intends to resign from her position as a member of our Board of Directors. Ms. Gruppo s resignation and Ms. Macdonald s intended resignation are not related to disagreements with us. The Company intends to fill the vacancy created by Ms. Macdonald s intended resignation when a suitable candidate is selected as soon as practicable following her resignation. It is anticipated that Ms. Edwards will join our audit committee to fill the vacancy created upon Ms. Macdonald s intended resignation. Board Composition Our Board of Directors currently consists of eight members, who are Michael Moritz, our Chairman, and Hilary Billings, Michael Dunn, Scott Galloway, Charles Heilbronn, Daniel Lyle, Jacqueline Macdonald and Alison May. We do not have a classified board. Ms. Billings and Ms. May are the only management members of our Board of Directors. Our preferred stockholders are parties to a voting agreement that contractually obligates these stockholders to vote their shares for election of directors in the manner set forth therein, which agreement will terminate upon the closing of this offering, provided that the public offering price is not less than $9.368 per share if the offering closes on or prior to October 15, 2003, or $18.67979 per share if the offering closes thereafter, and the gross proceeds to us are not less than $20.0 million. Upon termination of the voting agreement, there will be no further contractual obligations regarding the election of our directors. Our directors hold office until their successors have been duly elected or qualified or until the earlier of their death, resignation, disqualification or removal. There are no family relationships among any of our directors and executive officers. Table of Contents Director Compensation Our directors do not currently receive compensation for their services as members of the Board of Directors, although we reimburse our non-employee directors for out-of-pocket expenses incurred in connection with attending board and committee meetings. Upon completion of this offering, we will compensate our non-employee directors with an annual retainer fee of $10,000 per member, an additional $1,000 per member for every board meeting attended, an additional $500 per committee member for every committee meeting attended, and annual fees of $2,500 for the chairman of the audit committee and $1,500 for the chairman of the compensation committee. We also granted an option to purchase 1,280 shares of our common stock to Michael E. Dunn in his capacity as a director without any prior direct or indirect ownership interest in RedEnvelope. Employee directors are eligible to participate in our 1999 Stock Plan and will be eligible to participate in our 2003 Employee Stock Purchase Plan. Non-employee directors will be eligible to participate in our 1999 Stock Plan and our 2003 Directors Stock Option Plan. Audit Committee Our audit committee is responsible for reviewing and monitoring our financial statements and internal accounting procedures, recommending the selection of independent auditors by our board, evaluating the scope of the annual audit, reviewing audit results, consulting with management and our independent auditor prior to presentation of financial statements to stockholders and, as appropriate, initiating inquiries into aspects of our internal accounting controls and financial affairs. The current members of our audit committee are Daniel Lyle, serving as the committee chairman, Michael Dunn and Jacqueline Macdonald. Compensation Committee Our compensation committee is responsible for establishing and reviewing salaries, incentives and other forms of compensation for our directors, President and Chief Executive Officer, other executive officers and other employees, and administering various incentive compensation and benefit plans. During our last fiscal year, our compensation committee members were Claire Gruppo and Michael Moritz. In April 2003, Charles Heilbronn replaced Ms. Gruppo as a member of the compensation committee. Compensation Committee Interlocks and Insider Participation As noted above, our compensation committee consisted of Claire Gruppo and Michael Moritz during our last fiscal year and currently consists of Charles Heilbronn and Michael Moritz. None of our executive officers serves or has served as a member of the board of directors or compensation committee of any entity that has one or more of its executive officers serving on our Board of Directors or compensation committee. (1) Ms. May received other compensation consisting of the payment of insurance premiums for group term life benefits in the amount of $573. (2) Ms. Billings received other compensation consisting of the payment of insurance premiums for group term life benefits in the amount of $243 and a $3,923 matching contribution to our 401(k) plan on her behalf. (3) Ms. Dang received other compensation consisting of the payment of insurance premiums for group term life benefits in the amount of $159 and a $2,204 matching contribution to our 401(k) plan on her behalf. (4) Ms. Herzog received other compensation consisting of the payment of insurance premiums for group term life benefits in the amount of $88 and a $398 matching contribution to our 401(k) plan on her behalf. (5) Mr. McClanan served as our Chief Executive Officer until April 8, 2002 and his employment relationship with RedEnvelope terminated on May 3, 2002. (6) Mr. McClanan received other compensation consisting of a $100,000 cash severance payment, a $70,000 bonus payment, a severance payment of $30,000 payable in RedEnvelope s Series F Preferred Stock, $800 as compensation for consulting services rendered by Mr. McClanan after his employment relationship with RedEnvelope terminated, a cash payment of accrued paid time off in the amount of $23,270, the payment of insurance premiums for group term life benefits in the amount of $32, a $500 matching contribution to our 401(k) plan on his behalf and payment of other indirect expenses in the amount of $258. (7) Mr. Cunningham served as an executive officer during the fiscal year ended March 30, 2003 but was not an executive officer at the end of the fiscal year ended March 30, 2003. (in thousands, except per share data) Net loss $ (7,711 ) $ (1,217 ) (1) Ms. May s option vests as to 25% of the shares one year after the vesting commencement date and as to 1/48 monthly thereafter. Ms. May s options are subject to vesting acceleration provisions described under Employment Agreements below. (2) Ms. Billings option vests as to 1/48 of the shares monthly. In addition, Ms. Billings was granted an option to purchase 149,444 shares of common stock in April 2003 at an exercise price of $2.22 per share which vests as to 1/48 of the shares monthly. Ms. Billings options are subject to vesting acceleration provisions described under Employment Agreements below. (3) Ms. Dang s option vests as to 1/48 of the shares monthly. (4) Ms. Herzog s option vests as to 25% of the shares one year after the vesting commencement date and as to 1/48 monthly thereafter. (5) Ms. Herzog s option vests as to 7/48 of the shares seven months after the vesting commencement date and as to 1/48 monthly thereafter. (6) Mr. Cunningham s option vested as to 1/48 of the shares monthly. Mr. Cunningham s employment with RedEnvelope terminated effective as of August 31, 2002 and he has three years from the date of his termination to exercise the vested options. (7) Mr. Blum s option vests as to 5/48 of the shares five months after the vesting commencement date and as to 1/48 monthly thereafter. Mr. Blum s employment with RedEnvelope terminated effective as of April 11, 2003 and he had three months from the date of his termination to exercise his vested options. At the end of this period, these options were not exercised and therefore expired. Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values The following table sets forth certain information regarding exercised stock options during the fiscal year ended March 30, 2003 and unexercised options held as of March 30, 2003, by each of the named (1) All options granted to executive officers are early exercisable and, when and if exercised, will be subject to a repurchase right held by RedEnvelope, which right lapses in accordance with the respective vesting schedules for the option grants. Employment Agreements Alison L. May s employment offer letter dated May 12, 2002 provides that she will receive severance payments equal to twelve months of her then current base salary, paid ratably over a twelve month period, and twelve months of continued health coverage in the event her employment is constructively terminated or terminated other than for cause and provided that she signs our standard general release of any claims against RedEnvelope and resigns from all positions with RedEnvelope. In addition, her option to purchase our common stock may be exercised by delivering a full recourse five-year term promissory note and upon a change of control of RedEnvelope twenty-five percent of the then unvested shares held by Ms. May shall immediately vest. Under the Sarbanes-Oxley Act of 2002, we may not be able to permit Ms. May to exercise her option by delivering a promissory note pursuant to her offer letter while she is a director or executive officer of RedEnvelope. Hilary Billings letter agreement dated April 10, 2002 provides that if, at any time prior to the earlier to occur of the closing of our initial public offering or a change of control of RedEnvelope, her total option and shareholdings in RedEnvelope are below three percent of the total outstanding shares, options, warrants and other convertible securities on an as-converted-to-common stock basis (including unallocated stock options), then our management will recommend to the Board of Directors that additional options to purchase common stock be granted to her at the then fair market value of RedEnvelope Common Stock with the same vesting schedule as other options and stock then held by her to ensure that her percentage increases to three percent. These rights will immediately terminate upon the closing of this offering. In the event of a change of control of RedEnvelope, then twenty-five percent of Ms. Billings then unvested options or shares will become immediately vested. If Ms. Billings employment is terminated other than for cause within the twelve month period following a change of control of RedEnvelope, then an additional twenty-five percent of her remaining unvested options or shares will become immediately vested. In addition, in the event that Ms. Billings employment is constructively terminated or terminated other than for cause, she will receive severance payments equal to twelve months of her then current base salary, paid ratably over a twelve month period and twelve months of continued health coverage, provided that she signs our standard general release of all claims against RedEnvelope and resigns from all positions with RedEnvelope. Finally, Ms. Billings options provide that she may exercise them by delivering to us a full-recourse, five-year term promissory note, and she has three years from the date of the termination of her employment with RedEnvelope to exercise her options. Under the Sarbanes-Oxley Act of 2002 we Weighted average common shares outstanding: 315 346 Plus weighted average preferred shares outstanding: Series A (conversion rate of 1.0) 627 627 Series B (conversion rate of 1.0) 385 385 Series C (conversion rate of 1.5816) 877 877 Series D (conversion rate of 1.7983) 350 350 Series E (conversion rate of 1.2720) 1,900 1,900 Series F (conversion rate of .9886) 1,724 1,818 Table of Contents may not be able to permit Ms. Billings to exercise her option by delivering a promissory note pursuant to her letter agreement while she is a director or executive officer of RedEnvelope. Pamela Knox s employment offer letter dated May 20, 2003 provides that she will receive severance payments totalling $125,000, paid ratably over a six month period, and six months of continued health coverage in the event her employment is terminated without cause and provided that she signs our standard general release of any claims against RedEnvelope. John W. Roberts employment offer letter dated February 18, 2003 provides that he will receive severance payments totaling $44,250, paid ratably over a three month period, in the event his employment is terminated without cause and provided that he signs our standard general release of any claims against RedEnvelope. Benefit Plans 1999 Stock Plan. Our Board of Directors initially adopted, and our stockholders approved, our 1999 Stock Plan in March 1999. The plan has been amended a number of times since then, including most recently in July 2003 when our Board of Directors approved amending and restating the plan, effective upon the date of this offering and subject to stockholder approval. We intend to obtain stockholder approval of this amendment prior to the date of this offering. The description of the plan s features contained below reflects the amendment and restatement that we expect to become effective on the date of this offering. Our 1999 Stock Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code, of 1968, as amended (the Code ), to our employees and for the grant of nonstatutory stock options, stock purchase rights, stock bonus awards, restricted stock awards, (including restricted stock units), stock appreciation rights, phantom stock rights and other similar equity-based awards to our employees, directors and consultants. We have reserved a total of 2,228,864 shares of our common stock for issuance pursuant to the 1999 Stock Plan. In addition, our 1999 Stock Plan provides for annual increases in the number of shares available for issuance under the plan on the first day of each of our fiscal years 2005, 2006, 2007, 2008 and 2009, equal to the lesser of 4% of the outstanding shares of common stock on the first day of the applicable fiscal year, 426,985 shares, or another amount as our Board of Directors may determine, provided that the number of shares that may be added under this formula in any year shall be limited such that, after adding the shares under this evergreen formula, the total number of shares available for issuance under the Plan may not exceed 4% of RedEnvelope s fully diluted capital stock. Shares issued pursuant to the Plan may be newly authorized shares, or may be treasury shares. Shares that are issued under the Plan but are repurchased by RedEnvelope or otherwise forfeited by the participant will become available for reissuance under the Plan. As of June 29, 2003, we had issued 388,419 shares upon exercise of awards granted under the 1999 Stock Plan, there were outstanding options and other awards to purchase an aggregate of 999,859 shares of common stock with a weighted average exercise price of $2.82 per share, and, taking into account the additional shares that we expect to become available for issuance upon the date of this offering, 840,586 shares of common stock are available for grant. All share numbers reflected in this plan summary, as well as the exercise price applicable to outstanding awards, will be automatically proportionately adjusted in the event we undertake certain changes in our capital structure, such as a stock split, stock dividend or other similar transaction. Our Board of Directors or, with respect to different groups of participants, different committees appointed by our Board of Directors, will administer the 1999 Stock Plan. In the case of options intended to qualify as performance-based compensation within the meaning of Section 162(m) of the Code, the committee will consist of two or more outside directors within the meaning of Section 162(m) of the Code. In addition, in administering the 1999 Stock Plan, we intend to comply with other applicable legal and regulatory requirements as may apply from time to time, including any Nasdaq listing requirements. The administrator has the power to determine the terms of the awards granted, including the exercise or purchase price, the number of shares subject to each award, the exercisability or vesting of the awards, the form of consideration payable upon exercise or purchase, and any forfeiture restrictions or vesting and exercisability acceleration provisions that apply to awards. Table of Contents The plan administrator has broad discretion to establish and change the terms of awards granted under our 1999 Stock Plan, including discretion to determine the exercise price applicable to options, which may be less than the fair market value of our common stock on the date of grant. Notwithstanding that discretion, with respect to nonstatutory stock options intended to qualify as performance-based compensation within the meaning of Section 162(m) of the Code that are granted to certain of our officers and all incentive stock options, the exercise price must be at least equal to the fair market value of our common stock on the date of grant. The term of incentive stock options may not exceed 10 years from the date of grant. No employee may be granted options to purchase more than 341,588 shares in any fiscal year. In addition, the Code imposes certain limitations on the value of shares that may be issued subject to incentive stock options. After termination of the service relationship of one of our employees, directors or consultants, he or she may exercise his or her option for the period of time stated in the option agreement. Generally, if termination is due to death or disability, the option will remain exercisable for 12 months. In most other cases, the option will generally remain exercisable for 3 months although the administrator may grant options with a longer period to exercise or extend this period with respect to an outstanding option. In no case may an option be exercised later than the expiration of its term. Generally, with respect to options granted prior to this offering, such options were exercisable in full (including as to unvested shares) immediately upon grant, but unvested shares exercised are subject to repurchase by the Company at the optionee s original cost. Our repurchase right with respect to unvested option shares lapses over the vesting term applicable to the option. Options granted after the date of this offering will generally not be exercisable for unvested shares. Options granted under the 1999 Stock Plan generally vest as to 25% of the shares underlying the option on the first anniversary of the date of grant and as to 1/48th of the underlying shares each month thereafter, assuming service with us continues throughout such period. The administrator may vary this vesting schedule at any time in its discretion. The 1999 Stock Plan permits us, without seeking stockholder approval, to reprice outstanding options or to enter into an option exchange program with plan participants, pursuant to which we may affect a reduction in the exercise price of awards held by plan participants. We may also issue stock purchase rights under our 1999 Stock Plan. These rights enable a participant to purchase shares of common stock on such terms as are determined by the administrator and set forth in an agreement between us and the participant. The administrator may establish a purchase price equal to less than fair market value with respect to stock purchase rights and may impose repurchase or other forfeiture restrictions on the stock subject to stock purchase rights. In addition, we may issue stock bonus awards, restricted stock awards (including restricted stock units), stock appreciation rights, phantom stock and similar equity-based awards. The administrator has broad discretion to establish the terms and conditions of these awards and may issue these awards without requiring the participant to pay fair market value for the shares issued. These awards may be subject to vesting requirements and may be subject to repurchase by us or other forfeiture conditions. Our 1999 Stock Plan provides that in the event of a change of control of RedEnvelope, the successor corporation may assume or substitute each outstanding award. The definition of a change of control includes a sale of all or substantially all of our assets, certain mergers or consolidations of RedEnvelope with or into another company, the acquisition by any person of a majority of our outstanding shares of stock or certain changes in the composition of our Board of Directors. If the successor corporation does not agree to assume, or substitute new awards for, outstanding awards in connection with the change of control, then the outstanding awards will terminate upon the close of the change of control. The administrator has the discretion to accelerate vesting with respect to options not being assumed. With respect to options granted prior to the date of this offering, participants are generally entitled to acceleration of vesting of 25% of the shares subject to the option in connection with a change of control of RedEnvelope (although some awards may provide for additional vesting acceleration). Following the date of this offering, although the administrator may vary the award terms, we currently anticipate that most plan awards will provide for acceleration of vesting in the event the participant s service relationship with us is involuntarily terminated without cause, or the participant experiences a constructive termination, within 12 months following the change of control, as to 25% of a participant s then-unvested shares. Total weighted average preferred shares outstanding (as converted) 5,863 5,957 Table of Contents The 1999 Stock Plan will automatically terminate on the tenth anniversary of this offering, unless our Board of Directors terminates it prior to that date. We may not issue incentive stock options under the 1999 Stock Plan after March 2009. Our Board of Directors has broad discretion to amend the 1999 Stock Plan, although such amendments may generally not adversely affect the rights of participants holding outstanding awards. We will seek stockholder approval of amendments to the 1999 Stock Plan to the extent required by applicable law or Nasdaq listing requirements. 2003 Directors Stock Option Plan. The 2003 Directors Stock Option Plan was adopted by the Board of Directors on April 11, 2003 to be effective upon this offering. RedEnvelope will be submitting the 2003 Directors Stock Option Plan for approval by our stockholders prior to the closing of this offering. A total of 449,615 shares of common stock have been reserved for issuance under the 2003 Directors Stock Option Plan. All share numbers reflected in this plan summary will be automatically proportionately adjusted in the event we undertake certain changes in our capital structure, such as a stock split, stock dividend or other similar transaction. The 2003 Directors Stock Option Plan is intended to be a formula award plan providing for the grant of nonstatutory stock options to non-employee members of our Board of Directors. It is designed to work automatically, without the need for administration by our Board of Directors or RedEnvelope. To the extent that active administration becomes necessary with respect to this plan and to the extent practicable based upon the composition of our Board of Directors, it will be performed by our Board of Directors without involvement of directors having a personal stake in any of the matters at issue. Unless terminated earlier by our Board of Directors, the 2003 Directors Stock Option Plan will terminate in April 2013. To the extent that it becomes necessary for us to amend the 2003 Directors Stock Option Plan, our Board of Directors may amend it as it determines appropriate, however such amendments may generally not adversely affect the rights of participants holding outstanding awards. We will seek stockholder approval of amendments to this plan to the extent required by applicable law or Nasdaq listing requirements. Under the 2003 Directors Stock Option Plan, each non-employee director who first becomes a non-employee director after the effective date of the plan will receive an automatic initial grant of an option to purchase 40,000 shares of our common stock upon appointment or election, including Karen Edwards whom we expect to be appointed to our Board of Directors as soon as practicable following the completion of this offering. Initial grants to non-employee directors will vest and become exercisable as to 25% of the shares subject to the option on each of the first four anniversaries of the date of grant. The 2003 Directors Stock Option Plan also provides for annual grants, on the date of each annual meeting of our stockholders, to each non-employee director who has served on our Board of Directors for at least six months and who will continue to serve on our Board of Directors thereafter. The annual grant to non-employee directors (other than our non-employee Chairman of the Board) will be an option to purchase 10,000 shares of common stock and the annual grant to any non-employee Chairman of the Board will be an option to purchase 20,000 shares. All annual option grants will vest and become exercisable as to 100% of shares subject to the option on the first anniversary of the date of grant. The exercise price of all stock options granted under the 2003 Directors Stock Option Plan shall be equal to the fair market value of a share of our common stock on the date of grant of the option. Options granted under the 2003 Directors Stock Option Plan have a term of ten years. However, unvested options will terminate when the optionee ceases to serve as a director and vested options will terminate if they are not exercised within 12 months after the director s death or disability or within 3 months after the director ceases to serve as a director for any other reason. In the event of a change of control of RedEnvelope, the 2003 Directors Stock Option Plan provides that any successor corporation will assume or substitute new awards for options outstanding under the plan. In the event that a successor corporation does not agree to assume or substitute new awards for outstanding options, then the options will accelerate in full as of immediately prior to the change of control and terminate upon the close of the change of control. In the event of a change of control of RedEnvelope in which options are being assumed or new awards substituted for outstanding options and a director s service on our Board of Directors is being involuntarily terminated other than for cause following the transaction, his or her option will provide for acceleration of vesting of 25% of the then-unvested shares. Table of Contents The 2003 Directors Stock Option Plan will automatically terminate in April 2013 unless our Board terminates it earlier. 2003 Employee Stock Purchase Plan. The 2003 Employee Stock Purchase Plan was adopted by our Board of Directors in April 2003 and will become effective on the date of this offering. RedEnvelope will be submitting the 2003 Employee Stock Purchase Plan for approval by our stockholders prior to the closing of this offering. A total of 401,366 shares of our common stock will be made available for issuance under this plan. In addition, our 2003 Employee Stock Purchase Plan provides for annual increases in the number of shares available for issuance under the 2003 Employee Stock Purchase Plan on the first day of each of our fiscal years 2005, 2006, 2007, 2008 and 2009, equal to the lesser of 1% of the outstanding shares of our common stock on the first day of the applicable fiscal year, 106,746 shares or another amount as our board may determine. All share numbers reflected in this plan summary will be automatically proportionately adjusted in the event we undertake certain changes in our capital structure, such as a stock split, stock dividend or other similar transaction. Our 2003 Employee Stock Purchase Plan is intended to qualify under Section 423 of the Code. It allows employees to purchase our common stock at a discount to market price through payroll deductions. The plan is structured through a series of consecutive six-month offering periods. Except for the first such offering period, these offering periods generally start on the first trading day on or after May 1st and November 1st of each year and end, respectively, on the last trading day of the next October and April. All eligible employees will automatically be granted an option to participate in the plan and thereby enrolled in the first offering period, but payroll deductions and continued participation in the first offering period will not be determined until after the effective date of the Form S-8 registration statement, which is intended to register the shares reserved for issuance under the 2003 Employee Stock Purchase Plan. Our Board of Directors or a committee established by our Board of Directors will administer the 2003 Employee Stock Purchase Plan. In addition, in administering the 2003 Employee Stock Purchase Plan, we intend to comply with other applicable legal and regulatory requirements as may apply from time to time, including any Nasdaq listing requirements. Our Board of Directors or its committee has full and exclusive authority to interpret the terms of the 2003 Employee Stock Purchase Plan and determine eligibility. Our employees and employees of designated subsidiaries, if any, are eligible to participate in the 2003 Employee Stock Purchase Plan if they are customarily employed for at least 20 hours per week and more than 5 months in any calendar year. A participant may not transfer rights granted under the 2003 Employee Stock Purchase Plan other than by will, the laws of descent and distribution or as otherwise provided under the 2003 Employee Stock Purchase Plan. An employee may not be granted an option to purchase stock under the 2003 Employee Stock Purchase Plan if: the employee immediately after grant owns stock possessing 5% or more of the total combined voting power or value of all classes of our capital stock the employee s rights to purchase stock under all of our employee stock purchase plans accrues at a rate that exceeds $25,000 worth of stock for each calendar year Our 2003 Employee Stock Purchase Plan permits participants to purchase common stock through payroll deductions of up to 15% of their eligible compensation, which includes a participant s base salary commissions, bonuses and overtime compensation. A participant may purchase a maximum of 1,500 shares during a six-month offering period. Amounts deducted and accumulated by the participant are used to purchase shares of our common stock at the end of each six-month offering period. The purchase price is 85% of the lower of the fair market value of our common stock at the beginning of the offering period or at the end of the offering period. Participants may end their participation at any time during an offering period prior to a purchase date, at which point their payroll deductions accumulated to date will be returned to them. Participation ends automatically upon termination of employment with us. In the event of a change of control of RedEnvelope, the successor corporation may assume or substitute each right to purchase stock outstanding under the 2003 Employee Stock Purchase Plan. If the successor corporation refuses to assume or substitute new awards for these rights, the offering period then in progress will be shortened, and a new exercise date will be set. In such event, the administrator will Total weighted average shares outstanding used in computing pro forma net loss per share 6,178 6,303 Table of Contents provide notice of the new exercise date to each optionee at least 10 business days before the new exercise date. The administrator has the authority to amend or terminate our 2003 Employee Stock Purchase Plan, except that, subject to certain exceptions described in the 2003 Employee Stock Purchase Plan (including amendments necessary to avoid our incurring adverse accounting charges), no such action may adversely affect any outstanding rights to purchase stock under our 2003 Employee Stock Purchase Plan. We will seek stockholder approval of amendments to the 2003 Employee Stock Purchase Plan to the extent required by applicable tax or other law or by any applicable Nasdaq listing requirements. Unless terminated earlier by our Board of Directors, the 2003 Employee Stock Purchase Plan will terminate in April 2023. 401(k) Plan. Effective January 1999, we adopted the RedEnvelope, Inc. 401(k) plan covering employees. The 401(k) plan is intended to qualify under Section 401(k) of the Internal Revenue Code of 1986, as amended, so that contributions to the 401(k) plan by employees or by RedEnvelope, and the investment earnings thereon, are not taxable to employees until withdrawn from the 401(k) plan, and so that contributions by RedEnvelope, if any, will be deductible by RedEnvelope when made. Under the 401(k) plan, employees may elect to reduce their current compensation by up to the statutorily prescribed annual limit and to have the amount of such reduction contributed to the 401(k) plan. The 401(k) plan permits, but does not require, additional matching contributions to the 401(k) plan by RedEnvelope on behalf of all participants in the 401(k) plan. For fiscal year ended 2003, we made approximately $0.1 million in matching contributions to the 401(k) plan. Limitations on Directors Liability and Indemnification Agreements Our Amended and Restated Certificate of Incorporation limits the liability of our directors to the maximum extent permitted by Delaware law. Delaware law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for any of the following acts: any breach of their duty of loyalty to the corporation or its stockholders acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law unlawful payments of dividends or unlawful stock repurchases or redemptions any transaction from which the director derived an improper personal benefit Such limitation of liability does not apply to liabilities arising under the federal securities laws and does not affect the availability of equitable remedies such as injunctive relief or rescission. Our Amended and Restated Certificate of Incorporation and Bylaws provide that we will indemnify our directors and executive officers and other corporate agents to the fullest extent permitted by law. We believe that indemnification under our Bylaws covers at least negligence and gross negligence on the part of indemnified parties. Our bylaws also permit us to obtain insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in such capacity, regardless of whether the bylaws would permit indemnification. We have entered into agreements to indemnify our directors and executive officers, in addition to the indemnification provided for in our Amended and Restated Certificate of Incorporation and Bylaws, subject to the relevant limitations imposed by Delaware law. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys fees), judgments, fines and settlement amounts incurred by them in any action or proceeding, including any action by or in the right of RedEnvelope, arising out of their services as a director or executive officer of RedEnvelope, any subsidiary of RedEnvelope or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. Table of Contents CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS During the last three fiscal years, there has not been any transaction or series of similar transactions to which RedEnvelope was or is a party in which the amount involved exceeded or exceeds $60,000 and in which any director or executive officer of RedEnvelope, any holder of more than 5% of any class of RedEnvelope s voting securities or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest, other than the compensation arrangements described in Management and the transactions set forth below. We believe that we have executed all of the transactions set forth below on terms no less favorable to us than we could have obtained from unaffiliated third parties. It is our intention to ensure that all future transactions between us and our officers, directors and principal stockholders and their affiliates, are approved by a majority of the Board of Directors, including a majority of the independent and disinterested members of our Board of Directors, and are on terms no less favorable to us than those that we could obtain from unaffiliated third parties. Private Placement Financings The shares of Series A preferred stock, Series B preferred stock, Series C preferred stock, Series D preferred stock, Series E preferred stock and Series F preferred stock outstanding immediately prior to the offering are convertible into 626,610 shares, 385,122 shares, 876,706 shares, 349,963 shares, 1,899,535 shares and 1,818,241 shares, respectively, of common stock. All share and per share amounts below have been adjusted to reflect a 1 for 11.71 reverse stock split, to be effected prior to the completion of this offering. From the inception of RedEnvelope through June 29, 2003, we have issued shares of preferred stock, and in certain cases associated warrants to purchase common stock, in private placement transactions as follows: an aggregate of 675,766 shares of Series A preferred stock in March 1999, in connection with our reincorporation in Delaware, of which 626,610 outstanding shares will convert into 626,610 shares of common stock in connection with this offering. an aggregate of 385,122 shares of Series B preferred stock at $5.86 per share in March 1999(1), which will convert into 385,122 shares of common stock in connection with this offering. an aggregate of 542,006 shares of Series C preferred stock at $37.88 per share in July 1999, which will convert into 857,227 shares of common stock in connection with this offering(2). an aggregate of 12,316 shares of Series C preferred stock at $37.88 per share in September 1999, which will convert into 19,479 shares of common stock in connection with this offering. an aggregate of 194,610 shares of Series D preferred stock at $56.83 per share in November and December 1999, which will convert into 349,963 shares of common stock in connection with this offering. an aggregate of 1,270,092 shares of Series E preferred stock at $23.19 per share in July 2000, which will convert into 1,615,519 shares of common stock in connection with this offering. an aggregate of 163,883 shares of Series E preferred stock at $23.19 per share in August 2000, which will convert into 208,453 shares of common stock in connection with this offering. an aggregate of 32,345 shares of Series E preferred stock at $23.19 per share in September 2000, which will convert into 41,142 shares of common stock in connection with this offering. an aggregate of 27,061 shares of Series E preferred stock at $23.19 per share to Experian Marketing Solutions in March 2001, September 2001, May 2002, December 2002 and March 2003, which will convert into 34,421 shares of common stock in connection with this offering. (1) Unless otherwise noted, shares held by affiliated persons and entities have been added together for purposes of this chart. See Principal Stockholders for a chart of beneficial owners. (2) Holder of at least 5% of our common stock as of June 29, 2003. (3) Claire Gruppo, who was a member of our Board of Directors until August 2003, is affiliated with Direct Equity Partners, L.P. and has an investment interest in Direct Equity Partners I, L.P. (4) Director of RedEnvelope. (5) Charles Heilbronn, who is a member of our Board of Directors, is affiliated with Moussenvelope, L.L.C. (6) Michael Moritz, who is a member of our Board of Directors, is affiliated with Sequoia Capital. (7) Jacqueline A. Macdonald, who is a member of our Board of Directors, is affiliated with Sippl Macdonald Ventures. Table of Contents Agreements with Management We have entered into letter agreements with certain of our executive officers, which contain vesting acceleration or severance benefits upon termination of employment or a change of control of RedEnvelope. See Management Employment Agreements for a description of these letter agreements. Please see Management Aggregate Option Exercises and Option Values and Principal Stockholders for a description of the option and stock holdings of our directors and executive officers. Please see Management Limitations on Directors Liability and Indemnification Agreements for a description of our indemnification agreements with our directors and executive officers. RedEnvelope entered into a Transition Agreement and Release, as amended, with Martin McClanan, the former Chief Executive Officer of RedEnvelope, on September 26, 2001 in connection with the termination of his employment. The Agreement provides for, among other things, a bonus and cash severance payment in the aggregate amount of $170,000, the issuance of 4,015 shares of Series F preferred stock and the extension of the exercise period on Mr. McClanan s option to purchase common stock. The Company entered into a Transition Agreement and Release with Christopher Cunningham, the Company s former Chief Information Officer on August 22, 2002. The Agreement provides for, among other things, a cash severance payment of $125,000 and the extension of Mr. Cunningham s option exercise period. Loans to Management In July 1999, in connection with the exercise of an option to purchase common stock granted to Hilary Billings, our Brand Strategist and a member of our Board of Directors, pursuant to our 1999 Stock Plan, we provided a loan to Ms. Billings pursuant to two promissory notes each with an interest rate of 5.74% and with an outstanding aggregate principal amount of approximately $44,000. Each note is secured by a pledge agreement whereby the stock purchased with the notes is pledged as collateral for the notes. As amended in May 2002, the promissory notes are due on July 20, 2007. Investors Rights Agreement We have entered into an agreement with the holders of our preferred stock, including entities with which certain of our directors are affiliated, which provides the holders of the preferred stock and certain holders of warrants to purchase our capital stock with rights relating to the registration of their shares of common stock issuable upon conversion of preferred stock, issuable upon exercise of warrants or issuable upon conversion of preferred stock issued upon exercise of warrants. See Description of Capital Stock Registration Rights. These rights will survive this offering and will terminate at such time as Rule 144 or another similar exemption under the Securities Act is available for the sale of all such holders securities within a three month period, but in no event later than five years following the closing of this offering. Indemnification and Employment Agreements RedEnvelope has entered into indemnification agreements with its officers and directors containing provisions that may require RedEnvelope, among other things, to indemnify its officers and directors against certain liabilities that may arise by reason of their status or service as officers or directors (other than liabilities arising from willful misconduct and other than as limited by Delaware law) and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. See Management Limitation of Liability and Indemnification Matters. We have also entered into employment agreements with certain of our officers. See Management Employment Agreements and Change of Control Arrangements. Relationship with PriceWaterhouseCoopers LLP PriceWaterhouseCoopers LLP served as our independent auditor for the fiscal year ended April 2, 2000. Daniel Lyle, a member of our Board of Directors since July 2003, was a partner of Table of Contents PriceWaterhouseCoopers LLP until June 2003. The aggregate consideration paid to PriceWaterhouseCoopers LLP for auditing services performed during the fiscal year ended April 2, 2000 was approximately $160,800. Certain Option Grants in Current Fiscal Year Certain of our executive officers have been granted options to purchase shares of our common stock in the current fiscal year. Specifically, Hilary Billings, our Brand Strategist, was granted an option to purchase 149,444 shares of common stock at an exercise price of $2.22 per share on April 11, 2003, John Roberts, our Senior Vice President of Information Technology and Operations, was granted options to purchase 15,798 shares of common stock at an exercise price of $2.22 per share and 2,988 shares of common stock at an exercise price of $5.86 per share on April 11, 2003 and July 14, 2003, respectively, Pamela Knox, our Senior Vice President of Marketing, was granted an option to purchase 53,372 shares of common stock at an exercise price of $2.22 per share on June 6, 2003, Eric Wong, our Chief Financial Officer and Secretary, was granted an option to purchase 10,674 shares of common stock at an exercise price of $2.22 per share on April 11, 2003, Kathy Herzog, our Vice President of Planning, was granted an option to purchase 4,269 shares of common stock at an exercise price of $2.22 per share on April 11, 2003 and Kristine Dang, our General Merchandising Manager, was granted an option to purchase 6,404 shares of common stock at an exercise price of $2.22 per share on April 11, 2003. 5% Stockholders Sequoia Capital(1) 1,021,747 16.2 % 12.0 % 3000 Sand Hill Road, Suite 4-180 Menlo Park, CA 94025 Direct Equity Partners I, L.P.(2) 822,855 13.1 % 9.7 % Three First National Plaza, Suite 3800 Chicago, IL 60602 Moussenvelope, L.L.C.(3) 727,661 11.5 % 8.6 % 9 West 57th Street Suite 4605 New York, NY 10019 R. Ian Chaplin(4) 636,179 10.1 % 7.5 % 716 La Canada Street La Jolla, CA 92037 Weston Presidio(5) 456,845 7.2 % 5.4 % 2420 Sand Hill Road, Suite 206 Menlo Park, CA 94025 Capital Research Management Company(6) 360,281 5.7 % 4.2 % 333 South Hope Street, 55th Floor Los Angeles, CA 90071 * less than one percent of the outstanding shares of common stock. (1) Includes 58,789 shares and 478 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital Entrepreneurs Fund and 381,931 shares and 3,108 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital IX and 70,496 shares and 573 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital IX Principals Fund. SC IX Management LLC is the general partner, general partner and managing member of Sequoia Capital Entrepreneurs Fund, Sequoia Capital IX, and Sequoia Capital IX Principals Fund, respectively, and exercises voting and investment power over the shares held by those entities. Also includes 448,901 shares and 3,926 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital Franchise Fund and 53,094 shares and 451 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital Franchise Partners. SCFF Management LLC is the general partner of Sequoia Capital Franchise Fund and Sequoia Capital Franchise Partners and exercises voting and investment power over the shares held by those entities. (2) Represents 822,855 shares held by Direct Equity Partners I, L.P. The shares held by Direct Equity Partners I, L.P. may be deemed to be beneficially owned by DEP, L.L.C., the general partner of Direct Equity Partners I, L.P., by Madison Dearborn Capital Partners III, L.P., the controlling member of DEP, L.L.C., by Madison Dearborn Partners III, L.P., the general partner of Madison Dearborn Capital Partners III, L.P., by Madison Dearborn Partners LLC, the general partner of Madison Dearborn Partners III, L.P., and by a committee of limited partners of Madison Dearborn Partners III, L.P. (3) Moussescribe, which is the general partner of Moussecapade, L.P., which is the managing member of Moussenvelope, LLC, exercises voting and investment power over the shares held by this entity through its directors Charles Heilbronn, Michael Rena and Jean Elizabeth Hoysradt. Messrs. Heilbronn, Rena and Ms. Hoysradt disclaim beneficial ownership of the shares, except to the extent of their pecuniary interests therein. (4) Includes 61,686 shares held by Galloway Chaplin Capital, G.P. and 264,603 shares held by GCC RedEnvelope, of which Mr. Chaplin is a general partner of each entity. Mr. Chaplin disclaims Table of Contents beneficial ownership of the shares held by those entities, except to the extent of his pecuniary interest therein. Also includes 309,890 shares held by Mr. Chaplin, of which Mr. Chaplin has granted options to purchase 33,532 shares to certain individuals. (5) Includes 435,227 shares held by Weston Presidio Capital III, L.P. and 21,618 shares held by WPC Entrepreneur Fund, L.P. Weston Presidio Capital Management III, LLC is the general partner of Weston Presidio Capital III, L.P. and WPC Entrepreneur Fund, L.P. and exercises voting power over the shares held by these entities through its managing members Michael Lazarus and Michael Cronin. Investment decisions for Weston Presidio Capital Management III, LLC are made by the Weston Presidio investment committee, currently comprised of Michael Lazarus, Michael Cronin and James McElwee. Messrs. Lazarus, Cronin and McElwee disclaim beneficial ownership of the shares, except to the extent of their pecuniary interests therein. (6) Includes 360,281 shares held by SMALLCAP World Fund, Inc in the nominee name Clipperbay Co. Capital Research Management Company, an investment adviser registered under Section 203 of the Investment Advisers Act of 1940, as amended, is the investment adviser to SMALLCAP World Fund, Inc. (7) Represents 296,151 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, of which 98,716 options are vested at that time. (8) Includes 75,907 shares, of which 696 shares are subject to repurchase by RedEnvelope, and 295,647 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, of which 158,152 options are vested at that time. (9) Includes 13,007 shares and 19,725 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, of which 7,046 options are vested at that time. (10) Represents 14,515 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, of which 4,197 options are vested at that time. (11) Includes 3,969 shares and 66,716 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested. (12) Includes 38,458 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested. (13) Represents 5,017 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options will expire if not exercised prior to that time. (14) Includes 58,789 shares and 478 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital Entrepreneurs Fund and 381,931 shares, 3,108 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital IX and 70,496 shares and 573 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital IX Principals Fund. SC IX Management LLC is the general partner, general partner and managing member of Sequoia Capital Entrepreneurs Fund, Sequoia Capital IX, and Sequoia Capital IX Principals Funds, respectively, and exercises voting and investment power over the shares held by those entities. Also includes 448,901 shares and 3,926 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital Franchise Fund and 53,094 shares and 451 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, all of which options are vested, held by Sequoia Capital Franchise Partners. SCFF Management LLC is the general partner of Sequoia Capital Franchise Fund and Sequoia Capital Franchise Partners and exercises voting and investment power over the shares held by those entities. Mr. Moritz is a general partner or managing member, as applicable, of those entities and disclaims beneficial ownership of the shares, except to the extent of his pecuniary interest therein. (15) Represents 1,280 shares issuable upon exercise of options exercisable within 60 days of June 29, 2003, of which 266 are vested at that time and 12,532 shares issuable upon exercise of options granted to Mr. Dunn by R. Ian Chaplin and Scott Galloway. Table of Contents (16) Includes 61,686 shares held by Galloway Chaplin Capital, G.P. and 264,603 shares held by GCC RedEnvelope, of which Mr. Galloway is a general partner of each entity. Mr. Galloway disclaims beneficial ownership of the shares held by those entities, except to the extent of his pecuniary interest therein. Also includes 309,890 shares held by Mr. Galloway, of which shares, Mr. Galloway has granted options to purchase 33,532 shares to certain individuals. (17) Represents 727,661 shares held by Moussenvelope, LLC. Mr. Heilbronn is a director of Moussescribe LLC, the general partner of Moussescapade, L.P., which is the managing member of Moussenvelope, LLC and which holds voting and investment power over the shares held by this entity. Mr. Heilbronn disclaims beneficial ownership of the shares, except to the extent of his pecuniary interest therein. (18) Includes 79,668 shares held by Sippl Macdonald Ventures II, L.P. Sippl Macdonald Management LLC is the general partner of Sippl Macdonald Ventures II, L.P. and exercises voting and investment power over the shares held by this entity through its managing members Roger Sippl and Jacqueline Macdonald. Also includes 94,546 shares held by Sippl Macdonald Ventures III, L.P. Sippl Macdonald Management III, LLC is the general partner of Sippl Macdonald Ventures III, L.P. and exercises voting and investment power over the shares held by this entity through its managing members, Roger Sippl and Jacqueline Macdonald. Ms. Macdonald and Mr. Sippl disclaim beneficial ownership of the shares, except to the extent of their pecuniary interests therein. (19) See footnotes (7) through (18). Also includes 17,078 shares held by Eric Wong issuable upon exercise of options exercisable within 60 days of June 29, 2003, none of which options are vested at that time, 10,674 shares held by Kristel Craven issuable upon exercise of options exercisable within 60 days of June 29, 2003, of which 2,668 options are vested at that time, 15,798 shares held by John Roberts issuable upon exercise of options exercisable within 60 days of June 29, 2003, none of which options are vested at that time, and 53,372 shares held by Pamela Knox issuable upon exercise of options exercisable within 60 days of June 29, 2003, of which 10,674 options are vested at that time. Table of Contents DESCRIPTION OF CAPITAL STOCK Upon the completion of this offering, RedEnvelope will be authorized to issue 100,000,000 shares of common stock, $0.01 par value per share, and 2,000,000 shares of undesignated preferred stock, $0.01 par value per share. All share and per share amounts have been adjusted to give effect to the automatic conversion of all preferred stock into common stock and a 1 for 11.71 reverse stock split, each to be effected on or prior to completion of this offering. Common Stock As of June 29, 2003, there were 6,304,568 shares of common stock outstanding, as adjusted to reflect the conversion of all outstanding shares of preferred stock held of record by 143 stockholders. In addition, options to purchase 1,008,395 shares of common stock and warrants exercisable for 78,655 shares of common stock were also outstanding. After this offering, there will be 8,504,568 shares of common stock outstanding (assuming no exercise of the underwriters overallotment option or exercise of outstanding options under RedEnvelope s stock plans). The holders of common stock are entitled to one vote for each share held of record on all matters submitted to a vote of the stockholders. Subject to preferences that may be applicable to any outstanding preferred stock, holders of common stock are entitled to receive ratably such dividends as may be declared by our Board of Directors out of funds legally available for that purpose. Under the terms of our credit agreement with CapitalSource Finance LLC, our ability to pay dividends is contractually prohibited during the term of that agreement. See Dividend Policy. In the event of liquidation, dissolution or winding up of RedEnvelope, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to the prior distribution rights of any outstanding preferred stock. The common stock has no preemptive or conversion rights or other subscription rights. The outstanding shares of common stock are, and the shares of common stock to be issued upon completion of this offering will be, fully paid and non-assessable. Preferred Stock Upon the closing of this offering, all outstanding shares of preferred stock will be converted into 5,956,177 shares of common stock and the preferred stock will automatically be retired. Thereafter, our Board of Directors will have the authority, without further action by the stockholders, to issue up to 2,000,000 shares of preferred stock, $0.01 par value, in one or more series. Our Board of Directors will also have the authority to designate the rights, preferences, privileges and restrictions of each such series, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series. The issuance of preferred stock may have the effect of delaying, deferring or preventing a change in control of RedEnvelope without further action by the stockholders. The issuance of preferred stock with voting and conversion rights may also adversely affect the voting power of the holders of common stock. In certain circumstances, an issuance of preferred stock could have the effect of decreasing the market price of the common stock. Upon the closing of this offering, no shares of preferred stock will be outstanding. We currently have no plans to issue any shares of preferred stock. Warrants As of June 29, 2003, there was a warrant outstanding to purchase an aggregate of 791 shares of common stock at an exercise price of $56.88 per share, which survives the closing of this offering. In addition, there was a warrant outstanding to purchase an aggregate of 17,079 shares of common stock at an exercise price of $1.64 per share, which survives the closing of this offering. Finally, there were warrants outstanding to purchase an aggregate of 61,499 shares of preferred stock at a weighted average exercise price of $7.47 per share, which survive the closing of this offering and which will convert into warrants to purchase an aggregate of 60,795 shares of common stock at a weighted average exercise price of $7.56 per share upon the closing of this offering. Table of Contents Registration Rights The holders of 5,964,986 shares of common stock and warrants to purchase 78,665 shares of common stock or their transferees will be entitled to certain rights with respect to the registration of such shares under the Securities Act. These rights are provided under the terms of an agreement between RedEnvelope and the holders of these securities. Subject to limitations in the agreement, the holders of at least 40% of these securities then outstanding may require, on three occasions beginning six months after the date of this prospectus, that RedEnvelope use its best efforts to register these securities for public resale if registration on Form S-3 is not available. If RedEnvelope registers any of its common stock either for its own account or for the account of other security holders, the holders of these securities are entitled to include their shares of common stock in that registration, subject to the ability of the underwriters to limit the number of shares included in the offering. The holders of at least 20% of these securities then outstanding may also require RedEnvelope, on four occasions but not more than twice in any twelve-month period, to register all or a portion of these securities on Form S-3 when the use of that form becomes available to RedEnvelope, provided, among other limitations, that the proposed aggregate selling price is at least $2,000,000, net of any underwriters discounts or commissions. RedEnvelope will be responsible for paying all registration expenses (including the reasonable fees of legal counsel for the selling holders), and the holders selling their shares will be responsible for paying all selling expenses. Delaware Anti-Takeover Law and Certain Provisions of our Amended and Restated Certificate of Incorporation and Bylaws Provisions of Delaware law and RedEnvelope s Amended and Restated Certificate of Incorporation and Bylaws to be effective upon the closing of this offering could make the acquisition of RedEnvelope and the removal of incumbent directors more difficult. These provisions are expected to discourage certain types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of RedEnvelope to negotiate with us first. Delaware Law. RedEnvelope is subject to the provisions of Section 203 of the Delaware law. In general, the statute prohibits a publicly-held Delaware corporation from engaging in a business combination with an interested stockholder for a period of three years after the date that the person became an interested stockholder unless, subject to exceptions, the business combination or the transaction in which the person became an interested stockholder is approved in a prescribed manner. Generally, a business combination includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the stockholder. Generally, an interested stockholder is a person who, together with affiliates and associates, owns, or within three years prior, did own, 15% or more of the corporation s voting stock. These provisions may have the effect of delaying, deferring or preventing a change in control of RedEnvelope without further action by the stockholders. Certificate of Incorporation and Bylaw Provisions. RedEnvelope s Amended and Restated Certificate of Incorporation to be effective upon the closing of this offering provides that stockholder action can be taken only at an annual or special meeting of stockholders and may not be taken by written consent. In addition, our Amended and Restated Certificate of Incorporation authorizes undesignated preferred stock, making it possible for our Board of Directors to issue, without further stockholder action, preferred stock having voting or other rights or preferences that could prevent or make more difficult an attempted hostile takeover of RedEnvelope. Our Bylaws to be effective upon the closing of this offering provide that special meetings of stockholders can be called only by our Board of Directors, the Chairman of our Board, if any, or our President. Moreover, the business permitted to be conducted at any special meeting of stockholders is limited to the business brought before the meeting by our Board of Directors, the Chairman of our Board, if any, or our President. The Bylaws set forth an advance notice procedure with regard to the nomination, other than by or at the direction of our Board of Directors, of candidates for election as directors and with regard to business to be brought before an annual meeting of stockholders. Table of Contents Nasdaq National Market Listing Our shares will be listed on the Nasdaq National Market under the symbol REDE. Transfer Agent The Transfer Agent and Registrar for our common stock is American Stock Transfer Trust Co. The transfer agent s address is 59 Maiden Lane, Plaza Level, New York, NY 10038. Table of Contents SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no public market for our common stock. We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of shares of our common stock for sale will have on the market price of our common stock prevailing from time to time. Nevertheless, sales of substantial amounts of our common stock in the public market could adversely affect the market price of our common stock and could impair our future ability to raise capital through the sale of our equity securities. Upon the completion of this offering, we will have 8,504,568 shares of our common stock outstanding, assuming no exercise of the underwriters over-allotment option and no exercise of outstanding options or warrants after June 29, 2003. Of these outstanding shares, the 2,200,000 shares sold in this offering will be freely tradable, except that any shares held by our affiliates as that term is defined in Rule 144 promulgated under the Securities Act, may only be sold in compliance with the limitations described below. The remaining 6,304,568 shares of our common stock will continue to be deemed restricted securities as defined under Rule 144. Restricted shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rule 144 or Rule 701 promulgated under the Securities Act, which are summarized below. In addition, all of our stockholders have entered into market stand-off agreements with us and/or lock-up agreements with WR Hambrecht+Co whereby they have agreed not to sell any of their stock for 180 days following the date of this prospectus. Subject to the provisions of Rule 144 and Rule 701, additional shares will be available for sale in the public market as follows: beginning on the effective date of the registration statement, the 2,200,000 shares sold in this offering will be immediately available for sale in the public market after 180 days following the effective date of the registration statement 6,300,963 additional shares will become eligible for sale in the public market, subject to compliance with Rule 144 and Rule 701 as described below the remaining 3,605 shares will be eligible for sale in March 2004, subject to compliance with Rule 144 Lock-Up Agreements Each of our officers, directors, one percent or greater stockholders and certain other stockholders have agreed, subject to specified exceptions, that, without prior written consent of WR Hambrecht+Co, they will not offer, sell, contract to sell, pledge, grant any option to sell, or otherwise dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exercisable for shares of our common stock, or warrants or other rights to purchase our common stock during the 180-day period following the effective date of the registration statement. WR Hambrecht+Co, may, in its sole discretion, permit early release of shares subject to the lock-up agreements. In considering any request to release shares subject to a lock-up agreement, WR Hambrecht+Co will consider the possible impact of the release of the shares on the trading price of the stock sold in the offering. WR Hambrecht+Co does not have any present intention or any understandings, implicit or explicit, to release any of the shares subject to the lock-up agreements prior to the expiration of these lock-up periods. Rule 144 In general, under Rule 144 as currently in effect, a person, or group of persons whose shares are required to be aggregated, including an affiliate of RedEnvelope, who has beneficially owned shares for at least one year, is entitled to sell within any three-month period, a number of shares that does not exceed the greater of one percent of the then outstanding shares of our common stock, or the average weekly trading volume in our common stock during the four calendar weeks preceding the date on which notice of the sale is filed. In addition, a person who is not deemed to have been an affiliate at any time during the 90 days preceding a sale and who has beneficially owned the shares proposed to be sold for at least two Table of Contents years would be entitled to sell those shares under Rule 144(k) without regard to the requirements described above. When a person acquires shares from one of our affiliates, that person s holding period for the purpose of effecting a sale under Rule 144 would commence on the date of transfer from the affiliate. Rule 701 In general, under Rule 701 of the Securities Act, an employee, officer, director, consultant or advisor who purchased shares from us in connection with a compensatory stock or option plan or other written agreement in compliance with Rule 701 is eligible to resell those shares in reliance on Rule 144, but without compliance with certain restrictions, including the holding period contained in Rule 144. However, the shares issued pursuant to Rule 701 are subject to the lock-up agreements described above and under Plan of Distribution and will only become eligible for sale upon the expiration of those agreements. Registration of Shares Issued Pursuant to Benefits Plans We intend to file registration statements under the Securities Act as promptly as possible after the effective date of this offering to register shares to be issued pursuant to our employee benefit plans. As a result, any options or rights exercised under our 1999 Stock Plan, our 2003 Employee Stock Purchase Plan, our 2003 Directors Stock Option Plan or any other benefit plan after the effectiveness of the registration statements will also be freely tradable in the public market, subject to the market stand-off and lock-up agreements discussed above. However, such shares held by affiliates will still be subject to the volume limitation, manner of sale, notice and public information requirements of Rule 144. As of June 29, 2003, there were outstanding options under our benefit plans for the purchase of 999,859 shares of common stock, with an average exercise price of $3.45, each of which options were exercisable and subject to a standard repurchase option in favor of RedEnvelope to the extent such shares were not vested, in accordance with the terms of the grant. Public Offering Price Underwriting Discounts Proceeds, before expenses, to us The expenses of the offering, exclusive of the underwriting discounts, will be approximately $1.2 million. These fees and expenses are payable entirely by us. These fees include, among other things, our legal and accounting fees, printing expenses, expenses incurred in connection with meetings with potential investors, filing fees of the Securities and Exchange Commission and the National Association of Securities Dealers, Inc., fees of our transfer agent and registrar and the listing fees of the Nasdaq National Market. An electronic prospectus is available on the website maintained by WR Hambrecht+Co, and may also be made available on websites maintained by other underwriters, selected dealers and selling group members participating in this offering. Other than the prospectus in electronic format, the information on these websites is not part of this prospectus and has not been approved or endorsed by us. Table of Contents The OpenIPO Auction Process The distribution method being used in this offering is known as the OpenIPO auction, which differs from methods traditionally used in underwritten public offerings. In particular, the public offering price and the allocation of shares are determined primarily by an auction conducted by the underwriters. All qualified individual and institutional investors may place bids in an OpenIPO auction and investors submitting valid bids have an equal opportunity to receive an allocation of shares. The following describes how the underwriters and some selected dealers conduct the auction process and confirm bids from prospective investors: Before the registration statement relating to this offering becomes effective, the underwriters and participating dealers solicit bids from prospective investors through the Internet and by telephone and facsimile. The bids specify the number of shares of our common stock the potential investor proposes to purchase and the price the potential investor is willing to pay for the shares. These bids may be above or below the range set forth on the cover page of the prospectus. The minimum size of any bid is 100 shares. The shares offered by this prospectus may not be sold, nor may offers to buy be accepted, prior to the time that the registration statement filed with the Securities and Exchange Commission becomes effective. A bid received by the underwriters or a dealer involves no obligation or commitment of any kind prior to the closing of the auction. Bids can be modified or revoked at any time prior to the closing of the auction. Approximately two business days prior to the registration statement being declared effective, prospective investors receive, by e-mail, telephone or facsimile, a notice indicating the proposed effective date. After the registration statement relating to this offering has become effective, potential investors who have submitted bids to the underwriters or a dealer are contacted by e-mail, telephone or facsimile. Potential investors are advised that the registration statement has been declared effective and are requested to confirm their bids. The auction will close after the registration statement becomes effective at a time agreed to by us and WR Hambrecht+Co, which we anticipate will be immediately after the close of trading on the Nasdaq National Market on the same day on which the registration statement is declared effective. However, the date on which the auction will close cannot currently be predicted and will be determined by us and WR Hambrecht+Co based on general market conditions during the period after the registration statement is declared effective. If we are unable to determine a public offering price, close the auction and file a final prospectus with the Securities and Exchange Commission within 15 days after the registration statement is initially declared effective, we will be required to file with the Commission and have declared effective a post- effective amendment to the registration statement before the auction may be closed and before any bids may be accepted. If we are unable to close the auction within 15 days after the registration statement is initially declared effective, the underwriters or dealers will reconfirm all bids by either telephone or email following the filing and effectiveness of the post-effective amendment. After the registration statement has been declared effective, the public offering price of the common stock may be set at a price that is outside the range set forth on the cover of the prospectus. All bids that are not confirmed before the time specified by WR Hambrecht+Co, or if the time is not specified, by the close of the auction, are deemed withdrawn. Once a potential investor affirmatively confirms its previous bid, the confirmation remains valid unless subsequently withdrawn by the potential investor. Potential investors are able to withdraw their bids at any time before the close of the auction by notifying the underwriters or a participating dealer. If the public offering price range is changed before or after a potential investor affirmatively confirms a bid, or if the public offering price is outside the public offering range previously provided Table of Contents to the potential investor in the prospectus, the underwriters and participating dealers notify potential investors of the change and that offers will not be accepted until the potential investor has again reconfirmed its bid regardless of whether the potential investor s initial bid was above, below or at the public offering price. Following the closing of the auction, the underwriters determine the highest price at which all of the shares offered, including shares that may be purchased by the underwriter to cover any over-allotments, may be sold to potential investors. This price, which is called the clearing price, is determined based on the results of all valid bids at the time the auction is closed. The clearing price is not necessarily the public offering price, which is set as described in Determination of Public Offering Price below. The public offering price determines the allocation of shares to potential investors, with all bids submitted at or above the public offering price receiving a pro rata portion of the shares bid for. Once the auction closes and a clearing price is set as described below, the underwriters or a participating dealer accept the bids from those bidders whose bid is at or above the public offering price but may allocate to a prospective investor fewer shares than the number included in the investor s bid. Bidders receiving a pro rata portion of the shares bid receive an allocation of shares on a round lot basis, rounded to multiples of 100 or 1000 shares, depending on the size of the bid. No bids are rounded to a round lot higher than the original bid size. Because bids may be rounded down to round lots in multiples of 100 or 1000 shares, some bidders may receive allocations of shares that reflect a greater percentage decrease in their original bid than the average pro rata decrease. Thus, for example, if a bidder has confirmed a bid for 200 shares, and there is an average pro rata decrease of all bids of 30%, the bidder may receive an allocation of 100 shares (a 50% decrease from 200 shares) rather than receiving an allocation of 140 shares (a 30% decrease from 200 shares). In addition, some bidders may receive allocations of shares that reflect a lesser percentage decrease in their original bid than the average pro rata decrease. For example, if a bidder has confirmed a bid for 100 shares, and there is an average pro rata decrease of all bids of 30%, the bidder may receive an allocation of all 100 shares to avoid having the bid rounded down to zero. The underwriters or a participating dealer notifies successful bidders by e-mail, telephone or facsimile or mail that the auction has closed and that their confirmed bids have been accepted. Other bidders are notified that their bids have not been accepted. Potential investors may at any time expressly request that all, or any specific, communications between them and the underwriter and participating dealers be made by specific means of communication, including e-mail, telephone and facsimile. The underwriters and selected dealers that participate in this offering may request prospective investors to confirm their bids prior to the effective date of the registration statement, if that practice is used by these institutions in connection with initial public offerings that are not conducted using the OpenIPO process. Bidders should carefully review the procedures of, and communications from, the institution through which they bid to purchase our shares. In general, approximately two business days before the registration statement is declared effective, the underwriters and dealers will request potential investors to reconfirm the bids that they have submitted. If a bid is not reconfirmed prior to the close of the auction, it is rejected. If a bid is reconfirmed, it may still be modified or revoked prior to the auction closing; however, if the reconfirmed bid is not revoked prior to the effectiveness of the registration statement and the closing of the auction, it is considered a firm bid and may be accepted at the closing of the auction. The underwriters and these dealers will also seek reconfirmation of bids in the event that the price range of the offering is changed, or if the initial public offering price is set at a price that is outside the range that has previously been provided to potential investors. Table of Contents Determination of Public Offering Price The public offering price for this offering is ultimately determined by negotiation between the underwriters and us after the auction closes and does not necessarily bear any direct relationship to our assets, current earnings or book value or to any other established criteria of value, although these factors are considered in establishing the initial public offering price. Prior to the offering, there has been no public market for our common stock. The principal factor in establishing the public offering price is the clearing price resulting from the auction. The clearing price is the highest price at which all of the shares offered, including the shares that may be purchased by the underwriters to cover any over-allotments, may be sold to potential investors, based on the valid bids at the time the auction is run. The shares subject to the underwriters over-allotment option are used to calculate the clearing price whether or not the option is actually exercised. Factors considered in determining the initial public offering price include an assessment of our management, operating results, capital structure and business potential and the demand for similar securities of comparable companies. Changes, if any, in the public offering price are based primarily on the bids received. The public offering price may be lower, but will not be higher, than the clearing price based on negotiations between the underwriters and us. The public offering price always determines the allocation of shares to potential investors. Therefore, if the public offering price is below the clearing price, all bids that are at or above the public offering price receive a pro rata portion of the shares bid for. If sufficient bids are not received, or if we do not consider the clearing price to be adequate, or if we and the underwriters are not able to reach agreement on the public offering price, then we and the underwriters will either postpone or cancel this offering. Alternatively, we may file a post-effective amendment to the registration statement in order to conduct a new auction. The following simplified example illustrates how the public offering price is determined through the auction process: Company X offers to sell 1,000 shares in its public offering through the auction process. The underwriters, on behalf of Company X, receive five bids to purchase, all of which are kept confidential until the auction closes. The first bid is to pay $10.00 per share for 200 shares. The second bid is to pay $9.00 per share for 300 shares. The third bid is to pay $8.00 per share for 600 shares. The fourth bid is to pay $7.00 per share for 400 shares. The fifth bid is to pay $6.00 per share for 800 shares. Assuming that all of these bids are confirmed and not withdrawn or modified before the auction closes, and assuming that no additional bids are received, the clearing price used to determine the public offering price would be $8.00 per share, which is the highest price at which all 1,000 shares offered may be sold to potential investors who have submitted valid bids. However, the shares may be sold at a price below $8.00 per share based on negotiations between Company X and the underwriters. If the public offering price is the same as the $8.00 per share clearing price, the underwriters would confirm bids at or above $8.00 per share. Because 1,100 shares were bid for at or above the clearing price, each of the three potential investors who bid $8.00 per share or more would receive approximately 90% of the shares for which bids were made. The two potential investors whose bids were below $8.00 per share would not receive any shares in this example. If the public offering price is $7.00 per share, the underwriters would confirm bids that were made at or above $7.00 per share. No bids made at a price of less than $7.00 per share would be accepted. The four potential investors with the highest bids would receive a pro rata portion of the 1,000 shares offered, based on the 1,500 shares they requested, or two-thirds of the shares for which bids were made. The potential investor with the lowest bid would not receive any shares in this example. Total 1,000 $ 8,000 Requirements for Valid Bids Valid bids are those that meet the requirements, including eligibility, account status and size, established by the underwriters or participating dealers. In order to open a brokerage account with WR Hambrecht+Co, a potential investor must deposit $2,000 in its account. This brokerage account will be a general account subject to WR Hambrecht+Co s customary rules, and will not be limited to this offering. In addition, once the registration statement becomes effective and the auction closes, a prospective investor submitting a bid through a WR Hambrecht+Co brokerage account must have an account balance equal to or in excess of the amount of its bid or its bid is not accepted by WR Hambrecht+Co. However, other than the $2,000 described above, prospective investors are not required to deposit any money into their accounts until after the registration statement becomes effective. No funds will be transferred to WR Hambrecht+Co, and any amounts in excess of $2,000 may be withdrawn at any time until the acceptance of the bid and the subsequent closing of this offering. Conditions for valid bids, including eligibility standards and account funding requirements of other participating dealers other than WR Hambrecht+Co, may vary. The Closing of the Auction and Allocation of Shares The auction closes on a date estimated and publicly disclosed in advance by the underwriters on the website of WR Hambrecht+Co at www.wrhambrecht.com and www.openipo.com. The 2,200,000 shares offered by this prospectus, or 2,530,000 shares if the underwriters over-allotment option is exercised in full, will be purchased from us by the underwriters and sold through the underwriters and participating dealers to investors who have submitted valid bids at or higher than the public offering price. These investors are notified by e-mail, telephone, voice mail, facsimile or mail as soon as practicable following the closing of the auction that their bids have been accepted. Each participating dealer has agreed with the underwriters to sell the shares it purchases from the underwriters in accordance with the auction process described above, unless the underwriters otherwise consent. The underwriters reserve the right to reject bids that the underwriters deem manipulative or disruptive in order to facilitate the orderly completion of this offering, and the underwriters reserve the Table of Contents right, in exceptional circumstances, to alter this method of allocation as the underwriters deem necessary to ensure a fair and orderly distribution of the shares of our common stock. For example, large orders may be reduced to ensure a public distribution and bids may be rejected or reduced by the underwriters or participating dealers based on eligibility or creditworthiness criteria. In addition, the underwriters or the participating dealers may reject or reduce a bid by a prospective investor who has engaged in practices that could have a manipulative, disruptive or otherwise adverse effect on the offering. Some dealers participating in the selling group may submit firm bids that reflect indications of interest from their customers that they have received at prices within the initial public offering price range. In these cases, the dealer submitting the bid is treated as the bidder for the purposes of determining the clearing price and allocation of shares. Price and volume volatility in the market for our common stock may result from the somewhat unique nature of the proposed plan of distribution. Price and volume volatility in the market for our common stock after the completion of this offering may adversely affect the market price of our common stock. We have granted to the underwriters an option, exercisable no later than 30 days after the date of this prospectus, to purchase up to an aggregate of 330,000 additional shares of our common stock from us at the offering price, less the underwriting discounts and commissions set forth on the cover page of this prospectus. To the extent that the underwriters exercise this option, they will have a firm commitment to purchase the additional shares and we will be obligated to sell the additional shares to the underwriters. The underwriters may exercise the option only to cover over-allotments made in connection with the sale of shares offered. The underwriting agreement provides that we will indemnify the underwriters against specified liabilities, including liabilities under the Securities Act, or contribute to payments that the underwriters may be required to make. We have agreed not to offer, sell, contract to sell, pledge, grant any option to purchase, make any short sale or otherwise dispose of any shares of common stock, or any options or warrants to purchase common stock other than the shares of common stock or options to acquire common stock issued under our stock plans, for a period of 180 days after the date of this prospectus, except with the prior written consent of WR Hambrecht+Co. Each of our officers, directors and one percent stockholders have agreed, subject to specified exceptions, that, without prior written consent of WR Hambrecht+Co, they will not offer, sell, contract to sell, pledge, grant any option to sell, or otherwise dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exercisable for shares of our common stock, or warrants or other rights to purchase our common stock during the 180-day period following the date of this prospectus. Certain other stockholders have also agreed, subject to specified exceptions, that, without prior written consent of WR Hambrecht+Co, they will not offer, sell, contract to sell, pledge, grant any option to sell, or otherwise dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exercisable for shares of our common stock, or warrants or other rights to purchase our common stock during the 180-day period following the date of this prospectus. WR Hambrecht+Co, may, in its sole discretion, permit early release of shares subject to the lock-up agreements. In considering any request to release shares subject to a lock-up agreement WR Hambrecht+Co will consider the possible impact of the release of the shares on the trading price of the stock sold in the offering. WR Hambrecht+Co does not have any present intention or any understandings, implicit or explicit, to release any of the shares subject to the lock-up agreements prior to the expiration of these lock-up periods. In connection with the offering, the underwriters may purchase and sell shares of common stock in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the underwriters of a greater number of shares than they are required to purchase in the offering. Covered short sales are sales made in an amount not greater than the underwriters option to purchase additional shares from us in the offering. The underwriters may close out any covered short position by either exercising their option to purchase additional shares or purchasing shares in the open market. In determining the source of shares to close out Table of Contents CAPITALIZATION The following table sets forth our capitalization at June 29, 2003, (i) on an actual basis, (ii) on a pro forma basis after giving effect to the conversion of all shares of outstanding preferred stock into shares of common stock which will be effected upon the closing of this offering, and (iii) on a pro forma as-adjusted basis to reflect the receipt of the estimated net proceeds from the sale of 2,200,000 shares of common stock offered by us at the public offering price of $14.00 per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. The following information gives effect to a 1 for 11.71 reverse stock split to be effected prior to the completion of this offering. You should read the information below in conjunction with the Financial Statements and the related notes thereto and Management s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this prospectus. As of June 29, 2003 Table of Contents the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. Naked short sales are any sales in excess of such option. The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market after pricing that could adversely affect investors who purchase in the offering. Stabilizing transactions consist of various bids for or purchases of common stock made by the underwriters in the open market prior to the completion of the offering. These activities by the underwriters may stabilize, maintain or otherwise affect the market price of the common stock. As a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriters at any time. These transactions may be effected on the Nasdaq National Market, in the over-the-counter market or otherwise. WR Hambrecht+Co and Pacific Crest Securities Inc. currently intend to act as market makers for the common stock following this offering. However, they are not obligated to do so and may discontinue any market making at any time. Indemnity The underwriting agreement contains covenants of indemnity between the underwriters and us against certain civil liabilities, including liabilities under the Securities Act, and liabilities arising from breaches of representations and warranties contained in the underwriting agreement. Listing We have applied to list our common stock on Nasdaq National Market under the proposed trading symbol REDE. LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Venture Law Group, A Professional Corporation, Menlo Park, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by Morrison Foerster LLP, San Francisco, California. As of the date of this prospectus, certain attorneys of Venture Law Group and an investment entity affiliated with Venture Law Group own an aggregate of 13,519 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001239768_pdc-2003_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001239768_pdc-2003_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3e5928713595531f56df7c21c36734039b345f68 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001239768_pdc-2003_legal_matters.txt @@ -0,0 +1 @@ +S-1/A 1 s1a3.htm As filed with the Securities and Exchange Commission on September 15, 2003 Registration No. 333-105983 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ______________________ AMENDMENT NO. 3 TO FORM S-1 REGISTRATION STATEMENT Under THE SECURITIES ACT OF 1933 ______________________ PDC 2003 DRILLING PROGRAM I (Exact name of registrant as specified in its charter) West Virginia (State or other jurisdiction of incorporation or organization) 1381 (Primary Standard Industrial Classification Code Number) Applied for (IRS Employer Identification No.) 103 East Main Street Bridgeport, West Virginia 26330 304/842-6256 ___________________ (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ______________________ Steven R. Williams, President Petroleum Development Corporation 103 East Main Street Bridgeport, West Virginia 26330 304/842-6256 (Name, address including zip code, and telephone number, including area code, of agent for service) Copies to: Laurence S. Lese Duane Morris LLP 1667 K Street, N.W., Suite 700 Washington, D.C. 20006-1608 (202) 776-7800 Approximate date of commencement of proposed sale to the public: As soon as practicable after the registration statement becomes affective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 the Securities Act of 1933, check the following box. [x] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. [ ] CALCULATION OF REGISTRATION FEE Title of each class of securities to be registered Amount to be registered Proposed maximum offering price per unit Proposed maximum aggregate offering price Amount of registration fee (1) Units of general and limited partnership interest 2,625 units $20,000 $52,500,000 $4,248 (1) Registration fee calculated on the basis of $80.90 per $1 million of securities registered. The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, or until the registration statement shall become effective on such date as the Commission, acting pursuant to Section 8(a) shall determine. EXPLANATION The sole reason that PDC 2003 Drilling Program (the "Program") is filing this registration statement is to register additional securities for sale by the Program's two remaining limited partnerships, PDC 2003-C Limited Partnership and PDC 2003-D Limited Partnership. In October 2000, the Program filed with the SEC its original Form S-1 registration statement, SEC File No. 333-47622. In that registration statement, the Program registered a total of $150 million of its securities to sell over a three year period on behalf of its twelve constituent limited partnerships, PDC 2001-A Limited Partnership, PDC 2001-B Limited Partnership, PDC 2001-C Limited Partnership, and PDC 2001-D Limited Partnership; PDC 2002-A Limited Partnership, PDC 2002-B Limited Partnership, PDC 2002-C Limited Partnership, and PDC 2002-D Limited Partnership; and PDC 2003-A Limited Partnership, PDC 2003-B Limited Partnership, PDC 2003-C Limited Partnership, and PDC 2003-D Limited Partnership. The Program sold in excess of $57 million of its securities in the four PDC 2001-constituent limited partnerships; in excess of $57 million of its securities in the four PDC 2002-constituent limited partnerships; and in excess of $8 million of its securities in PDC 2003-A Limited Partnership. In view of its experience with respect to the sales of its securities in its first nine limited partnerships, the Program understood that it was likely that the approximately $28 million of its securities remaining unsold at the beginning of May 2003 would not be sufficient for the projected sales of its securities in the final three PDC 2003-constituent limited partnerships. In view of Rule 413 under the Securities Act of 1933, the Program understood that it would need to file a new registration statement under the Securities Act of 1933 to register additional securities that the Program believed would be sufficient for its final two limited partnerships to sell during their respective 2003 offering periods. Therefore, the Program has filed this Form S-1 registration statement to register Program securities to be sold by PDC 2003-C Limited Partnership and PDC 2003-D Limited Partnership. These two limited partnerships are the only limited partnerships sponsored by the Program that are authorized by the Program to use the prospectus portion of this registration statement to effect sales of the Program's securities. PROSPECTUS PDC 2003 DRILLING PROGRAM $52.5 Million Offered ($1,750,000 Minimum Subscriptions) Preformation General Partnership Units and Limited Partnership Units $20,000 per Unit (Minimum Subscription - $5,000) PDC 2003 Drilling Program, which we refer to as the "program" in this prospectus, is a series of up to twelve limited partnerships which Petroleum Development Corporation, the managing general partner, will form to drill, own, and operate natural gas and oil wells in Colorado, Michigan, North Dakota, West Virginia, Pennsylvania, Utah and other states. The program intends to drill its wells in Colorado. We have completed the offerings of our first ten limited partnerships, PDC 2001-A through -D Limited Partnerships, PDC 2002-A through -D Limited Partnerships, and PDC 2003-A and -B Limited Partnerships; each of these partnerships is currently conducting its business. The program sold an aggregate of approximately $[135] million of its securities in these ten limited partnerships. This prospectus relates solely to the offering of securities of PDC 2003-C Limited Partnership and PDC 2003-D Limited Partnership, the program's final two limited partnerships. These Securities Are Speculative and Involve a High Degree of Risk. See "Risk Factors" on page 5 for an explanation of the various risks involved in this offering. Investment risks and considerations include: Drilling gas and oil wells is highly risky; you might lose your entire investment in the program. No investor may participate in the management of any partnership. The program has not yet selected any prospects for gas and oil drilling; thus, no investor can evaluate any prospect before investing. Investors may be subject to unlimited liability. No public market exists or will develop for the units; you may not be able to sell your units when or if you wish. Significant tax considerations are involved in an investment. We must sell a minimum of $1.75 million with respect to PDC 2003-C Limited Partnership and $3.5 million with respect to PDC 2003-D Limited Partnership if we sell any units. We will sell units beyond the minimum amount on a best efforts basis. The offerings of partnerships designated PDC 2003- Limited Partnership will terminate on December 31, 2003. Bank One, West Virginia, N.A. will hold subscription proceeds of each partnership in a separate escrow account and will not release funds to a partnership before the sale of the minimum number of that partnership's units. See "Plan of Distribution" on page ___ for a discussion of the various terms and conditions involved in this offering. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Neither the attorney general of the State of New York nor the attorney general of the State of New Jersey nor the Bureau of Securities of the State of New Jersey has passed on or endorsed the merits of this offering. Any representation to the contrary is unlawful. Price to Public Underwriting Discounts and Commissions Proceeds to the Partnerships Per Unit .......... $ 20,000 $ 2,100 (10.5%) $ 17,900 (89.5%) Total Minimum ..... $ 1,750,000 $ 183,750 (10.5%) $ 1,566,250 (89.5%) Total Maximum ..... $52,500,000 $5,512,500 (10.5%) $46,987,500 (89.5%) PDC Securities Incorporated, Dealer Manager and an Affiliate of the Managing General Partner The date of this prospectus is , 2003. TABLE OF CONTENTS Page SUMMARY * RISK FACTORS * Special Risks of the Partnerships * Drilling natural gas and oil wells is speculative, may be unprofitable, and may result in the total loss of your investment * Spot market prices for natural gas typically have been lower in Colorado than spot market prices in the Eastern United States * Investors can anticipate an extended period before they achieve payout on their investment in the partnership * The Managing General Partner has not selected any prospects for acquisition, and as a result the investor partners will be unable to evaluate any prospect before they invest in the program * Because of a lengthy offering period, delays in the investment of an investor's subscription are likely; because of the delay, you can expect a delay in any cash distributions from the partnership to you. * Additional general partners will be individually liable for partnership obligations and liabilities beyond the amount of their subscriptions, partnership assets, and the assets of the Managing General Partner * The Managing General Partner and its affiliates will receive compensation from the partnership upon funding of the partnership and throughout the life of the partnership; these compensation payments could result in conflicts of interest by the Managing General Partner and its affiliates; compensation payments made to the Managing General Partner and its affiliates will reduce the amount of cash distributions that investors may receive * The partnership's wells might not produce commercial quantities of natural gas or oil; as a result, your investment in the partnership might not be profitable * Our retention of partnership revenues to pay for additional development work would result in a reduction of cash distributions to investors in the short term and may not increase cash distributions in the long term * Withholding funds for development work will decrease your cash distributions but may not decrease the taxes you must pay * There will be no public market for the units, and as a result an investor partner may not be able to sell his or her units * Sufficient insurance coverage may not be available for the partnership, thereby increasing the risk of loss for the investor partners * A partnership which drills fewer wells will be less diversified, thereby increasing the risk of financial loss for the investors * Through their involvement in partnership and other non-partnership activities, the Managing General Partner and its affiliates have interests which conflict with those of the investor partners; actions taken by the Managing General Partner in furtherance of its own interests could result in the partnership's being less profitable and a reduction in cash distributions to the investors * Unaffiliated persons might manage jointly-owned partnership prospects; a partnership could be financially liable for obligations of jointly-owned prospects; as a result, the expenses of the partnership might increase and the cash distributions to investors might decrease * The partnership may not borrow funds, even if needed for partnership operations; as a result, the partnership might not have sufficient capital for its operations and we might not be able to fully develop the partnership's wells; in that event, an investor might anticipate a reduction in cash distributions * The partnership and other partnerships sponsored by the Managing General Partner may compete with each other for prospects, equipment, contractors, and personnel; as a result, the partnership may find it more difficult to operate effectively and profitably * The partnership may drill exploratory wells, which involves a greater risk of financial loss than drilling development wells * The results of drilling previous partnerships sponsored by the Managing General Partner are not indicative of the results to be experienced by the partnerships; your investment in the partnership might not be profitable * In view of the cost sharing arrangements, the investor partners will bear the substantial amount of costs and risks of non-commercial wells * Investor partners may be personally liable if they violate the limited partnership agreement * Indemnification of additional general partners by the Managing General Partner could reduce the value of the partnership and the investment interests of the investor partners * Receipt by limited partners of partnership distributions could result in liability of the limited partners to the partnership * A significant financial loss by the Managing General Partner could result in our inability to indemnify additional general partners for personal losses suffered because of partnership liabilities * An investor partner may not receive a cash distribution if the distribution would cause a capital account deficit * The dealer manager is not independent and has not conducted an independent due diligence evaluation of the offering * Risks Pertaining to Natural Gas and Oil Investments * The drilling of natural gas and oil wells is highly speculative and risky and may result in unprofitable wells * The prices for natural gas and oil have been quite unstable; a decline in the price could cause the partnership to be unprofitable * Fluctuating market conditions and government regulations may cause a decline in the profitability of the partnership * Rapid growth of production in the Rocky Mountain region may result in lower prices and production restrictions until new pipeline facilities are put in service. * Environmental hazards involved in drilling gas and oil wells may result in substantial liabilities for the partnership * Increases in drilling costs would reduce the partnership's profitability * A reduced availability of drilling rigs, due in part to intense competition in drilling, may delay the drilling of partnership wells and cash distributions to investors * Failure by subcontractors to pay for materials or services could reduce the partnership's profitability * Delay in partnership gas production could reduce the partnership's profitability * Tax Status and Tax Risks * Partnership classification as a corporation or a publicly traded partnership would substantially alter the tax treatment of the partnership * An investment as a limited partner may not be advisable for a person who does not anticipate having substantial current taxable income from passive activities * An investment as an additional general partner in the partnership may not be advisable for a person whose taxable income from all sources is not recurring and is not subject to the higher marginal federal income tax rates * Under the Code, a partner's tax liabilities may exceed the cash distributions received by that partner * If the Service audits the partnership's tax returns, an investor partner might owe more taxes plus interest and penalties * Partnership losses after the conversion of general partnership interests to limited partnership interests will be passive losses for tax purposes * A material portion of the subscription proceeds will not be currently deductible * If the Service challenges the partnership's deduction for the prepayment of drilling costs, you could owe additional taxes plus interest and penalties * Counsel's tax opinion does not cover various tax considerations involved in one's investment in the partnership * CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS * TERMS OF THE OFFERING * General * Activation of the Partnerships * Types of Units * Conversion of units by the Managing General Partner and by additional general partners * Unit Repurchase Program * Investor Suitability * ASSESSMENTS AND FINANCING * SOURCE OF FUNDS AND USE OF PROCEEDS * Source of Funds * Use of Proceeds * Subsequent Source of Funds * PARTICIPATION IN COSTS AND REVENUES * Profits and Losses; Cash Distributions * Revenues * Costs * Partnership Costs * Allocations Among Investor Partners; Deficit Capital Account Balances * Cash Distribution Policy * Termination * COMPENSATION TO THE MANAGING GENERAL PARTNER AND AFFILIATES * PROPOSED ACTIVITIES * Introduction * Drilling Policy * Acquisition of Undeveloped Prospects * Title to Properties * PDC Prospects * Drilling and Completion Phase * Production Phase of Operations * Interests of Parties * Insurance * The Managing General Partner's Policy Regarding Roll-Up Transactions * COMPETITION, MARKETS AND REGULATION * Competition and Markets * Natural Gas Pricing * Regulation * Proposed Regulation * MANAGEMENT * General Management * Experience and Capabilities as Driller/Operator * Petroleum Development Corporation * Certain Shareholders of Petroleum Development Corporation * Remuneration * Legal Proceedings * CONFLICTS OF INTEREST * Certain Transactions * FIDUCIARY RESPONSIBILITY OF THE MANAGING GENERAL PARTNER * PRIOR ACTIVITIES * Prior Partnerships * Previous Drilling Activities * Previous Drilling Activities * Tax Deductions and Tax Credits of Participants in Previous Partnerships * Partnership Estimated Proved Reserves and Future Net Revenues * TAX CONSIDERATIONS * Summary of Conclusions * General Tax Effects of Partnership Structure * Intangible Drilling and Development Costs Deductions * Classification of Costs * Timing of Deductions * Recapture of IDC * Depletion Deductions * Depreciation Deductions * Interest Deductions * Transaction Fees * Basis and At Risk Limitations * Passive Loss Limitations * Introduction * General Partner Interests * Limited Partner Interests * Alternative Minimum Tax * Gain or Loss on Sale of Property or Units * Partnership Distributions * Partnership Allocations * Tax Shelter Rules * Profit Motive * Administrative Matters * Accounting Methods and Periods * Social Security Benefits; Self-employment Tax * State and Local Taxes * Individual Tax Advice Should Be Sought * SUMMARY OF LIMITED PARTNERSHIP AGREEMENT * Responsibility of Managing General Partner * Liability of General Partners, Including Additional General Partners * Liability of Limited Partners * Allocations and Distributions * Voting Rights * Retirement and Removal of the Managing General Partner * Term and Dissolution * Indemnification * Reports to Partners * Power of Attorney * Other Provisions * TRANSFERABILITY OF UNITS * PLAN OF DISTRIBUTION * SALES LITERATURE * LEGAL OPINIONS * EXPERTS * ADDITIONAL INFORMATION * GLOSSARY OF TERMS * SUMMARY This summary highlights material information from this prospectus. You should read the entire prospectus carefully and the attached appendices before you decide to invest. We direct prospective investors to the "Glossary of Terms" beginning on page ___ for definitions of various technical terms appearing throughout the prospectus. Business of the Partnerships Each partnership will drill, own, and operate natural gas and oil wells which may be located in Colorado, Michigan, West Virginia, Pennsylvania, Utah, Wyoming, North Dakota and/or other states and will produce and sell gas and oil from these wells. The partnerships intend to drill their respective wells in Colorado. Of the offering proceeds available for drilling operations, we plan to utilize most partnership proceeds in the drilling of development wells but may utilize up to 10% on one or more exploratory wells. A development well is a well which is drilled close to and to the same formation as wells which have already produced and sold oil or gas. An exploratory well is one which is drilled in an area where there has been no oil or gas production, or a well which is drilled to a previously untested or non-producing zone in an area where there are wells producing from other formations. See "Proposed Activities" (page ___) for a discussion of the various business activities that we propose to undertake after the operations of a partnership commence. The address and telephone number of the partnerships and Petroleum Development Corporation, the Managing General Partner, are 103 East Main Street, P.O. Box 26, Bridgeport, West Virginia 26330 and (304) 842-6256. Investment Objectives This section discusses the investment objectives of the partnerships in PDC 2003 Drilling Program. For reasons we discuss later in this summary and prospectus under "Risk Factors," you may not realize some or all of the benefits discussed below. You should only invest in this partnership if you can afford the loss of your entire investment. The program provides you with an opportunity to invest in the drilling, completion, and production of natural gas and oil wells. The objective of the investment is to produce the following benefits for investors in the program: Cash distributions from the sale of natural gas and oil. Investors will receive a portion of the cash profits from wells if we drill successful wells and if revenue from the wells exceeds expenses. We plan to drill partnership wells in areas where most successful wells continue to produce for 20 years or more. We expect to send the first partnership distribution to investors six months after a partnership closes. Closing of a partnership occurs at the end of the last day that we accept subscriptions from investors. A diversified investment in ten or more wells. We try to include at least ten wells in each partnership so that the impact of an unsuccessful well or wells is balanced by successful results of other wells. We also try to include wells from two or more geographic areas to offset poor results in one area by results in the other area. Reduce your taxes due in the year you make your investment. We have structured the partnership to allow you to deduct 87-89-1/2% of your investment from your taxable income in the year you invest as intangible drilling costs, which we refer to as "IDC." Under federal tax law, your federal tax savings will be based upon the IDC deduction, your marginal income tax rate and the amount of your investment in the partnership. There are factors which may limit your ability to use the deductions to reduce taxes, and you may have to recapture some or all of the tax savings if you sell your partnership interest. Accurate and timely reports, including Form K-1 tax information distributed the first week of February. We want you to know how and when your money is spent, what the operating results of the partnership are, and where the money you get in return comes from. We plan, prepare and distribute the Form K-1 tax information you need to prepare your taxes in early February each year, even though the Internal Revenue Service deadline is April 15, so you can file your tax return when you are ready. The production from natural gas and oil wells decreases as time passes, so your cash flow will also decrease over time. Natural gas and oil prices change constantly, so your cash flow can also increase or decrease from month to month. Your cash distributions will be partially sheltered from taxes by depletion. You may not receive some or all of these investment benefits for a variety of reasons including those discussed under "Risk Factors" later in the prospectus. Terms of the Offering (page ___) The Program. PDC 2003 Drilling Program is a series of up to twelve limited partnerships to be formed under the West Virginia Uniform Limited Partnership Act. In this prospectus, we refer to each as a "partnership" or in the plural as the "partnerships." We will offer and sell units of the various partnerships during 2001, 2002 and 2003. See "Terms of the Offering" (page ___) for a discussion of the terms and conditions involved in making an investment in the program. Each partnership when formed will constitute a separate business entity. A limited partnership agreement will govern the rights and obligations of the partners of each partnership. We attach a form of the limited partnership agreement as Appendix A to the prospectus. See "Summary of Partnership Agreement" (page ___) where we summarize the material features of the limited partnership agreement. The offering of the Program's four PDC 2001-designated limited partnerships, PDC 2001-A through -D Limited Partnerships, closed during 2001. We sold a total of $57,107,498 of subscriptions in these four limited partnerships. The offering of the Program's four PDC 2002-designated limited partnerships, PDC 2002-A through -D Limited Partnerships, closed during 2002. We sold a total of $57,115,432 of subscriptions in these four limited partnerships. The offering of the Program's first two PDC 2003-designated limited partnership, PDC 2003-A Limited Partnership and PDC 2003-B Limited Partnership, closed on April 30, 2003 and September 8, 2003, respectively. We sold a total of $[__________]_ of subscriptions in these two limited partnerships. Each of these ten limited partnerships has been funded and is currently conducting its respective business. The Managing General Partner. The managing general partner of each partnership will be Petroleum Development Corporation, which we refer to in this prospectus as the "Managing General Partner" or sometimes as "PDC." See "Management" (page ___) for a description of the management of PDC and of the business experience of the senior officers and employees of PDC. Units of Partnership Interest. You may choose to purchase units of general partnership interest or units of limited partnership interest in the particular partnership being offered. "Unit" means a partnership interest of a limited partner or of an additional general partner purchased by an investor partner. This interest is the right and obligation to share a proportional part of the investor partners' share of partnership income, expense, assets and liabilities. The fractional interest purchased by a one unit investment in the investor partners' interest in the partnership is the ratio of one unit to the total number of units sold. If you invest as an additional general partner, you will be able to apply tax deductions generated by the partnership to reduce your federal adjusted gross income regardless of the source of the income, but you will have unlimited liability for the activities of the partnership. If you are an individual investor and invest as a limited partner, you will be able to use your deductions only to reduce taxable income from passive sources. The Internal Revenue Service defines passive income as income from partnerships and rental activities. Your liability as a limited partner is restricted to your investment in the partnership. See "Terms of the Offering - Types of Units" (page ___) for a discussion of the different aspects involved in an investment in limited partnership interests and general partnership interests. Funding of a Partnership. In order to fund a partnership, we must sell a minimum of 87-1/2 units or $1,750,000 for PDC 2003-C Limited Partnerships and a minimum of 175 units or $3,500,000 for PDC 2003-D Limited Partnership. The maximum subscription for PDC 2003-C Limited Partnerships is 875 units or $17,500,000 and for PDC 2003-D Limited Partnership is 1,750 units or $35,000,000. For example, we must sell at least 87-1/2 units or $1,750,000 to fund the PDC 2003-C Limited Partnership and at least 175 units or $3,500,000 to fund the PDC 2003-D Limited Partnership. If you wish to see a table presenting the minimum and maximum subscriptions and the targeted offering termination and closing date for each partnership, see "Terms of the Offering - General" (page ___). Subscription and Escrow. All subscriptions are payable in cash upon subscription. We may not complete a sale of units to you until at least five business days after the date you have received a final prospectus. Once you submit your subscription and the five-day period has passed, your subscription is not revocable and you will not be able to get your subscription funds back, including the time your funds are in the escrow account, unless we do not complete the offering. We have selected Bank One, West Virginia as escrow agent to hold all subscription proceeds of each partnership in a separate interest-bearing escrow account. See "Terms of the Offering" (page ___) for a discussion of how we will hold your subscriptions between our receipt of your funds and the time we close the offering or return your funds if we do not complete the offering. Conversion of Units by the Managing General Partner and by Additional General Partners. We will convert all units of general partnership interest of a particular partnership into the same dollar amount of units of limited partnership interest of that partnership upon completion of drilling and completion operations of that partnership. Additional general partners may convert their units of general partnership interest into units of limited partnership interest if there is a material change in the amount of the partnership's insurance coverage. We must notify you if there is a large reduction of the insurance coverage, and you will be able to tell us to convert your interest any time during the 30 days preceding the change. You will not be able to convert your unit if the conversion would cause a termination of the partnership for federal tax purposes. See "Terms of the Offering - Conversion of Units by the Managing General Partner and by Additional General Partners" (page ___), "Proposed Activities - Insurance" (page ___), and "Tax Considerations - Conversion of Interests" (page ___) for a discussion of the circumstances involved in converting units to limited partnership interests, the nature and extent of the insurance PDC carries, and the tax implications involved in a conversion of interests. Unit Repurchase Program. Beginning with the third anniversary of the date of the first cash distribution of the particular partnership, investor partners of that partnership may offer their units to us for repurchase. Repurchase of units is subject to our financial ability to purchase the units and an opinion of counsel that the partnership will not be treated as a publicly traded partnership under the Internal Revenue Code. The purchase price will be not less than four times the most recent twelve months' cash distributions from production. See "Terms of the Offering - Unit Repurchase Program" (page ___) and "Tax Considerations - Gain or Loss on Sale of Property or Units" (page ___) for an explanation of how the repurchase program operates and for a discussion of the tax implications involved in a repurchase of units. Suitability Standards - Long-Term Investment. We have instituted strict suitability standards for investment in the partnerships. You may not invest unless you satisfy the suitability requirements. See "Terms of the Offering - Investor Suitability" (page ___) to see if you are eligible to purchase units in the program. Risk Factors. This offering involves numerous risks, including the risks associated with gas and oil drilling and investments in gas and oil drilling programs, unlimited liability as an additional general partner, lack of a trading market in the units, and significant tax considerations. See "Risk Factors" (page ___) and "Tax Considerations" (page ___). You should carefully consider the significant risk factors inherent in and affecting the business of the partnerships and this offering before making an investment. You should also carefully read the "Tax Considerations" section of the prospectus and the tax opinion of our tax counsel in Appendix D to the prospectus for a discussion of the tax implications involved in an investment in units. Compensation of the Managing General Partner (page ___) We and our affiliates will receive substantial compensation upon the formation and as a result of the operation of the partnership. We will receive fees for drilling and operating partnership wells, for marketing the natural gas produced by partnership wells, and for administering the partnerships, commissions and fees for selling the units of the partnerships, and a one-time drilling management fee equal to 2-1/2% of the aggregate subscriptions upon closing of each partnership. The compensation payable to the Managing General Partner and its affiliates will reduce the amount of cash distributions to investors. See "Compensation to the Managing General Partner and Affiliates" (page ___) where we discuss the Managing General Partner's equity interest in the partnership as well as the various fees, payments and reimbursements that the Managing General Partner and/or its affiliates will receive during the life of the partnership. Participation in Costs and Revenues (page ___) Generally, investor partners will receive 80% and the Managing General Partner will receive 20% of partnership profits and losses throughout the term of each partnership. Amounts will be paid to partners only after payment of fees and expenses to the Managing General Partner and its affiliates and only if there is sufficient cash available. The investors' share of Partnership profits is increased to 90% and our share is decreased to 10% if the partnership does not have an average annual return of 12.8% at any time during the first 10 years of the partnership. We calculate the average annual return as the sum of estimated initial tax savings of 25% of the investment plus investor cash distributions as a percentage of the investment, divided by the number of years since the closing of the partnership less 6 months. You can see an example of this calculation is shown on page ___. The interests of the investor partners and us could also change if we invest additional funds for tangible drilling and lease costs. See "Participation in Costs and Revenues - Revenues - Revisions to Sharing Arrangements" (page ___) and " - Costs - Lease Costs, Tangible Well Costs, and Gathering Line Costs" (page ___). In these sections, we explain the revenues and costs allocations involved in operation of the partnership's business. Application of Proceeds (page ___) We estimate that we will apply the proceeds from the aggregate funding of a partnership, after our cash contribution, as follows. See "Source of Funds and Use of Proceeds" (page ___). This section shows the amount of capital a partnership will have upon formation, the organization and offering costs, the management fee, and the amount of funds that will be available to a partnership to drill its wells. Activity Percentage of Total Capital Contributions Drilling and Completion Costs 89.3% Organization and Offering Costs 8.6% Management Fee 2.1% Total 100.0% Tax Considerations; Opinion of Counsel (page ___) Duane Morris LLP has issued to us its opinion, concerning all material federal income tax issues applicable to an investment in the partnerships. See "Tax Considerations" (page ___) for a discussion of the tax implications of an investment in the program. To fully understand these tax issues, you should read the tax opinion in Appendix D. Rights of the Investor Partners (page ___) The limited partnership agreement, which we attach to this prospectus as Appendix A, sets forth your rights as an investor partner. For a summary of your rights, see "Summary of Limited Partnership Agreement." RISK FACTORS Investment in the partnerships involves a high degree of risk and is suitable only for investors of substantial financial means who have no need of liquidity in their investments. As a prospective investor, you should consider carefully the following factors, in addition to the other information in this prospectus, prior to making your investment decision. Special Risks of the Partnerships Drilling natural gas and oil wells is speculative, may be unprofitable, and may result in the total loss of your investment. The drilling and completion operations to be undertaken by each of the partnerships for the development of natural gas and oil reserves are speculative and involve the possibility of a total loss of your investment in a partnership. Drilling activities may be unprofitable, not only from non-productive wells, but also from wells which do not produce natural gas or oil in sufficient quantities or quality to return a profit on the amounts expended. None of the prior partnerships sponsored by us has, to date, generated cash distributions in excess of investor subscriptions without tax savings. See "Prior Activities - Participants' Net Cash Table" and " - Percentage of Gross Return on Subscriptions" which reflect, respectively, the cash distributed to the investor partners and the gross returns to investor partners considering the cash distributions and tax benefits attributable to an investment in prior partnerships. Investment is suitable only for individuals who are financially able to withstand a total loss of their investment. See "Terms of the Offering - Investor Suitability" (page ___) to determine whether you qualify to invest in the program. Spot market prices for natural gas typically have been lower in Colorado than spot market prices in the Eastern United States. Historically, prices for natural gas in Colorado have, on average, been lower than those nationally as reflected by the natural gas prices traded on the New York Mercantile Exchange ("NYMEX"). For the years 1999 through 2002, Colorado natural gas prices as indicated by the Colorado Interstate Gas ("CIG") monthly index ranged from $1.20 per MMBtu to $8.63 per MMBtu, while during the same timeframe, the last day's settled price for Natural Gas NYMEX contracts ranged from $1.67 per MMBtu to $9.98 per MMBtu. For that period of 1999 through 2002 the average percentage relationship of the CIG monthly index was 79.2% of the NYMEX settled price. Investors can anticipate an extended period before they achieve payout on their investment in the partnership. Estimated payout periods of the various partnerships, which have conducted their drilling operations in Colorado, sponsored by the Managing General Partner from 1999 through 2002 range from 10 to 26 years based on estimated future net revenues of these various partnerships. See "Participants' Estimated Future and Total Payout and Payout Period" table below under "Prior Activities." The Managing General Partner has not selected any prospects for acquisition, and as a result the investor partners will be unable to evaluate any prospect before they invest in the program. We have not selected any prospect for acquisition by any partnership and will not select prospects for a particular partnership until after the activation of that partnership. You will not have an opportunity before purchasing units to evaluate for yourself the relevant geophysical, geological, economic or other information regarding the prospects to be selected. See "Proposed Activities - Acquisition of Undeveloped Prospects" (page ___) for a description of how we will select prospects for the partnership. Because of a lengthy offering period, delays in the investment of an investor's subscription are likely; because of the delay, you can expect a delay in any cash distributions from the partnership to you. Upon execution and delivery by you, your subscription will be irrevocable and cannot be withdrawn. Because the offering period for a particular partnership can extend for up to seven months, delays in the investment of proceeds from your initial subscription date are likely. As a result, you will be unable to invest funds in other investments. Also, because of the delay in the investment, there will be a delay in cash distributions to you by the partnership. Cash distributions will be paid only after payment of fees and expenses to the Managing General Partner and its affiliates and only if there is sufficient cash available. See "Terms of the Offering - General" (page ___) for a discussion of the procedures involved in the offering and in the formation of a partnership. Additional general partners will be individually liable for partnership obligations and liabilities beyond the amount of their subscriptions, partnership assets, and the assets of the Managing General Partner. Under West Virginia law, the state in which each partnership will organize, general partners of a partnership have unlimited liability with respect to that partnership. Therefore, the additional general partners will be liable individually and as a group for all obligations and liabilities of creditors and claimants, whether arising out of contract or tort, in the conduct of partnership operations. If you invest as an additional general partner, you may be liable for amounts in excess of your subscriptions, the assets of the partnership, including insurance coverage, and the assets of the Managing General Partner. The Managing General Partner and its affiliates will receive compensation from the partnership upon funding of the partnership and throughout the life of the partnership; these compensation payments could result in conflicts of interest by the Managing General Partner and its affiliates; compensation payments made to the Managing General Partner and its affiliates will reduce the amount of cash distributions that investors may receive. We will receive compensation throughout the life of the partnership. These compensation payments may result in conflicts of interest between the Managing General Partner and its affiliates and the investor partners and might lead us to take actions not most advantageous to the partnership. See "Conflicts of Interest" for a discussion of the conflicts of interest that may be present in connection with the operation of the partnership. In addition, the payment of compensation to the Managing General Partner and its affiliates will reduce the amount of cash distributions that investor partners may receive from the partnership. See "Compensation to the Managing General Partner and Affiliates" (page ___) for a discussion of fees, payments and reimbursements that the Managing General Partner and its affiliates will receive upon organization of the partnership and during its operating life. The partnership's wells might not produce commercial quantities of natural gas or oil; as a result, your investment in the partnership might not be profitable. The selection of prospects for natural gas and oil drilling is inherently speculative and is subject to a high degree of risk. We cannot predict whether any prospect will produce natural gas or oil or commercial quantities of natural gas or oil. We cannot predict the life and production of any well. The actual lives could differ from those anticipated. Partnership wells may not produce sufficient gas and oil for investors to receive a profit or even to recover their initial investment. See "Proposed Activities - Acquisition of Undeveloped Prospects" (page ___) for a discussion of how we will select prospects for the partnership. Our retention of partnership revenues to pay for additional development work would result in a reduction of cash distributions to investors in the short term and may not increase cash distributions in the long term. If development work is unsuccessful, no additional oil and gas may be produced, so there will not be an increase in cash distributions to offset those amounts withheld to pay the costs of the work. We intend initially to develop partnership properties only with the proceeds of the subscriptions and our capital contribution. However, these funds may not be sufficient to fund all of the partnership's development costs. In the future we may wish to rework or recomplete partnership wells and we will not hold money from the initial investment for that future work. Additionally, the limited partnership agreement does not permit the partnership to borrow funds on behalf of the partnership or for partnership activities. As a result, the partnership may have to retain revenues from its operations to pay for these development costs and, by so doing, would reduce the amount of cash distributions to the investors. See "Source of Funds and Use of Proceeds" for a discussion of the sources of partnership capital and our intended uses of that capital. Withholding funds for development work will decrease your cash distributions but may not decrease the taxes you must pay. Even though you do not receive the cash withheld to pay development costs, the Internal Revenue Service may consider some or all of the funds withheld as taxable income to you. So you could owe taxes on the income without cash from the partnership to pay the tax. If we retain funds for development work, it will reduce the amount of your cash distributions when the funds are being deducted, may not increase future cash flow, and may result in "phantom income" to you. Phantom income is income you must report as taxable income on your tax return even though you have not received the cash because it was used to fund the additional development work. See "Tax Considerations" for a discussion of the tax implications of an investment in the program. There will be no public market for the units, and as a result an investor partner may not be able to sell his or her units. There will be no public market for the units nor will a public market develop for the units. You may not be able to sell your partnership interests or may be able to sell them only for less than fair market value. A sale or transfer of units by you requires our prior written consent. See "Transferability of Units" (page ___) for a discussion of the limited liquidity of a purchase of units and how you might sell your units. Sufficient insurance coverage may not be available for the partnership, thereby increasing the risk of loss for the investor partners. It is possible that some or all of the insurance coverage which the partnership has available may become unavailable or prohibitively expensive. In that case, we may elect to change the insurance coverage. See "Proposed Activities - Insurance" (page ___) for a discussion of the extent of our insurance coverage. Additional general partners could be exposed to additional financial risk due to the reduced insurance coverage and due to the fact that additional general partners would continue to be individually liable for obligations and liabilities of the partnership. As an investor partner, you could be subject to greater risk of loss of your investment since less insurance would be available to protect your partnership from casualty losses. A partnership which drills fewer wells will be less diversified, thereby increasing the risk of financial loss for the investors. We intend to spread the risk of natural gas and oil drilling by participating in wells on a number of different prospects. However, the cost of drilling wells in different geographic locations varies greatly. A partnership subscribed at the minimum level or which drills more expensive wells would be able to participate in fewer prospects, resulting in a decrease of the diversification of the partnership's investment in prospects and an increase of your risk of financial loss of that partnership. See "Proposed Activities - Drilling and Completion Phase - Drilling and Operating Agreement" (page ___) for a discussion of the drilling and operating agreement that will govern the partnership's activities and of the costs involved in drilling and operating the partnership's wells. Through their involvement in partnership and other non-partnership activities, the Managing General Partner and its affiliates have interests which conflict with those of the investor partners; actions taken by the Managing General Partner in furtherance of its own interests could result in the partnership's being less profitable and a reduction in cash distributions to the investors. Our continued active participation in oil and gas activities for our own account and on behalf of other partnerships organized or to be organized by us, our sale of leases to and other transactions with the partnerships, and the manner in which partnership revenues are allocated create conflicts of interest with the partnerships. We have interests which inherently conflict with your interests. In operating the partnership, the Managing General Partner and its affiliates could take actions which benefit themselves and which do not benefit the partnership. These actions could result in the partnership's being less profitable. In that event, an investor partner could anticipate a reduction of cash distributions. See "Conflicts of Interest" (page ___) for a discussion of the various conflicts involved as a result of the Managing General Partner's activities. Unaffiliated persons might manage jointly-owned partnership prospects; a partnership could be financially liable for obligations of jointly-owned prospects; as a result, the expenses of the partnership might increase and the cash distributions to investors might decrease. The partnerships will usually acquire less than the full working interest in prospects and, as a result, will engage in joint activities with other working interest owners. Additionally, the partnership might purchase less than a 50% working interest in one or more prospects. As a result, someone other than the partnership or us may control and manage the partnership's prospects. A partnership could be held liable for the joint activity obligations of the other working interest owners, including nonpayment of costs and liabilities arising from the actions of the working interest owners. Full development of the prospects could be jeopardized in the event of the inability of other working interest owners to pay their respective shares of drilling and completion costs. As a result, the expenses of that partnership would increase, and cash distributions to you by that partnership would be less than what you had anticipated. See "Proposed Activities - Drilling and Completion Phase - Drilling and Operating Agreement" (page ___) for a discussion of the drilling and operating agreement that will govern the partnership's activities. The partnership may not borrow funds, even if needed for partnership operations; as a result, the partnership might not have sufficient capital for its operations and we might not be able to fully develop the partnership's wells; in that event, an investor might anticipate a reduction in cash distributions. The partnership intends to utilize substantially all available capital from this offering for the drilling and completion of wells and will have only nominal funds available for partnership purposes prior to the time as there is production from partnership well operations. The limited partnership agreement does not permit the partnership to borrow money as may be required for its business. Therefore, any future requirement for additional funding will have to come, if at all, from the partnership's production. There is no assurance that production will be sufficient to provide the partnership with necessary additional funding. As a result, it is possible that we will be unable to fully develop the partnership's wells and the partnership might be less profitable. In that event, an investor might anticipate a reduction in cash distributions from the partnership. See "Source of Funds and Use of Proceeds - Subsequent Source of Funds" (page ___) and "Proposed Activities - Production Phase of Operations - Expenditure of Production Revenues" (page ___) for a discussion of the funds available to the partnership for its drilling and operating activities. The partnership and other partnerships sponsored by the Managing General Partner may compete with each other for prospects, equipment, contractors, and personnel; as a result, the partnership may find it more difficult to operate effectively and profitably. During and after 2003, we plan to offer interests in other partnerships to be formed for substantially the same purposes as those of the partnerships. Therefore, a number of partnerships with unexpended capital funds, including those partnerships formed before and after the partnerships, may exist at the same time. Due to competition among partnerships for suitable prospects and availability of equipment, contractors, and our personnel, the fact that partnerships previously organized by us may still be purchasing prospects (when the partnership is attempting to purchase prospects) may make more difficult the completion of prospect acquisition activities by a partnership. In that event, it is possible that the partnership would be less profitable. The partnership may drill exploratory wells, which involves a greater risk of financial loss than drilling development wells. Each partnership may drill one or more exploratory wells. Drilling exploratory wells involves greater risks of dry holes and loss of your investment. A dry hole is a well which does not find enough oil or gas to justify the cost of completing the well. Dry holes must be plugged with cement and have the surface restored to near its original condition. Drilling development wells generally involves less risk of dry holes but developmental acreage is more expensive and subject to greater royalties and other burdens on production. If we drill unsuccessful wells, your investment in the partnership might not be profitable. See "Proposed Activities" (page ___) for a discussion of our proposed drilling program and how we intend to use the funds of the partnership. The results of drilling previous partnerships sponsored by the Managing General Partner are not indicative of the results to be experienced by the partnerships; your investment in the partnership might not be profitable. The partnership in which you invest may not be as successful as partnerships of previous programs sponsored by us. As a result, you should not consider information concerning the prior drilling experience of previous partnerships sponsored by us, presented under the caption "Prior Activities" (page ___), as being indicative of the results you might expect from your investment in these partnerships. Your investment in the partnership might not be profitable. In view of the cost sharing arrangements, the investor partners will bear the substantial amount of costs and risks of non-commercial wells. Under the cost and revenue sharing provisions of the limited partnership agreement, we and the investor partners may share in costs disproportionate to our respective sharing of revenues. Because the investor partners will bear the substantial amount of costs of acquiring, drilling and developing the prospects, the investor partners will bear the substantial amount of costs and risks of drilling dry holes and marginally productive wells. See "Participation in Costs and Revenues" (page ___) for a description of the costs and revenues sharing arrangements between the Managing General Partner and the investors. Investor partners may be personally liable if they violate the limited partnership agreement. As an investor partner, you may not participate in the management of partnership business. The limited partnership agreement forbids you as an investor partner from acting in a manner harmful to the business of the partnership. If you violate the terms of the limited partnership agreement, you may have to pay for those losses and may also have to pay other partners for all damages resulting from your breach of the limited partnership agreement. See "Summary of Limited Partnership Agreement" (page ___) for a description of your rights as a partner of the partnership. Indemnification of additional general partners by the Managing General Partner could reduce the value of the partnership and the investment interests of the investor partners. We have agreed to indemnify each of the additional general partners for obligations related to casualty and business losses which exceed available insurance coverage and partnership assets. Any successful claim of indemnification might reduce the value of the partnership. As a result, the value of your investment interest in the partnership would be reduced. In the event of a successful claim, you could lose your entire investment in the partnership. See "Summary of Partnership Agreement - Indemnification" (page ___) for a discussion of the indemnification provisions of the limited partnership agreement. Receipt by limited partners of partnership distributions could result in liability of the limited partners to the partnership. If limited partners receive a return of any part of their capital contributions to a partnership, without violation of the limited partnership agreement or the West Virginia Uniform Limited Partnership Act, those limited partners will be liable to the partnership for a period of one year after the return for the amount of the returned contributions. If the return is in violation of the limited partnership agreement or the West Virginia Act, the limited partners will be liable to the partnership for a period of six years after the return for the amount of the contribution wrongfully returned. A significant financial loss by the Managing General Partner could result in our inability to indemnify additional general partners for personal losses suffered because of partnership liabilities. As a result of our commitments as general partner of several partnerships and because of the unlimited liability of a general partner to third parties, our net worth is at risk of reduction if we suffer a significant financial loss. Because we are primarily responsible for the conduct of the partnership's affairs, a significant adverse financial reversal for us could result in our inability to pay for partnership liabilities and obligations. Additional general partners might be personally liable for payments of the partnership's liabilities and obligations. Therefore, the Managing General Partner's financial incapacity could increase your risk of personal liability as an additional general partner because PDC would be unable to indemnify you for any personal losses you suffered. See "Prior Activities - Prior Partnerships" (page ___) for a description of the extent of our financial obligations as managing general partner of other limited partnerships. An investor partner may not receive a cash distribution if the distribution would cause a capital account deficit. The limited partnership agreement prohibits you from receiving allocations or cash distributions to the extent the allocation or distribution would create deficits in your capital account. A deficit would occur, for example, if the sum of the expenses and losses allocated to a partner plus the distributions made to you exceed the sum of the income and gains allocated to you plus the amount you paid for your partnership interest. See "Tax Considerations" for a discussion of allocations and distributions. The dealer manager is not independent and has not conducted an independent due diligence evaluation of the offering. PDC Securities Incorporated, the dealer manager of this offering, is our affiliate and is not independent which creates a conflict of interest in its due diligence examination and evaluation of this offering. Risks Pertaining to Natural Gas and Oil Investments The drilling of natural gas and oil wells is highly speculative and risky and may result in unprofitable wells. Natural gas and oil drilling is a highly speculative activity marked by many unsuccessful efforts. You must recognize the possibility that the wells drilled may not be productive. Even completed wells may not produce enough natural gas or oil to show a profit. Delays and added expenses may also be caused by poor weather conditions affecting, among other things, the ability to lay pipelines. In addition, ground water, various clays, lack of porosity, and permeability may hinder or restrict production or even make production impractical or impossible. Any of these events could cause the partnership not to be profitable. See "Proposed Activities" (page ___) for a discussion of our drilling program. The prices for natural gas and oil have been quite unstable; a decline in the price could cause the partnership to be unprofitable. Global economic conditions, political conditions, and energy conservation have created unstable prices. Revenues of each partnership are directly related to natural gas and oil prices which we cannot predict. The prices for domestic natural gas and oil production have varied substantially over time and by location and may in the future. A decline in gas and oil prices would result in lower revenues for the partnership and a reduction of cash distributions to the partners of that partnership. Prices for natural gas and oil have been and are likely to remain extremely unstable. See "Competition, Markets and Regulation" (page ___) for a discussion of the marketing and pricing of natural gas and oil. Fluctuating market conditions and government regulations may cause a decline in the profitability of the partnership. The sale of any natural gas and oil produced by the partnerships will be affected by fluctuating market conditions and regulations, including environmental standards, set by state and federal agencies. From time-to-time, a surplus of natural gas or oil may occur in areas of the United States. The effect of a surplus may be to reduce the price the partnerships receive for their gas or oil production, or to reduce the amount of natural gas or oil that the partnerships may produce and sell. As a result, the partnership may not be profitable. See "Competition, Markets and Regulation" (page ___) for a discussion of the marketing and pricing of natural gas and oil. Rapid growth of production in the Rocky Mountain region may result in lower prices and production restrictions until new pipeline facilities are put in service. Beginning in 2001 the Rocky Mountain region, including PDC's Colorado properties, has experienced lower prices and production restrictions resulting from regional production that exceeds local markets and the capacity of pipelines to move gas to markets on the West Coast and in the Midwest. A major pipeline expansion was placed in service in May 2003 which should eliminate this problem. However if excess production exceeds the additional pipeline capacity, or if producers continue to add productive capacity and additional pipeline facilities or markets are not developed to utilize or transport the new supplies, the local surplus could continue or reoccur, resulting in lower prices and/or production curtailment. Environmental hazards involved in drilling gas and oil wells may result in substantial liabilities for the partnership. There are numerous natural hazards involved in the drilling of wells, including unexpected or unusual formations, pressures, blowouts involving possible damages to property and third parties, surface damages, bodily injuries, damage to and loss of equipment, reservoir damage and loss of reserves. Uninsured liabilities would reduce the funds available to a partnership, may result in the loss of partnership properties and may create liability for additional general partners. A partnership may be subject to liability for pollution, abuses of the environment and other similar damages. It is possible that insurance coverage may be insufficient to protect the partnership. In that event, partnership assets would pay personal injury and property damage claims and the costs of controlling blowouts or replacing destroyed equipment rather than for drilling activities. These payments would cause the partnership to be less profitable. See "Proposed Activities - Insurance" (page ___) for a discussion of our insurance coverage. Increases in drilling costs would reduce the partnership's profitability. The oil and gas industry historically has experienced periods of rapid cost increases. Increases in the cost of exploration and development would affect the ability of the partnerships to acquire additional leases, gas and oil equipment, and supplies and would increase the costs and lower the profits of that partnership. Lower profits would result in lower cash distributions to the partners of that partnership. A reduced availability of drilling rigs, due in part to intense competition in drilling, may delay the drilling of partnership wells and cash distributions to investors. A large number of companies and individuals engage in drilling for natural gas and oil and there is competition for the most desirable leases as well as materials and equipment to drill and complete wells. Increased drilling operations in some areas of the United States have resulted in the decreased availability of drilling rigs and gas/oil field tubular goods. Also, international developments and the possible improved economics of domestic oil and gas exploration may influence others to increase their domestic oil and gas exploration. These factors may reduce the availability of rigs to the partnership resulting in delays in drilling activities. The reduced availability of rigs could delay the partnership in drilling wells on a timely basis and delay the production of natural gas or oil and cash distributions to investors. A delay in drilling could also impact the timing of investors' tax deductions. See "Competition, Markets and Regulation - Competition and Markets" (page ___) and "Tax Considerations - Intangible Drilling and Development Costs Deductions" (page ___) for a discussion of the partnership's competition and the tax implications of drilling wells on a timely basis. Failure by subcontractors to pay for materials or services could reduce the partnership's profitability. If non-affiliated subcontractors fail to timely pay for materials and services, the wells of the partnerships could be subject to materialmen's and workmen's liens. In that event, the partnerships could incur excess costs in discharging these liens and the profitability of the partnership would decline. Delay in partnership gas or oil production could reduce the partnership's profitability. Drilling wells in areas remote from marketing facilities may delay production from those wells until sufficient reserves are established to justify construction of necessary pipelines and production facilities. The partnership's inability to complete wells in a timely fashion may also result in production delays. In addition, marketing demands which tend to be seasonal may reduce or delay production from wells. Wells drilled for the partnerships may have access to only one potential market. Local conditions including but not limited to closing businesses, conservation, shifting population, pipeline maximum operating pressure constraints, and development of local oversupply or deliverability problems could halt or reduce sales from partnership wells. Any of these delays in the production and sale of the partnership's gas and oil could reduce the partnership's profitability. Tax Status and Tax Risks It is possible that the tax treatment currently available with respect to natural gas and oil exploration and production will change on a retroactive or prospective basis as a result of additional legislative, judicial, or administrative actions. See "Tax Considerations" (page ___) and the tax opinion of our tax counsel which we attach as Appendix D to this prospectus for a discussion of the tax implications of an investment in the program. Partnership classification as a corporation or a publicly traded partnership would substantially alter the tax treatment of the partnership. Tax counsel has rendered its opinion that each partnership will be classified for federal income tax purposes as a partnership and not as a corporation or an association taxable as a corporation or as a "publicly traded partnership" taxable as a corporation. The opinion is not binding on the Internal Revenue Service or the courts. The Service could assert that a partnership should be classified as one of these other structures. If a partnership were so classified, any income, gain, loss, deduction, or credit of the partnership would remain at the entity level, and not flow through to you, the income of the partnership would be subject to corporate tax rates at the entity level and distributions to you may be considered dividend distributions subject to federal income tax at the investor partners' level. See "Tax Considerations - General Tax Effects of Partnership Structure" (page ___) which discusses the tax implications of classification of business entities. An investment as a limited partner may not be advisable for a person who does not anticipate having substantial current taxable income from passive activities. Net losses generated by the partnership and allocable to a limited partner generally will be subject to the passive activity rules. Under the passive activity rules, passive activity losses of limited partners who are individuals, estates, trusts, and personal service corporations are deductible only to the extent of that limited partner's passive activity income (less restrictive limitations apply to closely held C corporations). Therefore, limited partners may not be able to currently deduct all of the expenses and losses allocated to them from the partnership. See "Tax Considerations - Passive Loss Limitations" (page ___) for a discussion of taxation of passive losses. An investment as an additional general partner in the partnership may not be advisable for a person whose taxable income from all sources is not recurring and is not subject to the higher marginal federal income tax rates. An additional general partner generally will not be subject to the passive activity rules discussed in the previous paragraph. However, the expenses and losses allocated to a partner from the partnership may be used only to offset other taxable income the partner may have. In addition, as mentioned above, an additional general partner could be subject to additional personal liability under West Virginia law. Consequently, to compensate for that additional risk, a person choosing to invest as an additional general partner should ensure that he or she has sufficient current taxable income from all sources (including passive activities) subject to the higher marginal federal income tax rates to offset any expenses and losses allocated from the partnership. Under the Code, a partner's tax liabilities may exceed the cash distributions received by that partner. Federal income tax payable by you by reason of your distributive share of partnership taxable income for any year may exceed the cash distributed to you by the partnership. You must include in your own return for a taxable year your share of the items of the partnership's income, gain, profit, loss, and deductions for the year, to the extent required under the Internal Revenue Code as then in effect, whether or not cash proceeds are actually distributed to you. For example, income from the partnership's sale of gas production is taxable to you as ordinary income subject to depletion and other deductions; your distributive share of the partnership's taxable income will be taxable to you whether or not the income is actually distributed to you. If the Service audits the partnership's tax returns, an investor partner might owe more taxes plus interest and penalties. Although the partnerships will not be registered with the Service as "tax shelters," it is possible that the Service will audit each partnership's returns. If audits occur, tax adjustments might be made that would increase the amount of taxes due or increase the risk of audit of your individual tax return. If additional tax is owed, you may also owe interest and penalties in addition to that tax. In addition, costs and expenses may be incurred by a partnership in contesting the adjustments. The cost of responding to audits of your tax return will be borne solely by you. See "Tax Considerations - Administrative Matters" (page ___) for a discussion of Service audits of the tax returns of partners of a partnership. Partnership losses after the conversion of general partnership interests to limited partnership interests will be passive losses for tax purposes. Tax counsel to the Managing General Partner has rendered its opinion that interests in the partnerships held by the additional general partners generally will not be subject to the passive activity rules. However, if an additional general partner interest is converted to a limited partner interest prior to the spudding date, but after the end of the taxable year in which intangible drilling and development costs were incurred, intangible drilling and development costs will be subject to the passive activity rules. In addition, that portion of partnership gross income for the prior taxable year attributable to intangible drilling and development costs treated as passive loss will be considered passive income. A material portion of the subscription proceeds will not be currently deductible. A material portion of the subscription proceeds of a partnership will be expended for cost and expense items which will not be currently deductible for income tax purposes. See "Tax Considerations - Transaction Fees" (page ___) as to the tax treatment of fees incurred by the partnership. If the Service challenges the partnership's deduction for the prepayment of drilling costs, you could owe additional taxes plus interest and penalties. Some drilling cost expenditures may be made as prepayments during 2001 (with respect to partnerships designated as "PDC 2001- Limited Partnership"), 2002 (with respect to partnerships designated as "PDC 2002- Limited Partnership"), and 2003 (with respect to partnerships designated as "PDC 2003- Limited Partnership") for drilling and completion operations which in large part may be performed during 2002, 2003 and 2004, respectively. All or a portion of these prepayments may be then currently deductible by the applicable partnership if: the well to which the prepayment relates is spudded within 90 days after December 31, 2001, 2002 or 2003, respectively; a well is spudded when a drilling rig begins to drill the hole in the ground. the payment is not a mere deposit; and the payment serves a substantial business purpose or otherwise satisfies the clear reflection of income rule. A partnership could fail to satisfy the requirements for deduction of prepaid intangible drilling and development costs. The Service may challenge the deductibility of these prepayments. If that challenge were successful, you could owe additional taxes plus interest and penalties for years in which the deductions are disallowed. However, the prepaid expenses would be deductible in the tax year in which the services under the drilling contracts are actually performed. See "Tax Considerations - Intangible Drilling and Development Costs Deductions" (page ___) for a discussion of the tax treatment of these deductions. Counsel's tax opinion does not cover various tax considerations involved in one's investment in the partnership. Due to the lack of authority, or the essentially factual nature of the question, tax counsel to the partnership, Duane Morris LLP, has expressed no opinion as to the following: whether the losses of the partnership will be treated as derived from "activities not engaged in for profit," and therefore nondeductible from other gross income, whether any of the partnership's properties will be entitled to percentage depletion, whether any interest incurred by a partner with respect to any borrowings will be deductible or subject to limitations on deductibility, whether the fees to be paid to us and to third parties will be deductible, and the impact of an investment in the partnership on an investor's alternative minimum tax. Various of the above-referenced matters are factual in nature, and the facts are unknown at this time. Therefore, counsel is unable to render an opinion at this time with respect to these matters as to the tax consequences and burdens a taxpayer will likely experience as a result of an investment in the partnership. The facts when they become known with respect to the various matters referred to above may vary from taxpayer to taxpayer and may result in different tax consequences and burdens for individual taxpayers. You should recognize that an opinion of counsel merely represents counsel's best legal judgment under existing statutes, judicial decisions, and administrative regulations and interpretations. There can be no assurance, however, that some of the deductions claimed by a partnership will not be challenged successfully by the Service. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements, including, without limitation, trends impacting the natural gas and oil industry (including prices and market demand), the partnerships' success in drilling and development activities, the expected effect of deregulation and the partnerships' ability to expand their drilling activities geographically, and anticipated tax consequences, that involve risks and uncertainties. The partnerships' actual results and development could differ materially from those discussed or implied in the forward-looking statements as a result of these and other factors. Factors that may cause or contribute to those differences include those discussed under "Risk Factors," "Participation in Costs and Revenues" (page ___), "Proposed Activities" (page ___), "Competition, Markets and Regulation" (page ___), and "Tax Considerations" (page ___) as well as those discussed elsewhere in this prospectus. We caution you, however, that this list of factors may not be exhaustive. TERMS OF THE OFFERING General Up to twelve limited partnerships (four in 2001, four in 2002, four in 2003) Units of general partnership interest and units of limited partnership interest being offered - investor must choose $20,000 cost per unit Minimum subscription - $5,000 Minimum partnership - $1,500,000 in subscriptions Maximum partnership - $35,000,000 in subscriptions Maximum aggregate subscriptions for twelve partnerships - $202,500,000 Subscription proceeds will be placed in escrow until partnership funded. PDC 2003 Drilling Program will offer for sale an aggregate of 10,125 Units at $20,000 per unit, aggregating $202,500,000, of preformation interests in a series of up to twelve limited partnerships to be formed under the laws of West Virginia. You may purchase units only if you meet the suitability standards set forth below. We will offer units for sale over a three-year period. We completed our offering of our four PDC 2001-designated limited partnerships, PDC 2001-A through -D Limited Partnerships, on December 31, 2001, and sold a total of approximately $57 million of our securities in those limited partnerships; we completed our offering of our four PDC 2002-designated limited partnerships, PDC 2002-A through -D Limited Partnerships, on December 31, 2002, and sold a total of approximately $57 million of our securities in those limited partnerships; and we completed our offering of our initial two PDC 2003-designated limited partnerships, PDC 2003-A and -B Limited partnerships, on April 30, 2003 and September 8, 2003, and sold a total of approximately $[XX] million of our securities in those limited partnerships. Each of these partnerships has been funded and is currently operational. By this prospectus, the program will offer to sell a total of $52.5 million of its registered securities in PDC 2003-C Limited Partnership and PDC 2003-D Limited Partnership. The managing general partner of each partnership will be Petroleum Development Corporation, a publicly-owned Nevada corporation. We in our discretion may accept subscriptions for less than full units. The minimum subscription is one-quarter unit ($5,000). In the event you purchase units on more than one occasion during the offering period of a partnership, the minimum purchase on each occasion is $5,000 (one-quarter Unit). We will not sell units to tax-exempt investors or to foreign investors. You may elect to purchase units as an additional general partner or as a limited partner. Additionally, you may purchase units of general partnership interest and units of limited partnership interest. Upon the sale of at least the minimum number of units in a partnership (87-1/2 units aggregating $1,750,000 with respect to PDC 2003-C Limited Partnership and 175 units aggregating $3,500,000 with respect to PDC 2003-D Limited Partnership) and upon termination of the offering of units in that partnership, we will form a limited partnership under the laws of West Virginia. At that time the units of preformation general partnership interest and preformation limited partnership interest will become units of general partnership interest and units of limited partnership interest, respectively, in the particular partnership. There is no restriction on the composition of the type of partnership interests with respect to any partnership. If we do not sell the minimum required aggregate subscription amount of $1,750,000, or $3,500,000, as appropriate, in the offering of units of any partnership, we will not fund that partnership, and the escrow agent will promptly return all subscription proceeds with respect to that partnership to the respective subscribers in full with any interest earned on the escrowed funds and without any deduction from the escrowed funds. We may not complete a sale of units to any investor until at least five business days after the date the investor has received a final prospectus. In addition, we will send to each investor a confirmation of the purchase. The maximum subscription of any partnership will be the lesser of $17,500,000 with respect to PDC 2003-C Limited Partnership and $35,000,000 with respect to PDC 2003-D Limited Partnership. We will designate the various partnerships as follows. The subscription period for each of the partnerships in our program will be as follows, unless earlier terminated or withdrawn by us: Partnership Minimum Maximum Planned Name Subscription Subscription Termination PDC 2001-A $1.5 million $15 million May 7, 2001 PDC 2001-B $1.5 million $15 million September 5, 2001 PDC 2001-C $1.7 million $17 million November 9, 2001 PDC 2001-D $3.0 million $30 million December 31, 2001 We offered and sold the securities of each of these partnerships during 2001. We completed each of these offerings during 2001. We will not offer or sell any additional securities of any of these partnerships. PDC 2002-A $1.5 million $15 million April 30, 2002 PDC 2002-B $1.75 million $17.5 million September 9, 2002 PDC 2002-C $1.75 million $17.5 million November 11, 2002 PDC 2002-D $3.5 million $35 million December 31, 2002 We offered and sold the securities of each of these partnerships during 2002. We completed each of these offerings during 2002. We will not offer or sell any additional securities of any of these partnerships. PDC 2003-A $1.5 million $15 million April 30, 2003 PDC 2003-B $1.75 million $17.5 million September 8, 2003 PDC 2003-C $1.75 million $17.5 million November 10, 2003 PDC 2003-D $3.5 million $35 million December 31, 2003 We offered and sold the securities of PDC 2003-A Limited Partnership and PDC 2003-B Limited Partnership during 2003; we completed each of these offerings during 2003. We will not offer or sell any additional securities of either of these partnerships. We will offer and sell the securities of PDC 2003-C Limited Partnership and PDC 2003-D Limited Partnership only during 2003. The offering of any particular partnership may extend beyond its anticipated termination date by not more than sixty days or be terminated earlier; however, no offering of partnerships designated "PDC 2001- Limited Partnership," "PDC 2002- Limited Partnership" or "PDC 2003- Limited Partnership" may extend beyond December 31, 2001, 2002, or 2003, respectively. Although the offering of units in subsequent partnerships will not commence until the subscription of units in prior partnerships has reached the minimum subscription or that prior offering has terminated, we may choose to offer the units of PDC 2003-C Limited Partnership and PDC 2003-D Limited Partnership at the same time until the offering of units in PDC 2003-C Limited Partnership has terminated, in order that investors be allowed to diversify their investments in the two partnerships, if they so choose. Once the offering with respect to a particular partnership has closed, we will not offer or sell additional units with respect to that partnership. At or about the time of funding of a particular partnership, we anticipate that we will supplement this prospectus to reflect the results of the offering of that partnership. We will not commence operations of a particular partnership until termination of its offering period. We will fund each partnership promptly following the termination of its respective offering period, provided that the partnership has reached the minimum subscriptions. We will not fund any partnership beyond December 31, 2003, with respect to partnerships designated "PDC 2003- Limited Partnership." Subscriptions for units are payable $20,000 in cash per unit purchased upon subscription. Your subscription is not revocable after you submit it to us. Your subscription will continue to be irrevocable during the time your funds are in the escrow account. We will not return your subscription funds to you unless we decide not to complete the offering of the partnership you are investing in. We will place all subscription proceeds of each partnership in a separate interest-bearing escrow account with our escrow agent, Bank One, West Virginia, 707 Virginia Street, Second Floor, Charleston, West Virginia 25234, during the offering period of that partnership. The escrow agreement requires the escrow agent to invest escrowed funds upon receipt and forbids the escrow agent from disbursing funds except upon deposit of checks representing at least the minimum subscriptions and upon written instructions from us and the dealer manager. At that time the escrow agent will disburse the escrowed subscriptions in accordance with these instructions. In the event that we fail to raise the minimum subscriptions, the escrow agent will promptly return the escrowed funds to the subscribers. The escrow agent will promptly return escrowed subscriptions of partnerships not closed by the sixtieth day following the anticipated offering termination date to the respective investor of that partnership. However, if the offering of units in PDC 2003-C Limited Partnership or PDC 2003-D Limited Partnership, as appropriate, has not closed on or before December 31, 2003 the escrow agent will promptly return the escrowed funds of that particular partnership to those investors. The escrow agent will not commingle subscriptions with our funds, nor will subscriptions be subject to the claims of our creditors. The escrow agent will invest subscription proceeds during the offering period only in short-term institutional investments comprised of or secured by securities of the U.S. government. The interest rate on the escrow account is variable. We will direct the escrow agent to pay to the respective subscriber after closing any interest accrued on subscription funds prior to closing of the offering and funding of a partnership. Investors should make their checks for units payable to "Bank One, West Virginia as Escrow Agent for "PDC 2003- Limited Partnership" and give their checks to their broker for submission to the dealer manager and escrow agent. All subscription funds received by the selling brokers from investor partners will be transferred by noon of the next business day after receipt to the dealer-manager for transfer to Bank One, West Virginia by noon of the next business day after receipt for deposit into escrow. Your execution of the subscription agreement and its acceptance by us constitute your execution of the limited partnership agreement and your agreement to be bound by the terms of the limited partnership agreement as a partner, including your granting of a special power of attorney to us appointing us as your lawful representative to execute and file a certificate of limited partnership and any amendment of the certificate, governmental reports, certifications, contracts, and other matters. Activation of the Partnerships Each partnership will receive funds following termination of offering period. Each partnership is a separate business and economic entity from each other partnership. Partnerships will organize under West Virginia law. We will organize each partnership under the Act and each partnership will receive funds promptly following the termination of its offering period. However, we will not fund a partnership with less than the requisite minimum aggregate subscriptions. A partnership will not commence any drilling operations until after its funding. Each partnership will be a separate and distinct business and economic entity from each other partnership. Thus, as an investor partner, you will be a partner only of that partnership in which you specifically invest and will have no interest in any of the other partnerships (unless you also invest in other partnerships). Therefore, you should consider and rely solely upon the operations and success (or lack of success) of your own partnership in assessing the quality of your investment. Upon funding of a partnership, we will deposit the subscription funds in interest-bearing accounts or invest those funds in short-term highly-liquid securities where there is appropriate safety of principal, in that partnership's name until the funds are required for partnership purposes. Interest earned on amounts so deposited or invested will be the property of the respective partnership whose funds earned the interest. We anticipate that within 12 months following the formation of a partnership it will have expended or committed all subscriptions for partnership operations. We will return any unexpended and/or uncommitted subscriptions at the end of the 12-month period pro rata to the investor partners and we will reimburse those partners for organization and offering costs and the management fee allocable to the return of capital. The term "uncommitted capital" will not include amounts set aside for necessary operating capital reserves. We will file a certificate of limited partnership and any other documents required to form the partnerships with the State of West Virginia and will elect for the partnerships to be governed by the West Virginia Uniform Limited Partnership Act. We will also take all other actions necessary to qualify the partnerships to do business as limited partnerships or cause the limited partnership status of the partnerships to be recognized in any other jurisdiction where the partnerships conduct business. Types of Units Investor may choose to be limited partner or additional general partner. You may purchase units in a partnership as a limited partner or as an additional general partner. Although investor partners will generally share income, gains, losses, deductions, and cash distributions allocable to them pro rata based upon the amount of their subscriptions, there are material differences in the federal income tax effects and the liability associated with these different types of units. Any income, gain, loss, or deduction attributable to partnership activities will generally be allocable to the partners who bear the economic risk of loss with respect to these activities. Further, additional general partners generally may offset partnership losses and deductions against income from any source. Limited partners generally may offset partnership losses and deductions only against passive income. See "Tax Considerations" for a discussion of the tax implications of investing as a limited partner or as an additional general partner. You may transfer or assign your units of partnership interest in accordance with Section 7.03 of the limited partnership agreement. Transferees seeking to become substituted partners must meet the suitability requirements set forth in this prospectus. A substituted additional general partner will have the same rights and responsibilities, including unlimited liability, in the partnership as every other additional general partner. See "Risk Factors - Additional general partners will be individually liable for partnership obligations and liabilities beyond the amount of their subscriptions, partnership assets, and the assets of the Managing General Partner" for a discussion of the risks of investing as an additional general partner. You must indicate on the investor signature page of the subscription agreement the number of limited partnership units or general partnership units subscribed for. If you fail to indicate on the subscription agreement a choice between investing as a limited partner or as an additional general partner, we will not accept your subscription but will promptly return the subscription agreement and the tendered subscription funds to you. Limited Partners. The limited partners will consist of the initial limited partner, Steven R. Williams, one of our executive officers and directors, until the admission of a limited partner to the partnership, and each investor who purchases units of limited partnership interest being offered by this prospectus. The liability of a limited partner of the partnership for the partnership's debts and obligations will not exceed that partner's capital contributions, his or her share of partnership assets, and the return of any part of his or her capital contribution (a) for a period of one year afterwards for the amount of his or her returned contribution if a limited partner has received the return without violation of the limited partnership agreement or the West Virginia Act, but only to the extent necessary to discharge the limited partner's liabilities to creditors who extended credit to the partnership during the period the contribution was held by the partnership and (b) for a period of six years afterwards for the amount of the contribution wrongfully returned if a limited partner has received the return in violation of the limited partnership agreement or the West Virginia Act. General Partners. The general partners will consist of the managing general partner and each investor purchasing units of general partnership interest. We refer to these persons in this prospectus as "additional general partners." As a general partner of a partnership, each additional general partner will be fully liable for the debts, obligations and liabilities of the partnership individually and as a group with all other general partners as provided by the West Virginia Act to the extent liabilities are not satisfied from the proceeds of insurance, from the indemnification by us, or from the sale of partnership assets. See "Risk Factors - Additional general partners will be individually liable for partnership obligations and liabilities beyond the amount of their subscriptions, partnership assets, and the assets of the Managing General Partner" for a discussion of the risks if you invest as an additional general partner. While the activities of the partnership are covered by substantial insurance policies and indemnification by us which we discuss in this prospectus, it is possible that the additional general partners will incur personal liability (not covered by insurance, partnership assets, or indemnification) as a result of the activities of the partnership. Conversion of units by the Managing General Partner and by additional general partners We will convert all units of general partnership interest into units of limited partnership interest after drilling and completion operations are done. If there is a material change in a partnership's insurance coverage, additional general partners may convert prior to the change. Liability for investors will be limited after conversion. We will convert all units of general partnership interest of a particular partnership into units of limited partnership interest when drilling and completion operations of that partnership are done. Additional general partners may also convert their interests into limited partnership interests at any time within the 30 day period prior to any material change in the amount of the partnership's insurance coverage. Upon conversion they will become limited partners of that partnership. Effecting conversion is subject to the express requirements that the conversion will not cause a termination of the partnership for federal income tax purposes and that the additional general partner provides written notice to us of the intent to convert. Conversion of an additional general partner to a limited partner in a particular partnership will be effective upon our filing an amendment to the Certificate of Limited Partnership. We are obligated to file an amendment to the Certificate at any time during the full calendar month after receipt by us of the required notice of the additional general partner, provided that the conversion will not constitute a termination of the partnership for tax purposes. A conversion made in response to a material change in that partnership's insurance coverage will be effective prior to the effective date of the change in insurance coverage. After the conversion of a partner's general partnership interest to that of a limited partner, each converting additional general partner will continue to have unlimited liability regarding partnership liabilities arising prior to the effective date of the conversion, but will have limited liability to the same extent as limited partners after conversion to limited partner status is effected. See page ___ under the heading "Tax Considerations - Conversion of Interests" for an explanation of the tax considerations regarding a conversion of an additional general partner interest to a limited partner interest. We are not entitled to convert our interests into limited partnership interests. Limited partners do not have any right to convert their units into units of general partnership interest. In the event additional general partners desire to convert to limited partners due to a loss of insurance coverage, the partnership will cease drilling activities until all desired conversions can be made. Unit Repurchase Program Investors may tender units for repurchase at any time beginning with the third anniversary of the first cash distribution of the particular partnership. Investors may, at their election, sell their units to the Managing General Partner for not less than four times the most recent twelve months' cash distributions from production. The Managing General Partner is obligated to purchase in any calendar year units which aggregate 10% of the initial subscriptions, subject to its financial ability to do so and opinions of counsel. Beginning with the third anniversary of the date of the first cash distribution of the particular partnership, you may tender your units to us for repurchase. Subject to the available borrowing capacity under our loan agreements to effect repurchases and the opinion of counsel referred to below, each year we will offer to repurchase for cash a minimum of 10% of the units originally subscribed to in the particular partnership. Our offers to purchase units will, however, be conditioned on the receipt of an opinion of our counsel that the consummation of the offer will not cause the partnership to be treated as a "publicly traded partnership" for purposes of Code Section 7704 and on counsel's determination that the repurchases of a particular investor partner's units will not result in the termination of the partnership for federal income tax purposes. It is possible that repurchases of units could result in the units being "readily tradable on a secondary market or the substantial equivalent thereof," Code Section 7704(b)(2), the result of which the partnership could be deemed to be a "publicly-traded partnership." To limit the possibility of this characterization, we will require receipt of counsel's opinion. We will not favor one particular partnership over another in the repurchase of units. We will extend the offer equally to all interest holders participating in an individual partnership, excluding interests held by us. Notwithstanding the preceding sentence, if investor partners tender more than 10% of the units from a partnership or more units than we are able to purchase, we will purchase units on a "first-come, first-served" basis based on date of receipt by us of a letter of acceptance of the repurchase offer from the investor partner. To the extent that we are unable to repurchase all units tendered, because of limitations imposed by the Code or due to insufficient borrowing capacity under any loan banking agreement(s) to which we may be a party, a tendering investor partner will be entitled to have his or her units repurchased on a "first-come, first-served" basis, regardless of partnership, provided that the repurchase of a particular investor partner's units will not have the effect of causing termination of his or her partnership for tax purposes or of causing the partnership to be treated as a "publicly traded partnership." To the extent that we are unable to repurchase all units tendered at the same time by partners of any partnership, we will repurchase those particular units on a pro rata basis. In order to initiate the process in which we will repurchase your units, you must provide us written notification of your intention to have us purchase your units. We will provide you a written offer of a specified price for purchase of the particular units within 30 days of our receipt of the written notification. Upon receipt of the repurchase price established by us, you, if in fact you elect to accept the repurchase price, need to notify us in writing that the price is acceptable. We will promptly mail you a check for the proceeds of the purchase. The minimum offer which we may make will be a cash amount equal to not less than four times cash distributions from production of that particular partnership for the twelve months prior to the month preceding the date upon which we have received the written notification referred to above. We may, in our sole and absolute discretion, increase the offer for interests tendered for sale. An offering price established by us may not represent the fair market value of the units. In setting the offering price, we will consider our available funds and our desire to acquire production as represented by the unit and will take into account what we perceive to be our own best interests as a publicly-owned company. You are free to accept or not to accept the offer from us; you are in no way obligated to accept our offer. We will provide you with detailed information as to how we calculated our offer. We will also provide each interest holder with a calculation of the valuation of his or her interest, based on the most recent reserve evaluation prepared by an independent expert in accordance with SEC Regulation S-X, Article 4, Rule 4-10. This calculation will take into account our best estimate of anticipated production declines or increases, known price increases or decreases, operating, recompletion and plugging costs, and other relevant factors. Recompletion is the process of going into an existing producing well to complete the well in a new zone at a different depth, or to retreat the zone which is already producing, with the objective of increasing the production of oil or gas. When a well is unsuccessful, or when it has produced as much oil and gas as it can produce profitably, it must be plugged. Plugging a well requires that the well be filled partially or completely with cement so that any remaining oil or gas is trapped in the producing zone so it cannot leak to pollute the environment or create a safety hazard. To date, approximately 1,317 units (out of approximately 9,111 eligible units) of prior programs sponsored by us have been presented under the respective unit repurchase programs (which are the same as that of the partnership) for repurchase at prices ranging from 3 to 4.5 times the most recent 12 month cash distributions. Programs that we sponsored previous to 1998 provided for a three times cash distribution minimum offer price. The 9,111 units include all partnerships through and including PDC 1999-B Limited Partnership. More recent programs had not satisfied the three-year holding period. The figures reflect all partnerships formed by us from 1984 through September 1999. Investor Suitability Investment in the units involves a high degree of risk. You may invest only if you are qualified to purchase units. Investment is suitable only for investors having substantial financial resources who understand the long-term nature, tax consequences, and risk factors associated with this investment. Minimum requirements are $225,000 net worth, or a net worth of $60,000 and taxable income of $60,000. States with more stringent requirements are set forth below. Transferees of units must meet the suitability requirements set forth in this section. Tax-exempt investors and foreign investors may not purchase units. It is the obligation of persons selling units to make every reasonable effort to assure that the units are suitable for investors, based on the investor's investment objectives and financial situation, regardless of the investor's income or net worth. We will not sell units to tax-exempt investors or to foreign investors. We will sell units, including fractional units, to you only if you satisfy the following suitability requirements. Net worth will be determined exclusive of home, home furnishings and automobiles. In addition, we will sell units to you only if you make a written representation that you are the sole and true party in interest and that you are not purchasing for the benefit of any other person (or that you are purchasing for another person who meets all of the conditions set forth in this section). The following represent footnotes to various states set forth in the two following tables. Please refer to the following footnotes as appropriate. (X) California residents generally may not transfer units without the consent of the California Commissioner of Corporations. (Y) Michigan, Missouri, New Mexico, Ohio, Pennsylvania, and South Dakota investors may not invest if the dollar amount of their investment is equal to or more than 10% of their net worth. Purchasers of Units of Limited Partnership Interest. If you wish to purchase units of limited partnership interest in the partnership, you must satisfy the following suitability requirements for your state of residence, as summarized in the following table and accompanying footnotes, including those footnotes that precede this section. State AK AL AR AZ CA CO CT DC DE FL GA HI IA ID IL IN KS KY LA MA MD ME MN MS MI Requirement 2 1 4 (X) 1 1 1 1 1 5 (Y) State MO MT NC ND NE NH NJ NM NV NY OH Requirement 5 (Y) 1 5 1 3 1 1 (Y) 1 1 (Y) State OK OR PA RI SC SD TN TX UT VA VT WA WI WV WY Requirement 1 6 (Y) 1 6 (Y) 1 1 1 The following footnotes relate to the corresponding numbers in the table above. You must have a minimum net worth of $225,000 or a minimum net worth of $60,000 and had during the last tax year or estimate that you will have during the current tax year "taxable income" as defined in Section 63 of the Code of at least $60,000 without regard to an investment in units. You must be a person whose total purchase does not exceed 5% of your net worth if the purchase of securities is at least $10,000, and have either: (a) a minimum annual gross income of $60,000 and a minimum net worth of $60,000, exclusive of principal automobile, principal residence, and home furnishings, or (b) a minimum net worth of $225,000, exclusive of principal automobile, principal residence, and home furnishings. You must have either: (a) a net worth of not less than $250,000 (exclusive of home, furnishings, and automobiles), or (b) a net worth of not less than $125,000 (exclusive of home, furnishings, and automobiles), and $50,000 in taxable income. You must (a) have net worth of not less than $250,000 (exclusive of home, furnishings, and automobiles) and expect to have gross income in 2003 (with respect to the PDC 2003 designated partnerships) of $65,000 or more, or (b) have net worth of not less than $500,000 (exclusive of home, furnishings, and automobiles), or (c) have net worth of not less than $1,000,000, or (d) expect to have gross income in 2003 (with respect to the PDC 2003 designated partnerships) of not less than $200,000. You must have (a) a net worth of not less than $225,000 (exclusive of home, furnishings, and automobiles), or (b) a net worth of not less than $60,000 (exclusive of home, furnishings, and automobiles) and estimated 2003 taxable income as defined in Section 63 of the Internal Revenue Code of 1986 of $60,000 or more without regard to an investment in a partnership (with respect to the PDC 2003 designated partnerships). You must have either: (a) a net worth of at least $225,000 (exclusive of home, furnishings, and automobiles); or (b) a net worth of at least $60,000 (exclusive of home, furnishings, and automobiles) and taxable income, as defined in Section 63 of the Code, of $60,000 or more in 2003 for the PDC 2003 designated partnerships, without regard to the investment in the program; or (c) that you are purchasing in a fiduciary capacity for a person or entity who satisfies the requirements of (a) or (b). Purchasers of Units of General Partnership Interest. If you wish to purchase units of general partnership interest in the partnership, you must satisfy the following suitability requirements for your state of residence, as summarized in the following table and accompanying footnotes, including those footnotes that precede this section set forth above under "Investor Suitability." State AK AL AR AZ CA CO CT DC DE FL GA HI IA ID IL IN KS KY LA MA Requirement 2 4 5 6 (X) 1 1 5 1 5 1 4 State MD ME MN MS MI MO MT NC ND NE NH NJ NM NV NY Requirement 1 4 5 (Y) 4 (Y) 1 4 1 3 1 5 (Y) 1 State OH OK OR PA RI SC SD TN TX UT VA VT WA WI WV WY Requirement 4 (Y) 5 4 (Y) 1 7 (Y) 4 1 5 1 The following footnotes relate to the corresponding numbers in the table above. (1) You must have a minimum net worth of $225,000 or a minimum net worth of $60,000 and had during the last tax year or estimate that you will have during the current tax year "taxable income" as defined in Section 63 of the Code of at least $60,000 without regard to an investment in units. (2) You must be a person whose total purchase does not exceed 5% of your net worth if the purchase of securities is at least $10,000, and have either: (a) a minimum annual gross income of $60,000 and a minimum net worth of $60,000, exclusive of principal automobile, principal residence, and home furnishings, or (b) a minimum net worth of $225,000, exclusive of principal automobile, principal residence, and home furnishings. (3) You must have either: (a) a net worth of not less than $250,000 (exclusive of home, furnishings, and automobiles), or (b) a net worth of not less than $125,000 (exclusive of home, furnishings, and automobiles), and $50,000 in taxable income. (4) You must have (a) an individual or joint minimum net worth (exclusive of home, home furnishings and automobiles) with your spouse of $225,000, without regard to the investment in the program and a combined minimum gross income of $100,000 or more for the current year and for the two previous years; or (b) an individual or joint minimum net worth with your spouse in excess of $1,000,000, inclusive of home, home furnishings and automobiles; or (c) an individual or joint minimum net worth with your spouse in excess of $500,000, exclusive of home, home furnishings and automobiles; or (d) a combined minimum gross income in excess of $200,000 in the current year and the two previous years. (5) You must have (a) an individual or joint minimum net worth (exclusive of home, home furnishings, and automobiles) with your spouse of $225,000, without regard to an investment in the program, and an individual or combined taxable income of $60,000 or more for the previous year and an expectation of an individual or combined taxable income of $60,000 or more for each of the current year and the succeeding year; or (b) an individual or joint minimum net worth with your spouse in excess of $1,000,000, inclusive of home, home furnishings and automobiles; or (c) an individual or joint minimum net worth with your spouse in excess of $500,000, exclusive of home, home furnishings and automobiles; or (d) a combined minimum gross income in excess of $200,000 in the current year and the two previous years. (6) You must (a) have net worth of not less than $250,000 (exclusive of home, furnishings, and automobiles) and expect to have gross income in 2003 (with respect to the PDC 2003 designated partnerships) of $120,000 or more, or (b) have net worth of not less than $500,000 (exclusive of home, furnishings, and automobiles), or (c) have net worth of not less than $1,000,000, or (d) expect to have gross income in 2003 (with respect to the PDC 2003 designated partnerships) of not less than $200,000. (7) You must have (a) an individual or joint minimum net worth (exclusive of home, home furnishings, and automobiles) with your spouse of $225,000, without regard to an investment in the program, and an individual or combined taxable income of $60,000 or more for the previous year and an expectation of an individual or combined taxable income of $60,000 or more for each of the current year and the succeeding year; or (b) an individual or joint minimum net worth with your spouse in excess of $1,000,000 (inclusive of home, home furnishings and automobiles); or (c) an individual income in excess of $200,000 in each of the two most recent years or joint income with your spouse in excess of $300,000 in each of those years and have a reasonable expectation of reaching the same income level in the current year. Miscellaneous. Transferees of units seeking to become substituted partners must also meet the suitability requirements discussed above, as well as the requirements imposed by the limited partnership agreement, including transfers of units by a partner to a dependent or to a trust for the benefit of a dependent or transfers by will, gift or by the laws of descent and distribution. Where you purchase units in a fiduciary capacity for any other person (or for an entity in which you are deemed to be a "purchaser" of the subject units) all of the suitability standards set forth above will be applicable to that other person. You are required to execute your own subscription agreements. We will not accept any subscription agreement that has been executed by someone other than you or in the case of fiduciary accounts by someone who does not have the legal power of attorney to sign on your behalf. For details regarding how to subscribe, see "Special Subscription Instructions" which we attach as Appendix C. ASSESSMENTS AND FINANCING The units of the partnerships are not subject to assessments. The partnership may not borrow funds on behalf of the partnership or for partnership activities. Operations for drilling wells by the particular partnerships will be funded through subscription proceeds and capital contributed to the partnerships by the Managing General Partner. Over the term of a partnership, additional funds might be necessary to complete that partnership's activities. We intend to develop a particular partnership's interests in its prospects only with the proceeds of subscriptions and our capital contributions. However, these funds may not be sufficient to fund all costs and it may be necessary for a partnership to retain partnership revenues for the payment of these costs, or for us to advance the necessary funds to a partnership. We will not drill any wells beyond the initial wells. Additional development refers to work necessary or desirable to enhance production from existing wells. We will retain payment for the development work from partnership proceeds in one of two methods: (a) We will prepare an authority for expenditures estimate for the partnership. The operator will complete the development work and will bill the partnership for the work performed; or (b) We will prepare an authority for expenditures estimate for the partnership. The partnership will retain revenues from operations until it has accumulated sufficient funds to pay for the development work, at which time the operator will commence the work, and we will pay the operator as the work progresses. The choice of which option to use will be at our discretion, based on the amount of the anticipated expenditure and the urgency of the necessary work. Generally, we will elect option (a) for emergency and expenditures of less than $10,000 and option (b) for expenditures of $10,000 and greater. The limited partnership agreement does not permit the partnership to borrow funds on behalf of the partnership or for partnership activities. See Section 6.03(a) of the limited partnership agreement. SOURCE OF FUNDS AND USE OF PROCEEDS Source of Funds Upon completion of the offering, the sole funds available to each partnership will be the contributions of the investor partners $1,750,000 ranging to $17,500,000 for PDC 2003-C Limited Partnership and $3,500,000 ranging to $35,000,000 for PDC 2003-D Limited Partnership) and our contribution in cash ($380,625 ranging to $3,806,250 for PDC 2003-C Limited Partnership and $761,250 ranging to $7,612,500 for PDC 2003-D Limited Partnership) for a total amount of $2,130,625 for sale of 87-1/2 units ranging to $42,612,500 for sale of 1,750 units. Use of Proceeds The following table presents information respecting the financing of a partnership in four different circumstances: The sale of 750 units ($15,000,000), the maximum number of units for each of PDC 2002-A Limited Partnership and PDC 2003-A Limited Partnership, The sale of 75 units ($1,500,000), the minimum number of units for each of PDC 2002-A Limited Partnership and PDC 2003-A Limited Partnership, The sale of 1,750 units ($35,000,000), the maximum number of units for each of PDC 2002-D Limited Partnership and PDC 2003-D Limited Partnership, and The sale of 87-1/2 units ($1,750,000), the minimum number of units for each of PDC 2002-B and -C Limited Partnerships and PDC 2003-B and -C Limited Partnerships. In the table below, the percentages presented are based upon total investor partners' capital contributions and our capital contribution. PDC 2003-C Limited Partnership may sell a maximum of 875 units ($17,500,000) and must sell a minimum of 87-1/2 units ($1,750,000) for the particular partnership to close and be funded. PDC 2003-D Limited Partnership may sell a maximum of 1,750 units ($35,000,000) and must sell a minimum of 175 units ($3,500,000) for the particular partnership to close and be funded. The following table reflects that PDC Securities Incorporated, the dealer-manager of the program and our affiliate, may reallow in whole or in part up to $1,500,000 (for the sale of 750 units; a maximum of $3,500,000 for PDC 2003-D Limited Partnership for the sale of 1,750 units) ranging to $150,000 (for the sale of the minimum number of units; a minimum of $350,000 for PDC 2003-D Limited Partnership) for sales commissions, reimbursement of due diligence expenses, marketing support fees and other compensation payable to other NASD-licensed broker-dealers in connection with the sale of the units. Of these amounts, PDC Securities will receive and retain wholesaling fees equal to -1/2% of subscriptions; these fees will range from $8,750 for the sale of the minimum number of units for PDC 2003-C Limited Partnership ($17,500 for PDC 2003-D Limited Partnership) ranging to $87,500 for the sale of the maximum number of units for PDC 2003-C Limited Partnership ($175,000 for PDC 2003-D Limited Partnership). These payments will be made solely in cash on the amount of initial subscriptions. The table also reflects that we will pay organization and offering costs in excess of 10-1/2% of subscriptions, without recourse to the partnership. Included in the "Amount available for investment" line item is the cost to the partnerships of acquiring prospects, which may include prospects acquired from us. We will disburse substantially all of the funds available to the partnership for the following purposes and in the following manner: 750 Units Sold % 75 Units Sold % 1,750 Units Sold % 87-1/2 Units Sold % Total Partnership Capital $18,262,500 100.0% $1,826,250 100.0% $42,612,500 100.0% $2,130,625 100.0% LESS: Public offering expenses, dealer manager's fee and sales commission $ 1,575,000 8.6% $ 157,500 8.6% $ 3,675,000 8.6% $ 183,750 8.6% LESS: Management fee to managing general partner $ 375,000 2.1% $ 37,500 2.1% $ 875,000 2.1% $ 43,750 2.1% Amount available for investment $16,312,500 89.3% $1,631,250 89.3% $38,062,500 89.3% $1,903,125 89.3% Subsequent Source of Funds We will commit or expend substantially all of the partnership's initial capital following the offering. The limited partnership agreement does not permit the partnership to borrow any funds for its activities. Consequently, partnership production must satisfy any future requirements for additional capital. See "Risk Factors - A partnership may not borrow funds, even if needed for partnership operations; as a result, the partnership might not have sufficient capital for its operations and we might not be able to fully develop the partnership's wells; in that event, an investor might anticipate a reduction in cash distributions" for a discussion of the risks involved as a result of the prohibition of partnership borrowing. PARTICIPATION IN COSTS AND REVENUES Profits and Losses; Cash Distributions The limited partnership agreement provides for the allocation of profits and losses during the production phase of a particular partnership and for the distribution of cash available for distribution between investor partners and us, as follows: Investor Partners Managing General Partner Throughout term of Partnership 80% 20% The allocations and distributions to the investor partners and to us may vary during the ten years of partnership well operations commencing six months after the close of a partnership for any partnership that fails to meet the partnership's performance standard. See "Revenues - Revision to Sharing Arrangements," immediately below. Additionally, if we must increase our capital contribution above our required cash investment of 21-3/4% of subscriptions to cover tangible drilling and lease costs, our share of profits and losses and cash available for distribution will increase to equal our percentage investment, and the investor partners' share will correspondingly decrease. See "Costs - Lease Costs, Tangible Well Costs, and Gathering Line Costs," below for a discussion of the allocations of the costs of the partnership. Revision to Sharing Arrangements. The limited partnership agreement provides for the allocation of partnership profits and losses 80% to the investor partners and 20% to us throughout the term of each partnership. However, amounts will be paid to the partners only after payment of fees and expenses to the Managing General Partner and its affiliates and only if there is sufficient cash available. The limited partnership agreement provides for the enhancement of investor cash distributions if the particular partnership does not meet the performance standard described below during the ten-year period commencing six months after the close of that partnership and ending ten years later. The performance standard is as follows: If the average annual rate of return, as defined below, to the investor partners is less than 12.8% of their subscriptions, the allocation rate of all items of profit and loss and cash available for distribution for investor partners will increase by ten percentage points above the then-current sharing arrangements for investor partners and the allocation rate with respect to those items for the Managing General Partner will decrease by ten percentage points below the then-current sharing arrangements for the Managing General Partner, until the average annual rate of return increases to 12.8% or more, or until ten years and six months from the closing date of the partnership expire, whichever event shall occur sooner. "Average annual rate of return" for purposes of this preferred sharing arrangement means (1) the sum of cash distributions and estimated initial tax savings of 25% of investor subscriptions, realized for a $10,000 investment in the partnership, divided by (2) $10,000 multiplied by the number of years (less six months) which have elapsed since the closing of the partnership. To the extent that the sharing arrangements change in any particular year as a result of this performance standard, the allocations of revenues to the investor partners will increase accordingly and the allocation of revenues to the Managing General Partner will correspondingly decrease. The above-referenced revised sharing arrangement policy is not, and no investor should consider the policy to be, any form of guarantee or assurance of a rate of return on an investment in the partnership. The policy is the result of a contractual agreement by us as set forth in paragraph 4.02 of the limited partnership agreement. There is no guarantee or assurance whatsoever that the partnership will drill commercially successful gas or oil wells or that the cash distributions to the partners, including any cash distributions under the policy, will achieve a 12.8% rate of return. Example: It has been 5 years and 6 months since a partnership was closed. Investors have received cash distributions equal to 30% of their initial subscription. What is the status of the preferred return? To determine the status of the preferred return, you add the estimated initial tax savings of 25% and the 30% cash return for a total of 55%. Five years and six months have elapsed since the partnership closed, so we subtract 6 months to find the number of years to use to determine the average annual return (5 years 6 months less 6 months equals 5 years). Finally, divide the total return by the 5-year period to determine average annual rate of return (55% 5 years = 11% per year). The 11% per year is less than the 12.8% per year requirement, so the investor partners will share 90% of the cash available for distribution, and the Managing General Partner will receive 10%. The foregoing allocation of profits and losses is an allocation of each item of income, gain, loss, and deduction which, in the aggregate, constitute a profit or a loss. Revenues Natural Gas and Oil Revenues; Sales Proceeds. The limited partnership agreement provides for the allocation of revenues from natural gas and oil production and gain or loss from the sale or other disposition of productive wells and leases 80% to the investor partners and 20% to us. The production revenues to be allocated are subject to "Revision to Sharing Arrangements," immediately above, and to revisions due to increases in our capital contributions to cover tangible drilling and lease costs, as disclosed below under "Lease Costs, Tangible Well Costs, and Gathering Line Costs." Interest Income. We will credit to the investor partners 100% of any interest earned on the deposit of subscription funds prior to the closing of the offering and funding of the respective partnership. We will allocate and credit interest earned on the deposit of operating revenues and revenues from any other sources in the same percentages that oil and gas revenues are then being allocated to the investor partners and us. Sale of Equipment. We will allocate to us 100% of all revenues from sales of equipment. Sale of Productive Properties. In the event of the sale or other disposition of a productive well, a lease upon which the well is situated, or any equipment related to that lease or well, we will allocate and credit to the investor partners and us the gain from the sale or disposition in the same percentages as oil and gas revenues are then being allocated. The term "proceeds" above does not include revenues from a royalty, overriding royalty, lease interest reserved, or other promotional consideration reserved by a partnership in connection with any sale or disposition. We will allocate these revenues to the investor partners and us in the same percentages as allocation of oil and gas revenues. Costs Organization and Offering Costs. We, and not the partnership, will pay organization and offering costs, net of the dealer manager commissions, discounts and due diligence expenses, and wholesaling fees, of the partnerships. We will pay all legal, accounting, printing, and filing fees associated with the organization of the partnerships and the offerings of units. We will allocate to us 100% of these costs. The investor partners will pay all dealer manager commissions, discounts, and due diligence reimbursement and will be allocated 100% of these costs. However, we will allocate and charge to us 100% of organization and offering costs in excess of 10-1/2% of subscriptions. Management Fee. We will allocate the nonrecurring management fee 100% to the investor partners and 0% to us. The one-time management fee will equal 2-1/2% of the total subscriptions and is payable to the Managing General Partner upon closing of the particular partnership. Lease Costs, Tangible Well Costs, and Gathering Line Costs. We will allocate the costs of leases, tangible well costs and gathering line costs 0% to the investor partners and 100% to us. We will contribute and/or pay for the partnership's share of all leases, tangible drilling and completion costs, and gathering line costs. If these costs exceed our required 21-3/4% capital contribution, we will increase our capital contribution. In that event, our share of all items of profit and loss during the production phase of operations and cash available for distribution would be modified to equal for us the percentage arrived at by dividing our capital contributions by the capital available for investment; the investor partners' allocations of these items would be changed accordingly. Intangible Drilling Costs. Intangible drilling costs are costs required to drill a well and prepare the well for production. These costs have no salvage value. Items like the cost of drilling the well, the cost of grading the surface, labor costs, and geological costs associated with selecting a well site are intangible well costs. The cost of production equipment, casing pipe, and other equipment are tangible costs because it may be possible to remove them from a depleted or unsuccessful well and sell them or use them somewhere else. We will allocate intangible drilling costs and recapture of intangible drilling costs in proportion to the investor partners' and our respective payment of intangible drilling costs. Recapture, if any, attributable to intangible drilling and development costs will be allocable on the same percentage basis as the allocation of intangible drilling and development costs. Recapture means that you must include the income you receive for the sale of partnership interest as part of your regular taxable income to the extent the sales price exceeds your partnership tax basis, rather than as long-term capital gains. Regular income is generally taxed at a higher rater than long-term capital gains. Investor partners' portion of capital available for investment will pay the intangible expenses. The entire capital contribution of the investor partners, after payment of brokerage commissions, due diligence reimbursement, and the management fee, will be utilized to pay for IDC. If the capital contributions of the investor partners are insufficient to pay the intangible drilling costs, we will pay the additional amount of these costs, and in these circumstances the sharing arrangements for intangible drilling costs and recapture of intangible drilling costs will be in proportion to the investor partners' and our respective payment of intangible drilling costs. Operating Costs. Operating costs are the costs at the well level associated with producing and maintaining productive wells, like well tending charges, painting equipment and maintaining access roads. We will allocate and charge operating costs of partnership wells 80% to the investor partners and 20% to us, subject to revision in the event of the preferred return and/or our increased investment, as we have discussed in this section. Direct Costs. Direct costs are partnership level costs, primarily independent auditor and reserve engineer fees and tax preparation. We will allocate and charge direct costs of the partnerships 80% to the investor partners and 20% to us, subject to revision in the event of the preferred return and/or our increased investment, as we have discussed in this section. Administrative Costs. We will allocate 100% of the administrative costs of the partnerships to us. The table below summarizes the participation of the investor partners and us, taking account of our capital contribution, in the costs and revenues of the partnerships. See "Glossary of Terms," "Participation in Costs and Revenues," and the limited partnership agreement, Appendix A to this prospectus. With regard to the table below, we, without recourse to the partnerships, will pay organization and offering costs in excess of 10-1/2% of subscriptions. The "Direct Costs" line item represents operating costs incurred after the completion of productive wells, including monthly per-well charges paid to us. We will receive monthly reimbursement from the partnerships for their direct costs incurred by us on behalf of the partnerships. Managing Investor General Partners Partner Partnership Costs Broker-dealer Commissions and Expenses 100% 0% Management Fee 100% 0% Undeveloped Lease Costs 0% 100% Tangible Well Costs 0% 100% Intangible Drilling and Development Costs 100% 0% Total Drilling and Completion Costs 80% 20% Operating Costs 80% 20% Direct Costs 80% 20% Administrative Costs 0% 100% Partnership Revenues Sale of Oil and Gas Production (1) 80% 20% Sale of Productive Properties (1) 80% 20% Sale of Equipment 0% 100% Sale of Undeveloped Leases (1) 80% 20% Interest Income (1) 80% 20% ____________________ (1) The allocation of these partnership revenues are subject to revision. See "Revision to Sharing Arrangements" and "Lease Costs, Tangible Well Costs, and Gathering Line Costs," above. We estimate that direct costs allocable to the investor partners for the initial 12 months of their operations will be approximately $8,000 if minimum subscriptions ($1,500,000) are received (representing -1/2% of aggregate partnership capital), and approximately $292,000 if maximum subscriptions ($150,000,000) are received (representing 0.2% of aggregate partnership capital). The following table sets forth the components of these estimated charges to the investor partners during the first year after a partnership is formed, assuming the minimum and maximum subscriptions are obtained: Minimum Maximum Subscriptions Subscriptions (75 Units) (7,500 Units) Administrative Costs $ -0- $ -0- Total Administrative Costs $ -0- $ -0- Direct Costs: Audit and Tax Preparation $5,000 $120,000 Independent Engineering Reports 2,000 130,000 Materials, Supplies and Other 1,000 42,000 Total Direct Costs $8,000 $292,000 We will bear all administrative costs of the partnerships; however, the financial statements of the partnerships will reflect these costs, since generally accepted accounting principles require that all costs of doing business be included in the historical financial statements. The following table presents for each partnership formed by us in the last three years the dollar amount of direct costs and administrative costs incurred by the particular partnership in each year and the percentage of subscriptions raised reflected by those costs. Direct Costs 2000 2001 2002 Partnership Name Amount % of Subscriptions Amount % of Subscriptions Amount % of Subscriptions PDC 2000-A $9,893 0.20% $8,974 0.18% $6,215 0.13% PDC 2000-B 12,701 0.11% 9,815 0.08% 10,953 0.09% PDC 2000-C 11,501 0.08% 10,931 0.08% 13,586 0.10% PDC 2000-D 15,654 0.06% 18,540 0.07% 35,153 0.14% PDC 2001-A - - 11,191 0.12% 13,426 0.14% PDC 2001-B - - 12,135 0.10% 13,955 0.11% PDC 2001-C - - 12,260 0.12% 13,056 0.12% PDC 2001-D - - 17,507 0.07% 23,764 0.10% PDC 2002-A - - - - 12,133 0.17% PDC 2002-B - - - - 13,546 0.12% PDC 2002-C - - - - 12,784 0.14% PDC 2002-D - - - - 19,017 0.07% Administrative Costs 2000 2001 2002 Partnership Name Amount % of Subscriptions Amount % of Subscriptions Amount % of Subscriptions PDC 2000-A 0 0.00% 0 0.00% 0 0.00% PDC 2000-B 0 0.00% 0 0.00% 0 0.00% PDC 2000-C 0 0.00% 0 0.00% 0 0.00% PDC 2000-D 0 0.00% 0 0.00% 0 0.00% PDC 2001-A - - 0 0.00% 0 0.00% PDC 2001-B - - 0 0.00% 0 0.00% PDC 2001-C - - 0 0.00% 0 0.00% PDC 2001-D - - 0 0.00% 0 0.00% PDC 2002-A 0 0.00% PDC 2002-B 0 0.00% PDC 2002-C 0 0.00% PDC 2002-D 0 0.00% pppp Allocations Among Investor Partners; Deficit Capital Account Balances We will allocate revenues and costs of a partnership allocated to the investor partners among them in proportion to which the amount of each investor partner's capital contribution bears to the aggregate of the capital contributions of all investor partners in the partnership. To avoid the requirement of restoring a deficit capital account balance, there will be no allocations of losses to an investor partner to the extent those allocation would create or increase a deficit in his or her capital account (adjusted for liabilities, as provided in the limited partnership agreement). Cash Distribution Policy We plan to make distributions of partnership cash on a monthly basis, but will make distributions no less often than quarterly, only to the extent there are funds available for distribution. We will make cash distributions of 80% to the investor partners and 20% to the Managing General Partner throughout the term of the partnership; cash distributions may increase for investor partners and decrease for the Managing General Partner in view of the revised sharing arrangement policy and may decrease for investor partners and increase for the Managing General Partner if the Managing General Partner invests capital above its minimum capital contribution to cover additional tangible drilling and lease costs. We cannot presently predict amounts of cash distributions from the program. We intend to distribute substantially all of each partnership's available cash flow on a monthly basis; however, we will review the accounts of each partnership at least quarterly for the purpose of determining the distributable cash available for distribution. Amounts will be paid to partners only after payment of fees and expenses to the Managing General Partner and its affiliates and only if there is sufficient cash available. The ability of the partnerships to make or sustain cash distributions will depend upon numerous factors. We can give no assurance that any level of cash distributions to the investor partners will be attained, that cash distributions will equal or approximate cash distributions made to investors in prior drilling programs sponsored by us, or that any level of cash distributions can be maintained. See "Prior Activities" for a tabular presentation of how our previous drilling programs have performed. In general, the volume of production from producing properties declines with the passage of time. The cash flow generated by each partnership's activities and the amounts available for distribution to a partnership's respective partners will, therefore, decline in the absence of significant increases in the prices that the partnerships receive for their oil and gas production, or significant increases in the production of oil and gas from prospects resulting from the successful additional development of these prospects. In general, we will divide cash distributions 80% to the investor partners and 20% to us throughout the term of the partnership. However, we will revise partnership sharing arrangements during the ten-year revision period if the average annual rate of return does not equal established goals. See "Revenues - Revision to Sharing Arrangements," above. Our revised sharing arrangement policy is not, and no investor should consider the policy to be, any form of guarantee or assurance of a rate of return on an investment in the partnership. Moreover, we will revise the partnership sharing arrangements if we invest capital above our required minimum capital contribution to cover additional tangible drilling and lease costs. See "Costs - Lease Costs, Tangible Well Costs, and Gathering Line Costs," above. Cash will be distributed to the investor partners and us as a return on capital in the same proportion as their interest in the net income of the partnership. However, no investor partner will receive distributions to the extent the distributions would create or increase a deficit in that partner's capital account. For a fuller discussion of capital accounts and tax allocations, see "Tax Considerations - Partnership Allocations." Termination Upon termination and final liquidation of a partnership, we will distribute the assets of the partnership to the partners based upon their capital account balances. If we have a deficit in our capital account, we must restore the deficit; however, no investor partner will be obligated to restore his or her deficit, if any. Amendment of Partnership Allocation Provisions The Managing General Partner may amend the limited partnership agreement without investor approval, if necessary for partnership allocations to be recognized for federal tax purposes. We are authorized to amend the limited partnership agreement, if, in our sole discretion based on advice from our legal counsel or accountants, an amendment to revise the cost and revenue allocations is required for those allocations to be recognized for federal income tax purposes because of either the promulgation of Treasury Regulations or other developments in the tax law. Any new allocation provisions provided by an amendment must be made in a manner that would result in the most favorable aggregate consequences to the investor partners as nearly as possible consistent with the original allocations described in this prospectus. See Section 11.09 of the limited partnership agreement. COMPENSATION TO THE MANAGING GENERAL PARTNER AND AFFILIATES The following is a tabular presentation of the items of compensation discussed more fully below: Recipient Form of Compensation Amount Managing General Partner Partnership interest 20% interest Managing General Partner Management fee 2-1/2% of subscriptions (nonrecurring fee) Managing General Partner Sale of leases to Partnerships The lower of cost or fair market value Managing General Partner Contract drilling rates Competitive prices Managing General Partner Operator's per-well charges Competitive prices Managing General Partner Direct costs Cost Managing General Partner and Affiliates Payment for equipment, supplies, gas marketing and other services Competitive prices Affiliate Brokerage sales commissions; reimbursement of due diligence and marketing support expenses; wholesaling fees 10-1/2% of subscriptions - $157,500 ranging to $15.75 million For a tabular presentation of payments to us made by previous partnerships sponsored by us, see "Conflicts of Interest - Certain Transactions," below. The categories of compensation set forth above are comparable to the corresponding categories of compensation for other partnerships sponsored by us disclosed in the "Certain Transactions" table below, except with respect to the management fee which was not a feature of the 1993 partnerships sponsored by us. Following closing of a partnership and upon funding of that partnership, we will contribute to the partnership an amount in cash equal to 21-3/4% of the subscriptions of that partnership's investors. In exchange for our investment, we will receive a 20% interest in the partnership. Our interest in the partnership may vary in view of the revised sharing arrangement policy (see "Participation in Costs and Revenues - Profits and Losses; Cash Distributions - Revision to Sharing Arrangements" for a discussion of our allocations policy) and if we invest additional capital to fund that partnership's tangible drilling and lease costs (see "Participation in Costs and Revenues - Costs - Lease Costs, Tangible Well Costs, and Gathering Line Costs"). Upon completion of the offering with respect to each partnership and upon funding of that partnership, we will receive a one-time management fee of 2-1/2% of total contributions of the investor partners to the partnership, an amount equal to $37,500 for sale of the minimum number of units ranging to $3,750,000 for sale of the maximum number of units. Since we can sell a maximum of $17.5 million with respect to PDC 2003-C Limited Partnership and $35 million with respect to PDC 2003-D Limited Partnership, the maximum amount of the management fee would be $437,500 with respect to PDC 2003-C Limited Partnership and $875,000 with respect to PDC 2003-D Limited Partnership. The partnership will reimburse us for all documented out-of-pocket expenses incurred on behalf of the partnership; however, there will be no reimbursement of administrative costs by a partnership. We will sell (at the lower of fair market value on the date of purchase or our cost of the prospects) sufficient undeveloped prospects to the partnership to drill the partnership's wells. Fair market value for leases and prospects transferred from our inventory will be based on the cost at which similarly situated leases and prospects are available or traded from or between other unaffiliated companies operating in the same geographic area. The cost of the prospects will include a portion of our reasonable, necessary and actual expenses for geological, geophysical, engineering, interest expense, drafting, legal, and other like services allocated to the partnership's properties. We will not retain any overriding royalty for ourselves from the prospects (see "Proposed Activities - Acquisition of Prospects" for a discussion of our acquisition policy). Each partnership will enter into a drilling contract with us to drill and complete partnership wells. In those cases where the partnership acquires less than a 50% working interest in a prospect, a party other than us may drill, complete, and operate wells on the prospect. We may use our own personnel and equipment during the drilling and completion phase of operations. We will bill these services at rates not to exceed those charged for similar services and equipment by other non-affiliated operators in the partnership area of operations. To the extent that the contract prices exceed our actual costs of drilling and completion, we will be deemed to have received compensation. The amount of compensation which we could earn as a result of these arrangements is dependent upon many factors, including the actual cost of wells and the number of wells drilled. We estimate that we would need to drill approximately 40 - 60 wells annually to absorb fully existing technical, supervisory, and management costs. The partnership will pay us, as operator, for drilling and completing the partnership's wells, based upon the depth of the well at its deepest penetration and whether the well is completed or plugged as a dry hole. Different footage rates are established for each area of operations based on drilling and completion costs for that area. "Footage" is the depth in feet penetrated from the surface by the well as measured by the drilling contractor. See "Proposed Activities - Drilling and Completion Phase - Drilling and Operating Agreement." In addition, in each area where the partnership conducts its drilling activities, the partnership will pay the cost of the prospect, as defined, and tangible costs of drilling and completing the partnership wells. In the event these rates exceed competitive rates available from other persons in the area engaged in the business of providing comparable services or equipment, we will adjust the foregoing rates to an amount equal to that competitive rate, but not less than the cost of providing the services or equipment. In the event that the competitive industry rates in the area and our costs in providing these drilling and completion services are in excess of our contract drilling and completion rates, we will be bound by contract with the partnership to furnish the contracted services at the contract rates. We review on an ongoing basis the rates of unaffiliated driller-operators to determine competitive rates in the geographic area. Rates will be comparable to those charged by other operators in the prospect area for equivalent services. We will determine comparable rates from one of the following sources: offering memoranda or prospectuses for private or public drilling programs, quoted rates, published rates or costs, annual reports of public companies, or competitive bids. In utilizing outside contractors for drilling and completion operations (rather than performing these services ourselves), we will receive an overhead payment for services as defined in the Copas Accounting Procedure - Joint Operations equal to the most recently published per well average monthly drilling overhead rate for gas and oil wells in the area where they are located as published by Ernst & Young LLP in their 2002-2003 Survey of Combined Fixed Rate Overhead Charges for Oil and Gas Producers, and actual cost for any direct costs associated with drilling and completion operations. That monthly overhead rate as so published is currently $4,875 per well per month for wells in Colorado. The total cost per well for wells drilled by unaffiliated operators, including direct and overhead charges, may exceed the footage rates listed in this prospectus. In the event we determine to conduct our drilling activities in other geographical areas or to other geologic zones, we will supplement the prospectus to discuss the different areas or zones and the costs involved in conducting drilling activities in those areas or zones. During the production phase of operations, the operator will receive for each producing well a monthly fee based upon competitive industry rates for operations and field supervision and $75 for partnership accounting, engineering, management, and general and administrative expenses. The operator will bill non-routine operations to the partnership at their costs. See "Proposed Activities - Drilling and Completion Phase - Drilling and Operating Agreement" for a discussion of our drilling policy and the costs involved in drilling and operating partnership wells. The partnerships will reimburse us for direct costs incurred by us on behalf of the partnerships. We and our affiliates may enter into other transactions with the partnerships for services, supplies and equipment, and will be entitled to compensation at competitive prices and terms as determined by reference to charges of unaffiliated companies providing similar services, supplies and equipment. We intend to market some of the gas produced through our subsidiary Riley Natural Gas. See "Conflicts of Interest" for a discussion of the various conflicts of interest involved in the program. PDC Securities Incorporated, our affiliate, is the dealer-manager of the Program and in that capacity will receive as sales commissions, for reimbursement of due diligence and marketing support expenses and wholesaling fees $15,750,000 for sale of the maximum number of units ranging to $157,500 for sale of the minimum number of units. PDC Securities may, as dealer manager, reallow sales commissions and due diligence and marketing support expenses in whole or in part to NASD licensed broker-dealers for sale of the units, reimbursement of due diligence and marketing support expenses, and other compensation, but will retain the wholesaling fees of $7,500 ranging to $750,000. See "Plan of Distribution." PROPOSED ACTIVITIES Introduction The primary purpose of the partnerships will be drilling, completing, and producing natural gas and oil from development wells. We may conduct limited exploratory activities. Partnerships will acquire up to 100% of the working interest of each prospect, subject to royalty interests. Each partnership will be a separate business entity. Investors in one partnership will have no interest in any of the other partnerships. The partnerships will drill, complete, own and operate natural gas and oil wells. The partnership intends to drill its wells in Colorado. Partnership operations may include wells in North Dakota, Michigan, West Virginia, Pennsylvania, Utah, and Wyoming as described in this prospectus. We may also conduct partnership operations in other formations not described in the prospectus, in the previously listed states, or in Montana, New York, South Dakota, Kentucky, Tennessee, Indiana, Kansas, Nebraska, Ohio and/or Oklahoma as we may deem advisable. We intend to apply at least 90% of each partnership's capital contributions available for participation in drilling and completion activities to comparatively lower risk development wells but may apply some of the remaining 10% to comparatively higher risk exploratory wells. We will spread the risks to a limited extent by having each partnership participate in drilling operations on a number of different prospects. The cost of drilling wells in different geographic locations will vary greatly. If we drill more expensive wells, the partnership will be able to drill fewer wells. As a result, the partnership will be less able to diversify its investment, and the risk associated with drilling will increase. The number of wells drilled by a partnership is determined by the amount of funds raised for that partnership and the specific prospects drilled by that partnership, and cannot be determined in advance of funding of a partnership. The program provides you with an opportunity to invest in the drilling, completion, and production of natural gas and oil wells. Please see page 1 of this prospectus for a description of the objectives of the investment in the program. You should be aware that distributions will decrease over time due to the declining rate of production from wells. Changes in gas and oil prices will decrease or increase cash distributions. Distributions will be partially sheltered by the percentage depletion allowance. See "Risk Factors - Special Risks of the Partnerships," " - Risks Pertaining to Oil and Gas Investments," and " - Tax Status and Tax Risks," "Prior Activities," and "Tax Considerations - Summary of Conclusions," " - Intangible Drilling and Development Costs," " - Depletion Deduction," " - Partnership Distributions," and " - Partnership Allocations" for a discussion of the various risks involved if you invest in the program. The attainment of the partnership's business objectives will depend upon many factors, including our ability to select productive prospects, the drilling and completion of wells in an economical manner, the successful management of the prospects, the level of natural gas and oil prices in the future, the degree of governmental regulation over the production and sale of natural gas and oil, the future economic conditions in the United States (and the world), and changes in the Internal Revenue Code. Accordingly, we can give no assurance that the partnership will achieve its business objectives. Moreover, because each partnership will constitute a separate and distinct business and economic entity from each other Partnership, the degree to which the business objectives are achieved will vary among the partnerships. Various of the activities and policies of the partnership discussed throughout this section and elsewhere in the prospectus are defined in and governed by the limited partnership agreement, including that at least 90% of the net offering proceeds will be used to drill development wells; the requirements relating to the acquisition of prospects and the payment of royalties; the amount of our capital contribution to the partnership; the guidelines with respect to well pricing and the cost of services furnished by us; the states where the partnership's wells will be drilled; assessments and borrowing policies; voting rights of investor partners; the term of the partnership; and our compensation. Other policies and restrictions upon the activities of the partnership and us are not set forth in the limited partnership agreement, but instead reflect our current intention and thus are subject to change at our discretion. For these later activities, we, in making a change, will utilize our reasonable business judgment as manager of the partnership and will exercise our judgment consistent with our obligations as a fiduciary to the investor partners. Upon the successful completion of the offering, the partnership will effect the following transactions, each of which is more fully described below: (a) We will assign to the partnership up to 100% of the working interest in the prospects; and (b) The partnership will enter into a drilling and operating agreement with us or with unaffiliated persons as operator, providing for the drilling and completion of partnership wells and for the subsequent supervision of field operations with respect to each producing well. Drilling Policy Most wells will be direct offsets to producing wells. Each partnership will invest in a number of prospects, either by itself or in conjunction with other parties, consistent with the objective of maintaining a meaningful interest in the wells to be drilled. The partnerships will not acquire any interest in currently or formerly producing gas and oil wells. Most wells to be drilled by the partnerships will be adjacent to producing wells and drilled to the same formation(s) as the producing wells. Therefore, it is unlikely that a well on a prospect will have the effect of proving up any additional acreage outside of the prospect. For this reason, the partnerships are expected to acquire only spacing units on which wells are to be drilled without also acquiring any surrounding acreage. Nevertheless, if drilling on a partnership prospect proves up an adjoining spacing unit owned by us, or if there is reliable evidence that there would be material drainage of a partnership prospect by an adjoining spacing unit in which we own an interest, we will assign to the partnership a proportionate interest in the spacing unit. Acquisition of Undeveloped Prospects The Managing General Partner will select undeveloped prospects. Selection of prospects for a partnership will occur after that partnership has been funded. At least 90% of prospects will be development wells. The partnerships will acquire prospects at the lesser of cost or fair market value. Average royalty and overriding royalty burden will not exceed 20%. The Managing General Partner will not retain overriding royalty interests. We will select undeveloped prospects sufficient to drill the partnerships' wells. We have not pre-selected any prospects. Most prospects to be selected for the partnerships are expected to be single well proved undeveloped prospects. We define a prospect generally as a contiguous oil and gas leasehold estate, or lesser interest, upon which drilling operations may be conducted. Depending on its attributes, a prospect may be characterized as an "exploratory" or "development" site. Generally speaking, exploratory drilling involves the conduct of drilling operations in search of a new and yet undiscovered pool of oil and gas (or, alternatively, drilling within a discovered pool with the hope of greatly extending the limits of that pool), whereas development drilling involves drilling to a known producing formation in a previously discovered field. The partnership intends to conduct the majority of its development drilling operations in Colorado to develop Cretaceous Sandstones. We reserve the right to conduct partnership operations in New York, Ohio, Montana, North Dakota, Alabama, South Dakota, Tennessee, Kentucky, Indiana, Kansas, Nebraska, Pennsylvania, West Virginia, Utah, Wyoming and/or Oklahoma and/or to other formations as we may, in our sole and absolute discretion, deem advisable, provided that the locations and/or formations are, in our opinion, of comparable quality and character to those described in this prospectus. Wells in the intended area of operations are usually given a fracture treatment in which fluids are pumped into the potential zone in an attempt to create additional fractures and widen present fractures. We anticipate that gas will be produced from all the subject wells, and that most Wattenberg field wells will also produce significant quantities of oil. There could also be some oil and brine production from wells in any area. Many zones which contain oil and gas will not produce or will only produce at low rates unless they are treated to allow the oil and gas to reach the well more easily. One method to accomplish this is by using a fracture treatment. The most commonly used fracture treatment method uses a mixture of sand and treated water pumped at high pressure and flowrates into the well and out through holes in the pipe at the productive zone. This creates cracks in the pay zone which reach out into the zone to allow oil or gas to flow into the well more easily. When the pumping of the fracturing fluid is stopped, the sand props the fractures open so they don't reseal under the pressure from the earth above. The partnerships will acquire prospects under arrangements in which the partnership will acquire up to 100% of the working interest, subject to landowners' royalty interests and other royalty interests payable to unaffiliated third parties in varying amounts, provided that the weighted average of the royalty interests for all prospects of a particular partnership will not exceed 20%. In our discretion, we may acquire less than 100% of the working interest in a prospect provided that costs are reduced proportionately. The limited partnership agreement forbids us from acquiring or retaining any overriding royalty interest in the partnership's interest in the prospects. The partnerships will generally acquire less than 100% of the working interest in each prospect in which they participate. In order to comply with the conditions for the treatment of additional general partners' interests in the partnership as not passive activities (and not subjecting the additional general partners to limitation on the deduction of partnership losses attributable to the additional general partners to income from passive activities), we have represented that the partnerships will acquire and hold only operating mineral interests and that none of the partnership's revenues will be from non-working interests. We, for our sole benefit, may sell or otherwise dispose of prospect interests not acquired by the partnerships or may retain a working interest in the prospects and participate in the drilling and development of the prospect. In such case the partnership costs would be proportional to their interest in the property, and we (or the parties) would pay for the costs of the non-partnership interests. In acquiring interests in leases, the partnerships may pay consideration and make contractual commitments and agreements as we deem fair, reasonable and appropriate. While we expect to assign to the partnerships a substantial portion of the leases to be developed by the partnerships, the partnerships may also purchase leases directly from unaffiliated persons. We will transfer at our cost all leases which are transferred to the partnerships, unless we have reason to believe that cost is materially more than the fair market value of the property in which case the price will not exceed the fair market value of the property. We will obtain an appraisal from a qualified independent expert with respect to sales of our properties to the partnerships. The actual number, identity and percentage of working interests or other interests in prospects to be acquired by the partnerships will depend upon, among other things, the total amount of capital contributions to a partnership, the latest geological and geophysical data, potential title or spacing problems, availability and price of drilling services, tubular goods and services, approvals by federal and state departments or agencies, agreements with other working interest owners in the prospects, farm-ins, and continuing review of other prospects that may be available. Title to Properties The partnership will hold record title to leases in its name. We will assign the partnership interest in the lease to the partnership. Leases acquired by each partnership may initially and temporarily be held in our name, as nominee, to facilitate joint-owner operations and the acquisition of properties. The existence of the unrecorded assignments from the record owner will indicate that the leases are being held for the benefit of each particular partnership and that the leases are not subject to debts, obligations or liabilities of the record owner; however, unrecorded assignments may not fully protect the partnerships from the claims of our creditors. You must rely on us to use our best judgment to obtain appropriate title to leases. Provisions of the limited partnership agreement relieve us from any mistakes of judgment with respect to the waiver of title defects. We will take those steps as we deem necessary to assure that title to leases is acceptable for purposes of the partnerships. We are free, however, to use our own judgment in waiving title requirements and will not be liable for any failure of title to leases transferred to the partnerships. Further, we will not warrant the validity or merchantability of titles to any leases to be acquired by the partnerships. PDC Prospects We anticipate that our four geologists (see "Management - Petroleum Development Corporation" for their identities and a summary of their experience) will evaluate all prospects, utilizing log and geological data from our historic operations, production records from our and others' wells, and other information as may be available and useful. Most oil and gas is found in areas where the rocks include sandstones, shales, salt, gypsum and limestone. They are frequently deposited in distinct layers like the ones you sometimes see where highways cut through mountains. By studying the rocks penetrated by wells in an area, it is possible to develop "maps" of these different layers in the area. These maps help geologists predict the best places to drill new wells. As a result, nearly all wells drilled by the partnership will be direct offsets to existing producing wells. Where multiple zone potential exists, as it frequently does in the proposed areas of operations, the geologists attempt to optimize well locations to create wells with two or more productive horizons. As of March 31, 2003, we had acreage available as listed in the following table within the prospect area. State A Acreage West Virginia 600 Pennsylvania 350 Michigan 3,500 North Dakota 6,600 Colorado 62,400 Total 73,450 In addition, we expect to acquire additional acreage on an ongoing basis throughout 2003 and beyond for the program and future partnerships. We will not decide on the specific wells to be drilled in any partnership until the offering of units in that partnership has terminated. This means that you will not be able to evaluate the specific prospects that will be drilled by your partnership. However, by waiting as long as possible before selecting the specific prospects to be drilled by the partnership, we may have information available which helps us select better prospects for the partnership, and we may be able to include prospects which were not available when this prospectus was written or even before the partnership was closed. This section includes a general description of the characteristics we look for in prospects to be included in the program as well as more detailed information on several areas where we anticipate partnership wells may be drilled. We will provide supplemental information if and when we add additional prospect areas. In selecting areas where we plan to drill partnership wells, we look for areas with most or all of the following general characteristics: Natural gas is expected to be the primary product for most wells, but some prospects may be drilled primarily for their oil production potential or for combined oil and gas production Onshore wells with depths of 15,000 feet or less Expected average producing lives of 20 years or more Existing pipeline systems which allow quick connection for sales Adequate market capacity for increased gas production Low dry hole risk Most of the wells drilled by the partnerships will be targeted at natural gas producing intervals. These intervals may also contain oil and/or water which are produced in conjunction with the natural gas. Some natural gas also contains hydrocarbons like propane and butane which may be separated from the natural gas and sold. Water that is produced must be disposed of by an environmentally approved method, which adds to the cost of operating the wells. Over the past 30 years, we have drilled more than 2,200 wells at depths ranging from 1,000 feet to just over 14,000 feet. When we select new prospect areas, we look for places where the drilling conditions are similar to areas where we have had drilling experience and where the well depths do not exceed approximately 15,000 feet. Because we have had no offshore experience, we do not plan to include any offshore prospects in the program. Since we started organizing partnerships in 1984, we have completed more than 92 percent of the wells we have drilled for our partnerships to produce natural gas and/or oil. Our completion record reflects our selection of prospect areas where the probability of drilling dry holes is relatively low because producing intervals exist throughout a large area and because each well may access several intervals which are capable of producing natural gas or oil. Nevertheless, the fact that prospect areas where we are considering to drill our wells have had a history of successful drilling and production does not guarantee that the wells will be commercially successful if the wells do not produce sufficient quantities of natural gas and oil or if the prices for natural gas and oil are at low levels. All of the areas we are currently developing fit this general description and we plan to look for similar characteristics in prospect areas we might add in the future. We also look for areas where the characteristics of the producing formations lead to relatively long producing lives, generally of 20 years or more. Production from wells typically commences at a maximum rate that diminishes over the life of the well. This means that the income stream from the wells will also tend to decline over time, depending upon other factors including the sales price for the production and operating expenses. As we evaluate the geology of a prospect area, we also determine whether there is an adequate market for natural gas and oil which may be produced by the wells. For natural gas, this includes the existence of pipelines to move the gas from the wells to natural gas markets. We look at the proximity of existing pipelines to planned drilling, the cost of moving gas to market, and prices being paid for gas in the markets which are available. Similarly, there must be both a market and suitable transportation for oil production. Current Prospect Areas Colorado. Wattenberg Field, located north and east of Denver, Colorado, is in the Denver-Julesburg (DJ) basin. The field, discovered in 1970, has produced over 600 billion cubic feet of natural gas and 2.2 million barrels of oil. The typical well production profile has an initial high production rate and relatively rapid decline, followed by years of relatively shallow decline. Natural gas is the primary hydrocarbon; however, many wells will also produce oil. The purchase price for the gas may include revenue from the recovery of propane and butane in the gas stream, as well as a premium for the high-energy content of the gas. Wells in the area may include as many as four productive formations. From shallowest to deepest, these are the Sussex, the Niobrara, the Codell and the J Sand. The primary producing sand in most wells will be the Codell; this sand produces a combination of natural gas and oil. The Piceance Basin, located near the western border of Colorado, is a second Colorado prospect area. We expect our Piceance Basin wells to produce natural gas along with very small quantities of oil and water. The producing interval consists of 150' to 300' of productive sandstone in 10 to 15 different zones. The production zones are separated by layers of nonproductive shale resulting in a total interval of 2000' to 4000' penetrated by the well. The gas reserves and production are divided into these numerous smaller zones. Summary of Prospect Areas The following table summarizes some of the key characteristics of our current prospect areas: Prospect Productive Formation Depth Range Type of Reservoir Rock Thickness of Producing Interval Anticipated Production Wattenberg Field, Colorado Sussex 3,750' - 5,250' Sandstone 10' - 60' Natural gas Niobrara 6,500' - 7,500' Limestone 20' - 80' Natural gas Codell 6,750' - 7,750' Sandstone 10' - 30' Natural gas, oil J Sandstone 7,500' - 8,400' Sandstone 2' - 90' Natural gas Piceance Basin, Colorado Williams Fork 6,000' - 10,000' Sandstone and Coal 150' - 300' total pay in a 2,000 - 4,000 interval Natural gas Drilling and Completion Phase Partnership wells in Colorado may be exploratory or developmental with depths expected to range from approximately 7,500 to 9,500 feet in depth. The Managing General Partner will drill partnership wells near pipelines, gathering systems, or end users. The partnership will sell production on a competitive basis at the best available price. General: The table above shows the anticipated depths and target formations for planned areas of operations. We may drill some shallower or deeper development prospects in these areas. If we drill wells in other areas, it is likely that well depths will differ. After drilling, the operator will complete each well deemed by the operator to be capable of production of oil or gas in commercial quantities. We may drill exploratory wells to depths exceeding the proposed developmental well depths indicated above. In the event the funds allocated for exploratory wells are not used to drill exploratory wells, we will utilize these funds together with unexpended completion funds to drill additional development wells. We have acted as operator on all of the wells drilled by our previous drilling partnerships. We may substitute another operator or operators to perform the duties of the operator, on terms and conditions substantially the same as those discussed in this prospectus. Additionally, with respect to those prospects as to which the partnership owns less than a 50% working interest, it is possible that the majority owner of the prospects will select the operator for the wells drilled on the prospects and that the operator may not be us. In the event another company acts as operator, we will monitor the performance and activities of the operator, participate as the partnership's representative in decision-making with regard to the joint venture activities, and otherwise represent the partnership with regard to the activities of the joint venture. Where someone other than us serves as operator, the cost of drilling to the partnership will be the actual cost of third-party drilling, plus our costs of supervision, engineering, geology, accounting, and other services provided, as well as monthly overhead specified in "Compensation to the Managing General Partner and Affiliates," above. Prices of wells operated by third parties may exceed the footage based rates specified in the prospectus. We will represent each partnership in all operations matters, including the drilling, testing, completion and equipping of wells and the sale of each partnership's oil and gas production from wells of which we are the operator. We expect to be the operator of most if not all of the wells in which the partnerships own an interest. We will, in some cases, provide equipment and supplies, and will perform salt water disposal services and other services for the partnerships, provided that all these transactions will be at competitive prices and upon competitive terms. We may sell equipment to the partnerships as needed in the drilling or completion of partnership wells. All equipment will be sold at prices competitive in the area of operations. Gas Pipeline and Transmission: We will drill the partnership's wells in the vicinity of transmission pipelines, gathering systems, and/or end users. We believe that there are sufficient transmission pipelines, gathering systems, and end users for the partnership's production, subject to some seasonal curtailment. The cost, timing and availability of gathering pipelines connections and service varies from area to area, well to well, and over time. In selecting prospects for the partnerships, we include in our evaluation the anticipated cost, timing and expected reliability of gathering connections and capacity. Sometimes when a lot of development work is being done in an area, production can temporarily exceed the available markets and pipeline capacity to move gas to more distant markets. This can lead to lower gas prices relative to other areas as the producers compete for the available market by reducing prices. It can also lead to curtailments of production and periods when wells are shut-in due to lack of market. Beginning in 2001 and throughout most of 2002, the Rocky Mountain region, including our Colorado development areas, experienced reduced prices and occasional curtailments as a result of this sort of situation. In May of 2003 a new major pipeline to move gas from the Rocky Mountain region to Nevada and southern California was placed in service. The pipeline is designed to move over 900 million cubic feet of gas per day out of the region according to the owner, Kern River Pipeline Company. We expect this to solve the overcapacity problem. However, if producers continue to successfully develop new supplies in the area, a similar situation could develop again in the future. Sale of Production: Each partnership will sell the oil and gas produced from its prospects on a competitive basis at the best available terms and prices. We intend to utilize the services of our subsidiary Riley Natural Gas in marketing the gas produced from partnership wells. We will not make any commitment of future production that does not primarily benefit the partnerships. Generally, purchase contracts for the sale of oil are cancelable on 30 days' notice, whereas purchase contracts for the sale of natural gas may have a term of a number of years and may require the dedication of the gas from a well for the life of its reserves. Each partnership will sell natural gas discovered by it at negotiated prices based upon a number of factors, including the quality of the gas, well pressure, estimated reserves, prevailing supply conditions and any applicable price regulations promulgated by the Federal Energy Regulatory Commission. The partnership expects to sell oil discovered by it at free market prices. See "Competition, Markets and Regulation" for a discussion of these aspects of the drilling business. Price Hedging Oil and natural gas spot market prices have been extremely variable in the past, and the variability will probably continue in the future. In order to assure a more predictable cash flow stream from partnership wells, we may use financial hedges, puts, call, and other hedging instruments to help offset variations in prices. Sometimes these hedges may result in higher cash flow than would otherwise have been received, but at other times it may result in a more predictable but lower distribution. When we use hedges, we will treat our own share of the partnership gas in the same manner we treat the investors share in order to minimize potential conflicts of interest. We may choose to hedge only part of the gas and oil, or one product and not the other. See Footnote 10 to Consolidated Balance Sheets regarding hedging activities. Drilling and Operating Agreement On wells where the Managing General Partner is operator, it will have full control over the partnerships' wells. The operator must commence drilling wells within 180 days after funding of the partnership, but not later than March 31, 2002 for partnerships designated "PDC 2001- Limited Partnership," March 31, 2003 for partnerships designated "PDC 2002- Limited Partnership" and March 31, 2004 for partnerships designated as "PDC 2003- Limited Partnership." The costs charged for drilling and completion, dry holes, and monthly operations will be competitive with rates charged for similar services and will vary by the location of the wells. Rates for areas which are currently active are shown in the table in this section. Upon funding of each partnership, the particular partnership will enter into a drilling and operating agreement with us as operator. The drilling and operating agreement (filed as Exhibit 10(a) to the registration statement) provides that the operator will conduct and direct and have full control of all operations on the partnership's prospects. The operator will have no liability as operator to the partnership for losses sustained or liabilities incurred, except as may result from the operator's negligence or misconduct. Under the terms of the drilling and operating agreement, we may subcontract responsibilities as operator for partnership wells. We will retain responsibility for work performed by subcontractors as set forth in this prospectus. It is possible that we will not be operator on some of the partnership's prospects. Where the duties of operator are subcontracted to an independent third party, the cost of the wells to the partnership will be determined by the actual third party costs, plus our charges for supervision, engineering, geology, accounting and other services, and the fixed rate overhead charge for the area where the well is located. These charges are expected to be comparable to the rates in this prospectus. The partnership will pay a proportionate share of total lease, development, and operating costs, and will receive a proportionate share of production subject only to royalties and overriding royalties. At our discretion, the partnership may enter into joint ventures which allow a functional allocation of tangible, intangible and lease costs, where each joint venturer is responsible for its overhead costs, provided the partnership's interest in the revenues and income of the joint venture is proportional to its contribution to the total cost of the venture. Each partnership will be responsible only for its obligations and will be liable only for its proportionate share of the costs of developing and operating the prospects; and, in the event of the default by another party, we have agreed to indemnify the partnership and its partners for the obligations of that party. If any party fails or is unable to pay its share of expense within 60 days after receiving a statement for these expenses from us, we will pay the unpaid amount in the proportion that the interest of each party bears to the interest of all parties. In the event not all participants in a well wish to participate in a completion attempt, the parties desiring to do so may pay all costs of the completion attempt including the cost of necessary well equipment and a gathering pipeline, and those parties will receive all income and pay all operating costs from the well until they have received an amount equal to 300% of the completion and connection costs, after which time the non-consenting parties will have the right to receive their original interest in further revenues and expenses. The operator is obligated to commence drilling the wells on each prospect within 180 days of the date of the funding of the partnership, but in no case later than March 31, 2002 for partnerships designated "PDC 2001- Limited Partnership," March 31, 2003 for partnerships designated "PDC 2002- Limited Partnership," and March 31, 2004 for partnerships designated "PDC 2003- Limited Partnership." The operator's duties include testing formations during drilling, and completing the wells by installing surface and well equipment, gathering pipelines, heaters, separators, etc., as are necessary and normal in the area in which the prospect is located. We will pay the drilling and completion costs of the operator as incurred, except that we are permitted to make advance payments to the operator where necessary to secure tax benefits of prepaid drilling costs and where there is a substantial business purpose for the advance payment. In order to comply with conditions to secure the tax benefits of prepaid drilling costs, the operator under the terms of the drilling and operating agreement will not refund any portion of amounts paid in the event actual costs are less than amounts paid but will apply any amounts solely for payment of additional drilling services to the partnership. If the operator determines that the well is not likely to produce oil and/or gas in commercial quantities, the operator will plug and abandon the well in accordance with applicable regulations. Each partnership will bear its proportionate share of the cost of drilling and completing or drilling and abandoning wells, where we serve as operator as follows: The cost of the prospect; and 2) For intangible well costs: For each well completed and placed in production, an amount equal to the depth of the well in feet at its deepest penetration as recorded by the drilling contractor multiplied by the "intangible drilling and completion cost" in the following table, plus the actual extra completion cost of zones completed in excess of the cost of the first zone and actual additional costs incurred in the event that an intermediate or third string of surface casing is run, rig mobilization and trucking costs, the additional cost for directional drilling and drill stem testing, if required; or For each well which the partnership elects not to complete, an amount equal to the "intangible dry hole cost" in the following table, plus the additional costs incurred in the event that an intermediate or third string of surface casing is run, rig mobilization and trucking costs, the additional cost for directional drilling and drill stem testing, if required; and The tangible costs of drilling and completing the partnership wells and of gathering pipelines necessary to connect the well to the nearest appropriate sales point or delivery point. To the extent that a partnership acquires less than 100% of a prospect, its drilling and completion costs of that prospect will proportionately decrease. The depth used for determining well charges will be the deepest penetration by the drilling bit. FOOTAGE BASED RATES LOCATION TARGET FORMATIONS APPROXIMATE WELL DEPTH INTANGIBLE DRILLING AND COMPLETION COSTS INTANGIBLE DRY HOLE COST Wattenberg Field Colorado Cretaceous Codell 6,500' - 7,800' $60 per foot $20 per foot Wattenberg Field Colorado Cretaceous J Sandstone 7,000' - 8,000' $72 per foot $23 per foot Piceance Basin Colorado Cretaceous Mesaverde 7,000' - 10,000' $150 per foot $85 per foot In the event the foregoing rates exceed competitive rates available from other non-affiliated persons in the area engaged in the business of rendering or providing comparable services or equipment, we will adjust the foregoing rates to an amount equal to that competitive rate. The drilling and operating agreement provides that the partnership will pay the operator the prospect cost and the dry hole cost for each planned well prior to the spud date, and the balance of the completed well costs when the well is completed and ready for production, in the case of a completed well. The operator will provide all necessary labor, vehicles, supervision, management, accounting, and overhead services for normal production operations, and will deduct from partnership revenues a monthly charge based upon competitive industry rates for each producing well for operations and field supervision and a monthly charge of $75 per well for partnership accounting, engineering, management, and general and administrative expenses. Charges for areas with current operations are shown below. INITIAL PER WELL OPERATING CHARGES WELL LOCATION MONTHLY PARTNERSHIP ADMINISTRATION MONTHLY WELLTENDING FEE Wattenberg Field $75 $325 Piceance Basin $75 $600 The partnership will have the right to take in kind and separately dispose of its share of all oil and gas produced from its prospects, excluding its proportionate share of production required for lease operations and production unavoidably lost. Initially the partnership will designate the operator as its agent to market its production and authorize the operator to enter into and bind the partnership in those agreements as it deems in the best interest of the partnership for the sale of its oil and/or gas. If pipelines we have built by us are used in the delivery of natural gas to market, the operator may charge a gathering fee not to exceed that which would be charged by a non-affiliated third party for a similar service. The production and accounting charges may be adjusted annually beginning January 1, 2004 to an amount equal to the rates initially established by the drilling and operating agreement, multiplied by the ratio of the then current average weekly earnings of Crude Petroleum and Gas Production workers to the average weekly earnings of Crude Petroleum and Gas Production workers for 2003, as published by the United States Department of Labor, Bureau of Labor Statistics, provided that the charge may not exceed the rate which would be charged by the comparable operators in the area of operations. The drilling and operating agreement will continue in force so long as any well or wells produce, or are capable of production, and for an additional period of 180 days from cessation of all production. Production Phase of Operations The partnership will sell the produced gas to industrial users, gas brokers, interstate pipelines, or local utilities, subject to market sensitive contracts in which the price of gas sold will vary as a result of market forces. The partnership may enter into fixed price contracts or use financial hedges to reduce the variability of cash flow resulting from increases and decreases in gas and oil prices, which may result in greater or lower cash flow than if hedges were not used. The partnership will not complete contracts for sale of gas until after drilling of the wells. Oil will be sold to local purchasers at spot prices. General. Once the partnership's wells are "completed" (i.e., all surface equipment necessary to control the flow of, or to shut down, a well has been installed, including the gathering pipeline), production operations will commence. The partnership will not complete contracts for sale of gas or oil until after drilling of the wells, except as noted below. The partnership will sell the produced gas to industrial users, gas marketers, including affiliated marketers, commercial end users, interstate or intrastate pipelines or local utilities, primarily under market sensitive contracts in which the price of gas sold will vary as a result of market forces. Some leases, and thus the gas derived from wells drilled on those leases, may be dedicated to particular markets at the time we acquire those leases. The partnership may enter into fixed price contracts, or utilize derivatives, including hedges, swaps or options in order to offset some or all of the price variability for particular periods of time, generally for less than one year. The use of derivatives may entail fees, including the time value of money for margin requirements, which will be charged to the partnership. We may utilize our subsidiary Riley Natural Gas to market gas, enter into hedges or swaps, or purchase options on behalf of the partnership. Riley Natural Gas will be entitled to charge reasonable fees for its services, including out-of-pocket costs. These fees, however, will be equal to or less than fees charged to non-affiliated producers for similar services. Seasonal factors, such as effects of weather on costs, may impact the partnership's results. In addition, both sales volumes and prices tend to be affected by demand factors with a significant seasonal component. Expenditure of Production Revenues. The partnership's share of production revenue from a given well will be burdened by and/or subject to royalties and overriding royalties, monthly operating charges, taxes and other operating costs. The above items of expenditure involve amounts payable solely out of, or expenses incurred solely by reason of, production operations. The partnership's only source of revenues will be from production operations, because the partnership may not borrow any funds it may require to meet operation expenditures (see "Risk Factors - A partnership may not borrow funds, even if needed for partnership operations; as a result, the partnership might not have sufficient capital for its operations and we might not be able to fully develop the partnership's wells; in that event, an investor might anticipate a reduction in cash distributions" and "Source of Funds and Use of Proceeds - Subsequent Source of Funds" for a discussion of the implications of the partnership's not being able to borrow funds). It is our practice to deduct operating expenses from the production revenue for the corresponding period, and to defer the collection of operating expenses when revenues are insufficient to render full payment. Interests of Parties We, investor partners, and unaffiliated third parties (including landowners) share revenues from production of gas and oil from wells in which the partnership has an interest. The following chart expresses the interest of gross revenues derived from the wells. For the purpose of this chart, "gross revenues" is defined as the "Well Head Gas and Oil Revenue" paid by the purchasers. In the event the partnership acquires less than a 100% working interest, the percentages available to the partnership will decrease proportionately. Landowner and other royalty interests payable to unaffiliated third parties may vary, provided that the weighted average of the royalty interests for all prospects of a partnership shall not exceed 20%. The revenues to be distributed are subject to the revised sharing arrangement policy and to revisions if we make a capital contribution greater than our 21-3/4% requirement. Program Revenue Sharing Partnership Working Interest Third Party Royalties Entity Interest If 12-1/2% If 20% Managing General Partner 20% Partnership Interest 17.50% 16.00% Investor Partners 80% Partnership Interest 70.00% 64.00% Third Parties Landowners and Over- riding Royalties 12.50% 20.00% 100.00% 100.00% Insurance The Managing General Partner will carry public liability insurance of not less than $10 million during drilling operations and will maintain other insurance as appropriate. The Managing General Partner has a good faith duty to provide insurance coverage, sufficient, in its judgment, to protect the Investors against the foreseeable risks of drilling. Increasing cost of insurance could reduce partnership funds available for drilling. We, in our capacity as operator, will carry blowout, pollution, public liability and workmen's compensation insurance, but that insurance may not be sufficient to cover all liabilities. Each unit held by the additional general partners represents an open-ended security for unforeseen events such as blowouts, lost circulation, stuck drillpipe, etc., which may result in unanticipated additional liability materially in excess of the per unit subscription amount. We have obtained various insurance policies, as described below, and intend to maintain these policies subject to our analysis of their premium costs, coverage and other factors. We may, in our sole discretion, increase or decrease the policy limits and types of insurance from time to time as we deem appropriate under the circumstances, which may vary materially. We have obtained and expect to maintain the following types and amounts of insurance. We are the beneficiary under each policy and pay the premiums for each policy, except the Managing General Partner and the partnership are co-insured and co-beneficiaries with respect to the insurance coverage referred to in #2 and #5 below. Additionally, we as operator of the partnerships' wells require all of our subcontractors to carry varying amounts of liability insurance coverage with respect to their activities. In the event of a loss, the insurance policies of the particular subcontractor at risk would be drawn upon before the insurance of the Managing General Partner or that of the partnership. Workmen's compensation insurance in full compliance with the laws for the States of West Virginia, Michigan, Pennsylvania and Colorado; this insurance will be obtained for any other jurisdictions where a partnership conducts its business; Operator's bodily injury liability and property damage liability insurance, each with a limit of $1,000,000; Employer's liability insurance with a limit of not less than $1,000,000; 4. Automobile public liability insurance with a limit of not less than $1,000,000 per occurrence, covering all automobile equipment; and 5. Operator's umbrella liability insurance with a limit of $49,000,000 for each well location. We, as Managing General Partner and operator, have determined in good faith, in the exercise of our fiduciary duty as Managing General Partner and as operator, that adequate insurance has been obtained on behalf of the partnerships to provide the partnership with the coverage as we believe is sufficient to protect the investor partners against the foreseeable risks of drilling. We will obtain and maintain public liability insurance, including umbrella liability insurance, of at least two times the Partnership's capitalization, but in no event less than $10 million during drilling operations. In the event that two partnerships are conducting drilling activities simultaneously, as provided for under "Proposed Activities - Introduction" above, and the investor capital of the partnerships is in excess of $25 million in the aggregate, we will obtain additional liability insurance coverage during drilling in order to provide the above-referenced two-times insurance coverage with respect to the total capitalization of those partnerships which are conducting simultaneous drilling activities. We will maintain the two-times insurance coverage during its drilling activities. We will review the partnership insurance coverage prior to commencing drilling operations and periodically evaluate the sufficiency of insurance. We will obtain and maintain our insurance coverage as we determine to be commensurate with the level of risk involved. In more than 30 years of operations, drilling more than 2,200 wells in Tennessee, Ohio, Pennsylvania, Michigan, Colorado, North Dakota, Montana, Utah, Wyoming and West Virginia, our largest insurance claim has been less than $80,000. The annual cost of the insurance to the partnership is estimated to be approximately $625 per well in the year that it is drilled and approximately $140 per each producing well for the partnership liability and other insurance coverages. The costs of insurance are allocated based primarily upon the level of natural gas operations. Insurance premiums may increase in the future. The primary effect of increasing premiums cost is to reduce funds otherwise available for partnership drilling operations or for distribution to investors. We will notify all additional general partners at least 30 days prior to any material change in the amount of the insurance coverage. Within this 30-day period and otherwise after the expiration of one year following the closing of the offering with respect to a particular partnership, additional general partners have the right to convert their units into units of limited partnership interest by giving written notice to us and will have limited liability for any partnership operations conducted after the conversion date as a limited partner effective upon the filing of an amendment to the certificate of limited partnership of a partnership. At any time during this 30-day period, upon receipt of the required written notice from the additional general partner of his intent to convert, we will amend the limited partnership agreement and will file an amendment with the State of West Virginia prior to the effective date of the change in insurance coverage and effectuate the conversion of the interest of the former additional general partner to that of a limited partner. The Managing General Partner's Policy Regarding Roll-Up Transactions Although we have no intention of engaging the partnership in a "roll-up" transaction, it is possible at some indeterminate time in the future that the partnership will become so involved. In general, a roll-up means a transaction involving the acquisition, merger, conversion, or consolidation, directly or indirectly, of the partnership with or into another partnership, corporation or other entity, which we refer to as the "roll-up entity" and the issuance of securities by the roll-up entity to investor partners. A roll-up will not include a transaction involving the conversion to corporate, trust or association form of only the partnership if, as a result of the transaction, there is no significant adverse change in the voting rights of the investor partners, the term of existence of the partnership, our compensation, or the investment objectives of the partnership. The determination of "significant adverse change" will be made solely by us in the exercise of our reasonable business judgment as manager of the partnership and consistent with our obligations as a fiduciary to the investor partners. The limited partnership agreement provides various policies in the event that a roll-up should occur in the future. These policies include: (1) An appraisal of all partnership assets will be obtained from a competent independent expert, and a summary of the appraisal will be included in a report to the investor partners in connection with a proposed roll-up; (2) Any participant who votes "no" on the proposal will be offered a choice of: accepting the securities of the roll-up entity offered in the proposed roll-up; or either (a) remaining an investor partner in the partnership and preserving his or her interests in the partnership on the same terms and conditions as existed previously, or (b) receiving cash in an amount equal to his or her pro-rata share of the appraised value of the partnership's net assets; (3) The partnership will not participate in a proposed roll-up which would result in the diminishment of an investor partner's voting rights under the roll-up entity's chartering agreement; in which the investor partners' right of access to the records of the roll-up entity would be less than those provided by the limited partnership agreement; or in which any of the costs of the transaction would be borne by the partnership if the proposed roll-up is not approved by the investor partners. The limited partnership agreement further provides that the partnership will not participate in a roll-up transaction unless the roll-up transaction is approved by at least 66 2/3% in interest of the investor partners. See Section 5.07(m) of the limited partnership agreement. COMPETITION, MARKETS AND REGULATION Competition is intense in all phases of the oil and gas industry, including the acquisition of prospects and the sale of production. Competition for equipment and services is keen and can adversely affect drilling costs and the timing of drilling. Excess supplies and competition have depressed gas and oil prices at times, and there is no way to predict when unfavorable conditions may exist in the future. The partnership expects to sell its gas and oil subject to market sensitive contracts, so the price of gas and oil sold will vary as a result of market forces. Competition and Markets Competition is keen among persons and companies involved in the exploration for and production of oil and gas. The partnership will encounter strong competition at every phase of its business including acquiring properties suitable for exploration and development and marketing of oil and gas. It will compete with entities having financial resources and staffs substantially larger than those available to the partnership. There are thousands of oil and gas companies in the United States. The national supply of natural gas is widely diversified. As a result of this competition and Federal Energy Regulatory Commission ("FERC") and Congressional deregulation of gas and oil prices, prices are generally determined by competitive forces. There will also be competition among operators for drilling equipment, tubular goods, and drilling crews. The competition may affect the ability of each partnership to acquire leases suitable for development by the partnerships and to develop expeditiously the leases once they are acquired. The marketing of any oil and gas produced by a partnership will be affected by a number of factors which are beyond the partnership's control and whose exact effect cannot be accurately predicted. These factors include the volume and prices of crude oil imports, the availability and cost of adequate pipeline and other transportation facilities, the marketing of competitive fuels, such as coal and nuclear energy, and other matters affecting the availability of a ready market, such as fluctuating supply and demand. Among other factors, the supply and demand balance of crude oil and natural gas in world markets have caused significant variations in the prices of these products over recent years. FERC Order No. 636, issued in 1992, restructured the natural gas industry by requiring pipelines to separate their storage, sales and transportation functions and establishing an industry-wide structure for "open-access" transportation service. Order No. 637, issued in February 2000, further enhanced competitive initiatives, by removing price caps on short-term capacity release transactions. The accelerating deregulation of natural gas and electricity transmission has caused, and may continue to cause, a convergence of the gas and electric industries. CNG Transmission, which has purchased partnership production in the past, is an example of this convergence, having completed its merger with Dominion Resources, Inc., a large, Virginia-based provider of electric services, in January 2000. Demand for natural gas by the electric power sector is expected to increase through the next decade, according to the United States Energy Information Administration. Increased competition, particularly where coupled with the enforcement of stringent environmental regulations, may increase the electric industry's reliance on natural gas. Order No. 637 also enacted other regulatory policies that increase the flexibility of interstate gas transportation, maximize shippers' supply alternatives, and encourage domestic natural gas production in order to meet projected increases in natural gas demand. These increases in demand will come from a number of sources, including as boiler fuel to meet increase electric power generation needs and as an industrial fuel that is environmentally preferable to alternatives such as nuclear power and coal. This trend has been evident over the past year, particularly in the western U.S., where natural gas is the preferred fuel for environmental reasons, and electric power demand has directly affected demand for natural gas. Beginning in 1995, the North American Free Trade Agreement ("NAFTA") eliminated trade and investment barriers in the United States, Canada, and Mexico, increasing foreign competition for natural gas production. Legislation that Congress may consider with respect to oil and gas may increase or decrease the demand for the partnerships' production in the future, depending on whether the legislation is directed toward decreasing demand or increasing supply. Members of the Organization of Petroleum Exporting Countries establish prices and production quotas for petroleum products from time to time, with the intent of reducing the current global oversupply and maintaining or increasing price levels. We are unable to predict what effect, if any, future OPEC actions will have on the quantity of, or prices received for, oil and gas produced and sold from the partnerships' wells. Various parts of the prospect area are crossed by pipelines belonging to Colorado Interstate Gas, NARCO, Duke, Williams and others. These companies have all traditionally purchased substantial portions of their supply from Colorado producers. In addition, all are subject to regulations enacted by state commissions or the FERC which require them to transport gas for others. Transportation on these systems requires that delivered gas meet quality standards and that a tariff be paid for quantities transported. The partnership expects to sell gas from its wells to Duke Energy, Narco and Williams on the spot market via open access transportation arrangements through Colorado Interstate Gas, Williams or other pipelines. As a result of FERC regulations that require interstate gas pipelines to separate their merchant activities from their transportation activities and require them to release available capacity on both a short- and a long-term basis, local distribution companies must take an increasingly active role in acquiring their own gas supplies. Consequently, pipelines and local distribution companies are buying gas directly from gas producers and marketers, and retail unbundling efforts are causing many end-users to buy their own reserves. Activity by state regulatory commissions to review local distribution company procurement practices more carefully and to unbundle retail sales from transportation has caused gas purchasers to minimize their risks in acquiring and attaching gas supply and has added to competition in the natural gas marketplace. In Order No. 587 and other initiatives, FERC required pipelines to develop electronic communications in order to ensure that the gas industry is more competitive. Pipelines must provide standardized access via the Internet to information concerning capacity and prices, and standardized procedures are now available for nominating and scheduling deliveries. The industry has also developed methods to access and integrate all gas supply and transportation information on a nationwide basis, via the Internet, so as to create a national market. Furthermore, parallel developments toward an electronic marketplace for electric power, mandated by the FERC in Order Nos. 888 and 2000, are serving to create multi-national markets for energy products generally. These systems will allow rapid consummation of natural gas transactions. Gas purchased in West Virginia, could, for example, be used in Seattle. Although this system may initially lower prices due to increased competition, it is anticipated to expand natural gas markets and to improve the reliability of the markets. Natural Gas Pricing The Managing General Partner anticipates that the partnerships' gas will be sold at fair market value. The partnership may enter into fixed price contracts or use financial hedges to fix gas prices, which may result in greater or lower prices than market sensitive prices. The partnership anticipates that it will sell the gas and oil from its wells in Colorado subject to market sensitive contracts, the price of which will increase or decrease with market forces beyond our control. In the past, we have sold the gas in the Piceance Basin primarily to Williams Production RMT, which has an extensive gathering and transportation system in the field. In Wattenberg Field, the gas is sold to Duke Energy Field Services, which gathers and processes the gas and liquefiable hydrocarbons produced, or to Encana. The oil is sold primarily to Teppco. Gas produced in Colorado is subject to changes in market prices on a national level, as well as changes in the market within the Rocky Mountain Region. Sales may be affected for short periods of time by capacity interruptions on pipelines transporting gas out of the region. The PDC-sponsored partnerships have sold natural gas over the period May 1, 2002 through April 30, 2003 at prices ranging from $2.58 per Mcf to $12.20 per Mcf in the Appalachian Basin, $2.41 per Mcf to $ 7.10 per Mcf in Michigan, and $0.95 per Mcf to $7.18 per Mcf in the Rocky Mountain region. In the past, natural gas produced by the partnerships in the Rocky Mountain region has sold for less than the partnerships' prices received in the Appalachian and Michigan basins, but the partnerships' Rocky Mountain region development costs have been less than the costs per Mcfe of development in the Appalachian and Michigan basins. Notwithstanding this experience by previous PDC-sponsored partnerships, there can be no assurance that the partnership will receive similar prices for, or incur similar development costs in, its natural gas production. Sale of natural gas by the partnerships will be subject to regulation by governmental regulatory agencies. Generally, the regulatory agency in the state where a producing gas well is located supervises production activities and the transportation of gas sold into intrastate markets. The FERC regulates the rates for interstate transportation of natural gas but, under the Wellhead Decontrol Act of 1989, FERC may not regulate the price of gas. Deregulated gas production may be sold at market prices determined by supply, demand, Btu content, pressure, location of wells, and other factors. Regulation Federal and state laws and regulations have a significant impact on drilling and production operations. Environmental protection regulations may necessitate significant capital outlays by the partnership. Federal and state regulations will affect production of partnership oil and gas. In most areas of operations, the production of oil is regulated by conservation laws and regulations, which set allowable rates of production and otherwise control the conduct of oil operations. The partnership's drilling and production operations will also be subject to environmental protection regulations established by federal, state, and local agencies, which in turn may necessitate significant capital outlays which would materially affect the financial position and business operations of the partnership (see "Risk Factors - Environmental hazards involved in drilling gas and oil wells may result in substantial liabilities for the partnership"). Some states control production through regulations establishing the spacing of wells, limiting the number of days in a given month during which a well can produce and otherwise limiting the rate of allowable production. Through regulations enacted to protect against waste, conserve natural resources and prevent pollution, local, state and federal environmental controls will also affect partnership operations. These regulations could affect partnership operations and could necessitate spending funds on environmental protection measures, rather than on drilling operations. If any penalties or prohibitions were imposed on a partnership for violating those regulations, that partnership's operations could be adversely affected. In prior programs, expenses associated with compliance with environmental regulations have represented approximately 10-15% of the cost of drilling and completing wells, and it is expected that similar costs will be incurred in this program. These costs are included in the footage-based rates described at "Proposed Activities - Drilling and Operating Agreement," above. Proposed Regulation Various legislative proposals in Congress and in state legislatures could, if enacted, affect the petroleum and natural gas industries. These proposals involve, among other things, imposition of direct or indirect price limitations on natural gas production, expansion of drilling opportunities in areas that would compete with partnership production, imposition of land use controls (such as prohibiting drilling activities on federal and state lands in roadless wilderness areas), alternative fuel use requirements and/or tax incentives and other measures. At the present time, it is impossible to predict what proposals, if any, will actually be enacted by Congress or the various state legislatures and what effect, if any, the proposals will have on the partnerships' operations. MANAGEMENT General Management The Managing General Partner of the partnership is Petroleum Development Corporation ("PDC"), a publicly-owned Nevada corporation organized in 1955. The common stock of PDC is traded on the Nasdaq National Market. Since 1969, PDC has been engaged in the business of exploring for, developing and producing oil and natural gas primarily in the Appalachian Basin area of West Virginia, Tennessee, Pennsylvania, Ohio, Michigan and the Rocky Mountains. As of March 31, 2003, PDC had approximately 100 employees. PDC will make available to investor partners, upon request, audited financial statements of PDC for the most recent fiscal year and unaudited financial statements for interim periods. PDC's Internet address is www.petd.com. PDC posts on its Internet Web site its periodic and current reports and other information that it files with the SEC. We will actively manage and conduct the business of the partnerships, devoting our time and talents to management as we shall deem reasonably necessary. We will have the full and complete power to do any and all things necessary and incident to the management and conduct of each partnership's business. We will be responsible for maintaining partnership bank accounts, collecting partnership revenues, making distributions to the partners, delivering reports to the partners, and supervising the drilling, completion, and operation of the partnerships' natural gas and oil wells. In addition to managing the affairs of the partnership, the management and technical staff of PDC also manage the corporate affairs of the company, the affairs of 65 partnerships formed in the current and previous programs, and other joint ventures formed over the years. We own an interest in all of the older partnerships and wells in addition to the interest we will purchase in the PDC 2003 Drilling Program partnerships. Since we must divide our attention and efforts among many unrelated parties, your partnership will not receive our full attention or efforts at all times. Experience and Capabilities as Driller/Operator PDC will act as driller/operator for the program wells. Since 1969 PDC has drilled over 2,200 wells in Colorado, West Virginia, Tennessee, Ohio, Michigan, North Dakota, Utah, Wyoming, and Pennsylvania. PDC currently operates approximately 2,200 wells. PDC employs four geologists who develop prospects for drilling by PDC and who help oversee the drilling process. In addition, PDC has an engineering staff of four who are responsible for well completions, pipelines, and production operations. PDC retains drilling subcontractors, completion subcontractors, and a variety of other subcontractors in the performance of the work of drilling contract wells. In addition to technical management, PDC may provide services, at competitive rates, from PDC-owned service rigs, a water truck, steel tanks used temporarily on the well location during the drilling and completion of a well, roustabouts, and other assorted small equipment. A roustabout is an oil and gas field employee who provides skilled general labor for assembling well components and other similar tasks. PDC may lay short gathering lines, or may subcontract all or part of the work where it is more cost effective for a partnership. PDC employs full-time welltenders and supervisors to operate its wells. In addition, the engineering staff evaluates reserves of all wells at least annually and reviews well performance against expectations. All services provided by us are provided at rates less than or equal to prevailing rates for similar services provided by unaffiliated persons in the area. Petroleum Development Corporation The executive officers, directors and key technical personnel of PDC, their principal occupations for the past five years and additional information are set forth below: Positions and Held Current Name Age Offices Held Position Since James N. Ryan 71 Chairman, Chief Executive Officer and Director November 1983 Steven R. Williams 52 President and Director March 1983 Dale G. Rettinger 58 Chief Financial Officer, Executive Vice President, Treasurer and Director July 1980 Roger J. Morgan 76 Secretary November 1969 Vincent F. D'Annunzio 51 Director February 1989 Jeffrey C. Swoveland 48 Director March 1991 Donald B. Nestor 54 Director March 2000 Kimberly Luff Wakim 45 Director January 2003 Thomas Riley 50 Vice President - Gas Marketing and Acquisitions April 1996 Darwin L. Stump 48 Corporate Controller October 1980 Ersel Morgan 59 Vice President - Production April 1995 Eric Stearns 45 Vice President - Exploration and Development April 1985 Alan Smith 45 Senior Geologist April 1980 Bob Williamson 49 Geologist February 1991 Susan Foster 42 Engineer June 1997 Tom Carpenter 51 Senior Geologist December 1997 Dewey Gerdom 44 Western Region Manager August, 2000 Steve Trippett 47 Engineer June 1984 Wallace Darden 65 Engineer September 1993 James N. Ryan has served as President and Director of PDC from 1969 to 1983 and was elected Chairman and Chief Executive Officer in March 1983. Mr. Ryan plans to retire at the end of 2003. Steven R. Williams has served as President and Director of PDC since March 1983. Prior to joining PDC, Mr. Williams was employed by Exxon until 1979 and attended Stanford Graduate School of Business, graduating in 1981. He then worked with Texas Oil and Gas until July 1982, when he joined Exco Enterprises, an oil and gas investment company, as manager of operations. Upon Mr. Ryan's retirement, Mr. Williams will become Chief Executive Officer of PDC and will continue as PDC's President. Dale G. Rettinger has served as Vice President and Treasurer of PDC since July 1980, and was appointed Chief Financial Officer in September 1997. Mr. Rettinger was elected Director in 1985. Previously, Mr. Rettinger was a partner with Main Hurdman, Certified Public Accountants, having served in that capacity since 1976. Roger J. Morgan has been a member of the law firm of Young, Morgan & Cann, Clarksburg, West Virginia, since 1955. Mr. Morgan is not active in the day-to-day business of PDC, but his law firm provides legal services to PDC. Mr. Morgan retired as a Director of PDC in January 2003. Vincent F. D'Annunzio has served as president of Beverage Distributors, Inc., located in Clarksburg, West Virginia since 1985. Jeffrey C. Swoveland has served as Chief Financial Officer of Body Media, Inc., Pittsburgh, Pennsylvania since September 2000. Prior thereto, Mr. Swoveland was Vice President-Finance and Treasurer of Equitable Resources, Inc. since September 1994. Mr. Swoveland received an MS degree in finance from Carnegie Mellon University. Donald B. Nestor was elected as a Director in March 2000, is a Certified Public Accountant and a Partner in the CPA firm of Toothman, Rice, P.L.L.C. and is in charge of the firm's Buckhannon, West Virginia office. Mr. Nestor has served in that capacity since 1975. Kimberly Luff Wakim was appointed as a Director of PDC by the board of directors of PDC in January 2003 to complete the remainder of Mr. Morgan's term, which expires during 2003. The PDC Nominating Committee has nominated Ms. Wakim for a full three-year term as Director to commence upon her election at the PDC annual meeting of stockholders in July 2003. Ms. Wakim, an attorney and a CPA, is a Partner with the Pittsburgh, Pennsylvania law firm, Thorp, Reed & Armstrong LLP, where she serves as a member of the Executive Committee. Her areas of practice include creditor's rights, bankruptcy, workouts, commercial finance and transactions, commercial litigation, and commercial real estate. Ms. Wakim has practiced law with Thorp, Reed & Armstrong LLP since 1990. Thomas Riley has served as Vice President - Gas Marketing and Acquisitions of PDC since April 1996. Prior to joining PDC, Mr. Riley was president of Riley Natural Gas Company, a natural gas marketing company, from its inception in 1987. PDC acquired Riley Natural Gas in April 1996. Mr. Riley continues to serve as president of PDC's wholly-owned subsidiary. Darwin L. Stump has been an officer of PDC since April 1995 and has held the position of Corporate Controller since October 1980. Prior to joining PDC, he was a senior accountant with Main Hurdman, Certified Public Accountants. Mr. Stump is a CPA, a member of the AICPA, the West Virginia Society of CPAs and a graduate of West Virginia University with a B.S. degree in accounting. Ersel Morgan was elected Vice President-Production in April 1995. He joined PDC as a landsman in 1980. Eric Stearns was elected Vice President-Exploration and Development in April 1995. Mr. Stearns joined PDC in 1985 after working as a mudlogger for Hywell, Incorporated logging wells in the Appalachian Basin between 1982 and 1985, and for Petroleum Consultants, Inc. between 1984 and 1985. Alan Smith joined PDC in April 1980 as a geologist in the Tennessee Division. He has a BS degree in geology from Tennessee Technological University. As a senior geologist he has been responsible for the development of prospects and supervision of drilling operations since 1983. Bob Williamson joined PDC in February 1991, as a geologist. Mr. Williamson received a B.S. degree in geology from West Virginia University in 1980. Prior to joining PDC, he worked as a geologist for Ramco in Belpre, Ohio, for nearly nine years on projects in West Virginia, Kentucky, Kansas, and Oklahoma. Susan Foster joined PDC in June 1997, as a petroleum engineer. Ms. Foster has a BS degree in petroleum engineering from Pennsylvania State University. Prior to joining PDC, Ms. Foster worked as a petroleum engineer in the Appalachian Basin with several oil and gas companies. Tom Carpenter joined PDC in December 1997 as a senior geologist. Mr. Carpenter has a B.A. degree in geology from Miami University of Ohio and an M.S. degree in geology from West Virginia University as well as other post-graduate studies and seminars. Prior to joining PDC, Mr. Carpenter was employed as Manager of Exploration and Development of Alamco, Inc. from 1996-1997, and by Ashland Exploration, Inc. and Shell Oil Company. Dewey Gerdom joined PDC in August, 2000 as Manager of our Colorado office. Prior to joining the Company, Mr. Gerdom has over 24 years of experience in the industry including 15 years with Chevron. Steve Trippett joined PDC in June, 1984. For the past 11 years he has worked as a completion engineer for the Company, including the past 3 years in our Denver office. Wallace Darden joined PDC in September, 1993 as a completion engineer. Mr. Darden has over 41 years of experience in oilfield cementing and completion services, including 18 years with Haliburton. Certain Shareholders of Petroleum Development Corporation The following table sets forth information as of April 15, 2003, with respect to the common stock of PDC owned by each person who owns beneficially 5% or more of the outstanding voting common stock, by all directors individually, and by all directors and officers as a group. Name and Address Beneficial Ownership (1) Number Percent Fidelity Management 82 Devonshire Street Boston, MA 02109 1,624,500 10.4 Dimensional Fund Advisors Inc. 1299 Ocean Avenue Santa Monica, CA 90401 1,154,000 7.4 Steven R. Williams(2) 103 East Main Street Bridgeport, WV 26330 548,426 3.5 Dale G. Rettinger(2) 103 East Main Street Bridgeport, WV 26330 472,016 3.0 James N. Ryan(3) 103 East Main Street Bridgeport, WV 26330 266,089 1.7 Vincent F. D'Annunzio 37,899 * Jeffrey C. Swoveland 16,728 * Donald B. Nestor 1,000 * Kimberly Luff Wakim -0- -0- All directors and executive officers as a group (8 persons)(4) 1,342,158 8.6 ___________________________________ * Less than 1% (1) Includes shares over which the person currently holds or shares voting or investment power. Unless otherwise indicated in the footnotes to this table, the persons named in this table have sole voting and investment power with respect to the shares beneficially owned. (2) Includes options to purchase 178,000 shares that such person can currently exercise within 60 days. (3) Includes options to purchase 108,000 shares that such person can currently exercise within 60 days. (4) Includes options to purchase 464,000 shares that such persons can currently exercise within 60 days. Remuneration None of our officers or directors will receive any direct remuneration or other compensation from the partnerships. These persons will receive compensation solely from PDC. Information as to compensation paid by us to our directors and executive officers may be obtained from publicly available reports filed by us with the Securities and Exchange Commission under the Securities Exchange Act of 1934. Legal Proceedings We as driller/operator are subject to minor legal proceedings arising from the normal course of business. These legal actions are not considered material to the operations of the partnership or us. CONFLICTS OF INTEREST The Managing General Partner currently manages and in the future will sponsor and manage natural gas and oil drilling programs similar to the partnerships. The Managing General Partner decides which prospects each partnership will acquire. The Managing General Partner will act as operator of the partnership wells; the terms of the drilling and operating agreement have not been negotiated by non-affiliated persons. The Managing General Partner will provide drilling and completion services with respect to partnership wells. The Managing General Partner is general partner of numerous other partnerships, and owes duties of good-faith dealing to its other partnerships. The Managing General Partner and affiliates engage in significant drilling, operating, and producing activities for other partnerships. The partnerships are subject to various conflicts of interest arising out of their relationship with us. These conflicts include, but are not limited to, the following: Future Programs by Managing General Partner and Affiliates. We have the right and expect to continue to organize and manage oil and gas drilling programs in the future similar to the partnerships of the program, and to conduct operations now and in the future, jointly or separately, on our own behalf or for other private or public investors. Affiliates of ours also intend to conduct those activities on their own behalf. Officers, directors and employees of ours have participated, and will participate in the future, at cost, in working interests in wells in which we and our partnerships participate. To the extent that we engage in these activities or that our affiliates invest in the partnerships or other partnerships sponsored by us, conflicts of interest will arise. Fiduciary Responsibility of the Managing General Partner. We are accountable to the partnership as a fiduciary and consequently have a duty to exercise good faith and to deal fairly with the investors in handling the affairs of the partnership. While we will endeavor to avoid conflicts of interest to the extent possible, conflicts nevertheless may occur and, in that event, our actions may not be most advantageous to the partnership and could fall short of the full exercise of our fiduciary duty. In the event we should breach our fiduciary responsibilities, you would be entitled to an accounting and to recover any economic losses caused by our breach, only after either proving a breach in court or reaching a settlement with us. Independent Representation in Indemnification Proceeding. Counsel to the partnership and to us in connection with this offering are the same. This dual representation will continue in the future. However, in the event of an indemnification proceeding between the partnership and us, we will cause the partnership to retain separate and independent counsel to represent its interest in the proceeding. Due Diligence Review. PDC Securities Incorporated, the dealer manager of the offering, is our affiliate and its due diligence examination concerning this offering cannot be considered to be independent. See "Plan of Distribution" for a discussion of the procedures involved in the offering of the units for sale. Managing General Partner's Interest. Although we believe that our interest in partnership profits, losses, and cash distributions is equitable (see "Participation in Costs and Revenues" for a discussion of the allocation of the revenue and expense items of the partnership), our interest was not determined by arm's-length negotiation. Transactions between the Partnership and Operator. We will also act as operator. Accordingly, although we believe the terms of the drilling and operating agreement will be equitable, it will not be the subject of arm's-length negotiation. Furthermore, we may be confronted with a continuing conflict of interest with respect to the exercise and enforcement of the rights of the partnership under that agreement. See "Transactions with the Managing General Partner or Affiliates," below. Conflicting Drilling Activities. Our affiliates have engaged in significant drilling and producing activities for the accounts of affiliated partnerships related to previous drilling programs. In addition, we and our affiliates manage and operate natural gas and oil properties for investors in other drilling programs. Although the limited partnership agreement attempts to minimize any potential conflicts, we will be in a position to decide whether a natural gas or oil property will be retained or acquired for the account of the partnership or other drilling programs which we or our affiliates may presently operate or operate in the future. Conflicts with Other Programs. We realize that our conduct and the conduct of our affiliates in connection with the other drilling programs could give rise to a conflict of interest between the position of PDC as Managing General Partner of the partnership and the position of PDC or one of its affiliates as general partner or sponsor of additional programs. In resolving any conflicts, each partnership will be treated equitably with other partnerships on a basis consistent with the funds available to the partnerships and the time limitations on the investment of funds. However, no provision has been made for an independent review of conflicts of interest. We believe that the possibility of conflicts of interest between the partnership and prior programs is minimized by the fact that substantially all the funds available to prior drilling programs in which we or an affiliate serves as general partner have been committed to a specific drilling program. We follow a policy of developing next what we judge to be the best available prospect. Acquisition of new leases and information derived from wells already drilled result in a constant change in this assessment. We anticipate that generally only one partnership will be actively engaged in drilling at any time. However, if more than one partnership has funds available for drilling, the partnerships will alternate drilling of wells based on the "best available prospect" format. The determination of the "best available prospect" is based on our assessment of the economic potential of a prospect and its suitability to a particular partnership, and considers various factors including estimated reserves, target geological formations, gas and oil markets, geological and gas and oil market diversification within the partnership, royalties and overrides on the prospect, estimated lease and well costs, and limitations imposed by the prospectus and/or partnership agreements. The limited partnership agreement authorizes us to cause the partnership to acquire undivided interests in natural gas and oil properties, and to participate with other parties, including other drilling programs previously or subsequently conducted by us or our affiliates, in the conduct of exploration and drilling operations on those properties. Because we must deal fairly with the investors in all of our drilling programs, if conflicts between the interest of the partnership and other drilling programs do arise, we might not in every instance be able to resolve those conflicts to the maximum advantage of the partnership. From time to time, we may cause partnership prospects to be enlarged or contracted on the basis of geological data to define the productive limits of any pool discovered. The partnership is not required to expend additional funds for the acquisition of property unless the acquisition can be made from the capital contributions. The limited partnership agreement does not permit the partnership to borrow money as may be required for its business. If the property is not acquired by the partnership, the partnership may lose a promising prospect. Except as otherwise provided by the limited partnership agreement, a prospect might be acquired by us or an affiliate or other drilling programs conducted by them. In addition, subject to the restrictions set forth below, we in our sole discretion decide which prospects and what interest to transfer to the partnership. This may result in another drilling program sponsored by us acquiring property adjacent to partnership property. Another program could gain an advantage over the partnership by reason of the knowledge gained through the partnership's prior experience in the area or if the other drilling program were the first to discover or develop a productive pool of oil or natural gas. Acquisition of Prospects. We have discretion in selecting leases to be acquired by the partnership from us or our affiliates or third parties and the location and type of operations which the partnership will conduct on the leases. Some leases may be part of our existing inventory, although no leases have been designated for inclusion in the partnership at the present time. Neither we nor any affiliate will retain undeveloped acreage adjoining a partnership prospect in order to use partnership funds to "prove up" the acreage owned for our own account. Whenever we sell, transfer or convey an interest in a prospect to a particular partnership, we must, at the same time, sell to the partnership an equal proportionate interest in all of our leases in the same prospect (except any interests in producing wells). If we or an affiliate (except another affiliated limited partnership in which the interest of us or our affiliates is identical or less than their interest in the partnerships) subsequently proposes to acquire an interest in a prospect in which a partnership possesses an interest or in a prospect abandoned by the partnership within one year preceding the prospect acquisition, we or the affiliate will offer an equivalent interest to the partnership; and, if cash or financing is not available to the partnership to enable it to consummate a purchase of an equivalent interest in the property, neither we nor any of our affiliates will acquire the interest or property, but the term "affiliate" will not include another partnership where our or our affiliates' interest is identical to, or less than, their interest in the subject partnerships. The term "abandon" means the termination, either voluntarily or by operation of the lease or otherwise, of all of a partnership's interest in the prospect. These limitations will not apply after the lapse of five years from the date of formation of a partnership. A sale, transfer or conveyance to the partnership of less than all of our or our affiliates' interest in any prospect is prohibited unless the interest retained by us or our affiliates is a proportionate working interest, the respective obligations of the partnership and us or our affiliates are substantially the same immediately after the sale of the interest, and our or our affiliates' interest in revenues does not exceed an amount proportionate to the retained working interest. Neither we nor our affiliates will retain any overriding royalty interests or other burdens on the lease interests conveyed to the partnerships, and will not enter into any farmout arrangements with respect to our retained interest, except to non-affiliated third parties. The partnerships will acquire only those leases reasonably expected to meet the stated purposes of the partnerships. The partnerships will not acquire any lease for the purpose of a subsequent sale or farmout unless the acquisition is made after a well has been drilled to a depth sufficient to indicate that the acquisition would be in the partnerships' best interest. We expect that the partnership will develop substantially all of its leases and will farm out few, if any, leases. The partnerships will not farm out, sell or otherwise dispose of leases unless we, exercising the standard of a prudent operator, determine that: a partnership lacks sufficient funds to drill on the lease and cannot obtain suitable alternative financing; downgrading subsequent to a partnership's acquisition has rendered drilling undesirable; drilling would concentrate excessive funds in one location creating undue risk to a partnership; or the best interests of a partnership, based on the standard of a prudent operator, would be served by the disposition. In the event of a farmout, we will retain for the partnerships the economic interests and concessions as a reasonably prudent operator would retain under the circumstances. We will not farm out a lease for the primary purpose of avoiding payments of our partnership share of costs of drilling on that lease. However, the decision with respect to making farmouts and the terms of a farmout involve conflicts of interest because we may benefit from cost savings and reduction of risk, and in the event of a farmout to an affiliated limited partnership or other affiliate, we or our affiliates will represent both related entities. A farmout is a drilling location or lease we get from another company (or individual) which has leased the rights to drill on the property from the owners of the oil and gas rights. We usually must pay a share of the revenue from this property to the company which provides the farmout in addition to the royalty payments due to the owners of the oil and gas rights. Transactions with the Managing General Partner or Affiliates. We will furnish drilling and completion services with respect to some or all of the partnership wells. A subsidiary of ours may market gas produced from partnership wells. In addition, we will act as operator for the producing wells of the partnership. The prices to be charged the partnership for the supplies and services will be competitive with the prices of other unaffiliated persons in the same geographic area engaged in similar businesses. We expect to earn a profit for the services. Neither we nor any affiliate will render to the partnership any natural gas or oil field, equipage or other services nor sell or lease to the partnership any equipment or related supplies unless the person is engaged, independently of the partnership and as an ordinary and ongoing business, in the business of rendering the services or selling or leasing the equipment and supplies to a substantial extent to other persons in the natural gas and oil industry in addition to partnerships in which we or our affiliate has an interest, or, if that person is not engaged in that business then the compensation, price or rental will be the cost of the services, equipment or supplies to that person or the competitive rate which could be obtained in the area, whichever is less. Notwithstanding any provision to the contrary, we and our affiliates may not profit by drilling in contravention of our fiduciary obligations to the investor partners. Any services not otherwise described in this prospectus for which we or any of our affiliates are to be compensated will be embodied in a written contract which precisely describes the services to be rendered and the compensation to be paid. All benefits from marketing arrangements or other relationships affecting the property of us or our affiliates and the partnerships will be fairly and equitably apportioned according to the respective interests of each. Partnership funds will not be commingled with those of any other entity. No loans may be made by the partnership to us or any affiliate. We or any affiliate, other than other programs sponsored by us or our affiliates, may not purchase the partnerships' producing properties. Conflict in Establishing Unit Repurchase Price. Under our unit repurchase program (see "Terms of the Offering - Unit Repurchase Program" above for a description of the unit repurchase program), we, once we have received a request from an investor partner that we repurchase that partner's units, will establish an offering price. We will determine the offering price which will not necessarily represent the fair market value of the units. In setting the price, we will consider our available funds and our desire to acquire production as represented by the units. A conflict will arise in that the price set will be that which we consider to be in our own best interest (to keep the repurchase price as low as possible) and not necessarily in the best interest of the investor partner who is presenting the units for repurchase. Certain Transactions As of June 30, 2003, previous limited partnerships sponsored by us have made payments to us or our affiliates as follows: Name of Partnership Non- Recurring Management Fee Sales of Leases Footage Based Turnkey Drilling and Completion Contracts Footage and Daywork Drilling Contracts, Services, Chemicals, Supplies and Equipment Operators Charges General and Administrative Expense Reimbursement Pennwest Petroleum Group 1984 $ 61,556 $ 46,250 $ -- $1,824,938 $ 187,119 $- Pennwest Petroleum Group 1985-A 58,125 43,400 -- 1,829,937 187,334 - Petrowest Gas Group 1986-A 29,605 22,400 -- 873,847 89,624 - Petrowest Gas Group 1987 35,395 24,850 -- 1,062,332 108,718 - Petrowest Gas Group 1987-B 30,461 21,350 -- 913,794 93,514 - PDC 1987 14,079 715 459,153 -- -- - PDC 1988 23,842 17,150 -- 708,200 72,534 - PDC 1988-B 6,053 6,450 -- 779,587 79,604 - PDC 1988-C 41,052 26,250 1,361,857 -- -- - PDC 1989-P 47,171 34,230 -- 1,445,275 143,875 - PDC 1989-A 30,250 57,137 -- 1,085,641 -- - PDC 1989-B 92,750 175,194 3,328,695 -- -- - PDC 1990-A 5,150 62,209 -- 1,265,680 -- - PDC 1990-B 55,525 72,100 -- 2,025,511 -- - PDC 1990-C 86,950 117,215 -- 3,167,563 -- - PDC 1990-D 92,138 137,225 3,343,524 -- -- - PDC 1991-A 68,475 75,193 -- 2,511,640 -- - PDC 1991-B 46,587 62,209 -- 1,697,764 -- - PDC 1991-C 68,400 70,235 -- 2,513,765 -- - PDC 1991-D 31,463 153,721 4,812,667 -- -- - PDC 1992-A 72,717 77,319 -- 2,669,888 -- - PDC 1992-B 74,478 58,829 -- 2,754,778 -- - PDC 1992-C 59,722 149,657 -- 5,884,302 -- - PDC 1993-A -- 101,335 2,840,609 -- -- - PDC 1993-B -- 80,470 -- 2,286,886 -- - PDC 1993-C -- 96,248 -- 2,849,439 -- - PDC 1993-D -- 94,098 -- 2,724,096 -- - PDC 1993-E -- 272,730 6,930,264 -- -- - PDC 1994-A 51,387 110,084 -- 2,248,204 -- - PDC 1994-B 67,245 85,240 -- 2,921,974 -- - PDC 1994-C 58,647 63,548 -- 2,545,795 -- - PDC 1994-D 188,719 232,410 8,024,046 -- -- - PDC 1995-A 36,640 36,389 -- 1,566,615 -- - PDC 1995-B 46,441 59,044 -- 1,972,759 -- - PDC 1995-C 52,862 35,768 -- 2,276,962 -- - PDC 1995-D 203,927 293,036 8,628,760 -- -- - PDC 1996-A 64,405 109,573 -- 2,692,045 -- - PDC 1996-B 67,118 106,300 -- 2,813,259 -- - PDC 1996-C 98,662 174,509 -- 4,117,286 -- - PDC 1996-D 382,543 565,628 16,075,000 -- -- - PDC 1997-A 104,174 179,882 -- 4,351,672 -- - PDC 1997-B 168,987 271,709 -- 7,079,215 -- - PDC 1997-C 151,081 257,165 -- 6,314,878 -- - PDC 1997-D 462,989 593,138 19,546,905 -- -- - PDC 1998-A 131,803 178,267 -- 5,555,181 -- - PDC 1998-B 178,628 228,938 -- 7,541,358 -- - PDC 1998-C 195,320 221,506 -- 8,274,895 -- - PDC 1998-D 513,631 414,444 21,906,777 -- -- - PDC 1999-A 120,018 173,267 -- 5,047,537 -- - PDC 1999-B 138,497 167,131 -- 5,372,762 -- - PDC 1999-C 177,189 298,744 -- 7,408,976 -- - PDC 1999-D 467,734 795,958 19,550,451 -- -- - PDC 2000-A 123,918 131,531 -- 5,258,900 -- - PDC 2000-B 290,070 310,849 -- 12,307,206 -- -- PDC 2000-C 350,206 363,307 -- 14,870,672 -- -- PDC 2000-D 625,000 1,064,636 26,122,864 -- -- -- PDC 2001-A 234,595 249,008 -- 9,955,872 -- -- PDC 2001-B 316,964 385,262 -- 13,402,691 -- -- PDC 2001-C 265,681 330,336 -- 11,226,780 -- -- PDC 2001-D 610,458 755,828 25,799,097 -- -- -- PDC 2002-A 178,688 208,315 -- 7,564,615 -- -- PDC 2002-B 279,511 417,949 --- 11,740,764 --- --- PDC 2002-C (1) 235,955 318,428 --- 9,945,618 --- --- PDC 2002-D (2) 727,632 689,649 30,962,344 --- --- --- PDC 2003-A (3) 212,326 244,065 --- 8,992,121 --- --- (1) Partnership funded in November 2002. (2) Partnership funded in December 2002. (3) Partnership funded in April 2003. FIDUCIARY RESPONSIBILITY OF THE MANAGING GENERAL PARTNER The Managing General Partner is accountable to the partnerships as a fiduciary and must exercise good faith respecting the partnerships. The limited partnership agreement includes provisions indemnifying the Managing General Partner against liability for losses suffered by the partnership resulting from actions by the Managing General Partner. We are accountable to the partnerships as a fiduciary and consequently must exercise utmost good faith and integrity in handling partnership affairs. Under West Virginia law, we will owe the investor partners a duty of utmost good faith, fairness, and loyalty. In this regard, we are required to supervise and direct the activities of the partnership prudently and with that degree of care, including acting on an informed basis, which an ordinarily prudent person in a like position would use under similar circumstances. Moreover, we must act at all times in the best interests of the partnership and the investor partners. Since the law in this area is rapidly developing and changing, investors who have questions concerning our responsibilities as Managing General Partner should consult their own counsel. Where the question has arisen, courts have held that a limited partner may institute legal action on behalf of himself and all other similarly situated limited partners (a class action) to recover damages for a breach by a general partner of his fiduciary duty, or on behalf of the partnership (a partnership derivative action) to recover damages from third parties. In addition, limited partners may have the right, subject to procedural and jurisdictional requirements, to bring partnership class actions in federal courts to enforce their rights under the federal securities laws. Further, limited partners who have suffered losses in connection with the purchase or sale of their interests in a partnership may be able to recover such losses from a general partner where the losses result from a violation by the general partner of the antifraud provisions of the federal securities laws. The burden of proving a breach, and all or a portion of the expense of the lawsuit, would have to be borne by the limited partner bringing such action. In the event of a lawsuit for a breach of its fiduciary duty to the partnership and/or the investor partners, we, depending upon the particular circumstances involved, might be able to avail ourselves under West Virginia law of various defenses to the lawsuit, including statute of limitations, estoppel, laches, and doctrines such as the "clean hands" doctrine. The limited partnership agreement provides for indemnification of the Managing General Partner against liability for losses arising from the action or inaction of the Managing General Partner, if the Managing General Partner, in good faith, determined that the course of conduct was in the best interests of the partnership and the course of conduct did not constitute negligence or misconduct of the Managing General Partner. We may not be indemnified for any liability arising out of a breach of our duty to the partnership or our negligence, fraud, bad faith or misconduct in the performance of our fiduciary duty. The limited partnership agreement provides for indemnification of the Managing General Partner by the partnership for any losses, judgments, liabilities, expenses and amounts paid in settlement of any claims sustained by it in connection with the partnership, provided that the same were not the result of negligence or misconduct on the part of the Managing General Partner. Nevertheless, we shall not be indemnified for liabilities arising under federal and state securities laws unless (1) there has been a successful adjudication on the merits of each count involving securities law violations or (2) the claims have been dismissed with prejudice on the merits by a court of competent jurisdiction or (3) a court of competent jurisdiction approves a settlement of the claims against a particular indemnitee and finds that indemnification of the settlement and the related costs should be made, and the court considering the request for indemnification has been advised of the position of the Securities and Exchange Commission and of the position of any state securities regulatory authority in which securities of the partnership were offered or sold as to indemnification for violations of securities laws; provided, however, the court need only be advised of the positions of the securities regulatory authorities of those states (a) which are specifically set forth in the prospectus and (b) in which plaintiffs claim they were offered or sold partnership units. A successful claim by the Managing General Partner for indemnification would deplete partnership assets by the amount paid. As a result of these indemnification provisions, a purchaser of units may have a more limited right of legal action than he would have if this provision were not included in the limited partnership agreement. To the extent that the indemnification provisions purport to include indemnification for liabilities arising under the Securities Act of 1933, in the opinion of the Securities and Exchange Commission, this indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. The limited partnership agreement also provides that the partnership shall not incur the cost of the portion of any insurance which insures any party against any liability as to which the party is prohibited from being indemnified. PRIOR ACTIVITIES Prior Partnerships Petroleum Development Corporation ("PDC"), as general partner, has previously sponsored ten private and fourteen public drilling programs. PDC 2003 Drilling Program is the fifteenth public drilling program sponsored by PDC as general partner. The various drilling programs sponsored by PDC have raised a total of over $416 million. Each of the previous programs has had as its objective the drilling, completion, and production of oil and natural gas from development wells. The 1984 and 1985 partnerships split investment between shallow oil wells located in Pennsylvania, and gas wells located in the Appalachian Basin. All of the partnerships since and including 1986 were targeted at shallow development gas wells. All funds raised for previous partnerships were spent according to plans as described in the respective private placement memorandum or prospectus. All of the partnerships continue in operation, with monthly cash distributions to investors in all programs continuing. All of the previous programs realized the anticipated tax benefits, and to date the Internal Revenue Service has neither audited any partnership nor challenged any deductions or credits claimed by investors, to the best of the Managing General Partner's knowledge. For several reasons, including the unpredictability of natural gas and oil development and pricing and differences in property locations, program size, and economic conditions, operating results obtained by these prior partnerships should not be considered as indicative of the operating results obtainable by the partnerships. You should not assume that you will experience returns, if any, comparable to those experienced by investors in prior programs. The following table is presented to indicate certain sale characteristics concerning previous gas limited partnerships sponsored by us. Partnership Date of Partnership Formation Date of First Revenue Distribution (1) Number of Units Sold Number of Investors Subscription from Participants Previous Assessment Pennwest Petroleum Group 1984 12/84 4/85 32.83 37 $2,462,500 -- Pennwest Petroleum Group 1985-A 11/85 3/86 31.00 35 2,325,000 -- Petrowest Gas Group 1986-A 11/86 4/87 15.00 24 1,125,000 -- Petrowest Gas Group 1987 8/87 1/88 67.25 53 1,345,000 -- Petrowest Gas Group 1987-B 11/87 4/88 57.875 57 1,157,500 -- PDC 1987 12/87 6/88 26.75 20 535,000 -- PDC 1988 7/88 12/88 45.30 43 906,000 -- PDC 1988-B 11/88 4/89 49.50 63 990,000 -- PDC 1988-C 12/88 6/89 78.00 89 1,560,000 -- PDC 1989-P 6/89 12/89 89.625 99 1,792,500 -- PDC 1989-A 10/89 4/90 60.50 110 1,210,000 -- PDC 1989-B 12/89 6/90 185.50 225 3,710,000 -- PDC 1990-A 6/90 11/90 70.30 119 1,406,000 -- PDC 1990-B 9/90 1/91 111.05 153 2,221,000 --- PDC 1990-C 11/90 5/91 173.90 226 3,478,000 -- PDC 1990-D 12/90 6/91 184.275 269 3,685,500 -- PDC 1991-A 3/91 11/91 136.95 208 2,739,000 -- PDC 1991-B 9/91 2/92 93.175 169 1,863,500 -- PDC 1991-C 11/91 4/92 136.80 186 2,736,000 -- PDC 1991-D 12/91 6/92 262.925 432 5,258,500 -- PDC 1992-A 5/92 11/92 145.435 264 2,908,700 -- PDC 1992-B 9/92 1/93 148.955 265 2,979,100 --- PDC 1992-C 11/92 4/93 319.444 532 6,388,900 -- PDC 1993-A 12/92 6/93 151.30 219 3,026,000 -- PDC 1993-B 5/93 11/93 121.75 200 2,435,000 -- PDC 1993-C 9/93 2/94 152.34 232 3,046,700 -- PDC 1993-D 11/93 4/94 145.45 244 2,909,000 -- PDC 1993-E 12/93 7/94 367.94 535 7,358,800 -- PDC 1994-A 5/94 11/94 102.775 176 2,055,500 -- PDC 1994-B 9/94 2/95 134.49 239 2,689,804 -- PDC 1994-C 11/94 4/95 117.294 235 2,345,870 -- PDC 1994-D 12/94 6/95 377.438 529 7,548,761 -- PDC 1995-A 5/95 10/95 73.28 132 1,465,603 -- PDC 1995-B 9/95 1/96 92.88 164 1,857,648 -- PDC 1995-C 11/95 4/96 105.72 170 2,114,496 -- PDC 1995-D 12/95 6/96 407.854 491 8,157,071 -- PDC 1996-A 6/96 11/96 128.81 183 2,576,200 -- PDC 1996-B 9/96 3/97 134.24 223 2,684,707 -- PDC 1996-C 11/96 5/97 197.32 285 3,946,478 -- PDC 1996-D 12/96 6/97 765.09 932 15,301,726 -- PDC 1997-A 5/97 11/97 208.34 312 4,166,946 -- PDC 1997-B 9/97 3/98 337.97 435 6,759,470 -- PDC 1997-C 11/97 5/98 302.16 424 6,043,257 -- PDC 1997-D 12/97 6/98 925.98 1061 18,519,579 -- PDC 1998-A 6/98 12/98 263.61 362 5,272,135 --- PDC 1998-B 9/98 3/99 357.25 371 7,145,101 --- PDC 1998-C 11/98 5/99 390.64 432 7,812,783 --- PDC 1998-D 12/98 7/99 1,026.26 1059 20,525,261 --- PDC 1999-A 5/99 11/99 240.08 223 4,800,739 --- PDC 1999-B 9/99 3/00 278.00 249 5,539,893 --- PDC 1999-C 11/99 5/00 354.38 337 7,087,559 --- PDC 1999-D 12/99 7/00 935.47 857 18,709,342 --- PDC 2000-A 5/00 11/00 247.84 227 4,956,718 --- PDC 2000-B 9/00 3/01 580.14 459 11,602,809 --- PDC 2000-C 11/00 6/01 700.41 563 14,008,256 --- PDC 2000-D 12/00 07/01 1,250.00 1090 25,000,000 --- PDC 2001-A 5/01 11/01 469.19 462 9,383,798 --- PDC 2001-B 9/01 3/02 633.93 619 12,678,577 --- PDC 2001-C 11/01 5/02 531.36 595 10,627,234 --- PDC 2001-D 12/01 7/02 1,220.92 1,167 24,418,322 --- PDC 2002-A 4/02 11/02 357.38 384 7,147,522 --- PDC 2002-B 9/02 3/03 559.02 529 11,180,426 --- PDC 2002-C 11/02 5/03 471.91 478 9,438,203 --- PDC 2002-D 12/02 7/03 1,455.26 1,063 29,105,281 --- PDC 2003-A 4/03 (2) 424.65 451 8,483,045 --- ______________ --- (1) Cash distribution made each month since date of first distribution. (2) Partnership closed on April 30, 2003. Wells were drilled in the second and third quarters of 2003; first revenue distribution to commence in November 2003. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Capital and Expenditures of Prior Partnerships The following table provides information regarding the capital raised and expended by previous limited partnerships sponsored by us and our affiliates as of June 30, 2003. The information presented in the following table has been prepared in conformity with generally accepted accounting principles. Partnership Cash Contribution by Managing General Partner Total Partnership Revenues Allocated Total Expenditures, Net of Operating Costs, Direct Costs & Administrative Costs Total Operating Costs Total Direct Costs Total Administrative Costs Pennwest Petroleum Group 1984 129,605 2,618,911 2,592,105 916,847 21,944 0 Pennwest Petroleum Group 1985-A 122,368 2,348,527 2,447,368 984,631 22,312 0 Petrowest Gas Group 1986-A 59,210 1,366,700 1,184,210 562,374 16,279 0 Petrowest Gas Group 1987 70,789 1,991,928 1,415,789 754,361 1,309 0 Petrowest Gas Group 1987-B 60,921 1,018,719 1,218,421 406,226 17,043 0 PDC 1987 28,158 686,983 563,158 235,484 15,229 0 PDC 1988 47,684 1,448,528 953,684 455,056 20,644 0 PDC 1988-B 52,105 798,291 1,042,105 409,503 1,264 0 PDC 1988-C 82,105 1,569,707 1,642,105 697,978 17,028 0 PDC 1989-P 94,342 2,359,697 1,886,842 783,668 19,468 0 PDC 1989-A 114,278 2,008,697 1,324,278 664,676 67,083 0 PDC 1989-B 350,389 3,761,187 4,060,389 1,354,589 105,733 0 PDC 1990-A 132,789 1,018,373 1,538,789 414,123 55,373 0 PDC 1990-B 209,761 2,249,908 2,430,761 862,156 72,285 0 PDC 1990-C 328,478 3,676,247 3,806,478 1,415,651 109,695 0 PDC 1990-D 348,075 3,362,237 4,033,575 1,281,194 111,792 0 PDC 1991-A 258,683 3,021,503 2,997,683 1,042,506 105,661 0 PDC 1991-B 175,997 1,728,748 2,039,497 554,192 81,362 0 PDC 1991-C 258,400 2,759,503 2,994,400 924,474 95,637 0 PDC 1991-D 496,639 3,938,376 5,755,139 1,527,167 144,372 0 PDC 1992-A 274,711 1,324,105 3,183,411 613,357 65,624 0 PDC 1992-B 281,361 3,325,310 3,260,461 1,033,282 94,148 0 PDC 1992-C 603,396 8,261,662 6,992,296 2,389,400 141,058 0 PDC 1993-A 294,194 5,467,951 3,320,194 1,498,471 83,914 0 PDC 1993-B 236,736 2,002,959 2,671,736 658,588 83,771 0 PDC 1993-C 296,207 2,143,700 3,342,907 848,078 98,497 0 PDC 1993-D 282,819 2,250,899 3,191,819 694,346 93,193 0 PDC 1993-E 715,438 5,568,922 8,074,238 1,175,023 134,657 0 PDC 1994-A 449,641 1,423,378 2,505,141 634,864 59,864 0 PDC 1994-B 588,395 2,305,296 3,278,199 705,290 70,350 0 PDC 1994-C 513,159 1,783,648 2,859,029 560,945 69,425 0 PDC 1994-D 1,651,292 5,745,326 9,200,053 1,777,982 125,277 0 PDC 1995-A 320,601 1,236,357 1,786,204 400,569 51,080 0 PDC 1995-B 406,361 931,271 2,264,009 291,101 58,316 0 PDC 1995-C 462,546 1,183,911 2,577,042 488,444 59,643 0 PDC 1995-D 1,784,359 5,109,399 9,941,430 1,614,618 120,671 0 PDC 1996-A 560,324 2,545,140 3,136,524 645,288 51,570 0 PDC 1996-B 583,924 2,123,689 3,268,631 578,063 53,835 0 PDC 1996-C 858,359 2,327,971 4,822,837 714,812 65,185 0 PDC 1996-D 3,328,126 8,654,729 18,629,852 2,919,663 123,452 0 PDC 1997-A 906,311 2,128,372 5,073,257 589,568 52,890 0 PDC 1997-B 1,470,185 2,766,006 8,229,655 942,660 65,541 0 PDC 1997-C 1,314,409 3,989,104 7,357,666 1,157,772 67,067 0 PDC 1997-D 4,028,009 7,657,003 22,547,588 3,417,679 127,884 0 PDC 1998-A 1,146,690 3,393,900 6,418,825 1,100,738 45,889 0 PDC 1998-B 1,554,059 5,009,432 8,699,160 1,449,281 49,660 0 PDC 1998-C 1,699,280 5,075,220 9,512,063 1,808,121 53,080 0 PDC 1998-D 4,464,244 9,243,680 24,989,505 3,061,097 107,580 0 PDC 1999-A 1,044,161 3,511,305 5,844,900 840,807 33,930 0 PDC 1999-B 1,204,927 4,711,035 6,744,820 1,123,009 38,029 0 PDC 1999-C 1,541,544 4,592,259 8,629,103 1,090,372 41,254 0 PDC 1999-D 4,069,282 12,254,954 22,778,624 2,295,857 83,924 0 PDC 2000-A 1,078,086 3,578,478 6,034,804 630,335 25,082 0 PDC 2000-B 2,523,611 5,437,442 14,126,420 1,192,692 33,469 0 PDC 2000-C 3,046,796 4,836,558 17,055,052 1,354,061 36,017 0 PDC 2000-D 5,437,500 8,961,931 30,437,500 1,992,275 69,347 0 PDC 2001-A 2,040,976 3,369,247 11,424,774 646,475 24,617 0 PDC 2001-B 2,757,591 3,856,703 15,436,168 749,545 26,089 0 PDC 2001-C 2,311,423 2,973,228 12,938,657 627,130 25,316 0 PDC 2001-D 5,310,985 5,999,817 29,729,307 956,055 41,272 0 PDC 2002-A 1,554,586 2,137,001 8,702,108 345,825 12,133 0 PDC 2002-B 2,431,743 1,600,442 13,612,169 230,231 10,180 0 PDC 2002-C 2,052,809 1,533,082 11,491,012 201,371 12,784 0 PDC 2002-D(1) 6,330,399 0 35,435,680 - 19,017 0 PDC 2003-A(2) 1,845,062 0 10,328,107 - - 0 (1) Partnership closed in December 2002. Wells were drilled in the first quarter of 2003; first revenue distribution commenced in July 2003. (2) Partnership closed on April 30, 2003. Wells were drilled in the second and third quarters of 2003; first revenue distribution to commence in November 2003. Previous Drilling Activities The following table reflects the drilling activity of previous limited partnerships sponsored by us as of June 30, 2003. All of the wells drilled were development wells, except as otherwise noted. Productive Well Table June 30, 2003 Gross Wells(1) Net Wells(2) Partnership Oil Gas Dry Oil Gas Dry Pennwest Petroleum Group 1984 27 13 - 27 5.5 - Pennwest Petroleum Group 1985-A 14 13 1 14 7.8 .6 Petrowest Gas Group 1986-A 8 2 - 5.4 1.0 Petrowest Gas Group 1987 - 9 1(3) - 7.1 .1(3) Petrowest Gas Group - 9 1 - 5.5 .6 PDC 1987 - 7 - - 2.6 - PDC 1988 - 5 1 - 4.1 .8 PDC 1988-B - 5 - - 4.7 - PDC 1988-C - 9 1 - 7.0 .8 PDC 1989-P - 8 1 - 7.8 .9 PDC 1989-A - 6 1 - 5.5 .9 PDC 1989-B - 19 2 - 17.0 1.8 PDC 1990-A - 7 1 - 6.0 .9 PDC 1990-B - 11 - - 10.3 - PDC 1990-C - 15 2 - 14.4 2.0 PDC 1990-D - 16 1 - 15.8 1.0 PDC 1991-A - 13 - - 12.0 - PDC 1991-B - 8 2 - 7.2 2.0 PDC 1991-C - 12 2 - 11.2 1.5 PDC 1991-D - 21 5 - 20.4 4.4 PDC 1992-A - 12 2 - 11.0 2.0 PDC 1992-B - 14 1 - 12.3 .5 PDC 1992-C - 26 3 - 24.8 2.5 PDC 1993-A - 16 1 - 14.7 1.0 PDC 1993-B - 11 4 - 10.8 4.0 PDC 1993-C - 15 2 - 13.8 2.0 PDC 1993-D - 13 2 - 12.1 2.0 PDC 1993-E - 34 2 - 33.3 2.0 PDC 1994-A - 9 1 - 8.9 1.0 PDC 1994-B - 13 1 - 12.4 1.0 PDC 1994-C - 12 1 - 11.1 1.0 PDC 1994-D - 39 4 - 35.4 4.0 PDC 1995-A - 8 1 - 7.1 1.0 PDC 1995-B - 8 3 - 7.1 3.0 PDC 1995-C - 12 1 - 9.6 1.0 PDC 1995-D - 42 2 - 37.5 2.0 PDC 1996-A - 14 2 - 11.5 2.0 PDC 1996-B - 15 - - 13.2 - PDC 1996-C - 22 2 - 17.6 1.9 PDC 1996-D - 80(4) 5 - 62.3 4.3 PDC 1997-A - 21(5) 1 - 11.1 0.1 PDC 1997-B - 34(6) 2 - 23.4 2.0 PDC 1997-C - 28 2 - 19.5 1.1 PDC 1997-D - 94 7 - 72.7 4.5 PDC 1998-A - 29 2 - 19.2 2.0 PDC 1998-B - 41 2 - 26.9 1.9 PDC 1998-C - 37 1 - 29.9 1.0 PDC 1998-D - 89(7) 8(8) - 70.8(7) 7.6(8) PDC 1999-A - 24 0 - 19.5 0 PDC 1999-B - 26 1 - 21.0 0.5 PDC 1999-C - 24 2 - 20.9 2.0 PDC 1999-D - 51 0 - 37.5 0 PDC 2000-A - 14 0 - 10.50 0 PDC 2000-B - 25 2 - 18.0 2.0 PDC 2000-C - 31 0 - 22.1 0 PDC 2000-D - 41 2 - 32.0 1.4 PDC 2001-A - 32 0 - 15.4 0 PDC 2001-B - 18 1 - 15.9 .9 PDC 2001-C - 19 0 - 16.4 0 PDC 2001-D - 32 0 - 29.0 0 PDC 2002-A - 10 0 - 7.7 0 PDC 2002-B - 14 - - 12.8 0 PDC 2002-C - 14 - - 12.7 0 PDC 2002-D - 36 - - 32.3 0 PDC 2003-A (9) - 17 - - 7.8 - Total ...... 41 1,430 97 41 1,148.8 84.5 _____________________ (1) Gross wells include all wells in which the partnerships owned a Working Interest. (2) Net wells are the number of gross wells multiplied by the percentage Working Interest owned by the partnerships in the gross wells. (3) The dry hole indicated represents an exploratory well. (4) Ten wells in the Angel Antrim Shale Project were productive wells and subsequently plugged in third quarter of 2000. (5) Three wells in the Angel Antrim Shale Project were productive wells and subsequently plugged in the third quarter of 2000. (6) Six wells in the East 23 Antrim Shale Project were productive wells and subsequently plugged in the third quarter of 2000. (7) One of the gas wells represents an exploratory well with a net interest of .9. (8) Three of the dry holes represent exploratory wells with a net interest of 2.7. (9) Partnership funded in April 2003. Wells were drilled in the second and third quarters of 2003. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Payout and Net Cash Tables The following tables provide information concerning the operating results of previous limited partnerships sponsored by us as of June 30, 2003. The information presented in the following tables has been prepared in conformity with generally accepted accounting principles. Participants' Payout Table June 30, 2003 Partnership Investors' Funds Invested (1) Total Expenditures Including Operating Costs (2) Revenues Before Deducting Operating Costs(3) Total As of June 30, 2003 During Three Months Ended June 30, 2003 Pennwest Petroleum Group 1984 $2,093,125 $3,366,546 $2,317,329 $20,936 Pennwest PetroleumGroup 1,976,250 3,298,081 2,066,381 42,593 Petrowest Gas Group 1986-A 956,250 1,674,723 1,176,860 22,574 Petrowest Gas Group 1987 1,143,250 2,062,888 1,723,025 34,145 Petrowest Gas Group 1987-B 983,875 1,559,602 880,942 14,592 PDC 1987 454,750 773,173 593,380 8,834 PDC 1988 770,100 1,357,926 1,245,132 17,776 PDC 1988-B 841,500 1,380,225 684,567 14,357 PDC 1988-C 1,326,000 2,238,305 1,352,626 28,163 PDC 1989-P 1,523,625 2,555,484 2,037,656 39,772 PDC 1989-A 1,028,500 1,798,168 1,608,735 37,235 PDC 1989-B 3,153,500 4,893,665 3,028,096 58,264 PDC 1990-A 1,195,100 1,786,525 825,364 15,230 PDC 1990-B 1,887,850 2,971,608 1,807,975 36,799 PDC 1990-C 2,956,300 4,711,711 2,968,854 98,535 PDC 1990-D 3,132,674 4,817,373 2,734,414 56,032 PDC 1991-A 2,328,150 3,665,590 2,429,060 43,324 PDC 1991-B 1,583,975 2,379,399 1,390,982 28,905 PDC 1991-C 2,325,600 3,559,511 2,219,215 50,343 PDC 1991-D 4,469,725 6,616,966 3,188,009 91,244 PDC 1992-A 2,472,396 3,566,142 1,238,562 33,790 PDC 1992-B 2,532,246 3,889,650 2,668,584 70,838 PDC 1992-C 5,430,563 8,441,684 6,665,440 162,517 PDC 1993-A 2,647,750 4,336,987 4,490,842 71,708 PDC 1993-B 2,130,620 3,048,035 1,648,885 56,146 PDC 1993-C 2,665,865 3,837,024 1,792,431 47,780 PDC 1993-D 2,545,375 3,562,039 1,871,705 48,066 PDC 1993-E 6,438,950 8,449,618 4,617,271 121,086 PDC 1994-A 1,798,563 2,615,157 1,146,523 31,406 PDC 1994-B 2,353,579 3,313,173 1,851,583 58,591 PDC 1994-C 2,052,636 2,852,086 1,429,107 47,820 PDC 1994-D 6,605,166 9,080,236 4,618,298 155,699 PDC 1995-A 1,282,403 1,829,033 994,684 23,869 PDC 1995-B 1,625,442 2,140,071 753,355 18,916 PDC 1995-C 1,850,184 2,556,582 954,967 30,314 PDC 1995-D 7,137,437 9,559,966 4,125,863 142,433 PDC 1996-A 2,241,294 3,070,598 2,036,112 57,922 PDC 1996-B 2,335,695 3,121,679 1,698,951 61,246 PDC 1996-C 3,433,436 4,477,741 1,862,377 82,106 PDC 1996-D 13,312,502 17,208,709 6,923,783 276,402 PDC 1997-A 3,625,243 4,556,931 1,702,698 62,528 PDC 1997-B 5,880,739 7,400,242 2,212,806 86,921 PDC 1997-C 5,257,634 6,796,945 3,191,283 149,506 PDC 1997-D 16,112,034 20,985,450 6,125,603 335,911 PDC 1998-A 4,586,758 6,169,554 2,715,120 177,002 PDC 1998-B 6,216,237 8,344,248 4,007,546 279,407 PDC 1998-C 6,797,121 9,301,740 4,060,177 283,739 PDC 1998-D 17,856,977 22,974,995 7,394,944 583,200 PDC 1999-A 4,176,643 5,500,523 2,809,043 236,463 PDC 1999-B 4,819,707 6,468,719 3,768,828 313,607 PDC 1999-C 6,166,176 7,992,856 3,673,808 261,144 PDC 1999-D 16,277,127 20,613,160 9,803,964 638,069 PDC 2000-A 4,312,345 5,481,049 2,862,783 149,732 PDC 2000-B 10,094,444 12,583,733 4,349,953 342,670 PDC 2000-C 12,187,183 15,120,314 3,869,246 437,857 PDC 2000-D 21,750,000 26,649,292 7,169,545 803,792 PDC 2001-A 8,163,904 9,920,666 2,695,398 305,199 PDC 2001-B 11,030,362 13,299,082 3,085,363 580,350 PDC 2001-C 9,245,693 11,149,188 2,378,582 487,395 PDC 2001-D 21,243,940 25,216,180 4,799,853 1,177,932 PDC 2002-A 6,218,344 7,433,888 1,709,601 550,283 PDC 2002-B 9,726,970 11,372,753 1,280,353 576,774 PDC 2002-C 8,211,237 9,609,527 1,226,466 586,289 PDC 2002-D (4) 25,321,594 29,105,281 0 0 PDC 2003-A (5) 7,388,949 8,483,045 0 0 (1) Total Subscriptions, less commissions, management fee, and offering costs. (2) Includes the total of the subscriptions, assessments, funds advanced by the Managing General Partner to the general or limited partnerships, inclusive of operating costs. None of the partnerships has borrowed any funds. (3) Represents the accrued gross revenues credited to the participants from oil and gas revenues net of royalties to landowners, overriding royalty interest, and other burdens, excluding interest income. (4) Partnership funded December 2002; wells were drilled in the first quarter of 2003; first revenue distribution commenced in July 2003. (5) Partnership funded in April 2003; wells were drilled in the second and third quarters of 2003; first revenue distribution to commence in November 2003. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Participants' Net Cash Table June 30, 2003 Total Revenues After Deducting Operating Costs(3) Cash Distributions(4) Partnership Investors' Funds Invested(1) Total Expenditures Net of Operating Costs(2) Total As of June 30, 2003 Three Months Ended June 30, 2003 Total As of June 30, 2003 Three Months Ended June 30, 2003 Aggregate Section 29 Tax Credits(5) Pennwest Petroleum Group 1984 $2,093,125 $2,462,500 $1,413,284 $6,923 $1,343,782 $6,923 $571,757 Pennwest Petroleum Group 1985-A 1,976,250 2,325,000 1,093,300 24,099 1,050,028 24,099 716,864 Petrowest Gas Group 1986-A 956,250 1,125,000 627,137 11,468 600,367 11,468 505,102 Petrowest Gas Group 1987 1,143,250 1,345,000 1,005,137 16,521 962,517 16,521 579,823 Petowest Gas Group 1987-B 983,875 1,157,500 478,840 3,171 452,470 3,171 392,383 PDC 1987 454,750 535,000 355,207 4,335 337,635 4,335 251,862 PDC 1988 770,100 906,000 793,207 9,244 756,318 9,244 509,430 PDC 1988-B 841,500 990,000 294,342 623 270,502 623 286,312 PDC 1988-C 1,326,000 1,560,000 674,321 6,280 631,265 6,280 552,091 PDC 1989-P 1,523,625 1,792,500 1,274,671 21,866 1,196,786 21,866 907,101 PDC 1989-A 1,028,500 1,210,000 1,020,567 22,250 977,483 22,250 278,048 PDC 1989-B 3,153,500 3,710,000 1,844,431 31,615 1,738,795 31,615 1,780,305 PDC 1990-A 1,195,100 1,406,000 444,839 1,413 384,626 1,413 161,679 PDC 1990-B 1,887,850 2,221,000 1,057,367 21,453 1,019,607 21,453 698,164 PDC 1990-C 2,956,300 3,478,000 1,735,143 64,041 1,665,905 64,041 765,656 PDC 1990-D 3,132,674 3,685,500 1,602,541 25,041 1,541,674 25,041 933,900 PDC 1991-A 2,328,150 2,739,000 1,502,470 22,787 1,399,005 22,787 951,026 PDC 1991-B 1,583,975 1,863,500 875,083 11,720 846,208 11,720 556,159 PDC 1991-C 2,325,600 2,736,000 1,395,704 27,711 1,309,104 27,711 868,393 PDC 1991-D 4,469,725 5,258,500 1,829,543 51,286 1,756,531 51,286 1,152,905 PDC 1992-A 2,472,396 2,908,700 581,120 7,563 502,396 7,563 445,185 PDC 1992-B 2,532,246 2,979,100 1,758,034 43,382 1,696,977 43,382 1,045,436 PDC 1992-C 5,430,563 6,388,900 4,612,657 98,744 4,490,543 98,744 2,093,099 PDC 1993-A 2,647,750 3,026,000 3,179,855 32,953 2,985,679 32,953 149,551 PDC 1993-B 2,130,620 2,435,000 1,035,850 31,602 976,943 31,602 0 PDC 1993-C 2,665,865 3,046,700 1,002,107 21,965 945,721 21,965 0 PDC 1993-D 2,545,375 2,909,000 1,218,666 23,754 1,177,428 23,754 0 PDC 1993-E 6,438,950 7,358,800 3,526,453 74,334 3,377,505 74,334 0 PDC 1994-A 1,798,563 2,055,500 586,866 14,551 546,896 14,551 0 PDC 1994-B 2,353,579 2,689,804 1,228,215 38,463 1,172,957 38,463 0 PDC 1994-C 2,052,636 2,345,870 922,891 30,964 866,454 30,964 0 PDC 1994-D 6,605,166 7,548,761 3,086,823 102,626 2,899,968 102,626 0 PDC 1995-A 1,282,403 1,465,603 631,254 13,303 583,195 13,303 0 PDC 1995-B 1,625,442 1,857,648 470,933 6,564 414,925 6,564 0 PDC 1995-C 1,850,184 2,114,496 512,881 5,200 456,084 5,200 0 PDC 1995-D 7,137,437 8,157,071 2,722,968 89,502 2,512,272 89,502 0 PDC 1996-A 2,241,294 2,576,200 1,541,714 39,674 1,406,896 39,674 0 PDC 1996-B 2,335,695 2,684,707 1,261,979 49,700 1,137,063 49,700 0 PDC 1996-C 3,433,436 3,946,478 1,349,113 62,958 1,231,838 62,958 0 PDC 1996-D 13,312,502 15,301,726 5,016,800 170,065 4,658,710 170,065 0 PDC 1997-A 3,625,243 4,166,946 1,312,713 40,510 1,218,792 40,510 0 PDC 1997-B 5,880,739 6,759,470 1,572,034 56,837 1,422,633 56,837 0 PDC 1997-C 5,257,634 6,043,257 2,437,596 101,958 2,115,685 101,958 0 PDC 1997-D 16,112,034 18,519,579 3,659,732 192,664 3,275,847 192,664 0 PDC 1998-A 4,586,758 5,272,135 1,817,701 139,024 1,666,674 139,024 0 PDC 1998-B 6,216,237 7,145,101 2,808,400 200,987 2,715,002 200,987 0 PDC 1998-C 6,797,121 7,812,783 2,571,220 189,327 2,305,563 189,327 0 PDC 1998-D 17,856,977 20,525,261 4,945,211 488,312 4,483,647 488,312 0 PDC 1999-A 4,176,643 4,800,739 2,109,259 175,110 1,969,670 175,110 0 PDC 1999-B 4,819,707 5,539,893 2,840,002 238,401 2,652,798 238,401 0 PDC 1999-C 6,166,176 7,087,559 2,768,511 200,022 2,527,189 200,022 0 PDC 1999-D 16,277,127 18,709,342 7,900,146 492,600 7,712,843 492,600 0 PDC 2000-A 4,312,345 4,956,718 2,338,451 112,888 2,052,644 112,888 0 PDC 2000-B 10,094,444 11,602,809 3,369,029 242,886 2,950,319 242,886 0 PDC 2000-C 12,187,183 14,008,256 2,757,188 296,628 2,541,665 296,628 0 PDC 2000-D 21,750,000 25,000,000 5,520,253 586,901 4,788,314 586,901 0 PDC 2001-A 8,163,904 9,383,798 2,158,529 232,703 1,636,971 232,703 0 PDC 2001-B 11,030,362 12,678,577 2,464,857 433,141 2,138,659 433,141 0 PDC 2001-C 9,245,693 10,627,234 1,856,628 345,159 1,478,501 345,159 0 PDC 2001-D 21,243,940 24,418,322 4,001,995 958,601 3,032,389 958,601 0 PDC 2002-A 6,218,344 7,147,522 1,423,235 452,546 924,237 452,546 0 PDC 2002-B 9,726,970 11,180,426 1,088,026 490,689 655,320 490,689 0 PDC 2002-C 8,211,237 9,438,203 1,055,142 511,743 511,743 511,743 0 PDC 2002-D (6) 25,321,594 29,105,281 0 0 0 0 0 PDC 2003-A (7) 7,388,949 8,493,045 0 0 0 0 0 _____________________ (1) Total Subscriptions, less commissions, management fee, and offering costs. (2) Includes the total of the subscriptions, assessments, funds advanced by the Managing General Partner to the general or limited partnerships, exclusive of operating costs. None of the partnerships has borrowed any funds. (3) Represents the accrued gross revenues credited from oil and gas production, excluding operating costs, landowners' royalty interests, overriding royalty interests, and other burdens. (4) Represents the net cash distributed to the partnerships. All cash distributions to the partners were made from operations and constituted ordinary income. (5) Wells drilled after December 31, 1992 do not qualify for the credit. (6) Partnership funded in December 2002; wells were drilled in the first quarter of 2003; first revenue distribution commenced in July 2003. (7) Partnership funded in April 2003; were drilled in the second and third quarters of 2003; first revenue distribution to commence in November 2003. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Managing General Partner's Payout Table June 30, 2003 Revenues Before Deducting Operating Costs(2) Partnership Total Expenditures Including Operating Costs(1) Total As of June 30, 2003 During Three Months Ended June 30, 2003 Pennwest Petroleum Group 1984 $164,350 $301,582 $3,426 Pennwest Petroleum Group 156,230 282,147 6,959 Petrowest Gas Group 1986-A 88,140 189,840 3,825 Petrowest Gas Group 1987 108,571 268,903 5,664 Petrowest Gas Group 1987-B 82,088 137,777 2,440 PDC 1987 40,698 93,603 1,494 PDC 1988 71,459 203,396 3,020 PDC 1988-B 72,647 113,725 2,464 PDC 1988-C 118,806 217,082 4,723 PDC-1989-P 134,494 322,041 6,615 PDC 1989-A 257,869 399,962 9,309 PDC 1989-B 627,046 733,091 14,566 PDC 1990-A 221,760 193,009 3,807 PDC 1990-B 393,593 441,933 9,200 PDC 1990-C 620,113 707,393 24,634 PDC 1990-D 609,188 627,823 14,008 PDC 1991-A 480,259 592,443 10,831 PDC 1991-B 295,652 337,766 7,226 PDC 1991-C 455,000 540,288 12,586 PDC 1991-D 809,712 750,367 22,811 PDC 1992-A 296,250 85,543 0 PDC 1992-B 498,241 656,726 17,710 PDC 1992-C 1,081,071 1,596,222 40,629 PDC 1993-A 565,592 977,109 15,741 PDC 1993-B 366,060 354,074 12,325 PDC 1993-C 452,458 351,269 10,488 PDC 1993-D 417,319 379,194 10,551 PDC 1993-E 934,300 951,651 26,580 PDC 1994-A 584,712 276,855 7,851 PDC 1994-B 740,667 453,713 14,648 PDC 1994-C 637,313 354,541 11,955 PDC 1994-D 2,023,076 1,127,028 38,924 PDC 1995-A 408,820 241,673 5,967 PDC 1995-B 473,355 177,916 4,729 PDC 1995-C 568,547 228,944 7,579 PDC 1995-D 2,116,752 983,536 35,607 PDC 1996-A 762,784 509,028 14,480 PDC 1996-B 778,850 424,738 15,312 PDC 1996-C 1,125,093 465,594 20,527 PDC 1996-D 4,464,257 1,730,946 69,101 PDC 1997-A 1,158,784 425,674 15,632 PDC 1997-B 1,837,614 553,200 21,730 PDC 1997-C 1,785,561 797,821 37,376 PDC 1997-D 5,107,701 1,531,400 83,978 PDC 1998-A 1,395,899 678,780 44,251 PDC 1998-B 1,853,853 1,001,886 69,852 PDC 1998-C 2,071,524 1,015,043 70,935 PDC 1998-D 5,183,188 1,848,736 145,800 PDC 1999-A 1,219,114 702,262 59,116 PDC 1999-B 1,437,138 942,207 78,402 PDC 1999-C 1,767,873 918,451 65,286 PDC 1999-D 4,545,245 2,450,990 159,517 PDC 2000-A 1,209,172 715,695 37,433 PDC 2000-B 2,768,848 1,087,489 85,668 PDC 2000-C 3,324,816 967,312 109,464 PDC 2000-D 5,849,830 1,792,386 200,948 PDC 2001-A 2,175,199 673,849 76,300 PDC 2001-B 2,912,720 771,340 145,087 PDC 2001-C 2,441,915 594,646 121,849 PDC 2001-D 5,510,454 1,199,964 294,483 PDC 2002-A 1,626,178 427,400 137,571 PDC 2002-B 2,479,827 320,089 144,194 PDC 2002-C 2,095,640 306,616 146,572 PDC 2002-D (3) 6,330,399 0 0 PDC 2003-A (4) 1,845,062 0 0 (1) Includes Managing General Partner share of drilling costs. (2) Represents the accrued gross revenues credited to the managing general partner(s). (3) Partnership funded in December 2002; wells were drilled in the first quarter of 2003; first revenue distribution commenced in July 2003. (4) Partnership funded in April 2003; wells were drilled during the second and third quarters of 2003; first revenue distribution to commence in November 2003. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Managing General Partner's Net Cash Table June 30, 2003 Total Revenues After Deducting Operating Costs (2) Cash Distributions(3) Partnership Total Expenditures Net of Operating Total as of June 30, 2003 Three Months Ended June 30, 2003 Total as of June 30, 2003 Three Months Ended June 30, 2003 Aggregate Section 29 Tax Credits(4) Pennwest Petroleum Group 1984 $ 129,605 266,837 3,057 263,179 3,057 30,092 Pennwest Petroleum Group 1985-A 122,368 248,284 6,473 246,007 6,473 37,730 Petrowest Gas Group 1986-A 59,210 160,910 3,240 156,470 3,240 26,584 Petrowest Gas Group 1987 70,789 231,121 4,736 224,909 4,736 30,517 Petrowest Gas Group 1987-B 60,921 116,610 1,838 112,235 1,838 20,652 PDC 1987 28,158 81,063 1,257 78,419 1,257 13,256 PDC 1988 47,684 179,621 2,571 174,072 2,571 26,812 PDC 1988-B 52,105 93,182 1,742 88,575 1,742 15,069 PDC 1988-C 82,105 180,380 3,571 173,063 3,571 29,057 PDC 1989-P 94,342 281,889 5,673 268,501 5,673 47,742 PDC 1989-A 114,278 256,371 5,562 245,600 5,562 69,512 PDC 1989-B 350,389 456,434 7,903 430,025 7,903 445,076 PDC 1990-A 132,789 104,038 354 88,985 354 40,420 PDC 1990-B 209,761 258,101 5,362 248,661 5,362 174,541 PDC 1990-C 328,478 415,758 16,009 398,448 16,009 191,414 PDC 1990-D 348,075 366,710 6,260 351,493 6,260 233,475 PDC 1991-A 258,683 370,867 5,697 345,001 5,697 237,756 PDC 1991-B 175,997 218,111 2,930 212,336 2,930 139,040 PDC 1991-C 258,400 343,688 6,928 322,038 6,928 217,098 PDC 1991-D 496,639 437,294 12,822 419,041 12,822 288,226 PDC 1992-A 274,711 64,004 0 44,323 0 0 PDC 1992-B 281,361 439,846 10,845 427,635 10,845 261,359 PDC 1992-C 603,396 1,118,547 24,686 1,094,125 24,686 523,275 PDC 1993-A 294,194 705,711 7,234 663,087 7,234 33,649 PDC 1993-B 236,736 224,750 6,938 211,819 6,938 0 PDC 1993-C 296,207 195,018 4,821 182,641 4,821 0 PDC 1993-D 282,819 244,694 5,214 235,642 5,214 0 PDC 1993-E 715,438 732,789 16,317 700,093 16,317 0 PDC 1994-A 449,641 141,784 3,638 133,010 3,638 0 PDC 1994-B 588,395 301,441 9,616 287,626 9,616 0 PDC 1994-C 513,159 230,387 7,741 216,278 7,741 0 PDC 1994-D 1,651,292 755,244 25,656 708,530 25,656 0 PDC 1995-A 320,601 153,454 3,326 141,439 3,326 0 PDC 1995-B 406,361 110,922 1,641 96,920 1,641 0 PDC 1995-C 462,546 122,943 1,299 108,744 1,299 0 PDC 1995-D 1,784,359 651,143 22,375 598,469 22,375 0 PDC 1996-A 560,324 306,568 9,918 272,864 9,918 0 PDC 1996-B 583,924 229,812 1,363 198,583 1,363 0 PDC 1996-C 858,359 198,861 845 169,542 845 0 PDC 1996-D 3,328,126 594,815 42,516 505,293 42,516 0 PDC 1997-A 906,311 173,201 10,128 149,721 10,128 0 PDC 1997-B 1,470,185 185,771 3,306 148,421 3,306 0 PDC 1997-C 1,314,409 326,669 25,489 246,191 25,489 0 PDC 1997-D 4,028,009 451,708 48,165 355,737 48,165 0 PDC 1998-A 1,146,758 429,571 11,336 391,814 11,336 0 PDC 1998-B 1,554,059 702,092 50,247 678,743 50,247 0 PDC 1998-C 1,699,280 642,799 47,332 576,385 47,332 0 PDC 1998-D 4,464,244 1,129,792 27,233 1,014,401 27,233 0 PDC 1999-A 1,044,161 527,309 43,777 492,412 43,777 0 PDC 1999-B 1,204,927 709,996 59,599 663,195 59,599 0 PDC 1999-C 1,541,544 692,122 50,005 631,792 50,005 0 PDC 1999-D 4,069,282 1,975,027 123,149 1,928,201 123,149 0 PDC 2000-A 1,078,086 584,609 28,222 513,157 28,222 0 PDC 2000-B 2,523,611 842,252 60,721 737,574 60,721 0 PDC 2000-C 3,046,796 689,292 74,156 635,411 74,156 0 PDC 2000-D 5,437,500 1,380,056 146,724 1,197,071 146,724 0 PDC 2001-A 2,040,976 539,626 58,176 409,237 58,176 0 PDC 2001-B 2,757,591 616,211 108,284 534,661 108,284 0 PDC 2001-C 2,311,423 464,154 86,289 369,622 86,289 0 PDC 2001-D 5,310,985 1,000,495 239,650 758,094 239,650 0 PDC 2002-A 1,554,586 355,808 113,137 231,058 113,137 0 PDC 2002-B 2,431,743 272,005 122,672 163,829 122,672 0 PDC 2002-C 2,052,809 263,785 127,935 127,935 127,935 0 PDC 2002-D (5) 6,330,399 0 0 0 0 0 PDC 2003-A (6) 1,847,237 0 0 0 0 0 _____________________ (1) Includes Managing General Partner share of drilling costs, exclusive of operating costs. (2) Represents the accrued gross revenues credited from oil and gas production, excluding operating costs, landowners' royalty interests, overriding royalty interests, and other burdens. (3) Represents the net cash received from the partnerships' cash distributions. All cash distributions to the managing general partner were made from operations. (4) Wells drilled after December 31, 1992 do not qualify for the credit. (5) Partnership funded in December 2002; wells were drilled during the first quarter of 2003; first revenue distribution commenced in July 2003. (6) Partnership funded in April 2003; wells were drilled in the second and third quarters of 2003; first revenue distribution to commence in November 2003. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Tax Deductions and Tax Credits of Participants in Previous Partnerships The following table reflects the participants' share of the previous limited partnerships' available tax deductions that were reported in the partnerships' tax returns and the share of tax deductions as a percentage of their subscriptions. The following percentages do not reflect the effect of the revenues from the partnerships' operations and are subject to audit adjustments by the Service. The table also reflects the aggregate Section 29 nonconventional fuel production credit as a percentage of the participants' initial investment over the life of each partnership through March 31, 2003, and the federal tax savings from deductions and tax credits based on the maximum marginal tax rate in each year. Wells drilled after December 31, 1992 do not qualify for the credit. The final column shows these tax shelter ratios calculated in accordance with Service regulations. Programs with anticipated tax shelter ratios of greater than 2:1 in any of the first five years must register as tax shelters. We do not expect any of the prior partnerships or the partnerships in the current program to exceed the 2:1 ratio. The following table is based on past experience and should not be considered as necessarily indicative of the results that may be expected in these partnerships. It is suggested that prospective subscribers consult with their tax advisors concerning their specific tax circumstances and the tax benefits available to them individually, which may materially vary in various circumstances. First Year Tax Deductions Aggregate Deductions Thereafter Aggregate Section 29 Tax Credits (1) Estimated Federal Tax Savings (2) Tax Shelter Ratio (3) *Pennwest Petroleum Group 1984 70.87% 28.01% 23.22% 70.14% 1.5:1 *Pennwest Petroleum Group 1985-A 69.51% 29.77% 30.83% 76.84% 1.6:1 *Petrowest Gas Group 1986-A 70.10% 30.70% 44.90% 90.74% 1.9:1 *Petrowest Gas Group 1987 63.09% 36.14% 43.11% 79.80% 2.5:1 *Petrowest Gas Group 1987-B 68.70% 27.91% 33.90% 69.86% 2.2:1 *PDC 1987 70.30% 34.17% 47.08% 85.90% 2.7:1 *PDC 1988 68.57% 35.19% 56.23% 90.96% 3.0:1 *PDC 1988-B 66.70% 33.73% 28.92% 62.63% 2.0:1 *PDC 1988-C 69.20% 32.18% 35.39% 69.45% 2.3:1 *PDC 1989-P 63.68% 33.63% 47.99% 80.86% 2.7:1 *PDC 1989-A 69.80% 38.79% 50.61% 87.57% 2.9:1 *PDC 1989-B 69.10% 30.07% 22.98% 56.38% 1.8:1 *PDC 1990-A 67.92% 20.04% 11.50% 41.01% 1.3:1 *PDC 1990-B 71.50% 25.12% 31.43% 64.07% 2.1:1 *PDC 1990-C 70.60% 29.59% 22.01% 56.13% 1.8:1 *PDC 1990-D 69.70% 31.03% 25.34% 59.70% 1.9:1 *PDC 1991-A 69.80% 24.22% 34.72% 65.51% 2.2:1 *PDC 1991-B 67.00% 28.62% 29.84% 60.96% 2.0:1 *PDC 1991-C 69.60% 29.63% 31.74% 64.37% 2.1:1 *PDC 1991-D 69.80% 25.32% 21.92% 53.07% 1.7:1 *PDC 1992-A 68.24% 19.16% 15.31% 43.88% 1.4:1 *PDC 1992-B 69.60% 30.92% 35.09% 68.72% 2.2:1 *PDC 1992-C 69.20% 34.04% 32.76% 67.47% 2.2:1 *PDC 1993-A 69.00% 41.91% 4.94% 42.69% 1.3:1 *PDC 1993-B 68.10% 26.93% 35.16% 1.0:1 *PDC 1993-C 68.80% 24.90% 34.63% 0.9:1 *PDC 1993-D 68.60% 23.64% 34.04% 0.9:1 *PDC 1993-E 67.60% 27.07% 35.05% 0.9:1 *PDC 1994-A 87.70% 6.80% 37.42% 0.9:1 *PDC 1994-B 89.40% 9.34% 39.10% 1.0:1 *PDC 1994-C 89.70% 7.98% 38.68% 1.0:1 *PDC 1994-D 89.90% 8.73% 39.06% 1.0:1 *PDC 1995-A 89.60% 10.33% 39.57% 1.0:1 *PDC 1995-B 89.02% 7.11% 38.07% 1.0:1 *PDC 1995-C 89.71% 6.83% 38.23% 1.0:1 *PDC 1995-D 89.94% 7.37% 38.53% 1.0:1 *PDC 1996-A 89.94% 9.68% 39.45% 1.0:1 *PDC 1996-B 89.00% 8.49% 38.61% 1.0:1 *PDC 1996-C 89.42% 6.72% 38.07% 1.0:1 *PDC 1996-D 89.49% 6.36% 37.96% 1.0:1 *PDC 1997-A 89.50% 4.92% 37.39% 0.9:1 *PDC 1997-B 89.50% 4.36% 37.17% 0.9:1 *PDC 1997-C 89.50% 7.06% 38.24% 1.0:1 *PDC 1997-D 89.50% 4.76% 37.33% 0.9:1 *PDC 1998-A 89.50% 7.25% 38.31% 1.0:1 PDC 1998-B 89.50% 8.46% 38.79% 1.0:1 PDC 1998-C 89.50% 7.29% 38.33% 1.0:1 PDC 1998-D 89.50% 5.03% 37.44% 0.9:1 PDC 1999-A 89.50% 4.81% 37.35% 0.9:1 PDC 1999-B 89.50% 6.18% 37.89% 1.0:1 PDC 1999-C 89.50% 4.17% 37.09% 0.9:1 PDC 1999-D 89.50% 4.58% 37.25% 0.9:1 PDC 2000-A 89.50% 7.03% 38.23% 1.0:1 PDC 2000-B 89.50% 4.85% 37.36% 0.9:1 PDC 2000-C 89.50% 4.06% 37.05% 0.9:1 PDC 2000-D 89.50% 3.67% 36.90% 0.9:1 PDC 2001-A 89.50% 0.93% 35.36% 0.9:1 PDC 2001-B 89.50% 0.57% 35.22% 0.9:1 PDC 2001-C 89.50% 2.52% 35.98% 0.9:1 PDC 2001-D 89.50% 1.90% 35.74% 0.9:1 PDC 2002-A 89.50% 0.93% 34.91% 0.9:1 PDC 2002-B 89.50% 0.89% 34.89% 0.9:1 PDC 2002-C 89.50% 0.21% 34.63% 0.9:1 PDC 2002-D (4) 89.50% - 34.55% 0.9:1 PDC 2003-A (5) 89.5% - 34.55% 0.9:1 *Partnerships in existence for over five years. _____________________ (1) Wells drilled after December 31, 1992 do not qualify for the credit. (2) The Estimated Federal Tax Savings column reflects the percentage savings in taxes which would have been paid by an investor had he not had the use of the various deductions and credits available to a partner in the program and it assumes full use of deductions and tax credits at maximum federal income tax rates for individuals of 50% in 1984 - 1986, 40% in 1987 and 1988, and 33% in 1989 and 1990, 31% in 1991-1992, 36% in 1993, 39.6% in 1994 - 2000, 39.1% in 2001, 38.6% in 2002 and 35% in 2003. (3) Total deductions plus 200% of credits generated for partnerships first offered before December 31, 1986. Total deductions plus 350% of credits generated for partnerships offered after December 31, 1986. (4) Partnership funded in December 2002. (5) Partnership funded in April 2003. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Percentage of Gross Return on Subscriptions Through June 30, 2003 From Cash Distributions, Tax Savings from Deductions and Tax Credits (1) Program Cash Distribution(2) Cumulative Section 29 Credit (3) Total Cash And Tax Credit Tax Deductions Tax Effected(4) Total Return of Cash, Tax Deduction(5) Year/ Months Producing *Pennwest Petroleum 1984 54.53% 23.22% 77.75% 50.88% 128.63% 18/3 *Pennwest Petroleum 1985 44.90% 30.83% 75.73% 49.98% 125.71% 17/4 **Petrowest Gas Group 1986 53.09% 44.90% 97.99% 49.88% 147.87% 16/3 **Petrowest Gas Group 1987 71.32% 43.11% 114.42% 40.66% 155.09% 15/6 **Petrowest Gas Group 1987-B 38.95% 33.90% 72.85% 39.83% 112.68% 15/3 **PDC 1987 62.73% 47.08% 109.80% 43.00% 152.80% 15/1 **PDC 1988 82.63% 56.23% 138.85% 38.88% 177.73% 14/7 **PDC 1988-B 27.28% 28.92% 56.20% 37.72% 93.92% 14/3 **PDC 1988-C 40.31% 35.39% 75.70% 38.12% 113.82% 14/1 **PDC 1989-P 65.94% 47.99% 113.93% 36.77% 150.69% 13/7 **PDC 1989-A 79.88% 50.61% 130.49% 41.31% 171.79% 13/3 **PDC 1989-B 46.57% 22.98% 69.55% 37.36% 106.91% 13/1 **PDC 1990-A 27.34% 11.50% 38.84% 33.03% 71.86% 12/8 **PDC 1990-B 45.66% 31.43% 77.09% 36.50% 113.59% 12/6 **PDC 1990-C 47.25% 22.01% 69.26% 38.12% 107.38% 12/2 **PDC 1990-D 41.47% 25.34% 66.81% 38.39% 105.19% 12/1 **PDC 1991-A 50.85% 34.72% 85.57% 34.55% 120.12% 11/8 **PDC 1991-B 44.92% 29.84% 74.77% 34.94% 109.71% 11/5 **PDC 1991-C 47.27% 31.74% 79.01% 36.60% 115.62% 11/3 **PDC 1991-D 33.07% 21.92% 54.99% 34.95% 89.94% 11/1 **PDC 1992-A 17.23% 15.31% 32.54% 32.07% 64.61% 10/8 **PDC 1992-B 56.08% 35.09% 91.17% 37.65% 128.82% 10/6 **PDC 1992-C 68.75% 32.76% 101.52% 38.84% 140.36% 10/3 **PDC 1993-A 96.75% 4.94% 101.69% 42.18% 143.88% 10/1 **PDC 1993-B 39.69% - 39.69% 38.96% 78.65% 9/8 **PDC 1993-C 30.73% - 30.73% 38.37% 69.11% 9/5 **PDC 1993-D 39.73% - 39.73% 37.73% 77.47% 9/3 **PDC 1993-E 44.97% - 44.97% 38.83% 83.81% 9/0 **PDC 1994-A 25.84% - 25.84% 41.20% 67.04% 8/8 **PDC 1994-B 42.06% - 42.06% 43.05% 85.11% 8/5 **PDC 1994-C 35.97% - 35.97% 42.59% 78.56% 8/3 **PDC 1994-D 37.02% - 37.02% 43.00% 80.03% 8/1 **PDC 1995-A 38.39% - 38.39% 43.57% 81.96% 7/9 **PDC 1995-B 21.60% - 21.60% 41.91% 63.51% 7/6 **PDC 1995-C 20.87% - 20.87% 42.09% 62.97% 7/3 **PDC 1995-D 30.38% - 30.38% 42.43% 72.81% 7/1 **PDC 1996-A 51.83% - 51.83% 43.43% 95.27% 6/8 **PDC 1996-B 39.60% - 39.60% 42.51% 82.11% 6/4 **PDC 1996-C 28.71% - 28.71% 41.92% 70.63% 6/2 **PDC 1996-D 27.20% - 27.20% 41.79% 69.00% 6/1 **PDC 1997-A 26.70% - 26.70% 41.17% 67.87% 5/8 **PDC 1997-B 19.00% - 19.00% 40.92% 59.93% 5/4 **PDC 1997-C 31.69% - 31.69% 42.10% 73.79% 5/2 **PDC 1997-D 15.95% - 15.95% 41.10% 57.05% 5/0 **PDC 1998-A 30.95% - 30.95% 42.18% 73.14% 4/7 **PDC 1998-B 37.42% - 37.42% 42.71% 80.13% 4/4 **PDC 1998-C 29.12% - 29.12% 42.20% 71.32% 4/2 **PDC 1998-D 21.32% - 21.32% 41.22% 62.54% 4/0 **PDC 1999-A 40.58% - 40.58% 41.12% 81.70% 3/8 *PDC 1999-B 47.14% - 47.14% 41.72% 88.86% 3/4 *PDC 1999-C 34.93% - 34.93% 40.84% 75.77% 3/2 *PDC 1999-D 40.31% - 40.31% 41.02% 81.33% 3/0 *PDC 2000-A 41.02% - 41.02% 42.09% 83.11% 2/8 *PDC 2000-B 25.18% - 25.18% 41.14% 66.32% 2/4 *PDC 2000-C 17.95% - 17.95% 40.79% 58.74% 2/1 *PDC 2000-D 18.92% - 18.92% 40.62% 59.54% 1/11 *PDC 2001-A 17.35% - 17.35% 38.98% 56.33% 1/8 *PDC 2001-B 16.76% - 16.76% 38.82% 55.58% 1/4 *PDC 2001-C 13.81% - 13.81% 39.66% 53.47% 1/2 *PDC 2001-D 12.34% - 12.34% 39.39% 51.74% 1/0 *PDC 2002-A 12.93% - 12.93% 38.52% 51.45% 0/8 *PDC 2002-B 5.86% - 5.86% 38.50% 44.37% 0/4 *PDC 2002-C 5.42% - 5.42% 38.22% 43.64% 0/2 *PDC 2002-D (6) - - - - - - *PDC 2003-A (7) - - - - - - * Program contains oil and gas production. ** Program contains gas production. _____________________ (1) This table assumes investors were able to fully utilize all tax benefits at the maximum marginal Federal rate plus an assumed state rate of 4%. (2) Cash distributions to investors divided by investors' initial investment. (3) Credit earned on qualified production. Wells drilled after December 31, 1992 do not qualify for the credit. (4) Tax savings from deductions assuming investor is in the highest marginal bracket. Rates used (which are based on the maximum marginal federal income tax rate for individuals plus an assumed state rate of 4%) were 54% in 1984, 1985 and 1986, 42.5% in 1987, 37% in 1988, 1989 and 1990, 35% in 1991 and 1992, 40% in 1993, 43.6% in 1994 - 2000, 43.1% in 2001, 42.6% in 2002 and 39% in 2003. For purposes of this calculation, no effect has been given for the possible deduction of state income taxes for federal income tax purposes. (5) This column represents the sum of the percentage amounts set forth in columns 1, 2, and 4 of this table. (6) Partnership funded in December 2002; wells were drilled during the first quarter of 2003; first revenue distribution commenced in July 2003. (7) Partnership funded in April 2003; wells to be drilled during the second and third quarters of 2003; first revenue distribution to commence in November 2003. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Partnership Estimated Proved Reserves and Future Net Revenues The following table presents information regarding the public drilling programs sponsored by the Managing General Partner. The table reflects with respect to each partnership the estimated proved reserves and future net reserves as of January 1, 2003. The information presented in the following table has been prepared in conformity with generally accepted accounting principles. The information presented has been derived from reports prepared by an independent petroleum consultant, Wright & Company, Inc. and by the Managing General Partner's petroleum engineers as noted below. Partnership Proved Reserves and Future Net Revenues as of January 1, 2003 (1) Partnership Category of Proved Reserves Estimated Net Oil BBL Reserves Bbl Estimated Net Gas Reserves MCF Estimated Future Net Revenues Present Value Discounted at 10% Annum PDC 1989-A(2) Proved Developed 2,934 764,649 $1,942,887 $563,343 Proved Undeveloped - - - - Totals 2,934 764,649 $1,942,887 $563,343 PDC 1989-B(2) Proved Developed - 1,047,681 $2,197,690 $781,473 Proved Undeveloped - - - - Totals - 1,047,681 $2,197,690 $781,473 PDC 1990-A(2) Proved Developed - 200,849 $323,874 $148,343 Proved Undeveloped - - - - Totals - 200,849 $323,874 $148,343 PDC 1990-B(2) Proved Developed - 1,086,081 $2,777,053 $525,930 Proved Undeveloped - - - - Totals - 1,086,081 $2,777,053 $525,930 PDC 1990-C(2) Proved Developed - 1,665,784 $4,298,284 $1,492,698 Proved Undeveloped - - - - Totals - 1,665,784 $4,298,284 $1,492,698 PDC 1990-D(2) Proved Developed - 1,729,943 $4,266,026 $914,364 Proved Undeveloped - - - - Totals - 1,729,943 $4,266,026 $914,364 PDC 1991-A(2) Proved Developed - 911,902 $2,011,694 $483,890 Proved Undeveloped - - - - Totals - 911,902 $2,011,694 $483,890 PDC 1991-B(2) Proved Developed - 666,122 $1,600,585 $551,447 Proved Undeveloped - - - - Totals - 666,122 $1,600,585 $551,447 PDC 1991-C(2) Proved Developed - 1,154,912 $2,636,178 $714,586 Proved Undeveloped - - - - Totals - 1,154,912 $2,636,178 $714,586 PDC 1991-D(2) Proved Developed - 1,559,250 $3,825,870 $1,427,672 Proved Undeveloped - - - - Totals - 1,559,250 $3,825,870 $1,427,672 PDC 1992-A(2) Proved Developed - 240,900 $460,780 $232,012 Proved Undeveloped - - - - Totals - 240,900 $460,780 $232,012 PDC 1992-B(2) Proved Developed - 1,639,739 $4,174,359 $1,193,368 Proved Undeveloped - - - - Totals - 1,639,739 $4,174,359 $1,193,368 PDC 1992-C(2) Proved Developed - 3,252,604 $7,877,880 $2,907,821 Proved Undeveloped - - - - Totals - 3,252,604 $7,877,880 $2,907,821 PDC 1993-A(2) Proved Developed - 1,386,020 $3,315,896 $826,483 Proved Undeveloped - - - - Totals - 1,386,020 $3,315,896 $826,483 PDC 1993-B(2) Proved Developed - 1,135,955 $2,606,303 $842,899 Proved Undeveloped - - - - Totals - 1,135,955 $2,606,303 $842,899 PDC 1993-C(2) Proved Developed - 1,733,057 $4,402,688 $903,808 Proved Undeveloped - - - - Totals - 1,733,057 $4,402,688 $903,808 PDC 1993-D(2) Proved Developed - 1,283,821 $3,146,219 $797,899 Proved Undeveloped - - - - Totals - 1,283,821 $3,146,219 $797,899 PDC 1993-E(2) Proved Developed - 3,511,505 $9,344,737 $2,274,138 Proved Undeveloped - - - - Totals - 3,511,505 $9,344,737 $2,274,138 PDC 1994-A(2) Proved Developed - 911,268 $2,359,676 $520,283 Proved Undeveloped - - - - Totals - 911,268 $2,359,676 $520,283 PDC 1994-B(2) Proved Developed - 1,014,197 $2,486,589 $882,298 Proved Undeveloped - - - - Totals - 1,014,197 $2,486,589 $882,298 PDC 1994-C(2) Proved Developed - 976,281 $2,404,453 $659,468 Proved Undeveloped - - - - Totals - 976,281 $2,404,453 $659,468 PDC 1994-D(2) Proved Developed - 2,826,519 $6,590,785 $2,330,586 Proved Undeveloped - - - - Totals - 2,826,519 $6,590,785 $2,330,586 PDC 1995-A(2) Proved Developed - 273,834 $534,853 $271,583 Proved Undeveloped - - - - Totals - 273,834 $534,853 $271,583 PDC 1995-B(2) Proved Developed - 419,877 $980,242 $254,225 Proved Undeveloped - - - - Totals - 419,877 $980,242 $254,225 PDC 1995-C(2) Proved Developed - 563,616 $1,070,803 $345,570 Proved Undeveloped - - - - Totals - 563,616 $1,070,803 $345,570 PDC 1995-D(2) Proved Developed - 1,970,275 $4,113,276 $1,916,507 Proved Undeveloped - - - - Totals - 1,970,275 $4,113,276 $1,916,507 PDC 1996-A(2) Proved Developed - 711,727 $1,682,838 $854,348 Proved Undeveloped - - - - Totals - 711,727 $1,682,838 $854,348 PDC 1996-B(2) Proved Developed - 922,828 $1,973,808 $937,838 Proved Undeveloped - - - - Totals - 922,828 $1,973,808 $937,838 PDC 1996-C(2) Proved Developed - 985,147 $2,046,560 $935,886 Proved Undeveloped - - - - Totals - 985,147 $2,046,560 $935,886 PDC 1996-D(2) Proved Developed - 4,097,730 $8,443,425 $3,694,969 Proved Undeveloped - - - - Totals - 4,097,730 $8,443,425 $3,694,969 PDC 1997-A(2) Proved Developed - 944,092 $2,088,798 $1,017,638 Proved Undeveloped - - - - Totals - 944,092 $2,088,798 $1,017,638 PDC 1997-B(2) Proved Developed - 1,066,147 $2,039,092 $1,118,522 Proved Undeveloped - - - - Totals - 1,066,147 $2,039,092 $1,118,522 PDC 1997-C(2) Proved Developed - 2,174,585 $5,173,297 $2,429,386 Proved Undeveloped - - - - Totals - 2,174,585 $5,173,297 $2,429,386 PDC 1997-D(2) Proved Developed - 4,395,700 $9,956,500 $4,484,900 Proved Undeveloped - - - - Totals - 4,395,700 $9,956,500 $4,484,900 PDC 1998-A(2) Proved Developed - 1,859,264 $3,929,517 $2,255,829 Proved Undeveloped - - - - Totals - 1,859,264 $3,929,517 $2,255,829 PDC 1998-B(2) Proved Developed - 3,267,528 $7,526,889 $4,024,460 Proved Undeveloped - - - - Totals - 3,267,528 $7,526,889 $4,024,460 PDC 1998-C(2) Proved Developed - 3,715,036 $8,170,181 $4,353,424 Proved Undeveloped - - - - Totals - 3,715,036 $8,170,181 $4,353,424 PDC 1998-D(2) Proved Developed - 6,247,900 $14,394,116 $7,386,402 Proved Undeveloped - - - - Totals - 6,247,900 $14,394,116 $7,386,402 PDC 1999-A(2) Proved Developed - 3,210,772 $8,456,212 $4,064,014 Proved Undeveloped - - - - Totals - 3,210,772 $8,456,212 $4,064,014 PDC 1999-B(2) Proved Developed 15,468 4,645,251 $12,659,588 $6,005,089 Proved Undeveloped - - - - Totals 15,468 4,645,251 $12,659,588 $6,005,089 PDC 1999-C(2) Proved Developed 59,670 4,210,744 $12,205,689 $5,554,962 Proved Undeveloped - - - - Totals 59,670 4,210,744 $12,205,689 $5,554,962 PDC 1999-D(2) Proved Developed 186,215 10,622,637 $31,221,010 $14,442,413 Proved Undeveloped - - - - Totals 186,215 10,622,637 $31,221,010 $14,442,413 PDC 2000-A(2) Proved Developed 157,655 1,277,167 $6,134,020 $3,188,669 Proved Undeveloped - - - - Totals 157,655 1,277,167 $6,134,020 $3,188,669 PDC 2000-B(2) Proved Developed 216,138 4,067,883 $15,537,636 $7,471,685 Proved Undeveloped - - - - Totals 216,138 4,067,883 $15,537,636 $7,471,685 PDC 2000-C(2) Proved Developed 173,942 5,024,346 $15,894,205 $7,954,831 Proved Undeveloped - - - - Totals 173,942 5,024,346 $15,894,205 $7,954,831 PDC 2000-D(3) Proved Developed 436,830 9,388,090 $31,533,451 $15,669,185 Proved Undeveloped - - - - Totals 436,830 9,388,090 $31,533,451 $15,669,185 PDC 2001-A(3) Proved Developed 238,712 2,094,116 $9,352,715 $4,917,958 Proved Undeveloped - - - - Totals 238,712 2,094,116 $9,352,715 $4,917,958 PDC 2001-B(3) Proved Developed 192,248 6,537,828 $17,714,631 $9,240,025 Proved Undeveloped - - - - Totals 192,248 6,537,828 $17,714,631 $9,240,025 PDC 2001-C(3) Proved Developed 359,012 4,515,020 $17,007,074 $8,689,747 Proved Undeveloped - - - - Totals 359,012 4,515,020 $17,007,074 $8,689,747 PDC 2001-D(3) Proved Developed 361,705 9,660,381 $31,681,984 $15,995,692 Proved Undeveloped - - - - Totals 361,705 9,660,381 $31,681,984 $15,995,692 PDC 2002-A(3) Proved Developed 113,558 4,528,743 $12,334,525 $6,166,037 Proved Undeveloped - - - - Totals 113,558 4,528,743 $12,334,525 $6,166,037 PDC 2002-B(3) Proved Developed 144,359 4,751,391 $14,963,479 $7,898,126 Proved Undeveloped - - - - Totals 144,359 4,751,391 $14,963,479 $7,898,126 PDC 2002-C(3) Proved Developed 160,386 3,575,250 $11,334,206 $5,532,526 Proved Undeveloped - - - - Totals 160,386 3,575,250 $11,334,206 $5,532,526 PDC 2002-D(4) Proved Developed - - - - Proved Undeveloped - - - - Totals - - - - (1) For the partnerships PDC 1989-A through PDC 1992-C and for PDC 1994-A through PDC 2002-C, we own 20% of the reserves listed and the investor partners own 80% of the reserves listed above. In the PDC 1993-A, PDC 1993-B, PDC 1993-C, PDC 1993-D and PDC 1993-E Limited Partnerships, we own 18% of the reserves listed and the Investor Partners own 82% of the reserves listed above. (2) Reserve reports prepared by our petroleum engineers. (3) Reserve reports prepared by an independent petroleum consultant, Wright & Company, Inc. (4) The wells of these partnerships were drilled after December 31, 2002; therefore, reserve studies have not been conducted. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. Participants' Estimated Future and Total Payout and Payout Period For Partnerships Formed Since 1999 with Colorado Operations Based on Returns to Date and 2002 Reserve Report The following table shows the estimated payout and payout period for partnerships formed by PDC since 1999. PDC began drilling in Colorado in 1999, and all of the drilling activities for the remaining 2003 partnerships are currently planned for the two Colorado fields. The payout amounts and periods are based on the partnership reserve reports for December 31, 2002. The reserve reports assume that oil and gas prices remain constant at the December 2002 levels. The averages for December 2002 were $3.48 per Mcf of natural gas and $28.59 per barrel of oil. Changes in these prices, the estimated reserves, the estimated operating expenses and other factors would result in changes in the payout amounts and payout periods. Cash Estimated Future Cash Distributions Net Distributions Subscriptions Year through Revenues plus Estimated Future Net From Payout Partnership 12/31/2002 12/31/2002 Revenues Participants Anticipated PDC 1999-A(1) $ 1,794,560 $ 6,764,970 $ 8,559,530 $ 4,800,739 2009 PDC 1999-B(1) 2,414,397 10,127,670 12,542,067 5,539,893 2007 PDC 1999-C(1) 2,327,167 9,764,551 12,091,718 7,087,559 2011 PDC 1999-D(1) 7,220,243 24,976,808 32,197,051 18,709,342 2010 PDC 2000-A(1) 1,939,756 4,907,216 6,846,972 4,956,718 2011 PDC 2000-B(1) 2,707,433 12,430,109 15,137,542 11,602,809 2015 PDC 2000-C(1) 2,245,037 12,715,364 14,960,401 14,008,256 2026 PDC 2000-D(2) 4,201,413 25,226,761 29,428,174 25,000,000 2019 PDC 2001-A(2) 1,404,268 7,482,172 8,886,440 9,383,798 N/A PDC 2001-B(2) 1,705,518 14,171,705 15,877,223 12,678,577 2016 PDC 2001-C(2) 1,133,342 13,605,659 14,739,001 10,627,234 2014 PDC 2001-D(2) 2,073,788 25,345,587 27,419,375 24,418,322 2023 PDC 2002-A(2) 471,691 9,867,620 10,339,311 7,147,522 2014 PDC 2002-B(2) 164,631 11,970,783 12,135,414 11,180,426 2024 (1) Reserve reports prepared by our petroleum engineers. (2) Reserve reports prepared by an independent petroleum consultant, Wright & Company, Inc. You should not consider operating results obtained by these prior partnerships as indicative of the operating results obtainable by the partnerships. TAX CONSIDERATIONS We attach the tax opinion of Duane Morris LLP to the prospectus as Appendix D. You should review Appendix D in its entirety before investing in the program. All references in this "Tax Considerations" section are to the tax opinion set forth in Appendix D. The following is a summary of the opinions of Duane Morris LLP, counsel to the partnerships, which represent counsel's opinions on all material federal income tax consequences to the partnership and to you as an investor partner. There may be aspects of your particular tax situation which are not addressed in the following discussion or in Appendix D. Additionally, the resolution of tax issues depends upon future facts and circumstances not known to counsel as of the date of this prospectus; thus, no assurance as to the final resolution of these issues should be drawn from the following discussion. The following statements are based upon the provisions of the Internal Revenue Code of 1986, which we refer to as the "Code," existing and proposed regulations thereunder, current administrative rulings, and court decisions. On May 28, 2003, President Bush signed into law the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the "2003 Tax Act"). The following discussion takes into account the 2003 Tax Act as it affects you as an investor in the partnership. It is possible that legislative or administrative changes or future court decisions may significantly affect the statements and opinions expressed in this prospectus. Changes could be retroactive with respect to the transactions prior to the date of the changes. Moreover, uncertainty exists concerning some of the federal income tax aspects of the transactions being undertaken by the partnership. Some of the tax positions being taken by the Partnership may be challenged by the Internal Revenue Service, which we refer to as the "Service," and any challenge could be successful. Thus, there can be no assurance that all of the anticipated tax benefits of an investment in the partnership will be realized. Counsel's opinion is based upon the transactions described in this prospectus, which we refer to as the "transaction," and upon facts as they have been represented to counsel or determined by it as of the date of the opinion. Any alteration of the facts may adversely affect the opinions rendered. Because of the factual nature of the inquiry, it is not possible to reach a judgment as to the outcome on the merits (either favorable or unfavorable) of some material federal income tax issues as described more fully in this section. Summary of Conclusions Opinions expressed: The following is a summary of the specific opinions expressed by counsel. To fully understand the tax considerations of an investment in the program, you should read the discussion of these matters set forth in the tax opinion in Appendix D. 1. The material federal income tax benefits in the aggregate from an investment in the partnership will be realized. 2. The partnership will be treated as a partnership for federal income tax purposes and not as an association taxable as a corporation or as a "publicly traded partnership." See "General Tax Effects of Partnership Structure." 3. To the extent the partnership's wells are timely drilled and amounts are timely paid, the partners will be entitled to their pro rata share of the partnership's intangible drilling and development costs paid in 2001 with respect to the partnerships designated "PDC 2001- Limited Partnership," in 2002 with respect to the partnerships designated "PDC 2002- Limited Partnership," and in 2003 with respect to the partnerships designated "PDC 2003- Limited Partnership." However, these intangible drilling and development costs deductions may be subject to recapture, which could have the effect of requiring an investor to recognize additional ordinary income in later years. See "Intangible Drilling and Development Costs Deductions." 4. Neither the at risk nor the limitations related to the adjusted basis of an investor in his or her Partnership interest will limit the deductibility of losses generated from the partnership so long as the investor contributes cash to the partnership from "personal funds" (funds not borrowed by the investor). See "Basis and At Risk Limitations." 5. An additional general partner's interest will not be considered an interest in a passive activity within the meaning of Code Section 469 and losses generated while the general partner interest is so held will not be limited by the passive activity provisions. See "Passive Loss Limitations." 6. Limited partners' interests (other than those held by additional general partners who convert their interests into limited partners' interests) will be considered interests in a passive activity within the meaning of Code Section 469 and losses generated therefrom will be limited by the passive activity provisions. See "Passive Loss Limitations." 7. The partnership will not be terminated solely as the result of the conversion of partnership interests. See "Conversion of Interests." 8. To the extent provided in this section of the prospectus, the partners' distributive shares of partnership tax items will be determined and allocated substantially in accordance with the terms of the limited partnership agreement. See "Partnership Allocations." 9. The partnership will not be required to register with the Service as a tax shelter; the partners will not be required to disclose the partnership as a tax shelter on Form 8886; and the organizers of the partnership will not be required to maintain a list of the partners as participants in a tax shelter. See "Tax Shelter Rules." No opinion expressed: Due to the essentially factual nature of the question, counsel expresses no opinion on the following: 1. The impact of an investment in the partnership on an investor's alternative minimum tax. See "Alternative Minimum Tax." 2. Whether, under Code Section 183, the losses of the partnership will be treated as derived from "activities not engaged in for profit," and therefore nondeductible from other gross income, due to the inherently factual nature of a partner's interest and motive in engaging in the transaction. See "Profit Motive." 3. Whether each partner will be entitled to percentage depletion, due to the factual nature of determining the status of the partner as an independent producer and the partner's other oil and gas production. See "Depletion Deductions." 4. Without any assistance from us, some partners may choose to borrow the funds necessary to acquire a Unit and may incur interest expense in connection with that borrowing. Whether any interest incurred by a partner with respect to any borrowings will be deductible or subject to limitations on deductibility, due to the factual nature of the issue. See "Interest Deductions." 5. Whether the fees to be paid to us and to third parties will be deductible, due to the factual nature of the issue. Due to the inherently factual nature of the proper allocation of expenses among nondeductible syndication expenses, amortizable organization expenses, amortizable "start-up" expenditures, and currently deductible items, and because the issues involve questions concerning both the nature of the services performed and to be performed and the reasonableness of amounts charged, counsel is unable to express an opinion regarding that treatment. See "Transaction Fees." General Information: Certain matters contained in this "Tax Considerations" section are not considered to address a material tax consequence and are for general information, including the matters contained in sections dealing with gain or loss on the sale of units or of property, partnership distributions, tax audits, penalties, and state, local, and self-employment tax. See "General Tax Effects of Partnership Structure," "Gain or Loss on Sale of Properties or Units," "Partnership Distributions," "Administrative Matters," "Accounting Methods and Periods," "Social Security Benefits; Self-Employment Tax," and "State and Local Tax." Facts and Representations: The opinions of counsel are also based upon the facts described in this prospectus and upon representations made to counsel by us for the purpose of permitting counsel to render its opinions, including the following representations with respect to the program: 1. The limited partnership agreement to be entered into by and among the investor partners and us and any amendments to the agreement will be duly executed and will be made available to you upon written request. The limited partnership agreement will be duly recorded in all places required under the West Virginia Uniform Limited Partnership Act for the due formation of the partnership and for its continuation in accordance with the terms of the limited partnership agreement. The partnership will at all times be operated in accordance with the terms of the limited partnership agreement, the prospectus, and the West Virginia Act. 2. No election will be made by the partnership, investor partners, or us to be excluded from the application of the provisions of Subchapter K of the Code. 3. The partnership will own an operating mineral interest, as defined in the Code and in the Regulations, in all of the drill sites and none of the partnership's revenues will be from non-working interests. 4. The amounts that will be paid to the Managing General Partner as drilling fees, operating fees, and other fees will be amounts that would not exceed amounts that would be ordinarily paid for similar transactions between persons having no affiliation and dealing with each other at arms' length. 5. We will cause the partnership to properly elect to deduct currently all intangible drilling and development costs. 6. The partnership will have a December 31 taxable year and will report its income on the accrual basis. 7. The drilling and operating agreement to be entered into by and between the partnership and us will be duly executed and will govern the drilling of the partnership's wells. All partnership wells will be spudded by not later than March 30, 2002 for partnerships designated "PDC 2001- Limited Partnership," March 30, 2003 for partnerships designated "PDC 2002- Limited Partnership" and March 30, 2004 for partnerships designated "PDC 2003- Limited Partnership." Thereafter, each well will be completed with due diligence, if completion is warranted. 8. The drilling and operating agreement will be duly executed and will govern the operation of the partnership's wells. 9. Based upon our review of our experience with our previous drilling programs since 1984 (see "Prior Activities - Tax Deductions and Tax Credits of Participants in Previous Partnerships," above) and upon the intended operations of the partnership, we have represented that the sum of (a) the aggregate deductions, including depletion deductions, and (b) 350 percent of the aggregate credits from the partnership will not, as of the close of any of the first five years ending after the date on which units are offered for sale, exceed two times the cash invested by the partners in the partnership as of those dates. In that regard, we have reviewed the economics of our similar oil and gas drilling programs for the past several years, and have represented that we have determined that none of those programs has resulted in a tax shelter ratio greater than two to one. Further, we have represented that the deductions that are or will be represented as potentially allowable to an investor will not result in any partnership having a tax shelter ratio greater than two to one and believe that no person could reasonably infer from representations made, or to be made, in connection with the offering of units that the sums as of those dates will exceed two times the partners' cash investments as of those dates. 10. We have represented that at least 90% of the gross income of the partnership will constitute income derived from the exploration, development, production, and/or marketing of oil and gas. We have represented that we do not believe that any market will ever exist for the sale of units and that we will not make a market for the units. Further, the units will not be traded on an established securities market. 11. The partnership will have the objective of carrying on business for profit and dividing the gain from its operations. 12. We will not permit the purchase of units by tax-exempt investors or foreign investors. We will not drill, own or operate any wells located outside the United States. 14. No partner will incur any debt that is either (a) arranged by us, the partnership, or any other person who participated in the organization or management of the partnership or the sale of partnership interests (or any person related to such persons), or (b) secured by any asset of the partnership. The opinions of counsel are also subject to all the assumptions, qualifications, and limitations set forth in the following discussion and in the opinion, including the assumptions that each of the partners has full power, authority, and legal right to enter into and perform the terms of the limited partnership agreement and to take any and all actions under the agreement in connection with the transactions contemplated by the agreement. You should be aware that, unlike a ruling from the Service, an opinion of counsel represents only counsel's best judgment. There can be no assurance that the Service will not successfully assert positions which are inconsistent with the opinions of counsel set forth in this discussion and Appendix D or in the tax reporting positions taken by the partners or the partnership. You should consult your own tax advisor to determine the effect of the tax issues discussed in this section and in Appendix D on your individual tax situation. General Tax Effects of Partnership Structure Each partnership will be formed as a limited partnership under the limited partnership agreement and the laws of the State of West Virginia. No tax ruling will be sought from the Service as to the status of the partnership as a partnership for federal income tax purposes. Any tax benefits anticipated from an investment in a partnership would be adversely affected or eliminated if the partnership is treated as a corporation for federal income tax purposes. While counsel has opined that the partnership will initially be treated as a partnership for federal tax purpose, that opinion is not binding on the Service. The applicability of the federal income tax consequences described in this section depends on the treatment of the partnerships as partnerships for federal income tax purposes and not as corporations and not as associations taxable as corporations. Any tax benefits anticipated from an investment in a partnership would be adversely affected or eliminated if the partnership is treated as a corporation for federal income tax purposes. Counsel to the partnership is of the opinion that, at the time of its formation, each of the partnerships will be treated as a partnership for federal income tax purposes. The opinion is based on the provisions of the limited partnership agreement and applicable state law and representations made by us. The opinion of counsel is not binding on the Service and is based on existing law, which is to a great extent the result of administrative and judicial interpretation. In addition, we can give no assurance that a partnership will not lose partnership status as a result of changes in the manner in which it is operated or other facts upon which the opinion of counsel is based. Under the Code, a partnership is not a taxable entity and, accordingly, incurs no federal income tax liability. Rather, a partnership is a "pass-through" entity which is required to file an information return with the Service. In general, the character of a partner's share of each item of income, gain, loss, deduction, and credit is determined at the partnership level. Each partner is allocated a distributive share of those items in accordance with the partnership agreement and is required to take those items into account in determining the partner's income. Each partner includes those amounts in income for any taxable year of the partnership ending within or with the taxable year of the partner, without regard to whether the partner has received or will receive any cash distributions from the Partnership. Intangible Drilling and Development Costs Deductions Provided drilling is completed in a timely manner, investors will have the option of deducting their proportionate share of intangible drilling and development costs, which we refer to as "IDC" in 2001 for partnerships designated "PDC 2001- Limited Partnership," in 2002 for partnerships designated "PDC 2002- Limited Partnership," and in 2003 for partnerships designated "PDC 2003- Limited Partnership" or capitalizing it and deducting it over a 60-month period beginning in the month the expenditure is made. We anticipate that 87% of subscriptions will be utilized for IDC, which, as explained below, may be deductible in the year of investment against any form of income by additional general partners or against passive income by limited partners. If so, a one unit individual investor in the maximum marginal federal income tax bracket of 35% would reduce his federal income taxes payable by $6,090. However, these IDC deductions may be subject to recapture, which could have the effect of requiring a partner to recognize additional ordinary income in later years. Congress granted to the Treasury Secretary the authority to prescribe regulations that would allow taxpayers the option of deducting, rather than capitalizing, intangible drilling and development costs. The Secretary's rules state that, in general, the option to deduct IDC applies only to expenditures for drilling and development items that do not have a salvage value. The prospectus provides that approximately 87% of the investor partners' capital contributions (i.e, subscriptions net of dealer manager commissions, discounts, due diligence expenses, and wholesaling costs and the management fee) will be utilized for IDC, which may be deductible in the year of investment. As a result, we anticipate that additional general partners will realize a deduction of approximately 87% of their investment against any form of income in the year in which the investment is made, provided wells are spudded within the first 90 days of the following year. The deduction by limited partners will be restricted to passive income. Based on an 87% deduction, a one unit ($20,000) individual investor in the maximum marginal federal income tax bracket of 35% would reduce federal income taxes payable by $6,090. (Prior to the passage of the 2003 Tax Act, the maximum federal income tax bracket in effect for individuals for 2003 was 38.6%. At this rate, a one unit investor, under the same assumptions, would have reduced federal income taxes by $6,716.) The investor could also realize additional tax savings on state income taxes in many states, and self-employed investors could realize additional tax savings on self-employment taxes. A. Classification of Costs In general, IDC consists of those costs which in and of themselves have no salvage value. In previous partnerships sponsored by us from 1984 through 2002 (see "Prior Activities - Tax Deductions and Tax Credits of Participants in Previous Partnerships," above), intangible drilling costs have ranged from approximately 64.6% to 89.9% of the investor's contributions. While the planned activities of the partnership are similar in nature to those of prior partnerships, the amount of expenditures classified as IDC could be greater than or less than prior partnerships. In addition, a partnership's classification of a cost as IDC is not binding on the government, which might reclassify an item labeled as IDC as a cost which must be capitalized. To the extent not deductible, those amounts will be included in the partnership's basis in mineral property. B. Timing of Deductions Although the partnership will elect to deduct IDC, each investor has an option of deducting IDC, or capitalizing all or a part of the IDC and amortizing it on a straight-line basis over a sixty-month period, beginning with the taxable month in which the expenditure is made. In addition to the effect of this change on regular taxable income, the two methods have different treatment under the alternative minimum tax, which we refer to as "AMT" (see "Alternative Minimum Tax" below). In order for the IDC to qualify for deduction in 2001, 2002 and 2003, respectively, the wells for partnerships designated "PDC 2001- Limited Partnership," "PDC 2002- Limited Partnership," and "PDC 2003- Limited Partnership," respectively, must be spudded by March 30, 2002, 2003, and 2004, respectively. Other requirements must also be met. Although PDC will attempt to satisfy each requirement of the Service and judicial authority for deductibility of IDC in 2001, 2002, and 2003, respectively, for partnerships designated "PDC 2001- Limited Partnership," "PDC 2002- Limited Partnership," and "PDC 2003- Limited Partnership," respectively, we can give no assurance that the Service will not successfully contend that the IDC of a well which is not completed until 2001, 2002, or 2003, respectively, for partnerships designated "PDC 2001- Limited Partnership," "PDC 2002- Limited Partnership," or "PDC 2003- Limited Partnership," respectively, are not deductible in whole or in part until 2002, 2003, or 2004, respectively, for partnerships designated "PDC 2001- Limited Partnership," "PDC 2002- Limited Partnership," or "PDC 2003- Limited Partnership," respectively. Further, to the extent drilling of the partnership's wells does not commence by March 30, 2002, 2003, or 2004, respectively, for partnerships designated "PDC 2001- Limited Partnership," "PDC 2002- Limited Partnership," or "PDC 2003- Limited Partnership," respectively, the deductibility of all or a portion of the IDC may be deferred. Notwithstanding the foregoing, we can give no assurance that the Service will not challenge the current deduction of IDC because of the prepayment being made to a related party. If the Service were successful with a challenge, the partners' deductions for IDC would be deferred to later years. C. Recapture of IDC IDC previously deducted that is allocable to the property, directly or through the ownership of an interest in a partnership, and which would have been included in the adjusted basis of the property may be subject to recapture, which could have the effect of requiring an investor to recognize additional ordinary income in later years . Treasury regulations provide that recapture is determined at the partner level (subject to anti-abuse provisions). Where only a portion of recapture property is disposed of, any IDC related to the entire property is recaptured to the extent of the gain realized on the portion of the property sold. In the case of the disposition of an undivided interest in a property (as opposed to the disposition of a portion of the property), a proportionate part of the IDC with respect to the property is treated as allocable to the transferred undivided interest to the extent of any realized gain. See also "Gain or Loss on Sale of Property or Units." Depletion Deductions Investors generally will be entitled to claim cost depletion with respect to oil and gas properties which qualify for depletion, and investors who are entitled to percentage depletion may choose to claim the greater of cost depletion or percentage depletion. Investors who are independent producers (as described below) will be entitled to claim a percentage depletion deduction against their oil and gas income. The percentage depletion rate for oil and gas properties is generally 15% of the gross income generated by the property. The owner of an economic interest in an oil and gas property is generally entitled to claim the greater of percentage depletion or cost depletion with respect to oil and gas properties which qualify for the depletion methods. Percentage depletion is generally available only with respect to the domestic oil and gas production of "independent producers." In order to qualify as an independent producer, the taxpayer, either directly or through related parties, may not be involved in the refining of more than 50,000 barrels of oil (or equivalent of gas) on any day during the taxable year or in the retail marketing of oil and gas products exceeding $5 million per year in the aggregate. In the case of partnerships, the depletion allowance must be computed separately by each partner and not by the partnership. For properties placed in service after 1986, depletion deductions, to the extent they reduce basis in an oil and gas property, are subject to recapture under section 1254. Cost depletion for any year is determined by multiplying the number of units (e.g., barrels of oil or Mcf of gas) sold during the year by a fraction, the numerator of which is the cost or other basis of the mineral interest and the denominator of which is total reserves available at the beginning of the period. In no event can the cost depletion exceed the adjusted basis of the property to which it relates. Percentage depletion is a statutory allowance under which a deduction equal to a percentage of the taxpayer's gross income from each property is allowed in any taxable year. The allowable deduction generally is limited to 100% of the net income on a property-by-property basis, and further limited to 65% of a taxpayer's taxable income. In the case of "stripper well property," as that term is defined in Code Section 613A(c)(6)(D), the 100% of taxable income limitation has been eliminated for taxable years 1998 to 2003. Code Section 613A(c)(6)(H). It is anticipated that some of the properties of the partnerships will likely constitute "stripper well properties" for this purpose. Stripper wells are wells which are regarded by industry standards as being low producing wells. Generally, the term is applied to any well which produces less than 15 barrels of oil or 90 mcf per day of gas. The percentage depletion rate for oil and gas properties is generally 15% of the gross income generated by the property. However, for production from certain marginal properties, the percentage depletion rate may be increased up to 25%, depending upon the reference price for crude oil. Although the depletion rate for 2003 for such marginal properties has not yet been published, it is anticipated to be 15%. After 2003, such rate may change but will be within the range of 15% to 25%. A percentage depletion deduction that is disallowed in a year due to the 65% of taxable income limitation may be carried forward and allowed as a deduction for the following year, subject to the 65% limitation in that subsequent year. Percentage depletion deductions reduce the taxpayer's adjusted basis in the property. However, unlike cost depletion, deductions under percentage depletion are not limited to the adjusted basis of the property; the percentage depletion amount continues to be allowable as a deduction after the adjusted basis has been reduced to zero. The availability of depletion, whether cost or percentage, will be determined separately by each partner. Each partner must separately keep records of his share of the adjusted basis in an oil or gas property, adjust the share of the adjusted basis for any depletion taken on the property, and use the adjusted basis each year in the computation of his cost depletion or in the computation of his gain or loss on the disposition of the property. These requirements may place an administrative burden on a partner. These depletion deductions may be subject to recapture, which could have the effect of requiring an investor to recognize additional ordinary income in later years. See "Gain or Loss on Sale of Property or Units." Depreciation Deductions The partnership will claim depreciation, cost recovery, and amortization deductions with respect to its basis in partnership property as permitted by the Code. The cost of lease equipment and well equipment, such as casing, tubing, tanks, and pumping units, and the cost of oil or gas pipelines cannot be deducted currently but must be capitalized and recovered under the modified accelerated cost recovery system. The cost recovery deduction for most equipment used in domestic oil and gas exploration and production and for most of the tangible personal property used in natural gas gathering systems is calculated using the 200% declining balance method switching to the straight-line method, a seven-year recovery period, and a half-year convention. If an accelerated depreciation method is used, a portion of the depreciation will be a preference item for AMT purposes. For certain tangible property, the partnership will be allowed an additional depreciation deduction equal to 30% (or 50% for such property acquired and placed in service after May 5, 2003) of the adjusted basis of the property for the year in which the property is placed in service. The adjusted basis of the property is reduced by the additional depreciation deduction before computing the amount otherwise allowable as a depreciation deduction for the tax year in which the property is placed in service and all later years. In order to be entitled to this deduction, the partnership generally must purchase the property and place it in service before January 1, 2005. You will not be able to claim depreciation deductions or the additional first-year depreciation deduction because all tangible costs have been allocated to us. Interest Deductions In the transaction, the investor partners will acquire their interests by remitting cash in the amount of $20,000 per unit to the partnership. In no event will the partnership accept notes in exchange for a partnership interest. Nevertheless, without any assistance from us, some investors may choose to borrow the funds necessary to acquire a unit and may incur interest expense in connection with those loans. Based upon the purely factual nature of those loans, counsel is unable to express an opinion with respect to the deductibility of any interest paid or incurred on the loans. Transaction Fees Partnership expenditures classified as organizational expenses, and start-up expenses may be amortized over a period of not less than 60 months. No deduction is permitted for syndication expenses, including sales commissions for the purchase of Units. The partnership may classify a portion of the fees to be paid to third parties and to us or to the operator and its affiliates (as described in the prospectus under "Source of Funds and Use of Proceeds") as organizational expenses or other expenses that are required to be capitalized. There is no assurance that the Service will agree with, and counsel expresses no opinion with respect to, the allocation of the fees to deductible and nondeductible items. Generally, expenditures made in connection with the creation of, and with sales of interests in, a partnership will fit within one of several categories: organizational expenses; syndication expenses; and start-up expenditures. A partnership may elect to amortize and deduct its capitalized organizational expenses ratably over a period of not less than 60 months commencing with the month the partnership begins business. Examples of organizational expenses are legal fees for services incident to the organization of the partnership, such as negotiation and preparation of a partnership agreement, accounting fees for services incident to the organization of the partnership, and filing fees. No deduction is allowable for "syndication expenses," examples of which include brokerage fees, registration fees, legal fees of the underwriter or placement agent and the issuer (general partners or the partnership) for securities advice and for advice pertaining to the adequacy of tax disclosures in the prospectus or private placement memorandum for securities law purposes, printing costs, and other selling or promotional material. These costs must be capitalized. Payments for services performed in connection with the acquisition of capital assets must be amortized over the useful life of the assets. No deduction is allowable with respect to "start-up expenditures," although the expenditures may be capitalized and amortized over a period of not less than 60 months. The partnership intends to make payments to us, as described in greater detail in the prospectus. To be deductible, compensation paid to a general partner must be for services rendered by the partner other than in his capacity as a partner or for compensation determined without regard to partnership income. Fees which are not deductible because they fail to meet this test may be treated as special allocations of income to the recipient partner and decrease the net loss, or increase the net income among all partners. If the Service were to successfully challenge our allocations, a partner's taxable income could be increased, resulting in increased taxes and in liability for interest and penalties. Basis and At Risk Limitations Partners contributing cash from "personal funds" (i.e., funds not borrowed by the partner) will not be limited, to the extent of cash contributed, in their deductibility of partnership losses by the 'at risk' basis rules or the limitations related to a partner's basis in his partnership interest. A partner's share of partnership losses will be allowed only to the extent of the aggregate amount with respect to which the taxpayer is "at risk" for the activity at the close of the taxable year. In general, a partner is "at risk" to the extent of the amount of cash and the adjusted basis of other property contributed to the partnership. Any loss disallowed by the "at risk" limitation shall be treated as a deduction allocable to the activity in the first succeeding taxable year. The Code provides that a taxpayer must recognize taxable income to the extent that his "at risk" amount is reduced below zero. This recaptured income is limited to the sum of the loss deductions previously allowed to the taxpayer, less any amounts previously recaptured. A taxpayer may be allowed a deduction for the recaptured amounts included in his taxable income if and when he increases his amount "at risk" in a subsequent taxable year. The partners will purchase units by tendering cash to the partnership. To the extent the cash contributed constitutes the "personal funds" of the partners (i.e., funds not borrowed by the partner), the partners should be considered at risk with respect to those amounts. To the extent the cash contributed constitutes "personal funds," in the opinion of counsel, neither the at risk rules nor the adjusted basis rules will limit the deductibility of losses generated from the partnership. In no event, however, may a partner utilize his distributive share of partnership loss where the share exceeds the partner's basis in the partnership. Passive Loss Limitations A. Introduction The deductibility of losses generated from passive activities will be limited for certain taxpayers. The passive activity loss limitations apply to individuals, estates, trusts, and personal service corporations as well as, to a lesser extent, closely held C corporations. The definition of a "passive activity" generally encompasses all rental activities as well as all activities with respect to which the taxpayer does not "materially participate." Notwithstanding this general rule, however, the term "passive activity" does not include "any working interest in any oil or gas property which the taxpayer holds directly or through an entity which does not limit the liability of the taxpayer with respect to the interest." A taxpayer will be considered as materially participating in a venture only if the taxpayer is involved in the operations of the activity on a "regular, continuous, and substantial" basis. In addition, no limited partnership interest will be treated as an interest with respect to which a taxpayer materially participates. A passive activity loss is the amount by which the aggregate losses from all passive activities for the taxable year exceed the aggregate income from all passive activities for the year. Individuals and personal service corporations will be entitled to passive activity losses only to the extent of their passive income whereas closely held C corporations (other than personal service corporations) can offset passive activity losses against both passive and net active income, but not against portfolio income. In calculating passive income and loss, however, all activities of the taxpayer are aggregated. Passive activity losses disallowed as a result of the above rules will be suspended and can be carried forward indefinitely to offset future passive (or passive and active, in the case of a closely held C corporation) income. Upon the disposition of an entire interest in a passive activity in a fully taxable transaction not involving a related party, any passive loss that was suspended by the provisions of the passive activity rules generally is deductible from either passive or non-passive income. B. General Partner Interests General partner interests will not be considered as investments in passive activities for federal tax purposes. Additional general partners who convert to limited partner status after recording a tax loss from their investment in any year will continue to have income from the partnership treated as non-passive. A limited partner's interest in the partnership will be considered a passive activity and losses generated while the limited partnership interest is held will be limited by the passive activity provisions. In general, an additional general partner's interest in the partnership will not be considered a passive activity, and losses generated while the general partner interest is held will not be limited by the passive activity provisions. However, if an additional general partner interest is converted to a limited partner interest prior to the spudding date, but after the end of the taxable year in which IDC was incurred, IDC will be subject to the passive activity rules. In addition, that portion of partnership income for the prior taxable year attributable to IDC treated as passive loss will be considered passive. The "spudding date" is the date that drilling commences. If an additional general partner converts his interest to a limited partner interest under the terms of the limited partnership agreement, the character of a subsequently generated tax attribute will be dependent upon, among other things, the nature of the tax attribute and whether there arose, prior to conversion, losses to which the working interest exception applied. If a taxpayer has any loss from any taxable year from a working interest in any oil or gas property that is treated as a non-passive loss, then any net income from the property for any succeeding taxable year is to be treated as income that is not from a passive activity. Consequently, assuming that a converting additional general partner has losses from working interests which are treated as non-passive, income from the partnership allocable to the partner after conversion would be treated as income that is not from a passive activity. C. Limited Partner Interests Income and losses of limited partners will be treated as "passive" for federal tax purposes. If an investor partner invests in the partnership as a limited partner, his distributive share of the partnership's losses will be treated as passive activity losses, the availability of which will be limited to the partner's passive income. If the partner does not have sufficient passive income to utilize the passive activity loss, the disallowed passive activity loss will be suspended and may be carried forward to be deducted against passive income arising in future years. Further, upon the disposition of the interest to an unrelated party, in a fully taxable transaction the suspended losses will be available, as described above. Limited partners should generally be entitled to offset their distributive shares of passive income from the partnerships with deductions from other passive activities. Conversion of Interests The partnership, in the opinion of counsel, will not be terminated solely as a result of the conversion by additional general partners of their partnership interests into limited partnership interests. For a discussion of the conversion feature of the program, see "Terms of the Offering - Conversion of Units by Additional General Partners." As discussed above under the heading "Passive Loss Limitations," an additional general partner's interest in the partnership generally will not be subject to the passive activity loss rules. If, however, an additional general partner interest is converted to a limited partner interest prior to the spudding date, but after the end of the taxable year in which IDC was incurred, IDC would be subject to the passive activity loss rules. In addition, if an additional general partner interest is converted to a limited partner interest and such converting partner previously had been allocated losses that were treated as non-passive, any future partnership net income allocated to such partner will be treated as non-passive. Alternative Minimum Tax Due to the potentially significant impact of a purchase of units on an investor's tax liability, investors should discuss the implications of an investment in the partnership on their regular and AMT liabilities with their tax advisors prior to acquiring units. A taxpayer is subject to an alternative minimum tax ("AMT") to the extent that its "tentative minimum tax" exceeds its regular income tax liability. A corporate taxpayer's tentative minimum tax generally equals 20 percent of its alternative minimum taxable income ("AMTI") in excess of an exemption amount. The AMT rate for a noncorporate taxpayer is 26% or 28%, depending on the amount of its AMTI above an exemption amount. Alternative minimum taxable income is the taxpayer's regular taxable income increased by certain tax preferences and increased or decreased by certain tax adjustments. Certain items of income, deduction, gain and loss from the partnership will give rise to preferences or adjustments for AMT purposes. Excess percentage depletion (i.e., depletion in excess of basis) is not a preference item for AMT purposes for a taxpayer other than an integrated oil company. "Excess IDC" is generally not a preference item for AMT purposes for a taxpayer other than an integrated oil company, except to the extent that it reduces a taxpayer's AMTI by more than 40%. Excess IDC is the amount by which the taxpayer's IDC deduction exceeds the deduction that would have been allowed had IDCs been capitalized and amortized on a straight-line basis over ten years. Excess IDC is a preference, if at all, only to the extent that it exceeds 65% of the taxpayer's net income from oil and gas properties for the taxable year. For corporations other than integrated oil companies, the adjusted current earning adjustments were repealed. Gain or Loss on Sale of Property or Units Sale or exchange of property by the partnership or a unit by an investor could result in ordinary income rather than capital gain. In the case of a sale or exchange of a unit, an investor could be required to recognize ordinary income greater than the amount of the gain realized on the sale. If so, the additional ordinary income would be offset by additional capital loss, but that capital loss may not be immediately deductible. Investors who fail to report a sale or exchange of a unit in the partnership could be subject to a penalty. An investor may recognize gain either upon the sale of his or her partnership units or from the allocation of partnership gain as a result of the partnership's sale of its property. The maximum federal income tax rate on long-term capital gains for individual taxpayers is generall 15%, Prior to the passage of the 2003 Tax Act, such rate was generally 20%. Because of the recapture of IDCs and depletion, the sale may result in ordinary income to the investor, which is currently taxed at a maximum rate of 35% for individuals. If the amount of gain exceeds the amount of the deductions to be recaptured, the investor will recognize ordinary income to the extent of the recaptured deductions and capital gain for the remainder. If, upon the sale of units, the amount of deductions to be recaptured exceeds the gain realized, an investor may be required to recognize ordinary income greater than the amount of gain realized. To balance the excess income, the investor would recognize a capital loss for the difference between the gain and the income. Depending on an investor's particular tax situation, some or all of this loss might be deferred to future years, resulting in a greater tax liability in the year in which the sale was made and a reduced future tax liability. Any partner who sells or exchanges interests in a partnership must generally notify the partnership in writing within 30 days of the transaction in accordance with Regulations and must attach a statement to his tax return reflecting the facts regarding the sale or exchange. The notice must include names, addresses, and taxpayer identification numbers (if known) of the transferor and transferee and the date of the exchange. The partnership also is required to provide copies of the information it provides to the Service to the transferor and the transferee. Any investor who is required to notify the partnership of a transfer of his partnership interest, and, who fails to do so, may be fined $50 for each failure, limited to $100,000, provided there is no intentional disregard of the filing requirement. Similarly, the partnership may be fined for failure to report the transfer. The partnership's penalty is $50 for each failure, limited to $250,000, provided there is no intentional disregard of the filing requirement. The tax consequences to an assignee purchaser of a unit from a partner are not described in this prospectus. Any assignor of a unit should advise his assignee to consult his own tax advisor regarding the tax consequences of the assignment. Partnership Distributions Under the Code, any increase in a partner's share of partnership liabilities, or any increase in the partner's individual liabilities by reason of an assumption by him of partnership liabilities is considered to be a contribution of money by the partner to the partnership. Similarly, any decrease in a partner's share of partnership liabilities or any decrease in the partner's individual liabilities by reason of the partnership's assumption of the individual liabilities will be considered as a distribution of money to the partner by the partnership. The partners' adjusted bases in their units will initially consist of the cash they contribute to the partnership. Their bases will be increased by their share of partnership income and additional contributions and decreased by their share of partnership losses and distributions. To the extent that the actual or constructive distributions are in excess of a partner's adjusted basis in his partnership interest (after adjustment for contributions and his share of income and losses of the partnership), that excess will generally be treated as gain from the sale of a capital asset. In addition, gain could be recognized by a distributee partner upon the disproportionate distribution to that partner of unrealized receivables or substantially appreciated inventory. The limited partnership agreement prohibits distributions to any investor partner to the extent the distributions would create or increase a deficit in the partner's capital account. Partnership Allocations The partners' distributive shares of partnership income, gain, loss, and deduction should be determined and allocated substantially in accordance with the terms of the limited partnership agreement. The Service could contend that the allocations contained in the limited partnership agreement do not have substantial economic effect or are not in accordance with the partners' interests in the partnership and may seek to reallocate these items in a manner that will increase the income or gain or decrease the deductions allocable to a partner. Tax Shelter Rules Under federal tax law, there are various definitions of "tax shelters" and, depending upon which definition is satisfied, different obligations are required by the participants in or promoters of the tax shelter. Certain types of tax shelters must be "registered" with the Service by the organizer of the shelter. The Service assigns a tax shelter registration number to these types of shelters, and such number generally must be reported on the participants' tax returns. Another type of tax shelter (a so-called "Reportable Transaction") generally must be disclosed to the Service by the participants in the tax shelter using a Form 8886. In addition, promoters and organizers of either of these types of tax shelters generally must prepare and maintain a list of each of the participants in the tax shelter. The Service issued regulations on February 28, 2003, which define certain of these tax shelters and provide the disclosure and list maintenance requirements for these tax shelters. We believe the partnership will not be considered a tax shelter for these purposes. Accordingly, the partnership will not be required to register with the Service as a tax shelter, the partners will not be required to disclose the partnership as a tax shelter on Form 8886, and the organizers of the partnership will not be required to maintain a list of the partners as participants in a tax shelter. Profit Motive Investors who enter a business without economic, nontax profit motive may be denied the benefits of deductions associated with the business to the extent they exceed the income from the business. The existence of economic, nontax motives for entering into the transaction is essential if the partners are to obtain the tax benefits associated with an investment in the partnership. Where an activity entered into by an individual is not engaged in for profit, the individual's deductions with respect to that activity are limited to those not dependent upon the nature of the activity (e.g., interest and taxes); any remaining deductions will be limited to gross income from the activity for the year. Should it be determined that a partner's activities with respect to the transaction are "not for profit," the Service could disallow all or a portion of the deductions generated by the partnership's activities. The Code generally provides for a presumption that an activity is entered into for profit where gross income from the activity exceeds the deductions attributable to the activity for three or more of the five consecutive taxable years ending with the taxable year in question. At the taxpayer's election, the presumption can relate to three or more of the taxable years in the 5-year period beginning with the taxable year in which the taxpayer first engages in the activity. Due to the inherently factual nature of a partner's intent and motive in engaging in the transaction, counsel does not express an opinion as to the ultimate resolution of this issue in the event of a challenge by the Service. Partners must, however, seek to make a profit from their activities with respect to the transaction beyond any tax benefits derived from those activities or risk losing those tax benefits. Administrative Matters Returns and Audits. While no federal income tax is required to be paid by an organization classified as a partnership for federal income tax purposes, a partnership must file federal income tax information returns, which are subject to audit by the Service. Any audit may lead to adjustments, in which event you may be required to file amended personal federal income tax returns. Any audit may also lead to an audit of your individual tax return and adjustments to items unrelated to an investment in units. For purposes of reporting, audit, and assessment of additional federal income tax, the tax treatment of "partnership items" is determined at the partnership level. Partnership items will include those items that the Regulations provide are more appropriately determined at the partnership level than the partner level. The Service generally cannot initiate deficiency proceedings against an individual partner with respect to partnership items without first conducting an administrative proceeding at the partnership level as to the correctness of the partnership's treatment of the item. An individual partner may not file suit for a credit or a refund arising out of a partnership item without first filing a request for an administrative proceeding by the Service at the partnership level. Individual partners are entitled to notice of the administrative proceedings and decisions, except in the case of partners with less than 1% profits interest in a partnership having more than 100 partners. If a group of partners having an aggregate profits interest of 5% or more in a partnership so requests, however, the Service also must mail notice to a partner appointed by that group to receive notice. All partners, whether or not entitled to notice, are entitled to participate in the administrative proceedings at the partnership level, although the limited partnership agreement provides for waiver of some of these rights by the investor partners. All investor partners, including those not entitled to notice, may be bound by a settlement reached by the partnership's representative "tax matters partner," which will be Petroleum Development Corporation. If a proposed tax deficiency is contested in any court by any partner of a partnership or by us, all partners of that partnership may be deemed parties to the litigation and bound by the result reached. Consistency Requirements. You must generally treat partnership items on your federal income tax returns consistently with the treatment of the items on the partnership information return unless you file a statement with the Service identifying the inconsistency or otherwise satisfy the requirements for waiver of the consistency requirement. Failure to satisfy this requirement will result in an adjustment to conform your treatment of the item with the treatment of the item on the partnership return. Intentional or negligent disregard of the consistency requirement may subject you to substantial penalties. Compliance Provisions. Taxpayers are subject to several penalties and other provisions that encourage compliance with the federal income tax laws, including an accuracy-related penalty in an amount equal to 20% of the portion of an underpayment of tax caused by negligence, intentional disregard of rules or regulations or any "substantial understatement" of income tax. A "substantial understatement" of tax is an understatement of income tax that exceeds the greater of (a) 10% of the tax required to be shown on the return (the correct tax), or (b) $5,000 ($10,000 in the case of a corporation other than an S corporation or personal holding corporation). Except in the case of understatements attributable to "tax shelter" items, an item of understatement may not give rise to the penalty if (a) there is or was "substantial authority" for the taxpayer's treatment of the item or (b) all facts relevant to the tax treatment of the item are disclosed on the return or on a statement attached to the return, and there is a reasonable basis for the tax treatment of the item by the taxpayer. In the case of partnerships, the disclosure is to be made on the return of the partnership. Under the applicable Regulations, however, an individual partner may make adequate disclosure with respect to partnership items if conditions are met. In the case of understatements attributable to "tax shelter" items, the substantial understatement penalty may be avoided only if the taxpayer establishes that, in addition to having substantial authority for his position, he reasonably believed the treatment claimed was more likely than not the proper treatment of the item. A "tax shelter" item, for these purposes, is one that arises from a partnership (or other form of investment) the principal purpose of which is the avoidance or evasion of federal income tax. The definition of "tax shelter" for these purposes is different from the definitions for registration, disclosure and list maintenance purposes discussed above under "Tax Shelter Rules." A corporation is generally held to a higher standard to avoid the substantial understatement penalty attributable to tax shelter items. However, we do not believe the partnership will be considered a "tax shelter" for these purposes. Accounting Methods and Periods The partnership will use the accrual method of accounting and intends to select the calendar year as its taxable year. Social Security Benefits; Self-employment Tax A general partner's share of any income or loss attributable to units will constitute "net earnings from self-employment" for both social security and self-employment tax purposes, while a limited partner's share of these items will not constitute "net earnings from self-employment." State and Local Taxes The opinions expressed in this prospectus are limited to issues of federal income tax law and do not address issues of state or local law. We urge you to consult your tax advisors regarding the impact of state and local laws on your investment in the partnership. Individual Tax Advice Should Be Sought We have presented only a summary of the material tax considerations that may affect your decision regarding the purchase of units. The tax considerations attendant to an investment in a partnership are complex, vary with individual circumstances, and depend in some instances upon whether the investor acquires general partner interests or limited partner interests. You should review the tax consequences with your tax advisor. SUMMARY OF LIMITED PARTNERSHIP AGREEMENT The limited partnership agreement in the form attached to this prospectus as Appendix A will govern your rights and obligations. You, together with your personal advisers, should carefully study the limited partnership agreement in its entirety before submitting a subscription. The following statements concerning the limited partnership agreement are merely a summary of all the material terms of the limited partnership agreement, but do not purport to be complete and in no way amend or modify the limited partnership agreement. Responsibility of Managing General Partner The Managing General Partner shall have the exclusive management and control of all aspects of the business of the partnership. Sections 5.01 and 6.01 of the limited partnership agreement. No investor partner shall have any voice in the day-to-day business operations of the partnership. Section 7.01. The Managing General Partner is authorized to delegate and subcontract its duties under the limited partnership agreement to others, including entities related to it. Section 5.02. Liability of General Partners, Including Additional General Partners General partners, including additional general partners, will have unlimited liability for partnership activities. The additional general partners will be jointly and severally liable for all obligations and liabilities to creditors and claimants, whether arising out of contract or tort, in the conduct of partnership operations. Section 7.12. We, as operator, maintain general liability insurance. In addition, we have agreed to indemnify each of the additional general partners for obligations related to casualty and business losses which exceed available insurance coverage and partnership assets. Section 7.02. The additional general partners, by execution of the limited partnership agreement, grant to the Managing General Partner the exclusive authority to manage the partnership business in its sole discretion and to bind the partnership and all partners in its conduct of the partnership business. The additional general partners may not participate in the management of the partnership business; and the limited partnership agreement prohibits the additional general partners from acting in a manner harmful to the assets or the business of the partnership or to do any other act which would make it impossible to carry on the ordinary business of the partnership. If an additional general partner acts contrary to the terms of the limited partnership agreement, losses caused by his or her actions will be borne by that additional general partner alone and that additional general partner may be liable to other partners for all damages resulting from his or her breach of the limited partnership agreement. Section 7.01. Additional general partners who choose to assign their units in the future may do so only as provided in the limited partnership agreement. Liability of partners who have assigned their units may continue after the assignment unless a formal assumption and release of liability is effected. Section 7.03. Liability of Limited Partners The West Virginia Uniform Limited Partnership Act will govern the partnerships, under which law a limited partner's liability for the obligations of the partnership is limited to his or her capital contribution, his or her share of partnership assets and the return of any part of his or her capital contribution for a period of one year after the return (or six years in the event the return is in violation of the limited partnership agreement). A limited partner will not otherwise be liable for the obligations of the partnership unless, in addition to the exercise of his or her rights and powers as a limited partner, the person takes part in the control of the business of the partnership. Section 7.01. Allocations and Distributions General: Profits and losses are to be allocated and cash is to be distributed in the manner described in the section entitled "Participation in Costs and Revenues." See Article III of the limited partnership agreement. Time of Distributions: The Managing General Partner will determine and distribute not less frequently than quarterly cash available for distribution. Section 4.01. The Managing General Partner may, at its discretion, make distributions more frequently. Notwithstanding any other provision of the limited partnership agreement to the contrary, no partner will receive any distribution to the extent the distribution will create or increase a deficit in that partner's capital account (as increased by his or her share of partnership minimum gain). Section 4.03. Liquidating Distributions: Liquidating distributions will be made in the same manner as regular distributions; however, in the event of dissolution of the partnership, distributions will be made only after due provision has been made for, among other things, payment of all partnership debts and liabilities. Section 9.03. Voting Rights Investor partners owning 10% or more of the then outstanding units entitled to vote have the right to require the Managing General Partner to call a meeting of the partners. Section 7.07. Investor partners may vote with respect to partnership matters. A majority in interest of the then outstanding units entitled to vote constitutes a quorum. Each unit is entitled to one vote on all matters; each fractional unit is entitled to that fraction of one vote equal to the fractional interest in the unit. Except as otherwise provided in the limited partnership agreement, at any meeting of investor partners, approval of any matters considered at the meeting requires the affirmative vote of a majority of units represented, in person or by proxy, at the meeting at which a quorum is present. Approval of any of the following matters requires the affirmative vote of a majority of the then outstanding units entitled to vote, without the concurrence of the Managing General Partner: The sale of all or substantially all of the assets of the partnership; Removal of the Managing General Partner and election of a new managing general partner; Dissolution of the partnership; Any non-ministerial amendment to the limited partnership agreement; Cancellation of contracts for services with the Managing General Partner or affiliates; and The appointment of a liquidating trustee in the event the partnership is to be dissolved by reason of the retirement, dissolution, liquidation, bankruptcy, death, or adjudication of insanity or incapacity of the last remaining general partner. Additionally, the partnership is not permitted to participate in a roll-up transaction unless the roll-up has been approved by at least 66 2/3% in interest of investor partners. Sections 5.07(m) and 7.08. The Managing General Partner if it were removed by the investor partners may elect to retain its interest in the partnership as a limited partner in the successor limited partnership (assuming that the investor partners determined to continue the partnership and elected a successor managing general partner), in which case the former Managing General Partner would be entitled to vote its interest as a limited partner. Section 7.06. Investor partners may review the partnership's books and records and list of investor partners at any reasonable time and may copy the list of investor partners at their expense. Investor partners may submit proposals to the Managing General Partner for inclusion in the voting materials for the next meeting of investor partners for consideration by the investor partners. With respect to the merger or consolidation of the partnership or the sale of all or substantially all of the partnership's assets, investor partners may exercise dissenter's rights for fair appraisal of their units in accordance with Section 31-1-123 of the West Virginia Corporation Act. Sections 7.07, 7.08, and 8.01. Retirement and Removal of the Managing General Partner In the event that the Managing General Partner desires to withdraw from the partnership for whatever reason, it may do so only upon one hundred twenty (120) days prior written notice and with the written consent of the investor partners owning a majority of the then outstanding units. Section 6.03. In the event that the investor partners desire to remove the Managing General Partner, they may do so at any time with the consent of the investor partners owning a majority of the then outstanding units, and upon the selection of a successor managing general partner by the investor partners owning a majority of the then outstanding units. Section 7.06. Term and Dissolution The partnership will continue for a maximum period ending December 31, 2051 unless earlier dissolved upon the occurrence of any of the following: the written consent of the investor partners owning a majority of the then outstanding units; the retirement, bankruptcy, adjudication of insanity or incapacity, withdrawal, removal, or death (or, in the case of a corporate managing general partner, the retirement, withdrawal, removal, dissolution, liquidation, or bankruptcy) of a managing general partner, unless a successor managing general partner is selected by the partners under the limited partnership agreement or the remaining managing general partner, if any, continues the partnership's business; the sale, forfeiture, or abandonment of all or substantially all of the partnership's property; or the occurrence of any event causing dissolution of the partnership under the laws of the State of West Virginia. Section 9.01. Indemnification The Managing General Partner has agreed to indemnify each of the additional general partners for obligations related to casualty losses which exceed available insurance coverage and partnership assets. Section 7.02. If obligations incurred by the partnership are the result of the negligence or misconduct of an additional general partner, or the violation of the terms of the limited partnership agreement by the additional general partner, then the foregoing indemnification by the Managing General Partner will be unenforceable as to that additional general partner and that additional general partner will be liable to all other partners for damages and obligations resulting from their negligence or misconduct. Section 7.02. The Managing General Partner will be entitled to reimbursement and indemnification for all expenditures made (including amounts paid in settlement of claims) or losses or judgments suffered by it in the ordinary and proper course of the partnership's business, provided that the Managing General Partner has determined in good faith that the course of conduct which caused the loss or liability was in the best interests of the partnership, that the Managing General Partner was acting on behalf of or performing services for the partnership, and that the expenditures, losses or judgments were not the result of the negligence or misconduct on the part of the Managing General Partner. Section 6.04. The Managing General Partner will have no liability to the partnership or to any partner for any loss suffered by the partnership which arises out of any action or inaction of the Managing General Partner if the Managing General Partner, in good faith, determined that the course of conduct was in the best interest of the Partnership and the course of conduct did not constitute negligence or misconduct of the Managing General Partner. The Managing General Partner will be indemnified by the partnership to the limit of the insurance proceeds and tangible net assets of the partnership against any losses, judgments, liabilities, expenses and amounts paid in settlement of any claims sustained by it in connection with the partnership, provided that the same were not the result of negligence or misconduct on the part of the Managing General Partner. Notwithstanding the above, the Managing General Partner will not be indemnified for liabilities arising under federal and state securities laws unless there has been a successful adjudication on the merits of each count involving securities law violations; or the claims have been dismissed with prejudice on their merits by a court of competent jurisdiction; or a court of competent jurisdiction approves a settlement of the claims against a particular indemnitee and finds that indemnification of the settlement and the related costs should be made, and the court considering the request for indemnification has been advised of the position of the Securities and Exchange Commission and of the position of any state securities regulatory authority in which securities of the partnership were offered or sold as to indemnification for violations of securities laws; provided, however, the court need only be advised of the positions of the securities regulatory authorities of those states (a) which are specifically set forth in the prospectus and (b) in which plaintiffs claim they were offered or sold partnership units. In any claim for indemnification for federal or state securities laws violations, the party seeking indemnification must place before the court the position of the Securities and Exchange Commission, the Massachusetts Securities Division, and the Tennessee Securities Division or other respective state securities division with respect to the issue of indemnification for securities laws violations. The partnership will not incur the cost of the portion of any insurance which insures any party against any liability as to which the party is prohibited from being indemnified. Section 6.04. Reports to Partners The Managing General Partner will furnish to the investor partners of each partnership semi-annual and annual reports which will contain financial statements (including a balance sheet and statements of income, partners' equity and cash flows), which statements at fiscal year end will be audited by an independent accounting firm and will include a reconciliation of the statements with information provided to the investor partners for federal income tax purposes. Financial statements furnished in a partnership's semi-annual reports will not be audited. Semi-annually, all investor partners will also receive a summary itemization of the transactions between the Managing General Partner or any affiliate and the partnership showing all items of compensation received by the Managing General Partner and its affiliates. Annually beginning with the fiscal year ended December 31, 2001 with respect to partnerships designated "PDC 2001- Limited Partnership," December 31, 2002 with respect to partnerships designated "PDC 2002- Limited Partnership," and December 31, 2003, with respect to partnerships designated "PDC 2003- Limited Partnership," oil and gas reserve estimates prepared by an independent petroleum engineer will also be furnished to the investor partners. Annual reports will be provided to the investor partners within 120 days after the close of each partnership fiscal year, and semi-annual reports will be provided within 75 days after the close of the first six months of each partnership fiscal year. In addition, the investor partners will receive on a monthly basis while the partnership is participating in the drilling and completion activities of a program, reports containing a description of the partnership's acquisition of interests in prospects, including farmins and farmouts, and the drilling, completion and abandonment of wells thereon. All investor partners will receive a report containing information necessary for the preparation of their federal income tax returns and any required state income tax returns by March 15 of each calendar year. Investor partners will also receive in the monthly reports a summary of the status of wells drilled by the partnership, the amount of oil or gas from each well and the drilling schedule for proposed wells, if known. The Managing General Partner may provide other reports and financial statements as it deems necessary or desirable. Section 8.02. Power of Attorney Each partner will grant to the Managing General Partner a power of attorney to execute documents deemed by the Managing General Partner to be necessary or convenient to the partnership's business or required in connection with the qualification and continuance of the partnership. Section 10.01. Other Provisions Other provisions of the limited partnership agreement are summarized in this prospectus under the headings "Terms of the Offering," "Source of Funds and Use of Proceeds," "Participation in Costs and Revenues," "Management," "Fiduciary Responsibility of the Managing General Partner," and "Transferability of Units." We direct the attention of prospective investors to these sections. TRANSFERABILITY OF UNITS Your sale of units is limited; no public market exists or will develop for the units; you may not be able to sell your units at the price or when you want. Purchasers of units from you must satisfy the suitability requirements of this offering and as imposed by law. No public market exists or will develop for the units. You should consider an investment in the partnerships an illiquid investment. You may not be able to sell your units when and if you want to do so and at the price you believe to be fair. In addition, as a basis of counsel's opinion that the partnerships will not be treated as "publicly traded partnerships," we have represented that the units will not be traded on an established securities market or the substantial equivalent thereof. While units of the partnership are transferable, assignability of the units is limited, requiring among other things our consent. Section 7.03. Transfers of fractional units are prohibited, unless you own a fractional unit, in which case your entire fractional interest must be transferred. You may assign units only to a person otherwise qualified to become an investor partner, including the satisfaction of any relevant suitability requirements, as imposed by law or the partnership. In no event may you make an assignment which, in the opinion of counsel to the partnership, would result in the partnership being considered to have been terminated for purposes of Section 708 of the Code, unless we consent to an assignment, or which, in the opinion of counsel to the partnership, would result in the partnership being treated as a publicly traded partnership, or which, in the opinion of counsel to the partnership, may not be effected without registration under the Securities Act of 1933, or would result in the violation of any applicable state securities laws. A substituted additional general partner will have the same rights and responsibilities, including unlimited liability, in the partnership as every other additional general partner. Upon receipt of notice of a purported transfer or assignment of a unit of general partnership interest, we, after having determined that the purported transferee satisfies the suitability standards of an additional general partner and other conditions established by the program, will promptly notify the purported transferee of the partnership's consent to the transfer and will include with the notice a copy of the limited partnership agreement, together with a signature page. In the notification, we will advise the transferee that he or she will have the same rights and responsibilities, including unlimited liability, as every other additional general partner and that he or she will not become a partner of record until he or she returns the executed signature page to the partnership. A partnership need not recognize any assignment until the instrument of assignment has been delivered to us. The assignee of the interests has rights of ownership but may become a substituted investor partner and thus be entitled to all of the rights of an additional general partner or limited partner only upon meeting conditions, including paying all costs and expenses incurred in connection with the substitution, making representations to us, and executing appropriate documents to evidence its agreement to be bound by all of the terms and provisions of the applicable limited partnership agreement. Conversion of Units by the Managing General Partner and by Additional General Partners. Upon completion of drilling of a particular partnership, we will convert all units of general partnership interest of that partnership into units of limited partnership interest of that partnership. See "Terms of the Offering - Conversion of Units by the Managing General Partner and by Additional General Partners" for a discussion of how the conversion feature of the program works. Unit Repurchase Program. Beginning with the third anniversary of the date of the first cash distribution of the partnership, you may tender your units to us for repurchase, subject to conditions. See "Terms of the Offering - Unit Repurchase Program" for a discussion of how the unit repurchase program works. PLAN OF DISTRIBUTION An affiliate of the Managing General Partner is dealer manager of the offering. Sales will be made on a "minimum-maximum best efforts" basis through NASD-licensed broker-dealers. Broker-dealers will receive an amount equal to 10-1/2% of the subscription proceeds as sales commissions, expenses, and wholesaling fees. Purchase of units by the Managing General Partner and/or affiliates may allow the offering to satisfy the minimum sales requirements and allow the offering to close and a partnership to be funded. We will not sell units to tax-exempt investors or to foreign investors. We are offering for sale units of preformation limited and general partnership interest through PDC Securities Incorporated, the dealer manager, our affiliate, as principal distributor, and through NASD-licensed broker-dealers on a "minimum-maximum best efforts" basis for each partnership, to a select group of investors who meet the suitability standards set forth under "Terms of the Offering - Investor Suitability." We will not sell units to tax-exempt investors (including IRAs and other tax-exempt plans) or to foreign investors. "Minimum-maximum best efforts" means (1) that the various broker-dealers which will sell the units (a) will not be obligated to sell or to purchase any amount of units but (b) will be obligated to make a reasonable and diligent effort (that is, their "best efforts") to sell as many units as possible and (2) that the offering will not close unless the minimum number of units (87-1/2 units aggregating $1.75 million with respect to PDC 2003-C Limited Partnership and 175 units aggregating $3.5 million with respect to PDC 2003-D Limited Partnership) is sold within the offering period. The term "maximum" refers to the maximum proceeds of $17.5 million with respect to PDC 2003-C Limited Partnership and $35 million with respect to PDC 2003-D Limited Partnership) that can be raised with respect to any partnership. The dealer manager, an NASD member, will receive a sales commission equal to 8% of the investor partners' subscriptions; reimbursement of due diligence expenses, marketing support fees, and other compensation equal to 2% of the investor partners' subscriptions; and wholesaling fees equal to -1/2% of the investor partners' subscriptions, for an aggregate of $1,575,000 for the sale of the maximum number of 750 units ($157,500 for the sale of the minimum number of 75 units for a partnership). The dealer manager may reallow these commissions, expenses and fees, in whole or in part, to NASD-licensed broker-dealers for sale of the units. The dealer manager will not reallow the wholesaling fees. In no event will the total compensation paid to NASD members exceed 10-1/2% of subscriptions (comprised of 8% in sales commissions, -1/2% in wholesaling fees, 1-1/2% in marketing support fees and other compensation and -1/2% of subscriptions for reimbursement of bona fide due diligence expenses). Any commissions and other remuneration will be paid in cash solely on the amount of initial subscriptions and only as permitted under federal and state securities laws and applicable rules and regulations. As provided in the soliciting dealers agreements between PDC Securities Incorporated and the various soliciting dealers, we, prior to the time that we have received the minimum required subscriptions in cleared funds from subscribers that are suitable to be investor partners in the partnership in which units are then being offered, may advance to the various NASD-licensed broker-dealers from our own funds the sales commissions and due diligence expenses which would otherwise be payable in connection with the subscriptions prior to the close and funding of the partnership. If the sale of the minimum number of units has not occurred as of the time as the particular offering terminates or we determine not to organize and fund the partnership for any reason, those broker-dealers which have received commissions and due diligence expenses in advance from us with respect to the sale of units in that partnership are required by the soliciting-dealers agreements to return the commissions and due diligence expenses to us promptly. No sales commissions will be paid on sales of units to officers, directors, employees, or registered representatives of a soliciting dealer if the soliciting dealer, in its discretion, has elected to waive the sales commissions. Any units so purchased will be held for investment and not for resale. We, the dealer manager, and soliciting dealers have agreed to indemnify one another against civil liabilities, including liability under the Securities Act of 1933. In the opinion of the Securities and Exchange Commission, indemnification for liabilities under the Securities Act is against public policy as expressed in the Securities Act and is therefore unenforceable. Members of the selling group may be deemed to be "underwriters" as defined under the Securities Act, and their commissions and other payments may be deemed to be underwriting compensation. The dealer manager may offer the units and receive commissions in connection with the sale of units only in those states in which it is lawfully qualified to do so. We and our affiliates may elect to purchase units in the offering on the same terms and conditions as other investors, net of commissions. The purchase of units by us and/or our affiliates may have the effect of allowing the offering to be subscribed to the minimum, resulting in satisfaction of an express condition of the offering, and thus allow the offering to close. We and/or our affiliates will not purchase more than 10% of the units subscribed by the investor partners in any partnership. Additionally, not more than $50,000 of units purchased by us and affiliates are permitted to be applied to satisfying the minimum requirement. Any units purchased by us and/or our affiliates will be held for investment and not for resale. SALES LITERATURE In connection with the offering, the NASD-registered broker-dealers may utilize various sales literature which discusses aspects of the program, namely, a program highlight information piece which will constitute the prospectus summary ("Program Summary" in bullet format), an introduction to the program ("Flip Chart/Slide Presentation"), and prospect letters ("Broker-Dealer Guide"). The program may also utilize a program general summary piece ("Program Summary" in text format), a sheet presenting information regarding comparative investment deductions ("Investment Deductions"), and a Web site at www.pdcgas.com. Our sales material will not contain any material information which is not also set forth in the prospectus. The offering of units will be made only by means of this prospectus. LEGAL OPINIONS The validity of the units offered by this prospectus and federal income tax matters discussed under "Tax Considerations" and in the tax opinion set forth in Appendix D to the prospectus have been passed upon by Duane Morris LLP, 1667 K Street, N.W., Washington, D.C. 20006. EXPERTS The Partnership reserve and future net revenues information presented under "Prior Activities - Partnership Proved Reserves and Future Net Revenues" has been prepared by Wright & Company, Inc., Brentwood, Tennessee, independent petroleum consultants. The consolidated balance sheets of Petroleum Development Corporation and subsidiaries as of December 31, 2002 and 2001, included in this prospectus and in the registration statement have been included in this prospectus and in the registration statement in reliance upon the reports of KPMG LLP, independent auditors, appearing elsewhere in the registration statement, and upon the authority of said firm as experts in accounting and auditing. ADDITIONAL INFORMATION A registration statement on Form S-1 (Reg. No. 333-47622 and Reg. No. 333-105983) with respect to the units offered by this prospectus has been filed on behalf of the partnerships with the Securities and Exchange Commission, Washington, D.C. 20549, under the Securities Act of 1933. This prospectus does not contain all of the information set forth in the registration statement, portions of which have been omitted under the rules and regulations of the Securities and Exchange Commission. Reference is made to the registration statement, including exhibits, for further information. You may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This registration statement, as well as all exhibits and amendments, have been filed and will be filed electronically with the Commission through the Electronic Data Gathering, Analysis, and Retrieval ("EDGAR") system. The registration statement and all exhibits and amendments thereto are publicly available through the Commission's Web site (http://www.sec.gov). We hereby make reference to the copy of documents filed as exhibits to the Registration Statement for full statements of the provisions of those documents, and we qualify each statement in this prospectus in all respects by this reference. You may obtain copies of any materials filed as a part of the registration statement from the Securities and Exchange Commission by payment of the requisite fees for materials or you may examine these documents in the offices of the Commission without charge. The delivery of this prospectus at any time does not imply that the information contained in this prospectus is correct as of any time subsequent to the date of this prospectus. GLOSSARY OF TERMS The following terms used in this prospectus shall unless the context otherwise requires have the following respective meanings: Act: The West Virginia Uniform Limited Partnership Act. Additional General Partners: Those investor partners who purchase units as additional general partners, and their transferees and assigns. Administrative Costs: All customary and routine expenses incurred by the Managing General Partner for the conduct of program administration, including legal, finance, accounting, secretarial, travel, office rent, telephone, data processing and other items of a similar nature. Affiliate: An affiliate of a specified person means (a) any person directly or indirectly owning, controlling, or holding with power to vote 10 percent or more of the outstanding voting securities of the specified person; (b) any person 10 percent or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote, by the specified person; (c) any person directly or indirectly controlling, controlled by, or under common control with the specified person; (d) any officer, director, trustee or partner of the specified person; and (e) if the specified person is an officer, director, trustee or partner, any person for which the person acts in any capacity. Assessment: Additional amounts of capital which may be mandatorily required of or paid voluntarily by an investor partner beyond his subscription commitment. Capital Accounts: The accounts to be maintained for each partner on the books and records of the partnership under Section 3.01 of the limited partnership agreement. Capital Available for Investment: The sum of (a) the subscriptions, net of the sales commissions, due diligence expenses, marketing support fees and other compensation, and wholesaling fees, which aggregate 10-1/2% of subscriptions, and the management fee and (b) the capital contribution of the Managing General Partner. Capital Contribution: With respect to each investor partner, the total investment, including the original investment, assessments and amounts reinvested, by the investor partner to the capital of the partnership under Section 2.02 of the limited partnership agreement and, with respect to the Managing General Partner and initial limited partner, the total investment, including the original investment, assessments and amounts reinvested, to the capital of the partnership under Section 2.01 of the limited partnership agreement. Capital Expenditures: Those costs associated with property acquisition and the drilling and completion of oil and gas wells which are generally accepted as capital expenditures under the provisions of the Internal Revenue Code. Carried Interest: An equity interest in a program issued to a person without consideration, in the form of cash or tangible property, in an amount proportionately equivalent to that received from the participants. Code: The Internal Revenue Code of 1986, as amended. Cost: When used with respect to the sale of property to the partnership, means (a) the sum of the prices paid by the seller to an unaffiliated person for the property, including bonuses; (b) title insurance or examination costs, brokers' commissions, filing fees, recording costs, transfer taxes, if any, and like charges in connection with the acquisition of the property; (c) a pro rata portion of the seller's actual necessary and reasonable expenses for seismic and geophysical services; and (d) rentals and ad valorem taxes paid by the seller with respect to the property to the date of its transfer to the buyer, interest and points actually incurred on funds used to acquire or maintain the property, and the portion of the seller's reasonable, necessary and actual expenses for geological, engineering, drafting, accounting, legal and other like services allocated to the property cost in conformity with generally accepted accounting principles and industry standards, except for expenses in connection with the past drilling of wells which are not producers of sufficient quantities of oil or gas to make commercially reasonable their continued operations, and provided that the expenses enumerated in this subsection (d) hereof shall have been incurred not more than 36 months prior to the purchase by the partnership; provided that the period may be extended, at the discretion of the state securities administrator, upon proper justification. When used with respect to services, "cost" means the reasonable, necessary and actual expense incurred by the seller on behalf of the partnership in providing the services, determined in accordance with generally accepted accounting principles. As used elsewhere, "cost" means the price paid by the seller in an arm's-length transaction. Dealer Manager: PDC Securities Incorporated, our affiliate. Development Well: A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. Direct Costs: All actual and necessary costs directly incurred for the benefit of the partnership and generally attributable to the goods and services provided to the partnership by parties other than the Managing General Partner or its affiliates. Direct costs shall not include any cost otherwise classified as organization and offering expenses, administrative costs, operating costs or property costs. Direct costs may include the cost of services provided by the Managing General Partner or its affiliates if the services are provided by written contracts and in compliance with Section 5.07(e) of the limited partnership agreement. Distributable Cash: Cash remaining for distribution to the Managing General Partner and the investor partners after the payment of all partnership obligations, including debt service and the establishment of contingency reserves for anticipated future costs as determined by the Managing General Partner. Drilling and Completion Costs: All costs, excluding operating costs, of drilling, completing, testing, equipping and bringing a well into production or plugging and abandoning it, including all labor and other construction and installation costs incident thereto, location and surface damages, cementing, drilling mud and chemicals, drillstem tests and core analysis, engineering and well site geological expenses, electric logs, costs of plugging back, deepening, rework operations, repairing or performing remedial work of any type, costs of plugging and abandoning any well participated in by the Partnership, and reimbursements and compensation to well operators, including charges paid to the Managing General Partner as unit operator during the drilling and completion phase of a well, plus the cost of the gathering systems and of acquiring leasehold interests. Dry Hole: Any well abandoned without having produced oil or gas in commercial quantities. Escrow Agent: Bank One, West Virginia, National Association, Charleston, West Virginia, or its successor. Exploratory Well: A well drilled to find commercially productive hydrocarbons in an unproved area, to find a new commercially productive horizon in a field previously found to be productive of hydrocarbons at another horizon, or to significantly extend a known prospect. Farmout: An agreement in which the owner of a leasehold or working interest agrees to assign an interest in specific acreage to the assignees, retaining an interest such as an overriding royalty interest, an oil and gas payment, offset acreage or other type of interest, subject to the drilling of one or more specific wells or other performance as a condition of the assignment. Future Net Revenues: Estimated future cash in-flow from oil and natural gas sales of partnership estimated proved reserves as estimated by the petroleum engineers less estimated future production and development costs. Oil and natural gas sales assume oil and natural gas prices remain constant at December 2002 levels. Production and development costs are derived based on current cost levels and assume continuation of current economic conditions. Horizon: A zone of a particular formation; that part of a formation of sufficient porosity and permeability to form a petroleum reservoir. IDC: Intangible drilling and development costs. Independent Expert: A person with no material relationship to the Managing General Partner who is qualified and who is in the business of rendering opinions regarding the value of oil and gas properties based upon the evaluation of all pertinent economic, financial, geologic and engineering information available to the Managing General Partner. Initial Limited Partner: Steven R. Williams or any successor to his interest. Investor Partner: Any investor participating in the partnership as an Additional General Partner or a limited partner, but excluding the Managing General Partner and initial limited partner. Landowners' Royalty Interest: An interest in production, or the proceeds therefrom, to be received free and clear of all costs of development, operation, or maintenance, reserved by a landowner upon the creation of an oil and gas lease. Lease: Full or partial interests in: (a) undeveloped oil and gas leases; (b) oil and gas mineral rights; (c) licenses; (d) concessions; (e) contracts; (f) fee rights; or (g) other rights authorizing the owner thereof to drill for, reduce to possession and produce oil and gas. Limited Partners: Those investor partners who purchase units as limited partners, transferees or assignees who become limited partners, or additional general partners whose interests are converted to limited partnership interests under the provisions of the limited partnership agreement. Limited Partnership Agreement: The limited partnership agreement as it may be amended from time to time, the form of which is attached to the prospectus as Appendix A. Loss: The excess of the partnership's losses and deductions over the partnership's income and gains, computed in accordance with the provisions of the federal income tax laws. Management Fee: The fee to which the Managing General Partner is entitled under Section 6.06 of the limited partnership agreement. Managing General Partner: Petroleum Development Corporation or its successors. Mcf: One thousand cubic feet of natural gas measured at the standard temperature of 60degrees Fahrenheit and pressure of 14.65 psi. Net Subscriptions: An amount equal to total subscriptions of the investor partners less the amount of organization and offering costs of the partnership. Net Well: The sum of fractional working interests owned and drilled by the partnership. Non-Capital Expenditures: Those expenditures associated with property acquisition and the drilling and completion of oil and gas wells that under present law are generally accepted as fully deductible currently for federal income tax purposes. Offering Termination Date: December 31, 2001 with respect to partnerships designated "PDC 2001- Limited Partnership," December 31, 2002 with respect to partnerships designated "PDC 2002- Limited Partnership," and December 31, 2003 with respect to partnerships designated "PDC 2003- Limited Partnership" or the earlier date as the Managing General Partner, in its sole and absolute discretion, shall select. Oil and Gas Interest: Any oil or gas royalty or lease, or fractional interest therein, or certificate of interest or participation or investment contract relative to the royalties, leases or fractional interests, or any other interest or right which permits the exploration of, drilling for, or production of oil and gas or other related hydrocarbons or the receipt of the production or the proceeds thereof. Operating Costs: Expenditures made and costs incurred in producing and marketing oil or gas from completed wells, including, in addition to labor, fuel, repairs, hauling, materials, supplies, utility charges and other costs incident to or therefrom, ad valorem and severance taxes, insurance and casualty loss expense, and compensation to well operators or others for services rendered in conducting the operations. Organization and Offering Costs: All costs of organizing and selling the offering including, but not limited to, total underwriting and brokerage discounts and commissions (including fees of the underwriters' attorneys), expenses for printing, engraving, mailing, salaries of employees while engaged in sales activity, charges of transfer agents, registrars, trustees, escrow holders, depositaries, engineers and other experts, expenses of qualification of the sale of the securities under federal and state law, including taxes and fees, accountants' and attorneys' fees and other front end fees. Overriding Royalty Interest: An interest in the oil and gas produced under a specified oil and gas lease or leases, or the proceeds from the sale thereof, carved out of the working interest, to be received free and clear of all costs of development, operation, or maintenance. Participant: The purchaser of a unit in the program. Partners: The Managing General Partner, the additional general partners other than the Managing General Partner, and the limited partners. Reference to a "partner" shall mean any one of the partners. Partnership or Partnerships: One or all of the limited partnerships to be formed in the PDC 2003 Drilling Program comprised of a series of up to twelve limited partnerships to be designated as the PDC 2001-A Limited Partnership, the PDC 2001-B Limited Partnership, the PDC 2001-C Limited Partnership, PDC 2001-D Limited Partnership, PDC 2002-A Limited Partnership, PDC 2002-B Limited Partnership, PDC 2002-C Limited Partnership, PDC 2002-D Limited Partnership, PDC 2003-A Limited Partnership, PDC 2003-B Limited Partnership, PDC 2003-C Limited Partnership, and PDC 2003-D Limited Partnership. The partnerships will be governed by the West Virginia Uniform Limited Partnership Act. Together the partnerships, for purposes of this offering, are referred to as the PDC 2003 Drilling Program or sometimes as the program. The offerings of the securities of PDC 2001-A, -B, -C and -D Limited Partnerships, PDC 2002-A, -B, -C and -D Limited Partnerships, and PDC 2003-A and -B Limited Partnerships have closed. The Program will no longer offer or sell securities of those ten limited partnerships. Partnership Minimum Gain: Partnership minimum gain as defined in Treas. Reg. Section 1.704-2(d)(1). PDC: Petroleum Development Corporation. Profit: The excess of the partnership's income and gains over the partnership's losses and deductions, computed in accordance with the provisions of the federal income tax laws. Program: One or more limited partnerships formed, or to be formed, for the primary purpose of exploring for oil or gas. In this prospectus, PDC 2003 Drilling Program. Prospect: A contiguous oil and gas leasehold estate, or lesser interest therein, upon which drilling operations may be conducted. In general, a prospect is an area in which a partnership owns or intends to own one or more oil and gas interests, which is geographically defined on the basis of geological data by the Managing General Partner and which is reasonably anticipated by the Managing General Partner to contain at least one reservoir. An area covering lands which are believed by the Managing General Partner to contain subsurface structural or stratigraphic conditions making it susceptible to the accumulations of hydrocarbons in commercially productive quantities at one or more horizons. The area, which may be different for different horizons, shall be designated by the Managing General Partner in writing prior to the conduct of program operations and shall be enlarged or contracted from time to time on the basis of subsequently acquired information to define the anticipated limits of the associated hydrocarbon reserves and to include all acreage encompassed therein. A "prospect" with respect to a particular horizon may be limited to the minimum area permitted by state law or local practice, whichever is applicable, to protect against drainage from adjacent wells if the well to be drilled by the partnership is to a horizon containing proved reserves. Prospectus: The partnership's prospectus, including a preliminary prospectus, of which the limited partnership agreement is a part, under which the units are being offered and sold. Proved Developed Oil and Gas Reserves: Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery should be included as "proved developed reserves" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved. Proved Oil and Gas Reserves: Proved oil and gas reserves are the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions. (a) Reservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. The area of a reservoir considered proved includes (A) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, and (B) the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir. (b) Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the "proved" classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based. (c) Estimates or proved reserves do not include the following: (A) oil that may become available from known reservoirs but is classified separately as "indicated additional reserves; (B) crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, reservoir characteristics, or economic factors; (C) crude oil, natural gas, and natural gas liquids, that may occur in undrilled prospects; and (D) crude oil, natural gas, and natural gas liquids, that may be recovered from oil shales, coal, gilsonite and other sources. Proved Undeveloped Reserves: Proved undeveloped oil and gas reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless the techniques have been proved effective by actual tests in the area and in the same reservoir. Reservoir: A separate structural or stratigraphic trap containing an accumulation of oil or gas. Roll-Up: A transaction involving the acquisition, merger, conversion, or consolidation, either directly or indirectly, of the partnership and the issuance of securities of a roll-up entity. The term does not include: (a) a transaction involving securities of the partnership that have been listed for at least 12 months on a national exchange or traded through the National Association of Securities Dealers Automated Quotation National Market System; or (b) a transaction involving the conversion to corporate, trust or association form of only the partnership if, as a consequence of the transaction, there will be no significant adverse change in any of the following: (1) voting rights; (2) the term of existence of the partnership; (3) sponsor compensation; or (4) the partnership's investment objectives. Roll-Up Entity: A partnership, trust, corporation or other entity that would be created or survive after the successful completion of a proposed roll-up transaction. Royalty: A fractional undivided interest in the production of oil and gas wells, or the proceeds therefrom to be received free and clear of all costs of development, operations or maintenance. Royalties may be reserved by landowners upon the creation of an oil and gas lease ("landowner's royalty") or subsequently carved out of a working interest ("overriding royalty"). Securities Act: Securities Act of 1933, as amended. Sponsor: Any person directly or indirectly instrumental in organizing, wholly or in part, a program or any person who will manage or is entitled to manage or participate in the management or control of a program. "Sponsor" includes the managing and controlling general partner(s) and any other person who actually controls or selects the person who controls 25% or more of the exploratory, developmental or producing activities of the partnership, or any segment thereof, even if that person has not entered into a contract at the time of formation of the partnership. "Sponsor" does not include wholly independent third parties such as attorneys, accountants, and underwriters whose only compensation is for professional services rendered in connection with the offering of units. Whenever the context of these guidelines so requires, the term "sponsor" shall be deemed to include its affiliates. Spudding Date: The date that drilling commences. Subscriptions: The subscription agreement(s) or the amount indicated on the subscriptions agreements that the additional general partners and the limited partners have agreed to pay to a partnership. Tangible Costs: Those costs which are generally accepted as capital expenditures under the provisions of the Code. Treas. Reg.: A regulation promulgated by the Treasury Department under Title 26 of the United States Code. Unit: An undivided interest of an investor partner in the aggregate interest in the capital and profits of the partnership. Well Head Gas Price: The price paid by a gas purchaser for gas produced from partnership wells excluding any tax reimbursements or transportation allowances. Wholesaling Fee: A fee paid to a representative of the dealer manager who helps introduce and explain the program to registered representatives with firms executing a selling agreement with the dealer manager for the program. Working Interest: An interest in an oil and gas leasehold which is subject to some portion of the costs of development, operation, or maintenance. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS June 30, 2003 and December 31, 2002 Assets 2003 2002 (Unaudited) Current assets: Cash and cash equivalents $31,075,600 $ 51,023,500 Accounts and notes receivable 19,602,900 15,336,500 Inventories. 1,984,000 1,174,100 Prepaid expenses 4,601,800 4,125,300 Total current assets 57,264,300 71,659,400 Properties and equipment 232,792,300 195,258,800 Less accumulated depreciation, depletion, and amortization 63,523,400 57,143,700 169,268,900 138,115,100 Other assets 332,800 2,477,100 $226,866,000 $212,251,600 Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses $ 30,968,800 $ 28,687,200 Advances for future drilling contracts 12,899,600 37,283,800 Funds held for future distribution 8,680,000 3,917,900 Total current liabilities 52,548,400 69,888,900 Long-term debt 48,000,000 25,000,000 Other liabilities 2,317,500 4,137,200 Deferred income taxes 14,489,800 12,103,300 Asset retirement obligation 689,500 - Stockholders' equity: Common stock 156,400 157,300 Additional paid-in capital 28,714,400 29,316,800 Retained earnings 82,855,800 73,430,100 Accumulated other comprehensive income (2,905,800) (1,782,000) Total stockholders' equity 108,820,800 101,122,200 $226,866,000 $212,251,600 AN INVESTOR IN PDC 2003 DRILLING PROGRAM DOES NOT THEREBY ACQUIRE ANY INTEREST IN THE ASSETS OF PETROLEUM DEVELOPMENT CORPORATION PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) 1. Accounting Policies Reference is hereby made to the Company's audited Consolidated Balance Sheet at December 31, 2002 which contains a summary of significant accounting policies followed by the Company in preparation of its consolidated financial statements. These policies were also followed in preparing the unaudited balance sheet at June 30, 2003 included herein. 2. Basis of Presentation The Management of the Company believes that all adjustments (consisting of only normal recurring accruals) necessary to a fair statement of the financial position of the Company as of June 30, 2003 have been made. 3. Oil and Gas Properties Oil and Gas Properties are reported on the successful efforts method. 4. Contingencies and Commitments There are no material loss contingencies at June 30, 2003. There has been no change in commitments and contingencies as described in Note 8 of the Consolidated Balance Sheet at December 31, 2002. 5. Business Segments (Thousands) PDC's operating activities can be divided into three major segments: drilling and development, natural gas sales, and well operations. The Company drills natural gas wells for Company-sponsored drilling partnerships and retains an interest in each well. The Company also engages in oil and gas sales to residential, commercial and industrial end-users. The Company charges Company-sponsored partnerships and other third parties competitive industry rates for well operations and gas gathering. Segment information for June 30, 2003 and December 31, 2002 is as follows: June 30, 2003 December 31, 2002 SEGMENT ASSETS Drilling and Development $16,362 31,279 Natural Gas Sales 191,973 162,232 Well Operations 10,818 10,706 Unallocated amounts Cash - 1,736 Other 7,713 6,299 Total $226,866 212,252 AN INVESTOR IN PDC 2003 DRILLING PROGRAM DOES NOT THEREBY ACQUIRE ANY INTEREST IN THE ASSETS OF PETROLEUM DEVELOPMENT CORPORATION PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED BALANCE SHEETS - (Continued) (Unaudited) 6. Comprehensive income Comprehensive income includes certain items recorded directly to shareholders' equity and classified as other comprehensive income. The following table illustrates the calculation of comprehensive income for the quarter ended June 30, 2003. Net Income before cumulative effect of accounting change $9,624,300 Cumulative effect of change in accounting principle (net of taxes of $121,700) (198,600) Net income $9,425,700 Reclassification adjustment for settled contracts included in net income (net of tax of $435,000) 709,700 Changes in fair value of outstanding hedging positions (net of tax of $1,123,800) (1,833,500) Other comprehensive loss (1,123,800) Comprehensive Income $8,301,900 7. Common Stock Repurchase On March 13, 2003 the Company publicly announced the authorization by its Board of Directors to repurchase up to 5% of the Company's common stock (785,000 shares). This program is scheduled to expire on December 31, 2004. The following activity has occurred since inception of the plan on March 13, 2003 until June 30, 2003. Month of Purchase March, 2003 April, 2003 Average Price paid per share $6.02 $6.48 Broker/Dealer McDonald Investments McDonald Investments Number of Shares Purchased 46,500 49,900 Remaining Number of Shares to Purchase 738,500 688,600 8. Change in Accounting Principle In June 2001, the Financial Accounting Standard Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations" that requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. This statement is effective for fiscal years beginning after June 15, 2002. The Company adopted SFAS No. 143 on January 1, 2003 and recorded a net asset of $271,800 and a related liability of $592,100 (using a 6% discount rate) and a cumulative effect on change in accounting principle on prior years of $198,600 (net of taxes of $121,700). AN INVESTOR IN PDC 2003 DRILLING PROGRAM DOES NOT THEREBY ACQUIRE ANY INTEREST IN THE ASSETS OF PETROLEUM DEVELOPMENT CORPORATION PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED BALANCE SHEETS - (Continued) (Unaudited) 9. New Accounting Standards In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 addresses accounting and reporting for business combinations and is effective for all business combinations initiated after June 30, 2001. SFAS No. 142 addresses the accounting and reporting for acquired goodwill and other intangible assets. The new standard eliminates the requirement to amortize acquired goodwill; instead, such goodwill is required to be reviewed at least annually for impairment. The new standard also requires that, at a minimum, all intangible assets be aggregated and presented as a separate line item in the balance sheet. The adoption of SFAS No. 141 and SFAS No. 142 had no impact on the Company's total balance sheet, cash flows or results of operations. A reporting issue has arisen regarding the application of certain provisions of SFAS No. 141 and SFAS No. 142 to companies in the extractive industries, including oil and gas companies. The issue is whether SFAS No. 142 requires registrants to classify the costs of mineral rights associated with extracting oil and gas as intangible assets in the balance sheet, apart from other capitalized oil and gas property costs, and provide specific footnote disclosures. Historically, the Company has included the costs of mineral rights associated with extracting oil and gas as a component of oil and gas properties. If it is ultimately determined that SFAS No. 142 requires oil and gas companies to classify costs of mineral rights associated with extracting oil and gas as a separate intangible assets line item on the balance sheet, the Company would be required to reclassify the historical cost of approximately $5,455,700 and $4,208,800 of mineral rights associated with undeveloped oil and gas properties and $11,832,400 and $10,898,700 of mineral rights associated with developed oil and gas properties as of June 30, 2003 and December 31, 2002, respectively, out of oil and gas properties and into a separate intangible mineral rights assets line item. The Company's total balance sheet, cash flows and results of operations would not be affected since such intangible assets would continue to be amortized and assessed for impairment. AN INVESTOR IN PDC 2003 DRILLING PROGRAM DOES NOT THEREBY ACQUIRE ANY INTEREST IN THE ASSETS OF PETROLEUM DEVELOPMENT CORPORATION PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2002 and 2001 (With Independent Auditors' Report Thereon) Independent Auditors' Report The Stockholders and Board of Directors Petroleum Development Corporation: We have audited the consolidated balance sheets of Petroleum Development Corporation and subsidiaries as of December 31, 2002 and 2001. These consolidated balance sheets are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated balance sheets based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated balance sheets are free of material misstatement. An audit of the consolidated balance sheets includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated balance sheets. An audit of the consolidated balance sheets also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall balance sheet presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated balance sheets referred to above present fairly, in all material respects, the financial position of Petroleum Development Corporation and subsidiaries as of December 31, 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America. As discussed in note 10 to the consolidated financial statements, the Company changed its method of accounting for derivative instruments and hedging activities in 2001. KPMG LLP Pittsburgh, Pennsylvania February 25, 2003, except for Note 16, which is as of September 5, 2003. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2002 and 2001 2002 2001 Assets Current assets: Cash and cash equivalents $ 48,263,000 47,892,300 Restricted cash 2,760,500 283,300 Notes and accounts receivable 15,336,500 10,752,600 Inventories 1,174,100 1,117,900 Prepaid expenses 4,125,300 4,659,300 Total current assets 71,659,400 64,705,400 Properties and equipment: Oil and gas properties (successful efforts accounting method) 183,614,200 167,244,600 Pipelines 7,015,000 6,501,500 Transportation and other equipment 3,174,200 3,201,500 Land and buildings 1,455,400 1,402,400 195,258,800 178,350,000 Less accumulated depreciation, depletion and amortization 57,143,700 45,809,500 138,115,100 132,540,500 Other assets 2,477,100 2,606,200 $212,251,600 199,852,100 (Continued) AN INVESTOR IN PDC 2003 DRILLING PROGRAM DOES NOT THEREBY ACQUIRE ANY INTEREST IN THE ASSETS OF PETROLEUM DEVELOPMENT CORPORATION PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2002 and 2001 2002 2001 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 17,425,500 17,118,600 Other accrued expenses 11,261,700 7,924,200 Advances for future drilling contracts 37,283,800 31,592,200 Funds held for future distribution 3,917,900 4,650,800 Total current liabilities 69,888,900 61,285,800 Long-term debt 25,000,000 28,000,000 Other liabilities 4,137,200 4,082,700 Deferred income taxes 12,103,300 9,710,800 Commitments and contingencies Stockholders' equity: Common stock, par value $.01 per share; authorized 50,000,000 shares; issued and outstanding 15,734,767 and 16,245,752 shares 157,300 162,400 Additional paid-in capital 29,316,800 32,922,500 Retained earnings 73,430,100 64,145,300 Accumulated other comprehensive loss, net of tax (1,782,000) (457,400) Total stockholders' equity 101,122,200 96,772,800 $212,251,600 199,852,100 See accompanying notes to consolidated balance sheets. AN INVESTOR IN PDC 2003 DRILLING PROGRAM DOES NOT THEREBY ACQUIRE ANY INTEREST IN THE ASSETS OF PETROLEUM DEVELOPMENT CORPORATION PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets December 31, 2002 and 2001 (1) Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated balance sheets include the accounts of Petroleum Development Corporation and its wholly owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. The Company accounts for its investment in limited partnerships under the proportionate consolidation method. Under this method, the Company's balance sheets include its prorata share of assets and liabilities, respectively, of the limited partnerships in which it participates. The Company is involved in three business segments. The segments are drilling and development, natural gas sales and well operations (See Note 15). The Company grants credit to purchasers of oil and gas and the owners of managed properties, substantially all of whom are located in West Virginia, Tennessee, Pennsylvania, Ohio, Michigan, North Dakota and Colorado. Cash Equivalents The Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. Inventories Inventories of well equipment, parts and supplies are valued at the lower of average cost or market. An inventory of natural gas is recorded when gas is purchased in excess of deliveries to customers and is recorded at the lower of cost or market. An inventory of oil located in stock tanks on well locations, is carried at market at the end of each period. Oil and Gas Properties Exploration and development costs are accounted for by the successful efforts method. The Company assesses impairment of capitalized costs of proved oil and gas properties by comparing net capitalized costs to undiscounted future net cash flows on a field-by-field basis using expected prices. Prices utilized in each year's calculation for measurement purposes and expected costs are held constant throughout the estimated life of the properties. If net capitalized costs exceed undiscounted future net cash flow, the measurement of impairment is based on estimated fair value which would consider future discounted cash flows. Property acquisition costs are capitalized when incurred. Geological and geophysical costs and delay rentals are expensed as incurred. The costs of drilling exploratory wells are capitalized pending determination of whether the wells have discovered economically producible reserves. If reserves are not discovered, such costs are expensed as dry holes. Development costs, including equipment and intangible drilling costs related to both producing wells and developmental dry holes, are capitalized. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 Unproved properties are assessed on a property-by-property basis and properties considered to be impaired are charged to expense when such impairment is deemed to have occurred. Costs of proved properties, including leasehold acquisition, exploration and development costs and equipment, are depreciated or depleted by the unit-of-production method based on estimated proved developed oil and gas reserves. Upon sale or retirement of complete units of depreciable or depletable property, the net cost thereof, less proceeds or salvage value, is credited or charged to income. Upon retirement of a partial unit of property, the cost thereof is charged to accumulated depreciation and depletion. Based on the Company's experience, management believes site restoration, dismantlement and abandonment costs net of salvage to be immaterial in relation to operating costs. These costs are being expensed when incurred. Transportation Equipment, Pipelines and Other Equipment Transportation equipment, pipelines and other equipment are carried at cost. Depreciation is provided principally on the straight-line method over useful lives of 3 to 17 years. SFAS No. 144 provides a single accounting model for long-lived assets to be disposed of. The Company adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not affect the Company's balance sheets. In accordance with SFAS No. 144, long-lived assets, such as property, plant, and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Prior to the adoption of SFAS No. 144, the Company accounted for long-lived assets in accordance with SFAS No. 121, Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. Maintenance and repairs are charged to expense as incurred. Major renewals and betterments are capitalized. Upon the sale or other disposition of assets, the cost and related accumulated depreciation, depletion and amortization are removed from the accounts, the proceeds applied thereto and any resulting gain or loss is reflected in income. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 Buildings Buildings are carried at cost and depreciated on the straight-line method over estimated useful lives of 30 years. Advances for Future Drilling Contracts Represents funds received from Partnerships and other joint ventures for drilling activities which have not been completed and accordingly have not yet been recognized as income in accordance with the Company's income recognition policies. Retirement Plans The Company has a 401-K contributory retirement plan (401-K Plan) covering full-time employees. The Company provides a discretionary matching of employee contributions to the plan. The Company also has a profit sharing plan covering full-time employees. The Company's contributions to this plan are discretionary. The Company has a deferred compensation arrangement covering executive officers of the Company as a supplemental retirement benefit. The Company has established split-dollar life insurance arrangements with certain executive officers. Under these arrangements, advances are made to these officers equal to the premiums due. The advances are collateralized by the cash surrender value of the policies. The Company records as other assets its share of the cash surrender value of the policies. Revenue Recognition Oil and gas wells are drilled primarily on a contract basis. The Company follows the percentage-of-completion method of income recognition for drilling operations in progress. Sales of natural gas are recognized when sold, oil revenues are recognized when produced into a stock tank. Well operations income consists of operation charges for well upkeep, maintenance and operating lease income on tangible well equipment. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 Derivative Financial Instruments All derivatives are recognized on the consolidated balance sheet at their fair value. On the date the derivative contract is entered into, the Company designates the derivative as either a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability ("Cash flow" hedge), or a non-hedging derivative. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as cash-flow hedges to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively. No hedging activities were discontinued during 2002 or 2001. Changes in fair value of a derivative that is highly effective and that is designated and qualifies as a cash-flow hedge are recorded in other comprehensive income, until earnings are affected by the variability in cash flows of the designated hedged item. Changes in the fair value of non-hedging derivatives are reported in current-period earnings. The Company discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative expires or is sold, terminated, or exercised. Additionally, if the derivative is dedesignated as a hedging instrument, because it is unlikely that a forecasted transaction will occur, a hedged firm commitment no longer meets the definition of a firm commitment, or management determines that designation of the derivative as a hedging instrument is no longer appropriate, hedge accounting will discontinue. For the year ended December 31, 2000, prior to adoption of Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Certain Hedging Activities" and SFAS No. 138, "Accounting for Certain Hedging Activities", gains and losses related to qualifying hedges of firm commitments or anticipated transactions through the use of natural gas futures and option contracts were deferred and recognized in income or as adjustments of carrying amounts when the underlying hedged transaction occurred. In order for futures contracts to qualify as a hedge, there must be sufficient correlation to the underlying hedged transaction. The change in the fair value of derivative instruments which do not qualify for hedging were recognized into income in 2000. During 2000, the Company entered into an interest rate swap agreement which expires October 11, 2004 to reduce its exposure to market risks from changing interest rates. The interest rate differential to be paid or received was accrued and recognized as interest expense in the period incurred. Stock Compensation The Company has adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS 123 allows entities to continue to measure compensation cost for stock-based awards using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees," and to provide pro forma net income and pro forma earnings per share disclosures as if the fair value based method defined in SFAS 123 had been applied. The Company has elected to continue to apply the provisions of APB 25 and provide the pro forma disclosure provisions of SFAS 123. See Note 5. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. Estimates which are particularly significant to the consolidated balance sheets include estimates of oil and gas reserves and future cash flows from oil and gas properties. Fair Value of Financial Instruments The carrying values of the Company's receivables, payables and debt obligations are estimated to be substantially the same as the fair values as of December 31, 2002 and 2001. New Accounting Standards In June 2001, the FASB issued SFAS 143, Accounting for Asset Retirement Obligations (SFAS No. 143). SFAS No. 143 requires the Company to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. The Company also records a corresponding asset which is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The Company is required to adopt SFAS No. 143 on January 1, 2003. At this time, the Company cannot reasonably estimate the effect of the adoption of this Statement on its financial position. In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123. This statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending December 31, 2002 and are included in the notes to these financial statements. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 (2) Notes and Accounts Receivable Included in other assets are noncurrent accounts receivable as of December 31, 2002 and 2001, in the amounts of $445,600 and $173,600 net of an allowance for doubtful accounts of $445,600 and $174,600, respectively. The allowance for doubtful current accounts receivable as of December 31, 2002 and 2001 was $49,400 and $349,900, respectively. (3) Long-Term Debt On July 3, 2002 the Company executed a $100 million credit facility with Bank One, NA and BNP Paribas. The agreement provides for borrowing up to $100 million subject to and secured by adequate levels of oil and gas reserves. The current total borrowing base is $58.0 million of which the Company has activated $40 million of the facility. The Company is required to pay a commitment fee of 1/4 percent on the unused portion of the activated credit facility. Interest accrues at prime, with LIBOR (London Interbank Market Rate) alternatives available at the discretion of the Company. No principal payments are required until the credit agreement expires on July 3, 2005. As of December 31, 2002 and 2001 the outstanding balance was $25,000,000 and $28,000,000, respectively. Any amounts outstanding under the credit facility are secured by substantially all properties of the Company. The credit agreement requires, among other things, the existence of satisfactory levels of natural gas reserves, maintenance of certain working capital and tangible net worth ratios along with a restriction on the payment of dividends. As of December 31, 2002 and 2001 the Company was in compliance with all financial covenants in the credit agreement. At December 31, 2002, $10,000,000 of the outstanding balance was subject to an interest rate swap at a rate of 8.39%, $6,000,000 was subject to a 90-day LIBOR rate of 3.27% and $9,000,000 was subject to a prime rate of 4.25%. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 (4) Income Taxes The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2002 and 2001 are presented below: 2002 2001 Deferred tax assets: Allowance for doubtful accounts $ 199,300 199,300 Drilling notes 84,500 88,100 Alternative minimum tax credit carryforwards (Section 29) 2,055,500 1,715,800 Future abandonment 505,900 409,300 Deferred compensation 2,000,400 2,100,500 Other 40,600 48,900 Total gross deferred tax assets 4,886,200 4,561,900 Less valuation allowance - - Deferred tax assets 4,886,200 4,561,900 Less current deferred tax assets (included in prepaid expenses) (1,351,200) (1,133,400) Net non-current deferred tax assets 3,535,000 3,428,500 Deferred tax liabilities: Properties and equipment, principally due to differences in Depreciation and amortization (16,730,500) (13,419,800) Total gross deferred tax liabilities (16,730,500) (13,419,800) Net deferred tax liability (13,195,500) (9,991,300) Deferred income tax assets related to AOCI 1,092,200 280,500 Net deferred tax liability after AOCI $(12,103,300) (9,710,800) At December 31, 2002, the Company has alternative minimum tax credit carryforwards (Section 29) of approximately $2,055,500 which are available to reduce future federal regular income taxes over an indefinite period. Accumulated other comprehensive loss is net of tax of $1,092,200 and $280,500 as of December 31, 2002 and 2001, respectively. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 (5) Stockholders' Equity Changes in capital during 2002 and 2001 are as follows: Common stock issued Number Of Shares Amount Additional Paid-in- capital Retained Earnings Accumulated Other Comprehen-sive Income Total Balance, December 31, 2000 16,244,044 $162,400 32,917,000 49,177,500 - 82,256,900 Issuance of common stock 1,708 - - - - - Amortization of stock award - - 5,500 - - 5,500 Net income 14,967,800 14,967,800 Comprehensive income: Cumulative effect of change in accounting principle - January 1, 2001 (net of tax of $8,052,700) - - - - (12,079,100) - Reclassification adjustment for settlement of contracts Included in net income (net of tax of $3,046,900) - - - - 4,971,200 - Changes in fair value of outstanding hedging positions (net of tax of $4,076,100) - - - - 6,650,500 - Other comprehensive loss (457,400) (457,400) Comprehensive income _________ _________ _________ _________ ________ 14,510,400 Balance, December 31, 2001 16,245,752 $ 162,400 32,922,500 64,145,300 (457,400) 96,772,800 Issuance of common stock: Exercise of employee stock options 70,000 700 78,100 - - 78,800 Amortization of stock award - 5,500 - - 5,500 Repurchase and cancellation of treasury stock (580,985) (5,800) (3,689,300) (3,695,100) Net income - - - 9,284,800 - 9,284,800 Comprehensive income: Reclassification adjustment for settlement of contracts Included in net income (net of tax of $9,100) - - - - 14,800 - Changes in fair value of outstanding hedging positions and interest rate swap (net of tax of $820,900) - - - - (1,339,400) - Other comprehensive loss (1,324,600) (1,324,600) Comprehensive income _________ _________ _________ __________ ________ 7,960,200 Balance, December 31, 2002 15,734,767 $ 157,300 29,316,800 73,430,100 (1,782,000) 101,122,200 PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 Options Options amounting to 185,000 shares were granted during 2001 to certain employees and directors under the Company's Stock Option Plans. These options were granted with an exercise price equal to market value as of the date of grant and vest over a six month period. The outstanding options expire from 2005 to 2011. The estimated fair value of the options granted during 2001 was $3.70 per option. The fair value was estimated using the Black-Scholes option pricing model with the following assumptions for the 2001 grant: risk-free interest rate of 5.88%, expected dividend yield of 0%, expected volatility of 50.23% and expected life of 7 years. Number of Shares Average Exercise Price Range of Exercise Prices Outstanding December 31, 2000 1,045,000 $3.95 1.125 - 6.125 Granted 185,000 $6.25 6.25 - 6.25 Outstanding December 31, 2001 1,230,000 $4.29 1.125 - 6.25 Exercised (70,000) $1.125 1.125 - 1.125 Outstanding December 31, 2002 1,160,000 $4.48 1.125 - 6.25 As of December 31, 2002, there were 140,000 options outstanding and exercisable at the $1.125 exercise price which have a weighted average remaining contractual life of 2.9 years. Also as of December 31, 2002 there were 1,020,000 options outstanding and exercisable at a $3.75 to $6.25 exercise price range having a weighted average remaining contractual life of 5.9 years and weighted average exercise price of $4.95. Stock Redemption Agreement The Company has stock redemption agreements with three officers of the Company. The agreements require the Company to maintain life insurance on each executive in the amount of $1,000,000. The agreements provide that the Company shall utilize the proceeds from such insurance to purchase from such executives' estates or heirs, at their option, shares of the Company's stock. The purchase price for the outstanding common stock is to be based upon the average closing asked price for the Company's stock as quoted by NASDAQ during a specified period. The Company is not required to purchase any shares in excess of the amount provided for by such insurance. (6) Employee Benefit Plans The Company made 401-K Plan contributions of $288,000 and $260,800 for 2002 and 2001, respectively. The Company has a profit sharing plan (the Plan) covering full-time employees. The Company contributed $200,000 to the plan in cash during 2002 and 2001, respectively. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 During 2002 and 2001 the Company expensed and established a liability for $90,000 each year under a deferred compensation arrangement with the executive officers of the Company. At December 31, 2002 and 2001, the Company has recorded as other assets $501,000 and $402,100, respectively, related to the cash surrender value of the life insurance on certain executive officers. (7) Transactions with Affiliates As part of its duties as well operator, the Company received $60,620,222 in 2002 and $71,802,700 in 2001 representing proceeds from the sale of oil and gas and made distributions to investor groups according to their working interests in the related oil and gas properties. Funds held for future distribution on the consolidated balance sheet of $3,917,900 and $4,650,800 includes amounts owed to affiliated partnerships as of December 31, 2002 and 2001, respectively. The Company provided oil and gas well drilling services to affiliated partnerships. Substantially all of the Company's oil and gas well drilling operations was for such partnerships. The Company also provided related services of operation of wells, reimbursement of syndication costs, management fees, tax return preparation and other services relating to the operation of the partnerships. The Company received $20,008,900 in 2002 and $16,072,500 in 2001 for those services. Amounts due from the partnerships as of December 31, 2002 and 2001 were $1,028,000 and $1,246,200, and are included in notes and accounts receivable. During 2002 and 2001, the Company paid $51,800 and $30,100, respectively, to the Corporate Secretary's law firm for various legal services. (8) Commitments and Contingencies The nature of the independent oil and gas industry involves a dependence on outside investor drilling capital and involves a concentration of gas sales to a few customers. The Company sells natural gas to various public utilities and industrial customers. One customer, Cinnabar Energy Services, accounted for 10.8% and 13.1% of total revenues in 2002 and 2001, respectively. The Company would be exposed to natural gas price fluctuations on underlying purchase and sale contracts should the counterparties to the Company's hedging instruments or the counterparties to the Company's gas marketing contracts not perform. Such nonperformance is not anticipated. There were no counterparty default losses in 2002 or 2001. Substantially all of the Company's drilling programs contain a repurchase provision where Investors may tender their partnership units for repurchase at any time beginning with the third anniversary of the first cash distribution. The provision provides that the Company is obligated to purchase an aggregate of 10% of the initial subscriptions per calendar year (at a minimum price of four times the most recent 12 months' cash distributions), only if such units are tendered, subject to the Company's financial ability to do so. The maximum annual 10% repurchase obligation, if tendered by the investors, is currently approximately $1,878,200. The Company has adequate liquidity to meet this obligation. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 The Company is not party to any legal action that would materially affect the Company's results of operations or financial condition. (9) Lease Obligations The Company has entered into certain operating leases on behalf of itself and its Partnerships principally for the leasing of natural gas compressors on its Michigan operating facilities. The future minimum lease payments under these non-cancellable operating leases as of December 31, 2002 are as follows: Year Lease Amount 2003 $ 979,300 2004 397,800 2005 120,400 2006 50,200 $1,547,700 The Company's share of this lease expense for operating leases for the years ended December 31, 2002 and 2001 was $660,700 and $693,000, respectively. (10) Derivative Financial Instruments The Company utilizes commodity based derivative instruments as hedges to manage a portion of its exposure to price volatility stemming from its integrated natural gas production and marketing activities. These instruments consist of natural gas futures and option contracts traded on the New York Mercantile Exchange for Appalachian and Michigan production and CIG (Colorado Interest Gas Index)-based hedges traded by Bank One for Colorado production. The futures and option contracts hedge committed and anticipated natural gas purchases and sales, generally forecasted to occur within a 12 month period. The Company does not hold or issue derivatives for trading or speculative purposes. In addition, interest rate swap agreements are used to reduce the potential impact of increases in interest rates on variable rate long-term debt. Statement of Accounting Standards No. 133 and No. 138, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133/138), was issued by the Financial Accounting Standards Board. SFAS No. 133/138 standardized the accounting for derivative instruments, including certain derivative instruments embedded in other contracts. The Company adopted the provisions of the SFAS 133/138 effective January 1, 2001. The natural gas futures and options and the interest rate swap are derivatives pursuant to SFAS 133/138. The Company's derivatives are treated as hedges of committed and/or anticipated transactions and had a total estimated fair value of $(1,782,000) (net of tax) on December 31, 2002 and a total estimated fair value of $(457,400) (net of tax) on December 31, 2001. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 Natural gas futures and option contracts for the sale or purchase of natural gas are as follows: December 31, 2002 Amount (mmbtu) Fair Value Fair Value net of tax Futures contracts Marketing activities 3,950,000 $(1,431,400) $(887,400) Production activities 280,000 (209,700) (130,000) 4,230,000 $(1,641,100) $(1,017,400) Option contracts Marketing activities - - - Production activities 2,950,400 $(337,200) (209,100) 2,950,400 $(337,200) $(209,100) December 31, 2001 Futures contracts Marketing activities 1,680,000 $479,300 $297,200 Production activities - - - 1,680,000 $479,300 $297,200 Option contracts Marketing activities 20,000 $9,000 $ 5,600 Production activities - - - 20,000 $9,000 $ 5,600 The Company is required to maintain margin deposits with brokers for outstanding futures contracts. As of December 31, 2002 and 2001, cash in the amount of $2,760,500 and $283,300 was on deposit. Interest rate swap agreements are used to reduce the potential impact of increases in interest rates on variable rate long-term debt. At December 31, 2002 and 2001, the Company was a party to an interest rate swap agreement expiring on October 11, 2004. The agreement entitles the Company, on a quarterly basis, to a fixed-rate interest payment of 6.89% plus its current LIBOR rate margin (+1.50% At December 31, 2002) on a $10,000,000 notional amount related to its outstanding line of credit. The fair value of the interest rate swap agreement was $(896,000), $(555,000) net of tax at December 31, 2002 and $(1,226,200), $(760,200) net of tax at December 31, 2001. Current market pricing models were used to estimate fair value. PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 By using derivative financial instruments to hedge exposures to changes in interest rates and commodity prices, the Company exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates repayment risk. The Company minimizes the credit or repayment risk in derivative instruments by entering into transactions with high-quality counterparties. (11) Costs Incurred in Oil and Gas Property Acquisition, Exploration and Development Activities Costs incurred by the Company in oil and gas property acquisition, exploration and development are presented below: Years Ended December 31, 2002 2001 Property acquisition cost: Proved undeveloped properties $ 1,892,700 3,670,500 Producing properties 240,000 75,700 Development costs 16,429,400 35,411,900 $18,562,100 39,158,100 The proved reserves attributable to the development costs in the above table were 19,607,000 Mcf and 130,000 bbls for 2002 and 23,896,000 Mcf and 715,000 bbls for 2001 (amounts unaudited). Of the above development costs incurred for the years ended December 31, 2002 and 2001 the amounts of $2,699,500 and $7,026,900, respectively, were incurred to develop proved undeveloped properties from the prior year end. Property acquisition costs include costs incurred to purchase, lease or otherwise acquire a property. Development costs include costs incurred to gain access to and prepare development well locations for drilling, to drill and equip development wells and to provide facilities to extract, treat, gather and store oil and gas. (12) Oil and Gas Capitalized Costs Aggregate capitalized costs for the Company related to oil and gas exploration and production activities with applicable accumulated depreciation, depletion and amortization are presented below: December 31, 2002 2001 Proved properties: Tangible well equipment $114,431,800 100,805,800 Intangible drilling costs 64,973,600 61,930,200 Undeveloped properties 4,208,800 4,508,600 183,614,200 167,244,600 Less accumulated depreciation, depletion and amortization 50,664,600 39,503,200 $132,949,600 127,741,400 PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 (13) Net Proved Oil and Gas Reserves (Unaudited) The proved reserves of oil and gas of the Company have been estimated by an independent petroleum engineer, Wright & Company, Inc. at December 31, 2002 and 2001. These reserves have been prepared in compliance with the Securities and Exchange Commission rules based on year end prices. An analysis of the change in estimated quantities of oil and gas reserves, all of which are located within the United States, is shown below: Oil (BBLS) 2002 2001 Proved developed and Undeveloped reserves: Beginning of year 2,126,000 2,166,000 Revisions of previous estimates 124,000 (176,000) Beginning of year as revised 2,250,000 1,990,000 New discoveries and extensions Rocky Mountain Region 130,000 715,000 Dispositions to partnerships (80,000) (384,000) Production (227,000) (195,000) End of year 2,073,000 2,126,000 Proved developed reserves: Beginning of year 1,801,000 1,527,000 End of year 1,849,000 1,801,000 Gas (MCF) 2002 2001 Proved developed and undeveloped reserves: Beginning of year 118,608,000 118,640,000 Revisions of previous estimates 1,469,000 (8,694,000) Beginning of year as revised 120,077,000 109,946,000 New discoveries and extensions Rocky Mountain Region 19,607,000 23,896,000 Dispositions to partnerships (4,792,000) (9,263,000) Acquisitions Michigan Basin 4,000 - Rocky Mountain Region 75,000 2,000 Appalachian Basin 342,000 112,000 Production (6,462,000) ( 6,085,000) End of year 128,851,000 118,608,000 Proved developed reserves: Beginning of year 88,477,000 92,131,000 End of year 94,847,000 88,477,000 PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 (14) Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves (Unaudited) Summarized in the following table is information for the Company with respect to the standardized measure of discounted future net cash flows relating to proved oil and gas reserves. Future cash inflows are computed by applying year-end prices, adjusted for hedging contracts, of oil and gas relating to the Company's proved reserves to the year-end quantities of those reserves. Future production, development, site restoration and abandonment costs are derived based on current costs assuming continuation of existing economic conditions. Future income tax expenses are computed by applying the statutory rate in effect at the end of each year to the future pretax net cash flows, less the tax basis of the properties and gives effect to permanent differences, tax credits and allowances related to the properties. As of December 31, 2002 2001 Future estimated revenues $548,949,000 317,515,000 Future estimated production costs (143,878,000) (98,538,000) Future estimated development costs (50,971,000) (45,323,000) Future estimated income tax expense (105,876,000) (50,360,000) Future net cash flows 248,224,000 123,294,000 10% annual discount for estimated timing of cash flows ( 149,755,000) ( 76,855,000) Standardized measure of discounted future estimated net cash flows $98,469,000 46,439,000 The following table summarizes the principal sources of change in the standardized measure of discounted future estimated net cash flows: Years Ended December 31, 2002 2001 Sales of oil and gas production, net of production costs $(16,449,000) (19,876,000) Net changes in prices and production costs 143,574,000 (140,487,000) Extensions, discoveries and improved recovery, Less related cost 39,347,000 25,942,000 Dispositions to partnerships (6,940,000) (28,935,000) Acquisitions 1,167,000 189,000 Development costs incurred during the period 16,429,000 35,412,000 Revisions of previous quantity estimates 3,318,000 (23,818,000) Changes in estimated income taxes (55,516,000) 30,622,000 Accretion of discount (72,900,000) 62,751,000 $ 52,030,000 (58,200,000) PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 It is necessary to emphasize that the data presented should not be viewed as representing the expected cash flow from, or current value of, existing proved reserves since the computations are based on a large number of estimates and arbitrary assumptions. Reserve quantities cannot be measured with precision and their estimation requires many judgmental determinations and frequent revisions. The required projection of production and related expenditures over time requires further estimates with respect to pipeline availability, rates of demand and governmental control. Actual future prices and costs are likely to be substantially different from the current prices and costs utilized in the computation of reported amounts. Any analysis or evaluation of the reported amounts should give specific recognition to the computational methods utilized and the limitations inherent therein. (15) Business Segments (Thousands) PDC's operating activities can be divided into three major segments: drilling and development, natural gas sales, and well operations. The Company drills natural gas wells for Company-sponsored drilling partnerships and retains an interest in each well. The Company also engages in oil and gas sales to commercial and industrial end-users. The Company charges Company-sponsored partnerships and other third parties competitive industry rates for well operations and gas gathering. Segment information for the years ended December 31, 2002 and 2001 is as follows: 2002 2001 SEGMENT ASSETS Drilling and Development $31,279 36,202 Oil and Natural Gas Sales 162,232 142,865 Well Operations 10,706 11,975 Unallocated amounts Cash 1,736 422 Other 6,299 8,388 Total $212,252 199,852 2002 2001 EXPENDITURES FOR SEGMENT LONG-LIVED ASSETS Drilling and Development $ 1,800 5,963 Oil and Natural Gas Sales 16,674 35,488 Well Operations 1,221 839 Unallocated amounts 82 371 Total $ 19,777 42,661 PETROLEUM DEVELOPMENT CORPORATION AND SUBSIDIARIES Notes to Consolidated Balance Sheets - (Continued) December 31, 2002 and 2001 (16) New Accounting Standards In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 addresses accounting and reporting for business combinations and is effective for all business combinations initiated after June 30, 2001. SFAS No. 142 addresses the accounting and reporting for acquired goodwill and other intangible assets. The new standard eliminates the requirement to amortize acquired goodwill; instead, such goodwill is required to be reviewed at least annually for impairment. The new standard also requires that, at a minimum, all intangible assets be aggregated and presented as a separate line item in the balance sheet. The adoption of SFAS No. 141 and SFAS No. 142 had no impact on the Company's total balance sheet, cash flows or results of operations. A reporting issue has arisen regarding the application of certain provisions of SFAS No. 141 and SFAS No. 142 to companies in the extractive industries, including oil and gas companies. The issue is whether SFAS No. 142 requires registrants to classify the costs of mineral rights associated with extracting oil and gas as intangible assets in the balance sheet, apart from other capitalized oil and gas property costs, and provide specific footnote disclosures. Historically, the Company has included the costs of mineral rights associated with extracting oil and gas as a component of oil and gas properties. If it is ultimately determined that SFAS No. 142 requires oil and gas companies to classify costs of mineral rights associated with extracting oil and gas as a separate intangible assets line item on the balance sheet, the Company would be required to reclassify the historical cost of approximately $4,208,800 of mineral rights associated with undeveloped oil and gas properties and $10,898,700 of mineral rights associated with developed oil and gas properties as of December 31, 2002, respectively, out of oil and gas properties and into a separate intangible mineral rights assets line item. The Company's total balance sheet, cash flows and results of operations would not be affected since such intangible assets would continue to be amortized and assessed for impairment. APPENDIX A FORM OF LIMITED PARTNERSHIP AGREEMENT OF PDC 2003-___ LIMITED PARTNERSHIP TABLE OF CONTENTS Page ARTICLE I: The Partnership 1 1.01 Organization 1 1.02 Partnership Name 1 1.03 Character of Business 1 1.04 Principal Place of Business 1 1.05 Term of Partnership 2 1.06 Filings 2 1.07 Independent Activities 2 1.08 Definitions 3 ARTICLE II: Capitalization 12 2.01 Capital Contributions of the Managing General Partner and Initial Limited Partner 12 2.02 Capital Contributions of the Investor Partners 13 2.03 Additional Contributions 14 ARTICLE III: Capital Accounts and Allocations 14 3.01 Capital Accounts 14 3.02 Allocation of Profits and Losses 16 3.03 Depletion 22 3.04 Apportionment Among Partners 23 ARTICLE IV: Distributions 23 4.01 Time of Distribution 23 4.02 Distributions 23 4.03 Capital Account Deficits 24 4.04 Liability Upon Receipt of Distributions 25 ARTICLE V: Activities 25 5.01 Management 25 5.02 Conduct of Operations 25 5.03 Acquisition and Sale of Leases 27 5.04 Title to Leases 28 5.05 Farmouts 28 5.06 Release, Abandonment, and Sale or Exchange of Properties 29 5.07 Certain Transactions 29 ARTICLE VI: Managing General Partner 34 6.01 Managing General Partner 34 6.02 Authority of Managing General Partner 35 6.03 Certain Restrictions on Managing General Partner's Power and Authority 36 6.04 Indemnification of Managing General Partner 38 6.05 Withdrawal 39 6.06 Management Fee 39 6.07 Tax Matters and Financial Reporting Partner 39 ARTICLE VII: Investor Partners 40 7.01 Management 40 7.02 Indemnification of Additional General Partners 40 7.03 Assignment of Units 41 7.04 Prohibited Transfers 43 7.05 Withdrawal by Investor Partners 43 7.06 Removal of Managing General Partner 43 7.07 Calling of Meetings 44 7.08 Additional Voting Rights 44 7.09 Voting by Proxy 45 7.10 Conversion of Additional General Partner Interests into Limited Partner Interests 45 7.11 Unit Repurchase Program 46 7.12 Liability of Partners 47 ARTICLE VIII: Books and Records 47 8.01 Books and Records 47 8.02 Reports 48 8.03 Bank Accounts 50 8.04 Federal Income Tax Elections 50 ARTICLE IX: Dissolution; Winding-up 51 9.01 Dissolution 51 9.02 Liquidation 52 9.03 Winding-up 52 ARTICLE X: Power of Attorney 53 10.01 Managing General Partner as Attorney-in-Fact 53 10.02 Nature of Special Power 54 ARTICLE XI: Miscellaneous Provisions 54 11.01 Liability of Parties 54 11.02 Notices 54 11.03 Paragraph Headings 55 11.04 Severability 55 11.05 Sole Agreement 55 11.06 Applicable Law 55 11.07 Execution in Counterparts 55 11.08 Waiver of Action for Partition 55 11.09 Amendments 55 11.10 Consent to Allocations and Distributions 56 11.11 Ratification 56 11.12 Substitution of Signature Pages 56 11.13 Incorporation by Reference 56 Signature Page. . . . . . . . . . 57 FORM OF LIMITED PARTNERSHIP AGREEMENT OF PDC 2003- LIMITED PARTNERSHIP, A WEST VIRGINIA LIMITED PARTNERSHIP This LIMITED PARTNERSHIP AGREEMENT (the "Agreement") is made as of this ___ day of ___________, 2003 by and among Petroleum Development Corporation, a Nevada corporation, as managing general partner (the "Managing General Partner"), Steven R. Williams, a resident of West Virginia, as the Initial Limited Partner, and the Persons whose names are set forth on Exhibit A attached hereto, as additional general partners (the "Additional General Partners") or as limited partners (the "Limited Partners" and, collectively with Additional General Partners, the "Investor Partners"), pursuant to the provisions of the West Virginia Uniform Limited Partnership Act (the "Act"), on the following terms and conditions: ARTICLE I The Partnership 1.01 Organization. Subject to the provisions of this Agreement, the parties hereto do hereby form a limited partnership (the "Partnership") pursuant to the provisions of the Act. The Partners hereby agree to continue the Partnership as a limited partnership pursuant to the provisions of the Act and upon the terms and conditions set forth in this Agreement. 1.02 Partnership Name. The name of the Partnership shall be PDC 2003- Limited Partnership, a West Virginia limited partnership, and all business of the Partnership shall be conducted in such name. The Managing General Partner may change the name of the Partnership upon ten days notice to the Investor Partners. The Partnership shall hold all of its property in the name of the Partnership and not in the name of any Partner. 1.03 Character of Business. The principal business of the Partnership shall be to acquire Leases, drill sites, and other interests in oil and/or gas properties and to drill for oil, gas, hydrocarbons, and other minerals located in, on, or under such properties, to produce and sell oil, gas, hydrocarbons, and other minerals from such properties, and to invest and generally engage in any and all phases of the oil and gas business. Such business purpose shall include without limitation the purchase, sale, acquisition, disposition, exploration, development, operation, and production of oil and gas properties of any character. The Partnership shall not acquire property in exchange for Units. Without limiting the foregoing, Partnership activities may be undertaken as principal, agent, general partner, syndicate member, joint venturer, participant, or otherwise. 1.04 Principal Place of Business. The principal place of business of the Partnership shall be at 103 East Main Street, Bridgeport, West Virginia, 26330. The Managing General Partner may change the principal place of business of the Partnership to any other place within the State of West Virginia upon ten days notice to the Investor Partners. 1.05 Term of Partnership. The Partnership shall commence on the date the Partnership is organized, as set forth in Section 1.01, and shall continue until terminated as provided in Article IX hereof. Notwithstanding the foregoing, if Investor Partners agreeing to purchase $1,750,000 with respect to PDC 2003-B and -C Limited Partnerships and $3,500,000 with respect to PDC 2003-D Limited Partnership in Units have not subscribed and paid for their Units by the Offering Termination Date, then this Agreement shall be void in all respects, and all investments of the Investor Partners shall be promptly returned together with any interest earned thereon and without any deduction therefrom. The Managing General Partner and its Affiliates may purchase up to 10% (and no more) of the Units subscribed for by Investor Partners in the Partnership; however, not more than $50,000 of the Units purchased by the Managing General Partner and/or its Affiliates will be applied to satisfying the minimum. 1.06 Filings. (a) A Certificate of Limited Partnership (the "Certificate") has been filed in the office of the Secretary of State of West Virginia in accordance with the provisions of the Act. The Managing General Partner shall take any and all other actions reasonably necessary to perfect and maintain the status of the Partnership as a limited partnership under the laws of West Virginia. The Managing General Partner shall cause amendments to the Certificate to be filed whenever required by the Act. (b) The Managing General Partner shall execute and cause to be filed original or amended Certificates and shall take any and all other actions as may be reasonably necessary to perfect and maintain the status of the Partnership as a limited partnership or similar type of entity under the laws of any other states or jurisdictions in which the Partnership engages in business. (c) The agent for service of process on the Partnership shall be Steven R. Williams or any successor as appointed by the Managing General Partner. (d) Upon the dissolution of the Partnership, the Managing General Partner (or any successor managing general partner) shall promptly execute and cause to be filed certificates of dissolution in accordance with the Act and the laws of any other states or jurisdictions in which the Partnership has filed certificates. 1.07 Independent Activities. Each General Partner and each Limited Partner may, notwithstanding this Agreement, engage in whatever activities they choose, whether the same are competitive with the Partnership or otherwise, without having or incurring any obligation to offer any interest in such activities to the Partnership or any Partner. However, except as otherwise provided herein, the Managing General Partner and any of its Affiliates may pursue business opportunities that are consistent with the Partnership's investment objectives for their own account only after they have determined that such opportunity either cannot be pursued by the Partnership because of insufficient funds or because it is not appropriate for the Partnership under the existing circumstances. Neither this Agreement nor any activity undertaken pursuant hereto shall prevent the Managing General Partner from engaging in such activities, or require the Managing General Partner to permit the Partnership or any Partner to participate in any such activities, and as a material part of the consideration for the execution of this Agreement by the Managing General Partner and the admission of each Investor Partner, each Investor Partner hereby waives, relinquishes, and renounces any such right or claim of participation. Notwithstanding the foregoing, the Managing General Partner still has an overriding fiduciary obligation to the Investor Partners. 1.08 Definitions. Capitalized words and phrases used in this Agreement shall have the following meanings: (a) "Act" shall mean the Uniform Limited Partnership Act of the State of West Virginia, as set forth in 47-9-1 through 47-9-63 thereof, as amended from time to time (or any corresponding provisions of succeeding law). (b) "Additional General Partner" shall mean an Investor Partner who purchases Units as an additional general partner, and such partner's transferees and assigns. "Additional General Partners" shall mean all such Investor Partners. "Additional General Partner" shall not include, after a conversion, such Investor Partner who converts his interest into a Limited Partnership interest pursuant to Section 7.10 herein. (c) "Administrative Costs" shall mean all customary and routine expenses incurred by the Managing General Partner for the conduct of program administration, including legal, finance, accounting, secretarial, travel, office rent, telephone, data processing and other items of a similar nature. (d) "Affiliate" of a specified person shall mean (a) any person directly or indirectly owning, controlling, or holding with power to vote 10 percent or more of the outstanding voting securities of such specified person; (b) any person 10 percent or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote, by such specified person; (c) any person directly or indirectly controlling, controlled by, or under common control with such specified person; (d) any officer, director, trustee or partner of such specified person, and (e) if such specified person is an officer, director, trustee or partner, any person for which such person acts in any such capacity. (e) "Agreement" or "Partnership Agreement" shall mean this Limited Partnership Agreement, as amended from time to time. (f) "Capital Account" shall mean, with respect to any Partner, the capital account maintained for such Partner pursuant to Section 3.01 hereof. (g) "Capital Available for Investment" shall mean the sum of (a) Subscriptions, net of total underwriting and brokerage discounts, commissions, and expenses, up to an aggregate of 10-1/2% of Subscriptions, and the Management Fee and (b) the Capital Contribution of the Managing General Partner. (h) "Capital Contribution" shall mean the total investment, including the original investment, assessments, and amounts reinvested, by such Investor Partner to the capital of the Partnership pursuant to Section 2.02 herein, and, with respect to the Managing General Partner and the Initial Limited Partner, the total investment, including the original investment, assessments, and amounts reinvested, to the capital of the Partnership pursuant to Section 2.01 herein. (i) "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time (or any corresponding provisions of succeeding law). (j) "Cost," when used with respect to the sale of property to the Partnership, shall mean (a) the sum of the prices paid by the seller to an unaffiliated person for such property, including bonuses; (b) title insurance or examination costs, brokers' commissions, filing fees, recording costs, transfer taxes, if any, and like charges in connection with the acquisition of such property; (c) a pro rata portion of the seller's actual necessary and reasonable expenses for seismic and geophysical services; and (d) rentals and ad valorem taxes paid by the seller with respect to such property to the date of its transfer to the buyer, interest and points actually incurred on funds used to acquire or maintain such property, and such portion of the seller's reasonable, necessary and actual expenses for geological, engineering, drafting, accounting, legal and other like services allocated to the property cost in conformity with generally accepted accounting principles and industry standards, except for expenses in connection with the past drilling of wells which are not producers of sufficient quantities of oil or gas to make commercially reasonable their continued operations, and provided that the expenses enumerated in this subsection (d) hereof shall have been incurred not more than 36 months prior to the purchase by the Partnership; provided that such period may be extended, at the discretion of the state securities administrator, upon proper justification, When used with respect to services, "cost" means the reasonable, necessary and actual expense incurred by the seller on behalf of the Partnership in providing such services, determined in accordance with generally accepted accounting principles. As used elsewhere, "cost" means the price paid by the seller in an arm's-length transaction. (k) "Depreciation" shall mean, for each fiscal year or other period, an amount equal to the depreciation, amortization, or other cost recovery deduction allowable with respect to an asset for such year or other period, except that if the Gross Asset Value of an asset differs from its adjusted basis for federal income tax purposes at the beginning of such year or other period, Depreciation shall be an amount which bears the same ratio to such beginning Gross Asset Value as the federal income tax depreciation, amortization, or other cost recovery deduction for such year or other period bears to such beginning adjusted tax basis; provided, however, that if the federal income tax depreciation, amortization, or other cost recovery deduction for such year is zero, Depreciation shall be determined with reference to such beginning Gross Asset Value using any reasonable method selected by the Managing General Partner. (l) "Development Well" shall mean a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. (m) "Direct Costs" shall mean all actual and necessary costs directly incurred for the benefit of the Partnership and generally attributable to the goods and services provided to the Partnership by parties other than the Managing General Partner or its Affiliates. Direct costs shall not include any cost otherwise classified as organization and offering expenses, administrative costs, operating costs or property costs. Direct costs may include the cost of services provided by the Managing General Partner or its Affiliates if such services are provided pursuant to written contracts and in compliance with Section 5.07(e) of the Partnership Agreement. (n) "Drilling and Completion Costs" shall mean all costs, excluding Operating Costs, of drilling, completing, testing, equipping and bringing a well into production or plugging and abandoning it, including all labor and other construction and installation costs incident thereto, location and surface damages, cementing, drilling mud and chemicals, drillstem tests and core analysis, engineering and well site geological expenses, electric logs, costs of plugging back, deepening, rework operations, repairing or performing remedial work of any type, costs of plugging and abandoning any well participated in by the Partnership, and reimbursements and compensation to well operators, including charges paid to the Managing General Partner as unit operator during the drilling and completion phase of a well, plus the cost of the gathering system and of acquiring leasehold interests. (o) "Dry Hole" shall mean any well abandoned without having produced oil or gas in commercial quantities. (p) "Exploratory Well" shall mean a well drilled to find commercially productive hydrocarbons in an unproved area, to find a new commercially productive horizon in a field previously found to be productive of hydrocarbons at another horizon, or to significantly extend a known prospect. (q) "Farmout" shall mean an agreement whereby the owner of the leasehold or working interest agrees to assign his interest in certain specific acreage to the assignees, retaining some interest such as an overriding royalty interest, an oil and gas payment, offset acreage or other type of interest, subject to the drilling of one or more specific wells or other performance as a condition of the assignment. (r) "General Partners" shall mean the Additional General Partners and the Managing General Partner. (s) "Gross Asset Value" shall mean, with respect to any asset, the asset's adjusted basis for federal income tax purposes, except as follows: (1) The initial Gross Asset Value of any asset contributed by a Partner to the Partnership shall be the gross fair market value of such asset, as determined by the contributing Partner and the Partnership; (2) The Gross Asset Values of all Partnership assets shall be adjusted to equal their respective gross fair market values, as determined by the Managing General Partner, as of the following times: (a) the acquisition of an additional interest in the Partnership by any new or existing Partner in exchange for more than a de minimis Capital Contribution; (b) the distribution by the Partnership Property as consideration for an interest in the Partnership; and (c) the liquidation of the Partnership within the meaning of Treas. Reg. Section 1.704-1(b)(2)(ii)(g); provided, however, that the adjustments pursuant to clauses (a) and (b) above shall be made only if the Managing General Partner reasonably determines that such adjustments are necessary or appropriate to reflect the relative economic interests of the Partners in the Partnership; (3) The Gross Asset Value of any Partnership asset distributed to any Partner shall be the gross fair market value of such asset on the date of distribution; and (4) The Gross Asset Values of Partnership assets shall be increased (or decreased) to reflect any adjustments to the adjusted basis of such assets pursuant to Code Section 734(b) or Code Section 743(b), but only to the extent that such adjustments are taken into account in determining Capital Accounts pursuant to Treas. Reg. Section 1.704-1(b)(2)(iv)(m) and Section 3.02(g) hereof; provided, however, that Gross Asset Values shall not be adjusted pursuant to this Section (4) to the extent the Managing General Partner determines that an adjustment pursuant to Section (2) hereof is necessary or appropriate in connection with a transaction that would otherwise result in an adjustment pursuant to this Section (4). If the Gross Asset Value of an asset has been determined or adjusted pursuant to Section (i), Section (ii), or (iv) hereof, such Gross Asset value shall thereafter be adjusted by the Depreciation taken into account with respect to such asset for purposes of computing Profits and Losses. (t) "IDC" shall mean intangible drilling and development costs. (u) "Independent Expert" shall mean a person with no material relationship with the Managing General Partner or its Affiliates who is qualified and who is in the business of rendering opinions regarding the value of oil and gas properties based upon the evaluation of all pertinent economic, financial, geologic and engineering information available to the Managing General Partner or its Affiliates. (v) "Initial Limited Partner" shall mean Steven R. Williams or any successor to his interest. (w) "Investor Partner" shall mean any Person other than the Managing General Partner (i) whose name is set forth on Exhibit A, attached hereto, as an Additional General Partner or as a Limited Partner, or who has been admitted as an additional or Substituted Investor Partner pursuant to the terms of this Agreement, and (ii) who is the owner of a Unit. "Investor Partners" means all such Persons. All references in this Agreement to a majority in interest or a specified percentage of the Investor Partners shall mean Investor Partners holding more than 50% or such specified percentage, respectively, of the outstanding Units then held. (x) "Lease" shall mean full or partial interests in: (i) undeveloped oil and gas leases; (ii) oil and gas mineral rights; (iii) licenses; (iv) concessions; (v) contracts; (vi) fee rights; or (vii) other rights authorizing the owner thereof to drill for, reduce to possession and produce oil and gas. (y) "Limited Partner" shall mean an Investor Partner who purchases Units as a Limited Partner, such partner's transferees or assignees, and an Additional General Partner who converts his interest to a limited partnership interest pursuant to the provisions of the Agreement. "Limited Partners" shall mean all such Investor Partners. (z) "Management Fee" shall mean that fee to which the Managing General Partner is entitled pursuant to Section 6.06 hereof. (aa) "Managing General Partner" shall mean Petroleum Development Corporation or its successors, in their capacity as the Managing General Partner. (bb) "Mcf" shall mean one thousand cubic feet of natural gas. (cc) "Net Subscriptions" shall mean an amount equal to the total Subscriptions of the Investor Partners less the amount of Organization and Offering Costs of the Partnership. (dd) "Nonrecourse Deductions" shall have the meaning set forth in Treas. Reg. Section 1.704-2(b)(1). The amount of Nonrecourse Deductions for a Partnership fiscal year shall equal the net increase in the amount of Partnership Minimum Gain during that fiscal year reduced (but not below zero) by the aggregate distributions during that fiscal year of proceeds of a Nonrecourse Liability that are allocable to an increase in Partnership Minimum Gain, determined according to the provisions of Treas. Reg. Section 1.704-2(c). (ee) "Nonrecourse Liability" shall have the meaning set forth in Treas. Reg. Section 1.704-2(b)(3) and 1.752-1(a)(2). (ff) "Offering Termination Date" shall mean December 31, 2001 with respect to Partnerships designated "PDC 2001- Limited Partnership (December 31, 2002 with respect to Partnerships designated "PDC 2002- Limited Partnership" and December 31, 2003 with respect to Partnerships designated "PDC 2003- Limited Partnership") or such earlier date as the Managing General Partner, in its sole and absolute discretion, shall elect. (gg) "Oil and Gas Interest" shall mean any oil or gas royalty or lease, or fractional interest therein, or certificate of interest or participation or investment contract relative to such royalties, leases or fractional interests, or any other interest or right which permits the exploration of, drilling for, or production of oil and gas or other related hydrocarbons or the receipt of such production or the proceeds thereof. (hh) "Operating Costs" shall mean expenditures made and costs incurred in producing and marketing oil or gas from completed wells, including, in addition to labor, fuel, repairs, hauling, materials, supplies, utility charges and other costs incident to or therefrom, ad valorem and severance taxes, insurance and casualty loss expense, and compensation to well operators or others for services rendered in conducting such operations. (ii) "Organization and Offering Costs" shall mean all costs of organizing and selling the offering including, but not limited to, total underwriting and brokerage discounts and commissions (including fees of the underwriters' attorneys), expenses for printing, engraving, mailing, salaries of employees while engaged in sales activity, charges of transfer agents, registrars, trustees, escrow holders, depositaries, engineers and other experts, expenses of qualification of the sale of the securities under Federal and State law, including taxes and fees, accountants' and attorneys' fees and other frontend fees. (jj) "Overriding Royalty Interest" shall mean an interest in the oil and gas produced pursuant to a specified oil and gas lease or leases, or the proceeds from the sale thereof, carved out of the working interest, to be received free and clear of all costs of development, operation, or maintenance. (kk) "Partner Minimum Gain" shall mean an amount, with respect to each Partner Nonrecourse Debt, equal to the Partnership Minimum Gain that would result if such Partner Nonrecourse Debt were treated as a Nonrecourse Liability, determined in accordance with Treas. Reg. Section 1.704-2(i). (ll) "Partner Nonrecourse Debt" shall have the meaning set forth in Treas. Reg. Section 1.704-2(b)(4). (mm) "Partner Nonrecourse Deductions" shall have the meaning set forth in Treas. Reg. Section 1.704-2(i)(2). The amount of Partner Nonrecourse Deductions with respect to a Partner Nonrecourse Debt for a Partnership fiscal year shall equal the net increase in the amount of Partner Minimum Gain attributable to such Partner Nonrecourse Debt during that fiscal year reduced (but not below zero) by proceeds of the liability distributed during that fiscal year to the Partner bearing the economic risk of loss for such liability that are both attributable to the liability and allocable to an increase in Partner Minimum Gain attributable to such Partner Nonrecourse Debt, determined in accordance with Treas. Reg. Section 1.704-2(i)(3). (nn) "Partners" shall mean the Managing General Partner, the Initial Limited Partner, and the Investor Partners. "Partner" shall mean any one of the Partners. All references in this Agreement to a majority in interest or a specified percentage of the Partners shall mean Partners holding more than 50% or such specified percentage, respectively, of the outstanding Units then held. (oo) "Partnership" shall mean the partnership pursuant to this Agreement and the partnership continuing the business of this Partnership in the event of dissolution as herein provided. (pp) "Partnership Minimum Gain" shall have the meaning set forth in Treas. Reg. Section 1.704-2(b)(2) and 1.704-2(d)(1). (qq) "Permitted Transfer" shall mean any transfer of Units satisfying the provisions of Section 7.03 herein. (rr) "Person" shall mean any individual, partnership, corporation, trust, or other entity. (ss) "Profits" and "Losses" shall mean, for each fiscal year or other period, an amount equal to the Partnership's taxable income or loss for such year or period, determined in accordance with Code Section 703(a) (for this purpose, all items of income, gain, loss, or deduction required to be stated separately pursuant to Code Section 703(a)(1) shall be included in taxable income or loss), with the following adjustments: (1) Any income of the Partnership that is exempt from federal income tax and not otherwise taken into account in computing Profits or Losses pursuant to this Section 1.08(rr) shall be added to such taxable income or loss; (2) Any expenditures of the Partnership described in Code Section 705(a)(2)(B) or treated as Code Section 705(a)(2)(B) expenditures pursuant to Treas. Reg. Section 1.704-1(b)(2)(iv)(i), and not otherwise taken into account in computing Profits or Losses pursuant to this Section 1.08(rr) shall be subtracted from such taxable income or loss; (3) In the event the Gross Asset Value of any Partnership asset is adjusted pursuant to Section 1.08(r)(2) or Section 1.08(r)(3) hereof, the amount of such adjustment shall be taken into account as gain or loss from the disposition of such asset for purposes of computing Profits or Losses. (4) Gain or loss resulting from any disposition of Partnership Property with respect to which gain or loss is recognized for federal income tax purposes shall be computed by reference to the Gross Asset Value of the property disposed of, notwithstanding that the adjusted tax basis of such property differs from its Gross Asset Value; (5) In lieu of the depreciation, amortization, and other cost recovery deductions taken into account in computing such taxable income or loss, there shall be taken into account Depreciation for such fiscal year or other period, computed in accordance with Section 1.08(r) hereof; and (6) Notwithstanding any other provisions of this Section 1.08(rr), any items which are specially allocated pursuant to this Agreement shall not be taken into account in computing Profits or Losses. (tt) "Prospect" shall mean a contiguous oil and gas leasehold estate, or lesser interest therein, upon which drilling operations may be conducted. In general, a Prospect is an area in which the Partnership owns or intends to own one or more oil and gas interests, which is geographically defined on the basis of geological data by the Managing General Partner of such Partnership and which is reasonably anticipated by the Managing General Partner to contain at least one reservoir. An area covering lands which are believed by the Managing General Partner to contain subsurface structural or stratigraphic conditions making it susceptible to the accumulations of hydrocarbons in commercially productive quantities at one or more horizons. The area, which may be different for different horizons, shall be designated by the Managing General Partner in writing prior to the conduct of program operations and shall be enlarged or contracted from time to time on the basis of subsequently acquired information to define the anticipated limits of the associated hydrocarbon reserves and to include all acreage encompassed therein. A "prospect" with respect to a particular horizon may be limited to the minimum area permitted by state law or local practice, whichever is applicable, to protect against drainage from adjacent wells if the well to be drilled by the Partnership is to a horizon containing proved reserves. (uu) "Prospectus" shall mean that Prospectus (including any preliminary prospectus), of which this Agreement is a part, pursuant to which the Units are being offered and sold. (vv) "Proved Developed Oil and Gas Reserves shall mean the reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery should be included as "proved developed reserves" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved. (ww) "Proved Oil and Gas Reserves" shall mean the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions. (1) Reservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. The area of a reservoir considered proved includes (A) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, and (B) the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir. (2) Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the "proved" classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based. (3) Estimates or proved reserves do not include the following: (A) oil that may become available from known reservoirs but is classified separately as "indicated additional reserves"; (B) crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, reservoir characteristics, or economic factors; (C) crude oil, natural gas, and natural gas liquids, that may occur in undrilled prospects; and (D) crude oil, natural gas, and natural gas liquids, that may be recovered from oil shales, coal, gilsonite and other such sources. (xx) "Proved Undeveloped Reserves" shall mean the reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual tests in the area and in the same reservoir. (yy) "Reservoir" shall mean a separate structural or stratigraphic trap containing an accumulation of oil or gas. (zz) "Roll-Up" shall mean a transaction involving the acquisition, merger, conversion, or consolidation, either directly or indirectly, of the Partnership and the issuance of securities of a roll-up entity. Such term does not include: (1) a transaction involving securities of the Partnership that have been listed for at least 12 months on a national exchange or traded through the National Association of Securities Dealers Automated Quotation National Market System; or (2) a transaction involving the conversion to corporate, trust or association form of only the Partnership if, as a consequence of the transaction, there will be no significant adverse change in any of the following: (i) voting rights; (ii) the term of existence of the Partnership; (iii) sponsor compensation; or (iv) the Partnership's investment objectives. (aaa) "Roll-Up Entity" shall mean a partnership, trust, corporation or other entity that would be created or survive after the successful completion of a proposed roll-up transaction. (bbb) "Sponsor" shall mean any person directly or indirectly instrumental in organizing, wholly or in part, a program or any person who will manage or is entitled to manage or participate in the management or control of a program. "Sponsor" includes the managing and controlling general partner(s) and any other person who actually controls or selects the person who controls 25% or more of the exploratory, developmental or producing activities of the Partnership, or any segment thereof, even if that person has not entered into a contract at the time of formation of the Partnership. "Sponsor" does not include wholly independent third parties such as attorneys, accountants, and underwriters whose only compensation is for professional services rendered in connection with the offering of units. Whenever the context of these guidelines so requires, the term "sponsor" shall be deemed to include its affiliates. (ccc) "Subscription" shall mean the amount indicated on the Subscription Agreement that an Investor Partner has agreed to pay to the Partnership as his Capital Contribution. (ddd) "Subscription Agreement" shall mean the Agreement, attached to the Prospectus as Appendix B, pursuant to which an Investor subscribes to Units in the Partnership. (eee) "Substituted Investor Partner" shall mean any Person admitted to the Partnership as an Investor Partner pursuant to Section 7.03(c) hereof. (fff) "Treas. Reg." or "Regulation" shall mean the income tax regulations promulgated under the Code, as such regulations may be amended from time to time (including corresponding provisions of succeeding regulations). (ggg) "Unit" shall mean an undivided interest of the Investor Partners in the aggregate interest in the capital and profits of the Partnership. Each Unit represents Capital Contributions of $20,000 to the Partnership. (hhh) "Working Interest" shall mean an interest in an oil and gas leasehold which is subject to some portion of the costs of development, operation, or maintenance. ARTICLE II Capitalization Capital Contributions of the Managing General Partner and Initial Limited Partner. (a) (i) On or before the Offering Termination Date, the Managing General Partner shall make a Capital Contribution in cash to the Partnership of an amount equal to not less than 21-3/4% of the aggregate Capital Contributions of the Investor Partners. The Managing General Partner shall pay all Lease and tangible drilling costs as well as all Intangible Drilling Costs in excess of such costs paid by the Investor Partners with respect to the Partnership; to the extent that such costs are greater than the Managing General Partner's Capital Contribution set forth in the previous subsection, the Managing General Partner shall make such additional contributions in cash to the Partnership equal to such additional Costs; in the event of such additional Capital Contribution, the Managing General Partner's share of profits and losses and distributions shall equal the percentage arrived at by dividing the Managing General Partner's Capital Contribution by the Capital Available for Investment of the Partnership, except that such percentage may be revised by Sections 3.02 and 4.02. In consideration of making its Capital Contribution as reflected in this Section 2.01(a), becoming a General Partner, subjecting its assets to the liabilities of the Partnership, and undertaking other obligations as herein set forth, the Managing General Partner shall receive the interest in the Partnership allocated in Article III hereof. (b) The Initial Limited Partner shall contribute $100 in cash to the capital of the Partnership. Upon the earlier of the conversion of an Additional General Partner's interest into a Limited Partner's interest or the admission of a Limited Partner to the Partnership, the Partnership shall redeem in full, without interest or deduction, the Initial Limited Partner's Capital Contribution, and the Initial Limited Partner shall cease to be a Partner. 2.02 Capital Contributions of the Investor Partners. (a) Upon execution of this Agreement, each Investor Partner (whose names and addresses and number of Units to which Subscribed are set forth in Exhibit A) shall contribute to the capital of the Partnership the sum of $20,000 for each Unit purchased. The minimum subscription by an Investor Partner is one-quarter Unit ($5,000). (b) The contributions of the Investor Partners pursuant to subsection 2.02(a) hereof shall be in cash or by check subject to collection. (c) Until the Offering Termination Date and until such subsequent time as the contributions of the Investor Partners are invested in accordance with the provisions of the Prospectus, all monies received from persons subscribing as Investor Partners (i) shall continue to be the property of the investor making such payment, (ii) shall be held in escrow for such investor in the manner and to the extent provided in the Prospectus, and (iii) shall not be commingled with the personal monies or become an asset of the Managing General Partner or the Partnership. (d) Upon the original sale of Units by the Partnership, subscribers shall be admitted as Partners no later than 15 days after the release from the escrow account of the Capital Contributions to the Partnership, in accordance with the terms of the Prospectus; subscriptions shall be accepted or rejected by the Partnership within 30 days of their receipt; if rejected, all subscription monies shall be returned to the subscriber forthwith. (e) Except as provided in Section 4.03 hereof, any proceeds of the offering of Units for sale pursuant to the Prospectus not used, committed for use, or reserved as operating capital in the Partnership's operations within one year after the closing of such offering shall be distributed pro rata to the Investor Partners as a return of capital and the Managing General Partner shall reimburse such Investors for selling expenses, management fees, and offering expenses allocable to the return of capital. (f) Until proceeds from the public offering are invested in the Partnership's operations, such proceeds may be temporarily invested in income producing short-term, highly liquid investments, where there is appropriate safety of principal, such as U.S. Treasury Bills. Any such income shall be allocated pro rata to the Investor Partners providing such capital contributions. 2.03 Additional Contributions. Except as otherwise provided in this Agreement, no Investor Partner shall be required or obligated (a) to contribute any capital to the Partnership other than as provided in Section 2.02 hereof, or (b) to lend any funds to the Partnership. No interest shall be paid on any capital contributed to the Partnership pursuant to this Article II and, except as otherwise provided herein, no Partner, other than the Initial Limited Partner as authorized herein, may withdraw his Capital Contribution. The Units are nonassessable; however, General Partners are liable, in addition to their Capital Contributions, for Partnership obligations and liabilities represented by their ownership of interests as general partners, in accordance with West Virginia law. ARTICLE III Capital Accounts and Allocations 3.01 Capital Accounts. (a) General. A separate Capital Account shall be established and maintained for each Partner on the books and records of the Partnership. Capital Accounts shall be maintained in accordance with Treas. Reg. Section 1.704-1(b) and any inconsistency between the provisions of this Section 3.01 and such regulation shall be resolved in favor of the regulation. In the event the Managing General Partner shall determine that it is prudent to modify the manner in which the Capital Accounts, or any debits or credits thereto (including, without limitation, debits or credits relating to liabilities that are secured by contributed or distributed property or that are assumed by the Partnership of the Partners), are computed in order to comply with such regulations, the Managing General Partner may make such modification, provided that it is not likely to have a material effect on the amounts distributable to any Partner pursuant to Section 9.03 hereof upon the dissolution of the Partnership. The Managing General Partner also shall (i) make any adjustments that are necessary or appropriate to maintain equality between the Capital Accounts of the Partners and the amount of Partnership capital reflected on the Partnership's balance sheet, as computed for book purposes, in accordance with Treas. Reg. Section 1.704-1(b)(2)(iv)(q), and (ii) make any appropriate modifications in the event unanticipated events might otherwise cause this Agreement not to comply with Treas. Reg. Section 1.704-1(b). (b) Increases to Capital Accounts. Each Partner's Capital Account shall be credited with (i) the amount of money contributed by him to the Partnership; (ii) the amount of any Partnership liabilities that are assumed by him (within the meaning of Treas. Reg. Section 1.704-1(b)(2)(iv)(c)), but not by increases in his share of Partnership liabilities within the meaning of Code Section 752(a); (iii) the Gross Asset Value of property contributed by him to the Partnership (net of liabilities securing such contributed property that the Partnership is considered to assume or take subject to under Code Section 752); and (iv) allocations to him of Partnership Profits (or items thereof), including income and gain exempt from tax and Income and gain described in Treas. Reg. Section 1.704-1(b)(2)(iv)(g) (relating to adjustments to reflect book value). (c) Decreases to Capital Accounts. Each Partner's Capital Account shall be debited with (i) the amount of money distributed to him by the Partnership; (ii) the amount of his individual liabilities that are assumed by the Partnership (other than liabilities described in Treas. Reg. Section 1.704-1(b)(2)(iv)(b)(2) that are assumed by the Partnership and other than decreases in his share of Partnership liabilities within the meaning of Code Section 752(b)); (iii) the Gross Asset Value of property distributed to him by the Partnership (net of liabilities securing such distributed property that he is considered to assume or take subject to under Code Section 752); (iv) allocations to him of expenditures of the Partnership not deductible in computing Partnership taxable income and not properly chargeable to Capital Account (as described in Code Section 705(a)(2)(B)), and (v) allocations to him of Partnership Losses (or item thereof), including loss and deduction described in Treas. Reg. Section 1.704-1(b)(2)(iv)(g) (relating to adjustments to reflect book value), but excluding items described in (iv) above and excluding loss or deduction described in Treas. Reg. Section 1.704-1(b)(4)(iii) (relating to excess percentage depletion). (d) Adjustments to Capital Accounts Related to Depletion. (i) Solely for purposes of maintaining the Capital Accounts, each year the Partnership shall compute (in accordance with Treas. Reg. Section 1.704-1(b)(2)(iv)(k)) a simulated depletion allowance for each oil and gas property using that method, as between the cost depletion method and the percentage depletion method (without regard to the limitations of Code Section 613A(c)(3) which theoretically could apply to any Partner), which results in the greatest simulated depletion allowance. The simulated depletion allowance with respect to each oil and gas property shall reduce the Partners' Capital Accounts in the same proportion as the Partners were allocated adjusted basis with respect to such oil and gas property under Section 3.03(a) hereof. In no event shall the Partnership's aggregate simulated depletion allowance with respect to an oil and gas property exceed the Partnership's adjusted basis in the oil and gas property (maintained solely for Capital Account purposes). (ii) Upon the taxable disposition of an oil and gas property by the Partnership, the Partnership shall determine the simulated (hypothetical) gain or loss with respect to such oil and gas property (solely for Capital Account purposes) by subtracting the Partnership's simulated adjusted basis for the oil and gas property (maintained solely for Capital Account purposes) from the amount realized by the Partnership upon such disposition. Simulated adjusted basis shall be determined by reducing the adjusted basis by the aggregate simulated depletion charged to the Capital Accounts of all Partners in accordance with Section 3.01(d)(i) hereof. The Capital Accounts of the Partners shall be adjusted upward by the amount of any simulated gain on such disposition in proportion to such Partners' allocable share of the portion of total amount realized from the disposition of such property that exceeds the Partnership's simulated adjusted basis in such property. The Capital Accounts of the Partners shall be adjusted downward by the amount of any simulated loss in proportion to such Partners' allocable shares of the total amount realized from the disposition of such property that represents recovery of the Partnership's simulated adjusted basis in such property. (e) Restoration of Negative Capital Accounts. Except as otherwise provided in this Agreement, neither an Investor Partner nor the Initial Limited Partner shall be obligated to the Partnership or to any other Partner to restore any negative balance in his Capital Account. The Managing General Partner shall be obligated to restore the deficit balance in its Capital Account. 3.02 Allocation of Profits and Losses. (a) General. Except as provided in this Section 3.02 or in Section 2.01(a) and Section 3.03 hereof, Profits and Losses during the production phase of the Partnership shall be allocated 80% to the Investor Partners and 20% to the Managing General Partner; provided, that if the Managing General Partner's share of cash distributions is revised pursuant to Section 4.02, the allocations of Profits and Losses of the Partnership shall be allocated to reflect such revision. Notwithstanding the above allocations, the following special allocations shall be employed: (i) irrespective of any revisions effected by Section 2.01(a) or Section 4.02, IDC and recapture of IDC shall be allocated 100% to the Investor Partners and 0% to the Managing General Partner, except as otherwise provided in the following clause; however, in the event that a portion of the Capital Contribution of the Managing General Partner is utilized for IDC, as provided by Section 2.01(a)(ii), then IDC and recapture of IDC shall be allocated to the Investor Partners and the Managing General Partner in a percentage equal to their respective contribution to IDC; (ii) irrespective of any revisions effected by Section 2.01(a) or Section 4.02, the following provisions shall apply: Organization and Offering Costs net of commissions, due diligence expenses and wholesaling fees payable to the dealer manager and the soliciting dealers shall be paid by the Managing General Partner; such commissions, due diligence expenses and wholesaling fees payable to the dealer manager and the soliciting dealers shall be allocated 100% to the Investor Partners and 0% to the Managing General Partner; except that Organization and Offering Costs in excess of 10-1/2% of Subscriptions shall be allocated 100% to the Managing General Partner and 0% to the Investor Partners; (iii) irrespective of any revisions effected by Section 2.01(a) or Section 4.02, the Management Fee shall be allocated 100% to the Investor Partners and 0% to the Managing General Partner; (iv) irrespective of any revisions effected by Section 2.01(a) or Section 4.02, Costs of Leases and Costs of tangible equipment, including depreciation or cost recovery benefits, and revenues from the sale of equipment shall be allocated 0% to the Investor Partners and 100% to the Managing General Partner; (v) Drilling and Completion Costs shall be allocated 80% to the Investor Partners and 20% to the Managing General Partner; (vi) Direct Costs and Operating Costs shall be allocated 80% to the Investor Partners and 20% to the Managing General Partner; and (vii) irrespective of any revisions effected by Section 2.01(a) or Section 4.02, Administrative Costs shall be borne 100% by and allocated 100% to the Managing General Partner. (b) Capital Account Deficits. Notwithstanding anything to the contrary in Section 3.02(a), no Investor Partner shall be allocated any item to the extent that such allocation would create or increase a deficit in such Investor Partner's Capital Account. (i) Obligations to Restore. For purposes of this Section 3.02(b), in determining whether an allocation would create or increase a deficit in a Partner's Capital Account, such Capital Account shall be reduced for those items described in Treas. Reg. Section 1.704-1(b)(2)(ii)(d)(4), (5), and (6) and shall be increased by any amounts which such Partner is obligated to restore or is deemed obligated to restore pursuant to the penultimate sentences of Treas. Reg. Sections 1.704-2(g)(1) and 1.704-2(i)(5). Further, such Capital Accounts shall otherwise meet the requirements of Treas. Reg. Section 1.704-1(b)(2)(ii)(d). (ii) Reallocations. Any loss or deduction of the Partnership, the allocation of which to any Partner is prohibited by this Section 3.02(b), shall be reallocated to those Partners not having a deficit in their Capital Accounts (as adjusted in Section 3.02(b)(i)) in the proportion that the positive balance of each such Partner's adjusted Capital Account bears to the aggregate balance of all such Partners' adjusted Capital Accounts, with any remaining losses or deductions being allocated to the Managing General Partner. (iii) Qualified Income Offset. In the event any Investor Partner unexpectedly receives any adjustments, allocations, or distributions described in Treas. Reg. Section 1.704-1(b)(2)(ii)(d)(4), (5), or (6), items of Partnership income and gain shall be specifically allocated to such Partner in an amount and manner sufficient to eliminate (to the extent required by the Regulations) the total of the deficit balance in his Capital Account (as adjusted in Section 3.02(b)(i)) created by such adjustments, allocations, or distributions, provided that an allocation pursuant to this Section 3.02(b)(iii) shall be made if and only to the extent that such Partner would have a deficit in his Capital Account (as adjusted in Section 3.02(b)(i)) after all other allocations provided for in this Section 3 have been tentatively made as if this Section 3.02(b)(iii) were not in the Agreement. (iv) Gross Income Allocations. In the event an Investor Partner has a deficit Capital Account at the end of any Partnership fiscal year which is in excess of the sum of (i) the amount such Partner is obligated to restore pursuant to any provision of this Agreement and (ii) the amount such Partner is deemed to be obligated to restore pursuant to the penultimate sentences of Treas. Reg. Sections 1.704-2(g)(1) and 1.704-2(i)(5), such Partner shall be specially allocated items of Partnership income and gain in the amount of such excess as quickly as possible, provided that an allocation pursuant to this Section 3.02(b)(iv) shall be made only if and to the extent that such Partner would have a deficit Capital Account in excess of such sum after all other allocations provided for in this Section 3 have been made as if Section 3.02(b)(iii) hereof and this Section 3.02(b)(iv) were not in the Agreement. (c) Minimum Gain Chargeback. Notwithstanding any other provision of this Section 3.02, if there is a net decrease in Partnership Minimum Gain during any taxable year, pursuant to Treas. Reg. Section 1.704-2(f)(1), all Partners shall be allocated items of partnership income and gain for that year equal to that partner's share of the net decrease in Partnership Minimum Gain (within the meaning of Treas. Reg. Section 1.704-2(g)(2)). Notwithstanding the preceding sentence, no such chargeback shall be made to the extent one or more of the exceptions and/or waivers provided for in Treas. Reg. Section 1.704-2(f)(2)-(5) applies. Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Partner pursuant thereto. The items to be so allocated shall be determined in accordance with Treas. Reg. Section 1.704-2(f)(6). This Section 3.02(c) is intended to comply with the minimum gain chargeback requirement in such Section of the Regulations and shall be interpreted consistently therewith. To the extent permitted by such Section of the Regulations and for purposes of this Section 3.02(c) only, each Partner's Capital Account (as adjusted in Section 3.02(b)(i)) shall be determined prior to any other allocations pursuant to this Section 3 with respect to such tax year and without regard to any net decrease in Partner Minimum Gain during such fiscal year. (d) Partner Minimum Gain Chargeback. Notwithstanding any other provision of this Section 3 except Section 3.02(c), if there is a net decrease in Partner Minimum Gain attributable to a Partner Nonrecourse Debt during any Partnership fiscal year, rules similar to those contained in Section 3.02(c) shall apply in a manner consistent with Treas. Reg. Section 1.704-2(i)(4). This Section 3.02(d) is intended to comply with the minimum gain chargeback requirement in such Section of the Regulations and shall be interpreted consistently therewith. Solely for purposes of this Section 3.02(d), each Person's Capital Account deficit (as so adjusted) shall be determined prior to any other allocations pursuant to this Section 3 with respect to such fiscal year, other than allocations pursuant to Section 3.02(c) hereof. (e) Nonrecourse Deductions. Nonrecourse Deductions for any fiscal year or other period shall be specially allocated to the Partners (in proportion to their Units), in accordance with Treas. Reg. Section 1.704-2. (f) Partner Nonrecourse Deductions. Any Partner Nonrecourse Deductions for any fiscal year or other period shall be specially allocated to the Partner who bears the economic risk of loss with respect to the Partner Nonrecourse Debt to which such Partner Nonrecourse Deductions are attributable in accordance with Treas. Reg. Section 1.704-2(i). (g) Code Section 754 Adjustments. To the extent an adjustment to the adjusted tax basis of any Partnership asset pursuant to Code Section 734(b) or 743(b) is required, pursuant to Treas. Reg. Section 1.704-1(b)(2)(iv)(m), to be taken into account in determining Capital Accounts, the amount of such adjustment to the Capital Accounts shall be treated as an item of gain (if the adjustment increases the basis of the asset) or loss (if the adjustment decreases such basis) and such gain or loss shall be specially allocated to the Partners in a manner consistent with the manner in which their Capital Accounts are required to be adjusted pursuant to such Section of the Regulations. (h) Curative Allocations. (i) The "Regulatory Allocations" consist of the "Basic Regulatory Allocations," as defined in Section 3.02(h)(ii) hereof, the "Nonrecourse Regulatory Allocations," as defined in Section 3.02(h)(iii) hereof, and the "Partner Nonrecourse Regulatory Allocations," as defined in Section 3.02(h)(iv) hereof. (ii) The "Basic Regulatory Allocations" consist of allocations pursuant to Section 3.02(b)(ii), (iii), and (iv) hereof. Notwithstanding any other provision of this Agreement, other than the Regulatory Allocations, the Basic Regulatory Allocations shall be taken into account in allocating items of income, gain, loss, and deduction among the Partners so that, to the extent possible, the net amount of such allocations of other items and the Basic Regulatory Allocations to each Partner shall be equal to the net amount that would have been allocated to each such Partner if the Basic Regulatory Allocations had not occurred. For purposes of applying the foregoing sentence, allocations pursuant to this Section 3.02(h)(ii) shall only be made with respect to allocations pursuant to Section 3.02(g) hereof to the extent the Managing General Partner reasonably determines that such allocations will otherwise be inconsistent with the economic agreement among the parties to this Agreement. (iii) The "Nonrecourse Regulatory Allocations" consist of all allocations pursuant to Section 3.02(c) and 3.02(e) hereof. Notwithstanding any other provision of this Agreement, other than the Regulatory Allocations, the Nonrecourse Regulatory Allocations shall be taken into account in allocating items of income, gain, loss, and deduction among the Partners so that, to the extent possible, the net amount of such allocations of other items and the Nonrecourse Regulatory Allocations to each Partner shall be equal to the net amount that would have been allocated to each Partner if the Nonrecourse Regulatory Allocations had not occurred. For purposes of applying the foregoing sentence (i) no allocations pursuant to this Section 3.02(h)(iii) shall be made prior to the Partnership fiscal year during which there is a net decrease in Partnership Minimum Gain, and then only to the extent necessary to avoid any potential economic distortions caused by such net decrease in Partnership Minimum Gain, and (ii) allocations pursuant to this Section 3.02(h)(iii) shall be deferred with respect to allocations pursuant to Section 3.02(e) hereof to the extent the Managing General Partner reasonably determines that such allocations are likely to be offset by subsequent allocations pursuant to Section 3.02(c). (iv) The "Partner Nonrecourse Regulatory Allocations" consist of all allocations pursuant to Sections 3.02(d) and 3.02(f) hereof. Notwithstanding any other provision of this Agreement, other than the Regulatory Allocations, the Partner Nonrecourse Regulatory Allocations shall be taken into account in allocating items of income, gain, loss, and deduction among the Partners so that, to the extent possible, the net amount of such allocations of other items and the Partner Nonrecourse Regulatory Allocations to each Partner shall be equal to the net amount that would have been allocated to each such Partner if the Partner Nonrecourse Regulatory Allocations had not occurred. For purposes of applying the foregoing sentence (i) no allocations pursuant to this Section 3.02(h)(iv) shall be made with respect to allocations pursuant to Section 3.02(f) relating to a particular Partner Nonrecourse Debt prior to the Partnership fiscal year during which there is a net decrease in Partner Minimum Gain attributable to such Partner Nonrecourse Debt, and then only to the extent necessary to avoid any potential economic distortions caused by such net decrease in Partner Minimum Gain, and (ii) allocations pursuant to this Section 3.02(h)(iv) shall be deferred with respect to allocations pursuant to Section 3.02(f) hereof relating to a particular Partner Nonrecourse Debt to the extent the Managing General Partner reasonably determines that such allocations are likely to be offset by subsequent allocations pursuant to Section 3.02(d) hereof. (v) The Managing General Partner shall have reasonable discretion with respect to each Partnership fiscal year, to apply the provisions of Sections 3.02(h)(ii), (iii), and (iv) hereof among the Partners in a manner that is likely to minimize such economic distortions. (i) Other Allocations. Except as otherwise provided in this Agreement, all items of Partnership income, loss, deduction, and any other allocations not otherwise provided for shall be divided among the Unit Holders in the same proportions as they share Profits or Losses, as the case may be, for the year. (j) Agreement to be Bound. The Partners are aware of the income tax consequences of the allocations made by this Section 3.02 and hereby agree to be bound by the provisions of this Section 3.02 in reporting their shares of Partnership income and loss for income tax purposes. (k) Excess Nonrecourse Liabilities. Solely for purposes of determining a Partner's proportionate share of the "excess nonrecourse liabilities" of the Partnership within the meaning of Treas. Reg. Section 1.752-3(a)(3), the Partners' interests in Partnership profits are as follows: Investor Partners, 80% (in proportion to their Units) and the Managing General Partner, 20%. (l) Allocation Variations. The Managing General Partner shall have the authority to vary allocations to preserve and protect the intention of the Partners as follows: (i) It is the intention of the Partners that each Partner's distributive share of income, gain, loss, deduction or credit (or any item thereof) shall be determined and allocated in accordance with this Article 3 to the fullest extent permitted by Code Section 704(b). In order to preserve and protect the allocations provided for in this Article 3, the Managing General Partner shall have the authority to allocate income, gain, loss, deduction or credit (or any item thereof) arising in any year differently than that expressly provided for in this Article 3, if and to the extent that determining and allocating income, gain, loss, deduction or credit (or any item thereof) in the manner expressly provided for in this Article 3 would cause the allocations of each Partner's distributive share of income, gain, loss, deduction or credit (or any item thereof) not to be permitted by Code Section 704(b) and the Regulations promulgated thereunder. Any allocation made pursuant to this Section 3.02(l) shall be deemed to be a complete substitute for any allocation otherwise expressly provided for in this Article 3, and no amendment of this Agreement or further consent of any Partner shall be required therefor. (ii) In making any such allocation (the "new allocation") under this Section 3.02(l) the Managing General Partner shall be authorized to act only after having been advised by the Partnership's accountants and/or counsel that, under Code Section 704(b) and the Regulations thereunder, (i) the new allocation is necessary, and (ii) the new allocation is the minimum modification of the allocations otherwise expressly provided for in this Article 3 which is necessary in order to assure that, either in the then current year or in any preceding year, each Partner's distributive share of income, gain, loss, deduction or credit (or any item thereof) is determined and allocated in accordance with this Article 3 to the fullest extent permitted by Code Section 704(b) and the Regulations thereunder. (iii) If the Managing General Partner is required by this Section 3.02(l) to make any new allocation in a manner less favorable to the Investor Partners than is otherwise expressly provided for in this Article 3, then the Managing General Partner shall have the authority, only after having been advised by the Partnership's accountants and/or counsel that they are permitted by Code Section 704(b), to allocate income, gain, loss, deduction or credit (or any item thereof) arising in later years in such a manner as will make the allocations of income, gain, loss, deduction or credit (or any item thereof) to the Investor Partners as comparable as possible to the allocations otherwise expressly provided for or contemplated by this Article 3. (iv) Any new allocation made by the Managing General Partner under this Section 3.02(l) in reliance upon the advice of the Partnership's accountants and/or counsel shall be deemed to be made pursuant to the fiduciary obligation of the Managing General Partner to the Partnership and the Investor Partners, and no such new allocation shall give rise to any claim or cause of action by any Investor Partner. (m) Tax Allocations: Code Section 704(c). In accordance with Code Section 704(c) and the Regulations thereunder, income, gain, loss, and deduction with respect to any property contributed to the capital of the Partnership shall, solely for tax purposes, be allocated among the Partners so as to take account of any variation between the adjusted basis of such property to the Partnership for federal income tax purposes and its initial Gross Asset Value (computed in accordance with Section 1.08(r)(1). In the event the Gross Asset Value of any Partnership asset is adjusted pursuant to Section 1.08(r)(1) hereof, subsequent allocations of income, gain, loss, and deduction with respect to such asset shall take account of any variation between the adjusted basis of such asset for federal income tax purposes and its Gross Asset Value in the same manner as under Code Section 704(c) and the Regulations thereunder. Any elections or other decisions relating to such allocations shall be made by the Managing General Partner in any manner that reasonably reflects the purpose and intention of this Agreement. Allocations pursuant to this Section 3.02(m) are solely for purposes of federal, state, and local taxes and shall not affect, or in any way be taken into account in computing, any Person's Capital Account or share of Profits, Losses, other items, or distributions pursuant to any provision of this Agreement. 3.03 Depletion. (a) The depletion deduction with respect to each oil and gas property of the Partnership shall be computed separately for each Partner in accordance with Code Section 613A(c)(7)(D) for Federal income tax purposes. For purposes of such computation, the adjusted basis of each oil and gas property shall be allocated in accordance with the Partners' interests in the capital of the Partnership. Among the Investor Partners, such adjusted basis shall be apportioned among them in accordance with the number of Units held. (b) Upon the taxable disposition of an oil or gas property by the Partnership, the amount realized from and the adjusted basis of such property shall be allocated among the Partners (for purposes of calculating their individual gain or loss on such disposition for Federal income tax purposes) as follows: (i) The portion of the total amount realized upon the taxable disposition of such property that represents recovery of its simulated adjusted tax basis therein (as calculated pursuant to Section 3.01(d) hereof) shall be allocated to the Partners in the same proportion as the aggregate adjusted basis of such property was allocated to such Partners (or their predecessors in interest) pursuant to Section 3.03(a) hereof; and (ii) The portion of the total amount realized upon the taxable disposition of such property that represents the excess over the simulated adjusted tax basis therein shall be allocated in accordance with the provisions of Section 3.02 hereof as if such gain constituted an item of Profit. 3.04 Apportionment Among Partners. (a) Except as otherwise provided in this Agreement, all allocations and distributions to the Investor Partners shall be apportioned among them pro rata based on Units held by the Partners. (b) For purposes of Section 3.04(a) hereof, an Investor Partner's pro rata share in Units shall be calculated as of the end of the taxable year for which such allocation has been made; provided, however, that if a transferee of a Unit is admitted as an Investor Partner during the course of the taxable year, the apportionment of allocations and distributions between the transferor and transferee of such Unit shall be made in the manner provided in Section 3.04(c) hereof. (c) If, during any taxable year of the Partnership, there is a change in any Partner's interest in the Partnership, each Partner's allocation of any item of income, gain, loss, deduction, or credit of the Partnership for such taxable year, other than "allocable cash basis items" shall be determined by taking into account the varying interests of the Partners pursuant to such method as is permitted by Code Section 706(d) and the regulations thereunder. Each Partner's share of "allocable cash basis items" shall be determined in accordance with Code Section 706(d)(2) by (i) assigning the appropriate portion of each item to each day in the period to which it is attributable, and (ii) allocating the portion assigned to any such day among the Partners in proportion to their interests in the Partnership at the close of such day. "Allocable cash basis item" shall have the meaning ascribed to it by Code Section 706(d)(2)(B) and the regulations thereunder. ARTICLE IV Distributions 4.01 Time of Distribution. Cash available for distribution shall be determined by the Managing General Partner. The Managing General Partner shall distribute, in its discretion, such cash deemed available for distribution, but such distributions shall be made not less frequently than quarterly. 4.02 Distributions. (a) Except as otherwise provided below and in Section 2.01(a), all distributions (other than those made to wind up the Partnership in accordance with Section 9.03 hereof) shall be made 80% to the Investor Partners and 20% to the Managing General Partner. If the performance standard as defined below in subsection (b) is not fulfilled by a particular Partnership, that Partnership's sharing arrangement shall be modified, as set forth herein, for up to a ten-year period commencing six months after the closing date of that Partnership and ending ten years following such closing date. (b) The performance standard shall be as follows: (i) If the Average Annual Rate of Return, as defined below, to the Investor Partners is less than 12.8% of their Subscriptions, the allocation rate of all items of profit and loss and cash available for distribution for Investor Partners shall be increased by ten percentage points above the then-current sharing arrangements for Investor Partners and the allocation rate with respect to such items for the Managing General Partner will be decreased by ten percentage points below the then-current sharing arrangements for the Managing General Partner, until the Average Annual Rate of Return shall have increased to 12.8% or more, or until ten years and six months shall have expired from the closing date of the Partnership, whichever event shall occur sooner. (ii) Average Annual Rate of Return for purposes of this sharing arrangement shall be defined as (1) the sum of cash distributions and estimated initial tax savings of 25% of Subscriptions, realized for a $10,000 investment in the Partnership, divided by (2) $10,000 multiplied by the number of years (less six months) which have elapsed since the closing of the Partnership. (c) The Partnership shall not require that Investor Partners reinvest their share of cash available for distribution in the Partnership. In no event shall funds be advanced or borrowed for purposes of distributions, if the amount of such distributions would exceed the Partnership's accrued and received revenues for the previous four quarters, less paid and accrued operating costs with respect to such revenues. The determination of such revenues and costs shall be made in accordance with generally accepted accounting principles, consistently applied. Cash distributions from the Partnership to the Managing General Partner shall only be made in conjunction with distributions to Investor Partners and only out of funds properly allocated to the Managing General Partner's account. 4.03 Capital Account Deficits. No distributions shall be made to any Investor Partner to the extent such distribution would create or increase a deficit in such Partner's Capital Account (as adjusted in Section 3.02(b)(i)). Any distribution which is hereby prohibited shall be made to those Partners not having a deficit in their Capital Accounts (as adjusted in Section 3.02(b)(i)) in the proportion that the positive balance of each such Partner's adjusted Capital Account bears to the aggregate balance of all such Partners' adjusted Capital Accounts. Any cash available for distribution remaining after reduction of all adjusted Capital Accounts to zero shall be distributed to the Managing General Partner. 4.04 Liability Upon Receipt of Distributions. (a) If a Partner has received a return of any part of his Capital Contribution without violation of the Partnership Agreement or the Act, he is liable to the Partnership for a period of one year thereafter for the amount of such returned contribution, but only to the extent necessary to discharge the Partnership's liabilities to creditors who extended credit to the Partnership during the period the Capital Contribution was held by the Partnership. (b) If a Partner has received a return of any part of his Capital Contribution in violation of either the Partnership Agreement or the Act, he is liable to the Partnership for a period of six years thereafter for the amount of the Capital Contribution wrongfully returned. (c) A Partner receives a return of his Capital Contribution to the extent that the distribution to him reduces his share of the fair value of the net assets of the Partnership below the value, as set forth in the records required to be kept by West Virginia law, of his Capital Contribution which has not been distributed to him. ARTICLE V Activities 5.01 Management. The Managing General Partner shall conduct, direct, and exercise full and exclusive control over all activities of the Partnership. Investor Partners shall have no power over the conduct of the affairs of the Partnership or otherwise commit or bind the Partnership in any manner. The Managing General Partner shall manage the affairs of the Partnership in a prudent and businesslike fashion and shall use its best efforts to carry out the purposes and character of the business of the Partnership. 5.02 Conduct of Operations. (a)(i) The Managing General Partner shall establish a program of operations for the Partnership which shall be in conformance with the following policies: (x) no less than 90% of the Capital Contributions net of Organization and Offering Costs and the Management Fee shall be applied to drilling and completing Development Wells; (y) the Partnership shall drill all of its wells in West Virginia, Ohio, Pennsylvania, Colorado, New York, Kentucky, Michigan, Indiana, Kansas, Montana, South Dakota, Tennessee, Utah, Wyoming, Nebraska, North Dakota, and/or Oklahoma; and (z) the Prospects will be acquired pursuant to an arrangement whereby the Partnership will acquire up to 100% of the Working Interest, subject to landowners' royalty interests and the royalty interests payable to unaffiliated third parties in varying amounts, provided that the weighted average of such royalty interests for all Prospects of the Partnership shall not exceed 20%. (ii) The Investor Partners agree to participate in the Partnership's program of operations as established by the Managing General Partner; provided, that no well drilled to the point of setting casing need be completed if, in the Managing General Partner's opinion, such well is unlikely to be productive of oil or gas in quantities sufficient to justify the expenditures required for well completion. The Partnership may participate with others in the drilling of wells and it may enter into joint ventures, partnerships, or other such arrangements. (b) All transactions between the Partnership and the Managing General Partner or its Affiliates shall be on terms no less favorable than those terms which could be obtained between the Partnership and independent third parties dealing at arm's-length, subject to the provisions of Section 5.07 hereof. (c) The Partnership shall not participate in any joint operations on any co-owned Lease unless there has been acquired or reserved on behalf of the Partnership the right to take in kind or separately dispose of its proportionate share of the oil and gas produced from such Lease exclusive of production which may be used in development and production operations on the Lease and production unavoidably lost, and, if the Managing General Partner is the operator of such Lease, the Managing General Partner has entered into written agreements with every other person or entity owning any working or operating interest reserving to such person or entity a similar right to take in-kind, unless, in the opinion of counsel to the Partnership, the failure to reserve such right to take in-kind will not result in the Partnership being treated as a member of an association taxable as a corporation for Federal income tax purposes. (d) The relationship of the Partnership and the Managing General Partner (or any Affiliate retaining or acquiring an interest) as co-owners in Leases, except to the extent superseded by an Operating Agreement consistent with the preceding paragraph and except to the extent inconsistent with this Partnership Agreement, shall be governed by the AAPL Form 610 Model Operating Agreement-1982, with a provision reserving the right to take production in-kind, naming the Managing General Partner as operator and the Partnership as a nonoperator, and with the accounting procedure to govern as the accounting procedures under such Operating Agreements. (e) The Managing General Partner is generally expected to act as the operator of Partnership wells, and the Managing General Partner may designate such other persons as it deems appropriate to conduct the actual drilling and producing operations of the Partnership. (f) As operator of Partnership wells, the Managing General Partner or its Affiliates shall receive per-well charges for each producing well based on the Working Interest acquired by the Partnership. These per-well charges shall be subject to annual adjustment beginning January 1, 2003 [with respect to Partnerships designated as "PDC 2001- Limited Partnership," January 1, 2004 with respect to Partnerships designated as "PDC 2002- Limited Partnership" and January 1, 2005 with respect to Partnerships designated as "PDC 2003- Limited Partnership"] as provided in the accounting procedures of the operating agreements. (g) The Managing General Partner shall drill wells pursuant to drilling contracts with the Partnership based upon competitive prices and terms in the geographic area of operations, and to the extent that such prices exceed its Costs, the Managing General Partner shall be deemed to have received compensation. (h) The Managing General Partner shall be reimbursed by the Partnership for Direct Costs. The Managing General Partner shall not be reimbursed for any Administrative Costs. All other expenses shall be borne by the Partnership. (i) The Managing General Partner and its Affiliates may enter into other transactions (embodied in a written contract) with the Partnership, such as providing services, supplies, and equipment, and shall be entitled to compensation for such services at prices and on terms that are competitive in the geographic area of operations. (j) The Partnership shall make no loans to the Managing General Partner or any Affiliate thereof. (k) Neither the Managing General Partner nor any Affiliate shall loan any funds to the Partnership. (l) The funds of the Partnership shall not be commingled with the funds of any other Person. (m) Notwithstanding any provision herein to the contrary, no creditor shall receive, as a result of making any loan, a direct or indirect interest in the profits, capital, or property of the Partnership other than as a secured creditor. (n) The Managing General Partner shall have a fiduciary responsibility for the safekeeping and use of all funds and assets of the Partnership, whether or not in the Managing General Partner's possession or control, and shall not employ or permit another to employ such funds or assets in any manner except for the exclusive benefit of the Partnership. 5.03 Acquisition and Sale of Leases. (a) To the extent the Partnership does not acquire a full interest in a Lease from the Managing General Partner, the remainder of the interest in such Lease may be held by the Managing General Partner which may either retain and exploit it for its own account or sell or otherwise dispose of all or a part of such remaining interest. Profits from such exploitation and/or disposition shall be for the benefit of the Managing General Partner to the exclusion of the Partnership. Any Leases acquired by the Partnership from the Managing General Partner shall be acquired only at the Managing General Partner's Cost, unless the Managing General Partner shall have reason to believe that Cost is in excess of the fair market value of such property, in which case the price shall not exceed the fair market value. The Managing General Partner shall obtain an appraisal from a qualified independent expert with respect to sales of properties of the Managing General Partner and its Affiliates to the Partnership. Neither the Managing General Partner nor any Affiliate shall acquire or retain any carried, reversionary, or Overriding Royalty Interest on the Lease interests acquired by the Partnership, nor shall the Managing General Partner enter into any farmout arrangements with respect to its retained interest, except as provided in Section 5.05 hereof. (b) The Partnership shall acquire only Leases reasonably expected to meet the stated purposes of the Partnership. No Leases shall be acquired for the purpose of a subsequent sale or farmout unless the acquisition is made after a well has been drilled to a depth sufficient to indicate that such an acquisition would be in the Partnership's best interest. (c) Neither the Managing General Partner nor its Affiliates, except other partnerships sponsored by them, shall purchase any productive properties from the Partnership. 5.04 Title to Leases. (a) Record title to each Lease acquired by the Partnership may be temporarily held in the name of the Managing General Partner, or in the name of any nominee designated by the Managing General Partner, as agent for the Partnership until a productive well is completed on a Lease. Thereafter, record title to Leases shall be assigned to and placed in the name of the Partnership. (b) The Managing General Partner shall take the necessary steps in its best judgment to render title to the Leases to be assigned to the Partnership acceptable for the purposes of the Partnership. No operation shall be commenced on any Prospect acquired by the Partnership unless the Managing General Partner is satisfied that the undertaking of such operation would be in the best interest of Investor Partners and the Partnership. The Managing General Partner shall be free, however, to use its own best judgment in waiving title requirements and shall not be liable to the Partnership or the Investor Partners for any mistakes of judgment unless such mistakes were made in a manner not in accordance with general industry standards in the geographic area and such mistakes were not the result of negligence by the Managing General Partner; nor shall the Managing General Partner or its Affiliates be deemed to be making any warranties or representations, express or implied, as to the validity or merchantability of the title to any Lease assigned to the Partnership or the extent of the interest covered thereby. 5.05 Farmouts. (a) No Partnership Lease shall be farmed out, sold, or otherwise disposed of unless the Managing General Partner determines that (i) the Partnership lacks sufficient funds to drill on such Lease and is unable to obtain suitable financing, (ii) the Leases have been downgraded by events occurring after assignment to the Partnership, (iii) drilling on the Leases would result in an excessive concentration of Partnership funds creating, in the Managing General Partner's opinion, undue risk to the Partnership, or (iv) the Managing General Partner, exercising the standard of a prudent operator, determines that the farmout is in the best interests of the Partnership. (b) Farmouts between the Partnership and the Managing General Partner or its Affiliates, including any other affiliated limited partnership, shall be effected on terms deemed fair by the Managing General Partner. The Managing General Partner, exercising the standard of a prudent operator, shall determine that the farmout is in the best interest of the Partnership and the terms of the farmout are consistent with and, in any case, no less favorable to the Partnership than those utilized in the geographic area of operations for similar arrangements. The respective obligations and revenue sharing of all affiliated parties to the transactions shall be substantially the same, and the compensation arrangement or any other interest or right of either the Managing General Partner or its Affiliates shall be substantially the same in each participating partnership or, if different, shall be reduced to reflect the lower compensation arrangement. 5.06 Release, Abandonment, and Sale or Exchange of Properties. Except as provided elsewhere in this Article V and in Section 6.03, the Managing General Partner shall have full power to dispose of the production and other assets of the Partnership, including the power to determine which Leases shall be released or permitted to terminate, those wells to be abandoned, whether any Lease or well shall be sold or exchanged, and the terms therefor. In the event the Managing General Partner sells, transfers, or otherwise disposes of nonproducing property of the Partnership, the sale, transfer, or disposition shall, to the extent possible, be made at a price which is the higher of the fair market value of the property on the date of the sale, transfer, or disposition or the Cost of such property to the Partnership. 5.07 Certain Transactions. (a) Whenever the Managing General Partner or its Affiliates sell, transfer, or assign an interest in a Prospect to the Partnership, they shall assign to the Partnership an equal proportionate interest in each of the Leases comprising the Prospect. If the Managing General Partner or its Affiliates (except another affiliated partnership in which the interest of the Managing General Partner or its Affiliates is identical to or less than their interest in the Partnership) subsequently propose to acquire an interest in a Prospect in which the Partnership possesses an interest or in a Prospect abandoned by the Partnership within one year preceding such proposed acquisition, the Managing General Partner or its Affiliates shall offer an equivalent interest therein to the Partnership; and, if funds, including borrowings, are not available to the Partnership to enable it to consummate a purchase of an equivalent interest in such property and pay the development costs thereof, neither the Managing General Partner nor any of its Affiliates shall acquire such interest or property. The term "abandoned" shall mean the termination, either voluntarily or by operation of the Lease or otherwise, of all of the Partnership's interest in the Prospect. These limitations shall not apply after the lapse of five years from the date of formation of the Partnership. (b) The geological limits of a Prospect shall be enlarged or contracted on the basis of subsequently acquired geological data that further defines the productive limits of the underlying oil and/or gas reservoir and shall include all of the acreage determined by such subsequent data to be encompassed by such reservoir; further, where the Managing General Partner or Affiliate owns a separate property interest in such enlarged area, such interest shall be sold to the Partnership if the activities of the Partnership were material in establishing the existence of proved undeveloped reserves which are attributable to such separate property interest; provided, however, that the Partnership shall not be required to expend additional funds unless they are available from the initial capitalization of the Partnership or if the Managing General Partner believes it is prudent to borrow for the purpose of acquiring such additional acreage. (c) The Partnership shall not purchase properties from or sell properties to any other affiliated partnership. This prohibition, however, shall not apply to transactions among affiliated partnerships by which property is transferred from one to another in exchange for the transferee's obligation to conduct drilling activities on such property or to joint ventures among such affiliated partnerships, provided that the respective obligations and revenue sharing of all parties to the transaction are substantially the same and the compensation arrangement or any other interest or right of either the Managing General Partner or its Affiliates is the same in each affiliated partnership, or, if different, the aggregate compensation of the Managing General Partner is reduced to reflect the lower compensation arrangement. (d) During the existence of the Partnership, and before it has ceased operations, neither the Managing General Partner nor any of its Affiliates (excluding another partnership where the Managing General Partner's or its Affiliates' interest in such partnership is identical to or less than their interest in the Partnership) shall acquire, retain, or drill for their own account any oil and gas interest in any Prospect in which the Partnership possesses an interest, except for transactions whereby the Managing General Partner or such Affiliate acquires or retains a proportionate Working Interest, the respective obligations of the Managing General Partner or the Affiliate and the Partnership are substantially the same after the sale of the interest to the Partnership, and the Managing General Partner's or Affiliate's interest in revenues does not exceed the amount proportionate to its Working Interest. (e) Any services, equipment, or supplies which the Managing General Partner or an Affiliate furnishes to the Partnership shall be furnished at the lesser of the Managing General Partner's or the Affiliate's Cost or a competitive rate which could be obtained in the geographical area of operations unless the Managing General Partner or any Affiliate is engaged to a substantial extent, as an ordinary and ongoing business, in providing such services, equipment, or supplies to others in the industry, in which event, the services, supplies, or equipment may be provided by such person to the Partnership at prices competitive with those charged by others in the geographical area of operations which would be available to the Partnership. If such entity is not engaged in the business as set forth above, then such compensation, price or rental shall be the cost of such services, equipment or supplies to such entity, or the competitive rate which could be obtained in the area, whichever is less. Any drilling services provided by the Managing General Partner or its Affiliates shall be billed only on a per foot, per day, or per hour rate, or some combination thereof. No turnkey drilling contracts shall be made between the Managing General Partner or its Affiliates and the Partnership. Neither the Managing General Partner nor its Affiliates shall profit by drilling in contravention of its fiduciary obligations to the Partnership. Any such services for which the Managing General Partner or an Affiliate is to receive compensation shall be embodied in a written contract which precisely describes the services to be rendered and all compensation to be paid. (f) Advance payments by the Partnership to the Managing General Partner are prohibited, except where necessary to secure tax benefits of prepaid drilling costs. These payments, if any, shall not include nonrefundable payments for completion costs prior to the time that a decision is made that the well or wells warrant a completion attempt. (g) Neither the Managing General Partner nor its Affiliates shall make any future commitments of the Partnership's production which do not primarily benefit the Partnership, nor shall the Managing General Partner or any Affiliate utilize Partnership funds as compensating balances for the benefit of the Managing General Partner or the Affiliate. (h) No rebates or give-ups may be received by the Managing General Partner or any of its Affiliates, nor may the Managing General Partner or any Affiliate participate in any reciprocal business arrangements which would circumvent these restrictions. (i) During a period of five years from the date of formation of the Partnership, if the Managing General Partner or any of its Affiliates proposes to acquire from an unaffiliated person an interest in a Prospect in which the Partnership possesses an interest or in a Prospect in which the Partnership's interest has been terminated without compensation within one year preceding such proposed acquisition, the following conditions shall apply: (1) If the Managing General Partner or the Affiliate does not currently own property in the Prospect separately from the Partnership, then neither the Managing General Partner nor the Affiliate shall be permitted to purchase an interest in the Prospect. (2) If the Managing General Partner or the Affiliate currently owns a proportionate interest in the Prospect separately from the Partnership, then the interest to be acquired shall be divided between the Partnership and the Managing General Partner or the Affiliate in the same proportion as is the other property in the Prospect; provided however, if cash or financing is not available to the Partnership to enable it to consummate a purchase of the additional interest to which it is entitled, then neither the Managing General Partner nor the Affiliate shall be permitted to purchase any additional interest in the Prospect. (j) If the Partnership acquires property pursuant to a farmout or joint venture from an affiliated program, the Managing General Partner's and/or its Affiliates' aggregate compensation associated with the property and any direct and indirect ownership interest in the property may not exceed the lower of the compensation and ownership interest the Managing General Partner and/or its Affiliates could receive if the property were separately owned or retained by either one of the programs. (k) Neither the Managing General Partner nor any Affiliate, including affiliated programs, may purchase or acquire any property from the Partnership, directly or indirectly, except pursuant to transactions that are fair and reasonable to the Investor Partners of the Partnership and then subject to the following conditions: (1) A sale, transfer or conveyance, including a farmout, of an undeveloped property from the Partnership to the Managing General Partner or an Affiliate, other than an affiliated program, must be made at the higher of cost or fair market value. (2) A sale, transfer or conveyance of a developed property from the Partnership to the Managing General Partner or an Affiliate, other than an affiliated program in which the interest of the Managing General Partner is substantially similar to or less than its interest in the subject Partnership, shall not be permitted except in connection with the liquidation of the Partnership and then only at fair market value. (3) Except in connection with farmouts or joint ventures made in compliance with Section 5.07(j) above, a transfer of an undeveloped property from the Partnership to an affiliated drilling program must be made at fair market value if the property has been held for more than two years. Otherwise, if the Managing General Partner deems it to be in the best interest of the Partnership, the transfer may be made at cost. (4) Except in connection with farmouts or joint ventures made in compliance with Section 5.07(j) above, a transfer of any type of property from the Partnership to an affiliated production purchase or income program must be made at fair market value if the property has been held for more than six months or there have been significant expenditures made in connection with the property. Otherwise, if the Managing General Partner deems it to be in the best interest of the Partnership, the transfer may be made at cost as adjusted for intervening operations. (l) If the Partnership participates in other partnerships or joint ventures (multi-tier arrangements), the terms of any such arrangements shall not result in the circumvention of any of the requirements or prohibitions contained in this Partnership Agreement, including the following: (1) there will be no duplication or increase in organization and offering expenses, the Managing General Partner's compensation, Partnership expenses or other fees and costs; (2) there will be no substantive alteration in the fiduciary and contractual relationship between the Managing General Partner and the Investor Partners; and (3) there will be no diminishment in the voting rights of the Investor Partners. (m) In connection with a proposed Roll-Up, the following shall apply: (1) An appraisal of all Partnership assets shall be obtained from a competent independent expert. If the appraisal will be included in a prospectus used to offer the securities of a Roll-Up Entity, the appraisal shall be filed with the Securities and Exchange Commission and the Administrator as an exhibit to the registration statement for the offering. The appraisal shall be based on all relevant information, including current reserve estimates prepared by an independent petroleum consultant, and shall indicate the value of the Partnership's assets assuming an orderly liquidation as of a date immediately prior to the announcement of the proposed Roll-Up transaction. The appraisal shall assume an orderly liquidation of Partnership assets over a 12-month period. The terms of the engagement of the independent expert shall clearly state that the engagement is for the benefit of the Partnership and the Investor Partners. A summary of the independent appraisal, indicating all material assumptions underlying the appraisal, shall be included in a report to the Investor Partners in connection with a proposed Roll-Up. (2) In connection with a proposed Roll-Up, Investor Partners who vote "no" on the proposal shall be offered the choice of: (i) accepting the securities of the Roll-Up Entity offered in the proposed Roll-Up; or (ii) (a) remaining as Investor Partners in the Partnership and preserving their interests therein on the same terms and conditions as existed previously; or (b) receiving cash in an amount equal to the Investor Partners' pro-rata share of the appraised value of the net assets of the Partnership. (3) The Partnership shall not participate in any proposed Roll-Up which, if approved, would result in the diminishment of any Investor Partner's voting rights under the Roll-Up Entity's chartering agreement. In no event shall the democracy rights of Investor Partners in the Roll-Up Entity be less than those provided for under Sections 7.07 and 7.08 of this Agreement. If the Roll-Up Entity is a corporation, the democracy rights of Investor Partners shall correspond to the democracy rights provided for in this Agreement to the greatest extent possible. (4) The Partnership shall not participate in any proposed Roll-Up transaction which includes provisions which would operate to materially impede or frustrate the accumulation of shares by any purchaser of the securities of the Roll-Up Entity (except to the minimum extent necessary to preserve the tax status of the Roll-Up Entity); nor shall the Partnership participate in any proposed Roll-Up transaction which would limit the ability of an Investor Partner to exercise the voting rights of its securities of the Roll-Up Entity on the basis of the number of Partnership Units held by that Investor Partner. (5) The Partnership shall not participate in a Roll-Up in which Investor Partners' rights of access to the records of the Roll-Up Entity will be less than those provided for under Section 8.01 of this Agreement. (6) The Partnership shall not participate in any proposed Roll-Up transaction in which any of the costs of the transaction would be borne by the Partnership if the Roll-Up is not approved by the Investor Partners. (7) The Partnership shall not participate in a Roll-Up transaction unless the Roll-Up transaction is approved by at least 66 2/3% in interest of the Investor Partners. ARTICLE VI Managing General Partner 6.01 Managing General Partner. The Managing General Partner shall have the sole and exclusive right and power to manage and control the affairs of and to operate the Partnership and to do all things necessary to carry on the business of the Partnership for the purposes described in Section 1.03 hereof and to conduct the activities of the Partnership as set forth in Article V hereof. No financial institution or any other person, firm, or corporation dealing with the Managing General Partner shall be required to ascertain whether the Managing General Partner is acting in accordance with this Agreement, but such financial institution or such other person, firm, or corporation shall be protected in relying solely upon the deed, transfer, or assurance of and the execution of such instrument or instruments by the Managing General Partner. The Managing General Partner shall devote so much of its time to the business of the Partnership as in its judgment the conduct of the Partnership's business shall reasonably require and shall not be obligated to do or perform any act or thing in connection with the business of the Partnership not expressly set forth herein. The Managing General Partner may engage in business ventures of any nature and description independently or with others and neither the Partnership nor any of its Investor Partners shall have any rights in and to such independent ventures or the income or profits derived therefrom. However, except as otherwise provided herein, the Managing General Partner and any of its Affiliates may pursue business opportunities that are consistent with the Partnership's investment objectives for their own account only after they have determined that such opportunity either cannot be pursued by the Partnership because of insufficient funds or because it is not appropriate for the Partnership under the existing circumstances. 6.02 Authority of Managing General Partner. The Managing General Partner is specifically authorized and empowered, on behalf of the Partnership, and by consent of the Investor Partners herein given, to do any act or execute any document or enter into any contract or any agreement of any nature necessary or desirable, in the opinion of the Managing General Partner, in pursuance of the purposes of the Partnership. Without limiting the generality of the foregoing, in addition to any and all other powers conferred upon the Managing General Partner pursuant to this Agreement and the Act, and except as otherwise prohibited by law or hereunder, the Managing General Partner shall have the power and authority to: (a) Acquire leases and other interests in oil and/or gas properties in furtherance of the Partnership's business; (b) Enter into and execute pooling agreements, farm out agreements, operating agreements, unitization agreements, dry and bottom hole and acreage contribution letters, construction contracts, and any and all documents or instruments customarily employed in the oil and gas industry in connection with the acquisition, sale, exploration, development, or operation of oil and gas properties, and all other instruments deemed by the Managing General Partner to be necessary or appropriate to the proper operation of oil or gas properties or to effectively and properly perform its duties or exercise its powers hereunder; (c) Make expenditures and incur any obligations it deems necessary to implement the purposes of the Partnership; employ and retain such personnel as it deems desirable for the conduct of the Partnership's activities, including employees, consultants, and attorneys; and exercise on behalf of the Partnership, in such manner as the Managing General Partner in its sole judgment deems best, of all rights, elections, and obligations granted to or imposed upon the Partnership; (d) Manage, operate, and develop any Partnership property, and enter into operating agreements with respect to properties acquired by the Partnership, including an operating agreement with the Managing General Partner as described in the Prospectus, which agreements may contain such terms, provisions, and conditions as are usual and customary within the industry and as the Managing General Partner shall approve; (e) Compromise, sue, or defend any and all claims in favor of or against the Partnership; (f) Subject to the provisions of Section 8.04 hereof, make or revoke any election permitted the Partnership by any taxing authority; (g) Perform any and all acts it deems necessary or appropriate for the protection and preservation of the Partnership assets; (h) Maintain at the expense of the Partnership such insurance coverage for public liability, fire and casualty, and any and all other insurance necessary or appropriate to the business of the Partnership in such amounts and of such types as it shall determine from time to time; (i) Buy, sell, or lease property or assets on behalf of the Partnership; (j) Enter into agreements to hire services of any kind or nature; (k) Assign interests in properties to the Partnership; (l) Enter into soliciting dealer agreements and perform all of the Partnership's obligations thereunder, to issue and sell Units pursuant to the terms and conditions of this Agreement, the Subscription Agreements, and the Prospectus, to accept and execute on behalf of the Partnership Subscription Agreements, and to admit original and substituted Partners; and (m) Perform any and all acts, and execute any and all documents it deems necessary or appropriate to carry out the purposes of the Partnership. 6.03 Certain Restrictions on Managing General Partner's Power and Authority. Notwithstanding any other provisions of this Agreement to the contrary, neither the Managing General Partner nor any Affiliate of the Managing General Partner shall have the power or authority to, and shall not, do, perform, or authorize any of the following: (a) Borrow any money in the name or on behalf of the Partnership; (b) Use any revenues from Partnership operations for the purposes of acquiring Leases in new or unrelated Prospects or paying any Organization and Offering Expenses; provided, however, that revenues from Partnership operations may be used for other Partnership operations, including without limitation for the purposes of drilling, completing, maintaining, recompleting, and operating wells on existing Partnership Prospects and acquiring and developing new Leases to the extent such Leases are considered by the Managing General Partner in its sole discretion to be a part of a Prospect in which the Partnership then owns a Lease; (c) Without having first received the prior consent of the holders of a majority of the then outstanding Units entitled to vote, (i) sell all or substantially all of the assets of the Partnership (except upon liquidation of the Partnership pursuant to Article IX hereof), unless cash funds of the Partnership are insufficient to pay the obligations and other liabilities of the Partnership; (ii) dispose of the good will of the Partnership; (iii) do any other act which would make it impossible to carry on the ordinary business of the Partnership; or (iv) agree to the termination or amendment of any operating agreement to which the Partnership is a party, or waive any rights of the Partnership thereunder, except for amendments to the operating agreement which the Managing General Partner believes are necessary or advisable to ensure that the operating agreement conforms to any changes in or modifications to the Code or that do not adversely affect the Investor Partners in any material respect; (d) Guarantee in the name or on behalf of the Partnership the payment of money or the performance of any contract or other obligation of any Person other than the Partnership; (e) Bind or obligate the Partnership with respect to any matter outside the scope of the Partnership business; (f) Use the Partnership name, credit, or property for other than Partnership purposes; (g) Take any action, or permit any other person to take any action, with respect to the assets or property of the Partnership which does not benefit the Partnership, including, among other things, utilization of funds of the Partnership as compensating balances for its own benefit or the commitment of future production; (h) Benefit from any arrangement for the marketing of oil and gas production or other relationships affecting the property of the Managing General Partner and the Partnership, unless such benefits are fairly and equitably apportioned among the Managing General Partner, its Affiliates, and the Partnership; (i) Utilize Partnership funds to invest in the securities of another person except in the following instances: (1) investments in working interests or undivided lease interests made in the ordinary course of the Partnership's business; (2) temporary investments made in compliance with Section 2.02(f) of this Agreement; (3) investments involving less than 5% of Partnership capital which are a necessary and incidental part of a property acquisition transaction; and (4) investments in entities established solely to limit the Partnership's liabilities associated with the ownership or operation of property or equipment, provided, in such instances duplicative fees and expenses shall be prohibited; or (j) Sell, transfer, or assign its interest (except for a collateral assignment which may be granted to a bank or other financial institution) in the Partnership, or any part thereof, or otherwise to withdraw as Managing General Partner of the Partnership without one hundred twenty (120) days prior written notice to and the written consent of Investor Partners owning a majority of the then outstanding Units. 6.04 Indemnification of Managing General Partner. The Managing General Partner shall have no liability to the Partnership or to any Investor Partner for any loss suffered by the Partnership which arises out of any action or inaction of the Managing General Partner if the Managing General Partner, in good faith, determined that such course of conduct was in the best interest of the Partnership, that the Managing General Partner was acting on behalf of or performing services for the Partnership, and that such course of conduct did not constitute negligence or misconduct of the Managing General Partner. The Managing General Partner shall be indemnified by the Partnership against any losses, judgments, liabilities, expenses, and amounts paid in settlement of any claims sustained by it in connection with the Partnership, provided that the Managing General Partner has determined in good faith that the course of conduct which caused the loss or liability was in the best interests of the Partnership, that the Managing General Partner was acting on behalf of or performing services for the Partnership, and that the same were not the result of negligence or misconduct on the part of the Managing General Partner. Indemnification of the Managing General Partner is recoverable only from the tangible net assets of the Partnership, including the insurance proceeds from the Partnership's insurance policies and the insurance and indemnification of the Partnership's subcontractors, and is not recoverable from the Investor Partners. Notwithstanding the above, the Managing General Partner and any person acting as a broker-dealer shall not be indemnified for liabilities arising under Federal and state securities laws unless (a) there has been a successful adjudication on the merits of each count involving securities law violations, (b) such claims have been dismissed with prejudice on the merits by a court of competent jurisdiction, or (c) a court of competent jurisdiction approves a settlement of such claims against a particular indemnitee and finds that indemnification of the settlement and the related costs should be made, and the court considering the request for indemnification has been advised of the position of the Securities and Exchange Commission and of any state securities regulatory authority in which securities of the Partnership were offered or sold as to indemnification for violations of securities laws; provided however, the court need only be advised of the positions of the securities regulatory authorities of those states (i) which are specifically set forth in the program agreement and (ii) in which plaintiffs claim they were offered or sold program units. In any claim for indemnification for Federal or state securities laws violations, the party seeking indemnification shall place before the court the position of the Securities and Exchange Commission, the Massachusetts Securities Division, and the Tennessee Securities Division or respective state securities division, as the case may be, with respect to the issue of indemnification for securities law violations. The advancement of Partnership funds to a sponsor or its affiliates for legal expenses and other costs incurred as a result of any legal action for which indemnification is being sought is permissible only if the Partnership has adequate funds available and the following conditions are satisfied: (a) the legal action relates to acts or omissions with respect to the performance of duties or services on behalf of the Partnership, and (b) the legal action is initiated by a third party who is not a participant, or the legal action is initiated by a participant and a court of competent jurisdiction specifically approves such advancement, and (c) the sponsor or its affiliates undertake to repay the advanced funds to the Partnership, together with the applicable legal rate of interest thereon, in cases in which such party is found not to be entitled to indemnification. The Partnership shall not incur the cost of the portion of any insurance which insures the Managing General Partner against any liability as to which the Managing General Partner is herein prohibited from being indemnified. 6.05 Withdrawal. (a) Notwithstanding the limitations contained in Section 6.03(j) hereof, the Managing General Partner shall have the right, by giving written notice to the other Partners, to substitute in its stead as managing general partner any successor entity or any entity controlled by the Managing General Partner, provided that the successor Managing General Partner must have a tangible net worth of at least $5 million, and the Investor Partners, by execution of this Agreement, expressly consent to such a transfer, unless it would adversely affect the status of the Partnership as a partnership for federal income tax purposes. (b) The Managing General Partner may not voluntarily withdraw from the Partnership prior to the Partnership's completion of its primary drilling and/or acquisition activities, and then only after giving 120 days written notice. The Managing General Partner may not partially withdraw its property interests held by the Partnership unless such withdrawal is necessary to satisfy the bona fide request of its creditors or approved by a majority-in-interest vote of the Investor Partners. The Managing General Partner shall fully indemnify the Partnership against any additional expenses which may result from a partial withdrawal of property interests and such withdrawal may not result in a greater amount of direct costs or administrative costs being allocated to the Investor Partners. The withdrawing Managing General Partner shall pay all expenses incurred as a result of its withdrawal. 6.06 Management Fee. The Partnership shall pay the Managing General Partner, on the date the Partnership is organized (as set forth in Section 1.01), a one-time management fee equal to 2-1/2% of the total Subscriptions. 6.07 Tax Matters and Financial Reporting Partner. The Managing General Partner shall serve as the Tax Matters Partner for purposes of Code Sections 6221 through 6233 and as the Financial Reporting Partner. The Partnership may engage its accountants and/or attorneys to assist the Tax Matters Partner in discharging its duties hereunder. ARTICLE VII Investor Partners 7.01 Management. No Investor Partner shall take part in the control or management of the business or transact any business for the Partnership, and no Investor Partner shall have the power to sign for or bind the Partnership. Any action or conduct of Investor Partners on behalf of the Partnership is hereby expressly prohibited. Any Investor Partner who violates this Section 7.01 shall be liable to the remaining Investor Partners, the Managing General Partner, and the Partnership for any damages, costs, or expenses any of them may incur as a result of such violation. The Investor Partners hereby grant to the Managing General Partner or its successors or assignees the exclusive authority to manage and control the Partnership business in its sole discretion and to thereby bind the Partnership and all Partners in its conduct of the Partnership business. Investor Partners shall have the right to vote only with respect to those matters specifically provided for in these Articles. No Investor Partner shall have the authority to: (a) Assign the Partnership property in trust for creditors or on the assignee's promise to pay the debts of the Partnership; (b) Dispose of the goodwill of the business; (c) Do any other act which would make it impossible to carry on the ordinary business of the Partnership; (d) Confess a judgment; (e) Submit a Partnership claim or liability to arbitration or reference; (f) Make a contract or bind the Partnership to any agreement or document; (g) Use the Partnership's name, credit, or property for any purpose; (h) Do any act which is harmful to the Partnership's assets or business or by which the interests of the Partnership shall be imperiled or prejudiced; or (i) Perform any act in violation of any applicable law or regulations thereunder, or perform any act which is inconsistent with the terms of this Agreement. 7.02 Indemnification of Additional General Partners. The Managing General Partner agrees to indemnify each of the Additional General Partners for the amounts of obligations, risks, losses, or judgments of the Partnership or the Managing General Partner which exceed the amount of applicable insurance coverage and amounts which would become available from the sale of all Partnership assets. Such indemnification applies to casualty losses and to business losses, such as losses incurred in connection with the drilling of an unproductive well, to the extent such losses exceed the Additional General Partners' interest in the undistributed net assets of the Partnership. If, on the other hand, such excess obligations are the result of the negligence or misconduct of an Additional General Partner, or the contravention of the terms of the Partnership Agreement by the Additional General Partner, then the foregoing indemnification by the Managing General Partner shall be unenforceable as to such Additional General Partner and such Additional General Partner shall be liable to all other Partners for damages and obligations resulting therefrom. 7.03 Assignment of Units. (a) An Investor Partner may transfer all or any portion of his Units and the transferee shall become a Substituted Investor Partner (subject to all duties and obligations of an Investor Partner, including those contained in Section 4.04 herein, except to the extent excepted in the Act) subject to the following conditions (any transfer of such Units satisfying such conditions being referred to herein as a "Permitted Transfer"): (i) Except in the case of a transfer of Units at death or involuntarily by operation of law, the transferor and transferee shall execute and deliver to the Partnership such documents and instruments of conveyance as may be necessary or appropriate in the opinion of counsel to the Partnership to effect such transfer and to confirm the agreement of the transferee to be bound by the provisions of this Article VII. In any case not described in the preceding sentence, the transfer shall be confirmed by presentation to the Partnership of legal evidence of such transfer, in form and substance satisfactory to counsel to the Partnership. In all cases, the Partnership shall be reimbursed by the transferor and/or transferee for all costs and expenses that it reasonably incurs in connection with such transfer; (ii) The transferor and transferee shall furnish the Partnership with the transferee's taxpayer identification number and sufficient information to determine the transferee's initial tax basis in the Units transferred; and (iii) The written consent of the Managing General Partner to such transfer shall have been obtained. (b) A Person who acquires one or more Units but who is not admitted as a Substituted Investor Partner pursuant to Section 7.03(c) hereof shall be entitled only to allocations and distributions with respect to such Units in accordance with this Agreement, but shall have no right to any information or accounting of the affairs of the Partnership, shall not be entitled to inspect the books or records of the Partnership, and shall not have any of the rights of an Additional General Partner or a Limited Partner under the Act or the Agreement. (c) Subject to the other provisions of this Article VII, a transferee of Units may be admitted to the Partnership as a Substituted Investor Partner only upon satisfaction of the conditions set forth below in this Section 7.03(c): (i) The Managing General Partner consents to such admission; (ii) The Units with respect to which the transferee is being admitted were acquired by means of a Permitted Transfer; (iii) The transferee becomes a party to this Agreement as a Partner and executes such documents and instruments as the Managing General Partner may reasonably request (including, without limitation, amendments to the Certificate of Limited Partnership) as may be necessary or appropriate to confirm such transferee as a Partner in the Partnership and such transferee's agreement to be bound by the terms and conditions hereof; (iv) The transferee pays or reimburses the Partnership for all reasonable legal, filing, and publication costs that the Partnership incurs in connection with the admission of the transferee as a Partner with respect to the transferred Units; and (v) If the transferee is not an individual of legal majority, the transferee provides the Partnership with evidence satisfactory to counsel for the Partnership of the authority of the transferee to become a Partner and to be bound by the terms and conditions of this Agreement. (vi) In any calendar quarter in which a Substituted Investor Partner is admitted to the Partnership, the Managing General Partner shall amend the certificate of limited partnership to effect the substitution of such Substituted Investor Partners, although the Managing General Partner may do so more frequently. In the case of assignments, where the assignee does not become a Substituted Investor Partner, the Partnership shall recognize the assignment not later than the last day of the calendar month following receipt of notice of assignment and required documentation. (d) Each Investor Partner hereby covenants and agrees with the Partnership for the benefit of the Partnership and all Partners that (i) he is not currently making a market in Units and (ii) he will not transfer any Unit on an established securities market or a secondary market (or the substantial equivalent thereof) within the meaning of Code Section 7704(b) (and any regulations, proposed regulations, revenue rulings, or other official pronouncements of the Service or Treasury Department that may be promulgated or published thereunder). Each Investor Partner further agrees that he will not transfer any Unit to any Person unless such Person agrees to be bound by this Section 7.03 and to transfer such Units only to Persons who agree to be similarly bound. (e) Restrictions on assignment of Units or the substitution of Investor Partners shall be allowed only to the extent necessary to preserve the tax status of the Partnership or the classification of Partnership income for tax purposes and any restriction shall be supported by an opinion of the Partnership's counsel as to its legal necessity. 7.04 Prohibited Transfers. (a) Any purported Transfer of Units that is not a Permitted Transfer shall be null and void and of no effect whatever; provided, that, if the Partnership is required to recognize a transfer that is not a Permitted Transfer (or if the Managing General Partner, in its sole discretion, elects to recognize a transfer that is not a Permitted Transfer), the interest transferred shall be strictly limited to the transferor's rights to allocations and distributions as provided by this Agreement with respect to the transferred Units, which allocations and distributions may be applied (without limiting any other legal or equitable rights of the Partnership) to satisfy the debts, obligations, or liabilities for damages that the transferor or transferee of such Units may have to the Partnership. (b) In the case of a transfer or attempted transfer of Units that is not a Permitted Transfer, the parties engaging or attempting to engage in such transfer shall be liable to indemnify and hold harmless the Partnership and the other Partners from all cost, liability, and damage that any of such indemnified Persons may incur (including, without limitation, incremental tax liability and lawyers' fees and expenses) as a result of such transfer or attempted transfer and efforts to enforce the indemnity granted hereby. 7.05 Withdrawal by Investor Partners. Neither a Limited Partner nor an Additional General Partner may withdraw from the Partnership, except as otherwise provided in this Agreement. 7.06 Removal of Managing General Partner. (a) The Managing General Partner may be removed at any time with the consent of Investor Partners owning a majority of the then outstanding Units, and upon the selection of a successor managing general partner or partners by Investor Partners owning a majority of the then outstanding Units. (b) Any successor Managing General Partner may be removed upon the terms and conditions provided in this Section. (c) In the event a managing general partner is removed, its respective interest in the assets of the Partnership shall be determined by independent appraisal by a qualified independent petroleum engineering consultant who shall be selected by mutual agreement of the Managing General Partner and the incoming sponsor. Such appraisal will take into account an appropriate discount to reflect the risk of recovery of oil and gas reserves, and, at its election, the removed managing general partner's interest in the Partnership assets may be distributed to it or the interest of the managing general partner in the Partnership may be retained by it as a Limited Partner in the successor limited partnership; provided, however, that if immediate payment to the removed managing general partner would impose financial or operational hardship upon the Partnership, as determined by the successor managing general partner in the exercise of its fiduciary duties to the Partnership, payment (plus reasonable interest) to the removed managing general partner may be postponed to that time when, in the determination of the successor managing general partner, payment will not cause a hardship to the Partnership. The cost of such appraisal shall be borne by the Partnership. The successor managing general partner shall have the option to purchase at least 20% of the removed managing general partner's interest for the value determined by the independent appraisal. The removed managing general partner, at the time of its removal shall cause, to the extent it is legally possible, its successor to be transferred or assigned all its rights, obligations, and interests in contracts entered into by it on behalf of the Partnership. In any event, the removed managing general partner shall cause its rights, obligations, and interests in any such contract to terminate at the time of its removal. (d) Upon effectiveness of the removal of the managing general partner, the assets, books, and records of the Partnership shall be surrendered to the successor managing general partner, provided that the successor managing general partner shall have first (i) agreed to accept the responsibilities of the managing general partner, and (ii) made arrangements satisfactory to the original managing general partner to remove such managing general partner from personal liability on any Partnership borrowings or, if any Partnership creditor will not consent to such removal, agreed to indemnify the original managing general partner for any subsequent liabilities in respect to such borrowings. Immediately after the removal of the managing general partner, the successor managing general partner shall prepare, execute, file for recordation, and cause to be published, such notices or certificates as may be required by the Act. 7.07 Calling of Meetings. Investor Partners owning 10% or more of the then outstanding Units entitled to vote shall have the right to request that the Managing General Partner call a meeting of the Partners. The Managing General Partner shall call such a meeting and shall deposit in the United States mails within fifteen days after receipt of such request, written notice to all Investor Partners of the meeting and the purpose of the meeting, which shall be held on a date not less than thirty nor more than sixty days after the date of mailing of such notice, at a reasonable time and place. Investor Partners shall have the right to submit proposals to the Managing General Partner for inclusion in the voting materials for the next meeting of Investor Partners for consideration and approval by the Investor Partners. Investor Partners shall have the right to vote in person or by proxy. 7.08 Additional Voting Rights. Investor Partners shall be entitled to all voting rights granted to them by and under this Agreement and as specified by the Act. Each Unit is entitled to one vote on all matters; each fractional Unit is entitled to that fraction of one vote equal to the fractional interest in the Unit. Except as otherwise provided herein or in the Prospectus, at any meeting of Investor Partners, a vote of a majority in interest of Units represented at such meeting, in person or by proxy, with respect to matters considered at the meeting at which a quorum is present shall be required for approval of any such matters. In addition, except as otherwise provided in this Section and in Section 5.07(m), holders of a majority in interest of the then outstanding Units may, without the concurrence of the Managing General Partner, vote to (a) approve or disapprove the sale of all or substantially all of the assets of the Partnership, (b) dissolve the Partnership, (c) remove the Managing General Partner and elect a new managing general partner, (d) amend the Agreement; but any such amendment may not increase the duties or liabilities of any Investor Partner or the Managing General Partner or increase or decrease the profit or loss sharing or required capital contribution of any Investor Partner or the Managing General Partner without the approval of such Investor Partner or Managing General Partner; and any such amendment may not affect the classification of the Partnership's income or loss for federal income tax purposes without the unanimous approval of all Investor Partners, (e) elect a new managing general partner if the managing general partner elects to withdraw from the Partnership, and (f) cancel any contract for services with the Managing General Partner or any Affiliates without penalty upon sixty days' notice. The Partnership shall not participate in a Roll-Up unless the Roll-Up is approved by at least 66 2/3% in interest of the Investor Partners. A majority in interest of the then outstanding Units entitled to vote shall constitute a quorum. In determining the requisite percentage in interest of Units necessary to approve a matter on which the Managing General Partner and its Affiliates may not vote or consent, any Units owned by the Managing General Partner and its Affiliates shall not be included. With respect to the merger or consolidation of the Partnership or the sale of all or substantially all of the assets of the Partnership, Investor Partners shall have the right to exercise dissenter's rights in accordance with Section 31D-13-1301 et seq. of the West Virginia Business Corporation Act. 7.09 Voting by Proxy. The Investor Partners may vote either in person or by proxy. 7.10 Conversion of Additional General Partner Interests into Limited Partner Interests. (a) As provided herein, Additional General Partners may elect to convert, transfer, and exchange their interests for Limited Partner interests in the Partnership upon receipt by the Managing General Partner of written notice of such election. An Additional General Partner may request conversion of his interests for Limited Partner interests at any time after one year following the closing of the securities offering which relates to the Agreement and the disbursement to the Partnership of the proceeds of such securities offering. (b) The Managing General Partner shall notify all Additional General Partners at least 30 days prior to any material change in the amount of the Partnership's insurance coverage. Within this 30-day period, and notwithstanding Section 7.10(a), Additional General Partners shall have the right to immediately convert their Units into Units of limited partnership interest by giving written notice to the Managing General Partner. (c) The Managing General Partner shall convert the interests of all Additional General Partners in a particular Partnership to interests of Limited Partners in that Partnership upon completion of drilling of that Partnership. (d) The Managing General Partner shall cause the conversion to be effected as promptly as possible as prudent business judgment dictates. Conversion of an Additional General Partnership interest to a Limited Partnership interest in a particular Partnership shall be conditioned upon a finding by the Managing General Partner that such conversion will not cause a termination of the Partnership for federal income tax purposes, and will be effective upon the Managing General Partner's filing an amendment to its Certificate of Limited Partnership. The Managing General Partner is obligated to file an amendment to its Certificate at any time during the full calendar month after receipt of the required notice of the Additional General Partner and a determination of the Managing General Partner that the conversion will not constitute a termination of the Partnership for tax purposes. Effecting conversion is subject to the satisfaction of the condition that the electing Additional General Partner provide written notice to the Managing General Partner of such intent to convert. Upon such transfer and exchange, such Additional General Partners shall be Limited Partners; however, they will remain liable to the Partnership for any additional Capital Contribution(s) required for their proportionate share of any Partnership obligation or liability arising prior to the conversion. (e) Limited Partners may not convert and/or exchange their interests for Additional General Partner interests. 7.11 Unit Repurchase Program. (a) Beginning with the third anniversary of the date of the first cash distribution of the Partnership, Investor Partners may tender their Units to the Managing General Partner for repurchase, subject to the Managing General Partner's available borrowing capacity under its loan agreements to repurchase and the Managing General Partner's receipt of an opinion of counsel that the Managing General Partner's repurchase of Units pursuant to this Section will not cause the Partnership to be treated as a "publicly traded partnership" for purposes of Code Sections 469 and 7704. Failure to receive such opinion shall preclude the Managing General Partner from making any offers to repurchase Units. Subject to such borrowing capacity and legal opinion, the Managing General Partner shall offer to annually repurchase for cash a minimum of 10% of the Units originally subscribed to in the Partnership. (b) The Unit Repurchase Program shall be subject to the following conditions: (i) The Managing General Partner must receive written notification from the particular Investor Partner of such Partner's intention to exercise the repurchase right; and (ii) The Managing General Partner shall provide the Investor Partner a written offer of a specified price for purchase of the particular Units within 30 days of the Managing General Partner's receipt of written notification; and (iii) The Managing General Partner's offer shall remain open for 30 days after the Managing General Partner's mailing of the offer to the Investor Partner. (c) The Managing General Partner shall not favor one particular Partnership of which it is a Managing General Partner over another in the repurchase of Units. Each Partnership shall stand on equal footing before the Managing General Partner. To the extent that the Managing General Partner is unable, due to limitations imposed by the Code or insufficient borrowing capacity under the Managing General Partner's loan agreement(s) with banks, to repurchase all Units tendered, each tendering Investor Partner shall be entitled to have his Units repurchased on a "first come-first served" basis, regardless of Partnership, provided that the Managing General Partner determines that the repurchase of a particular Investor Partner's Units will not result in the termination of the Partnership for federal income tax purposes and in the Partnership's being treated as a "publicly traded partnership." If more than 10% of the Units of a particular Partnership are tendered during that Partnership's taxable year, Units shall be purchased on a "first come-first served" basis with respect to that Partnership. To the extent that the Managing General Partner is unable to repurchase all Units tendered at the same time by Partners of any Partnership, the Managing General Partner shall repurchase those particular Units on a pro-rata basis. (d) The offer price which the Managing General Partner shall make shall be a cash amount equal to four times cash distributions attributable to the tendered Unit from production for the 12 months prior to the month in which the above-referenced written notification is actually received by the Managing General Partner at its corporate offices. The Managing General Partner may, in its sole and absolute discretion, increase the offer price for interests tendered for sale. (e) Upon any repurchase, the Managing General Partner shall hold such purchased Units for its own use and not for resale and it shall not create a market in the Units. 7.12 Liability of Partners. Except as otherwise provided in this Agreement or as otherwise provided by the Act, each General Partner shall be jointly and severally liable for the debts and obligations of the Partnership. In addition, each Additional General Partner shall be jointly and severally liable for any wrongful acts or omissions of the Managing General Partner and/or the misapplication of money or property of a third party by the Managing General Partner acting within the scope of its apparent authority to the extent such acts or omissions are chargeable to the Partnership. ARTICLE VIII Books and Records 8.01 Books and Records. (a) For accounting and income tax purposes, the Partnership shall operate on a calendar year. (b) The Managing General Partner shall keep just and true records and books of account with respect to the operations of the Partnership and shall maintain and preserve during the term of the Partnership and for four years thereafter all such records, books of account, and other relevant Partnership documents. The Managing General Partner shall maintain for at least six years all records necessary to substantiate the fact that Units were sold only to purchasers for whom such Units were suitable. Such books shall be maintained at the principal place of business of the Partnership and shall be kept on the accrual method of accounting. (c) The Managing General Partner shall keep or cause to be kept complete and accurate books and records with respect to the Partnership's business, which books and records shall at all times be kept at the principal office of the Partnership. Any records maintained by the Partnership in the regular course of its business, including the names and addresses of Investor Partners, books of account, and records of Partnership proceedings, may be kept on or be in the form of RAM disks, magnetic tape, photographs, micrographics, or any other information storage device, provided that the records so kept are convertible into clearly legible written form within a reasonable period of time. The books and records of the Partnership shall be made available for review and copying by any Investor Partner or his representative at any reasonable time. (d) (i) An alphabetical list of the names, addresses and business telephone numbers of the Investor Partners of the Partnership along with the number of Units held by each of them (the "participant list") shall be maintained as a part of the books and records of the Partnership and shall be available for the inspection by any Investor Partner or its designated agent at the home office of the Partnership upon the request of the Investor Partner; (ii) The participant list shall be updated at least quarterly to reflect changes in the information contained therein; (iii) A copy of the participant list shall be mailed to any Investor Partner requesting the participant list within ten days of the request. The copy of the participant list shall be printed in alphabetical order, on white paper, and in a readily readable type size (in no event smaller than 10-point type). A reasonable charge for copy work may be charged by the Partnership. (iv) The purposes for which an Investor Partner may request a copy of the participant list include, without limitation, matters relating to voting rights under the Partnership Agreement and the exercise of Investor Partners' rights under federal proxy laws; and (v) If the Managing General Partner of the Partnership neglects or refuses to exhibit, produce, or mail a copy of the participant list as requested, the Managing General Partner shall be liable to any Investor Partner requesting the list for the costs, including attorneys' fees, incurred by that Investor Partner for compelling the production of the participant list, and for actual damages suffered by any Investor Partner by reason of such refusal or neglect. It shall be a defense that the actual purpose and reason for the requests for inspection or for a copy of the participant list is to secure the list of Investor Partners or other information for the purpose of selling such list or information or copies thereof, or of using the same for a commercial purpose other than in the interest of the applicant as an Investor Partner relative to the affairs of the Partnership. The Managing General Partner may require the Investor Partner requesting the participant list to represent that the list is not requested for a commercial purpose unrelated to the Investor Partner's interest in the Partnership. The remedies provided hereunder to Investor Partners requesting copies of the participant list are in addition to, and shall not in any way limit, other remedies available to Investor Partners under federal law, or the laws of any state. 8.02 Reports. The Managing General Partner shall deliver to each Investor Partner the following financial statements and reports at the times indicated below: (a) Within 75 days after the end of the first six months of each fiscal year (for such six month period) and within 120 days after the end of each fiscal year (for such year), financial statements, including a balance sheet and statements of income, Partners' equity, and cash flows, all of which shall be prepared in accordance with generally accepted accounting principles. The annual financial statements shall be accompanied by (i) a report of an independent certified public accountant designated by the Managing General Partner stating that an audit of such financial statements has been made in accordance with generally accepted auditing standards and that in its opinion such financial statements present fairly the financial condition, results of operations, and cash flow of the Partnership in accordance with generally accepted accounting principles and (ii) a reconciliation of such financial statements with the information furnished to the Investor Partners for federal income tax reporting purposes. (b) Annually by March 15 of each year, a report containing such information as may be deemed to enable each Investor Partner to prepare and file his federal income tax return and any required state income tax return. (c) Annually within 120 days after the end of each fiscal year, (i) a summary of the computations of the total estimated proved oil and gas reserves of the Partnership as of the end of such fiscal year and the dollar value thereof at then existing prices and a computation of each Investor Partner's interest in such value, such reserve computations to be based upon engineering reports prepared by qualified independent petroleum engineers, (ii) an estimate of the time required for the extraction of such proved reserves and the present worth thereof (discounted at a rate generally accepted in the oil and gas industry and undiscounted), and (iii) a statement that because of the time period required to extract such reserves the present value of revenues to be obtained in the future is less than if such revenues were immediately receivable. Each such reported shall be prepared in accordance with customary and generally accepted standards and practices for petroleum engineers and shall be prepared by a recognized independent petroleum engineer selected from time to time by the Managing General Partner. No later than 90 days following the occurrence of an event resulting in a reduction in an amount of 10% or more of the estimated value of the proved oil and gas reserves as last reported to the Investor Partners, other than a reduction resulting from normal production, sales of reserves, or product price changes, a new summary conforming to the requirements set forth above in this Section 8.02(c) shall be delivered to the Investor Partners. (d) Within 75 days after the end of the first six months of each fiscal year and within 120 days after the end of each fiscal year, (i) a summary itemization, by type and/or classification, of any transaction of the Partnership since the date of the last such report with the Managing General Partner or any Affiliate thereof and the total fees, compensation, and reimbursement paid by the Partnership (or indirectly on behalf of the Partnership) to the Managing General Partner and its Affiliates, and (ii) a schedule reflecting (A) the total costs of the Partnership (and, where applicable, the costs pertaining to each Lease) and the costs paid by the Managing General Partner and by the Investor Partners and (B) the total revenues of the Partnership and the revenues received by or credited to the accounts of the Managing General Partner and the Investing Partners. Each semi-annual report delivered by the Managing General Partner may contain summary estimates of the information described in subdivision (i) of Section 8.02(c). (e) Monthly within 15 days after the end of each calendar month while the Partnership is participating in the drilling and completion of wells in which it has an interest until the end of such activity, and thereafter for a period of three years within 75 days after the end of the first six months of each fiscal year and within 120 days after the end of each fiscal year, (i) a description of each Prospect or field in which the Partnership owns Leases including the cost, location, number of acres under lease, and the interest owned therein by the program (provided that after the initial description of each such Prospect or field has been provided to the Investor Partners only material changes, if any, with respect to such Prospect or field need be described), (ii) a description of all farmins, farmouts and joint ventures of the Partnership made since the date of the last such report, including the reason therefor, the location and timing thereof, the person to whom made and the terms thereof, and (iii) a summary of the wells drilled by the Partnership, indicating whether each of such wells has been completed, a statement of the cost of each well completed or abandoned and the reason for abandoning any well after commencement of production. Each report delivered by the Managing General Partner may contain summary estimates of the information described in subsection (iii). (f) The Managing General Partner shall cause the Partnership's independent auditors to audit the financial statements of the Partnership in accordance with generally accepted auditing standards. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, which would include an assessment as to whether or not the method used to make the allocations of costs was consistent with the method described in the Prospectus. If the Managing General Partner subsequently decides to allocate expenses in a manner different from the manner described in the Prospectus, such change shall be reported by the Managing General Partner to the Investor Partners together with an explanation of why such change was made and the basis for determining the reasonableness of the new allocation method. (g) Such other reports and financial statements as the Managing General Partner shall determine from time to time. (h) Concurrently with their transmittal to Investor Partners and as required, the Managing General Partner shall file a copy of each such report with the California Commissioner of Corporations and with the securities divisions of other states. 8.03 Bank Accounts. All funds of the Partnership shall be deposited in such separate bank account or accounts, short term obligations of the U.S. Government or its agencies, or other interest-bearing investments and money market or liquid asset mutual funds as shall be determined by the Managing General Partner. All withdrawals therefrom shall be made upon checks signed by the Managing General Partner or any person authorized to do so by the Managing General Partner. 8.04 Federal Income Tax Elections. (a) Except as otherwise provided in this Section 8.04, all elections required or permitted to be made by the Partnership under the Code shall be made by the Managing General Partner in its sole discretion. Each Partner agrees to provide the Partnership with all information necessary to give effect to any election to be made by the Partnership. (b) The Partnership shall elect to currently deduct IDC as an expense for income tax purposes and shall require any partnership, joint venture, or other arrangement in which it is a party to make such an election. ARTICLE IX Dissolution; Winding-up 9.01 Dissolution. (a) Except as otherwise provided herein, the retirement, withdrawal, removal, death, insanity, incapacity, dissolution, or bankruptcy of any Investor Partner shall not dissolve the Partnership. The successor to the rights of such Investor Partner shall have all the rights of an Investor Partner for the purpose of settling or administering the estate or affairs of such Investor Partner; provided, however, that no successor shall become a substituted Investor Partner except in accordance with Article VII hereof; provided, further, that upon the withdrawal of an Additional General Partner, the Partnership shall be dissolved and wound up unless at that time there is at least one other General Partner, in which event the business of the Partnership shall continue to be carried on. Neither the expulsion of any Investor Partner nor the admission or substitution of an Investor Partner shall work a dissolution of the Partnership. The estate of a deceased, insane, incompetent, or bankrupt Investor Partner shall be liable for all his liabilities as an Investor Partner. (b) The Partnership shall be dissolved upon the earliest to occur of: (i) the written consent of the Investor Partners owning a majority in interest of the then-outstanding Units to dissolve and wind up the affairs of the Partnership; (ii) subject to the provisions of Subsection (c) below, the retirement, withdrawal, removal, death, adjudication of insanity or incapacity, or bankruptcy (or, in the case of a corporate managing general partner, the withdrawal, removal, filing of a certificate of dissolution, liquidation, or bankruptcy) of the Managing General Partner; (iii) the sale, forfeiture, or abandonment of all or substantially all of the Partnership's property; (iv) December 31, 2050; (v) a dissolution event described in Subsection (a) above; or (vi) any event causing dissolution of the Partnership under the Act. (c) In the case of any event described in Subsection (b)(ii) above, if a successor Managing General Partner is selected by Partners owning a majority in interest of the then outstanding Units within ninety (90) days after such 9.01(b)(ii) event, and if such Investor Partners agree, within such 90 day period to continue the business of the Partnership, or if the remaining managing general partner, if any, continues the business of the Partnership, then the Partnership shall not be dissolved. (d) If the retirement, withdrawal, removal, death, insanity, incapacity, dissolution, liquidation, or bankruptcy of any Partner, or the assignment of a Partner's interest in the Partnership, or the substitution or admission of a new Partner, shall be deemed under the Act to cause a dissolution of the Partnership, then, except as provided in Section 9.01(c), the remaining Partners may, in accordance with the Act, continue the Partnership business as a new partnership and all such remaining Partners agree to be bound by the provisions of this Agreement. 9.02 Liquidation. Upon a dissolution and final termination of the Partnership, the Managing General Partner, or in the event there is no Managing General Partner, any other person or entity selected by the Investor Partners (hereinafter referred to as a "Liquidator") shall cause the affairs of the Partnership to be wound up and shall take account of the Partnership's assets (including contributions, if any, of the Managing General Partner pursuant to Section 3.01(e) herein) and liabilities, and the assets shall, subject to the provisions of Section 9.03(b) herein, be liquidated as promptly as is consistent with obtaining the fair market value thereof, and the proceeds therefrom (which dissolution and liquidation may be accomplished over a period spanning one or more tax years in the sole discretion of the Managing General Partner or Liquidator), to the extent sufficient therefor, shall be applied and distributed in accordance with Section 9.03. 9.03 Winding-up. (a) Upon the dissolution of the Partnership and winding up of its affairs, the assets of the Partnership shall be distributed as follows: (i) all of the Partnership's debts and liabilities to persons other than the Managing General Partner shall be paid and discharged; (ii) all outstanding debts and liabilities to the Managing General Partner shall be paid and discharged; (iii) assets shall be distributed to the Partners to the extent of their positive Capital Account balances, pro rata, in accordance with such positive Capital Account balances; and (iv) any assets remaining after the Partners' Capital Accounts have been reduced to zero pursuant to Section 9.03(c) herein shall be distributed 80% to the Investor Partners and 20% to the Managing General Partner, except as otherwise revised pursuant to Section 2.01(a) and/or Section 4.02. (b) Distributions pursuant to this Section 9.03 shall be made in cash or in kind to the Partners, at the election of the Partners. Notwithstanding the provision of this Section 9.03(b), in no event shall the Partners reserve the right to take in kind and separately dispose of their share of production. (c) Any in kind property distributions to the Investor Partners shall be made to a liquidating trust or similar entity for the benefit of the Investor Partners, unless at the time of the distribution: (1) the Managing General Partner shall offer the individual Investor Partners the election of receiving in kind property distributions and the Investor Partners accept such offer after being advised of the risks associated with such direct ownership; or (2) there are alternative arrangements in place which assure the Investor Partners that they will not, at any time, be responsible for the operation or disposition of Partnership properties. The winding up of the affairs of the Partnership and the distribution of its assets shall be conducted exclusively by the Managing General Partner or the Liquidator, who is hereby authorized to do any and all acts and things authorized by law for these purposes. ARTICLE X Power of Attorney 10.01 Managing General Partner as Attorney-in-Fact. The undersigned makes, constitutes, and appoints the Managing General Partner the true and lawful attorney for the undersigned, and in the name, place, and stead of the undersigned from time to time to make, execute, sign, acknowledge, and file: (a) Any notices or certificates as may be required under the Act and under the laws of any other state or jurisdiction in which the Partnership shall engage, or seek to engage, to do business and to do such other acts as are required to constitute the Partnership as a limited partnership under such laws. (b) Any amendment to the Agreement pursuant to and which complies with Section 11.09 herein. (c) Such certificates, instruments, and documents as may be required by, or may be appropriate under the laws of any state or other jurisdiction in which the Partnership is doing or intends to do business and with the use of the name of the Partnership by the Partnership. (d) Such certificates, instruments, and documents as may be required by, or as may be appropriate for the undersigned to comply with, the laws of any state or other jurisdiction to reflect a change of name or address of the undersigned. (e) Such certificates, instruments, and documents as may be required to be filed with the Department of Interior (including any bureau, office or other unit thereof, whether in Washington, D.C. or in the field, or any officer or employee thereof), as well as with any other federal or state agencies, departments, bureaus, offices, or authorities and pertaining to (i) any and all offers to lease, leases (including amendments, modifications, supplements, renewals, and exchanges thereof) of, or with respect to, any lands under the jurisdiction of the United States or any state including without limitation lands within the public domain, and acquired lands, and provides for the leasing thereof; (ii) all statements of interest and holdings on behalf of the Partnership or the undersigned; (iii) any other statements, notices, or communications required or permitted to be filed or which may hereafter be required or permitted to be filed under any law, rule, or regulation of the United States, or any state relating to the leasing of lands for oil or gas exploration or development; (iv) any request for approval of assignments or transfers of oil and gas leases, any unitization or pooling agreements and any other documents relating to lands under the jurisdiction of the United States or any state; and (v) any other documents or instruments which said attorney-in-fact in its sole discretion shall determine should be filed. (f) Any further document, including furnishing verified copies of the Agreement and/or excerpts therefrom, which said attorney-in-fact shall consider necessary or convenient in connection with any of the foregoing, hereby giving said attorney-in-fact full power and authority to do and perform each and every act and thing whatsoever requisite and necessary to be done in and about the foregoing as fully as the undersigned might and could do if personally present, and hereby ratifying and confirming all that said attorney-in-fact shall lawfully do to cause to be done by virtue hereof. 10.02 Nature of Special Power. The foregoing grant of authority: (a) is a special Power of Attorney coupled with an interest, is irrevocable, and shall survive the death of the undersigned; (b) shall survive the delivery of any assignment by the undersigned of the whole or any portion of his Units; except that where the assignee thereof has been approved by the Managing General Partner for admission to the Partnership as a substitute general or limited Partner as the case may be, the Power of Attorney shall survive the delivery of such assignment for the sole purpose of enabling said attorney-in-fact to execute, acknowledge, and file any instrument necessary to effect such substitution; and (c) may be exercised by said attorney-in-fact with full power of substitution and resubstitution and may be exercised by a listing of all of the Partners executing any instrument with a single signature of said attorney-in-fact. ARTICLE XI Miscellaneous Provisions 11.01 Liability of Parties. By entering into this Agreement, no party shall become liable for any other party's obligations relating to any activities beyond the scope of this Agreement, except as provided by the Act. If any party suffers, or is held liable for, any loss or liability of the Partnership which is in excess of that agreed upon herein, such party shall be indemnified by the other parties, to the extent of their respective interests in the Partnership, as provided herein. 11.02 Notices. Any notice, payment, demand, or communication required or permitted to be given by any provision of this Agreement shall be deemed to have been sufficiently given or served for all purposes if delivered personally to the party or to an officer of the party to whom the same is directed or sent by registered or certified mail, postage and charges prepaid, addressed as follows (or to such other address as the party shall have furnished in writing in accordance with the provisions of this Section): If to the Managing General Partner, 103 East Main Street, Bridgeport, West Virginia 26330; if to an Investor Partner, at such Investor Partner's address for purposes of notice which is set forth on Exhibit A attached hereto. Unless otherwise expressly set forth in this Agreement to the contrary, any such notice shall be deemed to be given on the date on which the same was deposited in a regularly maintained receptacle for the deposit of United States mail, addressed and sent as aforesaid. 11.03 Paragraph Headings. The headings in this Agreement are inserted for convenience and identification only and are in no way intended to describe, interpret, define, or limit the scope, extent, or intent of this Agreement or any provision hereof. 11.04 Severability. Every portion of this Agreement is intended to be severable. If any term or provision hereof is illegal or invalid by any reason whatsoever, such illegality or invalidity shall not affect the validity of the remainder of this Agreement. 11.05 Sole Agreement. This Agreement constitutes the entire understanding of the parties hereto with respect to the subject matter hereof and no amendment, modification, or alteration of the terms hereof shall be binding unless the same be in writing, dated subsequent to the date hereof and duly approved and executed by the Managing General Partner and such percentage of Investor Partners as provided in Section 11.09 of this Agreement. 11.06 Applicable Law. This Agreement, which shall be governed exclusively by its terms, is intended to comply with the Code and with the Act and shall be interpreted consistently therewith. 11.07 Execution in Counterparts. This Agreement may be executed in any number of counterparts with the same effect as if all parties hereto had all signed the same document. All counterparts shall be construed together and shall constitute one agreement. 11.08 Waiver of Action for Partition. Each of the parties irrevocably waives, during the term of the Partnership, any right that it may have to maintain any action for partition with respect to the Partnership and the property of the Partnership. 11.09 Amendments. (a) Unless otherwise specifically herein provided, this Agreement shall not be amended without the consent of the Investor Partners owning a majority of the then outstanding Units entitled to vote. (b) The Managing General Partner may, without notice to, or consent of, any Investor Partner, amend any provisions of these Articles, or consent to and execute any amendment to these Articles, to reflect: (i) A change in the name or location of the principal place of business of the Partnership; (ii) The admission of substituted or additional Investor Partners in accordance with these Articles; (iii) A reduction in, return of, or withdrawal of, all or a portion of any Investor Partner's Capital Contribution; (iv) A correction of any typographical error or omission; (v) A change which is necessary in order to qualify the Partnership as a limited partnership under the laws of any other state or which is necessary or advisable, in the opinion of the Managing General Partner, to ensure that the Partnership will be treated as a partnership and not as an association taxable as a corporation for federal income tax purposes; (vi) A change in the allocation provisions, in accordance with the provisions of Section 3.02(l) herein, in a manner that, in the sole opinion of the Managing General Partner (which opinion shall be determinative), would result in the most favorable aggregate consequences to the Investor Partners as nearly as possible consistent with the allocations contained herein, for such allocations to be recognized for federal income tax purposes due to developments in the federal income tax laws or otherwise; or (vii) Any other amendment similar to the foregoing; provided, however, that the Managing General Partner shall have no authority, right, or power under this Section to amend the voting rights of the Investor Partners. 11.10 Consent to Allocations and Distributions. The methods herein set forth by which allocations and distributions are made and apportioned are hereby expressly consented to by each Partner as an express condition to becoming a Partner. 11.11 Ratification. The Investor Partner whose signature appears at the end of this Article hereby specifically adopts and approves every provision of this Agreement to which the signature page is attached. 11.12 Substitution of Signature Pages. This Agreement has been executed in duplicate by the undersigned Investor Partners and one executed copy of the signature page is attached to the undersigned's copy of this Agreement. It is agreed that the other executed copy of such signature page may be attached to an identical copy of this Agreement together with the signature pages from counterpart Agreements which may be executed by other Investor Partners. 11.13 Incorporation by Reference. Every exhibit, schedule, and other appendix attached to this Agreement and referred to herein is hereby incorporated in this Agreement by reference. * * * * * SIGNATURE PAGE IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the day and year first written above. MANAGING GENERAL PARTNER: INITIAL LIMITED PARTNER: Petroleum Development Corporation Steven R. Williams 103 East Main Street 103 East Main Street Bridgeport, West Virginia 26330 Bridgeport, West Virginia 26330 By: ____________________________ Steven R. Williams President INVESTOR PARTNERS COMPLETE TO INVEST AS ADDITIONAL GENERAL PARTNER ADDITIONAL GENERAL PARTNER(S): NUMBER OF UNITS Name: _______________________________ PURCHASED (Print Name) __________________ _____________________________________ (Signature) SUBSCRIPTION PRICE $____________________ Address: ____________________________________ _____________________________________ By: Petroleum Development Corporation By: __________________________________ Its____________________________ Attorney-in-Fact COMPLETE TO INVEST AS LIMITED PARTNER LIMITED PARTNER(S): NUMBER OF UNITS Name:_______________________________ PURCHASED (Print Name) ______________________ ______________________________ (Signature) SUBSCRIPTION PRICE $____________________ Address: ___________________________________ ____________________________________ By: Petroleum Development Corporation By: __________________________________ Its ____________________________ Attorney-in-Fact EXHIBIT A TO AGREEMENT OF LIMITED PARTNERSHIP OF PDC 2003-___ LIMITED PARTNERSHIP, A WEST VIRGINIA LIMITED PARTNERSHIP Names and Addresses of Investors Nature of Interest Number of Units APPENDIX B TO PROSPECTUS PDC 2003 DRILLING PROGRAM SUBSCRIPTION AGREEMENT PDC 2003- Limited Partnership I hereby agree to purchase ______ Unit(s) in the PDC 2003- Limited Partnership (the "Partnership") at $20,000 per Unit. Enclosed please find my check in the amount of $________. My completion and execution of this Subscription Agreement also constitutes my execution of the Limited Partnership Agreement and the Certificate of Limited Partnership of the Partnership. If this Subscription is accepted, I agree to be bound and governed by the provisions of the Limited Partnership Agreement of the Partnership. With respect to this purchase, I am aware that a broker may sell Units to me only if I qualify according to the express suitability standards stated herein and in the Prospectus, and I represent that: (a) I have received a copy of the Prospectus for the Partnership. (b) I have a net worth of not less than $225,000 (exclusive of home, furnishings and automobiles); or I have a net worth of not less than $60,000 (exclusive of home, furnishings and automobiles) and had during my last tax year or estimate that I will have 2003 taxable income as defined in Section 63 of the Internal Revenue Code of 1986 of at least $60,000, without regard to an investment in the Partnership. (c) If a resident of Alabama, Alaska, Arizona, Arkansas, California, Indiana, Iowa, Kansas, Kentucky, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, New Hampshire, New Mexico, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Dakota, Tennessee, Texas, Vermont, or Washington, I am aware of and satisfy the additional suitability and other requirements stated in Appendix C to the Prospectus. (d) If a resident of California, I acknowledge and understand that the offering may not comply with all the rules set forth in Title 10 of the California Administrative Code; the following are some, but not necessarily all, of the possible deviations from the California rules: Program selling expenses may exceed the established limit; and the compensation formula varies from the California rules. Even in light of such non-compliance, I affirmatively state that I still want to invest in the Partnership. (e) Except as set forth in (f) below, I am purchasing Units for my own account. (f) If a fiduciary, I am purchasing for a person or entity having the appropriate income and/or net worth specified in (b) or (c) above. (g) I certify that the number shown as my Social Security or Taxpayer Identification Number on the signature page is correct. The above representations do not constitute a waiver of any rights that I may have under the statutes administered by the Securities and Exchange Commission or by any state regulatory agency administering statutes bearing on the sale of securities. The Managing General Partner may not complete a sale of Units to an investor until at least five business days after the date the investor receives a final Prospectus. In addition, the Managing General Partner will send each investor a confirmation of purchase. NOTICES (i) The purchase of Units as an Additional General Partner involves a risk of unlimited liability to the extent that the Partnership's liabilities exceed its insurance proceeds, the Partnership's assets, and indemnification by the Managing General Partner, as described in "Risk Factors" in the Prospectus. (ii) The NASD requires the Soliciting Dealer or registered representative to inform potential investors of all pertinent facts relating to the liquidity and marketability of the Units, including the following: (A) the risks involved in the offering, including the speculative nature of the investment and the speculative nature of drilling for oil and natural gas; (B) the financial hazards involved in the offering, including the risk of losing my entire investment; (C) the lack of a public trading market for the Units and the lack of liquidity of this investment; (D) the restrictions on transferability of the Units; and (E) the tax consequences of the investment. (iii) The investment in the Units is not liquid. Investors are required to execute their own subscription agreements. The Managing General Partner will not accept any subscription agreement that has been executed by someone other than the investor or in the case of fiduciary accounts by someone who does not have the legal power of attorney to sign on the investor's behalf. Signature and Power of Attorney I hereby appoint Petroleum Development Corporation, with full power of substitution, my true and lawful attorney to execute, file, swear to and record any Certificate(s) of Limited Partnership or amendments thereto (including but not limited to any amendments filed for the purpose of the admission of any substituted Partners) or cancellation thereof, including any other instruments which may be required by law in any jurisdiction to permit qualification of the Partnership as a limited partnership or for any other purpose necessary to implement the Limited Partnership Agreement, and as more fully described in Article X of the Limited Partnership Agreement. If a resident of California, I am aware of and satisfy the additional suitability requirements stated in Appendix C to the Prospectus and acknowledge the receipt of California Rule 260.141.11 at pages C-2, C-3, C-4 and C-5 of Appendix C to the Prospectus. Date: ________________________, 2003. ____________________________________ ____________________________________ Signature Signature ____________________________________ ____________________________________ Please Print Name Please Print Name ____________________________________ ____________________________________ Social Security or Tax Social Security or Tax Identification Number Identification Number I utilize the calendar year as my Federal income tax year, unless indicated otherwise as follows:. Mailing Address: Street City State Zip Code Address for Distributions and Notices, if different from above: Street City State Zip Code (Account or Reference No.) Business Telephone No. (___) ________________ Home Telephone No. (___) _____________________ Type of Units Purchased (check box below): Units as an Additional General Partner Units as a Limited Partner IF NO SELECTION IS MADE, WE CANNOT ACCEPT YOUR SUBSCRIPTION AND WILL HAVE TO RETURN THIS SUBSCRIPTION AGREEMENT AND YOUR MONEY TO YOU. Title to Units to be held (check box below): Individual Ownership Joint Tenants with Right of Survivorship (both persons must sign) Tenants in Common (both persons must sign) Other ______________________________ TO BE COMPLETED BY PETROLEUM DEVELOPMENT CORPORATION Petroleum Development Corporation, as the Managing General Partner of the Partnership, hereby accepts this Subscription and agrees to hold and invest the same pursuant to the terms and conditions of the Limited Partnership Agreement of the Partnership. ATTEST: PETROLEUM DEVELOPMENT CORPORATION _________________________________ By: _______________________________________ Secretary Title: ______________________________________ Date: ______________________________________ _________________________ TO BE COMPLETED BY REGISTERED REPRESENTATIVE (For Commission and Other Purposes) I hereby represent that I have discharged my affirmative obligations under Sections 2(B) and 3(D) of Rule 2810(b) of the NASD Conduct Rules and specifically have obtained information from the above-named subscriber concerning his/her net worth, annual income, federal income tax bracket, investment portfolio and other financial information and have determined that an investment in the Partnership is suitable for such subscriber, that such subscriber is or will be in a financial position to realize the benefits of this investment, and that such subscriber has a fair market net worth sufficient to sustain the risks for this investment. I have also informed the subscriber of all pertinent facts relating to the liquidity and marketability of an investment in the Partnership, of the risks of unlimited liability regarding an investment as an Additional General Partner, and of the passive loss limitations for tax purposes of an investment as a Limited Partner. ______________________________________ ____________________________________ Name of Brokerage Firm Office Number FC RR AE Number ______________________________________ ____________________________________ Registered Representative Office Address FC RR AE Name (Please Print) ______________________________________ ____________________________________ City State Zip Code FC RR AE Social Security Number ______________________________________ ________________________________, 2003 Area Code Telephone Number FC RR AE Signature Date APPENDIX C TO PROSPECTUS PDC 2003 DRILLING PROGRAM SPECIAL SUBSCRIPTION INSTRUCTIONS Checks for Units should be made payable to "Bank One as Escrow Agent for PDC 2003- Limited Partnership" and should be given to the subscriber's broker for submission to the Dealer Manager and Escrow Agent. The minimum subscription is $5,000. Subscriptions are payable only in cash upon subscription. In the event that a subscriber purchases Units in a particular Partnership on more than one occasion during an offering period, the minimum purchase on each occasion is $5,000 (one-quarter Unit). Signature Requirement. - Investors are required to execute their own subscription agreements. The Managing General Partner will not accept any subscription agreement that has been executed by someone other than the investor or in the case of fiduciary accounts someone who does not have the legal power of attorney to sign on the investor's behalf. Notice to Alaska Investors. - An Alaska investor must be (1) a person whose total purchase does not exceed 5% of his/her net worth if the purchase of securities is at least $10,000, and must have (2) either: (a) a minimum annual gross income of $60,000 and a minimum net worth of $60,000, exclusive of principal automobile, principal residence, and home furnishings, or (b) a minimum net worth of $225,000, exclusive of principal automobile, principal residence, and home furnishings. Registration of Securities in Minnesota. - The Program received an order of effectiveness on January 29, 2003 from the Registration Division of the Minnesota Department of Commerce permitting the Program to sell its securities to Minnesota investors. Under the laws of Minnesota, this license is effective for two years from its date of grant. Consequently, the Program will be permitted to continue to sell its securities to Minnesota investors throughout 2003. The Program's offering will terminate on December 31, 2003. Notice to New Hampshire Investors. - If a New Hampshire resident, I have either: (1) a net worth of not less than $250,000 (exclusive of home, furnishings, and automobiles), or (2) a net worth of not less than $125,000 (exclusive of home, furnishings and automobiles), and $50,000 in taxable income. Subscribers of Limited Partnership Interests: - If a North Carolina resident, I have either: (1) a net worth of not less than $225,000 (exclusive of home, furnishings and automobiles), or (2) a net worth of not less than $60,000 (exclusive of home, furnishings and automobiles) and an estimated taxable income as defined in Section 63 of the Internal Revenue Code of 1986 of $60,000 or more without regard to an investment in a Partnership in 2003 for Partnerships designated "PDC 2003- Limited Partnership." - If a Pennsylvania or South Dakota resident, I have either: (1) a net worth of at least $225,000 (exclusive of home, furnishings and automobiles) or (2) a net worth of at least $60,000 (exclusive of home, furnishings and automobiles) and a taxable income in 2002 for Partnerships designated PDC 2003- Limited Partnership of $60,000 or estimate that I will have an annual taxable income of $60,000 during my current tax year; or that I am purchasing in a fiduciary capacity for a person or entity having such net worth or such taxable income. My investment in the Partnership will not be equal to or more than 10% of my net worth. Subscribers of Additional General Partnership Interests: - Except as otherwise provided below, if a resident of Alabama, Arizona, Arkansas, Indiana, Iowa, Kansas, Kentucky, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, New Mexico, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Tennessee, Texas, Vermont, or Washington, I (1) have an individual or joint minimum net worth with my spouse of $225,000, without regard to the investment in the program, (exclusive of home, home furnishings and automobiles) and a combined minimum gross income of $100,000 or more for the current year and for the two previous years; notwithstanding the foregoing, as an investor in Arizona, Indiana, Iowa, Kansas, Kentucky, Michigan, New Mexico, Oklahoma, Oregon, Vermont and Washington, I have an individual or joint minimum net worth (exclusive of home, home furnishings, and automobiles) with my spouse of $225,000, without regard to an investment in the Program, and an individual or combined taxable income of $60,000 or more for the previous year and in expectation of an individual or combined taxable income of $60,000 or more for each of the current year and the succeeding year; or (2) have an individual or joint minimum net worth with my spouse in excess of $1,000,000, inclusive of home, home furnishings and automobiles; or (3) have an individual or joint minimum net worth with my spouse in excess of $500,000, exclusive of home, home furnishings and automobiles; or (4) have a combined minimum gross income of $200,000 in the current year and the two previous years. - If resident of South Dakota, I (1) have net worth, or a joint net worth with my spouse, of not less than $1,000,000 at the time of the purchase or (2) have an individual income in excess of $200,000 in each of the two most recent years or joint income with my spouse in excess of $300,000 in each of those years and have a reasonable expectation of reaching the same income level in the current year; or (3) have an individual or joint minimum net worth (exclusive of home, home furnishings, and automobiles) with my spouse of $225,000, without regard to an investment in the Program, and an individual or combined taxable income of $60,000 or more for the previous year and an expectation of an individual or combined taxable income of $60,000 or more for each of the current year and the succeeding year. - If I am a Michigan, Missouri, New Mexico, Ohio, Pennsylvania, or South Dakota resident, my investment in the Partnership will not be equal to or more than 10% of my net worth. ATTENTION CALIFORNIA INVESTORS - A resident of California who subscribes for Units of general partnership interest must represent that he (1) has a net worth of not less than $250,000 (exclusive of home, furnishings and automobiles) and had annual gross income during 2002 for Partnerships designated "PDC 2003- Limited Partnership" of $120,000 or more, or expects to have gross income in 2003 for Partnerships designated "PDC 2003- Limited Partnership of $120,000 or more, or (2) has a net worth of not less than $500,000 (exclusive of home, furnishings and automobiles), or (3) has a net worth of not less than $1,000,000, or (4) expects to have gross income in 2003 for Partnerships designated "PDC 2003- Limited Partnership" of not less than $200,000. - A resident of California who subscribes for Units of limited partnership interest must represent that he (1) has a net worth of not less than $250,000 (exclusive of home, furnishings and automobiles) and expects to have gross income in 2003 for Partnerships designated "PDC 2003- Limited Partnership" of $65,000 or more, or (2) has net worth of not less than $500,000 (exclusive of home, furnishings and automobiles), or (3) has a net worth of not less than $1,000,000, or (4) expects to have gross income in 2003 for Partnerships designated "PDC 2003- Limited Partnership of not less than $200,000. - If a resident of California, I am aware that: It is unlawful to consummate a sale or transfer of this security, or any interest therein, or to receive any consideration therefor, without the prior written consent of the Commissioner of Corporations of the State of California, except as permitted in the Commissioner's rules. As a condition of qualification of the Units for sale in the State of California, the following rule is hereby delivered to each California purchaser. California Administrative Code, Title 10, CH. 3, Rule 260.141.11. Restriction on transfer. (a) The issuer of a security upon which a restriction on transfer has been imposed pursuant to Sections 260.102.6, 260.102.141.10, and 260.534.10 shall cause a copy of this Section to be delivered to each issuee or transferee of such security at the time the certificate evidencing the security is delivered to the issuee or transferee. (b) It is unlawful for the holder of any such security to consummate a sale or transfer of such security, or any interest therein, without the prior written consent of the Commissioner (until this condition is removed pursuant to Section 260.141.12 of these rules), except: (1) to the issuer; (2) pursuant to the order or process of any court; (3) to any person described in Subdivision (i) of Section 25102 of the Code or Section 260.105.14 of these rules; (4) to the transferor's ancestors, descendants or spouse, or any custodian or trustee for the account of the transferor's ancestors, descendants, or spouse; or to a transferee by a trustee or custodian for the account of the transferee or the transferee's ancestors, descendants or spouse; (5) to the holders of securities of the same class of the same issuer; (6) by way of gift or donation intervivos or on death; (7) by or through a broker-dealer licensed under the Code (either acting as such or as a finder) to a resident of a foreign state, territory or country who is neither domiciled in this state to the knowledge of the broker-dealer, nor actually present in this state if the sale of such securities is not in violation of any securities law of the foreign state, territory or country concerned; (8) to a broker-dealer licensed under the Code in a principal transaction, or as an underwriter or member of an underwriting syndicate or selling group; (9) if the interest sold or transferred is a pledge or other lien given by the purchaser to the seller upon a sale of the security for which the Commissioner's written consent is obtained or under this rule not required; (10) by way of a sale qualified under Section 25111, 25112, 25113 or 25121 of the Code, of the securities to be transferred, provided that no order under Section 25140 or Subdivision (a) of Section 25143 is in effect with respect to such qualification; (11) by a corporation to a wholly-owned subsidiary of such corporation, or by a wholly-owned subsidiary of a corporation to such corporation; (12) by way of an exchange qualified under Section 25111, 25112 or 25113 of the Code, provided that no order under Section 25140 or Subdivision (a) of Section 25143 is in effect with respect to such qualification; (13) between residents of foreign states, territories or countries who are neither domiciled nor actually present in this state; (14) to the State Controller pursuant to the Unclaimed Property Law or to the administrator of the unclaimed property law of another state; (15) by the State Controller pursuant to the Unclaimed Property Law or by the administrator of the unclaimed property law of another state if, in either such case, such person (i) discloses to potential purchasers at the sale that transfer of the securities is restricted under this rule, (ii) delivers to each purchaser a copy of this rule, and (iii) advises the Commissioner of the name of each purchaser; or (16) by a trustee to a successor trustee when such transfer does not involve a change in the beneficial ownership of the securities; provided that any such transfer is on the condition that any certificate evidencing the security issued to such transferee shall contain the legend required by this section. (c) The certificates representing all such securities subject to such a restriction on transfer, whether upon initial issuance or upon any transfer thereof, shall bear on their face a legend, prominently stamped or printed thereon in capital letters of not less than 10-point size, reading as follows: "It is unlawful to consummate a sale or transfer of this security, or any interest therein, or to receive any consideration therefor, without the prior written consent of the Commissioner of Corporations of the State of California, except as permitted in the Commissioner's rules." As a condition of qualification of the Units for sale in the State of California, each California subscriber through the execution of the Subscription Agreement acknowledges his understanding that the California Department of Corporations has adopted certain regulations and guidelines which apply to oil and gas interests offered to the public in the State of California. September 5, 2003 Petroleum Development Corporation 103 East Main Street Bridgeport, West Virginia 26330 Re: PDC 2003 Drilling Program Dear Sirs: We have acted as counsel for PDC 2003 Drilling Program, in connection with the offer and sale of securities (the "Units") in a series of limited partnerships, PDC 2001- Limited Partnerships, PDC 2002- Limited Partnerships, and PDC 2003- Limited Partnerships (the "Partnerships") to be organized as limited partnerships under the West Virginia Uniform Limited Partnership Act and in connection with the preparation and filing with the Securities and Exchange Commission of a registration statement on Form S-1 (the "Registration Statement"). Capitalized terms used herein shall have the meaning ascribed to such terms in the Registration Statement, unless otherwise provided. We have examined and are familiar with: (i) the Registration Statement, including a prospectus (the "Prospectus"), (ii) the Partnerships' form of limited partnership agreement (the "Partnership Agreement"), and (iii) such other documents and instruments as we have considered necessary for purposes of the opinions hereinafter set forth. In our examination we have assumed the authenticity of original documents, the accuracy of copies and the genuineness of signatures. We have relied upon the representations and statements of the Managing General Partner of the Partnerships and its affiliates with respect to the factual determinations underlying the legal conclusions set forth herein, including a representation of Petroleum Development Corporation as to its net worth. We have not attempted to verify independently such representations and statements. Please note that we are opining only as to the matters expressly set forth herein, and no opinion should be inferred as to any other matters. We are unable to render opinions as to a number of federal income tax issues relating to an investment in Units and the operations of the Partnerships. Finally, we are not expressing any opinion with respect to the amount of allowable losses or credits that may be generated by the Partnerships or the amount of each Investor Partner's share of allowable losses or credits from the Partnerships' activities. This Appendix D to the Prospectus constitutes our opinion as to all material tax considerations of the offering. In our opinion, each of the legal conclusions rendered in this Appendix D to the Prospectus is correct in all material respects as of the date of this opinion, under the Internal Revenue Code of 1986, as amended (the "Code"), the rules and regulations promulgated thereunder, and existing interpretations thereof. The following opinion and statements are based upon the provisions of the Code, existing and proposed Treasury regulations thereunder, current administrative rulings, and court decisions as of the date of this opinion. On May 28, 2003, President Bush signed into law the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the "2003 Tax Act"). This opinion takes into account the 2003 Tax Act as it affects an investment in the Partnership. The federal income tax law is uncertain as to many of the tax matters material to an investment in the Partnership, and it is not possible to predict with certainty how the law will develop or how the courts will decide various issues if they are litigated. While this opinion fairly states our views as Counsel concerning the tax aspects of an investment in the Partnership, both the Internal Revenue Service (the "Service") and the courts may disagree with our position on certain issues. Moreover, uncertainty exists concerning some of the federal income tax aspects of the transactions being undertaken by the Partnership. Some of the tax positions being taken by the Partnership may be challenged by the Service and there is no assurance that any such challenge will not be successful. Thus, there can be no assurance that all of the anticipated tax benefits of an investment in the partnership will be realized. Our opinions are based upon the transactions described in the Prospectus (the "Transaction") and upon facts as they have been represented to us or determined by us as of the date of the opinion. Any alteration of the facts may adversely affect the opinions rendered. In our opinion, the preponderance of the material tax benefits, in the aggregate, will be realized by the Investor Partners. It is possible, however, that some of the tax benefits will be eliminated or deferred to future years. Because of the factual nature of the inquiry, it is not possible to reach a judgment as to the outcome on the merits (either favorable or unfavorable) of certain material federal income tax issues as described more fully herein. SUMMARY OF CONCLUSIONS Opinions expressed: The following is a summary of the specific opinions expressed by us with respect to Tax Considerations discussed herein. To be fully understood, the complete discussion of these matters should be read by each prospective Investor Partner. 1. The material federal income tax benefits in the aggregate from an investment in the Partnership will be realized. 2. The Partnership will be treated as a partnership for federal income tax purposes and not as an association taxable as a corporation or a publicly traded partnership. 3. To the extent the Partnership's wells are timely drilled and amounts are timely paid, the Partners will be entitled to their pro rata share of the Partnership's IDC paid in 2001, with respect to Partnerships designated "PDC 2001- Limited Partnership," 2002 with respect to Partnerships designated "PDC 2002- Limited Partnership" and 2003 with respect to Partnerships designated "PDC 2003- Limited Partnership." 4. The deductibility of losses generated from the Partnership will not be limited by the at risk rules or the limitations related to an Investor's adjusted basis in his Partnership interest so long as the Investor contributes cash to the Partnership from "personal funds" (i.e., funds not borrowed by the Investor). 5. Additional General Partners' interests will not be considered a passive activity within the meaning of Code section 469 and losses generated while such general partner interest is so held will not be limited by the passive activity provisions. 6. Limited Partners' interests (other than those held by Additional General Partners who convert their interests into Limited Partners' interests) will be considered interests in a passive activity within the meaning of Code section 469 and losses generated therefrom will be limited by the passive activity provisions. 7. The Partnership will not be terminated solely as the result of the conversion of Partnership interests. 8. To the extent provided herein, the Partners' distributive shares of Partnership tax items will be determined and allocated substantially in accordance with the terms of the Partnership Agreement. 9. The Partnership will not be required to register with the Service as a tax shelter; the Partners will not be required to disclose the Partnership as a tax shelter on Form 8886; and the organizers of the Partnership will not be required to maintain a list of the Partners as participants in a tax shelter. No opinion expressed: Due to the essentially factual nature of the question, we express no opinion on the following: 1. The impact of an investment in the Partnership on an Investor's alternative minimum tax. 2. Whether, under Code section 183, the losses of the Partnership will be treated as derived from "activities not engaged in for profit," and therefore nondeductible from other gross income, due to the inherently factual nature of a Partner's interest and motive in engaging in the Transaction. 3. Whether each Partner will be entitled to percentage depletion due to the factual nature of determining the status of the Partner as an independent producer and on the partner's other oil and gas production. 4. Without any assistance of the Managing General Partner or any of its affiliates, some Partners may choose to borrow the funds necessary to acquire a Unit and may incur interest expense in connection with those loans. Whether any interest incurred by a Partner with respect to any borrowings will be deductible or subject to limitations on deductibility, due to the factual nature of the issue. 5. Whether the fees to be paid to the Managing General Partner and to third parties will be deductible, due to the factual nature of the issue. Due to the inherently factual nature of the proper allocation of expenses among nondeductible syndication expenses, amortizable organization expenses, amortizable "start-up" expenditures, and currently deductible items, and because the issues involve questions concerning both the nature of the services performed and to be performed and the reasonableness of amounts charged, we are unable to express an opinion regarding such treatment. General Information: Certain matters contained herein are not considered to address a material tax consequence and are for general information, including the matters contained in sections dealing with gain or loss on the sale of Units or of property, Partnership distributions, tax audits, penalties, and state, local, and self-employment tax. Our opinions are also based upon the facts described in this Prospectus and upon certain representations made to us by the Managing General Partner for the purpose of permitting us to render our opinions, including the following representations with respect to the Program: 1. The Partnership Agreement to be entered into by and among the Managing General Partner and Investor Partners and any amendments thereto will be duly executed and will be made available to any Investor Partner upon written request. The Partnership Agreement will be duly recorded in all places required under the West Virginia Uniform Limited Partnership Act (the "Act") for the due formation of the Partnership and for the continuation thereof in accordance with the terms of the Partnership Agreement. The Partnership will at all times be operated in accordance with the terms of the Partnership Agreement, the Prospectus, and the Act. 2. No election will be made by the Partnership, Investor Partners, or Managing General Partner to be excluded from the application of the provisions of Subchapter K of the Code. 3. The Partnership will own an operating mineral interest, as defined in the Code and in the Regulations, in all of the Drill Sites and none of the Partnership's revenues will be from non-working interests. 4. The respective amounts that will be paid to the General Partners as Drilling Fees, Operating Fees, and other fees will be amounts that would not exceed amounts that would be ordinarily paid for similar transactions between Persons having no affiliation and dealing with each other at "arms' length." 5. The Managing General Partner will cause the Partnership to properly elect to deduct currently all Intangible Drilling and Development Costs. 6. The Partnership will have a December 31 taxable year and will report its income on the accrual basis. 7. The Drilling Agreement to be entered into by and among the Managing General Partner and the Partnership will be duly executed and will govern the drilling of the Partnership's Wells. All Partnership Wells will be spudded by the close of business on March 30, 2002 with respect to Partnerships designated "PDC 2001- Limited Partnership," March 30, 2003 with respect to Partnerships designated "PDC 2002- Limited Partnership," and March 30, 2004 with respect to Partnerships designated "PDC 2003- Limited Partnership." Thereafter, each well will be completed with due diligence, if completion is warranted. The entire amount to be paid to the Managing General Partner under the Drilling and Operating Agreement is attributable to Intangible Drilling and Development Costs and does not include a profit for services performed or materials provided by third parties which are passed through at actual cost. 8. The Drilling and Operating Agreement will be duly executed and will govern the operation of the Partnership's Wells. 9. Based upon the Managing General Partner's review of its experience with its previous drilling programs for the past several years and upon the intended operations of the Partnership, the sum of (i) the aggregate deductions, including depletion deductions, and (ii) 350 percent of the aggregate credits from the Partnership will not, as of the close of any of the first five years ending after the date on which Units are offered for sale, exceed two times the cash invested by the Partners in the Partnership as of such dates. In that regard, the Managing General Partner has reviewed the economics of its similar oil and gas drilling programs for the past several years, and has represented that it has determined that none of those programs has resulted in a tax shelter ratio greater than two to one. Further, the Managing General Partner has represented that the deductions and credits that are or will be represented as potentially allowable to an investor will not result in any Partnership having a tax shelter ratio greater than two to one and believes that no person could reasonably infer from representations made, or to be made, in connection with the offering of Units that such sums as of such dates will exceed two times the Partners' cash investments as of such dates. 10. At least 90% of the gross income of the Partnership will constitute income derived from the exploration, development, production, and/or marketing of oil and gas. The Managing General Partner does not believe that any market will ever exist for the sale of Units and the Managing General Partner will not make a market for the Units. Further, the Units will not be traded on an established securities market or the substantial equivalent thereof. 11. The Partnership will have the objective of carrying on business for profit and dividing the gain therefrom. 12. The Managing General Partner will not permit the purchase of Units by tax-exempt investors or foreign investors. The Partnership will not drill, own or operate any Well located outside the United States. 14. No Partner will incur any debt that either is: (i) arranged by the Partnership, the Managing General Partner, or any other person who participated in the organization or management of the Partnership or the sale of Units (or any person related to such persons), or (ii) secured by any asset of the Partnership. Our opinions are also subject to all the assumptions, qualifications, and limitations set forth in the following discussion, including the assumptions that each of the Partners has full power, authority, and legal right to enter into and perform the terms of the Partnership Agreement and to take any and all actions thereunder in connection with the transactions contemplated thereby. Each prospective Investor should be aware that, unlike a ruling from the Service, an opinion of counsel represents only such counsel's best judgment. There can be no assurance that the Service will not successfully assert positions which are inconsistent with our opinions set forth in this discussion or in the tax reporting positions taken by the Partners or the Partnership. Each prospective investor should consult his own tax advisor to determine the effect of the tax issues discussed herein on his individual tax situation. PARTNERSHIP STATUS The Partnership will be formed as a limited partnership pursuant to the Partnership Agreement and the laws of the State of West Virginia. The characterization of the Partnership as a partnership by state or local law, however, will not be determinative of the status of the Partnership for federal income tax purposes. The availability of any federal income tax benefits to an investor is dependent upon classification of the Partnership as a partnership rather than as a corporation or as an association taxable as a corporation for federal income tax purposes. We are of the opinion that the Partnership will be treated as a partnership for federal income tax purposes, and not as a corporation or as an association taxable as a corporation. However, there can be no assurance that the Service will not attempt to treat the Partnership as a corporation or as an association taxable as a corporation for federal income tax purposes. If the Service were to prevail on this issue, the tax benefits associated with taxation as a partnership would not be available to the Partners. Although the Partnership will be validly organized as a limited partnership under the laws of the state of West Virginia and will be subject to the Act, whether it will be treated for federal income tax purposes as a partnership or as a corporation or as an association taxable as a corporation will be determined under the Code rather than local law. As discussed below, our opinion that the Partnership will not be classified a corporation or as an association taxable as a corporation is based in part on entity classification regulations and in part on the fact that in our opinion the Partnership will not constitute a "publicly traded partnership." A. Association Taxable as a Corporation Our opinion that the Partnership will not be treated as an association taxable as a corporation is based on regulations issued by the Internal Revenue Service on December 17, 1996, generally effective as of January 1, 1997, regarding the tax classification of certain business organizations (the "Check the Box Regulations"). Under the Check the Box Regulations, in general, a business entity that is not otherwise required to be treated as a corporation under such regulations will be classified as a partnership if it has two or more members, unless the business entity elects to be treated as a corporation. The Partnership is not required under the Check the Box Regulations to be treated as a corporation and the Managing General Partner will not elect that the Partnership be treated as a corporation. Accordingly, in our opinion the Partnership will not be treated as an association taxable as a corporation. B. Publicly Traded Partnerships The Revenue Act of 1987 (the "1987 Act") added Code section 7704, "Certain Publicly Traded Partnerships Treated as Corporations." In treating certain "publicly traded partnerships" ("PTPs") as corporations for federal income tax purposes, Congress defined a PTP as any partnership, interests in which are either traded on an established securities market or readily tradable on a secondary market (or the substantial equivalent thereof). Code section 7704(b). Treas. Reg. section 1.7704-1(b) provides that an "established securities market" includes a national securities exchange registered under section 6 of the Securities Exchange Act of 1934 (the "1934 Act"), a national securities exchange exempt under the 1934 Act because of the limited volume of transactions, certain foreign security laws, regional or local exchanges, and an interdealer quotation system that regularly disseminates firm buy or sell quotations by identified brokers or dealers. The Managing General Partner has represented that the Units will not be traded on an established securities market. Notwithstanding the above general treatment of PTPs, Code section 7704(c) creates an exception to the treatment of PTPs as corporations for any taxable year if 90% or more of the gross income of the partnership for such taxable year consists of "qualifying income." Code section 7704(c)(2). For this purpose, qualifying income is defined to include, inter alia, "income and gains derived from the exploration, development, mining or production, processing, refining . . . or the marketing of any mineral or natural resource . . ." Code section 7704(d)(1)(E). The Managing General Partner has represented that it believes that, for all taxable years of the Partnership, 90% or more of the Partnership's gross income will consist of such qualifying income. Regarding the definition of PTPs contained in the Code, the Committee Reports to the 1987 Act provide that PTPs include entities with respect to which, inter alia, (i) "the holder of an interest has a readily available, regular and ongoing opportunity to sell or exchange his interest through a public means of obtaining or providing information of offers to buy, sell or exchange interests," (ii) "prospective buyers and sellers have the opportunity to buy, sell or exchange interests in a time frame and with the regularity and continuity that the existence of a market maker would provide," and (iii) there exists a "regular plan of redemptions or repurchases, or similar acquisitions of interests in the partnership such that holders of interests have readily available, regular and ongoing opportunities to dispose of their interests." The Service issued Treas. Reg. section 1.7704-1 to clarify when partnership interests that are not traded on an established securities market will be treated as readily tradable on a secondary market or the substantial equivalent thereof. Essentially, the Regulation provides that such a situation occurs if partners are readily able to buy, sell, or exchange their partnership interests in a manner that is comparable, economically, to trading on an established securities market. It is unclear whether the limited safe harbors provided in the Regulation would result in the Units being treated as not publicly traded and we express no opinion regarding this matter. However, the Managing General Partner's obligation to offer to purchase any Units is conditioned upon the receipt by the Partnership from its counsel of an opinion that such offers or obligations to offer will not cause the Partnership to be treated as "publicly traded." Due to the presence of the opinion of counsel condition, the Partnership, in our opinion, will not be treated as a PTP prior to the time any such offers are made to Investor Partners. Accordingly, the Partnership, in our opinion, will not be treated as a corporation for federal income tax purposes under Code section 7704 in the absence of the Partnership's interests being "readily tradable on a secondary market (or the substantial equivalent thereof)." Notwithstanding the above, the Service may promulgate regulations or release announcements which take the position that interests in partnerships such as the Partnership are readily tradable on a secondary market or the substantial equivalent thereof. However, treatment of the Partnership as a PTP should not result in its treatment as a corporation for federal income tax purposes due to the exception contained in Code section 7704(c) relating to PTPs meeting the 90% of gross income test so long as such gross income test is satisfied. C. Summary In our opinion the Partnership will not be treated as an association taxable as a corporation for federal income tax purposes by reason of the Check the Box Regulations. Further, since any right of the Managing General Partner to offer to purchase Units is conditioned upon the receipt of an opinion of counsel that the Partnership will not be treated as a PTP, and assuming the Partnership satisfies the 90% gross income test of Code section 7704, the Partnership, in our opinion, will not be treated as a corporation for federal income tax purposes. Accordingly, the Partnership in our opinion will be treated as a partnership for federal income tax purposes. If challenged by the Service on this issue, the Partners should prevail on the merits, and each Partner should be required to report his proportionate share of the Partnership's items of income and deductions on his individual federal income tax return. If in any taxable year the Partnership were to be treated for federal income tax purposes as a corporation or as an association taxable as a corporation, the Partnership income, gain, loss, deductions, and credits would be reflected only on its "corporate" tax return rather than being passed though to the Partners. In such event, the Partnership would be required to pay income tax at corporate rates on its net income, thereby reducing the amount of cash available to be distributed to the Partners. Additionally, all or a portion of any distribution made to Partners would be taxable as dividends, which would not be deductible by the Partnership. The discussion that follows is based on the assumption that the Partnership will be classified as a partnership for federal income tax purposes. FEDERAL TAXATION OF THE PARTNERSHIP Under the Code, a partnership is not a taxable entity and, accordingly, incurs no federal income tax liability. Rather, a partnership is a "pass-through" entity which is required to file an information return with the Service. In general, the character of a partner's share of each item of income, gain, loss, deduction, and credit is determined at the partnership level. Each partner is allocated a distributive share of such items in accordance with the partnership agreement and is required to take such items into account in determining the partner's income. Each partner includes such amounts in income for any taxable year of the partnership ending within or with the taxable year of the partner, without regard to whether the partner has received or will receive any cash distributions from the Partnership. TAX SHELTER RULES The Code provides that certain investments must be registered as tax shelters with the Service. Registration numbers for such tax shelters must be supplied to investors who are required to report the numbers on their personal tax returns. There are various definitions of "tax shelters" in the Code and Treasury Regulations and, depending upon which definition is satisfied, different obligations are required by the participants in or promoters of the tax shelter. Certain types of tax shelters must be "registered" with the Service in a particular manner, while others (i.e., so-called "Reportable Transactions") must be disclosed to the Service in a different manner. In addition, promoters or organizers of either of these types of tax shelters generally must prepare and maintain a list of each of the participants in the tax shelter. In our view, the Partnership will not be considered a tax shelter under any of the various definitions described herein. The registration requirements apply to an investment with respect to which any person could reasonably infer from the representations made, or to be made, in connection with the offering for sale of interests in the investment that the "tax shelter ratio" for any investor is greater than two to one as of the close of any of the first five years ending after the date on which such investment is offered for sale. Temp. Treas. Reg. section 301.6111-1T. The Managing General Partner has represented that, (i) based upon its experience with its previous drilling programs and upon the intended operations of the Partnership, it does not believe that the Partnership will have a tax shelter ratio greater than two to one, (ii) the deductions and credits that are or will be represented as potentially allowable to an investor will not result in any Partnership having a tax shelter ratio greater than two to one, and (iii) based upon a review of the economics of its similar oil and gas drilling programs for the past several years, it has determined that none of those programs has resulted in a tax shelter ratio greater than two to one. Accordingly, the Managing General Partner does not intend to cause the Partnership to register with the Service as a tax shelter. Based on the foregoing representations, we are of the opinion that the Partnership will not be required to register with the Service as a tax shelter. If it is subsequently determined that the Partnership was required to be registered with the Service as a tax shelter, the Partnership would be subject to certain penalties under Code section 6707, including a penalty ranging from $500 to 1% of the aggregate amount invested in Units for failing to register and $100 for each failure to furnish to a Partner a tax shelter registration number, and each Partner would be liable for a $250 penalty for failure to include the tax registration number on his tax return, unless such failure was due to reasonable cause. A Partner also would be liable for a penalty of $100 for failing to furnish the tax shelter registration number to any transferee of his Partnership interest. Counsel can give no assurance that, if the Partnership is determined to be a tax shelter which must be registered with the Service, the above penalties will not apply. In addition to the tax shelter registration requirements described above, (i) every taxpayer that participates in a "Reportable Transaction" generally must disclose the transaction to the Service using Form 8886 and (ii) every organizer and seller of a "Potentially Abusive Tax Shelter" (which is generally a Reportable Transaction or a tax shelter that is required to be registered) generally must prepare and maintain a list of each of the participants in the transaction. The Service has recently issued final regulations addressing these disclosure and list maintenance requirements, which are generally effective for transactions entered into on or after February 28, 2003. See Treas. Reg. sections 1.6011-4 and 301.6112-1. A Reportable Transaction (and accordingly, by definition, a Potentially Abusive Tax Shelter) includes certain transactions that give rise to a significant book-tax difference. Treas. Reg. sections 1.6011-4(b)(6) and 301.6112-1(b)(2)(i)(B). Although the Partnership's election to deduct IDC rather than capitalize it could give rise to a significant book-tax difference, a book-tax difference caused by deducting IDC pursuant to Code section 263(c) is not taken into account for these purposes. Rev. Proc. 2003-25, section 4.04, 2003-11 I.R.B. 601 (February 27, 2003). In addition, the Partnership does not otherwise satisfy the definition of a Reportable Transaction. Therefore, it is our view that an investment in the Partnership will not be a Reportable Transaction. Furthermore, the Partnership will not be a Potentially Abusive Tax Shelter because an investment in the Partnership will not be a Reportable Transaction and because the Partnership will not be a tax shelter that is required to be registered. Consequently, the Partners will not be required to disclose the Partnership as a tax shelter on Form 8886 and the organizers of the Partnership will not be required to maintain a list of the Partners as participants in a tax shelter. INTANGIBLE DRILLING AND DEVELOPMENT COSTS DEDUCTIONS Under Code section 263(a), taxpayers are denied deductions for capital expenditures, which expenditures are those that generally result in the creation of an asset having a useful life which extends substantially beyond the close of the taxable year. See also Treas. Reg. section 1.461-1(a)(2). In Indopco, Inc. v. Commissioner, 503 U.S. 79 (1992), the Supreme Court seemed to further limit the capitalization criteria by stating that the costs should be capitalized when they provide benefits that extend beyond one tax year. Notwithstanding these statutory and judicial general rules, Congress has granted to the Treasury Secretary the authority to prescribe regulations that would allow taxpayers the option of deducting, rather than capitalizing, intangible drilling and development costs ("IDC"). Code section 263(c). The Secretary's rules are embodied in Treas. Reg. section 1.612-4 and state that, in general, the option to deduct IDC applies only to expenditures for drilling and development items that do not have a salvage value. With respect to IDC incurred by a partnership, Code section 703 and Treas. Reg. section 1.703-1(b) provide that the option to deduct such costs is to be exercised at the partnership level and in the year in which the deduction is to be taken. The Managing General Partner has represented that the Partnership will elect to deduct IDC in accordance with Treas. Reg. section 1.612-4. In this regard, Additional General Partners generally will be entitled to deduct IDC against any form of income in the year in which the investment is made, provided wells are spudded within the first ninety days of the following year; subject to the same provision, Limited Partners generally will be entitled to deduct IDC against passive income. See discussions below concerning passive loss and credit limitations and alternative minimum tax, which may limit the benefit of an IDC deduction. A. Classification of Costs In general, IDC consists of those costs which in and of themselves have no salvage value. Treas. Reg. section 1.612-4(a) provides examples of items to which the option to deduct IDC applies, including all amounts paid for labor, fuel, repairs, hauling, and supplies, or any of them, which are used (i) in the drilling, shooting, and cleaning of wells, (ii) in such clearing of ground, draining, road making, surveying, and geological works as are necessary in the preparation for the drilling of wells, and (iii) in the construction of such derricks, tanks, pipelines, and other physical structures as are necessary for the drilling of wells and the preparation of wells for the production of oil or gas. The Service, in Rev. Rul. 70-414, 1970-2 C.B. 132, set forth further classifications of items subject to the option and those considered capital in nature. The ruling provides that the following items are not subject to the election of Treas. Reg. section 1.612-4(a): (i) oil well pumps (upon initial completion of the well), including the necessary housing structures; (ii) oil well pumps (after the well has flowed for a time), including the necessary housing structures; (iii) oil well separators, including the necessary housing structures; (iv) pipelines from the wellhead to oil storage tanks on the producing lease; (v) oil storage tanks on the producing lease; (vi) salt water disposal equipment, including any necessary pipelines; (vii) pipelines from the mouth of a gas well to the first point of control, such as a common carrier pipeline, natural gasoline plant, or carbon black plant; (viii) recycling equipment, including any necessary pipelines; and (ix) pipelines from oil storage tanks on the producing leasehold to a common carrier pipeline. A partnership's classification of a cost as IDC is not binding on the government, which might reclassify an item labeled as IDC as a cost which must be capitalized. In Bernuth v. Commissioner, 57 T.C. 225 (1971), aff'd, 470 F.2d 710 (2nd Cir. 1972), the Tax Court denied taxpayers a deduction for that portion of a turnkey drilling contract price that was in excess of a reasonable cost for drilling the wells in question under a turnkey contract, holding that the amount specified in the turnkey contract was not controlling. Similarly, the Service, in Rev. Rul. 73-211, 1973-1 C.B. 303, concluded that excessive turnkey costs are not deductible as IDC: [O]nly that portion of the amount of the taxpayer's total investment that is attributable to intangible drilling and development costs that would have been incurred in an arm's-length transaction with an unrelated drilling contractor (in accordance with the economic realities of the transaction) is deductible [as IDC]. To the extent the Partnership's prices meet the reasonable price standards imposed by Bernuth, supra, and Rev. Rul 73-211, supra, and to the extent such amounts are not allocable to tangible property, leasehold costs, and the like, the amounts paid to the Managing General Partner under the drilling contract should qualify as IDC and should be deductible at the time described below under "B. Timing of Deductions." That portion of the amount paid to the Managing General Partner that is in excess of the amount that would be charged by an independent driller under similar conditions will not qualify as IDC and will be required to be capitalized. We are unable to express an opinion regarding the reasonableness or proper characterization of the payments under the drilling agreement, since the determination of whether the amounts are reasonable or excessive is inherently factual in nature. No assurance can be given that the Service will not characterize a portion of the amount paid to the Managing General Partner as an excessive payment, to be capitalized as a leasehold cost, assignment fee, syndication fee, organization fee, or other cost, and not deductible as IDC. To the extent not deductible, such amounts will be included in the Partners' bases of their interests in the Partnership. B. Timing of Deductions As described above, Code section 263(c) and Treas. Reg. section 1.612-4 allow the Partnership to expense IDC as opposed to capitalizing such amounts. Even if the Partnership elects to expense the IDC, assuming a taxpayer is otherwise entitled to such a deduction, the taxpayer may elect to capitalize all or a part of the IDC and amortize same on a straight-line basis over a sixty month period, beginning with the taxable month in which such expenditure is made. Code section 59(e)(1) and (2)(c). For taxpayers entitled to deduct IDC, the timing of such deduction can vary, depending, in part, upon the taxpayer's method of accounting. The Managing General Partner has represented that the Partnership will use the accrual method of accounting. Under the accrual method, income is recognized when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. Treas. Reg. section 1.451-1(a). With respect to deductions, recognition results when all events which establish liability have occurred and the amount thereof can be determined with reasonable accuracy. Treas. Reg. section 1.461-1(a)(2). Regarding deductions, Code section 461(h)(1) provides that ". . . the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs." Code section 461(i)(2), provides that, in the case of a "tax shelter," economic performance with respect to the act of drilling an oil or gas well will ". . . be treated as having occurred within a taxable year if drilling of the well commences before the close of the 90th day after the close of the taxable year." "Tax shelter," for purposes of Code section 461, is defined to include the Partnership. However, with respect to a tax shelter which is a partnership, the maximum deduction that would be allowable for any prepaid expenses under this exception would be limited to the partner's "cash basis" in the partnership. Code section 461(i)(2)(B)(i). Such "cash basis" equals the partner's adjusted basis in the partnership, determined without regard to (i) any liability of the partnership and (ii) any amount borrowed by the partner with respect to the partnership which (I) was arranged by the partnership or by any person who participated in the organization, sale, or management of the partnership (or any person related to such person within the meaning of Code section 465(b)(3)(C)) or (II) was secured by any assets of the partnership. Code section 461(i)(2)(C). The Managing General Partner has represented that, as Operator, it will commence drilling operations by spudding each well on or before March 30, 2002 for Partnerships designated "PDC 2001- Limited Partnership," March 30, 2003 for Partnerships designated "PDC 2002- Limited Partnership," and March 30, 2004 for Partnerships designated "PDC 2003- Limited Partnership," and will complete each well, if completion is warranted, with due diligence thereafter. Further, the Managing General Partner has represented that, in any event, the Partnership will not have any such liability referred to in Code section 461(i)(2)(C), and the Partners will not so incur any such debt so as to result in application of the limiting provisions contained in Code section 461(i)(2)(B)(i). Notwithstanding the above, the deductibility of any prepaid IDC will be subject to the limitations of case law. These limitations provide that prepaid IDC is deductible when paid if (i) the expenditure constitutes a payment that is not merely a deposit, (ii) the payment is made for a business purpose, and (iii) deductions attributable to such outlay do not result in a material distortion of income. See Keller v. Commissioner, 79 T.C. 7 (1982), aff'd, 725 F.2d 1173 (8th Cir. 1984), Rev. Rul. 71-252, 1971-1 C.B. 146, Pauley v. U.S., 63-1 U.S.T.C. paragraph 9280 (S.D. Cal. 1963), Rev. Rul. 80-71, 1980-1 C.B. 106, Jolley v. Commissioner, 47 T.C.M. 1082 (1984), Dillingham v. U.S., 81-2 U.S.T.C. paragraph 9601 (W.D. Okla. 1981), and Stradlings Building Materials, Inc. v. Commissioner, 76 T.C. 84 (1981). Generally, these requirements may be met by a showing of a legally binding obligation (i.e., the payment was not merely a deposit), of a substantial legitimate business purpose for the payment, that performance of the services was required within a reasonable time, and of an arm's-length price. Similar requirements apply to cash basis taxpayers seeking to deduct prepaid IDC. The Managing General Partner is unable to represent that all of the Wells will be completed in 2001 for Partnerships designated "PDC 2001- Limited Partnership," 2002 for Partnerships designated "PDC 2002- Limited Partnership," and 2003 for Partnerships designated "PDC 2003- Limited Partnership"; however, the Managing General Partner has represented that any Well that is not completed in 2001 with respect to Partnerships designated "PDC 2001- Limited Partnership," in 2002 with respect to Partnerships designated "PDC 2002- Limited Partnership," and in 2003 with respect to Partnerships designated "PDC 2003- Limited Partnership" will be spudded by not later than March 30, 2002 for Partnerships designated "PDC 2001- Limited Partnership," March 30, 2003 for Partnerships designated "PDC 2002- Limited Partnership," and March 30, 2004 for Partnerships designated "PDC 2003- Limited Partnership," respectively. The Service has challenged the timing of the deduction of IDC when the wells giving rise to such deduction have been completed in a year subsequent to the year of prepayment. The decisions noted above hold that prepayments of IDC by a cash basis taxpayer are, under certain circumstances, deductible in the year of prepayment if some work is performed in the year of prepayment even though the well is not completed that year. In Keller v. Commissioner, supra, the Eighth Circuit Court of Appeals applied a three-part test for determining the current deductibility of prepaid IDC by a cash basis taxpayer, namely whether (i) the expenditure was a payment or a mere deposit, (ii) the payment was made for a valid business purpose and (iii) the prepayment resulted in a material distortion of income. The facts in that case dealt with two different forms of drilling contracts: footage or day-work contracts and turnkey contracts. Under the turnkey contracts, the prepayments were not refundable in any event, but in the event work was stopped on one well the remaining unused amount would be applied to another well to be drilled on a turnkey basis. Contrary to the Service's argument that this substitution feature rendered the payment a mere deposit, the court in Keller concluded that the prepayments were indeed "payments" because the taxpayer could not compel a refund. The court further found that the deduction clearly reflected income because under the unique characteristics of the turnkey contract the taxpayer locked in the price and shifted the drilling risk to the contractor, for a premium, effectively getting its bargained for benefit in the year of payment. Therefore, the court concluded that the cash basis taxpayers in that case properly could deduct turnkey payments in the year of payment. With respect to the prepayments under the footage or day-work contracts, however, the court found that the payments were mere deposits on the facts of the case, because the partnership had the power to compel a refund. The court was also unconvinced as to the business purpose for prepayment under the footage or day-work contracts, primarily because the testimony indicated that the drillers would have provided the required services with or without prepayment. Under the terms of the Drilling and Operating Agreement, if amounts paid by the Partnership prior to the commencement of drilling exceed amounts due the Managing General Partner thereunder, the Managing General Partner will not refund any portion of amounts paid by the Partnership, but rather will create a credit once the actual costs incurred by the Managing General Partner are compared to the amounts paid. Further, the Managing General Partner will expend such credit for additional IDC on additional wells selected by the Managing General Partner. The Service has adopted the position that the relationship between the parties may provide evidence that the drilling contract between the parties requiring prepayment may not be a bona fide arm's-length transaction, in which case a portion of the prepayment may be disallowed as being a "non-required payment." Section 4236, Internal Revenue Service Examination Tax Shelters Handbook (6-27-85). A similar position is taken by the Service in the Tax Shelter Audit Technique Guidelines. Internal Revenue Service Examination Tax Shelter Handbook. The Service has formally adopted its position on prepayments to related parties in Revenue Ruling 80-71, 1980-1 C.B. 106. In this ruling, a subsidiary corporation, which was a general partner in an oil and gas limited partnership, prepaid the partnership's drilling and completion costs under a turnkey contract entered into with the corporate parent of the general partner. The agreement did not provide for any date for commencing drilling operations and the contractor, which did not own any drilling equipment, was to arrange for the drilling equipment for the wells through subcontractors. Revenue Ruling 71-252, supra, was factually distinguished on the grounds of the business purpose of the transaction, immediate expenditure of prepaid receipts, and completion of the wells within two and one-half months. Rev. Rul. 80-71 found that the prepayment was not made in accordance with customary business practice and held on the facts that the payment was deductible in the tax year that the related general contractor paid the independent subcontractor. However, in Tom B. Dillingham v. United States, supra, the court held that, on the facts before it, a contract between related parties requiring a prepaid IDC did give rise to a deduction in the year paid. In that case, Basin Petroleum Corp. ("Basin") was the general partner of several drilling partnerships and also served as the partnership operator and general contractor. As general contractor, Basin was to conduct the drilling of the wells at a fixed price on a turnkey basis under an agreement that required payment prior to the end of the year in question. The stated reason for the prepayment was to provide Basin with working capital for the drilling of the wells and to temporarily provide funds to Basin for other operations. The agreement required drilling to commence within a reasonable period of time, and all wells were completed within the following year. Some of the wells were drilled by Basin with its own rigs and some were drilled by subcontractors. The court stated: The fact that the owner and contractor is the general partner of the partnership-owner does not change this result where, as here, the Plaintiffs have shown that prepayment was required for a legitimate business purpose and the transaction was not a sham to merely permit Plaintiff to control the timing of the deduction. IRC, Sec. 707(a). Plaintiffs were entitled to rely upon Revenue Ruling 71-252 by reason of Income Tax Regulations 26 C.F.R. section 601.601(d)(2)(v)(e) . . . Notwithstanding the foregoing, no assurance can be given that the Service will not challenge the current deduction of IDC because of the prepayment being made to a related party. If the Service were successful with such challenge, the Partners' deductions for IDC would be deferred to later years. The timing of the deductibility of prepaid IDC is inherently a factual determination which is to a large extent predicated on future events. The Managing General Partner has represented that the Drilling and Operating Agreement to be entered into with PDC by the Partnership will be duly executed by and delivered to PDC, the Partnership, and PDC as attorney-in-fact for the Partners and will govern the drilling, and, if warranted, the completion of each of the Wells. The Drilling and Operating Agreement requires PDC to commence drilling operations by spudding each Well on or before March 30, 2002 for Partnerships designated "PDC 2001- Limited Partnership," March 30, 2003 for Partnerships designated "PDC 2002- Limited Partnership," and March 30, 2004 for Partnerships designated "PDC 2003- Limited Partnership," and to complete each Well, if completion is warranted, with due diligence thereafter. Also, under the terms of the Drilling and Operating Agreement, PDC, as general contractor, will not refund any portion of amounts paid in the event actual costs are less than the amounts paid but will apply any such amounts solely for payment of additional drilling services to the Partners. Based upon this representation and others included within the opinion and assuming that the Drilling and Operating Agreement will be performed in accordance with its terms, we are of the opinion that the payment for IDC under the Drilling and Operating Agreement, if made in 2001 for Partnerships designated "PDC 2001- Limited Partnership," 2002 for Partnerships designated "PDC 2002- Limited Partnerships," and 2003 for Partnerships designated "PDC 2003- Limited Partnership" will be allowable as a deduction in 2001 for Partnerships designated "PDC 2001- Limited Partnership," 2002 for Partnerships designated "PDC 2002- Limited Partnerships," and 2003 for Partnerships designated "PDC 2003- Limited Partnership" subject to the other limitations discussed in this opinion. Although PDC will attempt to satisfy each requirement of the Service and judicial authority for deductibility of IDC in 2001 for Partnerships designated "PDC 2001- Limited Partnership," 2002 for Partnerships designated "PDC 2002- Limited Partnerships," and 2003 for Partnerships designated "PDC 2003- Limited Partnership" no assurance can be given that the Service will not successfully contend that the IDC of a well which is not completed until 2002 for Partnerships designated "PDC 2001- Limited Partnership," 2003 for Partnerships designated "PDC 2002- Limited Partnership," and 2004 for Partnerships designated "PDC 2003- Limited Partnership" are not deductible in whole or in part until 2002 or 2003 or 2004, respectively. Further, to the extent drilling of the Partnership's wells does not commence by March 30, 2002 for Partnerships designated "PDC 2001- Limited Partnership," March 30, 2003 for Partnerships designated "PDC 2002- Limited Partnership," and March 30, 2004 for Partnerships designated "PDC 2003- Limited Partnership," the deductibility of all or a portion of the IDC may be deferred under Code section 461. C. Recapture of IDC IDC which has been deducted is subject to recapture as ordinary income upon certain dispositions (other than by abandonment, gift, death, or tax-free exchange) of an interest in an oil or gas property. IDC previously deducted that is allocable to the property (directly or through the ownership of an interest in a partnership) and which would have been included in the adjusted basis of the property is recaptured to the extent of any gain realized upon the disposition of the property. Treasury regulations provide that recapture is determined at the partner level (subject to certain anti-abuse provisions). Treas. Reg. section 1.1254-5(b). Where only a portion of recapture property is disposed of, any IDC related to the entire property is recaptured to the extent of the gain realized on the portion of the property sold. In the case of the disposition of an undivided interest in a property (as opposed to the disposition of a portion of the property), a proportionate part of the IDC with respect to the property is treated as allocable to the transferred undivided interest to the extent of any realized gain. Treas. Reg. section 1.1254-1(c). DEPLETION DEDUCTIONS The owner of an economic interest in an oil and gas property is entitled to claim the greater of percentage depletion or cost depletion with respect to oil and gas properties which qualify for such depletion methods. In the case of partnerships, the depletion allowance must be computed separately by each partner and not by the partnership. Code section 613A(c)(7)(D). Notwithstanding this requirement, however, the Partnership, pursuant to Section 3.01(d)(i) of the Partnership Agreement, will compute a "simulated depletion allowance" at the Partnership level, solely for the purposes of maintaining Capital Accounts. Code sections 613A(d)(2) and 613A(d)(4). Cost depletion for any year is determined by multiplying the number of units (e.g., barrels of oil or Mcf of gas) sold during the year by a fraction, the numerator of which is the cost of the mineral interest and the denominator of which is the estimated recoverable units of reserve available as of the beginning of the depletion period. See Treas. Reg. section 1.611-2(a). In no event can the cost depletion exceed the adjusted basis of the property to which it relates. Percentage depletion is generally available only with respect to the domestic oil and gas production of certain "independent producers." In order to qualify as an independent producer, the taxpayer, either directly or through certain related parties, may not be involved in the refining of more 50,000 barrels of oil (or equivalent of gas) on any day during the taxable year or in the retail marketing of oil and gas products exceeding $5 million per year in the aggregate. In general, (i) component members of a controlled group of corporations, (ii) corporations, trusts, or estates under common control by the same or related persons and (iii) members of the same family (an individual, his spouse and minor children) are aggregated and treated as one taxpayer in determining the quantity of production (barrels of oil or cubic feet of gas per day) qualifying for percentage depletion under the independent producer's exemption. Code section 613A(c) (8). No aggregation is required among partners or between a partner and a partnership. An individual taxpayer is related to an entity engaged in refining or retail marketing if he owns 5% or more of such entity. Code section 613A(d)(3). Percentage depletion is a statutory allowance pursuant to which, under current law, a deduction equal to 15% of the taxpayer's gross income from the property is generally allowed in any taxable year, in general not to exceed (i) 100% of the taxpayer's taxable income from the property (computed without the allowance for depletion) or (ii) 65% of the taxpayer's taxable income for the year (computed without regard to percentage depletion and net operating loss and capital loss carrybacks). Code sections 613(a) and 613A(d)(1). In the case of "stripper well property," as that term is defined in Code section 613A(c)(6)(D), the 100% of taxable income limitation has been eliminated for taxable years 1998 to 2003. Code section 613A(c)(6)(H). It is anticipated that the properties of the Partnerships will likely constitute "stripper well properties" for this purpose. In the case of production from marginal properties, the percentage depletion rate may be increased up to 25% depending upon the reference price for crude oil in the preceding year. Code section 613A(c)(6). For purposes of computing the percentage depletion deduction, "gross income from the property" does not include any lease bonus, advance royalty, or other amount payable without regard to production from the property. Code section 613A(d)(5). Depletion deductions reduce the taxpayer's adjusted basis in the property. However, unlike cost depletion, deductions under percentage depletion are not limited to the adjusted basis of the property; the percentage depletion amount continues to be allowable as a deduction after the adjusted basis has been reduced to zero. Percentage depletion will be available, if at all, only to the extent that a taxpayer's average daily production of domestic crude oil or domestic natural gas does not exceed the taxpayer's depletable oil quantity or depletable natural gas quantity, respectively. Generally, the taxpayer's depletable oil quantity equals 1,000 barrels and depletable natural gas quantity equals 6,000,000 cubic feet. Code section 613A(c)(3) and (4). In computing his individual limitation, a Partner will be required to aggregate his share of the Partnership's oil and gas production with his share of production from all other oil and gas investments. Code section 613A(c). Taxpayers who have both oil and gas production may allocate the deduction limitation between the two types of production. The availability of depletion, whether cost or percentage, will be determined separately by each Partner. Each Partner must separately keep records of his share of the adjusted basis in an oil or gas property, adjust such share of the adjusted basis for any depletion taken on such property, and use such adjusted basis each year in the computation of his cost depletion or in the computation of his gain or loss on the disposition of such property. These requirements may place an administrative burden on a Partner. For properties placed in service after 1986, depletion deductions, to the extent they reduce the basis of an oil and gas property, are subject to recapture under Code section 1254. Since the availability of percentage depletion for a Partner is dependent upon the status of the partner as an independent producer, we also are unable to express an opinion on this matter. Because of the foregoing, we are unable to render any opinion as to the availability of percentage depletion. Each prospective investor is urged to consult with his personal tax advisor to determine whether percentage depletion would be available to him. DEPRECIATION DEDUCTIONS The Partnership will claim depreciation, cost recovery, and amortization deductions with respect to its basis in Partnership Property as permitted by the Code. For most tangible personal property placed in service after December 31, 1986, the "modified accelerated cost recovery system" ("MACRS") must be used in calculating the cost recovery deductions. Thus, the cost of lease equipment and well equipment, such as casing, tubing, tanks, and pumping units, and the cost of oil or gas pipelines cannot be deducted currently but must be capitalized and recovered under "MACRS." The cost recovery deduction for most equipment used in domestic oil and gas exploration and production and for most of the tangible personal property used in natural gas gathering systems is calculated using the 200% declining balance method switching to the straight-line method, a seven-year recovery period, and a half-year convention. For certain tangible property, the Partnership will be allowed an additional depreciation deduction equal to 30% (or 50% for such property acquired and placed in service after May 5, 2003) of the adjusted basis of the property for the year in which the property is placed in service. Code section 168(k)(1). The adjusted basis of the property must be reduced by the additional depreciation deduction before computing the amount otherwise allowable as a depreciation deduction for the tax year in which the property is placed in service and all later years. In order to be entitled to this deduction, the Partnership generally must purchase the property and place it in service before January 1, 2005. Code section 168(k). INTEREST DEDUCTIONS In the Transaction, the Investor Partners will acquire their interests by remitting cash in the amount of $20,000 per Unit to the Partnership. In no event will the Partnership accept notes in exchange for a Partnership interest. Nevertheless, without any assistance of the Managing General Partner or any of its affiliates, some Partners may choose to borrow the funds necessary to acquire a Unit and may incur interest expense in connection with those loans. Based upon the purely factual nature of any such loans, we are unable to express an opinion with respect to the deductibility of any interest paid or incurred thereon. TRANSACTION FEES The Partnership may classify a portion of the fees (the "Fees") to be paid to third parties and to the Managing General Partner or to the Operator and its affiliates (as described in the Prospectus under "Source of Funds and Use of Proceeds") as expenses which are deductible as organizational expenses or otherwise. There is no assurance that the Service will allow the deductibility of such expenses and counsel expresses no opinion with respect to the allocation of the Fees to deductible and nondeductible items. Generally, expenditures made in connection with the creation of, and with sales of interests in, a partnership will fit within one of several categories. A partnership may elect to amortize and deduct its organizational expenses (as defined in Code section 709(b)(2) and in Treas. Reg. section 1.709-2(a)) ratably over a period of not less than 60 months commencing with the month the partnership begins business. Organizational expenses are expenses which (i) are incident to the creation of the partnership, (ii) are chargeable to capital account, and (iii) are of a character which, if expended incident to the creation of a partnership having an ascertainable life, would (but for Code section 709(a)) be amortized over such life. Id. Examples of organizational expenses are legal fees for services incident to the organization of the partnership, such as negotiation and preparation of a partnership agreement, accounting fees for services incident to the organization of the partnership, and filing fees. Treas. Reg. section 1.709-2(a). Under Code section 709, no deduction is allowable for "syndication expenses," examples of which include brokerage fees, registration fees, legal fees of the underwriter or placement agent and the issuer (general partners or the partnership) for securities advice and for advice pertaining to the adequacy of tax disclosures in the prospectus or private placement memorandum for securities law purposes, printing costs, and other selling or promotional material. These costs must be capitalized. Treas. Reg. section 1.709-2(b). Payments for services performed in connection with the acquisition of capital assets must be amortized over the useful life of such assets. Code section 263. Under Code section 195, no deduction is allowable with respect to "start-up expenditures," although such expenditures may be capitalized and amortized over a period of not less than 60 months. Start-up expenditures are defined as amounts (i) paid or incurred in connection with (I) investigating the creation or acquisition of an active trade or business, (II) creating an active trade or business, or (III) any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of such activity becoming an active trade or business, and (ii) which, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the trade or business referred to in (i) above), would be allowable as a deduction for the taxable year in which paid or incurred. Code section 195(c)(1). The Partnership intends to make payments to the Managing General Partner, as described in greater detail in the Prospectus. To be deductible, compensation paid to a general partner must be for services rendered by the partner other than in his capacity as a partner or for compensation determined without regard to partnership income. Fees which are not deductible because they fail to meet this test may be treated as special allocations of income to the recipient partner (see Pratt v. Commissioner, 550 F.2d 1023 (5th Cir. 1977)), and thereby decrease the net loss or increase the net income among all partners. To the extent these expenditures described in the Prospectus are considered syndication costs (such as the fees paid to brokers and broker-dealers, and the fees paid for printing the Prospectus and possibly all or a portion of the Managing General Partner's management fee), they will be nondeductible by the Partnership. To the extent attributable to organization fees (such as the amounts paid for legal services incident to the organization of the Partnership), the expenditures may be amortizable over a period of not less than 60 months, commencing with the month the Partnership begins business, if the Partnership so elects; if no election is made, no deduction is available. Finally, to the extent any portion of the expenditures would be treated as "start-up," they could be amortized over a 60 month or longer period, provided the proper election was made. Due to the inherently factual nature of the proper allocation of expenses among nondeductible syndication expenses, amortizable organization expenses, amortizable "start-up" expenditures, and currently deductible items, and because the issues involve questions concerning both the nature of the services performed and to be performed and the reasonableness of amounts charged, we are unable to express an opinion regarding such treatment. If the Service were to successfully challenge the Managing General Partner's allocations, a Partner's taxable income could be increased, thereby resulting in increased taxes and in liability for interest and penalties. A Partner's share of Partnership losses will not be allowed as a deduction to the extent such share exceeds the amount of the Partner's adjusted tax basis in his Units. Code section 704(d). A Partner's initial adjusted tax basis in his Units will generally be equal to the cash he has invested to purchase his Units. Such adjusted tax basis will generally be increased by (i) additional amounts invested in the Partnership, including his share of net income, (ii) additional capital contributions, if any, and (iii) his share of Partnership borrowings, if any, based on the extent of his economic risk of loss for such borrowings. Such adjusted tax basis will generally be reduced, but not below zero by (i) his share of loss, (ii) his depletion deductions on his share of oil and gas income (until such deductions exhaust his share of the basis of property subject to depletion), (iii) distributions of cash and the adjusted basis of property other than cash made to him, and (iv) his share of reduction in the amount of indebtedness previously included in his basis. Treas. Reg. section 1.705-1(a)(1). In addition, Code section 465 provides, in part, that, if an individual or a closely held C (i.e., regularly taxed) corporation engages in any activity to which Code section 465 applies, any loss from that activity is allowed only to the extent of the aggregate amount with respect to which the taxpayer is "at risk" for such activity at the close of the taxable year. Code section 465(a)(1). A closely held C corporation is a corporation, more than fifty percent (50%) of the stock of which is owned, directly or indirectly, at any time during the last half of the taxable year by or for not more than five (5) individuals. Code sections 465(a)(1)(B), 542(a)(2). For purposes of Code section 465, a loss is defined as the excess of otherwise allowable deductions attributable to an activity over the income received or accrued from that activity. Code section 465(d). Any such loss disallowed by Code section 465 shall be treated as a deduction allocable to the activity in the first succeeding taxable year. Code section 465(a)(2). Code section 465(b)(1) provides that a taxpayer will be considered as being "at risk" for an activity with respect to amounts including (i) the amount of money and the adjusted basis of other property contributed by the taxpayer to the activity, and (ii) amounts borrowed with respect to such activity to the extent that the taxpayer (I) is personally liable for the repayment of such amounts, or (II) has pledged property, other than property used in the activity, as security for such borrowed amounts (to the extent of the net fair market value of the taxpayer's interest in such property). No property can be taken into account as security if such property is directly or indirectly financed by indebtedness that is secured by property used in the activity. Code section 465(b)(2). Further, amounts borrowed by the taxpayer shall not be taken into account if such amounts are borrowed (i) from any person who has an interest (other than an interest as a creditor) in such activity, or (ii) from a related person to a person (other than the taxpayer) having such an interest. Code section 465(b)(3). Related persons for purposes of Code section 465(b)(3) are defined to include related persons within the meaning of Code section 267(b) (which describes relationships between family members, corporations and shareholders, trusts and their grantors, beneficiaries and fiduciaries, and similar relationships), Code section 707(b)(1) (which describes relationships between partnerships and their partners) and Code section 52 (which describes relationships between persons engaged in businesses under common control). Code section 465(b)(3)(C). Finally, no taxpayer is considered at risk with respect to amounts for which the taxpayer is protected against loss through nonrecourse financing, guarantees, stop loss agreements, or other similar arrangements. Code section 465(b)(4). The Code provides that a taxpayer must recognize taxable income to the extent that his "at risk" amount is reduced below zero. This recaptured income is limited to the sum of the loss deductions previously allowed to the taxpayer, less any amounts previously recaptured. A taxpayer may be allowed a deduction for the recaptured amounts included in his taxable income if and when he increases his amount "at risk" in a subsequent taxable year. The Treasury has published proposed regulations relating to the at risk provisions of Code section 465. These proposed regulations provide that a taxpayer's at risk amount will include "personal funds" contributed by the taxpayer to an activity. Prop. Treas. Reg. section 1.465-22(a). "Personal funds" and "personal assets" are defined in Prop. Treas. Reg. section 1.465-9(f) as funds and assets which (i) are owned by the taxpayer, (ii) are not acquired through borrowing, and (iii) have a basis equal to their fair market value. In addition to a taxpayer's amount at risk being increased by the amount of personal funds contributed to the activity, the excess of the taxpayer's share of all items of income received or accrued from an activity during a taxable year over the taxpayer's share of allowable deductions from the activity for the year will also increase the amount at risk. Prop. Treas. Reg. section 1.465-22. A taxpayer's amount at risk will be decreased by (i) the amount of money withdrawn from the activity by or on behalf of the taxpayer, including distributions from a partnership, and (ii) the amount of loss from the activity allowed as a deduction under Code section 465(a). Id. The Partners will purchase Units by tendering cash to the Partnership. To the extent the cash contributed constitutes the "personal funds" of the Partners, the Partners should be considered at risk with respect to those amounts. To the extent the cash contributed constitutes "personal funds," in our opinion, neither the at risk rules nor the limitations related to adjusted basis will limit the deductibility of losses generated from the Partnership. PASSIVE LOSS AND CREDIT LIMITATIONS A. Introduction Code section 469 provides that the deductibility of losses generated from passive activities will be limited for certain taxpayers. The passive activity loss limitations apply to individuals, estates, trusts, and personal service corporations as well as, to a lesser extent, closely held C corporations. Code section 469(a)(2). The definition of a "passive activity" generally encompasses all rental activities as well as all activities with respect to which the taxpayer does not "materially participate." Code section 469(c). Notwithstanding this general rule, however, the term "passive activity" does not include "any working interest in any oil or gas property which the taxpayer holds directly or through an entity which does not limit the liability of the taxpayer with respect to such interest." Code section 469(c)(3),(4). A passive activity loss ("PAL") is defined as the amount (if any) by which the aggregate losses from all passive activities for the taxable year exceed the aggregate income from all passive activities for such year. Code section 469(d)(1). Classification of an activity as passive will result in the income and expenses generated therefrom being treated as "passive" except to the extent that any of the income is "portfolio" income and except as otherwise provided in regulations. Code section 469(e)(1)(A). Portfolio income is income from, inter alia, interest, dividends, and royalties not derived in the ordinary course of a trade or business. Income that is neither passive nor portfolio is "net active income." Code section 469(e)(2)(B). With respect to the deductibility of PALs, individuals and personal service corporations will be entitled to deduct such amounts only to the extent of their passive income whereas closely held C corporations (other than personal service corporations) can offset PALs against both passive and net active income, but not against portfolio income. Code section 469(a)(1), (e)(2). In calculating passive income and loss, however, all activities of the taxpayer are aggregated. Code section 469(d)(1). PALs disallowed as a result of the above rules will be suspended and can be carried forward indefinitely to offset future passive (or passive and active, in the case of a closely held C corporation) income. Code section 469(b). Upon the disposition of an entire interest in a passive activity in a fully taxable transaction not involving a related party, any passive loss that was suspended by the provisions of the Code section 469 passive activity rules is deductible from either passive or non-passive income. The deduction must be reduced, however, by the amount of income or gain realized from the activity in previous years. As noted above, a passive activity includes an activity with respect to which the taxpayer does not "materially participate." A taxpayer will be considered as materially participating in a venture only if the taxpayer is involved in the operations of the activity on a "regular, continuous, and substantial" basis. Code section 469(h)(1). With respect to the determination as to whether a taxpayer's participation in an activity is material, temporary regulations issued by the Service provide that, except for limited partners in a limited partnership, an individual will be treated as materially participating in an activity if and only if (i) the individual participates in the activity for more than 500 hours during such year, (ii) the individual's participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals for such year, (iii) the individual participates in the activity for more than 100 hours during the taxable year, and such individual's participation in such activity is not less than the participation in the activity of any other individual for such year, (iv) the activity is a trade or business activity of the individual, the individual participates in the activity for more than 100 hours during such year, and the individual's aggregate participation in all significant participation activities of this type during the year exceeds 500 hours, (v) the individual materially participated in the activity for 5 of the last 10 years, or (vi) the activity is a personal service activity and the individual materially participated in the activity for any 3 preceding years. Temp. Treas. Reg. section 1.469-5T(a). Notwithstanding the above, and except as may be provided in regulations, Code section 469(h)(2) provides that no limited partnership interest will be treated as an interest with respect to which a taxpayer materially participates. The temporary regulations create several exceptions to this rule and provide that a limited partner will not be treated as not materially participating in an activity of the partnership of which he is a limited partner if the limited partner would be treated as materially participating for the taxable year under paragraph (a)(1), (5), or (6) of Temp. Treas. Reg. section 1.469-5T (as described in (i), (v), and (vi) of the above paragraph) if the individual were not a limited partner for such taxable year. Temp. Treas. Reg. section 1.469-5T(e). For purposes of this rule, a partnership interest of an individual will not be treated as a limited partnership interest for the taxable year if the individual is an Additional General Partner in the partnership at all times during the partnership's taxable year ending with or within the individual's taxable year. Id. B. General Partner Interests Due to the factual nature of the applicability of the material participation factors to an Additional General Partner's participation in the activities of the Partnership, we cannot express an opinion with respect to whether such participation will be material. However, the "working interest" exception to the passive activity rules applies without regard to the level of the taxpayer's participation. Nevertheless, the presence or absence of material participation may be relevant for purposes of determining whether the investment interest expense rules of Code section 163(d) apply to limit the deductibility of interest incurred in connection with any borrowings of an Additional General Partner. As noted above, the term "passive activity" does not include any working interest in any oil or gas property which the taxpayer holds directly or through an entity which does not limit the taxpayer's liability with respect to such interest. Temp. Treas. Reg. section 1.469-1T(e)(4)(v) describes an interest in an entity that limits a taxpayer's liability with respect to the drilling or operation of a well as (i) a limited partnership interest in a partnership in which the taxpayer is not a general partner, (ii) stock in a corporation, or (iii) an interest in any other entity that, under applicable state law, limits the interest holder's potential liability. For purposes of this provision, indemnification agreements, stop loss arrangements, insurance, or any similar arrangements or combinations thereof are not taken into account in determining whether a taxpayer's liability is limited. Id. The Joint Committee on Taxation's General Explanation of the Tax Reform Act of 1986 (the "Bluebook") indicates that a "working interest" is an interest with respect to an oil and gas property that is burdened with the cost of development and operation of the property, and that generally has characteristics such as responsibility for signing authorizations for expenditures with respect to the activity, receiving periodic drilling and completion reports and reports regarding the amount of oil extracted, voting rights proportionate to the percentage of the working interest possessed by the taxpayer, the right to continue activities if the present operator decides to discontinue operations, a proportionate share of tort liability with respect to the property and some responsibility to share in further costs with respect to the property in the event a decision is made to spend more than amounts already contributed. The Regulations define a working interest as "a working or operating mineral interest in any tract or parcel of land (within the meaning of section 1.612-4(a))." Treas. Reg. section 1.469-1(e)(4)(iv). Under Treas. Reg. section 1.614-2(b), an operating mineral interest is defined as a separate mineral interest as described in section 614(a), in respect of which the costs of production are required to be taken into account by the taxpayer for purposes of computing the limitation of 50 percent of the taxable income from the property in determining the deduction for percentage depletion computed under section 613, or such costs would be so required to be taken into account if the . . . well . . . were in the production stage. The term does not include royalty interests or similar interests, such as production payments or net profits interests. For the purpose of determining whether a mineral interest is an operating mineral interest, "costs of production" do not include intangible drilling and development costs, exploration expenditures under section 615, or development expenditures under section 616. Taxes, such as production taxes, payable by holders of nonoperating interests are not considered costs of production for this purpose. A taxpayer may not aggregate operating mineral interests and nonoperating mineral interests such as royalty interests. The Managing General Partner has represented that the Partnership will acquire and hold only operating mineral interests, as defined in Code section 614(d) and the regulations thereunder, and that none of the Partnership's revenues will be from non-working interests. To the extent that the Additional General Partners (in their capacity as general partners) have working interests in the activities of the Partnership for purposes of Code section 469, we are of the opinion that an Additional General Partner's interest in the Partnership (as a general partner) generally will not be considered a passive activity within the meaning of Code section 469 and losses generated while such general partner interest is held will not be limited by the passive activity provisions. Notwithstanding this general rule, however, if an Additional General Partner interest is converted to a limited partner interest prior to the spudding date, but after the end of the taxable year in which IDC was incurred, IDC will be subject to the passive activity rules. See Temp. Treas. Reg. section 1.469-1T(e)(4). In addition, that portion of Partnership gross income for such prior taxable year attributable to IDC treated as passive loss will be considered passive income. The "spudding date" is the date that drilling commences. Notwithstanding the above, there can be no assurance that the Service will not contend that all general partner interests should be regarded as interests in a passive activity from the Partnership's inception due to the conversion feature contained in the Partnership Agreement. However, due to the exposure to unlimited liability for Partnership obligations incurred prior to such conversion, an attack by the Service with respect to the foregoing should not be successful. In addition, the Service, as shown in Temp. Treas. Reg. section 1.469-1T(e)(4)(iii), example (1), respects the nature of a general partnership interest prior to its conversion into limited partnership form: A, a calendar year individual, acquires on January 1, 1987, a general partnership interest in P, a calendar year partnership that holds a working interest in an oil or gas property. Pursuant to the partnership agreement, A is entitled to convert the general partnership interest into a limited partnership interest at any time. On December 1, 1987, pursuant to a contract with D, an independent drilling contractor, P commences drilling a single well pursuant to the working interest. Under the drilling contract, P pays D for the drilling only as the work is performed. All drilling costs are deducted by P in the year in which they are paid. At the end of 1987, A converts the general partnership interest into a limited partnership interest, effective immediately. The drilling of the well is completed on February 28, 1988. Since, in the example, A holds the working interest through an entity that does not limit A's liability throughout 1987 and through an entity that does limit A's liability in 1988, the example in the regulation concludes that A's interest in P's well is not an interest in a passive activity for 1987 but is an interest in a passive activity for 1988. If an Additional General Partner converts his interest to a Limited Partner interest pursuant to the terms of the Partnership Agreement, the character of a subsequently generated tax attribute will be dependent upon, inter alia, the nature of the tax attribute and whether there arose, prior to conversion, losses to which the working interest exception applied. Assuming the activities of a converting partner will not result in the Partner's being treated as materially participating under Temp. Treas. Reg. section 1.469-5T(a)(1), (5), or (6), as described above, the Limited Partner's activity after conversion should be treated as a passive activity. Code section 469(c)(1). Accordingly, any loss arising therefrom should be treated as a PAL under Code section 469(d), with the benefits thereof limited by Code section 469(a)(1), as described above. However, Code section 469(c)(3)(B) provides that, if a taxpayer has any loss from any taxable year from a working interest in any oil or gas property that is treated as a non-passive loss, then any net income from such property for any succeeding taxable year is to be treated as income that is not from a passive activity. Consequently, assuming that a converting Additional General Partner has losses from working interests which are treated as non-passive, income from the Partnership allocable to the Partner after conversion would be treated as income that is not from a passive activity. C. Limited Partner Interests If an Investor Partner (other than an Additional General Partner who converts his interest into that of a Limited Partner) invests in the Partnership as a Limited Partner, in the opinion of counsel, his distributive share of the Partnership's losses will be treated as PALs, the availability of which will be limited to the Partner's passive income for such year. If the Partner does not have sufficient passive income to utilize the PAL, the disallowed PAL will be suspended and may be carried forward (but not back) to be deducted against passive income arising in future years. Further, upon the complete disposition of the interest to an unrelated party, in a fully taxable transaction such suspended losses will be available, as described above. Regarding Partnership income, Limited Partners should generally be entitled to offset their distributive shares of such income with deductions from other passive activities, except to the extent such Partnership income is portfolio income. Since gross income from interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business is not passive income, a Limited Partner's share of income from royalties, income from the investment of the Partnership's working capital, and other items of portfolio income will not be treated as passive income. In addition, Code section 469(l)(3) grants the Secretary of the Treasury the authority to prescribe regulations requiring net income or gain from a limited partnership or other passive activity to be treated as not from a passive activity. D. Publicly Traded Partnerships Notwithstanding the above, Code section 469(k) treats net income from PTPs as portfolio income under the PAL rules. Further, each partner in a PTP is required to treat any losses from a PTP as separate from income and loss from any other PTP and also as separate from any income or loss from passive activities. Id. Losses attributable to an interest in a PTP that are not allowed under the passive activity rules are suspended and carried forward, as described above. Further, upon a complete taxable disposition of an interest in a PTP, any suspended losses are allowed (as described above with respect to the passive loss rules). As noted above, we have opined that the Partnership will not be a PTP. In the event the Partnership were treated as a PTP, any net income would be treated as portfolio income and each Partner's loss therefrom would be treated as separate from income and loss from any other PTP and also as separate from any income or loss from passive activities. Since the Partnership should not be treated as a PTP, the provisions of Code section 469(k), in our opinion, will not apply to the Partners in the manner outlined above prior to the time that such Partnership becomes a PTP. However, unlike the PTP rules of Code section 7704, the passive activity rules of Code section 469 do not provide an exception for partnerships that pass the 90% test of Code section 7704. Accordingly, if the Partnership were to be treated as a PTP under the passive activity rules, passive losses could be used only to offset passive income from the Partnership. CONVERSION OF INTERESTS Code section 708 provides that a partnership will be considered as terminated for federal income tax purposes if, inter alia, there is "a sale or exchange of 50 percent or more of the total interest in partnership capital and profits" within a 12 month period. If a conversion of an Additional General Partner's interest into a Limited Partner interest were treated as a "sale or exchange" for purposes of Code section 708, the Partnership would be terminated for federal income tax purposes if 50% or more of the profits and capital interests in the Partnership were sold or exchanged within a 12 month period. In Rev. Rul. 84-52, 1984-1 C.B. 157, the Service ruled that the conversion of a general partnership interest into a limited partnership interest in the same partnership will not give rise to the recognition of gain or loss under Code section 741 or section 1001. The holding of Rev. Rul. 84-52 was confirmed in Rev. Rul. 95-37, 1995-1 C.B. 130. The ruling noted that, under Code section 721, no gain or loss is recognized by a partnership or any of its partners upon the contribution of property to the partnership in exchange for an interest therein. Consequently, the partnership will not be terminated under Code section 708 since (i) the business of the partnership will continue after the conversion and (ii) pursuant to Treas. Reg. section 1.708-1(b)(2) a transaction governed by Code section 721 is not treated as a sale or exchange for purposes of Code section 708. Assuming that Rev. Rul. 84-52, supra, is not overruled, revoked, or modified, the Partnership, in our opinion, will not be terminated under Code section 708 solely as a result of the conversion of Partnership interests. Code section 752(b) treats any decrease in a partner's share of partnership liabilities as a distribution of money to the partner by the partnership. If, under the applicable regulatory or statutory provisions, a converting partner's share of liabilities is deemed to decrease, such decrease will result in gain to the partner to the extent it exceeds the partner's basis in his partnership interest. As discussed above under the heading "Passive Loss and Credit Limitations," an Additional General Partner's interest in the Partnership generally will not be subject to the passive activity loss rules. However, if an Additional General Partner interest is converted to a limited partner interest prior to the spudding date, but after the end of the taxable year in which IDC was incurred, IDC will be subject to the passive activity rules. If the conversion were to occur after the filing of the Partnership's information tax return but prior to the completion of the drilling and development of a well, an amended return might have to be filed, which might also require the Investors to file amended returns. Further, the Code provides that if a taxpayer has any loss attributable to a working interest which is treated in any taxable year as a loss which is not from a passive activity, then any net income attributable to the working interest in any succeeding taxable year is treated as income of the taxpayer which is not from a passive activity. Accordingly, if an Additional General Partner converts his interest into a Limited Partner interest, any income from that interest with respect to which he claimed deductions will be treated as nonpassive income. ALTERNATIVE MINIMUM TAX Code section 55 imposes on noncorporate taxpayers a two-tiered, graduated rate schedule for alternative minimum tax ("AMT") equal to the sum of (i) 26% of so much of the "taxable excess" as does not exceed $175,000, plus (ii) 28% of so much of the "taxable excess" as exceeds $175,000. Code section 55(b)(1)(A)(i). "Taxable excess" is defined as so much of the alternative minimum taxable income ("AMTI") for the taxable year as exceeds the exemption amount. Code section 55(b)(1)(A)(ii). AMTI is generally defined as the taxpayer's taxable income, increased or decreased by certain adjustments and items of tax preference. Code section 55(b)(2). The exemption amount for noncorporate taxpayers currently is (i) $58,000 in the case of a joint return or a surviving spouse, (ii) $40,250 in the case of an individual who is not a married individual or a surviving spouse, (iii) $29,000 in the case of a married individual who files a separate return, and (iv) $22,500 in the case of an estate or trust. Such amounts are phased out as a taxpayer's AMTI increases above certain levels. Code section 55(d)(1) and (3). Generally, the corporate AMT is similar to that of the individual AMT, with the corporation's regular taxable income increased or decreased by certain adjustments and items of tax preference, resulting in AMTI. The AMTI is reduced by $40,000 (which amount is phased-out as AMTI increases from $150,000 to $310,000) with the balance being taxed at twenty percent (20%). Code section 55(b), (d). The excess of this figure over the regular tax liability is the AMT. Certain small corporations are exempt from AMT. Code section 55(e). Individuals subject to the AMT are generally allowed a credit, equal to the portion of the AMT imposed by Code section 55 arising as a result of deferral preferences (or, with certain adjustments, equal to the entire AMT in the case of corporate AMT) for use against the taxpayer's future regular tax liability (but not the minimum tax liability). Code section 53. Under the AMT provisions, adjustments and items of tax preference that may arise from a Partner's acquisition of an interest in the Partnership include the following: 1. Generally, taxpayers who pay or incur IDC in the development of domestic oil or gas production may elect to either expense or capitalize these amounts. Code section 263(c). If an Investor Partner elects to deduct IDC, the difference between the amount of a Partner's IDC deduction and the amount which would have been currently deductible had IDC been capitalized and recovered over a 10-year period (so-called "Excess IDC") is generally an item of tax preference for the AMT to the extent that this amount exceeds 65% of that Investor Partner's net income from oil and gas properties for the taxable year. Code section 57(a)(2). This preference applies to Investor Partners that are integrated oil companies and to Investor Partners that are not integrated oil companies but, as to the latter, only to the extent that the failure to apply the preference would result in a reduction of the Investor Partner's alternative minimum taxable income by more than 40%. Code section 57(a)(2)(E). 2. Excess depletion constitutes a preference only in the case of integrated oil companies. Code section 57(a)(1). 3. Each Partner's AMTI will be increased (or decreased) by the amount by which the depreciation deductions allowable under Code sections 167 and 168 with respect to such property exceeds (or is less than) the depreciation determined under the alternative depreciation system using the one hundred fifty percent (150%) declining balance method switching to the straight-line method, when that produces a greater deduction, in lieu of the straight-line method otherwise prescribed by the ADS. Code section 56(a)(1). No ACE depreciation adjustment is necessary with respect to a corporate Partner for property placed in service in taxable years beginning after December 31, 1993. Code section 56(g)(4)(A)(i). 4. AMTI for a corporate Partner will be increased by seventy-five percent (75%) of the excess of the taxpayer's "adjusted current earnings" ("ACE") over the AMTI amount (computed without the ACE adjustment and without the net operating loss deduction). Code section 56(g)(1). As noted above, both corporate and individual taxpayers may elect this method of amortization for regular tax purposes. For years beginning after December 31, 1992, for corporations other than integrated oil companies, the ACE adjustments for percentage depletion and IDC are repealed. Code sections 56(g)(4)(F) and (D)(i), respectively. The IDC modification applies to IDCs paid or incurred in taxable years beginning after December 31, 1992. Due to the inherently factual nature of the applicability of the AMT to a Partner, we are unable to express an opinion with respect to such issues. Due to the potentially significant impact of a purchase of Units on an Investor's tax liability, investors should discuss the implications of an investment in the Partnership on their regular and AMT liabilities with their tax advisors prior to acquiring Units. GAIN OR LOSS ON SALE OF PROPERTIES Gain from the sale or other disposition of property is realized to the extent of the excess of the amount realized therefrom over the property's adjusted basis; conversely, loss is realized in an amount equal to the excess of the property's adjusted basis over the amount realized from such a disposition. Code section 1001(a). The amount realized is defined as the sum of any money received plus the fair market value of the property (other than money) received. Code section 1001(b). Accordingly, upon the sale or other disposition of the Partnership properties, the Partners will realize gain or loss to the extent of their pro rata share of the difference between the Partnership's adjusted basis in the property at the time of disposition and the amount realized upon disposition. In the absence of nonrecognition provisions, any gain or loss realized will be recognized for federal income tax purposes. Gain or loss recognized upon the disposition of property used in a trade or business and held for more than one year will be treated as long term capital gain or as ordinary loss. Code section 1231(a). Currently. For individual taxpayers, the maximum federal income tax rate on long-term capital gains is generally 15%, while the maximum federal income tax rate on ordinary income is 35%. Code sections 1(h)(1)(C) and 1(i). Prior to the passage of the 2003 Tax Act, such rates for 2003 were 20% and 38.6%, respectively. Notwithstanding the above, however, any gain realized may be taxed as ordinary income under one of several "recapture" provisions of the Code or under the characterization rules relating to "dealers" in personal property. Code section 1254 generally provides for the recapture of capital gains, arising from the sale of property which was placed in service after 1986, as ordinary income to the extent of the lesser of (i) the gain realized upon sale of the property, or (ii) the sum of (I) all IDC previously deducted and (II) all depletion deductions that reduced the property's basis. Code section 1254(a)(1). Ordinary income may also result from the recapture, pursuant to Code section 1245, of depreciation on the Partnership properties. Such recapture is the amount by which (i) the lower of (I) the recomputed basis of the property, or (II) the amount realized on the sale of the property exceeds (ii) the property's adjusted basis. Code section 1245(a)(1). Recomputed basis is generally the property's adjusted basis increased by depreciation and amortization deductions previously claimed with respect to the property. Code section 1245(a)(2). Unrecaptured section 1250 gain may result from the recapture of depreciation related to the sale of the Partnership's section 1250 property held for more than one year. Code section 1(h)(7). Currently, unrecaptured section 1250 gain is taxed at a rate of 25%. Code section 1(h)(1)(D). GAIN OR LOSS ON SALE OF UNITS If the Units are capital assets in the hands of the Partners, gain or loss realized by any such holders on the sale or other disposition of a Unit will be characterized as capital gain or capital loss. Code section 1221. Such gain or loss will be a long term capital gain or loss if the Unit is held for more than one year and short term capital gain if held one year or less. However, the portion of the amount realized by a Partner in exchange for a Unit that is attributable to the Partner's share of the Partnership's "unrealized receivables" or "inventory items" will be treated as an amount realized from the sale or exchange of property other than a capital asset. Code section 751. Unrealized receivables are defined in Code section 751(c) to include ". . . oil [or] gas . . . property . . . to the extent of the amount which would be treated as gain to which section . . . 1245(a) . . . or 1254(a) would apply if . . . such property had been sold by the partnership at its fair market value." A sale by the Partnership of the Partnership's properties could give rise to treatment of the gain thereunder as ordinary income as a result of Code sections 1245(a) or 1254(a). Accordingly, gain recognized by a Partner on the sale of a Unit would be taxed as ordinary income to the Partner to the extent of his share of the Partnership's gain on property that would be recaptured, upon sale, under those statutes. Property treated as an "inventory item" for purposes of Code section 751 includes (i) stock in trade of the partnership or other property of a kind which would properly be included in its inventory if on hand at the end of the taxable year, (ii) property held by the partnership primarily for sale to customers in the ordinary course of its trade or business, and (iii) any other partnership property which would constitute neither a capital asset nor property used in a trade or business under Code section 1231. Code sections 751(d)(2) and 1221(a)(1). Under the aforementioned provisions, a Partner would recognize ordinary income with respect to any deemed sale of assets under Code section 751; further, this ordinary income may be recognized even if the total amount realized on the sale of a Unit is equal to or less than the Partner's basis in the Unit. Any partner who sells or exchanges interests in a partnership holding unrealized receivables (which include IDC recapture and other items) or certain inventory items must notify the partnership of such transaction in accordance with Regulations under Code section 6050K and must attach a statement to his tax return reflecting certain facts regarding the sale or exchange. Regulations promulgated by the service provide that such notice to the partnership must be given in writing within 30 days of the sale or exchange (or, if earlier, by January 15 of the calendar year following the calendar year in which the exchange occurred), and must include names, addresses, and taxpayer identification numbers (if known) of the transferor and transferee and the date of the exchange. Code section 6722 provides that persons who fail to furnish this information to the partnership will be penalized $50 for each such failure, or, if such failure is due to intentional disregard to the filing requirement, the person will be penalized the greater of (i) $100 or (ii) 10% of the aggregate amount to be reported. Furthermore, a partnership is required to notify the Service of any sale or exchange of interests of which it has notice, and to report the names and addresses of the transferee and the transferor, along with all other required information. The partnership also is required to provide copies of the information it provides to the Service to the transferor and the transferee. The tax consequences to an assignee purchaser of a Unit from a Partner are not described herein. Any assignor of a Unit should advise his assignee to consult his own tax advisor regarding the tax consequences of such assignment. PARTNERSHIP DISTRIBUTIONS Under the Code, any increase in a partner's share of partnership liabilities, or any increase in such partner's individual liabilities by reason of an assumption by him of partnership liabilities is considered to be a contribution of money by the partner to the partnership. Similarly, any decrease in a partner's share of partnership liabilities or any decrease in such partner's individual liabilities by reason of the partnership's assumption of such individual liabilities will be considered as a distribution of money to the partner by the partnership. Code section 752(a), (b). The Partners' adjusted bases in their Units will initially consist of the cash they contribute to the Partnership. Code section 722. Their bases will be increased by their share of Partnership income and additional contributions and decreased by their share of Partnership losses and distributions. Code section 705(a). To the extent that such actual or constructive distributions are in excess of a Partner's adjusted basis in his Partnership interest (after adjustment for contributions and his share of income and losses of the Partnership), that excess will generally be treated as gain from the sale of a capital asset. Code section 731(a). In addition, gain could be recognized by a distributee partner upon the disproportionate distribution to that partner of unrealized receivables, substantially appreciated inventory or, in some cases, Code section 731 (c) marketable securities, i.e., actively traded financial instruments, foreign currencies or interests in certain defined properties. Code sections 751(b) and 731. Further, the Partnership Agreement prohibits distributions to any Investor Partner to the extent such would create or increase a deficit in the Partner's Capital Account. PARTNERSHIP ALLOCATIONS Allocations - General. Generally, a partner's taxable income is increased or decreased by his ratable share of partnership income or loss. Code section 701. However, the availability of these losses may be limited by the at risk rules of Code section 465, the passive activity rules of Code section 469, and the adjusted basis provisions of Code section 704(d). Code section 704(b) provides that if a partnership agreement does not provide for the allocation of each partner's distributive share of partnership income, gain, loss, deduction, or credit, or if the allocation of such items under the partnership agreement lacks "substantial economic effect," then each partner's share of those items must be allocated "in accordance with the partner's interest in the partnership." As discussed below, regulations under Code section 704(b) define substantial economic effect and prescribe the manner in which partners' capital accounts must be maintained in order for the allocations contained in the partnership agreement to be respected. Notwithstanding these provisions, special rules apply with respect to nonrecourse deductions since, under the Regulations, allocations of losses or deductions attributable to nonrecourse liabilities cannot have economic effect. The Service may contend that the allocations contained in the Partnership Agreement do not have substantial economic effect or are not in accordance with the Partners' interests in the Partnership and may seek to reallocate these items in a manner that will increase the income or gain or decrease the deductions allocable to a Partner. We are of the opinion that, to the extent provided herein, if challenged by the Service on this matter, the Partners' distributive shares of partnership income, gain, loss, deduction, or credit will be determined and allocated substantially in accordance with the terms of the Partnership Agreement to have substantial economic effect. Substantial Economic Effect. Although a partner's share of partnership income, gain, loss, deduction, and credit is generally determined in accordance with the partnership agreement, this share will be determined in accordance with the partner's interest in the partnership (determined by taking into account all facts and circumstances) and not by the partnership agreement if the partnership allocations do not have "substantial economic effect" and if the allocations are not respected under the nonrecourse deduction provisions of the regulations. Code section 704(b); Treas. Reg. sections 1.704-1(b)(2)(i), 1.704-2. Treasury regulations provide that: In order for an allocation to have economic effect, it must be consistent with the underlying economic arrangement of the partners. This means that in the event there is an economic benefit or economic burden that corresponds to an allocation, the partner to whom the allocation is made must receive such economic benefit or bear such economic burden. Treas. Reg. section 1.704-1(b)(2)(ii). The regulations further provide that an allocation will have economic effect only if, throughout the full term of the partnership, the partnership agreement provides (i) for the determination and maintenance of partner's capital accounts in accordance with specified rules contained therein, (ii) upon liquidation of the partnership or a partner's interest in the partnership, liquidating distributions are required to be made in accordance with the positive capital account balances of the partners after taking into account all capital account adjustments for the taxable year of the liquidation, and (iii) either (I) a partner with a deficit balance in his capital account following the liquidation is unconditionally obligated to restore the amount of such deficit balance to the partnership by the end of the taxable year of liquidation, or (II) the partnership agreement contains a qualified income offset ("QIO") provision as provided in Treas. Reg. section 1.704-1(b)(2)(ii)(d). Treas. Reg. sections 1.704-1(b)(2)(ii)(b) and 1.704-1(b)(2)(ii)(d). The capital account maintenance rules generally mandate that each partner's capital account be increased by (i) money contributed by the partner to the partnership, (ii) the fair market value (net of liabilities) of property contributed by the partner to the partnership, and (iii) allocations to the partner of partnership income and gain. Further, such capital account must be decreased by (i) money distributed to the partner from the partnership, (ii) the fair market value (net of liabilities) of property distributed to the partner from the partnership, and (iii) allocations to the partner of partnership losses and deductions. Treas. Reg. section 1.704-1(b)(2)(iv). Treas. Reg. section 1.704-1(b)(2)(iii) provides that an economic effect of an allocation is "substantial" if there is a reasonable possibility that the allocation will affect substantially the dollar amounts to be received by the partners from the partnership, independent of tax consequences. The economic effect of an allocation is not substantial if: at the time the allocation becomes part of the partnership agreement, (1) the after-tax economic consequences of at least one partner may, in present value terms, be enhanced compared to such consequences if the allocation (or allocations) were not contained in the partnership agreement, and (2) there is a strong likelihood that the after-tax economic consequences of no partner will, in present value terms, be substantially diminished compared to such consequences if the allocation (or allocations) were not contained in the partnership agreement. In determining the after-tax economic benefit or detriment to a partner, tax consequences that result from the interaction of the allocation with such partner's tax attributes that are unrelated to the partnership will be taken into account. Treas. Reg. section 1.704-1(b)(2)(iii)(a). While the Service stated that it will not rule on whether an allocation provision in a partnership agreement has substantial economic effect, several Technical Advice Memoranda ("TAMs") shed light on the Service's position on such matter. Notwithstanding the potential similarity between a TAM and a taxpayer's particular fact pattern, it should be noted that TAMs may not be used or cited as precedent. Code section 6110(k)(3), Treas. Reg. sections 301.6110-2(a) and -7(b). Nevertheless, TAMs do serve to illustrate the Service's position on certain specific cases. The TAMs relating to substantial economic effect focus on the tax avoidance purpose of any such above-described allocations and on the partnership plan for distributions upon liquidation. Illustrative of the Service's approach is TAM 8008054, in which the Service concluded that an allocation to the partners solely of items that the partnership had elected to expense (IDC) had as its principal purpose tax avoidance. The Service suggested that, had the allocation affected the parties' liquidation rights, the allocation would have had substantial economic effect: "In general, substantial economic effect has been found where all allocations of items of income, gain, loss, deduction or credit increase or decrease the respective capital accounts of the partners and distribution of assets made upon liquidation is made in accordance with capital accounts." The ruling noted that the investors "should have been allocated their share of costs over the intangible drilling costs." Id. The question whether economic effect is "substantial" is one of fact which may depend in part on the timing of income and deductions and on consideration of the investors' tax attributes unrelated to their investment in Units, and thus is not a question upon which a legal opinion can ordinarily be expressed. However, to the extent the tax brackets of all Partners do not differ at the time the allocation becomes part of the partnership agreement, the economic effect of the allocation provisions should be considered to be substantial. Code section 613A(c)(7)(D) requires that the basis of oil and gas properties owned by a partnership be allocated to the partners in accordance with their interests in the capital or income of the partnership. Final Regulations issued under Code section 613A(c)(7)(D) indicate that such basis must be allocated in accordance with the partners' interests in the capital of the partnership if their interests in partnership income vary over the life of the partnership for any reason other than for reasons such as the admission of a new partner. Treas. Reg. section 1.613A-3(e)(2). The terms "capital" and "income" are not defined in the Code or in the Regulations under Code section 613A. The Regulations under Code section 704 indicate that if all partnership allocations of income, gain, loss, and deduction (or items thereof) have substantial economic effect, an allocation of the adjusted basis of an oil or gas property among the partners will be deemed to be made in accordance with the partners' interests in partnership capital or income and will accordingly be recognized. Pursuant to the Partnership Agreement, (i) allocations will be made as mandated by the Regulations, (ii) liquidating distributions will be made in accordance with positive capital account balances, and (iii) a "qualified income offset" provision applies. However, while capital initially will be owned 78.25% by the Investor Partners and 21.75% by the Managing General Partner, IDC will be allocated 100% to the Investor Partners and other tax items will be allocated 80% to the Investor Partners. Except with respect to those excess allocations, under the Partnership Agreement the basis in oil and gas properties will be allocated in proportion to each Partner's respective share of the costs which entered into the Partnership's adjusted basis for each depletable property. Such allocations of basis appear reasonable and in compliance with the Regulations under Code section 704. Nevertheless, the Service may contend that the allocation to the Investors of IDC (100%) in excess of their capital contributions (78.25%) or the allocation to the Managing General Partner of other tax items (100% ranging to 0% upon the occurrence of certain events) in excess of its capital contribution (21.75%) is invalid and may reallocate such excess IDC or other items to the other Partners. Any such reallocation could increase an Investor Partner's tax liability. However, no assurance can be given, and we are unable to express an opinion, as to whether any special allocation of an item which is dependent upon basis in an oil and gas property will be recognized by the Service. Allocation and Distribution Shifts. Section 4.02(b)(i) of the Partnership Agreement provides that the Managing General Partner will subordinate up to 50% of its 20% share of Partnership cash distributions so that the Investor Partner might receive cash distributions equal to a minimum of 12.8% per year of their Subscriptions on a cumulative basis for the first five years of Partnership well operations. Section 3.02(a) of the Partnership Agreement provides for a corresponding shift in the allocation of Partnership income. Nonrecourse Deductions. As noted above, an allocation of loss or deduction attributable to nonrecourse liabilities of a partnership cannot have economic effect because the creditor alone bears any economic burden that corresponds to such an allocation. Thus, nonrecourse deductions must be allocated in accordance with the partners interests in the partnership. Treas. Reg. section 1.704-2(b)(1). Nonrecourse deduction allocations will be deemed to be made in accordance with partners' partnership interests if, and only if, four requirements are satisfied. First, the partners' capital accounts must be maintained properly and the distribution of liquidation proceeds must be in accordance with the partners' capital account balances. Second, beginning in the first taxable year in which there are nonrecourse deductions, and thereafter throughout the full term of the partnership, the partnership agreement must provide for allocation of nonrecourse deductions among the partners in a manner that is reasonably consistent with allocations, which have substantial economic effect, of some other significant partnership item attributable to the property securing nonrecourse liabilities of the partnership. Third, beginning in the first taxable year of the partnership in which the partnership has nonrecourse deductions or makes a distribution of proceeds of a nonrecourse liability that are allocable to an increase in minimum gain, and thereafter throughout the full term of the partnership, the partnership agreement contains a "minimum gain chargeback." A partnership agreement contains a "minimum gain chargeback" if, and only if, it provides that, subject to certain exceptions, in the event there is a net decrease in partnership minimum gain during a partnership taxable year, the partners must be allocated items of partnership income and gain for that year equal to each partner's share of the net decrease in partnership minimum gain during such year. A partner's share of the net decrease in partnership minimum gain is the amount of the total net decrease multiplied by the partner's percentage share of the partnership's minimum gain at the end of the immediately preceding taxable year. A partner's share of any decrease in partnership minimum gain resulting from a revaluation of partnership property (which would not cause a minimum gain chargeback) equals the increase in the partner's capital account attributable to the revaluation to the extent the reduction in minimum gain is caused by such revaluation. Similar rules apply with regard to partner nonrecourse liabilities and associated deductions. The fourth requirement of the nonrecourse allocation test provides that all other material allocations and capital account adjustments under the partnership agreement must be recognized under the general allocation requirements of the regulations under Code section 704(b). Under the Regulations, partners generally share nonrecourse liabilities in accordance with their interests in partnership profits. However, the Regulations generally require that nonrecourse liabilities be allocated among the partners first to reflect the partners' share of minimum gain and Code section 704(c) minimum gain. Any remaining nonrecourse liabilities are generally to be allocated in proportion to the partner's interests in partnership profits. The Partnership Agreement, at Section 3.02, contains a minimum gain chargeback. Further, the Partnership Agreement provides for the allocation of nonrecourse liabilities and deductions attributable thereto among the Partners first, in accordance with their respective shares of partnership minimum gain (within the meaning of Treas. Reg. section 1.704-2(b)(2); second, to the extent of each such Partner's gain under Code section 704(c) if the Partnership were to dispose of (in a taxable transaction) all Partnership property subject to one or more nonrecourse liabilities of the Partnership in full satisfaction of such liabilities and for no other consideration; and third, in accordance with the Partners' proportionate shares in the Partnership's excess nonrecourse liabilities of the Partnership. Treas. Reg. section 1.752-3. For this purpose, the Partnership Agreement provides for the allocation of excess nonrecourse liabilities of 80% to the Investor Partners and 20% to the Managing General Partner. Retroactive Allocations. To prevent retroactive allocations of partnership tax attributes to partners entering into a partnership late in the tax year, Code section 706(d) provides that a partner's distributive share of such attributes is to be determined by the use of methods prescribed by the Treasury Secretary which take into account the varying interests of the partners during the taxable year. The Partnership Agreement, at Section 3.04(c), provides that each Partner's allocation of tax items other than "allocable cash basis items" is to be determined under a method permitted by Code section 706(d) and the regulations thereunder. With respect to "allocable cash basis items," Section 3.04(c) requires an allocation in accordance with the requirements of Code section 706(d). Accordingly, the Partnership allocations should be considered to be in accordance with the provisions of Code section 706(d). PROFIT MOTIVE The existence of economic, nontax motives for entering into the Transaction is essential if the Partners are to obtain the tax benefits associated with an investment in the Partnership. Code section 183(a) provides that where an activity entered into by an individual is not engaged in for profit, no deduction attributable to that activity will be allowed except as provided therein. Should it be determined that a Partner's activities with respect to the Transaction fall within the "not for profit" ambit of Code section 183, the Service could disallow all or a portion of the deductions and credits generated by the Partnership's activities. Code section 183(d) generally provides for a presumption that an activity is entered into for profit within the meaning of the statute where gross income from the activity exceeds the deductions attributable to such activity for three or more of the five consecutive taxable years ending with the taxable year in question. At the taxpayer's election, such presumption can relate to three or more of the taxable years in the 5-year period beginning with the taxable year in which the taxpayer first engages in the activity. Temp. Treas. Reg. section 12.9. Whether an activity is engaged in for profit is determined under Code section 162 (relating to trade or business deductions) and 212(1) and (2) (relating to income producing deductions) except insofar as the above-described presumption applies. Treas. Reg. section 1.183-1(a). To establish that he is engaged in either a trade or business or an income producing activity, a Partner must be able to prove that he is engaged in the Transaction with an "actual and honest profit objective," Fox v. Commissioner, 80 T.C. 972, 1006 (1983), aff'd sub nom., Barnard v. Commissioner, 731 F.2d 230 (4th Cir. 1984), and that his profit objective is bona fide. Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), aff'd, 379 F.2d 252 (2d Cir. 1967), cert. denied, 389 U.S. 931 (1967). The inquiry turns on whether the primary purpose and intention of the Partner in engaging in the activity is, in fact, to make a profit apart from tax considerations. Hager v. Commissioner, 76 T.C. 759, 784. Such objective need not be reasonable, only honest, and the question of objective is to be determined from all the facts and circumstances. Sutton v. Commissioner, 84 T.C. 210 (1985), aff'd, 788 F.2d 695 (11th Cir. 1986). Among the factors that will normally be considered are: (i) the manner in which the taxpayer carries on the activity, (ii) the expertise of the taxpayer or his advisors, (iii) the time and effort expended by the taxpayer in carrying on the activity, (iv) whether an expectation exists that the assets used in the activity may appreciate in value, (v) the success of the taxpayer in carrying on similar or dissimilar activities, (vi) the taxpayer's history of income or losses with respect to the activity, (vii) the amount of occasional profits, if any, which are earned, and (viii) the financial status of the taxpayer. Treas. Reg. section 1.183-2(b). Where application of such factors to a particular activity is difficult, however, the Court will consider the totality of the circumstances instead. Estate of Baron v. Commissioner, 83 T.C. 542 (1984), aff'd, 798 F.2d 65 (2d Cir. 1986). As noted, the issue is one of fact to be resolved not on the basis of any one factor but on the basis of all the facts and circumstances. Treas. Reg. section 1.183-2(b). Greater weight is given to objective facts than the parties' mere statements of their intent. Siegel v. Commissioner, 78 T.C. 659 (1982), Engdahl v. Commissioner, 72 T.C. 659 (1979). Nevertheless, the Courts have recognized, in applying Code section 183, that "a taxpayer has the right to engage in a venture which has economic substance even though his motivation in the early years of the venture may have been to obtain a deduction to offset taxable income." Lemmen v. Commissioner, 77 T.C. 1326, 1346 (1981), acq., 1983-2 C.B. 1. Due to the inherently factual nature of a Partner's intent and motive in engaging in the Transaction, we do not express an opinion as to the ultimate resolution of this issue in the event of a challenge by the Service. Partners must, however, seek to make a profit from their activities with respect to the Transaction beyond any tax benefits derived from those activities or risk losing those tax benefits. TAX AUDITS Subchapter C of Chapter 63 of the Code provides that administrative proceedings for the assessment and collection of tax deficiencies attributable to a partnership must be conducted at the partnership, rather than the partner, level. Partners will be required to treat Partnership items of income, gain, loss, deduction, and credit in a manner consistent with the treatment of each such item on the Partnership's returns unless such Partner files a statement with the Service identifying the inconsistency. If the Partnership is audited, the tax treatment of each item will be determined at the Partnership level in a unified partnership proceeding. Conforming adjustments to the Partners' own returns will then occur unless such partner can establish a basis for inconsistent treatment (subject to waiver by the Service). PDC will be designated the "tax matters partner" ("TMP") for the Partnership and will receive notice of the commencement of a Partnership proceeding and notice of any administrative adjustments of Partnership items. The TMP is entitled to invoke judicial review of administrative determinations and to extend the period of limitations for assessment of adjustments attributable to Partnership items. Each Partner will receive notice of the administrative proceedings from the TMP and will have the right to participate in the administrative proceeding pursuant to the requirements of Code sections 6223 and 6224 and the regulations thereunder, unless the Partner waives such rights. The Code provides that, subject to waiver, partners will receive notice of the administrative proceedings from the Service and will have the right to participate in the administrative proceedings. However, the Code also provides that if a partnership has 100 or more partners, the partners with less than a 1% profits interest will not be entitled to receive notice from the Service or participate in the proceedings unless they are members of a "notice group" (a group of partners having in the aggregate a 5% or more profits interest in the partnership that requires the Service to send notice to the group and that designates one of their members to receive notice). Any settlement agreement entered into between the Service and one or more of the partners will be binding on such partners but will not be binding on the other partners, except that settlement by the TMP may be binding on certain partners, as described below. The Service must, on request, offer consistent settlement terms to the partners who had not entered into the earlier settlement agreement. If a partnership has more than 100 partners, the TMP is empowered under the Code to enter into binding settlement agreements on behalf of the partners with a less than 1% profits interest unless the partner is a member of a notice group or notifies the Service that the TMP does not have the authority to bind the partner in such a settlement. By executing the partnership agreement each partner respectively represents, warrants, and agrees that he will not form or exercise any right as a member of a notice group and will not file a statement notifying the Service that the TMP does not have binding settlement authority. Such waiver is permitted under the partnership audit provisions of the Code and will be binding on the Partners. The costs incurred by a Partner in responding to an administrative proceeding will be borne solely by such Partner. The Taxpayer Relief Act of 1997 added new sections 771-777 to the Code providing for alternative reporting treatment for partnerships and their partners in the case of partnerships having 100 or more partners. In general these provisions provide for somewhat simplified reporting of partnership items on the forms K-1 supplied to partners. The Managing General Partner has not determined whether to make the election provided pursuant to these new Code provisions. PENALTIES Under Code section 6662, a taxpayer will be assessed a penalty equal to twenty percent (20%) of the portion of an underpayment of tax attributable to negligence, disregard of a rule or regulation or a substantial understatement of tax. "Negligence" includes any failure to make a reasonable attempt to comply with the tax laws. Code section 6662(c). The regulations further provide that a position with respect to an item is attributable to negligence if it lacks a reasonable basis. Treas. Reg. section 1.6662-3(b)(1). Negligence is strongly indicated where, for example, a partner fails to comply with the requirements of Code section 6662, which requires that a partner treat partnership items on its return in a manner that is consistent with the treatment of such items on the partnership return. Treas. Reg. section 1.6662-3(b)(1)(iii). The term "disregard" includes any careless, reckless or intentional disregard of rules or regulations. Treas. Reg. section 1.6662-3(b)(2). A taxpayer who takes a position contrary to a revenue ruling or a notice will be subject to a penalty for intentional disregard if the contrary position fails to possess a realistic possibility of being sustained on its merits. Treas. Reg. section 1.6662-3(b)(2). An "understatement" is defined as the excess of the amount of tax required to be shown on the return of the taxable year over the amount of the tax imposed that is actually shown on the return, reduced by any rebate. Code section 6662(d)(2)(A). An understatement is "substantial" if it exceeds the greater of ten percent (10%) of the tax required to be shown on the return for the taxable year or $5,000 ($10,000 in the case of certain corporations). Code section 6662(d)(1)(A) and (B). Generally, the amount of an understatement is reduced by the portion thereof attributable to (i) the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment, or (ii) any item if the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached to the return, and there is a reasonable basis for the tax treatment of such item by the taxpayer. Code section 6662(d). Disclosure will generally be adequate if made on a properly completed Form 8275 (Disclosure Statement) or Form 8275R (Regulation Disclosure Statement) Treas. Reg. section 1.6662-4(f). However, in the case of "tax shelters," there will be a reduction of the understatement only to the extent it is attributable to the treatment of an item by the taxpayer with respect to which there is or was substantial authority for such treatment and only if the taxpayer reasonably believed that the treatment of such item by the taxpayer was more likely than not the proper treatment. The existence of substantial authority is determined as of the time the taxpayer's return is filed or on the last day of the taxable year to which the return relates and not when the investment is made. Treas. Reg. section 1.6662-4(d)(3)(iv)(C). Substantial authority exists if the weight of authorities supporting a position is substantial compared with the weight of authorities supporting contrary treatment. Treas. Reg. section 1.6662-4(d)(3)(i). Relevant authorities included statutes, Regulations, court cases, revenue rulings and procedures, and Congressional intent. However, among other things, conclusions reached in legal opinions are not considered authority. Treas. Reg. section 1.6662-4(d)(3)(iii). Moreover, a corporation must generally satisfy a standard higher than substantial authority to avoid a substantial understatement penalty in the case of a tax shelter. Code section 6662(d)(2)(C)(ii). The term "tax shelter" is defined for purposes of Code section 6662 as a partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, the principal purpose of which is the avoidance or evasion of federal income tax. Code section 6662(d)(2)(C)(ii). It is important to note that this definition of "tax shelter" differs from that contained in Code sections 461 and 6111, as discussed above. A tax shelter item includes an item of income, gain, loss, deduction, or credit that is directly or indirectly attributable to a partnership that is formed for the principal purpose of avoiding or evading federal income tax. The Secretary may waive all or a portion of the penalty imposed under Code section 6662 upon a showing by the taxpayer that there was reasonable cause for the understatement and that the taxpayer acted in good faith. Code section 6664(d). Although not anticipated by PDC, there may not be substantial authority for one or more reporting positions that the Partnership may take in its federal income tax returns. In such event, if the Partnership does not disclose or if it fails to adequately disclose any such position, or if such disclosure is deemed adequate but it is determined that there was no reasonable basis for the tax treatment of such a partnership item, the penalty will be imposed with respect to any substantial understatement determined to have been made, unless the Partnership is able to show reasonable cause and good faith in making the understatement as specified in such provisions. If the Partnership makes a disclosure for the purposes of avoiding the penalty, the disclosure is likely to result in an audit of such return and a challenge by the Service of such position taken. If it were determined that a Partner had underpaid tax for any taxable year, such Partner would have to pay the amount of underpayment plus interest on the underpayment from the date the tax was originally due. The interest rate on underpayments is determined by the Service based upon the federal short term rate of interest (as defined in Code section 1274(d)) plus 3%, or 5% for large corporate underpayments, and is compounded daily. Code section 6621. The rate of interest is adjusted monthly. A partnership, for federal income tax purposes, is required to file an annual informational tax return. The failure to properly file such a return in a timely fashion, or the failure to show on such return all information under the Code to be shown on such return, unless such failure is due to reasonable cause, subjects the partnership to civil penalties under the Code in an amount equal to $50 per month multiplied by the number of partners in the partnership, up to a maximum of $250 per partner per year. Code section 6698. In addition, upon any willful failure to file a partnership information return, a fine or other criminal penalty may be imposed on the party responsible for filing the return. ACCOUNTING METHODS AND PERIODS The Partnership will use the accrual method of accounting and intends to select the calendar year as its taxable year. As discussed above, a taxpayer using the accrual method of accounting will recognize income when all events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. Deductions will be recognized when all events which establish liability have occurred and the amount thereof can be determined with reasonable accuracy. However, all events which establish liability are not treated as having occurred prior to the time that economic performance occurs. Code section 461(h). All partnerships are required to conform their tax years to those of their owners; i.e., unless the partnership establishes a business purpose for a different tax year, the tax year of a partnership must be (i) the taxable year of one or more of its partners who have an aggregate interest in partnership profits and capital of greater than 50%, (ii) if there is no taxable year so described, the taxable year of all partners having interests of 5% or more in partnership profits or capital, or (iii) if there is no taxable year described in (i) or (ii), the calendar year. Code section 706. Until the taxable years of the Partners can be identified, no assurance can be given that the Service will permit the Partnership to adopt a calendar year. SOCIAL SECURITY BENEFITS; SELF-EMPLOYMENT TAX A General Partner's share of any income or loss attributable to his investment in Units will constitute "net earnings from self-employment" for either social security or self-employment tax purposes. The Social Security Act and the Code exclude from the definition of "net earnings from self-employment" a limited partner's distributive share of any item of income or loss from a partnership other than a guaranteed payment for personal services actually rendered. Therefore, a Limited Partner's share of income or loss attributable to his investment in Units will not constitute "net earnings from self-employment" for either social security or self-employment purposes. STATE AND LOCAL TAXES The opinions expressed herein are limited to issues of federal income tax law and do not address issues of state or local law. Investors are urged to consult their tax advisors regarding the impact of state and local laws on an investment in the Partnership. PROPOSED LEGISLATION AND REGULATIONS There can be no assurances that subsequent changes in the tax laws (through new legislation, court decisions, Service pronouncements, Treasury regulations, or otherwise) will or will not occur that may have an impact, adverse or positive, on the tax effect and consequences of this Transaction, as described above. We express no opinion as to any federal income tax issue or other matter except those set forth or confirmed above. We hereby consent to the filing of this opinion as Appendix D to the Prospectus and to all references to our firm in the Prospectus. Sincerely, /s/ Duane Morris LLP DUANE MORRIS LLP No dealer, salesman or other person has been authorized to give any information or make any representations other than those contained in this prospectus in connection with this offering. You should rely only upon the information contained in this prospectus. We have not authorized anyone to provide you with different information. If it is against the law in any state to make an offer to sell the units (or to solicit an offer from someone to buy the units), then this prospectus does not apply to any person in that state, and no offer or solicitation is made by this prospectus to any person and we do not authorize the use of this prospectus to any person in that state. Throughout this offering, all dealers effecting transactions in the registered securities, whether or not participating in this distribution, are required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. 10,125 Preformation Units of General and Limited Partnership Interest [PDC logo] PDC 2003 DRILLING PROGRAM $202,500,000 Aggregate Subscriptions PROSPECTUS [month] __, 2003 PDC SECURITIES INCORPORATED 103 East Main Street Bridgeport, West Virginia 26330 800/624-3821 Dealer Manager A Member of the National Association of Securities Dealers, Inc. and Securities Investor Protection Corporation PART II. INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses of Issuance and Distribution. Set forth below is an estimate of the approximate amount of the fees and expenses payable by the Registrant in connection with the issuance and distribution of Units of general and limited partnership interest, based upon the assumption that all Units offered are sold. SEC Registration Fee......................................$ 4,248 NASD Filing Fee................................................ 5,750 Printing.............................................................. 23,000 Accountants' Fees and Expenses...................... 2,000 Blue Sky Fees and Expenses............................ 25,000 Counsel Fees and Expenses.......................... ... 15,000 Miscellaneous.................................................... 5,002 $ 80,000 Item 14. Indemnification of Directors and Officers. Registrant hereby incorporates herein by reference Section 6.04 "Indemnification of Managing General Partner" of the Limited Partnership Agreement which is included as Appendix A to the Prospectus, which is filed as a part of this Registration Statement. Item 15. Recent Sales of Unregistered Sections. Not applicable. Item 16. Exhibits and Financial Schedules. (a) Exhibits. 8 Tax opinion of Duane Morris LLP (included as Appendix D to the prospectus, which is filed as a part of this Registration Statement). 23.1 Consent of Duane Morris LLP (included in Part II of Registration Statement). 23.2 Consent of KPMG LLP (included in Part II of Registration Statement). 23.3 Consent of Wright & Company, Inc. (included in Part II of Registration Statement). (b) Financial Statement Schedules: None. (c) Financial Data Schedule: None. Item 17. Undertakings. The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement; and (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (4) The registrant will not identify to any third party any prospects which will go into or are likely to be placed into the program, or are representative of prospects which may be placed in the program, whether such third party is a selling dealer or other party involved with making or directing investment decisions regarding the purchase of program interests, except to the extent such prospects have been identified in the prospectus or an amendment thereto. (5) To the extent a review of prospects or lease inventory is permitted to third parties, it will be: (a) only incidental to an underwriter's due diligence examination; (b) no reference to any specific property (unless such property is described in the prospectus or an amendment) will appear in any analysis or report on the program prepared by such third party; and (c) any third party, prior to receiving permission to examine properties will agree to the above conditions, and registrant will file a copy of such agreement(s) as an exhibit to the registration statement. (6) No prospective investors or their representatives will be permitted to examine any prospects or inventory or data related thereto which is not described in the prospectus or an amendment thereto. (7) An annual report on Form 10-K will be filed at the conclusion of the fiscal year following the year in which the registration statement is declared effective. (8) A Form 8-K or final SR to reflect the expenditure of the proceeds of the offering will be filed. (9) Any revised prospectuses required by the provisions of Section 10(a)(3) of the Securities Act of 1933, as amended, will be filed as post-effective amendments to the registration statement. (10) For the purpose of determining any liability under said Act (without thereby affecting the original effective date of this registration statement for the purpose of Section 10(a)(3) of said Act) each such post-effective amendment may be deemed to be a new registration statement relating to the securities offered thereby, and the offering of such securities at that time may be deemed to be the initial bona fide offering thereof and that such post-effective amendment will comply with the applicable forms and rules and regulations of the Commission in effect at the time such post-effective amendment is filed. (11) The prospectus will be supplemented at the close of any partnership to state the number of participants in that partnership, the amount of participation sold therein, the cumulative amount sold under all partnerships formed under the subject registration statement, the amount of interests to be offered in the next partnership and in succeeding partnerships to be formed under this registration statement. (12) The Registrant undertakes to send to each Investor Partner at least on an annual basis a detailed statement of any transactions with the Managing General Partner or its Affiliates, and of fees, commissions, compensation, and other benefits paid, or accrued to the Managing General Partner or its Affiliates for the fiscal year completed, showing the amount paid or accrued to each recipient and the services performed. (13) The Registrant undertakes to send to the Investor Partners, within 45 days after the close of each quarterly fiscal period, the information specified by the Form 10-Q, if such report is required to be filed with the Commission. (14) The Registrant undertakes to provide to the Investor Partners the financial statements required by Form 10-K for the first full fiscal year of operations of the Partnership. (15) The undersigned Registrant hereby undertakes to provide to the Underwriter at the closing specified in the underwriting agreements certificates in such denominations and registered in such names as required by the Underwriter to permit prompt deliver to each purchaser. (16) The registrant undertakes to file a sticker supplement pursuant to Rule 424(c) under the Act during the distribution period describing each property not identified in the prospectus at such time as there arises a reasonable probability that such property will be acquired and to consolidate all such stickers into a post-effective amendment filed at least once every three months, with the information contained in such amendment provided simultaneously to the existing Limited Partners. Each sticker supplement should disclose all compensation and fees received by the General Partner(s) and its affiliates in connection with any such acquisition. The post-effective amendment shall include audited financial statements meeting the requirements of Rule 3-05 of Regulation S-X only for properties acquired during the distribution period. (17) The registrant also undertakes to file, after the end of the distribution period, a current report on Form 8-K or Form S-R containing the financial statements and any additional information required by Rule 3-05 of Regulation S-X, to reflect each commitment (i.e., the signing of a binding purchase agreement) made after the end of the distribution period involving the use of 10 percent or more (on a cumulative basis) of the net proceeds of the offering and to provide the information contained in such report to the Limited Partners at least once each quarter after the distribution period of the offering has ended. Insofar as indemnification for liability 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 Act 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. SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Bridgeport, State of West Virginia, on September 15, 2003. PDC 2003 Drilling Program I (Registrant) By: Petroleum Development Corporation, a Nevada corporation, Managing General Partner By: /s/ Steven R. Williams Steven R. Williams, President of the Managing General Partner Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date /s/ James N. Ryan Chairman of the Board September 15<./R>, 2003 James N. Ryan (Principal Executive Officer) /s/ Steven R. Williams President and Director September 15, 2003 Steven R. Williams /s/ Dale G. Rettinger Chief Financial Officer, Dale G. Rettinger Executive Vice President, September 15, 2003 Treasurer, and Director (Principal Financial and Accounting Officer) /s/ Vincent F. D'Annunzio Director September 15, 2003 Vincent F. D'Annunzio EXHIBIT INDEX NUMBER DESCRIPTION PAGE 23.1. Consent of Duane Morris LLP (included in Part II of Registrant Statement). 23.2 Consent of KPMG LLP (included in Part II of Registration Statement). 23.3 Consent of Wright & Company, Inc. (included in Part II of Registration Statement). \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001245372_decrane_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001245372_decrane_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dd57c1f743678eca789d4c61759ad93a16bbcdd --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001245372_decrane_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Spolin Silverman Cohen & Bartlett LLP, Santa Monica, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001248124_cheviot_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001248124_cheviot_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1679c10b51f9571ccca0f84f2315a7c5bbf1799f --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001248124_cheviot_legal_matters.txt @@ -0,0 +1 @@ +legal matters will be passed upon for Keefe, Bruyette & Woods, Inc. by Luse Gorman Pomerenk & Schick, P.C., Washington, D.C. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001260968_marlin_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001260968_marlin_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b76f405f15b273319292a161e95c6eca3b845f27 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001260968_marlin_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered hereby will be passed upon for us by Morgan, Lewis Bockius LLP, Philadelphia, Pennsylvania. Certain legal matters will be passed upon for the underwriters by Sidley Austin Brown Wood LLP, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001261686_nptest_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001261686_nptest_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..bfe47e8ec53e778c071159e72cee229af7020dff --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001261686_nptest_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock being offered will be passed upon for us by Davis Polk & Wardwell, Menlo Park, California. Selected legal matters in connection with this offering will be passed on for the underwriters by Simpson Thacher & Bartlett LLP, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001263813_united_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001263813_united_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..290b6bc21b0ca0a0c3eabf67d3fdfdd7fc39c982 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001263813_united_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters in connection with the offering of the Class A common shares have been passed upon for United National Group by its Cayman Islands counsel, Walkers, Cayman Islands. Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York, acts as counsel for the underwriters. The underwriters are being advised as to certain legal matters with respect to Cayman Islands law by Maples and Calder, Cayman Islands. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001265532_grandriver_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001265532_grandriver_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..28458f05a309c2a28271d5eadbbe2b91aff42d02 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001265532_grandriver_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters of Delaware law relating to the validity of the Trust Preferred Securities will be passed upon on behalf of the Trust and GrandRiver Financial by [o], [City], Delaware, special Delaware counsel to the Trust. The validity of the Guarantee and certain matters relating thereto will be passed upon for GrandRiver Financial and certain United States federal income taxation matters will be passed upon for GrandRiver Financial and the Trust by Sidley Austin Brown & Wood LLP, New York, New York. The validity of the Class A Senior Preferred Shares and certain matters with respect to Bermuda law will be passed upon on behalf of the Trust and GrandRiver Financial by Appleby Spurling & Kempe, Hamilton, Bermuda. Simpson Thacher & Bartlett LLP, New York, New York, will pass upon certain legal matters for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001265533_grandriver_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001265533_grandriver_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..28458f05a309c2a28271d5eadbbe2b91aff42d02 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001265533_grandriver_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters of Delaware law relating to the validity of the Trust Preferred Securities will be passed upon on behalf of the Trust and GrandRiver Financial by [o], [City], Delaware, special Delaware counsel to the Trust. The validity of the Guarantee and certain matters relating thereto will be passed upon for GrandRiver Financial and certain United States federal income taxation matters will be passed upon for GrandRiver Financial and the Trust by Sidley Austin Brown & Wood LLP, New York, New York. The validity of the Class A Senior Preferred Shares and certain matters with respect to Bermuda law will be passed upon on behalf of the Trust and GrandRiver Financial by Appleby Spurling & Kempe, Hamilton, Bermuda. Simpson Thacher & Bartlett LLP, New York, New York, will pass upon certain legal matters for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CIK0001266467_webzen-inc_legal_matters.txt b/parsed_sections/legal_matters/2003/CIK0001266467_webzen-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d2e54f2cd91c642f671c95b7b203534c5c4ec77f --- /dev/null +++ b/parsed_sections/legal_matters/2003/CIK0001266467_webzen-inc_legal_matters.txt @@ -0,0 +1 @@ +Legal matters Certain legal matters in connection with the offered ADSs will be passed upon for us by Davis Polk & Wardwell, our United States counsel, and by Hanol Law Offices, our Korean counsel. Certain legal matters with respect to the offered ADSs will be passed upon for the underwriters by Paul, Hastings, Janofsky & Walker LLP, United States counsel for the underwriters, and by Shin & Kim, Korean counsel for the underwriters. Davis Polk & Wardwell may rely as to all matters of Korean law on the opinion of Hanol Law Offices. Hanol Law Offices may rely as to all matters of New York and United States federal law on the opinion of Davis Polk & Wardwell. Paul, Hastings, Janofsky & Walker LLP may rely as to all matters of Korean law on the opinion of Shin & Kim. Shin & Kim may rely as to all matters of New York and United States federal law on the opinion of Paul, Hastings, Janofsky & Walker LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/CILJF_china_legal_matters.txt b/parsed_sections/legal_matters/2003/CILJF_china_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..daa34678ad6a745b683e7b504e7933359f773cd2 --- /dev/null +++ b/parsed_sections/legal_matters/2003/CILJF_china_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of H shares under Chinese law will be passed upon for us and CLIC by King & Wood, Beijing, PRC, and for the underwriters by Haiwen & Partners, Beijing, PRC. Certain legal matters of United States and New York law will be passed upon for us and CLIC by Debevoise & Plimpton, New York, New York, and for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. Certain legal matters of Hong Kong law will be passed upon for us and CLIC by Allen & Overy, Hong Kong, SAR, and for the underwriters by Baker & McKenzie, Hong Kong, SAR. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/ECPG_encore_legal_matters.txt b/parsed_sections/legal_matters/2003/ECPG_encore_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68ce143e918f94153b2bf063806cdd65df5d1eb0 --- /dev/null +++ b/parsed_sections/legal_matters/2003/ECPG_encore_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the validity of the shares of common stock are being passed upon for us by Snell Wilmer L.L.P., Phoenix, Arizona. Certain legal matters will be passed upon for the underwriters by Latham Watkins LLP, Costa Mesa, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/NNI_nelnet-inc_legal_matters.txt b/parsed_sections/legal_matters/2003/NNI_nelnet-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..60323b8dc507f763a34ee481c624b16f44954064 --- /dev/null +++ b/parsed_sections/legal_matters/2003/NNI_nelnet-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Class A common stock offered hereby have been and are being passed upon for Nelnet by Perry, Guthery, Haase Gessford, P.C., L.L.O., Lincoln, Nebraska. Legal matters in connection with this offering are being passed upon for Nelnet by Cahill Gordon Reindel LLP, New York, New York, and for the underwriters by Davis Polk Wardwell, New York, New York. Shareholders of, and an Of Counsel to, Perry, Guthery, Haase Gessford, P.C., L.L.O. own an aggregate of 258,802 shares of Class A common stock of Nelnet. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/PETS_petmed_legal_matters.txt b/parsed_sections/legal_matters/2003/PETS_petmed_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a9d67d016c5454b5bb748f33eb1c09b1fe328429 --- /dev/null +++ b/parsed_sections/legal_matters/2003/PETS_petmed_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered by this prospectus will be passed upon for us by Katz, Barron, Squitero, Faust & Boyd, P.A., 100 N.E. Third Avenue, Suite 280, Fort Lauderdale, Florida 33301. EXPERTS The consolidated financial statements of PetMed Express, Inc. as of March 31, 2003, and for each of the three years then ended, appearing in this prospectus and registration statement have been audited by Goldstein Golub Kessler LLP, independent auditors, as set forth in their report thereon appearing elsewhere in this prospectus, and are included in reliance upon this report given on the authority of such firm as experts in auditing and accounting. ADDITIONAL INFORMATION We have filed with the SEC the registration statement on Form S-1 under the Securities Act for the common stock offered by this prospectus. This prospectus, which is a part of the registration statement, does not contain all of the information in the registration statement and the exhibits filed with it, portions of which have been omitted as permitted by SEC rules and regulations. For further information concerning us and the securities offered by this prospectus, we refer to the registration statement and to the exhibits filed with it. Statements contained in this prospectus as to the content of any contract or other document referred to are not necessarily complete. In each instance, we refer you to the copy of the contracts and/or other documents filed as exhibits to the registration statement, and these statements are qualified in their entirety by reference to the contract or document. The registration statement, including all exhibits, may be inspected without charge at the SEC's Public Reference Room at 450 Fifth Street, N.W. Washington, D.C. 20549, and at the SEC's regional offices located at New York, New York and Chicago, Illinois. You may request copies of these documents by writing to the Securities and Exchange Commission and paying the required fee for copying. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for more information about the operation of their public reference rooms. Copies of our filings are also available at the SEC website at http://www.sec.gov. The registration statement, including all exhibits and schedules and amendments, has been filed with the SEC through the Electronic Data Gathering, Analysis and Retrieval system. Following the effective date of the registration statement relating to this prospectus, we will continue to be subject to the reporting requirements of the Exchange Act and in accordance with these requirements, will continue to file annual, quarterly and special reports, and other information with the SEC. We also intend to furnish our shareholders with annual reports containing audited financial statements and other periodic reports as we think appropriate or as may be required by law. Copies of our SEC filings and other information about us are also available on our website at www.1800PetMeds.com. The information on our website is neither incorporated into, nor a part of, this prospectus. 51 PETMED EXPRESS, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS Fiscal Years Ended 2003, 2002 and 2001 -------------------------------------- Independent Auditor's Report................................ F-2 Consolidated Balance Sheets as of March 31, 2003 and 2002... F-3 Consolidated Statements of Operations for the three years ended March 31, 2003...................................... F-4 Consolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended March 31, 2003............................................ F-5 Consolidated Statements of Cash Flows for the three years ended March 31, 2003...................................... F-6 Notes to Consolidated Financial Statements..................F-7-F-17 Three months ended June 30, 2003 and 2002 ----------------------------------------- Condensed Consolidated Balance Sheets as of June 30, 2003 and March 31, 2003........................................ F-18 Condensed Consolidated Statements of Income for the three months ended June 30, 2003 and 2002....................... F-19 Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2003 and 2002................. F-20 Notes to Condensed Consolidated Financial Statements for the three months ended June 30 2003 and 2002..........F-21-F-24 F-1 INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Shareholders PetMed Express, Inc. and Subsidiaries: We have audited the accompanying consolidated balance sheets of PetMed Express, Inc. and Subsidiaries (the "Company") as of March 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended March 31, 2003. 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. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PetMed Express, Inc. and Subsidiaries as of March 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2003, in conformity with accounting principles generally accepted in the United States of America. May 10, 2003 /s/Goldstein Golub Kessler LLP New York, New York ------------------------------- Goldstein Golub Kessler LLP F-2 PETMED EXPRESS, INC. AND SUBISIDIARIES CONSOLIDATED BALANCE SHEETS
March 31, 2003 2002 ----------- ------------ ASSETS ------ Current assets: Cash and cash equivalents $ 984,169 $ 737,284 Accounts receivable, less allowance for doubtful accounts of $16,644 and $7,475, respectively 651,883 291,513 Inventories 4,268,146 2,306,620 Prepaid expenses and other current assets 478,108 148,608 ----------- ------------ Total current assets 6,382,306 3,484,025 Property and equipment, net 1,496,979 1,120,056 Deferred income taxes 581,356 - Intangible asset 365,000 - Other assets 200,155 50,155 ----------- ------------ Total assets $ 9,025,796 $ 4,654,236 =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable and accrued expenses 3,296,223 2,724,995 Current portion of loan obligation 68,442 68,442 ----------- ------------ Total current liabilities 3,364,665 2,793,437 Line of credit - 141,214 Loan obligation, less current portion 68,443 136,885 ----------- ------------ Total liabilities 3,433,108 3,071,536 Commitments and contingencies Shareholders' equity: Preferred stock, $.001 par value, 5,000,000 shares authorized; 2,500 convertible shares issued and outstanding with a liquidation preference of $4 per share 8,898 8,898 Common stock, $.001 par value, 40,000,000 shares authorized; 18,460,878 and 16,360,010 shares issued and outstanding, respectively 18,461 16,360 Additional paid-in capital 7,279,207 6,528,885 Accumulated deficit (1,713,878) (4,971,443) ----------- ------------ Total shareholders' equity 5,592,688 1,582,700 ----------- ------------ Total liabilities and shareholders' equity 9,025,796 4,654,236 =========== ============
See accompanying notes to consolidated financial statements. F-3 PETMED EXPRESS, INC. AND SUBISIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended March 31, ---------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Sales $ 54,974,916 $ 32,025,931 $ 10,006,285 Cost of sales 31,517,639 18,894,493 6,367,604 ------------ ------------ ------------ Gross profit 23,457,277 13,131,438 3,638,681 Operating expenses: General and administrative 7,956,786 6,094,493 4,506,509 Advertising 11,649,811 5,717,242 1,397,418 Severance charges - 195,000 - Depreciation and amortization 367,673 376,763 373,852 ------------ ------------ ------------ Total operating expenses 19,974,270 12,383,498 6,277,779 ------------ ------------ ------------ Income (loss) from operations 3,483,007 747,940 (2,639,098) ------------ ------------ ------------ Other income (expense): Adjustment of estimate for legal settlement - 345,000 - Gain (loss) on disposal of property and equipment 15,000 (314,332) - Interest expense (30,658) (48,835) (231,414) Interest income 6,973 18,582 52,922 Other, net 6,084 77,058 (9,117) ------------ ------------ ------------ Total other income (expense) (2,601) 77,473 (187,609) ------------ ------------ ------------ Income (loss) before provision for income taxes 3,480,406 825,413 (2,826,707) Provision for income taxes 222,841 - - ------------ ------------ ------------ Net income (loss) $ 3,257,565 $ 825,413 $ (2,826,707) ============ ============ ============ Net income (loss) per common share: Basic $ 0.19 $ 0.05 $ (0.28) ============ ============ ============ Diluted $ 0.16 $ 0.04 $ (0.28) ============ ============ ============ Weighted average number of common shares outstanding: Basic 17,300,130 16,360,010 9,943,625 ============ ============ ============ Diluted 20,749,515 19,739,493 9,943,625 ============ ============ ============
See accompanying notes to consolidated financial statements. F-4 PETMED EXPRESS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Years ended March 31, 2001, 2002 and 2003
Convertible Preferred Stock Common Stock Additional ------------------ ------------------------ Paid-In Accumulated Shares Amounts Shares Amounts Capital Deficit Total ------ -------- ---------- --------- ------------ ------------- ------------ Balance, March 31, 2000 6,250 $ 22,246 6,369,822 $ 6,370 $ 4,572,385 (2,970,149) $ 1,630,852 Conversion of convertible preferred stock into common stock (3,750) (13,348) 15,188 15 13,333 - - Sale of common stock, net of issuance costs - - 10,000,000 10,000 1,944,142 - 1,954,142 Purchase and Retirement of treasury stock - - (25,000) (25) (975) - (1,000) Net loss - - - - - (2,826,707) (2,826,707) ------ -------- ---------- --------- ------------ ------------- ------------ Balance, March 31, 2001 2,500 8,898 16,360,010 16,360 6,528,885 (5,796,856) 757,287 Net income - - - - - 825,413 825,413 ------ -------- ---------- --------- ------------ ------------- ------------ Balance, March 31, 2002 2,500 8,898 16,360,010 16,360 6,528,885 (4,971,443) 1,582,700 Issuance of common stock from exercise of stock options - - 1,018,833 1,019 304,360 - 305,379 Issuance of common stock from exercise of warrants - - 1,082,035 1,082 274,375 - 275,457 Tax benefit related to stock options exercised - - - - 171,587 - 171,587 Net income - - - - - 3,257,565 3,257,565 ------ -------- ---------- --------- ------------ ------------- ------------ Balance, March 31, 2003 2,500 $ 8,898 18,460,878 $ 18,461 $ 7,279,207 $ (1,713,878) $ 5,592,688 ====== ======== ========== ========= ============ ============= ============
See accompanying notes to consolidated financial statements. F-5 PETMED EXPRESS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended March 31, ---------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $ 3,257,565 $ 825,413 $ (2,826,707) Adjustments to reconcile net income loss) to net cash provided by (used in) operating activities: Depreciation and amortization 367,673 376,763 373,852 Tax benefit related to stock options exercised 171,587 - - Amortization of deferred membership fee revenue - (140,048) (462,139) (Gain) loss on disposal of property and equipment (15,000) 314,332 - Bad debt expense 15,027 6,862 (19,007) Deferred income taxes (581,356) - - (Increase) decrease in operating assets and liabilities: Accounts receivable (375,397) (135,907) 44,412 Inventories (1,961,526) (1,675,226) 1,121,302 Prepaid expenses and other current assets (329,500) (126,494) 328,430 Other assets (150,000) (42,500) 11,429 Accounts payable and accrued expenses 571,228 1,072,829 64,485 Deferred membership fee revenue - - 328,789 ------------ ------------ ------------ Net cash provided by (used in) operating activities 970,301 476,024 (1,035,154) ------------ ------------ ------------ Cash flows from investing activities: Net proceeds from the sale of propert and equipment 15,000 2,016,921 - Purchases of property and equipment (744,596) (555,645) (241,888) Certificate of deposit - - 300,000 Purchase of intangible asset (365,000) - - ------------ ------------ ------------ Net cash (used in) provided by investing activities (1,094,596) 1,461,276 58,112 ------------ ------------ ------------ Cash flows from financing activities: Payments on mortgage payable - (1,566,833) (65,079) Payments on capital lease obligations - (247,209) (179,183) (Payments) borrowings on loan agreement (68,442) 205,327 - Payments on line of credit agreement (141,214) - (634,985) Net proceeds from sale of common stock - - 1,954,142 Purchase and retirement of treasury stock - - (1,000) Proceeds from the exercise of stock options and warrants 580,836 - - ------------ ------------ ------------ Net cash provided by (used in) financing activities 371,180 (1,608,715) 1,073,895 ------------ ------------ ------------ Net increase in cash and cash equivalents 246,885 328,585 96,853 Cash and cash equivalents, at beginning of year 737,284 408,699 311,846 ------------ ------------ ------------ Cash and cash equivalents, at end of year $ 984,169 $ 737,284 $ 408,699 ============ ============ ============ Supplemental disclosure of cash flow information: Cash paid for interest $ 30,675 $ 29,150 $ 239,007 ============ ============ ============ Cash paid for income taxes $ 508,000 $ - $ - ============ ============ ============
See accompanying notes to consolidated financial statements. F-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Summary of Significant Accounting Policies Organization PetMed Express, Inc. and its subsidiaries, d/b/a 1-800- PetMeds, (the "Company") is a leading nationwide pet pharmacy. The Company markets prescription and non- prescription pet medications, along with health and nutritional supplements, for cats and dogs direct to the consumer. The Company markets its products through national television, on-line and direct mail advertising campaigns, which aim to increase the recognition of the "1-800-PetMeds" brand name, increase traffic on its web site at www.1800PetMeds.com , acquire new customers, and maximize repeat purchases. The majority of all of the Company's sales are to residents of the United States. The Company's executive offices are located in Pompano Beach, Florida. During the fiscal year ended March 31, 2001, the Company formed two wholly owned subsidiaries. One company was formed to assist in the purchasing of products and the other for advertising. The Company's fiscal year end is March 31. References herein to fiscal 2003, 2002, or 2001 refer to the Company's fiscal years ended March 31, 2003, 2002, and 2001, respectively. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. Revenue Recognition The Company generates revenue by selling pet medication products primarily to retail consumers and minimally to wholesale customers. The Company's policy is to recognize revenue from product sales upon shipment, when the rights of ownership and risk of loss have passed to the consumer. Deferred membership revenue consists of cash collected on the sale of one and three-year memberships. Membership fees are amortized to income ratably over the membership period. During fiscal year 2001 the Company discontinued the PetMed Express, Inc. membership plan. Outbound shipping and handling fees are included in sales and are billed upon shipment. Shipping and handling expenses are included in cost of sales. The majority of the Company's sales are paid by credit cards and the Company usually receives the cash settlement in one to three banking days. Credit card sales minimize our accounts receivable balances relative to our sales. The Company maintains an allowance for doubtful accounts for losses that the Company estimates will arise from the customers' inability to make required payments, arising from either credit card charge-backs or insufficient fund checks. The Company determines its estimates of the uncollectibility of accounts receivable by analyzing historical bad debts and current economic trends. At March 31, 2003 and 2002 the allowance for doubtful accounts was approximately $17,000 and $7,000, respectively. Cash and Cash Equivalents The Company considers all highly liquid investments with maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents at March 31, 2003 and 2002, consist of the Company's cash accounts, overnight repurchase agreements, and short-term investments with a maturity of three months or less. The carrying amount of cash equivalents approximates fair value. The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. Use of Estimates The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-7 (1) Summary of Significant Accounting Policies (Continued) Inventories Inventories consist of prescription and non-prescription pet medications that are available for sale and are priced at the lower of cost or market value using a weighted average cost method. The Company writes down its inventory for estimated obsolescence. At March 31, 2003 and 2002 the inventory reserve was approximately $87,000 and $75,000, respectively. Property and Equipment Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets. The furniture, fixtures, equipment and computer software are depreciated over periods ranging from three to seven years. Leasehold improvements and assets under capital lease agreements are amortized over the shorter of the underlying lease agreement or the useful life of the asset. Long-lived Assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Recoverability of assets is measured by a comparison of the carrying amount of the asset to net future cash flows expected to be generated from the asset. Intangible Asset The intangible asset consists of a toll free telephone number, which the Company obtained in the quarter ended September 30, 2002. The Company paid $365,000, to reimburse previously expended advertising costs relating to obtaining the rights to the toll free number. In accordance with the Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, the intangible asset is not being amortized, and is subject to an annual review for impairment. Advertising The Company's advertising expense consists primarily of television advertising, internet marketing, catalog and postcard production, and mailing costs. Television costs are expensed as the ads are televised and catalog and postcard costs are expensed when the related catalog and postcards are produced, distributed or superseded. Accounting for Stock-Based Compensation The Company accounts for employee stock options using the intrinsic value method as prescribed by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees. The Company follows the disclosure provisions of SFAS No. 123, Accounting for Stock- Based Compensation, for employee stock options. Had the Company determined employee compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income would have been decreased to the pro forma amounts indicated below:
Year Ended March 31, 2003 2002 2001 -------------------- ------------ ------------ ------------ Reported net income (loss): $ 3,257,565 $ 825,413 $ (2,826,707) Deduct: total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects 285,258 129,465 424,556 Proforma net income (loss): $ 2,972,307 $ 695,948 $ (3,251,263) ============ ============ ============ Reported basic net income (loss) per share: $ 0.19 $ 0.05 $ (0.28) ============ ============ ============ Proforma basic net income (loss) per share: $ 0.17 $ 0.04 $ (0.33) ============ ============ ============ Reported diluted net income (loss) per share: $ 0.16 $ 0.04 $ (0.28) ============ ============ ============ Proforma diluted net income (loss) per share: $ 0.14 $ 0.04 $ (0.33) ============ ============ ============
F-8 (1) Summary of Significant Accounting Policies (Continued) The per share weighted-average fair value of stock options granted during fiscal 2003, 2002, and 2001 was $1.28, $.70 and $.23, respectively, on the date of grant using the Black Scholes option-pricing model, as prescribed by SFAS No. 123, with the following weighted-average assumptions: no dividend yield; risk-free interest rates ranging from 4 to 6 percent; expected lives of 3-5 years, and expected volatility of 62 percent, 60 percent, and 91 percent, respectively. Fair Value of Financial Instruments The carrying amounts of the Company's cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the short-term nature of these instruments. The carrying amount of the loan payable approximates fair value as their interest rates approximate current market rates. Comprehensive Income The Company has adopted SFAS No. 130, Reporting Comprehensive Income, which requires that all items that are recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The items of other comprehensive income that are typically required to be displayed are foreign currency items, minimum pension liability adjustments and unrealized gains and losses on certain investments in debt and equity securities. There were no items of other comprehensive income for any periods presented herein. Income Taxes The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes, which generally requires recognition of deferred tax assets and liabilities for the expected future tax benefits or consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting carrying values and the tax bases of assets and liabilities, and are measured by applying enacted tax rates and laws for the taxable years in which those differences are expected to reverse. Recent Accounting Pronouncements The Company does not believe that any recently issued, but not yet effective, accounting standard, if currently adopted, will have a material effect on the Company's consolidated financial position, results of operations or cash flows. (2) Property and Equipment Major classifications of property and equipment consist of the following:
March 31, 2003 2002 --------- --------- Leasehold improvements 289,901 42,891 Computer software 327,197 302,537 Furniture, fixtures and equipment 1,606,484 1,325,635 Equipment and software under capital lease 113,398 280,849 --------- --------- 2,336,980 1,951,912 Less: accumulated depreciation and amortization (840,001) (831,856) --------- --------- Property and equipment, net $ 1,496,979 1,120,056 ========= =========
Amortization expense for equipment and software under capital leases was $24,123, $93,169, and $114,881 for fiscal 2003, 2002, and 2001, respectively. F-9 (3) Accounts Payable and Accrued Expenses Major classifications of accounts payable and accrued expenses consist of the following:
March 31, 2003 2002 --------- --------- Accounts payable 2,570,459 1,873,925 Accrued salaries 237,165 180,315 Other accrued liabilities 488,599 670,755 --------- --------- Accounts payable and accrued expenses $ 3,296,223 2,724,995 ========= =========
(4) Mortgage Payable, Line of Credit Agreement and Loan Obligation On May 31, 2001, the Company sold their 50,000 square foot office building, which houses the Company's principal executive offices and warehouse, to an unrelated third party. The Company received gross proceeds of $2,150,000, of which approximately $1,561,000 was used to pay off the mortgage, and the Company recognized a loss on the sale of approximately $185,000. The Company then entered into a five-year term lease agreement for 20,000 of the 50,000 square foot Pompano Beach office building. On February 22, 2002, the Company entered into a lease addendum which added approximately 12,000 square feet, effective June 1, 2002, to accommodate the Company's warehouse expansion. On July 22, 2002, the Company executed an agreement which increased the line of credit from $150,000 to $1,000,000. On March 18, 2003, the Company increased the line of credit agreement from $1,000,000 to $2,000,000, effective through July 22, 2004. The interest rate is at the published thirty day London Interbank Offered Rates ("LIBOR") plus 2.65% (3.92% and 5.75% at March 31, 2003 and 2002, respectively), and contains various financial and operating covenants. At March 31, 2003 and 2002, there was $0 and $141,000, respectively, outstanding under the line of credit agreement. On March 12, 2002, the Company entered into a $205,000, three year term loan agreement with a bank, with interest accruing at the lending institution's base rate plus 1% (5.25% and 5.75% at March 31, 2003 and 2002, respectively). The loan proceeds were used to purchase a $250,000 computer server. The aggregate loan maturities are $68,000 per year for three years. The line of credit and the term loan are secured by substantially all of the Company's assets. (5) Shareholders' Equity On November 22, 2000, Tricon Holdings, LLC, a Florida limited liability corporation ("Tricon") a related party (see Note 8), acquired 10,000,000 shares of the Company's authorized and unissued shares of common stock and warrants to purchase 3,000,000 shares of the Company's authorized and unissued shares of common stock. The warrants are exercisable at $.33 per share and expire on November 22, 2005. Tricon acquired the Company's shares and warrants in exchange for $2,000,000, which was paid in fiscal year 2001. On May 31, 2001, the Company's Board of Directors adopted an amendment to the Corporation's Articles of Incorporation to provide for the increase in the authorized amount of shares of common stock from 20,000,000 to 40,000,000 and adopt an amendment to the Company's 1998 Stock Option Plan (the "Plan") to increase the number of shares of common stock issuable under the Plan from 3,000,000 to 5,000,000 shares. F-10 (5) Shareholders' Equity (Continued) Preferred Stock In April 1998, the Company issued 250,000 shares of its $.001 par value preferred stock at a price of $4.00 per share, less issuance costs of $112,187. Each share of the preferred stock is convertible into approximately 4.05 shares of common stock at the election of the shareholder. The preferred stock was recorded at $887,813, net of the value of the beneficial conversion feature of $771,525. The value of the beneficial conversion feature was computed as the difference between the closing market price of the Company's common stock ($1.75 per share) and the conversion price of the preferred stock ($.988 per share) on the date the preferred stock was sold. This amount was immediately recognized as a reduction to net income available to common stockholders. The shares have a liquidation value of $4.00 per share and may pay dividends at the sole discretion of the Company. The Company does not anticipate paying dividends to the preferred shareholders in the foreseeable future. Each share of preferred stock is entitled to one vote on all matters submitted to a vote of shareholders of the Company. As of March 31, 2003 and 2002, 2,500 shares of the convertible preferred stock remained unconverted and outstanding. (6) Income Taxes Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities are as follows:
March 31, 2003 2002 --------- --------- Deferred tax assets: Bad debt and inventory reserves 39,041 30,946 Deferred compensation (stock options) 59,814 231,400 Intangible assets - 7,410 Accrued expenses 58,033 155,087 Net operating loss carryforward 1,439,932 1,856,732 --------- --------- Deferred tax assets 1,596,820 2,281,575 Less: valuation allowance (938,766) (2,204,877) --------- --------- Total deferred tax assets 658,054 76,698 Deferred tax liabilities: Depreciation (76,698) (76,698) --------- --------- Total net deferred taxes $ 581,356 - ========= =========
The change in the valuation allowance for the year ended March 31, 2003 and 2002, is approximately $1,266,000 and $349,204, respectively. At March 31, 2003, the Company had net operating loss carryforwards of approximately $3,800,000, of which $159,000 relate to the exercise of stock options that will result in an adjustment to equity when the benefit is realized. The net operating loss carryforwards expire in the years 2013 through 2020. The use of such net operating loss carryforwards is limited to approximately $266,000 annually; due to the November 22, 2000 change of control. F-11 (6) Income Taxes (Continued) The reconciliation of income tax provision computed at the U.S. federal statutory tax rates to income tax expense is as follows:
Year Ended March 31, 2003 2002 2001 ----------- ----------- ----------- Income taxes (tax benefit) at U.S. statutory rates $ 1,183,338 $ 280,640 $ (961,080) State income taxes (tax benefit), net of federal tax benefit 126,339 29,962 (102,609) Permanent differences 1,512 877 3,946 Other 177,763 - 33,647 Change in valuation allowance (1,266,111) - 1,026,096 Utilization of net operating losses - (311,479) - ----------- ------------ ----------- $ 222,841 $ - $ - =========== ============ ===========
(7) Stock Options and Warrants Stock Options Granted to Employees The Company established the 1998 Stock Option Plan (the "Plan") effective July 31, 1998, which provides for the issuance of qualified options to officers, directors and key employees, and nonqualified options to consultants and other service providers. The Company has reserved 5,000,000 shares of common stock for issuance under the Plan. The exercise prices of options issued under the Plan must be equal to or greater than the market price of the Company's common stock as of the date of issuance. The Company had 2,743,600 and 3,039,700 options outstanding under the Plan at March 31, 2003 and 2002, respectively. Options issued prior to July 31, 1998 are not included in the Plan. A summary of the status of stock options and certain warrants issued by the Company, together with changes during the periods indicated, is presented in the following table:
Weighted- average Options exercise price ------------- -------------- Balance at March 31, 2000 3,705,500 $ 1.84 Options Granted 1,175,000 0.35 Options Canceled (335,800) 4.73 ------------- -------------- Balance at March 31, 2001 4,544,700 $ 1.24 Options Granted 387,500 1.26 Options Canceled (695,100) 2.81 ------------- -------------- Balance at March 31, 2002 4,237,100 0.98 Options Granted 910,432 0.75 Options and Warrants Exercised (1,800,868) 0.36 Options Canceled (603,064) 1.45 ------------- -------------- Balance at March 31, 2003 2,743,600 $ 1.06 ============= ==============
F-12 (7) Stock Options and Warrants (Continued) The following table summarizes information for options currently outstanding and exercisable at March 31, 2003:
Options Outstanding Options Exercisable ------------------------------------ --------------------- Weighted- Weighted- Weighted- average average average Exercise Remaining Exercise Exercise Price Range Number Life Price Number Price -------------- ------------------------------------ --------------------- $ 0.20 - $0.86 862,500 4.35 years $0.44 539,164 $0.40 1.05 - 1.76 1,756,500 4.74 years 1.28 1,503,200 1.28 1.90 - 4.50 124,600 4.07 years 2.43 34,600 3.80 -------------- ------------------------------------ --------------------- $ 0.20 - $4.50 2,743,600 4.58 years $1.06 2,076,964 $1.09 ============== ==================================== =====================
At March 31, 2003 and March 31, 2002, the number of options exercisable was 2,076,964 and 2,752,803, respectively, and the weighted-average exercise price of those options was $1.09 and $.96, respectively. Adjustments are made for options forfeited prior to vesting. Warrants On November 22, 2000, Tricon Holdings, LLC, a Florida limited liability corporation ("Tricon"), acquired 10,000,000 shares of the Company's authorized and unissued shares of common stock and warrants to purchase 3,000,000 shares of the Company's authorized and unissued shares of common stock. The warrants are exercisable at $.33 per share and expire on November 22, 2005, and were assigned a value of $601,260 using the Black Scholes option-pricing model, as prescribed by SFAS No. 123, with the following weighted-average assumptions: dividend yield 0.0 percent; risk-free interest rates of 6.00 percent; expected lives of 3-5 years, and expected volatility of 91 percent. On September 30, 2002, Tricon exercised 300,000 warrants at the exercise price of $.33 per share, and the Company received proceeds of $99,000. (8) Related Party Transactions Guven Kivilcim, a member of Tricon Holdings, LLC and a member of the Company's board of directors, has an interest in Intelligent Switching & Software LLC, and Numind Software Systems, Inc., with which the Company conducted business with during the fiscal years ended March 31, 2003 and 2002. Intelligent Switching & Software LLC provided the Company with long distance telecommunication services, and Numind Software Systems, Inc. provided the Company with Internet and website design and hosting services. The Company paid $154,000 and $64,000 to Intelligent Switching & Software LLC, and $45,000 and $0 to Numind Software Systems, Inc., for services during the fiscal years ended March 31, 2003 and 2002, respectively. The Company owed $5,000 and $64,000 to Intelligent Switching & Software LLC, and $14,000 and $37,000 to Numind Software Systems, Inc., which were included in the Company's accounts payable balance as of March 31, 2003 and 2002, respectively. F-13 (9) Net Income Per Share In accordance with the provisions of SFAS No. 128, "Earnings Per Share," basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income per share includes the dilutive effect of potential stock options exercises, calculated using the treasury stock method. Outstanding stock options, warrants, and convertible preferred shares issued by the Company represent the only dilutive effect reflected in diluted weighted average shares outstanding. For the year ended March 31, 2001, potential common shares have not been included in the computation of diluted earnings per share, since the effect would be antidilutive. The following is a reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share computations for the periods presented:
Year Ended March 31, 2003 2002 2001 ----------- ----------- ----------- Net income (loss) (numerator): Net income (loss) $ 3,257,565 $ 825,413 $(2,826,707) =========== =========== =========== Shares (denominator) Weighted average number of common shares outstanding used in basic computation 17,300,130 16,360,010 9,943,625 Common shares issuable upon exercise of stock options and warrants 3,439,260 3,369,358 - Common shares issuable upon conversion of preferred shares 10,125 10,125 - ----------- ----------- ----------- Shares used in diluted computation 20,749,515 19,739,493 9,943,625 =========== =========== =========== Net income per common share: Basic $ 0.19 $ 0.05 $ (0.28) =========== =========== =========== Diluted $ 0.16 $ 0.04 $ (0.28) =========== =========== ===========
At March 31, 2003 and 2002, 124,600 and 2,124,600 shares, respectively, of common stock options and warrants, with a weighted average exercise price of $2.43 and $1.53, respectively, were excluded from the diluted net income per share computation as their exercise prices were greater than the average market price of the common shares for the period. (10) Valuation and Qualifying Accounts Activity in the Company's valuation and qualifying accounts consists of the following:
Year Ended March 31, 2003 2002 2001 ----------- ----------- ----------- Allowance for doubtful accounts: Balance at beginning of period $ 7,475 $ 9,740 $ 28,747 Provision for doubtful accounts 14,759 (319) (19,007) Write-off of uncollectible accounts receivable (5,590) (1,946) - ----------- ----------- ----------- Balance at end of period $ 16,644 $ 7,475 $ 9,740 =========== =========== =========== Valuation allowance for deferred tax assets: Balance at beginning of period $ 2,204,877 $ 2,554,081 $ 1,527,985 (Deletions) / additions (1,266,111) (349,204) 1,026,096 ----------- ----------- ----------- Balance at end of period $ 938,766 $ 2,204,877 $ 2,554,081 =========== =========== ===========
F-14 (11) Commitments and Contingencies Legal Matters Various complaints had been filed with the Florida Board of Pharmacy. These complaints, the majority of which were filed by veterinarians who are in competition with the Company for the sale of pet prescription-required products, alleged violations of the Pharmacy Practice Act and regulations promulgated thereunder. The vast majority of the complaints alleged that the Company, through its pharmacists, improperly dispensed prescription-required veterinary medication based on prescriptions verified through the Company's discontinued alternate veterinarian program. The alternate veterinarian program used a veterinarian outside the state of Florida to verify prescriptions for certain pets outside the state of Florida. While the program was not used for pets residing in the state of Florida, the complaints had, for the most part, been filed with the Florida Board of Pharmacy. Other complaints alleged the dispensing of medication without a valid prescription, the sale of non-conforming products and that the Company's pharmacy was operating at the same location as another pharmacy, with which it had a contractual relationship. The Company contested all allegations and continued discussions in an attempt to reach a resolution of these matters. In February 2002, the Company voluntarily ceased the use of its alternate veterinarian program, and in March 2002 a business decision was made to enter into a settlement agreement with the Florida Board of Pharmacy, rather than to proceed with costly and lengthy litigation. In April 2002, the Florida Board of Pharmacy approved the settlement agreement. The Florida Board of Pharmacy did not reach any finding of fact or conclusion of law that the Company committed any wrongdoing or violated any rules or laws governing the practice of pharmacy. According to the settlement agreement, the Company's pharmacy license was placed on probation for a period of three years and the Company, the Company's pharmacists and contracted pharmacy and pharmacist, paid approximately $120,000 in fines and investigative costs, in July 2002. The Company remains licensed with the State of Florida and continues to operate its principal business in Florida. Additional complaints have been filed with other states' Pharmacy Boards. These complaints, the majority of which were filed by veterinarians who are in competition with the Company for the sale of pet prescription-required products, allege violations of the Pharmacy Practice Act and regulations promulgated thereunder. The vast majority of the complaints allege that the Company, through its pharmacists, improperly dispensed prescription-required veterinary medication based on prescriptions verified through the Company's alternate veterinarian program. The Company contested all allegations and continued discussions in an attempt to reach a resolution of these matters. In fiscal 2003, the Company reached settlement agreements with the Louisiana, Missouri, New Mexico, and Ohio State Pharmacy Boards. According to the settlement agreements, the Company was required to terminate the alternate veterinarian program in the state and the Company's permit was placed on probation. As of March 31, 2003, the Company had paid all fines in full to cover any or all administrative and investigative costs associated with these settlements. At March 31, 2003, there was no accrual relating to these settlements. There can be no assurances made that other states will not attempt to take similar actions against the Company in the future. In February 2000, the United States Environmental Protection Agency ("EPA") issued a Stop Sale, Use or Removal Order to the Company regarding the alleged distribution or sale of misbranded Advantage products in violation of the Federal Insecticide, Fungicide, and Rodenticide Act ("FIFRA"), as amended. The order provides that the company shall not distribute, sell, use or remove the products listed in the order, which are allegedly misbranded. The order further provides that the Company shall not commence any sale or distribution of those products without the prior written approval from the EPA. The Stop Sale, Use or Removal Order does not assert any claim for monetary damages; rather, it is in the nature of a cease and desist order. The Company denied any alleged violations. On February 16, 2000, the Company submitted a written response to the order. The EPA assessed a fine in the amount of $445,000. In fiscal 2001 the Company accrued $445,000 of legal settlement expense. In September 2001, the Company and the EPA entered into a Consent Agreement and Final Order ("CAFO"). The settlement agreement required the Company to pay a civil penalty of $100,000 plus interest, requiring a payment of $56,000, which was paid in September 2002, and $53,000 due on September 30, 2003, a reduction from the previously assessed fine of $445,000. For the purpose of this CAFO, the Company admitted to the jurisdictional allegations set forth, and neither admitted nor denied the alleged violations. On September 28, 2001, the CAFO was approved and ordered by the regional judicial officer. Accordingly, a gain of $345,000 was reflected in the statement of income for the year ended March 31, 2002, to reflect the adjustment to this settlement. F-15 (11) Commitments and Contingencies (Continued) On March 19, 2002, Novartis Animal Health U.S., Inc. ("Novartis") filed a complaint against the Company and two other defendants in U.S. District Court for the Southern District of Florida. Novartis purports to assert seven claims related to the Company's alleged sale of pet medications produced for a Novartis Australian sister company: Count I: Infringement of Registered Trademark Under Section 32 of the Lanham Act, 15 U.S.C. 1114; Count II: Infringement of Unregistered Trademarks Under Section 43(a) of the Lanham Act, 15 U.S.C. 1125(a); Count III: False Advertising Under Section 43(a) of the Lanham act, 15 U.S.C. 1125(a); Count IV: Misleading Advertising Under Florida Statutory Law; Count V: Deceptive and Unfair Trade Practices Under Florida Statutory Law; Count VI: Injury to Business Reputation Under Florida Statutory Law; Count VII: Common Law Unfair Competition. Subsequent to the year ended March 31, 2003, the Company reached a final settlement agreement with Novartis. According to the confidential settlement agreement dated April 7, 2003, the Company has satisfactorily resolved the contested issues raised by the complaint and the confidential settlement terms will not have a material impact on the Company's operations and financial results. The Company is a defendant in a lawsuit in Texas state district court seeking injunctive and monetary relief styled Texas State Board of Pharmacy and State Board of Veterinary Medical Examiners v. PetMed Express, Inc. Cause No.GN- 202514, in the 201st Judicial District Court, Travis County, Texas. The Company in its initial pleading denied the allegations contained therein. The Company will vigorously defend, is confident of its compliance with the applicable law, and finds wrong-on-the-facts the vast majority of the allegations contained in the Plaintiffs' supporting documentation attached to the lawsuit. Discovery has recently commenced. At this early stage of the litigation it is difficult to assess any possible outcome or estimate any potential loss in the event of an adverse outcome. On May 1, 2001, the former Chief Financial Officer ("CFO") of the Company, provided notice of termination of his Executive Employment Agreement with the Company dated March 7, 2000, as amended. In the notice, the former CFO also demanded payment of certain benefits allegedly due under the Executive Employment Agreement. The Company continued discussions in an effort to resolve this matter, and in accordance with the CFO's Executive Employment Agreement, the Company accrued a severance charge for the amount of $120,000 in fiscal 2002. On October 31, 2001, the Company entered into a Release and Termination agreement with its former CFO. The former CFO's termination date was effective as of May 31, 2001. The agreement entitles the former CFO to receive an amount of $120,000, which was paid in fiscal 2002. The former CFO had a right to exercise any stock options granted to him by the Company (the "vested options"), for a period of 30 days from the termination date. Additionally, the former CFO agreed to provide consulting services to the Company on financial matters until March 31, 2002, for which he was separately compensated. On June 13, 2001, the Company entered into a Release and Termination agreement with its former Chief Operating Officer ("COO"). The former COO's termination date was effective as of May 18, 2001. The agreement entitles the former COO to receive an amount of $75,000, which was paid in fiscal 2002. The former COO had a right to exercise any stock options granted to him by the Company (the "vested options"), for a period of 30 days from the termination date. Additionally, the former COO agreed to provide consulting services to the Company on regulatory and legal matters until December 31, 2001, for which he was separately compensated. Routine Proceedings The Company is a party to routine litigation incidental to its business. The Company's management does not believe that the resolution of any or all of such routine litigation is likely to have a material adverse effect on the Company's financial condition or results of operations. Employment Agreement On March 16, 2001, the Company entered into an employment agreement with its Chief Executive Officer ("CEO"). Under the terms of this three-year agreement the Company will pay the CEO an annual salary of $150,000 for the first six months of the agreement, and thereafter his annual salary will be increased to $200,000. The Company also granted the CEO options to purchase 750,000 shares of its common stock under the Company's 1998 Stock Option Plan at an exercise price of $.32 per share, which vest at the rate of 187,500 options on each of March 16, 2001, 2002, 2003 and 2004. F-16 (11) Commitments and Contingencies (Continued) Operating Lease The Company leases their 32,000 square foot principal executive offices and warehouse, which expires in fiscal 2007. The Company is responsible for certain maintenance costs, taxes and insurance under this lease. The future minimum annual lease payments as of March 31, 2003, are as follows: Years Ending March 31, ---------------------- 2004 $ 277,000 2005 288,000 2006 300,000 2007 50,000 ----------- Total lease payments $ 915,000 =========== Rent expense was $253,000 and $149,000 for the year ended March 31, 2003 and 2002, respectively. (12) Subsequent Events Subsequent to fiscal 2003, the Company received net proceeds of $766,000 upon the exercise and issuance of 644,166 shares of common stock, of which 600,000 shares were exercised by the Company's president. (13) Quarterly Financial Data (unaudited) Summarized unaudited quarterly financial data for fiscal 2003 and 2002 is as follows:
Quarter Ended: June 30, 2002 September 30, 2002 December 31, 2002 March 31, 2003 (a) -------------- ------------- ------------------ ----------------- -------------- Sales $ 14,830,755 $ 14,229,702 $ 11,050,124 $ 14,864,335 Income from operations $ 1,291,235 $ 307,754 $ 693,269 $ 1,190,749 Net income $ 902,329 $ 204,887 $ 434,710 $ 1,715,639 Diluted net income per share $ 0.04 $ 0.01 $ 0.02 $ 0.09
Quarter Ended: June 30, 2001 September 30, 2001 December 31, 2001 March 31, 2002 -------------- ------------- ------------------ ----------------- -------------- Sales $ 5,363,650 $ 7,762,825 $ 8,248,904 $ 10,650,552 (Loss) income from operations $ (880,765) $ 56,246 $ 368,433 $ 1,204,026 Net (loss) income $ (1,090,684) $ 393,378 $ 353,348 $ 1,169,371 Diluted net (loss) income per share $ (0.07) $ 0.02 $ 0.02 $ 0.07
(a) The Company recorded a deferred tax asset of approximately $581,000, during the quarter ended March 31, 2003, resulting in an increase of diluted net income of $.03 per share. F-17 PETMED EXPRESS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, March 31, 2003 2003 ----------- ------------ (Unaudited) ASSETS ------ Current assets: Cash and cash equivalents $ 1,492,504 $ 984,169 Accounts receivable, less allowance for doubtful accounts of $26,071 and $16,644, respectively 1,297,609 651,883 Inventories 6,885,161 4,268,146 Prepaid expenses and other current assets 458,395 478,108 ----------- ------------ Total current assets 10,133,669 6,382,306 Property and equipment, net 1,579,530 1,496,979 Deferred income taxes 581,356 581,356 Intangible asset 365,000 365,000 Other assets 171,822 200,155 ----------- ------------ Total assets $12,831,377 $ 9,025,796 =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable $ 3,503,423 $ 2,570,459 Accrued expenses and other current liabilities 997,105 725,764 Current portion of loan obligation 68,442 68,442 ----------- ------------ Total current liabilities 4,568,970 3,364,665 Loan obligation, less current portion 51,332 68,443 ----------- ------------ Total liabilities 4,620,302 3,433,108 ----------- ------------ Commitments and contingencies Shareholders' equity: Preferred stock, $.001 par value, 5,000,000 shares authorized; 2,500 convertible shares issued and outstanding with a liquidation preference of $4 per share 8,898 8,898 Common stock, $.001 par value, 40,000,000 shares authorized; 19,140,877 and 18,460,878 shares issued and outstanding, respectively 19,141 18,461 Additional paid-in capital 8,464,330 7,279,207 Accumulated deficit (281,294) (1,713,878) ----------- ------------ Total shareholders' equity 8,211,075 5,592,688 ----------- ------------ Total liabilities and shareholders' equity $12,831,377 $ 9,025,796 =========== ============
See accompanying notes to condensed consolidated financial statements. F-18 PETMED EXPRESS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended June 30, 2003 2002 ------------ ------------- Sales $ 30,387,563 $ 14,830,755 Cost of sales 18,582,680 8,568,253 ------------ ------------- Gross profit 11,804,883 6,262,502 ------------ ------------- Operating expenses: General and administrative 3,021,254 2,083,423 Advertising 6,508,990 2,807,180 Depreciation and amortization 127,351 80,664 ------------ ------------- Total operating expenses 9,657,595 4,971,267 ------------ ------------- Income from operations 2,147,288 1,291,235 ------------ ------------- Other income (expense): Interest expense (2,681) (5,590) Interest income 2,149 4,133 Other, net 608 2,335 ------------ ------------- Total other income (expense) 76 878 ------------ ------------- Income before provision for income taxes 2,147,364 1,292,113 Provision for income taxes 714,780 389,784 ------------ ------------- Net income $ 1,432,584 $ 902,329 ============ ============= Net income per common share: Basic $ 0.08 $ 0.05 ============ ============= Diluted $ 0.06 $ 0.04 ============ ============= Weighted average number of common shares outstanding: Basic 19,010,438 16,590,779 ============ ============= Diluted 23,012,611 20,092,544 ============ =============
See accompanying notes to condensed consolidated financial statements. F-19 PETMED EXPRESS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended June 30, 2003 2002 ------------ ------------- Cash flows from operating activities: Net income $ 1,432,584 $ 902,329 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 127,351 80,664 Tax benefit related to stock options exercised 387,600 - Bad debt expense 9,588 1,728 (Increase) decrease in operating assets and liabilities: Accounts receivable (655,314) (50,850) Inventory (2,617,015) (1,992,435) Prepaid expenses and other current assets 19,713 (10,441) Other assets 28,333 - Accounts payable 932,964 448,248 Accrued expenses and other current liabilities 271,341 283,047 ------------ ------------- Net cash used in operating activities (62,855) (337,710) ------------ ------------- Cash flows from investing activities: Purchases of property and equipment (209,902) (312,461) ------------ ------------- Net cash used in investing activities (209,902) (312,461) ------------ ------------- Cash flows from financing activities: Proceeds from the exercise of stock options 798,203 159,000 Payments on loan obligation (17,111) (17,110) ------------ ------------- Net cash provided by financing activities 781,092 141,890 ------------ ------------- Net increase (decrease) in cash and cash equivalents 508,335 (508,281) Cash and cash equivalents, at beginning of period 984,169 737,284 ------------ ------------- Cash and cash equivalents, at end of period $ 1,492,504 $ 229,003 ============ ============= Supplemental disclosure of cash flow information: Cash paid for interest $ 2,404 $ 5,634 ============ ============= Cash paid for income taxes $ 32,500 $ - ============ =============
See accompanying notes to condensed consolidated financial statements. F-20 PETMED EXPRESS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1: Summary of Significant Accounting Policies Organization PetMed Express, Inc. and subsidiaries is a leading nationwide pet pharmacy. The Company markets prescription and non- prescription pet medications along with health and nutritional supplements for cats and dogs direct to the consumer. The Company offers consumers an attractive alternative for obtaining pet medications in terms of convenience, price, and speed of delivery. The Company markets its products through national television, on-line and direct mail advertising campaigns, which aim to increase the recognition of the "1-800-PetMeds" brand name, increase traffic on its web site at www.1800PetMeds.com , acquire new customers, and maximize repeat purchases. The Company's executive offices are located in Pompano Beach, Florida. The Company's fiscal year end is March 31, and references herein to fiscal 2004 or 2003 refer to the Company's fiscal years ending March 31, 2004 and 2003, respectively. Basis of Presentation and Consolidation The Company is no longer eligible as a small business filer, as of April 1, 2003 the Company holds the status of a regular Securities Exchange Act filer. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary to present fairly the financial position of the Company, after elimination of intercompany accounts and transactions, at June 30, 2003 and the statements of income for the three months ended June 30, 2003 and 2002 and cash flows for the three months ended June 30, 2003 and 2002. The results of operations for the three months ended June 30, 2003, are not necessarily indicative of the operating results expected for the fiscal year ending March 31, 2004. These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's annual report on Form 10-KSB for the fiscal year ended March 31, 2003. The condensed consolidated financial statements include the accounts of PetMed Express, Inc. and its wholly owned subsidiaries. All significant intercompany transaction has been eliminated upon consolidation. Use of Estimates The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Note 2: Net Income Per Share In accordance with the provisions of SFAS No. 128, "Earnings Per Share," basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income per share includes the dilutive effect of potential stock options exercises, calculated using the treasury stock method. Outstanding stock options, warrants, and convertible preferred shares issued by the Company represent the only dilutive effect reflected in diluted weighted average shares outstanding. F-21 The following is a reconciliation of the numerators and denominators of the basic and diluted net income per share computations for the periods presented:
Three Months Ended June 30, 2003 2002 ------------ ------------ Net income (numerator): Net income $ 1,432,584 $ 902,329 Shares (denominator) Weighted average number of common shares outstanding used in basic computation 19,010,438 16,590,779 Common shares issuable upon exercise of stock options and warrants 3,992,048 3,491,640 Common shares issuable upon conversion of preferred shares 10,125 10,125 ------------ ------------ Shares used in diluted computation 23,012,611 20,092,544 ============ ============ Net income per common share: Basic $ 0.08 $ 0.05 ============ ============ Diluted $ 0.06 $ 0.04 ============ ============
For the periods ended June 30, 2003 and 2002, 24,600 and 1,224,600 shares of common stock options and warrants, with a weighted average exercise price of $4.12 and $1.60, respectively, were excluded from the diluted net income per share computation as their exercise prices were greater than the average market price of the common shares for the period. Note 3: Accounting for Stock-Based Compensation The Company accounts for employee stock options using the intrinsic value method as prescribed by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees. The Company follows the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for employee stock options. Had the Company determined employee compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income would have been decreased to the pro forma amounts indicated below:
Three Months Ended June 30, 2003 2002 ------------ ------------ Reported net income: $ 1,432,584 $ 902,329 Deduct: total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects 44,859 91,290 ------------ ------------ Proforma net income: $ 1,387,725 $ 811,039 ============ ============ Reported basic net income per share: $ 0.08 $ 0.05 ============ ============ Proforma basic net income per share: $ 0.07 $ 0.05 ============ ============ Reported diluted net income per share: $ 0.06 $ 0.04 ============ ============ Proforma diluted net income per share: $ 0.06 $ 0.04 ============ ============
Note 4: Line of Credit The Company maintains a $2,000,000 line of credit, effective through July 22, 2004. The interest rate is at the published thirty day London Interbank Offered Rates ("LIBOR") plus 2.65% (3.75% at June 30, 2003), and contains various financial and operating covenants. At June 30, 2003, there was no outstanding balance under the line of credit agreement. F-22 Note 5: Commitments and Contingencies Various complaints had been filed with the Florida Board of Pharmacy. These complaints, the majority of which were filed by veterinarians who are in competition with the Company for the sale of pet prescription-required products, alleged violations of the Pharmacy Practice Act and regulations promulgated there under. The vast majority of the complaints alleged that the Company, through its pharmacists, improperly dispensed prescription-required veterinary medication based on prescriptions verified through the Company's discontinued alternate veterinarian program. The alternate veterinarian program used a veterinarian outside the state of Florida to verify prescriptions for certain pets outside the state of Florida. While the program was not used for pets residing in the state of Florida, the complaints had, for the most part, been filed with the Florida Board of Pharmacy. Other complaints alleged the dispensing of medication without a valid prescription, the sale of non-conforming products and that the Company's pharmacy was operating at the same location as another pharmacy, with which it had a contractual relationship. The Company contested all allegations and continued discussions in an attempt to reach a resolution of these matters. In February 2002, the Company voluntarily ceased the use of its alternate veterinarian program, and in March 2002 a business decision was made to enter into a settlement agreement with the Florida Board of Pharmacy, rather than to proceed with costly and lengthy litigation. In April 2002, the Florida Board of Pharmacy approved the settlement agreement. The Florida Board of Pharmacy did not reach any finding of fact or conclusion of law that the Company committed any wrongdoing or violated any rules or laws governing the practice of pharmacy. According to the settlement agreement, the Company's pharmacy license was placed on probation for a period of three years and the Company, the Company's pharmacists and contracted pharmacy and pharmacist, paid approximately $120,000 in fines and investigative costs, in July 2002. The Company remains licensed with the State of Florida and continues to operate its principal business in Florida. Additional complaints have been filed with other states' Pharmacy Boards. These complaints, the majority of which were filed by veterinarians who are in competition with the Company for the sale of pet prescription-required products, allege violations of the Pharmacy Practice Act and regulations promulgated there under. The vast majority of the complaints allege that the Company, through its pharmacists, improperly dispensed prescription-required veterinary medication based on prescriptions verified through the Company's alternate veterinarian program. The Company contested all allegations and continued discussions in an attempt to reach a resolution of these matters. In fiscal 2003, the Company reached settlement agreements with the Louisiana, Missouri, New Mexico, and Ohio State Pharmacy Boards. According to the settlement agreements, the Company was required to terminate the alternate veterinarian program in the state and the Company's permit was placed on probation. As of March 31, 2003, the Company had paid all fines in full to cover any or all administrative and investigative costs associated with these settlements. There can be no assurances made that other states will not attempt to take similar actions against the Company in the future. In February 2000, the United States Environmental Protection Agency ("EPA") issued a Stop Sale, Use or Removal Order to the Company regarding the alleged distribution or sale of misbranded Advantage products in violation of the Federal Insecticide, Fungicide, and Rodenticide Act ("FIFRA"), as amended. The order provides that the company shall not distribute, sell, use or remove the products listed in the order, which are allegedly misbranded. The order further provides that the Company shall not commence any sale or distribution of those products without the prior written approval from the EPA. The Stop Sale, Use or Removal Order does not assert any claim for monetary damages; rather, it is in the nature of a cease and desist order. The Company denied any alleged violations. On February 16, 2000, the Company submitted a written response to the order. The EPA assessed a fine in the amount of $445,000. In fiscal 2001 the Company accrued $445,000 of legal settlement expense. In September 2001, the Company and the EPA entered into a Consent Agreement and Final Order ("CAFO"). The settlement agreement required the Company to pay a civil penalty of $100,000 plus interest, requiring a payment of $56,000, which was paid in September 2002, and $53,000 due on September 30, 2003, a reduction from the previously assessed fine of $445,000. For the purpose of this CAFO, the Company admitted to the jurisdictional allegations set forth, and neither admitted nor denied the alleged violations. On September 28, 2001, the CAFO was approved and ordered by the regional judicial officer. Accordingly, a gain of $345,000 was reflected in the statement of income for the year ended March 31, 2002, to reflect the adjustment to this settlement. F-23 On March 19, 2002, Novartis Animal Health U.S., Inc. ("Novartis") filed a complaint against the Company and two other defendants in U.S. District Court for the Southern District of Florida. Novartis purports to assert seven claims related to the Company's alleged sale of pet medications produced for a Novartis Australian sister company: Count I: Infringement of Registered Trademark Under Section 32 of the Lanham Act, 15 U.S.C. 1114; Count II: Infringement of Unregistered Trademarks Under Section 43(a) of the Lanham Act, 15 U.S.C. 1125(a); Count III: False Advertising Under Section 43(a) of the Lanham act, 15 U.S.C. 1125(a); Count IV: Misleading Advertising Under Florida Statutory Law; Count V: Deceptive and Unfair Trade Practices Under Florida Statutory Law; Count VI: Injury to Business Reputation Under Florida Statutory Law; Count VII: Common Law Unfair Competition. Subsequent to the year ended March 31, 2003, the Company reached a final settlement agreement with Novartis. According to the confidential settlement agreement dated April 7, 2003, the Company had satisfactorily resolved the contested issues raised by the complaint and the confidential settlement terms had no material impact on the Company's operations and financial results. The Company is a defendant in a lawsuit in Texas state district court seeking injunctive and monetary relief styled Texas State Board of Pharmacy and State Board of Veterinary Medical Examiners v. PetMed Express, Inc. Cause No.GN-202514, in the 201st Judicial District Court, Travis County, Texas. The Company in its initial pleading denied the allegations contained therein. The Company will vigorously defend, is confident of its compliance with the applicable law, and finds wrong-on-the-facts the vast majority of the allegations contained in the Plaintiffs' supporting documentation attached to the lawsuit. Discovery has recently commenced. At this early stage of the litigation it is difficult to assess any possible outcome or estimate any potential loss in the event of an adverse outcome. Routine Proceedings The Company is a party to routine litigation incidental to its business. The Company's management does not believe that the resolution of any or all of such routine litigation is likely to have a material adverse effect on the Company's financial condition or results of operations. F-24 No dealer, sales representative or any other person has been authorized to give any information or to make any representations other than those contained in this prospectus and, if given or made, such information or representation must not be relied upon as having been authorized by the company or any of the underwriters. This prospectus does not constitute an offer of any securities other than those to which it relates or an offer to sell, or a solicitation of any offer to buy, to any person in any jurisdiction where such an offer or solicitation would be unlawful. Neither the delivery of this prospectus nor any sale made hereunder shall, under any circumstances, create an implication that the information set forth herein is correct as of any time subsequent to the date hereof. TABLE OF CONTENTS Page ---- 12,590,985 SHARES Prospectus Summary......... Risk Factors............... PETMED EXPRESS, INC. Forward-Looking Statements............... Capitalization............. PROSPECTUS Use of Proceeds............ ---------- Price Range of Common Stock and Dividend............. Policy..................... Selected Financial Data..................... Management's Discussion and Analysis or Plan of Operation............. Business................... Management................. Executive Compensation..... Certain Transactions....... Principal Shareholders..... Description of Securities............... Selling Shareholders....... Plan of Distribution....... Legal Matters.............. Experts.................... Additional Information..... Financial Statements ...... PART TWO INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The estimated expenses payable by us in connection with the distribution of the securities being registered are as follows: SEC Registration and Filing Fee........... $ 2,670 Legal Fees and Expenses*.................. 10,000 Accounting Fees and Expenses*............. 10,000 Financial Printing*....................... 2,000 Transfer Agent Fees*...................... 500 Blue Sky Fees and Expenses*............... -0- Miscellaneous*............................ 1,000 -------- TOTAL $ 26,170 ======== * Estimated None of the foregoing expenses are being paid by the selling shareholders. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Florida Business Corporation Act (the "Corporation Act") permits the indemnification of directors, employees, officers and agents of Florida corporations. Our Articles of Incorporation (the "Articles") and Bylaws provide that we shall indemnify our directors and officers to the fullest extent permitted by the Corporation Act. The provisions of the Corporation Act that authorize indemnification do not eliminate the duty of care of a director, and in appropriate circumstances equitable remedies such as injunctive or other forms of non-monetary relief will remain available under Florida law. In addition, each director will continue to be subject to liability for (a) violations of criminal laws, unless the director had reasonable cause to believe his conduct was lawful or had no reasonable cause to believe his conduct was unlawful, (b) deriving an improper personal benefit from a transaction, (c) voting for or assenting to an unlawful distribution and (d) willful misconduct or conscious disregard for our best interests in a proceeding by or in the right of a shareholder. The statute does not affect a director's responsibilities under any other law, such as the Federal securities laws. The effect of the foregoing is to require us to indemnify our officers and directors for any claim arising against such persons in their official capacities if such person acted in good faith and in a manner that he reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling PetMed pursuant to the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission, indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against these liabilities, other than the payment by PetMed in the successful defense of any action, suit or proceeding, is asserted, we will, unless in the opinion of our counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether indemnification by us against public policy. We will be governed by the final adjudication of this issue. II-1 ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES In May 2003, we issued 12,500 shares of our common stock to one individual upon the exercise of options at an exercise price of $.20 per share. The share issuance was exempt under Section 4(2) of the Securities Act. The option holder had access to information about us and the shares issued contain the appropriate restrictive legend restricting their transferability absent registration or an available exemption. In July 2002, we issued 12,500 shares of our common stock to two individuals upon the exercise of options at an exercise price of $.20 per share. The share issuance was exempt under Section 4(2) of the Securities Act. The option holders had access to information about us and the shares issued contain the appropriate restrictive legend restricting their transferability absent registration or an available exemption. In June 2002 we issued 10,500 shares of our common stock to a former employee. These shares were issued upon the exercise of options held by the former employee at $1.25 per share. The share issuance was exempt under Section 4(2) of the Securities Act. The option holder had access to information about us and the shares issued contain the appropriate restrictive legend restricting their transferability absent registration or an available exemption. In April 2002, upon the exercise of outstanding options, we issued 600,000 shares of common stock to two option holders in consideration of $159,000. Options to purchase 300,000 shares of common stock were exercised by our president. The remaining options were exercised by a consulting firm. The share issuances were exempt from registration by Section 4(2) of the Securities Act. The security holders had access to information about us and had the opportunity to ask questions about us. The shares issued contain a legend restricting their transferability absent registration or an available exemption. On November 22, 2000, we issued Tricon Holdings, LLC, a Florida limited liability corporation, 10,000,000 shares of common stock and warrants to purchase 3,000,000 shares of common stock. The warrants are exercisable at $.33 per share and expire on November 22, 2005. The shares of common stock and warrants were issued to Tricon Holdings in exchange for $2,000,000. The security issuances were exempt from registration by Section 4(2) of the Securities Act and Regulation D promulgated thereunder. The security holder had access to information about us and had the opportunity to ask questions about us. The securities issued contain a legend restricting their transferability absent registration or an available exemption. In March 2000, we gave $50,000 and granted warrants to purchase 20,000 shares of our common stock to Nico Pronk and Wayne Horne, principals of Noble Financial Group, in exchange for the termination of a consulting agreement between us and Noble Financial Group, an investment banking firm. The warrants are exercisable at $3.125 per share and expired on March 7, 2003. The warrant issuance was exempt from registration by Section 4(2) of the Securities Act. The security holder had access to information about us and had the opportunity to ask questions about us. The warrant issued contains a legend restricting its transferability absent registration or an available exemption. In November 1999, we granted warrants to purchase 75,000 shares of our common stock to JW Genesis Capital Markets, an investment advisory firm in exchange for investment banking related services. The warrants are exercisable at $1.48 per share at any time prior to November 12, 2004. The warrant issuance was exempt from registration by Section 4(2) of the Securities Act. The security holder had access to information about us and had the opportunity to ask questions about us. The warrant issued contains a legend restricting its transferability absent registration or an available exemption. II-2 In November 1999, we issued warrants to purchase 75,000 shares of our common stock a former shareholder, pursuant to a settlement of litigation. The warrants are exercisable at $3.50 per share at any time prior to November 1, 2002. The warrant issuance was exempt from registration by Section 4(2) of the Securities Act. The security holder had access to information about us and had the opportunity to ask questions about us. The warrant issued contains a legend restricting its transferability absent registration or an available exemption. We established the 1998 Stock Option Plan effective July 31, 1998, which provides for the issuance of qualified options to officers, directors and key employees, and nonqualified options to consultants and other service providers. Through August 12, 2003, we had issued and outstanding options to purchase approximately 2,075,103 shares of common stock under the Plan with exercise prices ranging from $.32 to $8.00 and various expiration dates. The options were issued to approximately 30 officers, directors, key employees, consultants and other service providers. The security issuances were exempt from registration by Section 4(2) of the Securities Act. The option holders had access to information about us and had the opportunity to ask questions about us. The options issued contain a legend restricting their transferability absent registration or an available exemption. With respect to each of the foregoing transactions, each * had access to business and financial information concerning us, * was afforded the opportunity to ask questions of our management concerning our operations and the terms of the offering, * represented that he, she or it was acquiring the securities for investment purposes only and not with a view towards distribution or resale except in compliance with applicable securities laws and * had such knowledge and experience in business and financial matters that he, she or it was able to evaluate the risks and merits of an investment. In addition, the certificates evidencing the securities that were issued contained a legend restricting their transferability absent registration under the Securities Act or the availability of an applicable exemption therefrom. Each of the transactions was exempt from the registration requirements of the Securities Act by reason of Sections 4(2) and/or 4(6) thereof and/or the rules and regulations thereunder, including Rule 506 of Regulation D. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Exhibits. Exhibit Number Description ------- ----------- (3) Articles of Incorporation and Bylaws. 3.1 Amended and Restated Articles of Incorporation (incorporated by reference to the Registration Statement on Form 10-SB, as amended, File No. 000-28827). 3.2 Bylaws of the Corporation (incorporated by reference to the Registration Statement on Form 10-SB, as amended, File No. 000-28827). II-3 (4) Instruments Defining the Rights of Security Holders. 4.1 Form of Warrant issued to Noble International Investments, Inc. (incorporated by reference to the Registration Statement on Form 10-SB, as amended, File No. 000-28827). 4.2 Specimen common stock certificate (incorporated by reference to the Registration Statement on Form 10-SB, as amended, File No. 000-28827). 4.3 Form of Non-Plan Option (incorporated by reference to the Registration Statement on Form SB-2, as amended, File No. 333-97565). 4.4 Form of Warrant (incorporated by reference to the Registration Statement on Form SB-2, as amended, File No. 333-97565). 4.5 Tricon Holdings, LLC Warrant (incorporated by reference to the Registration Statement on Form SB-2, as amended, File No. 333-97565). (5) Opinion of Counsel 5.1 Form of Opinion of Katz, Barron, Squitero, Faust & Boyd, P.A.* (10) Material Contracts 10.1 Second Amended and Restated Employment Agreement with Marc A. Puleo (incorporated by reference to Exhibit 10.1 of the Registrant's Annual Report on Form 10-KSB for the fiscal year ended March 31, 2000, Commission File No. 000-28827). 10.2 1998 Stock Option Plan (incorporated by reference to the Registration Statement on Form 10-SB, File No. 000- 28827). 10.3 Line of Credit Agreement with SouthTrust Bank, N.A. (incorporated by reference to the Registration Statement on Form 10-SB, File No. 000-28827). 10.4 Employment Agreement with Menderes Akdag (incorporated by reference to Exhibit 10 of the Registrant's Form 8-K on March 16, 2001, Commission File No. 000-28827). 10.5 Agreement for the Sale and Leaseback of the Land and Building. (incorporated by reference to Exhibit 99.1 of the Registrant's Form 8-K on June 14, 2001, Commission File No. 000-28827). 10.6 Line of Credit Renewal Agreement with SouthTrust Bank, N.A. (incorporated by reference to Exhibit 10.6 of the Registrant's Annual Report on Form 10-KSB for the fiscal year ended March 31, 2002, Commission File No. 000- 28827). 10.7 Loan Agreement with SouthTrust Bank, N.A. (incorporated by reference to Exhibit 10.7 of the Registrant's Annual Report on Form 10-KSB for the fiscal year ended March 31, 2002, Commission File No. 000-28827). 10.8 Second Line of Credit ($1,000,000) Agreement with SouthTrust Bank, N.A. (incorporated by reference to Exhibit 99.3 of the Registrant's Quarterly Report on Form 10- QSB for the three months ended June 30, 2002, Commission File No. 000-28827). 10.9 Third Line of Credit ($2,000,000) Agreement with SouthTrust Bank, N.A. (incorporated by reference to Exhibit 10.9 of the Registrant's Annual Report on Form 10-KSB for the fiscal year ended March 31, 2003, Commission File No. 000-28827). (16) Letter regarding Change in Certifying Accountant. 16.1 Letter from Lopez, Levi, & Associates LLC, regarding change in certifying accountants. (incorporated by reference to Exhibit 16 of the Registrant's Form 8-K on April 24, 2001, Commission File No. 000-28827). (21) Subsidiaries of Registrant. 21.1 Subsidiaries of Registrant (incorporated by reference to the Registration Statement on Form SB-2, as amended, File No. 333-97565). II-4 (23) Consents. 23.1 Consent of Counsel (see Exhibit 5). 23.2 Consent of Independent Certified Public Accountants.* * Filed herewith ITEM 17. UNDERTAKINGS The undersigned Registrant also undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; Provided, however, that paragraphs (a)(1)(i) and (a)(1)(ii) do not apply if the registration statement is on Form S-3 or Form S- 8, and the information required to be included in a post- effective amendment by those paragraphs is contained in periodic reports filed by the registrant pursuant to section 13 or section 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. Insofar 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 (the "Commission") such indemnification is against public policy as expressed in the Securities Act 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 preceding) 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 Securities Act and will be governed by the final adjudication of such issue. II-5 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this Post-Effective Amendment No. 1 to Form SB-2 on Form S-1 registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Pompano Beach, State of Florida on August 19, 2003. PETMED EXPRESS, INC. By: /s/ Menderes Akdag --------------------------- Menderes Akdag Chief Executive Officer and Principal Executive Officer Pursuant to the requirements of the Securities Act of 1933, as amended, this Post-Effective Amendment No. 1 to Form SB-2 on Form S-1 registration statement has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE ----------------------------------------------------------------------------------------- /s/ Menderes Akdag Chief Executive Officer August 19, 2003 ------------------------ (Principal Executive Officer) Menderes Akdag and Director /s/ Marc Puleo, M.D. Chairman of the Board, August 19, 2003 ------------------------ President and Director Marc Puleo, M.D. /s/ Bruce S. Rosenbloom Chief Financial Officer and ------------------------ Treasurer (Principal Financial August 19, 2003 Bruce S. Rosenbloom and Accounting Officer) /s/ Robert C. Schweitzer Director August 19, 2003 ------------------------ Robert C. Schweitzer /s/ Ronald Korn Director August 19, 2003 ------------------------ Ronald Korn /s/ Gian Fulgoni Director August 19, 2003 ------------------------ Gian Fulgoni ------------------------ Director Frank J. Formica
II-6 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/PRAA_pra-group_legal_matters.txt b/parsed_sections/legal_matters/2003/PRAA_pra-group_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..bd52188ba83ea2d990605e9e88299cce6ba79975 --- /dev/null +++ b/parsed_sections/legal_matters/2003/PRAA_pra-group_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby has been passed upon for us by Swidler Berlin Shereff Friedman, LLP, New York, New York. Certain legal matters in connection with this offering will be passed upon for the underwriters by Sidley Austin Brown Wood, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/SNX_td-synnex_legal_matters.txt b/parsed_sections/legal_matters/2003/SNX_td-synnex_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d13d175f816da7d1ac3beab32614cdfde64ce6ea --- /dev/null +++ b/parsed_sections/legal_matters/2003/SNX_td-synnex_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Selected legal matters with respect to the validity of the common stock offered by this prospectus will be passed upon for us by Pillsbury Winthrop LLP, Palo Alto, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/STX_seagate_legal_matters.txt b/parsed_sections/legal_matters/2003/STX_seagate_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7e2e85d5cbbd37c6649975ad6d6c28ad3749c82d --- /dev/null +++ b/parsed_sections/legal_matters/2003/STX_seagate_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common shares to be sold in this offering will be passed upon by Maples and Calder, Cayman Islands. Some legal matters as to U.S. law in connection with this offering will be passed upon for us by Simpson Thacher & Bartlett LLP, Palo Alto, California. Investment vehicles comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related persons and others own an interest representing less than 1% of the capital commitments of one of our sponsors, Silver Lake Partners. The underwriters have been represented by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. Investment partnerships comprised of members of and persons associated with Wilson Sonsini Goodrich & Rosati own an interest representing less than 1% of the capital commitments of Silver Lake Partners. In addition, Wilson Sonsini Goodrich & Rosati from time to time represents Seagate Technology, and formerly represented Seagate Delaware, in legal matters unrelated to this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/TZOO_travelzoo_legal_matters.txt b/parsed_sections/legal_matters/2003/TZOO_travelzoo_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3405ed1ba6c02cdd3ab8c111f37ac46b3940591 --- /dev/null +++ b/parsed_sections/legal_matters/2003/TZOO_travelzoo_legal_matters.txt @@ -0,0 +1,11 @@ +LEGAL MATTERS + + Bryan +Cave LLP, St. Louis, Missouri, as our counsel, has issued an opinion as to the +legality of the common stock. Milbank, Tweed, Hadley & McCloy LLP, Los Angeles, California, will pass upon certain legal matters for the +underwriter in connection with this offering. + +EXPERTS + + The consolidated +balance sheets of \ No newline at end of file diff --git a/parsed_sections/legal_matters/2003/XELLL_xcel_legal_matters.txt b/parsed_sections/legal_matters/2003/XELLL_xcel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..de672f97b3ab25ab86c31682e6d28edc1d6f77e0 --- /dev/null +++ b/parsed_sections/legal_matters/2003/XELLL_xcel_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters 153 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/AGO_assured_legal_matters.txt b/parsed_sections/legal_matters/2004/AGO_assured_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..42916c5e02a6d467ce51f0b7234e1cb10fac8b8a --- /dev/null +++ b/parsed_sections/legal_matters/2004/AGO_assured_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters as to U.S. law in connection with this offering will be passed upon for the issuer and the guarantor by Mayer, Brown, Rowe & Maw LLP, Chicago, Illinois. Certain legal matters under Bermuda law will be passed upon for the guarantor by Conyers Dill & Pearman, Hamilton, Bermuda. Certain legal matters in connection with this offering will be passed upon for the underwriters by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. LeBoeuf, Lamb, Greene & MacRae, L.L.P. has in the past performed, and continues to perform, services for us. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/ALNY_alnylam_legal_matters.txt b/parsed_sections/legal_matters/2004/ALNY_alnylam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a23bd1408bad9fb0be10ca4faa23552bb09a57b7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/ALNY_alnylam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock we are offering will be passed upon for us by Hale and Dorr LLP, Boston, Massachusetts. Legal matters in connection with this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/ANGO_angiodynam_legal_matters.txt b/parsed_sections/legal_matters/2004/ANGO_angiodynam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..bf2221cb063ad96fe85c4a1cdb2762d369f44ae9 --- /dev/null +++ b/parsed_sections/legal_matters/2004/ANGO_angiodynam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Davies Ward Phillips & Vineberg LLP will pass upon the validity of the common stock offered by this prospectus for us. Dorsey & Whitney LLP will pass upon certain legal matters in connection with this offering for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/AXS-PE_axis_legal_matters.txt b/parsed_sections/legal_matters/2004/AXS-PE_axis_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a9d9f42cccb9b9a27b7d0862776147ab874972e7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/AXS-PE_axis_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York is representing us in connection with this offering. Debevoise & Plimpton LLP will act as counsel to the selling shareholders. Certain legal matters in connection with this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. LeBoeuf, Lamb, Greene & MacRae, L.L.P. has acted as special counsel to us in connection with United States tax and regulatory matters. The validity of the issuance of common shares under Bermuda law will be passed upon for us by Conyers Dill & Pearman, Hamilton, Bermuda. Clyde & Co., special United Kingdom counsel, has advised us on all matters of United Kingdom law in connection with this offering. William Fry, special Irish counsel, has advised us on all matters of Ireland law in connection with this offering. B r & Karrer, special Switzerland counsel, has advised us on all matters of Switzerland law in connection with this offering. David King & Co., special Barbados legal counsel, has advised us on all matters of Barbados law in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/BGS_b-g-foods_legal_matters.txt b/parsed_sections/legal_matters/2004/BGS_b-g-foods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/BGS_b-g-foods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CAMT_camtek-ltd_legal_matters.txt b/parsed_sections/legal_matters/2004/CAMT_camtek-ltd_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8435c6b1ad51bce44023c02cf54a051a4f607d7c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CAMT_camtek-ltd_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the ordinary shares being offered hereby and legal matters under Israeli law in connection with the offering will be passed upon for us by Shiboleth, Yisraeli, Roberts, Zisman & Co., Tel Aviv, Israel, our Israeli counsel, and for the underwriters by Meitar Liquornik Geva & Leshem Brandwein, Ramat Gan, Israel. In addition, matters with respect to United States law will be passed upon for us by Kramer, Levin, Naftalis & Frankel LLP, New York, New York, and for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CBRE_cbre_legal_matters.txt b/parsed_sections/legal_matters/2004/CBRE_cbre_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..716ddfd3a271be3723104c6d3e9fd34631d2b283 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CBRE_cbre_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock being offered by the selling stockholders in the offering will be passed upon for us by Simpson Thacher & Bartlett LLP, Palo Alto, California. Selected legal matters in connection with the offering will be passed upon for the underwriters by Cravath, Swaine & Moore LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000003116_akorn-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000003116_akorn-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c2e75cf274a59f3135c79a10d54b0cce8fafbb56 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000003116_akorn-inc_legal_matters.txt @@ -0,0 +1,76 @@ +LEGAL MATTERS + + +The validity of the shares of common stock being +offered hereby will be passed upon for us by Jones, Walker, +Waechter, Poitevent, Carr re Den gre, +L.L.P., New Orleans, Louisiana. + +77 + + + +EXPERTS + + +Our financial statements as of and for the year +ended December 31, 2003, included in this prospectus and in +the registration statement have been audited by BDO Seidman, +LLP, independent registered public accountants, and are included +in reliance upon such report given upon the authority of said +firm as experts in auditing and accounting. Such report contains +an explanatory paragraph regarding our ability to continue as a +going concern. + + +The financial statements as of December 31, +2002 and for the years ended December 31, 2002 and 2001 +included in this prospectus and registration statement have been +audited by Deloitte Touche LLP, an independent +registered public accounting firm, as stated in their report +appearing elsewhere in this registration statement (which report +expresses an unqualified opinion and includes an explanatory +paragraph relating to our ability to continue as a going +concern), and is included in reliance upon such report given +upon their authority as experts in accounting and auditing. + +WHERE YOU CAN FIND MORE INFORMATION + + +We have filed a registration statement on +Form S-1 under the Securities Act, relating to the shares +of common stock being offered by this prospectus, and reference +is made to such registration statement. This prospectus +constitutes the prospectus of Akorn, Inc., filed as part of the +registration statement, and it does not contain all information +in the registration statement, as certain portions have been +omitted in accordance with the rules and regulations of the SEC. + + +We are subject to the informational requirements +of the Exchange Act, which requires us to file reports, proxy +statements and other information with the SEC. Such reports, +proxy statements and other information may be inspected at +public reference room of the SEC at Judiciary Plaza, +450 Fifth Street N.W., Washington D.C. 20549. Copies of +such material can be obtained from the facility at prescribed +rates. Please call the SEC toll free at 1-800-SEC-0330 for +information about its public reference room. Because we file +documents electronically with the SEC, you may also obtain this +information by visiting the SEC s website at +http://www.sec.gov or our website at http://www.akorn.com. +Information contained in our web site is not part of this +prospectus. + + +Our statements in this prospectus about the +contents of any contract or other document are not necessarily +complete. You should refer to the copy of our contract or other +document we have filed as an exhibit to the registration +statement for complete information. + + +You should rely only on the information +incorporated by reference or provided in this prospectus. We +have not authorized anyone else to provide you with different +information. The \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000012707_blount-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000012707_blount-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000012707_blount-inc_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000017927_carrols_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000017927_carrols_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000017927_carrols_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000032878_energy_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000032878_energy_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b9afca15411125e1645faf4a466181ee3606df98 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000032878_energy_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby has been passed upon by Roger John Lesinski, Esq., the General Counsel of ECD. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000091693_coinmach_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000091693_coinmach_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6f2dc3f944b567a0b05577a2b9de5a4dda8274d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000091693_coinmach_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs, the Class A common stock, the notes and the guarantees offered hereby will be passed upon for us by Mayer, Brown, Rowe Maw LLP, New York, New York. Certain legal matters relating to the offerings will be passed upon for the underwriters by Cahill Gordon Reindel LLP, New York, New York. Two members of Mayer, Brown, Rowe Maw LLP own approximately 1,035,000 common units of Holdings as of September 30, 2004. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000216543_bny_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000216543_bny_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..037908e364633cd001acbf59806b4d261c6d0c87 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000216543_bny_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters relating to the issuance of the notes will be passed upon for the issuer, the transferor and trust I by Carl Krasik, Esq., Associate General Counsel to Mellon Financial Corporation, Reed Smith LLP, Pittsburgh, Pennsylvania and McKee Nelson LLP, New York, New York. The federal income tax matters described under U.S. Federal Income Tax Consequences will be passed upon for the issuer, the transferor and trust I by McKee Nelson LLP, New York, New York. McKee Nelson LLP, New York, New York will act as counsel for the underwriters. Certain ERISA matters will be passed upon for the issuer by McKee Nelson LLP, New York, New York. Mr. Krasik is a shareholder of Mellon Financial Corporation and holds options to purchase additional shares of Mellon Financial Corporation s common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000225868_robotic_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000225868_robotic_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d66965459885cdd101485f12fb7aa6494df6387d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000225868_robotic_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock covered by this prospectus has been passed upon by Sonnenschein Nath Rosenthal LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000278041_internatio_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000278041_internatio_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9084aea402070908eadaf175c327426121bbc028 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000278041_internatio_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the preferred stock, the notes and our common stock will be passed upon for us by Jones, Walker, Waechter, Poitevent, Carrere & Denegre, L.L.P., New Orleans, Louisiana. Certain legal matters in connection with this offering will be passed upon for the underwriter by Venable LLP, Baltimore, Maryland. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000313478_hkn-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000313478_hkn-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88dfb33143e8a9643e20b0ba7d29e8416ce005db --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000313478_hkn-inc_legal_matters.txt @@ -0,0 +1,26 @@ +LEGAL MATTERS + + Certain matters +with respect to the validity of the shares of common stock offered hereby will be passed upon for us by McGuireWoods LLP, New York, New York. + + +EXPERTS + + The consolidated +financial statements of Harken Energy Corporation at December 31, 2002 and 2001, and for each of the two years in the period ended December 31, 2002, appearing in this Prospectus and Registration Statement, have been audited by Ernst & Young +LLP, independent + + + + 71 + +Table of Contents + + +auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm +as experts in accounting and auditing. + + The consolidated +financial statements of Harken Energy Corporation at December 31, 2000 and for the year then ended appearing in Harken Energy Corporation s Annual Report on Form 10-K, have been audited by Arthur Andersen LLP, independent auditors who have +ceased operations, as set forth in their report thereon included therein and incorporated herein by reference. For a discussion of the risks related to Arthur Andersen s audit of our financial statements for the year ended December 31, 2000, +please see Risk Related to Arthur Andersen LLP s Lack of Content under \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000317032_empi-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000317032_empi-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..217a5138a5255850f6c9cf165699dbb90cab2874 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000317032_empi-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by our counsel, Faegre & Benson LLP. Certain other legal matters in connection with the issuance of our common stock to be sold in this offering will be passed upon for us by Latham & Watkins LLP, Washington, D.C. Certain legal matters in connection with this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000319450_zilog-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000319450_zilog-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0894339793ee8e17e9df445d1dc6811b1182b768 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000319450_zilog-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, Palo Alto, California and for the underwriters by Heller Ehrman White & McAuliffe LLP, Menlo Park, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000350868_iteris-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000350868_iteris-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0eae430e45164fbdac7df646ec72a4c9ffc06192 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000350868_iteris-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the shares offered hereby will be passed upon for us by Dorsey & Whitney LLP, Irvine, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000356028_ca-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000356028_ca-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e15a54f05566493fd9cbec388a1916d5695cb6fe --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000356028_ca-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes and any shares of common stock issuable upon conversion of the notes offered hereby and certain other matters have been passed upon for us by Covington & Burling, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000356130_emc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000356130_emc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b1d2ba5b7a7b8fb765534b4938abe989d505ed15 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000356130_emc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of the common stock offered hereby will be passed upon for us by Nyemaster, Goode, West, Hansell & O Brien, P.C., Des Moines, Iowa. Certain legal matters related to the offering will be passed upon for the underwriters by Sidley Austin Brown & Wood LLP, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000719494_inrad_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000719494_inrad_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b46b86bab738103f9c1e511f1ada7eb557927dda --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000719494_inrad_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS 48 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000750813_seitel-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000750813_seitel-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9c6d28d7fa1bc445bf04c67626caabd631f2c7e8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000750813_seitel-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock and the Stockholder Warrants offered by this prospectus will be passed upon for us by Greenberg Traurig, LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000759896_eye-care_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000759896_eye-care_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000759896_eye-care_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000764843_sedona_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000764843_sedona_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bc46ce29d5a0d3ccfef7e353225bb763690ec0b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000764843_sedona_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered pursuant to this Prospectus was passed upon for us by Pepper Hamilton LLP. CHANGE IN COMPANY'S INDEPENDENT AUDITORS On June 20, 2003, Ernst & Young LLP ("E&Y") informed us that they were resigning from their role as our independent auditors, effective as of June 20, 2003. The audit report of E&Y on our consolidated financial statements for the years ended December 31, 2002 and December 31, 2001, did not contain an adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles, except that, in their report dated April 8, 2003, E&Y's opinion was modified to include an uncertainty about our ability to continue as a going concern. During its audit for the fiscal year ended December 31, 2002 and December 31, 2001, and for the subsequent interim period through the date of the Form 8-K filing, June 26, 2003, (i) we had no disagreements with E&Y on any matters of accounting principles or practices, financial statement disclosure or auditing scope and procedure, which, if not resolved to E&Y's satisfaction, would have caused E&Y to make reference to the matter in their report, and (ii) there have been no "reportable events" as defined in Item 304 (a)(1)(v) of Regulation S-K. Our Board of Directors accepted E&Y's resignation, effective June 20, 2003. Effective August 29, 2003, McGladrey & Pullen, LLP, a member firm of RSM International, was engaged as the principal accountant to audit our financial statements beginning with the fiscal year ended December 31, 2003. EXPERTS Our consolidated financial statements at December 31, 2003 appearing in this Prospectus and Registration Statement have been audited by McGladrey & Pullen, LLP, independent auditors, as set forth in their report thereon (which contains an explanatory paragraph describing conditions that raise substantial doubt about our ability to continue as a going concern as described in Note 1 to the consolidated financial statements) appearing elsewhere herein, and are included as in reliance upon such report given on the authority of such firms as experts in accounting and auditing. Our consolidated financial statements at December 31, 2002 and 2001, and for each of the two years in the period ended December 31, 2002, appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon (which contains an explanatory paragraph describing conditions that raise substantial doubt about our ability to continue as a going concern as described in Note 1 to the consolidated financial statements) appearing elsewhere herein and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000779681_cape_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000779681_cape_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..211bd078edb26cb7bf069f9b9d6457ea0e54257b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000779681_cape_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares being offered hereby will be passed upon for us by Sichenzia Ross Friedman Ference LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000788983_portola_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000788983_portola_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6b43d15d99f6ef1518ff2df754cee4e555af970f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000788983_portola_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fenwick West LLP, Mountain View, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000790708_impco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000790708_impco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..13834d3203befe43a076ddb255383d1fb8aeb534 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000790708_impco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the securities offered hereby will be passed on for us by Davis Wright Tremaine, LLP, Seattle, Washington. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000791398_eos_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000791398_eos_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..869ade696bb02cd2de6cd69d9ee1ec910f1b86ac --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000791398_eos_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters relating to the issuance of the shares of our common stock offered hereby have been passed upon by Pitney, Hardin, Kipp & Szuch LLP, our legal counsel. The opinion of our legal counsel is included as Exhibit 5 to the registration statement of which this prospectus is a part. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000797448_verso_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000797448_verso_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b52a1436fa2b9160b421a910fc6be1724a733af7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000797448_verso_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Rogers Hardin LLP, Atlanta, Georgia, has passed upon the validity of the shares of the Common Stock offered by this prospectus. As of the date hereof, certain partners of Rogers Hardin LLP hold an immaterial number of shares of Common Stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000798600_brandpartn_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000798600_brandpartn_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..078668ad86c9f0261c39c8d712331ec5b9335474 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000798600_brandpartn_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares being offered hereby will be passed upon for us by Baratta & Goldstein, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000804073_lowrance_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000804073_lowrance_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9c0046644cd0f199f959edfdf06fea7be9499772 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000804073_lowrance_legal_matters.txt @@ -0,0 +1 @@ +Legal matters" --> Legal matters The validity of the common stock offered hereby will be passed upon for Lowrance Electronics, Inc. and the selling stockholders by Locke Liddell Sapp LLP, Houston, Texas. Cravath, Swaine Moore LLP, New York, New York, is representing the underwriter. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000830916_multi_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000830916_multi_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..bc63c807cfc337c5a57b4ca8e89220af1fbdace0 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000830916_multi_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Selected legal matters with respect to the validity of the common stock offered by this prospectus will be passed upon for us by Pillsbury Winthrop LLP, Palo Alto, California. Selected legal matters relating to the offering will be passed upon for the underwriters by Clifford Chance US LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000832812_kindercare_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000832812_kindercare_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4adbaedeb1f969c57cfdb2bc91bda61c3a0cd06e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000832812_kindercare_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes offered hereby will be passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. Partners of Simpson Thacher & Bartlett LLP, members of their families, related persons and others have an indirect interest, through limited partnerships, which are investors in an affiliate of KLC Associates, L.P., in less than 1% of the common stock underlying the IDSs. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000834208_navteq_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000834208_navteq_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..22a4e23b3dce07bc3efa047a8b8cb2f2d5bc9090 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000834208_navteq_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Pepper Hamilton LLP, Washington, D.C., will pass upon the validity of the shares of common stock offered hereby. Legal matters relating to this offering will be passed upon for the underwriters by Sidley Austin Brown & Wood LLP, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000841888_asc-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000841888_asc-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000841888_asc-inc_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000844143_centric_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000844143_centric_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d8141b27c633cf275e34ced3ec1b291c942cb86d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000844143_centric_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for our company by Akin Gump Strauss Hauer & Feld LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000844789_us-home_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000844789_us-home_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..051df534fab208c6ae44d8e68fb1bbe75e333af8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000844789_us-home_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters in this offering, including the legality of the common stock offered pursuant to this prospectus, will be passed upon for us and the selling stockholders by Jackson Walker L.L.P., Dallas, Texas. Certain matters in this offering will be passed upon for the underwriters by Hunton & Williams LLP, Richmond, Virginia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000847597_tengtu_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000847597_tengtu_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..489eaf4e759fadde65d8d01c3f63671add6532c6 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000847597_tengtu_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Our counsel, Guzov Ofsink, LLC, located in New York, New York, is passing upon the validity of the issuance of the common stock and share warrants that we are offering under this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000851560_tarantella_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000851560_tarantella_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b577a32e9e312114e14cd7fdb0832b2c08fc30b6 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000851560_tarantella_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000855581_weida_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000855581_weida_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..45d2a5ce5cc2e1687141c9c76a6ea9d8426cdcb6 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000855581_weida_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Brown Raysman Millstein Felder & Steiner LLP, New York, New York. Certain legal matters relating to PRC law will be passed upon for us by Chen & Co. Law Firm, Shanghai, China. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000866415_internatio_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000866415_internatio_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..df0bb51d182f2043c37cad35201f660b56a97c2e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000866415_internatio_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by the selling stockholders will be passed on by the law firm of Bartel Eng Schroder, Sacramento, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000866535_retail_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000866535_retail_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d407baf6c881c6f9c561fefeb40b1852edccebfa --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000866535_retail_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will by passed on for us by Solomon Ward Seidenwurm & Smith, LLP, 401 B Street, Suite 1200, San Diego, California 92101. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000866830_entorian_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000866830_entorian_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..83e598683484e8218702cfaf25278cd00120606c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000866830_entorian_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Gray Cary Ware & Freidenrich LLP, Austin, Texas, will pass upon the validity of the issuance of the shares of our common stock offered by this prospectus. Vinson & Elkins L.L.P., Austin, Texas, will pass upon legal matters for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000873799_morgan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000873799_morgan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ca26d4c05d830f1ebdb29135ea4df27c237f4151 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000873799_morgan_legal_matters.txt @@ -0,0 +1 @@ +$ $ $ Spectrum Select* 28,529,412.378 5,084,554.722 554,768,114 3,150,000 37,216 30.31 Spectrum Technical 38,348,176.678 5,651,823.322 585,879,790 3,931,984 42,471 22.64 Spectrum Strategic 15,977,268.178 9,522,731.822 181,882,529 1,011,000 13,823 14.31 Spectrum Global Balanced 7,050,928.248 9,449,071.752 99,259,599 533,234 7,481 15.47 Spectrum Currency 13,995,530.483 13,004,469.517 182,537,858 3,031,645 19,229 15.66 positions as a UK Gilt trader and salesman at two UK stockbrokers: Wood MacKenzie and Johnson Matthey & Wallace. He then joined Sabre Fund Management Ltd., a CFTC-registered CTA located in London, as an assistant technical trader and researcher, and was later promoted to Director of Research. In December 1986, he moved to Brockham Securities Ltd, a privately owned sugar trading and managed futures company, to assist in the development and marketing of the firm's futures fund management services. In February 1987, he left Brockham Securities Ltd and, together with colleagues Michael Adam and Martin Lueck, founded Adam, Harding and Lueck Ltd., a computer-driven, research based CTA. Adam, Harding and Lueck Ltd. became registered with the CFTC in February 1987. By 1989, this firm had grown into the UK's largest CTA, with more than $50 million under management. At that time, the principals sold a 51% stake to E D & F Man Group Ltd., one of the largest distributors of futures funds internationally. Between 1989 and 1993, when assets under management rose from $50 million to $300 million, Mr. Harding headed up Adam, Harding and Lueck Ltd.'s quantitative research team, supervising about 15 full-time research staff, supported by a software team of around a dozen programmers. This team developed a multiplicity of quantitative trading strategies in addition to Adam, Harding and Lueck Ltd.'s successful trend-following trading approach. During this time, he was also involved in the company's international institutional marketing efforts, in particular in Europe, the Middle East, South East Asia, Japan and the U.S. In 1993, Mr. Harding was invited to present a paper to a special symposium of London's prestigious Royal Society, on the subject "Making Money From Mathematical Models." This paper was subsequently incorporated into two books on the subject. In September 1994, E D & F Man Group Ltd. bought out the minority shares owned by Mr. Harding and the original partners, and Adam, Harding and Lueck Ltd. was consolidated into E D & F Man Group Ltd.'s fund management division. Mr. Harding then formed and headed up a new division of E D & F Man Group Ltd., called E D & F Man Group Ltd. Quantitative Research, leading a research team that developed quantitative trading models primarily for use by E D & F Man Group Ltd.'s fund management companies. Mr. Harding left E D & F Man Group Ltd. in August 1996 to begin preparations for the launch of Winton, which he formed in February 1997. Osman Murgian is a founding director and a principal of Winton. Educated in Brighton College in England, Mr. Murgian was also one of the original shareholders and directors of Adam, Harding and Lueck Ltd. Mr. Murgian lives in Nairobi, Kenya, and is the owner of or an investor in a number of international businesses ranging from real estate to transportation. Mr. Murgian has a beneficial interest of more than 10% of Winton's share capital. This interest is held by Festuca Investments Ltd, an Isle of Man investment holding company. Martin John Hunt is a director and a principal of Winton. Mr. Hunt began his career in the UK managed futures industry in October 1983, at which time he was employed as a trainee trader for a trading advisor, Futures Fund Management Ltd. In January 1986, he was appointed manager of the trading operations for Sabre Fund Management, also a trading advisor. In February 1988, he joined Adam, Harding and Lueck Ltd., then a newly established trading advisor, where he was responsible for the company's trading operations. These trading operations were complex, and Mr. Hunt's role was to ensure the efficient execution of the firm's computer-generated futures and interbank orders on over $120 million of assets under management. These orders spanned more than 60 markets, 5 time zones and 15 exchanges worldwide. In August 1991, Mr. Hunt assumed responsibility for marketing and operations at Royston Investments, Ltd, which at the time was a CFTC-registered CTA. In March 1994, he established himself as an independent marketing and compliance consultant to firms in the UK managed futures industry. These consultancy activities continued until February 1997, when he was recruited by David Harding to handle the formation, structuring and subsequent day-to-day running of Winton. At Winton, Mr. Hunt supervises the trading operations, as well as being directly involved in the marketing of Winton's investment management approach worldwide. Mr. Hunt also has responsibility for the firm's regulatory compliance. During the five years preceding the date of this Supplement, there have been no material administrative, civil or criminal actions, including actions pending, on appeal or concluded, against Winton or its principals. Winton and its principals may, from time to time, trade futures, forwards, or options contracts for their own proprietary accounts. These accounts may take positions that are opposite, or ahead of, positions advocated for clients. Such trades may or may not be in accordance with the Winton trading programs described below. Although Winton maintains records of these trades, clients of Winton are not entitled to inspect these records except in certain limited circumstances. Description of the Diversified Trading Program Effective January 1, 2004 the general partner allocated 10-15% of Spectrum Technical's assets to Winton's Diversified Trading Program which has been trading since 1997. The Winton Diversified Trading Program uses a statistically-derived systematic model to trade a diversified portfolio of approximately 95 futures contracts. The contracts traded cover a global range and are widely diversified across the financial and commodity sectors. Winton expects the margin requirements for the portion of Spectrum Technical's assets traded pursuant to Winton's Diversified Trading Program to average about 20% of those assets. As of December 31, 2003 Winton Capital Management Limited was managing approximately $321 million pursuant to its Diversified Trading Program and approximately $326 million of client assets in all its programs (notional funds included). Description of Trading Methods and Strategies Winton's investment technique consists of trading a portfolio of around 95 futures contracts on major commodity exchanges and forward markets worldwide, employing a computerized, technical, trend-following trading system developed by its principals. This system tracks the daily price movements from these markets around the world, and carries out certain computations to determine each day how long or short the portfolio should be to maximize profit within a certain range of risk. If rising prices are anticipated, a long position will be established; a short position will be established if prices are expected to fall. The trading methods applied by Winton are proprietary, complex and confidential. As a result, the following discussion is of necessity general in nature and not intended to be exhaustive. Winton plans to continue the testing and reworking of its trading methodology and, therefore, retains the right to revise any methods or strategy, including the technical trading factors used, the markets traded and/or the money management principles applied. A Technical Trend-Following System. Technical analysis refers to analysis based on data intrinsic to a market, such as price and volume. This is to be contrasted with fundamental analysis which relies on factors external to a market, such as supply and demand. The Diversified Trading Program uses no fundamental factors. A trend-following system is one that attempts to take advantage of the observable tendency of the markets to trend, and to tend to make exaggerated movements in both upward and downward directions as a result of such trends. These exaggerated movements are largely explained as a result of the influence of crowd psychology or the herd instinct, amongst market participants. A trend-following system does not anticipate a trend, but seeks to capture it at an appropriate point in time. In fact, trend-following systems are frequently unprofitable for long periods of time in particular markets or market groups, and occasionally they are unprofitable for spells of more than a year, even in large portfolios. However, over a span of years, Winton believes such an approach, applied to a sufficiently diversified portfolio of markets, has proven to be consistently profitable. The Winton trading system works by capturing the probability of the size and direction of future price movements using sophisticated statistical indicators, or oscillators, derived from past price movements which characterize the degree of trending of each market at any time. Winton believes its application of advanced classical statistics to the understanding of market behavior provides it with an edge over other trend following systems. Winton believes this enables its system to suffer smaller losses during the inevitable whipsaw periods of market behavior and thus take better advantage of the significant trends when they occur, by focusing more resources on them. The system is developed using historical market prices in each contract ("in sample data"), and then tested on an independent period of market data ("out of sample data") to ensure that the observations have robust predictive power. This procedure seeks to avoid the risk of over optimising, which occurs when a system is allowed to fit itself to a historically-specific set of market conditions. A Non Discretionary System. Trade selection is not subject to intervention by Winton's principals or traders and therefore is not subject to the influences of individual judgement. As a systemic trading system, the Winton model utilizes expert knowledge to analyze market data and direct trades, thus eliminating the risk of basing a trading program on one indispensable person. Equally important is the fact that non-discretionary systems can be tested in simulation for long periods of time and the model's empirical characteristics can be measured. The system's output is rigorously adhered to in trading the portfolio and intentionally no importance is given to any external or fundamental factors. While it may be seen as unwise to ignore information of obvious value, such as that pertaining to political or economic developments, Winton believes the disadvantage of this approach is far outweighed by the advantage of the discipline that rigorous adherence to such a system instills. Significant profits are often made by the Winton system, by holding on to positions for much longer than conventional wisdom would dictate. An individual taking trading decisions, and paying attention to day-to-day events, could easily be deflected from the chance of fully capitalizing on such trends, when not adhering to such a system. Markets Traded. The Winton system trades in all the easily accessible and liquid U.S. and non-U.S. futures and forward contracts that it practically can. Forward markets include major currencies and precious and base metals, the latter two categories being traded on the London Metal Exchange. Winton is constantly looking for new opportunities to add additional markets to the portfolio, thus further increasing the portfolio's diversification. Diversification of Markets. Taking positions in a variety of unrelated markets has been shown, over time, to decrease system volatility. By employing a sophisticated and systematic schema for placing orders in a wide array of markets, Winton believes it can be demonstrated that there is a high expectation of an overall profit being realized after a sufficient period of time. The trading strategy and account management principles described here are factors upon which Winton will base its trading decisions. Such principles may be revised from time to time by Winton as it deems advisable or necessary. Accordingly, no assurance is given that all of these factors will be considered with respect to every trade or recommendation made or that consideration of any of these factors in a particular situation will lessen risk of loss or increase the potential for profits. Execution of Orders and Order Allocation Winton will select the type of order to be used in executing trades and may use any type of order permitted by the exchange on which the order is placed. Winton may place individual orders for each account or a block order for all accounts in which the same commodity interest is being cleared through the same futures commission merchant. In the latter instance, Winton employs an objective price allocation procedure in which all accounts are listed by account number and then trades are assigned, with the highest number on the list receiving the highest buy and the highest sell and the lowest number on the list receiving the lowest buy and the lowest sell. On occasion, it may direct the futures commission merchant for the accounts to employ the neutral allocation system generally used by the futures commission merchant to assign trades or it may use an average price system in which each client in the block order will receive the average price which is computed by multiplying the price by the quantity executed at each price divided by the total quantity executed. Partial fills will be allocated in proportion to account size. Past Performance of Winton Set forth below in Capsule A is the past performance history of Winton's Diversified Trading Program. The footnotes following Capsule A are an integral part of the Capsule. You are cautioned that the information set forth in the following Capsule performance summary is not necessarily indicative of, and may have no bearing on, any trading results that may be attained by Winton or Spectrum Technical in the future, since past results are not a guarantee of future results. There can be no assurance that Winton or the partnership will make any profits at all, or will be able to avoid incurring substantial losses. You should also note that interest income may constitute a significant portion of a commodity pool's total income and, in certain instances, may generate profits where there have been realized or unrealized losses from commodity trading. CAPSULE A Winton Capital Management Limited Winton Diversified Trading Program Name of commodity trading advisor: Winton Capital Management Limited Name of program: Winton Diversified Trading Program Inception of trading by commodity trading advisor: October 1997 Inception of trading in program: October 1997 Number of open accounts: 33 Aggregate assets overall: 257.8 million Aggregate assets in program: 252.3 million Worst monthly drawdown (12.97)% - (October 1997) Worst peak-to-valley drawdown: (31.09)% - (November 2001-May 2002) 2003 annual return: 25.52% 2002 annual return: 12.86% 2001 annual return: 5.56% 2000 annual return: 9.72% 1999 annual return: 13.24% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Footnotes to Winton's Capsule Performance Summaries "Inception of trading by commodity trading advisor" is the date on which Winton began trading client accounts. "Inception of trading in program" is the date on which Winton began trading client accounts pursuant to the program shown. "Number of open accounts" is the number of accounts directed by Winton pursuant to the program shown as of December 31, 2003. "Aggregate assets overall" is the aggregate amount of assets in non-proprietary accounts under the management of Winton as of December 31, 2003. "Aggregate assets in program" is the aggregate amount of assets in the program specified as of December 31, 2003. "Drawdown" means losses experienced by the trading program over a specified period. A small number of accounts in the portfolio composites have experienced monthly drawdowns and peak-to-valley drawdowns that are materially larger than the largest composite monthly drawdown and peak-to-valley drawdown. These variances result from factors such as small account size (i.e., accounts with net assets of less than the prescribed portfolio minimum, which therefore trade fewer contracts than the standard portfolio), intra-month account opening or closing, significant intra-month additions or withdrawals, and investment restrictions imposed by the client. "Largest monthly drawdown" means greatest percentage decline in net asset value due to losses sustained by the trading program from the beginning to the end of a calendar month during the most recent five calendar years. "Worst peak-to-valley drawdown" means greatest cumulative percentage decline in month-end net asset value of the trading program due to losses sustained during a period in which the initial month-end net asset value of the trading program is not equaled or exceeded by a subsequent month-end net asset value of the program during the most recent five calendar years. "Compound annual and year-to-date/period rate of return" presented in the composite performance capsules are calculated based on the "Fully-Funded Subset" method as prescribed by the CFTC. The rate of return is calculated by dividing the sum of net performance of the qualifying Fully-Funded Subset by the beginning net assets of the qualifying Fully-Funded Subset, except in periods of significant additions or withdrawals to the accounts in the qualifying Fully-Funded Subset. In such instances, the Fully-Funded Subset is adjusted to exclude accounts with significant additions or withdrawals that would materially distort the rate of return pursuant to the Fully-Funded Subset method. Returns are then compounded to arrive at the year-to-date rate of return. Morgan Stanley Spectrum Strategic L.P. 1. Allied Irish Capital Management, Ltd. Allied Irish is an Irish corporation registered with the CFTC as a commodity trading advisor since January 1994 and is a member of the National Futures Association in that capacity. Allied Irish's business office is located at 85 Pembroke Road, Ballsbridge, Dublin 4. Allied Irish's ultimate parent company is Allied Irish Banks plc, Ireland's largest banking and financial services group. Allied Irish has been authorized by the Irish Financial Services Regulatory Authority (formerly known as Central Bank of Ireland) under the Investment Intermediaries Act, 1995. As a commodity trading advisor, Allied Irish specializes in trading interest rate, currency, and equity index futures contracts, as well as foreign exchange on the interbank cash market. The primary focus of Allied Irish's futures trading is on the U.S. and European, futures exchanges with some participation in other markets. Foreign exchange trading covers the major currencies. Allied Irish began trading for Spectrum Strategic in May 1999. Performance Records A summary of performance information for each partnership from its commencement of operations through December 31, 2003 is set forth in Capsules I through V below. All performance information has been calculated on an accrual basis in accordance with accounting principles generally accepted in the United States of America and is "net" of all fees and charges. You should read the footnotes on page , which are an integral part of the following capsules. You are cautioned that the information set forth in each capsule is not indicative of, and has no bearing on, any trading results that may be attained by any partnership in the future. Past performance is not necessarily indicative of future results. We cannot assure you that a partnership will be profitable or will avoid incurring substantial losses. You should also note that interest income may constitute a significant portion of a partnership's total income and may generate profits where there have been realized or unrealized losses from futures, forwards, and options trading. Capsule I Performance of Spectrum Select Type of pool: publicly-offered fund Inception of trading: August 1991 Aggregate subscriptions: $557,918,114 Current capitalization: $441,522,484 Current net asset value per unit: $30.31 Worst monthly % drawdown past five years: (13.12)% (November 2001) Worst monthly % drawdown since inception: (13.72)% (January 1992) Worst month-end peak-to-valley drawdown past five years: (23.63)% (22 months, October 1998-July 2000) Worst month-end peak-to-valley drawdown since inception: (26.78)% (15 months, June 1995-August 1996) Cumulative return since inception: 203.10% Monthly Performance Principals Gerry Grimes is Managing Director of Allied Irish, an associated person of Allied Irish and a member of the Institute of Bankers. He became registered as an associated person of Allied Irish in January 1994. For 10 years up to March 1988, Mr. Grimes was employed by the Central Bank of Ireland in the following investment management positions: Chief Dealer, Money Market Division; Chief Dealer, Management of Official External Reserves; and Chief Forex Dealer. He represented Ireland on sub-committees of the European Central Bank Governors Committee in Basle. He has experience in liquidity and interest rate management, investment of external reserves ($5 billion) and their currency allocation and the management of the Irish pound in the European Exchange Rate Mechanism. Mr. Grimes joined Gandon Securities as a trader in March 1988 where he traded a range of interest rate contracts, and was appointed a Director in October 1990. He was an associated person with Gandon Fund Management from July 1991 to September 1993. From mid 1991, he was responsible for the development of Gandon Fund Management's activities including the marketing and development of managed futures programs. He left Gandon Securities and Gandon Fund Management in September 1993 and joined Allied Irish that month. Mr. Grimes was a founding member of Allied Irish and is responsible for the overall management, development, and control of Allied Irish's activities. Between January and September 2002, Mr. Grimes was also responsible for trading a portion of the Worldwide Financial Futures Program. Ian Kelly became Company Secretary of Allied Irish in August 1997. He is a member of the Institute of Chartered Accountants of Ireland. He is Chief Operating Officer of Allied Irish and is responsible for financial control, compliance, and the back-office and I.T. operations of the company. He joined Allied Irish in August 1997. Prior to joining Allied Irish, he worked from July 1994 to August 1997 in AIB Capital Markets Plc., an investment bank, and before that he worked with Coopers & Lybrand, an accountancy firm, from 1987 to June 1994. John O'Donnell became a non-executive Director of Allied Irish in March 2001. He is Head of Investment Banking in the Capital Markets Division of the AIB Group, a position he was appointed to in March 2001. Prior to this appointment he was Managing Director of AIB International Financial Services Limited, a subsidiary of the AIB Group, from January 1994 to December 1996 and was Managing Director of AIB Corporate Finance Limited, another subsidiary of the AIB Group, from December 1996 to March 2001. Mr. O'Donnell is a Fellow of both the Chartered Institute of Management Accountants and the Chartered Association of Certified Accountants. John Parsons became a Director of Allied Irish in January 1995. He graduated from Queen's University, Belfast with a B.Sc. in Computer Science and Statistics in 1986, and went on to obtain a Master of Business Administration degree from Cardiff University, in 1987. Before joining Allied Irish, Mr. Parsons worked for SBC Warburg in London as a proprietary trader in the Fixed Interest & Treasury Division. Prior to that, he worked with the Bank of Ireland Group from January 1989 to March 1993, initially as a Portfolio Manager with the Bank's fund management group and ultimately as Head of European Government Bonds with the Bank's Treasury operation. Mr. Parsons trades a portion of the Worldwide Financial Futures Program and he is the sole trader of the Equity Program offered by Allied Irish. David Thompson became a Director of Allied Irish in September 2002. He has a Certificate in Actuarial Practices and a Certificate in Investment Management from the Institute of Actuaries in London. Prior to joining Allied Irish, Mr. Thompson worked for Bank of Ireland Group as Head of Proprietary Trading (non-customer flow) between January 2001 and August 2002. Before that he was Head of their Euro Fixed Interest Trading Desk between June 1998 and January 2001 and prior to that worked as a proprietary trader on their fixed interest trading desk in Dublin (July 1995 to June 1998) and as a bond trader in their London office (March 1994 to July 1995). From 1987 to 1994 he worked for Eagle Star Insurance, initially as an actuarial programmer and ultimately as a foreign exchange and bond trader. Mr. Thompson trades a portion of the Worldwide Financial Futures Program. Mr. Treble became a non-executive director of Allied Irish in October 2003 and currently has a pending registration as principal with the NFA. He is Managing Director of AIB Global Treasury, a position he has held since February 2002. Prior to this appointment, he was Managing Director of AIB Month Treasury and International, from February 2001 to February 2002, and he held the position of General Manager, AIB Capital Markets Britain (Treasury & Corporate Banking) from August 1997 to February 2001. He has worked in AIB since 1982 and has an MBA in Financial Services. Allied Irish and its principals may, from time to time, trade futures, forwards, and options contracts for their own proprietary accounts. Allied Irish's Trading Strategies Allied Irish offers three trading programs, but will only trade the Worldwide Financial Futures Program for Spectrum Strategic. Trading for Spectrum Strategic will be at four times the leverage Allied Irish normally applies for the Worldwide Financial Futures Program. The two other trading programs offered by Allied Irish are the Foreign Exchange Program and the Equity Index Program. Worldwide Financial Futures Program The Worldwide Financial Futures Program is designed to provide returns using a multi-trader trading approach on a broad range of financial instruments. The capital is sub-allocated to a range of trading styles, including a portion traded by two individual traders, Mr. Parsons and Mr. Thompson. The allocation of capital to the individual traders and to the trading styles may be altered at the discretion of Allied Irish. A portion is traded using a systematic approach. Diversification is enhanced because no overall house view is imposed on the traders in the program, and this independence of operation is viewed as a key strength. There are the three elements to the current trading approvals. Mr. Thompson's trading style is based on an understanding of the medium to longer term economic, political and demographic trends in the world. An analysis of value is conducted for all major asset classes and fitted to this fundamental framework to determine the likely direction and magnitude of trends in the major financial markets. The timing and size of trades is determined through a combination of technical analysis and assessment of market psychology and positioning. The aim of Mr. Thompson's approach is to enter trends early, building up the size of the position as the trade becomes profitable. Exit of the trades occurs when market sentiment in favour of the trade reaches an extreme, but price movements cease to justify the euphoria. Profitable trades can be run for months at a time, but may be held for shorter periods, depending on the strength of the trends involved. Mr. Parsons' approach to trading markets is based on a fundamental analysis of economic, fiscal, and monetary developments in the world's major economies. Having compiled a set of expectations for the major interest rate, equity, and foreign exchange markets, Mr. Parsons then looks for significant levels of divergence relative to the market's expectations as a signal to enter a particular position. He uses technical analysis to help identify trends and trend changes as well as to seek to improve entry and exit levels. A portion of the Worldwide Financial Futures Program is traded using a technical trading system. The system has been developed to be consistent with Allied Irish's investment approach to financial markets. The system differs from most trend following trading systems in that a profit objective is built into the trade from inception. The system utilizes a break-out oriented approach that attempts to initiate trading at low risk entry points where the market has a higher probability than average of participating in a medium-to long-term trend. The futures contracts currently traded in the Worldwide Financial Futures Program include U.S., European, and Asian interest rate, currency, and stock index contracts. For most contracts, options may also be used from time to time. Options may be either bought or sold in this program. It should be noted that in relation to currency futures on both the Chicago Mercantile Exchange and the financial derivatives division of the New York Cotton Exchange, Allied Irish may convert spot transactions to futures contracts using the exchange for physicals mechanism. As of December 31, 2003, Allied Irish was managing approximately $336 million (notional funds included) of client assets pursuant to the Worldwide Financial Futures Program and approximately $637 million of client assets in all of its programs (notional funds included). Foreign Exchange Program The Foreign Exchange Program specializes in trading the inter-bank foreign exchange market. A fundamental assessment of market information is the main factor underlying the trading approach. To this end an assessment of the fundamental economic policy forces at work in different countries is first made. This is related to socio-political factors in play. A judgment is then made on how much of the economic and political influences are priced in following a review of international capital flows. In this regard consultation is made with a network of experts in the world's currency markets. Finally the price levels are examined in detail to determine appropriate trade parameters. Equity Index Program The program's objective is designed to minimize correlations with major global equity returns. The underlying investment approach is broadly similar to that taken in Allied Irish's other two programs in that the main inputs are an analysis of macroeconomic and global political trends. This program is traded by John Parsons and trades the major stock index futures. Risk Management The management of risk positions takes place at two levels within the programs at the overall program level by the trading controller and at the position taking level where each trader uses his individual money management skills. Given that the programs involve a multi-trader approach, a program controller role is adopted. Mr. Grimes is the trading controller for all three programs. This role involves the following: assessing the performance and risk of the programs from an overall level as distinct from a trader level; monitoring the traders' adherence to the risk parameters for each program as set out below; ensuring that the programs' overall objectives and those of individual traders are compatible; controlling the operations of the order desk and ensuring the positions are agreed between traders, order desk, back office, and counterparty. Mr. Grimes is also responsible for liaising with clients and conveying their views, wishes, and concerns to the trading team. To control the levels of exposure a daily end-of-day position report including contract open positions, margin utilized by contract, and margin utilized by trader is produced for the Worldwide Financial Futures and Equity Index Programs. The report for the Foreign Exchange Program looks at positions in equivalent U.S. dollar amount versus underlying U.S. dollar equity invested. For the Worldwide Financial Futures and Equity Index Programs, margin to equity is used to control position size while in the Foreign Exchange Program a gearing of equity is used to limit position size. Given the nature of the programs offered and the experience of the trading team, a limit of 6% margin to equity (including notional funds) is normally applied for the Worldwide Financial Futures and Equity Index Programs and a gearing of 3 times equity (including notional funds) for the Foreign Exchange Program. 2. Blenheim Capital Management, L.L.C. Blenheim Capital Management, L.L.C. is a Delaware limited liability company which was formed to provide commodity trading advisory services to clients. Through a corporate reorganization in July 2001, Blenheim was merged with Blenheim Investments, Inc., a New Jersey corporation. The ownership and capitalization of Blenheim are materially the same as those which existed in Blenheim Investments, Inc. Additionally, Blenheim succeeds to all the assets and obligations of its predecessor. Blenheim is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator, effective March 2, 1989, and is a member of the National Futures Association. Blenheim's address and telephone number are: Post Office Box 7242, Two Worlds Fair Drive, Somerset, New Jersey 08875-7242; (732) 302-0238. Principals Mr. Willem Kooyker is the Managing Member, Chairman and majority owner of Blenheim. He is registered with the CFTC as an associated person of Blenheim and a member of the National Futures Association in that capacity. He is a former member of the Board of Directors of the NY Coffee, Sugar and Cocoa Exchange, a former president of the NY Cocoa Clearing Association, and a former member of the NY Mercantile Exchange. He received a BA cum laude in Economics from Baruch College in New York and an MBA in International Finance and Economics from New York University. Mr. Kooyker began his trading career in the international commodities business in 1964 with Internatio-Muller in Rotterdam, The Netherlands, where eventually he became managing director of the International Trading Group. He stayed in this position until 1981, when he joined Commodities Corporation, Princeton, New Jersey, where he became President. At the time, Commodities Corporation was an active fund management company, operating predominantly in the futures markets. In October 1984, Mr. Kooyker started a new company, Tricon Holding Company, Ltd., a joint venture between Commodities Corporation and a group of Middle Eastern investors, which was a trading and consulting company in the futures as well as the physicals markets predominantly directed towards energy and industrial commodities. Tricon currently remains only active in the forest products industry, where it operates two sawmills in the western states of the United States. In January 1989, Mr. Kooyker started Blenheim, an independent fund management company and an advisor to several investment funds. Concurrent, but separate from Blenheim, Mr. Kooyker is the largest beneficial owner, but not an officer, of Derivatives Portfolio Management, L.L.C., a Delaware limited liability company formed in 1993 to provide administrative, risk management, and consulting services to institutions, commodity pool operators, and individual fund managers engaged in the financial instruments, securities, and futures markets as well as the cash trading business. DPM is registered with the CFTC as a commodity pool operator, effective January 26, 1994, and is a member of the National Futures Association in that capacity. DPM has a wholly-owned subsidiary named DPM Brokerage, LLC, a Delaware limited liability company formed in 1999 to provide introduction and execution services to individual clients and private investors. DPM Brokerage is registered with the CFTC as an introducing broker, effective August 16, 1999 and is a member of the National Futures Association in that capacity. In 1996, Mr. Kooyker became a 50% shareholder in The Thornton Group, L.L.C., a consulting company to entrepreneurial startup enterprises. Mr. Kooyker is registered with the CFTC as a principal and an associated person of Blenheim. He is also registered as a principal of DPM and DPM Brokerage. Thomas M. Kopczynski is a Vice President of Blenheim. He is registered with the CFTC as a principal and an associated person and is a member of the NFA in that capacity. Mr. Kopczynski has been with Blenheim for ten years. He is an integral part of Blenheim's trading staff. His broad knowledge of the market sectors in which Blenheim trades, retained by extensive analysis and consultation with key industry contacts, facilitates continuous investment opportunities and diversification. Mr. Kopczynski holds a B.S. in Economics with a concentration in Statistics from the Wharton School of the University of Pennsylvania. Guy J. Castranova, is the Secretary of Blenheim and has held this position since its inception. He is the President and Chief Operating Officer of DPM and DPM Brokerage, as well as a Vice President and Controller of Tricon. Mr. Castranova has been with Tricon since October 1986 and is responsible for the risk management of all physicals trading as well as the administration of all general and consolidation accounting. Prior to joining Tricon, Mr. Castranova was an accountant with two energy firms. In 1980 Mr. Castranova graduated from Saint Joseph's University with a BS degree in Accounting. He is registered as an associated person and principal of Blenheim, DPM, and DPM Brokerage, and is a member of the National Futures Association in those capacities. Blenheim and its principals may, from time to time, trade futures, forwards, and options contracts for their own proprietary accounts. If either Blenheim or its principals engage in such trading, you will not be able to inspect such records. Such trades may or may not be in accordance with the Blenheim trading program described below. As of December 31, 2003, Blenheim was managing approximately $68.1 million of client assets pursuant to its trading program. The Blenheim Global Markets Strategy The Global Markets Strategy designed and developed by the management team of Blenheim. The objective of the Global Markets Strategy is to capture substantial profits through the establishment of risk-controlled, strategic investment positions in markets where Blenheim has identified an unsustainable level of market disequilibrium that has not been reflected in the current market price. The essence of Blenheim's trading approach is its ability to use discretion in formulating the most effective mix of trading methodologies, investment vehicles, and markets to maintain performance objectives. As trading opportunities are identified, Blenheim analyzes potential trading applications in order to achieve maximum capital appreciation with prudent risk management procedures. Markets Traded Blenheim's portfolio is highly diversified and draws upon a potential of 35 markets, depending on the opportunities presented at any given time. The major markets traded by Blenheim include energy, industrials, precious metals, softs, grains, global fixed income, currencies and stock indices. Blenheim concentrates in those markets that, in its judgment and discretion, have a high degree of liquidity and a wide spectrum of historical price movement relative to other markets. Instruments Utilized Positions established are typically in derivative instruments such as futures options and OTC transactions. Blenheim may, however, trade to a limited extent in illiquid instruments for which market quotations are not readily available. In addition, Blenheim may trade in securities that are related to the financial and commodities markets currently traded by the fund. However, Blenheim will not be trading securities for Spectrum Strategic. Blenheim's Trading Style Blenheim uses a global macro approach to investing, which utilizes fundamental, geopolitical and technical research and analysis in its evaluation of the markets. Fundamental analysis attempts to examine factors external to the trading market which affect the supply and demand for a particular investment instrument in order to predict future prices. The geopolitial considerations include governmental interference and potential political conflicts which may alter the normal flow of capital and goods. Technical factors assume that market price patterns and price momentum, rather than external influences, indicate the supply and demand factors which are indicative of future price movements. Blenheim considers technical factors such as an instrument's recent price history, current prices of such instrument relative to price of other markets and their historical price relationships. Blenheim studies price charts to assess changes in market sentiment and examines volume and open interest to evaluate market liquidity. The Blenheim traders regularly monitor worldwide economic and political trends in order to identify and evaluate possible market and price imbalances. Operating within a global framework, long-term macroeconomic indicators are assessed on a multinational, country-by-country and market specific basis. Factors such as fiscal/monetary policies and cross-border capital flows are evaluated for their potential impact on the equity, fixed income, currency and commodity markets. Additionally, Blenheim's trading group utilizes econometric signals, as well as numerous other market sentiment indicators, to take advantage of short-term trading opportunities. Portfolio Management and Diversification Various techniques are employed in managing the portfolio and position volatility. In its discretionary trading, Blenheim generally initiates medium-sized positions at a market entry level. This initial position, generally considered the core strategic position, is typically initiated upon Blenheim's determination of an unsustainable level of market disequilibrium that has not been reflected in the current market price. Once market action begins to conform to Blenheim's initial assessment of price behavior, Blenheim will add to the original strategic position. In addition to managing the individual positions, Blenheim will also evaluate the positions within the context of an account's portfolio. Separate strategic positions are evaluated for direct and indirect correlation characteristics in order to further anticipate and manage portfolio volatility. Despite these precautions, Blenheim's trading program may be volatile at times. Diversification in an account's portfolio is a major consideration in its trading approach. While many of its trades are made on a short-term basis, Blenheim's basic strategy is to attempt to participate in long-term, major price movements. Evolution of the Trading Approach The trading strategy of Blenheim has evolved and will continue to do so based on ongoing research, testing of data and trading experience. Prior to 1991, Blenheim traded almost exclusively in commodity markets, with a particular emphasis on energy products. Since then, Blenheim has become active in the global fixed-income, stock indices and currency markets as well. In the past, Blenheim had included non-discretionary systematic computerized analysis in its trading practices. This strategy was driven by a series of trading systems that produced a result that was an amalgam of numerous systemic processes. It was then traded in conjunction with the discretionary approach. Under separate funds, Blenheim also managed a purely financial strategy and a long-only commodity trading strategy incorporating physical commodities. In this regard, Blenheim reserves the right to modify its trading approach to include any one or combination of trading methodologies it finds beneficial to its overall goals. These processes may include discretionary, systematic, or arbitage trading. Blenheim may use derivative instruments including futures, options, and forwards to reach its performance objectives. On rare occasions, Blenheim may withdraw from all markets. Blenheim's diversified portfolio is actively traded on domestic and foreign markets. In the early 1990s, approximately thirty-five percent (35%) to forty-five percent (45%) of equity, including notional funds, was generally committed to margin on commodities positions. Recently the percentage has been between twenty-five percent (25%) and thirty-five percent (35%). In the future the percentage committed may, from time to time, be substantially higher or lower. Variances in Leverage If particular opportunities present themselves based upon fundamental factors, Blenheim may increase the number of positions held. This will result in more capital needed to provide risk margin. Accordingly, within the overall parameters of Blenheim's money management rules, Blenheim employs no hard and fast formula as to the levels of capital committed to discretionary trading or any other trading strategy at any given time. The level of risk margin relative to equity committed to trading positions is expected to vary from period to period. The Blenheim traders will constantly monitor leverage in an effort to try to maximize its positive effects while trying to avoid overexposure to its potential negative characteristics. While there is no guaranty that this approach will be successful, Blenheim has used a consistent risk monitoring system for a number of years, one of the key components thereof involves monitoring the levels of risk margin to equity. Blenheim may leverage the account of Spectrum Strategic differently than the standard account using the Global Market Strategy, but will not leverage the account at more than 50% above the leverage of a standard account. 3. Eclipse Capital Management, Inc. Eclipse is a Delaware corporation organized in July 1983. Eclipse's main business address is 7700 Bonhomme, Suite 500, St. Louis, Missouri 63105. Eclipse has been registered with the CFTC as a commodity trading advisor since August 1986 and is a member of the National Futures Association in such capacity. Eclipse began trading for Spectrum Strategic in June 2000. Principals Thomas W. Moller, the sole shareholder of Eclipse, has served as its President, CEO, and sole director since founding the firm. Mr. Moller received an undergraduate degree in Business and Economics from Vanderbilt University and a graduate degree in Accounting from the University of Kentucky. He was a Certified Public Accountant and has a background in financial planning and investment management. In 1980, as chief financial officer of a privately held company, he designed and implemented one of the first variable rate loan hedge programs using interest rate futures contracts. In 1982, he formed Interest Rate Management, Inc., another commodity trading advisor which provided interest-rate-hedging advisory and management services. Since 1986, Mr. Moller has devoted his time exclusively to Eclipse and is primarily involved in the areas of trading, research, and product development. James R. Klingler, JD is Senior Vice President, Corporate Secretary, and General Counsel. Mr. Klingler has a BA in Economics from Vanderbilt University and a JD from Vanderbilt University School of Law. He previously worked as an associate with the St. Louis law firm of Thompson Coburn (formerly Coburn & Croft) and as a staff attorney with Mercantile Bancorporation, also in St. Louis. From January 1991 to December 1997, he was Compliance Counsel and, subsequently, Associate Vice President with A.G. Edwards & Sons, Inc. Mr. Klingler joined Eclipse in January 1998. Ronald R. Breitigam is Vice President Trading with primary responsibility for the implementation of the firm's trading strategies. After graduating from Pacific Union College in 1982, Mr. Breitigam became an independent floor trader at the Mid-America Commodity Exchange. He served as an institutional broker with Thomson McKinnon (1984-1985) and PaineWebber (1986) and, in 1986, formed his own trading company to work full time implementing various proprietary futures and options trading strategies. Mr. Breitigam joined Eclipse in May 1989. James W. Dille, PhD is Vice President Research and Technology with responsibility for computer-based research, development, and operations. Dr. Dille has undergraduate and graduate engineering degrees from the University of Virginia. He also received a master's and doctorate from Harvard University in Applied Sciences, specializing in the areas of Decision and Control Theory and Computer Science. From 1987 through 1993, he worked for the Boeing Company (formerly, McDonnell Douglas) in the Training Systems and Flight Simulation divisions, where he was responsible for research in the areas of computer architectures and networking. He is an affiliate professor at Washington University in St. Louis, teaching courses in numerical analysis and the simulation and analysis of complex systems. Dr. Dille joined Eclipse in January 1994. At this time, neither Eclipse nor its principals trade for their own account, but each reserves the right to do so in the future. If either Eclipse or its principals engage in such trading, you will not be able to inspect such records. Trading Programs Eclipse currently offers one trading program, the Global Monetary Program. The program is designed primarily for institutions, commodity pools, and certain other qualified investors. The Global Monetary Program employs a systematic trading approach, using multiple trend-following and macroeconomically driven models. Global Monetary Program: This "financial, metals and energy" program requires a minimum investment of $5 million and trades a global portfolio of futures and options on futures on interest rate instruments, currencies, stock indices, precious and base metals, and energy products, as well as interbank spot and forward currency markets. A key characteristic of this program is the extensive diversification achieved by applying multiple trading models to a wide variety of financial markets located throughout the world. As of December 31, 2003, Eclipse was managing approximately $379 million of client assets pursuant to its trading program (notional funds included). Trading Approach The trading program of Eclipse is systematic and its strategies are either macroeconomic or trend-following in nature, with the objective of capitalizing on intermediate- and long-term price trends. Eclipse makes all trading decisions pursuant to its proprietary trading, capital allocation, and risk management models. The Eclipse program makes use of multiple models to accentuate overall diversification. Macro-driven models generate trading signals through the quantitative analysis of environmental, macroeconomic, and intermarket data. Trend identification models use various technical and statistical analysis techniques to identify and evaluate price trends. Capital allocation models determine the percentage of trading capital allocated to various markets and trading models. Eclipse's risk management models were developed with the objective of limiting losses, capturing profits, and conserving capital in choppy, sideways markets. The risk management principles which Eclipse employs include: using stop orders to exit trades when markets are moving against an established position (although, depending on market circumstances, such "stop-loss" orders may be difficult or impossible to execute); diversifying positions among several different markets, futures, and/or futures groups to limit exposure in any one area; using multiple entry and exit points; limiting the assets committed as margin, generally within a range of 5% to 20% of assets managed, at minimum exchange margin requirements, but possibly above or below that range at certain times; and prohibiting the use of unrealized profits in a particular futures contract as margin for additional contracts in the same or a related futures contract. Decisions whether to trade a particular futures contract are based upon various factors, including liquidity, significance in terms of desired degrees of concentration, diversification, and profit potential, both historical and at a given time. These decisions are based upon output generated by a proprietary risk management program, but require the exercise of judgment by principals of Eclipse. The decision not to trade specific contracts for certain periods or to reduce the number of contracts traded may result at times in missing significant profit opportunities which otherwise would be captured by technical strategies. The specific contracts traded in each portfolio have been selected based on liquidity, historical volatility, and the degree of past directional movement. The actual number of contracts held at any particular point in time depends on a number of factors, including evaluation of market volatility and potential risk versus return. There are occasions when a trading model may indicate that no position is appropriate in a particular contract or contract group. In addition to technical trading in futures contracts, Eclipse may also employ trading techniques such as spreads and straddles and may buy or sell futures options. Eclipse may alter its trading programs, including, without limitation, its trading strategies, commodity interests, and markets traded and trading principles if Eclipse determines that such change is in the best interest of the accounts which it manages. Morgan Stanley Spectrum Global Balanced L.P. SSARIS Advisors, LLC SSARIS, a Delaware Limited Liability Company, was organized in May 2001. SSARIS's address is Financial Centre, 695 East Main Street, Suite 102, Stamford, Connecticut 06901. SSARIS has been registered as a commodity trading advisor since August 2001 and as a commodity pool operator since August 2001, and is a member of the National Futures Association in such capacities. SSARIS is a joint venture between State Street Global Alliance LLC, a limited liability company which is majority owned by State Street Global Advisors, Inc., and RTH Partners LLC, a limited liability company owned by the principals of The RXR Group, Inc. State Street Global Advisors, Inc. is a wholly-owned subsidiary of State Street Corporation. SSARIS is affiliated with State Street Global Advisors, the investment management division of State Street Bank and Trust Company, a wholly owned subsidiary of State Street Corporation. Principals Mr. Mark Rosenberg has served as the Chairman, a Director and the Chief Investment Officer of SSARIS since its formation in May 2001 and, as such, is the head of SSARIS's Investment Committee. Mr. Rosenberg is also the Chairman of SSARIS Management LLC. Mr. Rosenberg was the Chairman and Chief Investment Officer of RXR. Mr. Rosenberg has over thirty (30) years experience in the investment management industry. From August 1984 to July 1986, Mr. Rosenberg was employed by Prudential-Bache Securities, Inc., where he headed a group that specialized in institutional hedging and managed futures trading services. From December 1976 to July 1984, Mr. Rosenberg was employed by Merrill Lynch & Co. where he organized a group that was responsible for managing hedging and alternative investment strategies for Merrill's institutional clients. This entity became the Financial Futures and Options Group. Mr. Rosenberg's first job was on the floor of the New York Stock Exchange and subsequently the New York Mercantile Exchange, where he managed proprietary capital using a variety of quantitative techniques for Weis, Voisen & Cannon, a private investment boutique. Mr. Rosenberg is a fourth term Director of the Board of the Futures Industry Association, and arbiter for the NFA and is a member of the Financial Advisory Boards of both the Chicago Mercantile Exchange and the COMEX Division of NYMEX. Mr. Rosenberg is also a Director of the Foundation of Finance and Banking Research. Mr. Rosenberg also is involved in several community activities. He has donated time to Domus House, a refuge for abandoned children, and various entrepreneurial projects targeting low-income families. Mr. Peter A. Hinrichs has served as the Chief Financial Officer of SSARIS since its formation in May 2001 and is a member of SSARIS's Investment Committee. Mr. Hinrichs also is Chief Financial Officer of SSARIS Management LLC. Mr. Hinrichs was with RXR since its founding in 1983, where he was responsible for RXR's financial, administrative and operational functions. Mr. Hinrichs also was a member of RXR's Investment Committee. From September 1981 to July 1984, Mr. Hinrichs was employed by Merrill Lynch Futures Inc. in trading and administration and held a similar position at Prudential from July 1984 to August 1986. Mr. Hinrichs graduated from Curry College in 1981 with a Bachelor of Science degree in Business Management. He is active in his community as a Board member of Fountain House Inc., a non-profit rehabilitation center for the mentally ill, where he serves as an Investment Committee member. He also is active with a number of other charitable organizations. Mr. James F. Tomeo has served as the Chief Operating Officer, a Senior Portfolio Manager and a Director of SSARIS since its formation in May 2001. Mr. Tomeo also is a member of SSARIS's Investment Committee and is responsible for portfolio management, strategic planning and product development. Mr. Tomeo served as Chief Operating Officer and a Senior Portfolio Manager of RXR and was a member of the firm's Investment Committee. Before joining RXR in 1986, Mr. Tomeo worked for Donaldson, Lufkin and Jenrette as an alternative investment consultant, and the LTV Corporation in New York. Mr. Tomeo was formerly an advisor to Institutional Investor on matters related to Japanese pension fund reform, is the former Chairman of the International Committee of the Managed Funds Association and is the US representative to the Education and Research Committee of the Alternative Investment Management Association. Mr. Tomeo graduated from Bucknell University in May 1980 with a Bachelor of Science degree in Business Administration, the University of Hartford in 1987 with an MBA degree, and the Institute of International Studies and Training (Japanese business study program) in November 1988. He studied International Finance and Capital Markets at New York University. Alan J. Brown has been a Director of SSARIS since July 2003. Mr. Brown is a principal of State Street Global Advisors, Group Chief Investment Officer of State Street Global Advisors Worldwide, Chairman of State Street Global Advisors UK, and Executive Vice President of State Street. He is also a member of State Street Global Advisor's Executive Management Group. Mr. Brown is a director of Advanced Investment Partners, European Direct Capital Management, Rexiter Capital Management, Boston Capital Management and Global Alliance, LLC. Mr. Brown is also a member of State Street Global Advisor's Executive Management Group. Prior to joining State Street Global Advisors UK in 1995, Mr. Brown was Managing Director and Chief Investment Officer of PanAgora Asset Management Limited, and prior to that, Managing Director of Posthorn Global Asset Management in London. Mr. Brown began his career in the investment management business in 1974 at Morgan Grenfell, where he spent ten years. Mr. Brown holds a Masters degree in Physics from Cambridge University. Mr. Brown is on the board of the U.S. foundation for The Center for Economic Research and Graduate Education-Economic Institute attached to the Charles University in Prague. Jay Cromarty has been a Director of SSARIS since March 2003. Mr. Cromarty is the President of Global Alliance and a Senior Principal of State Street Global Advisors. Among other duties, Mr. Cromarty provides strategic management and marketing support to all of the Global Alliance investment management businesses. Mr. Cromarty is a director of Advanced Investment Partners, Boston Capital Management and Residential Capital Management. Before joining Global Alliance in May 1998, Mr. Cromarty served as the Managing Director of Sales and Marketing for State Street Global Advisors' Private Asset Management group. Prior to joining State Street Global Advisors in 1996, Mr. Cromarty was Vice President of The Boston Company, Inc., Director of Marketing and Client Service at PanAgora Asset Management and Senior Vice President of NatWest Investment Management. Mr. Cromarty holds a Bachelor of Science degree in Economics from the University of Maine and a Masters of Business Administration degree in Finance and Marketing from Babson College. Christopher M. Pope has been a Director of SSARIS Global Advisors and Director of Institutional Sales, Client Service, and Consultant Relations. Prior to joining State Street Global Advisors in 1988, Mr. Pope was responsible for marketing and client service at Travelers Investment Management Company and Travelers Keystone Fixed Income Advisors. Mr. Pope holds a Bachelor of Science degree from the University of Pennsylvania. Mr. Pope is a charter member of the Certified Employee Benefit Specialist program. Principals and employees of SSARIS are not permitted to trade futures, options on futures, or forward contracts for their own accounts. Principals and employees are, however, permitted to invest in funds traded by SSARIS. SSARIS's Investment Philosophy SSARIS trades its allocation from Spectrum Global Balanced pursuant to a variation of its Balanced Portfolio known as the Global Multi-Strategy program. The development of the trading program utilized for Spectrum Global Balanced stems from RXR's work over the years with institutional clients. In 1986, RXR began managing a portfolio called the Institutional Balanced Portfolio program (now known as the Balanced Portfolio), which was composed of U.S. stock, bond and non-U.S. financial and commodity interests. Its objective was capital appreciation with controlled volatility, a concept pioneered by Professor John Lintner of Harvard University, who conducted research on the addition of managed futures to portfolios of U.S. stocks and bonds. The philosophy for the investment program has its roots in Modern Portfolio Theory and the design of efficiently allocated portfolios. Effective June 1, 1998, RXR broadened the hedged equity and fixed income components to include participation in the world's major developed capital markets and increased the program's leverage to 1.4 times the original Balanced Portfolio Program. The resulting program is now known as the Global Multi-Strategy. SSARIS's Global Multi-Strategy program allocates to hedged equity, hedged fixed income, and long/short global assets. It is diversified by both style (divergence and convergence strategies) and asset class (global stocks, bonds, currencies and real assets). The hedged equity component may be composed of positions in FTSE 100, DAX, Nikkei 225, and S&P 500 futures indices. The hedged fixed income exposure may include British Gilt, German Bund, Japanese & US Treasury futures. Real asset exposure is diversified across energy, precious metal, base metal, and agricultural markets. The investment program uses a multi-determinant model to rebalance the independent strategies. The global stock and bond exposure is managed using models which interpret macroeconomic, relative value, inflation, interest rate, and price-related data. Exposure within the long/short global asset sector is regulated by combining individual market expected return analysis with a system that asset weights each market according to relative volatility and correlation. In the foreign exchange and commodity components, SSARIS analyzes price data to determine profit and risk potential. A proprietary asset allocation model is used to adjust exposure among approximately 40 markets so that no one market or sector can dominate performance. The investment program was designed to provide investors with a global investment alternative. Through the controlled use of futures and forward contracts, SSARIS manages both U.S. and non-U.S. capital markets, currency and commodity exposure in a single, integrated portfolio. As of December 31, 2003, SSARIS was managing approximately $53 million of client assets pursuant to the program utilized for Spectrum Global Balanced and approximately $612 million in all of their programs. Research and Development Research and development calls on the talents of personnel from several areas within the company. SSARIS has developed macro-economic and technical models that can detect price movements resulting from daily market activity and major changes in global business cycles. Using this information, portfolio managers construct investment portfolios that address the specific actuarial assumptions of their clients. No representation is made and no guarantee is given that Spectrum Global Balanced's objective will be realized or that SSARIS will achieve any particular level of performance or amount of profits in its trading for Spectrum Global Balanced's account. Losses incurred in the global and tangible assets component could cause Spectrum Global Balanced's account to substantially underperform accounts managed by asset allocation systems that do not include a managed futures component. Prospective investors must recognize not only that the foregoing discussion attempts to present only the most basic framework describing the trading program employed for Spectrum Global Balanced, but also, due to the proprietary and confidential nature of all trading approaches, any description will inevitably be general in nature. Furthermore, SSARIS's trading methods are continually evolving, as are the markets themselves. Morgan Stanley Spectrum Currency L.P. 1. John W. Henry & Company, Inc. (JWH ) JWH makes trading decisions for Spectrum Currency pursuant to the International Foreign Exchange Program. The International Foreign Exchange Program, which began trading client capital in August 1986, seeks to identify and capitalize on intermediate-term movements in a broad range of both major and minor currencies primarily trading on the interbank market. Positions are taken as outrights against the U.S. dollar, or non-dollar cross rates. This program uses the three-phase forex investment style. For a detailed description of JWH, its principals, and trading systems, including the International Foreign Currency Program, see "The Trading Advisors Morgan Stanley Spectrum Technical 3. John W. Henry & Company, Inc." beginning on page . 2. Sunrise Capital Partners, LLC The principals and senior officers of Sunrise Capital Partners are as follows: Martin P. Klitzner Principal, Managing Director Richard C. Slaughter Principal, Managing Director Dr. Gary B. Davis Principal Dr. John V. Forrest Principal Martin M. Ehrlich Principal, Vice President Marie Laufik Principal, Vice President Elissa Davis Principal The principals of Sunrise Capital Partners will make trading decisions for Spectrum Currency pursuant to the Currency Program. For a detailed description of Sunrise Capital Partners, its principals and trading systems, other than the Currency Program, which is discussed below, see "The Trading Advisors Morgan Stanley Spectrum Select 4. Sunrise Capital Management, Inc." beginning on page . The Currency Program follows approximately ten different major and minor currency markets, which may include, but are not limited to, the Japanese yen, British pound, euro currency, Swiss franc, Canadian dollar, Australian dollar, Swedish krona, New Zealand dollar, Singapore dollar, and South African rand. The Currency Program trades currency futures contracts on the International Monetary Market Division of the Chicago Mercantile Exchange and forward currency contracts in the interbank markets. In order to achieve adequate diversification for the Currency Program, major and minor currencies are traded as crossrates selectively against each other and/or as outrights against the U.S. dollar. As of December 31, 2003 Sunrise Capital Partners was managing approximately $146 million of client assets pursuant to the Currency Program and approximately $1.7 billion of client assets in all of its programs (notional funds excluded). EXCHANGE RIGHT If the conditions described below are satisfied, you may redeem your units in any partnership as of the last day of any calendar month and use the proceeds to purchase units of any of the other Spectrum Series partnerships. However, a Spectrum Series exchange will only be permitted as of the sixth month-end after you first became an investor in any Spectrum Series partnership, and as of the last day of each month thereafter. Each unit you purchase in a Spectrum Series exchange will be issued and sold at a price per unit equal to 100% of the net asset value of a unit as of the close of business on the exchange date. Any units you redeem in a Spectrum Series exchange will not be subject to a redemption charge. Units you acquire in a Spectrum Series exchange will be subject to redemption charges, but will be deemed to have the same purchase date as the units you exchanged for purposes of determining the applicability of any redemption charges. Thus, for example, if you hold units of Spectrum Strategic for 12 months, exchange those units for units of Spectrum Technical, then redeem any of those units 15 months later, you will not have to pay a redemption charge, because those units will be deemed to have been held for 27 months. When you request a Spectrum Series exchange, additional conditions must be satisfied. First, the partnership from which you are redeeming must have assets sufficient to discharge its liabilities and redeem units. In order to effect a Spectrum Series exchange, you must send a subscription agreement to a Morgan Stanley branch office, and that agreement must be received by the general partner at least five business days prior to the applicable exchange date. In that agreement, you must acknowledge that you are still eligible to purchase units on the exchange date. You must exchange a minimum of 50 units in a Spectrum Series exchange, unless you are liquidating your entire interest in a partnership. A form of subscription agreement is annexed to this prospectus as Exhibit B, and additional copies of the subscription agreement may be obtained by written request to the general partner or from a local Morgan Stanley branch office. In order to effect a Spectrum Series exchange, each partnership must have a sufficient number of units registered and qualified for sale under federal and applicable state securities laws pursuant to a current prospectus. While the general partner intends to maintain a sufficient number of registered units to effect series exchanges, it is under no obligation to do so. Therefore, the general partner cannot assure you that any units will be available for sale on an exchange date. Furthermore, states may impose significant burdens on, or alter the requirements for, qualifying units for sale. In that event, the general partner may not continue qualifying units for sale in those states, and residents of those states would not be eligible for a Spectrum Series exchange. In addition, states may impose more restrictive suitability and/or investment requirements than those set forth in the form of subscription agreement. Any such restrictions may limit the ability of residents of those states to effect a Spectrum Series exchange. In the event that not all subscription agreements can be processed because an insufficient number of units is available for sale on an exchange date, the general partner will allocate units in the manner it determines in its sole discretion. The general partner has not yet determined how it will allocate units in the event there are an insufficient number of units available on an exchange date. Units of any new partnership in the Spectrum Series may be offered to investors pursuant to exercise of the Spectrum Series exchange right. Before purchasing units of a new partnership, you will be required to receive a copy of a prospectus and any supplement to this prospectus describing the new partnership and its units, and you will be required to execute a new subscription agreement to purchase units of that partnership. Since a Spectrum Series exchange is equivalent to a redemption and an immediate reinvestment of the proceeds of the redemption, you should carefully review the portions of this prospectus describing redemptions and the tax consequences before effecting a Spectrum Series exchange. REDEMPTIONS Once you are an investor in a Spectrum Series partnership for at least six months, you may redeem all or part of your units, regardless of when such units were purchased. Redemptions may only be made in whole units, with a minimum of 50 units required for each redemption, unless you are redeeming your entire interest in a partnership. The general partner will redeem your units in the order in which they were purchased. Redemptions will only be effective as of the last day of the month in which a request for redemption in proper form has been timely received by the general partner. A "request for redemption" is a letter in the form specified by the general partner that must be sent by you to a local Morgan Stanley branch office and received by the general partner at least 5 business days prior to the redemption date. A form of request for redemption is annexed to the limited partnership agreement, which agreement is annexed to this prospectus as Exhibit A. Additional copies of the request for redemption may be obtained by written request to the general partner or a local Morgan Stanley branch office. If you redeem units, you will receive 100% of the net asset value of each unit redeemed as of the redemption date, less any applicable redemption charges. Since the general partner must receive your request for redemption at least five business days prior to the redemption date, you will not know the actual amount you are to receive prior to the redemption date. The "net asset value" of a unit is an amount equal to the partnership's net assets allocated to capital accounts represented by units, divided by the number of units outstanding. "Net assets" means the total assets of a partnership, including all cash and cash equivalents (valued at cost), accrued interest and amortization of original issue discount, and the market value of all open futures, forwards, and options positions and other assets of the partnership, less the total liabilities of the partnership, including, but not limited to, all brokerage, incentive and management fees, and extraordinary expenses, as determined in accordance with generally accepted accounting principles consistently applied under the accrual basis of accounting. The market value of a futures contract traded on a U.S. exchange means the settlement price on the exchange on which that futures contract is traded on the day net assets are being determined. However, if a futures contract could not have been liquidated on that day because of the operation of daily limits or other rules of the exchange or otherwise, the settlement price on the first subsequent day on which the futures contract could be liquidated will be the market value of that futures contract for that day. The market value of a forward or futures contract traded on a foreign exchange or market means its market value as determined by the general partner on a basis consistently applied for each different variety of forward contract or futures interest. If you redeem units on or prior to the last day of the twelfth month from the date of their purchase, those units will be subject to a redemption charge equal to 2% of their net asset value on the redemption date. If you redeem units after the last day of the twelfth month and on or prior to the last day of the twenty- fourth month from the date of their purchase, those units will be subject to a redemption charge equal to 1% of their net asset value on the redemption date. If you redeem units after the last day of the twenty-fourth month from the date of their purchase, those units will not be subject to a redemption charge. All redemption charges will be paid to Morgan Stanley DW and will not be shared with the financial advisor or additional selling agent who sold the units. Your units will be exempt from redemption charges under the following circumstances: If you redeem units at the first redemption date following notice of an increase in brokerage, management, or incentive fees, those units will not be subject to redemption charges. If you redeem units in a Spectrum Series exchange, the units you redeem will not be subject to redemption charges and, for purposes of determining the applicability of future redemption charges, the units you acquire will be deemed to have the same purchase date as the units you exchanged. If you redeem units of any other partnership for which Demeter serves as the general partner, the units you redeem from the other limited partnership will be subject to any applicable redemption charges, but the Spectrum Series units you purchase will not be subject to redemption charges. If you redeem units and have either paid a redemption charge with respect to the units or held the units for at least 24 months, you will not be subject to redemption charges with respect to any newly purchased units, provided the new units are purchased within twelve months of and in an amount no greater than the net proceeds of the prior redemption, and the units are held for at least six months from the date of purchase. In that event, you will still be subject to the minimum purchase and suitability requirements. The general partner will endeavor to pay redemptions within ten business days after the redemption date. A partnership may be forced to liquidate open futures, forward, and option positions to satisfy redemptions in the event it does not have sufficient cash on hand that is not required as margin on open positions, and may delay payment to limited partners requesting redemption of units of the proportionate part of the net asset value of the unit represented by the sums for which sufficient cash is not available. See "Risk Factors Partnership and Offering Risks Restricted investment liquidity in the units" on page . When you redeem units, payment will be made by credit to your customer account with Morgan Stanley DW, or by check mailed to you if your account is closed. Your right to redeem units is contingent upon the redeeming partnership having assets sufficient to discharge its liabilities on the redemption date, and timely receipt by the general partner of your request for redemption as described above. The terms and conditions applicable to redemptions in general, other than those prohibiting redemptions before the sixth month-end following the closing at which you first became an investor in a Spectrum Series partnership, and providing that redemptions may only be made as of the end of a calendar month, will also apply to redemptions effected on "special redemption dates." See "The Limited Partnership Agreements Books and Records; Reports to Limited Partners" on page . THE COMMODITY BROKERS Morgan Stanley DW Inc., Morgan Stanley & Co. Incorporated, and Morgan Stanley & Co. International Limited Morgan Stanley DW Inc., a Delaware corporation, acts as the partnerships' non-clearing commodity broker. Morgan Stanley DW, as the non-clearing commodity broker, holds each partnership's funds in customer segregated or secured accounts, and provides all required margin funds to the clearing commodity brokers. Morgan Stanley & Co. Incorporated, a Delaware corporation, acts as the partnerships' clearing commodity broker and foreign currency forward counterparty, and Morgan Stanley & Co. International Limited serves as the clearing commodity broker for trades that take place on the London Metal Exchange. Morgan Stanley DW monitors each partnership's futures positions that the clearing commodity brokers report they are carrying for any errors in trade prices or trade fill. Morgan Stanley DW also serves as the non-clearing commodity broker for all, and Morgan Stanley & Co. serves as the clearing commodity broker and foreign exchange counterparty for all but one, of the other commodity pools for which Demeter serves as general partner and commodity pool operator. Morgan Stanley International serves as the clearing commodity broker for the trades of such pools that take place on the London Metal Exchange. Morgan Stanley DW is a financial services company which provides to its individual, corporate, and institutional clients services as a broker in securities, futures, and options, a dealer in corporate, municipal and government securities, an investment adviser, and an agent in the sale of life insurance and various other products and services. Morgan Stanley DW has its main business office at 1585 Broadway, New York, New York 10036. Morgan Stanley DW is a member firm of the New York Stock Exchange, the American Stock Exchange, the Chicago Board Options Exchange, and other major securities exchanges. Morgan Stanley DW is registered with the CFTC as a futures commission merchant and is a member of the National Futures Association in such capacity. Morgan Stanley DW is also registered with the SEC as a broker-dealer and is a member of the NASD. Morgan Stanley DW and its affiliates currently service clients through a network of approximately 700 offices with approximately 12,000 financial advisors servicing individual and institutional client accounts. Morgan Stanley & Co. Incorporated is the clearing commodity broker for all trades for the partnerships, other than for those trades on the London Metal Exchange. Morgan Stanley & Co. has its main business office at 1585 Broadway, New York, New York 10036. Morgan Stanley & Co. is registered as a futures commission merchant, is a member of the National Futures Association, and is a member of most major U.S. and foreign commodity exchanges. Morgan Stanley & Co. is registered with the SEC as a broker-dealer and is a member of the NASD. Morgan Stanley & Co. International Limited, a United Kingdom corporation, acts as the partnerships' clearing commodity broker solely with regard to any trading on the London Metal Exchange. Morgan Stanley International has its main business office at 25 Cabot Square, Canary Wharf, London E14 4QA, England, is regulated by the United Kingdom Securities and Futures Authority as a member firm, and is a member of the London Metal Exchange and other securities and commodities exchanges worldwide. Morgan Stanley, the parent company of Morgan Stanley DW, Morgan Stanley & Co. and Morgan Stanley International, is a worldwide financial services firm, employing, directly and through its subsidiaries, more than 51,000 people worldwide in offices throughout the United States and 28 foreign countries. Morgan Stanley is a publicly-traded company listed on the New York Stock Exchange; its common stock had a market value of approximately $60 billion at November 30, 2003. At that date, Morgan Stanley had leading market positions in its three primary businesses (securities, asset management and credit services), and it ranked among the top asset managers globally, with over $462 billion in assets under management. Brokerage Arrangements The partnerships' brokerage arrangements with Morgan Stanley DW, Morgan Stanley & Co. and Morgan Stanley International are discussed in "Conflicts of Interest The brokerage arrangements with affiliates of the general partner were not negotiated at arm's-length or reviewed by any independent party for fairness" on page , " Customer agreements with the commodity brokers permit actions which could result in losses or lost profit opportunity" on page , and "Description of Charges Commodity Brokers" beginning on page . The general partner will review at least annually the brokerage arrangements of each partnership to ensure that those arrangements are fair, reasonable, and competitive, and represent the best price and services available, taking into consideration: the size of the partnership; the futures, forwards, and options trading activity; the services provided by the commodity brokers or any affiliate thereof to the partnership; the cost incurred by the commodity brokers or any affiliate thereof in organizing and operating the partnership and offering units; the overall costs to the partnership; any excess interest and compensating balance benefits to the commodity brokers from assets held thereby; and if the general partner does not receive any direct compensation from the partnership for its services as general partner, the risks incurred by the general partner as general partner of the partnership; Each customer agreement sets forth a standard of liability for the commodity broker and provides for indemnities of the commodity broker. See "Fiduciary Responsibility and Liability" beginning on page 17. LITIGATION At any given time, the commodity brokers are involved in numerous legal actions, some of which seek significant damages. On January 11, 1999 the SEC brought an action against 28 NASDAQ market makers, including Morgan Stanley & Co., and 51 individuals, including one current and one former trader employed by Morgan Stanley & Co., for certain conduct during 1994. The core of the charges against Morgan Stanley & Co. concerns improper or undisclosed coordination of price quotes with other broker-dealers and related reporting, recordkeeping, and supervisory deficiencies in violation of Sections 15(b)(4)(E), 15(c)(1) and (2) and 17(a) of the Securities Exchange Act and Rules 15c1-2, 15c2-7 and 17a-3 promulgated thereunder. Without admitting or denying the charges, Morgan Stanley & Co., consented to the entry of a cease and desist order and to the payment of a civil penalty of $350,000, disgorgement of $4,170, and to submit certain of its procedures to an independent consultant for review. In addition, one current and one former trader employed by Morgan Stanley & Co. accepted suspensions of less than two months each and were fined $25,000 and $30,000, respectively. On April 6, 2000, Morgan Stanley & Co., along with 16 other firms, entered into an industry-wide settlement with the SEC, IRS and the Department of Justice (intervening on behalf of a qui tam plaintiff) to resolve litigation and investigations relating to "yield burning" allegations. At the core of the "yield burning" litigation and investigations were allegations that, from 1990 to 1994, escrow providers excessively marked up securities sold to escrow accounts in connection with advance refunding transactions on behalf of municipal bond issuers. The practice was alleged to benefit the escrow provider to the detriment of either the United States Treasury or the municipal issuer. The industry-wide settlement required 17 firms to pay a total of over $139 million (over $120 million to the United States Treasury and over $18 million directly to municipal issuers). Without admitting or denying any wrongdoing, Morgan Stanley & Co. consented to the entry of an order directing that it cease and desist from violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and requiring it to pay $2.45 million to the United States Treasury. No payment to municipal issuers was required. On July 14, 2003, the Massachusetts Securities Division filed an administrative complaint alleging that Morgan Stanley DW Inc. filed false information in response to an inquiry from the Massachusetts Securities Division pertaining to mutual fund sales practices. On August 11, 2003, the Massachusetts Securities Division filed an administrative complaint, alleging that Morgan Stanley DW Inc. failed to make disclosures of incentive compensation for proprietary and partnered mutual fund transactions. On November 25, 2003, the Massachusetts Securities Division filed an administrative complaint, alleging that a former branch manager engaged in securities fraud and dishonest conduct in promoting the sales of proprietary mutual funds. Morgan Stanley DW Inc. answered the first two complaints on August 4 and September 16, 2003, respectively. Hearings on all of these matters are scheduled to commence on May 17, 2004. On September 15, 2003, Morgan Stanley DW Inc. and one of its officers entered into a settlement with the NASD pursuant to a Letter of Acceptance, Waiver and Consent. The Letter of Acceptance, Waiver and Consent alleges violations of applicable NASD rules in connection with various sales contests conducted from October 1999 to December 2002. Under the terms of the settlement, Morgan Stanley DW Inc. and its officer neither admitted nor denied the allegations of the Letter of Acceptance, Waiver and Consent and accepted a censure and the imposition of monetary fines in the amounts of $2 million and $250,000, respectively. On November 17, 2003, Morgan Stanley DW Inc. consented, without admitting or denying the findings, to the entry of an order by the Securities and Exchange Commission that resolved the Securities and Exchange Commission's investigations into certain practices relating to Morgan Stanley DW Inc.'s offer and sale of shares of certain registered investment companies from January 1, 2000 to the date of the order. Pursuant to the order, Morgan Stanley DW Inc. will: (a) distribute for the benefit of certain customers who purchased shares of mutual funds through Morgan Stanley DW Inc. pursuant to the marketing arrangements between Morgan Stanley DW Inc. and certain mutual fund complexes the amount of $50 million; (b) place on its website disclosures relating to certain marketing programs pursuant to which it offered and sold certain mutual funds; (c) prepare a Mutual Fund Bill of Rights that discloses, among other things, the differences in fees and expenses associated with the purchase of different classes or proprietary mutual fund shares; (d) prepare a plan by which certain customers' proprietary Class B shares can be converted to Class A shares; (e) retain an independent consultant to review, among other things, the adequacy of Morgan Stanley DW Inc.'s disclosures with respect to such marketing programs and other matters in connection with Morgan Stanley DW Inc.'s offer and sale of shares of mutual funds and compliance with the order; and (f) adopt the recommendations of the independent consultant. The number of purchase transactions of Class B shares that will be eligible to convert shares is approximately 8,000. The ultimate financial impact on Morgan Stanley DW Inc. of these conversions will depend on many variables, including the number of eligible purchasers who elect to convert to Class A shares (which carry different fees) and the terms of the conversion (which must be acceptable to the independent consultant). During the five years preceding the date of this prospectus, other than as described above, there have been no material criminal, civil, or administrative actions pending, on appeal, or concluded against the commodity brokers, the general partner, or any of their principals, which the general partner believes would be material to an investor's decision to invest in the partnerships. THE LIMITED PARTNERSHIP AGREEMENTS This section of the prospectus summarizes all material provisions of the limited partnership agreement of each partnership that are not discussed elsewhere in the prospectus. A form of the limited partnership agreements is annexed to the prospectus as Exhibit A. Each limited partnership agreement is identical, except as noted otherwise below or in Exhibit A. Capsule II Performance of Spectrum Technical Type of pool: publicly-offered fund Inception of trading: November 1994 Aggregate subscriptions: $589,811,774 Current capitalization: $538,184,278 Current net asset value per unit: $22.64 Worst monthly % drawdown past five years: (15.59)% (November 2001) Worst monthly % drawdown since inception: (15.59)% (November 2001) Worst month-end peak-to-valley drawdown past five years: (26.57)% (13 months, April 2001-April 2002) Worst month-end peak-to-valley drawdown since inception: (26.57)% (13 months, April 2001-April 2002) Cumulative return since inception: 126.40% Monthly Performance Nature of the Partnerships Spectrum Select was formed on March 21, 1991; Spectrum Technical, Spectrum Strategic, and Spectrum Global Balanced were each formed on April 29, 1994; and Spectrum Currency was formed on October 20, 1999. Each partnership was formed under Delaware law. The fiscal year of each partnership begins on January 1 of each year and ends on the following December 31. The units that you purchase and pay for in this offering will be fully paid and nonassessable. You may be liable to a partnership for liabilities that arose before the date of a redemption or Spectrum Series exchange. Your liability, however, will not exceed the sum of your unredeemed capital contribution, undistributed profits, if any, any distributions and amounts received upon a redemption or deemed received on a Spectrum Series exchange, together with interest on any such amount. However, a partnership will not make a claim against you for any amounts received in connection with a redemption of units or a Spectrum Series exchange unless the net assets of the partnership are insufficient to discharge the liabilities of the partnership that arose before any distributions were made to you. The general partner will be liable for all obligations of a partnership to the extent that the assets of the partnership are insufficient to pay those obligations. Management of Partnership Affairs You will not participate in the management or operations of a partnership. Under each limited partnership agreement, the general partner is solely responsible for managing the partnership. The general partner may use a partnership's funds only to operate the business of that partnership. The general partner may hire an affiliate to perform services for the partnership if the general partner determines that the affiliate is qualified to perform the services, and can perform those services under competitive terms that are fair and reasonable. Any agreement with an affiliate must be for a term not in excess of one year and be terminable by the partnership without penalty upon 60 days' prior written notice. Other responsibilities of the general partner include: determining whether a partnership will make a distribution; administering redemptions and series exchanges; preparing monthly and annual reports; preparing and filing tax returns for each partnership; signing documents on behalf of each partnership and its limited partners pursuant to powers of attorney; and supervising the liquidation of a partnership, if necessary. Sharing of Profits and Losses You will have a capital account in each partnership in which you invest, with an initial balance equal to the amount you paid for units of the partnership. The general partner also has a capital account. Each partnership's net assets will be calculated monthly, and your capital account will be adjusted as necessary to reflect any increases or decreases that may have occurred since the preceding month. Profits and losses will be shared by the general partner and limited partners in proportion to the size of their respective capital accounts. For a description of the federal tax allocations, see "Material Federal Income Tax Considerations Partnership Taxation Allocation of Partnership Profits and Losses" on page 129. Restrictions on Transfers or Assignments While you may transfer or assign your units, the transferee or assignee may not become a limited partner without the written consent of the general partner. You may only withdraw capital or profits from a partnership by redeeming units. The general partner may withdraw any portion of its interest in a partnership that exceeds the amount required under the limited partnership agreement without prior notice to or consent of the limited partners. In addition, the general partner may withdraw or assign its entire interest in a partnership if it gives 120 days' prior written notice to the limited partners. If a Month majority of the limited partners elect a new general partner or partners to continue the business of the partnership, the withdrawing general partner must pay all reasonable expenses incurred by the partnership in connection with its withdrawal. Any transfer or assignment of units by you will take effect at the end of the month in which the transfer or assignment is made, subject to the following conditions. A partnership is not required to recognize a transfer or assignment until it has received at least 30 days' prior written notice from the limited partner. The notice must be signed by the limited partner and include the address and social security or taxpayer identification number of the transferee or assignee and the number of units transferred or assigned. A transfer or assignment of less than all units held by you cannot occur if as a result either party to the transfer or assignment would own fewer than the minimum number of units required for an investment in the partnership (subject to certain exceptions relating to gifts, death, divorce, or transfers to family members or affiliates). The general partner will not permit a transfer or assignment of units unless it is satisfied that the transfer or assignment would not be in violation of Delaware law or applicable federal, state, or foreign securities laws; and notwithstanding the transfer or assignment, the partnership will continue to be classified as a partnership rather than as an association taxable as a corporation under the Internal Revenue Code of 1986, as amended. No transfer or assignment of units will be effective or recognized by a partnership if the transfer or assignment would result in the termination of that partnership for federal income tax purposes, and any attempt to transfer or assign units in violation of the limited partnership agreement will be ineffective. The limited partner must pay all costs, including any attorneys' and accountants' fees, related to a transfer or assignment. Amendments; Meetings Each limited partnership agreement may be amended by the general partner and by limited partners owning more than 50% of the units of that partnership. In addition, the general partner may make certain amendments to a limited partnership agreement without the consent of the limited partners, including any amendment that is not adverse to the limited partners or is required by the staff of the SEC, the CFTC, any other federal agency, any state "Blue Sky" official, or other governmental official, or to comply with applicable law. However, no amendment may be made to a limited partnership agreement without the consent of all partners affected if that amendment would reduce the capital account of any partner, modify the percentage of profits, losses, or distributions to which any partner is entitled, or change or alter the provisions of the limited partnership agreement relating to amendments requiring the consent of all partners. Upon written request to the general partner delivered either in person or by certified mail, you or your authorized attorney or agent may obtain a list of the names and addresses of, and units owned by, all limited partners in your partnership, provided that you pay reasonable duplicating and postage costs. Limited partners owning at least 10% of the units of a partnership may request a meeting to consider any matter upon which limited partners may vote. Upon receipt of such a request, the general partner must call a meeting of that partnership, by written notice sent by certified mail or delivered in person within 15 days of such request. The meeting must be held at least 30 but not more than 60 days after the mailing by the general partner of notice of the meeting. The notice must specify the date, a reasonable place and time, and the purpose of the meeting. At any meeting of the limited partners, the following actions may be taken upon the affirmative vote of limited partners owning more than 50% of the units: amend the limited partnership agreement; dissolve the partnership; remove and replace the general partner; elect a new general partner or general partners if the general partner terminates or liquidates or elects to withdraw from the partnership, or becomes insolvent, bankrupt, or is dissolved; terminate any contract with the general partner or any of its affiliates on 60 days' prior written notice; and approve the sale of all or substantially all of the assets of the partnership. Any of the foregoing actions may also be taken by limited partners without a meeting, without prior notice, and without a vote, by means of written consents signed by limited partners owning the required number of units. Notice of any actions taken by written consent must be given to non-consenting limited partners within seven business days. Books and Records; Reports to Limited Partners The books and records of each partnership are maintained at its principal office for at least five years. You or your authorized attorney or agent will have the right during normal business hours to inspect and copy the books and records of each partnership of which you are a limited partner. Alternatively, you may request that copies of the books and records be sent to you, provided that you pay all reasonable reproduction and distribution costs. The partnership will retain copies of subscription documentation in connection with purchases and exchanges of units for at least six years. Within 30 days after the close of each calendar month, the general partner will provide such financial and other information with respect to each partnership as the CFTC and National Futures Association, from time to time, may require, together with information concerning any material change in the brokerage commissions or fees payable by the partnerships to any commodity broker. You will also receive within 90 days after the close of each fiscal year an annual report containing audited financial statements for the partnerships. Annual reports will provide a detailed statement of any transactions with the general partner or its affiliates and of fees, commissions, and any compensation paid or accrued to the general partner or its affiliates. By March 15 of each year, the partnership will provide you with the tax information necessary for you to prepare your federal income tax return. The net asset value of each partnership's units, which is estimated daily by the general partner, will be promptly supplied to you upon written request. A written notice, including a description of limited partners' redemption and voting rights, will be mailed to the limited partners of a partnership within seven business days if any of the following events occur: the net asset value of a unit decreases by at least 50% from the net asset value of that unit as of the end of the immediately preceding month; the limited partnership agreement is materially amended; there is any change in trading advisors or any material change in a management agreement; there is any change in commodity brokers or any material change in the compensation arrangements with a commodity broker; there is any change in general partners or any material change in the compensation arrangements with a general partner; there is any change in the partnership's fiscal year; there is any material change in the partnership's trading policies as specified in the limited partnership agreement; or the partnership ceases to trade futures, forwards, and options. If you receive a notice as to a 50% decrease in net asset value per unit, that notice will also advise you that a "special redemption date" will take place when limited partners may redeem their units in the same manner as described under "Redemptions" beginning on page 117 for regular redemption dates. Further, following the close of business on the date of the 50% decrease giving rise to that notice, the partnership will liquidate all existing positions as promptly as reasonably practicable, and will suspend all futures, forwards, and options trading through the special redemption date. The general partner will then determine whether to reinstitute futures, forwards, and options trading or to terminate the partnership. In addition, subject to limits imposed under state guidelines incorporated in the limited partnership agreements, no increase in any of the management, incentive, or brokerage fees payable by the partnerships, or any of the caps on fees, may take effect until the first business day following a redemption date. In the event of such an increase: notice of the increase will be mailed to limited partners at least five business days prior to the last date on which a "request for redemption" must be received by the general partner with respect to the applicable redemption date; the notice will describe the redemption and voting rights of limited partners; and units redeemed at the first redemption date following the notice will not be subject to any redemption charges. Each limited partner expressly agrees that in the event of his death, he waives on behalf of himself and his estate the furnishing of any inventory, accounting, or appraisal of the assets of the partnership and any right to an audit or examination of the books of the partnership. PLAN OF DISTRIBUTION General Morgan Stanley DW is offering units pursuant to a selling agreement with the partnerships and the general partner. This offering is being conducted in accordance with the provisions of Rule 2810 of the Conduct Rules of the NASD. With the approval of the general partner, Morgan Stanley DW may appoint additional selling agents to make offers and sales of the units. These additional selling agents may include any securities broker which is a member in good standing of the NASD, as well as any foreign bank, dealer, institution, or person ineligible for membership in the NASD that agrees not to make any offers or sales of units within the U.S. or its territories, possessions, or areas subject to its jurisdiction, or to U.S. citizens or residents. Any such non-NASD member must also agree to comply with applicable provisions of the Conduct Rules of the NASD in making offers and sales of units. Morgan Stanley DW is offering the units on a "best efforts" basis without any agreement by Morgan Stanley DW to purchase units. The general partner may in the future register additional units of any partnership with the SEC. There is no maximum amount of funds which may be contributed to a partnership. The general partner may in the future subdivide or combine outstanding units of any partnership, in its discretion, provided that any subdivision or combination will not affect the net asset value of any limited partner's interest in the partnership. Each partnership has agreed to indemnify its trading advisors in connection with the offer and sale of units with respect to any misleading or untrue statement or alleged misleading or untrue statement of a material fact or material omission or alleged omission unrelated to its trading advisor(s). Each partnership has also agreed to indemnify Morgan Stanley DW, the general partner and any additional sellers in connection with the offer and sale of units. See "Fiduciary Responsibility and Liability" beginning on page . Continuing Offering Units of each partnership are being offered for sale at monthly closings held on the last day of each month. Units will be offered and sold at the net asset value of a unit of the partnership on the date of the monthly closing. Since you must subscribe for units prior to the month end closing date, you will not know the actual per unit purchase price until after the monthly closing has occurred. The sale amount will be delivered to the partnership that sold the unit. Escrow Arrangements During the continuing offering, if your subscription is not immediately rejected by the general partner, your subscription funds will be transferred to, and held in escrow by, JPMorgan Chase Bank, New York, New York. These subscription funds held in escrow will be invested in the escrow agent's interest-bearing money market account, and will earn the interest rate then paid by the bank on that account. If the general partner accepts your subscription, at the applicable month-end closing the escrow agent will pay your subscription funds to the appropriate partnership(s) and pay any interest earned on those funds to Morgan Stanley DW. Morgan Stanley DW in turn will credit your Morgan Stanley DW customer account with the interest. If the general partner rejects a subscription, the escrow agent will promptly pay the rejected subscription funds and any interest earned to Morgan Stanley DW, and Morgan Stanley DW will then credit your Morgan Stanley DW customer account with those amounts, and the funds will be immediately available for investment or withdrawal. If you closed your Morgan Stanley DW customer account, any subscription returned and interest earned will be paid by check. Interest will be earned on subscription funds from the day of deposit with the escrow agent to the day that funds are either paid to the appropriate partnership(s) in the case of accepted subscriptions or paid to Morgan Stanley DW in the case of rejected subscriptions. At all times during the continuing offering, and prior to each closing, subscription funds will be in the possession of the escrow agent, and at no time will the general partner hold or take possession of the funds. Compensation to Morgan Stanley DW Employees and Additional Selling Agents Except as described below, qualified employees of Morgan Stanley DW will receive from Morgan Stanley DW (payable solely from its own funds) a gross sales credit equal to 3% of the net asset value per unit as of the closing for each unit sold by them and issued at the closing. In addition, Morgan Stanley DW will continue to compensate such employees who continue to render services to limited partners with a gross sales credit of up to 86% of the brokerage fees received by Morgan Stanley DW from a partnership each month that are attributable to outstanding units sold by them. This compensation will begin: in the case of Spectrum Select, Spectrum Technical, and Spectrum Strategic, with the seventh month following the closing at which a unit was issued; in the case of Spectrum Global Balanced and Spectrum Currency, with the tenth month following the closing at which a unit was issued; the first month after a unit is issued pursuant to a non-series exchange; or the month as of which such continuous compensation is first payable with respect to units purchased in a Spectrum Series exchange, but with the seventh or tenth month measured from the date the subscriber first became a limited partner in a Spectrum Series partnership. In all cases, qualified Morgan Stanley DW employees will receive continuing compensation until the applicable partnership terminates or the unit is redeemed, whichever comes first. No part of this compensation will be paid by the partnership and, accordingly, net assets will not be reduced as a result of such compensation. Each person receiving continuing compensation must be a Morgan Stanley DW employee at the time of receipt of payment and must be registered as an associated person with the CFTC and be a member of the National Futures Association in such capacity only after either having passed the Series 3 or Series 31 examination or having been "grandfathered" as an associated person qualified to do commodity brokerage under the Commodity Exchange Act and the CFTC's regulations. These employees must also perform additional services, including: (a)inquiring of the general partner from time to time, at the request of limited partners, as to the net asset value of each partnership's units; (b)inquiring of the general partner, at the request of limited partners, regarding the futures, forwards, and options markets and the activities of the partnerships; (c)responding to questions of limited partners with respect to the monthly account statements, annual reports, financial statements, and annual tax information furnished periodically to limited partners; (d)providing advice to limited partners as to when and whether to make additional investments or to redeem or exchange units; (e)assisting limited partners in the redemption or exchange of units; and (f)providing such other services as limited partners from time to time may reasonably request. The additional compensation paid by Morgan Stanley DW may be deemed to be underwriting compensation. In addition, certain officers and directors of the general partner may receive compensation as employees of Morgan Stanley DW based, in part, on the amount of brokerage fees paid by the partnerships to Morgan Stanley DW. The selling agreement among Morgan Stanley DW, the general partner, and the partnerships provides that this compensation may only be paid by Morgan Stanley DW as long as continuing services are provided. Any limited partner may telephone, write, or visit a financial advisor at a Morgan Stanley branch office to avail himself of such services. Morgan Stanley DW will not pay its employees the 3% initial gross sales credit described above with respect to units purchased pursuant to a Spectrum Series exchange or non-Spectrum Series exchange. Such employees will, however, receive continuing gross sales credits with respect to brokerage fees received by Morgan Stanley DW from a partnership at the applicable rate. In the case of an investor who previously redeemed units in a Spectrum Series or non-Spectrum Series partnership and paid a redemption charge or held those units for at least 24 months, and invests in the Spectrum Series within 12 months of the redemption of the old units, the Morgan Stanley DW employee will not receive the initial gross sales credit of 3% but will receive a monthly gross sales credit of up to 86% of the brokerage fees received by Morgan Stanley DW from the partnership each month that are attributable to such units commencing the first month after the units are issued. Morgan Stanley DW may at any time implement cash sales incentive and/or promotional programs for its employees who sell units. These programs will provide for Morgan Stanley DW, and not any partnership or the general partner, to pay Morgan Stanley DW's employees bonus compensation based on sales of units. Any sales or promotional program will be approved by the NASD prior to its start. The aggregate of all compensation paid to employees of Morgan Stanley DW from the initial 3% gross sales credit, the redemption charges received by Morgan Stanley DW, and any sales incentives will not exceed 10% of the proceeds of the sale of units. Morgan Stanley DW may compensate any qualified additional selling agents for each unit sold by it by paying a selling commission, from Morgan Stanley DW's own funds, as determined by Morgan Stanley DW and the additional selling agents, but not to exceed 3% of the net asset value of the unit sold. Additional selling agents who are properly registered as futures commission merchants or introducing brokers with the CFTC and are members of the National Futures Association in such capacity may also receive from Morgan Stanley DW, payable from Morgan Stanley DW's own funds, continuing compensation for providing to limited partners the continuing services described above. This additional compensation paid by Morgan Stanley DW may be up to 42% of the brokerage fees generated by outstanding units sold by additional selling agents and received by Morgan Stanley DW as commodity broker for each partnership (except for employees of affiliates of Morgan Stanley DW, who will be compensated at the same rate as employees of Morgan Stanley DW). Additional selling agents may pay all or a portion of such additional compensation to their employees who have sold units and provide continuing services to limited partners if those employees are properly registered with the CFTC and are members of the National Futures Association. Additional compensation paid by Morgan Stanley DW may be deemed to be underwriting compensation. SUBSCRIPTION PROCEDURE The minimum subscription for most subscribers is $5,000, except that the minimum subscription is: $2,000 in the case of an IRA; or for eligible subscribers purchasing units pursuant to a non-Spectrum Series exchange, the lesser of $5,000, the proceeds from the redemption of 5 units, or 2 units in the case of an IRA, from commodity pools other than any of the Morgan Stanley Charter Series of partnerships, the proceeds from the redemption of 500 units, or 200 units in the case of an IRA, from any Charter Series partnership, or the proceeds from the redemption of such subscriber's entire interest in any other commodity pool for which the general partner serves as general partner and commodity pool operator. A subscription may be for units of one partnership, or may be divided among two or more partnerships, provided that: in the case of a new subscription, the minimum subscription for any one partnership is $1,000; and in the case of a non-Spectrum Series exchange, the minimum subscription for any one partnership is the proceeds of the redemption of 1 unit of the other commodity pool, or 100 units in the case of any Morgan Stanley Charter Series partnership. If you already own units in a partnership and you wish to make an additional investment in the same partnership, you may subscribe for units at a monthly closing with a minimum investment in that partnership of $500. In order to make your first purchase of units of a partnership, other than by means of an exchange, you must complete, sign, and deliver to Morgan Stanley DW a subscription agreement which will authorize the general partner and Morgan Stanley DW to transfer the full subscription amount from your Morgan Stanley DW customer account to the partnership's Escrow Account. If your subscription agreement is received by Morgan Stanley DW and not immediately rejected, you must have the appropriate amount in your Morgan Stanley DW customer account on the first business day following the date that your subscription agreement is received by Morgan Stanley DW. Morgan Stanley DW will deduct the subscription amount from your customer account and transfer funds into escrow with the escrow agent on that date. If you do not have a Morgan Stanley DW customer account or an account with an affiliate of Morgan Stanley DW, or do not have sufficient funds in your existing Morgan Stanley DW customer account, you should make appropriate arrangements with your Morgan Stanley financial advisor, or contact your local Morgan Stanley branch office. Do not mail any payment to the general partner, as it will be returned to you for proper placement with the Morgan Stanley branch office where your account is maintained. In the case of a Spectrum Series exchange or a non-Spectrum Series exchange, you must complete, sign, and deliver to your Morgan Stanley financial advisor a subscription agreement, which will authorize the general partner to redeem all or a portion of your interest in a partnership or another commodity pool for which the general partner serves as general partner and commodity pool operator, subject to terms of the applicable limited partnership agreement, and to use the proceeds, after deducting any applicable redemption charges, to purchase units in one or more of the partnerships. In accordance with an NASD rule, Morgan Stanley DW will not subscribe for units on your behalf if it has discretionary authority over your customer account, unless it gets prior written approval from you. If you subscribe by check, units will be issued subject to the collection of the funds represented by the check. If your check is returned unpaid, Morgan Stanley DW will notify the general partner, and the relevant partnership will cancel the units issued to you represented by the check. Any losses or profits sustained by the partnership allocable to the cancelled units will be allocated among the remaining partners. In the limited partnership agreements, each limited partner agrees to reimburse a partnership for any expense or loss (including any trading loss) incurred in connection with the issuance and cancellation of any units issued to the limited partner. Subscriptions for units are generally irrevocable by subscribers. However, you may revoke your subscription agreement and receive a full refund of the subscription amount and any accrued interest, or revoke the redemption of units in the other commodity pool in the case of an exchange, within five business days after execution of the subscription agreement or no later than 3:00 P.M., New York City time, on the date of the applicable monthly closing, whichever comes first, by delivering written notice to your Morgan Stanley financial advisor. There may be other rescission rights under applicable federal and state securities laws. The general partner may reject any subscription, in whole or in part, in its sole discretion. A sample form of the subscription agreement is annexed to this prospectus as Exhibit B. A separate copy of the subscription agreement accompanies this prospectus or you may obtain one, after delivery of this prospectus, from a local Morgan Stanley branch office. You will not receive any certificate evidencing units, but you will be sent confirmations of purchases in Morgan Stanley DW's customary form. Once you are an investor in a partnership, you may make additional cash purchases of units of that partnership without executing a new subscription agreement, by completing a subscription agreement update form, a sample of which is annexed to this prospectus as Exhibit C, and by contacting your Morgan Stanley financial advisor and authorizing your financial advisor to deduct the additional amount you want to invest from your Morgan Stanley DW customer account. Those amounts will be held in escrow, and applied towards the purchase of units, in the same manner as initial purchases described above. However, if a new prospectus has been issued since the date of your immediately prior subscription agreement, you will be required to complete a new subscription agreement update form. Further, your Morgan Stanley financial advisor will be required to confirm to the general partner that the information you provided, and the representations and warranties you made, in your original subscription agreement, including, in particular, that you satisfy applicable minimum financial suitability requirements, are still true and correct. You may not use the subscription procedure described in this paragraph to purchase additional units in a partnership by way of an exchange, or to purchase units of a partnership in which you are not currently an investor; in either of those cases, you must execute a new subscription agreement. PURCHASES BY EMPLOYEE BENEFIT PLANS ERISA CONSIDERATIONS Units might or might not be a suitable investment for an employee benefit plan. If you are a person with investment discretion on behalf of an employee benefit plan, before proceeding with a purchase of units, you should determine whether the purchase of units is permitted under the governing instruments of the plan, and is appropriate for that particular plan in view of its overall investment policy, the composition and diversification of its portfolio, and the other considerations discussed below. As used in this section, the term "employee benefit plans" refers to plans and accounts of various types, including their related trusts, which provide for the accumulation of a portion of an individual's earnings or compensation, as well as investment income earned thereon, typically free from federal income tax until such time as funds are distributed from the plan. These plans include corporate pension and profit-sharing plans, such as so-called "401( k)" plans, "simplified employee pension plans," so-called "Keogh" plans for self-employed individuals (including partners), and, for purposes of this discussion, individual retirement accounts, as described in Section 408 of the Internal Revenue Code of 1986, as amended. Notwithstanding the general requirement that investors in one or more partnerships must invest a minimum of $5,000, a minimum purchase requirement of $2,000 has been set for IRAs. The minimum subscription for any one of the partnerships must be at least $1,000. Greater minimum purchases may be mandated by the securities laws and regulations of certain states, and each investor should consult the subscription agreement to determine the applicable investment requirements. If the assets of an investing employee benefit plan were to be treated, for purposes of the reporting and disclosure provisions and certain other of the fiduciary responsibility provisions of Title I of the Employee Retirement Income Security Act of 1974, as amended, and Section 4975 of the Internal Revenue Code of 1986, as including an undivided interest in each of the underlying assets of a partnership, an investment in units would in general be an inappropriate investment for the plan. A U.S. Department of Labor regulation defines "plan assets" in situations where employee benefit plans purchase equity securities in investment entities such as a partnership. The regulation provides that the assets of an entity will not be deemed to be "plan assets" of an employee benefit plan which purchases an equity security of the entity if the equity security is a "publicly-offered security." A "publicly-offered security" is one which is: freely transferable; held by more than 100 investors independent of the issuer and of each other; and either registered under Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934, or sold to the plan as part of a public offering of such securities pursuant to an effective registration statement under the Securities Act of 1933, where the security is then timely registered under Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934. The units currently meet, and it is expected that the units will continue to meet, the criteria of the Regulation. The general partner believes, based upon the advice of its legal counsel, that income earned by the partnerships will not constitute "unrelated business taxable income" under Section 512 of the Internal Revenue Code of 1986 to employee benefit plans and other tax-exempt entities. Although the Internal Revenue Service has issued favorable private letter rulings to taxpayers in somewhat similar circumstances, other taxpayers may not use or cite such rulings as precedent. If you have investment discretion on behalf of an employee benefit plan, you should consult a professional tax adviser regarding the application of the foregoing matters to the purchase of units. Units may not be purchased with the assets of an employee benefit plan if the general partner, Morgan Stanley DW, any additional selling agents, any trading advisor, or any of their respective affiliates either: has investment discretion with respect to the investment of such plan assets; has authority or responsibility to give or regularly gives investment advice with respect to such plan assets for a fee and pursuant to an agreement or understanding that such advice will serve as a primary basis for investment decisions with respect to the plan assets and that such advice will be based on the particular investment needs of the plan; or is an employer maintaining or contributing to such plan. Subscribing for units does not create an IRA or other employee benefit plan. If you are considering the purchase of units on behalf of an IRA or other employee benefit plan, you must first ensure that the plan has been properly established in accordance with the Internal Revenue Code of 1986 and ERISA and the regulations and administrative rulings thereunder, and that the plan has been adequately funded. Then, after all of the considerations discussed above have been taken into account, the trustee or custodian of a plan who decides to or who is instructed to do so may subscribe for units in one or more of the partnerships, subject to the applicable minimum subscription requirement per partnership. Acceptance of subscriptions on behalf of IRAs or other employee benefit plans is in no respect a representation by the general partner, Morgan Stanley DW, any additional selling agents, any partnership, or any trading advisor that the investment meets all relevant legal requirements with respect to investments by plans generally or any particular plan, or that the investment is appropriate for plans generally or any particular plan. MATERIAL FEDERAL INCOME TAX CONSIDERATIONS Introduction The general partner has been advised by counsel, Cadwalader, Wickersham & Taft LLP, that in its opinion, the following summary correctly describes the material federal income tax consequences to a U.S. taxpayer who invests in a partnership. The opinions appearing in this section are the opinions of Cadwalader, Wickersham & Taft LLP, except as otherwise specifically noted. The following summary is based upon the Internal Revenue Code of 1986, rulings thereon, regulations promulgated thereunder, and existing interpretations thereof, any of which could be changed at any time and which changes could be retroactive. The federal income tax summary and the state and local income tax summary that follow, in general, relate only to the tax implications of an investment in the partnerships by individuals who are citizens or residents of the U.S. Except as indicated below or under "Purchases by Employee Benefit Plans-ERISA Considerations," the summaries do not address the tax implications of an investment in the partnerships by corporations, partnerships, trusts, and other non-individuals. Moreover, the summaries are not intended as a substitute for careful tax planning, particularly since certain of the tax consequences of owning an interest in the partnerships may not be the same for all taxpayers, such as non-individuals or foreign persons, or in light of an investor's personal investment circumstances. A complete discussion of all federal, state, and local tax aspects of an investment in each partnership is beyond the scope of the following summary, and prospective investors are urged to consult their own tax advisors on these matters. Partnership Status The general partner has been advised by its legal counsel, Cadwalader, Wickersham & Taft LLP, that in its opinion under current federal income tax law, each partnership will be classified as a partnership and not as an association (or a publicly traded partnership) taxable as a corporation. This opinion is based upon the facts set forth in this prospectus, including that a principal activity of each partnership consists of buying and selling futures, options, and forward contracts, and at least 90% of the partnership's gross income during each year consists of gains from such trading and interest income. No ruling has been requested from the Internal Revenue Service with respect to classification of each partnership and the general partner does not intend to request such a ruling. If a partnership were treated as an association (or a publicly traded partnership) taxable as a corporation, income or loss of the partnership would not be passed through to its partners, and the partnership would be subject to tax on its income at the rates applicable to corporations without deduction for any distributions to its partners. In addition, all or a portion of any distributions by the partnership to its partners could be taxable to the partners as dividends or capital gains. The discussion that follows assumes that each partnership will be treated as a partnership for federal income tax purposes. Partnership Taxation Partners, rather than a Partnership, are Subject to Federal Income Tax. None of the partnerships will pay federal income tax. Except as provided below with respect to certain nonresident aliens, each limited partner will report his distributive share of all items of partnership income, gain, loss, deduction, and credit for the partnership's taxable year ending within or with the partner's taxable year. A limited partner must report and pay tax on his share of partnership income for a particular year whether or not he has received any distributions from the partnership in that year. The characterization of an item of profit or loss will usually be determined at the partnership level. Syndication Expenses. None of the partnerships nor any partner thereof will be entitled to any deduction for syndication expenses (i.e., those amounts paid or incurred in connection with issuing and marketing units). There is a risk that some of the brokerage fees paid to Morgan Stanley DW could be treated as a nondeductible payment by the partnerships of syndication expenses. Allocation of Partnership Profits and Losses. In general, each limited partnership agreement allocates items of ordinary income and expense pro rata among the partners based upon their respective capital accounts as of the end of the month in which such items are accrued. Net recognized capital gain or loss is generally allocated among all partners based upon their respective capital accounts. However, net recognized capital gain or loss is allocated first to partners who have redeemed units in the partnership during a taxable year to the extent of the difference between the amount received on the redemption and the allocation account as of the date of redemption attributable to the redeemed units. Any remaining net recognized capital gain or loss is next allocated among all those partners whose capital accounts differ from their allocation accounts based on the respective differences for each partner. The special allocation of each partnership's net gain or loss upon a redemption of units, which retains the same character as in the hands of the partnership, may alter the character of a redeeming limited partner's income (by reducing the amount of long-term capital gain recognized upon receipt of redemption proceeds) and may accelerate the recognition of income by the limited partner. These allocation provisions are designed to reconcile tax allocations to economic allocations. However, the general partner cannot assure you that the Internal Revenue Service will not challenge the allocations, including each partnership's tax allocations in respect of redeemed units. If the allocation provided by each limited partnership agreement is not respected by the Internal Revenue Service for federal income tax purposes, the amount of income or loss allocated to the partners for federal income tax purposes may be increased or reduced or the character of the income or loss may be modified. Cash Distributions and Redemptions Because of the special allocation of partnership gain or loss upon a redemption of units, the amounts received upon the partial or complete redemption of a limited partner's units normally will not result in additional taxable income or loss to the limited partner. However, distributions by a partnership and amounts received upon the partial or complete redemption of a limited partner's units will be taxable to the limited partners to the extent cash distributions by a partnership or amounts received upon redemption by a limited partner exceed the partner's adjusted tax basis in his units. Such excess will be taxable to him as though it were a gain from a sale of the units. A loss will be recognized upon a redemption of units only if, following the redemption of all of a limited partner's units, the partner has any tax basis in his units remaining. In such case, the limited partner will recognize loss to the extent of the remaining basis. See "Redemptions." Generally, if a limited partner is not a "dealer" with respect to his interest in the partnership and he has held his interest in the partnership for more than one year, the gain or loss would be long-term capital gain or loss. Gain or Loss on Trading Activity Nature of Partnership Income. Each partnership does not expect to hold its futures, forwards, or options for sale to customers. For federal income tax purposes substantially all of the profit and loss generated by each partnership from its trading activities is expected to be capital gain and loss, which in turn may be either short-term, long-term, or a combination thereof. Nevertheless, certain foreign currency transactions could result in ordinary gain or loss, as discussed below. Further, interest paid to a partnership will be taxable currently to the limited partners as ordinary income. Thus, during taxable years in which little or no profit is generated from trading activities, a limited partner may still have interest income. Mark-to-Market. Section 1256 contracts held at the end of a partnership's taxable year will be treated as having been sold for the fair market value on the last day of the taxable year, and gain or loss will be taken into account for the year. Gain or loss with respect to a Section 1256 contract is generally treated as short-term capital gain or loss to the extent of 40% of the gain or loss, and long-term capital gain or loss to the extent of 60% of the gain or loss. Section 1256 contracts include regulated futures contracts which are futures contracts traded on regulated U.S. and certain foreign exchanges; foreign currency contracts that are traded in the interbank market and relate to currencies for which positions are also traded through regulated futures contracts; and U.S. and certain foreign exchange-traded options on commodities, including options on regulated futures contracts, debt securities, and stock indices. While the partnerships expect that a majority of their trading activities will be conducted in Section 1256 contracts, the partnerships also expect that a portion of their trading activities will be conducted in contracts that do not presently qualify as Section 1256 contracts, such as positions in futures contracts on most foreign exchanges and foreign currency forward contracts that do not relate to currencies for which positions are also traded through regulated futures contracts. Section 988. Currency gain or loss with respect to foreign currency forward contracts that do not relate to currencies for which positions are also traded through regulated futures contracts and futures contracts traded on most foreign exchanges may be treated as ordinary income or loss under Internal Revenue Code of 1986 Section 988. Each partnership has elected to treat these contracts as Section 1256 contracts (i.e., marked-to-market at year end). Pursuant to this election, gain or loss with respect to these contracts is treated as entirely short-term capital gain or loss. Subject to certain limitations, a limited partner, other than a corporation, estate, or trust, may elect to carry back net Section 1256 contract losses to each of the three preceding years. Net Section 1256 contract losses carried back to prior years may only be used to offset net Section 1256 contract gains. Generally, such losses are carried back as 40% short-term capital losses and 60% long-term capital losses. Capital assets not marked to market under Section 1256, such as any non-currency forward contracts, are not subject to the 60/40 tax regime for Section 1256 contracts, and gain or loss on sale generally will be long-term only if such property has been held for more than one year. Straddles. If a partnership incurs a loss upon the disposition of any position which is part of a "straddle" (i.e., two or more offsetting positions), recognition of that loss for tax purposes will be deferred until the partnership recognizes the gain in the offsetting position of the straddle (or successor position, or offsetting position to the successor position). Interest and other carrying charges allocable to positions which are part of a straddle must be capitalized, rather than deducted currently. Certain modified "short sale" rules may apply to positions held by a partnership so that what might otherwise be characterized as long-term capital gain would be characterized as short-term capital gain or potential short-term capital loss as long-term capital loss. For purposes of applying the above rules restricting the deductibility of losses with respect to offsetting positions, if a limited partner takes into account gain or loss with respect to a position held by the partnership, the limited partner will be treated as holding the partnership's position, except to the extent otherwise provided in regulations. Accordingly, positions held by a partnership may limit the deductibility of realized losses sustained by a limited partner with respect to positions held for his own account, and positions held by a limited partner for his own account may limit his ability to deduct realized losses sustained by a partnership. Thus, straddles may not be used to defer gain from one taxable year to the next. Reporting requirements generally require taxpayers to disclose all unrecognized gains with respect to positions held at the end of the taxable year. The above principle, whereby a limited partner may be treated as holding partnership positions, may also apply to require a limited partner to capitalize (rather than deduct) interest and carrying charges allocable to property held by him. Where the positions of a straddle are comprised of both Section 1256 and non-Section 1256 contracts, a partnership will be subject to the mixed straddle rules of the Internal Revenue Code of 1986 and the regulations promulgated thereunder. The appropriate tax treatment of any gains and losses from trading in mixed straddles will depend on what elections a partnership makes. Each partnership has elected to place all of its positions in a "mixed straddle" account which is marked-to-market daily. Under a special account cap, not more than 50% of net capital gain may be long-term capital gain, and not more than 40% of net capital loss may be short-term capital loss. Taxation of Limited Partners Limitations on Deductibility of Partnership Losses. The amount of partnership loss, including capital loss, which a limited partner will be entitled to take into account for federal income tax purposes is limited to the tax basis of his units, except in the case of certain limited partners including individuals and closely-held C corporations, for which he is "at risk" with respect to the units as of the end of the partnership's taxable year in which such loss occurred. Generally, a limited partner's initial tax basis will be the amount paid for each unit. A limited partner's adjusted tax basis will be his initial tax basis reduced by the limited partner's share of partnership distributions, losses, and expenses and increased by his share of partnership income and gains. The amount for which a limited partner is "at risk" with respect to his units in a partnership is generally equal to his tax basis for the units, less: any amounts borrowed in connection with his acquisition of the units for which he is not personally liable and for which he has pledged no property other than his units; any amounts borrowed from persons who have a proprietary interest in the partnership; and any amounts borrowed for which the limited partner is protected against loss through guarantees or similar arrangements. Because of the limitations imposed upon the deductibility of capital losses referred to below, a limited partner's share of a partnership's net capital losses, if any, will not materially reduce his federal income tax on his ordinary income. In addition, certain expenses of a partnership might be deductible by a limited partner only as itemized deductions and, therefore, will not reduce the federal taxable income of a limited partner who does not itemize his deductions. Furthermore, an individual who is subject to the alternative minimum tax for a taxable year may not realize any tax benefit from such itemized deductions. Limitations on Deductibility of Passive Losses. The partnerships' income will not be treated as a "passive activity" for purposes of the limitation on the deduction of passive activity losses. Limited Deduction of Certain Expenses. Certain miscellaneous itemized deductions, such as expenses incurred to maintain property held for investment, are deductible only to the extent that they exceed 2% of the adjusted gross income of an individual, trust, or estate. The amount of certain itemized deductions allowable to individuals is further reduced by an amount equal to the lesser of (i) 3% of the % % % % % % % % % % January 12.76 (1.88 ) (0.81 ) 1.21 (4.96 ) (1.16 ) 3.67 4.78 (1.84 ) February 6.60 (3.41 ) 1.94 (1.19 ) 2.48 0.41 1.13 (6.39 ) 5.10 March (9.17 ) (2.90 ) 11.38 (1.54 ) (2.48 ) 1.31 (1.82 ) 1.24 10.21 April 1.44 (3.20 ) (11.10 ) (4.02 ) 7.18 (4.62 ) (2.93 ) 4.82 3.60 May 6.38 5.64 (0.37 ) (0.43 ) (5.00 ) 3.28 (3.75 ) (3.84 ) 0.69 June (7.42 ) 15.02 (3.62 ) (2.78 ) 5.13 (1.10 ) 0.69 3.21 (1.12 ) July (3.04 ) 9.65 (3.36 ) (3.96 ) (3.90 ) (0.98 ) 9.33 (4.80 ) (2.44 ) August 3.39 4.40 1.34 3.74 0.95 10.29 (5.97 ) (0.35 ) (0.63 ) September (5.41 ) 6.43 8.19 (8.61 ) (1.51 ) 4.35 1.85 5.50 (3.33 ) October 9.14 (6.75 ) 5.37 2.90 (9.96 ) (0.73 ) 0.36 9.92 (0.09 ) November 1.20 (4.68 ) (15.59 ) 12.28 1.84 (6.17 ) 1.01 8.34 0.93 (0.90 ) December 7.66 5.20 2.47 12.06 3.83 5.98 4.57 (3.88 ) 6.09 (1.31 ) Compound Annual/ Period Rate of Return 22.98 23.31 (7.15 ) 7.85 (7.51 ) 10.18 7.49 18.35 17.59 (2.20 ) (2 months) Capsule III Performance of Spectrum Strategic Type of pool: publicly-offered fund Inception of trading: November 1994 Aggregate subscriptions: $182,893,529 Current capitalization: $121,270,439 Current net asset value per unit: $14.31 Worst monthly % drawdown past five years: (18.47)% (February 2000) Worst monthly % drawdown since inception: (18.47)% (February 2000) Worst month-end peak-to-valley drawdown past five years: (43.28)% (10 months, January 2000-October 2000) Worst month-end peak-to-valley drawdown since inception: (43.28)% (10 months, January 2000-October 2000) Cumulative return since inception: 43.10% Monthly Performance individual's adjusted gross income in excess of a certain threshold amount and (ii) 80% of such itemized deductions. Moreover, such investment expenses are miscellaneous itemized deductions that are not deductible by a non-corporate taxpayer in calculating its alternative minimum tax liability. Based upon the current and contemplated activities of the partnerships, the general partner has been advised by its legal counsel that, in such counsel's opinion, the expenses incurred by the partnerships in their futures, forwards, and options trading businesses should not be subject to the 2% "floor" or the 3% phaseout, except to the extent that the Internal Revenue Service promulgates regulations that so provide. However, that advice is not binding on a court or the Internal Revenue Service, and the Internal Revenue Service could assert, and a court could agree, that such expenses of the partnerships (including incentive fees) are investment expenses which are subject to these limitations. Tax Liability Will Exceed Distributions. Under federal tax laws, a limited partner must report and pay tax on his share of any partnership income each year, even though the general partner does not intend to make any distributions from the partnerships. Tax on Capital Gains and Losses. In general, for individuals, trusts, and estates, "long-term capital gains" are currently taxed at a maximum marginal tax rate of 20% and "short-term capital gains" and other income are currently taxed at a maximum marginal tax rate of 38.6%. Corporate taxpayers are currently subject to a maximum marginal tax rate of 35% on all capital gains and income. The excess of capital losses over capital gains is deductible by an individual against ordinary income on a one-for-one basis, subject to an annual limitation of $3,000 ($1,500 in the case of married individuals filing a separate return). Excess capital losses may be carried forward. Net losses from Section 1256 contracts are treated as 60% long-term capital loss and 40% short-term capital loss. Such losses may, at the individual taxpayer's election, be carried back to each of the preceding three years and applied against gains from Section 1256 contracts. Alternative Minimum Tax. The alternative minimum tax for individuals is imposed on "alternative minimum taxable income" in excess of certain exemption amounts. Alternative minimum taxable income consists of taxable income determined with certain adjustments and increased by the amount of items of tax preference. Alternative minimum taxable income may not be offset by certain interest deductions, including (in certain circumstances) interest incurred to purchase or carry units in the partnerships. Corporations are also subject to an alternative minimum tax. The extent to which the alternative minimum tax will be imposed will depend on the overall tax situation of each limited partner at the end of such taxable year. Limitation on Deductibility of Interest on Investment Indebtedness. Interest paid or accrued on indebtedness properly allocable to property held for investment is investment interest. Such interest is generally deductible by non-corporate taxpayers only to the extent it does not exceed net investment income. A limited partner's distributive share of net partnership income and any gain from the disposition of units will be treated as investment income, except that a limited partner's net capital gain from the disposition of units is not investment income unless the limited partner waives the benefit of the preferential tax rate on the gain. It is not clear whether a limited partner's distributive share of partnership net capital gain constitutes investment income where such gain is taxed at the maximum rate for capital gains. Interest expense incurred by a limited partner to acquire his units generally will be investment interest. Any investment interest disallowed as a deduction in a taxable year solely by reason of the limitation above is treated as investment interest paid or accrued in the succeeding taxable year. Taxation of Foreign Limited Partners. A nonresident alien individual, foreign corporation, or foreign partnership (a "foreign limited partner") generally should not be deemed to be engaged in a U.S. trade or business solely by virtue of an investment in the partnerships; provided that such foreign limited partner is not a "dealer" in commodities and, in the case of an individual, does not have certain present or former connections with the U.S. (e.g., is not present in the U.S. more than 182 days during his or her taxable year, or, in certain limited circumstances, a prior taxable year) and provided further, that such foreign limited partner is not engaged in a trade or business within the U.S. during the taxable year or, in certain limited circumstances, a prior taxable year to which income, gain, or loss from the partnerships is treated as "effectively connected." Capital gains earned by the partnerships and allocated to such a foreign limited partner will, as a general rule, not be subject to U.S. federal income taxation or withholding, but may be subject to taxation by the jurisdiction in which the foreign limited partner is resident, organized or Month operating. In the event that a partnership were found to be engaged in a U.S. trade or business, a foreign limited partner would be required to file a U.S. federal income tax return for such year and pay tax at full U.S. rates. In the case of a foreign limited partner which is a foreign corporation, an additional 30% "branch profits" tax might be imposed. Furthermore, in such event the partnerships would be required to withhold taxes from the income or gain allocable to such a foreign limited partner under Section 1446 of the Code. A foreign limited partner is not subject to U.S. tax on certain interest income, including income attributable to (i) original issue discount on Treasury bills that have a maturity of 183 days or less or (ii) commercial bank deposits, provided, in either case, that such foreign limited partner is not engaged in a trade or business within the U.S. during a taxable year. Additionally, a foreign limited partner not engaged in a trade or business within the U.S. is not subject to U.S. tax on interest income (other than certain so-called "contingent interest") attributable to obligations issued after July 18, 1984 that are in registered form if the foreign limited partner timely provides the relevant partnership with an IRS Form W-8BEN. Prospective foreign limited partners who are engaged in a U.S. trade or business or who act as dealers in commodities may be subject to U.S. income tax and should consult their tax advisors before investing in a partnership. The estate of a deceased foreign limited partner may be liable for U.S. estate tax and may be required to obtain an estate tax release from the Internal Revenue Service in order to transfer the units of such foreign limited partner. Foreign persons should consult their own tax advisers before deciding whether to invest in the partnerships. Tax Elections. The Internal Revenue Code of 1986 provides for optional adjustments to the basis of partnership property upon distributions of partnership property to a partner (Section 734) and transfers of units, including transfers by reason of death (Section 743), provided that a partnership election has been made pursuant to Section 754. As a result of the complexities and added expense of the tax accounting required to implement such an election, the general partner does not presently intend to make such an election for any of the partnerships. Therefore, any benefits which might be available to the partners by reason of such an election will be foreclosed. Tax Returns and Information. The partnerships will file their information returns using the accrual method of accounting. Within 75 days after the close of each partnership's taxable year, the partnership will furnish each limited partner, and any assignee of the units of a limited partner, copies of the partnership's Schedule K-1 indicating the limited partner's distributive share of tax items and any additional information as is reasonably necessary to permit the limited partners to prepare their own federal and state tax returns. Partnership's Taxable Year. Each partnership has the calendar year as its taxable year. Unrelated Business Taxable Income of Employee Benefit Plan Limited Partners and Other Tax-Exempt Investors. Income allocated to a limited partner which is an employee benefit plan or other tax-exempt entity should not be subject to tax under Section 511 of the Internal Revenue Code of 1986, provided that the units purchased by such plans and entities are not "debt-financed." However, if a partnership were to purchase physical commodities with borrowed funds (whether upon delivery under a futures or forward contract or otherwise) and to sell those commodities at a gain, the gain would likely constitute unrelated business income. The partnerships are entitled to engage in such leveraged purchases of physical commodities. Tax exempt investors should see "Purchases by Employee Benefit Plans ERISA Considerations" above. Tax Audits All partners are required under the Internal Revenue Code of 1986 to report all the partnership items on their own returns consistently with the treatment by the partnership, unless they file a statement with the Internal Revenue Service disclosing the inconsistencies. Adjustments in tax liability with respect to partnership items will be made at the partnership level. The general partner will represent each partnership All of the foregoing statements are based upon the existing provisions of the Internal Revenue Code of 1986 and the regulations promulgated thereunder and the existing administrative and judicial interpretations thereof. The general partner cannot assure you that legislative, administrative, or judicial changes will not occur which will modify such statements. The foregoing statements are not intended as a substitute for careful tax planning, particularly since certain of the federal income tax consequences of purchasing units may not be the same for all taxpayers. The partnerships' tax returns could be audited by the Internal Revenue Service and adjustments to the returns could be made as a result of such audits. If an audit results in adjustment, limited partners may be required to file amended returns and their returns may be audited. Accordingly, prospective purchasers of units are urged to consult their tax advisers with specific reference to their own tax situation under federal law and the provisions of applicable state, local, and foreign laws before subscribing for units. STATE AND LOCAL INCOME TAX ASPECTS In addition to the federal income tax consequences for individuals described under "Material Federal Income Tax Considerations" above, the partnerships and their limited partners may be subject to various state and local taxes. Certain of these taxes could, if applicable, have a significant effect on the amount of tax payable in respect of an investment in the partnerships. A limited partner's distributive share of the realized profits of a partnership may be required to be included in determining his reportable income for state or local tax purposes. Furthermore, state and local tax laws may not reflect recent changes made to the federal income tax law and, therefore, may be inconsistent with the federal income treatment of gains and losses arising from the partnerships' transactions in Section 1256 contracts. Accordingly, prospective limited partners should consult with their own tax advisers concerning the applicability of state and local taxes to an investment in the partnerships. The general partner has been advised by its legal counsel, Cadwalader, Wickersham & Taft LLP, that in such counsel's opinion, the partnerships should not be liable for New York City unincorporated business tax. Limited partners who are nonresidents of New York State will not be liable for New York State personal income tax on such partners' income from the partnerships, but may be liable for such tax to the extent such limited partners' allocable share of income attributable to the partnerships' transactions involves tangible personal property. Likewise, limited partners who are nonresidents of New York City will not be liable for New York City earnings tax on the partners' income from the partnerships. New York City residents may be subject to New York City personal income tax on the partners' income from the partnerships. No ruling from the New York State Department of Taxation and Finance or the New York City Department of Finance has been, or will be, requested regarding such matters. LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft LLP, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000873843_cast_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000873843_cast_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000873843_cast_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000874516_bvr_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000874516_bvr_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e18edf5de3b4aceef0d9ee4b5817fd10b1f7dc2c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000874516_bvr_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the ordinary shares offered in this offering from the Israel Law perspective will be passed upon for us by Bach, Arad, Scharf & Co. Law Offices, Tel Aviv, Israel. As of the date of this prospectus, a senior partner and an associate, at Bach, Arad, Scharf & Co. Law Offices, beneficially own an aggregate of 2,772,382 ordinary shares of the Company. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000879235_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000879235_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000879235_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000879774_wheeling_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000879774_wheeling_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..989df3d06d4315aae89a132ea134d5a42736e4d1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000879774_wheeling_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters regarding the securities of WPC and WPSC that are being offered pursuant to this Prospectus and the guarantees of the Series B Notes will be passed upon by Bingham McCutchen LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000891082_taco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000891082_taco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000891082_taco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000892986_warren_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000892986_warren_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..93ed382f84642421fe22266d41da09dbf6a84d00 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000892986_warren_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock being offered by this prospectus and certain other legal matters in connection with this offering will be passed upon for us by Patton Boggs LLP. Attorneys at Patton Boggs LLP beneficially own 25,000 shares of our common stock, a class A warrant to purchase 6,250 shares of our common stock and a class B warrant to purchase 6,250 shares of our common stock. Certain legal matters in connection with this offering will be passed upon for the underwriters by Jones Day. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000895380_allegro_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000895380_allegro_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b52ea17cca16b9a217172269df079539d8d36db8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000895380_allegro_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares offered by this prospectus has been passed upon for us by Dorsey & Whitney LLP, Minneapolis, Minnesota. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000898018_mountain_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000898018_mountain_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3118127154d6bd026806a7755ddb52ab98f049b4 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000898018_mountain_legal_matters.txt @@ -0,0 +1,2397 @@ +LEGAL MATTERS + + The validity of +the Shares offered by Mountain Bank Holding will be passed upon for Mountain Bank Holding by Graham & Dunn PC, Seattle, Washington, Pier 70, 2801 Alaskan Way, Suite 300, Seattle, Washington 98121-1128. + + + 50 + +Table of Contents + + +INDEX TO FINANCIAL STATEMENTS + + + FOR THE FISCAL YEARS ENDED DECEMBER 31, 2003 AND DECEMBER 31, 2002 + + + + + +Independent Auditor s Report on 2003 Financial Statements + + +F-1 + + +Consolidated Balance Sheets at December 31, 2003 and 2002 + + +F-2 + + +Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001 + + +F-3 + + +Consolidated Statements of Shareholders Equity for the years ended December 31, 2003, 2002 and 2001 + + +F-4 + + +Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 + + +F-5 + + +Notes to Consolidated Financial Statements + + +F-6-25 + + + + 51 + +Table of Contents + + Mountain + + Bank + + Holding + + Company + + and + + Subsidiary + + + + Consolidated + + Financial + + Report + + + + December 31 + + 2003 + +Table of Contents + + Contents + + + +Independent Auditor s Report + + +F-1 + + Consolidated Financial Statements + + + + + +Consolidated Balance Sheets + + +F-2 + + +Consolidated Statements of Income + + +F-3 + + +Consolidated Statements of Shareholders Equity + + +F-4 + + +Consolidated Statements of Cash Flows + + +F-5 + + +Notes to Consolidated Financial Statements + + +F-6-25 + + + +Table of Contents + + + +Independent Auditor s Report + + Board of Directors + Mountain Bank Holding Company + Enumclaw, Washington + + We have audited the accompanying consolidated balance sheets of Mountain Bank Holding Company and Subsidiary as of December 31, 2003 and 2002, and +the related consolidated statements of income, shareholders equity and cash flows for each of the three years in the period ended December 31, 2003. 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. + + We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 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. + + In our opinion, the consolidated financial +statements referred to above present fairly, in all material respects, the financial position of Mountain Bank Holding Company and Subsidiary as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each +of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. + + Tacoma, Washington + January 15, 2004 + + + + F-1 + +Table of Contents + + +Consolidated Balance Sheets + (Dollars in Thousands) + + Mountain Bank Holding Company and Subsidiary + December 31, 2003 and 2002 + + + + +2003 + + +2002 + + Assets + + + + + + + + + Cash and due from banks + + +$ +1,641 + +$ +1,522 + + Interest bearing deposits at other financial institutions + + + +13,920 + + +17,886 + + Securities available for sale + + + +32,290 + + +29,562 + + Federal Home Loan Bank and Federal Reserve Bank stock, at cost + + + +693 + + +671 + + Loans held for sale + + + +- + + +2,871 + + Loans + + + +98,744 + + +82,261 + + Allowance for credit losses + + + +1,101 + + +852 + + Net loans + + + +97,643 + + +81,409 + + Premises and equipment + + + +5,586 + + +4,890 + + Foreclosed real estate + + + +140 + + +151 + + Accrued interest receivable + + + +656 + + +601 + + Bank owned life insurance + + + +3,358 + + +3,205 + + Other assets + + + +349 + + +406 + + Total assets + + +$ +156,276 + +$ +143,174 + + Liabilities + + + + + + + + + Deposits: + + + + + + + + + Demand, non-interest bearing + + +$ +23,756 + +$ +19,819 + + Savings and interest-bearing demand + + + +66,720 + + +60,361 + + Time + + + +48,299 + + +46,831 + + Total deposits + + + +138,775 + + +127,011 + + Accrued interest payable + + + +159 + + +205 + + Note payable + + + +34 + + +36 + + Other liabilities + + + +413 + + +381 + + Total liabilities + + + +139,381 + + +127,633 + + Commitments and Contingencies + + + +- + + +- + + Shareholders Equity + + + + + + + + + Common stock (no par value); authorized 10,000,000 shares; issued and outstanding: 2003 2,176,677 shares; 2002 2,146,813 +shares + + + +1,088 + + +1,073 + + Additional paid-in capital + + + +9,655 + + +9,472 + + Retained earnings + + + +6,002 + + +4,626 + + Accumulated other comprehensive income + + + +150 + + +370 + + Total shareholders equity + + + +16,895 + + +15,541 + + Total liabilities and shareholders equity + + +$ +156,276 + +$ +143,174 + + + + + + See notes to consolidated financial statements. + + + + F-2 + +Table of Contents + + +Consolidated Statements of Income + (Dollars in Thousands, Except Per Share Amounts) + + Mountain Bank Holding Company and Subsidiary + Years Ended December 31, 2003, 2002 and 2001 + + + + +2003 + + +2002 + + +2001 + + Interest Income + + + + + + + + + + + + Loans + + +$ +7,275 + +$ +6,590 + +$ +6,376 + + Deposits in banks + + + +177 + + +230 + + +449 + + Investment income: + + + + + + + + + + + + Taxable + + + +940 + + +1,307 + + +1,368 + + Tax-exempt + + + +16 + + +18 + + +15 + + Dividends on stock + + + +49 + + +24 + + +53 + + Total interest income + + + +8,457 + + +8,169 + + +8,261 + + Interest Expense + + + + + + + + + + + + Deposits + + + +1,918 + + +2,560 + + +3,525 + + Note payable + + + +3 + + +3 + + +3 + + Total interest expense + + + +1,921 + + +2,563 + + +3,528 + + Net interest income + + + +6,536 + + +5,606 + + +4,733 + + Provision for Credit Losses + + + +385 + + +360 + + +85 + + Net interest income after provision for credit losses + + + +6,151 + + +5,246 + + +4,648 + + Non-Interest Income + + + + + + + + + + + + Service charges on deposit accounts + + + +572 + + +552 + + +519 + + Gains on mortgage loans sold + + + +614 + + +340 + + +291 + + Gains on sale of securities available for sale net + + + +- + + +29 + + +31 + + Bank owned life insurance income + + + +153 + + +174 + + +- + + Other + + + +276 + + +256 + + +306 + + Total non-interest income + + + +1,615 + + +1,351 + + +1,147 + + Non-Interest Expenses + + + + + + + + + + + + Salaries and employee benefits + + + +3,395 + + +2,869 + + +2,534 + + Occupancy + + + +330 + + +256 + + +218 + + Equipment + + + +535 + + +434 + + +372 + + Other + + + +1,507 + + +1,390 + + +1,253 + + Total non-interest expenses + + + +5,767 + + +4,949 + + +4,377 + + Income before income taxes + + + +1,999 + + +1,648 + + +1,418 + + Income Taxes + + + +623 + + +496 + + +478 + + Net income + + +$ +1,376 + +$ +1,152 + +$ +940 + + Earnings Per Share + + + + + + + + + + + + Basic + + +$ +.64 + +$ +.55 + +$ +.46 + + Diluted + + + +.61 + + +.52 + + +.44 + + + See notes to +consolidated financial statements. + + + + F-3 + +Table of Contents + + +Consolidated Statements of Shareholders Equity + (Dollars in Thousands) + + Mountain Bank Holding Company and Subsidiary + Years Ended December 31, 2003, 2002 and 2001 + + + + +Shares of +Common +Stock + + +Common +Stock + + +Additional +Paid-in +Capital + + +Retained +Earnings + + + +Accumulated +Other +Comprehensive +Income + + + +Total + + + + Balance at December 31, 2000 + + +1,945,136 + +$ +973 + +$ +7,543 + +$ +3,616 + + +$ +18 + + +$ +12,150 + + + Comprehensive income: + + + + + + + + + + + + + + + + + + + + + + + Net income + + + + + + + + + + + +940 + + + + + + + +940 + + + Other comprehensive income, net of tax: + + + + + + + + + + + + + + + + + + + + + + + Change in fair value of securities available for sale + + + + + + + + + + + + + + + +79 + + + +79 + + + Comprehensive income + + + + + + + + + + + + + + + + + + + +1,019 + + + 5% stock dividend + + +98,198 + + +49 + + +1,031 + + +(1,082 +) + + + + + + +(2 +) + + Sale of common stock under employee stock purchase plan + + +1,781 + + +1 + + +15 + + + + + + + + + + +16 + + + Exercise of stock options + + +16,000 + + +8 + + +32 + + + + + + + + + + +40 + + + Sale of common stock + + +6,286 + + +3 + + +66 + + + + + + + + + + +69 + + + Tax benefit from exercise of stock options + + + + + + + + +11 + + + + + + + + + + +11 + + + Balance at December 31, 2001 + + +2,067,401 + + +1,034 + + +8,698 + + +3,474 + + + +97 + + + +13,303 + + + Comprehensive income: + + + + + + + + + + + + + + + + + + + + + + + Net income + + + + + + + + + + + +1,152 + + + + + + + +1,152 + + + Other comprehensive income, net of tax: + + + + + + + + + + + + + + + + + + + + + + + Change in fair value of securities available for sale + + + + + + + + + + + + + + + +273 + + + +273 + + + Comprehensive income + + + + + + + + + + + + + + + + + + + +1,425 + + + Sale of common stock under employee stock purchase plan + + +1,762 + + +1 + + +19 + + + + + + + + + + +20 + + + Exercise of stock options + + +17,650 + + +8 + + +58 + + + + + + + + + + +66 + + + Sale of common stock + + +60,000 + + +30 + + +668 + + + + + + + + + + +698 + + + Tax benefit from exercise of stock options + + + + + + + + +29 + + + + + + + + + + +29 + + + Balance at December 31, 2002 + + +2,146,813 + + +1,073 + + +9,472 + + +4,626 + + + +370 + + + +15,541 + + + Comprehensive income: + + + + + + + + + + + + + + + + + + + + + + + Net income + + + + + + + + + + + +1,376 + + + + + + + +1,376 + + + Other comprehensive income, net of tax: + + + + + + + + + + + + + + + + + + + + + + + Change in fair value of securities available for sale + + + + + + + + + + + + + + + +(220 +) + + +(220 +) + + Comprehensive income + + + + + + + + + + + + + + + + + + + +1,156 + + + Sale of common stock under employee stock purchase plan + + +1,464 + + +1 + + +17 + + + + + + + + + + +18 + + + Exercise of stock options + + +28,400 + + +14 + + +66 + + + + + + + + + + +80 + + + Tax benefit from exercise of stock options + + + + + + + + +100 + + + + + + + + + + +100 + + + Balance at December 31, 2003 + + +2,176,677 + +$ +1,088 + +$ +9,655 + +$ +6,002 + + +$ +150 + + +$ +16,895 + + + + See notes to +consolidated financial statements. + + + F-4 + +Table of Contents + + +Consolidated Statements of Cash Flows + (Dollars in Thousands) + + Mountain Bank Holding Company and Subsidiary + Years Ended December 31, 2003, 2002 and 2001 + + + + +2003 + + + +2002 + + + +2001 + + + + Cash Flows from Operating Activities + + + + + + + + + + + + + + + Net income + + +$ +1,376 + + +$ +1,152 + + +$ +940 + + + Adjustments to reconcile net income to net cash provided by operating activities: + + + + + + + + + + + + + + + Provision for credit losses + + + +385 + + + +360 + + + +85 + + + Depreciation and amortization + + + +526 + + + +401 + + + +345 + + + Deferred federal income tax expense(benefit) + + + +28 + + + +22 + + + +(51 +) + + Net amortization and accretion of bond premiums and discounts + + + +443 + + + +313 + + + + + + + Gain on sales of securities available for sale + + + + + + + +(29 +) + + +(31 +) + + Stock dividends received + + + +(23 +) + + +(16 +) + + +(30 +) + + Gains on loans sold + + + +(614 +) + + +(340 +) + + +(291 +) + + Originations of loans held for sale + + + +(40,072 +) + + +(33,720 +) + + +(28,415 +) + + Proceeds from sales of loans + + + +43,557 + + + +32,282 + + + +28,149 + + + Bank owned life insurance income + + + +(153 +) + + +(174 +) + + + + + + (Increase) decrease in accrued interest receivable + + + +(55 +) + + +49 + + + +(27 +) + + Decrease in accrued interest payable + + + +(46 +) + + +(87 +) + + +(14 +) + + Other net + + + +285 + + + +(188 +) + + +274 + + + Net cash provided by operating activities + + + +5,637 + + + +25 + + + +934 + + + Cash Flows from Investing Activities + + + + + + + + + + + + + + + Net increase (decrease) in interest-bearing deposits in banks + + + +3,966 + + + +(4,431 +) + + +(6,117 +) + + Activity in securities available for sale and Federal Reserve Bank and FHLB stock: + + + + + + + + + + + + + + + Purchases + + + +(20,502 +) + + +(15,731 +) + + +(30,675 +) + + Maturities, prepayments and calls + + + +6,521 + + + +15,489 + + + +18,475 + + + Sales + + + +10,478 + + + +2,400 + + + +1,029 + + + Increase in loans made to customers, net of principal collections + + + +(16,619 +) + + +(13,786 +) + + +(3,283 +) + + Additions to premises and equipment + + + +(1,222 +) + + +(1,746 +) + + +(345 +) + + Purchase of bank owned life insurance + + + + + + + + + + + +(3,000 +) + + Net cash used in investing activities + + + +(17,378 +) + + +(17,805 +) + + +(23,916 +) + + Cash Flows from Financing Activities + + + + + + + + + + + + + + + Net increase in deposits + + + +11,764 + + + +14,900 + + + +22,534 + + + Net proceeds from issuance of stock + + + +98 + + + +784 + + + +125 + + + Repayment of note payable + + + +(2 +) + + +(2 +) + + +(2 +) + + Payment for fractional shares in stock dividend + + + + + + + + + + + +(2 +) + + Net cash provided by financing activities + + + +11,860 + + + +15,682 + + + +22,655 + + + Net change in cash and due from banks + + + +119 + + + +(2,098 +) + + +(327 +) + + Cash and Due from Banks + + + + + + + + + + + + + + + Beginning of year + + + +1,522 + + + +3,620 + + + +3,947 + + + End of year + + +$ +1,641 + + +$ +1,522 + + +$ +3,620 + + + Supplemental Disclosures of Cash Flow Information + + + + + + + + + + + + + + + Interest paid + + +$ +1,967 + + +$ +2,650 + + +$ +3,542 + + + Income taxes paid + + + +435 + + + +547 + + + +460 + + + Supplemental Disclosures of Non-Cash Investing and Financing Activities + + + + + + + + + + + + + + + Unrealized gain (loss) on securities available for sale, net of tax + + +($ +220 +) + +$ +273 + + + +79 + + + Foreclosed real estate acquired in settlement of loans, net + + + + + + + +(151 +) + + + + + + Stock dividend + + + + + + + + + + + +1,080 + + + + See notes to +consolidated financial statements. + + + F-5 + +Table of Contents + + +MOUNTAIN BANK HOLDING COMPANY AND SUBSIDIARY + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + December 31, 2003 and 2002 + + Note 1 Summary of Significant Accounting Policies + + Basis of Consolidation and Operations + + The consolidated financial statements include the accounts of Mountain Bank +Holding Company (the Company) and its wholly owned subsidiary, Mt. Rainier National Bank (the Bank). All significant intercompany transactions and balances have been eliminated. The Company is a holding company, which operates primarily through its +major subsidiary, the Bank. + + The Bank operates a main office +and five branches, and has a customer base centered in and around southeastern King County and northeastern Pierce County, Washington. The Bank provides loan and deposit services to customers, who are predominantly small- and middle-market \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000906347_virgin_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000906347_virgin_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..48ad3f063067063a05b8b520dd9d68d43870b68a --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000906347_virgin_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the rights and the shares of common stock offered by this prospectus will be passed upon for us by Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000906471_davco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000906471_davco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ac43bbe9745219f198c2c41c6edd0143b5e8c445 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000906471_davco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the issuance of the EISs, the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Torys LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by FriendCo Restaurants, Inc. and Heron Realty Corporation will be passed upon for us by Whiteford, Taylor & Preston LLP. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000909173_behavioral_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000909173_behavioral_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000909173_behavioral_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000911787_productivi_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000911787_productivi_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..39deb0c0b341328fa01d83993d7df93003faf314 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000911787_productivi_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby as to their being fully paid, legally issued and non-assessable will be passed upon for us by Kirkpatrick and Lockhart LLP, Miami, Florida. Kirkpatrick & Lockhart LLP does not have any interests in Productivity Technologies and has never been employed by Productivity Technologies on a contingent basis. The audited consolidated financial statements of Productivity Technologies for the year ended June 30, 2004 and June 30, 2003, have been audited by Follmer Rudzewicz PLC and have been audited by Doeren Mayhew for the year ended June 30, 2002. Follmer Rudzewicz PLC and Doeren Mayhew do not have any interests in Productivity Technologies and have never been employed by Productivity Technologies on a contingent basis. HOW TO GET MORE INFORMATION We have filed with the Securities and Exchange Commission in Washington, DC, a registration statement on Form S-1 under the Securities Act of 1933 with respect to the shares we are offering. Prior to the effective date of the registration statement we were not subject to the information requirements of the Securities Exchange Act of 1934 (the "Exchange Act"). At the time of the effectiveness of the registration statement we will become a "reporting company" and required to file reports pursuant to the provisions of the Exchange Act. This prospectus does not contain all of the information set forth in the registration statement, as permitted by the rules and regulations of the Commission. Reference is hereby made to the registration statement and exhibits thereto for further information with respect to Productivity Technologies and the shares to which this prospectus relates. Copies of the registration statement and other information filed by with the Commission can be inspected and copied at the public reference facilities maintained by the Commission in Washington, DC at 450 Fifth Street, NW, Washington, DC 20549. In addition, the Commission maintains a World Wide Web site that contains reports, proxy statements and other information regarding registrants such as Productivity Technologies which filed electronically with the Commission at the following Internet address: (http:www.sec.gov). \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000913586_mk_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000913586_mk_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0f64f9dec27d0dbb6958be7a549d07b09b634681 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000913586_mk_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters Weil, Gotshal & Manges LLP has passed upon the validity of the common stock on our behalf. Certain matters with respect to Canadian law will be passed upon by Fasken Martineau DuMoulin LLP on our behalf. Skadden, Arps, Slate, Meagher & Flom LLP is acting for the underwriters in connection with this offering. Certain matters with respect to Canadian law will be passed upon by Stikeman Elliott LLP on behalf of the underwriters. The partners and associates of Fasken Martineau DuMoulin LLP and Stikeman Elliott LLP are each expected to own less than 1% of the common stock of each of MK Resources Company and Leucadia National Corporation following the completion of this offering. Members of Weil, Gotshal & Manges LLP beneficially own, in the aggregate, approximately 108,000 shares of Leucadia National Corporation (representing less than 1% of the outstanding shares). \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000914747_morgan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000914747_morgan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ee02ca78391538fd179468950a6d626ea9d2ab34 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000914747_morgan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft LLP, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000919463_berry_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000919463_berry_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..93979bd1248904f7e563dcbd6c12f8d1a9760a5d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000919463_berry_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000922237_enova_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000922237_enova_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a8da3684049af8eabad51f9313583229d2987ff3 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000922237_enova_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock being offered will be passed upon by Reed Smith, LLP, Oakland, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000925263_morgan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000925263_morgan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ca26d4c05d830f1ebdb29135ea4df27c237f4151 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000925263_morgan_legal_matters.txt @@ -0,0 +1 @@ +$ $ $ Spectrum Select* 28,529,412.378 5,084,554.722 554,768,114 3,150,000 37,216 30.31 Spectrum Technical 38,348,176.678 5,651,823.322 585,879,790 3,931,984 42,471 22.64 Spectrum Strategic 15,977,268.178 9,522,731.822 181,882,529 1,011,000 13,823 14.31 Spectrum Global Balanced 7,050,928.248 9,449,071.752 99,259,599 533,234 7,481 15.47 Spectrum Currency 13,995,530.483 13,004,469.517 182,537,858 3,031,645 19,229 15.66 positions as a UK Gilt trader and salesman at two UK stockbrokers: Wood MacKenzie and Johnson Matthey & Wallace. He then joined Sabre Fund Management Ltd., a CFTC-registered CTA located in London, as an assistant technical trader and researcher, and was later promoted to Director of Research. In December 1986, he moved to Brockham Securities Ltd, a privately owned sugar trading and managed futures company, to assist in the development and marketing of the firm's futures fund management services. In February 1987, he left Brockham Securities Ltd and, together with colleagues Michael Adam and Martin Lueck, founded Adam, Harding and Lueck Ltd., a computer-driven, research based CTA. Adam, Harding and Lueck Ltd. became registered with the CFTC in February 1987. By 1989, this firm had grown into the UK's largest CTA, with more than $50 million under management. At that time, the principals sold a 51% stake to E D & F Man Group Ltd., one of the largest distributors of futures funds internationally. Between 1989 and 1993, when assets under management rose from $50 million to $300 million, Mr. Harding headed up Adam, Harding and Lueck Ltd.'s quantitative research team, supervising about 15 full-time research staff, supported by a software team of around a dozen programmers. This team developed a multiplicity of quantitative trading strategies in addition to Adam, Harding and Lueck Ltd.'s successful trend-following trading approach. During this time, he was also involved in the company's international institutional marketing efforts, in particular in Europe, the Middle East, South East Asia, Japan and the U.S. In 1993, Mr. Harding was invited to present a paper to a special symposium of London's prestigious Royal Society, on the subject "Making Money From Mathematical Models." This paper was subsequently incorporated into two books on the subject. In September 1994, E D & F Man Group Ltd. bought out the minority shares owned by Mr. Harding and the original partners, and Adam, Harding and Lueck Ltd. was consolidated into E D & F Man Group Ltd.'s fund management division. Mr. Harding then formed and headed up a new division of E D & F Man Group Ltd., called E D & F Man Group Ltd. Quantitative Research, leading a research team that developed quantitative trading models primarily for use by E D & F Man Group Ltd.'s fund management companies. Mr. Harding left E D & F Man Group Ltd. in August 1996 to begin preparations for the launch of Winton, which he formed in February 1997. Osman Murgian is a founding director and a principal of Winton. Educated in Brighton College in England, Mr. Murgian was also one of the original shareholders and directors of Adam, Harding and Lueck Ltd. Mr. Murgian lives in Nairobi, Kenya, and is the owner of or an investor in a number of international businesses ranging from real estate to transportation. Mr. Murgian has a beneficial interest of more than 10% of Winton's share capital. This interest is held by Festuca Investments Ltd, an Isle of Man investment holding company. Martin John Hunt is a director and a principal of Winton. Mr. Hunt began his career in the UK managed futures industry in October 1983, at which time he was employed as a trainee trader for a trading advisor, Futures Fund Management Ltd. In January 1986, he was appointed manager of the trading operations for Sabre Fund Management, also a trading advisor. In February 1988, he joined Adam, Harding and Lueck Ltd., then a newly established trading advisor, where he was responsible for the company's trading operations. These trading operations were complex, and Mr. Hunt's role was to ensure the efficient execution of the firm's computer-generated futures and interbank orders on over $120 million of assets under management. These orders spanned more than 60 markets, 5 time zones and 15 exchanges worldwide. In August 1991, Mr. Hunt assumed responsibility for marketing and operations at Royston Investments, Ltd, which at the time was a CFTC-registered CTA. In March 1994, he established himself as an independent marketing and compliance consultant to firms in the UK managed futures industry. These consultancy activities continued until February 1997, when he was recruited by David Harding to handle the formation, structuring and subsequent day-to-day running of Winton. At Winton, Mr. Hunt supervises the trading operations, as well as being directly involved in the marketing of Winton's investment management approach worldwide. Mr. Hunt also has responsibility for the firm's regulatory compliance. During the five years preceding the date of this Supplement, there have been no material administrative, civil or criminal actions, including actions pending, on appeal or concluded, against Winton or its principals. Winton and its principals may, from time to time, trade futures, forwards, or options contracts for their own proprietary accounts. These accounts may take positions that are opposite, or ahead of, positions advocated for clients. Such trades may or may not be in accordance with the Winton trading programs described below. Although Winton maintains records of these trades, clients of Winton are not entitled to inspect these records except in certain limited circumstances. Description of the Diversified Trading Program Effective January 1, 2004 the general partner allocated 10-15% of Spectrum Technical's assets to Winton's Diversified Trading Program which has been trading since 1997. The Winton Diversified Trading Program uses a statistically-derived systematic model to trade a diversified portfolio of approximately 95 futures contracts. The contracts traded cover a global range and are widely diversified across the financial and commodity sectors. Winton expects the margin requirements for the portion of Spectrum Technical's assets traded pursuant to Winton's Diversified Trading Program to average about 20% of those assets. As of December 31, 2003 Winton Capital Management Limited was managing approximately $321 million pursuant to its Diversified Trading Program and approximately $326 million of client assets in all its programs (notional funds included). Description of Trading Methods and Strategies Winton's investment technique consists of trading a portfolio of around 95 futures contracts on major commodity exchanges and forward markets worldwide, employing a computerized, technical, trend-following trading system developed by its principals. This system tracks the daily price movements from these markets around the world, and carries out certain computations to determine each day how long or short the portfolio should be to maximize profit within a certain range of risk. If rising prices are anticipated, a long position will be established; a short position will be established if prices are expected to fall. The trading methods applied by Winton are proprietary, complex and confidential. As a result, the following discussion is of necessity general in nature and not intended to be exhaustive. Winton plans to continue the testing and reworking of its trading methodology and, therefore, retains the right to revise any methods or strategy, including the technical trading factors used, the markets traded and/or the money management principles applied. A Technical Trend-Following System. Technical analysis refers to analysis based on data intrinsic to a market, such as price and volume. This is to be contrasted with fundamental analysis which relies on factors external to a market, such as supply and demand. The Diversified Trading Program uses no fundamental factors. A trend-following system is one that attempts to take advantage of the observable tendency of the markets to trend, and to tend to make exaggerated movements in both upward and downward directions as a result of such trends. These exaggerated movements are largely explained as a result of the influence of crowd psychology or the herd instinct, amongst market participants. A trend-following system does not anticipate a trend, but seeks to capture it at an appropriate point in time. In fact, trend-following systems are frequently unprofitable for long periods of time in particular markets or market groups, and occasionally they are unprofitable for spells of more than a year, even in large portfolios. However, over a span of years, Winton believes such an approach, applied to a sufficiently diversified portfolio of markets, has proven to be consistently profitable. The Winton trading system works by capturing the probability of the size and direction of future price movements using sophisticated statistical indicators, or oscillators, derived from past price movements which characterize the degree of trending of each market at any time. Winton believes its application of advanced classical statistics to the understanding of market behavior provides it with an edge over other trend following systems. Winton believes this enables its system to suffer smaller losses during the inevitable whipsaw periods of market behavior and thus take better advantage of the significant trends when they occur, by focusing more resources on them. The system is developed using historical market prices in each contract ("in sample data"), and then tested on an independent period of market data ("out of sample data") to ensure that the observations have robust predictive power. This procedure seeks to avoid the risk of over optimising, which occurs when a system is allowed to fit itself to a historically-specific set of market conditions. A Non Discretionary System. Trade selection is not subject to intervention by Winton's principals or traders and therefore is not subject to the influences of individual judgement. As a systemic trading system, the Winton model utilizes expert knowledge to analyze market data and direct trades, thus eliminating the risk of basing a trading program on one indispensable person. Equally important is the fact that non-discretionary systems can be tested in simulation for long periods of time and the model's empirical characteristics can be measured. The system's output is rigorously adhered to in trading the portfolio and intentionally no importance is given to any external or fundamental factors. While it may be seen as unwise to ignore information of obvious value, such as that pertaining to political or economic developments, Winton believes the disadvantage of this approach is far outweighed by the advantage of the discipline that rigorous adherence to such a system instills. Significant profits are often made by the Winton system, by holding on to positions for much longer than conventional wisdom would dictate. An individual taking trading decisions, and paying attention to day-to-day events, could easily be deflected from the chance of fully capitalizing on such trends, when not adhering to such a system. Markets Traded. The Winton system trades in all the easily accessible and liquid U.S. and non-U.S. futures and forward contracts that it practically can. Forward markets include major currencies and precious and base metals, the latter two categories being traded on the London Metal Exchange. Winton is constantly looking for new opportunities to add additional markets to the portfolio, thus further increasing the portfolio's diversification. Diversification of Markets. Taking positions in a variety of unrelated markets has been shown, over time, to decrease system volatility. By employing a sophisticated and systematic schema for placing orders in a wide array of markets, Winton believes it can be demonstrated that there is a high expectation of an overall profit being realized after a sufficient period of time. The trading strategy and account management principles described here are factors upon which Winton will base its trading decisions. Such principles may be revised from time to time by Winton as it deems advisable or necessary. Accordingly, no assurance is given that all of these factors will be considered with respect to every trade or recommendation made or that consideration of any of these factors in a particular situation will lessen risk of loss or increase the potential for profits. Execution of Orders and Order Allocation Winton will select the type of order to be used in executing trades and may use any type of order permitted by the exchange on which the order is placed. Winton may place individual orders for each account or a block order for all accounts in which the same commodity interest is being cleared through the same futures commission merchant. In the latter instance, Winton employs an objective price allocation procedure in which all accounts are listed by account number and then trades are assigned, with the highest number on the list receiving the highest buy and the highest sell and the lowest number on the list receiving the lowest buy and the lowest sell. On occasion, it may direct the futures commission merchant for the accounts to employ the neutral allocation system generally used by the futures commission merchant to assign trades or it may use an average price system in which each client in the block order will receive the average price which is computed by multiplying the price by the quantity executed at each price divided by the total quantity executed. Partial fills will be allocated in proportion to account size. Past Performance of Winton Set forth below in Capsule A is the past performance history of Winton's Diversified Trading Program. The footnotes following Capsule A are an integral part of the Capsule. You are cautioned that the information set forth in the following Capsule performance summary is not necessarily indicative of, and may have no bearing on, any trading results that may be attained by Winton or Spectrum Technical in the future, since past results are not a guarantee of future results. There can be no assurance that Winton or the partnership will make any profits at all, or will be able to avoid incurring substantial losses. You should also note that interest income may constitute a significant portion of a commodity pool's total income and, in certain instances, may generate profits where there have been realized or unrealized losses from commodity trading. CAPSULE A Winton Capital Management Limited Winton Diversified Trading Program Name of commodity trading advisor: Winton Capital Management Limited Name of program: Winton Diversified Trading Program Inception of trading by commodity trading advisor: October 1997 Inception of trading in program: October 1997 Number of open accounts: 33 Aggregate assets overall: 257.8 million Aggregate assets in program: 252.3 million Worst monthly drawdown (12.97)% - (October 1997) Worst peak-to-valley drawdown: (31.09)% - (November 2001-May 2002) 2003 annual return: 25.52% 2002 annual return: 12.86% 2001 annual return: 5.56% 2000 annual return: 9.72% 1999 annual return: 13.24% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Footnotes to Winton's Capsule Performance Summaries "Inception of trading by commodity trading advisor" is the date on which Winton began trading client accounts. "Inception of trading in program" is the date on which Winton began trading client accounts pursuant to the program shown. "Number of open accounts" is the number of accounts directed by Winton pursuant to the program shown as of December 31, 2003. "Aggregate assets overall" is the aggregate amount of assets in non-proprietary accounts under the management of Winton as of December 31, 2003. "Aggregate assets in program" is the aggregate amount of assets in the program specified as of December 31, 2003. "Drawdown" means losses experienced by the trading program over a specified period. A small number of accounts in the portfolio composites have experienced monthly drawdowns and peak-to-valley drawdowns that are materially larger than the largest composite monthly drawdown and peak-to-valley drawdown. These variances result from factors such as small account size (i.e., accounts with net assets of less than the prescribed portfolio minimum, which therefore trade fewer contracts than the standard portfolio), intra-month account opening or closing, significant intra-month additions or withdrawals, and investment restrictions imposed by the client. "Largest monthly drawdown" means greatest percentage decline in net asset value due to losses sustained by the trading program from the beginning to the end of a calendar month during the most recent five calendar years. "Worst peak-to-valley drawdown" means greatest cumulative percentage decline in month-end net asset value of the trading program due to losses sustained during a period in which the initial month-end net asset value of the trading program is not equaled or exceeded by a subsequent month-end net asset value of the program during the most recent five calendar years. "Compound annual and year-to-date/period rate of return" presented in the composite performance capsules are calculated based on the "Fully-Funded Subset" method as prescribed by the CFTC. The rate of return is calculated by dividing the sum of net performance of the qualifying Fully-Funded Subset by the beginning net assets of the qualifying Fully-Funded Subset, except in periods of significant additions or withdrawals to the accounts in the qualifying Fully-Funded Subset. In such instances, the Fully-Funded Subset is adjusted to exclude accounts with significant additions or withdrawals that would materially distort the rate of return pursuant to the Fully-Funded Subset method. Returns are then compounded to arrive at the year-to-date rate of return. Morgan Stanley Spectrum Strategic L.P. 1. Allied Irish Capital Management, Ltd. Allied Irish is an Irish corporation registered with the CFTC as a commodity trading advisor since January 1994 and is a member of the National Futures Association in that capacity. Allied Irish's business office is located at 85 Pembroke Road, Ballsbridge, Dublin 4. Allied Irish's ultimate parent company is Allied Irish Banks plc, Ireland's largest banking and financial services group. Allied Irish has been authorized by the Irish Financial Services Regulatory Authority (formerly known as Central Bank of Ireland) under the Investment Intermediaries Act, 1995. As a commodity trading advisor, Allied Irish specializes in trading interest rate, currency, and equity index futures contracts, as well as foreign exchange on the interbank cash market. The primary focus of Allied Irish's futures trading is on the U.S. and European, futures exchanges with some participation in other markets. Foreign exchange trading covers the major currencies. Allied Irish began trading for Spectrum Strategic in May 1999. Performance Records A summary of performance information for each partnership from its commencement of operations through December 31, 2003 is set forth in Capsules I through V below. All performance information has been calculated on an accrual basis in accordance with accounting principles generally accepted in the United States of America and is "net" of all fees and charges. You should read the footnotes on page , which are an integral part of the following capsules. You are cautioned that the information set forth in each capsule is not indicative of, and has no bearing on, any trading results that may be attained by any partnership in the future. Past performance is not necessarily indicative of future results. We cannot assure you that a partnership will be profitable or will avoid incurring substantial losses. You should also note that interest income may constitute a significant portion of a partnership's total income and may generate profits where there have been realized or unrealized losses from futures, forwards, and options trading. Capsule I Performance of Spectrum Select Type of pool: publicly-offered fund Inception of trading: August 1991 Aggregate subscriptions: $557,918,114 Current capitalization: $441,522,484 Current net asset value per unit: $30.31 Worst monthly % drawdown past five years: (13.12)% (November 2001) Worst monthly % drawdown since inception: (13.72)% (January 1992) Worst month-end peak-to-valley drawdown past five years: (23.63)% (22 months, October 1998-July 2000) Worst month-end peak-to-valley drawdown since inception: (26.78)% (15 months, June 1995-August 1996) Cumulative return since inception: 203.10% Monthly Performance Principals Gerry Grimes is Managing Director of Allied Irish, an associated person of Allied Irish and a member of the Institute of Bankers. He became registered as an associated person of Allied Irish in January 1994. For 10 years up to March 1988, Mr. Grimes was employed by the Central Bank of Ireland in the following investment management positions: Chief Dealer, Money Market Division; Chief Dealer, Management of Official External Reserves; and Chief Forex Dealer. He represented Ireland on sub-committees of the European Central Bank Governors Committee in Basle. He has experience in liquidity and interest rate management, investment of external reserves ($5 billion) and their currency allocation and the management of the Irish pound in the European Exchange Rate Mechanism. Mr. Grimes joined Gandon Securities as a trader in March 1988 where he traded a range of interest rate contracts, and was appointed a Director in October 1990. He was an associated person with Gandon Fund Management from July 1991 to September 1993. From mid 1991, he was responsible for the development of Gandon Fund Management's activities including the marketing and development of managed futures programs. He left Gandon Securities and Gandon Fund Management in September 1993 and joined Allied Irish that month. Mr. Grimes was a founding member of Allied Irish and is responsible for the overall management, development, and control of Allied Irish's activities. Between January and September 2002, Mr. Grimes was also responsible for trading a portion of the Worldwide Financial Futures Program. Ian Kelly became Company Secretary of Allied Irish in August 1997. He is a member of the Institute of Chartered Accountants of Ireland. He is Chief Operating Officer of Allied Irish and is responsible for financial control, compliance, and the back-office and I.T. operations of the company. He joined Allied Irish in August 1997. Prior to joining Allied Irish, he worked from July 1994 to August 1997 in AIB Capital Markets Plc., an investment bank, and before that he worked with Coopers & Lybrand, an accountancy firm, from 1987 to June 1994. John O'Donnell became a non-executive Director of Allied Irish in March 2001. He is Head of Investment Banking in the Capital Markets Division of the AIB Group, a position he was appointed to in March 2001. Prior to this appointment he was Managing Director of AIB International Financial Services Limited, a subsidiary of the AIB Group, from January 1994 to December 1996 and was Managing Director of AIB Corporate Finance Limited, another subsidiary of the AIB Group, from December 1996 to March 2001. Mr. O'Donnell is a Fellow of both the Chartered Institute of Management Accountants and the Chartered Association of Certified Accountants. John Parsons became a Director of Allied Irish in January 1995. He graduated from Queen's University, Belfast with a B.Sc. in Computer Science and Statistics in 1986, and went on to obtain a Master of Business Administration degree from Cardiff University, in 1987. Before joining Allied Irish, Mr. Parsons worked for SBC Warburg in London as a proprietary trader in the Fixed Interest & Treasury Division. Prior to that, he worked with the Bank of Ireland Group from January 1989 to March 1993, initially as a Portfolio Manager with the Bank's fund management group and ultimately as Head of European Government Bonds with the Bank's Treasury operation. Mr. Parsons trades a portion of the Worldwide Financial Futures Program and he is the sole trader of the Equity Program offered by Allied Irish. David Thompson became a Director of Allied Irish in September 2002. He has a Certificate in Actuarial Practices and a Certificate in Investment Management from the Institute of Actuaries in London. Prior to joining Allied Irish, Mr. Thompson worked for Bank of Ireland Group as Head of Proprietary Trading (non-customer flow) between January 2001 and August 2002. Before that he was Head of their Euro Fixed Interest Trading Desk between June 1998 and January 2001 and prior to that worked as a proprietary trader on their fixed interest trading desk in Dublin (July 1995 to June 1998) and as a bond trader in their London office (March 1994 to July 1995). From 1987 to 1994 he worked for Eagle Star Insurance, initially as an actuarial programmer and ultimately as a foreign exchange and bond trader. Mr. Thompson trades a portion of the Worldwide Financial Futures Program. Mr. Treble became a non-executive director of Allied Irish in October 2003 and currently has a pending registration as principal with the NFA. He is Managing Director of AIB Global Treasury, a position he has held since February 2002. Prior to this appointment, he was Managing Director of AIB Month Treasury and International, from February 2001 to February 2002, and he held the position of General Manager, AIB Capital Markets Britain (Treasury & Corporate Banking) from August 1997 to February 2001. He has worked in AIB since 1982 and has an MBA in Financial Services. Allied Irish and its principals may, from time to time, trade futures, forwards, and options contracts for their own proprietary accounts. Allied Irish's Trading Strategies Allied Irish offers three trading programs, but will only trade the Worldwide Financial Futures Program for Spectrum Strategic. Trading for Spectrum Strategic will be at four times the leverage Allied Irish normally applies for the Worldwide Financial Futures Program. The two other trading programs offered by Allied Irish are the Foreign Exchange Program and the Equity Index Program. Worldwide Financial Futures Program The Worldwide Financial Futures Program is designed to provide returns using a multi-trader trading approach on a broad range of financial instruments. The capital is sub-allocated to a range of trading styles, including a portion traded by two individual traders, Mr. Parsons and Mr. Thompson. The allocation of capital to the individual traders and to the trading styles may be altered at the discretion of Allied Irish. A portion is traded using a systematic approach. Diversification is enhanced because no overall house view is imposed on the traders in the program, and this independence of operation is viewed as a key strength. There are the three elements to the current trading approvals. Mr. Thompson's trading style is based on an understanding of the medium to longer term economic, political and demographic trends in the world. An analysis of value is conducted for all major asset classes and fitted to this fundamental framework to determine the likely direction and magnitude of trends in the major financial markets. The timing and size of trades is determined through a combination of technical analysis and assessment of market psychology and positioning. The aim of Mr. Thompson's approach is to enter trends early, building up the size of the position as the trade becomes profitable. Exit of the trades occurs when market sentiment in favour of the trade reaches an extreme, but price movements cease to justify the euphoria. Profitable trades can be run for months at a time, but may be held for shorter periods, depending on the strength of the trends involved. Mr. Parsons' approach to trading markets is based on a fundamental analysis of economic, fiscal, and monetary developments in the world's major economies. Having compiled a set of expectations for the major interest rate, equity, and foreign exchange markets, Mr. Parsons then looks for significant levels of divergence relative to the market's expectations as a signal to enter a particular position. He uses technical analysis to help identify trends and trend changes as well as to seek to improve entry and exit levels. A portion of the Worldwide Financial Futures Program is traded using a technical trading system. The system has been developed to be consistent with Allied Irish's investment approach to financial markets. The system differs from most trend following trading systems in that a profit objective is built into the trade from inception. The system utilizes a break-out oriented approach that attempts to initiate trading at low risk entry points where the market has a higher probability than average of participating in a medium-to long-term trend. The futures contracts currently traded in the Worldwide Financial Futures Program include U.S., European, and Asian interest rate, currency, and stock index contracts. For most contracts, options may also be used from time to time. Options may be either bought or sold in this program. It should be noted that in relation to currency futures on both the Chicago Mercantile Exchange and the financial derivatives division of the New York Cotton Exchange, Allied Irish may convert spot transactions to futures contracts using the exchange for physicals mechanism. As of December 31, 2003, Allied Irish was managing approximately $336 million (notional funds included) of client assets pursuant to the Worldwide Financial Futures Program and approximately $637 million of client assets in all of its programs (notional funds included). Foreign Exchange Program The Foreign Exchange Program specializes in trading the inter-bank foreign exchange market. A fundamental assessment of market information is the main factor underlying the trading approach. To this end an assessment of the fundamental economic policy forces at work in different countries is first made. This is related to socio-political factors in play. A judgment is then made on how much of the economic and political influences are priced in following a review of international capital flows. In this regard consultation is made with a network of experts in the world's currency markets. Finally the price levels are examined in detail to determine appropriate trade parameters. Equity Index Program The program's objective is designed to minimize correlations with major global equity returns. The underlying investment approach is broadly similar to that taken in Allied Irish's other two programs in that the main inputs are an analysis of macroeconomic and global political trends. This program is traded by John Parsons and trades the major stock index futures. Risk Management The management of risk positions takes place at two levels within the programs at the overall program level by the trading controller and at the position taking level where each trader uses his individual money management skills. Given that the programs involve a multi-trader approach, a program controller role is adopted. Mr. Grimes is the trading controller for all three programs. This role involves the following: assessing the performance and risk of the programs from an overall level as distinct from a trader level; monitoring the traders' adherence to the risk parameters for each program as set out below; ensuring that the programs' overall objectives and those of individual traders are compatible; controlling the operations of the order desk and ensuring the positions are agreed between traders, order desk, back office, and counterparty. Mr. Grimes is also responsible for liaising with clients and conveying their views, wishes, and concerns to the trading team. To control the levels of exposure a daily end-of-day position report including contract open positions, margin utilized by contract, and margin utilized by trader is produced for the Worldwide Financial Futures and Equity Index Programs. The report for the Foreign Exchange Program looks at positions in equivalent U.S. dollar amount versus underlying U.S. dollar equity invested. For the Worldwide Financial Futures and Equity Index Programs, margin to equity is used to control position size while in the Foreign Exchange Program a gearing of equity is used to limit position size. Given the nature of the programs offered and the experience of the trading team, a limit of 6% margin to equity (including notional funds) is normally applied for the Worldwide Financial Futures and Equity Index Programs and a gearing of 3 times equity (including notional funds) for the Foreign Exchange Program. 2. Blenheim Capital Management, L.L.C. Blenheim Capital Management, L.L.C. is a Delaware limited liability company which was formed to provide commodity trading advisory services to clients. Through a corporate reorganization in July 2001, Blenheim was merged with Blenheim Investments, Inc., a New Jersey corporation. The ownership and capitalization of Blenheim are materially the same as those which existed in Blenheim Investments, Inc. Additionally, Blenheim succeeds to all the assets and obligations of its predecessor. Blenheim is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator, effective March 2, 1989, and is a member of the National Futures Association. Blenheim's address and telephone number are: Post Office Box 7242, Two Worlds Fair Drive, Somerset, New Jersey 08875-7242; (732) 302-0238. Principals Mr. Willem Kooyker is the Managing Member, Chairman and majority owner of Blenheim. He is registered with the CFTC as an associated person of Blenheim and a member of the National Futures Association in that capacity. He is a former member of the Board of Directors of the NY Coffee, Sugar and Cocoa Exchange, a former president of the NY Cocoa Clearing Association, and a former member of the NY Mercantile Exchange. He received a BA cum laude in Economics from Baruch College in New York and an MBA in International Finance and Economics from New York University. Mr. Kooyker began his trading career in the international commodities business in 1964 with Internatio-Muller in Rotterdam, The Netherlands, where eventually he became managing director of the International Trading Group. He stayed in this position until 1981, when he joined Commodities Corporation, Princeton, New Jersey, where he became President. At the time, Commodities Corporation was an active fund management company, operating predominantly in the futures markets. In October 1984, Mr. Kooyker started a new company, Tricon Holding Company, Ltd., a joint venture between Commodities Corporation and a group of Middle Eastern investors, which was a trading and consulting company in the futures as well as the physicals markets predominantly directed towards energy and industrial commodities. Tricon currently remains only active in the forest products industry, where it operates two sawmills in the western states of the United States. In January 1989, Mr. Kooyker started Blenheim, an independent fund management company and an advisor to several investment funds. Concurrent, but separate from Blenheim, Mr. Kooyker is the largest beneficial owner, but not an officer, of Derivatives Portfolio Management, L.L.C., a Delaware limited liability company formed in 1993 to provide administrative, risk management, and consulting services to institutions, commodity pool operators, and individual fund managers engaged in the financial instruments, securities, and futures markets as well as the cash trading business. DPM is registered with the CFTC as a commodity pool operator, effective January 26, 1994, and is a member of the National Futures Association in that capacity. DPM has a wholly-owned subsidiary named DPM Brokerage, LLC, a Delaware limited liability company formed in 1999 to provide introduction and execution services to individual clients and private investors. DPM Brokerage is registered with the CFTC as an introducing broker, effective August 16, 1999 and is a member of the National Futures Association in that capacity. In 1996, Mr. Kooyker became a 50% shareholder in The Thornton Group, L.L.C., a consulting company to entrepreneurial startup enterprises. Mr. Kooyker is registered with the CFTC as a principal and an associated person of Blenheim. He is also registered as a principal of DPM and DPM Brokerage. Thomas M. Kopczynski is a Vice President of Blenheim. He is registered with the CFTC as a principal and an associated person and is a member of the NFA in that capacity. Mr. Kopczynski has been with Blenheim for ten years. He is an integral part of Blenheim's trading staff. His broad knowledge of the market sectors in which Blenheim trades, retained by extensive analysis and consultation with key industry contacts, facilitates continuous investment opportunities and diversification. Mr. Kopczynski holds a B.S. in Economics with a concentration in Statistics from the Wharton School of the University of Pennsylvania. Guy J. Castranova, is the Secretary of Blenheim and has held this position since its inception. He is the President and Chief Operating Officer of DPM and DPM Brokerage, as well as a Vice President and Controller of Tricon. Mr. Castranova has been with Tricon since October 1986 and is responsible for the risk management of all physicals trading as well as the administration of all general and consolidation accounting. Prior to joining Tricon, Mr. Castranova was an accountant with two energy firms. In 1980 Mr. Castranova graduated from Saint Joseph's University with a BS degree in Accounting. He is registered as an associated person and principal of Blenheim, DPM, and DPM Brokerage, and is a member of the National Futures Association in those capacities. Blenheim and its principals may, from time to time, trade futures, forwards, and options contracts for their own proprietary accounts. If either Blenheim or its principals engage in such trading, you will not be able to inspect such records. Such trades may or may not be in accordance with the Blenheim trading program described below. As of December 31, 2003, Blenheim was managing approximately $68.1 million of client assets pursuant to its trading program. The Blenheim Global Markets Strategy The Global Markets Strategy designed and developed by the management team of Blenheim. The objective of the Global Markets Strategy is to capture substantial profits through the establishment of risk-controlled, strategic investment positions in markets where Blenheim has identified an unsustainable level of market disequilibrium that has not been reflected in the current market price. The essence of Blenheim's trading approach is its ability to use discretion in formulating the most effective mix of trading methodologies, investment vehicles, and markets to maintain performance objectives. As trading opportunities are identified, Blenheim analyzes potential trading applications in order to achieve maximum capital appreciation with prudent risk management procedures. Markets Traded Blenheim's portfolio is highly diversified and draws upon a potential of 35 markets, depending on the opportunities presented at any given time. The major markets traded by Blenheim include energy, industrials, precious metals, softs, grains, global fixed income, currencies and stock indices. Blenheim concentrates in those markets that, in its judgment and discretion, have a high degree of liquidity and a wide spectrum of historical price movement relative to other markets. Instruments Utilized Positions established are typically in derivative instruments such as futures options and OTC transactions. Blenheim may, however, trade to a limited extent in illiquid instruments for which market quotations are not readily available. In addition, Blenheim may trade in securities that are related to the financial and commodities markets currently traded by the fund. However, Blenheim will not be trading securities for Spectrum Strategic. Blenheim's Trading Style Blenheim uses a global macro approach to investing, which utilizes fundamental, geopolitical and technical research and analysis in its evaluation of the markets. Fundamental analysis attempts to examine factors external to the trading market which affect the supply and demand for a particular investment instrument in order to predict future prices. The geopolitial considerations include governmental interference and potential political conflicts which may alter the normal flow of capital and goods. Technical factors assume that market price patterns and price momentum, rather than external influences, indicate the supply and demand factors which are indicative of future price movements. Blenheim considers technical factors such as an instrument's recent price history, current prices of such instrument relative to price of other markets and their historical price relationships. Blenheim studies price charts to assess changes in market sentiment and examines volume and open interest to evaluate market liquidity. The Blenheim traders regularly monitor worldwide economic and political trends in order to identify and evaluate possible market and price imbalances. Operating within a global framework, long-term macroeconomic indicators are assessed on a multinational, country-by-country and market specific basis. Factors such as fiscal/monetary policies and cross-border capital flows are evaluated for their potential impact on the equity, fixed income, currency and commodity markets. Additionally, Blenheim's trading group utilizes econometric signals, as well as numerous other market sentiment indicators, to take advantage of short-term trading opportunities. Portfolio Management and Diversification Various techniques are employed in managing the portfolio and position volatility. In its discretionary trading, Blenheim generally initiates medium-sized positions at a market entry level. This initial position, generally considered the core strategic position, is typically initiated upon Blenheim's determination of an unsustainable level of market disequilibrium that has not been reflected in the current market price. Once market action begins to conform to Blenheim's initial assessment of price behavior, Blenheim will add to the original strategic position. In addition to managing the individual positions, Blenheim will also evaluate the positions within the context of an account's portfolio. Separate strategic positions are evaluated for direct and indirect correlation characteristics in order to further anticipate and manage portfolio volatility. Despite these precautions, Blenheim's trading program may be volatile at times. Diversification in an account's portfolio is a major consideration in its trading approach. While many of its trades are made on a short-term basis, Blenheim's basic strategy is to attempt to participate in long-term, major price movements. Evolution of the Trading Approach The trading strategy of Blenheim has evolved and will continue to do so based on ongoing research, testing of data and trading experience. Prior to 1991, Blenheim traded almost exclusively in commodity markets, with a particular emphasis on energy products. Since then, Blenheim has become active in the global fixed-income, stock indices and currency markets as well. In the past, Blenheim had included non-discretionary systematic computerized analysis in its trading practices. This strategy was driven by a series of trading systems that produced a result that was an amalgam of numerous systemic processes. It was then traded in conjunction with the discretionary approach. Under separate funds, Blenheim also managed a purely financial strategy and a long-only commodity trading strategy incorporating physical commodities. In this regard, Blenheim reserves the right to modify its trading approach to include any one or combination of trading methodologies it finds beneficial to its overall goals. These processes may include discretionary, systematic, or arbitage trading. Blenheim may use derivative instruments including futures, options, and forwards to reach its performance objectives. On rare occasions, Blenheim may withdraw from all markets. Blenheim's diversified portfolio is actively traded on domestic and foreign markets. In the early 1990s, approximately thirty-five percent (35%) to forty-five percent (45%) of equity, including notional funds, was generally committed to margin on commodities positions. Recently the percentage has been between twenty-five percent (25%) and thirty-five percent (35%). In the future the percentage committed may, from time to time, be substantially higher or lower. Variances in Leverage If particular opportunities present themselves based upon fundamental factors, Blenheim may increase the number of positions held. This will result in more capital needed to provide risk margin. Accordingly, within the overall parameters of Blenheim's money management rules, Blenheim employs no hard and fast formula as to the levels of capital committed to discretionary trading or any other trading strategy at any given time. The level of risk margin relative to equity committed to trading positions is expected to vary from period to period. The Blenheim traders will constantly monitor leverage in an effort to try to maximize its positive effects while trying to avoid overexposure to its potential negative characteristics. While there is no guaranty that this approach will be successful, Blenheim has used a consistent risk monitoring system for a number of years, one of the key components thereof involves monitoring the levels of risk margin to equity. Blenheim may leverage the account of Spectrum Strategic differently than the standard account using the Global Market Strategy, but will not leverage the account at more than 50% above the leverage of a standard account. 3. Eclipse Capital Management, Inc. Eclipse is a Delaware corporation organized in July 1983. Eclipse's main business address is 7700 Bonhomme, Suite 500, St. Louis, Missouri 63105. Eclipse has been registered with the CFTC as a commodity trading advisor since August 1986 and is a member of the National Futures Association in such capacity. Eclipse began trading for Spectrum Strategic in June 2000. Principals Thomas W. Moller, the sole shareholder of Eclipse, has served as its President, CEO, and sole director since founding the firm. Mr. Moller received an undergraduate degree in Business and Economics from Vanderbilt University and a graduate degree in Accounting from the University of Kentucky. He was a Certified Public Accountant and has a background in financial planning and investment management. In 1980, as chief financial officer of a privately held company, he designed and implemented one of the first variable rate loan hedge programs using interest rate futures contracts. In 1982, he formed Interest Rate Management, Inc., another commodity trading advisor which provided interest-rate-hedging advisory and management services. Since 1986, Mr. Moller has devoted his time exclusively to Eclipse and is primarily involved in the areas of trading, research, and product development. James R. Klingler, JD is Senior Vice President, Corporate Secretary, and General Counsel. Mr. Klingler has a BA in Economics from Vanderbilt University and a JD from Vanderbilt University School of Law. He previously worked as an associate with the St. Louis law firm of Thompson Coburn (formerly Coburn & Croft) and as a staff attorney with Mercantile Bancorporation, also in St. Louis. From January 1991 to December 1997, he was Compliance Counsel and, subsequently, Associate Vice President with A.G. Edwards & Sons, Inc. Mr. Klingler joined Eclipse in January 1998. Ronald R. Breitigam is Vice President Trading with primary responsibility for the implementation of the firm's trading strategies. After graduating from Pacific Union College in 1982, Mr. Breitigam became an independent floor trader at the Mid-America Commodity Exchange. He served as an institutional broker with Thomson McKinnon (1984-1985) and PaineWebber (1986) and, in 1986, formed his own trading company to work full time implementing various proprietary futures and options trading strategies. Mr. Breitigam joined Eclipse in May 1989. James W. Dille, PhD is Vice President Research and Technology with responsibility for computer-based research, development, and operations. Dr. Dille has undergraduate and graduate engineering degrees from the University of Virginia. He also received a master's and doctorate from Harvard University in Applied Sciences, specializing in the areas of Decision and Control Theory and Computer Science. From 1987 through 1993, he worked for the Boeing Company (formerly, McDonnell Douglas) in the Training Systems and Flight Simulation divisions, where he was responsible for research in the areas of computer architectures and networking. He is an affiliate professor at Washington University in St. Louis, teaching courses in numerical analysis and the simulation and analysis of complex systems. Dr. Dille joined Eclipse in January 1994. At this time, neither Eclipse nor its principals trade for their own account, but each reserves the right to do so in the future. If either Eclipse or its principals engage in such trading, you will not be able to inspect such records. Trading Programs Eclipse currently offers one trading program, the Global Monetary Program. The program is designed primarily for institutions, commodity pools, and certain other qualified investors. The Global Monetary Program employs a systematic trading approach, using multiple trend-following and macroeconomically driven models. Global Monetary Program: This "financial, metals and energy" program requires a minimum investment of $5 million and trades a global portfolio of futures and options on futures on interest rate instruments, currencies, stock indices, precious and base metals, and energy products, as well as interbank spot and forward currency markets. A key characteristic of this program is the extensive diversification achieved by applying multiple trading models to a wide variety of financial markets located throughout the world. As of December 31, 2003, Eclipse was managing approximately $379 million of client assets pursuant to its trading program (notional funds included). Trading Approach The trading program of Eclipse is systematic and its strategies are either macroeconomic or trend-following in nature, with the objective of capitalizing on intermediate- and long-term price trends. Eclipse makes all trading decisions pursuant to its proprietary trading, capital allocation, and risk management models. The Eclipse program makes use of multiple models to accentuate overall diversification. Macro-driven models generate trading signals through the quantitative analysis of environmental, macroeconomic, and intermarket data. Trend identification models use various technical and statistical analysis techniques to identify and evaluate price trends. Capital allocation models determine the percentage of trading capital allocated to various markets and trading models. Eclipse's risk management models were developed with the objective of limiting losses, capturing profits, and conserving capital in choppy, sideways markets. The risk management principles which Eclipse employs include: using stop orders to exit trades when markets are moving against an established position (although, depending on market circumstances, such "stop-loss" orders may be difficult or impossible to execute); diversifying positions among several different markets, futures, and/or futures groups to limit exposure in any one area; using multiple entry and exit points; limiting the assets committed as margin, generally within a range of 5% to 20% of assets managed, at minimum exchange margin requirements, but possibly above or below that range at certain times; and prohibiting the use of unrealized profits in a particular futures contract as margin for additional contracts in the same or a related futures contract. Decisions whether to trade a particular futures contract are based upon various factors, including liquidity, significance in terms of desired degrees of concentration, diversification, and profit potential, both historical and at a given time. These decisions are based upon output generated by a proprietary risk management program, but require the exercise of judgment by principals of Eclipse. The decision not to trade specific contracts for certain periods or to reduce the number of contracts traded may result at times in missing significant profit opportunities which otherwise would be captured by technical strategies. The specific contracts traded in each portfolio have been selected based on liquidity, historical volatility, and the degree of past directional movement. The actual number of contracts held at any particular point in time depends on a number of factors, including evaluation of market volatility and potential risk versus return. There are occasions when a trading model may indicate that no position is appropriate in a particular contract or contract group. In addition to technical trading in futures contracts, Eclipse may also employ trading techniques such as spreads and straddles and may buy or sell futures options. Eclipse may alter its trading programs, including, without limitation, its trading strategies, commodity interests, and markets traded and trading principles if Eclipse determines that such change is in the best interest of the accounts which it manages. Morgan Stanley Spectrum Global Balanced L.P. SSARIS Advisors, LLC SSARIS, a Delaware Limited Liability Company, was organized in May 2001. SSARIS's address is Financial Centre, 695 East Main Street, Suite 102, Stamford, Connecticut 06901. SSARIS has been registered as a commodity trading advisor since August 2001 and as a commodity pool operator since August 2001, and is a member of the National Futures Association in such capacities. SSARIS is a joint venture between State Street Global Alliance LLC, a limited liability company which is majority owned by State Street Global Advisors, Inc., and RTH Partners LLC, a limited liability company owned by the principals of The RXR Group, Inc. State Street Global Advisors, Inc. is a wholly-owned subsidiary of State Street Corporation. SSARIS is affiliated with State Street Global Advisors, the investment management division of State Street Bank and Trust Company, a wholly owned subsidiary of State Street Corporation. Principals Mr. Mark Rosenberg has served as the Chairman, a Director and the Chief Investment Officer of SSARIS since its formation in May 2001 and, as such, is the head of SSARIS's Investment Committee. Mr. Rosenberg is also the Chairman of SSARIS Management LLC. Mr. Rosenberg was the Chairman and Chief Investment Officer of RXR. Mr. Rosenberg has over thirty (30) years experience in the investment management industry. From August 1984 to July 1986, Mr. Rosenberg was employed by Prudential-Bache Securities, Inc., where he headed a group that specialized in institutional hedging and managed futures trading services. From December 1976 to July 1984, Mr. Rosenberg was employed by Merrill Lynch & Co. where he organized a group that was responsible for managing hedging and alternative investment strategies for Merrill's institutional clients. This entity became the Financial Futures and Options Group. Mr. Rosenberg's first job was on the floor of the New York Stock Exchange and subsequently the New York Mercantile Exchange, where he managed proprietary capital using a variety of quantitative techniques for Weis, Voisen & Cannon, a private investment boutique. Mr. Rosenberg is a fourth term Director of the Board of the Futures Industry Association, and arbiter for the NFA and is a member of the Financial Advisory Boards of both the Chicago Mercantile Exchange and the COMEX Division of NYMEX. Mr. Rosenberg is also a Director of the Foundation of Finance and Banking Research. Mr. Rosenberg also is involved in several community activities. He has donated time to Domus House, a refuge for abandoned children, and various entrepreneurial projects targeting low-income families. Mr. Peter A. Hinrichs has served as the Chief Financial Officer of SSARIS since its formation in May 2001 and is a member of SSARIS's Investment Committee. Mr. Hinrichs also is Chief Financial Officer of SSARIS Management LLC. Mr. Hinrichs was with RXR since its founding in 1983, where he was responsible for RXR's financial, administrative and operational functions. Mr. Hinrichs also was a member of RXR's Investment Committee. From September 1981 to July 1984, Mr. Hinrichs was employed by Merrill Lynch Futures Inc. in trading and administration and held a similar position at Prudential from July 1984 to August 1986. Mr. Hinrichs graduated from Curry College in 1981 with a Bachelor of Science degree in Business Management. He is active in his community as a Board member of Fountain House Inc., a non-profit rehabilitation center for the mentally ill, where he serves as an Investment Committee member. He also is active with a number of other charitable organizations. Mr. James F. Tomeo has served as the Chief Operating Officer, a Senior Portfolio Manager and a Director of SSARIS since its formation in May 2001. Mr. Tomeo also is a member of SSARIS's Investment Committee and is responsible for portfolio management, strategic planning and product development. Mr. Tomeo served as Chief Operating Officer and a Senior Portfolio Manager of RXR and was a member of the firm's Investment Committee. Before joining RXR in 1986, Mr. Tomeo worked for Donaldson, Lufkin and Jenrette as an alternative investment consultant, and the LTV Corporation in New York. Mr. Tomeo was formerly an advisor to Institutional Investor on matters related to Japanese pension fund reform, is the former Chairman of the International Committee of the Managed Funds Association and is the US representative to the Education and Research Committee of the Alternative Investment Management Association. Mr. Tomeo graduated from Bucknell University in May 1980 with a Bachelor of Science degree in Business Administration, the University of Hartford in 1987 with an MBA degree, and the Institute of International Studies and Training (Japanese business study program) in November 1988. He studied International Finance and Capital Markets at New York University. Alan J. Brown has been a Director of SSARIS since July 2003. Mr. Brown is a principal of State Street Global Advisors, Group Chief Investment Officer of State Street Global Advisors Worldwide, Chairman of State Street Global Advisors UK, and Executive Vice President of State Street. He is also a member of State Street Global Advisor's Executive Management Group. Mr. Brown is a director of Advanced Investment Partners, European Direct Capital Management, Rexiter Capital Management, Boston Capital Management and Global Alliance, LLC. Mr. Brown is also a member of State Street Global Advisor's Executive Management Group. Prior to joining State Street Global Advisors UK in 1995, Mr. Brown was Managing Director and Chief Investment Officer of PanAgora Asset Management Limited, and prior to that, Managing Director of Posthorn Global Asset Management in London. Mr. Brown began his career in the investment management business in 1974 at Morgan Grenfell, where he spent ten years. Mr. Brown holds a Masters degree in Physics from Cambridge University. Mr. Brown is on the board of the U.S. foundation for The Center for Economic Research and Graduate Education-Economic Institute attached to the Charles University in Prague. Jay Cromarty has been a Director of SSARIS since March 2003. Mr. Cromarty is the President of Global Alliance and a Senior Principal of State Street Global Advisors. Among other duties, Mr. Cromarty provides strategic management and marketing support to all of the Global Alliance investment management businesses. Mr. Cromarty is a director of Advanced Investment Partners, Boston Capital Management and Residential Capital Management. Before joining Global Alliance in May 1998, Mr. Cromarty served as the Managing Director of Sales and Marketing for State Street Global Advisors' Private Asset Management group. Prior to joining State Street Global Advisors in 1996, Mr. Cromarty was Vice President of The Boston Company, Inc., Director of Marketing and Client Service at PanAgora Asset Management and Senior Vice President of NatWest Investment Management. Mr. Cromarty holds a Bachelor of Science degree in Economics from the University of Maine and a Masters of Business Administration degree in Finance and Marketing from Babson College. Christopher M. Pope has been a Director of SSARIS Global Advisors and Director of Institutional Sales, Client Service, and Consultant Relations. Prior to joining State Street Global Advisors in 1988, Mr. Pope was responsible for marketing and client service at Travelers Investment Management Company and Travelers Keystone Fixed Income Advisors. Mr. Pope holds a Bachelor of Science degree from the University of Pennsylvania. Mr. Pope is a charter member of the Certified Employee Benefit Specialist program. Principals and employees of SSARIS are not permitted to trade futures, options on futures, or forward contracts for their own accounts. Principals and employees are, however, permitted to invest in funds traded by SSARIS. SSARIS's Investment Philosophy SSARIS trades its allocation from Spectrum Global Balanced pursuant to a variation of its Balanced Portfolio known as the Global Multi-Strategy program. The development of the trading program utilized for Spectrum Global Balanced stems from RXR's work over the years with institutional clients. In 1986, RXR began managing a portfolio called the Institutional Balanced Portfolio program (now known as the Balanced Portfolio), which was composed of U.S. stock, bond and non-U.S. financial and commodity interests. Its objective was capital appreciation with controlled volatility, a concept pioneered by Professor John Lintner of Harvard University, who conducted research on the addition of managed futures to portfolios of U.S. stocks and bonds. The philosophy for the investment program has its roots in Modern Portfolio Theory and the design of efficiently allocated portfolios. Effective June 1, 1998, RXR broadened the hedged equity and fixed income components to include participation in the world's major developed capital markets and increased the program's leverage to 1.4 times the original Balanced Portfolio Program. The resulting program is now known as the Global Multi-Strategy. SSARIS's Global Multi-Strategy program allocates to hedged equity, hedged fixed income, and long/short global assets. It is diversified by both style (divergence and convergence strategies) and asset class (global stocks, bonds, currencies and real assets). The hedged equity component may be composed of positions in FTSE 100, DAX, Nikkei 225, and S&P 500 futures indices. The hedged fixed income exposure may include British Gilt, German Bund, Japanese & US Treasury futures. Real asset exposure is diversified across energy, precious metal, base metal, and agricultural markets. The investment program uses a multi-determinant model to rebalance the independent strategies. The global stock and bond exposure is managed using models which interpret macroeconomic, relative value, inflation, interest rate, and price-related data. Exposure within the long/short global asset sector is regulated by combining individual market expected return analysis with a system that asset weights each market according to relative volatility and correlation. In the foreign exchange and commodity components, SSARIS analyzes price data to determine profit and risk potential. A proprietary asset allocation model is used to adjust exposure among approximately 40 markets so that no one market or sector can dominate performance. The investment program was designed to provide investors with a global investment alternative. Through the controlled use of futures and forward contracts, SSARIS manages both U.S. and non-U.S. capital markets, currency and commodity exposure in a single, integrated portfolio. As of December 31, 2003, SSARIS was managing approximately $53 million of client assets pursuant to the program utilized for Spectrum Global Balanced and approximately $612 million in all of their programs. Research and Development Research and development calls on the talents of personnel from several areas within the company. SSARIS has developed macro-economic and technical models that can detect price movements resulting from daily market activity and major changes in global business cycles. Using this information, portfolio managers construct investment portfolios that address the specific actuarial assumptions of their clients. No representation is made and no guarantee is given that Spectrum Global Balanced's objective will be realized or that SSARIS will achieve any particular level of performance or amount of profits in its trading for Spectrum Global Balanced's account. Losses incurred in the global and tangible assets component could cause Spectrum Global Balanced's account to substantially underperform accounts managed by asset allocation systems that do not include a managed futures component. Prospective investors must recognize not only that the foregoing discussion attempts to present only the most basic framework describing the trading program employed for Spectrum Global Balanced, but also, due to the proprietary and confidential nature of all trading approaches, any description will inevitably be general in nature. Furthermore, SSARIS's trading methods are continually evolving, as are the markets themselves. Morgan Stanley Spectrum Currency L.P. 1. John W. Henry & Company, Inc. (JWH ) JWH makes trading decisions for Spectrum Currency pursuant to the International Foreign Exchange Program. The International Foreign Exchange Program, which began trading client capital in August 1986, seeks to identify and capitalize on intermediate-term movements in a broad range of both major and minor currencies primarily trading on the interbank market. Positions are taken as outrights against the U.S. dollar, or non-dollar cross rates. This program uses the three-phase forex investment style. For a detailed description of JWH, its principals, and trading systems, including the International Foreign Currency Program, see "The Trading Advisors Morgan Stanley Spectrum Technical 3. John W. Henry & Company, Inc." beginning on page . 2. Sunrise Capital Partners, LLC The principals and senior officers of Sunrise Capital Partners are as follows: Martin P. Klitzner Principal, Managing Director Richard C. Slaughter Principal, Managing Director Dr. Gary B. Davis Principal Dr. John V. Forrest Principal Martin M. Ehrlich Principal, Vice President Marie Laufik Principal, Vice President Elissa Davis Principal The principals of Sunrise Capital Partners will make trading decisions for Spectrum Currency pursuant to the Currency Program. For a detailed description of Sunrise Capital Partners, its principals and trading systems, other than the Currency Program, which is discussed below, see "The Trading Advisors Morgan Stanley Spectrum Select 4. Sunrise Capital Management, Inc." beginning on page . The Currency Program follows approximately ten different major and minor currency markets, which may include, but are not limited to, the Japanese yen, British pound, euro currency, Swiss franc, Canadian dollar, Australian dollar, Swedish krona, New Zealand dollar, Singapore dollar, and South African rand. The Currency Program trades currency futures contracts on the International Monetary Market Division of the Chicago Mercantile Exchange and forward currency contracts in the interbank markets. In order to achieve adequate diversification for the Currency Program, major and minor currencies are traded as crossrates selectively against each other and/or as outrights against the U.S. dollar. As of December 31, 2003 Sunrise Capital Partners was managing approximately $146 million of client assets pursuant to the Currency Program and approximately $1.7 billion of client assets in all of its programs (notional funds excluded). EXCHANGE RIGHT If the conditions described below are satisfied, you may redeem your units in any partnership as of the last day of any calendar month and use the proceeds to purchase units of any of the other Spectrum Series partnerships. However, a Spectrum Series exchange will only be permitted as of the sixth month-end after you first became an investor in any Spectrum Series partnership, and as of the last day of each month thereafter. Each unit you purchase in a Spectrum Series exchange will be issued and sold at a price per unit equal to 100% of the net asset value of a unit as of the close of business on the exchange date. Any units you redeem in a Spectrum Series exchange will not be subject to a redemption charge. Units you acquire in a Spectrum Series exchange will be subject to redemption charges, but will be deemed to have the same purchase date as the units you exchanged for purposes of determining the applicability of any redemption charges. Thus, for example, if you hold units of Spectrum Strategic for 12 months, exchange those units for units of Spectrum Technical, then redeem any of those units 15 months later, you will not have to pay a redemption charge, because those units will be deemed to have been held for 27 months. When you request a Spectrum Series exchange, additional conditions must be satisfied. First, the partnership from which you are redeeming must have assets sufficient to discharge its liabilities and redeem units. In order to effect a Spectrum Series exchange, you must send a subscription agreement to a Morgan Stanley branch office, and that agreement must be received by the general partner at least five business days prior to the applicable exchange date. In that agreement, you must acknowledge that you are still eligible to purchase units on the exchange date. You must exchange a minimum of 50 units in a Spectrum Series exchange, unless you are liquidating your entire interest in a partnership. A form of subscription agreement is annexed to this prospectus as Exhibit B, and additional copies of the subscription agreement may be obtained by written request to the general partner or from a local Morgan Stanley branch office. In order to effect a Spectrum Series exchange, each partnership must have a sufficient number of units registered and qualified for sale under federal and applicable state securities laws pursuant to a current prospectus. While the general partner intends to maintain a sufficient number of registered units to effect series exchanges, it is under no obligation to do so. Therefore, the general partner cannot assure you that any units will be available for sale on an exchange date. Furthermore, states may impose significant burdens on, or alter the requirements for, qualifying units for sale. In that event, the general partner may not continue qualifying units for sale in those states, and residents of those states would not be eligible for a Spectrum Series exchange. In addition, states may impose more restrictive suitability and/or investment requirements than those set forth in the form of subscription agreement. Any such restrictions may limit the ability of residents of those states to effect a Spectrum Series exchange. In the event that not all subscription agreements can be processed because an insufficient number of units is available for sale on an exchange date, the general partner will allocate units in the manner it determines in its sole discretion. The general partner has not yet determined how it will allocate units in the event there are an insufficient number of units available on an exchange date. Units of any new partnership in the Spectrum Series may be offered to investors pursuant to exercise of the Spectrum Series exchange right. Before purchasing units of a new partnership, you will be required to receive a copy of a prospectus and any supplement to this prospectus describing the new partnership and its units, and you will be required to execute a new subscription agreement to purchase units of that partnership. Since a Spectrum Series exchange is equivalent to a redemption and an immediate reinvestment of the proceeds of the redemption, you should carefully review the portions of this prospectus describing redemptions and the tax consequences before effecting a Spectrum Series exchange. REDEMPTIONS Once you are an investor in a Spectrum Series partnership for at least six months, you may redeem all or part of your units, regardless of when such units were purchased. Redemptions may only be made in whole units, with a minimum of 50 units required for each redemption, unless you are redeeming your entire interest in a partnership. The general partner will redeem your units in the order in which they were purchased. Redemptions will only be effective as of the last day of the month in which a request for redemption in proper form has been timely received by the general partner. A "request for redemption" is a letter in the form specified by the general partner that must be sent by you to a local Morgan Stanley branch office and received by the general partner at least 5 business days prior to the redemption date. A form of request for redemption is annexed to the limited partnership agreement, which agreement is annexed to this prospectus as Exhibit A. Additional copies of the request for redemption may be obtained by written request to the general partner or a local Morgan Stanley branch office. If you redeem units, you will receive 100% of the net asset value of each unit redeemed as of the redemption date, less any applicable redemption charges. Since the general partner must receive your request for redemption at least five business days prior to the redemption date, you will not know the actual amount you are to receive prior to the redemption date. The "net asset value" of a unit is an amount equal to the partnership's net assets allocated to capital accounts represented by units, divided by the number of units outstanding. "Net assets" means the total assets of a partnership, including all cash and cash equivalents (valued at cost), accrued interest and amortization of original issue discount, and the market value of all open futures, forwards, and options positions and other assets of the partnership, less the total liabilities of the partnership, including, but not limited to, all brokerage, incentive and management fees, and extraordinary expenses, as determined in accordance with generally accepted accounting principles consistently applied under the accrual basis of accounting. The market value of a futures contract traded on a U.S. exchange means the settlement price on the exchange on which that futures contract is traded on the day net assets are being determined. However, if a futures contract could not have been liquidated on that day because of the operation of daily limits or other rules of the exchange or otherwise, the settlement price on the first subsequent day on which the futures contract could be liquidated will be the market value of that futures contract for that day. The market value of a forward or futures contract traded on a foreign exchange or market means its market value as determined by the general partner on a basis consistently applied for each different variety of forward contract or futures interest. If you redeem units on or prior to the last day of the twelfth month from the date of their purchase, those units will be subject to a redemption charge equal to 2% of their net asset value on the redemption date. If you redeem units after the last day of the twelfth month and on or prior to the last day of the twenty- fourth month from the date of their purchase, those units will be subject to a redemption charge equal to 1% of their net asset value on the redemption date. If you redeem units after the last day of the twenty-fourth month from the date of their purchase, those units will not be subject to a redemption charge. All redemption charges will be paid to Morgan Stanley DW and will not be shared with the financial advisor or additional selling agent who sold the units. Your units will be exempt from redemption charges under the following circumstances: If you redeem units at the first redemption date following notice of an increase in brokerage, management, or incentive fees, those units will not be subject to redemption charges. If you redeem units in a Spectrum Series exchange, the units you redeem will not be subject to redemption charges and, for purposes of determining the applicability of future redemption charges, the units you acquire will be deemed to have the same purchase date as the units you exchanged. If you redeem units of any other partnership for which Demeter serves as the general partner, the units you redeem from the other limited partnership will be subject to any applicable redemption charges, but the Spectrum Series units you purchase will not be subject to redemption charges. If you redeem units and have either paid a redemption charge with respect to the units or held the units for at least 24 months, you will not be subject to redemption charges with respect to any newly purchased units, provided the new units are purchased within twelve months of and in an amount no greater than the net proceeds of the prior redemption, and the units are held for at least six months from the date of purchase. In that event, you will still be subject to the minimum purchase and suitability requirements. The general partner will endeavor to pay redemptions within ten business days after the redemption date. A partnership may be forced to liquidate open futures, forward, and option positions to satisfy redemptions in the event it does not have sufficient cash on hand that is not required as margin on open positions, and may delay payment to limited partners requesting redemption of units of the proportionate part of the net asset value of the unit represented by the sums for which sufficient cash is not available. See "Risk Factors Partnership and Offering Risks Restricted investment liquidity in the units" on page . When you redeem units, payment will be made by credit to your customer account with Morgan Stanley DW, or by check mailed to you if your account is closed. Your right to redeem units is contingent upon the redeeming partnership having assets sufficient to discharge its liabilities on the redemption date, and timely receipt by the general partner of your request for redemption as described above. The terms and conditions applicable to redemptions in general, other than those prohibiting redemptions before the sixth month-end following the closing at which you first became an investor in a Spectrum Series partnership, and providing that redemptions may only be made as of the end of a calendar month, will also apply to redemptions effected on "special redemption dates." See "The Limited Partnership Agreements Books and Records; Reports to Limited Partners" on page . THE COMMODITY BROKERS Morgan Stanley DW Inc., Morgan Stanley & Co. Incorporated, and Morgan Stanley & Co. International Limited Morgan Stanley DW Inc., a Delaware corporation, acts as the partnerships' non-clearing commodity broker. Morgan Stanley DW, as the non-clearing commodity broker, holds each partnership's funds in customer segregated or secured accounts, and provides all required margin funds to the clearing commodity brokers. Morgan Stanley & Co. Incorporated, a Delaware corporation, acts as the partnerships' clearing commodity broker and foreign currency forward counterparty, and Morgan Stanley & Co. International Limited serves as the clearing commodity broker for trades that take place on the London Metal Exchange. Morgan Stanley DW monitors each partnership's futures positions that the clearing commodity brokers report they are carrying for any errors in trade prices or trade fill. Morgan Stanley DW also serves as the non-clearing commodity broker for all, and Morgan Stanley & Co. serves as the clearing commodity broker and foreign exchange counterparty for all but one, of the other commodity pools for which Demeter serves as general partner and commodity pool operator. Morgan Stanley International serves as the clearing commodity broker for the trades of such pools that take place on the London Metal Exchange. Morgan Stanley DW is a financial services company which provides to its individual, corporate, and institutional clients services as a broker in securities, futures, and options, a dealer in corporate, municipal and government securities, an investment adviser, and an agent in the sale of life insurance and various other products and services. Morgan Stanley DW has its main business office at 1585 Broadway, New York, New York 10036. Morgan Stanley DW is a member firm of the New York Stock Exchange, the American Stock Exchange, the Chicago Board Options Exchange, and other major securities exchanges. Morgan Stanley DW is registered with the CFTC as a futures commission merchant and is a member of the National Futures Association in such capacity. Morgan Stanley DW is also registered with the SEC as a broker-dealer and is a member of the NASD. Morgan Stanley DW and its affiliates currently service clients through a network of approximately 700 offices with approximately 12,000 financial advisors servicing individual and institutional client accounts. Morgan Stanley & Co. Incorporated is the clearing commodity broker for all trades for the partnerships, other than for those trades on the London Metal Exchange. Morgan Stanley & Co. has its main business office at 1585 Broadway, New York, New York 10036. Morgan Stanley & Co. is registered as a futures commission merchant, is a member of the National Futures Association, and is a member of most major U.S. and foreign commodity exchanges. Morgan Stanley & Co. is registered with the SEC as a broker-dealer and is a member of the NASD. Morgan Stanley & Co. International Limited, a United Kingdom corporation, acts as the partnerships' clearing commodity broker solely with regard to any trading on the London Metal Exchange. Morgan Stanley International has its main business office at 25 Cabot Square, Canary Wharf, London E14 4QA, England, is regulated by the United Kingdom Securities and Futures Authority as a member firm, and is a member of the London Metal Exchange and other securities and commodities exchanges worldwide. Morgan Stanley, the parent company of Morgan Stanley DW, Morgan Stanley & Co. and Morgan Stanley International, is a worldwide financial services firm, employing, directly and through its subsidiaries, more than 51,000 people worldwide in offices throughout the United States and 28 foreign countries. Morgan Stanley is a publicly-traded company listed on the New York Stock Exchange; its common stock had a market value of approximately $60 billion at November 30, 2003. At that date, Morgan Stanley had leading market positions in its three primary businesses (securities, asset management and credit services), and it ranked among the top asset managers globally, with over $462 billion in assets under management. Brokerage Arrangements The partnerships' brokerage arrangements with Morgan Stanley DW, Morgan Stanley & Co. and Morgan Stanley International are discussed in "Conflicts of Interest The brokerage arrangements with affiliates of the general partner were not negotiated at arm's-length or reviewed by any independent party for fairness" on page , " Customer agreements with the commodity brokers permit actions which could result in losses or lost profit opportunity" on page , and "Description of Charges Commodity Brokers" beginning on page . The general partner will review at least annually the brokerage arrangements of each partnership to ensure that those arrangements are fair, reasonable, and competitive, and represent the best price and services available, taking into consideration: the size of the partnership; the futures, forwards, and options trading activity; the services provided by the commodity brokers or any affiliate thereof to the partnership; the cost incurred by the commodity brokers or any affiliate thereof in organizing and operating the partnership and offering units; the overall costs to the partnership; any excess interest and compensating balance benefits to the commodity brokers from assets held thereby; and if the general partner does not receive any direct compensation from the partnership for its services as general partner, the risks incurred by the general partner as general partner of the partnership; Each customer agreement sets forth a standard of liability for the commodity broker and provides for indemnities of the commodity broker. See "Fiduciary Responsibility and Liability" beginning on page 17. LITIGATION At any given time, the commodity brokers are involved in numerous legal actions, some of which seek significant damages. On January 11, 1999 the SEC brought an action against 28 NASDAQ market makers, including Morgan Stanley & Co., and 51 individuals, including one current and one former trader employed by Morgan Stanley & Co., for certain conduct during 1994. The core of the charges against Morgan Stanley & Co. concerns improper or undisclosed coordination of price quotes with other broker-dealers and related reporting, recordkeeping, and supervisory deficiencies in violation of Sections 15(b)(4)(E), 15(c)(1) and (2) and 17(a) of the Securities Exchange Act and Rules 15c1-2, 15c2-7 and 17a-3 promulgated thereunder. Without admitting or denying the charges, Morgan Stanley & Co., consented to the entry of a cease and desist order and to the payment of a civil penalty of $350,000, disgorgement of $4,170, and to submit certain of its procedures to an independent consultant for review. In addition, one current and one former trader employed by Morgan Stanley & Co. accepted suspensions of less than two months each and were fined $25,000 and $30,000, respectively. On April 6, 2000, Morgan Stanley & Co., along with 16 other firms, entered into an industry-wide settlement with the SEC, IRS and the Department of Justice (intervening on behalf of a qui tam plaintiff) to resolve litigation and investigations relating to "yield burning" allegations. At the core of the "yield burning" litigation and investigations were allegations that, from 1990 to 1994, escrow providers excessively marked up securities sold to escrow accounts in connection with advance refunding transactions on behalf of municipal bond issuers. The practice was alleged to benefit the escrow provider to the detriment of either the United States Treasury or the municipal issuer. The industry-wide settlement required 17 firms to pay a total of over $139 million (over $120 million to the United States Treasury and over $18 million directly to municipal issuers). Without admitting or denying any wrongdoing, Morgan Stanley & Co. consented to the entry of an order directing that it cease and desist from violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and requiring it to pay $2.45 million to the United States Treasury. No payment to municipal issuers was required. On July 14, 2003, the Massachusetts Securities Division filed an administrative complaint alleging that Morgan Stanley DW Inc. filed false information in response to an inquiry from the Massachusetts Securities Division pertaining to mutual fund sales practices. On August 11, 2003, the Massachusetts Securities Division filed an administrative complaint, alleging that Morgan Stanley DW Inc. failed to make disclosures of incentive compensation for proprietary and partnered mutual fund transactions. On November 25, 2003, the Massachusetts Securities Division filed an administrative complaint, alleging that a former branch manager engaged in securities fraud and dishonest conduct in promoting the sales of proprietary mutual funds. Morgan Stanley DW Inc. answered the first two complaints on August 4 and September 16, 2003, respectively. Hearings on all of these matters are scheduled to commence on May 17, 2004. On September 15, 2003, Morgan Stanley DW Inc. and one of its officers entered into a settlement with the NASD pursuant to a Letter of Acceptance, Waiver and Consent. The Letter of Acceptance, Waiver and Consent alleges violations of applicable NASD rules in connection with various sales contests conducted from October 1999 to December 2002. Under the terms of the settlement, Morgan Stanley DW Inc. and its officer neither admitted nor denied the allegations of the Letter of Acceptance, Waiver and Consent and accepted a censure and the imposition of monetary fines in the amounts of $2 million and $250,000, respectively. On November 17, 2003, Morgan Stanley DW Inc. consented, without admitting or denying the findings, to the entry of an order by the Securities and Exchange Commission that resolved the Securities and Exchange Commission's investigations into certain practices relating to Morgan Stanley DW Inc.'s offer and sale of shares of certain registered investment companies from January 1, 2000 to the date of the order. Pursuant to the order, Morgan Stanley DW Inc. will: (a) distribute for the benefit of certain customers who purchased shares of mutual funds through Morgan Stanley DW Inc. pursuant to the marketing arrangements between Morgan Stanley DW Inc. and certain mutual fund complexes the amount of $50 million; (b) place on its website disclosures relating to certain marketing programs pursuant to which it offered and sold certain mutual funds; (c) prepare a Mutual Fund Bill of Rights that discloses, among other things, the differences in fees and expenses associated with the purchase of different classes or proprietary mutual fund shares; (d) prepare a plan by which certain customers' proprietary Class B shares can be converted to Class A shares; (e) retain an independent consultant to review, among other things, the adequacy of Morgan Stanley DW Inc.'s disclosures with respect to such marketing programs and other matters in connection with Morgan Stanley DW Inc.'s offer and sale of shares of mutual funds and compliance with the order; and (f) adopt the recommendations of the independent consultant. The number of purchase transactions of Class B shares that will be eligible to convert shares is approximately 8,000. The ultimate financial impact on Morgan Stanley DW Inc. of these conversions will depend on many variables, including the number of eligible purchasers who elect to convert to Class A shares (which carry different fees) and the terms of the conversion (which must be acceptable to the independent consultant). During the five years preceding the date of this prospectus, other than as described above, there have been no material criminal, civil, or administrative actions pending, on appeal, or concluded against the commodity brokers, the general partner, or any of their principals, which the general partner believes would be material to an investor's decision to invest in the partnerships. THE LIMITED PARTNERSHIP AGREEMENTS This section of the prospectus summarizes all material provisions of the limited partnership agreement of each partnership that are not discussed elsewhere in the prospectus. A form of the limited partnership agreements is annexed to the prospectus as Exhibit A. Each limited partnership agreement is identical, except as noted otherwise below or in Exhibit A. Capsule II Performance of Spectrum Technical Type of pool: publicly-offered fund Inception of trading: November 1994 Aggregate subscriptions: $589,811,774 Current capitalization: $538,184,278 Current net asset value per unit: $22.64 Worst monthly % drawdown past five years: (15.59)% (November 2001) Worst monthly % drawdown since inception: (15.59)% (November 2001) Worst month-end peak-to-valley drawdown past five years: (26.57)% (13 months, April 2001-April 2002) Worst month-end peak-to-valley drawdown since inception: (26.57)% (13 months, April 2001-April 2002) Cumulative return since inception: 126.40% Monthly Performance Nature of the Partnerships Spectrum Select was formed on March 21, 1991; Spectrum Technical, Spectrum Strategic, and Spectrum Global Balanced were each formed on April 29, 1994; and Spectrum Currency was formed on October 20, 1999. Each partnership was formed under Delaware law. The fiscal year of each partnership begins on January 1 of each year and ends on the following December 31. The units that you purchase and pay for in this offering will be fully paid and nonassessable. You may be liable to a partnership for liabilities that arose before the date of a redemption or Spectrum Series exchange. Your liability, however, will not exceed the sum of your unredeemed capital contribution, undistributed profits, if any, any distributions and amounts received upon a redemption or deemed received on a Spectrum Series exchange, together with interest on any such amount. However, a partnership will not make a claim against you for any amounts received in connection with a redemption of units or a Spectrum Series exchange unless the net assets of the partnership are insufficient to discharge the liabilities of the partnership that arose before any distributions were made to you. The general partner will be liable for all obligations of a partnership to the extent that the assets of the partnership are insufficient to pay those obligations. Management of Partnership Affairs You will not participate in the management or operations of a partnership. Under each limited partnership agreement, the general partner is solely responsible for managing the partnership. The general partner may use a partnership's funds only to operate the business of that partnership. The general partner may hire an affiliate to perform services for the partnership if the general partner determines that the affiliate is qualified to perform the services, and can perform those services under competitive terms that are fair and reasonable. Any agreement with an affiliate must be for a term not in excess of one year and be terminable by the partnership without penalty upon 60 days' prior written notice. Other responsibilities of the general partner include: determining whether a partnership will make a distribution; administering redemptions and series exchanges; preparing monthly and annual reports; preparing and filing tax returns for each partnership; signing documents on behalf of each partnership and its limited partners pursuant to powers of attorney; and supervising the liquidation of a partnership, if necessary. Sharing of Profits and Losses You will have a capital account in each partnership in which you invest, with an initial balance equal to the amount you paid for units of the partnership. The general partner also has a capital account. Each partnership's net assets will be calculated monthly, and your capital account will be adjusted as necessary to reflect any increases or decreases that may have occurred since the preceding month. Profits and losses will be shared by the general partner and limited partners in proportion to the size of their respective capital accounts. For a description of the federal tax allocations, see "Material Federal Income Tax Considerations Partnership Taxation Allocation of Partnership Profits and Losses" on page 129. Restrictions on Transfers or Assignments While you may transfer or assign your units, the transferee or assignee may not become a limited partner without the written consent of the general partner. You may only withdraw capital or profits from a partnership by redeeming units. The general partner may withdraw any portion of its interest in a partnership that exceeds the amount required under the limited partnership agreement without prior notice to or consent of the limited partners. In addition, the general partner may withdraw or assign its entire interest in a partnership if it gives 120 days' prior written notice to the limited partners. If a Month majority of the limited partners elect a new general partner or partners to continue the business of the partnership, the withdrawing general partner must pay all reasonable expenses incurred by the partnership in connection with its withdrawal. Any transfer or assignment of units by you will take effect at the end of the month in which the transfer or assignment is made, subject to the following conditions. A partnership is not required to recognize a transfer or assignment until it has received at least 30 days' prior written notice from the limited partner. The notice must be signed by the limited partner and include the address and social security or taxpayer identification number of the transferee or assignee and the number of units transferred or assigned. A transfer or assignment of less than all units held by you cannot occur if as a result either party to the transfer or assignment would own fewer than the minimum number of units required for an investment in the partnership (subject to certain exceptions relating to gifts, death, divorce, or transfers to family members or affiliates). The general partner will not permit a transfer or assignment of units unless it is satisfied that the transfer or assignment would not be in violation of Delaware law or applicable federal, state, or foreign securities laws; and notwithstanding the transfer or assignment, the partnership will continue to be classified as a partnership rather than as an association taxable as a corporation under the Internal Revenue Code of 1986, as amended. No transfer or assignment of units will be effective or recognized by a partnership if the transfer or assignment would result in the termination of that partnership for federal income tax purposes, and any attempt to transfer or assign units in violation of the limited partnership agreement will be ineffective. The limited partner must pay all costs, including any attorneys' and accountants' fees, related to a transfer or assignment. Amendments; Meetings Each limited partnership agreement may be amended by the general partner and by limited partners owning more than 50% of the units of that partnership. In addition, the general partner may make certain amendments to a limited partnership agreement without the consent of the limited partners, including any amendment that is not adverse to the limited partners or is required by the staff of the SEC, the CFTC, any other federal agency, any state "Blue Sky" official, or other governmental official, or to comply with applicable law. However, no amendment may be made to a limited partnership agreement without the consent of all partners affected if that amendment would reduce the capital account of any partner, modify the percentage of profits, losses, or distributions to which any partner is entitled, or change or alter the provisions of the limited partnership agreement relating to amendments requiring the consent of all partners. Upon written request to the general partner delivered either in person or by certified mail, you or your authorized attorney or agent may obtain a list of the names and addresses of, and units owned by, all limited partners in your partnership, provided that you pay reasonable duplicating and postage costs. Limited partners owning at least 10% of the units of a partnership may request a meeting to consider any matter upon which limited partners may vote. Upon receipt of such a request, the general partner must call a meeting of that partnership, by written notice sent by certified mail or delivered in person within 15 days of such request. The meeting must be held at least 30 but not more than 60 days after the mailing by the general partner of notice of the meeting. The notice must specify the date, a reasonable place and time, and the purpose of the meeting. At any meeting of the limited partners, the following actions may be taken upon the affirmative vote of limited partners owning more than 50% of the units: amend the limited partnership agreement; dissolve the partnership; remove and replace the general partner; elect a new general partner or general partners if the general partner terminates or liquidates or elects to withdraw from the partnership, or becomes insolvent, bankrupt, or is dissolved; terminate any contract with the general partner or any of its affiliates on 60 days' prior written notice; and approve the sale of all or substantially all of the assets of the partnership. Any of the foregoing actions may also be taken by limited partners without a meeting, without prior notice, and without a vote, by means of written consents signed by limited partners owning the required number of units. Notice of any actions taken by written consent must be given to non-consenting limited partners within seven business days. Books and Records; Reports to Limited Partners The books and records of each partnership are maintained at its principal office for at least five years. You or your authorized attorney or agent will have the right during normal business hours to inspect and copy the books and records of each partnership of which you are a limited partner. Alternatively, you may request that copies of the books and records be sent to you, provided that you pay all reasonable reproduction and distribution costs. The partnership will retain copies of subscription documentation in connection with purchases and exchanges of units for at least six years. Within 30 days after the close of each calendar month, the general partner will provide such financial and other information with respect to each partnership as the CFTC and National Futures Association, from time to time, may require, together with information concerning any material change in the brokerage commissions or fees payable by the partnerships to any commodity broker. You will also receive within 90 days after the close of each fiscal year an annual report containing audited financial statements for the partnerships. Annual reports will provide a detailed statement of any transactions with the general partner or its affiliates and of fees, commissions, and any compensation paid or accrued to the general partner or its affiliates. By March 15 of each year, the partnership will provide you with the tax information necessary for you to prepare your federal income tax return. The net asset value of each partnership's units, which is estimated daily by the general partner, will be promptly supplied to you upon written request. A written notice, including a description of limited partners' redemption and voting rights, will be mailed to the limited partners of a partnership within seven business days if any of the following events occur: the net asset value of a unit decreases by at least 50% from the net asset value of that unit as of the end of the immediately preceding month; the limited partnership agreement is materially amended; there is any change in trading advisors or any material change in a management agreement; there is any change in commodity brokers or any material change in the compensation arrangements with a commodity broker; there is any change in general partners or any material change in the compensation arrangements with a general partner; there is any change in the partnership's fiscal year; there is any material change in the partnership's trading policies as specified in the limited partnership agreement; or the partnership ceases to trade futures, forwards, and options. If you receive a notice as to a 50% decrease in net asset value per unit, that notice will also advise you that a "special redemption date" will take place when limited partners may redeem their units in the same manner as described under "Redemptions" beginning on page 117 for regular redemption dates. Further, following the close of business on the date of the 50% decrease giving rise to that notice, the partnership will liquidate all existing positions as promptly as reasonably practicable, and will suspend all futures, forwards, and options trading through the special redemption date. The general partner will then determine whether to reinstitute futures, forwards, and options trading or to terminate the partnership. In addition, subject to limits imposed under state guidelines incorporated in the limited partnership agreements, no increase in any of the management, incentive, or brokerage fees payable by the partnerships, or any of the caps on fees, may take effect until the first business day following a redemption date. In the event of such an increase: notice of the increase will be mailed to limited partners at least five business days prior to the last date on which a "request for redemption" must be received by the general partner with respect to the applicable redemption date; the notice will describe the redemption and voting rights of limited partners; and units redeemed at the first redemption date following the notice will not be subject to any redemption charges. Each limited partner expressly agrees that in the event of his death, he waives on behalf of himself and his estate the furnishing of any inventory, accounting, or appraisal of the assets of the partnership and any right to an audit or examination of the books of the partnership. PLAN OF DISTRIBUTION General Morgan Stanley DW is offering units pursuant to a selling agreement with the partnerships and the general partner. This offering is being conducted in accordance with the provisions of Rule 2810 of the Conduct Rules of the NASD. With the approval of the general partner, Morgan Stanley DW may appoint additional selling agents to make offers and sales of the units. These additional selling agents may include any securities broker which is a member in good standing of the NASD, as well as any foreign bank, dealer, institution, or person ineligible for membership in the NASD that agrees not to make any offers or sales of units within the U.S. or its territories, possessions, or areas subject to its jurisdiction, or to U.S. citizens or residents. Any such non-NASD member must also agree to comply with applicable provisions of the Conduct Rules of the NASD in making offers and sales of units. Morgan Stanley DW is offering the units on a "best efforts" basis without any agreement by Morgan Stanley DW to purchase units. The general partner may in the future register additional units of any partnership with the SEC. There is no maximum amount of funds which may be contributed to a partnership. The general partner may in the future subdivide or combine outstanding units of any partnership, in its discretion, provided that any subdivision or combination will not affect the net asset value of any limited partner's interest in the partnership. Each partnership has agreed to indemnify its trading advisors in connection with the offer and sale of units with respect to any misleading or untrue statement or alleged misleading or untrue statement of a material fact or material omission or alleged omission unrelated to its trading advisor(s). Each partnership has also agreed to indemnify Morgan Stanley DW, the general partner and any additional sellers in connection with the offer and sale of units. See "Fiduciary Responsibility and Liability" beginning on page . Continuing Offering Units of each partnership are being offered for sale at monthly closings held on the last day of each month. Units will be offered and sold at the net asset value of a unit of the partnership on the date of the monthly closing. Since you must subscribe for units prior to the month end closing date, you will not know the actual per unit purchase price until after the monthly closing has occurred. The sale amount will be delivered to the partnership that sold the unit. Escrow Arrangements During the continuing offering, if your subscription is not immediately rejected by the general partner, your subscription funds will be transferred to, and held in escrow by, JPMorgan Chase Bank, New York, New York. These subscription funds held in escrow will be invested in the escrow agent's interest-bearing money market account, and will earn the interest rate then paid by the bank on that account. If the general partner accepts your subscription, at the applicable month-end closing the escrow agent will pay your subscription funds to the appropriate partnership(s) and pay any interest earned on those funds to Morgan Stanley DW. Morgan Stanley DW in turn will credit your Morgan Stanley DW customer account with the interest. If the general partner rejects a subscription, the escrow agent will promptly pay the rejected subscription funds and any interest earned to Morgan Stanley DW, and Morgan Stanley DW will then credit your Morgan Stanley DW customer account with those amounts, and the funds will be immediately available for investment or withdrawal. If you closed your Morgan Stanley DW customer account, any subscription returned and interest earned will be paid by check. Interest will be earned on subscription funds from the day of deposit with the escrow agent to the day that funds are either paid to the appropriate partnership(s) in the case of accepted subscriptions or paid to Morgan Stanley DW in the case of rejected subscriptions. At all times during the continuing offering, and prior to each closing, subscription funds will be in the possession of the escrow agent, and at no time will the general partner hold or take possession of the funds. Compensation to Morgan Stanley DW Employees and Additional Selling Agents Except as described below, qualified employees of Morgan Stanley DW will receive from Morgan Stanley DW (payable solely from its own funds) a gross sales credit equal to 3% of the net asset value per unit as of the closing for each unit sold by them and issued at the closing. In addition, Morgan Stanley DW will continue to compensate such employees who continue to render services to limited partners with a gross sales credit of up to 86% of the brokerage fees received by Morgan Stanley DW from a partnership each month that are attributable to outstanding units sold by them. This compensation will begin: in the case of Spectrum Select, Spectrum Technical, and Spectrum Strategic, with the seventh month following the closing at which a unit was issued; in the case of Spectrum Global Balanced and Spectrum Currency, with the tenth month following the closing at which a unit was issued; the first month after a unit is issued pursuant to a non-series exchange; or the month as of which such continuous compensation is first payable with respect to units purchased in a Spectrum Series exchange, but with the seventh or tenth month measured from the date the subscriber first became a limited partner in a Spectrum Series partnership. In all cases, qualified Morgan Stanley DW employees will receive continuing compensation until the applicable partnership terminates or the unit is redeemed, whichever comes first. No part of this compensation will be paid by the partnership and, accordingly, net assets will not be reduced as a result of such compensation. Each person receiving continuing compensation must be a Morgan Stanley DW employee at the time of receipt of payment and must be registered as an associated person with the CFTC and be a member of the National Futures Association in such capacity only after either having passed the Series 3 or Series 31 examination or having been "grandfathered" as an associated person qualified to do commodity brokerage under the Commodity Exchange Act and the CFTC's regulations. These employees must also perform additional services, including: (a)inquiring of the general partner from time to time, at the request of limited partners, as to the net asset value of each partnership's units; (b)inquiring of the general partner, at the request of limited partners, regarding the futures, forwards, and options markets and the activities of the partnerships; (c)responding to questions of limited partners with respect to the monthly account statements, annual reports, financial statements, and annual tax information furnished periodically to limited partners; (d)providing advice to limited partners as to when and whether to make additional investments or to redeem or exchange units; (e)assisting limited partners in the redemption or exchange of units; and (f)providing such other services as limited partners from time to time may reasonably request. The additional compensation paid by Morgan Stanley DW may be deemed to be underwriting compensation. In addition, certain officers and directors of the general partner may receive compensation as employees of Morgan Stanley DW based, in part, on the amount of brokerage fees paid by the partnerships to Morgan Stanley DW. The selling agreement among Morgan Stanley DW, the general partner, and the partnerships provides that this compensation may only be paid by Morgan Stanley DW as long as continuing services are provided. Any limited partner may telephone, write, or visit a financial advisor at a Morgan Stanley branch office to avail himself of such services. Morgan Stanley DW will not pay its employees the 3% initial gross sales credit described above with respect to units purchased pursuant to a Spectrum Series exchange or non-Spectrum Series exchange. Such employees will, however, receive continuing gross sales credits with respect to brokerage fees received by Morgan Stanley DW from a partnership at the applicable rate. In the case of an investor who previously redeemed units in a Spectrum Series or non-Spectrum Series partnership and paid a redemption charge or held those units for at least 24 months, and invests in the Spectrum Series within 12 months of the redemption of the old units, the Morgan Stanley DW employee will not receive the initial gross sales credit of 3% but will receive a monthly gross sales credit of up to 86% of the brokerage fees received by Morgan Stanley DW from the partnership each month that are attributable to such units commencing the first month after the units are issued. Morgan Stanley DW may at any time implement cash sales incentive and/or promotional programs for its employees who sell units. These programs will provide for Morgan Stanley DW, and not any partnership or the general partner, to pay Morgan Stanley DW's employees bonus compensation based on sales of units. Any sales or promotional program will be approved by the NASD prior to its start. The aggregate of all compensation paid to employees of Morgan Stanley DW from the initial 3% gross sales credit, the redemption charges received by Morgan Stanley DW, and any sales incentives will not exceed 10% of the proceeds of the sale of units. Morgan Stanley DW may compensate any qualified additional selling agents for each unit sold by it by paying a selling commission, from Morgan Stanley DW's own funds, as determined by Morgan Stanley DW and the additional selling agents, but not to exceed 3% of the net asset value of the unit sold. Additional selling agents who are properly registered as futures commission merchants or introducing brokers with the CFTC and are members of the National Futures Association in such capacity may also receive from Morgan Stanley DW, payable from Morgan Stanley DW's own funds, continuing compensation for providing to limited partners the continuing services described above. This additional compensation paid by Morgan Stanley DW may be up to 42% of the brokerage fees generated by outstanding units sold by additional selling agents and received by Morgan Stanley DW as commodity broker for each partnership (except for employees of affiliates of Morgan Stanley DW, who will be compensated at the same rate as employees of Morgan Stanley DW). Additional selling agents may pay all or a portion of such additional compensation to their employees who have sold units and provide continuing services to limited partners if those employees are properly registered with the CFTC and are members of the National Futures Association. Additional compensation paid by Morgan Stanley DW may be deemed to be underwriting compensation. SUBSCRIPTION PROCEDURE The minimum subscription for most subscribers is $5,000, except that the minimum subscription is: $2,000 in the case of an IRA; or for eligible subscribers purchasing units pursuant to a non-Spectrum Series exchange, the lesser of $5,000, the proceeds from the redemption of 5 units, or 2 units in the case of an IRA, from commodity pools other than any of the Morgan Stanley Charter Series of partnerships, the proceeds from the redemption of 500 units, or 200 units in the case of an IRA, from any Charter Series partnership, or the proceeds from the redemption of such subscriber's entire interest in any other commodity pool for which the general partner serves as general partner and commodity pool operator. A subscription may be for units of one partnership, or may be divided among two or more partnerships, provided that: in the case of a new subscription, the minimum subscription for any one partnership is $1,000; and in the case of a non-Spectrum Series exchange, the minimum subscription for any one partnership is the proceeds of the redemption of 1 unit of the other commodity pool, or 100 units in the case of any Morgan Stanley Charter Series partnership. If you already own units in a partnership and you wish to make an additional investment in the same partnership, you may subscribe for units at a monthly closing with a minimum investment in that partnership of $500. In order to make your first purchase of units of a partnership, other than by means of an exchange, you must complete, sign, and deliver to Morgan Stanley DW a subscription agreement which will authorize the general partner and Morgan Stanley DW to transfer the full subscription amount from your Morgan Stanley DW customer account to the partnership's Escrow Account. If your subscription agreement is received by Morgan Stanley DW and not immediately rejected, you must have the appropriate amount in your Morgan Stanley DW customer account on the first business day following the date that your subscription agreement is received by Morgan Stanley DW. Morgan Stanley DW will deduct the subscription amount from your customer account and transfer funds into escrow with the escrow agent on that date. If you do not have a Morgan Stanley DW customer account or an account with an affiliate of Morgan Stanley DW, or do not have sufficient funds in your existing Morgan Stanley DW customer account, you should make appropriate arrangements with your Morgan Stanley financial advisor, or contact your local Morgan Stanley branch office. Do not mail any payment to the general partner, as it will be returned to you for proper placement with the Morgan Stanley branch office where your account is maintained. In the case of a Spectrum Series exchange or a non-Spectrum Series exchange, you must complete, sign, and deliver to your Morgan Stanley financial advisor a subscription agreement, which will authorize the general partner to redeem all or a portion of your interest in a partnership or another commodity pool for which the general partner serves as general partner and commodity pool operator, subject to terms of the applicable limited partnership agreement, and to use the proceeds, after deducting any applicable redemption charges, to purchase units in one or more of the partnerships. In accordance with an NASD rule, Morgan Stanley DW will not subscribe for units on your behalf if it has discretionary authority over your customer account, unless it gets prior written approval from you. If you subscribe by check, units will be issued subject to the collection of the funds represented by the check. If your check is returned unpaid, Morgan Stanley DW will notify the general partner, and the relevant partnership will cancel the units issued to you represented by the check. Any losses or profits sustained by the partnership allocable to the cancelled units will be allocated among the remaining partners. In the limited partnership agreements, each limited partner agrees to reimburse a partnership for any expense or loss (including any trading loss) incurred in connection with the issuance and cancellation of any units issued to the limited partner. Subscriptions for units are generally irrevocable by subscribers. However, you may revoke your subscription agreement and receive a full refund of the subscription amount and any accrued interest, or revoke the redemption of units in the other commodity pool in the case of an exchange, within five business days after execution of the subscription agreement or no later than 3:00 P.M., New York City time, on the date of the applicable monthly closing, whichever comes first, by delivering written notice to your Morgan Stanley financial advisor. There may be other rescission rights under applicable federal and state securities laws. The general partner may reject any subscription, in whole or in part, in its sole discretion. A sample form of the subscription agreement is annexed to this prospectus as Exhibit B. A separate copy of the subscription agreement accompanies this prospectus or you may obtain one, after delivery of this prospectus, from a local Morgan Stanley branch office. You will not receive any certificate evidencing units, but you will be sent confirmations of purchases in Morgan Stanley DW's customary form. Once you are an investor in a partnership, you may make additional cash purchases of units of that partnership without executing a new subscription agreement, by completing a subscription agreement update form, a sample of which is annexed to this prospectus as Exhibit C, and by contacting your Morgan Stanley financial advisor and authorizing your financial advisor to deduct the additional amount you want to invest from your Morgan Stanley DW customer account. Those amounts will be held in escrow, and applied towards the purchase of units, in the same manner as initial purchases described above. However, if a new prospectus has been issued since the date of your immediately prior subscription agreement, you will be required to complete a new subscription agreement update form. Further, your Morgan Stanley financial advisor will be required to confirm to the general partner that the information you provided, and the representations and warranties you made, in your original subscription agreement, including, in particular, that you satisfy applicable minimum financial suitability requirements, are still true and correct. You may not use the subscription procedure described in this paragraph to purchase additional units in a partnership by way of an exchange, or to purchase units of a partnership in which you are not currently an investor; in either of those cases, you must execute a new subscription agreement. PURCHASES BY EMPLOYEE BENEFIT PLANS ERISA CONSIDERATIONS Units might or might not be a suitable investment for an employee benefit plan. If you are a person with investment discretion on behalf of an employee benefit plan, before proceeding with a purchase of units, you should determine whether the purchase of units is permitted under the governing instruments of the plan, and is appropriate for that particular plan in view of its overall investment policy, the composition and diversification of its portfolio, and the other considerations discussed below. As used in this section, the term "employee benefit plans" refers to plans and accounts of various types, including their related trusts, which provide for the accumulation of a portion of an individual's earnings or compensation, as well as investment income earned thereon, typically free from federal income tax until such time as funds are distributed from the plan. These plans include corporate pension and profit-sharing plans, such as so-called "401( k)" plans, "simplified employee pension plans," so-called "Keogh" plans for self-employed individuals (including partners), and, for purposes of this discussion, individual retirement accounts, as described in Section 408 of the Internal Revenue Code of 1986, as amended. Notwithstanding the general requirement that investors in one or more partnerships must invest a minimum of $5,000, a minimum purchase requirement of $2,000 has been set for IRAs. The minimum subscription for any one of the partnerships must be at least $1,000. Greater minimum purchases may be mandated by the securities laws and regulations of certain states, and each investor should consult the subscription agreement to determine the applicable investment requirements. If the assets of an investing employee benefit plan were to be treated, for purposes of the reporting and disclosure provisions and certain other of the fiduciary responsibility provisions of Title I of the Employee Retirement Income Security Act of 1974, as amended, and Section 4975 of the Internal Revenue Code of 1986, as including an undivided interest in each of the underlying assets of a partnership, an investment in units would in general be an inappropriate investment for the plan. A U.S. Department of Labor regulation defines "plan assets" in situations where employee benefit plans purchase equity securities in investment entities such as a partnership. The regulation provides that the assets of an entity will not be deemed to be "plan assets" of an employee benefit plan which purchases an equity security of the entity if the equity security is a "publicly-offered security." A "publicly-offered security" is one which is: freely transferable; held by more than 100 investors independent of the issuer and of each other; and either registered under Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934, or sold to the plan as part of a public offering of such securities pursuant to an effective registration statement under the Securities Act of 1933, where the security is then timely registered under Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934. The units currently meet, and it is expected that the units will continue to meet, the criteria of the Regulation. The general partner believes, based upon the advice of its legal counsel, that income earned by the partnerships will not constitute "unrelated business taxable income" under Section 512 of the Internal Revenue Code of 1986 to employee benefit plans and other tax-exempt entities. Although the Internal Revenue Service has issued favorable private letter rulings to taxpayers in somewhat similar circumstances, other taxpayers may not use or cite such rulings as precedent. If you have investment discretion on behalf of an employee benefit plan, you should consult a professional tax adviser regarding the application of the foregoing matters to the purchase of units. Units may not be purchased with the assets of an employee benefit plan if the general partner, Morgan Stanley DW, any additional selling agents, any trading advisor, or any of their respective affiliates either: has investment discretion with respect to the investment of such plan assets; has authority or responsibility to give or regularly gives investment advice with respect to such plan assets for a fee and pursuant to an agreement or understanding that such advice will serve as a primary basis for investment decisions with respect to the plan assets and that such advice will be based on the particular investment needs of the plan; or is an employer maintaining or contributing to such plan. Subscribing for units does not create an IRA or other employee benefit plan. If you are considering the purchase of units on behalf of an IRA or other employee benefit plan, you must first ensure that the plan has been properly established in accordance with the Internal Revenue Code of 1986 and ERISA and the regulations and administrative rulings thereunder, and that the plan has been adequately funded. Then, after all of the considerations discussed above have been taken into account, the trustee or custodian of a plan who decides to or who is instructed to do so may subscribe for units in one or more of the partnerships, subject to the applicable minimum subscription requirement per partnership. Acceptance of subscriptions on behalf of IRAs or other employee benefit plans is in no respect a representation by the general partner, Morgan Stanley DW, any additional selling agents, any partnership, or any trading advisor that the investment meets all relevant legal requirements with respect to investments by plans generally or any particular plan, or that the investment is appropriate for plans generally or any particular plan. MATERIAL FEDERAL INCOME TAX CONSIDERATIONS Introduction The general partner has been advised by counsel, Cadwalader, Wickersham & Taft LLP, that in its opinion, the following summary correctly describes the material federal income tax consequences to a U.S. taxpayer who invests in a partnership. The opinions appearing in this section are the opinions of Cadwalader, Wickersham & Taft LLP, except as otherwise specifically noted. The following summary is based upon the Internal Revenue Code of 1986, rulings thereon, regulations promulgated thereunder, and existing interpretations thereof, any of which could be changed at any time and which changes could be retroactive. The federal income tax summary and the state and local income tax summary that follow, in general, relate only to the tax implications of an investment in the partnerships by individuals who are citizens or residents of the U.S. Except as indicated below or under "Purchases by Employee Benefit Plans-ERISA Considerations," the summaries do not address the tax implications of an investment in the partnerships by corporations, partnerships, trusts, and other non-individuals. Moreover, the summaries are not intended as a substitute for careful tax planning, particularly since certain of the tax consequences of owning an interest in the partnerships may not be the same for all taxpayers, such as non-individuals or foreign persons, or in light of an investor's personal investment circumstances. A complete discussion of all federal, state, and local tax aspects of an investment in each partnership is beyond the scope of the following summary, and prospective investors are urged to consult their own tax advisors on these matters. Partnership Status The general partner has been advised by its legal counsel, Cadwalader, Wickersham & Taft LLP, that in its opinion under current federal income tax law, each partnership will be classified as a partnership and not as an association (or a publicly traded partnership) taxable as a corporation. This opinion is based upon the facts set forth in this prospectus, including that a principal activity of each partnership consists of buying and selling futures, options, and forward contracts, and at least 90% of the partnership's gross income during each year consists of gains from such trading and interest income. No ruling has been requested from the Internal Revenue Service with respect to classification of each partnership and the general partner does not intend to request such a ruling. If a partnership were treated as an association (or a publicly traded partnership) taxable as a corporation, income or loss of the partnership would not be passed through to its partners, and the partnership would be subject to tax on its income at the rates applicable to corporations without deduction for any distributions to its partners. In addition, all or a portion of any distributions by the partnership to its partners could be taxable to the partners as dividends or capital gains. The discussion that follows assumes that each partnership will be treated as a partnership for federal income tax purposes. Partnership Taxation Partners, rather than a Partnership, are Subject to Federal Income Tax. None of the partnerships will pay federal income tax. Except as provided below with respect to certain nonresident aliens, each limited partner will report his distributive share of all items of partnership income, gain, loss, deduction, and credit for the partnership's taxable year ending within or with the partner's taxable year. A limited partner must report and pay tax on his share of partnership income for a particular year whether or not he has received any distributions from the partnership in that year. The characterization of an item of profit or loss will usually be determined at the partnership level. Syndication Expenses. None of the partnerships nor any partner thereof will be entitled to any deduction for syndication expenses (i.e., those amounts paid or incurred in connection with issuing and marketing units). There is a risk that some of the brokerage fees paid to Morgan Stanley DW could be treated as a nondeductible payment by the partnerships of syndication expenses. Allocation of Partnership Profits and Losses. In general, each limited partnership agreement allocates items of ordinary income and expense pro rata among the partners based upon their respective capital accounts as of the end of the month in which such items are accrued. Net recognized capital gain or loss is generally allocated among all partners based upon their respective capital accounts. However, net recognized capital gain or loss is allocated first to partners who have redeemed units in the partnership during a taxable year to the extent of the difference between the amount received on the redemption and the allocation account as of the date of redemption attributable to the redeemed units. Any remaining net recognized capital gain or loss is next allocated among all those partners whose capital accounts differ from their allocation accounts based on the respective differences for each partner. The special allocation of each partnership's net gain or loss upon a redemption of units, which retains the same character as in the hands of the partnership, may alter the character of a redeeming limited partner's income (by reducing the amount of long-term capital gain recognized upon receipt of redemption proceeds) and may accelerate the recognition of income by the limited partner. These allocation provisions are designed to reconcile tax allocations to economic allocations. However, the general partner cannot assure you that the Internal Revenue Service will not challenge the allocations, including each partnership's tax allocations in respect of redeemed units. If the allocation provided by each limited partnership agreement is not respected by the Internal Revenue Service for federal income tax purposes, the amount of income or loss allocated to the partners for federal income tax purposes may be increased or reduced or the character of the income or loss may be modified. Cash Distributions and Redemptions Because of the special allocation of partnership gain or loss upon a redemption of units, the amounts received upon the partial or complete redemption of a limited partner's units normally will not result in additional taxable income or loss to the limited partner. However, distributions by a partnership and amounts received upon the partial or complete redemption of a limited partner's units will be taxable to the limited partners to the extent cash distributions by a partnership or amounts received upon redemption by a limited partner exceed the partner's adjusted tax basis in his units. Such excess will be taxable to him as though it were a gain from a sale of the units. A loss will be recognized upon a redemption of units only if, following the redemption of all of a limited partner's units, the partner has any tax basis in his units remaining. In such case, the limited partner will recognize loss to the extent of the remaining basis. See "Redemptions." Generally, if a limited partner is not a "dealer" with respect to his interest in the partnership and he has held his interest in the partnership for more than one year, the gain or loss would be long-term capital gain or loss. Gain or Loss on Trading Activity Nature of Partnership Income. Each partnership does not expect to hold its futures, forwards, or options for sale to customers. For federal income tax purposes substantially all of the profit and loss generated by each partnership from its trading activities is expected to be capital gain and loss, which in turn may be either short-term, long-term, or a combination thereof. Nevertheless, certain foreign currency transactions could result in ordinary gain or loss, as discussed below. Further, interest paid to a partnership will be taxable currently to the limited partners as ordinary income. Thus, during taxable years in which little or no profit is generated from trading activities, a limited partner may still have interest income. Mark-to-Market. Section 1256 contracts held at the end of a partnership's taxable year will be treated as having been sold for the fair market value on the last day of the taxable year, and gain or loss will be taken into account for the year. Gain or loss with respect to a Section 1256 contract is generally treated as short-term capital gain or loss to the extent of 40% of the gain or loss, and long-term capital gain or loss to the extent of 60% of the gain or loss. Section 1256 contracts include regulated futures contracts which are futures contracts traded on regulated U.S. and certain foreign exchanges; foreign currency contracts that are traded in the interbank market and relate to currencies for which positions are also traded through regulated futures contracts; and U.S. and certain foreign exchange-traded options on commodities, including options on regulated futures contracts, debt securities, and stock indices. While the partnerships expect that a majority of their trading activities will be conducted in Section 1256 contracts, the partnerships also expect that a portion of their trading activities will be conducted in contracts that do not presently qualify as Section 1256 contracts, such as positions in futures contracts on most foreign exchanges and foreign currency forward contracts that do not relate to currencies for which positions are also traded through regulated futures contracts. Section 988. Currency gain or loss with respect to foreign currency forward contracts that do not relate to currencies for which positions are also traded through regulated futures contracts and futures contracts traded on most foreign exchanges may be treated as ordinary income or loss under Internal Revenue Code of 1986 Section 988. Each partnership has elected to treat these contracts as Section 1256 contracts (i.e., marked-to-market at year end). Pursuant to this election, gain or loss with respect to these contracts is treated as entirely short-term capital gain or loss. Subject to certain limitations, a limited partner, other than a corporation, estate, or trust, may elect to carry back net Section 1256 contract losses to each of the three preceding years. Net Section 1256 contract losses carried back to prior years may only be used to offset net Section 1256 contract gains. Generally, such losses are carried back as 40% short-term capital losses and 60% long-term capital losses. Capital assets not marked to market under Section 1256, such as any non-currency forward contracts, are not subject to the 60/40 tax regime for Section 1256 contracts, and gain or loss on sale generally will be long-term only if such property has been held for more than one year. Straddles. If a partnership incurs a loss upon the disposition of any position which is part of a "straddle" (i.e., two or more offsetting positions), recognition of that loss for tax purposes will be deferred until the partnership recognizes the gain in the offsetting position of the straddle (or successor position, or offsetting position to the successor position). Interest and other carrying charges allocable to positions which are part of a straddle must be capitalized, rather than deducted currently. Certain modified "short sale" rules may apply to positions held by a partnership so that what might otherwise be characterized as long-term capital gain would be characterized as short-term capital gain or potential short-term capital loss as long-term capital loss. For purposes of applying the above rules restricting the deductibility of losses with respect to offsetting positions, if a limited partner takes into account gain or loss with respect to a position held by the partnership, the limited partner will be treated as holding the partnership's position, except to the extent otherwise provided in regulations. Accordingly, positions held by a partnership may limit the deductibility of realized losses sustained by a limited partner with respect to positions held for his own account, and positions held by a limited partner for his own account may limit his ability to deduct realized losses sustained by a partnership. Thus, straddles may not be used to defer gain from one taxable year to the next. Reporting requirements generally require taxpayers to disclose all unrecognized gains with respect to positions held at the end of the taxable year. The above principle, whereby a limited partner may be treated as holding partnership positions, may also apply to require a limited partner to capitalize (rather than deduct) interest and carrying charges allocable to property held by him. Where the positions of a straddle are comprised of both Section 1256 and non-Section 1256 contracts, a partnership will be subject to the mixed straddle rules of the Internal Revenue Code of 1986 and the regulations promulgated thereunder. The appropriate tax treatment of any gains and losses from trading in mixed straddles will depend on what elections a partnership makes. Each partnership has elected to place all of its positions in a "mixed straddle" account which is marked-to-market daily. Under a special account cap, not more than 50% of net capital gain may be long-term capital gain, and not more than 40% of net capital loss may be short-term capital loss. Taxation of Limited Partners Limitations on Deductibility of Partnership Losses. The amount of partnership loss, including capital loss, which a limited partner will be entitled to take into account for federal income tax purposes is limited to the tax basis of his units, except in the case of certain limited partners including individuals and closely-held C corporations, for which he is "at risk" with respect to the units as of the end of the partnership's taxable year in which such loss occurred. Generally, a limited partner's initial tax basis will be the amount paid for each unit. A limited partner's adjusted tax basis will be his initial tax basis reduced by the limited partner's share of partnership distributions, losses, and expenses and increased by his share of partnership income and gains. The amount for which a limited partner is "at risk" with respect to his units in a partnership is generally equal to his tax basis for the units, less: any amounts borrowed in connection with his acquisition of the units for which he is not personally liable and for which he has pledged no property other than his units; any amounts borrowed from persons who have a proprietary interest in the partnership; and any amounts borrowed for which the limited partner is protected against loss through guarantees or similar arrangements. Because of the limitations imposed upon the deductibility of capital losses referred to below, a limited partner's share of a partnership's net capital losses, if any, will not materially reduce his federal income tax on his ordinary income. In addition, certain expenses of a partnership might be deductible by a limited partner only as itemized deductions and, therefore, will not reduce the federal taxable income of a limited partner who does not itemize his deductions. Furthermore, an individual who is subject to the alternative minimum tax for a taxable year may not realize any tax benefit from such itemized deductions. Limitations on Deductibility of Passive Losses. The partnerships' income will not be treated as a "passive activity" for purposes of the limitation on the deduction of passive activity losses. Limited Deduction of Certain Expenses. Certain miscellaneous itemized deductions, such as expenses incurred to maintain property held for investment, are deductible only to the extent that they exceed 2% of the adjusted gross income of an individual, trust, or estate. The amount of certain itemized deductions allowable to individuals is further reduced by an amount equal to the lesser of (i) 3% of the % % % % % % % % % % January 12.76 (1.88 ) (0.81 ) 1.21 (4.96 ) (1.16 ) 3.67 4.78 (1.84 ) February 6.60 (3.41 ) 1.94 (1.19 ) 2.48 0.41 1.13 (6.39 ) 5.10 March (9.17 ) (2.90 ) 11.38 (1.54 ) (2.48 ) 1.31 (1.82 ) 1.24 10.21 April 1.44 (3.20 ) (11.10 ) (4.02 ) 7.18 (4.62 ) (2.93 ) 4.82 3.60 May 6.38 5.64 (0.37 ) (0.43 ) (5.00 ) 3.28 (3.75 ) (3.84 ) 0.69 June (7.42 ) 15.02 (3.62 ) (2.78 ) 5.13 (1.10 ) 0.69 3.21 (1.12 ) July (3.04 ) 9.65 (3.36 ) (3.96 ) (3.90 ) (0.98 ) 9.33 (4.80 ) (2.44 ) August 3.39 4.40 1.34 3.74 0.95 10.29 (5.97 ) (0.35 ) (0.63 ) September (5.41 ) 6.43 8.19 (8.61 ) (1.51 ) 4.35 1.85 5.50 (3.33 ) October 9.14 (6.75 ) 5.37 2.90 (9.96 ) (0.73 ) 0.36 9.92 (0.09 ) November 1.20 (4.68 ) (15.59 ) 12.28 1.84 (6.17 ) 1.01 8.34 0.93 (0.90 ) December 7.66 5.20 2.47 12.06 3.83 5.98 4.57 (3.88 ) 6.09 (1.31 ) Compound Annual/ Period Rate of Return 22.98 23.31 (7.15 ) 7.85 (7.51 ) 10.18 7.49 18.35 17.59 (2.20 ) (2 months) Capsule III Performance of Spectrum Strategic Type of pool: publicly-offered fund Inception of trading: November 1994 Aggregate subscriptions: $182,893,529 Current capitalization: $121,270,439 Current net asset value per unit: $14.31 Worst monthly % drawdown past five years: (18.47)% (February 2000) Worst monthly % drawdown since inception: (18.47)% (February 2000) Worst month-end peak-to-valley drawdown past five years: (43.28)% (10 months, January 2000-October 2000) Worst month-end peak-to-valley drawdown since inception: (43.28)% (10 months, January 2000-October 2000) Cumulative return since inception: 43.10% Monthly Performance individual's adjusted gross income in excess of a certain threshold amount and (ii) 80% of such itemized deductions. Moreover, such investment expenses are miscellaneous itemized deductions that are not deductible by a non-corporate taxpayer in calculating its alternative minimum tax liability. Based upon the current and contemplated activities of the partnerships, the general partner has been advised by its legal counsel that, in such counsel's opinion, the expenses incurred by the partnerships in their futures, forwards, and options trading businesses should not be subject to the 2% "floor" or the 3% phaseout, except to the extent that the Internal Revenue Service promulgates regulations that so provide. However, that advice is not binding on a court or the Internal Revenue Service, and the Internal Revenue Service could assert, and a court could agree, that such expenses of the partnerships (including incentive fees) are investment expenses which are subject to these limitations. Tax Liability Will Exceed Distributions. Under federal tax laws, a limited partner must report and pay tax on his share of any partnership income each year, even though the general partner does not intend to make any distributions from the partnerships. Tax on Capital Gains and Losses. In general, for individuals, trusts, and estates, "long-term capital gains" are currently taxed at a maximum marginal tax rate of 20% and "short-term capital gains" and other income are currently taxed at a maximum marginal tax rate of 38.6%. Corporate taxpayers are currently subject to a maximum marginal tax rate of 35% on all capital gains and income. The excess of capital losses over capital gains is deductible by an individual against ordinary income on a one-for-one basis, subject to an annual limitation of $3,000 ($1,500 in the case of married individuals filing a separate return). Excess capital losses may be carried forward. Net losses from Section 1256 contracts are treated as 60% long-term capital loss and 40% short-term capital loss. Such losses may, at the individual taxpayer's election, be carried back to each of the preceding three years and applied against gains from Section 1256 contracts. Alternative Minimum Tax. The alternative minimum tax for individuals is imposed on "alternative minimum taxable income" in excess of certain exemption amounts. Alternative minimum taxable income consists of taxable income determined with certain adjustments and increased by the amount of items of tax preference. Alternative minimum taxable income may not be offset by certain interest deductions, including (in certain circumstances) interest incurred to purchase or carry units in the partnerships. Corporations are also subject to an alternative minimum tax. The extent to which the alternative minimum tax will be imposed will depend on the overall tax situation of each limited partner at the end of such taxable year. Limitation on Deductibility of Interest on Investment Indebtedness. Interest paid or accrued on indebtedness properly allocable to property held for investment is investment interest. Such interest is generally deductible by non-corporate taxpayers only to the extent it does not exceed net investment income. A limited partner's distributive share of net partnership income and any gain from the disposition of units will be treated as investment income, except that a limited partner's net capital gain from the disposition of units is not investment income unless the limited partner waives the benefit of the preferential tax rate on the gain. It is not clear whether a limited partner's distributive share of partnership net capital gain constitutes investment income where such gain is taxed at the maximum rate for capital gains. Interest expense incurred by a limited partner to acquire his units generally will be investment interest. Any investment interest disallowed as a deduction in a taxable year solely by reason of the limitation above is treated as investment interest paid or accrued in the succeeding taxable year. Taxation of Foreign Limited Partners. A nonresident alien individual, foreign corporation, or foreign partnership (a "foreign limited partner") generally should not be deemed to be engaged in a U.S. trade or business solely by virtue of an investment in the partnerships; provided that such foreign limited partner is not a "dealer" in commodities and, in the case of an individual, does not have certain present or former connections with the U.S. (e.g., is not present in the U.S. more than 182 days during his or her taxable year, or, in certain limited circumstances, a prior taxable year) and provided further, that such foreign limited partner is not engaged in a trade or business within the U.S. during the taxable year or, in certain limited circumstances, a prior taxable year to which income, gain, or loss from the partnerships is treated as "effectively connected." Capital gains earned by the partnerships and allocated to such a foreign limited partner will, as a general rule, not be subject to U.S. federal income taxation or withholding, but may be subject to taxation by the jurisdiction in which the foreign limited partner is resident, organized or Month operating. In the event that a partnership were found to be engaged in a U.S. trade or business, a foreign limited partner would be required to file a U.S. federal income tax return for such year and pay tax at full U.S. rates. In the case of a foreign limited partner which is a foreign corporation, an additional 30% "branch profits" tax might be imposed. Furthermore, in such event the partnerships would be required to withhold taxes from the income or gain allocable to such a foreign limited partner under Section 1446 of the Code. A foreign limited partner is not subject to U.S. tax on certain interest income, including income attributable to (i) original issue discount on Treasury bills that have a maturity of 183 days or less or (ii) commercial bank deposits, provided, in either case, that such foreign limited partner is not engaged in a trade or business within the U.S. during a taxable year. Additionally, a foreign limited partner not engaged in a trade or business within the U.S. is not subject to U.S. tax on interest income (other than certain so-called "contingent interest") attributable to obligations issued after July 18, 1984 that are in registered form if the foreign limited partner timely provides the relevant partnership with an IRS Form W-8BEN. Prospective foreign limited partners who are engaged in a U.S. trade or business or who act as dealers in commodities may be subject to U.S. income tax and should consult their tax advisors before investing in a partnership. The estate of a deceased foreign limited partner may be liable for U.S. estate tax and may be required to obtain an estate tax release from the Internal Revenue Service in order to transfer the units of such foreign limited partner. Foreign persons should consult their own tax advisers before deciding whether to invest in the partnerships. Tax Elections. The Internal Revenue Code of 1986 provides for optional adjustments to the basis of partnership property upon distributions of partnership property to a partner (Section 734) and transfers of units, including transfers by reason of death (Section 743), provided that a partnership election has been made pursuant to Section 754. As a result of the complexities and added expense of the tax accounting required to implement such an election, the general partner does not presently intend to make such an election for any of the partnerships. Therefore, any benefits which might be available to the partners by reason of such an election will be foreclosed. Tax Returns and Information. The partnerships will file their information returns using the accrual method of accounting. Within 75 days after the close of each partnership's taxable year, the partnership will furnish each limited partner, and any assignee of the units of a limited partner, copies of the partnership's Schedule K-1 indicating the limited partner's distributive share of tax items and any additional information as is reasonably necessary to permit the limited partners to prepare their own federal and state tax returns. Partnership's Taxable Year. Each partnership has the calendar year as its taxable year. Unrelated Business Taxable Income of Employee Benefit Plan Limited Partners and Other Tax-Exempt Investors. Income allocated to a limited partner which is an employee benefit plan or other tax-exempt entity should not be subject to tax under Section 511 of the Internal Revenue Code of 1986, provided that the units purchased by such plans and entities are not "debt-financed." However, if a partnership were to purchase physical commodities with borrowed funds (whether upon delivery under a futures or forward contract or otherwise) and to sell those commodities at a gain, the gain would likely constitute unrelated business income. The partnerships are entitled to engage in such leveraged purchases of physical commodities. Tax exempt investors should see "Purchases by Employee Benefit Plans ERISA Considerations" above. Tax Audits All partners are required under the Internal Revenue Code of 1986 to report all the partnership items on their own returns consistently with the treatment by the partnership, unless they file a statement with the Internal Revenue Service disclosing the inconsistencies. Adjustments in tax liability with respect to partnership items will be made at the partnership level. The general partner will represent each partnership All of the foregoing statements are based upon the existing provisions of the Internal Revenue Code of 1986 and the regulations promulgated thereunder and the existing administrative and judicial interpretations thereof. The general partner cannot assure you that legislative, administrative, or judicial changes will not occur which will modify such statements. The foregoing statements are not intended as a substitute for careful tax planning, particularly since certain of the federal income tax consequences of purchasing units may not be the same for all taxpayers. The partnerships' tax returns could be audited by the Internal Revenue Service and adjustments to the returns could be made as a result of such audits. If an audit results in adjustment, limited partners may be required to file amended returns and their returns may be audited. Accordingly, prospective purchasers of units are urged to consult their tax advisers with specific reference to their own tax situation under federal law and the provisions of applicable state, local, and foreign laws before subscribing for units. STATE AND LOCAL INCOME TAX ASPECTS In addition to the federal income tax consequences for individuals described under "Material Federal Income Tax Considerations" above, the partnerships and their limited partners may be subject to various state and local taxes. Certain of these taxes could, if applicable, have a significant effect on the amount of tax payable in respect of an investment in the partnerships. A limited partner's distributive share of the realized profits of a partnership may be required to be included in determining his reportable income for state or local tax purposes. Furthermore, state and local tax laws may not reflect recent changes made to the federal income tax law and, therefore, may be inconsistent with the federal income treatment of gains and losses arising from the partnerships' transactions in Section 1256 contracts. Accordingly, prospective limited partners should consult with their own tax advisers concerning the applicability of state and local taxes to an investment in the partnerships. The general partner has been advised by its legal counsel, Cadwalader, Wickersham & Taft LLP, that in such counsel's opinion, the partnerships should not be liable for New York City unincorporated business tax. Limited partners who are nonresidents of New York State will not be liable for New York State personal income tax on such partners' income from the partnerships, but may be liable for such tax to the extent such limited partners' allocable share of income attributable to the partnerships' transactions involves tangible personal property. Likewise, limited partners who are nonresidents of New York City will not be liable for New York City earnings tax on the partners' income from the partnerships. New York City residents may be subject to New York City personal income tax on the partners' income from the partnerships. No ruling from the New York State Department of Taxation and Finance or the New York City Department of Finance has been, or will be, requested regarding such matters. LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft LLP, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000925306_morgan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000925306_morgan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..473c662da18fc6dad3c4d8effb5e046650146436 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000925306_morgan_legal_matters.txt @@ -0,0 +1 @@ +positions as a UK Gilt trader and salesman at two UK stockbrokers: Wood MacKenzie and Johnson Matthey & Wallace. He then joined Sabre Fund Management Ltd., a CFTC-registered CTA located in London, as an assistant technical trader and researcher, and was later promoted to Director of Research. In December 1986, he moved to Brockham Securities Ltd, a privately owned sugar trading and managed futures company, to assist in the development and marketing of the firm's futures fund management services. In February 1987, he left Brockham Securities Ltd and, together with colleagues Michael Adam and Martin Lueck, founded Adam, Harding and Lueck Ltd., a computer-driven, research based CTA. Adam, Harding and Lueck Ltd. became registered with the CFTC in February 1987. By 1989, this firm had grown into the UK's largest CTA, with more than $50 million under management. At that time, the principals sold a 51% stake to E D & F Man Group Ltd., one of the largest distributors of futures funds internationally. Between 1989 and 1993, when assets under management rose from $50 million to $300 million, Mr. Harding headed up Adam, Harding and Lueck Ltd.'s quantitative research team, supervising about 15 full-time research staff, supported by a software team of around a dozen programmers. This team developed a multiplicity of quantitative trading strategies in addition to Adam, Harding and Lueck Ltd.'s successful trend-following trading approach. During this time, he was also involved in the company's international institutional marketing efforts, in particular in Europe, the Middle East, South East Asia, Japan and the U.S. In 1993, Mr. Harding was invited to present a paper to a special symposium of London's prestigious Royal Society, on the subject "Making Money From Mathematical Models." This paper was subsequently incorporated into two books on the subject. In September 1994, E D & F Man Group Ltd. bought out the minority shares owned by Mr. Harding and the original partners, and Adam, Harding and Lueck Ltd. was consolidated into E D & F Man Group Ltd.'s fund management division. Mr. Harding then formed and headed up a new division of E D & F Man Group Ltd., called E D & F Man Group Ltd. Quantitative Research, leading a research team that developed quantitative trading models primarily for use by E D & F Man Group Ltd.'s fund management companies. Mr. Harding left E D & F Man Group Ltd. in August 1996 to begin preparations for the launch of Winton, which he formed in February 1997. Osman Murgian is a founding director and a principal of Winton. Educated in Brighton College in England, Mr. Murgian was also one of the original shareholders and directors of Adam, Harding and Lueck Ltd. Mr. Murgian lives in Nairobi, Kenya, and is the owner of or an investor in a number of international businesses ranging from real estate to transportation. Mr. Murgian has a beneficial interest of more than 10% of Winton's share capital. This interest is held by Festuca Investments Ltd, an Isle of Man investment holding company. Martin John Hunt is a director and a principal of Winton. Mr. Hunt began his career in the UK managed futures industry in October 1983, at which time he was employed as a trainee trader for a trading advisor, Futures Fund Management Ltd. In January 1986, he was appointed manager of the trading operations for Sabre Fund Management, also a trading advisor. In February 1988, he joined Adam, Harding and Lueck Ltd., then a newly established trading advisor, where he was responsible for the company's trading operations. These trading operations were complex, and Mr. Hunt's role was to ensure the efficient execution of the firm's computer-generated futures and interbank orders on over $120 million of assets under management. These orders spanned more than 60 markets, 5 time zones and 15 exchanges worldwide. In August 1991, Mr. Hunt assumed responsibility for marketing and operations at Royston Investments, Ltd, which at the time was a CFTC-registered CTA. In March 1994, he established himself as an independent marketing and compliance consultant to firms in the UK managed futures industry. These consultancy activities continued until February 1997, when he was recruited by David Harding to handle the formation, structuring and subsequent day-to-day running of Winton. At Winton, Mr. Hunt supervises the trading operations, as well as being directly involved in the marketing of Winton's investment management approach worldwide. Mr. Hunt also has responsibility for the firm's regulatory compliance. During the five years preceding the date of this Supplement, there have been no material administrative, civil or criminal actions, including actions pending, on appeal or concluded, against Winton or its principals. Winton and its principals may, from time to time, trade futures, forwards, or options contracts for their own proprietary accounts. These accounts may take positions that are opposite, or ahead of, positions advocated for clients. Such trades may or may not be in accordance with the Winton trading programs described below. Although Winton maintains records of these trades, clients of Winton are not entitled to inspect these records except in certain limited circumstances. Description of the Diversified Trading Program Effective January 1, 2004 the general partner allocated 10-15% of Spectrum Technical's assets to Winton's Diversified Trading Program which has been trading since 1997. The Winton Diversified Trading Program uses a statistically-derived systematic model to trade a diversified portfolio of approximately 95 futures contracts. The contracts traded cover a global range and are widely diversified across the financial and commodity sectors. Winton expects the margin requirements for the portion of Spectrum Technical's assets traded pursuant to Winton's Diversified Trading Program to average about 20% of those assets. As of December 31, 2003 Winton Capital Management Limited was managing approximately $321 million pursuant to its Diversified Trading Program and approximately $326 million of client assets in all its programs (notional funds included). Description of Trading Methods and Strategies Winton's investment technique consists of trading a portfolio of around 95 futures contracts on major commodity exchanges and forward markets worldwide, employing a computerized, technical, trend-following trading system developed by its principals. This system tracks the daily price movements from these markets around the world, and carries out certain computations to determine each day how long or short the portfolio should be to maximize profit within a certain range of risk. If rising prices are anticipated, a long position will be established; a short position will be established if prices are expected to fall. The trading methods applied by Winton are proprietary, complex and confidential. As a result, the following discussion is of necessity general in nature and not intended to be exhaustive. Winton plans to continue the testing and reworking of its trading methodology and, therefore, retains the right to revise any methods or strategy, including the technical trading factors used, the markets traded and/or the money management principles applied. A Technical Trend-Following System. Technical analysis refers to analysis based on data intrinsic to a market, such as price and volume. This is to be contrasted with fundamental analysis which relies on factors external to a market, such as supply and demand. The Diversified Trading Program uses no fundamental factors. A trend-following system is one that attempts to take advantage of the observable tendency of the markets to trend, and to tend to make exaggerated movements in both upward and downward directions as a result of such trends. These exaggerated movements are largely explained as a result of the influence of crowd psychology or the herd instinct, amongst market participants. A trend-following system does not anticipate a trend, but seeks to capture it at an appropriate point in time. In fact, trend-following systems are frequently unprofitable for long periods of time in particular markets or market groups, and occasionally they are unprofitable for spells of more than a year, even in large portfolios. However, over a span of years, Winton believes such an approach, applied to a sufficiently diversified portfolio of markets, has proven to be consistently profitable. The Winton trading system works by capturing the probability of the size and direction of future price movements using sophisticated statistical indicators, or oscillators, derived from past price movements which characterize the degree of trending of each market at any time. Winton believes its application of advanced classical statistics to the understanding of market behavior provides it with an edge over other trend following systems. Winton believes this enables its system to suffer smaller losses during the inevitable whipsaw periods of market behavior and thus take better advantage of the significant trends when they occur, by focusing more resources on them. The system is developed using historical market prices in each contract ("in sample data"), and then tested on an independent period of market data ("out of sample data") to ensure that the observations have robust predictive power. This procedure seeks to avoid the risk of over optimising, which occurs when a system is allowed to fit itself to a historically-specific set of market conditions. A Non Discretionary System. Trade selection is not subject to intervention by Winton's principals or traders and therefore is not subject to the influences of individual judgement. As a systemic trading system, the Winton model utilizes expert knowledge to analyze market data and direct trades, thus eliminating the risk of basing a trading program on one indispensable person. Equally important is the fact that non-discretionary systems can be tested in simulation for long periods of time and the model's empirical characteristics can be measured. The system's output is rigorously adhered to in trading the portfolio and intentionally no importance is given to any external or fundamental factors. While it may be seen as unwise to ignore information of obvious value, such as that pertaining to political or economic developments, Winton believes the disadvantage of this approach is far outweighed by the advantage of the discipline that rigorous adherence to such a system instills. Significant profits are often made by the Winton system, by holding on to positions for much longer than conventional wisdom would dictate. An individual taking trading decisions, and paying attention to day-to-day events, could easily be deflected from the chance of fully capitalizing on such trends, when not adhering to such a system. Markets Traded. The Winton system trades in all the easily accessible and liquid U.S. and non-U.S. futures and forward contracts that it practically can. Forward markets include major currencies and precious and base metals, the latter two categories being traded on the London Metal Exchange. Winton is constantly looking for new opportunities to add additional markets to the portfolio, thus further increasing the portfolio's diversification. Diversification of Markets. Taking positions in a variety of unrelated markets has been shown, over time, to decrease system volatility. By employing a sophisticated and systematic schema for placing orders in a wide array of markets, Winton believes it can be demonstrated that there is a high expectation of an overall profit being realized after a sufficient period of time. The trading strategy and account management principles described here are factors upon which Winton will base its trading decisions. Such principles may be revised from time to time by Winton as it deems advisable or necessary. Accordingly, no assurance is given that all of these factors will be considered with respect to every trade or recommendation made or that consideration of any of these factors in a particular situation will lessen risk of loss or increase the potential for profits. Execution of Orders and Order Allocation Winton will select the type of order to be used in executing trades and may use any type of order permitted by the exchange on which the order is placed. Winton may place individual orders for each account or a block order for all accounts in which the same commodity interest is being cleared through the same futures commission merchant. In the latter instance, Winton employs an objective price allocation procedure in which all accounts are listed by account number and then trades are assigned, with the highest number on the list receiving the highest buy and the highest sell and the lowest number on the list receiving the lowest buy and the lowest sell. On occasion, it may direct the futures commission merchant for the accounts to employ the neutral allocation system generally used by the futures commission merchant to assign trades or it may use an average price system in which each client in the block order will receive the average price which is computed by multiplying the price by the quantity executed at each price divided by the total quantity executed. Partial fills will be allocated in proportion to account size. Past Performance of Winton Set forth below in Capsule A is the past performance history of Winton's Diversified Trading Program. The footnotes following Capsule A are an integral part of the Capsule. You are cautioned that the information set forth in the following Capsule performance summary is not necessarily indicative of, and may have no bearing on, any trading results that may be attained by Winton or Spectrum Technical in the future, since past results are not a guarantee of future results. There can be no assurance that Winton or the partnership will make any profits at all, or will be able to avoid incurring substantial losses. You should also note that interest income may constitute a significant portion of a commodity pool's total income and, in certain instances, may generate profits where there have been realized or unrealized losses from commodity trading. CAPSULE A Winton Capital Management Limited Winton Diversified Trading Program Name of commodity trading advisor: Winton Capital Management Limited Name of program: Winton Diversified Trading Program Inception of trading by commodity trading advisor: October 1997 Inception of trading in program: October 1997 Number of open accounts: 33 Aggregate assets overall: 257.8 million Aggregate assets in program: 252.3 million Worst monthly drawdown (12.97)% - (October 1997) Worst peak-to-valley drawdown: (31.09)% - (November 2001-May 2002) 2003 annual return: 25.52% 2002 annual return: 12.86% 2001 annual return: 5.56% 2000 annual return: 9.72% 1999 annual return: 13.24% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Performance Records A summary of performance information for each partnership from its commencement of operations through December 31, 2003 is set forth in Capsules I through V below. All performance information has been calculated on an accrual basis in accordance with accounting principles generally accepted in the United States of America and is "net" of all fees and charges. You should read the footnotes on page , which are an integral part of the following capsules. You are cautioned that the information set forth in each capsule is not indicative of, and has no bearing on, any trading results that may be attained by any partnership in the future. Past performance is not necessarily indicative of future results. We cannot assure you that a partnership will be profitable or will avoid incurring substantial losses. You should also note that interest income may constitute a significant portion of a partnership's total income and may generate profits where there have been realized or unrealized losses from futures, forwards, and options trading. Capsule I Performance of Spectrum Select Type of pool: publicly-offered fund Inception of trading: August 1991 Aggregate subscriptions: $557,918,114 Current capitalization: $441,522,484 Current net asset value per unit: $30.31 Worst monthly % drawdown past five years: (13.12)% (November 2001) Worst monthly % drawdown since inception: (13.72)% (January 1992) Worst month-end peak-to-valley drawdown past five years: (23.63)% (22 months, October 1998-July 2000) Worst month-end peak-to-valley drawdown since inception: (26.78)% (15 months, June 1995-August 1996) Cumulative return since inception: 203.10% Monthly Performance Footnotes to Winton's Capsule Performance Summaries "Inception of trading by commodity trading advisor" is the date on which Winton began trading client accounts. "Inception of trading in program" is the date on which Winton began trading client accounts pursuant to the program shown. "Number of open accounts" is the number of accounts directed by Winton pursuant to the program shown as of December 31, 2003. "Aggregate assets overall" is the aggregate amount of assets in non-proprietary accounts under the management of Winton as of December 31, 2003. "Aggregate assets in program" is the aggregate amount of assets in the program specified as of December 31, 2003. "Drawdown" means losses experienced by the trading program over a specified period. A small number of accounts in the portfolio composites have experienced monthly drawdowns and peak-to-valley drawdowns that are materially larger than the largest composite monthly drawdown and peak-to-valley drawdown. These variances result from factors such as small account size (i.e., accounts with net assets of less than the prescribed portfolio minimum, which therefore trade fewer contracts than the standard portfolio), intra-month account opening or closing, significant intra-month additions or withdrawals, and investment restrictions imposed by the client. "Largest monthly drawdown" means greatest percentage decline in net asset value due to losses sustained by the trading program from the beginning to the end of a calendar month during the most recent five calendar years. "Worst peak-to-valley drawdown" means greatest cumulative percentage decline in month-end net asset value of the trading program due to losses sustained during a period in which the initial month-end net asset value of the trading program is not equaled or exceeded by a subsequent month-end net asset value of the program during the most recent five calendar years. "Compound annual and year-to-date/period rate of return" presented in the composite performance capsules are calculated based on the "Fully-Funded Subset" method as prescribed by the CFTC. The rate of return is calculated by dividing the sum of net performance of the qualifying Fully-Funded Subset by the beginning net assets of the qualifying Fully-Funded Subset, except in periods of significant additions or withdrawals to the accounts in the qualifying Fully-Funded Subset. In such instances, the Fully-Funded Subset is adjusted to exclude accounts with significant additions or withdrawals that would materially distort the rate of return pursuant to the Fully-Funded Subset method. Returns are then compounded to arrive at the year-to-date rate of return. Morgan Stanley Spectrum Strategic L.P. 1. Allied Irish Capital Management, Ltd. Allied Irish is an Irish corporation registered with the CFTC as a commodity trading advisor since January 1994 and is a member of the National Futures Association in that capacity. Allied Irish's business office is located at 85 Pembroke Road, Ballsbridge, Dublin 4. Allied Irish's ultimate parent company is Allied Irish Banks plc, Ireland's largest banking and financial services group. Allied Irish has been authorized by the Irish Financial Services Regulatory Authority (formerly known as Central Bank of Ireland) under the Investment Intermediaries Act, 1995. As a commodity trading advisor, Allied Irish specializes in trading interest rate, currency, and equity index futures contracts, as well as foreign exchange on the interbank cash market. The primary focus of Allied Irish's futures trading is on the U.S. and European, futures exchanges with some participation in other markets. Foreign exchange trading covers the major currencies. Allied Irish began trading for Spectrum Strategic in May 1999. Month Principals Gerry Grimes is Managing Director of Allied Irish, an associated person of Allied Irish and a member of the Institute of Bankers. He became registered as an associated person of Allied Irish in January 1994. For 10 years up to March 1988, Mr. Grimes was employed by the Central Bank of Ireland in the following investment management positions: Chief Dealer, Money Market Division; Chief Dealer, Management of Official External Reserves; and Chief Forex Dealer. He represented Ireland on sub-committees of the European Central Bank Governors Committee in Basle. He has experience in liquidity and interest rate management, investment of external reserves ($5 billion) and their currency allocation and the management of the Irish pound in the European Exchange Rate Mechanism. Mr. Grimes joined Gandon Securities as a trader in March 1988 where he traded a range of interest rate contracts, and was appointed a Director in October 1990. He was an associated person with Gandon Fund Management from July 1991 to September 1993. From mid 1991, he was responsible for the development of Gandon Fund Management's activities including the marketing and development of managed futures programs. He left Gandon Securities and Gandon Fund Management in September 1993 and joined Allied Irish that month. Mr. Grimes was a founding member of Allied Irish and is responsible for the overall management, development, and control of Allied Irish's activities. Between January and September 2002, Mr. Grimes was also responsible for trading a portion of the Worldwide Financial Futures Program. Ian Kelly became Company Secretary of Allied Irish in August 1997. He is a member of the Institute of Chartered Accountants of Ireland. He is Chief Operating Officer of Allied Irish and is responsible for financial control, compliance, and the back-office and I.T. operations of the company. He joined Allied Irish in August 1997. Prior to joining Allied Irish, he worked from July 1994 to August 1997 in AIB Capital Markets Plc., an investment bank, and before that he worked with Coopers & Lybrand, an accountancy firm, from 1987 to June 1994. John O'Donnell became a non-executive Director of Allied Irish in March 2001. He is Head of Investment Banking in the Capital Markets Division of the AIB Group, a position he was appointed to in March 2001. Prior to this appointment he was Managing Director of AIB International Financial Services Limited, a subsidiary of the AIB Group, from January 1994 to December 1996 and was Managing Director of AIB Corporate Finance Limited, another subsidiary of the AIB Group, from December 1996 to March 2001. Mr. O'Donnell is a Fellow of both the Chartered Institute of Management Accountants and the Chartered Association of Certified Accountants. John Parsons became a Director of Allied Irish in January 1995. He graduated from Queen's University, Belfast with a B.Sc. in Computer Science and Statistics in 1986, and went on to obtain a Master of Business Administration degree from Cardiff University, in 1987. Before joining Allied Irish, Mr. Parsons worked for SBC Warburg in London as a proprietary trader in the Fixed Interest & Treasury Division. Prior to that, he worked with the Bank of Ireland Group from January 1989 to March 1993, initially as a Portfolio Manager with the Bank's fund management group and ultimately as Head of European Government Bonds with the Bank's Treasury operation. Mr. Parsons trades a portion of the Worldwide Financial Futures Program and he is the sole trader of the Equity Program offered by Allied Irish. David Thompson became a Director of Allied Irish in September 2002. He has a Certificate in Actuarial Practices and a Certificate in Investment Management from the Institute of Actuaries in London. Prior to joining Allied Irish, Mr. Thompson worked for Bank of Ireland Group as Head of Proprietary Trading (non-customer flow) between January 2001 and August 2002. Before that he was Head of their Euro Fixed Interest Trading Desk between June 1998 and January 2001 and prior to that worked as a proprietary trader on their fixed interest trading desk in Dublin (July 1995 to June 1998) and as a bond trader in their London office (March 1994 to July 1995). From 1987 to 1994 he worked for Eagle Star Insurance, initially as an actuarial programmer and ultimately as a foreign exchange and bond trader. Mr. Thompson trades a portion of the Worldwide Financial Futures Program. Mr. Treble became a non-executive director of Allied Irish in October 2003 and currently has a pending registration as principal with the NFA. He is Managing Director of AIB Global Treasury, a position he has held since February 2002. Prior to this appointment, he was Managing Director of AIB Treasury and International, from February 2001 to February 2002, and he held the position of General Manager, AIB Capital Markets Britain (Treasury & Corporate Banking) from August 1997 to February 2001. He has worked in AIB since 1982 and has an MBA in Financial Services. Allied Irish and its principals may, from time to time, trade futures, forwards, and options contracts for their own proprietary accounts. Allied Irish's Trading Strategies Allied Irish offers three trading programs, but will only trade the Worldwide Financial Futures Program for Spectrum Strategic. Trading for Spectrum Strategic will be at four times the leverage Allied Irish normally applies for the Worldwide Financial Futures Program. The two other trading programs offered by Allied Irish are the Foreign Exchange Program and the Equity Index Program. Worldwide Financial Futures Program The Worldwide Financial Futures Program is designed to provide returns using a multi-trader trading approach on a broad range of financial instruments. The capital is sub-allocated to a range of trading styles, including a portion traded by two individual traders, Mr. Parsons and Mr. Thompson. The allocation of capital to the individual traders and to the trading styles may be altered at the discretion of Allied Irish. A portion is traded using a systematic approach. Diversification is enhanced because no overall house view is imposed on the traders in the program, and this independence of operation is viewed as a key strength. There are the three elements to the current trading approvals. Mr. Thompson's trading style is based on an understanding of the medium to longer term economic, political and demographic trends in the world. An analysis of value is conducted for all major asset classes and fitted to this fundamental framework to determine the likely direction and magnitude of trends in the major financial markets. The timing and size of trades is determined through a combination of technical analysis and assessment of market psychology and positioning. The aim of Mr. Thompson's approach is to enter trends early, building up the size of the position as the trade becomes profitable. Exit of the trades occurs when market sentiment in favour of the trade reaches an extreme, but price movements cease to justify the euphoria. Profitable trades can be run for months at a time, but may be held for shorter periods, depending on the strength of the trends involved. Mr. Parsons' approach to trading markets is based on a fundamental analysis of economic, fiscal, and monetary developments in the world's major economies. Having compiled a set of expectations for the major interest rate, equity, and foreign exchange markets, Mr. Parsons then looks for significant levels of divergence relative to the market's expectations as a signal to enter a particular position. He uses technical analysis to help identify trends and trend changes as well as to seek to improve entry and exit levels. A portion of the Worldwide Financial Futures Program is traded using a technical trading system. The system has been developed to be consistent with Allied Irish's investment approach to financial markets. The system differs from most trend following trading systems in that a profit objective is built into the trade from inception. The system utilizes a break-out oriented approach that attempts to initiate trading at low risk entry points where the market has a higher probability than average of participating in a medium-to long-term trend. The futures contracts currently traded in the Worldwide Financial Futures Program include U.S., European, and Asian interest rate, currency, and stock index contracts. For most contracts, options may also be used from time to time. Options may be either bought or sold in this program. It should be noted that in relation to currency futures on both the Chicago Mercantile Exchange and the financial derivatives division of the New York Cotton Exchange, Allied Irish may convert spot transactions to futures contracts using the exchange for physicals mechanism. As of December 31, 2003, Allied Irish was managing approximately $336 million (notional funds included) of client assets pursuant to the Worldwide Financial Futures Program and approximately $637 million of client assets in all of its programs (notional funds included). Foreign Exchange Program The Foreign Exchange Program specializes in trading the inter-bank foreign exchange market. A fundamental assessment of market information is the main factor underlying the trading approach. To this end an assessment of the fundamental economic policy forces at work in different countries is first made. This is related to socio-political factors in play. A judgment is then made on how much of the economic and political influences are priced in following a review of international capital flows. In this regard consultation is made with a network of experts in the world's currency markets. Finally the price levels are examined in detail to determine appropriate trade parameters. Equity Index Program The program's objective is designed to minimize correlations with major global equity returns. The underlying investment approach is broadly similar to that taken in Allied Irish's other two programs in that the main inputs are an analysis of macroeconomic and global political trends. This program is traded by John Parsons and trades the major stock index futures. Risk Management The management of risk positions takes place at two levels within the programs at the overall program level by the trading controller and at the position taking level where each trader uses his individual money management skills. Given that the programs involve a multi-trader approach, a program controller role is adopted. Mr. Grimes is the trading controller for all three programs. This role involves the following: assessing the performance and risk of the programs from an overall level as distinct from a trader level; monitoring the traders' adherence to the risk parameters for each program as set out below; ensuring that the programs' overall objectives and those of individual traders are compatible; controlling the operations of the order desk and ensuring the positions are agreed between traders, order desk, back office, and counterparty. Mr. Grimes is also responsible for liaising with clients and conveying their views, wishes, and concerns to the trading team. To control the levels of exposure a daily end-of-day position report including contract open positions, margin utilized by contract, and margin utilized by trader is produced for the Worldwide Financial Futures and Equity Index Programs. The report for the Foreign Exchange Program looks at positions in equivalent U.S. dollar amount versus underlying U.S. dollar equity invested. For the Worldwide Financial Futures and Equity Index Programs, margin to equity is used to control position size while in the Foreign Exchange Program a gearing of equity is used to limit position size. Given the nature of the programs offered and the experience of the trading team, a limit of 6% margin to equity (including notional funds) is normally applied for the Worldwide Financial Futures and Equity Index Programs and a gearing of 3 times equity (including notional funds) for the Foreign Exchange Program. 2. Blenheim Capital Management, L.L.C. Blenheim Capital Management, L.L.C. is a Delaware limited liability company which was formed to provide commodity trading advisory services to clients. Through a corporate reorganization in July 2001, Blenheim was merged with Blenheim Investments, Inc., a New Jersey corporation. The ownership and capitalization of Blenheim are materially the same as those which existed in Blenheim Investments, Inc. Additionally, Blenheim succeeds to all the assets and obligations of its predecessor. Blenheim is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator, effective March 2, 1989, and is a member of the National Futures Association. Blenheim's address and telephone number are: Post Office Box 7242, Two Worlds Fair Drive, Somerset, New Jersey 08875-7242; (732) 302-0238. Principals Mr. Willem Kooyker is the Managing Member, Chairman and majority owner of Blenheim. He is registered with the CFTC as an associated person of Blenheim and a member of the National Futures Association in that capacity. He is a former member of the Board of Directors of the NY Coffee, Sugar and Cocoa Exchange, a former president of the NY Cocoa Clearing Association, and a former member of the NY Mercantile Exchange. He received a BA cum laude in Economics from Baruch College in New York and an MBA in International Finance and Economics from New York University. Mr. Kooyker began his trading career in the international commodities business in 1964 with Internatio-Muller in Rotterdam, The Netherlands, where eventually he became managing director of the International Trading Group. He stayed in this position until 1981, when he joined Commodities Corporation, Princeton, New Jersey, where he became President. At the time, Commodities Corporation was an active fund management company, operating predominantly in the futures markets. In October 1984, Mr. Kooyker started a new company, Tricon Holding Company, Ltd., a joint venture between Commodities Corporation and a group of Middle Eastern investors, which was a trading and consulting company in the futures as well as the physicals markets predominantly directed towards energy and industrial commodities. Tricon currently remains only active in the forest products industry, where it operates two sawmills in the western states of the United States. In January 1989, Mr. Kooyker started Blenheim, an independent fund management company and an advisor to several investment funds. Concurrent, but separate from Blenheim, Mr. Kooyker is the largest beneficial owner, but not an officer, of Derivatives Portfolio Management, L.L.C., a Delaware limited liability company formed in 1993 to provide administrative, risk management, and consulting services to institutions, commodity pool operators, and individual fund managers engaged in the financial instruments, securities, and futures markets as well as the cash trading business. DPM is registered with the CFTC as a commodity pool operator, effective January 26, 1994, and is a member of the National Futures Association in that capacity. DPM has a wholly-owned subsidiary named DPM Brokerage, LLC, a Delaware limited liability company formed in 1999 to provide introduction and execution services to individual clients and private investors. DPM Brokerage is registered with the CFTC as an introducing broker, effective August 16, 1999 and is a member of the National Futures Association in that capacity. In 1996, Mr. Kooyker became a 50% shareholder in The Thornton Group, L.L.C., a consulting company to entrepreneurial startup enterprises. Mr. Kooyker is registered with the CFTC as a principal and an associated person of Blenheim. He is also registered as a principal of DPM and DPM Brokerage. Thomas M. Kopczynski is a Vice President of Blenheim. He is registered with the CFTC as a principal and an associated person and is a member of the NFA in that capacity. Mr. Kopczynski has been with Blenheim for ten years. He is an integral part of Blenheim's trading staff. His broad knowledge of the market sectors in which Blenheim trades, retained by extensive analysis and consultation with key industry contacts, facilitates continuous investment opportunities and diversification. Mr. Kopczynski holds a B.S. in Economics with a concentration in Statistics from the Wharton School of the University of Pennsylvania. Guy J. Castranova, is the Secretary of Blenheim and has held this position since its inception. He is the President and Chief Operating Officer of DPM and DPM Brokerage, as well as a Vice President and Controller of Tricon. Mr. Castranova has been with Tricon since October 1986 and is responsible for the risk management of all physicals trading as well as the administration of all general and consolidation accounting. Prior to joining Tricon, Mr. Castranova was an accountant with two energy firms. In 1980 Mr. Castranova graduated from Saint Joseph's University with a BS degree in Accounting. He is registered as an associated person and principal of Blenheim, DPM, and DPM Brokerage, and is a member of the National Futures Association in those capacities. Blenheim and its principals may, from time to time, trade futures, forwards, and options contracts for their own proprietary accounts. If either Blenheim or its principals engage in such trading, you will not be able to inspect such records. Such trades may or may not be in accordance with the Blenheim trading program described below. As of December 31, 2003, Blenheim was managing approximately $68.1 million of client assets pursuant to its trading program. The Blenheim Global Markets Strategy The Global Markets Strategy designed and developed by the management team of Blenheim. The objective of the Global Markets Strategy is to capture substantial profits through the establishment of risk-controlled, strategic investment positions in markets where Blenheim has identified an unsustainable level of market disequilibrium that has not been reflected in the current market price. The essence of Blenheim's trading approach is its ability to use discretion in formulating the most effective mix of trading methodologies, investment vehicles, and markets to maintain performance objectives. As trading opportunities are identified, Blenheim analyzes potential trading applications in order to achieve maximum capital appreciation with prudent risk management procedures. Markets Traded Blenheim's portfolio is highly diversified and draws upon a potential of 35 markets, depending on the opportunities presented at any given time. The major markets traded by Blenheim include energy, industrials, precious metals, softs, grains, global fixed income, currencies and stock indices. Blenheim concentrates in those markets that, in its judgment and discretion, have a high degree of liquidity and a wide spectrum of historical price movement relative to other markets. Instruments Utilized Positions established are typically in derivative instruments such as futures options and OTC transactions. Blenheim may, however, trade to a limited extent in illiquid instruments for which market quotations are not readily available. In addition, Blenheim may trade in securities that are related to the financial and commodities markets currently traded by the fund. However, Blenheim will not be trading securities for Spectrum Strategic. Blenheim's Trading Style Blenheim uses a global macro approach to investing, which utilizes fundamental, geopolitical and technical research and analysis in its evaluation of the markets. Fundamental analysis attempts to examine factors external to the trading market which affect the supply and demand for a particular investment instrument in order to predict future prices. The geopolitial considerations include governmental interference and potential political conflicts which may alter the normal flow of capital and goods. Technical factors assume that market price patterns and price momentum, rather than external influences, indicate the supply and demand factors which are indicative of future price movements. Blenheim considers technical factors such as an instrument's recent price history, current prices of such instrument relative to price of other markets and their historical price relationships. Blenheim studies price charts to assess changes in market sentiment and examines volume and open interest to evaluate market liquidity. The Blenheim traders regularly monitor worldwide economic and political trends in order to identify and evaluate possible market and price imbalances. Operating within a global framework, long-term macroeconomic indicators are assessed on a multinational, country-by-country and market specific basis. Factors such as fiscal/monetary policies and cross-border capital flows are evaluated for their potential impact on the equity, fixed income, currency and commodity markets. Additionally, Blenheim's trading group utilizes econometric signals, as well as numerous other market sentiment indicators, to take advantage of short-term trading opportunities. Portfolio Management and Diversification Various techniques are employed in managing the portfolio and position volatility. In its discretionary trading, Blenheim generally initiates medium-sized positions at a market entry level. This initial position, generally considered the core strategic position, is typically initiated upon Blenheim's determination of an unsustainable level of market disequilibrium that has not been reflected in the current market price. Once market action begins to conform to Blenheim's initial assessment of price behavior, Blenheim will add to the original strategic position. In addition to managing the individual positions, Blenheim will also evaluate the positions within the context of an account's portfolio. Separate strategic positions are evaluated for direct and indirect correlation characteristics in order to further anticipate and manage portfolio volatility. Despite these precautions, Blenheim's trading program may be volatile at times. Diversification in an account's portfolio is a major consideration in its trading approach. While many of its trades are made on a short-term basis, Blenheim's basic strategy is to attempt to participate in long-term, major price movements. Evolution of the Trading Approach The trading strategy of Blenheim has evolved and will continue to do so based on ongoing research, testing of data and trading experience. Prior to 1991, Blenheim traded almost exclusively in commodity markets, with a particular emphasis on energy products. Since then, Blenheim has become active in the global fixed-income, stock indices and currency markets as well. In the past, Blenheim had included non-discretionary systematic computerized analysis in its trading practices. This strategy was driven by a series of trading systems that produced a result that was an amalgam of numerous systemic processes. It was then traded in conjunction with the discretionary approach. Under separate funds, Blenheim also managed a purely financial strategy and a long-only commodity trading strategy incorporating physical commodities. In this regard, Blenheim reserves the right to modify its trading approach to include any one or combination of trading methodologies it finds beneficial to its overall goals. These processes may include discretionary, systematic, or arbitage trading. Blenheim may use derivative instruments including futures, options, and forwards to reach its performance objectives. On rare occasions, Blenheim may withdraw from all markets. Blenheim's diversified portfolio is actively traded on domestic and foreign markets. In the early 1990s, approximately thirty-five percent (35%) to forty-five percent (45%) of equity, including notional funds, was generally committed to margin on commodities positions. Recently the percentage has been between twenty-five percent (25%) and thirty-five percent (35%). In the future the percentage committed may, from time to time, be substantially higher or lower. Variances in Leverage If particular opportunities present themselves based upon fundamental factors, Blenheim may increase the number of positions held. This will result in more capital needed to provide risk margin. Accordingly, within the overall parameters of Blenheim's money management rules, Blenheim employs no hard and fast formula as to the levels of capital committed to discretionary trading or any other trading strategy at any given time. The level of risk margin relative to equity committed to trading positions is expected to vary from period to period. The Blenheim traders will constantly monitor leverage in an effort to try to maximize its positive effects while trying to avoid overexposure to its potential negative characteristics. While there is no guaranty that this approach will be successful, Blenheim has used a consistent risk monitoring system for a number of years, one of the key components thereof involves monitoring the levels of risk margin to equity. Blenheim may leverage the account of Spectrum Strategic differently than the standard account using the Global Market Strategy, but will not leverage the account at more than 50% above the leverage of a standard account. 3. Eclipse Capital Management, Inc. Eclipse is a Delaware corporation organized in July 1983. Eclipse's main business address is 7700 Bonhomme, Suite 500, St. Louis, Missouri 63105. Eclipse has been registered with the CFTC as a commodity trading advisor since August 1986 and is a member of the National Futures Association in such capacity. Eclipse began trading for Spectrum Strategic in June 2000. Principals Thomas W. Moller, the sole shareholder of Eclipse, has served as its President, CEO, and sole director since founding the firm. Mr. Moller received an undergraduate degree in Business and Economics from Vanderbilt University and a graduate degree in Accounting from the University of Kentucky. He was a Certified Public Accountant and has a background in financial planning and investment management. In 1980, as chief financial officer of a privately held company, he designed and implemented one of the first variable rate loan hedge programs using interest rate futures contracts. In 1982, he formed Interest Rate Management, Inc., another commodity trading advisor which provided interest-rate-hedging advisory and management services. Since 1986, Mr. Moller has devoted his time exclusively to Eclipse and is primarily involved in the areas of trading, research, and product development. James R. Klingler, JD is Senior Vice President, Corporate Secretary, and General Counsel. Mr. Klingler has a BA in Economics from Vanderbilt University and a JD from Vanderbilt University School of Law. He previously worked as an associate with the St. Louis law firm of Thompson Coburn (formerly Coburn & Croft) and as a staff attorney with Mercantile Bancorporation, also in St. Louis. From January 1991 to December 1997, he was Compliance Counsel and, subsequently, Associate Vice President with A.G. Edwards & Sons, Inc. Mr. Klingler joined Eclipse in January 1998. Ronald R. Breitigam is Vice President Trading with primary responsibility for the implementation of the firm's trading strategies. After graduating from Pacific Union College in 1982, Mr. Breitigam became an independent floor trader at the Mid-America Commodity Exchange. He served as an institutional broker with Thomson McKinnon (1984-1985) and PaineWebber (1986) and, in 1986, formed his own trading company to work full time implementing various proprietary futures and options trading strategies. Mr. Breitigam joined Eclipse in May 1989. James W. Dille, PhD is Vice President Research and Technology with responsibility for computer-based research, development, and operations. Dr. Dille has undergraduate and graduate engineering degrees from the University of Virginia. He also received a master's and doctorate from Harvard University in Applied Sciences, specializing in the areas of Decision and Control Theory and Computer Science. From 1987 through 1993, he worked for the Boeing Company (formerly, McDonnell Douglas) in the Training Systems and Flight Simulation divisions, where he was responsible for research in the areas of computer architectures and networking. He is an affiliate professor at Washington University in St. Louis, teaching courses in numerical analysis and the simulation and analysis of complex systems. Dr. Dille joined Eclipse in January 1994. At this time, neither Eclipse nor its principals trade for their own account, but each reserves the right to do so in the future. If either Eclipse or its principals engage in such trading, you will not be able to inspect such records. Trading Programs Eclipse currently offers one trading program, the Global Monetary Program. The program is designed primarily for institutions, commodity pools, and certain other qualified investors. The Global Monetary Program employs a systematic trading approach, using multiple trend-following and macroeconomically driven models. Global Monetary Program: This "financial, metals and energy" program requires a minimum investment of $5 million and trades a global portfolio of futures and options on futures on interest rate instruments, currencies, stock indices, precious and base metals, and energy products, as well as interbank spot and forward currency markets. A key characteristic of this program is the extensive diversification achieved by applying multiple trading models to a wide variety of financial markets located throughout the world. As of December 31, 2003, Eclipse was managing approximately $379 million of client assets pursuant to its trading program (notional funds included). Trading Approach The trading program of Eclipse is systematic and its strategies are either macroeconomic or trend-following in nature, with the objective of capitalizing on intermediate- and long-term price trends. Eclipse makes all trading decisions pursuant to its proprietary trading, capital allocation, and risk management models. The Eclipse program makes use of multiple models to accentuate overall diversification. Macro-driven models generate trading signals through the quantitative analysis of environmental, macroeconomic, and intermarket data. Trend identification models use various technical and statistical analysis techniques to identify and evaluate price trends. Capital allocation models determine the percentage of trading capital allocated to various markets and trading models. Eclipse's risk management models were developed with the objective of limiting losses, capturing profits, and conserving capital in choppy, sideways markets. The risk management principles which Eclipse employs include: using stop orders to exit trades when markets are moving against an established position (although, depending on market circumstances, such "stop-loss" orders may be difficult or impossible to execute); diversifying positions among several different markets, futures, and/or futures groups to limit exposure in any one area; using multiple entry and exit points; limiting the assets committed as margin, generally within a range of 5% to 20% of assets managed, at minimum exchange margin requirements, but possibly above or below that range at certain times; and prohibiting the use of unrealized profits in a particular futures contract as margin for additional contracts in the same or a related futures contract. Decisions whether to trade a particular futures contract are based upon various factors, including liquidity, significance in terms of desired degrees of concentration, diversification, and profit potential, both historical and at a given time. These decisions are based upon output generated by a proprietary risk management program, but require the exercise of judgment by principals of Eclipse. The decision not to trade specific contracts for certain periods or to reduce the number of contracts traded may result at times in missing significant profit opportunities which otherwise would be captured by technical strategies. The specific contracts traded in each portfolio have been selected based on liquidity, historical volatility, and the degree of past directional movement. The actual number of contracts held at any particular point in time depends on a number of factors, including evaluation of market volatility and potential risk versus return. There are occasions when a trading model may indicate that no position is appropriate in a particular contract or contract group. In addition to technical trading in futures contracts, Eclipse may also employ trading techniques such as spreads and straddles and may buy or sell futures options. Eclipse may alter its trading programs, including, without limitation, its trading strategies, commodity interests, and markets traded and trading principles if Eclipse determines that such change is in the best interest of the accounts which it manages. Morgan Stanley Spectrum Global Balanced L.P. SSARIS Advisors, LLC SSARIS, a Delaware Limited Liability Company, was organized in May 2001. SSARIS's address is Financial Centre, 695 East Main Street, Suite 102, Stamford, Connecticut 06901. SSARIS has been registered as a commodity trading advisor since August 2001 and as a commodity pool operator since August 2001, and is a member of the National Futures Association in such capacities. SSARIS is a joint venture between State Street Global Alliance LLC, a limited liability company which is majority owned by State Street Global Advisors, Inc., and RTH Partners LLC, a limited liability company owned by the principals of The RXR Group, Inc. State Street Global Advisors, Inc. is a wholly-owned subsidiary of State Street Corporation. SSARIS is affiliated with State Street Global Advisors, the investment management division of State Street Bank and Trust Company, a wholly owned subsidiary of State Street Corporation. Principals Mr. Mark Rosenberg has served as the Chairman, a Director and the Chief Investment Officer of SSARIS since its formation in May 2001 and, as such, is the head of SSARIS's Investment Committee. Mr. Rosenberg is also the Chairman of SSARIS Management LLC. Mr. Rosenberg was the Chairman and Chief Investment Officer of RXR. Mr. Rosenberg has over thirty (30) years experience in the investment management industry. From August 1984 to July 1986, Mr. Rosenberg was employed by Prudential-Bache Securities, Inc., where he headed a group that specialized in institutional hedging and managed futures trading services. From December 1976 to July 1984, Mr. Rosenberg was employed by Merrill Lynch & Co. where he organized a group that was responsible for managing hedging and alternative investment strategies for Merrill's institutional clients. This entity became the Financial Futures and Options Group. Mr. Rosenberg's first job was on the floor of the New York Stock Exchange and subsequently the New York Mercantile Exchange, where he managed proprietary capital using a variety of quantitative techniques for Weis, Voisen & Cannon, a private investment boutique. Mr. Rosenberg is a fourth term Director of the Board of the Futures Industry Association, and arbiter for the NFA and is a member of the Financial Advisory Boards of both the Chicago Mercantile Exchange and the COMEX Division of NYMEX. Mr. Rosenberg is also a Director of the Foundation of Finance and Banking Research. Mr. Rosenberg also is involved in several community activities. He has donated time to Domus House, a refuge for abandoned children, and various entrepreneurial projects targeting low-income families. Mr. Peter A. Hinrichs has served as the Chief Financial Officer of SSARIS since its formation in May 2001 and is a member of SSARIS's Investment Committee. Mr. Hinrichs also is Chief Financial Officer of SSARIS Management LLC. Mr. Hinrichs was with RXR since its founding in 1983, where he was responsible for RXR's financial, administrative and operational functions. Mr. Hinrichs also was a member of RXR's Investment Committee. From September 1981 to July 1984, Mr. Hinrichs was employed by Merrill Lynch Futures Inc. in trading and administration and held a similar position at Prudential from July 1984 to August 1986. Mr. Hinrichs graduated from Curry College in 1981 with a Bachelor of Science degree in Business Management. He is active in his community as a Board member of Fountain House Inc., a non-profit rehabilitation center for the mentally ill, where he serves as an Investment Committee member. He also is active with a number of other charitable organizations. Mr. James F. Tomeo has served as the Chief Operating Officer, a Senior Portfolio Manager and a Director of SSARIS since its formation in May 2001. Mr. Tomeo also is a member of SSARIS's Investment Committee and is responsible for portfolio management, strategic planning and product development. Mr. Tomeo served as Chief Operating Officer and a Senior Portfolio Manager of RXR and was a member of the firm's Investment Committee. Before joining RXR in 1986, Mr. Tomeo worked for Donaldson, Lufkin and Jenrette as an alternative investment consultant, and the LTV Corporation in New York. Mr. Tomeo was formerly an advisor to Institutional Investor on matters related to Japanese pension fund reform, is the former Chairman of the International Committee of the Managed Funds Association and is the US representative to the Education and Research Committee of the Alternative Investment Management Association. Mr. Tomeo graduated from Bucknell University in May 1980 with a Bachelor of Science degree in Business Administration, the University of Hartford in 1987 with an MBA degree, and the Institute of International Studies and Training (Japanese business study program) in November 1988. He studied International Finance and Capital Markets at New York University. Alan J. Brown has been a Director of SSARIS since July 2003. Mr. Brown is a principal of State Street Global Advisors, Group Chief Investment Officer of State Street Global Advisors Worldwide, Chairman of State Street Global Advisors UK, and Executive Vice President of State Street. He is also a member of State Street Global Advisor's Executive Management Group. Mr. Brown is a director of Advanced Investment Partners, European Direct Capital Management, Rexiter Capital Management, Boston Capital Management and Global Alliance, LLC. Mr. Brown is also a member of State Street Global Advisor's Executive Management Group. Prior to joining State Street Global Advisors UK in 1995, Mr. Brown was Managing Director and Chief Investment Officer of PanAgora Asset Management Limited, and prior to that, Managing Director of Posthorn Global Asset Management in London. Mr. Brown began his career in the investment management business in 1974 at Morgan Grenfell, where he spent ten years. Mr. Brown holds a Masters degree in Physics from Cambridge University. Mr. Brown is on the board of the U.S. foundation for The Center for Economic Research and Graduate Education-Economic Institute attached to the Charles University in Prague. Jay Cromarty has been a Director of SSARIS since March 2003. Mr. Cromarty is the President of Global Alliance and a Senior Principal of State Street Global Advisors. Among other duties, Mr. Cromarty provides strategic management and marketing support to all of the Global Alliance investment management businesses. Mr. Cromarty is a director of Advanced Investment Partners, Boston Capital Management and Residential Capital Management. Before joining Global Alliance in May 1998, Mr. Cromarty served as the Managing Director of Sales and Marketing for State Street Global Advisors' Private Asset Management group. Prior to joining State Street Global Advisors in 1996, Mr. Cromarty was Vice President of The Boston Company, Inc., Director of Marketing and Client Service at PanAgora Asset Management and Senior Vice President of NatWest Investment Management. Mr. Cromarty holds a Bachelor of Science degree in Economics from the University of Maine and a Masters of Business Administration degree in Finance and Marketing from Babson College. Christopher M. Pope has been a Director of SSARIS Global Advisors and Director of Institutional Sales, Client Service, and Consultant Relations. Prior to joining State Street Global Advisors in 1988, Mr. Pope was responsible for marketing and client service at Travelers Investment Management Company and Travelers Keystone Fixed Income Advisors. Mr. Pope holds a Bachelor of Science degree from the University of Pennsylvania. Mr. Pope is a charter member of the Certified Employee Benefit Specialist program. Principals and employees of SSARIS are not permitted to trade futures, options on futures, or forward contracts for their own accounts. Principals and employees are, however, permitted to invest in funds traded by SSARIS. SSARIS's Investment Philosophy SSARIS trades its allocation from Spectrum Global Balanced pursuant to a variation of its Balanced Portfolio known as the Global Multi-Strategy program. The development of the trading program utilized for Spectrum Global Balanced stems from RXR's work over the years with institutional clients. In 1986, RXR began managing a portfolio called the Institutional Balanced Portfolio program (now known as the Balanced Portfolio), which was composed of U.S. stock, bond and non-U.S. financial and commodity interests. Its objective was capital appreciation with controlled volatility, a concept pioneered by Professor John Lintner of Harvard University, who conducted research on the addition of managed futures to portfolios of U.S. stocks and bonds. The philosophy for the investment program has its roots in Modern Portfolio Theory and the design of efficiently allocated portfolios. Effective June 1, 1998, RXR broadened the hedged equity and fixed income components to include participation in the world's major developed capital markets and increased the program's leverage to 1.4 times the original Balanced Portfolio Program. The resulting program is now known as the Global Multi-Strategy. SSARIS's Global Multi-Strategy program allocates to hedged equity, hedged fixed income, and long/short global assets. It is diversified by both style (divergence and convergence strategies) and asset class (global stocks, bonds, currencies and real assets). The hedged equity component may be composed of positions in FTSE 100, DAX, Nikkei 225, and S&P 500 futures indices. The hedged fixed income exposure may include British Gilt, German Bund, Japanese & US Treasury futures. Real asset exposure is diversified across energy, precious metal, base metal, and agricultural markets. The investment program uses a multi-determinant model to rebalance the independent strategies. The global stock and bond exposure is managed using models which interpret macroeconomic, relative value, inflation, interest rate, and price-related data. Exposure within the long/short global asset sector is regulated by combining individual market expected return analysis with a system that asset weights each market according to relative volatility and correlation. In the foreign exchange and commodity components, SSARIS analyzes price data to determine profit and risk potential. A proprietary asset allocation model is used to adjust exposure among approximately 40 markets so that no one market or sector can dominate performance. The investment program was designed to provide investors with a global investment alternative. Through the controlled use of futures and forward contracts, SSARIS manages both U.S. and non-U.S. capital markets, currency and commodity exposure in a single, integrated portfolio. As of December 31, 2003, SSARIS was managing approximately $53 million of client assets pursuant to the program utilized for Spectrum Global Balanced and approximately $612 million in all of their programs. Research and Development Research and development calls on the talents of personnel from several areas within the company. SSARIS has developed macro-economic and technical models that can detect price movements resulting from daily market activity and major changes in global business cycles. Using this information, portfolio managers construct investment portfolios that address the specific actuarial assumptions of their clients. No representation is made and no guarantee is given that Spectrum Global Balanced's objective will be realized or that SSARIS will achieve any particular level of performance or amount of profits in its trading for Spectrum Global Balanced's account. Losses incurred in the global and tangible assets component could cause Spectrum Global Balanced's account to substantially underperform accounts managed by asset allocation systems that do not include a managed futures component. Prospective investors must recognize not only that the foregoing discussion attempts to present only the most basic framework describing the trading program employed for Spectrum Global Balanced, but also, due to the proprietary and confidential nature of all trading approaches, any description will inevitably be general in nature. Furthermore, SSARIS's trading methods are continually evolving, as are the markets themselves. Morgan Stanley Spectrum Currency L.P. 1. John W. Henry & Company, Inc. (JWH ) JWH makes trading decisions for Spectrum Currency pursuant to the International Foreign Exchange Program. The International Foreign Exchange Program, which began trading client capital in August 1986, seeks to identify and capitalize on intermediate-term movements in a broad range of both major and minor currencies primarily trading on the interbank market. Positions are taken as outrights against the U.S. dollar, or non-dollar cross rates. This program uses the three-phase forex investment style. For a detailed description of JWH, its principals, and trading systems, including the International Foreign Currency Program, see "The Trading Advisors Morgan Stanley Spectrum Technical 3. John W. Henry & Company, Inc." beginning on page . 2. Sunrise Capital Partners, LLC The principals and senior officers of Sunrise Capital Partners are as follows: Martin P. Klitzner Principal, Managing Director Richard C. Slaughter Principal, Managing Director Dr. Gary B. Davis Principal Dr. John V. Forrest Principal Martin M. Ehrlich Principal, Vice President Marie Laufik Principal, Vice President Elissa Davis Principal The principals of Sunrise Capital Partners will make trading decisions for Spectrum Currency pursuant to the Currency Program. For a detailed description of Sunrise Capital Partners, its principals and trading systems, other than the Currency Program, which is discussed below, see "The Trading Advisors Morgan Stanley Spectrum Select 4. Sunrise Capital Management, Inc." beginning on page . The Currency Program follows approximately ten different major and minor currency markets, which may include, but are not limited to, the Japanese yen, British pound, euro currency, Swiss franc, Canadian dollar, Australian dollar, Swedish krona, New Zealand dollar, Singapore dollar, and South African rand. The Currency Program trades currency futures contracts on the International Monetary Market Division of the Chicago Mercantile Exchange and forward currency contracts in the interbank markets. In order to achieve adequate diversification for the Currency Program, major and minor currencies are traded as crossrates selectively against each other and/or as outrights against the U.S. dollar. As of December 31, 2003 Sunrise Capital Partners was managing approximately $146 million of client assets pursuant to the Currency Program and approximately $1.7 billion of client assets in all of its programs (notional funds excluded). EXCHANGE RIGHT If the conditions described below are satisfied, you may redeem your units in any partnership as of the last day of any calendar month and use the proceeds to purchase units of any of the other Spectrum Series partnerships. However, a Spectrum Series exchange will only be permitted as of the sixth month-end after you first became an investor in any Spectrum Series partnership, and as of the last day of each month thereafter. Each unit you purchase in a Spectrum Series exchange will be issued and sold at a price per unit equal to 100% of the net asset value of a unit as of the close of business on the exchange date. Any units you redeem in a Spectrum Series exchange will not be subject to a redemption charge. Units you acquire in a Spectrum Series exchange will be subject to redemption charges, but will be deemed to have the same purchase date as the units you exchanged for purposes of determining the applicability of any redemption charges. Thus, for example, if you hold units of Spectrum Strategic for 12 months, exchange those units for units of Spectrum Technical, then redeem any of those units 15 months later, you will not have to pay a redemption charge, because those units will be deemed to have been held for 27 months. When you request a Spectrum Series exchange, additional conditions must be satisfied. First, the partnership from which you are redeeming must have assets sufficient to discharge its liabilities and redeem units. In order to effect a Spectrum Series exchange, you must send a subscription agreement to a Morgan Stanley branch office, and that agreement must be received by the general partner at least five business days prior to the applicable exchange date. In that agreement, you must acknowledge that you are still eligible to purchase units on the exchange date. You must exchange a minimum of 50 units in a Spectrum Series exchange, unless you are liquidating your entire interest in a partnership. A form of subscription agreement is annexed to this prospectus as Exhibit B, and additional copies of the subscription agreement may be obtained by written request to the general partner or from a local Morgan Stanley branch office. In order to effect a Spectrum Series exchange, each partnership must have a sufficient number of units registered and qualified for sale under federal and applicable state securities laws pursuant to a current prospectus. While the general partner intends to maintain a sufficient number of registered units to effect series exchanges, it is under no obligation to do so. Therefore, the general partner cannot assure you that any units will be available for sale on an exchange date. Furthermore, states may impose significant burdens on, or alter the requirements for, qualifying units for sale. In that event, the general partner may not continue qualifying units for sale in those states, and residents of those states would not be eligible for a Spectrum Series exchange. In addition, states may impose more restrictive suitability and/or investment requirements than those set forth in the form of subscription agreement. Any such restrictions may limit the ability of residents of those states to effect a Spectrum Series exchange. In the event that not all subscription agreements can be processed because an insufficient number of units is available for sale on an exchange date, the general partner will allocate units in the manner it determines in its sole discretion. The general partner has not yet determined how it will allocate units in the event there are an insufficient number of units available on an exchange date. Units of any new partnership in the Spectrum Series may be offered to investors pursuant to exercise of the Spectrum Series exchange right. Before purchasing units of a new partnership, you will be required to receive a copy of a prospectus and any supplement to this prospectus describing the new partnership and its units, and you will be required to execute a new subscription agreement to purchase units of that partnership. Since a Spectrum Series exchange is equivalent to a redemption and an immediate reinvestment of the proceeds of the redemption, you should carefully review the portions of this prospectus describing redemptions and the tax consequences before effecting a Spectrum Series exchange. REDEMPTIONS Once you are an investor in a Spectrum Series partnership for at least six months, you may redeem all or part of your units, regardless of when such units were purchased. Redemptions may only be made in whole units, with a minimum of 50 units required for each redemption, unless you are redeeming your entire interest in a partnership. The general partner will redeem your units in the order in which they were purchased. Redemptions will only be effective as of the last day of the month in which a request for redemption in proper form has been timely received by the general partner. A "request for redemption" is a letter in the form specified by the general partner that must be sent by you to a local Morgan Stanley branch office and received by the general partner at least 5 business days prior to the redemption date. A form of request for redemption is annexed to the limited partnership agreement, which agreement is annexed to this prospectus as Exhibit A. Additional copies of the request for redemption may be obtained by written request to the general partner or a local Morgan Stanley branch office. If you redeem units, you will receive 100% of the net asset value of each unit redeemed as of the redemption date, less any applicable redemption charges. Since the general partner must receive your request for redemption at least five business days prior to the redemption date, you will not know the actual amount you are to receive prior to the redemption date. The "net asset value" of a unit is an amount equal to the partnership's net assets allocated to capital accounts represented by units, divided by the number of units outstanding. "Net assets" means the total assets of a partnership, including all cash and cash equivalents (valued at cost), accrued interest and amortization of original issue discount, and the market value of all open futures, forwards, and options positions and other assets of the partnership, less the total liabilities of the partnership, including, but not limited to, all brokerage, incentive and management fees, and extraordinary expenses, as determined in accordance with generally accepted accounting principles consistently applied under the accrual basis of accounting. The market value of a futures contract traded on a U.S. exchange means the settlement price on the exchange on which that futures contract is traded on the day net assets are being determined. However, if a futures contract could not have been liquidated on that day because of the operation of daily limits or other rules of the exchange or otherwise, the settlement price on the first subsequent day on which the futures contract could be liquidated will be the market value of that futures contract for that day. The market value of a forward or futures contract traded on a foreign exchange or market means its market value as determined by the general partner on a basis consistently applied for each different variety of forward contract or futures interest. If you redeem units on or prior to the last day of the twelfth month from the date of their purchase, those units will be subject to a redemption charge equal to 2% of their net asset value on the redemption date. If you redeem units after the last day of the twelfth month and on or prior to the last day of the twenty- fourth month from the date of their purchase, those units will be subject to a redemption charge equal to 1% of their net asset value on the redemption date. If you redeem units after the last day of the twenty-fourth month from the date of their purchase, those units will not be subject to a redemption charge. All redemption charges will be paid to Morgan Stanley DW and will not be shared with the financial advisor or additional selling agent who sold the units. Your units will be exempt from redemption charges under the following circumstances: If you redeem units at the first redemption date following notice of an increase in brokerage, management, or incentive fees, those units will not be subject to redemption charges. If you redeem units in a Spectrum Series exchange, the units you redeem will not be subject to redemption charges and, for purposes of determining the applicability of future redemption charges, the units you acquire will be deemed to have the same purchase date as the units you exchanged. If you redeem units of any other partnership for which Demeter serves as the general partner, the units you redeem from the other limited partnership will be subject to any applicable redemption charges, but the Spectrum Series units you purchase will not be subject to redemption charges. If you redeem units and have either paid a redemption charge with respect to the units or held the units for at least 24 months, you will not be subject to redemption charges with respect to any newly purchased units, provided the new units are purchased within twelve months of and in an amount no greater than the net proceeds of the prior redemption, and the units are held for at least six months from the date of purchase. In that event, you will still be subject to the minimum purchase and suitability requirements. The general partner will endeavor to pay redemptions within ten business days after the redemption date. A partnership may be forced to liquidate open futures, forward, and option positions to satisfy redemptions in the event it does not have sufficient cash on hand that is not required as margin on open positions, and may delay payment to limited partners requesting redemption of units of the proportionate part of the net asset value of the unit represented by the sums for which sufficient cash is not available. See "Risk Factors Partnership and Offering Risks Restricted investment liquidity in the units" on page . When you redeem units, payment will be made by credit to your customer account with Morgan Stanley DW, or by check mailed to you if your account is closed. Your right to redeem units is contingent upon the redeeming partnership having assets sufficient to discharge its liabilities on the redemption date, and timely receipt by the general partner of your request for redemption as described above. The terms and conditions applicable to redemptions in general, other than those prohibiting redemptions before the sixth month-end following the closing at which you first became an investor in a Spectrum Series partnership, and providing that redemptions may only be made as of the end of a calendar month, will also apply to redemptions effected on "special redemption dates." See "The Limited Partnership Agreements Books and Records; Reports to Limited Partners" on page . THE COMMODITY BROKERS Morgan Stanley DW Inc., Morgan Stanley & Co. Incorporated, and Morgan Stanley & Co. International Limited Morgan Stanley DW Inc., a Delaware corporation, acts as the partnerships' non-clearing commodity broker. Morgan Stanley DW, as the non-clearing commodity broker, holds each partnership's funds in customer segregated or secured accounts, and provides all required margin funds to the clearing commodity brokers. Morgan Stanley & Co. Incorporated, a Delaware corporation, acts as the partnerships' clearing commodity broker and foreign currency forward counterparty, and Morgan Stanley & Co. International Limited serves as the clearing commodity broker for trades that take place on the London Metal Exchange. Morgan Stanley DW monitors each partnership's futures positions that the clearing commodity brokers report they are carrying for any errors in trade prices or trade fill. Morgan Stanley DW also serves as the non-clearing commodity broker for all, and Morgan Stanley & Co. serves as the clearing commodity broker and foreign exchange counterparty for all but one, of the other commodity pools for which Demeter serves as general partner and commodity pool operator. Morgan Stanley International serves as the clearing commodity broker for the trades of such pools that take place on the London Metal Exchange. Morgan Stanley DW is a financial services company which provides to its individual, corporate, and institutional clients services as a broker in securities, futures, and options, a dealer in corporate, municipal and government securities, an investment adviser, and an agent in the sale of life insurance and various other products and services. Morgan Stanley DW has its main business office at 1585 Broadway, New York, New York 10036. Morgan Stanley DW is a member firm of the New York Stock Exchange, the American Stock Exchange, the Chicago Board Options Exchange, and other major securities exchanges. Morgan Stanley DW is registered with the CFTC as a futures commission merchant and is a member of the National Futures Association in such capacity. Morgan Stanley DW is also registered with the SEC as a broker-dealer and is a member of the NASD. Morgan Stanley DW and its affiliates currently service clients through a network of approximately 700 offices with approximately 12,000 financial advisors servicing individual and institutional client accounts. Morgan Stanley & Co. Incorporated is the clearing commodity broker for all trades for the partnerships, other than for those trades on the London Metal Exchange. Morgan Stanley & Co. has its main business office at 1585 Broadway, New York, New York 10036. Morgan Stanley & Co. is registered as a futures commission merchant, is a member of the National Futures Association, and is a member of most major U.S. and foreign commodity exchanges. Morgan Stanley & Co. is registered with the SEC as a broker-dealer and is a member of the NASD. Morgan Stanley & Co. International Limited, a United Kingdom corporation, acts as the partnerships' clearing commodity broker solely with regard to any trading on the London Metal Exchange. Morgan Stanley International has its main business office at 25 Cabot Square, Canary Wharf, London E14 4QA, England, is regulated by the United Kingdom Securities and Futures Authority as a member firm, and is a member of the London Metal Exchange and other securities and commodities exchanges worldwide. Morgan Stanley, the parent company of Morgan Stanley DW, Morgan Stanley & Co. and Morgan Stanley International, is a worldwide financial services firm, employing, directly and through its subsidiaries, more than 51,000 people worldwide in offices throughout the United States and 28 foreign countries. Morgan Stanley is a publicly-traded company listed on the New York Stock Exchange; its common stock had a market value of approximately $60 billion at November 30, 2003. At that date, Morgan Stanley had leading market positions in its three primary businesses (securities, asset management and credit services), and it ranked among the top asset managers globally, with over $462 billion in assets under management. Brokerage Arrangements The partnerships' brokerage arrangements with Morgan Stanley DW, Morgan Stanley & Co. and Morgan Stanley International are discussed in "Conflicts of Interest The brokerage arrangements with affiliates of the general partner were not negotiated at arm's-length or reviewed by any independent party for fairness" on page , " Customer agreements with the commodity brokers permit actions which could result in losses or lost profit opportunity" on page , and "Description of Charges Commodity Brokers" beginning on page . The general partner will review at least annually the brokerage arrangements of each partnership to ensure that those arrangements are fair, reasonable, and competitive, and represent the best price and services available, taking into consideration: the size of the partnership; the futures, forwards, and options trading activity; the services provided by the commodity brokers or any affiliate thereof to the partnership; the cost incurred by the commodity brokers or any affiliate thereof in organizing and operating the partnership and offering units; the overall costs to the partnership; any excess interest and compensating balance benefits to the commodity brokers from assets held thereby; and if the general partner does not receive any direct compensation from the partnership for its services as general partner, the risks incurred by the general partner as general partner of the partnership; Each customer agreement sets forth a standard of liability for the commodity broker and provides for indemnities of the commodity broker. See "Fiduciary Responsibility and Liability" beginning on page 17. LITIGATION At any given time, the commodity brokers are involved in numerous legal actions, some of which seek significant damages. On January 11, 1999 the SEC brought an action against 28 NASDAQ market makers, including Morgan Stanley & Co., and 51 individuals, including one current and one former trader employed by Morgan Stanley & Co., for certain conduct during 1994. The core of the charges against Morgan Stanley & Co. concerns improper or undisclosed coordination of price quotes with other broker-dealers and related reporting, recordkeeping, and supervisory deficiencies in violation of Sections 15(b)(4)(E), 15(c)(1) and (2) and 17(a) of the Securities Exchange Act and Rules 15c1-2, 15c2-7 and 17a-3 promulgated thereunder. Without admitting or denying the charges, Morgan Stanley & Co., consented to the entry of a cease and desist order and to the payment of a civil penalty of $350,000, disgorgement of $4,170, and to submit certain of its procedures to an independent consultant for review. In addition, one current and one former trader employed by Morgan Stanley & Co. accepted suspensions of less than two months each and were fined $25,000 and $30,000, respectively. On April 6, 2000, Morgan Stanley & Co., along with 16 other firms, entered into an industry-wide settlement with the SEC, IRS and the Department of Justice (intervening on behalf of a qui tam plaintiff) to resolve litigation and investigations relating to "yield burning" allegations. At the core of the "yield burning" litigation and investigations were allegations that, from 1990 to 1994, escrow providers excessively marked up securities sold to escrow accounts in connection with advance refunding transactions on behalf of municipal bond issuers. The practice was alleged to benefit the escrow provider Capsule II Performance of Spectrum Technical Type of pool: publicly-offered fund Inception of trading: November 1994 Aggregate subscriptions: $589,811,774 Current capitalization: $538,184,278 Current net asset value per unit: $22.64 Worst monthly % drawdown past five years: (15.59)% (November 2001) Worst monthly % drawdown since inception: (15.59)% (November 2001) Worst month-end peak-to-valley drawdown past five years: (26.57)% (13 months, April 2001-April 2002) Worst month-end peak-to-valley drawdown since inception: (26.57)% (13 months, April 2001-April 2002) Cumulative return since inception: 126.40% Monthly Performance to the detriment of either the United States Treasury or the municipal issuer. The industry-wide settlement required 17 firms to pay a total of over $139 million (over $120 million to the United States Treasury and over $18 million directly to municipal issuers). Without admitting or denying any wrongdoing, Morgan Stanley & Co. consented to the entry of an order directing that it cease and desist from violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and requiring it to pay $2.45 million to the United States Treasury. No payment to municipal issuers was required. On July 14, 2003, the Massachusetts Securities Division filed an administrative complaint alleging that Morgan Stanley DW Inc. filed false information in response to an inquiry from the Massachusetts Securities Division pertaining to mutual fund sales practices. On August 11, 2003, the Massachusetts Securities Division filed an administrative complaint, alleging that Morgan Stanley DW Inc. failed to make disclosures of incentive compensation for proprietary and partnered mutual fund transactions. On November 25, 2003, the Massachusetts Securities Division filed an administrative complaint, alleging that a former branch manager engaged in securities fraud and dishonest conduct in promoting the sales of proprietary mutual funds. Morgan Stanley DW Inc. answered the first two complaints on August 4 and September 16, 2003, respectively. Hearings on all of these matters are scheduled to commence on May 17, 2004. On September 15, 2003, Morgan Stanley DW Inc. and one of its officers entered into a settlement with the NASD pursuant to a Letter of Acceptance, Waiver and Consent. The Letter of Acceptance, Waiver and Consent alleges violations of applicable NASD rules in connection with various sales contests conducted from October 1999 to December 2002. Under the terms of the settlement, Morgan Stanley DW Inc. and its officer neither admitted nor denied the allegations of the Letter of Acceptance, Waiver and Consent and accepted a censure and the imposition of monetary fines in the amounts of $2 million and $250,000, respectively. On November 17, 2003, Morgan Stanley DW Inc. consented, without admitting or denying the findings, to the entry of an order by the Securities and Exchange Commission that resolved the Securities and Exchange Commission's investigations into certain practices relating to Morgan Stanley DW Inc.'s offer and sale of shares of certain registered investment companies from January 1, 2000 to the date of the order. Pursuant to the order, Morgan Stanley DW Inc. will: (a) distribute for the benefit of certain customers who purchased shares of mutual funds through Morgan Stanley DW Inc. pursuant to the marketing arrangements between Morgan Stanley DW Inc. and certain mutual fund complexes the amount of $50 million; (b) place on its website disclosures relating to certain marketing programs pursuant to which it offered and sold certain mutual funds; (c) prepare a Mutual Fund Bill of Rights that discloses, among other things, the differences in fees and expenses associated with the purchase of different classes or proprietary mutual fund shares; (d) prepare a plan by which certain customers' proprietary Class B shares can be converted to Class A shares; (e) retain an independent consultant to review, among other things, the adequacy of Morgan Stanley DW Inc.'s disclosures with respect to such marketing programs and other matters in connection with Morgan Stanley DW Inc.'s offer and sale of shares of mutual funds and compliance with the order; and (f) adopt the recommendations of the independent consultant. The number of purchase transactions of Class B shares that will be eligible to convert shares is approximately 8,000. The ultimate financial impact on Morgan Stanley DW Inc. of these conversions will depend on many variables, including the number of eligible purchasers who elect to convert to Class A shares (which carry different fees) and the terms of the conversion (which must be acceptable to the independent consultant). During the five years preceding the date of this prospectus, other than as described above, there have been no material criminal, civil, or administrative actions pending, on appeal, or concluded against the commodity brokers, the general partner, or any of their principals, which the general partner believes would be material to an investor's decision to invest in the partnerships. THE LIMITED PARTNERSHIP AGREEMENTS This section of the prospectus summarizes all material provisions of the limited partnership agreement of each partnership that are not discussed elsewhere in the prospectus. A form of the limited partnership agreements is annexed to the prospectus as Exhibit A. Each limited partnership agreement is identical, except as noted otherwise below or in Exhibit A. Month Nature of the Partnerships Spectrum Select was formed on March 21, 1991; Spectrum Technical, Spectrum Strategic, and Spectrum Global Balanced were each formed on April 29, 1994; and Spectrum Currency was formed on October 20, 1999. Each partnership was formed under Delaware law. The fiscal year of each partnership begins on January 1 of each year and ends on the following December 31. The units that you purchase and pay for in this offering will be fully paid and nonassessable. You may be liable to a partnership for liabilities that arose before the date of a redemption or Spectrum Series exchange. Your liability, however, will not exceed the sum of your unredeemed capital contribution, undistributed profits, if any, any distributions and amounts received upon a redemption or deemed received on a Spectrum Series exchange, together with interest on any such amount. However, a partnership will not make a claim against you for any amounts received in connection with a redemption of units or a Spectrum Series exchange unless the net assets of the partnership are insufficient to discharge the liabilities of the partnership that arose before any distributions were made to you. The general partner will be liable for all obligations of a partnership to the extent that the assets of the partnership are insufficient to pay those obligations. Management of Partnership Affairs You will not participate in the management or operations of a partnership. Under each limited partnership agreement, the general partner is solely responsible for managing the partnership. The general partner may use a partnership's funds only to operate the business of that partnership. The general partner may hire an affiliate to perform services for the partnership if the general partner determines that the affiliate is qualified to perform the services, and can perform those services under competitive terms that are fair and reasonable. Any agreement with an affiliate must be for a term not in excess of one year and be terminable by the partnership without penalty upon 60 days' prior written notice. Other responsibilities of the general partner include: determining whether a partnership will make a distribution; administering redemptions and series exchanges; preparing monthly and annual reports; preparing and filing tax returns for each partnership; signing documents on behalf of each partnership and its limited partners pursuant to powers of attorney; and supervising the liquidation of a partnership, if necessary. Sharing of Profits and Losses You will have a capital account in each partnership in which you invest, with an initial balance equal to the amount you paid for units of the partnership. The general partner also has a capital account. Each partnership's net assets will be calculated monthly, and your capital account will be adjusted as necessary to reflect any increases or decreases that may have occurred since the preceding month. Profits and losses will be shared by the general partner and limited partners in proportion to the size of their respective capital accounts. For a description of the federal tax allocations, see "Material Federal Income Tax Considerations Partnership Taxation Allocation of Partnership Profits and Losses" on page 129. Restrictions on Transfers or Assignments While you may transfer or assign your units, the transferee or assignee may not become a limited partner without the written consent of the general partner. You may only withdraw capital or profits from a partnership by redeeming units. The general partner may withdraw any portion of its interest in a partnership that exceeds the amount required under the limited partnership agreement without prior notice to or consent of the limited partners. In addition, the general partner may withdraw or assign its entire interest in a partnership if it gives 120 days' prior written notice to the limited partners. If a majority of the limited partners elect a new general partner or partners to continue the business of the partnership, the withdrawing general partner must pay all reasonable expenses incurred by the partnership in connection with its withdrawal. Any transfer or assignment of units by you will take effect at the end of the month in which the transfer or assignment is made, subject to the following conditions. A partnership is not required to recognize a transfer or assignment until it has received at least 30 days' prior written notice from the limited partner. The notice must be signed by the limited partner and include the address and social security or taxpayer identification number of the transferee or assignee and the number of units transferred or assigned. A transfer or assignment of less than all units held by you cannot occur if as a result either party to the transfer or assignment would own fewer than the minimum number of units required for an investment in the partnership (subject to certain exceptions relating to gifts, death, divorce, or transfers to family members or affiliates). The general partner will not permit a transfer or assignment of units unless it is satisfied that the transfer or assignment would not be in violation of Delaware law or applicable federal, state, or foreign securities laws; and notwithstanding the transfer or assignment, the partnership will continue to be classified as a partnership rather than as an association taxable as a corporation under the Internal Revenue Code of 1986, as amended. No transfer or assignment of units will be effective or recognized by a partnership if the transfer or assignment would result in the termination of that partnership for federal income tax purposes, and any attempt to transfer or assign units in violation of the limited partnership agreement will be ineffective. The limited partner must pay all costs, including any attorneys' and accountants' fees, related to a transfer or assignment. Amendments; Meetings Each limited partnership agreement may be amended by the general partner and by limited partners owning more than 50% of the units of that partnership. In addition, the general partner may make certain amendments to a limited partnership agreement without the consent of the limited partners, including any amendment that is not adverse to the limited partners or is required by the staff of the SEC, the CFTC, any other federal agency, any state "Blue Sky" official, or other governmental official, or to comply with applicable law. However, no amendment may be made to a limited partnership agreement without the consent of all partners affected if that amendment would reduce the capital account of any partner, modify the percentage of profits, losses, or distributions to which any partner is entitled, or change or alter the provisions of the limited partnership agreement relating to amendments requiring the consent of all partners. Upon written request to the general partner delivered either in person or by certified mail, you or your authorized attorney or agent may obtain a list of the names and addresses of, and units owned by, all limited partners in your partnership, provided that you pay reasonable duplicating and postage costs. Limited partners owning at least 10% of the units of a partnership may request a meeting to consider any matter upon which limited partners may vote. Upon receipt of such a request, the general partner must call a meeting of that partnership, by written notice sent by certified mail or delivered in person within 15 days of such request. The meeting must be held at least 30 but not more than 60 days after the mailing by the general partner of notice of the meeting. The notice must specify the date, a reasonable place and time, and the purpose of the meeting. At any meeting of the limited partners, the following actions may be taken upon the affirmative vote of limited partners owning more than 50% of the units: amend the limited partnership agreement; dissolve the partnership; remove and replace the general partner; elect a new general partner or general partners if the general partner terminates or liquidates or elects to withdraw from the partnership, or becomes insolvent, bankrupt, or is dissolved; terminate any contract with the general partner or any of its affiliates on 60 days' prior written notice; and approve the sale of all or substantially all of the assets of the partnership. Any of the foregoing actions may also be taken by limited partners without a meeting, without prior notice, and without a vote, by means of written consents signed by limited partners owning the required number of units. Notice of any actions taken by written consent must be given to non-consenting limited partners within seven business days. Books and Records; Reports to Limited Partners The books and records of each partnership are maintained at its principal office for at least five years. You or your authorized attorney or agent will have the right during normal business hours to inspect and copy the books and records of each partnership of which you are a limited partner. Alternatively, you may request that copies of the books and records be sent to you, provided that you pay all reasonable reproduction and distribution costs. The partnership will retain copies of subscription documentation in connection with purchases and exchanges of units for at least six years. Within 30 days after the close of each calendar month, the general partner will provide such financial and other information with respect to each partnership as the CFTC and National Futures Association, from time to time, may require, together with information concerning any material change in the brokerage commissions or fees payable by the partnerships to any commodity broker. You will also receive within 90 days after the close of each fiscal year an annual report containing audited financial statements for the partnerships. Annual reports will provide a detailed statement of any transactions with the general partner or its affiliates and of fees, commissions, and any compensation paid or accrued to the general partner or its affiliates. By March 15 of each year, the partnership will provide you with the tax information necessary for you to prepare your federal income tax return. The net asset value of each partnership's units, which is estimated daily by the general partner, will be promptly supplied to you upon written request. A written notice, including a description of limited partners' redemption and voting rights, will be mailed to the limited partners of a partnership within seven business days if any of the following events occur: the net asset value of a unit decreases by at least 50% from the net asset value of that unit as of the end of the immediately preceding month; the limited partnership agreement is materially amended; there is any change in trading advisors or any material change in a management agreement; there is any change in commodity brokers or any material change in the compensation arrangements with a commodity broker; there is any change in general partners or any material change in the compensation arrangements with a general partner; there is any change in the partnership's fiscal year; there is any material change in the partnership's trading policies as specified in the limited partnership agreement; or the partnership ceases to trade futures, forwards, and options. If you receive a notice as to a 50% decrease in net asset value per unit, that notice will also advise you that a "special redemption date" will take place when limited partners may redeem their units in the same manner as described under "Redemptions" beginning on page 117 for regular redemption dates. Further, following the close of business on the date of the 50% decrease giving rise to that notice, the partnership will liquidate all existing positions as promptly as reasonably practicable, and will suspend all futures, forwards, and options trading through the special redemption date. The general partner will then determine whether to reinstitute futures, forwards, and options trading or to terminate the partnership. In addition, subject to limits imposed under state guidelines incorporated in the limited partnership agreements, no increase in any of the management, incentive, or brokerage fees payable by the partnerships, or any of the caps on fees, may take effect until the first business day following a redemption date. In the event of such an increase: notice of the increase will be mailed to limited partners at least five business days prior to the last date on which a "request for redemption" must be received by the general partner with respect to the applicable redemption date; the notice will describe the redemption and voting rights of limited partners; and units redeemed at the first redemption date following the notice will not be subject to any redemption charges. Each limited partner expressly agrees that in the event of his death, he waives on behalf of himself and his estate the furnishing of any inventory, accounting, or appraisal of the assets of the partnership and any right to an audit or examination of the books of the partnership. PLAN OF DISTRIBUTION General Morgan Stanley DW is offering units pursuant to a selling agreement with the partnerships and the general partner. This offering is being conducted in accordance with the provisions of Rule 2810 of the Conduct Rules of the NASD. With the approval of the general partner, Morgan Stanley DW may appoint additional selling agents to make offers and sales of the units. These additional selling agents may include any securities broker which is a member in good standing of the NASD, as well as any foreign bank, dealer, institution, or person ineligible for membership in the NASD that agrees not to make any offers or sales of units within the U.S. or its territories, possessions, or areas subject to its jurisdiction, or to U.S. citizens or residents. Any such non-NASD member must also agree to comply with applicable provisions of the Conduct Rules of the NASD in making offers and sales of units. Morgan Stanley DW is offering the units on a "best efforts" basis without any agreement by Morgan Stanley DW to purchase units. The general partner may in the future register additional units of any partnership with the SEC. There is no maximum amount of funds which may be contributed to a partnership. The general partner may in the future subdivide or combine outstanding units of any partnership, in its discretion, provided that any subdivision or combination will not affect the net asset value of any limited partner's interest in the partnership. Each partnership has agreed to indemnify its trading advisors in connection with the offer and sale of units with respect to any misleading or untrue statement or alleged misleading or untrue statement of a material fact or material omission or alleged omission unrelated to its trading advisor(s). Each partnership has also agreed to indemnify Morgan Stanley DW, the general partner and any additional sellers in connection with the offer and sale of units. See "Fiduciary Responsibility and Liability" beginning on page . Continuing Offering Units of each partnership are being offered for sale at monthly closings held on the last day of each month. Units will be offered and sold at the net asset value of a unit of the partnership on the date of the monthly closing. Since you must subscribe for units prior to the month end closing date, you will not know the actual per unit purchase price until after the monthly closing has occurred. The sale amount will be delivered to the partnership that sold the unit. Escrow Arrangements During the continuing offering, if your subscription is not immediately rejected by the general partner, your subscription funds will be transferred to, and held in escrow by, JPMorgan Chase Bank, New York, New York. These subscription funds held in escrow will be invested in the escrow agent's interest-bearing money market account, and will earn the interest rate then paid by the bank on that account. If the general partner accepts your subscription, at the applicable month-end closing the escrow agent will pay your subscription funds to the appropriate partnership(s) and pay any interest earned on those funds to Morgan Stanley DW. Morgan Stanley DW in turn will credit your Morgan Stanley DW customer account with the interest. If the general partner rejects a subscription, the escrow agent will promptly pay the rejected subscription funds and any interest earned to Morgan Stanley DW, and Morgan Stanley DW will then credit your Morgan Stanley DW customer account with those amounts, and the funds will be immediately available for investment or withdrawal. If you closed your Morgan Stanley DW customer account, any subscription returned and interest earned will be paid by check. Interest will be earned on subscription funds from the day of deposit with the escrow agent to the day that funds are either paid to the appropriate partnership(s) in the case of accepted subscriptions or paid to Morgan Stanley DW in the case of rejected subscriptions. At all times during the continuing offering, and prior to each closing, subscription funds will be in the possession of the escrow agent, and at no time will the general partner hold or take possession of the funds. Compensation to Morgan Stanley DW Employees and Additional Selling Agents Except as described below, qualified employees of Morgan Stanley DW will receive from Morgan Stanley DW (payable solely from its own funds) a gross sales credit equal to 3% of the net asset value per unit as of the closing for each unit sold by them and issued at the closing. In addition, Morgan Stanley DW will continue to compensate such employees who continue to render services to limited partners with a gross sales credit of up to 86% of the brokerage fees received by Morgan Stanley DW from a partnership each month that are attributable to outstanding units sold by them. This compensation will begin: in the case of Spectrum Select, Spectrum Technical, and Spectrum Strategic, with the seventh month following the closing at which a unit was issued; in the case of Spectrum Global Balanced and Spectrum Currency, with the tenth month following the closing at which a unit was issued; the first month after a unit is issued pursuant to a non-series exchange; or the month as of which such continuous compensation is first payable with respect to units purchased in a Spectrum Series exchange, but with the seventh or tenth month measured from the date the subscriber first became a limited partner in a Spectrum Series partnership. In all cases, qualified Morgan Stanley DW employees will receive continuing compensation until the applicable partnership terminates or the unit is redeemed, whichever comes first. No part of this compensation will be paid by the partnership and, accordingly, net assets will not be reduced as a result of such compensation. Each person receiving continuing compensation must be a Morgan Stanley DW employee at the time of receipt of payment and must be registered as an associated person with the CFTC and be a member of the National Futures Association in such capacity only after either having passed the Series 3 or Series 31 examination or having been "grandfathered" as an associated person qualified to do commodity brokerage under the Commodity Exchange Act and the CFTC's regulations. These employees must also perform additional services, including: (a)inquiring of the general partner from time to time, at the request of limited partners, as to the net asset value of each partnership's units; (b)inquiring of the general partner, at the request of limited partners, regarding the futures, forwards, and options markets and the activities of the partnerships; (c)responding to questions of limited partners with respect to the monthly account statements, annual reports, financial statements, and annual tax information furnished periodically to limited partners; (d)providing advice to limited partners as to when and whether to make additional investments or to redeem or exchange units; (e)assisting limited partners in the redemption or exchange of units; and (f)providing such other services as limited partners from time to time may reasonably request. The additional compensation paid by Morgan Stanley DW may be deemed to be underwriting compensation. In addition, certain officers and directors of the general partner may receive compensation as employees of Morgan Stanley DW based, in part, on the amount of brokerage fees paid by the partnerships to Morgan Stanley DW. The selling agreement among Morgan Stanley DW, the general partner, and the partnerships provides that this compensation may only be paid by Morgan Stanley DW as long as continuing services are provided. Any limited partner may telephone, write, or visit a financial advisor at a Morgan Stanley branch office to avail himself of such services. Morgan Stanley DW will not pay its employees the 3% initial gross sales credit described above with respect to units purchased pursuant to a Spectrum Series exchange or non-Spectrum Series exchange. Such employees will, however, receive continuing gross sales credits with respect to brokerage fees received by Morgan Stanley DW from a partnership at the applicable rate. In the case of an investor who previously redeemed units in a Spectrum Series or non-Spectrum Series partnership and paid a redemption charge or held those units for at least 24 months, and invests in the Spectrum Series within 12 months of the redemption of the old units, the Morgan Stanley DW employee will not receive the initial gross sales credit of 3% but will receive a monthly gross sales credit of up to 86% of the brokerage fees received by Morgan Stanley DW from the partnership each month that are attributable to such units commencing the first month after the units are issued. Morgan Stanley DW may at any time implement cash sales incentive and/or promotional programs for its employees who sell units. These programs will provide for Morgan Stanley DW, and not any partnership or the general partner, to pay Morgan Stanley DW's employees bonus compensation based on sales of units. Any sales or promotional program will be approved by the NASD prior to its start. The aggregate of all compensation paid to employees of Morgan Stanley DW from the initial 3% gross sales credit, the redemption charges received by Morgan Stanley DW, and any sales incentives will not exceed 10% of the proceeds of the sale of units. Morgan Stanley DW may compensate any qualified additional selling agents for each unit sold by it by paying a selling commission, from Morgan Stanley DW's own funds, as determined by Morgan Stanley DW and the additional selling agents, but not to exceed 3% of the net asset value of the unit sold. Additional selling agents who are properly registered as futures commission merchants or introducing brokers with the CFTC and are members of the National Futures Association in such capacity may also receive from Morgan Stanley DW, payable from Morgan Stanley DW's own funds, continuing compensation for providing to limited partners the continuing services described above. This additional compensation paid by Morgan Stanley DW may be up to 42% of the brokerage fees generated by outstanding units sold by additional selling agents and received by Morgan Stanley DW as commodity broker for each partnership (except for employees of affiliates of Morgan Stanley DW, who will be compensated at the same rate as employees of Morgan Stanley DW). Additional selling agents may pay all or a portion of such additional compensation to their employees who have sold units and provide continuing services to limited partners if those employees are properly registered with the CFTC and are members of the National Futures Association. Additional compensation paid by Morgan Stanley DW may be deemed to be underwriting compensation. SUBSCRIPTION PROCEDURE The minimum subscription for most subscribers is $5,000, except that the minimum subscription is: $2,000 in the case of an IRA; or for eligible subscribers purchasing units pursuant to a non-Spectrum Series exchange, the lesser of $5,000, the proceeds from the redemption of 5 units, or 2 units in the case of an IRA, from commodity pools other than any of the Morgan Stanley Charter Series of partnerships, the proceeds from the redemption of 500 units, or 200 units in the case of an IRA, from any Charter Series partnership, or the proceeds from the redemption of such subscriber's entire interest in any other commodity pool for which the general partner serves as general partner and commodity pool operator. A subscription may be for units of one partnership, or may be divided among two or more partnerships, provided that: in the case of a new subscription, the minimum subscription for any one partnership is $1,000; and in the case of a non-Spectrum Series exchange, the minimum subscription for any one partnership is the proceeds of the redemption of 1 unit of the other commodity pool, or 100 units in the case of any Morgan Stanley Charter Series partnership. If you already own units in a partnership and you wish to make an additional investment in the same partnership, you may subscribe for units at a monthly closing with a minimum investment in that partnership of $500. In order to make your first purchase of units of a partnership, other than by means of an exchange, you must complete, sign, and deliver to Morgan Stanley DW a subscription agreement which will authorize the general partner and Morgan Stanley DW to transfer the full subscription amount from your Morgan Stanley DW customer account to the partnership's Escrow Account. If your subscription agreement is received by Morgan Stanley DW and not immediately rejected, you must have the appropriate amount in your Morgan Stanley DW customer account on the first business day following the date that your subscription agreement is received by Morgan Stanley DW. Morgan Stanley DW will deduct the subscription amount from your customer account and transfer funds into escrow with the escrow agent on that date. If you do not have a Morgan Stanley DW customer account or an account with an affiliate of Morgan Stanley DW, or do not have sufficient funds in your existing Morgan Stanley DW customer account, you should make appropriate arrangements with your Morgan Stanley financial advisor, or contact your local Morgan Stanley branch office. Do not mail any payment to the general partner, as it will be returned to you for proper placement with the Morgan Stanley branch office where your account is maintained. In the case of a Spectrum Series exchange or a non-Spectrum Series exchange, you must complete, sign, and deliver to your Morgan Stanley financial advisor a subscription agreement, which will authorize the general partner to redeem all or a portion of your interest in a partnership or another commodity pool for which the general partner serves as general partner and commodity pool operator, subject to terms of the applicable limited partnership agreement, and to use the proceeds, after deducting any applicable redemption charges, to purchase units in one or more of the partnerships. In accordance with an NASD rule, Morgan Stanley DW will not subscribe for units on your behalf if it has discretionary authority over your customer account, unless it gets prior written approval from you. If you subscribe by check, units will be issued subject to the collection of the funds represented by the check. If your check is returned unpaid, Morgan Stanley DW will notify the general partner, and the relevant partnership will cancel the units issued to you represented by the check. Any losses or profits sustained by the partnership allocable to the cancelled units will be allocated among the remaining partners. In the limited partnership agreements, each limited partner agrees to reimburse a partnership for any expense or loss (including any trading loss) incurred in connection with the issuance and cancellation of any units issued to the limited partner. Subscriptions for units are generally irrevocable by subscribers. However, you may revoke your subscription agreement and receive a full refund of the subscription amount and any accrued interest, or revoke the redemption of units in the other commodity pool in the case of an exchange, within five business days after execution of the subscription agreement or no later than 3:00 P.M., New York City time, on the date of the applicable monthly closing, whichever comes first, by delivering written notice to your Morgan Stanley financial advisor. There may be other rescission rights under applicable federal and state securities laws. The general partner may reject any subscription, in whole or in part, in its sole discretion. A sample form of the subscription agreement is annexed to this prospectus as Exhibit B. A separate copy of the subscription agreement accompanies this prospectus or you may obtain one, after delivery of this prospectus, from a local Morgan Stanley branch office. You will not receive any certificate evidencing units, but you will be sent confirmations of purchases in Morgan Stanley DW's customary form. Once you are an investor in a partnership, you may make additional cash purchases of units of that partnership without executing a new subscription agreement, by completing a subscription agreement update form, a sample of which is annexed to this prospectus as Exhibit C, and by contacting your Morgan Stanley financial advisor and authorizing your financial advisor to deduct the additional amount you want to invest from your Morgan Stanley DW customer account. Those amounts will be held in escrow, and applied towards the purchase of units, in the same manner as initial purchases described above. However, if a new prospectus has been issued since the date of your immediately prior subscription agreement, you will be required to complete a new subscription agreement update form. Further, your Morgan Stanley financial advisor will be required to confirm to the general partner that the information you provided, and the representations and warranties you made, in your original subscription agreement, including, in particular, that you satisfy applicable minimum financial suitability requirements, are still true and correct. You may not use the subscription procedure described in this paragraph to purchase additional units in a partnership by way of an exchange, or to purchase units of a partnership in which you are not currently an investor; in either of those cases, you must execute a new subscription agreement. PURCHASES BY EMPLOYEE BENEFIT PLANS ERISA CONSIDERATIONS Units might or might not be a suitable investment for an employee benefit plan. If you are a person with investment discretion on behalf of an employee benefit plan, before proceeding with a purchase of units, you should determine whether the purchase of units is permitted under the governing instruments of the plan, and is appropriate for that particular plan in view of its overall investment policy, the composition and diversification of its portfolio, and the other considerations discussed below. As used in this section, the term "employee benefit plans" refers to plans and accounts of various types, including their related trusts, which provide for the accumulation of a portion of an individual's earnings or compensation, as well as investment income earned thereon, typically free from federal income tax until such time as funds are distributed from the plan. These plans include corporate pension and profit-sharing plans, such as so-called "401( k)" plans, "simplified employee pension plans," so-called "Keogh" plans for self-employed individuals (including partners), and, for purposes of this discussion, individual retirement accounts, as described in Section 408 of the Internal Revenue Code of 1986, as amended. Notwithstanding the general requirement that investors in one or more partnerships must invest a minimum of $5,000, a minimum purchase requirement of $2,000 has been set for IRAs. The minimum subscription for any one of the partnerships must be at least $1,000. Greater minimum purchases may be mandated by the securities laws and regulations of certain states, and each investor should consult the subscription agreement to determine the applicable investment requirements. If the assets of an investing employee benefit plan were to be treated, for purposes of the reporting and disclosure provisions and certain other of the fiduciary responsibility provisions of Title I of the Employee Retirement Income Security Act of 1974, as amended, and Section 4975 of the Internal Revenue Code of 1986, as including an undivided interest in each of the underlying assets of a partnership, an investment in units would in general be an inappropriate investment for the plan. A U.S. Department of Labor regulation defines "plan assets" in situations where employee benefit plans purchase equity securities in investment entities such as a partnership. The regulation provides that the assets of an entity will not be deemed to be "plan assets" of an employee benefit plan which purchases an equity security of the entity if the equity security is a "publicly-offered security." A "publicly-offered security" is one which is: freely transferable; held by more than 100 investors independent of the issuer and of each other; and either registered under Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934, or sold to the plan as part of a public offering of such securities pursuant to an effective registration statement under the Securities Act of 1933, where the security is then timely registered under Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934. The units currently meet, and it is expected that the units will continue to meet, the criteria of the Regulation. The general partner believes, based upon the advice of its legal counsel, that income earned by the partnerships will not constitute "unrelated business taxable income" under Section 512 of the Internal Revenue Code of 1986 to employee benefit plans and other tax-exempt entities. Although the Internal Revenue Service has issued favorable private letter rulings to taxpayers in somewhat similar circumstances, other taxpayers may not use or cite such rulings as precedent. If you have investment discretion on behalf of an employee benefit plan, you should consult a professional tax adviser regarding the application of the foregoing matters to the purchase of units. Units may not be purchased with the assets of an employee benefit plan if the general partner, Morgan Stanley DW, any additional selling agents, any trading advisor, or any of their respective affiliates either: has investment discretion with respect to the investment of such plan assets; has authority or responsibility to give or regularly gives investment advice with respect to such plan assets for a fee and pursuant to an agreement or understanding that such advice will serve as a primary basis for investment decisions with respect to the plan assets and that such advice will be based on the particular investment needs of the plan; or is an employer maintaining or contributing to such plan. Subscribing for units does not create an IRA or other employee benefit plan. If you are considering the purchase of units on behalf of an IRA or other employee benefit plan, you must first ensure that the plan has been properly established in accordance with the Internal Revenue Code of 1986 and ERISA and the regulations and administrative rulings thereunder, and that the plan has been adequately funded. Then, after all of the considerations discussed above have been taken into account, the trustee or custodian of a plan who decides to or who is instructed to do so may subscribe for units in one or more of the partnerships, subject to the applicable minimum subscription requirement per partnership. Acceptance of subscriptions on behalf of IRAs or other employee benefit plans is in no respect a representation by the general partner, Morgan Stanley DW, any additional selling agents, any partnership, or any trading advisor that the investment meets all relevant legal requirements with respect to investments by plans generally or any particular plan, or that the investment is appropriate for plans generally or any particular plan. MATERIAL FEDERAL INCOME TAX CONSIDERATIONS Introduction The general partner has been advised by counsel, Cadwalader, Wickersham & Taft LLP, that in its opinion, the following summary correctly describes the material federal income tax consequences to a U.S. taxpayer who invests in a partnership. The opinions appearing in this section are the opinions of Cadwalader, Wickersham & Taft LLP, except as otherwise specifically noted. The following summary is based upon the Internal Revenue Code of 1986, rulings thereon, regulations promulgated thereunder, and existing interpretations thereof, any of which could be changed at any time and which changes could be retroactive. The federal income tax summary and the state and local income tax summary that follow, in general, relate only to the tax implications of an investment in the partnerships by individuals who are citizens or residents of the U.S. Except as indicated below or under "Purchases by Employee Benefit Plans-ERISA Considerations," the summaries do not address the tax implications of an investment in the partnerships by corporations, partnerships, trusts, and other non-individuals. Moreover, the summaries are not intended as a substitute for careful tax planning, particularly since certain of the tax consequences of owning an interest in the partnerships may not be the same for all taxpayers, such as non-individuals or foreign persons, or in light of an investor's personal investment circumstances. A complete discussion of all federal, state, and local tax aspects of an investment in each partnership is beyond the scope of the following summary, and prospective investors are urged to consult their own tax advisors on these matters. Partnership Status The general partner has been advised by its legal counsel, Cadwalader, Wickersham & Taft LLP, that in its opinion under current federal income tax law, each partnership will be classified as a partnership and not as an association (or a publicly traded partnership) taxable as a corporation. This opinion is based upon the facts set forth in this prospectus, including that a principal activity of each partnership consists of buying and selling futures, options, and forward contracts, and at least 90% of the partnership's gross income during each year consists of gains from such trading and interest income. No ruling has been requested from the Internal Revenue Service with respect to classification of each partnership and the general partner does not intend to request such a ruling. If a partnership were treated as an association (or a publicly traded partnership) taxable as a corporation, income or loss of the partnership would not be passed through to its partners, and the partnership would be subject to tax on its income at the rates applicable to corporations without deduction for any distributions to its partners. In addition, all or a portion of any distributions by the partnership to its partners could be taxable to the partners as dividends or capital gains. The discussion that follows assumes that each partnership will be treated as a partnership for federal income tax purposes. Partnership Taxation Partners, rather than a Partnership, are Subject to Federal Income Tax. None of the partnerships will pay federal income tax. Except as provided below with respect to certain nonresident aliens, each limited partner will report his distributive share of all items of partnership income, gain, loss, deduction, and credit for the partnership's taxable year ending within or with the partner's taxable year. A limited partner must report and pay tax on his share of partnership income for a particular year whether or not he has received any distributions from the partnership in that year. The characterization of an item of profit or loss will usually be determined at the partnership level. Syndication Expenses. None of the partnerships nor any partner thereof will be entitled to any deduction for syndication expenses (i.e., those amounts paid or incurred in connection with issuing and marketing units). There is a risk that some of the brokerage fees paid to Morgan Stanley DW could be treated as a nondeductible payment by the partnerships of syndication expenses. Allocation of Partnership Profits and Losses. In general, each limited partnership agreement allocates items of ordinary income and expense pro rata among the partners based upon their respective capital accounts as of the end of the month in which such items are accrued. Net recognized capital gain or loss is generally allocated among all partners based upon their respective capital accounts. However, net recognized capital gain or loss is allocated first to partners who have redeemed units in the partnership during a taxable year to the extent of the difference between the amount received on the redemption and the allocation account as of the date of redemption attributable to the redeemed units. Any remaining net recognized capital gain or loss is next allocated among all those partners whose capital accounts differ from their allocation accounts based on the respective differences for each partner. The special allocation of each partnership's net gain or loss upon a redemption of units, which retains the same character as in the hands of the partnership, may alter the character of a redeeming limited partner's income (by reducing the amount of long-term capital gain recognized upon receipt of redemption proceeds) and may accelerate the recognition of income by the limited partner. These allocation provisions are designed to reconcile tax allocations to economic allocations. However, the general partner cannot assure you that the Internal Revenue Service will not challenge the allocations, including each partnership's tax allocations in respect of redeemed units. If the allocation provided by each limited partnership agreement is not respected by the Internal Revenue Service for federal income tax purposes, the amount of income or loss allocated to the partners for federal income tax purposes may be increased or reduced or the character of the income or loss may be modified. Cash Distributions and Redemptions Because of the special allocation of partnership gain or loss upon a redemption of units, the amounts received upon the partial or complete redemption of a limited partner's units normally will not result in additional taxable income or loss to the limited partner. However, distributions by a partnership and amounts received upon the partial or complete redemption of a limited partner's units will be taxable to the limited partners to the extent cash distributions by a partnership or amounts received upon redemption by a limited partner exceed the partner's adjusted tax basis in his units. Such excess will be taxable to him as though it were a gain from a sale of the units. A loss will be recognized upon a redemption of units only if, following the redemption of all of a limited partner's units, the partner has any tax basis in his units remaining. In such case, the limited partner will recognize loss to the extent of the remaining basis. See "Redemptions." Generally, if a limited partner is not a "dealer" with respect to his interest in the partnership and he has held his interest in the partnership for more than one year, the gain or loss would be long-term capital gain or loss. Gain or Loss on Trading Activity Nature of Partnership Income. Each partnership does not expect to hold its futures, forwards, or options for sale to customers. For federal income tax purposes substantially all of the profit and loss generated by each partnership from its trading activities is expected to be capital gain and loss, which in turn may be either short-term, long-term, or a combination thereof. Nevertheless, certain foreign currency transactions could result in ordinary gain or loss, as discussed below. Further, interest paid to a partnership will be taxable currently to the limited partners as ordinary income. Thus, during taxable years in which little or no profit is generated from trading activities, a limited partner may still have interest income. Mark-to-Market. Section 1256 contracts held at the end of a partnership's taxable year will be treated as having been sold for the fair market value on the last day of the taxable year, and gain or loss will be taken into account for the year. Gain or loss with respect to a Section 1256 contract is generally treated as short-term capital gain or loss to the extent of 40% of the gain or loss, and long-term capital gain or loss to the extent of 60% of the gain or loss. Section 1256 contracts include regulated futures contracts which are futures contracts traded on regulated U.S. and certain foreign exchanges; foreign currency contracts that are traded in the interbank market and relate to currencies for which positions are also traded through regulated futures contracts; and U.S. and certain foreign exchange-traded options on commodities, including options on regulated futures contracts, debt securities, and stock indices. While the partnerships expect that a majority of their trading activities will be conducted in Section 1256 contracts, the partnerships also expect that a portion of their trading activities will be conducted in contracts that do not presently qualify as Section 1256 contracts, such as positions in futures contracts on most foreign exchanges and foreign currency forward contracts that do not relate to currencies for which positions are also traded through regulated futures contracts. Section 988. Currency gain or loss with respect to foreign currency forward contracts that do not relate to currencies for which positions are also traded through regulated futures contracts and futures contracts traded on most foreign exchanges may be treated as ordinary income or loss under Internal Revenue Code of 1986 Section 988. Each partnership has elected to treat these contracts as Section 1256 contracts (i.e., marked-to-market at year end). Pursuant to this election, gain or loss with respect to these contracts is treated as entirely short-term capital gain or loss. Subject to certain limitations, a limited partner, other than a corporation, estate, or trust, may elect to carry back net Section 1256 contract losses to each of the three preceding years. Net Section 1256 contract losses carried back to prior years may only be used to offset net Section 1256 contract gains. Generally, such losses are carried back as 40% short-term capital losses and 60% long-term capital losses. Capital assets not marked to market under Section 1256, such as any non-currency forward contracts, are not subject to the 60/40 tax regime for Section 1256 contracts, and gain or loss on sale generally will be long-term only if such property has been held for more than one year. % % % % % % % % % % January 12.76 (1.88 ) (0.81 ) 1.21 (4.96 ) (1.16 ) 3.67 4.78 (1.84 ) February 6.60 (3.41 ) 1.94 (1.19 ) 2.48 0.41 1.13 (6.39 ) 5.10 March (9.17 ) (2.90 ) 11.38 (1.54 ) (2.48 ) 1.31 (1.82 ) 1.24 10.21 April 1.44 (3.20 ) (11.10 ) (4.02 ) 7.18 (4.62 ) (2.93 ) 4.82 3.60 May 6.38 5.64 (0.37 ) (0.43 ) (5.00 ) 3.28 (3.75 ) (3.84 ) 0.69 June (7.42 ) 15.02 (3.62 ) (2.78 ) 5.13 (1.10 ) 0.69 3.21 (1.12 ) July (3.04 ) 9.65 (3.36 ) (3.96 ) (3.90 ) (0.98 ) 9.33 (4.80 ) (2.44 ) August 3.39 4.40 1.34 3.74 0.95 10.29 (5.97 ) (0.35 ) (0.63 ) September (5.41 ) 6.43 8.19 (8.61 ) (1.51 ) 4.35 1.85 5.50 (3.33 ) October 9.14 (6.75 ) 5.37 2.90 (9.96 ) (0.73 ) 0.36 9.92 (0.09 ) November 1.20 (4.68 ) (15.59 ) 12.28 1.84 (6.17 ) 1.01 8.34 0.93 (0.90 ) December 7.66 5.20 2.47 12.06 3.83 5.98 4.57 (3.88 ) 6.09 (1.31 ) Compound Annual/ Period Rate of Return 22.98 23.31 (7.15 ) 7.85 (7.51 ) 10.18 7.49 18.35 17.59 (2.20 ) (2 months) Capsule III Performance of Spectrum Strategic Type of pool: publicly-offered fund Inception of trading: November 1994 Aggregate subscriptions: $182,893,529 Current capitalization: $121,270,439 Current net asset value per unit: $14.31 Worst monthly % drawdown past five years: (18.47)% (February 2000) Worst monthly % drawdown since inception: (18.47)% (February 2000) Worst month-end peak-to-valley drawdown past five years: (43.28)% (10 months, January 2000-October 2000) Worst month-end peak-to-valley drawdown since inception: (43.28)% (10 months, January 2000-October 2000) Cumulative return since inception: 43.10% Monthly Performance Straddles. If a partnership incurs a loss upon the disposition of any position which is part of a "straddle" (i.e., two or more offsetting positions), recognition of that loss for tax purposes will be deferred until the partnership recognizes the gain in the offsetting position of the straddle (or successor position, or offsetting position to the successor position). Interest and other carrying charges allocable to positions which are part of a straddle must be capitalized, rather than deducted currently. Certain modified "short sale" rules may apply to positions held by a partnership so that what might otherwise be characterized as long-term capital gain would be characterized as short-term capital gain or potential short-term capital loss as long-term capital loss. For purposes of applying the above rules restricting the deductibility of losses with respect to offsetting positions, if a limited partner takes into account gain or loss with respect to a position held by the partnership, the limited partner will be treated as holding the partnership's position, except to the extent otherwise provided in regulations. Accordingly, positions held by a partnership may limit the deductibility of realized losses sustained by a limited partner with respect to positions held for his own account, and positions held by a limited partner for his own account may limit his ability to deduct realized losses sustained by a partnership. Thus, straddles may not be used to defer gain from one taxable year to the next. Reporting requirements generally require taxpayers to disclose all unrecognized gains with respect to positions held at the end of the taxable year. The above principle, whereby a limited partner may be treated as holding partnership positions, may also apply to require a limited partner to capitalize (rather than deduct) interest and carrying charges allocable to property held by him. Where the positions of a straddle are comprised of both Section 1256 and non-Section 1256 contracts, a partnership will be subject to the mixed straddle rules of the Internal Revenue Code of 1986 and the regulations promulgated thereunder. The appropriate tax treatment of any gains and losses from trading in mixed straddles will depend on what elections a partnership makes. Each partnership has elected to place all of its positions in a "mixed straddle" account which is marked-to-market daily. Under a special account cap, not more than 50% of net capital gain may be long-term capital gain, and not more than 40% of net capital loss may be short-term capital loss. Taxation of Limited Partners Limitations on Deductibility of Partnership Losses. The amount of partnership loss, including capital loss, which a limited partner will be entitled to take into account for federal income tax purposes is limited to the tax basis of his units, except in the case of certain limited partners including individuals and closely-held C corporations, for which he is "at risk" with respect to the units as of the end of the partnership's taxable year in which such loss occurred. Generally, a limited partner's initial tax basis will be the amount paid for each unit. A limited partner's adjusted tax basis will be his initial tax basis reduced by the limited partner's share of partnership distributions, losses, and expenses and increased by his share of partnership income and gains. The amount for which a limited partner is "at risk" with respect to his units in a partnership is generally equal to his tax basis for the units, less: any amounts borrowed in connection with his acquisition of the units for which he is not personally liable and for which he has pledged no property other than his units; any amounts borrowed from persons who have a proprietary interest in the partnership; and any amounts borrowed for which the limited partner is protected against loss through guarantees or similar arrangements. Because of the limitations imposed upon the deductibility of capital losses referred to below, a limited partner's share of a partnership's net capital losses, if any, will not materially reduce his federal income tax on his ordinary income. In addition, certain expenses of a partnership might be deductible by a limited partner only as itemized deductions and, therefore, will not reduce the federal taxable income of a limited partner who does not itemize his deductions. Furthermore, an individual who is subject to the alternative minimum tax for a taxable year may not realize any tax benefit from such itemized deductions. Limitations on Deductibility of Passive Losses. The partnerships' income will not be treated as a "passive activity" for purposes of the limitation on the deduction of passive activity losses. Limited Deduction of Certain Expenses. Certain miscellaneous itemized deductions, such as expenses incurred to maintain property held for investment, are deductible only to the extent that they exceed 2% of the adjusted gross income of an individual, trust, or estate. The amount of certain itemized deductions allowable to individuals is further reduced by an amount equal to the lesser of (i) 3% of the Month individual's adjusted gross income in excess of a certain threshold amount and (ii) 80% of such itemized deductions. Moreover, such investment expenses are miscellaneous itemized deductions that are not deductible by a non-corporate taxpayer in calculating its alternative minimum tax liability. Based upon the current and contemplated activities of the partnerships, the general partner has been advised by its legal counsel that, in such counsel's opinion, the expenses incurred by the partnerships in their futures, forwards, and options trading businesses should not be subject to the 2% "floor" or the 3% phaseout, except to the extent that the Internal Revenue Service promulgates regulations that so provide. However, that advice is not binding on a court or the Internal Revenue Service, and the Internal Revenue Service could assert, and a court could agree, that such expenses of the partnerships (including incentive fees) are investment expenses which are subject to these limitations. Tax Liability Will Exceed Distributions. Under federal tax laws, a limited partner must report and pay tax on his share of any partnership income each year, even though the general partner does not intend to make any distributions from the partnerships. Tax on Capital Gains and Losses. In general, for individuals, trusts, and estates, "long-term capital gains" are currently taxed at a maximum marginal tax rate of 20% and "short-term capital gains" and other income are currently taxed at a maximum marginal tax rate of 38.6%. Corporate taxpayers are currently subject to a maximum marginal tax rate of 35% on all capital gains and income. The excess of capital losses over capital gains is deductible by an individual against ordinary income on a one-for-one basis, subject to an annual limitation of $3,000 ($1,500 in the case of married individuals filing a separate return). Excess capital losses may be carried forward. Net losses from Section 1256 contracts are treated as 60% long-term capital loss and 40% short-term capital loss. Such losses may, at the individual taxpayer's election, be carried back to each of the preceding three years and applied against gains from Section 1256 contracts. Alternative Minimum Tax. The alternative minimum tax for individuals is imposed on "alternative minimum taxable income" in excess of certain exemption amounts. Alternative minimum taxable income consists of taxable income determined with certain adjustments and increased by the amount of items of tax preference. Alternative minimum taxable income may not be offset by certain interest deductions, including (in certain circumstances) interest incurred to purchase or carry units in the partnerships. Corporations are also subject to an alternative minimum tax. The extent to which the alternative minimum tax will be imposed will depend on the overall tax situation of each limited partner at the end of such taxable year. Limitation on Deductibility of Interest on Investment Indebtedness. Interest paid or accrued on indebtedness properly allocable to property held for investment is investment interest. Such interest is generally deductible by non-corporate taxpayers only to the extent it does not exceed net investment income. A limited partner's distributive share of net partnership income and any gain from the disposition of units will be treated as investment income, except that a limited partner's net capital gain from the disposition of units is not investment income unless the limited partner waives the benefit of the preferential tax rate on the gain. It is not clear whether a limited partner's distributive share of partnership net capital gain constitutes investment income where such gain is taxed at the maximum rate for capital gains. Interest expense incurred by a limited partner to acquire his units generally will be investment interest. Any investment interest disallowed as a deduction in a taxable year solely by reason of the limitation above is treated as investment interest paid or accrued in the succeeding taxable year. Taxation of Foreign Limited Partners. A nonresident alien individual, foreign corporation, or foreign partnership (a "foreign limited partner") generally should not be deemed to be engaged in a U.S. trade or business solely by virtue of an investment in the partnerships; provided that such foreign limited partner is not a "dealer" in commodities and, in the case of an individual, does not have certain present or former connections with the U.S. (e.g., is not present in the U.S. more than 182 days during his or her taxable year, or, in certain limited circumstances, a prior taxable year) and provided further, that such foreign limited partner is not engaged in a trade or business within the U.S. during the taxable year or, in certain limited circumstances, a prior taxable year to which income, gain, or loss from the partnerships is treated as "effectively connected." Capital gains earned by the partnerships and allocated to such a foreign limited partner will, as a general rule, not be subject to U.S. federal income taxation or withholding, but may be subject to taxation by the jurisdiction in which the foreign limited partner is resident, organized or operating. In the event that a partnership were found to be engaged in a U.S. trade or business, a foreign limited partner would be required to file a U.S. federal income tax return for such year and pay tax at full U.S. rates. In the case of a foreign limited partner which is a foreign corporation, an additional 30% "branch profits" tax might be imposed. Furthermore, in such event the partnerships would be required to withhold taxes from the income or gain allocable to such a foreign limited partner under Section 1446 of the Code. A foreign limited partner is not subject to U.S. tax on certain interest income, including income attributable to (i) original issue discount on Treasury bills that have a maturity of 183 days or less or (ii) commercial bank deposits, provided, in either case, that such foreign limited partner is not engaged in a trade or business within the U.S. during a taxable year. Additionally, a foreign limited partner not engaged in a trade or business within the U.S. is not subject to U.S. tax on interest income (other than certain so-called "contingent interest") attributable to obligations issued after July 18, 1984 that are in registered form if the foreign limited partner timely provides the relevant partnership with an IRS Form W-8BEN. Prospective foreign limited partners who are engaged in a U.S. trade or business or who act as dealers in commodities may be subject to U.S. income tax and should consult their tax advisors before investing in a partnership. The estate of a deceased foreign limited partner may be liable for U.S. estate tax and may be required to obtain an estate tax release from the Internal Revenue Service in order to transfer the units of such foreign limited partner. Foreign persons should consult their own tax advisers before deciding whether to invest in the partnerships. Tax Elections. The Internal Revenue Code of 1986 provides for optional adjustments to the basis of partnership property upon distributions of partnership property to a partner (Section 734) and transfers of units, including transfers by reason of death (Section 743), provided that a partnership election has been made pursuant to Section 754. As a result of the complexities and added expense of the tax accounting required to implement such an election, the general partner does not presently intend to make such an election for any of the partnerships. Therefore, any benefits which might be available to the partners by reason of such an election will be foreclosed. Tax Returns and Information. The partnerships will file their information returns using the accrual method of accounting. Within 75 days after the close of each partnership's taxable year, the partnership will furnish each limited partner, and any assignee of the units of a limited partner, copies of the partnership's Schedule K-1 indicating the limited partner's distributive share of tax items and any additional information as is reasonably necessary to permit the limited partners to prepare their own federal and state tax returns. Partnership's Taxable Year. Each partnership has the calendar year as its taxable year. Unrelated Business Taxable Income of Employee Benefit Plan Limited Partners and Other Tax-Exempt Investors. Income allocated to a limited partner which is an employee benefit plan or other tax-exempt entity should not be subject to tax under Section 511 of the Internal Revenue Code of 1986, provided that the units purchased by such plans and entities are not "debt-financed." However, if a partnership were to purchase physical commodities with borrowed funds (whether upon delivery under a futures or forward contract or otherwise) and to sell those commodities at a gain, the gain would likely constitute unrelated business income. The partnerships are entitled to engage in such leveraged purchases of physical commodities. Tax exempt investors should see "Purchases by Employee Benefit Plans ERISA Considerations" above. Tax Audits All partners are required under the Internal Revenue Code of 1986 to report all the partnership items on their own returns consistently with the treatment by the partnership, unless they file a statement with the Internal Revenue Service disclosing the inconsistencies. Adjustments in tax liability with respect to partnership items will be made at the partnership level. The general partner will represent each partnership All of the foregoing statements are based upon the existing provisions of the Internal Revenue Code of 1986 and the regulations promulgated thereunder and the existing administrative and judicial interpretations thereof. The general partner cannot assure you that legislative, administrative, or judicial changes will not occur which will modify such statements. The foregoing statements are not intended as a substitute for careful tax planning, particularly since certain of the federal income tax consequences of purchasing units may not be the same for all taxpayers. The partnerships' tax returns could be audited by the Internal Revenue Service and adjustments to the returns could be made as a result of such audits. If an audit results in adjustment, limited partners may be required to file amended returns and their returns may be audited. Accordingly, prospective purchasers of units are urged to consult their tax advisers with specific reference to their own tax situation under federal law and the provisions of applicable state, local, and foreign laws before subscribing for units. STATE AND LOCAL INCOME TAX ASPECTS In addition to the federal income tax consequences for individuals described under "Material Federal Income Tax Considerations" above, the partnerships and their limited partners may be subject to various state and local taxes. Certain of these taxes could, if applicable, have a significant effect on the amount of tax payable in respect of an investment in the partnerships. A limited partner's distributive share of the realized profits of a partnership may be required to be included in determining his reportable income for state or local tax purposes. Furthermore, state and local tax laws may not reflect recent changes made to the federal income tax law and, therefore, may be inconsistent with the federal income treatment of gains and losses arising from the partnerships' transactions in Section 1256 contracts. Accordingly, prospective limited partners should consult with their own tax advisers concerning the applicability of state and local taxes to an investment in the partnerships. The general partner has been advised by its legal counsel, Cadwalader, Wickersham & Taft LLP, that in such counsel's opinion, the partnerships should not be liable for New York City unincorporated business tax. Limited partners who are nonresidents of New York State will not be liable for New York State personal income tax on such partners' income from the partnerships, but may be liable for such tax to the extent such limited partners' allocable share of income attributable to the partnerships' transactions involves tangible personal property. Likewise, limited partners who are nonresidents of New York City will not be liable for New York City earnings tax on the partners' income from the partnerships. New York City residents may be subject to New York City personal income tax on the partners' income from the partnerships. No ruling from the New York State Department of Taxation and Finance or the New York City Department of Finance has been, or will be, requested regarding such matters. LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft LLP, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000927829_nitromed_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000927829_nitromed_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..297fa652088ca3713e9ed236741429ff54b807bc --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000927829_nitromed_legal_matters.txt @@ -0,0 +1 @@ +Legal matters The validity of the shares of common stock we are offering will be passed upon for us by Wilmer Cutler Pickering Hale and Dorr LLP, Boston, Massachusetts. Legal matters in connection with this offering will be passed upon for the underwriters by Ropes & Gray LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0000941738_wheeling_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0000941738_wheeling_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3c5f58b6add21316646ebd0766585dd53bc8cb6 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0000941738_wheeling_legal_matters.txt @@ -0,0 +1 @@ +Legal matters Kirkpatrick & Lockhart LLP, Pittsburgh, Pennsylvania will pass upon the validity of the issuance of the shares being sold in this offering. Certain legal matters will be passed upon for the underwriters by Davis Polk & Wardwell, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001001606_blount_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001001606_blount_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001001606_blount_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001003111_neon_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001003111_neon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3a8d97c0ef98c514d422d88a993e11ea7756a153 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001003111_neon_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock and the notes offered hereby will be passed upon for our company by Day, Berry & Howard LLP, Stamford, CT 06901. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001009379_metropolit_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001009379_metropolit_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ea5158450267f822b84d4b58184ed76003189de2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001009379_metropolit_legal_matters.txt @@ -0,0 +1 @@ +December 31, 1999 (1) Lewis N. Lester has investment and voting control over the shares held by Global Capital Funding Group, L.P. (2) Carl N. Singer has investment and voting control over the shares held by Active Investors II and Active Investors III. (3) Red Scott has investment and voting control over the shares held by PJC Associates, Ltd. (4) George Parry has investment and voting control over the shares held by Avenue Asset Partners. (5) David Berman has investment and voting control over the shares held by Berman Berman, P.A. (6) Director (7) Karl M. Sachs is a Director of the Company. PLAN OF DISTRIBUTION The selling security holders and any of their pledgees, assignees and successors-in- interest may, from time to time, sell any or all of their shares of common stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. The selling security holders may use any one or more of the following methods when selling shares: ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers; block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; purchases by a broker-dealer as principal and resale by the broker-dealer for its account; an exchange distribution in accordance with the rules of the applicable exchange; privately negotiated transactions; short sales; broker-dealers may agree with the selling security holders to sell a specified number of such shares at a stipulated price per share; a combination of any such methods of sale; and any other method permitted pursuant to applicable law. The selling security holders may also sell shares under Rule 144 under the Securities Act, if available, rather than under this prospectus. Broker-dealers engaged by the selling security holders may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the selling security holders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated. The selling security holders do not expect these commissions and discounts to exceed what is customary in the types of transactions involved. The selling security holders may from time to time pledge or grant a security interest in some or all of the shares or common stock or warrants owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell the shares of common stock from time to time under this prospectus, or under an amendment to this prospectus June 30, 1999 Table of Contents under Rule 424(b)(3) or other applicable provision of the Securities Act of 1933 amending the list of selling security holders to include the pledgee, transferee or other successors in interest as selling security holders under this prospectus. The selling security holders also may transfer the shares of common stock in other circumstances, in which case the transferees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus. The selling security holders and any broker-dealers or agents that are involved in selling the shares may be deemed to be underwriters within the meaning of the Securities Act in connection with such sales. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. The selling security holders have informed us that they do not have any agreement or understanding, directly or indirectly, with any person to distribute the common stock. We are required to pay all fees and expenses incident to the registration of the shares. We have agreed to indemnify the selling security holders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act. SHARES ELIGIBLE FOR FUTURE SALE As of April 30, 2004, we have 45,711,008 shares of common stock issued and outstanding. This does not include shares that may be issued upon exercise of options or warrants. We cannot predict the effect, if any, that market sales of common stock or the availability of these shares for sale will have on the market price of our shares from time to time. Nevertheless, the possibility that substantial amounts of common stock may be sold in the public market could negatively damage and affect market prices for our common stock and could damage our ability to raise capital through the sale of our equity securities. INDEMNIFICATION OF OFFICERS AND DIRECTORS The Florida Business Corporation Act (the Corporation Act ) permits the indemnification of directors, employees, officers and agents of Florida corporations. Our Articles of Incorporation (the Articles ) and Bylaws provide that we shall indemnify our directors and officers to the fullest extent permitted by the Corporation Act. The provisions of the Corporation Act that authorize indemnification do not eliminate the duty of care of a director, and in appropriate circumstances equitable remedies such as injunctive or other forms of non-monetary relief will remain available under Florida law. In addition, each director will continue to be subject to liability for (a) violations of criminal laws, unless the director had reasonable cause to believe his conduct was lawful or had no reasonable cause to believe his conduct was unlawful, (b) deriving an improper personal benefit from a transaction, (c) voting for or assenting to an unlawful distribution and (d) willful misconduct or conscious disregard for our best interests in a proceeding by or in the right of a shareholder. The statute does not affect a director s responsibilities under any other law, such as the Federal securities laws. The effect of the foregoing is to require us to indemnify our officers and directors for any claim arising against such persons in their official capacities if such person acted in good faith and in a manner that he reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to our directors, officers or persons in control pursuant to the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the act and is therefore unenforceable. LEGAL MATTERS The validity of the securities offered by this prospectus will be passed upon for us by Adorno Yoss, P.A., 350 East Las Olas Boulevard, Suite 1700, Fort Lauderdale, FL 33301, Florida. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001013021_coinmach_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001013021_coinmach_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6f2dc3f944b567a0b05577a2b9de5a4dda8274d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001013021_coinmach_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs, the Class A common stock, the notes and the guarantees offered hereby will be passed upon for us by Mayer, Brown, Rowe Maw LLP, New York, New York. Certain legal matters relating to the offerings will be passed upon for the underwriters by Cahill Gordon Reindel LLP, New York, New York. Two members of Mayer, Brown, Rowe Maw LLP own approximately 1,035,000 common units of Holdings as of September 30, 2004. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001017907_first_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001017907_first_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c0c29531ac3acafa250a51369edca3c4352653c1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001017907_first_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS 128 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001018350_microcell_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001018350_microcell_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..731bc14e2ff917e153aae6955741643710a92a36 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001018350_microcell_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Stikeman Elliott LLP, Montreal, Quebec, Canada has passed upon the legality of the class A restricted voting shares and class B non-voting shares offered by this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001018833_quadramed_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001018833_quadramed_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4c108e7d46ff8eb7d5d50b86f7fcbad1e86593ad --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001018833_quadramed_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock that may be sold using this prospectus will be passed upon for us by Miles & Stockbridge P.C., McLean, Virginia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001021949_mellon_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001021949_mellon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..037908e364633cd001acbf59806b4d261c6d0c87 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001021949_mellon_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters relating to the issuance of the notes will be passed upon for the issuer, the transferor and trust I by Carl Krasik, Esq., Associate General Counsel to Mellon Financial Corporation, Reed Smith LLP, Pittsburgh, Pennsylvania and McKee Nelson LLP, New York, New York. The federal income tax matters described under U.S. Federal Income Tax Consequences will be passed upon for the issuer, the transferor and trust I by McKee Nelson LLP, New York, New York. McKee Nelson LLP, New York, New York will act as counsel for the underwriters. Certain ERISA matters will be passed upon for the issuer by McKee Nelson LLP, New York, New York. Mr. Krasik is a shareholder of Mellon Financial Corporation and holds options to purchase additional shares of Mellon Financial Corporation s common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001023031_direct_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001023031_direct_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..56b19b3acd160a72383e16ade07c2ce6d254253c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001023031_direct_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Baker, Donelson, Bearman, Caldwell Berkowitz, PC, Memphis, Tennessee. Certain legal matters in connection with the offering will be passed upon for the underwriters by LeBoeuf, Lamb, Greene MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. From time to time, LeBoeuf, Lamb, Greene MacRae, L.L.P. has provided legal services to us and some of our subsidiaries. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001028358_genitope_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001028358_genitope_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8bf4507bcded5fd3f9a5cf3816005eb442b1c701 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001028358_genitope_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cooley Godward LLP, Palo Alto, California. Certain legal matters will be passed upon for the underwriters by Morrison Foerster LLP, San Francisco, California. As of the date of this prospectus, an attorney with Cooley Godward LLP and an investment partnership affiliated with Cooley Godward LLP own in the aggregate less than one percent of the outstanding shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001033660_animas_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001033660_animas_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..581c7215f92bc398e697dca830f0e4617937ab1a --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001033660_animas_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered hereby is being passed upon for us by Pepper Hamilton LLP, Philadelphia, Pennsylvania. Certain legal matters in connection with this offering will be passed upon for the underwriters by Ballard Spahr Andrews Ingersoll, LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001040597_neenah_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001040597_neenah_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001040597_neenah_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001040599_neenah_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001040599_neenah_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001040599_neenah_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001044391_stratus_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001044391_stratus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c448d1e844414753b0cdc252aa90ce9d0136749f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001044391_stratus_legal_matters.txt @@ -0,0 +1,14008 @@ +LEGAL MATTERS + + + The legality of the shares offered by this prospectus will be passed upon for us by Giordano, Halleran & Ciesla, a Professional Corporation, Middletown, +New Jersey. Certain legal matters will be passed on for the underwriter by Lehman & Eilen LLP, Uniondale, New York. + +71 + + + + + + +EXPERTS + + + Certain financial statements of the Company included in this prospectus have been audited by Amper, Politziner & Mattia, P.C., independent auditors, as +indicated in their reports with respect thereto, and are included in reliance upon the authority of the firm as experts in giving such reports. + + + + +ADDITIONAL INFORMATION + + + We have filed with the SEC a Registration Statement on Form S-1 under the Securities Act with respect to the offered common stock. We have not +included in this prospectus additional information contained in the Registration Statement and you should refer to the Registration Statement and its exhibits for further information. The Registration +Statement and exhibits and schedules filed as a part thereof, may be inspected, without charge, at the Public Reference Section of the SEC at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., +Washington, D.C. 20549 and at the regional offices at the SEC located at Northwestern Atrium Center, 500 West Madison Avenue, Suite 1400, Chicago, Illinois 60611-2511. The SEC maintains a +worldwide web site on the Internet at http://www.sec.gov that contains reports, proxy and information statements regarding registrants that file +electronically with the SEC. Copies of all or any portion of the Registration Statement may be obtained from the public reference section of the SEC upon payment of the prescribed fees. + +72 + + + + + + +STRATUS SERVICES GROUP, INC. + + INDEX TO FINANCIAL STATEMENTS + + +As of September 30, 2003 and 2002 + +and for the Years Ended September 30, 2003, 2002 and 2001 + +Independent Auditors Report + +F-2 + +Financial Statements + + + + +Balance Sheets + +F-3 + + +Statements of Operations + +F-4 + + +Statements of Cash Flows + +F-5 + + +Statements of Stockholders' Equity + +F-7 + + +Statements of Comprehensive Income + +F-13 + + +Notes to Financial Statements + +F-14 + + + + + + +As of March 31, 2004 and 2003 + and for the Six Months Ended December 31, 2004 and 2003 + + + + +Condensed Balance Sheets + +F-50 + +Condensed Statements of Operations + +F-51 + +Condensed Statements of Cash Flows + +F-52 + +Notes to Interim Financial Statements + +F-53 + +F-1 + + + + + + +Independent Auditors' Report + + +To +the Stockholders of + +Stratus Services Group, Inc. + + We +have audited the accompanying balance sheets of Stratus Services Group, Inc. as of September 30, 2003 and 2002, and the related statements of operations, stockholders' +equity, cash flows and comprehensive income for each of the three years in the period ended September 30, 2003. These financial statements are the responsibility of the Company's management. +Our responsibility is to express an opinion of these financial statements based on our audits. + + We +conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 principals 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. + + In +our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Stratus Services Group, Inc. as of +September 30, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting +principles generally accepted in the United States of America. + + The +accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the +Company has suffered recurring losses from operations and has a net capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management's plans regarding +those matters also are described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. + + In +connection with our audits of the financial statements referred to above, we audited the financial Schedule II. In our opinion, the financial schedule, when considered in +relation to the financial statements taken as a whole, presents fairly, in all material respects, the information stated therein. + + + +/s/ AMPER, POLITZINER & MATTIA, P.C. AMPER, POLITZINER & MATTIA, P.C. + +Edison, +New Jersey + +December 19, 2003 + +F-2 + + + + + + +STRATUS SERVICES GROUP, INC. + + Balance Sheets + + + + + +September 30, + + + + + +2003 + +2002 + + +Assets + + +Current Assets + + + + + + + + + +Cash and cash equivalents + +$ +53,753 + +$ +162,646 + + + +Accounts receivable less allowance for doubtful accounts of $1,733,00 and $1,742,000 + + +12,833,749 + + +9,179,543 + + + +Unbilled receivables + + +671,271 + + +2,065,972 + + + +Notes receivable (current portion) + + +25,240 + + + + + + +Other receivables + + + + + +250,000 + + + +Prepaid insurance + + +2,271,715 + + +2,709,331 + + + +Prepaid expenses and other current assets + + +277,262 + + +333,601 + + + + + + + + + + + + +16,132,990 + + +14,701,093 + + +Notes receivable (net of current portion) + + + + + +95,166 + + + + + + + + + +Note receivable related party + + +128,000 + + + + + +Property and equipment, net of accumulated depreciation + + +937,718 + + +1,281,817 + + +Intangible assets, net of accumulated amortization + + +1,501,579 + + +802,145 + + +Goodwill + + +5,816,353 + + +7,085,582 + + +Deferred registration costs + + +374,365 + + +5,768 + + +Other assets + + +164,380 + + +154,991 + + + + + + + + + + + +$ +25,150,551 + +$ +24,031,396 + + + + + + + + + +Liabilities and Stockholders' Equity + + +Current liabilities + + + + + + + + + +Loans payable (current portion) + +$ +737,514 + +$ +464,830 + + + +Loans payable related parties + + +503,337 + + +116,000 + + + +Notes payable acquisitions (current portion) + + +657,224 + + +578,040 + + + +Line of credit + + +8,312,275 + + +7,739,117 + + + +Cash overdraft + + +699,057 + + +731,501 + + + +Insurance obligation payable + + +97,506 + + +128,075 + + + +Accounts payable and accrued expenses + + +4,787,404 + + +3,941,347 + + + +Accrued payroll and taxes + + +2,473,596 + + +1,828,629 + + + +Payroll taxes payable + + +5,021,411 + + +2,460,677 + + + +Put options liability + + +823,000 + + + + + + + + + + + + + + + +24,112,324 + + +17,988,216 + + +Loans payable (net of current portion) + + + + + +37,890 + + + + + +217,965 + + + +Notes payable acquisitions (net of current portion) + + +2,065,280 + + +1,919,532 + + +Convertible debt + + +40,000 + + +40,000 + + + +Series A voting redeemable convertible preferred stock, $.01 par value, 1,458,933 shares issued and outstanding (including unpaid dividends of $651,752) + + +3,809,752 + + + + + + + + + + + + + + + +30,065,246 + + +20,165,713 + + +Temporary equity put options + + + + + + + + + + + +823,000 + + + +Commitments and contingencies + + + + + + + + + + + + + + + +Stockholders' equity + + + + + + + + + + + + + + + + +Preferred stock, $.01 par value, 5,000,000 shares authorized + + + + + + + + + + + Series A voting redeemable convertible preferred stock, $.01 par value, 1,458,933 shares issued and outstanding, liquidation preference of $4,376,799 (including unpaid dividends of $345,376) + + + + + + + + + + + +3,293,376 + + + + + + Series E non-voting convertible preferred stock, $.01 par value, 40,257 and 16,683 shares issued and outstanding, liquidation preference of $4,025,835 (including unpaid dividends of $60,295 and $20,000) + + + + + +4,086,130 + + + + + +1,485,947 + + + + + + Series F voting convertible preferred stock, $.01 par value, 8,000 and 10,000 shares issued and outstanding, liquidation preference of $800,000 (including unpaid dividends of $28,000 and $-0-) + + + + + +828,000 + + + + + +1,000,000 + + + + + + Series H non-voting convertible preferred stock, $.01 par value, -0- and 5,000 shares issued and outstanding + + + + + + + + + + + +500,000 + + + +Common Stock, $.01 par value, 100,000,000 shares authorized, 19,795,038 and 11,522,567 shares issued and outstanding + + + + + +197,950 + + + + + +115,226 + + + +Additional paid-in capital + + +11,728,943 + + +12,626,733 + + +Accumulated deficit + + +(21,755,718 +) + +(15,978,599 +) + + + + + + + + + +Total stockholders' equity (deficiency) + + +(4,914,695 +) + +3,042,683 + + + + + + + + + + + +$ +25,150,551 + +$ +24,031,396 + + + + + + + + + +See accompany summary of accounting policies and notes to financial statements. + +F-3 + + + + + +STRATUS SERVICES GROUP, INC. + + Statements of Operations + + + + + +Years Ended September 30, + + + + + +2003 + +2002 + +2001 + + +Revenues + +$ +76,592,209 + +$ +45,859,801 + +$ +29,274,041 + + +Cost of revenues + + + + + +65,186,431 + + + + + +37,624,716 + + + + + +22,122,318 + + + + + + + + + + + + +Gross profit + + + + + +11,405,778 + + + + + +8,235,085 + + + + + +7,151,723 + + + +Selling, general and administrative expenses + + + + + +13,309,072 + + + + + +11,114,340 + + + + + +9,866,505 + + + +Loss on impairment of goodwill + + + + + + + + + + + +300,000 + + + + + +700,000 + + + +Other charges + + + + + +753,000 + + + + + +140,726 + + + + + +375,306 + + + + + + + + + + + + +Operating (loss) from continuing operations + + + + + +(2,656,294 + +) + + + +(3,319,981 + +) + + + +(3,790,088 + +) + + + + + + + + + + +Other income (expenses) + + + + + + + + + + + + + + + + + + + + + + +Finance charges + + + + + + + + +(54,991 +) + + +Interest and financing costs + + +(1,887,900 +) + +(1,689,635 +) + +(1,707,730 +) + + +(Loss) on sale of investment + + + + + +(2,159,415 +) + + + + + +Other income (expense) + + +111,062 + + +83,398 + + +(47,963 +) + + + + + + + + + + + + + +(1,776,838 +) + +(3,765,652 +) + +(1,810,684 +) + + + + + + + + + + +(Loss) from continuing operations before income taxes + + +(4,433,132 +) + +(7,085,633 +) + +(5,600,772 +) + +Income taxes + + + + + + + + +340,000 + + + + + + + + + + + +(Loss) from continuing operations + + +(4,433,132 +) + +(7,085,633 +) + +(5,940,772 +) + +Discontinued operations earnings (loss) from discontinued operations + + +(1,322,967 +) + +(1,060,008 +) + +93,315 + + +Gain (loss) on sale of discontinued operations + + +(21,020 +) + +1,759,056 + + + + + + + + + + + + + + +Net (loss) + + +(5,777,119 +) + +(6,386,585 +) + +(5,847,457 +) + +Dividends and accretion on preferred stock + + +(1,629,874 +) + +(1,041,810 +) + +(63,000 +) + + + + + + + + + + +Net (loss) attributable to common stockholders + +$ +(7,406,993 +) +$ +(7,428,395 +) +$ +(5,910,457 +) + + + + + + + + + + + +Basic: + + + + + + + + + + + + +Earnings (loss) from continuing operations + +$ +(.34 +) +$ +(.77 +) +$ +(1.00 +) + + +Earnings from discontinued operations + + +(.08 +) + +.07 + + +.01 + + + +Net earnings (loss) + +$ +(.42 +) +$ +(.70 +) +$ +(.99 +) + + + + Diluted: + + + + + + + + + + + + + + + + + + + + + + +Earnings (loss) from continuing operations + +$ +(.34 +) +$ +(.77 +) +$ +(1.00 +) + + +Earnings from discontinued operations + + +(.08 +) + +.07 + + +.01 + + + +Net earnings (loss) + +$ +(.42 +) +$ +(.70 +) +$ +(.99 +) + +Weighted average shares, outstanding per common share + + + + + + + + + + + + + + + + + + + + + + +Basic + + +17,510,918 + + +10,555,815 + + +5,996,134 + + + +Diluted + + +17,510,918 + + +10,555,815 + + +5,996,134 + + +See +accompany summary of accounting policies and notes to financial statements. + +F-4 + + + + + + +STRATUS SERVICES GROUP, INC. + + Statements of Cash Flows + + + + + +Years Ended September 30, + + + + + +2003 + +2002 + +2001 + + +Cash flows from operating activities + + + + + + + + + + + + +Net earnings (loss) from continuing operations + +$ +(4,433,132 +) +$ +(7,085,633 +) +$ +(5,940,772 +) + + +Net earnings (loss) from discontinued operations + + +(1,343,987 +) + +699,048 + + +93,315 + + + +Adjustments to reconcile net earnings (loss) to net cash used by operating activities + + + + + + + + + + + + + +Depreciation + + +538,386 + + +510,059 + + +409,860 + + + + +Amortization + + +393,982 + + +565,427 + + +359,134 + + + + +Provision for doubtful accounts + + +875,000 + + +1,658,000 + + +661,000 + + + + +Loss on impairment of goodwill + + + + + +400,000 + + +700,000 + + + + +Deferred financing costs amortization + + +1,608 + + +405,471 + + +209,897 + + + + +Loss on sale of investment + + + + + +2,159,415 + + + + + + + +Gain (loss) on extinguishments of convertible debt + + + + + +(3,277 +) + +70,560 + + + + +Accrued penalties on Series B Convertible Preferred Stock + + + + + +28,080 + + + + + + + +(Gain) loss on sales of discontinued operations + + +21,020 + + +(1,759,056 +) + + + + + + +Deferred taxes + + + + + + + + +340,000 + + + + +Interest expense amortization for the intrinsic value of the beneficial conversion feature of convertible debentures + + + + + +104,535 + + +1,146,463 + + + + +Common stock and warrants issued for fees + + +47,000 + + + + + + + + + + +Imputed interest + + +66,832 + + + + + + + + + + +Accrued interest + + +80,336 + + +106,687 + + +64,410 + + + + +Compensation stock options + + + + + + + + +67,900 + + + +Changes in operating assets and liabilities + + + + + + + + + + + + + +Due from factor/accounts receivable + + +(3,134,505 +) + +(2,796,986 +) + +(2,347,247 +) + + + +Prepaid insurance + + +437,616 + + +(1,273,053 +) + +(1,003,604 +) + + + +Prepaid expenses and other current assets + + +153,589 + + +(26,455 +) + +201,023 + + + + +Other assets + + +(5,229 +) + +(5,111 +) + +(65,652 +) + + + +Insurance obligation payable + + +(30,569 +) + +(421,385 +) + +182,360 + + + + +Accrued payroll and taxes + + +644,967 + + +366,891 + + +356,375 + + + + +Payroll taxes payable + + +2,560,734 + + +1,630,854 + + +417,310 + + + + +Accounts payable and accrued expenses + + +694,221 + + +1,057,157 + + +1,672,204 + + + + + + + + + + + + + + +Total adjustments + + +3,344,988 + + +2,707,253 + + +3,441,993 + + + + + + + + + + + + + + +(2,432,131 +) + +(3,679,332 +) + +(2,405,464 +) + + + + + + + + + + +Cash flows (used in) investing activities + + + + + + + + + + + + +Purchase of property and equipment + + +(243,995 +) + +(322,748 +) + +(755,801 +) + + +Proceeds from sale of investment + + + + + +206,631 + + + + + + +Payments for business acquisitions + + +(61,644 +) + +(336,726 +) + +(1,218,674 +) + + +Net proceeds from sale of discontinued operations + + +1,120,770 + + +1,709,079 + + + + + + +Costs incurred in connection with investment + + + + + + + + +(17,046 +) + + +Collect of notes receivable + + +4,594 + + + + + + + + + +Loans receivable + + + + + + + + +(40,500 +) + + + + + + + + + + + + + +819,725 + + +1,256,236 + + +(2,032,021 +) + + + + + + + + + + +Cash flows from financing activities + + + + + + + + + + + + +Payments of registration costs + + +(374,365 +) + + + + + + + + +Proceeds from issuance of common stock + + + + + +222,083 + + +1,412,772 + + + +Proceeds from issuance of preferred stock + + +1,442,650 + + +1,932,131 + + + + + + +Proceeds from loans payable + + +879,000 + + +1,729,898 + + +255,000 + + + +Payments of loans payable + + +(636,391 +) + +(1,073,440 +) + +(70,180 +) + + +Proceeds from loans payable related parties + + +587,337 + + +166,000 + + +160,000 + + + +Payments of loans payable related parties + + +(200,000 +) + +(50,000 +) + + + + + +Payments of notes payable acquisitions + + +(687,775 +) + +(1,117,001 +) + +(320,394 +) + + +Net proceeds from line of credit + + +573,158 + + +432,536 + + +2,065,156 + + + + + + + + + + + + + + +F-5 + + + + +Net proceeds from convertible debt + + + + + +327,775 + + +2,664,239 + + + +Redemption of convertible debt + + + + + +(302,896 +) + +(2,222,883 +) + + +Proceeds from temporary equity put options + + + + + + + + +60,000 + + + +Cash overdraft + + +(32,444 +) + +731,501 + + + + + + +Cost in connection with common stock issued for acquisition + + + + + +(2,000 +) + + + + + +Redemption of preferred stock + + + + + +(455,000 +) + + + + + +Purchase of treasury stock + + + + + + + + +(265,125 +) + + +Dividends paid + + +(47,657 +) + +(11,667 +) + + + + + + + + + + + + + + + + +1,503,513 + + +2,413,920 + + +3,578,585 + + + + + + + + + + + +Net change in cash and cash equivalents + + +(108,893 +) + +(9,176 +) + +(858,900 +) + + + + + + + + + + +Cash and cash equivalents beginning + + +162,646 + + +171,822 + + +1,030,722 + + + + + + + + + + + +Cash and cash equivalents ending + +$ +53,753 + +$ +162,646 + +$ +171,822 + + + + + + + + + + + +Supplemental disclosure of cash paid + + + + + + + + + + + + +Interest + +$ +2,042,821 + +$ +1,937,930 + +$ +739,872 + + + + + + + + + + + +Schedule of noncash investing and financing activities + + + + + + + + + + + + +Fair value of assets acquired + +$ +1,266,519 + +$ +1,816,727 + +$ +4,568,674 + + + +Less: cash paid + + +(176,644 +) + +(336,727 +) + +(1,218,674 +) + + +Less: common stock and put options issued + + + + + +(380,000 +) + +(800,000 +) + + + + + + + + + + + +Liabilities assumed + +$ +1,089,875 + +$ +1,100,000 + +$ +2,550,000 + + + + + + + + + + + + +Purchase of treasury stock in exchange for loans + +$ + + +$ + + +$ +402,000 + + + + + + + + + + + + +Issuance of common stock in exchange for investment + +$ + + +$ + + +$ +61,000 + + + + + + + + + + + + +Issuance of common stock upon conversion of convertible debt + +$ + + +$ +736,003 + +$ +542,500 + + + + + + + + + + + + +Issuance of Series E Preferred Stock in exchange for Series H Preferred Stock + +$ +508,250 + +$ + + +$ + + + + + + + + + + + + + +Issuance of Series B Preferred Stock in exchange for convertible and other debt (including $160,000 loans payable related parties) + +$ + + +$ +1,016,499 + +$ + + + + + + + + + + + + + +Issuance of Series E Preferred Stock in exchange for Series B Preferred Stock + +$ + + +$ +875,210 + +$ + + + + + + + + + + + + + +Issuance of common stock in exchange for accounts payable and accrued expenses + +$ +37,500 + +$ +59,000 + +$ + + + + + + + + + + + + + +Issuance of common stock for fees + +$ +27,500 + + + + + + + + + + + + + + + + + + +Issuance of common stock upon conversion of convertible preferred stock + +$ +925,000 + +$ + + +$ + + + + + + + + + + + + + +Issuance of Series E Preferred Stock in exchange for penalties + +$ +362,792 + +$ + + +$ + + + + + + + + + + + + + +Issuance of Series F Preferred Stock in exchange for accrued dividends + +$ +84,943 + +$ + + +$ + + + + + + + + + + + + + +Issuance of warrants for fees + +$ +19,500 + +$ +55,000 + +$ + + + + + + + + + + + + + +Issuance of preferred stock in exchange for investment + +$ + + +$ + + +$ +1,592,000 + + + + + + + + + + + + +Issuance of preferred stock for fees in connection with private placement ($410,000) and investment ($727,000) + +$ + + +$ + + +$ +1,137,000 + + + + + + + + + + + + +Issuance of common stock for fees in connection with private placement and investment + +$ + + +$ + + +$ +30,000 + + + + + + + + + + + + +Cumulative dividends and accretion on preferred stock + +$ +1,582,217 + +$ +1,030,143 + +$ +63,000 + + + + + + + + + + + +See accompanying summary of accounting policies and notes to financial statements. + +F-6 + + + + + + +STRATUS SERVICES GROUP, INC. + + Statement of Stockholders' Equity (Deficiency) + + + + + + + + +Common Stock + +Preferred Stock + + + + +Total + +Amount + +Shares + +Amount + +Shares + +Balance September 30, 2000 + +$ +6,799,445 + +$ +57,120 + +5,712,037 + +$ + + + + +Net (loss) + + +(5,847,457 +) + + + + + + + + + + +Unrealized loss on securities available for sale + + +(1,200,000 +) + + + + + + + + + + +Dividend and accretion on preferred stock + + +(63,000 +) + + + + + + + + + + +Purchase and retirement of treasury stock + + +(15,125 +) + +(33 +) +(3,333 +) + + + + + +Purchase of treasury stock + + +(652,000 +) + + + + + + + + + + +Beneficial conversion feature of convertible debt + + +1,213,747 + + + + + + + + + + + +Warrants issued in connection with issuance of convertible debt + + +88,000 + + + + + + + + + + + +Compensation expense in connection with stock options granted (no tax effect) + + +67,900 + + + + + + + + + + + +Beneficial conversion feature of convertible debt redeemed + + +(631,881 +) + + + + + + + + + + +Conversion of convertible debt + + +429,448 + + +5,194 + +519,394 + + + + + + +Issuance of common stock in connection with acquisition + + + + + +4,000 + +400,000 + + + + + + +Proceeds from the private placements of common stock (net of costs of $432,228) for cash + + +1,002,772 + + +14,497 + +1,449,666 + + + + + + +Issuance of shares for services provided + + +30,000 + + +300 + +30,000 + + + + + + +Issuance of stock in exchange for investment + + +61,000 + + +500 + +50,000 + + + + + + +Issuance of stock with put options + + + + + +600 + +60,000 + + + + + + + + + + + + + + + + + +Balance September 30, 2001 + +$ +1,282,849 + +$ +82,178 + +8,217,764 + +$ + + + + +See +accompanying summary of accounting policies and notes to financial statements. + +F-7 + + + + + + +Treasury + +Stock + +Additional + +Paid-In + +Capital + +Deferred + +Compensation + +Accumulated + +Other + +Comprehensive + +Loss + +Accumulated + +Deficit + + +Balance September 30, 2000 + +$ + + +$ +10,554,782 + +$ +(67,900 +) + + + +$ +(3,744,557 +) + +Net (loss) + + + + + + + + + + + + + + +(5,847,457 +) + +Unrealized loss on securities available for sale + + + + + + + + + + + +(1,200,000 +) + + + + +Dividend and accretion on preferred stock + + + + + +(63,000 +) + + + + + + + + + + +Purchase and retirement of treasury stock + + + + + +(15,092 +) + + + + + + + + + + +Purchase of treasury stock + + +(652,000 +) + + + + + + + + + + + + + +Beneficial conversion feature of convertible debt + + + + + +1,213,747 + + + + + + + + + + + +Warrants issued in connection with issuance of convertible debt + + + + + +88,000 + + + + + + + + + + + +Compensation expense in connection with stock options granted (no tax effect) + + + + + + + + +67,900 + + + + + + + + +Beneficial conversion feature of convertible debt redeemed + + + + + +(631,881 +) + + + + + + + + + + +Conversion of convertible debt + + +652,000 + + +(227,746 +) + + + + + + + + + + +Issuance of common stock in connection with acquisition + + + + + +(4,000 +) + + + + + + + + + + +Proceeds from the private placements of common stock (net of costs of $432,228) for cash + + + + + +988,275 + + + + + + + + + + + +Issuance of shares for services provided + + + + + +29,700 + + + + + + + + + + + +Issuance of stock in exchange for investment + + + + + +60,500 + + + + + + + + + + + +Issuance of stock with put options + + + + + +(600 +) + + + + + + + + + + + + + + + + + + + + + + + +Balance September 30, 2001 + +$ + + +$ +11,992,685 + +$ + + +$ +(1,200,000 +) +$ +(9,592,014 +) + +See +accompanying summary of accounting policies and notes to financial statements. + +F-8 + + + + + + + + + +Common Stock + +Preferred Stock + + + + + +Total + +Amount + +Shares + +Amount + +Shares + + +Net (loss) + + +(6,386,585 +) + + + + + + + + + + + + +Dividend and accretion on preferred stock + + +(135,667 +) + + + + + + +906,143 + + + + + +Beneficial conversion feature of convertible debt and convertible preferred stock + + +136,000 + + + + + + + +(695,000 +) + + + + +Beneficial conversion feature of convertible debt redeemed + + +(69,541 +) + + + + + + + + + + + + +Conversion of convertible debt + + +736,003 + + +25,375 + +2,537,479 + + + + + + + + +Issuance of common stock in connection with acquisition + + +378,000 + + +4,000 + +400,000 + + + + + + + + +Proceeds from the private placements of common stock (net of costs of $9,750) for cash + + +222,083 + + +2,777 + +277,724 + + + + + + + + +Issuance of warrants for services provided + + +55,000 + + + + + + + + + + + + + +Issuance of Series B preferred stock in exchange for loans payable + + +934,907 + + + + + + + +1,016,499 + + +203,300 + + +Issuance of common stock in exchange for accounts payable and accrual expenses + + +59,000 + + +896 + +89,600 + + + + + + + + +Proceeds from the issuance of preferred stock (net of costs $402,870) for cash + + +2,162,131 + + + + + + + +2,565,001 + + +82,650 + + +Redemption of Series B Preferred Stock + + +(455,000 +) + + + + + + +(455,000 +) + +(91,000 +) + +Redemption of convertible debt + + +(20,577 +) + + + + + + + + + + + + +Reclassification adjustment for loss on securities available for sale included in net income + + +1,200,000 + + + + + + + + + + + + + +Reclassification of Series A Preferred Stock to Stockholders' Equity + + +2,916,000 + + + + + + + +2,916,000 + + +1,458,933 + + +Conversion of Series B Preferred Stock to Series E Preferred Stock + + +28,080 + + + + + + + +28,080 + + +(163,267 +) + +Forgiveness of dividends on Series B Preferred Stock + + + + +$ + + + + +$ +(2,400 +) + + + + + + + + + + + + + + + + + +Balance September 30, 2002 + +$ +3,042,683 + +$ +115,226 + +11,522,567 + +$ +6,279,323 + +$ +1,490,616 + + +See +accompanying summary of accounting policies and notes to financial statements. + +F-9 + + + + + + +Treasury + +Stock + +Additional + +Paid-In + +Capital + +Deferred + +Compensation + +Accumulated + +Other + +Comprehensive + +Loss + +Accumulated + +Deficit + + +Net (loss) + + + + + + + + + + + + + + +(6,386,585 +) + +Dividend and accretion on preferred stock + + + + + +(1,041,810 +) + + + + + + + + + + +Beneficial conversion feature of convertible debt and convertible preferred stock + + + + + +831,000 + + + + + + + + + + + +Beneficial conversion feature of convertible debt redeemed + + + + + +(69,541 +) + + + + + + + + + + +Conversion of convertible debt + + + + + +710,628 + + + + + + + + + + + +Issuance of common stock in connection with acquisition + + + + + +374,000 + + + + + + + + + + + +Proceeds from the private placements of common stock (net of costs of $9,750) for cash + + + + + +219,306 + + + + + + + + + + + +Issuance of warrants for services provided + + + + + +55,000 + + + + + + + + + + + +Issuance of Series B preferred stock in exchange for loans payable + + + + + +(81,592 +) + + + + + + + + + + +Issuance of common stock in exchange for accounts payable and accrual expenses + + + + + +58,104 + + + + + + + + + + + +Proceeds from the issuance of preferred stock (net of costs $402,870) for cash + + + + + +(402,870 +) + + + + + + + + + + +Redemption of Series B Preferred Stock + + + + + + + + + + + + + + + + + +Redemption of convertible debt + + + + + +(20,577 +) + + + + + + + + + + +Reclassification adjustment for loss on securities available for sale included in net income + + + + + + + + + + + +1,200,000 + + + + + +Reclassification of Series A Preferred Stock to Stockholders' Equity + + + + + + + + + + + + + + + + + +Conversion of Series B Preferred Stock to Series E Preferred Stock + + + + + + + + + + + + + + + + + +Forgiveness of dividends on Series B Preferred Stock + + + + + +2,400 + + + + + + + + + + + + + + + + + + + + + + + + +Balance September 30, 2002 + +$ + + +$ +12,626,733 + +$ + + +$ + + +$ +(15,978,599 +) + +See +accompanying summary of accounting policies and notes to financial statements. + +F-10 + + + + + + + + + +Common Stock + +Preferred Stock + + + + + +Total + +Amount + +Shares + +Amount + +Shares + + +Net (loss) + + +(5,777,119 +) + + + + + + + + + + + +Dividend and accretion on preferred stock + + +(47,657 +) + + + + + + +1,582,217 + + + + +Beneficial conversion feature of convertible debt and convertible preferred stock + + + + + + + + + + +(711,000 +) + + + +Issuance of common stock for fees + + +27,500 + + +1,000 + +100,000 + + + + + + + +Conversion of Series E Preferred Stock for Common Stock + + + + + +59,224 + +5,922,471 + + +(725,700 +) +(7,352 +) + +Conversion of Series F Preferred Stock for Common Stock + + + + + +20,000 + +2,000,000 + + +(200,000 +) +(2,000 +) + +Issuance of warrants for services provided + + +19,500 + + + + + + + + + + + + +Issuance of Series E preferred stock in exchange for loans payable + + +100,000 + + + + + + + +100,000 + +1,000 + + +Issuance of common stock in exchange for accounts payable and accrual expenses + + +37,500 + + +2,500 + +250,000 + + + + + + + +Proceeds from the issuance of Series E Preferred Stock (net of costs $543,600) for cash + + +1,492,650 + + + + + + + +2,036,250 + +20,362 + + +Issuance of Series E Preferred Stock for penalties + + + + + + + + + + +362,792 + +3,628 + + +Issuance of Series E Preferred Stock for accrued penalties + + + + + + + + + + + + +849 + + +Conversion of Series H Preferred Stock for Series E Preferred Stock (including $8,750 of accrued dividends) + + + + + + + + + + + + +87 + + +Reclassification of Series A Preferred Stock to Liabilities + + +(3,809,752 +) + + + + + + +(3,809,752 +) +(1,458,933 +) + + + + + + + + + + + + + + +Balance September 30, 2003 + +$ +(4,914,695 +) +$ +197,950 + +19,795,038 + +$ +4,914,130 + +48,257 + + +See +accompanying summary of accounting policies and notes to financial statements. + +F-11 + + + + + + +Treasury + +Stock + +Additional + +Paid-In + +Capital + +Deferred + +Compensation + +Accumulated + +Other + +Comprehensive + +Loss + +Accumulated + +Deficit + + +Net (loss) + + + + + + + + + + + + + + +(5,777,119 +) + +Dividend and accretion on preferred stock + + + + + +(1,629,874 +) + + + + + + + + + + +Beneficial conversion feature of convertible debt and convertible preferred stock + + + + + +711,000 + + + + + + + + + + + +Issuance of common stock for fees + + + + + +26,500 + + + + + + + + + + + +Conversion of Series E Preferred Stock for Common Stock + + + + + +666,476 + + + + + + + + + + + +Conversion of Series F Preferred Stock for Common Stock + + + + + +180,000 + + + + + + + + + + + +Issuance of warrants for services provided + + + + + +19,500 + + + + + + + + + + + +Issuance of Series E preferred stock in exchange for loans payable + + + + + + + + + + + + + + + + + +Issuance of common stock in exchange for accounts payable and accrual expenses + + + + + +35,000 + + + + + + + + + + + +Proceeds from the issuance of Series E Preferred Stock (net of costs $543,600) for cash + + + + + +(543,600 +) + + + + + + + + + + +Issuance of Series E Preferred Stock for penalties + + + + + +(362,792 +) + + + + + + + + + + +Issuance of Series E Preferred Stock for accrued dividends + + + + + + + + + + + + + + + + + +Conversion of Series H Preferred Stock for Series F Preferred Stock (including $8,750 of accrued dividends) + + + + + + + + + + + + + + + + + +Reclassification of Series A Preferred Stock to Liabilities + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Balance September 30, 2003 + +$ + + +$ +11,728,943 + +$ + + +$ + + +$ +(21,755,718 +) + +See +accompanying summary of accounting policies and notes to financial statements. + +F-12 + + + + + + +STRATUS SERVICES GROUP, INC. + + Statements of Comprehensive Income + + + + + +Years Ended September 30, + + + + + +2003 + +2002 + +2001 + + +Net (loss) + +$ +(5,777,119 +) +$ +(6,386,585 +) +$ +(5,847,457 +) + +Unrealized loss on securities available for sale + + + + + + + + + + + + + + + + + +(1,200,000 + +) + +Reclassification adjustment for loss on securities available for sale included in net income + + + + + + + + + + + +1,200,000 + + + + + + + + + + + + + + + + + + +Comprehensive income (loss) + +$ +(5,777,119 +) +$ +(5,186,585 +) +$ +(7,047,457 +) + + + + + + + + + + +See +accompanying summary of accounting policies and notes to financial statements. + +F-13 + + + + + + +STRATUS SERVICES GROUP, INC. + + Notes to Financial Statements + + +Note 1 Nature of Operations and Summary of Significant Accounting Policies + +Operations + + Stratus Services Group, Inc. (the "Company") is a national provider of staffing and productivity consulting services. As of September 30, 2003, the +Company operated a network of 31 offices in 8 states. + + The +Company operates as one business segment. The one business segment consists of its traditional staffing services and SMARTSolutions , a structured program to monitor and +enhance the production of a client's labor resources. The Company's customers are in various industries and are located throughout the United States. Credit is granted to substantially all customers. +No collateral is maintained. + +Basis of Presentation + + The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of +liabilities in the normal course of business. As shown in the financial statements, the Company incurred significant losses from continuing +operations of $4,433,00 and $7,086,000 during the years ended September 30, 2003 and 2002, respectively and has a working capital deficit of $7,979,000 at September 30, 2003. These +factors, among others, indicate that the Company may be unable to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification +of liabilities that might be necessary should the Company be unable to continue as a going concern. + + Management +recognizes that the Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to allow it to satisfy its obligations on a timely +basis, to fund the operation and capital needs, and to obtain additional financing as may be necessary. + + Management +of the Company has taken steps to revise and reduce its operating requirements, which it believes will be sufficient to assure continued operations and implementation of the +Company's plans. The steps include closing or selling branches that are not profitable, consolidating branches and reductions in staffing and other selling, general and administrative expense. + + The +Company continues to pursue other sources of equity or long-term debt financings. The Company also continues to negotiate payment plans and other accommodations with its +creditors. + +Revenue Recognition + + The Company recognizes revenue as the services are performed by its workforce. The Company's customers are billed weekly. At balance sheet dates, there are +accruals for unbilled receivables and related compensation costs. + + The +following summarizes revenues: + + + + +Years Ended September 30, + + + + +2003 + +2002 + +2001 + +Staffing + +$ +76,011,503 + +$ +45,153,269 + +$ +28,435,796 + +Payrolling + + +580,706 + + +706,532 + + +838,245 + + + + + + + + + + +$ +76,592,209 + +$ +45,859,801 + +$ +29,274,041 + + + + + + + + +F-14 + + + + Unlike +traditional staffing services, under a payrolling arrangement, the Company's customer recruits and identifies individuals for the Company to hire to provide services to the +Customer. The Company becomes the statutory employer although the customer maintains substantially all control over those employees. Accordingly, Emerging Issues Task Force ("EITF") 99-19, +"Reporting revenue Gross as a Principal versus Net as an Agent" requires that the Company does not reflect the direct payroll costs paid to such employees in revenues and costs of revenue. + +Use of Estimates + + The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that +affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses +during the reporting period. Actual results could differ from those estimates. + +Cash Equivalents and Concentration of Cash + + The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company maintains its cash in +bank deposit accounts, which, at times may exceed federally insured limits. The Company has not experienced any losses in such accounts. + +Comprehensive Income (Loss) + + Comprehensive income (loss) is the total of net income (loss) and other non-owner changes in equity including unrealized gains or losses on +available-for-sale marketable securities. + +Earnings/Loss Per Share + + The Company utilizes Statement of Financial Accounting Standards No. 128 "Earnings Per Share," (SFAS 128), whereby basic earnings per share ("EPS") +excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS assumes conversion of +dilutive options and warrants, and the issuance of common stock for all other potentially dilutive equivalent shares outstanding. + +F-15 + + + + Following +is a reconciliation of the numerator and denominator of Basic EPS to the numerator and denominator of Diluted EPS for all years presented. + + + + +Years Ended September 30, + + + + + +2003 + +2002 + +2001 + + +Numerator: + + + + + + + + + + + +Basic EPS + + + + + + + + + + + + +Net earnings (loss) + +$ +(5,777,119 +) +$ +(6,386,585 +) +$ +(5,847,457 +) + + +Dividends and accretion on preferred stock + + +1,629,874 + + +1,041,810 + + +63,000 + + + + + + + + + + + +Net earnings (loss) attributable to common stockholders + +$ +(7,406,993 +) +$ +(7,428,395 +) +$ +(5,910,457 +) + + + + + + + + + + +Denominator: + + + + + + + + + + + + + + + + + + + + + +Basic EPS + + + + + + + + + + + + +Weighted average shares outstanding + + +17,510,918 + + +10,555,815 + + +5,996,134 + + + + + + + + + + + + +Per share amount + +$ +(.42 +) +$ +(.70 +) +$ +(.99 +) + + + + + + + + + + +Effect of stock options and warrants + + + + + + + + + + + + + + + + + + + + + +Dilutive EPS + + + + + + + + + + + + + + + + + + + + + + +Weighted average shares outstanding including incremental shares + + +17,510,918 + + +10,555,815 + + +5,996,134 + + + + + + + + + + + + +Per share amount + +$ +(.42 +) +$ +(.70 +) +$ +(.99 +) + + + + + + + + + + +Investment + + The investment represented securities available for sale which were stated at fair value. Unrealized holding gains and losses were reflected as a net amount in +accumulated other comprehensive loss until realized. The entire investment, which consisted of an investment in a publicly-traded foreign company (see Note 4), was sold in the year ended +September 30, 2002 at a gross realized loss of $2,159,415. There were no gross realized gains and losses on sales of available-for-sale securities for the years ended +September 30, 2003 and 2001. + +F-16 + + + +Property and Equipment + + Property and equipment is stated at cost, less accumulated depreciation. Depreciation is provided over the estimated useful lives of the assets as follows: + + + + +Method + +Estimated + +Useful Life + +Furniture and fixtures + +Declining balance + +5 years + +Office equipment + +Declining balance + +5 years + +Computer equipment + +Straight-line + +5 years + +Computer software + +Straight-line + +3 years + +Vans + +Straight-line + +5 years + +Goodwill + + Effective October 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 142. "Goodwill and other +Intangible Assets." The provisions at SFAS No. 142 require that intangible assets not subject to amortization and goodwill be tested for impairment annually or more frequently if events or +changes in circumstances indicate that the carrying value may not be recoverable. Amortization of goodwill and intangible assets with indefinite lives, including such assets recorded in past business +combinations, ceased upon adoption. Thus no amortization for such goodwill was recognized in the accompanying statement of operations for the year ended September 30, +2003, compared to $289,177 and $332,636 for the years ended September 30, 2002 and 2001, respectively. + + In +order to assess the fair value of our goodwill as of the adoption date, we engaged an independent valuation firm to assist in determining the fair value. The valuation process +appraised our assets and liabilities using a combination of present value and multiple of earnings valuation techniques. Based upon the results of the valuations it was determined that there was no +impairment of goodwill. + + Prior +to the adoption of SFAS No. 142 on October 1, 2002, the Company amortized goodwill over its estimated useful life of fifteen years and evaluated goodwill for +impairment in conjunction with its other long-lived assets. In this connection, the Company recorded charges of $400,000 and $700,000 in the years ended September 30, 2002 and 2001, +respectively. $100,000 has been reclassified to discontinued operations in the year ended September 30, 2002. The steady decline in revenue and earnings of certain previously acquired business +units and in the case of one business unit, the loss of a major customer, required that the Company adjust the carrying value of the goodwill. + +Factoring + + The Company's factoring agreement (see Note 5) with a financing institution ("factor") had been accounted for as a sale of receivables under Statement of +Financial Accounting Standards No. 125 "Accounting for Transfers and Services of Financial Assets and Extinguishment of Liabilities." ("SFAS" No. 125). + +F-17 + + + +Fair Values of Financial Instruments + + Fair values of cash and cash equivalents, accounts receivable, accounts payable and short-term borrowings approximate cost due to the short period of +time to maturity. Fair values of long-term debt, which have been determined based on borrowing rates currently available to the Company for loans with similar terms or maturity, +approximate the carrying amounts in the financial statements. + +Stock-Based Compensation + + The Company accounts for stock-based compensation issued to its employees and directors in accordance with Accounting Principle Board No. 25, "Accounting +for Stock Issued to Employees," and has elected to adopt the "disclosure only" provisions of SFAS No. 123 as amended by provisions of SFAS No. 148, "Accounting for Stock-Based +Compensation Transition and Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a +voluntary change to the fair value based method of accounting for stock-based compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require new +permanent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used in reported results. + + For +SFAS No. 148 purposes, the fair value of each option granted is estimated as of the date of grant using the Black-Scholer option pricing model with the following weighted +average assumptions used: + + + + +Years Ended September 30, + + + + +2003 + +2002 + +2001 + +Risk-free interest rate + +4% + +4% + +5% + +Dividend yield + +0% + +0% + +0% + +Expected life + +4 - 7 years + +4 - 7 years + +4 - 7 years + +Volatility + +100% + +100% + +84% + +F-18 + + + + If +the Company had elected to recognize the compensation costs of its stock option plans based on the fair value of the awards under those plans in accordance with SFAS No. 148, +net loss and loss per share would have been adjusted to the proforma amounts below: + + + + +Years Ended September 30, + + + + + +2003 + +2002 + +2001 + + +Net (loss) attributable to common stockholders, as reported + +$ +(7,406,993 +) +$ +(7,428,395 +) +$ +(5,910,457 +) + +Deduct: + + + + + + + + + + + +Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects + + +(1,974,862 +) + +(2,392,090 +) + +(2,136,353 +) + + + + + + + + + + +Pro forma net (loss) attributable to common stockholders + +$ +(9,381,855 +) +$ +(9,820,485 +) +$ +(8,046,810 +) + + + + + + + + + + +(Loss) from continuing operations per common share attributable to common stockholders: + + + + + + + + + + + + + + + + + + + + + +Basic as reported + +$ +(.42 +) +$ +(.70 +) +$ +(.99 +) + +Basic pro forma + +$ +(.54 +) +$ +(.93 +) +$ +(1.35 +) + +Diluted as reported + + + +$ + +(.42 + +) + +$ + +(.70 + +) + +$ + +(.99 + +) + +Basic pro forma + +$ +(.54 +) +$ +(.93 +) +$ +(1.35 +) + +Income Taxes + + The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the +enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. The Company provides a valuation allowance for deferred tax assets for which it does not +consider realization of such assets to be more likely than not. + +Advertising Costs + + Advertising costs are expensed as incurred. The expenses for the years ended September 30, 2003, 2002 and 2001 were $136,000, $122,000 and $143,000, +respectively, and are included in selling, general and administrative expenses. + +Impairment of Long-Lived Assets + + The Company evaluates the recoverability of its long-lived assets in accordance with Statement of Financial Accounting Standards No. 144 +"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 requires recognition of impairment of long-lived assets in the +event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. + +F-19 + + + +New Accounting Pronouncements + + In June 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 141, "Business Combinations." SFAS No. 141 establishes +new standards for accounting and reporting requirements for business combinations and requires that the purchase method of accounting be used for all business combinations initiated after +June 30, 2001. SFAS No. 141 also requires that acquired intangible assets be recognized as assets apart from goodwill if they meet one of the two specified criteria. Additionally, the +statement adds certain disclosure requirements to those required by APB 16, including disclosure of the primary reasons for the business combination and the allocation of the purchase price paid to +the assets acquired and liabilities assumed by major balance sheet caption. This statement is required to be applied to all business combinations initiated after June 30, 2001 and to all +business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later. Use of the pooling-of-interests method is +prohibited. The adoption of SFAS No. 141 did not have an impact on the Company's financial condition or results of operations. + + In +June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142, which must be applied to fiscal years beginning after +December 15, 2001, modifies the accounting and reporting of goodwill and intangible assets. The pronouncement requires entities to discontinue the amortization of goodwill, reallocate all +existing goodwill among its reporting segments based on criteria set by SFAS No. 142, and perform initial impairment tests by applying a fair-value-based analysis on the goodwill in +each reporting segment. Any impairment at the initial adoption date shall be recognized as the effect of a change in accounting principle. Subsequent to the initial adoption, goodwill shall be tested +for impairment annually or more frequently if circumstances indicate a possible impairment. + + Under +SFAS No. 142, entities are required to determine the useful life of other intangible assets and amortize the value over the useful life. If the useful life is determined to +be indefinite, no amortization will be recorded. For intangible assets recognized prior to the adoption of SFAS No. 142, the useful life should be reassessed. Other intangible assets are +required to be tested for impairment in a manner similar to goodwill. The Company adopted SFAS No. 142 and completed a transitional impairment test, as required by SFAS No. 142, and +determined that there was no impairment of goodwill as of October 1, 2002. + + In +August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS +No. 121, "Accounting for the Impairment of Long-Lived Assets for the Long-Lived Assets to be Disposed of." SFAS No. 144 retains the requirements of SFAS +No. 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an +impairment loss as the difference between the carrying amount and the fair value of the asset. SFAS No. 144 removes goodwill from its scope. SFAS No. 144 is applicable to financial +statements issued for fiscal years beginning after December 15, 2001, or for our fiscal year ending September 30, 2003. The adoption of SFAS No. 144 did not have any material +adverse impact on the Company's financial position or results of our operations. + + In +June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" which nullifies EITF No. 94-3, "Liability +Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a +cost associated with an exit or disposal + +F-20 + + + +activity +be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity's +commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 +is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a material impact on the Company's financial position +and results of operations. + + In +January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities." Interpretation 46 changes the criteria by which one company includes +another entity in its consolidated financial statements. Previously, the criteria were based on control through voting interest. Interpretation 46 requires a variable interest entity to be +consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns +or both. A company that consolidates a variable interest entity is called the primary beneficiary of that entity. The consolidation requirements of Interpretation 46 apply immediately to variable +interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period ending after December 15, 2003. +Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company does not +expect the adoption to have a material impact on the Company's financial position or results of operations. + + In +April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS 33 on Derivative Instruments and Hedging Activities." SFAS No. 149 is intended to result in more +consistent reporting of contracts as either freestanding derivative instruments subject to SFAS No. 33 in its entirety, or as hybrid instruments with debt host contracts and embedded derivative +features. In addition, SFAS No. 149 clarifies the definition of a derivative by providing guidance on the meaning of initial net investments related to derivatives. SFAS No. 149 is +effective for contracts entered into or modified after June 30, 2003. The Company does not expect that the adoption of SFAS No. 149 will have an impact on its financial position, results +of operations or cash flows. + + In +May 2003, the FASB issued FASB Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 +changes the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires that those instruments be classified as liabilities (or assets +in certain circumstances) in statements of financial position. This statement affects the issuer's accounting for three types of freestanding financial instruments including (1) mandatorily +redeemable shares that are required to be redeemed at a specified or determinable date or upon an event certain to occur, (2) put options and forward purchase contracts, which involves +financial instruments embodying an obligation that the issuers must or could choose to settle by issuing a variable number of its shares or other equity instruments based solely on something other +than the issuer's own equity shares and (3) certain obligations that can be settled with shares, the monetary value of which is (i) fixed, tied solely or predominantly to a variable such +as a market index, or (ii) varies inversely with the value of the issuers' shares. For public companies, SFAS No. 150 became effective at the beginning of the first interim period +beginning after June 15, 2003. As a result of SFAS No. 150, the Company has classified put options that were previously classified as "Temporary equity" and its Series A +redeemable convertible preferred stock as liabilities at September 30, 2003. + +F-21 + + + +Reclassifications + + Certain prior year financial statement amounts have been reclassified to be consistent with the presentation for the current year. + +Note 2 Acquisitions + + On October 27, 2000, the Company purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of seven offices of +Tandem, a division of Outsource International, Inc. The initial purchase price for the assets was $125,000; of which $50,000 was paid in cash at the closing and the remaining $75,000 was +represented by a promissory note secured by the assets purchased by the Company. The note was payable in twenty-four equal monthly installments of principal and interest at a variable rate +of prime plus two percent beginning December 1, 2000. In January 2001, the Company exercised an option to repay the outstanding balance of the note plus $175,000 in lieu of an earnout +payment of thirty percent of the Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") of the acquired business for a two-year period. + + The +excess of cost paid over net assets acquired resulted in goodwill of $855,718, computed as follows: + +Net assets acquired + + + + + + +Furniture and equipment + +$ +31,650 + + + +Accrued holiday and vacation pay + + +(21,758 +) + + + + + + + + + +9,892 + + + + + + + +Amounts paid + + + + + + +Cash + + +50,000 + + + +Note payable + + +75,000 + + + +Earnout payable + + +175,000 + + + +Finder's fees ($511,250) and professional fees paid to third parties + + +565,610 + + + + + + + + + + +865,610 + + + + + + + + +Excess of amounts paid over net assets acquired goodwill + +$ +855,718 + + + + + + + + On +January 2, 2001, the Company purchased substantially all of the tangible and intangible assets of Cura Staffing, Inc. and The WorkGroup Professional +Services, Inc. The purchase price was $175,000 of which $100,000 was paid in cash at the closing and the remaining $75,000 was represented by a 90-day promissory note for $50,000 +and $25,000 payable $5,000 a month beginning after the payment of the 90-day promissory note. The promissory note bore interest at 6% a year. + +F-22 + + + + The +excess of cost paid over net assets acquired resulted in goodwill of $228,144, computed as follows: + +Net assets acquired + + + + + + +Furniture and equipment + +$ +11,000 + + + +Accrued holiday and vacation pay + + +(12,000 +) + + + + + + + + + +(1,000 +) + + + + + + +Amounts paid + + + + + + + + + + +Cash + + +100,000 + + + +Note payable and other payables + + +75,000 + + + +Finder's fees ($25,000) and professional fees paid to third parties + + +52,144 + + + + + + + + + + +227,144 + + + + + + + +Excess of amounts paid over net assets acquired goodwill + + + +$ + +228,144 + + + + + + + + + On +July 27, 2001, the Company purchased substantially all of the tangible and intangible assets, excluding accounts receivable of the clerical and light industrial staffing +division of Source One Personnel, Inc. ("Source One"). As a result of the acquisition, the Company has expanded its presence in the Philadelphia to New York corridor. + + The +initial purchase price for the assets was $3,400,000, of which $200,000 in cash, and 400,000 shares of the Company's restricted common stock were paid at the closing and the +remaining $2,400,000 was represented by two promissory notes. In addition, Source One is entitled to earnout payments based upon the acquired business achieving certain performance levels during each +of the three fiscal years beginning October 1, 2001. There was no earnout payment due for the years ended September 30, 2003 and 2002. There was an additional $42,163 of costs paid to +third parties in connection with the acquisition. The first note, representing $600,000, was payable in one installment of $600,000 plus accrued interest at 7% per year, at 180 days after the +closing. The second note, representing $1,800,000 bears interest at 7% per year and is payable over a four-year period in equal quarterly payments beginning 120 days after the +closing. Source One had agreed to allow the Company to defer the payment of the first note and the February 2002 installment of the second note until the earlier of the receipt of the proceeds +from the sale of the Company's Engineering Division (see Note 4) or April 30, 2002. In June 2002, Source One agreed to forbear from exercising remedies against the Company until +June 30, 2002. On July 31, 2002, the Company cured all payment defaults under the first and second notes. In exchange for the forbearance, the Company issued 250,000 shares of its +restricted Common Stock to Source One. Source One has a put option to sell 400,000 shares back to the Company at $2 per share between 24 months after the closing and final payment of the second +note, but not less than 48 months (see Note 17). + +F-23 + + + + The +following table summarizes the fair value of the assets acquired at the date of acquisition based upon a third-party valuation of certain intangible assets: + +Property and Equipment + +$ +105,000 + +Intangible assets + + +636,300 + +Goodwill + + +2,700,863 + + + + +Total assets acquired + +$ +3,442,163 + + + + + Of +the $636,300 of intangible assets, $127,300 was assigned to a covenant-not-to-compete and $509,000 was assigned to the customer list. The +intangible assets are being amortized over their estimated useful life of four years. +Goodwill is not being amortized under the provision of SFAS No. 142. All of the goodwill is expected to be deductible for tax purposes. + + Effective +January 1, 2002, the Company purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of seven offices of Provisional Employment +Solutions, Inc. ("PES"). The initial purchase price was $1,480,000, represented by a $1,100,000 promissory note and 400,000 shares of the Company's common stock. There was an additional +$334,355 of costs paid to third parties in connection with the acquisitions. In addition, PES is entitled to earnout payments of 15% of pretax profit of the acquired business up to a total of +$1.25 million or the expiration of ten years, whichever occurs first. There was no earnout payment due for the years ended September 30, 2003 and 2002. The note bears interest at 6% a +year and is payable over a ten-year period in equal quarterly payments. + + The +following table summarizes the fair value of the assets acquired at the date of acquisition based upon a third-party valuation of certain intangible assets: + +Property and Equipment + +$ +42,000 + +Intangible assets + + +468,596 + +Goodwill + + +1,306,131 + + + + +Total assets acquired + +$ +1,816,727 + + + + + Of +the $468,596 of intangible assets, $85,880 was assigned to covenant-not-to-compete and $382,716 was assigned to the customer list. The intangible +assets are being amortized over their estimated useful life of two to four years. Goodwill is not being amortized under the provision of SFAS No. 142. All of the goodwill is expected to be +deductible for tax purposes. + +F-24 + + + + Effective as of December 1, 2002, (the "Effective Date"), the Company purchased substantially all of the tangible and intangible assets, excluding accounts +receivable, of six offices of Elite Personnel Services ("Elite"), a California corporation. The Elite branches provide temporary light industrial and clerical staffing in six business locations in +California and Nevada. The Company also took over Elite's Downey, California office, from which Elite serviced no accounts but which it utilized as a corporate office. The company intends to continue +to utilize the Downey office as a regional corporate facility. The acquisition of Elite furthers the Company's expansion into the California staffing market. Pursuant to the terms of an Asset Purchase +Agreement between the Registrant and Elite dated November 19, 2002 (the "Asset Purchase Agreement"), the purchase price payable at closing (the "Base Purchase Price") for the assets was +$1,264,000, all of which was represented by an unsecured promissory note. In addition to the Base Purchase Price, Elite will also receive as a deferred purchase price, an amount equal to 10% of the +annual "Gross Profits" as defined in the Asset Purchase Agreement of the acquired business between $2,500,000 and $3,200,000, and 15% of the annual Gross Profits of the acquired business in excess of +$3,200,000 for a period of two years from the Effective Date. The note includes a stated imputed interest at 4% per year and is payable over an eight-year period in equal monthly payments +beginning 30 days after the Effective Date. In connection with the transaction, Elite, its President and other key management members entered into non-competition and +non-solicitation agreements pursuant to which they agreed not to compete with the Registrant in the territories of the acquired business for periods ranging from twelve months to five +years, and to not solicit the employees or customers of the acquired business for periods ranging from twelve months to five years. + + For +financial accounting purposes, interest on the note has been imputed at a rate of 11% per year. Accordingly, the note and Base Purchase Price has been recorded at $845,875. In +accordance with SFAS No. 141, "Business Combinations" the contingent portion of the purchase price has been recognized as a liability to the extent that the net acquired assets exceed the +purchase price. Accordingly, $244,000 is included in "Accounts payable and accrued expenses" on the attached balance sheet as of September 30, 2003. There was an additional $176,644 of costs +paid to third parties in connection with the acquisition. + + The +following summarizes the fair value of the assets acquired at the date of acquisition based upon a third-party valuation of certain intangible assets: + +Property and Equipment + +$ +75,000 + +Covenant-not-to-compete + + +19,500 + +Customer list + + +1,172,019 + + + + +Total assets acquired + +$ +1,266,519 + + + + + The +covenant-not-to-compete and customer list are being amortized over their estimated useful life of five and seven years, respectively. + + The +above acquisitions have been accounted for as purchases. The results of operations are included in the Company's statements of operations from the effective date of acquisition. + + The +unaudited pro forma results of operations presented below assume that the acquisitions had occurred at the beginning of fiscal 2002. This information is presented for informational +purposes only + +F-25 + + + +and +includes certain adjustments such as goodwill amortization resulting from the acquisitions and interest expense related to acquisition debt. + + + + +Unaudited + +Year Ending September 30, + + + + + +2003 + +2002 + + +Revenues + +$ +82,170,209 + +$ +75,194,801 + + +Net (loss) from continuing operations attributable to common stockholders + + + + + +(6,003,032 + +) + + + +(8,513,443 + +) + +Net (loss) per share attributable to common stockholders + + + + + + + + + + + + + + + + +Basic + +$ +(.34 +) +$ +(.81 +) + + +Diluted + +$ +(.34 +) +$ +(.81 +) + + The +maturities on notes payable-acquisitions are as follows: + +Year Ending September 30 + + + + +2004 + +$ +657,224 + +2005 + + +683,062 + +2006 + + +198,071 + +2007 + + +215,356 + +2008 + + +234,356 + +Thereafter through 2013 + + +734,435 + + + + + + +$ +2,722,504 + + + + +Note 3 Discontinued Operations + +Sale of Engineering Division + + On January 24, 2002, the Company entered into an agreement to sell the assets of its Engineering Services Division (the "Division") to SEA Consulting +Services Corporation ("SEA"). + + On +March 28, 2002, the Company completed the sale of the assets of the Division to SEA pursuant to the Asset Purchase Agreement dated as of January 24, 2002, among the +Company, SEP, LLC ("SEP"), Charles Sahyoun, Sahyoun Holders LLC and SEA. The transaction was approved by a vote of the Company's stockholders at the Company's annual meeting of stockholders held on +March 28, 2002. + + The +assets of the Division had been transferred to SEP, a limited liability company in which the Company owned a 70% interest, at the time of the execution of the Asset Purchase +Agreement. Sahyoun Holders, LLC, a company wholly-owned by Charles Sahyoun, the President of the Division, owned the remaining 30% interest in SEP. + + Under +the terms of the Asset Purchase Agreement, the Company received an initial cash payment of $1,560,000, which represented 80% of the initial $2,200,000 installment of the purchase +price payable to SEP net of a $200,000 broker's fee due to a third party. Sahyoun Holdings, LLC received the other 20% of the initial net installment of the purchase price, or $440,000. + +F-26 + + + + The +Asset Purchase Agreement required SEA to make the following additional payments to SEP: + +(i)A +payment of $1 million, plus or minus the amount by which SEA's profit for the six months ending June 30, 2002, as determined pursuant to the Asset +Purchase Agreement, were less than $600,000 (the "Second Payment"); + +(ii)A +payment of $1 million, plus or minus the amount by which SEA's profit for the six months ending December 31, 2002, as determined pursuant to the Asset +Purchase Agreement, were greater or less than $600,000 (the "Third Payment"); + +(iii)Five +subsequent annual payments (the "Subsequent Payments") which will be based upon a multiple of the annual successive increases, if any, in SEA's profit during the +five year period beginning on January 1, 2003 and ending December 31, 2007. + + Pursuant +to an allocation and indemnity agreement entered into by the Company, Sahyoun Holdings, LLC and Charles Sahyoun (the "Allocation and Indemnity Agreement"), the Company was +entitled to $250,000 of the Second Payment and $250,000 of the Third Payment. On April 15, 2002, by letter agreement between the Company, Sahyoun Holdings, LLC and Joseph J. Raymond, Sr., the +Chairman and Chief Executive Officer of the Company, the parties agreed to a modification of the Allocation and Indemnity Agreement. Per that letter agreement, Sahyoun Holdings, LLC provided the +Company with $200,000 cash in exchange for the Company's short-term, 90-day demand note, due and payable by August 1, 2002 in the amount of $250,000. Such $250,000 was +repaid by the Company from its $250,000 share of the Second Payment which was received in June 2002. + + Sahyoun +Holdings, LLC and Charles Sahyoun guaranteed the $250,000 payment to be made to the Company from the Third Payment, regardless of the operating results of SEA. In +December 2002, the Company and Charles Sahyoun agreed to offset the $250,000 of the Third Payment due to the Company against $250,000 of accrued commissions due Charles Sahyoun. As a result, +the Company is not entitled to any additional payments under the Asset Purchase Agreement. + + The +transaction resulted in a gain, which was calculated as follows: + +Initial cash payment + +$ +2,200,000 + + +Guaranteed additional payments + + +500,000 + + +Less costs of sale: + + + + + + +Allocations to Sahyoun Holdings, LLC + + +(440,000 +) + + +Broker's fee + + +(200,000 +) + + +Other costs + + +(100,921 +) + + + + + + +Balance + + +1,959,079 + + +Net assets sold + + +200,023 + + + + + + + +Gain + +$ +1,759,056 + + + + + + + + Revenues +from the Division were $2,730,000 and $7,245,000 for the years ended September 30, 2002 and 2001, respectively. + +F-27 + + + +Sale of Certain Branches + + On March 9, 2003, the Company completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of its Colorado +Springs, Colorado office. Pursuant to the terms of an asset purchase agreement between the Company and US Temp Services, Inc. ("US Temps") dated March 9, 2003, the purchase price for the +purchased assets was $20,000 which was paid by a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $608 over a three year period. The note is +secured by a security interest on all of the purchased assets. + + The +purchase price for the assets acquired by US Temps was arrived at through arms-length negotiations between the parties and resulted in a gain on sale of $13,958. + + On +August 22, 2003, the Company completed the sale, effective as of August 18, 2003 (the "ALS Effective Date") of substantially all of the tangible and intangible assets, +excluding accounts receivable, of its Miami Springs, Florida office. Pursuant to the terms of the Asset Purchase Agreement between the Company and ALS, LLC, a Florida limited liability company ("ALS") +dated August 22, 2003 (the "Purchase Agreement"), the purchase price for the purchased assets was $128,000, which was paid by a promissory note, which bears interest at the rate of 7% per year +with payments over a 60 month period. The amount of the monthly payments due under the note will be the greater of $10 per month or 20% of the monthly net profits generated by the staffing +business originating from the purchased assets, commencing October 31, 2003. However, until such time as all outstanding amounts due and owing by the Company to ALS, as of the date of the +Purchase Agreement in the amount of $289,635, have been +paid in full, these monthly payments shall be deducted from any and all amounts due from the Company to ALS. The note is secured by a security interesting all of the purchased assets. + + In +connection with the transaction, ALS entered into a non-compete and non-solicitation agreement pursuant to which ALS agreed not to compete with the Company +with respect to any of the Company's other remaining offices for a period of 18 months. + + The +purchase price for the assets acquired by ALS was arrived at through negotiations with a related party purchaser and resulted in a gain on sale of $10,777. The son of our President +and Chief Executive Officer is a 50% member in ALS, LLC. + + On +September 10, 2003, the Company completed the sale, effective as of September 15, 2003 (the "Effective Date"), of substantially all of the tangible and intangible +assets, excluding account receivable, of five of its New Jersey offices to D/O Staffing LLC ("D/O"). The offices sold are the following: Elizabeth, New Jersey; New Brunswick, New Jersey; Paterson, New +Jersey; Perth Amboy, New Jersey and Trenton, New Jersey. Pursuant to the terms of an asset purchase agreement between D/O and us dated September 10, 2003 (the "D/O Purchase Agreement"), the +base purchase price for the purchased assets was $1,250,000 payable as follows: + +(i)$1,150,000 +payable in certified funds at the closing; and + +(ii)$100,000 +payable in certified funds into escrow at the closing to be held in escrow by attorneys for the Buyer pursuant to the terms of an escrow agreement, to account +for certain post-closing adjustments. + + Additionally, +the Company may be entitled to receive as a deferred purchase price (the "Bonus"), an amount equal to $125,000 if, for the one year period measured from the Effective Date, +the + +F-28 + + + +purchased +assets generate for D/O at least $18,000,000 in actual billings by client accounts serviced by the Company as of the Closing and transferred by the Company to D/O pursuant to the D/O +Purchase Agreement. The Bonus, if any, is payable by a promissory note, payable over 24 months and bearing interest at an interest rate of 6% a year. + + The +purchase price for the assets was arrived at through arms-length negotiations between the parties and resulted in a (loss) on sale of ($50,354). + + On +September 29, 2003, the Company completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of its Las Vegas, Nevada office. +Pursuant to the terms of an asset purchase agreement between the Company and US Temps dated September 29, 2003, the purchase price for the purchased assets was $105,000, all of which was paid +by a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $2,030, over a five year period. The note is secured by a security interest on all of +the purchased assets. + + The +purchase price for the assets acquired by US Temps was arrived at through arms-length negotiations between the parties and resulted in a gain on sale of $4,599. + + The +net loss on sale for the aforementioned certain branches are calculated as follows: + +Sales price: + + + + + + +Cash + +$ +1,150,000 + + + +Promissory notes + + +253,000 + + + +Escrow receivable + + +100,000 + + + + + + + + + +$ +1,503,000 + + + +Less costs of sales + + +(29,229 +) + + + + + + +Balance + + +1,473,771 + + +Net assets sold + + +1,494,791 + + + + + + + +(Loss) + +$ +(21,020 +) + + + + + + + Revenues +from the aforementioned certain branches were $18,089,065, $19,261,294 and $20,734,244 for the years ended September 30, 2003, 2002 and 2001, respectively. + + The +statements of operations for all periods presented have been reclassified to reflect the operating results of the Division and sold branches as discontinued operations. + +Note 4 Transactions with Artisan (UK) plc + + On June 26, 2001, the Company entered into an agreement to purchase 63,025,000 ordinary shares, representing 26.3% of the outstanding shares of +enterpriseAsia.com ("EPA"), a London AIM listed company (see Note 1), from Artisan (UK) pic ("Artisan"). In exchange, the Company issued to Artisan 850,837 shares of the Company's +Series A preferred stock (see Note 14). This transaction was consummated, effective August 15, 2001. + + The +cost of the investment in EPA and value assigned to the preferred stock issued was based upon the market price per share of EPA on the date the transaction was consummated. +Accordingly, + +F-29 + + + +the +original cost of the investment was $1,592,000 and, therefore, the 850,837 shares of preferred stock were assigned a value of $1.87 per share. + + On +July 3, 2001, the Company received $900,000 from Artisan.com Limited ("Artisan.com"), a company affiliated with Artisan, in exchange for 900,000 shares of the Company's common +stock in a private placement. The transaction was in accordance with an agreement dated June 26, 2001 between the Company and Artisan.com. + + In +connection with the transactions with Artisan and Artisan.com, the Company issued 608,096 shares of its Series A preferred stock and 30,000 shares of its common stock for +finders' fees to third parties. + + The +Company entered into the transactions with Artisan to provide immediate and possible future working capital through the sale of the Company's stock to Artisan and to provide the +Company with business expansion opportunities in Asia through the investment in and relationship with EPA. + + The +value of the preferred stock and common stock issued for finders' fees was allocated to the investment in EPA and a reduction to additional paid-in capital based on the +relative value of the original investment of $1,592,000 and the $900,000 received for the 900,000 shares of the Company's common stock. Accordingly, the original cost of the investment in EPA +increased by $757,000 and additional paid-in capital was reduced by $417,700. + + The +Company was unable to exercise significant influence over EPA's operating and financial policies. Therefore, the investment in EPA was classified as +available-for-sale securities and was reported as fair value in the attached balance sheet. + + The +Company has entered into an agreement with Artisan, the current beneficial owner of the Series A Preferred Stock, which requires the Company to purchase 1,458,933 shares of +Series A Preferred Stock from Artisan.com and one of its affiliates if the Company raises at least $4 million of gross proceeds in a proposed public offering of securities. (See +Note 14). + +Note 5 Factoring Agreement + + The Company had a factoring agreement with an unrelated party under which it was able to sell qualified trade accounts receivable, with limited recourse +provisions. The Company was required to repurchase or replace any receivable remaining uncollected for more than 90 days. During the year ended September 30, 2001, gross proceeds from +the sale of receivables was $10,204,208. There were no gains or losses in connection with the sale or repurchase of receivables under the factoring agreement. + + On +December 12, 2000, the Company terminated its agreement with the factor. As part of the termination agreement, the Company repurchased all accounts receivable from the factor +with proceeds from a new line of credit (See Note 6). + +Note 6 Line of Credit + + The Company has a loan and security agreement (the "Loan Agreement") with a lending institution whereby the Company can borrow up to 85% of eligible accounts +receivable, as defined, not to exceed the lesser of $12 million or six times the Company's tangible net worth (as defined). Until December 2002, borrowings under the Agreement bore +interest at 11/2% above the prime rate (see + +F-30 + + + +below) +and are collateralized by substantially all of the Company's assets. The Loan Agreement expires on June 12, 2004. + + At +September 30, 2003, the Company was in violation of the following covenants under the Loan Agreement: + +(i)Failing +to meet the tangible net worth requirement, and; + +(ii)The +Company's common Stock being delisted from the Nasdaq SmallCap Market + + The +Company has received a waiver from the lender on the above violations and, in December 2002, entered into a modification of the Loan Agreement. The modification provided that +borrowings under the Loan Agreement bore interest at 13/4% above the prime rate, as long as the Company was in violation of any of the covenants under the Loan Agreement. + + Effective +April 10, 2003, the Company entered into another modification of the Loan Agreement which provides that borrowings under the Loan Agreement bear interest at 3% above the +prime rate. The prime rate at September 30, 2003 was 4%. + +Note 7 Property and Equipment + + Property and equipment consist of the following as of September 30: + + + + +2003 + +2002 + + +Furniture and fixtures + +$ +709,372 + +$ +666,941 + + +Office equipment + + +118,604 + + +119,719 + + +Computer equipment + + +1,168,148 + + +1,163,135 + + +Computer software + + +217,463 + + +193,028 + + +Vans + + +196,179 + + +216,319 + + + + + + + + + + + + +2,409,766 + + +2,359,142 + + +Accumulated depreciation + + +(1,472,048 +) + +(1,077,325 +) + + + + + + + + +Net property and equipment + +$ +937,718 + +$ +1,281,817 + + + + + + + + + +Note 8 Goodwill and other Intangible Assets + + Effective October 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and other +Intangible Assets." The provisions of SFAS No. 142 require that intangible assets not subject to amortization and goodwill be tested for impairment annually or more frequently if events or +changes in circumstances indicate that the carrying value may not be recoverable. Amortization of goodwill and intangible assets with indefinite lives, including such assets recorded in past business +combinations, ceased upon adoption. Thus no amortization for such goodwill was recognized in the accompanying statement of operations for the year ended September 30, 2003, compared to $289,177 +and $332,636 for the years ended September 30, 2002 and 2001, respectively. + + In +order to assess the fair value of our goodwill as of the adoption date, we engaged an independent valuation firm to assist in determining the fair value. The valuation process +appraised our assets and liabilities using a combination of present value and multiple of earnings valuation + +F-31 + + + +techniques. +Based upon the results of the valuation, it was determined that there was no impairment of goodwill. + + The +following table provides a reconciliation of net (loss) attributable to common stockholders for exclusion of goodwill amortization: + + + + +Years Ended September 30, + + + + + +2003 + +2002 + +2001 + + +Reported net (loss) attributable to common stockholders + +$ +(7,406,993 +) +$ +(7,428,395 +) +$ +(5,910,457 +) + +Add: Goodwill amortization + + + + + +289,177 + + +332,636 + + + + + + + + + + + +Adjusted net (loss) attributable to common stockholders + +$ +(7,406,993 +) +$ +(7,139,218 +) +$ +(5,577,821 +) + + + + + + + + + + +Basic earnings (loss) per share: + + + + + + + + + + + + + + + + + + + + + +Reported net earnings (loss) attributable to common stockholders + +$ +(.42 +) +$ +(.70 +) +$ +(.99 +) + +Add: Goodwill amortization + + + + + +.03 + + +.06 + + + + + + + + + + + +Adjusted net earnings (loss) attributable to common stockholders + +$ +(.42 +) +$ +(.67 +) +$ +(.93 +) + + + + + + + + + + +Diluted earnings (loss) per share: + + + + + + + + + + + + + + + + + + + + + +Reported net earnings (loss) attributable to common stockholders + +$ +(.42 +) +$ +(.70 +) +$ +(.99 +) + +Add: Goodwill amortization + + + + + +.03 + + +.06 + + + + + + + + + + + +Adjusted net earnings (loss) attributable to common stockholders + + +(.42 +) +$ +(.67 +) +$ +(.93 +) + + + + + + + + + + + The +changes in the carrying amount of goodwill for the years ended September 30 were as follows: + +Balance as of September 30, 2000 + +$ +3,716,538 + + +Additions + + +3,784,726 + + +Amortization + + +(332,636 +) + +Impairment + + +(700,000 +) + + + + + + +Balance as of September 30, 2001 + + +6,468,628 + + +Additions + + +1,306,131 + + +Amortization + + +(289,177 +) + +Impairment + + +(400,000 +) + + + + + + +Balance as of September 30, 2002 + + +7,085,582 + + +Disposal of certain branches (see Note 3) + + +(1,269,229 +) + + + + + + +Balance as of September 30, 2003 + +$ +5,816,353 + + + + + + + +F-32 + + + + Intangible +assets consist of the following as of September 30: + + + + +2003 + +2002 + + +Covenant-not-to-compete + +$ +230,480 + +$ +213,180 + + +Customer list + + +1,957,709 + + +891,716 + + + + + + + + + + + + +2,188,189 + + +1,104,896 + + +Less: accumulated amortization + + +(686,610 +) + +(302,751 +) + + + + + + + + + + +$ +1,501,579 + +$ +802,145 + + + + + + + + + + Estimated +amortization expenses for each of the next five years is as follows: + +For the Years Ending September 30 + + + + +2004 + +$ +422,000 + +2005 + + +371,000 + +2006 + + +179,000 + +2007 + + +156,000 + +2008 + + +153,000 + + Amortization +expense of amortizable intangible assets for the years ended September 30, 2003, 2002 and 2001 was $393,982, $276,251 and $26,500, respectively. + +Note 9 Loans Payable + + Loans payable consist of the following as of September 30: + + + + + + + +2003 + +2002 + + +Notes, secured by vans with a book value of $78,740 as of September 30, 2003 + +(i +) +$ +76,223 + +$ +104,971 + + +18% promissory note + +(ii +) + +80,000 + + +80,000 + + +Stock repurchase note + +(iii +) + +76,246 + + +168,121 + + +Demand note + +(iv +) + +52,975 + + +204,703 + + +Demand notes + +(v +) + +420,500 + + +125,000 + + +Short-term loan + +(vi +) + +69,460 + + + + + + + + + + + + + + + + + + + +775,404 + + +682,795 + + +Less current portion + + + + +(737,514 +) + +(464,830 +) + + + + + + + + + + +Non-current portion + + + +$ +37,890 + +$ +217,965 + + + + + + + + + + + +(i)Payable +$3,453 per month, including interest at 9.25% to 10% a year. + +(ii)Note +was due in April 2002. In addition, the Company issued 20,000 shares of its common stock to the noteholder. The noteholder has the right to demand the +repurchase by the Company of the shares issued, until the note is paid in full, at $1.00 per share plus 15% interest. Accordingly, $3,000 was charged to interest expense in the year ended +September 30, 2001 and $23,000, +F-33 + + + +representing +the put option plus interest, is included in "Temporary equity put options" on the attached balance sheets as of September 30, 2003 and 2002. + +(iii)Promissory +note issued in January 2001 in connection with the purchase of treasury stock. Note is payable $8,000 per month, including interest at 15% a year. + +(iv)On +September 30, 2002, the Company converted $215,000 of accounts payable due to Source One (see Note 2) into a demand note. The non-interest +bearing note is due in sixteen monthly installments of $13,437. The amount reflected above is net of $775 of imputed interest. + +(v)Due +to non-related parties on demand, bearing interest at various rates. + +(vi)Short-term +loan payable $7,500 month bearing interest at 8%. + + The +maturities on loans payable are as follows: + +Year Ending September 30 + + + + +2004 + +$ +737,514 + +2005 + + +37,890 + + + + + + +$ +775,404 + + + + +Note 10 Related Party Transactions + +Consulting Agreement + + The son of the Chief Executive Officer of the Company (the "CEO") provides consulting services to the Company. Consulting expense was $53,000, $125,000 and +$281,000 for the years ended September 30, 2003, 2002 and 2001, respectively. + + The +Company has paid consulting fees to an entity whose stockholder is another son of the Chief Executive Officer of the Company. Consulting fees amounted to $86,000, $141,000 and +$119,000 for the years ended September 30, 2003, 2002 and 2001, respectively. + +Sale of Common Stock + + During the year ended September 30, 2002, the Company sold 177,722 shares of its common stock in private placements to a relative of the CEO of the Company +at prices approximating the then current market of $.87 to $.93 per share, for total gross proceeds of $156,833. + + During +the year ended September 30, 2001, the Company sold 382,999 shares of its common stock in private placements to relatives of the CEO of the Company at prices approximating +the then current market of $.93 to $1.43 per share, for total gross proceeds of $410,000, less expenses of $5,958. + +Loans Payable + + During the year ended September 30, 2002, the CEO loaned $75,000 to the Company which was repaid during the year ended September 30, 2003. During +the year ended September 30, 2003, the CEO made various loans to the Company aggregating $215,000 of which $175,000 was repaid by September 30, 2003. + +F-34 + + + + During the year ended September 30, 2002, a son of the CEO loaned $41,000 to the Company, which is still outstanding at September 30, 2003. During +the year ended September 30, 2003, this son of the CEO, another son of the CEO and the brother of the CEO loaned the Company $100,000, $6,000 and $100,000, respectively. All of these amounts +are outstanding at September 30, 2003. + + During +the year ended September 30, 2003, a member of the Board of Directors of the Company and a trust formed for the benefit of the family of another member of the Board of +Directors loaned $100,000 and $116,337, respectively, to the Company. Both of these amounts are outstanding at September 30, 2003. + + All +of the aforementioned loans are unsecured, due on demand and bear interest at various rates. + +Preferred Stock + + In March 2002, a $160,000 note payable by the Company to a company owned by the CEO was exchanged for 32,000 shares of Series B Convertible +Preferred Stock (see Note 14). + + In +July 2002, the CEO invested $1,000,000 in the Company in exchange for 10,000 shares of newly created Series F Convertible Preferred Stock (see Note 14). + +Joint Venture + + The Company provides information technology staffing services through a joint venture, Stratus Technology Services, LLC ("STS"), in which the Company has a 50% +interest. A son of the CEO of the Company has a majority interest in the other 50% venturer. STS commenced operations during the +year ended September 30, 2001. The Company's gain (loss) from operations of STS of $30,473, $46,312 and $(36,344) for the years ended September 30, 2003, 2002 and 2001, respectively, is +included in other income (expense) in the statements of operations. + + Summarized +financial information of STS is not provided because the investment is not material. + +Note Receivable + + The $128,000 "Note Receivable related party" as of September 30, 2003, is the amount due from ALS in connection with the sale of the Company's +Miami Springs, Florida office (see Note 3). ALS is the holding company for Advantage Services Group, LLC ("Advantage"). + +Cost of Revenues + + During the year ended September 30, 2003, Advantage, a company in which a son of the CEO holds a 50% interest, provided payrolling services to certain of +the Company's customers under an arrangement pursuant to which the Company paid Advantage a fee equal to the cost of providing such services plus a specified percentage above Advantage's cost. The +total amount paid to Advantage under this arrangement in fiscal 2003 was $1,224,131 (see Note 23). + +F-35 + + + +Note 11 Accounts Payable and Accrued Expenses + + Accounts payable consist of the following as of September 30: + + + + +2003 + +2002 + +Accounts payable + +$ +2,743,971 + +$ +2,144,573 + +Accrued compensation + + +105,480 + + +383,545 + +Accrued workers' compensation expense + + +786,773 + + +768,739 + +Workers' compensation claims reserve + + +495,794 + + +365,131 + +Accrued interest + + +241,883 + + +161,547 + +Contingent portion of acquisition purchase price (see Note 2) + + +244,000 + + + + +Accrued other + + +169,503 + + +117,812 + + + + + + + + +$ +4,787,404 + +$ +3,941,347 + + + + + + +Note 12 Income Taxes + + Deferred tax attributes resulting from differences between financial accounting amounts and tax bases of assets and liabilities follow: + + + + +2003 + +2002 + + +Current assets and liabilities + + + + + + + + + +Allowance for doubtful accounts + +$ +693,000 + +$ +697,000 + + + +Valuation allowance + + +(693,000 +) + +(697,000 +) + + + + + + + + +Net current deferred tax asset + +$ + + +$ + + + + + + + + + + +Non-current assets and liabilities + + + + + + + + + +Net operating loss carryforward + +$ +7,327,000 + +$ +4,572,000 + + + +Intangibles + + +394,000 + + + + + + +Valuation allowance + + +(7,327,000 +) + +(4,572,000 +) + + + + + + + + +Net non-current deferred tax asset + +$ + + +$ + + + + + + + + + + + The +change in valuation allowance was an increase of $2,751,000, $2,355,000 and $2,316,000 for the years ended September 30, 2003, 2002, and 2001, respectively. + + + + +2003 + +2002 + +2001 + + +Income taxes (benefit) is comprised of: + + + + + + + + + + + + +Current + +$ + + +$ + + +$ + + + + +Deferred + + +(2,751,000 +) + +(2,355,000 +) + +(1,976,000 +) + + +Change in valuation allowance + + +2,751,000 + + +2,355,000 + + +2,316,000 + + + + + + + + + + + + + +$ + + +$ + + +$ +340,000 + + + + + + + + + + + +F-36 + + + + At +September 30, 2003, the Company has available the following federal net operating loss carryforwards for tax purposes: + +Expiration Date Year Ending September 30, + + + + +2012 + +$ +122,000 + +2018 + + +1,491,000 + +2019 + + +392,000 + +2021 + + +4,860,000 + +2022 + + +4,407,000 + +2023 + + +6,060,000 + + The +utilization of the net operating loss carryforwards may be limited due to changes in control. + + The +effective tax rate on net earnings (loss) varies from the statutory federal income tax rate for periods ended September 30, 2003, 2002 and 2001. + + + + +2003 + +2002 + +2001 + + +Statutory rate + +(34.0 +)% +(34.0 +)% +(34.0 +)% + +State taxes net + +(6.0 +) +(6.0 +) +(6.0 +) + +Other differences, net + + + + + +(0.4 +) + +Valuation allowance + +40.0 + +40.0 + +40.4 + + +Benefit from net operating loss carryforwards + + + + + + + + + + + + + + + + + + + + +% + +% + +% + + + + + + + + + + +Note 13 Convertible Debt + + At various times during the years ended September 30, 2002 and 2001, the Company issued, through private placements, a total of $508,050 and $3,643,402, +respectively, of convertible debentures. The debentures bore interest at 6% a year, payable quarterly and had a maturity date of five years from issuance. Each debenture was convertible after +120 days from issuance into the number of shares of the Company's common stock determined by dividing the principal amount of the debenture by the lesser of (a) 120% of the closing bid +price of the common stock on the trading day immediately preceding the issuance date or (b) 75% of the average closing bid price of the common stock for the five trading days immediately +preceding the date of the conversion. The Company had the right to prepay any of the debentures at any time at a prepayment rate that varied from 115% to 125% of the amount of the debenture depending +on when the prepayment was made. + + The +discount arising from the 75% beneficial conversion feature aggregated $136,000 and $1,213,747 in the years ended September 30, 2002 and 2001, respectively, and was being +charged to interest expense during the period from the issuance of the debenture to the earliest time at which the debenture became convertible. + + Deferred +finance costs incurred in connection with the issuance of the debentures aggregated approximately $100,000 and $738,000 in the years ended September 30, 2002 and 2001, +respectively, and was being amortized over the five year term of the debentures. Included in the $738,000 is $88,000 for 50,000 five-year, $5.00 warrants and 100,000 five-year, +$7.50 warrants issued as finders' fees. In + +F-37 + + + +addition, +the Company paid approximately $80,000 and $280,000 in the years ended September 30, 2002 and 2001, respectively, in exchange for extending the earliest conversion date and the +maturity date by an additional 120 days on approximately $592,000 and $1,048,500 of debentures, respectively. These amounts were charged to deferred finance costs and were being amortized over +120 days. Included in interest expense for the years ended September 30, 2002 and 2001 is approximately $290,000 and $146,000, respectively, for amortization of deferred finance costs in +connection with the debentures. + + During +the years ended September 30, 2002 and 2001, the Company redeemed $270,180 and $1,897,220 of debentures, respectively, resulting in a gain (loss) of approximately $3,000 +and ($71,000), respectively, which is included in "Other income (expense)" in the statements of operations. The gain (loss) is comprised of the following: + + + + +2002 + +2001 + + +Beneficial conversion feature + +$ +90,000 + +$ +632,000 + + +Forgiveness of debt + + +12,000 + + + + + +Prepayment premiums + + +(44,000 +) + +(326,000 +) + +Deferred finance costs + + +(54,000 +) + +(377,000 +) + +Other costs + + +(1,000 +) + + + + + + + + + + + + + +$ +3,000 + +$ +(71,000 +) + + + + + + + + + During +the year ended September 30, 2002, $970,593 of debentures were converted into 2,537,479 shares of common stock at prices ranging from $.30 to $.60 per share. During the +year ended September 30, 2001, $542,500 of debentures were converted into 628,060 shares of common stock at prices ranging from $.85 to $.90 per share. The Company issued 108,666 shares of +treasury stock to a debenture holder in connection with a conversion during the year ended September 30, 2001. + + In +March 2002, the Company entered into an agreement with the holder (the "Debenture Holder") of all but $40,000 of the outstanding debentures pursuant to which it issued to the +Debenture Holder 231,300 shares of Series B Convertible Preferred Stock (see Note 14) in exchange for (i) $456,499 aggregate principal amount of debentures, (ii) the +cancellation of a $400,000 promissory note issued by the Company to the Debenture Holder in January 2002, and (iii) $300,000 in cash. As a result, only $40,000 of Debentures remains +outstanding at September 30, 2002 and 2003. + +Note 14 Preferred Stock + +a. Series A + + In August 2001, the Company issued 1,458,933 shares of Series A Convertible Preferred Stock (the "Series A Preferred Stock") in connection +with transactions with Artisan (see Note 4). + + The +shares of Series A Preferred Stock have a stated value of $3.00 per share. The difference between the carrying value and redemption value of the Series A Preferred +Stock is being accreted through a charge to additional paid-in-capital through the June 30, 2008 redemption date. + + The +Series A Preferred Stock entitles the holders thereof to cumulative dividends at $.21 per share per year, payable semi-annually, commencing on December 31, +2001, when and if declared by the Board of Directors. The shares of Series A Preferred Stock are convertible at the option of the holder + +F-38 + + + +into +shares of the Company's Common Stock on a one-for-one basis. On June 30, 2008, the Company will be required to redeem any shares of Series A Preferred Stock +outstanding at a redemption price of $3.00 per share together with accrued and unpaid dividends, payable at the Company's option, either in cash or in shares of common stock. For purposes of +determining the number of shares which the Company will be required to issue if it chooses to pay the redemption price in shares of Common Stock, the Common Stock will have a value equal to the +average closing price of the Common Stock during the five trading days immediately preceding the date of redemption. + + At +the Company's Annual Meeting of Stockholders held on March 28, 2002, the stockholders approved the issuance by the Company of the full number of shares of Common Stock, which +may be issued by the Company in connection with the conversion of the Series A Preferred Stock. Accordingly, the Company's obligation to redeem a portion of the outstanding shares of +Series A Preferred Stock, if such approval was not obtained, was terminated and the Series A Preferred Stock was reclassified to permanent equity and is included in Stockholders' equity +at September 30, 2002. Pursuant to SFAS No. 150, the current value of the Series A Preferred Stock, including accrued dividends, is classified as a liability at +September 30, 2003. + + In +July 2003, the Company entered into an agreement with Artisan pursuant to which the Company has agreed to redeem the aggregate 1,458,933 shares of its Series A Preferred +Stock owned by Artisan.com and Cater Barnard (USA) plc, an affiliate of Artisan. These shares represent all of the shares of Series A Preferred Stock currently outstanding. The obligation to +redeem the Series A Preferred Stock is contingent upon the Company's sale of not less than $4,000,000 of units consisting of one share of common stock and one common stock warrant ("Units") in +a proposed "best-efforts" +public offering of securities (the "Offering"). If the Company sells at least $4,000,000 of Units in the Offering, it will be obligated to pay $500,000 to Artisan within 15 days after the +$4,000,000 of Units are sold. In addition, the Company will be obligated to pay Artisan an additional $250,000 by January 31, 2005 or, at the Company's option, issue to Artisan shares of the +Company's common stock having an aggregate market value of $250,000, based upon the average closing bid prices of the common stock for the 30 trading days preceding January 31, 2005. If the +Company fails to make the $250,000 payment in cash or stock, it will be required to pay Artisan $300,000 in cash, plus interest calculated on a daily basis at a rate of 18% from the date of the +default to the date the default is cured. The Company has also agreed to issue to Artisan a number of shares of the Company's common stock which will represent 5.5% of its outstanding common stock, +subject to certain adjustments, upon completion of the sale of $4,000,000 million of units of common stock so that the total number of shares of common stock issued to Artisan will equal 5.5% +of the Company's common stock after giving effect to the assumed exercise of all warrants and options that then have exercise prices equal to or less than the then current market price of the +Company's common stock and the conversion of all convertible securities that then have conversion prices equal to or less than the then current market price of the Company's common stock. + +b. Series B + + In March 2002, the Company issued 32,000 shares of Series B Convertible Preferred Stock (the "Series B Preferred Stock") in exchange for a +$160,000 note due to a company owned by the Chief Executive of the Company (see Note 10). An additional 231,300 shares were issued to the Debenture Holder (see Note 14) in exchange for +(i) 456,499 aggregate principal amount of debentures, (ii) cancellation of a $400,000 promissory note due to the Debenture Holder and (iii) $300,000 in cash. + +F-39 + + + + The +shares of Series B Convertible Preferred Stock have a stated value of $5 per share. Holders of the Series B Preferred Stock are entitled to cumulative dividends at a +rate of 6% of the stated value per year, payable when and as declared by the Board of Directors. Dividends may be paid in cash or, at the option of the Company, in shares of Common Stock, under +certain circumstances. Holders of Series B Preferred Stock are entitled to a liquidation preference of $5.00 per share plus accrued dividends. The Series B Preferred Stock is convertible +into shares of Common Stock at the option of the holder at any time. The number of shares of Common Stock into which each share of Series B Preferred Stock is convertible is determined by +dividing the aggregate liquidation preference of the shares being converted by the lesser of (i) $4.65 or (ii) 75% of the closing bid price of the Common Stock on the trading day +preceding the date of conversion. The discount arising from the beneficial conversion feature was treated as a dividend from the date of issuance to the earliest conversation date. + + In +June 2002, the Company redeemed for cash, 91,000 shares of Series B Preferred Stock at $5.00 per share, totaling $455,000. + + At +a Special Meeting of Stockholders held on July 26, 2002, the Company received approval from its stockholders of a proposal to approve the issuance of shares of Common Stock +upon conversion of the Series B Preferred Stock in excess of the limits imposed by the rules of the Nasdaq Stock Market, in the event that the Company's Common Stock is reinstated for trading +on the Nasdaq Stock Market. + + In +July 2002, the remaining 172,300 shares of Series B Preferred Stock (including the 32,000 shares held by a company owned by the Chief Executive Officer of the Company) +were exchanged for 8,615 shares of Series E Convertible Preferred Stock (the "Series E Preferred Stock"). + +c. Series E + + In July 2002, the Company sold 7,650 shares of newly created Series E Preferred Stock in a private placement for $765,000 in cash and issued an +additional 8,615 shares of Series E Preferred Stock in exchange for all of the outstanding shares of Series B Preferred Stock, which had an aggregate stated value of $861,500. In +addition, $41,790 of dividends and penalties, which had accrued on the Series B Preferred Stock prior to the exchange were exchanged for 418 shares of Series E Preferred Stock. + + In +July 2003, the Company sold 14,362 shares of Series E Preferred Stock in private placements for $1,436,250 in cash. Also, in July 2003, the Company entered into +an agreement with the holder of the Series H Convertible Preferred Stock (the "Series H Preferred Stock") pursuant to which the 5,000 shares of Series H Preferred Stock plus +accrued dividends of $8,750 were exchanged for 5,087 shares of Series E Preferred Stock. + + On +July 30, 2003, the Company and the Series E holders entered into a letter agreement (the "Compromise Agreement") to compromise certain disputed penalties arising out of +the Company's alleged failure to timely cause the suspension of the effectiveness of the Company's Form S-1 Registration Statement, filed with the SEC on behalf of the +Series E holders to terminate at the earliest possible date. Pursuant to the terms of the Compromise Agreement, while the Company does not admit that it failed to fulfill its contractual +obligations to the Series E shareholders, in the interest of amicably resolving this matter, the Company issued an additional 4,477 shares of Series E Preferred Stock to the +Series E shareholders. + + The +shares of Series E Preferred Stock have a stated value of $100 per share. The holders of the Series E Preferred stock are entitled to cumulative dividends at a rate of +6% of the stated value per + +F-40 + + + +year, +payable every 120 days, in preference and priority to any payment of any dividend on the Company's Common Stock. Dividends may be paid, at the Company's option, either in cash or in +shares of Common Stock, valued at the Series E Conversion Price (as defined below). Holders of Series E Preferred Stock are entitled to a liquidation preference of $100 per share, plus +accrued and unpaid dividends. + + The +Series E Preferred Stock is convertible into Common Stock at a conversion price equal to 75% of the average of the closing bid prices, for the five trading days preceding the +conversion date, for the Common Stock. The number of shares issuable upon conversion is determined by multiplying the number of shares of Series E Preferred Stock to be converted by $100, and +dividing the result by the Series E Conversion Price then if effect. + + Holders +of Series E Preferred Stock do not have any voting rights, except as required by law. + + The +Company may redeem the shares of the Series E Preferred Stock at any time prior to conversion, at a redemption price of 115% of the purchase price paid for the Series E +Preferred Shares, plus any accrued but unpaid dividends. + + The +discount arising from the beneficial conversion feature is being treated as a dividend from the date of issuance to the earliest conversion date. + + During +the year ended September 30, 2003, holders of Series E Preferred Stock converted 7,352 shares into 5,922,471 shares of Common Stock at conversion prices between +$.075 and $.2475. + +d. Series F + + In July 2002, the Company's Chief Executive Officer invested $1,000,000 in the Company in exchange for 10,000 shares of newly created Series F +Convertible Preferred Stock (the "Series F Preferred Stock"), which has a stated value of $100 per share. + + The +holder of the Series F Preferred Stock is entitled to receive, from assets legally available therefore, cumulative dividends at a rate of 7% per year, accrued daily, payable +monthly, in preference and priority to any payment of any dividend on the Common Stock and on the Series F Preferred Stock. Dividends may be paid, at the Company's option, either in cash or in +shares of Common Stock, valued at the Series F Conversion Price (as defined below). Holders of Series F Preferred Stock are entitled to a liquidation preference of $100 per share, plus +accrued and unpaid dividends. + + The +Series F Preferred Stock is convertible into Common Stock at a conversion price (the "Series F Conversion Price") equal to $.10 per share. The number of shares issuable +upon conversion is determined by multiplying the number of shares of Series F Preferred Stock to be converted by $100, and dividing the result by the Series F Conversion Price. + + Except +as otherwise required by law, holders of Series F Preferred Stock and holders of Common Stock shall vote together as a single class on each matter submitted to a vote of +stockholders. Each outstanding share of Series F Preferred Stock shall be entitled to the number of votes equal to the number of full shares of Common Stock into which each such share of +Series F Preferred Stock is then convertible on the date for determination of stockholders entitled to vote at the meeting. Holders of the Series F Preferred Stock are entitled to vote +at the meeting. Holders of the Series F Preferred Stock are entitled to vote as a separate class on any proposed amendment to the terms of the Series F Preferred Stock which would +increase or decrease the number of authorized shares of Series F + +F-41 + + + +Preferred +Stock or have an adverse impact on the Series F Preferred Stock and on any proposal to create a new class of shares having rights or preferences equal to or having priority to the +Series F Preferred Stock. + + The +Company may redeem the shares of the Series F Preferred Stock at any time prior to conversion at a redemption price of 115% of the purchase price paid for the Series F +Preferred Shares plus any accrued but unpaid dividends. + + During +the year ended September 30, 2003, the Company's Chief Executive Officer converted 2,000 shares of the Series F Preferred Stock into 2,000,000 shares of Common +Stock. + +e. Series H + + In September 2002, the Company sold 5,000 shares of the newly created Series H Preferred Stock in a private placement for $500,000 in cash. + + The +Series H Preferred Stock was convertible into Common Stock at a conversion price (the "Series H Conversion Price") equal to the lower of $.20 per share or the average +market price of the Common Stock for the five trading days immediately preceding the conversion date. The number of shares issuable upon conversion was determinable by multiplying the number of shares +of Series H Preferred Stock to be converted by $100 and dividing the result by the Series H Conversion Price then in effect. + + Holders +of Series H Preferred Stock did not have any voting rights, except as required by law. + + In +July 2003, the 5,000 shares of the Series H Preferred Stock, plus accrued dividends of $8,750 were exchanged for 5,087 shares of Series E Preferred Stock. + +Note 15 Other Charges + +Year ended September 30, 2003: + + During the period May 1, 2001 through May 20, 2002, the Company maintained workers' compensation insurance with an insurance company, with a +deductible of $150,000 per incident. The Company had established reserves based upon its evaluation of the status of claims still open in conjunction with claims reserve information provided to the +Company by the insurance company. The Company believes that the insurance company has paid and reserved claims in excess of what should have been paid or reserved. Although the Company believes it can +recover some of the amounts already paid, this can only be pursued through litigation against the insurance company. Since there is no assurance the Company will prevail, the Company recorded +$1,186,000 of additional payments made and reserves in the year ended September 30, 2003. $433,000 of such amount is included in discontinued operations. + +Year ended September 30, 2002: + + Included in "Other Charges" are costs incurred in connection with financing not obtained ($75,066), penalties associated with the Series B Preferred Stock +($28,160), and the fair value of shares issued to Source One in connection with a forbearance agreement ($37,500) (see Note 2). + +F-42 + + + +Year ended September 30, 2001: + + During the year ended September 30, 2001, the Company discontinued negotiations to sell the Engineering Division and discontinued efforts to make certain +acquisitions. In this connection, costs associated with these activities were charged to operations. The Company also charged operations for costs incurred in connection with various financing not +obtained and costs associated with closed offices. The total charged to operations for the foregoing was $460,800. + + In +September 2001, the Company placed 1,500,000 of unregistered shares of its common stock into an escrow account in anticipation of receiving a loan, which was to be +collateralized by the shares of common stock. The loan transaction was never consummated, but in October 2001 the shares were illegally transferred out of the escrow account by a third party to +a foreign jurisdiction. Subsequent thereto, all but 89,600 shares were returned to the Company and cancelled. The Company, which made several attempts to recover the shares, recorded a $59,000 charge +to operations in the year ended September 30, 2001, representing the market value of the shares not returned. The 89,600 shares were recorded as issued shares in the year ended +September 30, 2002 and $59,000 was credited to stockholders' equity. The Company has not pursued litigation to attempt to recover the remaining 89,600 shares, due to the prohibitive costs of +retaining counsel and instituting an action in a foreign jurisdiction. + +Note 16 Commitments and Contingencies + +Office Leases + + The Company leases offices and equipment under various leases expiring through 2007. Monthly payments under these leases are $52,000. + + The +following is a schedule by years of approximate future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms +in excess of one year, as of September 30, 2003. + +For the Years Ending September 30, + + + + +2004 + +$ +547,000 + +2005 + + +295,000 + +2006 + + +185,000 + +2007 + + +169,000 + + Rent +expense was $910,000, $801,000 and $697,000 for the years ended September 30, 2003, 2002 and 2001, respectively. + +Other + + From time to time, the Company is involved in litigation incidental to its business including employment practices claims. There is currently no litigation that +management believes will have a material impact on the Company's financial position. + +F-43 + + + +Note 17 Temporary Equity (Put Options Liability) + + Temporary equity-put options consist of the following as of September 30, 2003 and 2002: + +Put options on 400,000 shares of the Company's Common Stock issued in connection with the acquisition of Source One (see Note 2) + +$ +800,000 + +Put options on 20,000 shares of the Company's Common Stock issued in connection with a loan payable (see Note 9) + + +23,000 + + + + + + +$ +823,000 + + + + + Pursuant +to SFAS No. 150, the put options are classified as a liability at September 30, 2003. Prior thereto, they were presented between liabilities and stockholders' +equity. + + On +July 29, 2003, the Company received written notification from Source One that it was exercising its option which requires the Company to buy back 400,000 shares of its Common +Stock at $2 per share. The Company had thirty days from the receipt of the notification, unless otherwise agreed to in writing, to pay the $800,000. The Company is attempting to negotiate an +arrangement, which would permit the Company to pay this amount over an extended period of time or upon receipt of financing. No assurance can be given that Source One will agree to such an agreement. + +Note 18 Stock Options and Warrants + + The Company currently has in place four stock option plans, the 1999 Equity Incentive Plan ("1999 Plan"), the 2000 Equity Incentive Plan ("2000 Plan"), the 2001 +Equity Incentive Plan ("2001 Plan"), and the 2002 Equity Incentive Plan ("2002 Plan") (collectively the "Equity Incentive Plans" or the "Plans"). The terms of these Plans are substantially similar. +The aggregate number of shares reserved for issuance under each of the Plans and the shares issued and vested as of September 30, 2003 are, respectively, as follows: + +500,000 shares authorized, 190,478 issued, 159,228 vested + + + +1999 Plan + +500,000 shares authorized, 270,000 issued, 210,000 vested + + + +2000 Plan + +1,000,000 shares authorized, 800,000 issued, 800,000 vested + + + +2001 Plan + +5,000,000 shares authorized, 4,234,000 issued, 4,202,000 vested + + + +2002 Plan + + In +addition, in 2000, the Company issued to the Chief Executive Officer of the Company, options to acquire 1,000,000 shares at $6.00 per share. These options have a ten-year +term and are exercisable at the earlier of five years or when the Company achieves earnings of $1.00 per share in a fiscal year. These options will be forfeited if the Chief Executive Officer leaves +the employment of the Company. + + The +Company has also issued 1,270,000 under option agreements with officers of the Company. + +F-44 + + + + A +summary of the Company's stock option activity and related information for the years ended September 30 follows: + + + + +Options + +Weighted Average + +Exercise Price + +Outstanding at September 30, 2000 + +1,987,205 + +$ +5.01 + + +Granted + +1,900,000 + + +2.05 + + +Canceled + +(279,464 +) + +4.08 + + +Exercised + + + + + + + + + + + +Outstanding at September 30, 2001 + + + +3,607,741 + + + +$ + +3.52 + + +Granted + +3,659,000 + + +.66 + + +Canceled + +(1,010,392 +) + +2.49 + + +Exercised + + + + + + + + + + + +Outstanding at September 30, 2002 + + + +6,256,349 + + + +$ + +2.01 + + +Granted + +1,788,460 + + +.23 + + +Canceled + +(280,331 +) + +1.30 + + +Exercised + + + + + + + + + + + +Outstanding at September 30, 2003 + +7,764,478 + +$ +1.63 + + + + + + +Exercisable at September 30, 2003 + +6,641,228 + +$ +.92 + + + + + + + The +exercise prices range from $.23 to $6.00 per share. + + The +weighted-average fair value of options was $.19, $.37 and $1.40 in the years ended September 30, 2003, 2002 and 2001, respectively. + + Following +is a summary of the status of stock options outstanding at September 30, 2003: + + + + +Outstanding Options + + + + + + + + + + + + +Weighted + +Average + +Remaining + +Contractual + +Life + + + + +Exercisable Options + +Exercise Price + +Number + +Weighted + +Average + +Exercise Price + +Number + +Weighted + +Average + +Exercise Price + +$ +.23 + +1,758,460 + +9.5 years + +$ +.23 + +1,758,460 + +$ +.23 + + +.65 + +3,134,000 + +8.5 years + + +.65 + +3,134,000 + + +.65 + + +.75 + +20,000 + +8.4 years + + +.75 + +4,000 + + +.75 + + +1.00 + +20,000 + +8.0 years + + +1.00 + +4,000 + + +1.00 + + +1.10 + +1,300,000 + +7.5 years + + +1.10 + +1,300,000 + + +1.10 + + +3.00 + +110,000 + +3.9 years + + +3.00 + +110,000 + + +3.00 + + +5.625 + +397,500 + +6.8 years + + +5.625 + +306,250 + + +5.625 + + +6.00 + +1,024,518 + +6.5 years + + +6.00 + +24,518 + + +6.00 + + + + + + + + + + + + + + + + + + + +7,764,478 + + + + + + +6,641,228 + + + + +F-45 + + + + The +Company has issued the following warrants: + +Number of Warrants + +Price Per Share + +Expiring In + +130,000 + +$ +8.70 + +2004 + +66,667 + + +7.50 + +2004 + +65,000 + + +4.00 + +2005 + +10,000 + + +5.00 + +2005 + +20,000 + + +6.00 + +2005 + +26,667 + + +0.75 + +2006 + +50,000 + + +5.00 + +2006 + +100,000 + + +7.50 + +2006 + +200,000 + + +1.00 + +2007 + +30,000 + + +5.00 + +2007 + +75,000 + + +0.3510 + +2006 + + The +Company issued 130,000 of the warrants to its underwriters in connection with the Company's Initial Public Offering and 485,000 warrants to investors and consultants in connection +with private placements. The balance of the warrants has been issued in exchange for services rendered to the Company. + + A +summary of the Company's warrant activity and related information for the years ended September 30 follows: + + + + +Warrants + +Weighted Average + +Exercise Price + +Outstanding at September 30, 2000 + +291,667 + +$ +7.07 + + +Granted + +166,667 + + +5.27 + + +Canceled + + + + + + + +Exercised + + + + + + + + + + + +Outstanding at September 30, 2001 + + + +458,334 + + + + + +6.50 + + +Granted + +240,000 + + +1.52 + + +Canceled + + + + + + + +Exercised + + + + + + + + + + + +Outstanding at September 30, 2002 + + + +698,334 + + + +$ + +4.91 + + +Granted + +75,000 + + +.35 + + +Canceled + + + + + + + +Exercised + + + + + + + + + + + +Outstanding at September 30, 2003 + +773,334 + +$ +4.47 + + + + + + + The +exercise prices range from $.35 to $8.70 per share. + + The +weighted-average fair value of warrants granted was $.26, $.29 and $.59 in the years ended September 30, 2003, 2002 and 2000, respectively. + +F-46 + + + +Note 19 Major Customers + + The Company had no customers who accounted for more than 10% of total revenues for the years ended September 30, 2003, 2002 and 2001. Major customers are +those who account for more than 10% of total revenues. + +Note 20 Retirement Plans + + The Company maintains two 401(k) savings plans for its employees. The terms of the plan define qualified participants as those with at least three months of +service. Employee contributions are discretionary up to a maximum of 15% of compensation. The Company can match up to 20% of the employees' first 5% contributions. The Company's 401(k) expense for the +years ended September 30, 2003, 2002 ad 2001 was $-0-, $8,000 and $50,000, respectively. + +Note 21 Private Placements + + In June 2001, the Company entered into an agreement with an investment banker to raise $1,200,000 through the sale of the Company's stock through private +placements at a price per share calculated at a +30% discount to the 20-day average of the mean between the closing bid and asked prices. The agreement provided that the Company pays a placement fee to the investment banker of 10% of the +gross proceeds received from the private placements and also issues five-year warrants equal to 10% of the number of shares sold at an exercise price equal to the price per share of the +private placement. In addition, the Company was to pay the investment banker's expenses in connection with the agreement, not to exceed $50,000. During the years ended September 30, 2002 and +2001, the Company sold 100,002 and 166,667 shares, respectively, at $.75 per share under this agreement. In connection therewith, the Company paid $91,750 and $16,250 to the investment banker and +issued warrants to purchase 10,000 and 16,667 shares of the Company's common stock in the years ended September 30, 2002 and 2001, respectively. + + For +the years ended September 30, 2002 and 2001, private placements resulted in the issuance of 277,724 and 1,449,666 shares of common stock, respectively (see Notes 4, 10 and +14). + + In +the year ended September 30, 2001, the Company issued 1,458,933 shares of Series A Preferred Stock (see Note 4). Additionally, for the years ended +September 30, 2003 and September 30, 2002, private placements and exchanges resulted in the issuance of 263,300 and -0- shares of Series B Preferred Stock, +16,683 and 18,839 shares of Series E Preferred Stock, 10,000 and 0 shares of Series F Preferred Stock, and 5,000 and -0- shares of Series H Preferred +Stock, respectively (see Note 14). + +F-47 + + + +Note 22 Selected Quarterly Financial Data (unaudited) + + + + +First Quarter + +Second Quarter + +Third Quarter + +Fourth Quarter + + +Year ended September 30, 2003 + + + + + + + + + + + + + + + +Revenues from continuing operations + +$ +14,611,085 + +$ +19,056,373 + +$ +21,547,937 + +$ +21,382,814 + + + +Gross profit from continuing operations + + +2,486,814 + + +2,706,150 + + +3,104,788 + + +3,108,026 + + + +Net earnings (loss) from discontinued operations + + +40,809 + + +(459,026 +) + +(344,879 +) + +(580,891 +) + + +Net (loss) from continuing operations + + +(1,097,308 +) + +(1,777,332 +) + +(1,124,577 +) + +(2,063,789 +) + + +Net (loss) attributable to common stockholders + + +(1,056,499 +) + +(2,236,358 +) + +(1,469,456 +) + +(2,644,680 +) + + + + Basic earnings (loss) per share attributable to common stockholders: + + + + + + + + + + + +(.03 + +) + + + +(.02 + +) + + + +(.11 + +) + + + +Continued operations + + +(.07 +) + +(.10 +) + +(.06 +) + +(.03 +) + + + +Discontinued operations + + +(.07 +) + +(.13 +) + +(.08 +) + +(.14 +) + + + + +Total + + + + + + + + + + + + + + + +Diluted earnings per share attributable to common stockholders: + + + + + +(.03 +) + +(.02 +) + +(.11 +) + + + +Continued operations + + +(.07 +) + +(.10 +) + +(.06 +) + +(.03 +) + + + +Discontinued operations + + +(.07 +) + +(.13 +) + +(.08 +) + +(.14 +) + + + + +Total + + + + + + + + + + + + + + + + + +First Quarter + +Second Quarter + +Third Quarter + +Fourth Quarter + + +Year ended September 30, 2002 + + + + + + + + + + + + + + + +Revenues from continuing operations + +$ +8,033,201 + +$ +11,814,283 + +$ +12,411,463 + +$ +13,600,854 + + + +Gross profit from continuing operations + + +1,768,993 + + +1,989,244 + + +2,080,388 + + +2,396,460 + + + +Net earnings (loss) from discontinued operations + + +149,958 + + +1,341,988 + + +(412,789 +) + +(380,109 +) + + +Net (loss) from continuing operations + + +(934,635 +) + +(1,113,432 +) + +(4,240,073 +) + +(1,839,303 +) + + +Net (loss) attributable to common stockholders + + +(784,677 +) + +228,556 + + +(4,652,862 +) + +(2,219,412 +) + + + + Basic earnings (loss) per share attributable to common stockholders: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Continued operations + + +(.10 +) + +(.11 +) + +(.37 +) + +(.16 +) + + + +Discontinued operations + + +(.02 +) + +.13 + + +(.03 +) + +(.03 +) + + + + +Total + + +(.08 +) + +.02 + + +(.40 +) + +(.19 +) + +Diluted earnings per share attributable to common stockholders: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Continued operations + + +(.10 +) + +(.11 +) + +(.37 +) + +(.16 +) + + + +Discontinued operations + + +.02 + + +.13 + + +.03 + + +(.03 +) + + + + +Total + + +(.08 +) + +.02 + + +(.40 +) + +(.19 +) + +F-48 + + + + + + +First Quarter + +Second Quarter + +Third Quarter + +Fourth Quarter + + +Year ended September 30, 2001 + + + + + + + + + + + + + + + +Revenues from continuing operations + +$ +9,871,007 + +$ +6,349,223 + +$ +5,774,764 + +$ +7,279,047 + + + +Gross profit from continuing operations + + +2,811,290 + + +1,522,197 + + +1,287,237 + + +1,500,999 + + + +Net earnings (loss) from discontinued operations + + +160,570 + + +(107,470 +) + +(41,848 +) + +82,063 + + + +Net (loss) from continuing operations + + +152,929 + + +(2,045,178 +) + +(1,482,660 +) + +(2,628,863 +) + + +Net (loss) attributable to common stockholders + + +313,499 + + +(2,152,648 +) + +(1,524,508 +) + +(2,546,800 +) + + + + Basic earnings (loss) per share attributable to common stockholders: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Continued operations + + +.02 + + +(.36 +) + +(.26 +) + +(.37 +) + + + +Discontinued operations + + +.03 + + +(.02 +) + + + + +.01 + + + + + +Total + + +.05 + + +(.38 +) + +(.26 +) + +(.36 +) + + + + Diluted earnings per share attributable to common stockholders: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Continued operations + + +.02 + + +(.36 +) + +(.26 +) + +(.37 +) + + + +Discontinued operations + + +.03 + + +(.02 +) + + + + +.01 + + + + + +Total + + +.05 + + +(.38 +) + +(.26 +) + +(.36 +) + +Note 23 Subsequent Events + +a.In +November 2003, holders of an aggregate of 1,718,460 common stock options, with exercise prices ranging from $1.10 to $6.00, voluntarily canceled such options in consideration +for the potential benefit that would inure to such holders as shareholders, by way of the elimination of the potential dilution represented by the options being canceled. + +b.On +November 20, 2003, the Company's Chief Executive Officer converted 2,000 shares of Series F Preferred Stock into 2,000,000 shares of common stock. + +c.On +December 11, 2003, holders of Series E Preferred Stock converted 2,150 shares into 1,853,448 shares of common stock at a conversion price of $.116. + +d.In +November 2003, the Company agreed to pay Advantage $20,000 per month until it has paid $225,000 owed to Advantage in connection with services provided to the Company (see +Note 10). The Company's obligation to pay this amount is secured by a warrant to purchase 2,000,000 shares of the Company's common stock. The warrant, which is exercisable only if the Company +defaults on its payment obligations to Advantage, has an exercise price equal to the lower of $.15 per share or 75% of the then current market price of the common stock. +F-49 + + + + + + +STRATUS SERVICES GROUP, INC. + + Condensed Consolidated Balance Sheets + + + + + +March 31, + +2004 + +September 30, + +2003 + + + + + +(Unaudited) + + + + + + + +Assets + + +Current assets + + + + + + + + + +Cash + +$ +594,714 + +$ +53,753 + + + +Accounts receivable less allowance for doubtful accounts of $1,812,000 and $1,733,000 + + +11,572,741 + + +12,833,749 + + + +Unbilled receivables + + +1,348,064 + + +671,271 + + + +Notes receivable (current portion) + + +32,221 + + +25,240 + + + +Prepaid insurance + + +1,603,789 + + +2,271,715 + + + +Prepaid expenses and other current assets + + +195,616 + + +277,262 + + + + + + + + + + + + +15,347,145 + + +16,132,990 + + +Notes receivable (net of current portion) + + + + + +82,649 + + + + + +95,166 + + + +Note receivable related party + + +128,000 + + +128,000 + + +Property and equipment, net of accumulated depreciation + + +747,902 + + +937,718 + + +Intangible assets, net of accumulated amortization + + +1,277,921 + + +1,501,509 + + +Goodwill + + +5,816,353 + + +5,816,353 + + +Deferred registration costs + + +571,001 + + +374,365 + + +Other assets + + +204,144 + + +164,380 + + + + + + + + + + + +$ +24,175,115 + +$ +25,150,551 + + + + + + + + + +Liabilities and Stockholders' Equity (Deficiency) + + +Current liabilities + + + + + + + + + +Loans payable (current portion) + +$ +453,128 + +$ +737,514 + + + +Loans payable related parties + + +457,337 + + +503,377 + + + +Notes payable acquisitions (current portion) + + +726,099 + + +657,224 + + + +Line of credit + + +8,107,908 + + +8,312,275 + + + +Cash overdraft + + +16,181 + + +699,057 + + + +Insurance obligation payable + + +352 + + +97,506 + + + +Accounts payable and accrued expenses + + +5,250,049 + + +4,787,404 + + + +Accrued payroll and taxes + + +3,082,554 + + +2,473,596 + + + +Payroll taxes payable + + +5,160,509 + + +5,021,411 + + + +Put options liability + + +823,000 + + +823,000 + + + + + + + + + + + + +24,077,117 + + +24,112,324 + + +Loans payable (net of current portion) + + + + + +17,205 + + + + + +37,890 + + + +Notes payable acquisitions (net of current portion) + + +1,729,979 + + +2,065,280 + + +Convertible debt + + +40,000 + + +40,000 + + + +Series A voting redeemable convertible preferred stock, $.01 par value, 1,458,933 shares issued and outstanding, liquidation preference of $4,376,799 (including unpaid dividends of $804,940 and +$671,752) + + +4,073,600 + + +3,809,752 + + + + + + + + + + + + +29,937,901 + + +30,065,216 + + +Commitments and contingencies + + + + + + + + + + + + + + + +Stockholders' equity (deficiency) + + + + + + + + +Preferred stock, $.01 par value, 5,000,000 shares authorized + + + + + + + + + + + Series E non-voting convertible preferred stock, $.01 par value, 47,728 and 40,257 shares issued and outstanding, liquidation preference of $4,772,920 (including unpaid dividends of $166,467 and +$60,295) + + + + + +4,939,387 + + + + + +4,086,130 + + + + + + Series F voting convertible preferred stock, $.01 par value, 6,000 and 8,000 shares issued and outstanding, liquidation preference of $600,000 (including unpaid dividends of $51,000 and $28,000) + + + + + +651,000 + + + + + +828,000 + + + +Common stock, $.01 par value, 100,000,000 shares authorized; 24,948,576 and 19,795,038 shares issued and outstanding + + +249,486 + + +197,950 + + +Additional paid-in capital + + +11,058,150 + + +11,728,943 + + +Accumulated deficit + + +(22,660,809 +) + +(21,755,718 +) + + + + + + + + + +Total stockholders' equity (deficiency) + + +(5,762,786 +) + +(4,914,695 +) + + + + + + + + + + +$ +24,175,115 + +$ +25,150,551 + + + + + + + + + +See notes to condensed consolidated financial statements + +F-50 + + + + + +STRATUS SERVICES GROUP, INC. + + Condensed Consolidated Statements of Operations + + (Unaudited) + + + + + +Six Months Ended + +March 31, + + + + + +2004 + +2003 + + + + + + + + +(Restated) + + + + +Revenues + +$ +47,399,789 + +$ +33,667,458 + + +Cost of revenues + + + + + +41,094,382 + + + + + +28,474,494 + + + + + + + + + + +Gross Profit + + +6,305,407 + + +5,192,964 + + +Selling, general and administrative expenses + + + + + +6,182,240 + + + + + +6,054,297 + + + +Other charges + + + + + +340,000 + + + + + + + + + +Operating income (loss) from continuing operations + + +123,167 + + +(1,201,333 +) + + + + + + + + +Other income (expenses) + + + + + + + + + + + + + + + + +Interest and financing costs + + +(1,016,674 +) + +(928,490 +) + + +Other income (expense) + + +(11,584 +) + +28,940 + + + + + + + + + + + + +(1,028,258 +) + +(899,550 +) + + + + + + + + +Loss from continuing operations + + +(905,091 +) + +(2,100,883 +) + +Discontinued operations (loss) from discontinued operations + + + + + + + + + + + +(418,217 + +) + + + + + + + + +Net (loss) + + +(905,091 +) + +(2,519,100 +) + + +Dividends and accretion on preferred stock + + +(1,248,757 +) + +(773,757 +) + + + + + + + + +Net (loss) attributable to common stockholders + +$ +(2,153,848 +) +$ +(3,292,857 +) + + + + + + + + +Net earnings (loss) per share attributable to common stockholders + + + + + + + + + + + Basic: + + + + + + + + + + + + + + + + + +(Loss) from continuing operations + +$ +(.10 +) +$ +(.18 +) + + + +(Loss) from discontinued operations + + + + + +(.03 +) + + + + + + + + + + + +Net earnings (loss) + +$ +(.10 +) +$ +(.21 +) + + + + + + + + + +Diluted: + + + + + + + + + + +(Loss) from continuing operations + +$ +(.10 +) +$ +(.18 +) + + + +(Loss) from discontinued operations + + + + + +(.03 +) + + + + + + + + + + + +Net earnings (loss) + +$ +(.10 +) +$ +(.21 +) + + + + + + + + +Weighted average shares outstanding per common share + + + + + + + + + +Basic + + +22,600,135 + + +15,950,320 + + + +Diluted + + +22,600,135 + + +15,950,320 + + +See +notes to condensed consolidated financial statements + +F-51 + + + + + + +STRATUS SERVICES GROUP, INC. + + Condensed Consolidated Statements of Cash Flows + + (Unaudited) + + + + + +Six Months Ended March 31, + + + + + +2004 + +2003 + + + + + + + + +(Restated) + + + + +Cash flows from operating activities + + + + + + + + + +Net (loss) from continuing operations + +$ +(905,091 +) +$ +(2,100,883 +) + + +Net (loss) from discontinued operations + + + + + +(418,217 +) + + +Adjustments to reconcile net (loss) to net cash provided by (used in) operating activities + + + + + + + + + + +Depreciation + + +207,334 + + +273,069 + + + + +Amortization + + +223,658 + + +181,057 + + + + +Provision for doubtful accounts + + +75,000 + + +50,000 + + + + +Deferred financing costs amortization + + +804 + + +804 + + + + +Accrued interest + + +135,091 + + +(7,388 +) + + + +Imputed interest + + +42,122 + + +22,747 + + + + +Dividends and accretion on preferred stock + + +263,848 + + + + + + +Changes in operating assets and liabilities + + + + + + + + + + +Accounts receivable + + +509,215 + + +(3,939,546 +) + + + +Prepaid insurance + + +667,926 + + +234,585 + + + + +Prepaid expenses and other current assets + + +81,646 + + +13,533 + + + + +Other assets + + +(40,568 +) + +(25,908 +) + + + +Insurance obligation payable + + +(97,154 +) + +(128,075 +) + + + +Accrued payroll and taxes + + +608,958 + + +647,104 + + + + +Payroll taxes payable + + +139,098 + + +655,817 + + + + +Accounts payable and accrued expenses + + +384,554 + + +1,645,892 + + + + + + + + + + + + +Total adjustments + + +3,201,532 + + +(376,309 +) + + + + + + + + + + + +2,296,441 + + +(2,895,409 +) + + + + + + + + +Cash flows (used in) investing activities + + + + + + + + + +Purchase of property and equipment + + +(17,518 +) + +(188,350 +) + + +Collection of notes receivable + + +5,536 + + + + + + +Payments for business acquisitions + + + + + +(61,644 +) + + + + + + + + + + + +(11,982 +) + +(249,994 +) + + + + + + + + +Cash flows from (used in) financing activities + + + + + + + + + +Payment of registration costs + + +(196,636 +) + + + + + +Proceeds from issuance of Preferred Stock + + + + + +186,400 + + + +Proceeds from loans payable + + +12,337 + + +380,000 + + + +Payments of loans payable + + +(312,408 +) + +(106,813 +) + + +Proceeds from loans payable related parties + + + + + +300,000 + + + +Payments of loans payable related parties + + +(51,000 +) + +(75,000 +) + + +Payments of notes payable acquisitions + + +(308,548 +) + +(352,489 +) + + +Net (payments)/proceeds from line of credit + + +(204,367 +) + +2,619,991 + + + +Cash overdraft + + +(682,876 +) + +313,128 + + + +Dividends paid + + + + + +(47,657 +) + + + + + + + + + + + +(1,743,498 +) + +3,217,560 + + + + + + + + + +Net change in cash and cash equivalents + + +540,961 + + +72,157 + + +Cash and cash equivalents beginning + + +53,753 + + +162,646 + + + + + + + + + +Cash and cash equivalents ending + +$ +594,714 + +$ +234,803 + + + + + + + + + +Supplemental disclosure of cash paid + + + + + + + + + +Interest + +$ +617,735 + +$ +1,047,762 + + + + + + + + + +Schedule of noncash investing and financing activities + + + + + + + + + +Fair value of assets acquired + +$ + + +$ +1,266,519 + + + +Less: cash paid + + + + + +(176,644 +) + + + + + + + + + +Liabilities assumed + +$ + + +$ +1,089,875 + + + + + + + + + +Issuance of common stock upon conversion of convertible preferred stock + +$ +572,500 + +$ +754,200 + + + + + + + + + +Issuance of common stock in exchange for accounts payable and accrued expenses + +$ +57,000 + +$ +37,500 + + + + + + + + + +Cumulative dividends and accretion on preferred stock + +$ +1,248,757 + +$ +493,100 + + + + + + + + + +See +notes to condensed consolidated financial statements + +F-52 + + + + + + +STRATUS SERVICES GROUP, INC. + + Notes to Condensed Consolidated Financial Statements + + (Unaudited) + + +NOTE 1 BASIS OF PRESENTATION + + The accompanying condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the +Securities and Exchange Commission. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United +States have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring +adjustments) that, in the opinion of management, are necessary to present fairly the financial position, the results of operations and cash flows of the Company for the periods presented. It is +suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on +Form 10-K. + + The +results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year. + + The +following summarizes revenues: + + + + +Three Months Ended March 31, + +Six Months Ended + +March 31, + + + + +2004 + +2003 + +2004 + +2003 + + + + + + + +(Restated) + + + + + + +(Restated) + + +Staffing + +$ +23,513,725 + +$ +18,886,667 + +$ +47,361,255 + +$ +33,254,675 + +Payrolling + + + + + +169,706 + + +38,534 + + +412,783 + + + + + + + + + + + + +$ +23,513,725 + +$ +19,056,373 + +$ +47,399,789 + +$ +33,667,458 + + + + + + + + + + + Unlike +traditional staffing services, under a payrolling arrangement, the Company's customer recruits and identifies individuals for the Company to hire to provide services to the +customer. The Company becomes the statutory employer although the customer maintains substantially all control over those employees. Accordingly, Emerging Issues Task Force ("EITF") 99-19, +"Reporting Revenue Gross as a Principal versus Net as an Agent" requires that the Company does not reflect the direct payroll costs paid to such employees in revenues and cost of revenue. + +NOTE 2 NEW ACCOUNTING PRONOUNCEMENTS + + FASB Interpretation No. 46 ("FIN 46") Consolidation of Variable Interest Entities was effective for all enterprises with variable +interests in variable interest entities created after January 31, 2003. FIN 46R, which was revised in December 2003, was effective for all entities to which the provisions of +FIN 46 were not applied as of December 24, 2003. The Company adopted the provision of FIN 46R as +of March 31, 2004. Under FIN 46R, if an entity is determined to be a variable interest entity, it must be consolidated by the enterprise that absorbs the majority of the entity's +expected losses, receives a majority of the entity's expected residual returns, or both. + + As +a result of adopting FIN 46R, the Company has consolidated Stratus Technology Services, LLC ("STS"), a joint venture in which the Company has a 50% interest (See +Note 11). The Company was deemed to be the primary beneficiary of STS since a son of the Chief Executive Officer of the Company has a majority interest in the other 50% venturer. STS provides +information technology staffing services. After elimination of inter-company balances, the only asset remaining of STS included + +F-53 + + + +in +the Company's consolidated balance sheet is employee advances of $7,447, which is included in "Other Assets". + + Prior +to the adoption of FIN 46R, the Company accounted for its investment in STS under the equity method and accordingly, included its share of the earnings (loss) of STS in +"Other income (expense)". Beginning with the third quarter of fiscal 2004, STS will no longer be accounted for under the equity method, and its revenues and expenses will be included in the Company's +consolidated statement of operations and will reflect the other venturer's share of earnings (loss) as a minority interest. + + Creditors +of STS have no recourse to the general credit of the Company. + +NOTE 3 LIQUIDITY + + At March 31, 2004, the Company had limited liquid resources. Current liabilities were $24,077,117 and current assets were $15,347,145. The difference of +$8,729,972 is a working capital deficit, which is primarily the result of losses incurred during the last four years. Current liabilities include a cash overdraft of $16,181, which is represented by +outstanding checks. These conditions raise substantial doubts about the Company's ability to continue as a going concern. The financial statements do not include any adjustments to reflect the +possible future effect on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. + + The +Company's continuation of existence is dependent upon the continued cooperation of its creditors, its ability to generate sufficient cash flow to meet its continuing obligations on a +timely basis, to fund the operating and capital needs, and to obtain additional financing as may be necessary. + + Management +of the Company has taken steps to revise and reduce its operating requirements, which it believes will be sufficient to assure continued operations and implementation of the +Company's plans. The steps include closing branches that are not profitable, consolidating branches and reductions in staffing and other selling, general and administrative expenses. + + The +Company continues to pursue other sources of equity or long-term debt financings. The Company also continues to negotiate payment plans and other accommodations with its +creditors. + +NOTE 4 EARNINGS/LOSS PER SHARE + + Basic "Earnings Per Share" ("EPS") excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of +common shares outstanding during the period. Diluted EPS assumes conversion of dilutive options and warrants, and the issuance of common stock for all other potentially dilutive equivalent shares +outstanding. There were no dilutive shares for the three and six months ended March 31, 2004 and 2003. + +NOTE 5 INTANGIBLE ASSETS + + We completed our annual impairment review of goodwill during the first quarter of fiscal 2004 and determined that no impairment charge was required. + +F-54 + + + + As +of March 31, 2004 and September 30, 2003, intangible assets consisted of the following: + + + + +March 31, 2004 + +September 30, 2003 + + +Covenant-not-to-compete + +$ +230,480 + +$ +230,480 + + +Customer list + + +1,957,709 + + +1,957,709 + + + + + + + + + + + + +2,188,189 + + +2,188,189 + + +Less: accumulated amortization + + +(910,268 +) + +(686,610 +) + + + + + + + + + + +$ +1,277,921 + +$ +1,501,579 + + + + + + + + + + Estimated +amortization expense for each of the next five years is as follows: + +For the Twelve Months Ending March 31, + + + + +2005 + +$ +401,000 + +2006 + + +206,000 + +2007 + + +156,000 + +2008 + + +156,000 + +2009 + + +152,000 + +NOTE 6 LINE OF CREDIT + + The Company has a loan and security agreement (the "Loan Agreement") with a lending institution whereby the Company can borrow up to 85% of eligible accounts +receivable, as defined, not to exceed the lesser of $12 million or six times the Company's tangible net worth (as defined). Until April 10, 2003, borrowings under the Loan Agreement bore +interest at + + 13/4% +above the prime rate (see below) and are collateralized by substantially all of the Company's assets. The Loan Agreement expires on June 12, 2005. + + At +March 31, 2004, the Company was in violation of the following covenants under the Loan Agreement: + + (i) Failing +to meet the tangible net worth requirement, and; + + (ii) The +Company's Common Stock being delisted from the Nasdaq SmallCap Market + + The +Company has received a waiver from the lender on the above. + + Effective +April 10, 2003, the Company entered into a modification of the Loan Agreement which provides that borrowings under the Loan Agreement bear interest at 3% above the prime +rate. The prime rate at March 31, 2004 was 4%. + +NOTE 7 PREFERRED STOCK + +a. Series A + + The shares of Series A Preferred Stock have a stated value of $3.00 per share. The difference between the carrying value and redemption value of the +Series A Preferred Stock was being accreted + +F-55 + + + +through +a charge to additional paid-in-capital through September 30, 2003, since prior to September 30, 2003, the current value of the Series A Preferred +Stock, including accrued dividends, had been included in stockholders' equity. Pursuant to SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities +and Equity", the current value of the Series A Preferred Stock, including accrued dividends was classified as a liability at September 30, 2003. Accordingly, subsequent to +September 30, 2003, the difference between the carrying value and redemption value of the Series A Preferred Stock is being accreted through a charge to interest expense through the +June 30, 2008 redemption date. + + The +Series A Preferred Stock entitles the holders thereof to cumulative dividends at $.21 per share per year, payable semi-annually, commencing on December 31, +2001, when and if declared by the Board of Directors. The shares of Series A Preferred Stock are convertible at the option of the holder into shares of the Company's Common Stock on a +one-for-one basis. On June 30, 2008, the Company will be required to redeem any shares of Series A Preferred Stock outstanding at a redemption price of $3.00 per +share together with accrued and unpaid dividends, payable at the Company's option, either in cash or in shares of common stock. For purposes of determining the number of shares which the Company will +be required to issue if it chooses to pay the redemption price in shares of Common Stock, the Common Stock will have a value equal to the average closing price of the Common Stock during the five +trading days immediately preceding the date of redemption. + + In +July 2003, the Company entered into an agreement with Artisan (UK) plc ("Artisan") pursuant to which the Company has agreed to redeem the aggregate 1,458,933 shares of its +Series A Preferred Stock owned by Artisan.com and Cater Barnard (USA) plc, an affiliate of Artisan. These shares represent all of the shares of Series A Preferred Stock currently +outstanding. The agreement, as amended in March 2004, provides that the Company's obligation to redeem the Series A Preferred Stock is contingent upon the Company's sale of not less than +$1,000,000 of units consisting of one share of common stock and one common stock warrant ("Units") in a proposed "best-efforts" public offering of securities (the "Offering"). If the +Company sells at least $1,000,000 of Units in the Offering, it will be obligated to pay $500,000 to Artisan within 7 days after the $1,000,000 of Units are sold. In addition, the Company will +be obligated to pay Artisan an additional $250,000 by January 31, 2005 or, at the Company's option, issue to Artisan shares of the Company's common stock having an aggregate market value of +$250,000, based upon the average closing bid prices of the common stock for the 30 trading days preceding January 31, 2005. If the Company fails to make the $250,000 payment in cash or stock, +it will be required to pay Artisan $300,000 in cash, plus interest calculated on a daily basis at a rate of 18% a year from the date of the default to the date the default is cured. The Company has +also agreed to issue to Artisan 1,750,000 shares of the Company's common stock within 7 days of the initial closing of the Offering. + +b. Series E + + The shares of Series E Preferred Stock have a stated value of $100 per share. The holders of the Series E Preferred stock are entitled to cumulative +dividends at a rate of 6% of the stated value per year, payable every 120 days, in preference and priority to any payment of any dividend on the Company's Common Stock. Dividends may be paid, +at the Company's option, either in cash or in shares of Common Stock, valued at the Series E Conversion Price (as defined below). Holders of + +F-56 + + + +Series E +Preferred Stock are entitled to a liquidation preference of $100 per share, plus accrued and unpaid dividends. + + The +Series E Preferred Stock is convertible into Common Stock at a conversion price equal to 75% of the average of the closing bid prices, for the five trading days preceding the +conversion date, for the Common Stock. The number of shares issuable upon conversion is determined by multiplying the number of shares of Series E Preferred Stock to be converted by $100, and +dividing the result by the Series E Conversion Price then in effect. + + Holders +of Series E Preferred Stock do not have any voting rights, except as required by law. + + The +Company may redeem the shares of the Series E Preferred Stock at any time prior to conversion, at a redemption price of 115% of the purchase price paid for the Series E +Preferred Shares, plus any accrued but unpaid dividends. + + The +discount arising from the beneficial conversion feature was treated as a dividend from the date of issuance to the earliest conversion date. + + During +the six months ended March 31, 2004, holders of Series E Preferred Stock converted 3,725 shares into 2,853,538 shares of common stock at conversion prices between +$.116 and $.1575. During the six months ended March 31, 2003, holders of Series E Preferred Stock converted 5,637 shares into 4,718,911 shares of Common Stock at conversion prices +between $.108 and $.186. + +c. Series F + + In July 2002, the Company's Chief Executive Officer (the "CEO") invested $1,000,000 in the Company in exchange for 10,000 shares of newly created +Series F Convertible Preferred Stock (the "Series F Preferred Stock"), which has a stated value of $100 per share. + + The +holder of the Series F Preferred Stock is entitled to receive, from assets legally available therefore, cumulative dividends at a rate of 7% per year, accrued daily, payable +monthly, in preference and priority to any payment of any dividend on the Common Stock and on the Series F Preferred Stock. Dividends may be paid, at the Company's option, either in cash or in +shares of Common Stock, valued at the Series F Conversion Price (as defined below). Holders of Series F Preferred Stock are entitled to a liquidation preference of $100 per share, plus +accrued and unpaid dividends. + + The +Series F Preferred Stock is convertible into Common Stock at a conversion price (the "Series F Conversion Price") equal to $.10 per share. The number of shares issuable +upon conversion is determined by multiplying the number of shares of Series F Preferred Stock to be converted by $100, and dividing the result by the Series F Conversion Price. + + Except +as otherwise required by law, holders of Series F Preferred Stock and holders of Common Stock shall vote together as a single class on each matter submitted to a vote of +stockholders. Each outstanding share of Series F Preferred Stock shall be entitled to the number of votes equal to the number of full shares of Common Stock into which each such share of +Series F Preferred Stock is then convertible on the date for determination of stockholders entitled to vote at the meeting. Holders of the Series F Preferred Stock are entitled to vote +at the meeting. Holders of the Series F Preferred Stock are entitled to vote as a separate class on any proposed amendment to the terms of the Series F + +F-57 + + + +Preferred +Stock which would increase or decrease the number of authorized shares of Series F Preferred Stock or have an adverse impact on the Series F Preferred Stock and on any proposal +to create a new class of shares having rights or preferences equal to or having priority to the Series F Preferred Stock. + + The +Company may redeem the shares of the Series F Preferred Stock at any time prior to conversion at a redemption price of 115% of the purchase price paid for the Series F +Preferred Shares plus any accrued but unpaid dividends. + + During +the six months ended March 31, 2004, the Company's CEO converted 2,000 shares of the Series F Preferred Stock into 2,000,000 shares of common stock. During the six +months ended March 31, 2003, the Company's CEO converted 2,000 shares of the Series F Preferred Stock into 2,000,000 shares of common stock. + +NOTE 8 STOCK-BASED COMPENSATION + + The Company accounts for its stock-based compensation plans using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, +"Accounting for Stock Issued to Employees". Accordingly, no stock-based employee compensation cost has been recognized in the financial statements as all options granted under the Company's stock +option plan, had an exercise price at least equal to the market value of the underlying common stock on the date of grant. The pro forma information below is based on provisions of SFAS +No. 123, "Accounting for Stock-Based + +F-58 + + + +Compensation", +as amended by SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure", issued in December 2002. + + + + +Three Months Ended March 31, + +Six Months Ended March 31, + + + + + +2004 + +2003 + +2004 + +2003 + + + + + + + + +(Restated) + + + + + + +(Restated) + + + + +Net (loss) from continuing operations attributable to common stockholders, as reported + +$ +(2,162,750 +) +$ +1,777,332 +) +$ +(2,153,848 +) +$ +(2,874,640 +) + +Deduct: + + + + + + + + + + + + + + +Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects + + +(208,700 +) + +(827,908 +) + +(417,400 +) + +(1,419,238 +) + + + + + + + + + + + + +Proforma net (loss) from continuing operations attributable to common stockholders + +$ +(2,371,450 +) +$ +(2,605,240 +) +$ +(2,571,248 +) +$ +(4,293,878 +) + + + + + + + + + + + + +Earnings(loss) from continuing operations per common share attributable to common stockholders: + + + + + + + + + + + + + + +Basic as reported + +$ +(.09 +) +$ +(.10 +) +$ +(.10 +) +$ +(.18 +) + +Basic pro forma + +$ +(.10 +) +$ +(.15 +) +$ +(.11 +) +$ +(.27 +) + +Diluted as reported + +$ +(.09 +) +$ +(.10 +) +$ +(.10 +) +$ +(.18 +) + +Diluted pro forma + +$ +(.10 +) +$ +(.15 +) +$ +(.11 +) +$ +(.27 +) + +NOTE 9 ACQUISITION + + Effective as of December 1, 2002, (the "Effective Date"), the Company purchased substantially all of the tangible and intangible assets, excluding accounts +receivable, of six offices of Elite Personnel Services ("Elite"), a California corporation. The Elite branches provide temporary light industrial and clerical staffing in six business locations in +California and Nevada. The Company also took over Elite's Downey, California office, from which Elite serviced no accounts but which it utilized as a corporate office. The Company intends to continue +to utilize the Downey office as a regional corporate facility. The acquisition of Elite furthers the Company's expansion into the California staffing market. Pursuant to the terms of an Asset Purchase +Agreement between the Company and Elite dated November 19, 2002 (the "Asset Purchase Agreement"), the purchase price payable at closing (the "Base Purchase Price") for the assets was +$1,264,000, all of which was represented by an unsecured promissory note. In addition to the Base Purchase Price, Elite will also receive as a deferred purchase price, an amount equal to 10% of the +annual "Gross Profits" as defined in the Asset Purchase Agreement of the acquired business between $2,500,000 and $3,200,000, and 15% of the annual Gross Profits of the acquired business in excess of +$3,200,000 for a period of two years from the Effective Date. In connection with the transaction, Elite, its President and other key management members entered into non-competition and +non-solicitation agreements pursuant to which they agreed not to compete with the Company in the territories of the acquired business for periods ranging from twelve months to five + +F-59 + + + +years, +and to not solicit the employees or customers of the acquired business for periods ranging from twelve months to five years. + + For +financial accounting purposes, interest on the note has been imputed at a rate of 11% per year. Accordingly, the note and Base Purchase Price has been recorded at $845,875. In +accordance with SFAS No. 141, "Business Combinations" the contingent portion of the purchase price has been recognized as a liability to the extent that the net acquired assets exceed the +purchase price. Accordingly, $244,000 is included in "Accounts payable and accrued expenses" on the attached balance sheets as of March 31, 2004 and September 30, 2003. There was an +additional $176,644 of costs paid to third parties in connection with the acquisition. + + The +following summarizes the fair value of the assets acquired at the date of acquisition based upon a third-party valuation of certain intangible assets: + +Property and equipment + +$ +75,000 + +Covenant-not-to-compete + + +19,500 + +Customer list + + +1,172,019 + + + + +Total assets acquired + +$ +1,266,519 + + + + + The +covenant-not-to-compete and customer list are being amortized over their estimated useful life of five and seven years, respectively. + + The +unaudited pro forma results of operations for the six months ended March 31, 2003 presented below assume that the acquisition had occurred at the beginning of fiscal 2003. +This information is presented for informational purposes only and includes certain adjustments such as amortization of intangibles resulting from the acquisitions and interest expense related to +acquisition debt. + +Revenues + +$ +39,245,458 + + +Net (loss) from continuing operations attributable to common stockholders + + +(2,814,666 +) + +Net (loss) per share attributable to common stockholders + + + + + + + + + + +Basic + +$ +(.18 +) + + +Diluted + +$ +(.18 +) + +NOTE 10 DISCONTINUED OPERATIONS + +Sale of Certain Branches + + On March 9, 2003, the Company completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of its Colorado +Springs, Colorado office. Pursuant to the terms of an asset purchase agreement between the Company and US Temp Services, Inc. ("US Temps") dated March 9, 2003, the purchase price for the +purchased assets was $20,000 which was paid by a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $608 over a three year period. The note is +secured by a security interest on all of the purchased assets. + +F-60 + + + + The +purchase price for the assets acquired by US Temps was arrived at through negotiations between the parties and resulted in a gain on sale of $13,958. + + On +August 22, 2003, the Company completed the sale, effective as of August 18, 2003 (the "ALS Effective Date") of substantially all of the tangible and intangible assets, +excluding accounts receivable, of its Miami Springs, Florida office. Pursuant to the terms of the Asset Purchase Agreement between the Company and ALS, LLC, a Florida limited liability company ("ALS") +dated August 22, 2003 (the "Purchase Agreement"), the purchase price for the purchased assets was $128,000, which was paid by a promissory note, which bears interest at the rate of 7% per year +with payments over a 60 month period. The amount of the monthly payments due under the note is greater of $10 per month or 20% of the monthly net profits generated by the staffing business originating +from the purchased assets. However, until such time as all outstanding amounts due and owing by the Company to ALS, as of the date of the Purchase Agreement in the amount of $289,635, ($150,000 at +March 31, 2004), have been paid in full, these monthly payments shall be deducted from any and all amounts due from the Company to ALS (see Note 11). The note is secured by a security +interest in all of the purchased assets. + + In +connection with the transaction, ALS entered into a non-compete and non-solicitation agreement pursuant to which ALS agreed not to compete with the Company +with respect to any of the Company's other remaining offices for a period of 18 months. + + The +purchase price for the assets acquired by ALS was arrived at through negotiations with a related party purchaser and resulted in a gain on sale of $10,777. The son of the Company's +President and Chief Executive Officer is a 50% member in ALS, LLC. + + On +September 10, 2003, the Company completed the sale, effective as of September 15, 2003 (the "Effective Date"), of substantially all of the tangible and intangible +assets, excluding accounts receivable, of five of its New Jersey offices to D/O Staffing LLC ("D/O"). The offices sold are the following: Elizabeth, New Brunswick, Paterson, Perth Amboy, and Trenton, +New Jersey. Pursuant to the terms of an asset purchase agreement between D/O and the Company dated September 10, 2003 (the D/O Purchase Agreement"), the base purchase price for the purchased +assets was $1,250,000 payable as follows: + +(i)$1,150,000 +payable in certified funds at the closing; and + +(ii)$100,000 +payable in certified funds into escrow at the closing to be held in escrow by attorneys for the Buyer pursuant to the terms of an escrow agreement, to account +for certain post-closing adjustments. + + Additionally, +the Company may be entitled to receive as a deferred purchase price (the "Bonus"), an amount equal to $125,000, if, for the one year period measured from the Effective +Date, the purchased assets generate for D/O at least $18,000,000 in actual billings by client accounts serviced by the Company as of the Closing and transferred by the Company to D/O pursuant to the +D/O Purchase Agreement. The Bonus, if any, is payable by a promissory note, payable over 24 months and bearing interest at an interest rate of 6% a year. + + The +purchase price for the assets was arrived at through negotiations between the parties and resulted in a (loss) on sale of $(50,354). + +F-61 + + + + On +September 29, 2003, the Company completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of its Las Vegas, Nevada office. +Pursuant to the terms of an asset purchase agreement between the Company and US Temps dated September 29, 2003, the purchase price for the purchased assets was $105,000, all of which was paid +by a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $2,030, over a five year period. The note is secured by a security interest on al of the +purchased assets. + + The +purchase price for the assets acquired by US Temps was arrived at through negotiations between the parties and resulted in a gain on sale of $4,599. + + Revenues +from the aforementioned certain branches were $4,822,397 and $10,236,332 for the three and six months ended March 31, 2003, respectively. + + The +statement of operations for the three and six months ended March 31, 2003, has been reclassified to reflect the operating results of the sold branches as discontinued +operations. + +NOTE 11 RELATED PARTY TRANSACTIONS + +Consulting Agreement + + The son of the Chief Executive Officer of the Company (the ("CEO") provides consulting services to the Company. Consulting expense was $16,200 and $30,100 for the +six months ended March 31, 2004 and 2003, respectively. The Company has paid consulting fees to an entity whose stockholder is another son of the CEO of the Company. Consulting fees amounted to +$14,000 and $50,000 for the six months ended March 31, 2004 and 2003, respectively. + +Joint Venture + + The Company provides information technology staffing services through a joint venture, Stratus Technology Services, LLC ("STS"), in which the Company has a 50% +interest. A son of the CEO of the Company has a majority interest in the other 50% venturer. The Company's income (loss) from operations of STS of $(19,280) and $28,136 for the six months ended +March 31, 2004 and 2003, respectively, and $(24,575) and $22,346 for the three months ended March 31, 2004 and 2003, respectively, is included in other income (expense) in the statements +of operations. + + Effective +March 31, 2004, the Company adopted the provisions of FIN 46R as it relates to STS (See Note 2). + +Note Receivable + + The $128,000 "Note Receivable related party" as of March 31, 2004, is the amount due from ALS in connection with the sale of the Company's +Miami Springs, Florida office (see Note 10). ALS is the holding company for Advantage Services Group, LLC ("Advantage"). + +Cost of Revenues + + In November 2003, the Company entered into agreements with Advantage, whereby Advantage is to provide payrolling services with respect to four of the +Company's accounts, at Advantage's cost plus + +F-62 + + + +a +fee ranging between 2% to 3%. The Company has pledged the four accounts as security for its obligation under these agreements. In addition, if the aggregate payroll of employees provided under these +agreements does not equal at least $8 million by November 30, 2004, the Company will be required to pay Advantage an amount equal to 8% of the shortfall. Costs incurred under the +agreements and a previous agreement was $3,871,593 and $1,210,232 in the six months ended March 31, 2004 and 2003, respectively. + + In +addition to the foregoing, in November 2003, the Company agreed to pay Advantage $5,000 per week until $225,000 owed to Advantage in connection with the previous agreement for +payrolling services has been paid. As of March 31, 2004, $75,000 has been paid under this agreement. The obligation to pay this amount is secured by a warrant to purchase 2,000,000 shares of +the Company's common stock. The warrant, which is exercisable only if the Company defaults on its payment obligations to Advantage, has an exercise price equal to the lower of $.15 per share or 75% of +the then current market price of the common stock. + +F-63 + + + +STRATUS SERVICES GROUP, INC. + +10,000,000 Units + + PROSPECTUS + +Essex & York, Inc. + +May , 2004 + + + + + + + + + +PART II + + INFORMATION NOT REQUIRED IN PROSPECTUS + + +Item 13. Other Expenses of Issuance and Distribution. + + The following table sets forth the expenses to be paid in connection with this offering. Although all of the common stock being registered hereby is for the +account of certain security holders, the Registrant has agreed to pay all fees related to this issuance and distribution, except for commissions, fees and discounts of any underwriters, brokers, +dealers or agents retained by the security holders. All the fees are estimates except the Securities and Exchange Commission registration fee and the NASD Filing Fee. + + + + +Assuming + +Minimum is + +Sold + +Assuming + +Maximum is + +Sold + +Registration fee Securities and Exchange Commission + +$ +1,655 + +$ +1,655 + +NASD filing fee + + +2,545 + + +2,545 + +Accounting fees and expenses + + +40,000 + + +40,000 + +Legal fees and expenses + + +115,000 + + +115,000 + +Blue sky fees and expenses + + +30,000 + + +30,000 + +Transfer Agent + + +5,000 + + +5,000 + +Printing + + +170,000 + + +170,000 + +Non-accountable expense allowance + + +30,000 + + +300,000 + +Miscellaneous + + +5,000 + + +5,000 + + + + + + +TOTAL + +$ +400,000 + +$ +670,000 + + + + + + +Item 14. Indemnification of Directors and Officers. + + Delaware General Corporation Law, Section 102(b)(7), authorizes a corporation to eliminate or limit personal liability of members of its board of directors +for violations of a director's fiduciary duty of care. Such elimination or limitation of personal liability is not permitted, however, where there has been a breach of the duty of loyalty, failure to +act in good faith, intentional misconduct or knowing violation of law, or payment of a dividend or approval of a stock repurchase which was deemed illegal or where a director obtains an improper +personal benefit. + + The +Registrant's Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1 to Amendment No. 1 to the Company's Registration Statement on Form SB-2 +as filed with the Securities and Exchange Commission on September 3, 1999) provides that a director of the Company shall, to the maximum extent permitted by Section 102(b)(7) or any +successor provision or provisions, have no personal liability to the Registrant or its stockholders for monetary damages for breach of fiduciary duty as a director. + + Delaware +General Corporation Law, Section 145, permits a corporation organized under Delaware law to indemnify directors and officers with respect to any matter in which the +director or officer acted in good faith and in a manner he reasonably believed to be not opposed to the best interests of the +corporation and, with respect to any criminal action, had no reasonable cause to believe his conduct was unlawful. + + The +Registrant's Amended and Restated Certificate of Incorporation and Bylaws (filed as Exhibit 3.2 to Amendment No. 6 to the Company's Registration Statement on Form +SB-2 as filed with the Securities and Exchange Commission on February 1, 2000) provides that any director or officer of the Company involved in any action, suit or proceeding, the +basis of which is alleged action or inaction by such director or officer while he was acting in an official capacity as a director or officer of the + +II-1 + + + +Registrant +or as a director, trustee, officer, employee or agent of another entity at the request of the Registrant, shall be indemnified and held harmless by the Registrant to the fullest extent +permitted by Section 145 against all expense, liability and loss reasonably incurred or suffered by such person in connection therewith. Such indemnification as to such alleged action or +inaction continues as to an indemnitee who has after such alleged action or inaction ceased to be a director or officer of the Registrant or a director, officer, trustee, employee or agent of such +other entity and inures to the benefit of the indemnitee's heirs, executors and administrators. The Certificate of Incorporation also provides that the right to indemnification shall be a contract +right which shall not be affected adversely as to any indemnitee by any amendment to the Certificate of Incorporation with respect to any action or inaction occurring prior to such amendment and shall +include, unless otherwise restricted or prohibited by law or the Registrant's By-laws, the right to be paid by the Registrant for expenses incurred in defending any such proceeding in +advance of its final disposition. The Registrant's Board of Directors may also grant these indemnification rights to any employee or agent of the Registrant or to any person who is or was a director, +officer, employee or agent of the Registrant's affiliates, predecessors or subsidiaries. + +Item 15. Recent Sales of Unregistered Securities. + + During the period between December 2000 and September 30, 2001, the Registrant issued to 37 investors, 6% convertible debentures (the "Debentures") +in the aggregate principal amount of $3,643,402. Based upon information provided by the investors, the Company determined that each investor was an "Accredited Investor" (as that term is defined in +Regulation D promulgated under the Securities Act). The placement agents for the 6% Debenture private placement were May Davis Group, Inc. and Hornblower & Weeks, Inc. (the +"Placement Agents"). In consideration for placing such securities, the Registrant agreed to issue to the Placement Agents five (5) year warrants to acquire 75,000 shares of common stock at an +exercise price of $7.50 per share and five (5) year warrants to acquire 50,000 shares of common stock at an exercise price of $5.00. The issuance and sale of these securities was made in +reliance on the exemption provided by Section 4(2) of and Rule 506 of Regulation D promulgated under the Securities Act. + + In +July 2001, the Registrant issued 1,458,933 shares of Series A Preferred Stock to Artisan (UK) plc ("Artisan") in exchange for 1,458,933 ordinary shares of +enterpriseASIA.com, a London AM listed +company. At the same time, the Registrant sold 900,000 shares of common stock to Artisan.com Limited, an affiliate of Artisan, at an aggregate purchase price of $900,000. In connection with these +transactions, the Registrant issued 1,824,288 shares of Series A Preferred Stock and 30,000 shares of common stock as finders fees to third parties. Each of these transactions described above +was made in reliance upon the exemption provided by Section 4(2) of the Securities Act of 1933. + + On +August 7, 2001, the Registrant issued 400,000 shares of common stock to Source One Personnel, Inc. ("Source One") in connection with its acquisition of substantially all +of the assets, excluding accounts receivable, of Source One. The issuance of the shares was made in reliance upon the exemption provided by Section 4(2) and Rule 506 of +Regulation D of the Securities Act of 1933. + + Between +September 21, 2001 and October 8, 2001 the Registrant sold a total of 383,000 shares of common stock for an aggregate purchase price of $410,000 to Charles A. +Sahyoun, the President of the Registrant's Engineering Services Division until its sale in March 2002, Jeffrey J. Raymond, Jr., Nicole Raymond, Jake Raymond and Jamie Raymond. The issuance of +the shares was made in reliance upon the exemption provided by Section 4(2) of the Securities Act of 1933. + + On +December 28, 2001, the Registrant issued 400,000 shares of its common stock to Provision Employment Solutions, Inc. ("PES") in connection with our acquisition of +substantially all of the assets, excluding accounts receivable, of PES. The issuance of the shares was made in reliance upon the exemption provided by Section 4(2) and Rule 506 of +Regulation D of the Securities Act of 1933. + +II-2 + + + + During +the quarter ended December 31, 2001, the Registrant sold 266,670 shares of its common stock at $0.75 per share through a private placement. This offering was conducted +under Section 4(2) of and Rule 506 under the Securities Act of 1933. In connection with the private placement, the Registrant issued five (5) year warrants to the placement agent +for the offering to acquire 26,667 shares of common stock at an exercise price of $0.75 per share. + + In +October 2001, the Registrant granted five (5) year warrants to a consultant to acquire 200,000 shares of common stock at an exercise price of $1.00 per share in +connection with consulting services rendered. The issuance of the warrants was made under Section 4(2) of and Rule 506 under the Securities Act of 1933. + + In +March 2002, the Registrant entered into an agreement with the holder of all but $40,000 of the Registrant's Debentures pursuant to which the Registrant issued to the Debenture +Holder, 231,300 shares of Series B Convertible Preferred Stock (the "Series B Preferred Stock") in exchange for (i) $456,499 aggregate principal amount of Debentures, +(ii) the cancellation of a $400,000 promissory +note previously issued by the Registrant to the Debenture Holder, and (iii) $300,000 in cash. In addition, the Debenture Holder converted, between January and March, 2002, $643,501 principal +amount of Debentures into 1,736,979 shares of Common Stock. These transactions were conducted under Section 4(2) of and Rule 506 under the Securities Act of 1933. + + In +March 2002, the Registrant sold 60,000 shares of its Series B Preferred Stock at $5.00 per share to Pinnacle Investment Partners, LLP ("Pinnacle") in an offering relying +on Section 4(2) of and Rule 506 under the Securities Act of 1933. + + In +July 2002, the Registrant sold 7,650 shares of its Series E Preferred Stock at $100 per share through a private placement to 30 Accredited Investors. This offering was +conducted under Section 4(2) of and Rule 506 of Regulation D promulgated under the Securities Act of 1933. + + In +July 2003, the Registrant issued 250,000 shares of common stock to Source One Personnel, Inc. ("Source Once") in connection with Source One's agreement to forbear from +exercising certain remedies against us. This issuance was conducted under Section 4(2) and Rule 506 under the Securities Act of 1933. + + Additionally, +in July 2002, the Registrant entered into an Agreement with Pinnacle pursuant to which Pinnacle exchanged its remaining 140,300 shares of Series B Preferred +Stock, along with accrued dividends and penalties of $41,790 for 7,433 shares of Series E Preferred Stock. In addition, the Registrant entered into an Agreement with Transworld Management +Services, Inc. ("Transworld") a corporation wholly owned by Joseph J. Raymond, the Registrant's President and CEO, pursuant to which Transworld exchanged its 32,000 shares of Series B +Preferred Stock for 1,600 shares of Series E Preferred Stock and waived all accrued dividends and penalties. These exchange transactions were conducted under Section 4(2) and +Rule 506 of Regulation D promulgated under the Securities Act of 1933. + + On +July 30, 2002, the Registrant sold 10,000 shares of Series F Preferred Stock at an aggregate price of $1,000,000 to the Registrant's President and CEO, Joseph J. +Raymond, Sr. This offering was conducted under Section 4(2) of and Rule 506 of Regulation D promulgated under the Securities Act of 1933. + + On +September 30, 2002, the Registrant sold 5,000 shares of Series H Preferred Stock at $100.00 per share to Pinnacle in an offering relying on Section 4(2) of and +Rule 506 under the Securities Act of 1933. + + In +October and November 2002, holders of Series E Preferred Stock converted 5,205 shares into 4,486,911 shares of the Registrant's common stock at conversion prices between +$.108 and $.1365. The + +II-3 + + + +issuances +of the common stock upon such conversions were made in reliance upon the exemptions from registration provided under Section 3(a)(9) of the Securities Act of 1933. + + In +January 2003, Joseph J. Raymond, the Registrant's President and Chief Executive Officer, converted 1,000 shares of Series F Preferred Stock into 1,000,000 shares of the +Registrant's common stock at a conversion price of $.10 per share. The issuance of the common stock upon such conversion was made in reliance upon the exemptions from registration provided under +Section 3(a)(9) of the Securities Act of 1933. + + In +February 2003, Pinnacle agreed to convert a $100,000 short-term note previously issued to it by the Registrant into 1,000 shares of Series E Preferred Stock. +In addition, Pinnacle purchased 6,000 shares of Series E Preferred Stock from the Registrant for $600,000. The issuance of the common stock upon the conversion of the note and the issuance of +the Series E Preferred Stock was made in reliance upon the exemptions provided under Rule 506 and Section 4(2) of the Securities Act of 1933. + + In +February 2003, Joseph J. Raymond, the Registrant's President and Chief Executive Officer converted 1,000 shares of Series F Preferred Stock into 1,000,000 shares of the +Registrant's common stock at a conversion price of $.10 per share. The issuance of the common stock upon such conversion was made in reliance upon the exemption from registration provided by +Section 3(a)(9) of the Securities Act of 1933. + + In +March and April 2003, holders of Series E Preferred Stock converted 1,445 shares of Series E Preferred Stock into 642,000 shares of the Registrant's common stock +at conversion prices between $.185 and $.248. The issuances of common stock upon such conversions were made in reliance upon the exemption provided under Section 3(a)(9) of the Securities Act +of 1933. + + In +July 2003, the Registrant sold an aggregate of 14,362 shares of Series E Preferred Stock to 31 accredited investors. This offering was conducted under +Section 4(2) of and Rule 506 promulgated under the Securities Act of 1933. + + In +July 2003, holders of Series E Preferred Stock converted 200 shares of Series E Preferred Stock into 126,894 shares of common stock at a conversion price of +$.1576 per share. In addition, in July 2003, the holder of the Registrant's Series H Preferred Stock exchanged 5,000 shares of Series H Preferred Stock +for 5,087 shares of Series E Preferred Stock. Each of these issuance was made in reliance upon the exemption provided by Section 3(a)(9) of the Securities Act of 1933. + + In +January and March 2004 the Registrant issued an aggregate of 11,196 shares of Series E Preferred Stock to holders of its Series E Preferred Stock in respect of penalties +which had accrued as a result of the Registrant's failure to timely register the shares issuable upon conversion of the Series E Preferred Stock for public resale. This issuance was made under +Section 4(2) of the Securities Act of 1933, as amended. + + In +each of the offerings described above that were made in reliance upon Section 4(2) of the Securities Act, the Registrant determined that each purchaser was sophisticated and +had access to the type of information that would generally be available in a registration statement filed under the Securities Act in connection with such an offering. + +II-4 + + + +Item 16. Exhibits and Financial Statement Schedules. + +(a)Exhibit Index + +Number + +Description + +1.1 + +Form of Underwriting Agreement between Stratus Services Group, Inc. and Essex & York, Inc. (filed with Amendment No. 4 to the Registration Statement) + +2.1 + + + +Asset Purchase Agreement, dated July 9, 1997, among Stratus Services Group, Inc. and Royalpar Industries, Inc., Ewing Technical Design, Inc., LPL Technical Services, Inc. and Mainstream Engineering Company, Inc., as amended by Amendment No. 1 to +the Asset Purchase Agreement, dated as of July 29, 1997.(1) + +2.2 + + + +Asset Purchase Agreement, effective January 1, 1999, by and between Stratus Services Group, Inc. and B&R Employment Inc.(1) + +2.3 + + + +Asset Purchase Agreement, dated June 16, 2000, by and between Stratus Services Group, Inc. and Out Source International of America, Inc.(5) + +2.4 + + + +Asset Purchase Agreement, dated October 13, 2000, by and between Stratus Services Group, Inc. and Out Source International of America, Inc.(6) + +2.5 + + + +Asset Purchase Agreement, dated January 2, 2001, by and between Stratus Services Group, Inc. and Cura Staffing Inc. and Professional Services, Inc.(15) + +2.6 + + + +Asset Purchase Agreement, dated July 27, 2001, by and between Stratus Services Group, Inc. and Source One Personnel, Inc.(8) + +2.7 + + + +Asset Purchase Agreement, dated December 27, 2001, by and between Stratus Services Group, Inc. and Provisional Employment Solutions, Inc.(9) + +2.8 + + + +Asset Purchase Agreement, dated as of January 24, 2002 among Stratus Services Group, Inc., Charles Sahyoun, Sahyoun Holdings, LLC and SEA Consulting Services Corporation. Information has been omitted from the exhibit pursuant to an order granting +confidential treatment.(16) + +2.9 + + + +Asset Purchase Agreement dated as of March 4, 2002, by and among Wells Fargo Credit, Inc. and Stratus Services Group, Inc.(22) + +2.10 + + + +Asset Purchase Agreement dated November 19, 2002, by and between Stratus Services Group, Inc. and Elite Personnel Services, Inc.(23) + +3.1 + + + +Amended and Restated Certificate of Incorporation of the Registrant.(1) + +3.1.1 + + + +Certificate of Designation, Preferences and Rights of Series A Preferred Stock.(10) + +3.1.2 + + + +Certificate of Amendment to Certificate of Designation.(14) + +3.1.3 + + + +Certificate of Designation, Preferences and Rights of Series B Preferred Stock.(14) + +3.1.4 + + + +Certificate of Designation, Preferences and Rights of Series E Preferred Stock.(21) + +3.1.5 + + + +Certificate of Amendment to Certificate of Designation, Preferences and Rights of Series E Preferred Stock.(21) + +3.1.6 + + + +Certificate of Designation, Preferences and Rights of Series F Preferred Stock.(21) + +3.1.7 + + + +Certificate of Designation, Preference and Rights of Series H Preferred Stock.(24) + +3.2 + + + +By-Laws of the Registrant.(2) + + + + + +II-5 + + + +4.1.1 + + + +Specimen Common Stock Certificate of the Registrant.(1) + +4.1.2 + + + +Form of 6% Convertible Debenture.(11) + +4.1.3 + + + +Specimen Series A Preferred Stock Certificate of the Registrant.(14) + +4.1.4 + + + +Agreement dated as of June 26, 2001 between Stratus Services Group, Inc. and Artisan (UK) plc.(10) + +4.1.5 + + + +Subscription Agreement dated as of June 26, 2001 between Stratus Services Group, Inc. and Artisan.com Limited.(10) + +4.1.8 + + + +Specimen Series E Stock Certificate of Registrant.(21) + +4.1.9 + + + +Specimen Series F Stock Certificate of Registrant.(21) + +4.1.10 + + + +Exchange Agreement between Pinnacle Investment Partners, LP and the Registrant.(21) + +4.1.11 + + + +Exchange Agreement between Transworld Management Services, Inc. and the Registrant.(21) + +4.1.12 + + + +Stock Purchase Agreement between Joseph J. Raymond, Sr., and the Registrant regarding Series F Preferred Stock.(21) + +4.2.1 + + + +Warrant for the Purchase of 10,000 Shares of Common Stock of Stratus Services Group, Inc., dated November 30, 1998, between Alan Zelinsky and Stratus Services Group, Inc., and supplemental letter thereto dated December 2, 1998.(1) + +4.2.2 + + + +Warrant for the Purchase of 40,000 Shares of Common Stock of Stratus Services Group, Inc., dated November 23, 1998, between David Spearman and Stratus Services Group, Inc.(1) + +4.2.3 + + + +Warrant for the Purchase of 10,000 Shares of Common Stock of Stratus Services Group, Inc., dated November 30, 1998, between Sanford Feld and Stratus Services Group, Inc., and supplemental letter thereto dated December 2, 1998.(1) + +4.2.4 + + + +Warrant for the Purchase of 20,000 Shares of Common Stock of Stratus Services Group, Inc., dated November 30, 1998, between Peter DiPasqua, Jr. and Stratus Services Group, Inc.(1) + +4.2.5 + + + +Warrant for the Purchase of 20,000 Shares of Common Stock of Stratus Services Group, Inc., dated December 2, 1998, between Shlomo Appel and Stratus Services Group, Inc.(1) + +4.2.6 + + + +Form of Underwriter's Warrant Agreement between Registrant and Hornblower & Weeks, Inc., including form of warrant certificate.(7) + +4.2.7 + + + +Warrant for the Purchase of Common Stock dated as of December 4, 2000 issued to May Davis Group, Inc.(13) + +4.2.8 + + + +Warrant for the Purchase of Common Stock dated as of December 4, 2000 issued to Hornblower & Weeks, Inc.(13) + +4.2.9 + + + +Warrant for the Purchase of Common Stock dated as of December 12, 2001 issued to International Capital Growth.(15) + +4.2.10 + + + +Warrant for the Purchase of Common Stock dated as of April 9, 2002 issued to CEOCast.(22) + +4.2.11 + + + +Warrant for the Purchase of Common Stock dated as of October 17, 2001 issued to Stetson Consulting.(22) + +4.2.12 + + + +Form of Warrant Agreement between Stratus Services Group, Inc. and American Stock Transfer Company, including form of warrant certificate for warrant comprising part of unit. (filed with Amendment No. 2 to the Registration Statement) + + + + + +II-6 + + + +5 + + + +Opinion and Consent of Giordano, Halleran & Ciesla, P.C. (filed with Amendment No. 4 to the Registration Statement) + +9.1.1 + + + +Voting proxy agreement between Artisan (UK) plc, Stratus Services Group, Inc. and Joseph J. Raymond, Sr.(17) + +10.1.1 + + + +Employment Agreement dated September 1, 1997, between Stratus Services Group, Inc. and Joseph J. Raymond.(1) + +10.1.6 + + + +Executive Employment Agreement dated September 1, 1997 between Stratus Services Group, Inc. and Michael A. Maltzman.(1) + +10.1.7 + + + +Consulting Agreement, dated as of August 11, 1997, between Stratus Services Group, Inc. and Jeffrey J. Raymond.(1) + +10.1.8 + + + +Non-Competition Agreement, dated June 19, 2000 between Stratus Services Group, Inc. and Out Source International of America, Inc.(5) + +10.1.9 + + + +Non-Competition Agreement, dated October 27, 2000 between Stratus Services Group, Inc. and Out Source International of America, Inc.(6) + +10.1.10 + + + +Option to purchase 1,000,000 shares of Stratus Services Group, Inc. Common Stock issued to Joseph J. Raymond.(11) + +10.1.11 + + + +Option to purchase 500,000 shares of Stratus Services Group, Inc. Common Stock issued to Joseph J. Raymond.(19) + +10.1.12 + + + +Option to purchase 1,750,000 shares of Stratus Services Group, Inc. Common Stock issued to Joseph J. Raymond.(19) + +10.1.13 + + + +Non-Competition Agreements dated December 1, 2002 between Stratus Services Group, Inc. and each of Elite Personnel Services, Inc. and Bernard Freedman.(23) + +10.1.14 + + + +Employment Agreement dated December 1, 2002 between Stratus Services Group, Inc. and Bernard Freedman.(23) + +10.2.1 + + + +Lease, effective October 1, 2002, for offices located at 500 Craig Road, Manalapan, New Jersey 07726(22) + +10.3.1 + + + +Loan and Security Agreement, dated December 8, 2000, between Capital Tempfunds, Inc. and Stratus Services Group, Inc.(11) + +10.3.2 + + + +First Amendment to Loan and Security Agreement between Capital Temp Funds and Stratus Services Group, Inc.(28) + +10.3.3 + + + +Second Amendment to Loan and Security Agreement between Capital Temp Funds and Stratus Services Group, Inc.(28) + +10.3.4 + + + +Third Amendment to Loan and Security Agreement between Capital Temp Funds and Stratus Services Group, Inc.(28) + +10.4.2 + + + +Promissory Note and Security Agreement in the amount of $400,000, dated as of June 19, 2000, issued by Stratus Services Group, Inc. to Out Source International of America, Inc.(5) + +10.4.3 + + + +Promissory Note in the amount of $100,000, dated as of June 19, 2000, issued by Stratus Services Group, Inc. to Out Source International of America, Inc.(5) + +10.4.4 + + + +Promissory Note and Security Agreement in the amount of $75,000, dated as of October 27, 2000, issued by Stratus Services Group, Inc. to Out Source International of America, Inc.(6) + + + + + +II-7 + + + +10.4.5 + + + +Promissory Note and Security Agreement in the amount of $600,000, dated as of July 27, 2001, issued by Stratus Services Group, Inc. to Source One Personnel, Inc.(8) + +10.4.6 + + + +Promissory Note and Security Agreement in the amount of $1.8 million, dated as of July 27, 2001, issued by Stratus Services Group, Inc. to Source One Personnel, Inc.(8) + +10.4.7 + + + +Promissory Note in the amount of $1,264,000 dated as of December 1, 2002, issued by Stratus Services Group, Inc. to Elite Personnel Services, Inc.(23) + +10.5.1 + + + +Registration Rights Agreement, dated August, 1997, by and among Stratus Services Group, Inc. and AGR Financial, L.L.C.(1) + +10.5.2 + + + +Registration Rights Agreement, dated August 1997, by and among Stratus Services Group, Inc. and Congress Financial Corporation (Western).(1) + +10.5.3 + + + +Form of Registration Rights Agreement, dated December 4, 2000, by and among Stratus Services Group, Inc. and purchasers of the Stratus Services Group, Inc. 6% Convertible Debenture.(11) + +10.5.4 + + + +Registration Rights Agreement, dated as of December 4, 2000, between Stratus Services Group, Inc., May Davis Group, Inc., Hornblower & Weeks, Inc. and the other parties named therein.(13) + +10.6.1 + + + +Stock Purchase and Investor Agreement, dated August 1997, by and between Stratus Services Group, Inc. and Congress Financial Corporation (Western).(1) + +10.6.2 + + + +Stock Purchase and Investor Agreement, dated August 1997, by and among Stratus Services Group, Inc. and AGR Financial, L.L.C.(1) + +10.6.3 + + + +Form of Securities Purchase Agreement, dated December 4, 2000 by and between Stratus Services Group, Inc. and purchasers of the Stratus Services Group, Inc. 6% Convertible Debenture.(11) + +10.7.1 + + + +1999 Equity Incentive Plan(1) + +10.7.2 + + + +2000 Equity Incentive Plan(11) + +10.7.3 + + + +2001 Equity Incentive Plan(12) + +10.7.4 + + + +2002 Equity Incentive Plan(19) + +10.7.5 + + + +Form of Option issued under 1999 Equity Incentive Plan.(19) + +10.7.6 + + + +Form of Option issued under 2000 Equity Incentive Plan.(19) + +10.7.7 + + + +Form of Option issued under 2001 Equity Incentive Plan.(19) + +10.7.8 + + + +Form of Option issued under 2002 Equity Incentive Plan.(19) + +10.8 + + + +Debt to Equity Conversion Agreement by and between Stratus Services Group, Inc. and B&R Employment, Inc.(3) + +10.8.1 + + + +Amendment to Debt to Equity Conversion Agreements by and between Stratus Services Group and B&R Employment, Inc.(2) + +10.8.2 + + + +Forbearance Agreement dated January 24, 2002 between Stratus Services Group, Inc. and Source One Personnel.(20) + +10.8.3 + + + +Modification of Forbearance Agreement dated June 4, 2002 between Stratus Services Group, Inc. and Source One Personnel, together with Exhibits thereto.(21) + + + + + +II-8 + + + +10.10 + + + +Allocation and Indemnity Agreement dated as of January 24, 2002 among the Company, Charles Sahyoun and Sahyoun Holdings, LLC.(20) + +10.11 + + + +Letter Agreement dated April 15, 2002 between Stratus Services Group, Inc., Sahyoun Holdings, LLC and Joseph J. Raymond, Sr. amending the Allocation and Indemnity Agreement dated April 18, 2002.(17) + +10.12 + + + +Exchange Agreement dated March 11, 2002 by and between Transworld Management Services, Inc. and Stratus Services Group, Inc.(22) + +10.13 + + + +Securities Purchase Agreement dated March 11, 2002, by and between Pinnacle Investment Group, LP and Stratus Services Group, Inc.(22) + +10.14 + + + +Operating Agreement of Stratus Technology Services.(28) + +10.15 + + + +Form of Securities Purchase Agreement between the Registrant and Series E Shareholders.(27) + +10.16 + + + +Compromise Agreement between the Registrant and Series E Shareholders dated July 30, 2003.(27) + +10.17 + + + +Redemption Agreement dated March 2, 2004 between Artisan (UK) plc and the Company. (filed with Amendment No. 2 to the Registration Statement) + +10.18 + + + +Agreement to Exchange Series H Preferred shares for Series E Preferred shares between the Company and Pinnacle Investment Partners, L.P.(27) + +10.19 + + + +Letter Agreement regarding Employee Services Agreement between Stratus Services Group, Inc. and Advantage Services Group, LLC.(28) + +10.20 + + + +Letter Agreement regarding Receivables between Stratus Services Group, Inc. and Advantage Services Group, LLC.(28) + +21 + + + +Subsidiaries of Registrant.(15) + +23.1 + + + +Consent of Amper, Politzner & Mattia, P.A., Independent Accountants. (filed herewith) + +23.2 + + + +Consent of Giordano, Halleran & Ciesla. (filed with Exhibit 5) + +24 + + + +Power of Attorney (located on signature pages of Form S-1 Registration Statement being amended by this Amendment No. 5). + +99.1 + + + +Form of Escrow Agreement among Stratus Services Group, Inc, Essex & York, Inc. and JPMorgan Chase Bank (filed with Amendment No. 4 to the Registration Statement) + +99.2 + + + +Form of Escrow Agreement among American Stock Transfer and Trust Company, Essex & York, Inc. and Stratus Services Group, Inc. (filed with Amendment No. 4 to the Registration Statement) + +Footnote 1 + +Incorporated by reference to similarly numbered Exhibits filed with Amendment No. 1 to the Company's Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities +and Exchange Commission on September 3, 1999. + +Footnote 2 + + + +Incorporated by reference to similarly numbered Exhibits filed with Amendment No. 6 to the Company's Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on +February 1, 2000. + + + + + +II-9 + + + +Footnote 3 + + + +Incorporated by reference to similarly numbered Exhibits filed with Amendment No. 3 to the Company's Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on +December 17, 1999. + +Footnote 4 + + + +Incorporated by reference to similarly numbered Exhibits filed with Amendment No. 7 to the Company's Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on +March 17, 2000. + +Footnote 5 + + + +Incorporated by reference to the Exhibits to the Company's Form 8-K, as filed with the Securities and Exchange Commission on June 30, 2000 + +Footnote 6 + + + +Incorporated by reference to the Exhibits to the Company's Form 8-K, as filed with the Securities and Exchange Commission on November 3, 2000 + +Footnote 7 + + + +Incorporated by reference to Exhibit 1.2 filed with Amendment No. 5 to the Company's Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on February 11, +2000. + +Footnote 8 + + + +Incorporated by reference to the Exhibits to the Company's Form 8-K, as filed with the Securities and Exchange Commission on August 9, 2001. + +Footnote 9 + + + +Incorporated by reference to the Exhibits to the Company's Form 8-K, as filed with the Securities and Exchange Commission on January 2, 2002. + +Footnote 10 + + + +Incorporated by reference to Exhibit 3 filed with Form 10-Q for the Quarter ended June 30, 2001 as filed with the Securities and Exchange Commission on August 14, 2001. + +Footnote 11 + + + +Incorporated by reference to similarly number Exhibits to the Company's Form 10-KSB, as filed with the Securities and Exchange Commission on December 29, 2000. + +Footnote 12 + + + +Incorporated by reference to similarly numbered Exhibits filed with the Company's Registration Statement on Form S-1 (Registration Statement No. 333-55312) as filed with the Securities and Exchange Commission on February 9, +2001. + +Footnote 13 + + + +Incorporated by reference to the Exhibits to the Company's Form S-1/A, as filed with the Securities and Exchange Commission on April 11, 2001. + +Footnote 14 + + + +Incorporated by reference to the Exhibits to the Company Form 8-K, as filed with the Securities and Exchange Commission on April 4, 2002. + +Footnote 15 + + + +Incorporated by reference to similarly numbered Exhibits filed with the Registrant's Form 10-K for the fiscal year ended September 30, 2001 and filed with the Securities and Exchange Commission on January 25, 2002. + +Footnote 16 + + + +Incorporated by reference to similarly numbered Exhibits filed with the Registrant's Form 10-K/A for the fiscal year ended September 30, 2001, as filed with the Securities and Exchange Commission on March 5, 2002. + +Footnote 17 + + + +Incorporated by reference to the Exhibits to the Company's Form 10-Q for the quarter ended March 31, 2002, as filed with the Securities and Exchange Commission on May 15, 2002. + +Footnote 18 + + + +Incorporated by reference to the Exhibits to the Company's Form 8-K, as filed with the Securities and Exchange Commission on April 4, 2002. + +Footnote 19 + + + +Incorporated by reference to the Exhibits to the Company's Form S-8, as filed with the Securities and Exchange Commission on September 17, 2002. + + + + + +II-10 + + + +Footnote 20 + + + +Incorporated by reference to the Exhibits to the Company's Form 10-K, as filed with the Securities and Exchange Commission on January 25, 2002, as amended by the Company's Form 10-K/A, as filed with the Securities and Exchange Commission on +March 5, 2002. + +Footnote 21 + + + +Incorporated by reference to the Company's 10-Q, for the quarter ended June 30, 2002, as filed with the Securities and Exchange Commission on August 14, 2002. + +Footnote 22 + + + +Incorporated by reference to the similarly numbered Exhibits filed with the Company's Registration Statement on Form S-1 (Registration Statement No. 333-100149) as filed with the Securities and Exchange Commission on September 27, +2002. + +Footnote 23 + + + +Incorporated by reference to the Exhibits to the Company's Form 8-K, as filed with the Securities and Exchange Commission on November 26, 2002. + +Footnote 24 + + + +Incorporated by reference to the similarly numbered Exhibits to the Company's Form 10-K, as filed with the Securities and Exchange Commission on December 23, 2002. + +Footnote 25 + + + +Incorporated by reference to the Exhibits to the Company's Form S-1, as filed with the Securities and Exchange Commission on February 3, 2003. + +Footnote 26 + + + +Incorporated by reference to the Exhibits to the Company's Form S-1, as filed with the Securities and Exchange Commission on March 20, 2003. + +Footnote 27 + + + +Incorporated by reference to the similarly numbered exhibits to the Company's Form 10-Q for the quarterly period ended June 30, 2003, as filed with the Securities and Exchange Commission on August 13, 2003. + +Footnote 28 + + + +Incorporated by reference to the similarly numbered exhibits to the Company's Form 10-K for the fiscal year ended September 30, 2003, as filed with the Securities and Exchange Commission on December 24, 2003. + +(b)Financial Statement Schedules + + Schedule II Valuation and Qualifying Accounts (see page II-14 and page F-2 for Report) + + All +other schedules are omitted because they are not applicable or the required information is shown in the Financial Statements or notes thereto. + +Item 17. Undertakings. + +(a)The +undersigned Registrant hereby undertakes: + +(1)To +file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: + +(i)To +include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; + +(ii)To +reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post effective amendment thereof) +which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in the +amount of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering +range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) under the Securities Act if, in the aggregate, the changes in amount and price represent no +more than a 20% change in the + +II-11 + + + +maximum +aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. + +(iii)To +include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such +information in the registration statement; + +(2)That, +for the purpose of determining any liability under the Securities Act of 1933, each such post effective amendment shall be deemed to be a new registration statement relating to +the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. + +(3)To +remove from registration by means of a post effective amendment any of the securities being registered which remain unsold at the termination of the offering. + +(b)Insofar +as indemnification for liabilities arising under the Securities Act 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 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment of 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 the Registrant is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. + +(c)The +undersigned Registrant hereby undertakes that: + +(1)For +the purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in +reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be +part of this registration statement as of the time it was declared effective. + +(2)For +the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new +registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. + +II-12 + + + + + + +Stratus Services Group, Inc. + + Schedule II Valuation and Qualifying Accounts + + +Allowance for Doubtful Accounts + + +Balance at + +beginning + +of period + +Charged to + +bad debt + +expense(3) + +Other(1) + +Deductions + +(Write-offs + +of bad + +debts) + +Balance at + +end of period + +September 30: + + + + + + + + + + + + + + + + + +2003 + +$ +1,742,000 + +$ +875,000 + +$ + + +$ +(884,000 +) +$ +1,733,000 + + +2002 + + +551,000 + + +1,650,000 + + + + + +(459,000 +) + +1,742,000 + + +2001 + + +255,000 + + +661,000 + + +30,000 + + +(395,000 +) + +551,000 + +Allowance for Recourse Obligation + + +Balance at + +beginning + +of period + +Charged to + +bad debt + +expense + +Other + +Deductions + +(Write-offs + +of + +bad debts) + +Balance at + +end of + +period + +September 30: + + + + + + + + + + + + + + + + + +2003 + +$ + + +$ + + +$ + + +$ + + +$ + + + +2002 + + + + + + + + + + + + + + + + + +2001 + + +30,000 + + + + + +(30,000 +) + + + + + + +Allowance for Investment in Related Party + + +Balance at + +beginning + +of period + +Charged to + +bad debt + +expense + +Other + +Deductions + +(Write-offs + +of + +bad debts) + +Balance at + +end of + +period + +September 30: + + + + + + + + + + + + + + + + + +2003 + +$ + + +$ + + +$ + + +$ + + +$ + + + +2002 + + + + + + + + + + + + + + + + + +2001 + + +663,000 + + + + + + + + +(663,000 +) + + + +Valuation Allowance for Deferred Taxes + + +Balance at + +beginning + +of period + +Charged to + +costs and + +expenses(2) + +Other + +Deductions + +Balance at + +end of + +period + +September 30: + + + + + + + + + + + + + + + + + +2003 + +$ +5,269,000 + +$ +2,353,000 + +$ + + +$ + + +$ +7,622,000 + + +2002 + + +2,914,000 + + +2,355,000 + + + + + + + + +5,269,000 + + +2001 + + +598,000 + + +2,316,000 + + + + + + + + +2,914,000 + +(1)Transfers +between valuation accounts. + +(2)Reflects +the increase (decrease) in the valuation allowance associated with net operating losses of the Company. + +(3)Includes +$100,000 and $244,000 charged to discontinued operations in the year ended September 30, 2003 and 2002, respectively. +II-13 + + + + + + +SIGNATURES + + + Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Amendment No. 5 to Registration Statement on +Form S-1 to be signed on its behalf by the undersigned, thereunto duly authorized, in the Township of Manalapan, the State of New Jersey, on May 18, 2004. + + + + + + + +STRATUS SERVICES GROUP, INC. + + + + + +By: + + + +/s/ JOSEPH J. RAYMOND + + + + + + Joseph J. Raymond + Chairman and Chief Executive Officer + + Pursuant to the requirements of the Securities Exchange Act of 1933, this Amendment No. 5 to the Registration Statement has been signed below by the following persons on behalf of +the Registrant and in the capacities and on the dates indicated. + + + +Name + +Title + +Date + +/s/ JOSEPH J. RAYMOND Joseph J. Raymond + + + +Chairman, Chief Executive Officer (Principal Executive Officer) + + + +May 18, 2004 + +/s/ MICHAEL A. MALTZMAN Michael A. Maltzman + + + +Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) + + + +May 18, 2004 + +* Michael J. Rutkin + + + +Director + + + +May 18, 2004 + +* Donald W. Feidt + + + +Director + + + +May 18, 2004 + +* Sanford I. Feld + + + +Director + + + +May 18, 2004 + +*By: + + + +/s/ JOSEPH J. RAYMOND + + + + + + + + As Attorney in Fact + + + +II-14 + +QuickLinks + +TABLE OF CONTENTS \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001048611_color_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001048611_color_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0cee648529c8051879e3c824f63f5c49a3edbf9e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001048611_color_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the shares offered in this prospectus will be passed upon for us by Foley Hoag LLP, Boston, Massachusetts. John D. Patterson, Jr., a partner of Foley Hoag LLP, serves as secretary of our company and owns an aggregate of 7,111 shares of our common stock. Legal matters will be passed upon for the underwriters by Bingham McCutchen LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001049172_b-g-foods_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001049172_b-g-foods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001049172_b-g-foods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001049291_trappeys_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001049291_trappeys_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001049291_trappeys_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001049296_bgh_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001049296_bgh_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001049296_bgh_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001049303_polaner_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001049303_polaner_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001049303_polaner_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001050180_phase_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001050180_phase_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d426d77640b69d947c63a5ee8e278018535ce076 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001050180_phase_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Testa, Hurwitz Thibeault, LLP, Boston, Massachusetts. Legal matters in connection with this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, Boston, Massachusetts. Attorneys at Skadden, Arps, Slate, Meagher Flom LLP beneficially own a less than one percent interest in a limited partnership that owns shares of our common stock. The attorneys at Skadden, Arps, Slate, Meagher Flom LLP do not have the power to vote or dispose of shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001053221_metabasis_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001053221_metabasis_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..510adcf954511ca61a78747a2bb5fe97965411d8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001053221_metabasis_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock being offered by this prospectus will be passed upon for us by Cooley Godward LLP, San Diego, California. As of the date of this prospectus, investment funds affiliated with Cooley Godward LLP owned 131,968 shares of our preferred stock and warrants to purchase 35,221 shares of our preferred stock having a weighted average exercise price of $1.26 per share, which will convert into 22,371 shares of common stock and warrants to purchase 5,940 shares of common stock having a weighted average exercise price of $7.44 per share as of the completion of this offering. Certain legal matters relating to the offering will be passed upon for the underwriters by Latham & Watkins LLP, San Diego, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001056904_radiation_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001056904_radiation_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c3dcae99c06b9633901c2603991a901c4f299c77 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001056904_radiation_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock we are offering by this prospectus will be passed upon by Shumaker, Loop Kendrick, LLP, Tampa, Florida. Certain matters related to this offering will be passed upon for the underwriters by Alston Bird LLP, Atlanta, Georgia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001062606_knova_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001062606_knova_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..fc38d6f93cedfbaa9c1fddf1471c34f2ebe05326 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001062606_knova_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of our common stock offered by this prospectus will be passed upon for us by Ellis, Funk, Goldberg, Labovitz & Dokson, P.C., Atlanta, Georgia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001063699_alliance_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001063699_alliance_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d20579cbdebccc31e23c9e46deee4027072de645 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001063699_alliance_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantee by the subsidiary guarantor, will be passed upon for us by Kirkland Ellis LLP, New York, New York. Certain partners of Kirkland Ellis LLP are also members of Randolph Street Partners II which will own 15,893 IDSs and 9,030 shares of Class B common stock upon completion of the reorganization and this offering. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001064226_hyland_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001064226_hyland_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0387414a7663fb3ad418d1c9c5ec2c0dd1868cf3 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001064226_hyland_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the common shares offered hereby will be passed upon for Hyland Software, Inc. by Calfee, Halter Griswold LLP, Cleveland, Ohio. A member of Calfee, Halter Griswold LLP beneficially owns 17,000 common shares of Hyland Software, Inc. Shearman Sterling LLP, New York, New York, will pass upon certain legal matters in connection with this offering for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001066138_lodgian_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001066138_lodgian_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..06d75c4d4718482d1a766b3d3601efb292f2bea4 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001066138_lodgian_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of the common stock will be passed upon for us by Morris, Manning Martin, LLP, Atlanta, Georgia. Sidley Austin Brown Wood LLP, New York, New York, will act as counsel to the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001066656_ceres_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001066656_ceres_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ee02ca78391538fd179468950a6d626ea9d2ab34 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001066656_ceres_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft LLP, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001066658_morgan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001066658_morgan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ee02ca78391538fd179468950a6d626ea9d2ab34 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001066658_morgan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft LLP, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077229_deeter_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077229_deeter_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077229_deeter_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077230_mercer_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077230_mercer_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077230_mercer_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077231_a-m_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077231_a-m_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077231_a-m_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077232_advanced_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077232_advanced_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077232_advanced_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077233_belcher_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077233_belcher_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077233_belcher_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077234_peerless_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077234_peerless_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077234_peerless_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077235_dalton_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077235_dalton_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077235_dalton_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077237_dalton_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077237_dalton_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077237_dalton_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077238_dalton_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077238_dalton_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077238_dalton_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077239_dalton_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077239_dalton_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077239_dalton_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001077552_gentek-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001077552_gentek-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ec996f7533d2bfb1032f8f7273be981f402d7c87 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001077552_gentek-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the common stock offered by this prospectus will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001081235_healthesse_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001081235_healthesse_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41ee6d0048620ec8675527de35c26394ea8e03da --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001081235_healthesse_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. Certain legal matters in connection with this offering will be passed upon for the underwriters by King & Spalding LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001082002_carrols_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001082002_carrols_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001082002_carrols_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001082003_carrols_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001082003_carrols_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001082003_carrols_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001082005_carrols-j_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001082005_carrols-j_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001082005_carrols-j_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001082006_quanta_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001082006_quanta_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001082006_quanta_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001082007_pollo_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001082007_pollo_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001082007_pollo_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001082008_pollo_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001082008_pollo_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001082008_pollo_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001083132_immunicon_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001083132_immunicon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..89dc1a3bccacd344c7efdeb9d5a517759112637e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001083132_immunicon_legal_matters.txt @@ -0,0 +1,9043 @@ +Legal matters + +The validity of the common stock we are offering will be passed upon for us by Morgan, Lewis & Bockius LLP, Philadelphia, Pennsylvania. Dewey Ballantine +LLP, New York, New York, is counsel for the underwriters in connection with this offering. + + + + +Experts + +The consolidated financial statements of Immunicon Corporation and subsidiaries as of December 31, 2002 and 2003, and for each of the three years in the +period ended December 31, 2003, and for the period from August 25, 1983 (date of inception) to December 31, 2003, included in this prospectus have been audited by +Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein and have been so included in reliance upon the report of such firm given upon their authority as experts +in accounting and auditing. + +The +consolidated financial statements for the period from August 25, 1983 (date of inception) to December 31, 2000 referred to in this prospectus had been audited by Arthur Andersen LLP, +independent auditors, as stated in their report appearing herein, and are referred to herein in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. +Arthur Andersen LLP has not consented to the inclusion of their report in this prospectus, and we have not +obtained their consent to do so in reliance upon Rule 437a of the Securities Act. We refer you to "Risk factors Arthur Andersen LLP has not consented to the inclusion of their +report in this prospectus, and your ability to recover damages from Arthur Andersen may be limited." + + 121 + + + + + + +Where you can find additional information + +We have filed with the SEC a registration statement on Form S-1 under the Securities Act of 1933 with respect to the common stock we are +offering. This prospectus, which constitutes a part of the registration statement, does not contain all of the information in the registration statement and the exhibits of the registration statement. +For further information with respect to us and our common stock, we refer you to the registration statement and to the exhibits to the registration statement. + +You +may read and copy the registration statement of which this prospectus is a part at the SEC's Public Reference Room, which is located at 450 Fifth Street, N.W., Washington, D.C. 20549. You can +request copies of the registration statement by writing to the SEC and paying a fee for the copying cost. Please call the SEC at 1-800-SEC-0330 for more information +about the operation of the SEC's Public Reference Room. In addition, the SEC maintains an Internet web site, which is located at www.sec.gov, that contains reports, proxy and information statements +and other information regarding issuers that file electronically with the SEC. You may access the registration statement of which this prospectus is a part at the SEC's Internet web site. Upon +completion of this offering, we will be subject to the information reporting requirements of the Securities Exchange Act of 1934, and we will file reports, proxy statements and other information with +the SEC. + +We +maintain an Internet web site at www.immunicon.com. We have not incorporated by reference into this prospectus the information on our web site, and +you should not consider it to be a part of this prospectus. + +This +prospectus includes statistical data obtained from industry publications. These industry publications generally indicate that the authors of these publications have obtained information from +sources believed to be reliable but do not guarantee the accuracy and completeness of their information. While we believe these industry publications to be reliable, we have not independently verified +their data. + + 122 + + INDEX TO FINANCIAL STATEMENTS + + + + +Page + +Independent Auditors' Report + +F-2 + +Report of predecessor auditors, Arthur Andersen + +F-3 + +Consolidated financial statements as of December 31, 2002 and December 31, 2003 and for the years ended December 31, 2001, 2002, and 2003, and for the period from August 25, 1983 (date of inception) to +December 31, 2003: + + + + +Balance sheets + +F-4 + + +Statements of operations + +F-5 + + +Statements of stockholders' equity (deficit) + +F-6 + + +Statements of cash flows + +F-8 + + +Notes to consolidated financial statements + +F-9 + + F-1 + + INDEPENDENT AUDITORS' REPORT + +Board +of Directors and Shareholders of + +Immunicon Corporation + +Huntingdon Valley, Pennsylvania + +We +have audited the accompanying consolidated balance sheets of Immunicon Corporation and subsidiaries (a development stage company) (the "Company") as of December 31, 2002 and 2003, and the +related consolidated statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2003, and for the period from +August 25, 1983 (date of inception) to December 31, 2003. 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. The Company's financial statements for the period from August 25, 1983 (date of inception) to December 31, 1998 were audited by other +auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their report dated April 11, 2001. The financial statements for the period +from August 25, 1983 (date of inception) to December 31, 1998 reflect total revenues and net loss of $3,249,000 and $4,241,576, respectively, of the related totals. The other auditors' +report has been furnished to us, and our opinion, insofar as it relates to the amounts included for such prior periods, is based solely on the report of such other auditors. + +We +conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 and the report of other auditors provide a reasonable basis for our opinion. + +In +our opinion, based on our audits and the report of other auditors, such financial statements present fairly, in all material respects, the financial position of the Company at December 31, +2002 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, and for the period from August 25, 1983 (date of +inception) to December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. + +/s/ +Deloitte & Touche LLP + +Philadelphia, Pennsylvania + +February +13, 2004 (March 9, 2004 as to Note 14) + + F-2 + + +The following report of Arthur Andersen LLP ("Andersen") is a copy of the report previously issued by Andersen on April 11, 2001. The report of Andersen is included in this registration +statement pursuant to Rule 2-02(c) of regulation S-X. The Company has not been able to obtain a reissued report from Andersen. Andersen has not consented to the inclusion of its report +in this registration statement. Because Andersen has not consented to the inclusion of its report in this registration statement, it may be difficult to seek remedies against Andersen, and the ability +to seek relief against Andersen may be impaired. + +REPORT OF ARTHUR ANDERSEN, INDEPENDENT AUDITORS + +To Immunicon Corporation: + +We +have audited the accompanying consolidated balance sheets of Immunicon Corporation (a Delaware corporation) and subsidiary as of December 31, 1999 and 2000, and the related consolidated +statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 2000 and from the period from inception (August 25, +1983) to December 31, 2000. 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. + +We +conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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. + +In +our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Immunicon Corporation and subsidiary as of +December 31, 1999 and 2000, and the results of their operations and their cash flows for the each of the three years in the period ended December 31, 2000 and for the period from +inception (August 25, 1983) to December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. + +/s/ +Arthur Andersen LLP + +Philadelphia, Pennsylvania + +April 11, 2001 + + F-3 + + CONSOLIDATED BALANCE SHEETS + + + + +December 31, + +2002 + + +December 31, + +2003 + + +Pro forma + +stockholders' + +equity at + +December 31, 2003 + + + + + + + + + + + +(unaudited) + + + + +ASSETS + + + + + + + + + + + +Current assets: + + + + + + + + + + + + +Cash and cash equivalents + +$ +18,469,690 + +$ +30,600,725 + + + + + + +Short-term investments + + +3,070,350 + + + + + + + + + +Loans from employees + + +22,799 + + +1,201 + + + + + + +Prepaid expenses + + +279,593 + + +318,940 + + + + + + +Other current assets + + +43,998 + + +166,666 + + + + + + + + + + + + + + + + + +Total current assets + + +21,886,430 + + +31,087,532 + + + + + +Property and equipment net + + +2,613,304 + + +3,560,786 + + + + + +Assets related to financing activities + + + + + +673,736 + + + + + +Other assets + + +176,255 + + +412,400 + + + + + + + + + + + + + + + +Total assets + +$ +24,675,989 + +$ +35,734,454 + + + + + + + + + + + + + + + +LIABILITIES AND STOCKHOLDERS' EQUITY + + + + + + + + + + + + + + + + + + + + + +Current liabilities: + + + + + + + + + + + + +Current portion of long-term debt + +$ +2,332,253 + +$ +3,359,661 + + + + + + +Accounts payable + + +930,410 + + +1,007,969 + + + + + + +Accrued expenses + + +1,782,055 + + +2,787,029 + + + + + + +Current portion of deferred revenue + + +685,066 + + +97,343 + + + + + + + + + + + + + + + + + +Total current liabilities + + +5,729,784 + + +7,252,002 + + + + + + + + + + + + + + + +Long-term debt + + +2,336,249 + + +3,791,998 + + + + + + + + + + + + + + + +Deferred revenue + + + + + +25,005 + + + + + + + + + + + + + + + +Commitments and contingencies + + + + + + + + + + + +Stockholders' equity: + + + + + + + + + + + + + + + + + + + + + + +Convertible preferred stock (liquidation value of $62,687,822 as of December 31, 2002, and $87,755,822 as of December 31, 2003) + + +60,124,068 + + +85,115,117 + + + + + + +Common stock, $.001 par value 25,000,000 authorized, 440,311 and 485,820 shares issued and outstanding as of December 31, 2002 and 2003, respectively, and 15,933,633 pro forma (unaudited) + + +440 + + +486 + + +15,934 + + +Additional paid-in capital + + +2,556,209 + + +7,032,990 + + +92,132,659 + + +Deferred stock-based compensation + + +(88,841 +) + +(3,857,806 +) + +(3,857,806 +) + +Loan for stock options + + +(19,300 +) + +(19,300 +) + +(19,300 +) + +Deficit accumulated during the development stage + + +(45,962,620 +) + +(63,606,038 +) + +(63,606,038 +) + + + + + + + + + + + + +Total stockholders' equity + + +16,609,956 + + +24,665,449 + +$ +24,665,449 + + + + + + + + + + + +Total liabilities and stockholders' equity + +$ +24,675,989 + +$ +35,734,454 + + + + + + + + + + + + + + + +See notes to consolidated financial statements. + + F-4 + + CONSOLIDATED STATEMENTS OF OPERATIONS + Years ended December 31, 2001, 2002 and 2003, and for the period from August 25, 1983 (date of inception) to +December 31, 2003 + + + + + + + + + + + + + +Period from + +August 25, + +1983 (date of + +inception) to + +December 31, + +2003 + + + + + + + +Years Ended December 31, + + + + + + +2001 + + + +2002 + + + +2003 + + + + + + + + + + +Revenue: + + + + + + + + + + + + + + + +License revenue from related party (Note 11) + +$ +575,388 + +$ +620,844 + +$ +2,635,842 + +$ +4,014,999 + + + +Other revenue + + + + + +311,658 + + +338,280 + + +3,898,938 + + + + + + + + + + + + + + + +Total revenue + + +575,388 + + +932,502 + + +2,974,122 + + +7,913,937 + + + + + + + + + + + + + +Expenses: + + + + + + + + + + + + + + + +Research and development + + +10,492,733 + + +15,796,644 + + +16,032,614 + + +54,539,910 + + + +General and administrative + + +2,662,049 + + +3,563,648 + + +4,511,966 + + +18,440,522 + + + + + + + + + + + + + + + +Total operating expenses + + +13,154,782 + + +19,360,292 + + +20,544,580 + + +72,980,432 + + + + + + + + + + + + + +Operating loss + + +(12,579,394 +) + +(18,427,790 +) + +(17,570,458 +) + +(65,066,495 +) + + + + + + + + + + + + +Other income from related party + + + + + + + + +250,000 + + +250,000 + + +Interest income + + + + + +820,804 + + + + + +576,999 + + + + + +246,991 + + + + + + + + + +Interest expense + + +(282,972 +) + +(470,339 +) + +(569,951 +) + + + + + + + + + + + + + + + +Interest income (expense), net + + +537,832 + + +106,660 + + +(322,960 +) + +1,210,457 + + + + + + + + + + + + + +Net loss attributable to common stockholders + +$ +(12,041,562 +) +$ +(18,321,130 +) +$ +(17,643,418 +) +$ +(63,606,038 +) + + + + + + + + + + + + +Net loss per common share-basic and diluted + +$ +(28.44 +) +$ +(42.31 +) +$ +(37.90 +) + + + + + + + + + + + + + + + + +Weighted average common shares outstanding-basic and diluted + + +423,340 + + +433,014 + + +465,527 + + + + + + + + + + + + + + + + + +Pro forma net loss per common share-basic and diluted (unaudited) (see Note 2) + + + + + + + +$ +(1.28 +) + + + + + + + + + + + + + + + + + + +Pro forma weighted average common shares outstanding basic and diluted (unaudited) (See Note 2) + + + + + + + + +13,824,340 + + + + + + + + + + + + + + + + + + + +See notes to consolidated financial statements. + + F-5 + + CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) + +Period from August 25, 1983 (date of inception) to December 31, 2003 + + + + +Convertible + +preferred stock + + +Common stock + + + + + + + + + + + +Deficit + +accumulated + +during the + +development + +stage + + + + + + + + + + + + + +Deferred + +stock-based + +compensation + + + + + + + + + + + + + +Additional + +paid-in capital + + + +Employee + +loan + + + + + + + + + + +Shares + + + +Amount + + + +Shares + + + +Amount + + + +Total + + + + + + + + + + +Balance, August 25, 1983 (inception) + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Issuance of common stock + + + +$ + + +72,426 + +$ +73 + +$ +1,865,628 + +$ + + +$ + + +$ + + +$ +1,865,701 + + + +Sale of Series A, B and C preferred stock + +96,350 + + +963,500 + + + + + + + + + + + + + + + + + + + +963,500 + + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(1,113,368 +) + +(1,113,368 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, June 25, 1994 + + + +96,350 + + + + + +963,500 + + + +72,426 + + + + + +73 + + + + + +1,865,628 + + + + + + + + + + + + + + + + + +(1,113,368 + +) + + + +1,715,833 + + + + +Exercise of options to purchase common stock + + + + + + +2,334 + + +2 + + +7,968 + + + + + + + + + + + +7,970 + + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(1,030,988 +) + +(1,030,988 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, July 1, 1995 + + + +96,350 + + + + + +963,500 + + + +74,760 + + + + + +75 + + + + + +1,873,596 + + + + + + + + + + + + + + + + + +(2,144,356 + +) + + + +692,815 + + + + +Exercise of options to purchase common stock + + + + + + +9,244 + + +9 + + +378 + + + + + + + + + + + +387 + + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(459,462 +) + +(459,462 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, July 1, 1996 + + + +96,350 + + + + + +963,500 + + + +84,004 + + + + + +84 + + + + + +1,873,974 + + + + + + + + + + + + + + + + + +(2,603,818 + +) + + + +233,740 + + + + +Net income + + + + + + + + + + + + + + + + + + + + + +71,984 + + +71,984 + + + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 1996 + + + +96,350 + + + + + +963,500 + + + +84,004 + + + + + +84 + + + + + +1,873,974 + + + + + + + + + + + + + + + + + +(2,531,834 + +) + + + +305,724 + + + + +Exercise of options to purchase common stock + + + + + + +17 + + + + + +50 + + + + + + + + + + + +50 + + + +Net income + + + + + + + + + + + + + + + + + + + + + +99,659 + + +99,659 + + + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 1997 + + + +96,350 + + + + + +963,500 + + + +84,021 + + + + + +84 + + + + + +1,874,024 + + + + + + + + + + + + + + + + + +(2,432,175 + +) + + + +405,433 + + + + +April 1998 issuance of common stock for consulting services rendered + + + + + + +5,000 + + +5 + + +5,245 + + + + + + + + + + + +5,250 + + + +Exercise of options to purchase common stock + + + + + + +292,420 + + +292 + + +78,440 + + + + + + + + + + + +78,732 + + + +Compensation expense related to 25,334 stock options granted for consulting services rendered + + + + + + + + + + + + +232,377 + + + + + + + + + + + +232,377 + + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(1,809,401 +) + +(1,809,401 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 1998 + + + +96,350 + + + + + +963,500 + + + +381,441 + + + + + +381 + + + + + +2,190,086 + + + + + + + + + + + + + + + + + +(4,241,576 + +) + + + +(1,087,609 + +) + + +September 1999 issuance of common stock in connection with the acquisition of technology rights + + + + + + +13,334 + + +13 + + +14,967 + + + + + + + + + + + +14,980 + + + +Exercise of options to purchase common stock + + + + + + +667 + + +1 + + +99 + + + + + + + + + + + +100 + + + +March 1999 sale of Series D preferred stock, net of expenses of $103,233 + +33,251,090 + + +10,596,967 + + + + + + + + + + + + + + + + + + + +10,596,967 + + + +May 1999 issuance of warrant to purchase 194,200 shares of Series D preferred stock in connection with credit facility + + + + + + + + + + + + +15,036 + + + + + + + + + + + +15,036 + + + +Compensation expense related to 13,802 stock options granted for consulting services rendered + + + + + + + + + + + + +7,317 + + + + + + + + + + + +7,317 + + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(4,404,211 +) + +(4,404,211 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 1999 (Forward) + + + +33,347,440 + + + +$ + +11,560,467 + + + +395,442 + + + +$ + +395 + + + +$ + +2,227,505 + + + +$ + + + + + +$ + + + + + +$ + +(8,645,787 + +) + +$ + +5,142,580 + + + +(Continued) + +See notes to consolidated financial statements. + + F-6 + + CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) + Period from August 25, 1983 (date of inception) to December 31, 2003 (continued) + + + + +Convertible + +preferred stock + + +Common stock + + + + + + + + + + + +Deficit + +accumulated + +during the + +development + +stage + + + + + + + + + + +Additional + +paid-in + +capital + + + +Deferred + +stock-based + +compensation + + + + + + + + + + + + + +Employee + +loan + + + + + + + + + + +Shares + + +Amount + + + +Shares + + + +Amount + + + +Total + + + + + + + + + + +Balance, December 31, 1999 + +33,347,440 + +$ +11,560,467 + +395,442 + +$ +395 + +$ +2,227,505 + +$ + + +$ + + +$ +(8,645,787 +) +$ +5,142,580 + + + +September 2000 issuance of common stock for consulting services rendered + + + + + + +8,334 + + +9 + + +19,978 + + + + + + + + + + + +19,987 + + + +Exercise of options to purchase common stock + + + + + + +10,001 + + +10 + + +25,830 + + + + + + + + + + + +25,840 + + + +February 2000 issuance of warrant to purchase 155,376 shares of Series D preferred stock in connection with credit facility + + + + + + + + + + + + +6,250 + + + + + + + + + + + +6,250 + + + +June 2000 sale of Series E preferred stock, net of expenses of $137,785 + +2,083,336 + + +9,737,228 + + + + + + + + + + + + + + + + + + + +9,737,228 + + + +August 2000 sale of Series E preferred stock + +2,505,276 + + +11,875,008 + + + + + + + + + + + + + + + + + + + +11,875,008 + + + +Issuance of 31,669 stock options for consulting services rendered + + + + + + + + + + + + +31,340 + + +(31,340 +) + + + + + + + + + + + +Compensation expense related to stock options + + + + + + + + + + + + + + + +5,977 + + + + + + + + +5,977 + + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(6,954,141 +) + +(6,954,141 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 2000 + + + +37,936,052 + + + + + +33,172,703 + + + +413,777 + + + + + +414 + + + + + +2,310,903 + + + + + +(25,363 + +) + + + + + + + + + +(15,599,928 + +) + + + +19,858,729 + + + + +December 2001 sale of Series F Preferred stock, net of expenses of $1,798,635 + +7,187,500 + + +26,951,365 + + + + + + + + + + + + + + + + + + + +26,951,365 + + + +January 2001 issuance of common stock for consulting services rendered + + + + + + +10,000 + + +10 + + +23,990 + + + + + + + + + + + +24,000 + + + +Exercise of options to purchase common stock + + + + + + +200 + + + + + +210 + + + + + + + + + + + +210 + + + +January 2001 issuance of 7,384 warrants to purchase Series E preferred stock in connection with credit facility + + + + + + + + + + + + +7,484 + + + + + + + + + + + +7,484 + + + +Issuance of 37,003 stock options for consulting services + + + + + + + + + + + + +25,468 + + +(25,468 +) + + + + + + + + + + + +Compensation expense related to stock options + + + + + + + + + + + + + + + +11,725 + + + + + + + + +11,725 + + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(12,041,562 +) + +(12,041,562 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 2001 + + + +45,123,552 + + + + + +60,124,068 + + + +423,977 + + + + + +424 + + + + + +2,368,055 + + + + + +(39,106 + +) + + + + + + + + + +(27,641,490 + +) + + + +34,811,951 + + + + +Exercise of options to purchase common stock + + + + + + +16,334 + + +16 + + +21,123 + + + + + + + + + + + +21,139 + + + +Issuance of 58,336 stock options for consulting services rendered + + + + + + + + + + + + +69,999 + + +(69,999 +) + + + + + + + + + + + +Compensation expense related to stock options + + + + + + + + + + + + + + + +20,264 + + + + + + + + +20,264 + + + +April 2002 issuance of warrant to purchase 25,000 Series F preferred stock in connection with credit facility + + + + + + + + + + + + +60,014 + + + + + + + + + + + +60,014 + + + +August 2002 issuance of 22,669 common stock warrants for directors' services + + + + + + + + + + + + +37,018 + + + + + + + + + + + +37,018 + + + +June 2002 loan issued to employee to exercise stock options + + + + + + + + + + + + + + + + + + +(19,300 +) + + + + +(19,300 +) + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(18,321,130 +) + +(18,321,130 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 2002 + + + +45,123,552 + + + + + +60,124,068 + + + +440,311 + + + + + +440 + + + + + +2,556,209 + + + + + +(88,841 + +) + + + +(19,300 + +) + + + +(45,962,620 + +) + + + +16,609,956 + + + + +June 2003 sale of Series F preferred stock, net of expenses of $76,951 + +6,187,000 + + +24,671,049 + + + + + + + + + + + + + + + + + + + +24,671,049 + + + +August 2003 sale of Series F preferred stock + +80,000 + + +320,000 + + + + + + + + + + + + + + + + + + + +320,000 + + + +Exercise of options to purchase common stock + + + + + + +5,832 + + +6 + + +17,465 + + + + + + + + + + + +17,471 + + + +Issuance of 49,935 stock options for consulting services rendered + + + + + + + + + + + + +268,015 + + +(268,015 +) + + + + + + + + + + + +Compensation expense related to stock options + + + + + + + + + + + + + + + +263,321 + + + + + + + + +263,321 + + + +Issuance of common stock in lieu of director cash compensation + + + + + + +38,677 + + +39 + + +127,629 + + + + + + + + + + + +127,668 + + + +December 2003 issuance of common stock to an employee + + + + + + +1,000 + + +1 + + +2,399 + + + + + + + + + + + +2,400 + + + +April 2003 issuance of warrant to purchase 13,750 shares of Series F preferred stock in connection with credit facility + + + + + + + + + + + + +28,581 + + + + + + + + + + + +28,581 + + + +April 2003 issuance of warrant to purchase 20,834 shares of common stock in connection with credit facility + + + + + + + + + + + + +19,868 + + + + + + + + + + + +19,868 + + + +May 2003 issuance of 22,669 shares of common stock warrants for directors' services + + + + + + + + + + + + +15,899 + + + + + + + + + + + +15,899 + + + +Deferred stock-based compensation related to options granted to employees and directors + + + + + + + + + + + + +3,996,925 + + +(3,996,925 +) + + + + + + + + + + + +Amortization of deferred compensation + + + + + + + + + + + + + + + +232,654 + + + + + + + + +232,654 + + + +Net loss + + + + + + + + + + + + + + + + + + + + + +(17,643,418 +) + +(17,643,418 +) + + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 2003 + + + +51,390,552 + + + +$ + +85,115,117 + + + +485,820 + + + +$ + +486 + + + +$ + +7,032,990 + + + +$ + +(3,857,806 + +) + +$ + +(19,300 + +) + +$ + +(63,606,038 + +) + +$ + +24,665,449 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +(Concluded) + + + +See notes to consolidated financial statements. + + F-7 + + CONSOLIDATED STATEMENTS OF CASH FLOWS + Years ended December 31, 2001, 2002 and 2003, and for the period from August 25, 1983 (date of inception) to December 31, + +2003 + + + + + + + + + + + + + +Period from + +August 25, + +1983 (date of + +inception) to + +December 31, + +2003 + + + + + + + +Year Ended December 31, + + + + + + +2001 + + + +2002 + + + +2003 + + + + + + + + + +Operating activities: + + + + + + + + + + + + + + + + + Net loss + + + +$ + +(12,041,562 + +) + +$ + +(18,321,130 + +) + +$ + +(17,643,418 + +) + +$ + +(63,606,038 + +) + + +Adjustment to reconcile net loss to net cash used in operating activities: + + + + + + + + + + + + + + + + +Depreciation and amortization + + +767,813 + + +1,247,619 + + +1,206,894 + + +4,619,139 + + + + +Interest expense on warrants + + +7,484 + + +13,336 + + +30,083 + + +72,189 + + + + +(Gain) loss on disposal of property and equipment + + + + + +(357 +) + +1,036 + + +3,846 + + + + +Compensation expense related to the issuance of stock, stock options and warrants + + +35,725 + + +57,282 + + +641,941 + + +1,029,035 + + + + +Change in: + + + + + + + + + + + + + + + + + + +Prepaid expenses and other + + +30,017 + + +23,111 + + +(140,417 +) + +(486,807 +) + + + + + +Other assets + + + + + + + + +(855,247 +) + +(980,247 +) + + + + + +Accounts payable + + +(51,588 +) + +376,606 + + +77,558 + + +1,007,968 + + + + + + +Accrued expenses + + +(382,621 +) + +525,356 + + +1,004,974 + + +2,798,754 + + + + + + +Deferred revenue + + +(122,982 +) + +(620,844 +) + +(562,717 +) + +110,552 + + + + + + + + + + + + + + + + + + +Net cash used in operating activities + + +(11,757,714 +) + +(16,699,021 +) + +(16,239,313 +) + +(55,431,609 +) + + + + + + + + + + + + +Investing activities: + + + + + + + + + + + + + + + + + Purchase of investments + + + + + +(33,988,139 + +) + + + +(16,606,599 + +) + + + + + + + + + +(54,919,987 + +) + + +Proceeds from maturities of investments + + +4,810,000 + + +46,692,797 + + +3,000,000 + + +54,502,797 + + + +Cash proceeds from disposals of property and equipment + + + + + +660 + + + + + +910 + + + +Purchases of property and equipment + + +(628,672 +) + +(472,446 +) + +(2,071,764 +) + +(7,761,104 +) + + + + + + + + + + + + + + + + + +Net cash (used in) provided by + +investing activities + + +(29,806,811 +) + +29,614,412 + + +928,236 + + +(8,177,384 +) + + + + + + + + + + + + +Financing activities: + + + + + + + + + + + + + + + + + Proceeds from exercise of stock options + + + + + +300 + + + + + +1,839 + + + + + +17,471 + + + + + +332,689 + + + + +Proceeds from term debt + + +1,200,000 + + +5,000,000 + + +5,519,316 + + +15,597,316 + + + +Payments on term debt + + +(1,045,502 +) + +(2,330,319 +) + +(3,036,159 +) + +(7,445,655 +) + + +Proceeds from sale of common stock + + + + + + + + + + + +1,665,701 + + + +Loan issuance fees + + + + + +(5,885 +) + +(49,565 +) + +(55,450 +) + + +Proceeds from sale of preferred stock + + +26,951,365 + + + + + +24,991,049 + + +84,115,117 + + + + + + + + + + + + + + + + + + +Net cash provided by financing activities + + +27,106,163 + + +2,665,635 + + +27,442,112 + + +94,209,718 + + + + + + + + + + + + + + + +Net increase (decrease) in cash and cash equivalents + + + + + +(14,458,362 + +) + + + +15,581,026 + + + + + +12,131,035 + + + + + +30,600,725 + + + + + +Cash and cash equivalents, beginning of period + + + + + +17,347,026 + + + + + +2,888,664 + + + + + +18,469,690 + + + + + + + + + + + + + + + + + + + + + + +Cash and cash equivalents, end of period + + + +$ + +2,888,664 + + + +$ + +18,469,690 + + + +$ + +30,600,725 + + + +$ + +30,600,725 + + + + + + + + + + + + + + +Supplemental cash flow information: + + + + + + + + + + + + + + + + +Cash paid for interest + + + +$ + +198,731 + + + +$ + +301,773 + + + +$ + +678,200 + + + + + + + + + +See notes to consolidated financial statements. + + F-8 + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + +Years ended December 31, 2001, 2002 and 2003, and for the period from +August 25, 1983 (date of inception) to December 31, 2003. + +1. The Company + +Background and operations + +Immunicon +Corporation (the "Company") was incorporated in Pennsylvania on August 25, 1983, for the purpose of developing novel methods for targeting and separating biological components. The +Company currently is engaged in rare-event detection and diagnosis, particularly in the +area of cancer diagnostics. In 2000, the Company changed its state of incorporation to the State of Delaware. + +The +Company's operations to date have been focused on research and development activities. The Company operates in one segment and has its principal offices in Huntingdon Valley, PA., although it +maintains a small research laboratory in the Netherlands. The Company has incurred significant losses since its inception through December 31, 2003, and has a deficit accumulated during the +development stage of $63.6 million. From its inception through June 1994 the Company raised a total of $1.7 million from sales of 72,426 shares of its common stock, of which +$1.5 million was raised in 1984 from the sale of 10,000 shares to three investors. The Company raised $363,500 from the sale of its Series A Convertible Preferred Stock in 1988, $300,000 +from the sale of its Series B Convertible Preferred Stock in 1989 and $300,000 from the sale of its Series C Convertible Preferred Stock in 1990. From 1999 through 2003, the Company +raised $51.9 million from the sale of Series F Convertible Preferred Stock, $21.6 million from the sale of Series E Convertible Preferred Stock and $10.6 million +from the sale of Series D Convertible Preferred Stock, respectively, net of financing costs (see Note 7). As of December 31, 2003, the Company had cash and cash equivalents of +$30.6 million. + +The +Company has not generated any revenues from product sales and has incurred substantial losses since its inception. The Company anticipates incurring additional losses over at least the next +several years and such losses may increase as the Company expands its research and development activities. Substantial financing will be needed by the Company to fund its operations and to +commercially develop its product candidates. There is no assurance that such financing will be available when needed. Operations of the Company are subject to certain additional risks and +uncertainties including, among others, dependence on Veridex, LLC ("Veridex"), a Johnson & Johnson company, to market the Company's cancer diagnostic product candidates, the uncertainty of +product development (including clinical trial results), regulatory clearance and approval, supplier and manufacturing dependence, competition, reimbursement availability, dependence on exclusive +licenses and other relationships, uncertainties regarding patents and proprietary rights, dependence on key personnel and other risks related to governmental regulations and approvals. Management +believes, however, that cash, cash equivalents and borrowing available under its line of credit at December 31, 2003, will be sufficient to maintain operations through at least +December 31, 2004. + +2. Summary of significant accounting policies + +Basis of presentation + +The +Company has generated limited revenue to date, and its activities have consisted primarily of developing and licensing products, raising capital and recruiting personnel. Accordingly, the Company +is considered to be in the development stage as of December 31, 2003 as defined by Statement of Financial Accounting Standards ("SFAS") No. 7, Accounting and Reporting by Development +Stage Enterprises. + +Principles of consolidation + +The +consolidated financial statements herein include balances of Immunicon Corporation and its wholly owned subsidiaries, Immunivest Corporation, IMMC Holdings, Inc., and Immunicon +Europe, Inc. All intercompany balances and transactions have been eliminated in consolidation. + + F-9 + + + +Use of estimates + +The +preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect +reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the +reporting period. Actual results could differ from those estimates. + +Fair value of financial instruments + +The +Company has estimated the fair value of our financial instruments using available market information and appropriate methodologies. However, considerable judgment is required in interpreting +market data to develop the estimates of fair value. + +The +following methods and assumptions were used to estimate the fair value of each class of financial instruments: + +Cash and cash equivalents and accounts payable The carrying amounts of these items approximate their fair values at December 31, 2002 +and 2003 due to the short-term maturities of these instruments. + +Long-term debt Interest rates that are currently available to us for issuance of debt with similar terms and remaining +maturities are used to estimate fair value for debt issues for which quoted market prices are not available. + +As +of December 31, 2002 and 2003, the outstanding long-term obligations and the corresponding fair market value are as follows (see also note 6): + +December 31, + + + +Remaining + +principal payments + + + +Fair market + +value + + +2002 + +4,626,083 + +5,087,855 + +2003 + +7,149,514 + +7,386,474 + +Cash and cash equivalents + +The +Company considers all highly liquid investments purchased with original maturities of three months or less when purchased to be cash equivalents. + +Short-term investments + +Short-term +investments are investments purchased with maturities of longer than 90 days, but less than one year, held at a financial institution. Short-term investments +are accounted for in accordance with SFAS No. 115, Accounting for Certain Investments in Debtand Equity +Securities, and accordingly, those classified as held-to-maturity are carried at cost plus accrued interest. + +The +cost or amortized cost and estimated market value of investments at December 31, 2002 were as follows: + +December 31, 2002 + + + +Cost or + +amortized cost + + + +Gross + +unrealized + +gains + + + +Gross + +unrealized + +losses + + + +Estimated + +market value + + +Corporate debt securities + +$3,070,350 + +$ + +$(29,220) + +$3,041,130 + + + + + + + + + + +Total + +$3,070,350 + +$ + +$(29,220) + +$3,041,130 + + + + + + + + + + + F-10 + + + +No investments were held by the Company as of December 31, 2003. Proceeds from the maturity of investments were $46,692,797 and $3,000,000 during the +years ended December 31, 2002 and 2003, respectively. + +The +Company maintains a certificate of deposit, which has been pledged as collateral against a letter of credit supplied to the landlord on its principal location. As of December 31, 2002 and +2003, this certificate of deposit of $125,000 is classified as restricted and is reported in Other Assets on the accompanying consolidated balance sheets. In fiscal year 2003, the Company entered into +a security deposit pledge agreement with one of our lenders (see Note 6) related to a $2,000,000 equipment line of credit whereby we pledge to the lender 50% of any amounts borrowed. This +security deposit earns 2% simple interest per annum from the commencement date, as long as we are not in default of our loan. The amount of this security deposit will decrease to 50% of the +outstanding principal balance on a calendar biannual basis as long as we are not in default. As of December 31, 2003, this deposit balance was $251,509, of which $181,511 is classified as long +term asset and reported in Other assets on the accompanying consolidated balance sheet. The current portion of this deposit is reported in Other current assets on the accompanying consolidated balance +sheet. + +Property and equipment + +Property +and equipment are recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Useful lives are estimated as follows: + +Property and Equipment + + + +Years + + +Computer equipment + +3 years + +Laboratory equipment + +5 years + +Manufacturing equipment + +5 years + +Office furniture and equipment + +5 years + +Leasehold improvements + +Lesser of useful life or lease term + +Long Lived Assets + +The +Company periodically evaluates the carrying value of long-term assets when events and circumstances warrant such review. The carrying value of a long-lived asset is +considered impaired when the anticipated undiscounted cash flows from such asset are separately identifiable and are less than the carrying value. In that event a loss is recognized based on the +amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined by reference to quoted market prices, if available, or the +utilization of certain valuation techniques such as using the anticipated cash flows discounted at a rate commensurate with the risk involved. + +Concentrations of credit risk and limited suppliers + +The +financial instruments that potentially subject the Company to concentrations of risk are cash and cash equivalents. The Company's cash and cash equivalents are maintained in three financial +institutions in amounts that typically exceed federally insured limits. The Company has not +experienced any losses in such accounts and believes it is not exposed to significant credit risk in this area. It is the Company's practice to place its cash equivalents and short-term +investments in money market accounts or high quality securities in accordance with a written policy approved by the Board of Directors. + +The +Company relies on a single supplier for a component of its instrument system. The failure of this supplier, including a subcontractor, to deliver on schedule could delay or interrupt delivery to +customers and thereby adversely affect the Company's operating results. + + F-11 + + + +Revenue recognition + +In +accordance with US Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, +up-front non-refundable license fees are recorded as deferred revenue and recognized over the estimated development period. Further, the Company has reviewed the effects of +Emerging Issues Task Force ("EITF") Pronouncement No. 00-21 Revenue Arrangements with Multiple Deliverables ("EITF +00-21") to determine whether these pronouncements are applicable to the Company, as appropriate. Milestone payments received to date under the contract with Veridex are non-refundable, +have been deferred and are being amortized on a straight-line basis over the estimated development period. The Company estimated the initial development period to be from the initiation of +the contract with Veridex, August 2000 to December 31, 2003, when the Company estimated it would deliver its initial instrument platform and clinical test. The Company received United States Food and +Drug Administration ("FDA") clearance for its breast cancer monitoring test in January 2004 (see Note 14) and therefore believes that its estimate is appropriate. Amounts received by the Company as +reimbursement for research and development are recorded as a reduction in research and development expense, as the related costs are incurred (see Note 8). + +The +Company can earn up to an additional $6.5 million in research related milestone receipts and $10.0 million related to achieving certain sales targets. The Company plans to recognize the +research related milestones receipts over the estimated development period for the various products for which milestone receipts can be earned and plans to recognize the payments related to sales in +the period earned. + +Disclosures About Segments of an Enterprise + +Operating +segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker, or +decision-making group, in making decisions regarding resource allocation and assessing performance. To date, the Company has viewed its operations and manages its business as one segment operating +primarily in the United States of America. + +Research and development + +Research +and development costs are charged to expense as incurred. + +Recapitalization + +On +June 15, 2000, the Company effected a 1-for-10 reverse stock split of all outstanding shares of common stock, as well as for stock options and warrants to purchase common stock. In addition, +the conversion ratios for all series of Preferred stock were adjusted. All references in the accompanying financial statements to the number of shares and per share data have been retroactively +restated to reflect the reverse stock split. + +Stock-based compensation + +The +Company accounts for stock-based compensation based on the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to +Employees ("APB No. 25"), which states that, for fixed plans, no compensation expense is recorded for stock options or other stock-based awards to employees that are +granted with an exercise price equal to or above the estimated fair value per share of the Company's common stock on the grant date. In the event that stock options are granted with an + + F-12 + + + +exercise price below the estimated fair value of the Company's common stock at the grant date, the difference between the fair value of the Company's common stock and the exercise price of the stock +option is recorded as deferred compensation. Deferred compensation is amortized to compensation expense on a straight-line basis over the vesting period of the stock option. The Company +has adopted the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123") and SFAS No. 148, Accounting for Stock Based +Compensation Transition and Disclosure an Amendment of FASB Statement No. 123 ("SFAS +No. 148"), which requires compensation expense to be disclosed based on the fair value of the options granted at the date of the grant (see Note 7). + +Had +compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method required by SFAS +No. 123, the Company would have reported the pro forma net loss amounts indicated below. + + + + +Year Ended December 31, + + + + + + +2001 + + + +2002 + + + +2003 + + + + + + +Net loss, as reported + +$ +(12,041,562 +) +$ +(18,321,130 +) +$ +(17,643,418 +) + +Add: Stock-based compensation expense included in reported net loss + + +35,725 + + +57,282 + + +641,941 + + +Deduct: Total stock-based compensation expense determined under fair value method for all awards + + +(127,797 +) + +(185,515 +) + +(801,411 +) + + + + + + + + + + +Pro forma net loss + +$ +(12,133,634 +) +$ +(18,449,363 +) +$ +(17,802,888 +) + + + + + + + + + + +Net loss per share (basic and diluted) as reported + +$ +(28.44 +) +$ +(42.31 +) +$ +(37.90 +) + + + + + + + + + + +Pro forma net loss per share (basic and diluted) + +$ +(28.66 +) +$ +(42.61 +) +$ +(38.24 +) + + + + + + + + + + +The fair value of each option is estimated on the date of grant using the minimum value method with the following weighted average assumptions: risk-free +interest rate of 4.9%, 4.0%, and 3.14% during 2001, 2002, and 2003, respectively; an expected life of 5 years; and a dividend yield of zero. + +Stock +compensation arrangements with non-employees are accounted for in accordance with SFAS No. 123, as amended by SFAS No. 148, and EITF No. 96-18, Accounting for +Equity Instruments That Are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, using a fair value approach. + +Net loss per share + +Basic +and diluted net loss per common share is calculated in accordance with SFAS No. 128, Earnings Per Share ("SFAS No. 128") and SEC Staff +Accounting Bulletin No. 98 ("SAB No. 98"). Under the provisions of SFAS No. 128 and SAB No. 98, basic net loss per common share is calculated by dividing the net loss +applicable to common stockholders by the weighted-average number of unrestricted common shares outstanding during the period. Diluted net loss per common share is the same as basic net loss per common +share, since the effects of potentially dilutive securities are antidilutive for all periods presented. + + F-13 + + + +Anti-dilutive +common shares not included in net loss attributable to common stockholders are summarized as follows: + + + + +Year Ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + +Common stock options + +379,114 + +546,642 + +882,123 + +Warrants + +110,898 + +132,232 + +176,017 + +Convertible preferred stock + +6,677,789 + +11,269,813 + +13,358,813 + + + + + + + + + +Total + +7,167,801 + +11,948,687 + +14,416,953 + + + + + + + + +Fully diluted shares outstanding for the years ended December 31, 2001, 2002 and 2003, would have been 7,101,129, 11,702,827 and 13,824,340, +respectively. + +Unaudited pro forma net loss per share + +Unaudited +pro forma net loss per share is computed using the weighted average number of common shares outstanding, including the pro forma effects of automatic conversion of all outstanding redeemable +convertible preferred stock and accrued dividends through each balance sheet date into shares of the Company's common stock effective upon the assumed closing of the Company's proposed initial +offering as if such conversions had occurred at the date of original issuance. The Company's historical capital structure is not indicative of its prospective structure due to the automatic conversion +of all shares of preferred stock into common stock concurrent with the closing of the Company's +anticipated initial public offering. Accordingly, historical basic net loss per common share should not be used as an indicator of future earnings per common share. + +The +following table reconciles the weighted-average common shares used in the computation of basic and diluted net loss available to common stockholders per share to the unaudited pro forma net loss +available to common stockholders: + + + + +Years Ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + +Basic and diluted weighted-average common shares outstanding + +423,340 + +433,014 + +465,527 + +Effect of pro forma conversion of preferred stock (unaudited): + + + + + + + + +Series A Convertible Preferred Stock + +669,343 + +669,343 + +669,343 + + +Series B Convertible Preferred Stock + +236,952 + +236,952 + +236,952 + + +Series C Convertible Preferred Stock + +296,016 + +296,016 + +296,016 + + +Series D Convertible Preferred Stock + +2,216,742 + +2,216,742 + +2,216,742 + + +Series E Convertible Preferred Stock + +3,059,083 + +3,059,083 + +3,059,083 + + +Series F Convertible Preferred Stock + +199,653 + +4,791,677 + +6,880,677 + + + + + + + + +Pro forma weighted-average common shares outstanding (unaudited) + +7,101,129 + +11,702,827 + +13,824,340 + + + + + + + + +Based on the net loss attributable to common stockholders of $17,643,418 and after giving effect to the pro forma conversion of preferred stock, the pro forma +net loss per common share basic and diluted is $1.28 (unaudited). + +Income taxes + +Deferred +tax liabilities and assets are provided for differences between the book and tax bases of existing assets and liabilities and tax loss carryforwards and credits, using tax rates expected to +be in effect in the years in which differences are expected to reverse. The valuation allowance reduces deferred tax assets to an amount that represents management's best estimate of the amount of +such deferred tax assets that more likely than not will be realized. + + F-14 + + + +New accounting pronouncements + +In +April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB +Statement No. 13, and Technical Corrections ("SFAS No. 145"). SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses +from Extinguishment of Debt, SFAS No. 44, Accounting for Intangible Assets of Motor Carriers and SFAS No. 64, Extinguishments of Debt Made to +Satisfy Sinking-Fund Requirements. SFAS No. 145 also amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for +sale-leaseback transactions and the required +accounting for certain lease modifications that have economic effects that are similar to sale leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to +make various technical corrections, clarify meanings or describe their applicability under changed conditions. The provisions of SFAS No. 145 related to the rescission of SFAS No. 4 are +to be applied in fiscal years beginning after May 15, 2002; the provisions related to SFAS No. 13 are to be effective for transactions occurring after +May 15, 2002; all other provisions of SFAS No. 145 are to be effective for financial statements issued on or after May 15, 2002. Early adoption of SFAS No. 145 is +encouraged. The adoption of SFAS No. 145 has not had a material impact on our current financial statements. + +In +June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS No. 146"). SFAS +No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and replaces EITF No. 94-3, Liability +Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs in a Restructuring). The provisions of SFAS No. 146 +are effective for exit or disposal activities that are initiated after December 31, 2002. We believe that SFAS No. 146 may have a prospective effect on our financial statements for costs +associated with future exit or disposal activities the Company may undertake after December 31, 2003. + +In +May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and +Equity ("SFAS No. 150"). SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both +liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were +previously classified as equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first +interim period after June 15, 2003. The adoption of SFAS No. 150 has not had a material impact on our current financial statements. The FASB is addressing certain implementation issues +associated with the application of SFAS No. 150, including those related to mandatorily redeemable financial instruments representing noncontrolling interests in subsidiaries included in +consolidated financial statements. The Company will monitor the actions of the FASB and assess the impact, if any, that these actions may have on the Company's financial statements. + +In +November 2002, the FASB issued FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of +Indebtedness of Others ("FIN 45"). FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under +certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in +issuing the guarantee. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, +irrespective of the guarantor's fiscal year-end. The disclosure requirements are + + F-15 + + + +effective for financial statements of periods ending after December 15, 2002. The adoption of FIN 45 has not had a material impact on the Company's current financial statements. + +In +November 2002, the EITF issued EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables ("EITF 00-21"). EITF 00-21 +addresses the determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how the related revenues should be measured and allocated to the +separate units of accounting, i.e., the delivery or +performance of multiple products, services, and/or rights to use assets. In applying this guidance, separate contracts with the same party, entered into at or near the same time, will be presumed to +be a package, and the consideration will be measured and allocated to the separate units based on their relative fair values. EITF 00-21 applies to revenue arrangements entered into after +June 30, 2003. We adopted this new accounting guidance effective July 1, 2003 and the adoption did not have a material impact on our financial position, results of operations or cash +flows. + +In +January 2003, the FASB issued Interpretation 46, Consolidation of Variable Interest Entities ("FIN 46") with the objective of +improving financial reporting by companies involved with variable interest entities. FIN 46 clarifies the application of Accounting Research Bulletin No. 51 to certain entities, defined as +variable interest entities, in which equity investors do not have characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities +without additional subordinated support from other parties. In December 2003, the FASB issued a revision to FIN 46 ("FIN 46R") to clarify some of the provisions of FIN 46. The +Company currently has no entities which have the characteristics of a variable interest entity. Furthermore, the Company does not expect that the adoption of the remaining provision of FIN 46R +in the quarter ending March 31, 2004 will have an impact on the Company's financial statements. + +3. Initial Public Offering + +On December 8, 2003, the Company filed a Registration Statement on Form S-1 under the Securities Exchange Act of 1933 with the SEC. This initial public offering ("IPO") is +expected to become effective in the first quarter of fiscal 2004. We have applied to have our common stock approved for quotation on The Nasdaq National Market System under the symbol "IMMC." In +connection with the IPO, the Company had incurred costs totaling $673,736 to date, and has included these costs on the December 31, 2003 consolidated balance sheet as "Assets Related to Financing +Activities." + +4. Property and equipment + +Property +and equipment are comprised of the following: + + + + +December 31, + +2002 + + + +December 31, + +2003 + + + + + + +Laboratory equipment + +$ +1,214,613 + +$ +1,387,411 + + +Office furniture and equipment + + +570,883 + + +610,908 + + +Leasehold improvements + + +1,812,069 + + +3,195,260 + + +Manufacturing equipment + + +367,744 + + +632,073 + + +Computer equipment + + +960,832 + + +1,169,664 + + + + + + + + + +Property and equipment, gross + + +4,926,141 + + +6,995,316 + + +Less Accumulated depreciation + + +(2,312,837 +) + +(3,434,530 +) + + + + + + + + +Property and equipment, net + +$ +2,613,304 + +$ +3,560,786 + + + + + + + + + + F-16 + + + +Depreciation expense on property and equipment for the years ended December 31, 2001, 2002 and 2003 was $772,403, $894,880 and $1,123,246, respectively. + +5. Accrued expenses + +Accrued +expenses are comprised of the following: + + + + +December 31, + +2002 + + + +December 31, + +2003 + + +Salary related expense + +$ +330,760 + +$ +546,047 + +Clinical research and trial costs + + +616,710 + + +607,643 + +Contracted research costs + + +130,265 + + +164,929 + +Deferral loan premium + + +264,693 + + +138,889 + +Accounting and legal fees + + +61,450 + + +663,700 + +Leasehold improvements + + +110,000 + + +39,645 + +Other + + +268,177 + + +626,176 + + + + + + +Accrued expenses + +$ +1,782,055 + +$ +2,787,029 + + + + + + + F-17 + + 6. Long-term debt + +As +of December 31, 2003, the Company had an aggregate of $7,149,514 of bank debt outstanding under $15,450,000 of credit facilities with two lending institutions. + +In +May 1999, the Company entered into a $1,250,000 credit facility ("first credit facility") with a financial institution. From February 2000 to November 2001, the first credit +facility was amended to increase the facility to a total of $3,450,000. Collateral for this loan is a first lien on all assets of the Company except for the Company's intangible intellectual property +and except for the assets pledged under the equipment line of credit agreement with another lending institution ("third credit facility") discussed below. Borrowings under the first credit facility +are repayable over various periods ranging from 22 to 42 months and bear interest at the US Treasury note yield to maturity on the date of borrowings plus 300-basis points (8.00% to +9.74%). The Company issued a warrant to purchase 194,200 shares of Series D Convertible Preferred Stock with an exercise price of $0.3218 per share in connection with the initial loan and in +February 2000, in connection with an amendment to the loan, issued additional warrants to purchase 155,376 shares of Series D Convertible Preferred Stock. In connection with another +amendment to the loan, the Company issued, in January 2001, warrants to purchase 7,384 shares of Series E Convertible Preferred Stock at an exercise price of $4.74 (see Note 7). +As of December 31, 2003, the Company has repaid all of the outstanding balances under the first credit facility. + +In +April 2002, the Company obtained a second credit facility of $5,000,000 (the "second credit facility") from the same financial institution responsible for the first credit facility and +borrowed the full amount in May 2002. This facility bears interest at 2% above the prime rate or 6.75%, whichever +is greater. The loan is payable over the 36 month period ending April 2005. In April 2003, this credit facility was amended to increase the facility to $7,000,000. The $2,000,000 +supplemental loan was advanced in two tranches. The first tranche was subject to the Company obtaining equipment financing of $3,000,000 from another lending institution. The second tranche was +subject to the Company raising $10,000,000 from the sale of additional shares of the Company's stock to investors. The Company met these conditions and borrowed the full $2,000,000 by +July 2003. Collateral for this loan is a first lien on all assets of the Company except for the Company's intangible intellectual property and except for the assets pledged under the equipment +line of credit agreement with another lending institution discussed below. Interest on these supplemental advances is prime plus 4.25% with a minimum of 8.5% and is repayable over 36 months. +The Company issued a warrant to purchase 25,000 and 13,750 shares of Series Convertible F Preferred Stock in April 2002 and April 2003, respectively, with an exercise price of $4.00 per +share in connection with this loan (see Note 7). As of December 31, 2003, the Company has $3,937,754 outstanding under the second credit facility. + +In +April 2003, the Company obtained $5,000,000 in the form of equipment lines of credit from another lending institution (the "third credit facility"). Interest on this loan ranged from 8.25% +to 9.25% and is repayable over 36 to 60 months. Collateral for this loan is a first lien on those assets specifically pledged under this line of credit and a subordinated lien on all remaining +assets of the Company except for the Company's intangible intellectual property. The Company issued a warrant to purchase 20,834 shares of common stock of the Company with an exercise price of $4.00 +per share in connection with this loan (see Note 7). The initial advance on this facility was $3,000,000. The Company obtained the right to borrow the second advance of $2,000,000 in +December 2003 upon the filing of our Registration statement on Form S-1 for our IPO (see Note 3). + + F-18 + + + +In +connection with this second advance the Company entered into a security deposit pledge agreement. This security deposit earns 2% simple interest per annum from the commencement date, as long as the +Company is not in default of the loan. The amount of this security deposit will decrease to 50% of the outstanding principal balance on a calendar biannual basis as long as we are not in default. The +security deposit will be returned upon completion of an initial public offering. As of December 31, 2003, this deposit balance was $251,509, of which $181,511 is classified as long term asset +and reported as "Other assets" on the accompanying consolidated balance sheet. The current portion of this deposit is reported in "Other current assets" on the accompanying consolidated balance sheet. +As of December 31, 2003, the Company had $3,211,760 outstanding under the third credit facility. + +As +of December 31, 2001, 2002 and 2003, interest rates in effect for outstanding obligations under the credit facilities were 8.00%-9.74%, 6.75%-9.74% and 6.75%-9.25%, +respectively. + +All +the credit facilities are subject to certain covenants, including maintaining a minimum level of earnings before interest, taxes, depreciation and amortization, as defined in the loan agreement, +maintaining a minimum percentage of our cash available for investing with the lending institution and +providing audited financial statements within 120 days after the close of the fiscal year. For the year ended December 31, 2002, the Company's submission of their audited financial +statements was made shortly after the 120 day requirement and therefore the Company was in default of the loan agreement. The Company has obtained appropriate waivers from the lender. The +Company was in compliance with its covenants for the years ended December 31, 2001 and 2003. + +As +of December 31, 2002 and 2003, the Company had $42,420 and $2,145 of capital lease obligations outstanding, respectively. The capital leases are payable in fixed monthly payments of +principal and interest, with interest at rates ranging from 11.9% to 12.5%. + +Interest +expense under these capital lease obligations amounted to $13,378, $8,241 and $2,552, for the years ended December 31, 2001, 2002 and 2003, respectively. + +Future +principal payment obligations on long-term debt as of December 31, 2003 are as follows: + +2004 + + + +$ + +3,359,661 + + + +2005 + + +2,391,055 + + +2006 + + +1,191,350 + + +2007 + + +209,593 + + +2008 + + + + + + + + + + +Total + + +7,151,659 + + +Less current portion + + +(3,359,661 +) + + + + + + + + +$ +3,791,998 + + + + + + + + F-19 + + + +7. Stockholders' equity + +Convertible preferred stock + +As +of December 31, 2003, the authorized and outstanding convertible preferred stock, by series, was as follows: + + + + +December 31, 2003 + + +Series + + + +Shares + +authorized + + + +Shares + +outstanding + + + +Carrying + +amount + + + +Liquidation + +value per + +share + + + +Common + +stock + +equivalent + + +A + +36,350 + +36,350 + +$ +363,500 + +$ +16.00 + +669,343 + +B + +30,000 + +30,000 + + +300,000 + + +15.40 + +236,952 + +C + +30,000 + +30,000 + + +300,000 + + +14.80 + +296,016 + +D + +34,870,666 + +33,251,090 + + +10,596,967 + + +0.32 + +2,216,742 + +E + +5,500,000 + +4,588,612 + + +21,612,236 + + +4.74 + +3,059,083 + +F + +15,080,000 + +13,454,500 + + +51,942,414 + + +4.00 + +8,969,677 + + + + + + + + + + + + + + + + + + + +$ +85,115,117 + + + + +15,447,813 + + + + + + + + + + + + + +In the years ended December 31, 2003 and 2001, the Company sold 6,187,000 and 7,187,500 shares of Series F Convertible Preferred stock ("Series +F"), respectively, at $4.00 per share. Proceeds to the Company were $24,671,049, net of $76,951 financing costs and $26,951,365, net of $1,798,635 in financing costs, respectively, as of +December 31, 2003 and 2001. + +In +August 2003, the Company sold 80,000 Series F shares at $5.00 per share and simultaneously entered into a License and Supply Agreement for certain elements of our technology with the +purchaser. We deemed that these Series F shares should be valued at $4.00 per share based on a similar transaction, and that $80,000 or $1.00 per share was deemed to represent deferred license +fee revenue related to certain exclusivity provisions of the License and Supply Agreement, which expire two years from the date of the agreement. The deferred license revenue therefore is amortized +into income over the period of two years (see Note 8). The Series F shares are convertible into common stock at the rate of one common share for each Series F share. + +In +2000, the Company sold 4,588,612 shares of Series E Convertible Preferred stock ("Series E") at $4.74 per share. Proceeds to the Company were $21,612,236, net of $137,785 in financing costs. +The Series E shares are convertible into common stock at the rate of one common share for each Series E share. + +In +1999, the Company sold 33,251,090 shares of Series D Convertible Preferred stock ("Series D") at $0.3218 per share. Proceeds to the Company were $10,596,967, net of $103,233 in financing +costs. The Series D shares are convertible into common stock at the rate of one common share for each ten Series D shares. + +From +1988 to 1990, the Company sold Series A, B and C Convertible Preferred stock ("Series A, B and C") at $10 per share. The Series A, B and C stock were entitled to cumulative +dividends at the annual rate of $.60 per share, if and when declared. As of December 31, 1998, cumulative dividends were $52,410. In connection with the sale of the Series D stock in +1999, no further dividends are to accrue on the Series A, B and C stock and no payments with respect to such accrued dividends will be made unless approved by a vote of 66.67% of the shares of +the Series F, E and D holders. + + F-20 + + + +The +Series F, E and D stock have preferences in liquidation, on a pro-rata basis, to the Series A, B and C stock and common stock. The Series A, B and C have +preferences in liquidation to the common stock. + +At +December 31, 2003, each share of Preferred Stock was convertible into common stock by dividing the liquidation price per share, along with any premium paid by the stated conversion price. +The Series A, B, C, D, E and F shares have conversion prices of $0.5793, $1.30, $1.00, $3.22, $4.74 and $4.00, respectively, and have voting rights equal to the number of shares of common stock +into which they are convertible. + +The +Series A, B, C, D, E and F stock may be converted into common stock at the holder's option and are automatically converted into common stock upon the completion of an initial public +offering, as defined. + +Common stock + +Each +of our directors is entitled to receive $6,000 in annual cash compensation for 2003 and have the option to receive all or any portion of the compensation in the form of shares of our common stock +instead of cash compensation. During fiscal 2003, the Company issued an aggregate of 38,677 shares of our common stock to our directors who elected to receive shares of common stock in lieu of cash +compensation (see Note 11). + +In +2001, the Company issued 10,000 shares of common stock for scientific advisory services in regards to patents owned by the Company. This issuance related to past services and therefore the Company +recorded a $24,000 expense for the fair value of the shares on the date of issuance. In 2003, the Company issued 1,000 shares of common stock to an employee for past services to the Company. The +Company recorded compensation expense of $2,400 for the fair value of the shares on the date of issuance. + +In +the period from inception to December 31, 2000, the Company issued 26,668 shares of common stock for scientific and strategic advisory services and as consideration for certain rights +granted to the Company from a university (see note 8) and recorded compensation expense of $40,217 for the fair value of the shares on the date of issuance using the fair value method. + +Stock Options + +Under +the Company's Equity Compensation Plan (the "Plan"), the stockholders authorized options to purchase up to 1,000,000 shares of common stock that may be granted to directors, employees and +outside consultants. On January 19, 2001, December 12, 2001, June 16, 2003 and December 31, 2003, the Plan was further amended to increase the number of shares available under the Plan by 166,667, +1,033,333, 400,000 and 166,667 shares, respectively. As of December 31, 2002 and 2003, the total number of options authorized under the Plan is 2,200,000 and 2,766,667, respectively. Options +vest according to their terms, generally 20% to 25% per year over four to five years or 50% per year over two years. All options expire either five or ten years after the grant date. The Company +accounts for options granted to employees in accordance with APB No. 25. Had compensation cost for options been charged to expense consistent with the provisions of SFAS No. 123, the +Company's net loss would have increased by approximately $92,072, $128,233, $159,470 for the years ended December 31, 2001, 2002 and 2003, respectively. The fair value of each option is estimated on +the date of grant using the minimum value method with the following weighted average assumptions: + + F-21 + + + +risk-free interest rate of 4.9%, 4.0%, and 3.14% during the years ended December 31, 2001, 2002, and 2003, respectively; an expected life of five years; and a dividend yield of zero. The fair +value of the options granted during the years ended December 31, 2001, 2002 and 2003 were estimated at $2.40, $2.41 and $7.86 per share, respectively. + +Information +relative to the Company's stock options is as follows: + + + + + +Years ended December 31, + + + + + +2001 + + +2002 + + +2003 + + + + +Options + + + +Weighted + +average + +exercise + +price + + + +Options + + + +Weighted + +average + +exercise + +price + + + +Options + + + +Weighted + +average + +exercise + +price + + +Options outstanding at the beginning of the year + +929,726 + +$1.91 + +1,039,776 + +$1.98 + +1,777,793 + +$2.18 + + + Granted + +141,788 + +2.40 + +838,559 + +2.40 + +827,034 + +2.72 + + + Exercised + +(200 +) +1.05 + +(16,334 +) +1.29 + +(3,609 +) +2.53 + + + Canceled + +(31,538 +) +1.96 + +(84,208 +) +2.04 + +(35,923 +) +2.58 + +Options outstanding at the end of the year + +1,039,776 + +$1.98 + +1,777,793 + +$2.18 + +2,565,295 + +$2.35 + +Options exercisable at the end of the year + +379,113 + +$2.14 + +546,642 + +$2.07 + +882,123 + +$2.08 + +The weighted-average exercise prices and weighted-average fair values of options granted are as follows: + + + + + +Years ended December 31, + + + + +2001 + + +2002 + + +2003 + + + + + +Weighted average exercise price + + + +Weighted average fair value + + + +Weighted average exercise price + + + +Weighted average fair value + + + +Weighted average exercise price + + + +Weighted average fair value + + +Option Price equal to FMV + +$2.40 + +$2.40 + +$2.40 + +$2.40 + +$ + +$ + +Option Price greater than FMV + +$ + +$ + +$ + +$ + +$ + +$ + +Option Price less than FMV + +$ + +$ + +$2.40 + +$3.08 + +$2.72 + +$7.86 + + F-22 + + + +The following table summarizes information relating to the Company's stock options at December 31, 2003: + +Range of + +Exercise Price + + + +Outstanding as of + +December 31, 2003 + + + +Weighted average + +remaining + +contractual life + + + +Weighted + +average + +exercise price + + + +Exercisable + +as of + +December 31, 2003 + + + +Weighted + +average + +exercise price + + +$1.05 - $1.65 + +432,495 + +5.92 + +1.23 + +322,396 + +1.20 + +$2.40 - $2.55 + +1,902,732 + +8.47 + +2.44 + +382,993 + +2.40 + +$3.00 + +176,734 + +3.09 + +3.00 + +176,734 + +3.00 + +$6.00 + +53,334 + +9.97 + +6.00 + + + + + + + + + + + + + + + + + + +2,565,295 + +7.57 + +2.35 + +882,123 + +2.08 + + F-23 + + + +In December 2003, we granted options to purchase 100,000 shares of our common stock to our Chief Executive Officer, 40,000 shares of our common stock to our +Chief Financial Officer, and 16,667 shares of our common stock to our Chief Scientific Officer, in each case at an exercise price below fair value, determined with hindsight. These options vest upon +the earlier of five years from the date of grant or the achievement by each respective employee of certain performance milestones. The vesting for the options given to the Chief Executive Officer and +Chief Financial Officer occur as follows: + + >25% +on the first anniversary of the completion of a financing which raises at least $50 million in net proceeds; + + >25% +upon the achievement of net sales to end users, as defined, of at least $2 million per month for three consecutive months; and + + >50% +upon the achievement of net sales to end users, as defined, of at least $8 million per month for three consecutive months. + +The +vesting for our Chief Scientific Officer is as follows: + + >25% +on the first anniversary of the completion of a financing which raises at least $50 million in net proceeds; + + >25% +upon the commercial launch of the CellSpotter/AutoPrep configuration for an in vitro diagnostic or research use +only application, as determined by our compensation committee; and + + >50% +upon the commercial launch of CellTracks, as determined by our compensation committee. + +Stock-based +compensation for these grants is accounted for in accordance with APB No. 25. Accordingly, the total amount of compensation expense is based on the difference between the exercise +price and the fair value of the stock on the grant date. Such compensation expense is recognized based on management's best estimate of the period in which the performance criteria will be met, with +consideration of the expense that would be recognized under the grants' cliff vesting provisions. As of December 31, 2003, $48,038 was recognized as compensation expense that relates to the +aforementioned grants. + +During +the period from October 1, 2002 through December 31, 2003, the Company issued options to certain employees and directors under the Plan with exercise prices below the estimated +fair value, determined with hindsight, of the Company's common stock on the date of grant. In accordance with the requirements of APB No. 25, the Company has recorded deferred stock-based +compensation for the difference between the exercise price of the stock options and the estimated fair value of the Company's stock on the date of grant. This deferred stock-based compensation is +being amortized to expense on a straight-line-basis over the vesting period, generally four years to five years. During the year ended December 31, 2003, the Company recorded total deferred +stock-based compensation including stock-based compensation for the milestone-based grants described above of $3,996,925. During the year ended December 31, 2003, the Company recorded total +stock-based compensation +expense as a charge to income including stock-based compensation for the milestone-based grants described above of $232,654. + +The +Company issued 37,003, 58,336 and 49,935 options during the years ended December 31, 2001, 2002 and 2003, respectively, to consultants providing legal, scientific advisory and other +professional services. The Company believes that the fair values of the stock options are more reliably measurable than the fair values of the services received. The estimated fair values of the stock +options granted are + + F-24 + + + +calculated at each reporting date using the fair value method, as prescribed by SFAS No. 123, EITF 96-18 and FIN 28, using the following weighted-average assumptions: risk-free +interest rate of 4.6%, 3.4%, and 3.1% and a volatility rate of 0.55%, 53.2% and 46.8% during the years ended December 31, 2001, 2002 and 2003, respectively; an expected life of +five years; and a dividend yield of zero. The stock-based compensation expense related to non-employees will fluctuate as the deemed fair market value of the common stock fluctuates as the +options are earned. In connection with the grants of stock options to non-employees during the years ended December 31, 2001, 2002 and 2003, the Company recorded stock-based compensation +expense of $11,725, $20,264 and $263,321, respectively. In the period from inception to December 31, 2000, the Company issued 112,787 options to consultants providing legal, scientific advisory +and other professional services and recorded stock-based compensation expense of $245,671 for these option issuances using the fair value method. + +Warrants + +In connection with a loan obtained from affiliates in June 1998, the Company issued 33,334 warrants to purchase the Company's Common stock at an exercise price of $3.75 per share. On the date +of issuance, these warrants were deemed to have nominal fair value. As of December 31, 2003, 2,223 of these warrants, which expire June 24, 2004, have been exercised. + +In +March 1999, in connection with the sale of Series D Preferred Stock, the Company issued warrants to purchase 720,000 shares of Series D Preferred Stock at an exercise price of +$0.3218 per share. These warrants expire in March 2004. + +In +May 1999, the Company issued a warrant to purchase 194,200 shares of Series D Preferred Stock at an exercise price of $0.3218 per share in connection with obtaining a credit facility +from a bank (see Note 6). In connection with these warrants, the Company recorded $15,036 of additional interest expense in 1999 representing the fair value of such warrants. In +February 2000, the Company issued an additional warrant to purchase 155,376 shares of Series D Preferred Stock at an exercise price of $0.3218 per share in connection with obtaining an +increase in borrowing capacity under the credit facility. In connection with these warrants, the Company recorded $6,250 of additional interest expense in 2000 representing the fair value of such +warrants. In January 2001, the Company issued additional warrants to purchase 7,384 shares of Series E Preferred Stock at an exercise price of $4.74 in connection with obtaining an +increase in borrowing capacities under the credit facility. In connection +with these warrants, the Company recorded $7,484 of additional interest expense in 2001 representing the fair value of such warrants. The fair value of such warrants was determined using the fair +value method in accordance with SFAS No. 123. + +In +connection with director compensation policy, the Company has issued 8,001, 22,669 and 22,669 warrants to purchase shares of common stock in August 2001, August 2002 and +May 2003, respectively (see Note 11). + +In +April 2002 in connection with obtaining the $5,000,000 credit facility (see Note 6), the Company issued a warrant to purchase 25,000 shares of Series F Preferred Stock at an +exercise price of $4.00. In connection with these warrants, the Company recorded $60,014 in 2002 as a prepaid asset representing the fair value of such warrants determined by using the fair value +method in accordance with SFAS No. 123. The asset is being amortized over the life of the loan. As of December 31, 2003, unamortized portion of the asset amounted to $26,673. In +the years ended December 31, 2002 and 2003, the Company recorded $13,336 and $20,005, respectively, as an expense representing amortization of this asset. + + F-25 + + + +In +April 2003, the Company obtained $7 million in additional credit in the form of equipment lines of credit from two lending institutions. The Company issued a warrant to purchase +13,750 shares of Series F Preferred Stock with an exercise price of $4.00 per share in connection with $2 million of this loan commitment. The Company issued a warrant to purchase 20,834 +shares of common stock of the Company with an exercise price of $6.00 per share in connection with $5 million of this loan commitment. In connection with these warrants, the Company recorded +$48,449 in 2003 as a prepaid asset representing the fair value of such warrants determined using the fair value method, in accordance with SFAS No. 123. The asset is being amortized over the +life of the loans. As of December 31, 2003, unamortized portion of the asset amounted to $38,372. In the year ended December 31, 2003, the Company recorded $10,077 as an expense +representing amortization of this asset. + +The +total number of warrants outstanding as of December 31, 2003, expressed on an as converted to common stock equivalent basis, is 210,687. + +8. Commitments and contingencies + +Sponsored research and licensing agreements + +In August 2000, the Company entered into a Development, License and Supply Agreement (the "Development Agreement") with Ortho Clinical Diagnostics, Inc. ("Ortho"), a subsidiary of +Johnson and Johnson, Inc., whereby the Company licensed certain rights to its technology and assumed certain development obligations for its cancer diagnostic product candidates. In exchange +Ortho agreed to market and distribute the Company's cancer diagnostic product candidates. On November 10, 2003, the Company executed an amendment to this agreement whereby all of rights and +responsibilities of Ortho were transferred to Veridex LLC. In addition, the Company and Veridex re-negotiated certain clinical development and regulatory milestones. The agreement has a +term of 20 years and may be terminated earlier by either party under certain conditions. The Company is not aware of any intentions by Veridex to terminate the agreement. + +In +connection with the Development Agreement, Veridex made a $1.5 million up-front, non-refundable license fee payment to the Company. In addition, another subsidiary of +Johnson and Johnson ("J&J sub") purchased $5 million of the Company's Series E Preferred Stock. Under this agreement, Veridex is obligated to pay us approximately 30% of their net sales +from the sale of reagents, test kits, and certain other consumable products and disposable items. In addition, the Company will receive additional payments from Veridex if the Company achieves certain +development and sales milestones as defined in the Development Agreement. In March 2001, January 2003 and May 2003, Veridex made three separate $500,000 and one $1,000,000 +nonrefundable payments to the Company for the completion of certain of these milestones. The up-front license fee and the milestone payments have been deferred and are being amortized on a +straight-line basis over the estimated development period from date of receipt through December 2003. Under the terms of the Development Agreement, the Company is required to invest +in related research based on a percentage of sales as defined in the Development Agreement. In December 2001 and July 2003, J&J sub purchased $3 million and $3.3 million of +Series F Preferred Stock, respectively. + +The +Company entered into a License and Supply Agreement ("License and Supply Agreement") with a corporation for development, manufacturing, marketing and sales of products incorporating their +respective proprietary technologies. The term of the agreement is from August 14, 2003 through the + + F-26 + + + +life of the relevant patent rights, the latest of which expires in October 2017. In lieu of the upfront license fee, the corporation purchased 80,000 shares of Series F Preferred Stock +at a premium price of $5 per share. The Company received $400,000 in proceeds for the combined transaction. As shares of the Series F Convertible shares were valued at $4.00 per share in a +similar transaction, the same value was applied to this transaction. As such, $80,000 or $1.00 per share was deemed to represent deferred license fee related to certain exclusivity provisions of the +License and Supply Agreement, which expires two years from its effective date. The deferred license revenue therefore is amortized into income over the period of two years. As of December 31, +2003, the unamortized deferred license revenue related to this arrangement amounted to $65,001, and the Company recognized revenue of $14,999 related to the arrangement herein. + +The +Company entered into a sponsored research agreement ("Sponsored Research Agreement") with a university on June 1, 1999. The term of the sponsored research agreement was from June 1, +1999 through May 31, 2002. The Company paid the university for research and development costs incurred during the research program, which was $190,000 per year for three years, or a total of +$570,000. An initial payment of $47,500 was made upon the execution with subsequent, equal quarterly payments of $47,500 paid through the duration of the agreement. + +The +Company entered a licensing agreement ("Licensing Agreement") with a university on June 1, 1999 in an effort to develop licensed subject matter and identify future technologies. The +technology developed relates to the isolation, enrichment and characterization of circulating epithelial cells, while determining their relationship to cancer disease states. The Company was granted a +royalty bearing, exclusive license to use, manufacture and distribute licensed products developed as part of the licensing agreement with the university. The term of this agreement is for +15 years. + +In +consideration of the rights granted by the university, the Company will pay the university the following: A nonrefundable annual license maintenance royalty of $25,000, along with a royalty equal +to one percent of net sales of licensed products. As of December 31, 2003, the Company has yet to manufacture any products developed as a result of the licensing agreement. In the event the +Company pays a royalty to a third party for use of patented technology which materially enables the functionality of the university's developed technology, then the Company shall be entitled to +receive a credit against royalties due the university in the amount of the third party royalty payments. + +The +Company reimbursed the university for all previously incurred patent related expenses. In addition, the Company is responsible for all fees associated with the patents filing and prosecuting, +enforcing and maintaining the rights of the patented technology. In consideration for the rights granted by the university, the Company issued the university 13,334 shares of Common stock, which was +valued at $14,980 and recorded as research and development expense. + +In +1997 the Company entered into a license agreement with a university ("Netherlands Agreement") covering optical analysis of particles similar to cells and cell particles. In consideration of the +rights granted by the university, the Company will pay the university a royalty equal to three percent of net sales of products covered by the licensed technology for which a valid patent exists or +one and three-quarters percent (1.75%) of net sales of products covered by the licensed technology for which no valid patent exists. As of December 31, 2003, the Company has yet to manufacture +any products developed as a result of the Netherlands Agreement. + + F-27 + + Facility and capital leases + +In 1999, the Company entered into a seven-year operating lease on its current headquarters office facility. The Company leased additional space in an adjacent facility in 2000 and in 2002. +The lease was further amended effective October 1, 2003 to add additional space and extend the term of the lease through September 30, 2010. In total, the Company has approximately +41,500 square feet under lease at its headquarters. On April 1, 2002 the Company leased approximately 1,400 sq. ft. of office space in the Netherlands to support research activities. This lease +expires on April 30, 2004 with automatic two-year extension. On October 1, 2002 the Company entered into a 22-month sublease agreement for approximately 582 sq. ft. of space +in its existing office facility, which will end on July 31, 2004. Total rental income for the year ended December 31, 2002 and 2003 was $1,027 and $10,476, respectively. Anticipated +rental income is $6,111 for 2004. Rent expense net of sublease rental income for all locations for years ended December 31, 2001, 2002 and 2003 was $496,243, $579,247 and $665,590, +respectively. + +The +Company has two equipment leases which are recorded as capital leases. As of December 31, 2002 and 2003, the Company had $42,420 and $2,145 of capital lease obligations outstanding, +respectively. The capital leases are payable in fixed monthly payments of principal and interest, with interest at rates ranging from 11.9 percent to 12.5 percent and the net book value +of the related property was $9,229 and $0 at December 31, 2002 and 2003, respectively. Amortization of assets recorded under capital leases is included with depreciation expense. + +Future +minimum lease payments under the capital and operating leases as of December 31, 2003 are as follows: + + + + +Capital + + + +Operating + + +2004 + +$ +2,177 + +$ +713,624 + +2005 + + + + + +735,053 + +2006 + + + + + +747,038 + +2007 + + + + + +755,190 + +2008 + + + + + +752,097 + +2009 and thereafter + + + + + +1,364,148 + + + + + + +Total minimum lease payments + + +2,177 + +$ +5,067,150 + + + + + + + +Amount representing interest + + +32 + + + + + + + + + + + +Present value of net minimum payments + + +2,145 + + + + +Less: Current portion + + +2,145 + + + + + + + + + + + +Long-term capital lease obligation + +$ + + + + + + + + + + + + +Leasehold improvements + +As noted above, the Company amended its facility lease to add additional 8,150 square feet of office space. The estimated renovation cost for the expanded space is $1 million. + +Employment contracts + +On March 20, 2003 the Company entered into employment contracts with its Chief Executive Officer, Chief Financial Officer and Chief Scientific Officer ("Named Employees"). The contracts require +that the Company continue salary and benefits for the Named Employees for a period of one year as well +as accelerate any unvested options if any of the Named Employees is terminated, except for Good Reason or in the event of a Change of Control, as defined in the contracts. + + F-28 + + + +9. Defined contribution plan + +The Company maintains a defined contribution benefit plan in accordance with the provisions of Section 401(k) of the Internal Revenue Code. The Plan ("Plan") covers all +full-time employees of the Company that are at least 21 years of age and have completed three months of service. The Company matches 20 percent of the first two percent of +the participant's elected salary deferral. For the years ended December 31, 2001, 2002 and 2003, the Company contributed $11,244, $15,888, and $19,527, respectively, to the Plan. + +10. Income taxes + +The Company follows SFAS No. 109, Accounting for Income Taxes, which requires the liability method of accounting for +income taxes. Under the liability method, deferred tax assets and liabilities are recognized for the future tax consequences, measured by enacted tax rates, attributable to temporary differences +between the financial statement ("GAAP") carrying amounts of existing assets and liabilities and their respective tax bases as well as net operating losses and tax credit carryforwards, for years in +which taxes are expected to be paid or recovered. + +In +the years from December 31, 1999 through December 31, 2003, the Company has significant federal and state net operating losses (NOL's) available to offset future +taxable income. As of December 31, 2003, the Company has federal NOL's of $61,075,315, which begin to expire in 2005. Since the Company has not yet achieved profitability, +management believes the deferred tax assets for the aforementioned years does not satisfy the realization criteria set forth in SFAS No. 109 and has therefore recorded a full valuation +allowance against the deferred tax asset. + +It +should be noted that the availability and/or utilization of the NOL carryforward against future taxable income, if any, may be limited as a result of certain changes in ownership that may have +occurred or may occur in future periods. + +No +current or deferred income tax expense (benefit) has been recorded for all periods presented. + +The +sources of income/(loss) before the provision for income taxes are listed below: + + + + +December 31, + +2001 + + + +December 31, + +2002 + + + +December 31, + +2003 + + + + + + +US + +$ +(12,041,562 +) +$ +(18,033,846 +) +$ +(17,343,156 +) + +Foreign + + + + + +(287,284 +) + +(300,262 +) + + + + + + + + + + +Income/(loss) before provision for income taxes + +$ +(12,041,562 +) +$ +(18,321,130 +) +$ +(17,643,418 +) + + + + + + + + + + +A reconciliation of the statutory federal income tax expense (benefit) is listed below: + + + + +December 31, + +2001 + + + +December 31, + +2002 + + + +December 31, + +2003 + + + + + +Statutory income tax benefit + +$ +(4,214,547 +) +$ +(6,412,396 +) +$ +(6,175,196 +) + +State benefit, net of federal + + +(781,497 +) + +(1,189,041 +) + +(1,145,058 +) + +Permanent items + + +10,984 + + +20,150 + + +87,299 + + +Change in valuation allowance + + +4,985,060 + + +8,428,133 + + +7,495,330 + + +R&D Credit + + + + + +(846,846 +) + +(262,375 +) + + + + + + + + + + +Total provision/(benefit) + +$ + + +$ + + +$ + + + + + + + + + + + + + F-29 + + + +The provision for income taxes is summarized as follows: + + + + +December 31, + +2001 + + + +December 31, + +2002 + + + +December 31, + +2003 + + + + + + +Current + + + + + + + + + + + + +Federal + +$ + + +$ + + +$ + + + + +State + + + + + + + + + + + + + +Total Current + + + + + + + + + + + + + + + + + + + + +Deferred + + + + + + + + + + + + +Federal + + +(4,203,563 +) + +(7,239,092 +) + +(6,350,272 +) + + +State + + +(781,497 +) + +(1,189,041 +) + +(1,145,058 +) + + + +Total Deferred + + +(4,985,060 +) + +(8,428,133 +) + +(7,495,330 +) + +Change in valuation allowance + + +4,985,060 + + +8,428,133 + + +7,495,330 + + + + + + + + + + + +Total provision for income taxes + +$ + + +$ + + +$ + + + + + + + + + + + + +The tax effect of the temporary differences that give rise to deferred income tax assets and liabilities are listed below: + + + + +December 31, + +2002 + + + +December 31, + +2003 + + + + + + +Deferred tax assets + + + + + + + + +Accrued expenses + +$ +6,647 + +$ +68,803 + + +Deferred income + + +284,233 + + +50,762 + + +Deferred compensation + + + + + +276,550 + + +Research & development credit (Federal) + + +1,444,494 + + +1,706,869 + + +Net operating losses + + +18,564,368 + + +25,340,148 + + + + + + + + + +Total deferred tax assets + + +20,299,742 + + +27,443,132 + + + + + + + + + +Deferred tax liabilities + + + + + + + + +Depreciation and amortization + + +(204,301 +) + +(167,215 +) + + + + + + + + +Total deferred tax liabilities + + +(204,301 +) + +(167,215 +) + + + + + + + + +Net deferred tax assets + + +20,095,441 + + +27,275,917 + + + + + + + + + +Federal + + +17,178,060 + + +23,276,407 + + +State + + +2,917,381 + + +3,999,510 + + + + + + + + + +Total + + +20,095,441 + + +27,275,917 + + +Valuation allowance + + +(20,095,441 +) + +(27,275,917 +) + + + + + + + + +Recorded deferred tax asset/(liability) + +$ + + +$ + + + + + + + + + + +11. Related party transactions + +The Company had a receivable from an employee of the Company in the amount of $20,000 as of December 31, 2002 and $0 as of December 31, 2003. The loan was made in +June 2001 and matured on the earlier of December 26, 2002 or the date the employee refinanced his mortgage on his residence. The loan accrued interest at 8% annually. The full amount +due, including interest of $2,733, was paid in full on March 18, 2003. + +In +June 2002 the Company accepted a note from an employee for $19,300 in payment for the proceeds of the exercise of stock options for 14,667 common shares. The note is secured by the shares, +bears interest of 4% per annum and is repayable on the earlier of August 1, 2004, 60 days following the successful + + F-30 + + + +completion +on an initial public offering of the common stock of Immunicon or sixty days following the sale of Immunicon. The Company recorded the note as a reduction in Stockholders' equity. + +Each +of our directors is entitled to receive $6,000 in annual cash compensation for the year ended December 31, 2003 and had the option to receive all or any portion of the compensation in the +form of shares of our common stock instead of cash compensation. In addition, each of our directors who are not affiliated with any of our principal stockholders received an option to purchase 8,000 +shares of our common stock. Directors who are affiliated with any of our principal stockholders received warrants to purchase 8,000 shares of our common stock. Each non-employee +chairperson of a committee of our board of directors also receives an option to purchase an additional 2,000 shares. These options and warrants generally become vested over a period of two years. +During the year ended December 31, 2003, we issued an aggregate of 38,677 shares of our common stock to our directors who elected to receive shares of common stock in lieu of cash compensation. +The number of shares issued was determined by the amount of cash compensation that would have been paid to these directors. The shares were issued at a price that was below fair value and therefore +the company recorded a compensation expense for the difference between fair value and the value given to these shares. The Company issued 8,001, 22,669, and 22,669 warrants to our board of directors +in August 2001, August 2002 and May 2003, respectively, each at an exercise price of $2.40. The estimated fair values of these warrants were determined utilizing the fair value +method, as prescribed by SFAS No. 123, using the following assumptions: risk-free interest rates of 4.6%, 3.4% and 3.1% and a volatility rate of 0.55%, 53.2% and 46.8% during 2001, +2002, and 2003, respectively; an expected life of 10 years and a dividend yield of zero. + +In +addition, Johnson and Johnson Development Corporation beneficially owns 11% of the Company and is a wholly-owned subsidiary of Johnson & Johnson, Inc. We have a Development, License +and Supply agreement with Veridex, another wholly-owned subsidiary of Johnson & Johnson. This agreement provides Veridex with exclusive worldwide rights to commercialize cell analysis products +based on our technologies in the field of cancer (see Note 8). The Company has recognized revenues of $575,388, $620,844 and $2,620,843 in fiscal year 2001, 2002 and 2003, respectively under +this agreement. The Company recorded these revenues as "License revenue from related party" in the consolidated statement of operations. As of December 31, 2002 and 2003, the Company had a receivable +from Veridex of $0 and $87,703, respectively, and a payable to Veridex of $0 and $28,023, respectively. + +In +addition, the Company sold all of its rights to a trademark to Johnson & Johnson, Inc. for $250,000 in fiscal 2003 and recorded it as Other Income from Related Party on the +consolidated statement of operations. + +In +August 2003, the Company sold Series F Preferred Stock and entered into a License and Supply Agreement ("License and Supply Agreement") with a corporation (see Note 8). The Company +received $400,000 in proceeds for the combined transaction. As shares of the Series F Convertible shares were valued at $4.00 per share in a similar transaction, the same value was applied to +the shares in this transaction. The amount above the value of the Series F shares was deemed attributable to the License and Supply Agreement and recorded as deferred license revenue. The +Company recorded the $80,000 premium as deferred license revenue and amortizes it into income over the period of the exclusive supply arrangement with the corporation, which is two years. As of +December 31, 2003, the unamortized deferred license revenue related to this arrangement amounted to $65,001, and the Company recognized revenue of $14,999 related to the arrangement and +recorded it as "License revenue from related party" in the consolidated statement of operations in fiscal 2003. + + F-31 + + + +12. Supplemental expense information + +The supplemental expense information below provides additional information about the amounts recorded as research and development expenses and general and administrative +expenses in the accompanying statements of operations: + +Research and development expenses + +Research and development expenses are comprised of the following: + + + + +Years Ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + +Salaries, benefits and taxes + +$ +4,283,380 + +$ +6,132,220 + +$ +7,607,785 + +Laboratory supplies and expenses + + +925,095 + + +1,401,755 + + +2,239,912 + +Instrument development costs + + +1,035,251 + + +3,057,232 + + +2,047,538 + +Clinical trial expenses + + +1,713,024 + + +2,167,410 + + +931,558 + +Contracted research costs + + +928,871 + + +1,235,138 + + +1,609,906 + +All others + + +1,607,112 + + +1,802,889 + + +1,595,915 + + + + + + + + + + +$ +10,492,733 + +$ +15,796,644 + +$ +16,032,614 + + + + + + + + +General and administrative expenses + +General and administrative expenses are comprised of the following: + + + + +Years Ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + +Salaries, benefits and taxes + +$ +1,086,853 + +$ +1,412,724 + +$ +1,928,627 + +Depreciation expense + + +772,403 + + +894,880 + + +1,123,246 + +Legal and professional fees + + +612,896 + + +890,176 + + +972,534 + +All others + + +189,897 + + +365,868 + + +487,559 + + + + + + + + + + +$ +2,662,049 + +$ +3,563,648 + +$ +4,511,966 + + + + + + + + + F-32 + + + +13. Quarterly financial data (unaudited) + +The following table presents unaudited quarterly financial data. These quarterly results of operations for the periods shown are not necessarily indicative of future results of +operations. + + + + +Net loss + + + +Net loss + +available to + +common + +shareholders + +per share + +basic and diluted + + + + + + +Year ended December 31, 2002 + + + + + + + + +First quarter + +$ +(4,442,052 +) +$(10.44 +) + + +Second quarter + + +(4,503,009 +) +(10.57 +) + + +Third quarter + + +(4,638,868 +) +(10.54 +) + + +Fourth quarter + + +(4,737,201 +) +(10.76 +) + +Year ended December 31, 2003 + + + + + + + + +First quarter + + +(4,340,718 +) +(9.84 +) + + +Second quarter + + +(3,827,305 +) +(8.35 +) + + +Third quarter + + +(4,619,085 +) +(9.64 +) + + +Fourth quarter + + +(4,856,310 +) +(10.05 +) + +14. Subsequent event + +On January 21, 2004, FDA granted Veridex, LLC clearance for marketing of the CellSearch Epithelial Cell Kit/Cell Spotter Analyzer as an "Immunomagnetic Cancer Cell +Selection and Enumeration System". This clearance is necessary for the Company to initiate sales through Veridex of its metastatic breast cancer monitoring technology. + +On +January 23, 2004, the Company granted options to purchase 66,679 shares of common stock to certain employees, directors and consultants under the Equity Compensation Plan with exercise +prices below the fair value of the Company's common stock on the date of the grant. The Company expects to recognize compensation expense in the year ending December 31, 2004 of $328,291 based +on the difference between the exercise price and the fair market value on the date of the grant. + +On +March 2, 2004, the Company held its annual meeting of stockholders at which the following actions were approved: + + A +2-for-3 reverse stock split of the Company's outstanding common stock, which became effective on March 9, 2004. All share and per share information included herein +has been adjusted to reflect this reverse stock split. + + An +amendment and restatement of the Company's Equity Compensation Plan ("ECP"), which increased the shares of common stock available for future distribution by 1 million +shares upon the effectiveness of the Registration Statement for the IPO and stated after giving effect to the 2-for-3 reverse split referred to above. The total number of shares reserved under the ECP +upon such effectiveness would be 3,766,667. On a pro forma basis as of December 31, 2003 and assuming the increase of 1 million shares, the number of shares of common stock available for future +issuance would be 1,167,547. + + The +establishment of the 2004 Employee Stock Purchase Plan ("ESPP"), which would reserve 200,000 common shares for purchase under this ESPP, and would become effective upon +the effectiveness of the Registration Statement for the IPO. + + The +Third Amended and Restated Certificate of Incorporation, to become effective upon the closing of the IPO. + + The +reelection of the current Board of Directors for a term which will continue until the Company's next annual meeting of stockholders in 2005. + + F-33 + + + + Through +and including , 2004 (the 25th day after the date of this prospectus), federal securities +laws may require all dealers that effect transactions in our common +stock, whether or not participating in this offering, to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to +their unsold allotments or subscriptions. + + + + + + +Part II + +INFORMATION NOT REQUIRED IN PROSPECTUS + +Item 13. Other expenses of issuance and distribution + +The +following table sets forth the costs and expenses, other than the underwriting discounts and commissions, payable by us in connection with the issuance and distribution of the common stock being +registered. All amounts are estimates except the SEC registration fee, the NASD filing fee and the Nasdaq National Market listing fee. + + + + +Amount + + + + + +SEC registration fee + +$ +8,290 + +NASD filing fee + + +10,160 + +Nasdaq National Market listing fee + + +100,000 + +Printing and engraving expenses + + +500,000 + +Legal fees and expenses + + +750,000 + +Accounting fees and expenses + + +300,000 + +Blue Sky fees and expenses (including legal fees) + + +10,000 + +Transfer agent and registrar fees and expenses + + +6,000 + +Miscellaneous fees and expenses + + +15,550 + + + + + +Total + +$ +1,700,000 + + + + +Item 14. Indemnification of directors and officers + +The +registrant's certificate of incorporation permits indemnification to the fullest extent permitted by Delaware law. The registrant's bylaws require the registrant to indemnify any person who was or +is an authorized representative of the registrant, and who was or is a party or is threatened to be made by a party to any corporate proceeding, by reason of the fact that such person was or is an +authorized representative of the Registrant, against judgments, penalties, fines and amounts paid in settlement and +expenses actually and reasonably incurred by such person in connection with such third party proceeding if such person acted in good faith and in a manner such person reasonably believed to be in, or +not opposed to, the best interests of the registrant and, with respect to any criminal third party proceeding (including any action or investigation which could or does lead to any criminal third +party proceedings) had no reasonable cause to believe such conduct was unlawful. The registrant shall also indemnify any person who was or is an authorized representative of the registrant and who was +or is a party or is threatened to be made a party to any corporate proceeding by reason of the fact that such person was or is an authorized representative of the registrant, against expenses actually +and reasonably incurred by such person in connection with the defense or settlement of such corporate action if such person acted in good faith and in a manner reasonably believed to be in, or not +opposed to, the best interests of the registrant, except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to +the registrant unless and only to the extent that the Delaware Court of Chancery or the court in which such corporate proceeding was pending shall determine upon application that, despite the +adjudication of liability but in view of all the circumstances of the case, such authorized representative is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery +or such other court shall deem proper. Such indemnification is mandatory under the registrant's bylaws as to expenses actually and reasonably incurred to the extent that an authorized representative +of the registrant had been successful on the merits or otherwise in defense of any third party or corporate proceeding or in + + II-1 + + + +defense of any claim, issue or matter therein. The determination of whether an individual is entitled to indemnification may be made by a majority of disinterested directors, independent legal +counsel in a written legal opinion or the stockholders. Delaware law also permits indemnification in connection with a proceeding brought by or in the right of the registrant to procure a judgment in +its favor. Insofar as indemnification for liabilities arising under the Securities Act of 1933, the Securities Act, may be permitted to directors, officers or persons controlling the registrant +pursuant to the foregoing provisions, the registrant has been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the +Securities Act and is therefore unenforceable. + +The +Underwriting Agreement provides that the underwriters are obligated, under certain circumstances, to indemnify directors, officers, and controlling persons of the Registrant against certain +liabilities, including liabilities under the Securities Act. Reference is made to the form of Underwriting Agreement filed as Exhibit 1.1 to this Registration Statement. + +Item 15. Recent sales of unregistered securities + +During +the three-year period preceding the date of this offering, we issued and sold the following securities (the option, warrant, share and price numbers below give effect, where +applicable, to the two-for-three reverse stock split of our common stock completed in March 2004): + +1.Options +to purchase 1,851,992 shares of our common stock, at a weighted average exercise price of $2.84, to employees, consultants, directors and officers pursuant to our equity +compensation plan, consisting of options to purchase 101,783 shares in 2001 at a weighted average exercise price of $2.40, 838,559 shares in 2002 at a weighted average exercise price of $2.40, +827,034 shares in 2003 at a weighted average exercise price of $2.72, and 84,616 shares in 2004 at a weighted average exercise price of $9.00. We relied on the exemption from the registration +requirements of the Securities Act provided by Rule 701 promulgated under the Securities Act. + +2.An +aggregate of 32,357 shares of our common stock upon the exercise of stock options granted to employees, consultants, directors and officers pursuant to our equity compensation plan, +at an aggregate exercise price of $46,598, consisting of 200 shares issued in 2001 at an aggregate exercise price of $210.00, 16,334 shares issued in 2002 at an aggregate exercise price of $21,140, +3,609 shares issued in 2003 at an aggregate exercise price of $9,136 and 12,214 shares issued in 2004 at an aggregate exercise price of $16,112. We relied on the exemption from the registration +requirements of the Securities Act provided by Rule 701 promulgated under the Securities Act. + +3.An +aggregate of 18,677 shares of our common stock in 2003 to our directors who elected to receive shares of common stock in lieu of annual cash compensation in an aggregate amount of +$22,500 in accordance with our director compensation policy, consisting of 17,500 shares issued in May 2003 in lieu of an aggregate amount of $21,000 in cash compensation and 1,177 shares +issued in November 2003 in lieu of $1,500 in cash compensation. We relied on the exemption from the registration requirements of the Securities Act provided by Rule 701 promulgated under +the Securities Act. + +4.An +aggregate of 20,000 shares of our common stock in May 2003 to four of our principal stockholders, all of which are accredited investors, in lieu of issuing shares of common stock to +our directors affiliated with these principal stockholders who elected to receive shares of common stock in lieu of annual cash compensation in an aggregate amount of $24,000 in + + II-2 + + + +accordance +with our director compensation policy. We relied on the exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof. + +5.In +August 2001, we issued warrants to purchase an aggregate of 8,001 shares of our common stock at an exercise price of $2.40 per share to three of our principal stockholders, +all of which are accredited investors, in lieu of granting options as compensation for board service to certain of our directors who are affiliated with these principal stockholders. We relied on the +exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof. + +6.In +December 2001, we sold an aggregate of 7,187,500 shares of our Series F preferred stock at a purchase price of $4.00 per share to twenty-four accredited investors for +an aggregate purchase price of $28,750,000. UBS Warburg LLC acted as the exclusive placement agent for this financing and received $1,646,265 as consideration for its services. We relied on the +exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof and Rule 506 of Regulation D promulgated thereunder. + +7.In +April 2002, we issued to Silicon Valley Bank a warrant to purchase 25,000 shares of our Series F preferred stock at an exercise price of $4.00 per share in connection +with a line of credit. We relied on the exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof. + +8.In +August 2002, we issued warrants to purchase an aggregate of 22,669 shares of our common stock at an exercise price of $2.40 per share to four of our principal stockholders, +all of which are accredited investors, in lieu of granting options as compensation for board service to certain of our directors who are affiliated with these principal stockholders. We relied on the +exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof. + +9.In +April 2003, we issued to Silicon Valley Bank a warrant to purchase 13,750 shares of our Series F preferred stock at an exercise price of $4.00 per share in connection +with a line of credit. We relied on the exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof. + +10.In +April 2003, we issued to General Electric Capital Corporation a warrant to purchase 20,834 shares of our common stock at an exercise price of $6.00 per share in connection +with a line of credit. We relied on the exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof. + +11.In +May 2003, we issued warrants to purchase an aggregate of 22,669 shares of our common stock at an exercise price of $2.40 per share to four of our principal stockholders, all +of which are accredited investors, in lieu of granting options as compensation for board service to certain of our directors who are affiliated with these principal stockholders. We relied on the +exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof. + +12.In +June 2003, we sold an aggregate of 6,187,000 shares of our Series F preferred stock at a purchase price of $4.00 per share to thirty-four accredited investors for an +aggregate purchase price of $24,748,000. We relied on the exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof and Rule 506 of +Regulation D promulgated thereunder. + + II-3 + + + +13.In +August 2003, we sold 80,000 shares of our Series F preferred stock at a purchase price of $5.00 per share to Research and Diagnostic Systems, Inc., an +accredited investor, for an aggregate purchase price of $400,000. We relied on the exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof and +Rule 506 of Regulation D promulgated thereunder. + +14.In +January 2004, we issued warrants to purchase an aggregate of 18,668 shares of our common stock at an exercise price of $9.00 per share to three of our principal +stockholders, all of which are accredited investors, in lieu of granting options as compensation for board service to certain of our directors who are affiliated with these principal stockholders. We +relied on the exemption from the registration requirements of the Securities Act provided by Section 4(2) thereof. + +15.An +aggregate of 720,000 shares of our Series D preferred stock in March 2004 to six accredited investors upon the exercise of outstanding warrants previously issued to +such investors in March 1999, at an aggregate exercise price of $231,699. We relied on the exemption from the registration requirements of the Securities Act provided by Section 4(2) +thereof. + +16.An +aggregate of 10,667 shares of our common stock in March 2004 to one accredited investor upon the exercise of outstanding warrants previously issued to affiliates of such +investor who are also accredited investors in August 2001, August 2002 and May 2003, at an aggregate exercise price of $25,600. We relied on the exemption from the registration +requirements of the Securities Act provided by Section 4(2) thereof. + +17.In +March 2004, we issued a warrant to purchase 3,334 shares of our common stock at an exercise price of $1.50 per share to one accredited investor in connection with the +performance of research and development consulting services by the investor for us beginning in August 1999. We relied on the exemption from the registration requirements of the Securities Act +provided by Section 4(2) thereof. + +The +recipients of securities in the transactions described above represented to us their intentions to acquire the securities for investment purposes only and not with a view to or for sale in +connection with any distribution thereof and appropriate legends were affixed to the share certificates and warrants issued in such transactions. All recipients had adequate access, through their +relationships with us and otherwise, to information about us. + +With +respect to the sales and issuances referenced in items 1-3 above, we relied on the exemption from the registration requirements of the Securities Act provided by Rule 701 promulgated under the +Securities Act. All of these sales and issuances were made to employees, consultants, directors and officers pursuant to a written compensatory benefit plan (in the case of items 1-2 above, our equity +compensation plan, and, in the case of item 3 above, our director compensation policy). All consultants to which we issued such securities were natural persons that provided bona fide services to us +or our majority-owned subsidiaries, other than services in connection with the offer or sale of securities in a capital-raising transaction or that directly or indirectly promoted or maintained a +market for our securities. + +None +of the sales or issuances referenced in items 1-3 above involved the sale or offering of an amount of securities that exceeded, during the 12-month period preceding each such sale or issuance, +the greater of: (i) $1,000,000; (ii) 15% of our total assets, measured as of the most recent balance sheet date (no older than our last fiscal year end) preceding such sale or issuance; or (iii) 15% +of the outstanding amount of the class of securities sold or offered in reliance on Rule 701 promulgated + + II-4 + + + +under the Securities Act, measured as of the most recent balance sheet date (no older than our last fiscal year end) preceding such sale or issuance. Each participant in our equity compensation plan +or under our director compensation policy described in items 1-3 above was provided with a copy of the respective plan or policy. In addition, as of the date of the last of the sales or issuances +described in items 1-3 above, we did not have sales in excess of $5 million during any 12-month period. + +Item 16. Exhibits + +Exhibit + +number + + +Description + + 1.1 + +Form of Underwriting Agreement. + + 3.1 + + + +Form of Amended and Restated Certificate of Incorporation of Immunicon Corporation to be filed and to become effective upon completion of this offering. + + 3.2 + + + +Form of Bylaws of Immunicon Corporation to become effective upon completion of this offering. + + 4.1 + + + +Form of Immunicon Corporation Common Stock Certificate. + + 5.1 + + + +Opinion of Morgan, Lewis & Bockius LLP. + +10.1 + + + +Form of Warrant to Purchase Stock issued by Immunicon Corporation to Silicon Valley Bank and accompanying schedule. + +10.2 + + + +Form of First Amendment to Warrant to Purchase Stock between Immunicon Corporation and Silicon Valley Bank and accompanying schedule. + +10.3 + + + +Form of Series D Preferred Stock Purchase Warrant issued by Immunicon Corporation on March 15, 1999 and accompanying schedule. + +10.4 + + + +Form of Common Stock Purchase Warrant issued by Immunicon Corporation and accompanying schedule. + +10.5 + + + +Form of Common Stock Purchase Warrant, issued by Immunicon Corporation on July 1, 1998 and accompanying schedule. + +10.6 + + + +Warrant to Purchase 31,250 Shares of Common Stock, issued by Immunicon Corporation on April 28, 2003 to General Electric Capital Corporation. + +10.7 + + + +Second Amended and Restated Investors' Rights Agreement, dated December 13, 2001, among Immunicon Corporation and the parties set forth therein. + +10.8 + + + +Amendment to Second Amended and Restated Investors' Rights Agreement, dated March 6, 2003, among Immunicon Corporation and the parties set forth therein. + +10.9 + + + +Second Amendment to Second Amended and Restated Investors' Rights Agreement, dated June 30, 2003, among Immunicon Corporation and the parties set forth therein. + +10.10 + + + +Loan and Security Agreement, dated April 30, 2002, among Immunicon Corporation, its subsidiaries and Silicon Valley Bank. + +10.11 + + + +Form of Negative Pledge Agreement, dated April 30, 2002, among Immunicon Corporation, its subsidiaries and Silicon Valley Bank, and accompanying schedule. + +10.12 + + + +Amendment to Loan and Security Agreement, dated April 28, 2003, among Immunicon Corporation, its subsidiaries and Silicon Valley Bank. + + II-5 + + + +10.13 + + + +Master Security Agreement, dated April 15, 2003, between Immunicon Corporation and General Electric Capital Corporation. + +10.14 + + + +Amendment to Master Security Agreement, dated April 15, 2003, between Immunicon Corporation and General Electric Capital Corporation. + +10.15 + + + +Registration Rights Agreement, dated May 14, 1999, between Immunicon Corporation and Silicon Valley Bank. + +10.16 + + + +Registration Rights Agreement, dated January 31, 2000, between Immunicon Corporation and Silicon Valley Bank. + +10.17 + + + +Registration Rights Agreement, dated December 23, 2000, between Immunicon Corporation and Silicon Valley Bank. + +10.18 + + + +Registration Rights Agreement, dated April 28, 2003, between Immunicon Corporation and Silicon Valley Bank. + +10.19 + + + +Registration Rights Agreement, dated April 28, 2003, between Immunicon Corporation and GE Capital Corporation + +10.20 + + + +Agreement of Lease, dated August 20, 1999, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.21 + + + +First Amendment to Agreement of Lease, dated August 20, 1999, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.22 + + + +Second Amendment to Agreement of Lease, dated September 19, 2000, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.23 + + + +Confirmation of Lease Term, dated November 17, 2000, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.24 + + + +Third Amendment to Agreement of Lease, dated April 24, 2002, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.25 + + + +Fourth Amendment to Agreement of Lease, dated September 30, 2002, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.26 + + + +Fifth Amendment to Agreement of Lease, dated September 25, 2003, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.27** + + + +Development, License and Supply Agreement, dated August 17, 2000, between Immunicon Corporation and Ortho-Clinical Diagnostics, Inc. + +10.28** + + + +Amendment to Development, License and Supply Agreement, dated December 10, 2002, between Immunicon Corporation and Ortho-Clinical Diagnostics, Inc. + +10.29** + + + +Letter agreement regarding Development, License and Supply Agreement, dated November 10, 2003, between Immunicon Corporation and Veridex, LLC. + +10.30** + + + +License and Supply Agreement, dated August 14, 2003, between Immunicon Corporation and Research and Diagnostic Systems, Inc. + +10.31** + + + +Master Supply Agreement, dated November 19, 2002, between Immunicon Corporation and Astro Instrumentation, LLC. + + II-6 + + + +10.32** + + + +Non-Exclusive License and Supply Agreement, dated as of November 1, 2003, between Immunicon Corporation and Molecular Probes, Inc. + +10.33** + + + +Agreement, dated February 10, 2003, between Immunicon Corporation and Pfizer Inc. + +10.34 + + + +Master Services Agreement, dated December 17, 2002, between Immunicon Corporation and Igeneon Krebs-Immuntherapie Forschungs-und Entwicklungs-AG. + +10.35** + + + +Exclusive License Agreement, dated June 21, 1999, between Immunicon Corporation and the Board of Regants of the University of Texas System. + +10.36** + + + +License Agreement, dated April 1, 1997, between Immunivest Corporation and Twente University. + +10.37** + + + +Technology Development Agreement, dated April 1, 1997, between Immunicon Corporation and University of Twente. + +10.38 + + + +Letter agreement, dated April 15, 2003, between Immunicon Corporation and Edward L. Erickson. + +10.39 + + + +Letter agreement, dated April 15, 2003, between Immunicon Corporation and James G. Murphy. + +10.40 + + + +Letter agreement, dated April 15, 2003, between Immunicon Corporation and Leon W.M.M. Terstappen, M.D., Ph.D. + +10.41 + + + +Consulting Agreement, dated January 10, 2000, between Immunicon Corporation and Paul A. Liberti, Ph.D. + +10.42 + + + +Letter agreement, dated February 21, 2002, between Immunicon Corporation and Paul A. Liberti, Ph.D. + +10.43 + + + +Letter agreement, dated September 16, 2002, between Immunicon Corporation and Paul A. Liberti, Ph.D. + +10.44 + + + +Letter Agreement, dated November 18, 2003, between Immunicon Corporation and Paul A. Liberti, Ph.D. + +10.45 + + + +Immunicon Corporation Amended and Restated Equity Compensation Plan. + +10.46 + + + +Immunicon Corporation 2004 Employee Stock Purchase Plan. + +10.47** + + + +Non-Exclusive License Agreement, dated July 1, 2002, between Immunicon Corporation and Streck Laboratories, Inc. + +10.48** + + + +Amendment to Non-Exclusive License Agreement, dated July 24, 2003, between Immunicon Corporation and Streck Laboratories, Inc. + +10.49 + + + +Form of Letter Agreement, to be entered into between Immunicon Corporation and James L. Wilcox, Esq. + +10.50 + + + +Form of Employee Non-Compete Agreement to be entered into between Immunicon Corporation and James L. Wilcox, Esq. + +10.51 + + + +Employee Non-Compete Agreement, dated March 15, 1999, between Immunicon Corporation and Edward L. Erickson. + + II-7 + + + +10.52 + + + +Employee Non-Compete Agreement, dated November 1, 1999, between Immunicon Corporation and James G. Murphy. + +10.53 + + + +Non-Compete Agreement, dated October 24, 1994, between Immunicon Corporation and Leon W.W.M. Terstappen, M.D., Ph.D. + +10.54 + + + +Third Amendment to Second Amended and Restated Investors' Rights Agreement, dated March 15, 2004, among Immunicon Corporation and the parties set forth therein. + +10.55** + + + +Supply Agreement, dated December 13, 2003, between Immunicon Corporation and Astro Instrumentation, LLC. + +10.56 + + + +Form of Common Stock Purchase Warrant issued by Immunicon Corporation on January 23, 2004 and accompanying schedule. + +10.57 + + + +Common Stock Purchase Warrant issued by Immunicon Corporation to BioProbe BV on March 23, 2004. + +10.58 + + + +Letter agreement, dated April 1, 2004, between Immunicon Corporation and Pfizer Inc. + +21.1 + + + +Subsidiaries of Immunicon Corporation. + +23.1# + + + +Consent of Deloitte & Touche LLP. + +23.2 + + + +Consent of Morgan, Lewis & Bockius LLP (included in Exhibit 5.1). + +24.1 + + + +Power of Attorney (included on signature page). + +#Filed herewith. + +**Certain information in these exhibits has been omitted and has been filed separately with the Securities and Exchange Commission pursuant to a confidential +treatment request under 17 C.F.R. Sections 200.80(b)(4), 200.83 and 230.406. + + II-8 + + + +Item 17. Undertakings + +The +undersigned registrant hereby undertakes to provide to the underwriters, at the closing specified in the underwriting agreement, certificates in such denominations and registered in such names as +required by the underwriters to permit prompt delivery to each purchaser. + +Insofar +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 Act 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. + +The +undersigned registrant hereby undertakes that: + +(1)For +purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in +reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be +part of this registration statement as of the time it was declared effective; and + +(2)For +the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new +registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. + + II-9 + + SIGNATURES + +Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Amendment No. 7 to Registration Statement to be signed on its behalf by the undersigned, +thereunto duly authorized, in the city of Huntingdon Valley, in the Commonwealth of Pennsylvania, on April 15, 2004. + + + + + + + +IMMUNICON CORPORATION + + + + + +By: + +/s/ EDWARD L. ERICKSON Edward L. Erickson + Chairman, President and Chief Executive +Officer + +Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 7 to Registration Statement has been signed by the following persons in +the capacities indicated on the dates indicated. + + + +Signature + + +Title + + +Date + + + + + + + + + + + +/s/ EDWARD L. ERICKSON Edward L. Erickson + +Chairman, President and Chief Executive Officer (Principal Executive Officer) + +April 15, 2004 + +/s/ JAMES G. MURPHY James G. Murphy + + + +Senior Vice President, Finance and Administration, and Chief Financial Officer (Principal Financial and Accounting Officer) + + + +April 15, 2004 + +* Jonathan Cool + + + +Director + + + +April 15, 2004 + +* J. William Freytag, Ph.D. + + + +Director + + + +April 15, 2004 + +* Brian J. Geiger + + + +Director + + + +April 15, 2004 + +* Ann Hanham, Ph.D. + + + +Director + + + +April 15, 2004 + + II-10 + + + +* Zola P. Horovitz + + + +Director + + + +April 15, 2004 + +* Allen J. Lauer + + + +Director + + + +April 15, 2004 + +* Marc Ostro, Ph.D. + + + +Director + + + +April 15, 2004 + +* Seth A. Rudnick, M.D. + + + +Director + + + +April 15, 2004 + +* Elizabeth E. Tallett + + + +Director + + + +April 15, 2004 + + + + + +*By: +/s/ EDWARD L. ERICKSON Edward L. Erickson + Attorney-in-Fact + + II-11 + +Exhibit index + +Exhibit + +number + + +Description + + 1.1 + +Form of Underwriting Agreement. + + 3.1 + +Form of Amended and Restated Certificate of Incorporation of Immunicon Corporation to be filed and to become effective upon completion of this offering. + + 3.2 + +Form of Bylaws of Immunicon Corporation to become effective upon completion of this offering. + + 4.1 + +Form of Immunicon Corporation Common Stock Certificate. + + 5.1 + +Opinion of Morgan, Lewis & Bockius LLP. + +10.1 + +Form of Warrant to Purchase Stock issued by Immunicon Corporation to Silicon Valley Bank and accompanying schedule. + +10.2 + +Form of First Amendment to Warrant to Purchase Stock between Immunicon Corporation and Silicon Valley Bank and accompanying schedule. + +10.3 + +Form of Series D Preferred Stock Purchase Warrant issued by Immunicon Corporation on March 15, 1999 and accompanying schedule. + +10.4 + +Form of Common Stock Purchase Warrant issued by Immunicon Corporation and accompanying schedule. + +10.5 + +Form of Common Stock Purchase Warrant, issued by Immunicon Corporation on July 1, 1998 and accompanying schedule. + +10.6 + +Warrant to Purchase 31,250 Shares of Common Stock, issued by Immunicon Corporation on April 28, 2003 to General Electric Capital Corporation. + +10.7 + +Second Amended and Restated Investors' Rights Agreement, dated December 13, 2001, among Immunicon Corporation and the parties set forth therein. + +10.8 + +Amendment to Second Amended and Restated Investors' Rights Agreement, dated March 6, 2003, among Immunicon Corporation and the parties set forth therein. + +10.9 + +Second Amendment to Second Amended and Restated Investors' Rights Agreement, dated June 30, 2003, among Immunicon Corporation and the parties set forth therein. + +10.10 + +Loan and Security Agreement, dated April 30, 2002, among Immunicon Corporation, its subsidiaries and Silicon Valley Bank. + +10.11 + +Form of Negative Pledge Agreement, dated April 30, 2002, among Immunicon Corporation, its subsidiaries and Silicon Valley Bank, and accompanying schedule. + +10.12 + +Amendment to Loan and Security Agreement, dated April 28, 2003, among Immunicon Corporation, its subsidiaries and Silicon Valley Bank. + +10.13 + +Master Security Agreement, dated April 15, 2003, between Immunicon Corporation and General Electric Capital Corporation. + +10.14 + +Amendment to Master Security Agreement, dated April 15, 2003, between Immunicon Corporation and General Electric Capital Corporation. + +10.15 + +Registration Rights Agreement, dated May 14, 1999, between Immunicon Corporation and Silicon Valley Bank. + +10.16 + +Registration Rights Agreement, dated January 31, 2000, between Immunicon Corporation and Silicon Valley Bank. + +10.17 + +Registration Rights Agreement, dated December 23, 2000, between Immunicon Corporation and Silicon Valley Bank. + +10.18 + +Registration Rights Agreement, dated April 28, 2003, between Immunicon Corporation and Silicon Valley Bank. + +10.19 + +Registration Rights Agreement, dated April 28, 2003, between Immunicon Corporation and GE Capital Corporation + +10.20 + +Agreement of Lease, dated August 20, 1999, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.21 + +First Amendment to Agreement of Lease, dated August 20, 1999, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.22 + +Second Amendment to Agreement of Lease, dated September 19, 2000, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.23 + +Confirmation of Lease Term, dated November 17, 2000, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.24 + +Third Amendment to Agreement of Lease, dated April 24, 2002, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.25 + +Fourth Amendment to Agreement of Lease, dated September 30, 2002, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.26 + +Fifth Amendment to Agreement of Lease, dated September 25, 2003, between Immunicon Corporation and Masons Mill Partners, L.P. + +10.27** + +Development, License and Supply Agreement, dated August 17, 2000, between Immunicon Corporation and Ortho-Clinical Diagnostics, Inc. + +10.28** + +Amendment to Development, License and Supply Agreement, dated December 10, 2002, between Immunicon Corporation and Ortho-Clinical Diagnostics, Inc. + +10.29** + +Letter agreement regarding Development, License and Supply Agreement, dated November 10, 2003, between Immunicon Corporation and Veridex, LLC. + +10.30** + +License and Supply Agreement, dated August 14, 2003, between Immunicon Corporation and Research and Diagnostic Systems, Inc. + +10.31** + +Master Supply Agreement, dated November 19, 2002, between Immunicon Corporation and Astro Instrumentation, LLC. + +10.32** + +Non-Exclusive License and Supply Agreement, dated as of November 1, 2003, between Immunicon Corporation and Molecular Probes, Inc. + +10.33** + +Agreement, dated February 10, 2003, between Immunicon Corporation and Pfizer Inc. + +10.34 + +Master Services Agreement, dated December 17, 2002, between Immunicon Corporation and Igeneon Krebs-Immuntherapie Forschungs-und Entwicklungs-AG. + +10.35** + +Exclusive License Agreement, dated June 21, 1999, between Immunicon Corporation and the Board of Regants of the University of Texas System. + +10.36** + +License Agreement, dated April 1, 1997, between Immunivest Corporation and Twente University. + +10.37** + +Technology Development Agreement, dated April 1, 1997, between Immunicon Corporation and University of Twente. + +10.38 + +Letter agreement, dated April 15, 2003, between Immunicon Corporation and Edward L. Erickson. + +10.39 + +Letter agreement, dated April 15, 2003, between Immunicon Corporation and James G. Murphy. + +10.40 + +Letter agreement, dated April 15, 2003, between Immunicon Corporation and Leon W.M.M. Terstappen, M.D., Ph.D. + +10.41 + +Consulting Agreement, dated January 10, 2000, between Immunicon Corporation and Paul A. Liberti, Ph.D. + +10.42 + +Letter agreement, dated February 21, 2002, between Immunicon Corporation and Paul A. Liberti, Ph.D. + +10.43 + +Letter agreement, dated September 16, 2002, between Immunicon Corporation and Paul A. Liberti, Ph.D. + +10.44 + +Letter Agreement, dated November 18, 2003, between Immunicon Corporation and Paul A. Liberti, Ph.D. + +10.45 + +Immunicon Corporation Amended and Restated Equity Compensation Plan. + +10.46 + +Immunicon Corporation 2004 Employee Stock Purchase Plan. + +10.47** + +Non-Exclusive License Agreement, dated July 1, 2002, between Immunicon Corporation and Streck Laboratories, Inc. + +10.48** + +Amendment to Non-Exclusive License Agreement, dated July 24, 2003, between Immunicon Corporation and Streck Laboratories, Inc. + +10.49 + +Form of Letter Agreement to be entered into between Immunicon Corporation and James L. Wilcox, Esq. + +10.50 + +Form of Employee Non-Compete Agreement to be entered into between Immunicon Corporation and James L. Wilcox, Esq. + +10.51 + +Employee Non-Compete Agreement, dated March 15, 1999, between Immunicon Corporation and Edward L. Erickson. + +10.52 + +Employee Non-Compete Agreement, dated November 1, 1999, between Immunicon Corporation and James G. Murphy. + +10.53 + +Non-Compete Agreement, dated October 24, 1994, between Immunicon Corporation and Leon W.W.M. Terstappen, M.D., Ph.D. + +10.54 + +Third Amendment to Second Amended and Restated Investors' Rights Agreement, dated March 15, 2004, among Immunicon Corporation and the parties set forth therein. + +10.55** + +Supply Agreement, dated December 13, 2003, between Immunicon Corporation and Astro Instrumentation, LLC. + +10.56 + +Form of Common Stock Purchase Warrant issued by Immunicon Corporation on January 23, 2004 and accompanying schedule. + +10.57 + +Common Stock Purchase Warrant issued by Immunicon Corporation to BioProbe BV on March 23, 2004. + +10.58 + +Letter agreement, dated April 1, 2004, between Immunicon Corporation and Pfizer Inc. + +21.1 + +Subsidiaries of Immunicon Corporation. + +23.1# + +Consent of Deloitte & Touche LLP. + +23.2 + +Consent of Morgan, Lewis & Bockius LLP (included in Exhibit 5.1). + +24.1 + +Power of Attorney (included on signature page). + +#Filed herewith. + + ** Certain information in these exhibits has been omitted and has been filed separately with the Securities and Exchange Commission pursuant to a confidential treatment +request under +17 C.F.R. Sections 200.80(b)(4), 200.83 and 230.406. + +QuickLinks \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001085223_switchboar_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001085223_switchboar_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ac611a680680eb1eb497bd6562b53d708ae48c6d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001085223_switchboar_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock being offered by us will be passed upon by Weil, Gotshal & Manges LLP, Boston, Massachusetts. Certain legal matters in connection with this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. Additional legal matters in connection with this offering will be passed upon for ePresence by Hale and Dorr LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001086319_gasco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001086319_gasco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4c4be8d20f08ac0843032993fa9952256a95723e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001086319_gasco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of common stock offered by this prospectus will be passed on for us by Dill, Dill, Carr, Stonbraker & Hutchings, P.C., Denver, Colorado. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001087277_aptimus_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001087277_aptimus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..064e812d55569b595ebae006b1c076a8a1568638 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001087277_aptimus_legal_matters.txt @@ -0,0 +1 @@ +You may review a copy of the registration statement from the public reference section of the Securities and Exchange Commission in Room 1024, Judiciary Plaza, 450 5th Street, N.W., Washington, D.C. 20549. You may also obtain copies of such materials at prescribed rates from the public reference section at the Commission, Room 1024, Judiciary Plaza, 450 5th Street, N.W., Washington, D.C. 20549. You may call the Commission at 1-800-SEC-0330 for further information on the public reference rooms. In addition, the Securities and Exchange Commission maintains a Web site on the Internet at the address http://www.sec.gov that contains reports, proxy information statements and other information regarding registrants, such as Aptimus, that file electronically with the Securities and Exchange Commission. You may read and copy any reports, statements or other information that we file with the Commission at the addresses indicated above, and you may also access them electronically at the web site set forth above. These Commission filings are also available to the public from commercial document retrieval services. 2004 $ 130 $ 86 2005 -- 62 2006 -- 63 2007 -- Past due greater than 90 days 100 % 100 % LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable $ 297 $ 636 $ 891 Accrued and other liabilities 344 259 419 Current portion of capital lease obligations 68 Present value of capital lease obligations Year ended December 31, $2,915 $4,571 56.8 % Year ended December 31, Net operating loss carryforwards $ 20,565 $ 20,222 Nondeductible allowances and accruals 358 106 Expense related to stock options and warrants 77 Total minimum lease payments (unaudited) Weighted average dilutive effect of warrants to purchase common stock (unaudited) Accrued network publisher fees $157 $ 27 $ 93 Accrued commissions 17 55 60 Deferred revenue 12 37 49 Accrued vacation 70 68 70 Other 88 72 Year ended December 31, (unaudited) Cash flows from operating activities Net income (loss) $(17,878 ) $(5,504 ) $(1,511 ) $(1,041 ) $ 235 Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,268 1,305 315 189 149 Bad debt expense (recovery) (296 ) (2 ) 26 19 75 Amortization of deferred stock compensation 371 11 103 2 -- Compensation on shares of common stock issued -- 76 -- -- -- Abandonment of fixed assets from lease -- 377 -- -- -- renegotiation Restructuring costs 4,998 -- -- -- -- Cash paid for restructuring costs (1,900 ) (15 ) -- -- -- Loss (gain) on disposal of property and 74 (2 ) 37 44 1 equipment Impairment of long-term investment 197 107 -- -- -- Amortization of discount on short-term (84 ) (4 ) -- -- -- investments Amortization of discount on convertible notes -- -- 7 -- 3 payable Changes in assets and liabilities, net of effects of business acquisitions: Accounts receivable 2,267 (259 ) (415 ) (15 ) (1,246 ) Prepaid expenses and other assets 564 60 (17 ) 88 78 Accounts payable (2,384 ) 108 339 167 195 Accrued and other liabilities (739 ) (77 ) (85 ) (28 ) Years ended December 31, Six months ended June 30, Net cash used in operations $(3,819 ) $(1,201 ) $ (350 ) strategic investments are currently planned, unanticipated expenses, poor financial results or unanticipated opportunities requiring financial commitments could give rise to earlier financing requirements. In addition, we do not currently anticipate any expenditures outside the ordinary course of business in pursuing the market strategies described in this prospectus. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our shareholders would be reduced, and these securities might have rights, preferences or privileges senior to those of our common stock. Additional financing may not be available on terms favorable to us, or at all. The delisting from the Nasdaq SmallCap Market may make raising additional capital more difficult. If adequate funds are not available or are not available on acceptable terms, our ability to fund our expansion, take advantage of business opportunities, develop or enhance services or products or otherwise respond to competitive pressures would be significantly limited, and we might need to significantly restrict our operations. The following table summarizes the contractual obligations and commercial commitments entered into by the Company, in thousands. Payments Due by Period Six months ending December 31, Year ending December 31, Total Contractual Cash Obligations $1,025 $132 $260 $233 $250 $100 $50 Reserve balance $68,000 $76,000 $61,000 % Of overall AR reserved 20.2 % 12.5 % 6.2 % EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth information, as of October 15, 2004, regarding our directors, executive officers and key employees: Name Age Position Total current liabilities 709 996 1,310 Convertible notes payable, net of unamortized discount -- Costs related to issuance of stock (unaudited) (5 ) (5 ) Exercise of stock options (unaudited) 34 14 14 Conversion of Note Payable (unaudited) 381 305 (35 ) Director and Executive Compensation Director Compensation Our directors do not receive cash compensation for their services as directors or members of committees of the Board, but are reimbursed for their reasonable expenses incurred in attending Board or Committee meetings. Our 2001 Stock Plan, as amended (the Stock Plan ), permits the grant of restricted shares of our Common Stock and options for the purchase of shares of our Common Stock to, among others, directors. In accordance with the Stock Plan, the following four (4) grants were made to Tim Choate in 2003: 8,750 shares in January 2003, 50,000 shares in March 2003, 5,367 shares in April 2003 and 25,000 shares in August 2003. In addition, directors Robert W. Wrubel and Eric Helgeland each received a grant of 25,000 shares, and director John B. Balousek received a grant of 75,000 shares in March 2003. Compensation Committee Interlocks and Insider Participation Our Compensation Committee is currently composed of Messrs. Balousek, Wrubel and Helgeland. No member of the Compensation Committee is an officer or employee. The Compensation Committee, however, did not meet during the fiscal year ended December 31, 2003, and the Board performed the duties otherwise performed by the Compensation Committee. Timothy C. Choate, our Chief Executive Officer and President, recused himself and did not participate in the Board s discussions and voting in respect to option grants made to Mr. Choate during the fiscal year, but otherwise participated in Board discussions and voting in respect to all other option grants during the fiscal year ended December 31, 2003. No executive officer serves as a member of the Compensation Committee of any entity that has one or more executive officers serving as a member of our Board. In addition, no interlocking relationship exists between any member of our Board and any member of the compensation committee of any other company, nor has any such interlocking relationship existed in the past. Executive Compensation The following table sets forth the compensation paid to the Company s Chief Executive Officer and two most highly compensated executive officers for the years ended December 31, 2001, 2002 and 2003. Summary Compensation Table Long-Term Compensation Annual Compensation Securities Underlying Name and Principal Position Salary Bonus Options # Restricted Stock($) (1) Reflects a restricted stock grant under our 2001 Stock Plan. The fair value of the common stock on the date of grant, September 27, 2001, was $0.45 per share. The restricted stock was sold in the Company s issuer tender offer that closed in November 2001. (2) Reflects $179,663 in cash compensation and $15,500 in compensation related to the fair market value of an option granted with a zero strike price. The following table sets forth certain information regarding stock option grants to our Chief Executive Officer and two most highly compensated executive officers during the year ended December 31, 2003. The potential realizable value is calculated based on the assumption that the Common Stock appreciates at the annual rate shown, compounded annually, from the date of grant until the expiration of its term. These numbers are calculated based on SEC requirements and do not reflect our projection or estimate of future stock price growth. Potential realizable values are computed by: multiplying the number of shares of Common Stock subject to a given option by the exercise price; assuming that the aggregate stock value derived from that calculation compounds at the annual five percent (5%) or ten percent (10%) rate shown in the table for the entire ten-year term of the option; and subtracting from that result the aggregate option exercise price. Option Grants in 2003 Individual Grants Potential Realizable Value At Assumed Annual Rates Of Stock Price Appreciation For Option Term Name Number Of Securities Underlying Options Granted % of Total Options Granted to Employees In Fiscal Year(1) Exercise Price (Per Share) Expiration Date 0% 5% 10% (2) Represents options vesting according to the following schedule: 100% at issue. (3) The exercise price per share was equal to the fair market value of the Common Stock on the date of grant as reported by the Nasdaq Small-Cap Market. (4) Represents options vesting according to the following schedule: three-year term, quarterly vesting. (5) The exercise price per share was equal to the fair market value of the Common Stock on the date of grant as reported by the Nasdaq OTCBB. (6) Option grant in recognition of Mr. Choate personally guaranteeing the Company s line of credit debt. Option Exercises and Fiscal Year End Values The following table sets forth for our Chief Executive Officer and two most highly compensated executive officers the number of shares acquired upon exercise of stock options during the year ended December 31, 2003, and the number of shares subject to exercisable and unexercisable stock options held at December 31, 2003. Number Of Securities Underlying Unexercised Options At December 31, 2003 Value Of Unexercised In-The- Money Options At December 31, 2003(1) Name Shares Acquired On Exercise Value Realized Exercisable Unexercisable Exercisable Unexercisable registration statement to effectiveness. In addition, we did not grant the investors warrants, rights of first refusal, board representation rights, or other rights typically found in similar investments. We believe such discounts are typical in private placements of the stock of publicly-traded companies and it was required by our investors in this instance. PRINCIPAL SHAREHOLDERS The following table sets forth certain information known to us with respect to the beneficial ownership of its Common Stock as of February 13, 2004, by (i) each person known by us to be the beneficial owner of more than five percent (5%) of the outstanding Common Stock, (ii) each of our directors, (iii) each of our four most highly compensated executive officers, and (iv) all directors and officers as a group. Except as otherwise indicated, we believe that the beneficial owners of the Common Stock listed below, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Directors, Named Executive Officers and 5% Shareholders(1) Number of Shares Beneficially Owned(2) % of Total Shares Owned(3) APTIMUS, INC. BALANCE SHEET (in thousands) December 31, June 30, $ 1,941 $ 3,975 $ 4,551 Commitments and contingent liabilities (note 9) Shareholders' equity Common stock, no par value; 100,000 Shares authorized, 4,221, 5,213 and 5,692 (unaudited) issued and outstanding at December 31, 2002 and 2003 and June 30, 2004 (unaudited), respectively 60,282 63,098 63,427 Additional paid-in capital 2,506 2,679 2,644 Deferred stock compensation (2 ) -- -- Accumulated deficit (61,554 ) (63,065 ) (62,830 ) Total shareholders' equity 1,232 2,712 3,241 $ 1,941 $ 3,975 $ 4,551 APTIMUS, INC. STATEMENT OF OPERATIONS (in thousands, except per share data) Year ended December 31, Six months ended June 30, Total operating expenses 20,317 8,441 6,049 2,888 4,522 Net income (loss) $(17,878 ) $(5,504 ) $(1,511 ) $(1,041 ) $ 235 Earnings (loss) per share: Basic $ (1.44 ) $(1.35 ) $(0.35 ) $(0.25 ) $ 0.04 Diluted $ (1.44 ) $(1.35 ) $(0.35 ) $(0.25 ) $ 0.03 Weighted average shares outstanding: Basic 12,400 4,073 4,333 4,221 5,446 Diluted 12,400 4,073 4,333 4,221 7,029 APTIMUS, INC. STATEMENT OF SHAREHOLDERS EQUITY (in thousands) Common Stock Shares Amount Additional paid-in capital Deferred stock Compensation Accumulated Deficit Total Shareholders' equity Balances at December 31, 2000 15,505 65,874 2,518 (352 ) (38,172 ) 29,868 Repurchase of common stock (12,162 ) (5,637 ) 7 (5,630 ) Exercise of stock options and warrants 56 14 (14 ) -- Issuance of shares under employee stock purchase program 7 3 3 Issuance of restricted shares under 2001 Stock Plan 635 304 304 Deferred compensation related to forfeitures of stock options (281 ) 281 -- Amortization of deferred stock Compensation 58 58 Adjustments to common stock in connection with a business acquisition (56 ) (81 ) (81 ) Net loss (17,878 ) (17,878 ) Balance on December 31, 2003 5,213 $ 63,098 $ 2,679 $ -- $(63,065 ) $ 2,712 Balance on June 30, 2004 (unaudited) 5,692 $63,427 $2,644 $ -- $(62,830 ) $3,241 APTIMUS, INC. STATEMENT OF CASH FLOWS (in thousands) Year ended December 31, Six months ended June 30, Net cash used by operating activities (12,542 ) (3,819 ) (1,201 ) (575 ) (350 ) Net cash provided (used) by financing (7,423 ) (168 ) 2,986 (33 ) (17 ) activities Cash and cash equivalents at end of period $ 3,651 $ 667 $ 2,368 $ 71 $ 1,776 through based contracts is recognized based on the proportion of impressions or click throughs delivered, to the total number of guaranteed impressions or click throughs provided for under the related contracts, as such contracts allow for billing based on delivery and do not require delivery of a minimum amount. List rental revenues are received from the rental of customer names to third parties through the use of list brokers. Prior to 2003 revenue from list rental activities was recognized in the period the names were delivered by the list broker to the third party. Advertising costs The Company expenses advertising costs as incurred. Total advertising expense for the years ended December 31, 2001, 2002, 2003 and the unaudited three months ended June 30, 2004, were $1,455,000, $8,000, $45,000 and zero, respectively. Research and development costs Research and development costs are expensed as incurred. Web site development costs Costs incurred in developing the Company s web sites are accounted for in accordance with Emerging Issues Task Force Issues Summary 00-02, Accounting for web site Development Costs. As such, the Company expenses all costs incurred that relate to the planning and post implementation phases of development. Costs incurred in the development phase are capitalized and recognized over the web site s estimated useful life if the web site is expected to have a useful life beyond one year. Costs capitalized are included in fixed assets and are amortized over three years. Costs associated with repair or maintenance of existing sites or the development of web site content are expensed as incurred. Income taxes The Company accounts for income taxes under the asset and liability method, which requires 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. If it is more likely than not that some portion of a deferred tax asset will not be realized, a valuation allowance is recorded. Net loss per share Basic earnings (loss) per share represents net income (loss) available to common shareholders divided by the weighted average number of shares outstanding during the period. Diluted earnings (loss) per share represents net income (loss) available to common shareholders divided by the weighted average number of shares outstanding, including the potentially dilutive impact of common stock options and warrants. Common stock options and warrants are converted using the treasury stock method. The following table sets forth the computation of the numerators and denominators in the basic and diluted earnings (loss) per share calculations for the periods indicated and those common stock equivalent securities not included in the diluted net loss per share calculation as their effect on earnings (loss) per share is anti-dilutive (in thousands): Year ended December 31, Six months ended June 30, (unaudited) Numerator: Net income (loss) (A) $(17,878 ) $(5,504 ) $(1,511 ) $(1,041 ) $ 235 Year ended December 31, Six months ended June 30, Weighted average of common stock and common stock equivalents (C) 12,400 4,073 4,333 4,221 7,029 Earnings (loss) per share: Basic (A) / (B) $(1.44 ) $(1.35 ) $(0.35 ) $(0.25 ) $ 0.04 Diluted (A) / (C) $(1.44 ) $(1.35 ) $(0.35 ) $(0.25 ) $ 0.03 1,252 1,408 2,086 1,785 1,669 Year ended December 31, Six months ended June 30, (unaudited) Net loss, as reported $ (17,878 ) $ (5,504 ) $ (1,511 ) $(10,041 ) $ 235 Add: Total stock-based employee compensation expense, included in the determination of net income as reported, net of related tax effects 59 11 104 1 -- Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (932 ) (373 ) (249 ) (89 ) (242 ) Pro forma net income (loss) $ (18,751 ) $ (5,866 ) $ (1,656 ) $ (1,129 ) $ (7 ) Earnings per share: Basic - as reported $ (1.44 ) $ (1.35 ) $ (.35 ) $(0.25 ) $ 0.04 Basic - pro forma $ (1.51 ) $ (1.44 ) $ (.38 ) $(0.27 ) $ (0.00 ) Diluted - as reported $ (1.44 ) $ (1.35 ) $ (.35 ) $(0.25 ) $ 0.03 Diluted - pro forma $ (1.51 ) $ (1.44 ) $ (.38 ) $(0.27 ) $ (0.00 ) For SFAS No. 123 pro forma disclosure, the fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model for the years ended December 31, 2001, 2002 and 2003, with the following assumptions used for grants to employees: Year ended December 31, Six months ended June 30, In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on the reported results. The disclosure provisions of SFAS No. 148 are effective for financial statements for fiscal years ending after December 15, 2002. The Company has adopted the disclosure provisions of SFAS No. 148. In January 2003, the Financial Accounting Standards Board ( FASB ) issued Interpretation No. 46 ( FIN 46 ) Consolidation of Variable Interest Entities. Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity, as defined, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity s activities or entitled to receive a majority of the entity s residual returns. Certain provisions of FIN 46 were deferred until the period ending after March 15, 2004. The adoption of FIN 46 did not have a material impact on the Company s financial position, cash flows or results of operations. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ( SFAS 149 ), which amends SFAS 133 for certain decisions made by the FASB Derivatives Implementation Group. In particular, SFAS 149: (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45 Guarantor s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, and (4) amends certain other existing pronouncements. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS 149 are to be applied prospectively. The adoption of SFAS 149 did not have a material impact on the Company s financial position, cash flows or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The adoption of this standard has not resulted in an impact to results of operations or financial position of the Company, as the Company has no financial instruments that fall within the scope of this standard. 3. Restructuring Costs On February 20, 2001, we announced our intention to reposition the Company to provide online advertising services to companies who engage in direct marketing activities, focusing all of our resources on building a direct marketing network. As part of this repositioning all activities related to our consumer-direct web sites, including FreeShop.com, Desteo.com, and CatalogSite.com were discontinued. As a result of these activities, we reduced staffing levels by 161 employees during the first quarter of 2001. In June of 2001, the decision was made to modify the restructuring plan by disposing of the technology acquired in the XMarkstheSpot acquisition, to reduce staffing by an additional 26 employees and to dispose of additional equipment and software no longer being used in operations. Restructuring costs of $4,998,000 for the year ended December 31, 2001, were recognized in accordance with the guidance of Emerging Issues Task Force 94-3. The restructuring resulted in the following charges during 2001 (in thousands): Types of Costs First Quarter Second Quarter Third Quarter Fourth Quarter Total Total $2,806 $2,192 $ -- $ -- $4,998 Balance of severance accrual at end of period $ 511 $ 204 $57 $15 $ 15 In addition to severance costs, the repositioning resulted in the disposal and abandonment of capitalized software and fixed assets. In conjunction with the disposal of these assets, the Company received approximately $51,000 of proceeds, which is included in the restructuring costs. Additionally, during 2001, we recorded a restructuring charge related to the impairment of intangible assets related to the repositioning activities. Intangible assets related to the acquisitions of Commonsite, LLC and Travel Companions International, Inc. were impaired in the first quarter of 2001 as they related to our consumer direct web site business for which a plan of exit was implemented in the first quarter of 2001. Intangible assets related to the business acquisition of XMarkstheSpot, Inc. were impaired in the second quarter of 2001 as the majority of the acquired workforce was terminated and the acquired technology was replaced. At December 31, 2003, no assets or liabilities that were to be disposed of as part of the 2001 restructuring plan remained on the balance sheet, we do not anticipate any additional costs to be recorded as a result of the 2001 restructuring plan and all planned expenditures under the 2001 restructuring plan have been completed. 4. Accounts receivable Accounts receivable consist of the following (in thousands): December 31, June 30, (unaudited) Accounts receivable $ 606 $ 980 $ 2,203 Less: Allowance for doubtful accounts (76 ) (61 ) (113 ) $ 530 $ 919 $ 2,090 5. Property and equipment Property and equipment consist of the following (in thousands): December 31, June 30, 3,657 3,227 2,935 Less: Accumulated depreciation and amortization (3,217 ) (2,819 ) (2,450 ) $ 440 $ 408 $ 485 prime plus three percent. Timothy C. Choate, the Company Chief Executive Officer, personally guaranteed the line-of-credit. At December 31, 2003 and June 30, 2004 (unaudited) there was no balance outstanding under the line-of-credit. 7. Accrued and other liabilities Accrued and other liabilities consist of the following (in thousands): December 31, June 30, $344 $259 $419 Year ending December 31, Capital leases Operating leases Less: Amount representing interest (29 ) Less: Current portion (101 ) Capital lease obligations, net of current portion $ -- Updated disclosure as of June 30, 2004 (unaudited). Period ending Capital leases Operating leases Total minimum lease payments $ 956 Effective June 12, 2001, the shareholders approved the 2001 Stock Plan (the 2001 Plan) to provide for the granting of stock options and restricted stock to employees, directors and consultants of the Company to provide them with incentives for their service. As of December 31, 2003, under the terms of the 2001 Plan, 915,998 shares of common stock remain unissued and not subject to options and have been reserved for issuance to plan participants. The Plans are administered by the Board of Directors of the Company, which determines the terms and conditions of the options or restricted stock shares granted, including exercise price, number of shares granted and the vesting period of such shares. The maximum term of options is ten years from the date of grant. The options are generally granted at the estimated fair value of the underlying stock, as determined by the Board of Directors, on the date of grant. As of December 31, 2003, options to purchase 788,613 and 915,998 shares of common stock were available for future grant under the 1997 Plan and the 2001 Plan, respectively. During 2001, 635,000 shares of restricted stock were issued to the Board of Directors and certain members of senior management that by its terms became fully vested as a result of the tender offer. For the years ended December 31, 2001, 2002 and 2003, $304,000, $1,000 and zero, respectively, of deferred compensation was recorded for options and restricted stock grants for which the exercise price was lower than the fair market value at the date of grant. The deferred compensation recognized is amortized over the vesting period of the related options in accordance with Financial Accounting Standards Board interpretation No. 28. During the year ended December 31, 2001, $281,000 of unamortized deferred compensation was reversed due to forfeitures of options. No such reversals were made in the years ended December 31, 2002 and 2003. The following table presents option activity under the Plans (in thousands, except prices): Year ended December 31, Six months ended June 30, Shares Weighted Average Exercise Price Shares Weighted Average Exercise Price Shares Weighted Average Exercise Price Shares Weighted Average Exercise Price (unaudited) Options outstanding at beginning of period 1,397 $6.12 1,235 $1.88 1,394 $1.02 $1,522 $0.87 Options granted 1,258 0.40 755 0.76 643 0.42 150 7.81 Options exercised 223 0.35 124 0.38 228 0.60 78 0.44 Options forfeited 1,197 5.56 472 3.04 287 6.92 2 9.15 Options outstanding at end of period 1,235 $1.88 1,394 $1.02 1,522 $0.87 $1,592 $0.88 Weighted average fair value of options granted during the period $0.29 $0.48 $0.32 $4.65 The following table summarizes information about stock options outstanding under the Plans at December 31, 2003 (in thousands, except prices and remaining contractual life): Options outstanding Options exercisable Range of exercise prices Number of shares Weighted average remaining contractual life (in years) Weighted average exercise price Number of shares Weighted average exercise price 1,522 8.2 $ 0.87 1,081 $ 0.97 Net increase (decrease) in cash and cash (9,203 ) (2,984 ) 1,701 (596 ) (592 ) equivalents Cash and cash equivalents at beginning of 12,854 3,651 667 Year ended December 31, Average fair value Average exercise price Options granted with exercise prices less than the fair value of the stock on the date of grant $ -- $ -- $0.58 $ -- $ -- $0.07 Options granted with exercise prices equal to the fair value of the stock on the date of grant $0.29 $0.48 $0.31 $0.40 $0.76 $0.44 Options granted with exercise prices greater than the fair value of the stock on the date of grant $-- $0.10 $-- $-- $1.49 $-- During the years ended December 31, 2001, 2002 and 2003, the Company granted options to purchase zero, 6,000 and 35,000 shares of common stock, respectively, to consultants and advisors. The Company follows SFAS No. 123 in accounting for options and warrants issued to non-employees. During the years ended December 31, 2002 and 2003, the Company recognized $1,000 and $8,000, respectively, of expense in connection with options issued to consultants and advisors. The Company did not issue any options to non-employees during the year ended December 31, 2001. In determining the fair value of the options and warrants granted or issued to non-employees on the date of grant, the Company used the Black-Scholes option-pricing model with the following assumptions: Year ended December 31, Weighted average risk free interest rate N/A 1.75% 2.53% Weighted average expected life (in years) N/A 1.00 4.00 Volatility N/A 100% 100% Dividends N/A none none 12. Equity based compensation Amounts included in the statement of operations for equity based compensation is as follows, in thousands: Year ended December 31, Six months ended June 30 Total Equity-based compensation $371 $11 $104 $1 $-- up to 100% of the first 6% of the compensation elected for contribution to the plan by an employee. Each participant is fully vested in his or her contributions and the investment earnings thereon, but vesting in any matching contributions by us takes place over a period of five years. The Company has made no matching contributions to the plan as of December 31, 2003. 15. Income taxes A current provision for income taxes was not recorded for the years ended December 31, 2001, 2002 and 2003 due to taxable losses incurred during such periods. A valuation allowance has been recorded for deferred tax assets because realization is primarily dependent on generating sufficient taxable income prior to the expiration of net operating loss carry-forwards. Deferred tax assets at December 31, 2002 and 2003 are as follows (in thousands): December 31, 21,000 20,436 Less: Valuation allowance (21,000 ) (20,436 ) At December 31, 2003, the Company had net operating loss carry forwards of approximately $62.7 million for federal income tax reporting purposes. The net operating losses will expire beginning in 2012 if not previously utilized. Should certain changes in the Company s ownership occur, there could be a limitation on the utilization of its net operating losses. 16. Supplemental cash flow information The following items are supplemental information required for the statement of cash flows (in thousands): Year ended December 31, Six months ended June 30, (unaudited) Cash paid during the period for interest $ 154 $24 $ 24 $ 4 $ 30 Fixed assets acquired with capital leases $ 143 $ -- $203 $ -- $ -- Directors and Officers insurance premium financed $ 126 $ -- $ -- $ -- $ -- Repurchase of common stock with note payable $ 838 $ -- $ -- $ -- $ -- Common stock issued in connection with business combination $(81 ) $ -- $ -- $ -- $ -- 17. Quarterly financial information (unaudited) The following table sets forth the Company s unaudited quarterly financial information for the years ending December 31, 2001, 2002, and 2003 (in thousands, except per share data). Three months ended Total liabilities 3/31/01 6/30/01 9/30/01 12/31/01 Revenue $ 926 $ 381 $ 188 $ 379 Net loss $(8,858 ) $(5,475 ) $(1,848 ) $(1,697 ) Basic and diluted net loss per share $(0.57 ) $(0.42 ) $(0.15 ) $(0.20 ) Three months ended 3/31/02 6/30/02 9/30/02 12/31/02 Revenue $ 773 $ 782 $ 537 $ 823 Net loss $(1,297 ) $(1,486 ) $(2,000 ) $(721 ) Basic and diluted net loss per share $(0.33 ) $(0.37 ) $(0.49 ) $(0.17 ) Three months ended 3/31/03 6/30/03 9/30/03 12/31/03 Revenue $ 911 $ 938 $ 1,405 $ 1,317 Net loss $(604 ) $(437 ) $ (273 ) $ (197 ) Basic and diluted net loss per share $(0.14 ) $(0.10 ) $(0.06 ) $(0.04 ) 1,513,669 SHARES TO BE SOLD BY CURRENT SHAREHOLDERS COMMON STOCK PROSPECTUS [Insert date SEC declares it effective], 2004 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The table below lists the fees and expenses, other than underwriting discounts and commissions, which the registrant will pay in connection with the offering described in this registration statement. All the expenses are estimates, except the Securities and Exchange Commission registration fee. Amount Securities and Exchange Commission registration fee $ 1031 .78 Legal fees and expenses 75,000 .00 Accounting fees and expenses 55,000 .00 Miscellaneous expenses 5,000 .00 Total $ 126,031 .78 II-1 ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Sections 23B.08.500 through 23B.08.600 of the Washington Business Corporation Act (the Washington Act ) authorize a court to award, or a corporation s board of directors to grant, indemnification to directors and officers on terms sufficiently broad to permit indemnification under certain circumstances for liabilities arising under the Securities Act of 1933, as amended (the Securities Act ). Article 6 of the Registrant s Second Amended and Restated Articles of Incorporation and Article IX of the Registrant s Amended and Restated Bylaws together provide for indemnification of the Registrant s directors, officers, employees and agents to the maximum extent permitted by Washington law. The Registrant has entered into agreements with its directors and officers arising out of their service as officers and director, as applicable, and has agreed to advance expenses to defend claims subject to indemnification. The directors and officers of the Registrant also may be indemnified against liability they may incur for serving in that capacity pursuant to a liability insurance policy maintained by the Registrant for such purpose. Section 23B.08.320 of the Washington Act authorizes a corporation to limit a director s liability to the corporation or its shareholders for monetary damages for acts or omissions as a director, except in certain circumstances involving intentional misconduct, self-dealing or illegal corporate loans or distributions, or any transaction from which the director personally receives a benefit in money, property or services to which the director is not legally entitled. Article 6 of the Registrant s Second Amended and Restated Articles of Incorporation contains provisions implementing, to the fullest extent permitted by Washington law, such limitations on a director s liability to the Registrant and its shareholders. Insofar as indemnification for liabilities arising under the Securities Act may be permitted for directors, officers or persons controlling the Registrant pursuant to the foregoing provisions, the registrant has been informed that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. II-2 ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. Since December 31, 2000, the registrant has issued and sold the following unregistered securities: In November 2001, an aggregate of 635,000 shares of common stock were issued to the following seven persons pursuant to restricted stock grants: Timothy C. Choate; John Ballantine, John D. Balousek, Kirk Loevner, William Fritsch, John A. Wade and David H. Davis. The sales and issuance of these securities were exempt from Securities Act registration under Rule 506 of Regulation D and Section 4(2) of the Securities Act, on the basis that the grants were to directors and officers of the Company and did not involve a public offering. In November 2001, we also issued 89,196 shares of common stock to XMarkstheSpot, Inc. representing a portion of the consideration payable to the shareholders of XMarkstheSpot, Inc. in connection with our December 2000, acquisition of that company s assets that we held in reserve to secure the representation and warranty obligations of XMarkstheSpot. The sales and issuance of these securities were exempt from Securities Act registration under Rule 506 of Regulation D and Section 4(2) of the Securities Act, on the basis that the shares were issued to certified investors and did not involve a public offering. In October 2002, we issued 150,000 shares of unregistered common stock to the landlord of its Seattle office space, Merrill Place LLC, as additional consideration in connection with the modification of our Seattle real property lease. In exchange, the company was released from further obligation to lease approximately 25,000 square feet of office space for the 2 -year balance of the lease term and a corresponding aggregate base lease obligation of approximately $1,400,000. The fair market value of the stock at the time of the issuance was $76,000. The shares were issued in reliance upon the exemptions from registration provided by Rule 506 of Regulation D and Section 4(2) under the Securities Act, as Merrill is an accredited investor. In July 2003, we completed raising $305,000 pursuant to the terms of a Convertible Promissory Note, which will pay interest of 6% per annum like a bond, but can be converted to shares of common stock at the option of the holder at a fixed price of $0.80 per share. The note has a 36-month term. Principal and accrued interest is payable quarterly, commencing one year from the closing date. In addition to the notes, we issued to the investors warrants to purchase a total of 127,094 shares of common stock for $0.50 per share to SF Tech JV, Timothy Choate, Maura O Neill, Fred Felker IRA, Robert Wrubel, John Steuart IRA, and Marian Felker IRA. Timothy Choate and Robert Wrubel are the only parties related to the Company that participated. The warrants have a term of five years. The notes and warrants were issued in reliance upon the exemptions from registration provided by Rule 506 of Regulation D and Section 4(2) under the Securities Act. In December 2003, we completed a $2.75 million private placement investment with Apex Capital, LLC and Special Situations Technology Funds. The Company sold an aggregate of 776,690 shares of unregistered Aptimus, Inc. common stock at a price of $3.55 per share to the following investors: Permal U.S. Opportunities Limited; Zaxis Institutional Partners, LP; Zaxis Institutional Offshore; Zaxis Partners, LP; Net Market Partners, LP; Charles H. Finnie; Special Situations Technology Fund, LP; Special Situations Technology Fund II, LP. The shares were issued in reliance upon the exemptions from registration provided by Rule 506 of Regulation D and Section 4(2) under the Securities Act. II-3 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) The following exhibits are filed as part of this report: Exhibit Number Description 3.1* Second Amended and Restated Articles of Incorporation of registrant. 3.1.1(2) Articles of Amendment filed September 16, 2000. 3.1.2(6) Articles of Amendment filed March 29, 2002. 3.2* Amended and Restated Bylaws of registrant. 4.1* Specimen Stock Certificate. 4.2* Form of Common Stock Warrant. 4.3(3) Rights Agreement dated as of March 12, 2002, between registrant and Mellon Investor Services LLC, as rights agent. 5.1(12) Opinion of Dorsey & Whitney LLP 10.1*(8) Form of Indemnification Agreement between the registrant and each of its directors. 10.2*(8) 1997 Stock Option Plan, as amended. 10.3*(8) Form of Stock Option Agreement. 10.4* Loan and Security Agreement, dated September 18, 1998, between registrant and Imperial Bank. 10.5* Lease Agreement, dated September 23, 1997 and amended as of February 16, 1999, between registrant and Merrill Place LLC. 10.5.1* Second Amendment to Lease, dated November 30, 1999, between registrant and Merrill Place LLC. 10.6(1)(8) Aptimus, Inc. 2001 Stock Plan. 10.6.1(2)(8) Form of Stock Option Agreement. 10.6.2(2)(8) Form of Restricted Stock Agreement (for grants). 10.6.3(2)(8) Form of Restricted Stock Agreement (for rights to purchase). 10.7(4)(8) Change in Control Agreement, dated as of December 6, 2002, by and between registrant and Timothy C. Choate 10.8(4)(8) Form of Change in Control Agreement, dated as of December 6, 2002, by and between registrant and each of certain executive managers of registrant 10.9(4) Amendment to Lease Agreement, dated October 1, 2002, between registrant and Merrill Place LLC. 10.10(5) Form of Convertible Note Purchase Agreement, dated as of July 1, 2003, by and between the Company and certain investors. 10.11(5) Form of Convertible Secured Promissory Note, dated July 2003, executed by and between the Company and payable to the order of certain investors. 10.12(5) Form of Common Stock Warrant, dated July 2003, by and between the Company and certain investors. 10.13(5) Form of Security Agreement, dated as of July 1, 2003, by and between the Company and certain investors. 10.14(5) Form of Registration Rights Agreement, dated as of July 1, 2003, by and between the Company and certain investors. 10.15(10) Agreement of Lease, dated as of April 29, 2004, by and between Sixth and Virginia Properties and the Company. 10.16(9) Stock Purchase Agreement, dated as of December 4, 2003, by and between the Company and certain investors. 16.1(11) Letter dated December 12, 2001, from PricewaterhouseCoopers LLP to the Securities and Exchange Commission. 23.1 Consent of Moss Adams LLP, independent accountants. 23.2(12) Consent of Dorsey & Whitney LLP (including in Exhibit 5.1) _________________ II-4 * Incorporated by reference to the Company's Registration Statement on Form S-1 (No. 333-81151). (1) Incorporated by reference to the Company s Proxy Statement on Schedule 14A, dated May 17, 2001. (2) Incorporated by reference to the Company s Quarterly Report on Form 10-Q, dated November 14, 2001. (3) Incorporated by reference to the Company s Current Report on Form 8-K, dated March 12, 2002. (4) Incorporated by reference to the Company s Annual Report on Form 10-K, dated March 28, 2003. (5) Incorporated by reference to the Company s Quarterly Report on Form 10-Q, dated August 14, 2003. (6) Incorporated by reference to the Company s Quarterly Report on Form 10-Q, dated May 15, 2002. (7) Confidential treatment has been granted as to certain portions of this Exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. (8) Management compensation plan or agreement. (9) Incorporated by reference to the Company s Annual Report on Form 10-K, dated March 30, 2004 (10) Incorporated by reference to the Company s Quarterly Report on Form 10-Q, dated May 17, 2004. (11) Incorporated by reference to the Company s Current Report on Form 8-K, dated December 17, 2001. (12) Previously filed with Amendment No. 1 to this Registration Statement on July 28, 2004. (b) Financial Statement Schedules: Schedule No. Description 1.1 Valuation and Qualifying Accounts and Reserves 2001, 2002 and 2003 Valuation and Qualifying Accounts and Reserves 2001, 2002 and 2003 Balance at beginning of period Charges to costs and expenses Charges to other accountants Deductions Balance at end of period Year ended December 31, 2001 Allowance for doubtful accounts 1,801,059 (296,481 ) -- 1,436,578 68,000 Tax valuation allowance 13,765,815 -- 4,468,418 -- 18,234,233 Year ended December 31, 2002 Allowance for doubtful accounts 68,000 (2,361 ) -- (10,361 ) 76,000 Tax valuation allowance 18,234,233 -- 2,765,767 -- 21,000,000 Year ended December 31, 2003 Allowance for doubtful accounts 76,000 26,395 -- (41,395 ) 61,000 Tax valuation allowance 21,000,000 -- 521,000 -- 21,521,000 II-5 ITEM 17. UNDERTAKINGS. The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the change sin volume and price represent no more than 20% change in the maximum aggregate offering price set forth in the Calculation of Registration Fee table in the effective registration statement. (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; Provided, however, That paragraphs (a)(1)(i) and (a)(1)(ii) of this section do not apply if the registration statement is on Form S-3, Form S-8 or Form F-3, and the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed with or furnished to the Commission by the registrant pursuant to section 13 or section 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. Insofar 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 Act 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. II-6 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Seattle, state of Washington, on November 11, 2004. Aptimus, Inc. By: /s/ David H. Davis General Counsel, Secretary and Vice President of Business Development Pursuant to the requirements of the Securities Act of 1933, as amended, this registration statement has been signed by the following persons in the capacities and on the dates indicated below. Signature Title Date * Timothy C. Choate Chief Executive Officer and Chairman of Board of Directors (principal executive officer) November 11, 2004 * John A. Wade Chief Financial Officer, (principal finance and accounting officer) November 11, 2004 * John B. Balousek Director November 11, 2004 * Robert W. Wrubel Director November 11, 2004 * Eric Helgeland Director November 11, 2004 * /s/ David H. Davis Attorney-in-Fact Director November 11, 2004 II-7 Employee severance $1,462 $ 503 $ -- $ -- $1,965 Capitalized software costs 364 -- -- -- 364 Disposal of fixed assets, Net 4 534 -- -- 538 Impairment of intangible assets Year ended December 31, $1,305 44.8 % $315 6.9 % (75. 9)% The decrease in depreciation is a result of fixed assets becoming fully depreciated. Loss (Gain) on Disposal of Long-Term Assets. Loss (gain) on disposal of long-term assets consists of gains and losses on disposals of assets and impairments on long-term investments. Loss on disposal of long-term assets decreased by $68,000, or 65%, to $37,000 in 2003 from $105,000 in 2002. In the prior year the majority of the loss related to the write down of a long-term investment. In the current year the loss on disposal of assets relates to disposal of many smaller fixed assets. Lease renegotiation costs and impairment of leasehold improvements. No significant additional lease renegotiation costs or impairments of leasehold improvements occurred in 2003 or are expected in 2004. Interest expense. Interest expense in 2003 relates to capital equipment leases, the line-of-credit, and the convertible notes payable. Interest expense totaled $41,000 and $24,000 in the years ended December 31, 2003, and 2002, respectively. Interest Income. Interest income consists of interest income on cash and cash equivalents and short-term investments. Interest income decreased by $38,000, or 83%, to $8,000 in 2003 from $46,000 in 2002. Interest income has decreased as the balance available for investment has decreased due to use of cash for operations. Income Taxes. No provision for federal income taxes has been recorded for any of the periods presented due to our current loss position. Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Revenues. Revenue (In thousands, except percentages) 2001 Revenue Per Thousand Impressions (CPM) (In thousands, except percentages and CPM data) 2001 Core placement CPM $ 3.18 $ 45.41 1,328.0 % Core placement page impressions 1,303 1,932 48.3 % Core placement, % of total revenue 0.2 % 3.0 % 1,400.0 % Other placement CPM $ 20.91 $ 16.84 (19.5 %) Other placement page impressions 20,985 60,299 187.3 % Other placement, % of total revenue 23.4 % 34.8 % 48.7 % The increase in revenues resulted from a $2.2 million increase in revenues from our network and a $1.2 million decrease in the discontinued FreeShop site related revenues. Revenue related to our network increased due to an increase in the number of ad impressions and corresponding user transactions taking place on the network. The quantity of transactions increased as a result of adding more publishers and clients to the network and sending more emails. For the year ended December 31, 2002, our average revenue per thousand impressions for our core placements increased to $45 per thousand impressions compared to $3 for the comparable period in 2001. Our average revenue per thousand impressions for our other placements for the year ended December 31, 2002 decreased to $17 from $21 for the comparable period in 2001. The number of page impressions for core placements and other placements for the year ending December 31, 2002 increased to 1,932,000 and 60,299,000, respectively, compared to 1,303,000 and 20,985,000, respectively, for the comparable period in 2001. The increase in page impressions was the result of adding more publishers to the Aptimus Network. In addition, the average revenue per thousand impressions for our core placements increased as a result of the introduction of our Dynamic Revenue Optimization technology in June 2002. The average revenue per thousand impressions for our other placements decreased slightly as a result of a higher concentration of lower paying offers in the offer mix. The average number of emails sent per month in 2002 increased by 425% to 170 million compared to the monthly average of 13 million in 2001. This increase in email volume was tempered by a 31.7% decrease in email revenue per thousand impressions to $0.84, compared to $1.23 for the corresponding period in 2001. Email represented 58.4% of our total revenue in 2002, compared to 26.7% of our total revenue in 2001, representing an increase of 118.7%. Email marketing was implemented as part of our network model in the third quarter of 2001 and did not provide revenues for an entire year in 2001. We source our results based leads from two primary network sources - web sites and email lists. For the year ended December 31, 2002, leads derived from email list sources accounted for $1.7 million or 58% of our overall revenue compared to $0.5 million or 29% for the year ended December 31, 2001. Revenue related to the FreeShop site decreased as a result of discontinuation of our consumer-direct web sites. Cost of revenues. Cost of revenues consists of fees to web site publishers and email list owners participating in our network. (In thousands, except percentages) 2001 % of revenue (In thousands, except percentages) 2001 % of revenue Year ended December 31, $6,185 330.0 % $1,972 67.7 % (68. 1)% The decrease in sales and marketing expenses is primarily a result of a $1.6 million reduction in advertising and public relations spending and $1.8 million in reduced payroll costs. Bad debt expense, net of recoveries, was $(2,000) and $(296,000) in the year ended December 31, 2002 and 2001, respectively. Connectivity and network costs. (In thousands, except percentages) 2001 % of revenue Year ended December 31, $1,780 95.0 % $1,312 45.0 % (26. 3)% This decrease resulted from the elimination of costs associated with the FreeShop site in May of 2001. Research and development. (In thousands, except percentages) 2001 % of revenue Year ended December 31, $1,632 87.1 % $559 19.2 % (65. 7)% Reductions in staff resulting from the restructuring and cost cutting efforts have reduced labor expenses by approximately $480,000 and outside services by approximately $440,000 compared to the prior year. General and administrative. (In thousands, except percentages) 2001 % of revenue Year ended December 31, $2,423 129.3 % $1,687 57.9 % (30. 4)% The three largest factors in the decrease in general and administrative expenses was a decrease in legal, accounting and other outside service fees of approximately $260,000, a decrease in equity-based compensation in the amount of 226,000 and one time costs in 2001 of approximately $370,000. The one time costs in 2001 resulted from termination of an operating agreement acquired as part of the XmarksTheSpot acquisition, and costs incurred for investment banking services related to potential strategic transactions. Depreciation and amortization. (In thousands, except percentages) 2001 % of revenue Mar. 31, 2002 June 30, 2002 Sept. 30, 2002 Dec. 31, 2002 Mar. 31, 2003 June 30, 2003 Sept. 30, 2003 Dec. 31, Revenues generated through network publishers and opt-in email list owners are recorded on a gross basis in accordance with Emerging Issues Task Force consensus 99-19 (EITF 99-19). Fees paid to network publishers and opt-in email list owners related to these revenues are shown as Cost of revenues on the Statement of Operations. Revenue (In thousands, except percentages) 2002 Revenue Per Thousand Impressions (CPM) (In thousands, except percentages and CPM data) 2002 Core placement CPM $ 45.41 $ 266.06 486.0 % Core placement page impressions 1,932 3,172 64.2 % Core placement, % of total revenue 3.0 % 18.5 % 516.7 % Other placement CPM $ 16.84 $ 14.08 (16.4 %) Other placement page impressions 60,299 177,000 94.0 % Other placement, % of total revenue 34.8 % 36.0 % 3.5 % The increase in revenue is primarily due to expansion of our Aptimus Network, including the addition of new web site distribution publishers thereby increasing our page impressions and corresponding user transactions, and the expansion of our advertiser client base. A primary focus for the company in 2004 is to continue expanding the number of publishers in our Network, thereby increasing the number of placements, both core and other, and corresponding page impressions. We source our results based leads from two primary network sources - web sites and email lists. In 2003, we distinguished for the first time the two client types we have identified since that time: continuity-type clients and campaign-type clients. For the period ending December 31, 2003, campaign clients accounted for $839,000 or 18% of our revenue. As we did not distinguish between campaign-type and continuity-type clients prior to 2003, no campaign-type client revenue was identified in the comparable period in 2002 or in prior years. For the year ended December 31, 2003, our average revenue per thousand impressions for our core placements increased to $266 per thousand impressions compared to $45 for the comparable period in 2002. Our average revenue per thousand impressions for our other placements for the year ended December 31, 2003 decreased to $14 from $16 for the comparable period in 2002. The number of page impressions for core placements and other placements for the year ending December 31, 2003 increased to 3,172,000 and 117,000,000, respectively, compared to 1,932,000 and 60,299,000, respectively, for the comparable period in 2002. The increase in page impressions was the result of adding more publishers to the Aptimus Network and adding additional placements within existing publisher websites. In addition, the average revenue per thousand impressions for our core placements increased as a result of further refinements to our Dynamic Revenue Optimization technology and a higher performing offer mix. The average revenue per thousand impressions for our other placements decreased slightly as a result of a higher concentration of lower paying offers in the offer mix. For the year ended December 31, 2003, leads derived from email list sources accounted for $2.1 million or 45.5% of our total revenue compared to $1.7 million or 58.4% of our total revenue for the year ended December 31, 2002, representing a 22.1% decrease. While we expect our revenues from lead generation sourced via our email lists to remain at close to current revenue levels in future periods subject to quarterly positive and negative fluctuations, we anticipate their contribution as a percentage of total revenues will continue to decline as we focus all our efforts in respect to offer distribution on expansion of our network of website publishers. The average number of emails sent per month in the year ending December 31, 2003 increased by 158% to 439 million compared from 170 million for the same period in 2002. The increase was due to the fact we added approximately 15 million names to our email database and we substantially increased the use of our third-party bulk mail service provider. This increase in email volume was tempered by a 53.6% decrease in email revenue per thousand impressions to $0.39, compared to $0.84 for the corresponding period in 2002. Cost of revenues. Cost of revenues consists of fees to web site publishers and email list owners participating in our network. (In thousands, except percentages) 2002 % of revenue This increase is directly related to the increase in our revenue. Cost of revenues have increased at a lower rate than revenues as a result of email based campaigns. Email based campaigns that are sent to Company-owned lists do not have any publisher fees associated with them. Also the cost of delivering the emails and certain third-party costs are generally deducted before calculating the fees due publishers for email based campaigns not sent to Company-owned lists. Cost of revenues are expected to increase in 2004 as a result of the addition of new web site publishers. Sales and marketing. Sales and marketing expenses consisted primarily of marketing and operational personnel costs, bad debts, and outside sales costs. (In thousands, except percentages) 2002 % of revenue Year ended December 31, $1,971 67.6 % $1,288 28.2 % (34. 7)% The decrease in sales and marketing expenses is primarily a result of a $430,000 reduction in payroll costs and a $230,000 reduction in rent expense. The decrease in payroll costs is a result of a decrease in the amount of high level management in the sales and marketing area. The reduction in rent expense is a result of renegotiating the Seattle lease in October of 2002, and the San Francisco lease in January 2003. In November 2003, we signed a lease for new office space in San Francisco. The cost of the new lease is consistent with the cost of the lease for our former San Francisco office space. We have also signed a lease for new office space in Seattle that commences at the June 30, 2004, termination of our current Seattle office lease. The cost of the new Seattle office lease is consistent with that of our current lease. Bad debt expense, net of recoveries, was $26,000 and $(2,000) in the year ended December 31, 2003 and 2002, respectively. Sales and marketing payroll costs are expected to increase in 2004 as a small number of new sales, business development and account management personnel are expected to be hired in 2004. As we add employees and our business grows, we will likely need to hire a management-level employee, most likely in the sales and business development area, to help manage our expanding activities. Other than payroll related costs, sales and marketing expenses in 2004 are expected to be relatively consistent with amounts in 2003. Connectivity and network costs. Connectivity and network costs consist of expenses associated with the fees, maintenance and usage of our network as well as email delivery costs. Such costs include email delivery costs, Internet connection charges, hosting facility costs, banner ad serving fees and personnel costs. (In thousands, except percentages) 2002 % of revenue Year ended December 31, $1,312 45.0 % $1,023 22.4 % (22. 0)% The decrease in connectivity and network costs is primarily a result of a $182,000 decrease in connectivity costs and an $114,000 decrease in email delivery costs. These reductions were offset by small increases in several other categories. Connectivity costs decreased primarily as a result of terminating our offsite hosting contract with EDS. Email delivery costs decreased as a result of using different email delivery vendors with lower costs for delivery. Internet and network connectivity expenses are expected to increase slightly as we add additional power supply backup to our network and outsource certain server hosting functions in 2004 compared to amounts in 2003. The EDS contract was cancelled in July 2003, which resulted in five months of savings in 2003. Also January 2004 was the last month that an external provider was used for delivery of email. In 2003 email delivery fees were approximately $300,000. Although most of the email delivery costs will be eliminated in 2004 there will be some increases in internal costs associated with this change. The fees paid to list owners for these email based campaigns to licensed lists are in the same range as fees paid to publishers. Research and development. Research and development expenses primarily include personnel costs related to maintaining and enhancing the features, content and functionality of our web sites, network and related systems. (In thousands, except percentages) 2002 % of revenue General and administrative. General and administrative expenses primarily consist of management, financial and administrative personnel expenses and professional service fees. (In thousands, except percentages) 2002 % of revenue Year ended December 31, $1,687 57.9 % $1,319 28.9 % (21. 8)% The decrease in general and administrative expenses is primarily a result of a $154,000 reduction in payroll costs and a $115,000 reduction in rent expense. The decrease in payroll costs is a result of a decrease in the number of general and administrative staff. The reduction in rent expense is a result of renegotiating the Seattle lease in October of 2002, and the San Francisco lease in January 2003. General and administrative expenses in 2004 are expected to be slightly higher than amounts in 2003. We expect our external legal and accounting fees will increase in 2004 and beyond as a result of ongoing efforts to insure compliance with evolving federal securities laws. In addition, we expect our insurance premiums to increase as a result of our plan to increase the coverage limits of our Directors and Officers insurance policy upon its renewal later in 2004. For these same reasons and the fact our business will be growing, we believe our legal, accounting and insurance expense will continue to trend upward in future years. Depreciation and amortization. Depreciation and amortization expenses consist of depreciation on leased and owned computer equipment, software, office equipment and furniture and amortization on intellectual property. (In thousands, except percentages) 2002 % of revenue List rental revenues are received from the rental of customer names to third parties through the use of list brokers. Prior to 2003, revenue from list rental activities was recognized in the period the names were delivered by the list broker to the third party. Allowance for Doubtful Accounts The estimate of allowance for doubtful accounts is comprised of two parts, a specific account analysis and a general reserve. Accounts where specific information indicates a potential loss may exist are reviewed and a specific reserve against amounts due is recorded. As additional information becomes available such specific account reserves are updated. Additionally, a general reserve is applied to the aging categories based on historical collection and write-off experience. As trends in historical collection and write-offs change, the percentages applied against the aging categories are updated. Except were specific information indicates otherwise, the following rates were applied against the total balance due from the client when they had an amount in the applicable aging category as of the date the reserve analysis was performed: As of December 31, 2001 2002 Additional metrics related to the allowance for doubtful accounts are as follow: As of December 31, 2001 2002 2001 2002 2003 2001 2002 2001 2002 2002 Our business has been operating at a loss and generating negative cash flows from operations since inception. As of December 31, 2003, we had an accumulated deficit of approximately $63.1 million. With the reductions in continuing operating expenses that have been made and growth in revenues, we anticipate achieving positive earnings and cash flows during the year ending December 31, 2004. However, there are still many challenges to achieving this goal, including the availability of the continued market acceptance of results-based advertising, and the achievement is by no means assured. See Risks Related to Our Business . On March 7, 2003, our common stock was delisted from the Nasdaq SmallCap Market due to our noncompliance with the continued listing standards for that market. Since March 7, 2003, our common stock has been quoted on the OTCBB under the symbol APTM . On October 21, 2004, we announced results for the third fiscal quarter of 2004. For the quarter, we reported a profit of $901,000 representing $0.13 per share (calculated on a fully-diluted weighted average of 7.1 million shares) on revenues of $4.4 million. This represents a $1,174,000 improvement from the net loss of $273,000 for the same period in 2003 (which represented a $0.06 loss per share, calculated on a then weighted average of 4.3 million basic shares outstanding). The reported profit and per share amounts are determined without consideration of income tax expense. The tax benefit of the Company s Net Operating Loss Carry Forward has been fully reserved. Cost of revenue, or the fees earned by our network publishers and email list owners, during the quarter were $2,064,000, or 47% of revenues, compared to $552,000, or 39% of revenues, in the comparable period of 2003, and compared to $1,313,000, or 44% of revenues in the second quarter of 2004. Cost of revenues has been increasing as a percentage of total revenues primarily due to our focus on increasing revenues from our network of website publishers, which typically are paid a higher publisher fee, combined with a lower emphasis on email distribution, which typically has lower associated fees. We ended the quarter with $2.2 million in cash, a 25% increase from the $1.76 million in cash at the end of the second quarter of 2004. This positive cash position was achieved even while we sequentially increased our accounts receivables balance by $600,000. Results of Operations Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003 Revenues. We derive our revenues primarily from response-based advertising contracts. Leads are obtained through promoting our clients offers across our Aptimus Network of web site publishers and opt-in email lists. Revenues generated through network publishers and opt-in email list owners are recorded on a gross basis in accordance with Emerging Issues Task Force consensus 99-19 (EITF 99-19). Fees paid to network publishers and opt-in email list owners related to these revenues are shown as Cost of revenues on the Statement of Operations. Revenue (In thousands, except percentages) 2003 Revenue Per Thousand Impressions (CPM) (In thousands, except percentages and CPM data) 2003 six months of 2004 as compared to the comparable period in 2003 is a result of continuity type revenues increasing at a faster rate than campaign-type revenues. We expect campaign-oriented revenues to make up less than 10% of our revenues in the future as we continue to focus our efforts developing continuity-type relationships. We source our results based leads from two primary network sources - web sites and email lists. For the six months ended June 30, 2004, leads derived from email list sources accounted for $1.2 million or 26% of our overall revenue compared to $1.4 million or 76% for the six month period ended June 30, 2003. While we expect our revenues from lead generation sourced via our email lists to remain at close to current revenue levels in future periods subject to quarterly positive and negative fluctuations, we anticipate their contribution as a percentage of total revenues will continue to decline as we focus our offer distribution efforts on the expansion of our network of website publishers. The current quarter continued a trend of growth in revenues. For the six-month period ending June 30, 2004, our average revenue per thousand impressions (CPMs) for our core placements and other placements increased to $315 and $17 per thousand impressions, respectively, compared to $82 and $15, respectively, for the comparable six-month period in 2003. The number of page impressions for core placements and other placements for the six-month period ending June 30, 2004 increased to 7,025,000 and 72,877,000, respectively, compared to 1,480,000 and 22,004,000, respectively, for the comparable six-month period in 2003. The increase in page impressions was the result of adding more publishers to the Aptimus Network and adding additional placements within existing publisher websites. In addition, the average revenue per thousand impressions for both core and other placements increased as a result of enhancements to our Dynamic Revenue Optimization technology and a higher performing offer mix. The average number of emails sent per month in the first six months of 2004 decreased by 62% to 219 million from 546 million for the same period in 2003 as we entirely eliminated use of our third-party bulk mail service provider, reduced the frequency of our mailings each month, began using our Dynamic Revenue Optimization system in conjunction with our mailings and focused our mailings on the most responsive users within our email database. This decrease in email volume was offset by a 133% increase in email revenue per thousand impressions to $1.00, compared to $0.43 for the corresponding period in 2003. Email represented 25.1% of our total revenue in the first six months of 2004, compared to 75.7% of total revenue in the comparison period in 2003 representing a 66.8% decrease. We expect the revenue per thousand impressions of our core placements to be consistent with current levels over the long term while it might fluctuate immaterially quarter-to-quarter depending on the mix of publishers in our network and placements within those publishers. We expect over the long term the revenue per thousand impressions of our other placements will fluctuate to an even greater degree depending on the placements within our network and the mix of offers in our system. Revenues grew 64.8% from the first to the second quarter of 2004 and 37.1% from the fourth quarter of 2003 to the first quarter of 2004. It is expected that revenues will continue to grow as we increase our client and publisher network, although at a lower percentage rate than during the first two quarters of the year. We have added five new employees to our business development staff since the beginning of December 2003, whose job is to identify publishers for potential inclusion in our network, engage those publishers in negotiations and contract with them on mutually acceptable terms. Our plan is to continue to expand our network with new distribution publishers and client offers. Cost of revenues. Cost of revenues consists of fees to web site publishers and email list owners participating in our network. (In thousands, except percentages) 2003 % of revenue (In thousands, except percentages) 2003 % of revenue Three months ended June 30, $323 34.4 % $522 17.5 % 61.6 % Six months ended June 30, $671 36.3 % $959 20.1 % 42.9 % The increase in sales and marketing expenses was a result of increases in sales commissions due to increased sales, increases in bad debt expense, hiring of additional business development employees and increased marketing costs associated with the recent launch of our EasyJoin affiliate network. These items accounted for 43%, 30.0% and 23% of the increase in expense, respectively. Bad debt expense, net of recoveries, was $75,000 and $19,000 in the six months ended June 30, 2004 and 2003, respectively, and $64,000 and $4,000 in the three months ended June 30, 2004 and 2003, respectively. It is expected that sales and marketing expenses will increase further in the remaining quarters of the year due to increased sales commissions on higher revenues and the hiring of additional employees. However, sales and marketing expense is not expected to increase significantly as a percentage of revenues. Connectivity and Network Costs. Connectivity and network costs consist of expenses associated with the maintenance and usage of our network as well as email delivery costs. Such costs include Internet connection charges, hosting facility costs, email delivery costs and personnel costs. (In thousands, except percentages) 2003 % of revenue Three months ended June 30, $348 37.1 % $213 7.2 % (38. 8)% Six months ended June 30, $627 33.9 % $389 8.1 % (38. 0)% This decrease was primarily the result of decreases in connectivity and email delivery costs, which were offset by increases in labor costs, maintenance agreement costs and address verification costs. As a percentage of the total change in this account these factors accounted for 88%, 58%, (20%), (10%) and (7%), respectively. The decrease in connectivity resulted from moving our network production environment in-house. In the first six months of 2003 the network production environment was hosted by EDS Corporation. Similarly the decrease in email delivery costs was a result of moving the remaining email programs in-house. In 2003 a third party performed the majority of the email delivery. The increase in labor related costs is a result of pay reductions, which were in place in the first quarter of 2003 and the hiring of an additional network engineer during the quarter. The amount of wages reduced in the last quarter of 2002 and the first quarter of 2003 were paid to employees in the first quarter of 2004. The increased maintenance is related to additional maintenance contracts on hardware and software. Address verification costs are campaign related and vary from month to month depending on the number of offers requiring this service. Connectivity and network costs for the remaining quarters of 2004 are expected to increase slightly compared to the second quarter of 2004 as a result of an increase in backup capabilities and an increase in the amount of space rented at hosting facilities. Research and Development. Research and development expenses primarily consist of personnel costs related to maintaining and enhancing the features, content and functionality of our Web sites, network and related systems. (In thousands, except percentages) 2003 % of revenue (In thousands, except percentages) 2003 % of revenue Three months ended June 30, $329 35.1 % $390 13.1 % 18.5 % Six months ended June 30, $679 36.7 % $729 15.2 % 7.4 % The increase in general and administrative expense was primarily due to increases in labor costs. The increase in labor related costs is a result of pay reductions, which were in place in the first quarter of 2003 and the last quarter of 2002. The wages reduced in the last quarter of 2002 and the first quarter of 2003 were paid to senior executives in the second quarter of 2004. Total general and administrative expenses for the third and fourth quarter of 2004 are expected to be similar to the second quarter of 2004. Depreciation and Amortization. Depreciation and amortization expenses consist of depreciation on leased and owned computer equipment, software, office equipment and furniture and amortization on intellectual property and purchased email lists. (In thousands, except percentages) 2003 % of revenue 2002 2003 2002 2003 2001 2002 2003 2003 2001 2002 2003 2003 2001 2002 2003 2003 2001 2002 2003 2003 2001 2002 2003 2003 2001 2002 2003 2003 2002 2003 2002 2003 2002 2003 2001 2002 2003 2001 2002 2003 2003 2001 2002 2003 2003 Contractual Obligations Total 2004 2005 2006 2007 2008 TABLE OF CONTENTS PROSPECTUS SUMMARY 6 THE OFFERING 7 SUMMARY FINANCIAL DATA 8 RISKS RELATED TO OUR BUSINESS 9 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS 23 USE OF PROCEEDS 23 DIVIDEND POLICY 23 SELLING SHAREHOLDERS 23 SELECTED FINANCIAL DATA 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS 28 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 46 BUSINESS 47 PROPERTIES 55 LEGAL PROCEEDINGS 55 EXECUTIVE OFFICERS AND DIRECTORS 55 RELATED PARTY TRANSACTIONS 59 PRINCIPAL SHAREHOLDERS 63 DESCRIPTION OF CAPITAL SECURITIES 64 MARKET FOR OUR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 66 PLAN OF DISTRIBUTION 67 LEGAL MATTERS 68 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001089511_alaska_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001089511_alaska_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001089511_alaska_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001089512_acs-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001089512_acs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001089512_acs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001089513_acs-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001089513_acs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001089513_acs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001089514_acs-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001089514_acs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001089514_acs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001089517_acs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001089517_acs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001089517_acs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001089518_acs-long_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001089518_acs-long_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001089518_acs-long_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001089520_acs-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001089520_acs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001089520_acs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001089524_acs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001089524_acs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001089524_acs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001090069_cherokee_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001090069_cherokee_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e2df454006421e506b7f84ac487e2a9b8bc087af --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001090069_cherokee_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us and certain of the selling stockholders by Skadden, Arps, Slate, Meagher & Flom LLP, Los Angeles, California, and for the underwriters by Latham & Watkins LLP, Los Angeles, California. Skadden, Arps, Slate, Meagher & Flom LLP has from time to time represented certain of the underwriters, Oaktree and GFI on unrelated matters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001091158_visual_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001091158_visual_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f74eae13bea27eff848aa68fc4082bab7fba829e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001091158_visual_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Latham Watkins LLP, San Diego, California. Dorsey Whitney LLP, Irvine, California will pass upon certain legal matters for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001091171_blue-nile_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001091171_blue-nile_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..db323cd548869dbafb8c08aa38e5f2efcdb75bca --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001091171_blue-nile_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Cooley Godward LLP, Palo Alto, California. Cooley Godward LLP owns an aggregate of 12,480 shares of our common stock. Certain legal matters will be passed upon for the underwriters by Wilson Sonsini Goodrich Rosati, Professional Corporation, Seattle, Washington. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001091756_ibasis-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001091756_ibasis-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a7ab4cb35bf14d6f70fde27f9d5f46a391f08fa4 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001091756_ibasis-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities has been passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001094019_newtek_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001094019_newtek_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffa568f6926985c6f7bb7bc404d63cf822d390b1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001094019_newtek_legal_matters.txt @@ -0,0 +1 @@ +Table of Contents A penalty bid is an arrangement permitting an underwriter to reclaim the selling concession that would otherwise accrue to an underwriter if the common stock originally sold by the underwriter was later repurchased by the underwriter and therefore was not effectively sold to the public by such underwriter. In general, the purchase of a security to stabilize or to reduce a short position could cause the price of the security to be higher than it might be otherwise. These transactions may be effected on the Nasdaq National Market or otherwise. Neither we nor the underwriters make any representation or prediction about the direction or magnitude of any effect that the transactions described above may have on the price of our common stock. In addition, neither we nor the underwriters make any representation that the underwriters will engage in these types of transactions or that these types of transactions, once commenced, will not be discontinued without notice. Table of Contents LEGAL MATTERS Cozen O Connor will pass on the validity of our common stock being registered. Ellenoff Grossman & Schole LLP will pass upon certain legal matters on behalf of the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001095277_intersecti_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001095277_intersecti_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..84a3f735da1b97d68c14e49723a03c8fe347cde9 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001095277_intersecti_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock we are offering will be passed upon for us by Stroock Stroock Lavan LLP, New York, New York. The underwriters have been represented by Cravath, Swaine Moore LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001097396_ceres_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001097396_ceres_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..473c662da18fc6dad3c4d8effb5e046650146436 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001097396_ceres_legal_matters.txt @@ -0,0 +1 @@ +positions as a UK Gilt trader and salesman at two UK stockbrokers: Wood MacKenzie and Johnson Matthey & Wallace. He then joined Sabre Fund Management Ltd., a CFTC-registered CTA located in London, as an assistant technical trader and researcher, and was later promoted to Director of Research. In December 1986, he moved to Brockham Securities Ltd, a privately owned sugar trading and managed futures company, to assist in the development and marketing of the firm's futures fund management services. In February 1987, he left Brockham Securities Ltd and, together with colleagues Michael Adam and Martin Lueck, founded Adam, Harding and Lueck Ltd., a computer-driven, research based CTA. Adam, Harding and Lueck Ltd. became registered with the CFTC in February 1987. By 1989, this firm had grown into the UK's largest CTA, with more than $50 million under management. At that time, the principals sold a 51% stake to E D & F Man Group Ltd., one of the largest distributors of futures funds internationally. Between 1989 and 1993, when assets under management rose from $50 million to $300 million, Mr. Harding headed up Adam, Harding and Lueck Ltd.'s quantitative research team, supervising about 15 full-time research staff, supported by a software team of around a dozen programmers. This team developed a multiplicity of quantitative trading strategies in addition to Adam, Harding and Lueck Ltd.'s successful trend-following trading approach. During this time, he was also involved in the company's international institutional marketing efforts, in particular in Europe, the Middle East, South East Asia, Japan and the U.S. In 1993, Mr. Harding was invited to present a paper to a special symposium of London's prestigious Royal Society, on the subject "Making Money From Mathematical Models." This paper was subsequently incorporated into two books on the subject. In September 1994, E D & F Man Group Ltd. bought out the minority shares owned by Mr. Harding and the original partners, and Adam, Harding and Lueck Ltd. was consolidated into E D & F Man Group Ltd.'s fund management division. Mr. Harding then formed and headed up a new division of E D & F Man Group Ltd., called E D & F Man Group Ltd. Quantitative Research, leading a research team that developed quantitative trading models primarily for use by E D & F Man Group Ltd.'s fund management companies. Mr. Harding left E D & F Man Group Ltd. in August 1996 to begin preparations for the launch of Winton, which he formed in February 1997. Osman Murgian is a founding director and a principal of Winton. Educated in Brighton College in England, Mr. Murgian was also one of the original shareholders and directors of Adam, Harding and Lueck Ltd. Mr. Murgian lives in Nairobi, Kenya, and is the owner of or an investor in a number of international businesses ranging from real estate to transportation. Mr. Murgian has a beneficial interest of more than 10% of Winton's share capital. This interest is held by Festuca Investments Ltd, an Isle of Man investment holding company. Martin John Hunt is a director and a principal of Winton. Mr. Hunt began his career in the UK managed futures industry in October 1983, at which time he was employed as a trainee trader for a trading advisor, Futures Fund Management Ltd. In January 1986, he was appointed manager of the trading operations for Sabre Fund Management, also a trading advisor. In February 1988, he joined Adam, Harding and Lueck Ltd., then a newly established trading advisor, where he was responsible for the company's trading operations. These trading operations were complex, and Mr. Hunt's role was to ensure the efficient execution of the firm's computer-generated futures and interbank orders on over $120 million of assets under management. These orders spanned more than 60 markets, 5 time zones and 15 exchanges worldwide. In August 1991, Mr. Hunt assumed responsibility for marketing and operations at Royston Investments, Ltd, which at the time was a CFTC-registered CTA. In March 1994, he established himself as an independent marketing and compliance consultant to firms in the UK managed futures industry. These consultancy activities continued until February 1997, when he was recruited by David Harding to handle the formation, structuring and subsequent day-to-day running of Winton. At Winton, Mr. Hunt supervises the trading operations, as well as being directly involved in the marketing of Winton's investment management approach worldwide. Mr. Hunt also has responsibility for the firm's regulatory compliance. During the five years preceding the date of this Supplement, there have been no material administrative, civil or criminal actions, including actions pending, on appeal or concluded, against Winton or its principals. Winton and its principals may, from time to time, trade futures, forwards, or options contracts for their own proprietary accounts. These accounts may take positions that are opposite, or ahead of, positions advocated for clients. Such trades may or may not be in accordance with the Winton trading programs described below. Although Winton maintains records of these trades, clients of Winton are not entitled to inspect these records except in certain limited circumstances. Description of the Diversified Trading Program Effective January 1, 2004 the general partner allocated 10-15% of Spectrum Technical's assets to Winton's Diversified Trading Program which has been trading since 1997. The Winton Diversified Trading Program uses a statistically-derived systematic model to trade a diversified portfolio of approximately 95 futures contracts. The contracts traded cover a global range and are widely diversified across the financial and commodity sectors. Winton expects the margin requirements for the portion of Spectrum Technical's assets traded pursuant to Winton's Diversified Trading Program to average about 20% of those assets. As of December 31, 2003 Winton Capital Management Limited was managing approximately $321 million pursuant to its Diversified Trading Program and approximately $326 million of client assets in all its programs (notional funds included). Description of Trading Methods and Strategies Winton's investment technique consists of trading a portfolio of around 95 futures contracts on major commodity exchanges and forward markets worldwide, employing a computerized, technical, trend-following trading system developed by its principals. This system tracks the daily price movements from these markets around the world, and carries out certain computations to determine each day how long or short the portfolio should be to maximize profit within a certain range of risk. If rising prices are anticipated, a long position will be established; a short position will be established if prices are expected to fall. The trading methods applied by Winton are proprietary, complex and confidential. As a result, the following discussion is of necessity general in nature and not intended to be exhaustive. Winton plans to continue the testing and reworking of its trading methodology and, therefore, retains the right to revise any methods or strategy, including the technical trading factors used, the markets traded and/or the money management principles applied. A Technical Trend-Following System. Technical analysis refers to analysis based on data intrinsic to a market, such as price and volume. This is to be contrasted with fundamental analysis which relies on factors external to a market, such as supply and demand. The Diversified Trading Program uses no fundamental factors. A trend-following system is one that attempts to take advantage of the observable tendency of the markets to trend, and to tend to make exaggerated movements in both upward and downward directions as a result of such trends. These exaggerated movements are largely explained as a result of the influence of crowd psychology or the herd instinct, amongst market participants. A trend-following system does not anticipate a trend, but seeks to capture it at an appropriate point in time. In fact, trend-following systems are frequently unprofitable for long periods of time in particular markets or market groups, and occasionally they are unprofitable for spells of more than a year, even in large portfolios. However, over a span of years, Winton believes such an approach, applied to a sufficiently diversified portfolio of markets, has proven to be consistently profitable. The Winton trading system works by capturing the probability of the size and direction of future price movements using sophisticated statistical indicators, or oscillators, derived from past price movements which characterize the degree of trending of each market at any time. Winton believes its application of advanced classical statistics to the understanding of market behavior provides it with an edge over other trend following systems. Winton believes this enables its system to suffer smaller losses during the inevitable whipsaw periods of market behavior and thus take better advantage of the significant trends when they occur, by focusing more resources on them. The system is developed using historical market prices in each contract ("in sample data"), and then tested on an independent period of market data ("out of sample data") to ensure that the observations have robust predictive power. This procedure seeks to avoid the risk of over optimising, which occurs when a system is allowed to fit itself to a historically-specific set of market conditions. A Non Discretionary System. Trade selection is not subject to intervention by Winton's principals or traders and therefore is not subject to the influences of individual judgement. As a systemic trading system, the Winton model utilizes expert knowledge to analyze market data and direct trades, thus eliminating the risk of basing a trading program on one indispensable person. Equally important is the fact that non-discretionary systems can be tested in simulation for long periods of time and the model's empirical characteristics can be measured. The system's output is rigorously adhered to in trading the portfolio and intentionally no importance is given to any external or fundamental factors. While it may be seen as unwise to ignore information of obvious value, such as that pertaining to political or economic developments, Winton believes the disadvantage of this approach is far outweighed by the advantage of the discipline that rigorous adherence to such a system instills. Significant profits are often made by the Winton system, by holding on to positions for much longer than conventional wisdom would dictate. An individual taking trading decisions, and paying attention to day-to-day events, could easily be deflected from the chance of fully capitalizing on such trends, when not adhering to such a system. Markets Traded. The Winton system trades in all the easily accessible and liquid U.S. and non-U.S. futures and forward contracts that it practically can. Forward markets include major currencies and precious and base metals, the latter two categories being traded on the London Metal Exchange. Winton is constantly looking for new opportunities to add additional markets to the portfolio, thus further increasing the portfolio's diversification. Diversification of Markets. Taking positions in a variety of unrelated markets has been shown, over time, to decrease system volatility. By employing a sophisticated and systematic schema for placing orders in a wide array of markets, Winton believes it can be demonstrated that there is a high expectation of an overall profit being realized after a sufficient period of time. The trading strategy and account management principles described here are factors upon which Winton will base its trading decisions. Such principles may be revised from time to time by Winton as it deems advisable or necessary. Accordingly, no assurance is given that all of these factors will be considered with respect to every trade or recommendation made or that consideration of any of these factors in a particular situation will lessen risk of loss or increase the potential for profits. Execution of Orders and Order Allocation Winton will select the type of order to be used in executing trades and may use any type of order permitted by the exchange on which the order is placed. Winton may place individual orders for each account or a block order for all accounts in which the same commodity interest is being cleared through the same futures commission merchant. In the latter instance, Winton employs an objective price allocation procedure in which all accounts are listed by account number and then trades are assigned, with the highest number on the list receiving the highest buy and the highest sell and the lowest number on the list receiving the lowest buy and the lowest sell. On occasion, it may direct the futures commission merchant for the accounts to employ the neutral allocation system generally used by the futures commission merchant to assign trades or it may use an average price system in which each client in the block order will receive the average price which is computed by multiplying the price by the quantity executed at each price divided by the total quantity executed. Partial fills will be allocated in proportion to account size. Past Performance of Winton Set forth below in Capsule A is the past performance history of Winton's Diversified Trading Program. The footnotes following Capsule A are an integral part of the Capsule. You are cautioned that the information set forth in the following Capsule performance summary is not necessarily indicative of, and may have no bearing on, any trading results that may be attained by Winton or Spectrum Technical in the future, since past results are not a guarantee of future results. There can be no assurance that Winton or the partnership will make any profits at all, or will be able to avoid incurring substantial losses. You should also note that interest income may constitute a significant portion of a commodity pool's total income and, in certain instances, may generate profits where there have been realized or unrealized losses from commodity trading. CAPSULE A Winton Capital Management Limited Winton Diversified Trading Program Name of commodity trading advisor: Winton Capital Management Limited Name of program: Winton Diversified Trading Program Inception of trading by commodity trading advisor: October 1997 Inception of trading in program: October 1997 Number of open accounts: 33 Aggregate assets overall: 257.8 million Aggregate assets in program: 252.3 million Worst monthly drawdown (12.97)% - (October 1997) Worst peak-to-valley drawdown: (31.09)% - (November 2001-May 2002) 2003 annual return: 25.52% 2002 annual return: 12.86% 2001 annual return: 5.56% 2000 annual return: 9.72% 1999 annual return: 13.24% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Performance Records A summary of performance information for each partnership from its commencement of operations through December 31, 2003 is set forth in Capsules I through V below. All performance information has been calculated on an accrual basis in accordance with accounting principles generally accepted in the United States of America and is "net" of all fees and charges. You should read the footnotes on page , which are an integral part of the following capsules. You are cautioned that the information set forth in each capsule is not indicative of, and has no bearing on, any trading results that may be attained by any partnership in the future. Past performance is not necessarily indicative of future results. We cannot assure you that a partnership will be profitable or will avoid incurring substantial losses. You should also note that interest income may constitute a significant portion of a partnership's total income and may generate profits where there have been realized or unrealized losses from futures, forwards, and options trading. Capsule I Performance of Spectrum Select Type of pool: publicly-offered fund Inception of trading: August 1991 Aggregate subscriptions: $557,918,114 Current capitalization: $441,522,484 Current net asset value per unit: $30.31 Worst monthly % drawdown past five years: (13.12)% (November 2001) Worst monthly % drawdown since inception: (13.72)% (January 1992) Worst month-end peak-to-valley drawdown past five years: (23.63)% (22 months, October 1998-July 2000) Worst month-end peak-to-valley drawdown since inception: (26.78)% (15 months, June 1995-August 1996) Cumulative return since inception: 203.10% Monthly Performance Footnotes to Winton's Capsule Performance Summaries "Inception of trading by commodity trading advisor" is the date on which Winton began trading client accounts. "Inception of trading in program" is the date on which Winton began trading client accounts pursuant to the program shown. "Number of open accounts" is the number of accounts directed by Winton pursuant to the program shown as of December 31, 2003. "Aggregate assets overall" is the aggregate amount of assets in non-proprietary accounts under the management of Winton as of December 31, 2003. "Aggregate assets in program" is the aggregate amount of assets in the program specified as of December 31, 2003. "Drawdown" means losses experienced by the trading program over a specified period. A small number of accounts in the portfolio composites have experienced monthly drawdowns and peak-to-valley drawdowns that are materially larger than the largest composite monthly drawdown and peak-to-valley drawdown. These variances result from factors such as small account size (i.e., accounts with net assets of less than the prescribed portfolio minimum, which therefore trade fewer contracts than the standard portfolio), intra-month account opening or closing, significant intra-month additions or withdrawals, and investment restrictions imposed by the client. "Largest monthly drawdown" means greatest percentage decline in net asset value due to losses sustained by the trading program from the beginning to the end of a calendar month during the most recent five calendar years. "Worst peak-to-valley drawdown" means greatest cumulative percentage decline in month-end net asset value of the trading program due to losses sustained during a period in which the initial month-end net asset value of the trading program is not equaled or exceeded by a subsequent month-end net asset value of the program during the most recent five calendar years. "Compound annual and year-to-date/period rate of return" presented in the composite performance capsules are calculated based on the "Fully-Funded Subset" method as prescribed by the CFTC. The rate of return is calculated by dividing the sum of net performance of the qualifying Fully-Funded Subset by the beginning net assets of the qualifying Fully-Funded Subset, except in periods of significant additions or withdrawals to the accounts in the qualifying Fully-Funded Subset. In such instances, the Fully-Funded Subset is adjusted to exclude accounts with significant additions or withdrawals that would materially distort the rate of return pursuant to the Fully-Funded Subset method. Returns are then compounded to arrive at the year-to-date rate of return. Morgan Stanley Spectrum Strategic L.P. 1. Allied Irish Capital Management, Ltd. Allied Irish is an Irish corporation registered with the CFTC as a commodity trading advisor since January 1994 and is a member of the National Futures Association in that capacity. Allied Irish's business office is located at 85 Pembroke Road, Ballsbridge, Dublin 4. Allied Irish's ultimate parent company is Allied Irish Banks plc, Ireland's largest banking and financial services group. Allied Irish has been authorized by the Irish Financial Services Regulatory Authority (formerly known as Central Bank of Ireland) under the Investment Intermediaries Act, 1995. As a commodity trading advisor, Allied Irish specializes in trading interest rate, currency, and equity index futures contracts, as well as foreign exchange on the interbank cash market. The primary focus of Allied Irish's futures trading is on the U.S. and European, futures exchanges with some participation in other markets. Foreign exchange trading covers the major currencies. Allied Irish began trading for Spectrum Strategic in May 1999. Month Principals Gerry Grimes is Managing Director of Allied Irish, an associated person of Allied Irish and a member of the Institute of Bankers. He became registered as an associated person of Allied Irish in January 1994. For 10 years up to March 1988, Mr. Grimes was employed by the Central Bank of Ireland in the following investment management positions: Chief Dealer, Money Market Division; Chief Dealer, Management of Official External Reserves; and Chief Forex Dealer. He represented Ireland on sub-committees of the European Central Bank Governors Committee in Basle. He has experience in liquidity and interest rate management, investment of external reserves ($5 billion) and their currency allocation and the management of the Irish pound in the European Exchange Rate Mechanism. Mr. Grimes joined Gandon Securities as a trader in March 1988 where he traded a range of interest rate contracts, and was appointed a Director in October 1990. He was an associated person with Gandon Fund Management from July 1991 to September 1993. From mid 1991, he was responsible for the development of Gandon Fund Management's activities including the marketing and development of managed futures programs. He left Gandon Securities and Gandon Fund Management in September 1993 and joined Allied Irish that month. Mr. Grimes was a founding member of Allied Irish and is responsible for the overall management, development, and control of Allied Irish's activities. Between January and September 2002, Mr. Grimes was also responsible for trading a portion of the Worldwide Financial Futures Program. Ian Kelly became Company Secretary of Allied Irish in August 1997. He is a member of the Institute of Chartered Accountants of Ireland. He is Chief Operating Officer of Allied Irish and is responsible for financial control, compliance, and the back-office and I.T. operations of the company. He joined Allied Irish in August 1997. Prior to joining Allied Irish, he worked from July 1994 to August 1997 in AIB Capital Markets Plc., an investment bank, and before that he worked with Coopers & Lybrand, an accountancy firm, from 1987 to June 1994. John O'Donnell became a non-executive Director of Allied Irish in March 2001. He is Head of Investment Banking in the Capital Markets Division of the AIB Group, a position he was appointed to in March 2001. Prior to this appointment he was Managing Director of AIB International Financial Services Limited, a subsidiary of the AIB Group, from January 1994 to December 1996 and was Managing Director of AIB Corporate Finance Limited, another subsidiary of the AIB Group, from December 1996 to March 2001. Mr. O'Donnell is a Fellow of both the Chartered Institute of Management Accountants and the Chartered Association of Certified Accountants. John Parsons became a Director of Allied Irish in January 1995. He graduated from Queen's University, Belfast with a B.Sc. in Computer Science and Statistics in 1986, and went on to obtain a Master of Business Administration degree from Cardiff University, in 1987. Before joining Allied Irish, Mr. Parsons worked for SBC Warburg in London as a proprietary trader in the Fixed Interest & Treasury Division. Prior to that, he worked with the Bank of Ireland Group from January 1989 to March 1993, initially as a Portfolio Manager with the Bank's fund management group and ultimately as Head of European Government Bonds with the Bank's Treasury operation. Mr. Parsons trades a portion of the Worldwide Financial Futures Program and he is the sole trader of the Equity Program offered by Allied Irish. David Thompson became a Director of Allied Irish in September 2002. He has a Certificate in Actuarial Practices and a Certificate in Investment Management from the Institute of Actuaries in London. Prior to joining Allied Irish, Mr. Thompson worked for Bank of Ireland Group as Head of Proprietary Trading (non-customer flow) between January 2001 and August 2002. Before that he was Head of their Euro Fixed Interest Trading Desk between June 1998 and January 2001 and prior to that worked as a proprietary trader on their fixed interest trading desk in Dublin (July 1995 to June 1998) and as a bond trader in their London office (March 1994 to July 1995). From 1987 to 1994 he worked for Eagle Star Insurance, initially as an actuarial programmer and ultimately as a foreign exchange and bond trader. Mr. Thompson trades a portion of the Worldwide Financial Futures Program. Mr. Treble became a non-executive director of Allied Irish in October 2003 and currently has a pending registration as principal with the NFA. He is Managing Director of AIB Global Treasury, a position he has held since February 2002. Prior to this appointment, he was Managing Director of AIB Treasury and International, from February 2001 to February 2002, and he held the position of General Manager, AIB Capital Markets Britain (Treasury & Corporate Banking) from August 1997 to February 2001. He has worked in AIB since 1982 and has an MBA in Financial Services. Allied Irish and its principals may, from time to time, trade futures, forwards, and options contracts for their own proprietary accounts. Allied Irish's Trading Strategies Allied Irish offers three trading programs, but will only trade the Worldwide Financial Futures Program for Spectrum Strategic. Trading for Spectrum Strategic will be at four times the leverage Allied Irish normally applies for the Worldwide Financial Futures Program. The two other trading programs offered by Allied Irish are the Foreign Exchange Program and the Equity Index Program. Worldwide Financial Futures Program The Worldwide Financial Futures Program is designed to provide returns using a multi-trader trading approach on a broad range of financial instruments. The capital is sub-allocated to a range of trading styles, including a portion traded by two individual traders, Mr. Parsons and Mr. Thompson. The allocation of capital to the individual traders and to the trading styles may be altered at the discretion of Allied Irish. A portion is traded using a systematic approach. Diversification is enhanced because no overall house view is imposed on the traders in the program, and this independence of operation is viewed as a key strength. There are the three elements to the current trading approvals. Mr. Thompson's trading style is based on an understanding of the medium to longer term economic, political and demographic trends in the world. An analysis of value is conducted for all major asset classes and fitted to this fundamental framework to determine the likely direction and magnitude of trends in the major financial markets. The timing and size of trades is determined through a combination of technical analysis and assessment of market psychology and positioning. The aim of Mr. Thompson's approach is to enter trends early, building up the size of the position as the trade becomes profitable. Exit of the trades occurs when market sentiment in favour of the trade reaches an extreme, but price movements cease to justify the euphoria. Profitable trades can be run for months at a time, but may be held for shorter periods, depending on the strength of the trends involved. Mr. Parsons' approach to trading markets is based on a fundamental analysis of economic, fiscal, and monetary developments in the world's major economies. Having compiled a set of expectations for the major interest rate, equity, and foreign exchange markets, Mr. Parsons then looks for significant levels of divergence relative to the market's expectations as a signal to enter a particular position. He uses technical analysis to help identify trends and trend changes as well as to seek to improve entry and exit levels. A portion of the Worldwide Financial Futures Program is traded using a technical trading system. The system has been developed to be consistent with Allied Irish's investment approach to financial markets. The system differs from most trend following trading systems in that a profit objective is built into the trade from inception. The system utilizes a break-out oriented approach that attempts to initiate trading at low risk entry points where the market has a higher probability than average of participating in a medium-to long-term trend. The futures contracts currently traded in the Worldwide Financial Futures Program include U.S., European, and Asian interest rate, currency, and stock index contracts. For most contracts, options may also be used from time to time. Options may be either bought or sold in this program. It should be noted that in relation to currency futures on both the Chicago Mercantile Exchange and the financial derivatives division of the New York Cotton Exchange, Allied Irish may convert spot transactions to futures contracts using the exchange for physicals mechanism. As of December 31, 2003, Allied Irish was managing approximately $336 million (notional funds included) of client assets pursuant to the Worldwide Financial Futures Program and approximately $637 million of client assets in all of its programs (notional funds included). Foreign Exchange Program The Foreign Exchange Program specializes in trading the inter-bank foreign exchange market. A fundamental assessment of market information is the main factor underlying the trading approach. To this end an assessment of the fundamental economic policy forces at work in different countries is first made. This is related to socio-political factors in play. A judgment is then made on how much of the economic and political influences are priced in following a review of international capital flows. In this regard consultation is made with a network of experts in the world's currency markets. Finally the price levels are examined in detail to determine appropriate trade parameters. Equity Index Program The program's objective is designed to minimize correlations with major global equity returns. The underlying investment approach is broadly similar to that taken in Allied Irish's other two programs in that the main inputs are an analysis of macroeconomic and global political trends. This program is traded by John Parsons and trades the major stock index futures. Risk Management The management of risk positions takes place at two levels within the programs at the overall program level by the trading controller and at the position taking level where each trader uses his individual money management skills. Given that the programs involve a multi-trader approach, a program controller role is adopted. Mr. Grimes is the trading controller for all three programs. This role involves the following: assessing the performance and risk of the programs from an overall level as distinct from a trader level; monitoring the traders' adherence to the risk parameters for each program as set out below; ensuring that the programs' overall objectives and those of individual traders are compatible; controlling the operations of the order desk and ensuring the positions are agreed between traders, order desk, back office, and counterparty. Mr. Grimes is also responsible for liaising with clients and conveying their views, wishes, and concerns to the trading team. To control the levels of exposure a daily end-of-day position report including contract open positions, margin utilized by contract, and margin utilized by trader is produced for the Worldwide Financial Futures and Equity Index Programs. The report for the Foreign Exchange Program looks at positions in equivalent U.S. dollar amount versus underlying U.S. dollar equity invested. For the Worldwide Financial Futures and Equity Index Programs, margin to equity is used to control position size while in the Foreign Exchange Program a gearing of equity is used to limit position size. Given the nature of the programs offered and the experience of the trading team, a limit of 6% margin to equity (including notional funds) is normally applied for the Worldwide Financial Futures and Equity Index Programs and a gearing of 3 times equity (including notional funds) for the Foreign Exchange Program. 2. Blenheim Capital Management, L.L.C. Blenheim Capital Management, L.L.C. is a Delaware limited liability company which was formed to provide commodity trading advisory services to clients. Through a corporate reorganization in July 2001, Blenheim was merged with Blenheim Investments, Inc., a New Jersey corporation. The ownership and capitalization of Blenheim are materially the same as those which existed in Blenheim Investments, Inc. Additionally, Blenheim succeeds to all the assets and obligations of its predecessor. Blenheim is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator, effective March 2, 1989, and is a member of the National Futures Association. Blenheim's address and telephone number are: Post Office Box 7242, Two Worlds Fair Drive, Somerset, New Jersey 08875-7242; (732) 302-0238. Principals Mr. Willem Kooyker is the Managing Member, Chairman and majority owner of Blenheim. He is registered with the CFTC as an associated person of Blenheim and a member of the National Futures Association in that capacity. He is a former member of the Board of Directors of the NY Coffee, Sugar and Cocoa Exchange, a former president of the NY Cocoa Clearing Association, and a former member of the NY Mercantile Exchange. He received a BA cum laude in Economics from Baruch College in New York and an MBA in International Finance and Economics from New York University. Mr. Kooyker began his trading career in the international commodities business in 1964 with Internatio-Muller in Rotterdam, The Netherlands, where eventually he became managing director of the International Trading Group. He stayed in this position until 1981, when he joined Commodities Corporation, Princeton, New Jersey, where he became President. At the time, Commodities Corporation was an active fund management company, operating predominantly in the futures markets. In October 1984, Mr. Kooyker started a new company, Tricon Holding Company, Ltd., a joint venture between Commodities Corporation and a group of Middle Eastern investors, which was a trading and consulting company in the futures as well as the physicals markets predominantly directed towards energy and industrial commodities. Tricon currently remains only active in the forest products industry, where it operates two sawmills in the western states of the United States. In January 1989, Mr. Kooyker started Blenheim, an independent fund management company and an advisor to several investment funds. Concurrent, but separate from Blenheim, Mr. Kooyker is the largest beneficial owner, but not an officer, of Derivatives Portfolio Management, L.L.C., a Delaware limited liability company formed in 1993 to provide administrative, risk management, and consulting services to institutions, commodity pool operators, and individual fund managers engaged in the financial instruments, securities, and futures markets as well as the cash trading business. DPM is registered with the CFTC as a commodity pool operator, effective January 26, 1994, and is a member of the National Futures Association in that capacity. DPM has a wholly-owned subsidiary named DPM Brokerage, LLC, a Delaware limited liability company formed in 1999 to provide introduction and execution services to individual clients and private investors. DPM Brokerage is registered with the CFTC as an introducing broker, effective August 16, 1999 and is a member of the National Futures Association in that capacity. In 1996, Mr. Kooyker became a 50% shareholder in The Thornton Group, L.L.C., a consulting company to entrepreneurial startup enterprises. Mr. Kooyker is registered with the CFTC as a principal and an associated person of Blenheim. He is also registered as a principal of DPM and DPM Brokerage. Thomas M. Kopczynski is a Vice President of Blenheim. He is registered with the CFTC as a principal and an associated person and is a member of the NFA in that capacity. Mr. Kopczynski has been with Blenheim for ten years. He is an integral part of Blenheim's trading staff. His broad knowledge of the market sectors in which Blenheim trades, retained by extensive analysis and consultation with key industry contacts, facilitates continuous investment opportunities and diversification. Mr. Kopczynski holds a B.S. in Economics with a concentration in Statistics from the Wharton School of the University of Pennsylvania. Guy J. Castranova, is the Secretary of Blenheim and has held this position since its inception. He is the President and Chief Operating Officer of DPM and DPM Brokerage, as well as a Vice President and Controller of Tricon. Mr. Castranova has been with Tricon since October 1986 and is responsible for the risk management of all physicals trading as well as the administration of all general and consolidation accounting. Prior to joining Tricon, Mr. Castranova was an accountant with two energy firms. In 1980 Mr. Castranova graduated from Saint Joseph's University with a BS degree in Accounting. He is registered as an associated person and principal of Blenheim, DPM, and DPM Brokerage, and is a member of the National Futures Association in those capacities. Blenheim and its principals may, from time to time, trade futures, forwards, and options contracts for their own proprietary accounts. If either Blenheim or its principals engage in such trading, you will not be able to inspect such records. Such trades may or may not be in accordance with the Blenheim trading program described below. As of December 31, 2003, Blenheim was managing approximately $68.1 million of client assets pursuant to its trading program. The Blenheim Global Markets Strategy The Global Markets Strategy designed and developed by the management team of Blenheim. The objective of the Global Markets Strategy is to capture substantial profits through the establishment of risk-controlled, strategic investment positions in markets where Blenheim has identified an unsustainable level of market disequilibrium that has not been reflected in the current market price. The essence of Blenheim's trading approach is its ability to use discretion in formulating the most effective mix of trading methodologies, investment vehicles, and markets to maintain performance objectives. As trading opportunities are identified, Blenheim analyzes potential trading applications in order to achieve maximum capital appreciation with prudent risk management procedures. Markets Traded Blenheim's portfolio is highly diversified and draws upon a potential of 35 markets, depending on the opportunities presented at any given time. The major markets traded by Blenheim include energy, industrials, precious metals, softs, grains, global fixed income, currencies and stock indices. Blenheim concentrates in those markets that, in its judgment and discretion, have a high degree of liquidity and a wide spectrum of historical price movement relative to other markets. Instruments Utilized Positions established are typically in derivative instruments such as futures options and OTC transactions. Blenheim may, however, trade to a limited extent in illiquid instruments for which market quotations are not readily available. In addition, Blenheim may trade in securities that are related to the financial and commodities markets currently traded by the fund. However, Blenheim will not be trading securities for Spectrum Strategic. Blenheim's Trading Style Blenheim uses a global macro approach to investing, which utilizes fundamental, geopolitical and technical research and analysis in its evaluation of the markets. Fundamental analysis attempts to examine factors external to the trading market which affect the supply and demand for a particular investment instrument in order to predict future prices. The geopolitial considerations include governmental interference and potential political conflicts which may alter the normal flow of capital and goods. Technical factors assume that market price patterns and price momentum, rather than external influences, indicate the supply and demand factors which are indicative of future price movements. Blenheim considers technical factors such as an instrument's recent price history, current prices of such instrument relative to price of other markets and their historical price relationships. Blenheim studies price charts to assess changes in market sentiment and examines volume and open interest to evaluate market liquidity. The Blenheim traders regularly monitor worldwide economic and political trends in order to identify and evaluate possible market and price imbalances. Operating within a global framework, long-term macroeconomic indicators are assessed on a multinational, country-by-country and market specific basis. Factors such as fiscal/monetary policies and cross-border capital flows are evaluated for their potential impact on the equity, fixed income, currency and commodity markets. Additionally, Blenheim's trading group utilizes econometric signals, as well as numerous other market sentiment indicators, to take advantage of short-term trading opportunities. Portfolio Management and Diversification Various techniques are employed in managing the portfolio and position volatility. In its discretionary trading, Blenheim generally initiates medium-sized positions at a market entry level. This initial position, generally considered the core strategic position, is typically initiated upon Blenheim's determination of an unsustainable level of market disequilibrium that has not been reflected in the current market price. Once market action begins to conform to Blenheim's initial assessment of price behavior, Blenheim will add to the original strategic position. In addition to managing the individual positions, Blenheim will also evaluate the positions within the context of an account's portfolio. Separate strategic positions are evaluated for direct and indirect correlation characteristics in order to further anticipate and manage portfolio volatility. Despite these precautions, Blenheim's trading program may be volatile at times. Diversification in an account's portfolio is a major consideration in its trading approach. While many of its trades are made on a short-term basis, Blenheim's basic strategy is to attempt to participate in long-term, major price movements. Evolution of the Trading Approach The trading strategy of Blenheim has evolved and will continue to do so based on ongoing research, testing of data and trading experience. Prior to 1991, Blenheim traded almost exclusively in commodity markets, with a particular emphasis on energy products. Since then, Blenheim has become active in the global fixed-income, stock indices and currency markets as well. In the past, Blenheim had included non-discretionary systematic computerized analysis in its trading practices. This strategy was driven by a series of trading systems that produced a result that was an amalgam of numerous systemic processes. It was then traded in conjunction with the discretionary approach. Under separate funds, Blenheim also managed a purely financial strategy and a long-only commodity trading strategy incorporating physical commodities. In this regard, Blenheim reserves the right to modify its trading approach to include any one or combination of trading methodologies it finds beneficial to its overall goals. These processes may include discretionary, systematic, or arbitage trading. Blenheim may use derivative instruments including futures, options, and forwards to reach its performance objectives. On rare occasions, Blenheim may withdraw from all markets. Blenheim's diversified portfolio is actively traded on domestic and foreign markets. In the early 1990s, approximately thirty-five percent (35%) to forty-five percent (45%) of equity, including notional funds, was generally committed to margin on commodities positions. Recently the percentage has been between twenty-five percent (25%) and thirty-five percent (35%). In the future the percentage committed may, from time to time, be substantially higher or lower. Variances in Leverage If particular opportunities present themselves based upon fundamental factors, Blenheim may increase the number of positions held. This will result in more capital needed to provide risk margin. Accordingly, within the overall parameters of Blenheim's money management rules, Blenheim employs no hard and fast formula as to the levels of capital committed to discretionary trading or any other trading strategy at any given time. The level of risk margin relative to equity committed to trading positions is expected to vary from period to period. The Blenheim traders will constantly monitor leverage in an effort to try to maximize its positive effects while trying to avoid overexposure to its potential negative characteristics. While there is no guaranty that this approach will be successful, Blenheim has used a consistent risk monitoring system for a number of years, one of the key components thereof involves monitoring the levels of risk margin to equity. Blenheim may leverage the account of Spectrum Strategic differently than the standard account using the Global Market Strategy, but will not leverage the account at more than 50% above the leverage of a standard account. 3. Eclipse Capital Management, Inc. Eclipse is a Delaware corporation organized in July 1983. Eclipse's main business address is 7700 Bonhomme, Suite 500, St. Louis, Missouri 63105. Eclipse has been registered with the CFTC as a commodity trading advisor since August 1986 and is a member of the National Futures Association in such capacity. Eclipse began trading for Spectrum Strategic in June 2000. Principals Thomas W. Moller, the sole shareholder of Eclipse, has served as its President, CEO, and sole director since founding the firm. Mr. Moller received an undergraduate degree in Business and Economics from Vanderbilt University and a graduate degree in Accounting from the University of Kentucky. He was a Certified Public Accountant and has a background in financial planning and investment management. In 1980, as chief financial officer of a privately held company, he designed and implemented one of the first variable rate loan hedge programs using interest rate futures contracts. In 1982, he formed Interest Rate Management, Inc., another commodity trading advisor which provided interest-rate-hedging advisory and management services. Since 1986, Mr. Moller has devoted his time exclusively to Eclipse and is primarily involved in the areas of trading, research, and product development. James R. Klingler, JD is Senior Vice President, Corporate Secretary, and General Counsel. Mr. Klingler has a BA in Economics from Vanderbilt University and a JD from Vanderbilt University School of Law. He previously worked as an associate with the St. Louis law firm of Thompson Coburn (formerly Coburn & Croft) and as a staff attorney with Mercantile Bancorporation, also in St. Louis. From January 1991 to December 1997, he was Compliance Counsel and, subsequently, Associate Vice President with A.G. Edwards & Sons, Inc. Mr. Klingler joined Eclipse in January 1998. Ronald R. Breitigam is Vice President Trading with primary responsibility for the implementation of the firm's trading strategies. After graduating from Pacific Union College in 1982, Mr. Breitigam became an independent floor trader at the Mid-America Commodity Exchange. He served as an institutional broker with Thomson McKinnon (1984-1985) and PaineWebber (1986) and, in 1986, formed his own trading company to work full time implementing various proprietary futures and options trading strategies. Mr. Breitigam joined Eclipse in May 1989. James W. Dille, PhD is Vice President Research and Technology with responsibility for computer-based research, development, and operations. Dr. Dille has undergraduate and graduate engineering degrees from the University of Virginia. He also received a master's and doctorate from Harvard University in Applied Sciences, specializing in the areas of Decision and Control Theory and Computer Science. From 1987 through 1993, he worked for the Boeing Company (formerly, McDonnell Douglas) in the Training Systems and Flight Simulation divisions, where he was responsible for research in the areas of computer architectures and networking. He is an affiliate professor at Washington University in St. Louis, teaching courses in numerical analysis and the simulation and analysis of complex systems. Dr. Dille joined Eclipse in January 1994. At this time, neither Eclipse nor its principals trade for their own account, but each reserves the right to do so in the future. If either Eclipse or its principals engage in such trading, you will not be able to inspect such records. Trading Programs Eclipse currently offers one trading program, the Global Monetary Program. The program is designed primarily for institutions, commodity pools, and certain other qualified investors. The Global Monetary Program employs a systematic trading approach, using multiple trend-following and macroeconomically driven models. Global Monetary Program: This "financial, metals and energy" program requires a minimum investment of $5 million and trades a global portfolio of futures and options on futures on interest rate instruments, currencies, stock indices, precious and base metals, and energy products, as well as interbank spot and forward currency markets. A key characteristic of this program is the extensive diversification achieved by applying multiple trading models to a wide variety of financial markets located throughout the world. As of December 31, 2003, Eclipse was managing approximately $379 million of client assets pursuant to its trading program (notional funds included). Trading Approach The trading program of Eclipse is systematic and its strategies are either macroeconomic or trend-following in nature, with the objective of capitalizing on intermediate- and long-term price trends. Eclipse makes all trading decisions pursuant to its proprietary trading, capital allocation, and risk management models. The Eclipse program makes use of multiple models to accentuate overall diversification. Macro-driven models generate trading signals through the quantitative analysis of environmental, macroeconomic, and intermarket data. Trend identification models use various technical and statistical analysis techniques to identify and evaluate price trends. Capital allocation models determine the percentage of trading capital allocated to various markets and trading models. Eclipse's risk management models were developed with the objective of limiting losses, capturing profits, and conserving capital in choppy, sideways markets. The risk management principles which Eclipse employs include: using stop orders to exit trades when markets are moving against an established position (although, depending on market circumstances, such "stop-loss" orders may be difficult or impossible to execute); diversifying positions among several different markets, futures, and/or futures groups to limit exposure in any one area; using multiple entry and exit points; limiting the assets committed as margin, generally within a range of 5% to 20% of assets managed, at minimum exchange margin requirements, but possibly above or below that range at certain times; and prohibiting the use of unrealized profits in a particular futures contract as margin for additional contracts in the same or a related futures contract. Decisions whether to trade a particular futures contract are based upon various factors, including liquidity, significance in terms of desired degrees of concentration, diversification, and profit potential, both historical and at a given time. These decisions are based upon output generated by a proprietary risk management program, but require the exercise of judgment by principals of Eclipse. The decision not to trade specific contracts for certain periods or to reduce the number of contracts traded may result at times in missing significant profit opportunities which otherwise would be captured by technical strategies. The specific contracts traded in each portfolio have been selected based on liquidity, historical volatility, and the degree of past directional movement. The actual number of contracts held at any particular point in time depends on a number of factors, including evaluation of market volatility and potential risk versus return. There are occasions when a trading model may indicate that no position is appropriate in a particular contract or contract group. In addition to technical trading in futures contracts, Eclipse may also employ trading techniques such as spreads and straddles and may buy or sell futures options. Eclipse may alter its trading programs, including, without limitation, its trading strategies, commodity interests, and markets traded and trading principles if Eclipse determines that such change is in the best interest of the accounts which it manages. Morgan Stanley Spectrum Global Balanced L.P. SSARIS Advisors, LLC SSARIS, a Delaware Limited Liability Company, was organized in May 2001. SSARIS's address is Financial Centre, 695 East Main Street, Suite 102, Stamford, Connecticut 06901. SSARIS has been registered as a commodity trading advisor since August 2001 and as a commodity pool operator since August 2001, and is a member of the National Futures Association in such capacities. SSARIS is a joint venture between State Street Global Alliance LLC, a limited liability company which is majority owned by State Street Global Advisors, Inc., and RTH Partners LLC, a limited liability company owned by the principals of The RXR Group, Inc. State Street Global Advisors, Inc. is a wholly-owned subsidiary of State Street Corporation. SSARIS is affiliated with State Street Global Advisors, the investment management division of State Street Bank and Trust Company, a wholly owned subsidiary of State Street Corporation. Principals Mr. Mark Rosenberg has served as the Chairman, a Director and the Chief Investment Officer of SSARIS since its formation in May 2001 and, as such, is the head of SSARIS's Investment Committee. Mr. Rosenberg is also the Chairman of SSARIS Management LLC. Mr. Rosenberg was the Chairman and Chief Investment Officer of RXR. Mr. Rosenberg has over thirty (30) years experience in the investment management industry. From August 1984 to July 1986, Mr. Rosenberg was employed by Prudential-Bache Securities, Inc., where he headed a group that specialized in institutional hedging and managed futures trading services. From December 1976 to July 1984, Mr. Rosenberg was employed by Merrill Lynch & Co. where he organized a group that was responsible for managing hedging and alternative investment strategies for Merrill's institutional clients. This entity became the Financial Futures and Options Group. Mr. Rosenberg's first job was on the floor of the New York Stock Exchange and subsequently the New York Mercantile Exchange, where he managed proprietary capital using a variety of quantitative techniques for Weis, Voisen & Cannon, a private investment boutique. Mr. Rosenberg is a fourth term Director of the Board of the Futures Industry Association, and arbiter for the NFA and is a member of the Financial Advisory Boards of both the Chicago Mercantile Exchange and the COMEX Division of NYMEX. Mr. Rosenberg is also a Director of the Foundation of Finance and Banking Research. Mr. Rosenberg also is involved in several community activities. He has donated time to Domus House, a refuge for abandoned children, and various entrepreneurial projects targeting low-income families. Mr. Peter A. Hinrichs has served as the Chief Financial Officer of SSARIS since its formation in May 2001 and is a member of SSARIS's Investment Committee. Mr. Hinrichs also is Chief Financial Officer of SSARIS Management LLC. Mr. Hinrichs was with RXR since its founding in 1983, where he was responsible for RXR's financial, administrative and operational functions. Mr. Hinrichs also was a member of RXR's Investment Committee. From September 1981 to July 1984, Mr. Hinrichs was employed by Merrill Lynch Futures Inc. in trading and administration and held a similar position at Prudential from July 1984 to August 1986. Mr. Hinrichs graduated from Curry College in 1981 with a Bachelor of Science degree in Business Management. He is active in his community as a Board member of Fountain House Inc., a non-profit rehabilitation center for the mentally ill, where he serves as an Investment Committee member. He also is active with a number of other charitable organizations. Mr. James F. Tomeo has served as the Chief Operating Officer, a Senior Portfolio Manager and a Director of SSARIS since its formation in May 2001. Mr. Tomeo also is a member of SSARIS's Investment Committee and is responsible for portfolio management, strategic planning and product development. Mr. Tomeo served as Chief Operating Officer and a Senior Portfolio Manager of RXR and was a member of the firm's Investment Committee. Before joining RXR in 1986, Mr. Tomeo worked for Donaldson, Lufkin and Jenrette as an alternative investment consultant, and the LTV Corporation in New York. Mr. Tomeo was formerly an advisor to Institutional Investor on matters related to Japanese pension fund reform, is the former Chairman of the International Committee of the Managed Funds Association and is the US representative to the Education and Research Committee of the Alternative Investment Management Association. Mr. Tomeo graduated from Bucknell University in May 1980 with a Bachelor of Science degree in Business Administration, the University of Hartford in 1987 with an MBA degree, and the Institute of International Studies and Training (Japanese business study program) in November 1988. He studied International Finance and Capital Markets at New York University. Alan J. Brown has been a Director of SSARIS since July 2003. Mr. Brown is a principal of State Street Global Advisors, Group Chief Investment Officer of State Street Global Advisors Worldwide, Chairman of State Street Global Advisors UK, and Executive Vice President of State Street. He is also a member of State Street Global Advisor's Executive Management Group. Mr. Brown is a director of Advanced Investment Partners, European Direct Capital Management, Rexiter Capital Management, Boston Capital Management and Global Alliance, LLC. Mr. Brown is also a member of State Street Global Advisor's Executive Management Group. Prior to joining State Street Global Advisors UK in 1995, Mr. Brown was Managing Director and Chief Investment Officer of PanAgora Asset Management Limited, and prior to that, Managing Director of Posthorn Global Asset Management in London. Mr. Brown began his career in the investment management business in 1974 at Morgan Grenfell, where he spent ten years. Mr. Brown holds a Masters degree in Physics from Cambridge University. Mr. Brown is on the board of the U.S. foundation for The Center for Economic Research and Graduate Education-Economic Institute attached to the Charles University in Prague. Jay Cromarty has been a Director of SSARIS since March 2003. Mr. Cromarty is the President of Global Alliance and a Senior Principal of State Street Global Advisors. Among other duties, Mr. Cromarty provides strategic management and marketing support to all of the Global Alliance investment management businesses. Mr. Cromarty is a director of Advanced Investment Partners, Boston Capital Management and Residential Capital Management. Before joining Global Alliance in May 1998, Mr. Cromarty served as the Managing Director of Sales and Marketing for State Street Global Advisors' Private Asset Management group. Prior to joining State Street Global Advisors in 1996, Mr. Cromarty was Vice President of The Boston Company, Inc., Director of Marketing and Client Service at PanAgora Asset Management and Senior Vice President of NatWest Investment Management. Mr. Cromarty holds a Bachelor of Science degree in Economics from the University of Maine and a Masters of Business Administration degree in Finance and Marketing from Babson College. Christopher M. Pope has been a Director of SSARIS Global Advisors and Director of Institutional Sales, Client Service, and Consultant Relations. Prior to joining State Street Global Advisors in 1988, Mr. Pope was responsible for marketing and client service at Travelers Investment Management Company and Travelers Keystone Fixed Income Advisors. Mr. Pope holds a Bachelor of Science degree from the University of Pennsylvania. Mr. Pope is a charter member of the Certified Employee Benefit Specialist program. Principals and employees of SSARIS are not permitted to trade futures, options on futures, or forward contracts for their own accounts. Principals and employees are, however, permitted to invest in funds traded by SSARIS. SSARIS's Investment Philosophy SSARIS trades its allocation from Spectrum Global Balanced pursuant to a variation of its Balanced Portfolio known as the Global Multi-Strategy program. The development of the trading program utilized for Spectrum Global Balanced stems from RXR's work over the years with institutional clients. In 1986, RXR began managing a portfolio called the Institutional Balanced Portfolio program (now known as the Balanced Portfolio), which was composed of U.S. stock, bond and non-U.S. financial and commodity interests. Its objective was capital appreciation with controlled volatility, a concept pioneered by Professor John Lintner of Harvard University, who conducted research on the addition of managed futures to portfolios of U.S. stocks and bonds. The philosophy for the investment program has its roots in Modern Portfolio Theory and the design of efficiently allocated portfolios. Effective June 1, 1998, RXR broadened the hedged equity and fixed income components to include participation in the world's major developed capital markets and increased the program's leverage to 1.4 times the original Balanced Portfolio Program. The resulting program is now known as the Global Multi-Strategy. SSARIS's Global Multi-Strategy program allocates to hedged equity, hedged fixed income, and long/short global assets. It is diversified by both style (divergence and convergence strategies) and asset class (global stocks, bonds, currencies and real assets). The hedged equity component may be composed of positions in FTSE 100, DAX, Nikkei 225, and S&P 500 futures indices. The hedged fixed income exposure may include British Gilt, German Bund, Japanese & US Treasury futures. Real asset exposure is diversified across energy, precious metal, base metal, and agricultural markets. The investment program uses a multi-determinant model to rebalance the independent strategies. The global stock and bond exposure is managed using models which interpret macroeconomic, relative value, inflation, interest rate, and price-related data. Exposure within the long/short global asset sector is regulated by combining individual market expected return analysis with a system that asset weights each market according to relative volatility and correlation. In the foreign exchange and commodity components, SSARIS analyzes price data to determine profit and risk potential. A proprietary asset allocation model is used to adjust exposure among approximately 40 markets so that no one market or sector can dominate performance. The investment program was designed to provide investors with a global investment alternative. Through the controlled use of futures and forward contracts, SSARIS manages both U.S. and non-U.S. capital markets, currency and commodity exposure in a single, integrated portfolio. As of December 31, 2003, SSARIS was managing approximately $53 million of client assets pursuant to the program utilized for Spectrum Global Balanced and approximately $612 million in all of their programs. Research and Development Research and development calls on the talents of personnel from several areas within the company. SSARIS has developed macro-economic and technical models that can detect price movements resulting from daily market activity and major changes in global business cycles. Using this information, portfolio managers construct investment portfolios that address the specific actuarial assumptions of their clients. No representation is made and no guarantee is given that Spectrum Global Balanced's objective will be realized or that SSARIS will achieve any particular level of performance or amount of profits in its trading for Spectrum Global Balanced's account. Losses incurred in the global and tangible assets component could cause Spectrum Global Balanced's account to substantially underperform accounts managed by asset allocation systems that do not include a managed futures component. Prospective investors must recognize not only that the foregoing discussion attempts to present only the most basic framework describing the trading program employed for Spectrum Global Balanced, but also, due to the proprietary and confidential nature of all trading approaches, any description will inevitably be general in nature. Furthermore, SSARIS's trading methods are continually evolving, as are the markets themselves. Morgan Stanley Spectrum Currency L.P. 1. John W. Henry & Company, Inc. (JWH ) JWH makes trading decisions for Spectrum Currency pursuant to the International Foreign Exchange Program. The International Foreign Exchange Program, which began trading client capital in August 1986, seeks to identify and capitalize on intermediate-term movements in a broad range of both major and minor currencies primarily trading on the interbank market. Positions are taken as outrights against the U.S. dollar, or non-dollar cross rates. This program uses the three-phase forex investment style. For a detailed description of JWH, its principals, and trading systems, including the International Foreign Currency Program, see "The Trading Advisors Morgan Stanley Spectrum Technical 3. John W. Henry & Company, Inc." beginning on page . 2. Sunrise Capital Partners, LLC The principals and senior officers of Sunrise Capital Partners are as follows: Martin P. Klitzner Principal, Managing Director Richard C. Slaughter Principal, Managing Director Dr. Gary B. Davis Principal Dr. John V. Forrest Principal Martin M. Ehrlich Principal, Vice President Marie Laufik Principal, Vice President Elissa Davis Principal The principals of Sunrise Capital Partners will make trading decisions for Spectrum Currency pursuant to the Currency Program. For a detailed description of Sunrise Capital Partners, its principals and trading systems, other than the Currency Program, which is discussed below, see "The Trading Advisors Morgan Stanley Spectrum Select 4. Sunrise Capital Management, Inc." beginning on page . The Currency Program follows approximately ten different major and minor currency markets, which may include, but are not limited to, the Japanese yen, British pound, euro currency, Swiss franc, Canadian dollar, Australian dollar, Swedish krona, New Zealand dollar, Singapore dollar, and South African rand. The Currency Program trades currency futures contracts on the International Monetary Market Division of the Chicago Mercantile Exchange and forward currency contracts in the interbank markets. In order to achieve adequate diversification for the Currency Program, major and minor currencies are traded as crossrates selectively against each other and/or as outrights against the U.S. dollar. As of December 31, 2003 Sunrise Capital Partners was managing approximately $146 million of client assets pursuant to the Currency Program and approximately $1.7 billion of client assets in all of its programs (notional funds excluded). EXCHANGE RIGHT If the conditions described below are satisfied, you may redeem your units in any partnership as of the last day of any calendar month and use the proceeds to purchase units of any of the other Spectrum Series partnerships. However, a Spectrum Series exchange will only be permitted as of the sixth month-end after you first became an investor in any Spectrum Series partnership, and as of the last day of each month thereafter. Each unit you purchase in a Spectrum Series exchange will be issued and sold at a price per unit equal to 100% of the net asset value of a unit as of the close of business on the exchange date. Any units you redeem in a Spectrum Series exchange will not be subject to a redemption charge. Units you acquire in a Spectrum Series exchange will be subject to redemption charges, but will be deemed to have the same purchase date as the units you exchanged for purposes of determining the applicability of any redemption charges. Thus, for example, if you hold units of Spectrum Strategic for 12 months, exchange those units for units of Spectrum Technical, then redeem any of those units 15 months later, you will not have to pay a redemption charge, because those units will be deemed to have been held for 27 months. When you request a Spectrum Series exchange, additional conditions must be satisfied. First, the partnership from which you are redeeming must have assets sufficient to discharge its liabilities and redeem units. In order to effect a Spectrum Series exchange, you must send a subscription agreement to a Morgan Stanley branch office, and that agreement must be received by the general partner at least five business days prior to the applicable exchange date. In that agreement, you must acknowledge that you are still eligible to purchase units on the exchange date. You must exchange a minimum of 50 units in a Spectrum Series exchange, unless you are liquidating your entire interest in a partnership. A form of subscription agreement is annexed to this prospectus as Exhibit B, and additional copies of the subscription agreement may be obtained by written request to the general partner or from a local Morgan Stanley branch office. In order to effect a Spectrum Series exchange, each partnership must have a sufficient number of units registered and qualified for sale under federal and applicable state securities laws pursuant to a current prospectus. While the general partner intends to maintain a sufficient number of registered units to effect series exchanges, it is under no obligation to do so. Therefore, the general partner cannot assure you that any units will be available for sale on an exchange date. Furthermore, states may impose significant burdens on, or alter the requirements for, qualifying units for sale. In that event, the general partner may not continue qualifying units for sale in those states, and residents of those states would not be eligible for a Spectrum Series exchange. In addition, states may impose more restrictive suitability and/or investment requirements than those set forth in the form of subscription agreement. Any such restrictions may limit the ability of residents of those states to effect a Spectrum Series exchange. In the event that not all subscription agreements can be processed because an insufficient number of units is available for sale on an exchange date, the general partner will allocate units in the manner it determines in its sole discretion. The general partner has not yet determined how it will allocate units in the event there are an insufficient number of units available on an exchange date. Units of any new partnership in the Spectrum Series may be offered to investors pursuant to exercise of the Spectrum Series exchange right. Before purchasing units of a new partnership, you will be required to receive a copy of a prospectus and any supplement to this prospectus describing the new partnership and its units, and you will be required to execute a new subscription agreement to purchase units of that partnership. Since a Spectrum Series exchange is equivalent to a redemption and an immediate reinvestment of the proceeds of the redemption, you should carefully review the portions of this prospectus describing redemptions and the tax consequences before effecting a Spectrum Series exchange. REDEMPTIONS Once you are an investor in a Spectrum Series partnership for at least six months, you may redeem all or part of your units, regardless of when such units were purchased. Redemptions may only be made in whole units, with a minimum of 50 units required for each redemption, unless you are redeeming your entire interest in a partnership. The general partner will redeem your units in the order in which they were purchased. Redemptions will only be effective as of the last day of the month in which a request for redemption in proper form has been timely received by the general partner. A "request for redemption" is a letter in the form specified by the general partner that must be sent by you to a local Morgan Stanley branch office and received by the general partner at least 5 business days prior to the redemption date. A form of request for redemption is annexed to the limited partnership agreement, which agreement is annexed to this prospectus as Exhibit A. Additional copies of the request for redemption may be obtained by written request to the general partner or a local Morgan Stanley branch office. If you redeem units, you will receive 100% of the net asset value of each unit redeemed as of the redemption date, less any applicable redemption charges. Since the general partner must receive your request for redemption at least five business days prior to the redemption date, you will not know the actual amount you are to receive prior to the redemption date. The "net asset value" of a unit is an amount equal to the partnership's net assets allocated to capital accounts represented by units, divided by the number of units outstanding. "Net assets" means the total assets of a partnership, including all cash and cash equivalents (valued at cost), accrued interest and amortization of original issue discount, and the market value of all open futures, forwards, and options positions and other assets of the partnership, less the total liabilities of the partnership, including, but not limited to, all brokerage, incentive and management fees, and extraordinary expenses, as determined in accordance with generally accepted accounting principles consistently applied under the accrual basis of accounting. The market value of a futures contract traded on a U.S. exchange means the settlement price on the exchange on which that futures contract is traded on the day net assets are being determined. However, if a futures contract could not have been liquidated on that day because of the operation of daily limits or other rules of the exchange or otherwise, the settlement price on the first subsequent day on which the futures contract could be liquidated will be the market value of that futures contract for that day. The market value of a forward or futures contract traded on a foreign exchange or market means its market value as determined by the general partner on a basis consistently applied for each different variety of forward contract or futures interest. If you redeem units on or prior to the last day of the twelfth month from the date of their purchase, those units will be subject to a redemption charge equal to 2% of their net asset value on the redemption date. If you redeem units after the last day of the twelfth month and on or prior to the last day of the twenty- fourth month from the date of their purchase, those units will be subject to a redemption charge equal to 1% of their net asset value on the redemption date. If you redeem units after the last day of the twenty-fourth month from the date of their purchase, those units will not be subject to a redemption charge. All redemption charges will be paid to Morgan Stanley DW and will not be shared with the financial advisor or additional selling agent who sold the units. Your units will be exempt from redemption charges under the following circumstances: If you redeem units at the first redemption date following notice of an increase in brokerage, management, or incentive fees, those units will not be subject to redemption charges. If you redeem units in a Spectrum Series exchange, the units you redeem will not be subject to redemption charges and, for purposes of determining the applicability of future redemption charges, the units you acquire will be deemed to have the same purchase date as the units you exchanged. If you redeem units of any other partnership for which Demeter serves as the general partner, the units you redeem from the other limited partnership will be subject to any applicable redemption charges, but the Spectrum Series units you purchase will not be subject to redemption charges. If you redeem units and have either paid a redemption charge with respect to the units or held the units for at least 24 months, you will not be subject to redemption charges with respect to any newly purchased units, provided the new units are purchased within twelve months of and in an amount no greater than the net proceeds of the prior redemption, and the units are held for at least six months from the date of purchase. In that event, you will still be subject to the minimum purchase and suitability requirements. The general partner will endeavor to pay redemptions within ten business days after the redemption date. A partnership may be forced to liquidate open futures, forward, and option positions to satisfy redemptions in the event it does not have sufficient cash on hand that is not required as margin on open positions, and may delay payment to limited partners requesting redemption of units of the proportionate part of the net asset value of the unit represented by the sums for which sufficient cash is not available. See "Risk Factors Partnership and Offering Risks Restricted investment liquidity in the units" on page . When you redeem units, payment will be made by credit to your customer account with Morgan Stanley DW, or by check mailed to you if your account is closed. Your right to redeem units is contingent upon the redeeming partnership having assets sufficient to discharge its liabilities on the redemption date, and timely receipt by the general partner of your request for redemption as described above. The terms and conditions applicable to redemptions in general, other than those prohibiting redemptions before the sixth month-end following the closing at which you first became an investor in a Spectrum Series partnership, and providing that redemptions may only be made as of the end of a calendar month, will also apply to redemptions effected on "special redemption dates." See "The Limited Partnership Agreements Books and Records; Reports to Limited Partners" on page . THE COMMODITY BROKERS Morgan Stanley DW Inc., Morgan Stanley & Co. Incorporated, and Morgan Stanley & Co. International Limited Morgan Stanley DW Inc., a Delaware corporation, acts as the partnerships' non-clearing commodity broker. Morgan Stanley DW, as the non-clearing commodity broker, holds each partnership's funds in customer segregated or secured accounts, and provides all required margin funds to the clearing commodity brokers. Morgan Stanley & Co. Incorporated, a Delaware corporation, acts as the partnerships' clearing commodity broker and foreign currency forward counterparty, and Morgan Stanley & Co. International Limited serves as the clearing commodity broker for trades that take place on the London Metal Exchange. Morgan Stanley DW monitors each partnership's futures positions that the clearing commodity brokers report they are carrying for any errors in trade prices or trade fill. Morgan Stanley DW also serves as the non-clearing commodity broker for all, and Morgan Stanley & Co. serves as the clearing commodity broker and foreign exchange counterparty for all but one, of the other commodity pools for which Demeter serves as general partner and commodity pool operator. Morgan Stanley International serves as the clearing commodity broker for the trades of such pools that take place on the London Metal Exchange. Morgan Stanley DW is a financial services company which provides to its individual, corporate, and institutional clients services as a broker in securities, futures, and options, a dealer in corporate, municipal and government securities, an investment adviser, and an agent in the sale of life insurance and various other products and services. Morgan Stanley DW has its main business office at 1585 Broadway, New York, New York 10036. Morgan Stanley DW is a member firm of the New York Stock Exchange, the American Stock Exchange, the Chicago Board Options Exchange, and other major securities exchanges. Morgan Stanley DW is registered with the CFTC as a futures commission merchant and is a member of the National Futures Association in such capacity. Morgan Stanley DW is also registered with the SEC as a broker-dealer and is a member of the NASD. Morgan Stanley DW and its affiliates currently service clients through a network of approximately 700 offices with approximately 12,000 financial advisors servicing individual and institutional client accounts. Morgan Stanley & Co. Incorporated is the clearing commodity broker for all trades for the partnerships, other than for those trades on the London Metal Exchange. Morgan Stanley & Co. has its main business office at 1585 Broadway, New York, New York 10036. Morgan Stanley & Co. is registered as a futures commission merchant, is a member of the National Futures Association, and is a member of most major U.S. and foreign commodity exchanges. Morgan Stanley & Co. is registered with the SEC as a broker-dealer and is a member of the NASD. Morgan Stanley & Co. International Limited, a United Kingdom corporation, acts as the partnerships' clearing commodity broker solely with regard to any trading on the London Metal Exchange. Morgan Stanley International has its main business office at 25 Cabot Square, Canary Wharf, London E14 4QA, England, is regulated by the United Kingdom Securities and Futures Authority as a member firm, and is a member of the London Metal Exchange and other securities and commodities exchanges worldwide. Morgan Stanley, the parent company of Morgan Stanley DW, Morgan Stanley & Co. and Morgan Stanley International, is a worldwide financial services firm, employing, directly and through its subsidiaries, more than 51,000 people worldwide in offices throughout the United States and 28 foreign countries. Morgan Stanley is a publicly-traded company listed on the New York Stock Exchange; its common stock had a market value of approximately $60 billion at November 30, 2003. At that date, Morgan Stanley had leading market positions in its three primary businesses (securities, asset management and credit services), and it ranked among the top asset managers globally, with over $462 billion in assets under management. Brokerage Arrangements The partnerships' brokerage arrangements with Morgan Stanley DW, Morgan Stanley & Co. and Morgan Stanley International are discussed in "Conflicts of Interest The brokerage arrangements with affiliates of the general partner were not negotiated at arm's-length or reviewed by any independent party for fairness" on page , " Customer agreements with the commodity brokers permit actions which could result in losses or lost profit opportunity" on page , and "Description of Charges Commodity Brokers" beginning on page . The general partner will review at least annually the brokerage arrangements of each partnership to ensure that those arrangements are fair, reasonable, and competitive, and represent the best price and services available, taking into consideration: the size of the partnership; the futures, forwards, and options trading activity; the services provided by the commodity brokers or any affiliate thereof to the partnership; the cost incurred by the commodity brokers or any affiliate thereof in organizing and operating the partnership and offering units; the overall costs to the partnership; any excess interest and compensating balance benefits to the commodity brokers from assets held thereby; and if the general partner does not receive any direct compensation from the partnership for its services as general partner, the risks incurred by the general partner as general partner of the partnership; Each customer agreement sets forth a standard of liability for the commodity broker and provides for indemnities of the commodity broker. See "Fiduciary Responsibility and Liability" beginning on page 17. LITIGATION At any given time, the commodity brokers are involved in numerous legal actions, some of which seek significant damages. On January 11, 1999 the SEC brought an action against 28 NASDAQ market makers, including Morgan Stanley & Co., and 51 individuals, including one current and one former trader employed by Morgan Stanley & Co., for certain conduct during 1994. The core of the charges against Morgan Stanley & Co. concerns improper or undisclosed coordination of price quotes with other broker-dealers and related reporting, recordkeeping, and supervisory deficiencies in violation of Sections 15(b)(4)(E), 15(c)(1) and (2) and 17(a) of the Securities Exchange Act and Rules 15c1-2, 15c2-7 and 17a-3 promulgated thereunder. Without admitting or denying the charges, Morgan Stanley & Co., consented to the entry of a cease and desist order and to the payment of a civil penalty of $350,000, disgorgement of $4,170, and to submit certain of its procedures to an independent consultant for review. In addition, one current and one former trader employed by Morgan Stanley & Co. accepted suspensions of less than two months each and were fined $25,000 and $30,000, respectively. On April 6, 2000, Morgan Stanley & Co., along with 16 other firms, entered into an industry-wide settlement with the SEC, IRS and the Department of Justice (intervening on behalf of a qui tam plaintiff) to resolve litigation and investigations relating to "yield burning" allegations. At the core of the "yield burning" litigation and investigations were allegations that, from 1990 to 1994, escrow providers excessively marked up securities sold to escrow accounts in connection with advance refunding transactions on behalf of municipal bond issuers. The practice was alleged to benefit the escrow provider Capsule II Performance of Spectrum Technical Type of pool: publicly-offered fund Inception of trading: November 1994 Aggregate subscriptions: $589,811,774 Current capitalization: $538,184,278 Current net asset value per unit: $22.64 Worst monthly % drawdown past five years: (15.59)% (November 2001) Worst monthly % drawdown since inception: (15.59)% (November 2001) Worst month-end peak-to-valley drawdown past five years: (26.57)% (13 months, April 2001-April 2002) Worst month-end peak-to-valley drawdown since inception: (26.57)% (13 months, April 2001-April 2002) Cumulative return since inception: 126.40% Monthly Performance to the detriment of either the United States Treasury or the municipal issuer. The industry-wide settlement required 17 firms to pay a total of over $139 million (over $120 million to the United States Treasury and over $18 million directly to municipal issuers). Without admitting or denying any wrongdoing, Morgan Stanley & Co. consented to the entry of an order directing that it cease and desist from violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and requiring it to pay $2.45 million to the United States Treasury. No payment to municipal issuers was required. On July 14, 2003, the Massachusetts Securities Division filed an administrative complaint alleging that Morgan Stanley DW Inc. filed false information in response to an inquiry from the Massachusetts Securities Division pertaining to mutual fund sales practices. On August 11, 2003, the Massachusetts Securities Division filed an administrative complaint, alleging that Morgan Stanley DW Inc. failed to make disclosures of incentive compensation for proprietary and partnered mutual fund transactions. On November 25, 2003, the Massachusetts Securities Division filed an administrative complaint, alleging that a former branch manager engaged in securities fraud and dishonest conduct in promoting the sales of proprietary mutual funds. Morgan Stanley DW Inc. answered the first two complaints on August 4 and September 16, 2003, respectively. Hearings on all of these matters are scheduled to commence on May 17, 2004. On September 15, 2003, Morgan Stanley DW Inc. and one of its officers entered into a settlement with the NASD pursuant to a Letter of Acceptance, Waiver and Consent. The Letter of Acceptance, Waiver and Consent alleges violations of applicable NASD rules in connection with various sales contests conducted from October 1999 to December 2002. Under the terms of the settlement, Morgan Stanley DW Inc. and its officer neither admitted nor denied the allegations of the Letter of Acceptance, Waiver and Consent and accepted a censure and the imposition of monetary fines in the amounts of $2 million and $250,000, respectively. On November 17, 2003, Morgan Stanley DW Inc. consented, without admitting or denying the findings, to the entry of an order by the Securities and Exchange Commission that resolved the Securities and Exchange Commission's investigations into certain practices relating to Morgan Stanley DW Inc.'s offer and sale of shares of certain registered investment companies from January 1, 2000 to the date of the order. Pursuant to the order, Morgan Stanley DW Inc. will: (a) distribute for the benefit of certain customers who purchased shares of mutual funds through Morgan Stanley DW Inc. pursuant to the marketing arrangements between Morgan Stanley DW Inc. and certain mutual fund complexes the amount of $50 million; (b) place on its website disclosures relating to certain marketing programs pursuant to which it offered and sold certain mutual funds; (c) prepare a Mutual Fund Bill of Rights that discloses, among other things, the differences in fees and expenses associated with the purchase of different classes or proprietary mutual fund shares; (d) prepare a plan by which certain customers' proprietary Class B shares can be converted to Class A shares; (e) retain an independent consultant to review, among other things, the adequacy of Morgan Stanley DW Inc.'s disclosures with respect to such marketing programs and other matters in connection with Morgan Stanley DW Inc.'s offer and sale of shares of mutual funds and compliance with the order; and (f) adopt the recommendations of the independent consultant. The number of purchase transactions of Class B shares that will be eligible to convert shares is approximately 8,000. The ultimate financial impact on Morgan Stanley DW Inc. of these conversions will depend on many variables, including the number of eligible purchasers who elect to convert to Class A shares (which carry different fees) and the terms of the conversion (which must be acceptable to the independent consultant). During the five years preceding the date of this prospectus, other than as described above, there have been no material criminal, civil, or administrative actions pending, on appeal, or concluded against the commodity brokers, the general partner, or any of their principals, which the general partner believes would be material to an investor's decision to invest in the partnerships. THE LIMITED PARTNERSHIP AGREEMENTS This section of the prospectus summarizes all material provisions of the limited partnership agreement of each partnership that are not discussed elsewhere in the prospectus. A form of the limited partnership agreements is annexed to the prospectus as Exhibit A. Each limited partnership agreement is identical, except as noted otherwise below or in Exhibit A. Month Nature of the Partnerships Spectrum Select was formed on March 21, 1991; Spectrum Technical, Spectrum Strategic, and Spectrum Global Balanced were each formed on April 29, 1994; and Spectrum Currency was formed on October 20, 1999. Each partnership was formed under Delaware law. The fiscal year of each partnership begins on January 1 of each year and ends on the following December 31. The units that you purchase and pay for in this offering will be fully paid and nonassessable. You may be liable to a partnership for liabilities that arose before the date of a redemption or Spectrum Series exchange. Your liability, however, will not exceed the sum of your unredeemed capital contribution, undistributed profits, if any, any distributions and amounts received upon a redemption or deemed received on a Spectrum Series exchange, together with interest on any such amount. However, a partnership will not make a claim against you for any amounts received in connection with a redemption of units or a Spectrum Series exchange unless the net assets of the partnership are insufficient to discharge the liabilities of the partnership that arose before any distributions were made to you. The general partner will be liable for all obligations of a partnership to the extent that the assets of the partnership are insufficient to pay those obligations. Management of Partnership Affairs You will not participate in the management or operations of a partnership. Under each limited partnership agreement, the general partner is solely responsible for managing the partnership. The general partner may use a partnership's funds only to operate the business of that partnership. The general partner may hire an affiliate to perform services for the partnership if the general partner determines that the affiliate is qualified to perform the services, and can perform those services under competitive terms that are fair and reasonable. Any agreement with an affiliate must be for a term not in excess of one year and be terminable by the partnership without penalty upon 60 days' prior written notice. Other responsibilities of the general partner include: determining whether a partnership will make a distribution; administering redemptions and series exchanges; preparing monthly and annual reports; preparing and filing tax returns for each partnership; signing documents on behalf of each partnership and its limited partners pursuant to powers of attorney; and supervising the liquidation of a partnership, if necessary. Sharing of Profits and Losses You will have a capital account in each partnership in which you invest, with an initial balance equal to the amount you paid for units of the partnership. The general partner also has a capital account. Each partnership's net assets will be calculated monthly, and your capital account will be adjusted as necessary to reflect any increases or decreases that may have occurred since the preceding month. Profits and losses will be shared by the general partner and limited partners in proportion to the size of their respective capital accounts. For a description of the federal tax allocations, see "Material Federal Income Tax Considerations Partnership Taxation Allocation of Partnership Profits and Losses" on page 129. Restrictions on Transfers or Assignments While you may transfer or assign your units, the transferee or assignee may not become a limited partner without the written consent of the general partner. You may only withdraw capital or profits from a partnership by redeeming units. The general partner may withdraw any portion of its interest in a partnership that exceeds the amount required under the limited partnership agreement without prior notice to or consent of the limited partners. In addition, the general partner may withdraw or assign its entire interest in a partnership if it gives 120 days' prior written notice to the limited partners. If a majority of the limited partners elect a new general partner or partners to continue the business of the partnership, the withdrawing general partner must pay all reasonable expenses incurred by the partnership in connection with its withdrawal. Any transfer or assignment of units by you will take effect at the end of the month in which the transfer or assignment is made, subject to the following conditions. A partnership is not required to recognize a transfer or assignment until it has received at least 30 days' prior written notice from the limited partner. The notice must be signed by the limited partner and include the address and social security or taxpayer identification number of the transferee or assignee and the number of units transferred or assigned. A transfer or assignment of less than all units held by you cannot occur if as a result either party to the transfer or assignment would own fewer than the minimum number of units required for an investment in the partnership (subject to certain exceptions relating to gifts, death, divorce, or transfers to family members or affiliates). The general partner will not permit a transfer or assignment of units unless it is satisfied that the transfer or assignment would not be in violation of Delaware law or applicable federal, state, or foreign securities laws; and notwithstanding the transfer or assignment, the partnership will continue to be classified as a partnership rather than as an association taxable as a corporation under the Internal Revenue Code of 1986, as amended. No transfer or assignment of units will be effective or recognized by a partnership if the transfer or assignment would result in the termination of that partnership for federal income tax purposes, and any attempt to transfer or assign units in violation of the limited partnership agreement will be ineffective. The limited partner must pay all costs, including any attorneys' and accountants' fees, related to a transfer or assignment. Amendments; Meetings Each limited partnership agreement may be amended by the general partner and by limited partners owning more than 50% of the units of that partnership. In addition, the general partner may make certain amendments to a limited partnership agreement without the consent of the limited partners, including any amendment that is not adverse to the limited partners or is required by the staff of the SEC, the CFTC, any other federal agency, any state "Blue Sky" official, or other governmental official, or to comply with applicable law. However, no amendment may be made to a limited partnership agreement without the consent of all partners affected if that amendment would reduce the capital account of any partner, modify the percentage of profits, losses, or distributions to which any partner is entitled, or change or alter the provisions of the limited partnership agreement relating to amendments requiring the consent of all partners. Upon written request to the general partner delivered either in person or by certified mail, you or your authorized attorney or agent may obtain a list of the names and addresses of, and units owned by, all limited partners in your partnership, provided that you pay reasonable duplicating and postage costs. Limited partners owning at least 10% of the units of a partnership may request a meeting to consider any matter upon which limited partners may vote. Upon receipt of such a request, the general partner must call a meeting of that partnership, by written notice sent by certified mail or delivered in person within 15 days of such request. The meeting must be held at least 30 but not more than 60 days after the mailing by the general partner of notice of the meeting. The notice must specify the date, a reasonable place and time, and the purpose of the meeting. At any meeting of the limited partners, the following actions may be taken upon the affirmative vote of limited partners owning more than 50% of the units: amend the limited partnership agreement; dissolve the partnership; remove and replace the general partner; elect a new general partner or general partners if the general partner terminates or liquidates or elects to withdraw from the partnership, or becomes insolvent, bankrupt, or is dissolved; terminate any contract with the general partner or any of its affiliates on 60 days' prior written notice; and approve the sale of all or substantially all of the assets of the partnership. Any of the foregoing actions may also be taken by limited partners without a meeting, without prior notice, and without a vote, by means of written consents signed by limited partners owning the required number of units. Notice of any actions taken by written consent must be given to non-consenting limited partners within seven business days. Books and Records; Reports to Limited Partners The books and records of each partnership are maintained at its principal office for at least five years. You or your authorized attorney or agent will have the right during normal business hours to inspect and copy the books and records of each partnership of which you are a limited partner. Alternatively, you may request that copies of the books and records be sent to you, provided that you pay all reasonable reproduction and distribution costs. The partnership will retain copies of subscription documentation in connection with purchases and exchanges of units for at least six years. Within 30 days after the close of each calendar month, the general partner will provide such financial and other information with respect to each partnership as the CFTC and National Futures Association, from time to time, may require, together with information concerning any material change in the brokerage commissions or fees payable by the partnerships to any commodity broker. You will also receive within 90 days after the close of each fiscal year an annual report containing audited financial statements for the partnerships. Annual reports will provide a detailed statement of any transactions with the general partner or its affiliates and of fees, commissions, and any compensation paid or accrued to the general partner or its affiliates. By March 15 of each year, the partnership will provide you with the tax information necessary for you to prepare your federal income tax return. The net asset value of each partnership's units, which is estimated daily by the general partner, will be promptly supplied to you upon written request. A written notice, including a description of limited partners' redemption and voting rights, will be mailed to the limited partners of a partnership within seven business days if any of the following events occur: the net asset value of a unit decreases by at least 50% from the net asset value of that unit as of the end of the immediately preceding month; the limited partnership agreement is materially amended; there is any change in trading advisors or any material change in a management agreement; there is any change in commodity brokers or any material change in the compensation arrangements with a commodity broker; there is any change in general partners or any material change in the compensation arrangements with a general partner; there is any change in the partnership's fiscal year; there is any material change in the partnership's trading policies as specified in the limited partnership agreement; or the partnership ceases to trade futures, forwards, and options. If you receive a notice as to a 50% decrease in net asset value per unit, that notice will also advise you that a "special redemption date" will take place when limited partners may redeem their units in the same manner as described under "Redemptions" beginning on page 117 for regular redemption dates. Further, following the close of business on the date of the 50% decrease giving rise to that notice, the partnership will liquidate all existing positions as promptly as reasonably practicable, and will suspend all futures, forwards, and options trading through the special redemption date. The general partner will then determine whether to reinstitute futures, forwards, and options trading or to terminate the partnership. In addition, subject to limits imposed under state guidelines incorporated in the limited partnership agreements, no increase in any of the management, incentive, or brokerage fees payable by the partnerships, or any of the caps on fees, may take effect until the first business day following a redemption date. In the event of such an increase: notice of the increase will be mailed to limited partners at least five business days prior to the last date on which a "request for redemption" must be received by the general partner with respect to the applicable redemption date; the notice will describe the redemption and voting rights of limited partners; and units redeemed at the first redemption date following the notice will not be subject to any redemption charges. Each limited partner expressly agrees that in the event of his death, he waives on behalf of himself and his estate the furnishing of any inventory, accounting, or appraisal of the assets of the partnership and any right to an audit or examination of the books of the partnership. PLAN OF DISTRIBUTION General Morgan Stanley DW is offering units pursuant to a selling agreement with the partnerships and the general partner. This offering is being conducted in accordance with the provisions of Rule 2810 of the Conduct Rules of the NASD. With the approval of the general partner, Morgan Stanley DW may appoint additional selling agents to make offers and sales of the units. These additional selling agents may include any securities broker which is a member in good standing of the NASD, as well as any foreign bank, dealer, institution, or person ineligible for membership in the NASD that agrees not to make any offers or sales of units within the U.S. or its territories, possessions, or areas subject to its jurisdiction, or to U.S. citizens or residents. Any such non-NASD member must also agree to comply with applicable provisions of the Conduct Rules of the NASD in making offers and sales of units. Morgan Stanley DW is offering the units on a "best efforts" basis without any agreement by Morgan Stanley DW to purchase units. The general partner may in the future register additional units of any partnership with the SEC. There is no maximum amount of funds which may be contributed to a partnership. The general partner may in the future subdivide or combine outstanding units of any partnership, in its discretion, provided that any subdivision or combination will not affect the net asset value of any limited partner's interest in the partnership. Each partnership has agreed to indemnify its trading advisors in connection with the offer and sale of units with respect to any misleading or untrue statement or alleged misleading or untrue statement of a material fact or material omission or alleged omission unrelated to its trading advisor(s). Each partnership has also agreed to indemnify Morgan Stanley DW, the general partner and any additional sellers in connection with the offer and sale of units. See "Fiduciary Responsibility and Liability" beginning on page . Continuing Offering Units of each partnership are being offered for sale at monthly closings held on the last day of each month. Units will be offered and sold at the net asset value of a unit of the partnership on the date of the monthly closing. Since you must subscribe for units prior to the month end closing date, you will not know the actual per unit purchase price until after the monthly closing has occurred. The sale amount will be delivered to the partnership that sold the unit. Escrow Arrangements During the continuing offering, if your subscription is not immediately rejected by the general partner, your subscription funds will be transferred to, and held in escrow by, JPMorgan Chase Bank, New York, New York. These subscription funds held in escrow will be invested in the escrow agent's interest-bearing money market account, and will earn the interest rate then paid by the bank on that account. If the general partner accepts your subscription, at the applicable month-end closing the escrow agent will pay your subscription funds to the appropriate partnership(s) and pay any interest earned on those funds to Morgan Stanley DW. Morgan Stanley DW in turn will credit your Morgan Stanley DW customer account with the interest. If the general partner rejects a subscription, the escrow agent will promptly pay the rejected subscription funds and any interest earned to Morgan Stanley DW, and Morgan Stanley DW will then credit your Morgan Stanley DW customer account with those amounts, and the funds will be immediately available for investment or withdrawal. If you closed your Morgan Stanley DW customer account, any subscription returned and interest earned will be paid by check. Interest will be earned on subscription funds from the day of deposit with the escrow agent to the day that funds are either paid to the appropriate partnership(s) in the case of accepted subscriptions or paid to Morgan Stanley DW in the case of rejected subscriptions. At all times during the continuing offering, and prior to each closing, subscription funds will be in the possession of the escrow agent, and at no time will the general partner hold or take possession of the funds. Compensation to Morgan Stanley DW Employees and Additional Selling Agents Except as described below, qualified employees of Morgan Stanley DW will receive from Morgan Stanley DW (payable solely from its own funds) a gross sales credit equal to 3% of the net asset value per unit as of the closing for each unit sold by them and issued at the closing. In addition, Morgan Stanley DW will continue to compensate such employees who continue to render services to limited partners with a gross sales credit of up to 86% of the brokerage fees received by Morgan Stanley DW from a partnership each month that are attributable to outstanding units sold by them. This compensation will begin: in the case of Spectrum Select, Spectrum Technical, and Spectrum Strategic, with the seventh month following the closing at which a unit was issued; in the case of Spectrum Global Balanced and Spectrum Currency, with the tenth month following the closing at which a unit was issued; the first month after a unit is issued pursuant to a non-series exchange; or the month as of which such continuous compensation is first payable with respect to units purchased in a Spectrum Series exchange, but with the seventh or tenth month measured from the date the subscriber first became a limited partner in a Spectrum Series partnership. In all cases, qualified Morgan Stanley DW employees will receive continuing compensation until the applicable partnership terminates or the unit is redeemed, whichever comes first. No part of this compensation will be paid by the partnership and, accordingly, net assets will not be reduced as a result of such compensation. Each person receiving continuing compensation must be a Morgan Stanley DW employee at the time of receipt of payment and must be registered as an associated person with the CFTC and be a member of the National Futures Association in such capacity only after either having passed the Series 3 or Series 31 examination or having been "grandfathered" as an associated person qualified to do commodity brokerage under the Commodity Exchange Act and the CFTC's regulations. These employees must also perform additional services, including: (a)inquiring of the general partner from time to time, at the request of limited partners, as to the net asset value of each partnership's units; (b)inquiring of the general partner, at the request of limited partners, regarding the futures, forwards, and options markets and the activities of the partnerships; (c)responding to questions of limited partners with respect to the monthly account statements, annual reports, financial statements, and annual tax information furnished periodically to limited partners; (d)providing advice to limited partners as to when and whether to make additional investments or to redeem or exchange units; (e)assisting limited partners in the redemption or exchange of units; and (f)providing such other services as limited partners from time to time may reasonably request. The additional compensation paid by Morgan Stanley DW may be deemed to be underwriting compensation. In addition, certain officers and directors of the general partner may receive compensation as employees of Morgan Stanley DW based, in part, on the amount of brokerage fees paid by the partnerships to Morgan Stanley DW. The selling agreement among Morgan Stanley DW, the general partner, and the partnerships provides that this compensation may only be paid by Morgan Stanley DW as long as continuing services are provided. Any limited partner may telephone, write, or visit a financial advisor at a Morgan Stanley branch office to avail himself of such services. Morgan Stanley DW will not pay its employees the 3% initial gross sales credit described above with respect to units purchased pursuant to a Spectrum Series exchange or non-Spectrum Series exchange. Such employees will, however, receive continuing gross sales credits with respect to brokerage fees received by Morgan Stanley DW from a partnership at the applicable rate. In the case of an investor who previously redeemed units in a Spectrum Series or non-Spectrum Series partnership and paid a redemption charge or held those units for at least 24 months, and invests in the Spectrum Series within 12 months of the redemption of the old units, the Morgan Stanley DW employee will not receive the initial gross sales credit of 3% but will receive a monthly gross sales credit of up to 86% of the brokerage fees received by Morgan Stanley DW from the partnership each month that are attributable to such units commencing the first month after the units are issued. Morgan Stanley DW may at any time implement cash sales incentive and/or promotional programs for its employees who sell units. These programs will provide for Morgan Stanley DW, and not any partnership or the general partner, to pay Morgan Stanley DW's employees bonus compensation based on sales of units. Any sales or promotional program will be approved by the NASD prior to its start. The aggregate of all compensation paid to employees of Morgan Stanley DW from the initial 3% gross sales credit, the redemption charges received by Morgan Stanley DW, and any sales incentives will not exceed 10% of the proceeds of the sale of units. Morgan Stanley DW may compensate any qualified additional selling agents for each unit sold by it by paying a selling commission, from Morgan Stanley DW's own funds, as determined by Morgan Stanley DW and the additional selling agents, but not to exceed 3% of the net asset value of the unit sold. Additional selling agents who are properly registered as futures commission merchants or introducing brokers with the CFTC and are members of the National Futures Association in such capacity may also receive from Morgan Stanley DW, payable from Morgan Stanley DW's own funds, continuing compensation for providing to limited partners the continuing services described above. This additional compensation paid by Morgan Stanley DW may be up to 42% of the brokerage fees generated by outstanding units sold by additional selling agents and received by Morgan Stanley DW as commodity broker for each partnership (except for employees of affiliates of Morgan Stanley DW, who will be compensated at the same rate as employees of Morgan Stanley DW). Additional selling agents may pay all or a portion of such additional compensation to their employees who have sold units and provide continuing services to limited partners if those employees are properly registered with the CFTC and are members of the National Futures Association. Additional compensation paid by Morgan Stanley DW may be deemed to be underwriting compensation. SUBSCRIPTION PROCEDURE The minimum subscription for most subscribers is $5,000, except that the minimum subscription is: $2,000 in the case of an IRA; or for eligible subscribers purchasing units pursuant to a non-Spectrum Series exchange, the lesser of $5,000, the proceeds from the redemption of 5 units, or 2 units in the case of an IRA, from commodity pools other than any of the Morgan Stanley Charter Series of partnerships, the proceeds from the redemption of 500 units, or 200 units in the case of an IRA, from any Charter Series partnership, or the proceeds from the redemption of such subscriber's entire interest in any other commodity pool for which the general partner serves as general partner and commodity pool operator. A subscription may be for units of one partnership, or may be divided among two or more partnerships, provided that: in the case of a new subscription, the minimum subscription for any one partnership is $1,000; and in the case of a non-Spectrum Series exchange, the minimum subscription for any one partnership is the proceeds of the redemption of 1 unit of the other commodity pool, or 100 units in the case of any Morgan Stanley Charter Series partnership. If you already own units in a partnership and you wish to make an additional investment in the same partnership, you may subscribe for units at a monthly closing with a minimum investment in that partnership of $500. In order to make your first purchase of units of a partnership, other than by means of an exchange, you must complete, sign, and deliver to Morgan Stanley DW a subscription agreement which will authorize the general partner and Morgan Stanley DW to transfer the full subscription amount from your Morgan Stanley DW customer account to the partnership's Escrow Account. If your subscription agreement is received by Morgan Stanley DW and not immediately rejected, you must have the appropriate amount in your Morgan Stanley DW customer account on the first business day following the date that your subscription agreement is received by Morgan Stanley DW. Morgan Stanley DW will deduct the subscription amount from your customer account and transfer funds into escrow with the escrow agent on that date. If you do not have a Morgan Stanley DW customer account or an account with an affiliate of Morgan Stanley DW, or do not have sufficient funds in your existing Morgan Stanley DW customer account, you should make appropriate arrangements with your Morgan Stanley financial advisor, or contact your local Morgan Stanley branch office. Do not mail any payment to the general partner, as it will be returned to you for proper placement with the Morgan Stanley branch office where your account is maintained. In the case of a Spectrum Series exchange or a non-Spectrum Series exchange, you must complete, sign, and deliver to your Morgan Stanley financial advisor a subscription agreement, which will authorize the general partner to redeem all or a portion of your interest in a partnership or another commodity pool for which the general partner serves as general partner and commodity pool operator, subject to terms of the applicable limited partnership agreement, and to use the proceeds, after deducting any applicable redemption charges, to purchase units in one or more of the partnerships. In accordance with an NASD rule, Morgan Stanley DW will not subscribe for units on your behalf if it has discretionary authority over your customer account, unless it gets prior written approval from you. If you subscribe by check, units will be issued subject to the collection of the funds represented by the check. If your check is returned unpaid, Morgan Stanley DW will notify the general partner, and the relevant partnership will cancel the units issued to you represented by the check. Any losses or profits sustained by the partnership allocable to the cancelled units will be allocated among the remaining partners. In the limited partnership agreements, each limited partner agrees to reimburse a partnership for any expense or loss (including any trading loss) incurred in connection with the issuance and cancellation of any units issued to the limited partner. Subscriptions for units are generally irrevocable by subscribers. However, you may revoke your subscription agreement and receive a full refund of the subscription amount and any accrued interest, or revoke the redemption of units in the other commodity pool in the case of an exchange, within five business days after execution of the subscription agreement or no later than 3:00 P.M., New York City time, on the date of the applicable monthly closing, whichever comes first, by delivering written notice to your Morgan Stanley financial advisor. There may be other rescission rights under applicable federal and state securities laws. The general partner may reject any subscription, in whole or in part, in its sole discretion. A sample form of the subscription agreement is annexed to this prospectus as Exhibit B. A separate copy of the subscription agreement accompanies this prospectus or you may obtain one, after delivery of this prospectus, from a local Morgan Stanley branch office. You will not receive any certificate evidencing units, but you will be sent confirmations of purchases in Morgan Stanley DW's customary form. Once you are an investor in a partnership, you may make additional cash purchases of units of that partnership without executing a new subscription agreement, by completing a subscription agreement update form, a sample of which is annexed to this prospectus as Exhibit C, and by contacting your Morgan Stanley financial advisor and authorizing your financial advisor to deduct the additional amount you want to invest from your Morgan Stanley DW customer account. Those amounts will be held in escrow, and applied towards the purchase of units, in the same manner as initial purchases described above. However, if a new prospectus has been issued since the date of your immediately prior subscription agreement, you will be required to complete a new subscription agreement update form. Further, your Morgan Stanley financial advisor will be required to confirm to the general partner that the information you provided, and the representations and warranties you made, in your original subscription agreement, including, in particular, that you satisfy applicable minimum financial suitability requirements, are still true and correct. You may not use the subscription procedure described in this paragraph to purchase additional units in a partnership by way of an exchange, or to purchase units of a partnership in which you are not currently an investor; in either of those cases, you must execute a new subscription agreement. PURCHASES BY EMPLOYEE BENEFIT PLANS ERISA CONSIDERATIONS Units might or might not be a suitable investment for an employee benefit plan. If you are a person with investment discretion on behalf of an employee benefit plan, before proceeding with a purchase of units, you should determine whether the purchase of units is permitted under the governing instruments of the plan, and is appropriate for that particular plan in view of its overall investment policy, the composition and diversification of its portfolio, and the other considerations discussed below. As used in this section, the term "employee benefit plans" refers to plans and accounts of various types, including their related trusts, which provide for the accumulation of a portion of an individual's earnings or compensation, as well as investment income earned thereon, typically free from federal income tax until such time as funds are distributed from the plan. These plans include corporate pension and profit-sharing plans, such as so-called "401( k)" plans, "simplified employee pension plans," so-called "Keogh" plans for self-employed individuals (including partners), and, for purposes of this discussion, individual retirement accounts, as described in Section 408 of the Internal Revenue Code of 1986, as amended. Notwithstanding the general requirement that investors in one or more partnerships must invest a minimum of $5,000, a minimum purchase requirement of $2,000 has been set for IRAs. The minimum subscription for any one of the partnerships must be at least $1,000. Greater minimum purchases may be mandated by the securities laws and regulations of certain states, and each investor should consult the subscription agreement to determine the applicable investment requirements. If the assets of an investing employee benefit plan were to be treated, for purposes of the reporting and disclosure provisions and certain other of the fiduciary responsibility provisions of Title I of the Employee Retirement Income Security Act of 1974, as amended, and Section 4975 of the Internal Revenue Code of 1986, as including an undivided interest in each of the underlying assets of a partnership, an investment in units would in general be an inappropriate investment for the plan. A U.S. Department of Labor regulation defines "plan assets" in situations where employee benefit plans purchase equity securities in investment entities such as a partnership. The regulation provides that the assets of an entity will not be deemed to be "plan assets" of an employee benefit plan which purchases an equity security of the entity if the equity security is a "publicly-offered security." A "publicly-offered security" is one which is: freely transferable; held by more than 100 investors independent of the issuer and of each other; and either registered under Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934, or sold to the plan as part of a public offering of such securities pursuant to an effective registration statement under the Securities Act of 1933, where the security is then timely registered under Section 12(b) or Section 12(g) of the Securities Exchange Act of 1934. The units currently meet, and it is expected that the units will continue to meet, the criteria of the Regulation. The general partner believes, based upon the advice of its legal counsel, that income earned by the partnerships will not constitute "unrelated business taxable income" under Section 512 of the Internal Revenue Code of 1986 to employee benefit plans and other tax-exempt entities. Although the Internal Revenue Service has issued favorable private letter rulings to taxpayers in somewhat similar circumstances, other taxpayers may not use or cite such rulings as precedent. If you have investment discretion on behalf of an employee benefit plan, you should consult a professional tax adviser regarding the application of the foregoing matters to the purchase of units. Units may not be purchased with the assets of an employee benefit plan if the general partner, Morgan Stanley DW, any additional selling agents, any trading advisor, or any of their respective affiliates either: has investment discretion with respect to the investment of such plan assets; has authority or responsibility to give or regularly gives investment advice with respect to such plan assets for a fee and pursuant to an agreement or understanding that such advice will serve as a primary basis for investment decisions with respect to the plan assets and that such advice will be based on the particular investment needs of the plan; or is an employer maintaining or contributing to such plan. Subscribing for units does not create an IRA or other employee benefit plan. If you are considering the purchase of units on behalf of an IRA or other employee benefit plan, you must first ensure that the plan has been properly established in accordance with the Internal Revenue Code of 1986 and ERISA and the regulations and administrative rulings thereunder, and that the plan has been adequately funded. Then, after all of the considerations discussed above have been taken into account, the trustee or custodian of a plan who decides to or who is instructed to do so may subscribe for units in one or more of the partnerships, subject to the applicable minimum subscription requirement per partnership. Acceptance of subscriptions on behalf of IRAs or other employee benefit plans is in no respect a representation by the general partner, Morgan Stanley DW, any additional selling agents, any partnership, or any trading advisor that the investment meets all relevant legal requirements with respect to investments by plans generally or any particular plan, or that the investment is appropriate for plans generally or any particular plan. MATERIAL FEDERAL INCOME TAX CONSIDERATIONS Introduction The general partner has been advised by counsel, Cadwalader, Wickersham & Taft LLP, that in its opinion, the following summary correctly describes the material federal income tax consequences to a U.S. taxpayer who invests in a partnership. The opinions appearing in this section are the opinions of Cadwalader, Wickersham & Taft LLP, except as otherwise specifically noted. The following summary is based upon the Internal Revenue Code of 1986, rulings thereon, regulations promulgated thereunder, and existing interpretations thereof, any of which could be changed at any time and which changes could be retroactive. The federal income tax summary and the state and local income tax summary that follow, in general, relate only to the tax implications of an investment in the partnerships by individuals who are citizens or residents of the U.S. Except as indicated below or under "Purchases by Employee Benefit Plans-ERISA Considerations," the summaries do not address the tax implications of an investment in the partnerships by corporations, partnerships, trusts, and other non-individuals. Moreover, the summaries are not intended as a substitute for careful tax planning, particularly since certain of the tax consequences of owning an interest in the partnerships may not be the same for all taxpayers, such as non-individuals or foreign persons, or in light of an investor's personal investment circumstances. A complete discussion of all federal, state, and local tax aspects of an investment in each partnership is beyond the scope of the following summary, and prospective investors are urged to consult their own tax advisors on these matters. Partnership Status The general partner has been advised by its legal counsel, Cadwalader, Wickersham & Taft LLP, that in its opinion under current federal income tax law, each partnership will be classified as a partnership and not as an association (or a publicly traded partnership) taxable as a corporation. This opinion is based upon the facts set forth in this prospectus, including that a principal activity of each partnership consists of buying and selling futures, options, and forward contracts, and at least 90% of the partnership's gross income during each year consists of gains from such trading and interest income. No ruling has been requested from the Internal Revenue Service with respect to classification of each partnership and the general partner does not intend to request such a ruling. If a partnership were treated as an association (or a publicly traded partnership) taxable as a corporation, income or loss of the partnership would not be passed through to its partners, and the partnership would be subject to tax on its income at the rates applicable to corporations without deduction for any distributions to its partners. In addition, all or a portion of any distributions by the partnership to its partners could be taxable to the partners as dividends or capital gains. The discussion that follows assumes that each partnership will be treated as a partnership for federal income tax purposes. Partnership Taxation Partners, rather than a Partnership, are Subject to Federal Income Tax. None of the partnerships will pay federal income tax. Except as provided below with respect to certain nonresident aliens, each limited partner will report his distributive share of all items of partnership income, gain, loss, deduction, and credit for the partnership's taxable year ending within or with the partner's taxable year. A limited partner must report and pay tax on his share of partnership income for a particular year whether or not he has received any distributions from the partnership in that year. The characterization of an item of profit or loss will usually be determined at the partnership level. Syndication Expenses. None of the partnerships nor any partner thereof will be entitled to any deduction for syndication expenses (i.e., those amounts paid or incurred in connection with issuing and marketing units). There is a risk that some of the brokerage fees paid to Morgan Stanley DW could be treated as a nondeductible payment by the partnerships of syndication expenses. Allocation of Partnership Profits and Losses. In general, each limited partnership agreement allocates items of ordinary income and expense pro rata among the partners based upon their respective capital accounts as of the end of the month in which such items are accrued. Net recognized capital gain or loss is generally allocated among all partners based upon their respective capital accounts. However, net recognized capital gain or loss is allocated first to partners who have redeemed units in the partnership during a taxable year to the extent of the difference between the amount received on the redemption and the allocation account as of the date of redemption attributable to the redeemed units. Any remaining net recognized capital gain or loss is next allocated among all those partners whose capital accounts differ from their allocation accounts based on the respective differences for each partner. The special allocation of each partnership's net gain or loss upon a redemption of units, which retains the same character as in the hands of the partnership, may alter the character of a redeeming limited partner's income (by reducing the amount of long-term capital gain recognized upon receipt of redemption proceeds) and may accelerate the recognition of income by the limited partner. These allocation provisions are designed to reconcile tax allocations to economic allocations. However, the general partner cannot assure you that the Internal Revenue Service will not challenge the allocations, including each partnership's tax allocations in respect of redeemed units. If the allocation provided by each limited partnership agreement is not respected by the Internal Revenue Service for federal income tax purposes, the amount of income or loss allocated to the partners for federal income tax purposes may be increased or reduced or the character of the income or loss may be modified. Cash Distributions and Redemptions Because of the special allocation of partnership gain or loss upon a redemption of units, the amounts received upon the partial or complete redemption of a limited partner's units normally will not result in additional taxable income or loss to the limited partner. However, distributions by a partnership and amounts received upon the partial or complete redemption of a limited partner's units will be taxable to the limited partners to the extent cash distributions by a partnership or amounts received upon redemption by a limited partner exceed the partner's adjusted tax basis in his units. Such excess will be taxable to him as though it were a gain from a sale of the units. A loss will be recognized upon a redemption of units only if, following the redemption of all of a limited partner's units, the partner has any tax basis in his units remaining. In such case, the limited partner will recognize loss to the extent of the remaining basis. See "Redemptions." Generally, if a limited partner is not a "dealer" with respect to his interest in the partnership and he has held his interest in the partnership for more than one year, the gain or loss would be long-term capital gain or loss. Gain or Loss on Trading Activity Nature of Partnership Income. Each partnership does not expect to hold its futures, forwards, or options for sale to customers. For federal income tax purposes substantially all of the profit and loss generated by each partnership from its trading activities is expected to be capital gain and loss, which in turn may be either short-term, long-term, or a combination thereof. Nevertheless, certain foreign currency transactions could result in ordinary gain or loss, as discussed below. Further, interest paid to a partnership will be taxable currently to the limited partners as ordinary income. Thus, during taxable years in which little or no profit is generated from trading activities, a limited partner may still have interest income. Mark-to-Market. Section 1256 contracts held at the end of a partnership's taxable year will be treated as having been sold for the fair market value on the last day of the taxable year, and gain or loss will be taken into account for the year. Gain or loss with respect to a Section 1256 contract is generally treated as short-term capital gain or loss to the extent of 40% of the gain or loss, and long-term capital gain or loss to the extent of 60% of the gain or loss. Section 1256 contracts include regulated futures contracts which are futures contracts traded on regulated U.S. and certain foreign exchanges; foreign currency contracts that are traded in the interbank market and relate to currencies for which positions are also traded through regulated futures contracts; and U.S. and certain foreign exchange-traded options on commodities, including options on regulated futures contracts, debt securities, and stock indices. While the partnerships expect that a majority of their trading activities will be conducted in Section 1256 contracts, the partnerships also expect that a portion of their trading activities will be conducted in contracts that do not presently qualify as Section 1256 contracts, such as positions in futures contracts on most foreign exchanges and foreign currency forward contracts that do not relate to currencies for which positions are also traded through regulated futures contracts. Section 988. Currency gain or loss with respect to foreign currency forward contracts that do not relate to currencies for which positions are also traded through regulated futures contracts and futures contracts traded on most foreign exchanges may be treated as ordinary income or loss under Internal Revenue Code of 1986 Section 988. Each partnership has elected to treat these contracts as Section 1256 contracts (i.e., marked-to-market at year end). Pursuant to this election, gain or loss with respect to these contracts is treated as entirely short-term capital gain or loss. Subject to certain limitations, a limited partner, other than a corporation, estate, or trust, may elect to carry back net Section 1256 contract losses to each of the three preceding years. Net Section 1256 contract losses carried back to prior years may only be used to offset net Section 1256 contract gains. Generally, such losses are carried back as 40% short-term capital losses and 60% long-term capital losses. Capital assets not marked to market under Section 1256, such as any non-currency forward contracts, are not subject to the 60/40 tax regime for Section 1256 contracts, and gain or loss on sale generally will be long-term only if such property has been held for more than one year. % % % % % % % % % % January 12.76 (1.88 ) (0.81 ) 1.21 (4.96 ) (1.16 ) 3.67 4.78 (1.84 ) February 6.60 (3.41 ) 1.94 (1.19 ) 2.48 0.41 1.13 (6.39 ) 5.10 March (9.17 ) (2.90 ) 11.38 (1.54 ) (2.48 ) 1.31 (1.82 ) 1.24 10.21 April 1.44 (3.20 ) (11.10 ) (4.02 ) 7.18 (4.62 ) (2.93 ) 4.82 3.60 May 6.38 5.64 (0.37 ) (0.43 ) (5.00 ) 3.28 (3.75 ) (3.84 ) 0.69 June (7.42 ) 15.02 (3.62 ) (2.78 ) 5.13 (1.10 ) 0.69 3.21 (1.12 ) July (3.04 ) 9.65 (3.36 ) (3.96 ) (3.90 ) (0.98 ) 9.33 (4.80 ) (2.44 ) August 3.39 4.40 1.34 3.74 0.95 10.29 (5.97 ) (0.35 ) (0.63 ) September (5.41 ) 6.43 8.19 (8.61 ) (1.51 ) 4.35 1.85 5.50 (3.33 ) October 9.14 (6.75 ) 5.37 2.90 (9.96 ) (0.73 ) 0.36 9.92 (0.09 ) November 1.20 (4.68 ) (15.59 ) 12.28 1.84 (6.17 ) 1.01 8.34 0.93 (0.90 ) December 7.66 5.20 2.47 12.06 3.83 5.98 4.57 (3.88 ) 6.09 (1.31 ) Compound Annual/ Period Rate of Return 22.98 23.31 (7.15 ) 7.85 (7.51 ) 10.18 7.49 18.35 17.59 (2.20 ) (2 months) Capsule III Performance of Spectrum Strategic Type of pool: publicly-offered fund Inception of trading: November 1994 Aggregate subscriptions: $182,893,529 Current capitalization: $121,270,439 Current net asset value per unit: $14.31 Worst monthly % drawdown past five years: (18.47)% (February 2000) Worst monthly % drawdown since inception: (18.47)% (February 2000) Worst month-end peak-to-valley drawdown past five years: (43.28)% (10 months, January 2000-October 2000) Worst month-end peak-to-valley drawdown since inception: (43.28)% (10 months, January 2000-October 2000) Cumulative return since inception: 43.10% Monthly Performance Straddles. If a partnership incurs a loss upon the disposition of any position which is part of a "straddle" (i.e., two or more offsetting positions), recognition of that loss for tax purposes will be deferred until the partnership recognizes the gain in the offsetting position of the straddle (or successor position, or offsetting position to the successor position). Interest and other carrying charges allocable to positions which are part of a straddle must be capitalized, rather than deducted currently. Certain modified "short sale" rules may apply to positions held by a partnership so that what might otherwise be characterized as long-term capital gain would be characterized as short-term capital gain or potential short-term capital loss as long-term capital loss. For purposes of applying the above rules restricting the deductibility of losses with respect to offsetting positions, if a limited partner takes into account gain or loss with respect to a position held by the partnership, the limited partner will be treated as holding the partnership's position, except to the extent otherwise provided in regulations. Accordingly, positions held by a partnership may limit the deductibility of realized losses sustained by a limited partner with respect to positions held for his own account, and positions held by a limited partner for his own account may limit his ability to deduct realized losses sustained by a partnership. Thus, straddles may not be used to defer gain from one taxable year to the next. Reporting requirements generally require taxpayers to disclose all unrecognized gains with respect to positions held at the end of the taxable year. The above principle, whereby a limited partner may be treated as holding partnership positions, may also apply to require a limited partner to capitalize (rather than deduct) interest and carrying charges allocable to property held by him. Where the positions of a straddle are comprised of both Section 1256 and non-Section 1256 contracts, a partnership will be subject to the mixed straddle rules of the Internal Revenue Code of 1986 and the regulations promulgated thereunder. The appropriate tax treatment of any gains and losses from trading in mixed straddles will depend on what elections a partnership makes. Each partnership has elected to place all of its positions in a "mixed straddle" account which is marked-to-market daily. Under a special account cap, not more than 50% of net capital gain may be long-term capital gain, and not more than 40% of net capital loss may be short-term capital loss. Taxation of Limited Partners Limitations on Deductibility of Partnership Losses. The amount of partnership loss, including capital loss, which a limited partner will be entitled to take into account for federal income tax purposes is limited to the tax basis of his units, except in the case of certain limited partners including individuals and closely-held C corporations, for which he is "at risk" with respect to the units as of the end of the partnership's taxable year in which such loss occurred. Generally, a limited partner's initial tax basis will be the amount paid for each unit. A limited partner's adjusted tax basis will be his initial tax basis reduced by the limited partner's share of partnership distributions, losses, and expenses and increased by his share of partnership income and gains. The amount for which a limited partner is "at risk" with respect to his units in a partnership is generally equal to his tax basis for the units, less: any amounts borrowed in connection with his acquisition of the units for which he is not personally liable and for which he has pledged no property other than his units; any amounts borrowed from persons who have a proprietary interest in the partnership; and any amounts borrowed for which the limited partner is protected against loss through guarantees or similar arrangements. Because of the limitations imposed upon the deductibility of capital losses referred to below, a limited partner's share of a partnership's net capital losses, if any, will not materially reduce his federal income tax on his ordinary income. In addition, certain expenses of a partnership might be deductible by a limited partner only as itemized deductions and, therefore, will not reduce the federal taxable income of a limited partner who does not itemize his deductions. Furthermore, an individual who is subject to the alternative minimum tax for a taxable year may not realize any tax benefit from such itemized deductions. Limitations on Deductibility of Passive Losses. The partnerships' income will not be treated as a "passive activity" for purposes of the limitation on the deduction of passive activity losses. Limited Deduction of Certain Expenses. Certain miscellaneous itemized deductions, such as expenses incurred to maintain property held for investment, are deductible only to the extent that they exceed 2% of the adjusted gross income of an individual, trust, or estate. The amount of certain itemized deductions allowable to individuals is further reduced by an amount equal to the lesser of (i) 3% of the Month individual's adjusted gross income in excess of a certain threshold amount and (ii) 80% of such itemized deductions. Moreover, such investment expenses are miscellaneous itemized deductions that are not deductible by a non-corporate taxpayer in calculating its alternative minimum tax liability. Based upon the current and contemplated activities of the partnerships, the general partner has been advised by its legal counsel that, in such counsel's opinion, the expenses incurred by the partnerships in their futures, forwards, and options trading businesses should not be subject to the 2% "floor" or the 3% phaseout, except to the extent that the Internal Revenue Service promulgates regulations that so provide. However, that advice is not binding on a court or the Internal Revenue Service, and the Internal Revenue Service could assert, and a court could agree, that such expenses of the partnerships (including incentive fees) are investment expenses which are subject to these limitations. Tax Liability Will Exceed Distributions. Under federal tax laws, a limited partner must report and pay tax on his share of any partnership income each year, even though the general partner does not intend to make any distributions from the partnerships. Tax on Capital Gains and Losses. In general, for individuals, trusts, and estates, "long-term capital gains" are currently taxed at a maximum marginal tax rate of 20% and "short-term capital gains" and other income are currently taxed at a maximum marginal tax rate of 38.6%. Corporate taxpayers are currently subject to a maximum marginal tax rate of 35% on all capital gains and income. The excess of capital losses over capital gains is deductible by an individual against ordinary income on a one-for-one basis, subject to an annual limitation of $3,000 ($1,500 in the case of married individuals filing a separate return). Excess capital losses may be carried forward. Net losses from Section 1256 contracts are treated as 60% long-term capital loss and 40% short-term capital loss. Such losses may, at the individual taxpayer's election, be carried back to each of the preceding three years and applied against gains from Section 1256 contracts. Alternative Minimum Tax. The alternative minimum tax for individuals is imposed on "alternative minimum taxable income" in excess of certain exemption amounts. Alternative minimum taxable income consists of taxable income determined with certain adjustments and increased by the amount of items of tax preference. Alternative minimum taxable income may not be offset by certain interest deductions, including (in certain circumstances) interest incurred to purchase or carry units in the partnerships. Corporations are also subject to an alternative minimum tax. The extent to which the alternative minimum tax will be imposed will depend on the overall tax situation of each limited partner at the end of such taxable year. Limitation on Deductibility of Interest on Investment Indebtedness. Interest paid or accrued on indebtedness properly allocable to property held for investment is investment interest. Such interest is generally deductible by non-corporate taxpayers only to the extent it does not exceed net investment income. A limited partner's distributive share of net partnership income and any gain from the disposition of units will be treated as investment income, except that a limited partner's net capital gain from the disposition of units is not investment income unless the limited partner waives the benefit of the preferential tax rate on the gain. It is not clear whether a limited partner's distributive share of partnership net capital gain constitutes investment income where such gain is taxed at the maximum rate for capital gains. Interest expense incurred by a limited partner to acquire his units generally will be investment interest. Any investment interest disallowed as a deduction in a taxable year solely by reason of the limitation above is treated as investment interest paid or accrued in the succeeding taxable year. Taxation of Foreign Limited Partners. A nonresident alien individual, foreign corporation, or foreign partnership (a "foreign limited partner") generally should not be deemed to be engaged in a U.S. trade or business solely by virtue of an investment in the partnerships; provided that such foreign limited partner is not a "dealer" in commodities and, in the case of an individual, does not have certain present or former connections with the U.S. (e.g., is not present in the U.S. more than 182 days during his or her taxable year, or, in certain limited circumstances, a prior taxable year) and provided further, that such foreign limited partner is not engaged in a trade or business within the U.S. during the taxable year or, in certain limited circumstances, a prior taxable year to which income, gain, or loss from the partnerships is treated as "effectively connected." Capital gains earned by the partnerships and allocated to such a foreign limited partner will, as a general rule, not be subject to U.S. federal income taxation or withholding, but may be subject to taxation by the jurisdiction in which the foreign limited partner is resident, organized or operating. In the event that a partnership were found to be engaged in a U.S. trade or business, a foreign limited partner would be required to file a U.S. federal income tax return for such year and pay tax at full U.S. rates. In the case of a foreign limited partner which is a foreign corporation, an additional 30% "branch profits" tax might be imposed. Furthermore, in such event the partnerships would be required to withhold taxes from the income or gain allocable to such a foreign limited partner under Section 1446 of the Code. A foreign limited partner is not subject to U.S. tax on certain interest income, including income attributable to (i) original issue discount on Treasury bills that have a maturity of 183 days or less or (ii) commercial bank deposits, provided, in either case, that such foreign limited partner is not engaged in a trade or business within the U.S. during a taxable year. Additionally, a foreign limited partner not engaged in a trade or business within the U.S. is not subject to U.S. tax on interest income (other than certain so-called "contingent interest") attributable to obligations issued after July 18, 1984 that are in registered form if the foreign limited partner timely provides the relevant partnership with an IRS Form W-8BEN. Prospective foreign limited partners who are engaged in a U.S. trade or business or who act as dealers in commodities may be subject to U.S. income tax and should consult their tax advisors before investing in a partnership. The estate of a deceased foreign limited partner may be liable for U.S. estate tax and may be required to obtain an estate tax release from the Internal Revenue Service in order to transfer the units of such foreign limited partner. Foreign persons should consult their own tax advisers before deciding whether to invest in the partnerships. Tax Elections. The Internal Revenue Code of 1986 provides for optional adjustments to the basis of partnership property upon distributions of partnership property to a partner (Section 734) and transfers of units, including transfers by reason of death (Section 743), provided that a partnership election has been made pursuant to Section 754. As a result of the complexities and added expense of the tax accounting required to implement such an election, the general partner does not presently intend to make such an election for any of the partnerships. Therefore, any benefits which might be available to the partners by reason of such an election will be foreclosed. Tax Returns and Information. The partnerships will file their information returns using the accrual method of accounting. Within 75 days after the close of each partnership's taxable year, the partnership will furnish each limited partner, and any assignee of the units of a limited partner, copies of the partnership's Schedule K-1 indicating the limited partner's distributive share of tax items and any additional information as is reasonably necessary to permit the limited partners to prepare their own federal and state tax returns. Partnership's Taxable Year. Each partnership has the calendar year as its taxable year. Unrelated Business Taxable Income of Employee Benefit Plan Limited Partners and Other Tax-Exempt Investors. Income allocated to a limited partner which is an employee benefit plan or other tax-exempt entity should not be subject to tax under Section 511 of the Internal Revenue Code of 1986, provided that the units purchased by such plans and entities are not "debt-financed." However, if a partnership were to purchase physical commodities with borrowed funds (whether upon delivery under a futures or forward contract or otherwise) and to sell those commodities at a gain, the gain would likely constitute unrelated business income. The partnerships are entitled to engage in such leveraged purchases of physical commodities. Tax exempt investors should see "Purchases by Employee Benefit Plans ERISA Considerations" above. Tax Audits All partners are required under the Internal Revenue Code of 1986 to report all the partnership items on their own returns consistently with the treatment by the partnership, unless they file a statement with the Internal Revenue Service disclosing the inconsistencies. Adjustments in tax liability with respect to partnership items will be made at the partnership level. The general partner will represent each partnership All of the foregoing statements are based upon the existing provisions of the Internal Revenue Code of 1986 and the regulations promulgated thereunder and the existing administrative and judicial interpretations thereof. The general partner cannot assure you that legislative, administrative, or judicial changes will not occur which will modify such statements. The foregoing statements are not intended as a substitute for careful tax planning, particularly since certain of the federal income tax consequences of purchasing units may not be the same for all taxpayers. The partnerships' tax returns could be audited by the Internal Revenue Service and adjustments to the returns could be made as a result of such audits. If an audit results in adjustment, limited partners may be required to file amended returns and their returns may be audited. Accordingly, prospective purchasers of units are urged to consult their tax advisers with specific reference to their own tax situation under federal law and the provisions of applicable state, local, and foreign laws before subscribing for units. STATE AND LOCAL INCOME TAX ASPECTS In addition to the federal income tax consequences for individuals described under "Material Federal Income Tax Considerations" above, the partnerships and their limited partners may be subject to various state and local taxes. Certain of these taxes could, if applicable, have a significant effect on the amount of tax payable in respect of an investment in the partnerships. A limited partner's distributive share of the realized profits of a partnership may be required to be included in determining his reportable income for state or local tax purposes. Furthermore, state and local tax laws may not reflect recent changes made to the federal income tax law and, therefore, may be inconsistent with the federal income treatment of gains and losses arising from the partnerships' transactions in Section 1256 contracts. Accordingly, prospective limited partners should consult with their own tax advisers concerning the applicability of state and local taxes to an investment in the partnerships. The general partner has been advised by its legal counsel, Cadwalader, Wickersham & Taft LLP, that in such counsel's opinion, the partnerships should not be liable for New York City unincorporated business tax. Limited partners who are nonresidents of New York State will not be liable for New York State personal income tax on such partners' income from the partnerships, but may be liable for such tax to the extent such limited partners' allocable share of income attributable to the partnerships' transactions involves tangible personal property. Likewise, limited partners who are nonresidents of New York City will not be liable for New York City earnings tax on the partners' income from the partnerships. New York City residents may be subject to New York City personal income tax on the partners' income from the partnerships. No ruling from the New York State Department of Taxation and Finance or the New York City Department of Finance has been, or will be, requested regarding such matters. LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft LLP, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001100124_celebrate_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001100124_celebrate_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..77a7e04914bccd0ad3073b56374791936a663343 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001100124_celebrate_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Heller Ehrman White McAuliffe LLP, Seattle, Washington, and for the underwriters by O Melveny Myers LLP, Newport Beach, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001100722_bi-llc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001100722_bi-llc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001100722_bi-llc_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001100723_omark_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001100723_omark_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001100723_omark_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001100724_4520-corp_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001100724_4520-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001100724_4520-corp_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001100725_gear_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001100725_gear_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001100725_gear_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001100726_dixon_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001100726_dixon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001100726_dixon_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001100727_frederick_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001100727_frederick_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001100727_frederick_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001103390_ardea_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001103390_ardea_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3822ea9053220ad9f835162ee76e9422a3bc8279 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001103390_ardea_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered will be passed upon for us by Morgan, Lewis Bockius LLP, San Francisco, California. Heller Ehrman White McAuliffe LLP, Menlo Park, California, is acting as counsel for the underwriters in connection with selected legal matters relating to the shares of common stock offered by this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001104252_ddi-corp_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001104252_ddi-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..021b65547932299a06064f8d17440ac9bad83398 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001104252_ddi-corp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock described in this prospectus has been passed upon by Paul, Hastings, Janofsky & Walker LLP, Costa Mesa, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001108271_conor_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001108271_conor_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0700162e73643a16f3d862789cb1752e81ffba58 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001108271_conor_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of common stock offered by this prospectus will be passed upon for us by our counsel, Cooley Godward LLP, Palo Alto, California. Dewey Ballantine LLP, New York, New York, is counsel for the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001108320_smtc-corp_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001108320_smtc-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4987dafca78c3070369edb2b82deeefa5e19a44e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001108320_smtc-corp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares to be issued in this offering has been passed upon for us by Ropes & Gray LLP, Boston, Massachusetts. Some partners of Ropes & Gray LLP are members in RGIP LLC, which beneficially owns 27,971 shares of common stock. RGIP LLC is also an investor in certain of the Bain Capital Funds. The Details of Exchangeable Shares Certain Canadian Federal Income Tax Considerations has been passed upon for us by Goodmans LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001108482_shopping_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001108482_shopping_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b2d1686b93af1653eb1e9026d5913d00599687c3 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001108482_shopping_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the ordinary shares being offered by this prospectus and other legal matters concerning this offering relating to Israeli law will be passed upon for us by Meitar Liquornik Geva & Leshem Brandwein, Ramat Gan, Israel. Certain legal matters concerning this offering relating to United States law will be passed upon for us by Fenwick & West LLP, Mountain View, California. On matters of Israeli law, Fenwick & West LLP is relying upon the opinion of Meitar Liquornik Geva & Leshem Brandwein. In connection with this offering, Herzog, Fox & Neeman, Tel Aviv, Israel, has advised the underwriters with respect to certain Israeli law matters and Kirkland & Ellis LLP, New York, New York, has advised the underwriters with respect to certain United States law matters. Partners of Meitar Liquornik Geva & Leshem Brandwein beneficially own in the aggregate 48,185 of our ordinary shares. Herzog, Fox & Neeman provides and has in the past provided legal advice to us concerning various intellectual property matters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001108727_ipcs-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001108727_ipcs-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..fcd6240db0127b7436322e67e6f3434d933bb2ff --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001108727_ipcs-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Mayer, Brown, Rowe & Maw LLP, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001108906_greenfield_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001108906_greenfield_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ea9cb7025d91d0d47bd4a5e8c656509aec850006 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001108906_greenfield_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Preston Gates Ellis LLP, Seattle, Washington, will pass upon the validity of the common stock offered hereby. Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York, will pass upon certain legal matters in connection with this offering for the underwriters. Partners and other attorneys of Preston Gates Ellis LLP, individually and through investment partnerships, hold an aggregate of 10,206 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001111247_rightnow_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001111247_rightnow_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c127459332d48c8daa062543685e856944a7aeab --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001111247_rightnow_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Dorsey & Whitney LLP, Great Falls, Montana, Irvine, California and Minneapolis, Minnesota. Dorsey & Whitney LLP and certain of its partners own 27,778 shares of our common stock. Certain legal matters relating to this offering will be passed upon for the underwriters by Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP, Menlo Park, California. Members of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP participating in the consideration of legal matters related to the common stock offered by us in this offering are the beneficial owners of 11,111 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001112422_motive-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001112422_motive-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5b57d5bc723f57dbd23c82c64cf49a57122e003d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001112422_motive-inc_legal_matters.txt @@ -0,0 +1 @@ +legal matters by their counsel and to certain other conditions. The underwriters are obligated to take and pay for all of the shares of our common stock offered by this prospectus if any such shares are taken. However, the underwriters are not required to take or pay for the shares covered by the underwriters over-allotment option described below. The underwriters initially propose to offer part of the shares of our common stock directly to the public at the public offering price listed on the cover page of this prospectus and part to securities dealers at a price that represents a concession not in excess of $ a share under the public offering price. No underwriter may allow, and no dealer may reallow, any concession to other underwriters or to certain dealers. After the initial offering of the shares of our common stock, the offering price and other selling terms may from time to time be varied by the representatives of the underwriters. We have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of 750,000 additional shares of common stock at the public offering price set forth on the cover page of this prospectus, less underwriting discounts and commissions. The underwriters may exercise this option solely for the purpose of covering over-allotments, if any, made in connection with the offering of the shares of common stock offered by this prospectus. To the extent the option is exercised, each underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of the additional shares of common stock as the number listed next to such underwriter s name in the preceding table bears to the total number of shares of common stock set forth next to the names of all underwriters in the preceding table. If the underwriter s over-allotment option is exercised in full, the total price to the public would be $ , the total underwriters discounts and commissions would be $ and the total proceeds to us would be $ . The underwriters have informed us that they do not intend sales to discretionary accounts to exceed five percent of the total number of shares of common stock offered by them. We, our directors and executive officers and certain other of our stockholders have each agreed that, without the prior written consent of J.P. Morgan Securities Inc. on behalf of the underwriters, during the period ending 180 days after the date of this prospectus, we will not, directly or indirectly: offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of, directly or indirectly, any shares of common stock or any securities convertible into or exercisable or exchangeable for our common stock; or Table of Contents Index to Financial Statements \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001113469_prn-corp_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001113469_prn-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f5c5dc96e84d320566d68f49802162d4bdede77a --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001113469_prn-corp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Selected legal matters with respect to the validity of the common stock offered by this prospectus will be passed upon for us by Pillsbury Winthrop LLP, Palo Alto, California. Selected legal matters relating to the offering will be passed upon for the underwriters by Weil, Gotshal & Manges LLP, Redwood Shores, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001115091_fuzebox_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001115091_fuzebox_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1c75bb3b9543824564687335c7daee8b499ddd5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001115091_fuzebox_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of our securities offered will be passed on for CallWave by Reicker, Pfau, Pyle, McRoy & Herman LLP, 1421 State Street, Suite B, Santa Barbara, California. Certain members of Reicker, Pfau, Pyle, McRoy & Herman hold 90,300 shares of our common stock. Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California is acting as counsel to the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001115143_acusphere_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001115143_acusphere_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9871d375bbcbb0643ae02ee89ff7f70d7a247fd5 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001115143_acusphere_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the shares is being passed upon for us by Testa, Hurwitz & Thibeault, LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001115285_eyetech_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001115285_eyetech_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..20a89d984c648c75048b859347428959575edd47 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001115285_eyetech_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the validity of the shares of common stock offered hereby will be passed upon for us by Morrison Foerster, LLP, New York, New York. Ropes Gray LLP, Boston, Massachusetts has acted as counsel for the underwriters in connection with certain legal matters related to this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001116449_xenogen_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001116449_xenogen_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b3bbe916f9a441a3c55528f8042e072fe989e1b7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001116449_xenogen_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Wilson Sonsini Goodrich & Rosati, Professional Corporation, San Francisco, California. The underwriters are being represented by Morrison & Foerster LLP, San Francisco, California. Certain members of, and investment partnerships comprised of members of, and persons associated with, Wilson Sonsini Goodrich & Rosati own an interest representing less than 1% of the shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001117629_gpc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001117629_gpc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f8f463a5189a202fbcda287ffc3e408b81fac09c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001117629_gpc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares and certain other legal matters will be passed upon by Shearman & Sterling LLP, Frankfurt, Germany and New York, New York, counsel for GPC Biotech AG, and Sullivan & Cromwell LLP, Frankfurt, Germany, counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001122080_pny_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001122080_pny_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b38fe0e572a3e61ace48820ef791dee6cd1e29dc --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001122080_pny_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Gibson, Dunn & Crutcher LLP, New York, New York. Weil, Gotshal & Manges LLP advised the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001123979_senomyx_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001123979_senomyx_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..85d65cee885e516c05ae41d27fb9d813a92f0561 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001123979_senomyx_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Cooley Godward LLP, San Diego, California, will pass upon the validity of the common stock offered by this prospectus for us. As of the date of this prospectus, investment funds affiliated with Cooley Godward LLP beneficially own an aggregate of 12,239 shares of our common stock. Cleary, Gottlieb, Steen & Hamilton, New York, New York, will pass upon legal matters for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001124941_qxo_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001124941_qxo_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..22bc659c21b0d1b531336749ab720a1f9959f0b5 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001124941_qxo_legal_matters.txt @@ -0,0 +1 @@ +Legal matters The validity of the issuance of the shares of common stock offered hereby has been passed upon for us by Schiff Hardin LLP, Chicago, Illinois. Legal matters in connection with this offering will be passed upon for the underwriters by Winston & Strawn LLP, Chicago, Illinois. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001125011_kanbay_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001125011_kanbay_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0b4d61c6aa39ba33375d58e361943860da3ee673 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001125011_kanbay_legal_matters.txt @@ -0,0 +1,17 @@ +Legal matters + +96 + +Experts + +96 + +Where you can find additional information + +96 + +Index to historical consolidated financial statements + +F-1 + + i \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001126119_brightmail_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001126119_brightmail_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7287fe1d8c53c1e670185f59c35ba5bafeecf91e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001126119_brightmail_legal_matters.txt @@ -0,0 +1 @@ +Legal matters The validity of the shares of common stock offered by this prospectus and certain other legal matters are being passed upon for us by our counsel, Wilson Sonsini Goodrich & Rosati, Palo Alto, California. Davis Polk & Wardwell, Menlo Park, California is representing the underwriters of this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001126167_claria_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001126167_claria_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..967867626c0a9e7e7785f11e822d4bf0ca3b0f2e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001126167_claria_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fenwick & West LLP, Mountain View, California, will pass upon the validity of the issuance of the shares of common stock offered by this prospectus for us. Certain legal matters in connection with this offering will be passed upon for the underwriters by Shearman & Sterling LLP, San Francisco, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001131933_tolerrx_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001131933_tolerrx_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c71e1e1b9b52a603f12c036e23e810ec5ba2623e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001131933_tolerrx_legal_matters.txt @@ -0,0 +1 @@ +Legal matters The validity of our common stock offered hereby will be passed upon by Bingham McCutchen LLP, Boston, Massachusetts. Legal matters in connection with this offering will be passed upon for the underwriters by Morgan, Lewis & Bockius LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001133181_salmedix_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001133181_salmedix_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..eb25a28276fb41d70599ca9be72daefbe264dacb --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001133181_salmedix_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Latham & Watkins LLP, San Diego, California and for the underwriters by Cooley Godward LLP, San Diego, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001133324_inphonic_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001133324_inphonic_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..822ca2962980db27ca954e164d7564c5f78af0e2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001133324_inphonic_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Gray Cary Ware & Freidenrich LLP, Washington, DC, will pass upon the validity of the shares of common stock on our behalf. Selected legal matters relating to this offering will be passed upon for the underwriters by Morgan, Lewis & Bockius LLP, Pittsburgh, PA. Gray Cary Ware & Freidenrich LLP announced on October 18, 2004 that it intends to merge with Piper Rudnick LLP, effective as of January 1, 2005. Mount Washington Associates, L.L.C., an investment entity affiliated with Piper Rudnick LLP, a selling stockholder in this offering, beneficially owns an aggregate of 17,774 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001136655_arbinet_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001136655_arbinet_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..19b8b96a21496b4fcd301d6e90da818ccff941b6 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001136655_arbinet_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the validity of the shares of common stock offered hereby will be passed upon for us by Morgan, Lewis & Bockius LLP, Princeton, New Jersey. Shearman & Sterling LLP, Washington, D.C., will pass upon certain legal matters for the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001140486_atheros_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001140486_atheros_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..bbb9790c49d40ec9c765228b7a44343fa62c3f26 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001140486_atheros_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Selected legal matters with respect to the validity of the common stock offered by this prospectus will be passed upon for us by Pillsbury Winthrop LLP, Palo Alto, California. Entities in which attorneys and former attorneys of Pillsbury Winthrop LLP are members and certain partners of Pillsbury Winthrop LLP beneficially own an aggregate of 104,226 shares of Atheros common stock. Selected legal matters relating to the offering will be passed upon for the underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001141438_mellon_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001141438_mellon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..037908e364633cd001acbf59806b4d261c6d0c87 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001141438_mellon_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters relating to the issuance of the notes will be passed upon for the issuer, the transferor and trust I by Carl Krasik, Esq., Associate General Counsel to Mellon Financial Corporation, Reed Smith LLP, Pittsburgh, Pennsylvania and McKee Nelson LLP, New York, New York. The federal income tax matters described under U.S. Federal Income Tax Consequences will be passed upon for the issuer, the transferor and trust I by McKee Nelson LLP, New York, New York. McKee Nelson LLP, New York, New York will act as counsel for the underwriters. Certain ERISA matters will be passed upon for the issuer by McKee Nelson LLP, New York, New York. Mr. Krasik is a shareholder of Mellon Financial Corporation and holds options to purchase additional shares of Mellon Financial Corporation s common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001142512_ziprealty_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001142512_ziprealty_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..280d8109342c3b95568379c5fbe717dca8e645a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001142512_ziprealty_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS We are not currently subject to any material legal proceedings. From time to time we have been, and we currently are, a party to litigation and subject to claims incident to the ordinary course of our business. The amounts in dispute in these matters are not material to us, and we believe that the resolution of these proceedings will not have a material adverse effect on our business or financial results. FACILITIES Our principal executive offices are located in a leased facility in Emeryville, California, consisting of approximately 15,825 square feet of office space, under a five-year lease that expires in 2007. This facility accommodates our principal administrative and finance operations. We occupy a leased facility in each of our operating districts to accommodate offices for our district director and support staff. We generally do not provide office space for our ZipAgent force. We do not own any real property. We believe that our leased facilities are adequate to meet our current needs and that additional facilities will be available for lease to meet our future needs. Table of Contents Risk factors Our business model requires access to real estate listing services provided by third parties that we do not control, and the demand for our services may be reduced if our ability to display listings on our web site is restricted. A key component of our business model is that through our web site we offer clients access to, and the ability to search, real estate listings posted on the MLSs in the markets we serve. Most large metropolitan areas in the United States have at least one MLS, though there is no national MLS. The homes in each MLS are listed voluntarily by its members, who are licensed real estate brokers. The information distributed in an MLS allows brokers to cooperate in the identification of buyers for listed properties. If our access to one or more MLS databases were restricted or terminated, our service could be adversely affected and our business may be harmed. Because participation in an MLS is voluntary, a broker or group of brokers may decline to post their listings to the existing MLS and instead create a new proprietary real estate listing service. If a broker or group of brokers created a separate real estate listing database, we may be unable to obtain access to that private listing service on commercially reasonable terms, if at all. As a result, the percentage of available real estate listings that our clients would be able to search using our web site would be reduced, perhaps significantly, thereby making our services less attractive to potential clients. Additionally, the National Association of Realtors, or NAR, the dominant trade organization in the residential real estate industry, has recently adopted a mandatory policy for NAR-affiliated MLSs regarding the use and display of MLS listings data on virtual office web sites, or VOWs. We operate a VOW, which is a password protected website which allows us to show comprehensive MLS data directly to consumers without their having to visit an agent. Individual MLSs affiliated with NAR, which includes the vast majority of MLSs in the United States, will be required to implement their own individual VOW policies consistent with the NAR policy by July 1, 2005. NAR has extended the deadline for the implementation of its rules at least three times during an investigation by the antitrust division of the U.S. Department of Justice into NAR s policy that dictates how brokers can display other brokers property listings on their web sites. We presently do not know whether or when the NAR rules will be implemented in their current form or in a revised form, if at all. Once these individual MLS VOW policies are implemented, the NAR policy currently provides that member brokerages will have up to six months to comply with the policy. The NAR policy is designed to provide structure to the individual MLS VOW policies, subject to a number of areas in which the individual MLSs may tailor the policy to meet their local needs. One NAR policy provision with which the individual MLSs must adhere, once required to be implemented, is known as an opt-out. This provision creates a mechanism for individual brokers to prevent their listings data from being displayed on certain competitors VOWs. MLS members and participants, including individual brokers, could exercise a blanket opt-out, which would not allow their listings to be displayed on any competing VOW, or a selective opt-out, in which they could selectively prevent certain competing VOWs from displaying their listings, while allowing other VOWs to do so. A few of the MLSs of which we are a member, as well as at least one of the state Association of REALTORS of which we are a member, have adopted VOW policies with opt-out provisions, apparently in anticipation of their required implementation of the NAR policy. To our knowledge, to date no members or participants of any of those MLSs have exercised such an opt-out right. Should any such right be exercised, it could restrict our ability to display comprehensive MLS home listings data to our consumers, which is a key part of our business model. Should our ability to display MLS listings information on our web site be significantly restricted, it may reduce demand for our services and lead to a decrease in the number of residential real estate transactions completed by our ZipAgents, as well as increase our costs of ensuring compliance with such restrictions. Table of Contents Risk factors Total other income (expense), net (30 ) (2,006 ) (2,192 ) (2,230 ) If we fail to recruit, hire and retain qualified agents, we may be unable to service our clients and our growth could be impaired. Our business requires us to hire employees who are licensed real estate agents, and our strategy is based on consistently and rapidly growing our team of ZipAgents. Competition for qualified agents is intense, particularly in the markets in which we compete. While there are many licensed real estate agents in our markets and throughout the country, historically we have had difficulties in recruiting and retaining properly qualified licensed agents due particularly to agent discomfort with using technology and being actively managed by an employer. In addition, our lower per transaction agent commission model may be unattractive to certain higher performing agents. If we are unable to recruit, train and retain a sufficient number of qualified licensed real estate agents, we may be unable to service our clients properly and grow our business. Historically we have experienced a high degree of agent turnover, most of which occurs in the first few months after commencing employment. This turnover has required us to expend a substantial amount of time and money to replace agents who have left as we have been growing our business. If this situation worsens, our rate of expansion into new markets could be slowed and we will continue to employ a significantly higher number of new agents with less experience operating in our business model, which could cause us to be less effective at expanding our market share in our existing markets and entering new markets. Furthermore, we rely on federal and state exemptions from minimum wage and fair labor standards laws for our ZipAgents, who are compensated solely through commissions. Such exemptions may not continue to be available, or we may not qualify for such exemptions, which could subject us to penalties and damages for non-compliance. If similar exemptions are not available in states where we desire to expand our operations or if they cease to be available in the states where we currently operate, we may need to modify our agent compensation structure in such states. Our failure to effectively manage the growth of our ZipAgents and our information and control systems could adversely affect our ability to service our clients. As our operations have expanded, we have experienced rapid growth in our headcount from 233 total employees, including 162 ZipAgents, at December 31, 2001 to 919 total employees, including 782 ZipAgents, at September 30, 2004. We expect to continue to increase headcount in the future, particularly the number of ZipAgents. Our rapid growth has demanded, and will continue to demand, substantial resources and attention from our management. We will need to continue to hire additional qualified agents and improve and maintain our technology to properly manage our growth. If we do not effectively manage our growth, our client service and responsiveness could suffer and our costs could increase, which could negatively affect our brand and operating results. As we grow, our success will depend on our ability to continue to implement and improve our operational, financial and management information and control systems on a timely basis, together with maintaining effective cost controls. This ability will be particularly critical as we implement new systems and controls to help us comply with the more stringent requirements of being a public company, including the requirements of the Sarbanes-Oxley Act of 2002, which require management to evaluate and assess the effectiveness of our internal controls and our disclosure controls and procedures. Effective internal controls are required by law and are necessary for us to provide reliable financial reports and effectively prevent fraud. Effective disclosure controls and procedures will be required by law and are necessary for us to file complete, accurate and timely reports under the Securities Exchange Act of 1934. Any inability to provide reliable financial reports or prevent fraud or to file complete, accurate and timely reports under the Securities Exchange Act could harm our business, harm our reputation or result in a decline in or stock price. We are continuing to evaluate Total other income (expense), net 9 304 (30 ) (2,006 ) (2,192 ) (2,230 ) Table of Contents Risk factors and, where appropriate, enhance our systems, procedures and internal controls. We are in the process of establishing our disclosure controls and procedures. If our systems, procedures or controls are not adequate to support our operations and reliable, accurate and timely financial and other reporting, we may not be able to successfully satisfy regulatory and investor scrutiny, offer our services and implement our business plan. Our operating results are subject to seasonality and vary significantly among quarters during each calendar year, making meaningful comparisons of successive quarters difficult. The residential real estate market traditionally has experienced seasonality, with a peak in the spring and summer seasons and a decrease in activity during the fall and winter seasons. Revenues in each quarter are significantly affected by activity during the prior quarter, given the typical 30- to 45-day time lag between contract execution and closing. Historically, this seasonality has caused our revenues, operating income, net income and cash flow from operating activities to be lower in the first and fourth quarters and higher in the second and third quarters of each year. Factors affecting the timing of real estate transactions that can cause our quarterly results to fluctuate include: timing of widely observed holidays and vacation periods and availability of real estate agents and related service providers during these periods; a desire to relocate prior to the start of the school year; timing of employment compensation changes, such as raises and bonuses; and the time between entry into a purchase contract for real estate and closing of the transaction. We expect our revenues to continue to be subject to these seasonal fluctuations, which, combined with our recent growth, make it difficult to compare successive quarters. Interest rates have been at historic lows for the past several years, and increases in interest rates have the potential to negatively impact the housing market. When interest rates rise, all other things being equal, housing becomes less affordable, since at a given income level people cannot qualify to borrow as much principal, or given a fixed principal amount they will be faced with higher monthly payments. This result may mean that fewer people will be able to afford homes at prevailing prices, potentially leading to fewer transactions or reductions in home prices in certain regions, depending also on the relevant supply-demand dynamics of those markets. Since we operate in only 12 markets around the country, it is possible that we could experience a more pronounced impact than we would experience if our operations were more diversified. Should we experience softening in our markets and not be able to offset the potential negative market influences on price and volume by increasing our transaction volume through market share growth, our financial results could be negatively impacted. If consumers do not continue to use the Internet as a tool in their residential real estate buying or selling process, we may be unable to attract new clients and our growth and financial results may suffer. We rely substantially on our web site and web-based marketing for our client lead generation. As the residential real estate business has traditionally been characterized by personal, face-to-face relationships between buyers and sellers and their agents, our success will depend to a certain extent on the willingness of consumers to increase their use of online services in the real estate sales and purchasing process. In addition, our success will depend on consumers visiting our web site early in Table of Contents Risk factors their selling or buying process so that we can interface with potential clients before they have engaged a real estate agent to represent them in their transactions. If we are unable to convince visitors to our web site to transact business with us, our ZipAgents will have fewer opportunities to represent clients in residential real estate transactions and our net revenues could suffer. Our success depends in part on our ability to successfully expand into additional real estate markets. We currently operate in 12 markets, including 11 of the 25 most populous U.S. metropolitan statistical areas. A part of our business strategy is to grow our business by entering into additional real estate markets. Key elements of this expansion include our ability to identify strategically attractive real estate markets and to successfully establish our brand in those markets. We consider many factors when selecting a new market to enter, including: the economic conditions and demographics of a market; the general prices of real estate in a market; Internet use in a market; competition within a market from local and national brokerage firms; rules and regulations governing a market; the ability and capacity of our organization to manage expansion into additional geographic areas, additional headcount and increased organizational complexity; the existence of local MLSs; and state laws governing cash rebates and other regulatory restrictions. We have not entered a new geographic market since July 2000 and have limited experience expanding into and operating in multiple markets, managing multiple sales regions or addressing the factors described above. In addition, this expansion could involve significant initial start-up costs. We expect that significant revenues from new markets will be achieved, if ever, only after we have been operating in that market for some time and begun to build market awareness of our services. As a result, geographic expansion is likely to significantly increase our expenses and cause fluctuations in our operating results. In addition, if we are unable to successfully penetrate these new markets, we may continue to incur costs without achieving the expected revenues, which would harm our financial condition and results of operations. Unless we develop, maintain and protect a strong brand identity, our business may not grow and our financial results may suffer. We believe a strong brand is a competitive advantage in the residential real estate industry because of the fragmentation of the market and the large number of agents and brokers available to the consumer. Because our brand is relatively new, we currently do not have strong brand identity. In addition, we recently redesigned our logo and marketing slogan, which could result in loss of the brand recognition we currently have and confusion among consumers. We believe that establishing and maintaining brand identity and brand loyalty is critical to attracting new clients. In order to attract and retain clients, and respond to competitive pressures, we expect to increase our marketing and business development expenditures to maintain and enhance our brand in the future. We plan to expand our current online, radio, outdoor and newspaper advertising and conduct future television advertising campaigns. We plan to increase our advertising expenditures substantially in the future. While we intend to enhance our marketing and advertising activities in order to promote our Table of Contents Risk factors brand, these activities may not have a material positive impact on our brand identity. In addition, maintaining our brand will depend on our ability to provide a high-quality consumer experience and high quality service, which we may not do successfully. If we are unable to maintain and enhance our brand, our ability to attract new clients or successfully expand our operations will be harmed. We have numerous competitors, many of which have valuable industry relationships and access to greater resources than we do. The residential real estate market is highly fragmented, and we have numerous competitors, many of which have greater name recognition, longer operating histories, larger client bases, and significantly greater financial, technical and marketing resources than we do. Some of those competitors are large national brokerage firms or franchisors, such as Prudential Financial, Inc., RE/ MAX International Inc. and Cendant Corporation, which owns the Century 21, Coldwell Banker and ERA franchise brands, a large corporate relocation business and NRT Incorporated, the largest brokerage in the United States. NRT owns and operates brokerages that are typically affiliated with one of the franchise brands owned by Cendant. We are also subject to competition from local or regional firms, as well as individual real estate agents. We also compete or may in the future compete with various online services, such as InterActiveCorp and its LendingTree unit, HouseValues, Inc., HomeGain, Inc., Homestore, Inc. and its Realtor.com affiliate and Yahoo! Inc. that also look to attract and monetize home buyers and sellers using the Internet. Homestore is affiliated with NAR, the National Association of Home Builders, or NAHB, a number of major MLSs and Cendant, which may provide Homestore with preferred access to listing information and other competitive advantages. In addition, our technology-focused business model is a relatively new approach to the residential real estate market and many consumers may be hesitant to choose us over more established brokerage firms employing traditional techniques. Some of our competitors are able to undertake more extensive marketing campaigns, make more attractive offers to potential agents and clients and respond more quickly to new or emerging technologies. Over the past several years there has been a slow but steady decline in average commissions charged in the real estate brokerage industry, with the average commission percentage decreasing from 5.44% in 2000 to 5.14% in 2003 according to REAL Trends. Some of our competitors with greater resources may be able to better withstand the short- or long-term financial effects of this trend. In addition, the barriers to entry to providing an Internet-enabled real estate service are low, making it possible for current or new competitors to adopt certain aspects of our business model, including offering comprehensive MLS data to clients via the Internet, thereby reducing our competitive advantage. We may not be able to compete successfully for clients and agents, and increased competition could result in price reductions, reduced margins or loss of market share, any of which would harm our business, operating results and financial condition. Changes in federal and state real estate laws and regulations, and rules of industry organizations such as the National Association of REALTORS , could adversely affect our business. The real estate industry is heavily regulated in the United States, including regulation under the Fair Housing Act, the Real Estate Settlement Procedures Act, state and local licensing laws and regulations and federal and state advertising laws. In addition to existing laws and regulations, states and industry participants and regulatory organizations could enact legislation, regulatory or other policies in the future, which could restrict our activities or significantly increase our compliance costs. Moreover, the provision of real estate services over the Internet is a new and evolving business, and legislators, regulators and industry participants may advocate additional legislative or regulatory initiatives governing the conduct of our business. If existing laws or regulations are amended or new laws or Table of Contents Risk factors regulations are adopted, we may need to comply with additional legal requirements and incur significant compliance costs, or we could be precluded from certain activities. Because we operate through our web site, state and local governments other than where the subject property is located may attempt to regulate our activities, which could significantly increase our compliance costs and limit certain of our activities. In addition, industry organizations, such as NAR and other state and local organizations, can impose standards or other rules affecting the manner in which we conduct our business. As mentioned above, NAR has adopted rules that, if implemented, could result in a reduction in the number of home listings that could be viewed on our web site. NAR has extended the deadline for the implementation of its rules at least twice during an investigation by the antitrust division of the U.S. Department of Justice into NAR s policy that dictates how brokers can display other brokers property listings on their web sites. We presently do not know whether or when the NAR rules will be implemented in their current form or in a revised form, if at all. The implementation of the rules will not limit our access to listing information, but could limit the display of listing information to our clients through our web site in the manner we currently utilize, as well as increase our costs of ensuring compliance with such rules. Any significant lobbying or related activities, either of governmental bodies or industry organizations, required to respond to current or new initiatives in connection with our business could substantially increase our operating costs and harm our business. We derive a significant portion of our leads through third parties, and if any of our significant lead generation relationships are terminated or become more expensive, our ability to attract new clients and grow our business may be adversely affected. We generate leads for our ZipAgents through many sources, including leads from third parties with which we have only non-exclusive, short-term agreements that are generally terminable on little or no notice and with no penalties. Our largest third-party lead source in the first nine months of 2004, HomeGain, Inc., which competes with us for online customer acquisition, generated approximately 22% of our leads during that period. In addition, during the second quarter of 2004 our exclusive co-branded relationship which we had in four markets with one third-party lead source, Yahoo! Inc., was terminated, effective July 31, 2004. Leads from this source accounted for approximately 14% of our leads and 8% of our net revenues during the first nine months of 2004. These leads were inexpensive relative to those generated from competing sources, although they also were characterized by a lower conversion rate than is typical from our other sources. As a result, our lead replacement strategy includes delivering fewer leads to the agents in the areas impacted by the termination of the Yahoo! co-branded relationship with those leads characterized by what we believe to be higher conversion potential based upon historical experience. Should this replacement strategy not be successful, or any of our other lead generation relationships become materially more expensive such that we could not obtain substitute sources on acceptable terms, our ability to attract new clients and grow our business may be impaired. Our business could be harmed by economic events that are out of our control and may be difficult to predict. The success of our business depends in part on the health of the residential real estate market, which traditionally has been subject to cyclical economic swings. The purchase of residential real estate is a significant transaction for most consumers, and one which can be delayed or terminated based on the availability of discretionary income. Economic slowdown or recession, rising interest rates, adverse tax policies, lower availability of credit, increased unemployment, lower consumer confidence, lower wage and salary levels, war or terrorist attacks, or the public perception that any of these events may occur, could adversely affect the demand for residential real estate and would harm our business. Also, if interest rates increase significantly, homeowners ability to purchase a new home or a higher priced home may be reduced as higher monthly payments would make housing less affordable. In addition, Table of Contents Risk factors these conditions could lead to a decline in new listings, transaction volume and sales prices, any of which would harm our operating results. Our ability to expand our business may be limited by state laws governing cash rebates to home buyers. A significant component of our value proposition to our home buyer clients is a cash rebate provided to the buyer at closing. Currently, our clients who are home buyers represent a substantial majority of our business and revenues. Certain states, such as Alaska, Kansas, Kentucky, Louisiana, Mississippi, New Jersey, Oklahoma, Oregon and Tennessee, may presently prohibit sharing any commissions with, or providing rebates to, clients who are not licensed real estate agents. In addition, other states may limit or restrict our cash rebate program as currently structured, including Missouri and New York. Should we decide to expand into any of these states, we may have to adjust our pricing structure or refrain from offering rebates to buyers in these states. Moreover, we cannot predict whether alternative approaches will be cost effective or easily marketable to prospective clients. The failure to enter into these markets, or others that adopt similar restrictions, or to successfully attract clients in these markets, could harm our business. We may be unable to integrate our technology with each MLS on a cost-effective basis, which may harm our operating results and adversely affect our ability to service clients. Each MLS is operated independently and is run on its own technology platform. As a result, we must constantly modify our technology to successfully interact with each independent MLS in order to maintain access to that MLS s home listings information. In addition, when a new MLS is created, we must customize our technology to work with that new system. These activities require constant attention and significant resources. We may be unable to successfully interoperate with the MLSs without significantly increasing our engineering costs, which would increase our operating expenses without a related increase in net revenues and cause our operating results to suffer. We may also be unable to interoperate with the MLSs at all, which may adversely affect the demand for our services. If we fail to comply with real estate brokerage laws and regulations, we may incur significant financial penalties or lose our license to operate. Due to the geographic scope of our operations and the nature of the real estate services we perform, we are subject to numerous federal, state and local laws and regulations. For example, we are required to maintain real estate brokerage licenses in each state in which we operate and to designate individual licensed brokers of record. If we fail to maintain our licenses, lose the services of our designated broker of record or conduct brokerage activities without a license, we may be required to pay fines or return commissions received, our licenses may be suspended or we may be subject to other civil and/or criminal penalties. As we expand into new markets, we will need to obtain and maintain the required brokerage licenses and comply with the applicable laws and regulations of these markets, which may be different from those to which we are accustomed, may be difficult to obtain and will increase our compliance costs. In addition, because the size and scope of real estate sales transactions have increased significantly during the past several years, both the difficulty and cost of compliance with the numerous state licensing regimes and possible losses resulting from non-compliance have increased. Our failure to comply with applicable laws and regulations, the possible loss of real estate brokerage licenses or litigation by government agencies or affected clients may have a material adverse effect on our business, financial condition and operating results, and may limit our ability to expand into new markets. Table of Contents Risk factors We may have liabilities in connection with real estate brokerage activities. As a licensed real estate broker, we and our licensed employees are subject to statutory due diligence, disclosure and standard-of-care obligations. In the ordinary course of business we and our employees are subject to litigation from parties involved in transactions for alleged violations of these obligations. In addition, we may be required to indemnify our employees who become subject to litigation arising out of our business activities, including for claims related to the negligence of those employees. An adverse outcome in any such litigation could negatively impact our reputation and harm our business. We may be subject to liability for the Internet content that we publish. As a publisher of online content, we face potential liability for negligence, copyright, patent or trademark infringement, or other claims based on the nature and content of the material that we publish or distribute. Such claims may include the posting of confidential data, erroneous listings or listing information and the erroneous removal of listings. These types of claims have been brought successfully against the providers of online services in the past and could be brought against us or others in our industry. In addition, we may face liability if a MLS member or participant utilizes an opt-out provision, as previously discussed, and we fail to comply with that requirement. These claims, whether or not successful, could harm our reputation, business and financial condition. Although we carry general liability insurance, our insurance may not cover claims of these types or may be inadequate to protect us for all liability that we may incur. We monitor and evaluate the use of our web site by our registered users, which could raise privacy concerns. Visitors to our web site that register with us receive access to home listing and related information that we do not make available to unregistered users. As part of the registration process, our registered users consent to our use of information we gather from their use of our web site, such as the geographic areas in which they search for homes, the price range of homes they view, their activities while on our web site and other similar information. They also provide us with personal information such as telephone numbers and email addresses. While our registered users consent to our internal use of this information, if we were to use this information outside the scope of their consent or otherwise fail to keep this information confidential from third parties, including our former agents, we may be subject to legal claims or government action and our reputation and business could be harmed. While we do not share web site use and other personal information with any third parties, except with our clients consent to third parties involved in the transaction process, concern among consumers regarding our use of personal information gathered from visitors to our web site could cause them not to register with us. This would reduce the number of leads we derive from our web site. Because our web site is our primary client acquisition tool, any resistance by consumers to register on our web site would harm our business and results of operations, and could cause us to alter our business practices or incur significant expenses to educate consumers regarding the use we make of information. We may need to change the manner in which we conduct our business if government regulation of the Internet increases. The adoption or modification of laws or regulations relating to the Internet could adversely affect the manner in which we currently conduct our business. In addition, the growth and development of the market for online commerce may lead to more stringent consumer protection laws that may impose additional burdens on us. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. For example, both the U.S. government as well as the State of California have enacted Internet laws regarding privacy and sharing of customer information with third parties. Laws applicable to the Internet remain largely unsettled, even in areas where there Table of Contents Risk factors has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet. In addition, because each state in which we do business requires us to be a licensed real estate broker, and residents of states in which we do not do business could potentially access our web site, changes in Internet regulation could lead to situations in which we are considered to operate or do business in such states. This could result in potential claims or regulatory action. If we are required to comply with new regulations or new interpretations of existing regulations, we may not be able to differentiate our services from traditional competitors and may not attract a sufficient number of clients for our business to be successful. Our reputation and client and agent service offerings may be harmed by system failures and computer viruses. The performance and reliability of our technology infrastructure is critical to our reputation and ability to attract and retain clients and agents. Our network infrastructure is currently co-located at a single facility in Sunnyvale, California and we do not currently operate a back-up facility. As a result, any system failure or service outage at this primary facility would result in a loss of service for the duration of the failure or outage. Any system error or failure, or a sudden and significant increase in traffic, may significantly delay response times or even cause our system to fail resulting in the unavailability of our Internet platform. For example, earlier this year we experienced an unscheduled outage that lasted approximately 12 hours. During this period our clients and prospective clients were unable to access our web site or receive notifications of new listings. While we have taken measures to prevent unscheduled outages, outages may occur in the future. In addition, our systems and operations are vulnerable to interruption or malfunction due to certain events beyond our control, including natural disasters, such as earthquakes, fire and flood, power loss, telecommunication failures, break-ins, sabotage, computer viruses, intentional acts of vandalism and similar events. Our network infrastructure is located in the San Francisco Bay area, which is susceptible to earthquakes and has, in the past, experienced power shortages and outages, any of which could result in system failures and service outages. We may not be able to expand our network infrastructure, either on our own or through use of third party hosting systems or service providers, on a timely basis sufficient to meet demand. Any interruption, delay or system failure could result in client and financial losses, litigation or other consumer claims and damage to our reputation. Our intellectual property rights are valuable and our failure to protect those rights could adversely affect our business. Our intellectual property rights, including existing and future patents, trademarks, trade secrets, and copyrights, are and will continue to be valuable and important assets of our business. We believe that our proprietary ZAP technology and ZipNotify, as well as our ability to interoperate with multiple MLSs and our other technologies and business practices, are competitive advantages and that any duplication by competitors would harm our business. We have taken measures to protect our intellectual property, but these measures may not be sufficient or effective. For example, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. We also seek to maintain certain intellectual property as trade secrets. Intellectual property laws and contractual restrictions may not prevent misappropriation of our intellectual property or deter others from developing similar technologies. In addition, others may develop technologies that are similar or superior to our technology, including our patented technology. Any significant impairment of our intellectual property rights could harm our business. Table of Contents Risk factors We may in the future be subject to intellectual property rights disputes, which could divert management attention, be costly to defend and require us to limit our service offerings. Our business depends on the protection and utilization of our intellectual property. Other companies may develop or acquire intellectual property rights that could prevent, limit or interfere with our ability to provide our products and services. One or more of these companies, which could include our competitors, could make claims alleging infringement of their intellectual property rights. Any intellectual property claims, with or without merit, could be time-consuming and expensive to litigate or settle and could significantly divert management resources and attention. Our technologies may not be able to withstand any third-party claims or rights against their use. If we were unable to successfully defend against such claims, we may have to: pay damages; stop using the technology found to be in violation of a third party s rights; seek a license for the infringing technology; or develop alternative non-infringing technology. If we have to obtain a license for the infringing technology, it may not be available on reasonable terms, if at all. Developing alternative non-infringing technology could require significant effort and expense. If we cannot license or develop alternative technology for the infringing aspects of our business, we may be forced to limit our product and service offerings. Any of these results could reduce our ability to compete effectively, and harm our business and results of operations. If we fail to attract and retain our key personnel, our ability to meet our business goals will be impaired and our financial condition and results of operations will suffer. The loss of the services of one or more of our key personnel could seriously harm our business. In particular, our success depends on the continued contributions of Eric A. Danziger, our President and Chief Executive Officer, and other senior level sales, operations, marketing, technology and financial officers. Our business plan was developed in large part by our senior level officers and its implementation requires their skills and knowledge. None of our officers or key employees has an employment agreement, and their employment is at will. We do not have key person life insurance policies covering any of our executives. We intend to evaluate acquisitions or investments in complementary technologies and businesses and we may not realize the anticipated benefits from, and may have to pay substantial costs related to, any acquisitions or investments that we undertake. As part of our business strategy, we plan to evaluate acquisitions of, or investments in, complementary technologies and businesses. We may be unable to identify suitable acquisition candidates in the future or be able to make these acquisitions on a commercially reasonable basis, or at all. If we complete an acquisition or investment, we may not realize the benefits we expect to derive from the transaction. Any future acquisitions and investments would have several risks, including: our inability to successfully integrate acquired technologies or operations; diversion of management s attention; problems maintaining uniform standards, procedures, controls and policies; potentially dilutive issuances of equity securities or the incurrence of debt or contingent liabilities; expenses related to amortization of intangible assets; Table of Contents Risk factors risks associated with operating a business or in a market in which we have little or no prior experience; potential write offs of acquired assets; loss of key employees of acquired businesses; and our inability to recover the costs of acquisitions or investments. If we are required to expense options, it could significantly reduce our net income in future periods. The Financial Accounting Standards Board, or FASB, issued an Exposure Draft, Share-Based Payment: an amendment of Statement of Financial Accounting Standards No. 123 and No. 95 in March 2004 that would require a company to recognize compensation cost for all share based payments, including employee stock options, at fair value beginning in 2005 and subsequent reporting periods. Recently the FASB concluded that the amendment referred to in the Exposure Draft would be effective for public companies for interim or annual periods beginning after June 15, 2005. If the amendment is enacted as described in the Exposure Draft, we will be required to record an expense for our stock-based compensation plans using the fair value method beginning on July 1, 2005. This expense could exceed the expense we currently record for our stock-based compensation plans and correspondingly reduce our net income in future periods. RISKS RELATED TO THIS OFFERING Our common stock could trade at prices below the initial public offering price. Before this offering, there has not been a public trading market for shares of our common stock. An active trading market may not develop or be sustained after this offering. The initial public offering price for the shares of common stock sold in this offering will be determined by negotiations between us and representatives of the underwriters. This price may bear no relationship to the price at which our common stock will trade after this offering. Our stock price may be volatile, and you may not be able to resell your shares at or above the initial public offering price. The trading price of our common stock after this offering may fluctuate widely, depending upon many factors, some of which are beyond our control. These factors include, among others, the risks identified above and the following: variations in our quarterly results of operations; announcements by us or our competitors or lead source providers; changes in estimates of our performance or recommendations, or termination of coverage by securities analysts; inability to meet quarterly or yearly estimates or targets of our performance; the hiring or departure of key personnel, including agents or groups of agents or key executives; changes in our reputation; acquisitions or strategic alliances involving us or our competitors; changes in the legal and regulatory environment affecting our business; and market conditions in our industry and the economy as a whole. Table of Contents Risk factors In addition, the stock market in general, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our actual operating performance. Also, in the past, following periods of volatility in the overall market and the market price of a company s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management s attention and resources and could harm the price of our common stock. Although we carry general liability and errors and omissions insurance, our insurance may not cover claims of these types or may be inadequate to protect us from all liability that we may incur. Our share price could decline due to the large number of outstanding shares of our common stock eligible for future sale. The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market after this offering, or from the perception that these sales could occur. These sales could also make it more difficult for us to sell our equity or equity-related securities in the future at a time and price that we deem appropriate. Immediately after this offering is completed, we will have 19,054,856 shares of common stock outstanding, or 19,737,356 shares if the representatives of the underwriters exercise their over-allotment option in full. The 4,550,000 shares sold pursuant to this offering will be immediately tradable without restriction. Of the remaining shares: no shares will be eligible for sale immediately upon completion of this offering; 12,399,323 shares will be eligible for sale upon the expiration of lock-up agreements, subject in some cases to the volume and other restrictions of Rule 144 and Rule 701 under the Securities Act of 1933, as amended; and 1,860,504 shares will be eligible for sale upon the exercise of vested options after the expiration of the lock-up agreements. The lock-up agreements expire 180 days after the date of this prospectus, provided that the 180-day lock-up period may be extended in most cases for up to 37 additional days under certain circumstances where we announce or pre-announce earnings or a material event within approximately 18 days prior to, or approximately 16 days after, the termination of the 180-day period. The representatives of the underwriters may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements. After the closing of this offering, we intend to register approximately 4,149,920 shares of common stock that have been issued or reserved for future issuance under our stock incentive plans. Our principal stockholders, executive officers and directors own a significant percentage of our stock, and as a result, the trading price for our shares may be depressed and these stockholders can take actions that may be adverse to your interests. Our executive officers and directors and entities affiliated with them will, in the aggregate, beneficially own more than two-thirds of our common stock following this offering. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. These stockholders, acting together, will have the ability to exert control over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders who are Operating expenses: Cost of revenues 6,969 13,450 19,929 14,710 24,389 Product development 1,899 1,559 1,717 1,363 1,639 Marketing and business development 3,225 4,451 5,003 3,782 6,325 General and administrative 5,447 10,378 9,464 7,141 10,014 Stock-based compensation 185 84 85 57 Operating expenses: Cost of revenues 250 3,798 6,969 13,450 19,929 14,710 24,389 Product development 700 2,623 1,899 1,559 1,717 1,363 1,639 Marketing and business development 638 10,497 3,225 4,451 5,003 3,782 6,325 General and administrative 673 4,613 5,447 10,378 9,464 7,141 10,014 Stock-based compensation 124 185 84 85 57 Operating expenses: Cost of revenues 6,969 13,450 19,929 14,710 24,389 Product development 1,899 1,559 1,717 1,363 1,639 Marketing and business development 3,225 4,451 5,003 3,782 6,325 General and administrative 5,447 10,378 9,464 7,141 10,014 Stock-based compensation 185 84 85 57 Total stock-based compensation $ 185 $ 84 $ 85 $ 57 $ Table of Contents Risk factors executive officers or directors, or who have representatives on our board of directors, could dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination that could be favorable to you. You will experience immediate and substantial dilution in the book value of your common stock. Investors purchasing shares of our common stock in this offering will pay more for their shares than the amount paid by existing stockholders who acquired shares prior to this offering. If you purchase common stock in this offering, you will incur immediate and substantial dilution in net tangible book value of approximately $7.63 per share. If the holders of outstanding options or warrants exercise those securities, you will most likely incur further dilution. See Dilution for additional information. Our charter documents and Delaware law could prevent a takeover that stockholders consider favorable and could also reduce the market price of our stock. Our amended and restated certificate of incorporation and our bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could also make it more difficult for stockholders to elect directors and take other corporate actions. These provisions include: providing for a classified board of directors with staggered, three-year terms; not providing for cumulative voting in the election of directors; authorizing the board to issue, without stockholder approval, preferred stock with rights senior to those of common stock; prohibiting stockholder action by written consent; limiting the persons who may call special meetings of stockholders; and requiring advance notification of stockholder nominations and proposals. In addition, the provisions of Section 203 of Delaware General Corporate Law govern us. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time. These and other provisions in our amended and restated certificate of incorporation, our bylaws and under Delaware law could discourage potential takeover attempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions. See Description of capital stock Preferred Stock and Description of capital stock Anti-takeover Effects of Provisions of Our Amended and Restated Certificate of Incorporation, Our Bylaws and Delaware Law. Table of Contents Special note regarding forward-looking statements This prospectus includes forward-looking statements. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words believe, may, will, should, could, estimate, continue, anticipate, intend, expect, plan, potential, predict and similar expressions, as they relate to us, are intended to identify forward-looking statements. Forward-looking statements contained in this prospectus include, but are not limited to, statements relating to: our future financial results; our future growth and expansion into new markets; our future advertising and marketing activities; and our future investment in technology. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Risk factors. No forward-looking statement is a guarantee of future performance and you should not place undue reliance on any forward-looking statement. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. Except as otherwise required by law, we undertake no obligation to update or revise any forward-looking statement contained in this prospectus. Table of Contents Use of proceeds We estimate that we will receive net proceeds of $44.5 million from the sale of the 4,550,000 shares of common stock offered by us in this offering, based on an assumed initial public offering price of $11.00 per share, the mid-point of the range on the cover of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters over-allotment option is exercised in full, we estimate that we will receive net proceeds of $51.5 million. The principal purposes of this offering are to obtain additional capital, to create a public market for our common stock and to facilitate our future access to the public equity markets. We currently estimate that we will use the net proceeds of this offering for general corporate purposes, including working capital. We have not assigned specific portions of the net proceeds of this offering for any particular uses, and we will retain broad discretion in the allocation of these proceeds. Although we evaluate potential acquisitions of complementary businesses, technologies or other assets in the ordinary course of business, we have no specific understandings, commitments or agreements with respect to any acquisition at this time. Pending such uses, we intend to invest the funds in short-term, investment-grade securities. We cannot predict whether the proceeds invested will yield a favorable return. Dividend policy We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not currently expect to pay any cash dividends. Income (loss) from operations (2,099 ) (868 ) 441 Table of Contents Capitalization The following table sets forth: our actual capitalization at September 30, 2004; our pro forma capitalization after giving effect to the conversion of all outstanding shares of preferred stock into shares of common stock immediately prior to the completion of this offering; and our pro forma capitalization as adjusted to reflect the sale of 4,550,000 shares of common stock offered by us at an assumed initial public offering price of $11.00 per share, the mid-point of the range on the cover of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. You should read the capitalization table together with the sections of this prospectus entitled Selected financial data and Management s discussion and analysis of financial condition and results of operations and with our financial statements and related notes beginning on page F-1. At September 30, 2004 Pro forma Actual Pro forma as adjusted (in thousands) Mandatorily redeemable convertible preferred stock, $0.001 par value; 59,342,640 shares authorized, 12,927,786 shares issued and outstanding, actual; no shares authorized, issued and outstanding, pro forma and pro forma as adjusted 65,317 Mandatorily redeemable convertible preferred stock warrants 6,415 71,732 Stockholders equity (deficit): Common stock, $0.001 par value; 80,000,000 shares authorized, 1,577,070 shares issued and outstanding, actual; 100,000,000 shares authorized, pro forma and pro forma as adjusted; 14,504,856 shares issued and outstanding, pro forma; 19,054,856 shares issued and outstanding, pro forma as adjusted 2 14 19 Additional paid-in capital 1,382 73,102 117,644 Deferred stock-based compensation (489 ) (489 ) (489 ) Accumulated equity (deficit) (53,018 ) (53,018 ) (53,018 ) Total stockholders equity (deficit) (52,123 ) 19,609 64,156 Total capitalization $ 19,609 $ 19,609 $ 64,156 In addition to the shares of common stock to be outstanding after the offering, we may issue additional shares of common stock under the following plans and arrangements: 4,912,729 shares issuable upon exercise of outstanding warrants at a weighted average exercise price of $3.93 per share as of September 30, 2004; 2,894,657 shares issuable upon exercise of outstanding options at a weighted average exercise price of $3.36 per share as of September 30, 2004; and 1,255,263 shares available for future grant or issuance under our equity incentive plans. (in thousands) Interest expense $ (2,118 ) $ (2,273 ) $ Table of Contents Dilution If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma net tangible book value per share of our common stock after this offering. At September 30, 2004, our pro forma net tangible book value was $19.6 million, or $1.35 per share of common stock. Pro forma net tangible book value per share is equal to our stockholders equity (deficit) less goodwill and other intangible assets, divided by the total number of shares of our common stock outstanding as of September 30, 2004, after giving effect to the conversion of our preferred stock into common stock. After giving effect to the sale of the shares of our common stock offered by us at an assumed initial public offering price of $11.00 per share, the mid-point of the range on the cover of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma net tangible book value at September 30, 2004 would have been $64.2 million, or $3.37 per share. This represents an immediate increase in pro forma net tangible book value of $2.02 per share to existing stockholders and an immediate dilution of $7.63 per share to new investors purchasing shares of our common stock in this offering. The following table illustrates the dilution per share: Initial public offering price per share $ 11.00 Pro forma net tangible book value per share at September 30, 2004, before giving effect to this offering $ 1.35 Increase in pro forma net tangible book value per share attributable to new investors purchasing shares in this offering 2.02 (in thousands) Product development $ 1,559 $ 1,717 $ Pro forma net tangible book value per share after giving effect to this offering 3.37 Dilution in pro forma net tangible book value per share to new investors $ 7.63 If the underwriters exercise their over-allotment option in full, the pro forma net tangible book value per share after giving effect to this offering would be $3.60 per share, and the dilution in pro forma net tangible book value per share to new investors would be $7.40 per share. The following table summarizes, as of September 30, 2004, the differences between the number of shares of common stock purchased from us, after giving effect to the conversion of our preferred stock into common stock, the total cash consideration paid and the average price per share paid by the existing stockholders and by the new investors purchasing stock in this offering at an assumed initial public offering price of $11.00 per share, the mid-point of the range on the cover of this prospectus, before deducting the underwriting discounts and commissions and estimated offering expenses payable by us: Shares purchased Total cash consideration Average price Number Percentage Amount Percentage per share Existing stockholders 14,504,856 76.1 % $ 66,227,000 57.0 % $ 4.57 New investors 4,550,000 23.9 50,050,000 43.0 11.00 Total 19,054,856 100.0 % $ 116,277,000 100.0 % If the underwriters exercise their over-allotment option in full, our existing stockholders would own 73.5% and our new investors would own 26.5% of the total number of shares of our common stock outstanding after this offering. The preceding discussion and tables assume no exercise of stock options or warrants outstanding as of September 30, 2004. As of September 30, 2004, there were: 4,912,729 shares issuable upon exercise of outstanding warrants at a weighted average exercise price of $3.93 per share; 2,894,657 shares issuable upon exercise of outstanding options at a weighted average exercise price of $3.36 per share; and 1,255,263 shares available for future grant or issuance under our equity incentive plans. Net income (loss) $ (2,977 ) $ (2,225 ) $ 446 $ Table of Contents Selected financial data You should read the following selected financial data together with Management s discussion and analysis of financial condition and results of operations and our financial statements and related notes included elsewhere in this prospectus. The statements of operations data for the years ended December 31, 2001, 2002 and 2003, and the balance sheet data at December 31, 2002 and 2003, are derived from our financial statements appearing elsewhere in this prospectus, which have been audited by PricewaterhouseCoopers LLP, independent registered public accounting firm. The statements of operations data for the period from January 25, 1999 (inception) to December 31, 1999 and the year ended December 31, 2000, and the balance sheet data at December 31, 1999, 2000 and 2001, are derived from our financial statements that are not included in this prospectus. The statements of operations data for the nine months ended September 30, 2003 and 2004, and the balance sheet data at September 30, 2004, are derived from our unaudited financial statements included elsewhere in this prospectus. In management s opinion, these unaudited statements have been prepared on substantially the same basis as the audited financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial information for the periods presented. The historical results are not necessarily indicative of the results to be expected in any future period. Pro forma basic and diluted net loss per share have been computed to give effect to the conversion of mandatorily redeemable convertible preferred stock into common stock upon the closing of our initial public offering on an as-if-converted basis for the year ended December 31, 2003 and the nine months ended September 30, 2004 as if such conversion occurred at the beginning of the respective period or original issue date, if later. Table of Contents Selected financial data Period from January 25, Nine months ended 1999 (inception) Year ended December 31, September 30, Statements of operations to December 31, Net revenues 43 1,386 3,963 17,163 33,807 24,527 44,741 Total operating expenses 2,261 21,655 17,725 29,922 36,198 27,053 42,493 Income (loss) from operations (2,218 ) (20,269 ) (13,762 ) (12,759 ) (2,391 ) (2,526 ) 2,248 Net income (loss) available to common stockholders $ (2,209 ) $ (19,965 ) $ (14,177 ) $ (15,396 ) $ (5,214 ) $ (5,228 ) $ Net income (loss) $ (2,209 ) $ (19,965 ) $ (13,792 ) $ (14,765 ) $ (4,583 ) $ (4,756 ) $ 2,296 Preferred stock dividends 385 631 631 472 472 Amount allocated to participating preferred shares 1,611 Net income (loss) per share: Basic $ (9.96 ) $ (10.63 ) $ (3.57 ) $ (3.59 ) $ 0.14 Diluted $ (9.96 ) $ (10.63 ) $ (3.57 ) $ (3.59 ) $ 0.03 Weighted average common shares outstanding: Basic 1,423,697 1,447,867 1,459,058 1,455,936 1,509,783 Diluted 1,423,697 1,447,867 1,459,058 1,455,936 6,572,166 December 31, (unaudited) (in thousands) Cash and cash equivalents $ 15,866 $ 5,999 $ 931 $ 8,961 $ 10,357 $ 21,527 Working capital 15,519 5,085 (171 ) 7,817 8,234 18,425 Total assets 16,329 10,063 4,018 12,047 12,430 25,821 Total long-term liabilities 873 316 17,082 207 171 Total liabilities 366 2,356 1,962 19,827 3,535 6,212 Mandatorily redeemable convertible preferred stock and warrants 18,157 29,726 37,554 42,392 63,556 71,732 Total stockholders equity (deficit) (2,195 ) (22,019 ) (35,497 ) (50,172 ) (54,660 ) (52,123 ) Table of Contents Management s discussion and analysis of financial condition and results of operations The following discussion should be read together with our financial statements and related notes appearing elsewhere in this prospectus. This discussion contains forward-looking statements based upon current expectations that involve numerous risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including but not limited to those set forth under Risk factors and elsewhere in this prospectus. We undertake no obligation to update any information contained in these forward-looking statements. OVERVIEW General We are a full-service residential real estate brokerage firm, using the Internet, proprietary technology and efficient business processes to provide home buyers and sellers with high-quality service and value. Our solution includes a client-centric business approach, a sophisticated web site that empowers home buyers and sellers with relevant information, a proprietary business management technology platform and significant financial savings for consumers. We share a portion of our commissions with our buyer clients in the form of a cash rebate, and typically represent our seller clients at fee levels below those offered by most traditional brokerage companies in our markets. Generally, our seller clients pay a total brokerage fee of 4.5% to 5.0% of the transaction value, of which 2.5% to 3.0% is paid to agents representing buyers. Our net revenues are comprised primarily of commissions earned as agents for buyers and sellers in residential real estate transactions. We record revenues net of rebate or commission discount, if any, paid or offered to our clients. We also receive revenues from certain co-marketing arrangements, such as our relationship with E-LOAN, Inc., which provides the mortgage center on our web site and pays us a flat monthly fee that is established on a periodic basis. Generally, non-commission revenues represent less than 5% of our net revenues during any period. Our net revenues are principally driven by the number of transactions we close and the average net revenue per transaction. Average net revenue per transaction is a function of the home sales price and percentage commission we receive on each transaction. We were founded in 1999, currently have operations in 12 major metropolitan areas, and as of September 30, 2004 employed 919 people, of whom 782 were ZipAgents. Trends in our business Our business has experienced rapid growth since our inception in 1999, primarily as a result of increased transaction volume and increased average net revenue per transaction. In 2001, we generated $4.0 million in net revenues, compared to $17.2 million in 2002 and $33.8 million 2003. The number of our closed transactions increased from approximately 840 in 2001 to approximately 5,400 in 2003, and our average net revenue per transaction increased from approximately $4,600 in 2001 to over $6,000 in 2003. Our transaction volume is primarily driven by the number of ZipAgents we employ, which increased from 162 at December 31, 2001 to 440 at December 31, 2003. Our average net revenue per transaction increased over this time primarily as a result of increasing home prices and a reduction in our rebate paid to buyers. As we add additional ZipAgents, we believe we will continue to increase our transaction volume and grow our business. Historically, we have maintained our agent productivity in excess of the industry average as we have added additional ZipAgents, and we expect to continue to do so in the future. We also intend to hire agents who already work for competing brokerage firms in our existing markets. By hiring those established agents who we anticipate will be successful within our business model, we believe we can increase our transaction volume without Table of Contents Management s discussion and analysis of financial condition and results of operations diluting the number of potential transactions per agent, which could offset a decrease in overall market demand. In addition, we believe that customer acquisition is one of our core competencies, and while we anticipate that the difficulty of acquiring a sufficient number of leads online may increase over time, we expect that we can mitigate some of that impact with repeat and referral business, as well as by increasing our visibility and credibility to potential clients over time. Since our market share has averaged less than 1% over the past twelve months in our existing markets in aggregate, we believe that there is significant opportunity to increase our market share and grow our revenues, even if the overall level of sales decline due to changing consumer sentiment, interest rate increases or other economic or geopolitical factors. However, we anticipate the pace of our growth in percentage terms to slow as our company increases in size. Over time, we have made significant adjustments to our cost structure and revenue model in order to improve the financial results of our business. In 2001, we completed a reduction in force involving approximately 45 employees in a restructuring effort completed prior to the hiring of our current CEO. We have also modified the compensation structure for ZipAgents over time and may do so again in the future. Initially, new ZipAgents were paid a base salary for the first three months of employment, and we provided leased automobiles to many of our ZipAgents. We cancelled the leased automobile program in December 2002, and we phased out this base salary program during the first two quarters of 2003. By the second half of 2003, we had eliminated base salary for our ZipAgents and began compensating them only through commissions and expense allowances. During this period, we also instituted threshold productivity standards that ZipAgents were required to meet before being entitled to receive leads without charge. Currently, our ZipAgents earn a compensation package consisting of a percentage of the commissions they generate for us that ranges from 40% to 75% of our net revenues after deducting certain other items, as well as an expense allowance of up to $1,500 per month. We also provide our ZipAgents with health, retirement and other benefits, and pay for certain marketing costs. ZipAgents may also be granted equity incentives based on performance. We have lowered our buyer rebate percentage several times to improve our revenue model. In January 2002, we lowered our rebate from 1% of the home sales price to 33.3% of our commission, up to a maximum of 1% of the home sales price. In September 2002, we reduced our buyer rebate to 25% of our commission, up to a maximum of 1% of the home sales price. In March 2004, we further reduced our buyer rebate to 20% of our commission, removing the up to 1% qualifier. The effect of each of the buyer rebate reductions was recognized over a phase-in period of approximately two to four months as the reduction only affected new clients immediately while existing clients continued under the prior rebate policy for transactions already in progress and for transactions opened within a short period after the reduction was announced. We implemented these buyer rebate percentage reductions for several reasons, including our determination that our growing reputation for service allowed us not to compete solely on price, our efforts to improve our revenue model and agent compensation model, and our desire to offer a simplified rebate structure to our clients. We achieved profitability for the first time in the third quarter of 2003 and maintained profitability for the fourth quarter as well, primarily as a result of increased transaction volume, higher average net revenue per transaction and improved management of discretionary expenses. However, as a result of the seasonality to which our business is subject, we again experienced a net loss in the first quarter of 2004. We returned to profitability in the second and third quarters of 2004, primarily as a result of higher average net transaction revenue and increased transactional volume due to our increased ZipAgent force and seasonal factors. Over the past several years there has been a slow but steady decline in average commissions charged in the real estate brokerage industry, in part due to companies such as ours exerting downward pressure on prices with a lower commission structure, as well as by what, in our view, appears to be an increase in consumer willingness to negotiate fees with their agents. We believe that many consumers Table of Contents Management s discussion and analysis of financial condition and results of operations are focusing on absolute commission dollars paid to sell their home as opposed to accepting a traditional standard market commission percentage. According to REAL Trends, while the average commission percentage decreased from 5.44% in 2000 to 5.14% in 2003, total commission revenues increased from $42.6 billion to $59.6 billion during that same period, influenced by steadily increasing sales volumes and higher median sales prices. In the event that commissions continue to decline, we have designed our business model around an attractive cost structure and operational efficiencies which we believe should allow us to continue to offer our services at prices less than those charged by the majority of our competitors. Market seasonality, cyclicality and interest rate influences The residential real estate brokerage market is influenced both by annual seasonality factors, as well as by overall economic cycles. While individual markets vary, opened transaction volume activity nationally tends to progressively increase from January through the summer months, then gradually slows over the last three to four months of the calendar year. Revenues in each quarter are significantly affected by activity during the prior quarter, given the typical 30- to 45-day time lag between contract execution and closing. While we believe that seasonality has been somewhat masked by our overall growth, we have been, and believe we will continue to be, influenced by overall market activity. We generally experience the most significant impact in the first and fourth quarters of each year, when our revenues are typically lower relative to the second and third quarters as a result of traditionally slower home sales activity and reduced listings inventory between Thanksgiving and Presidents Day. We believe that the overall macroeconomic environment and periodic business cycles can influence the general health of the residential real estate market at any given point in time. Generally, when economic times are fair or good, the housing market tends to perform well. If the economy is weak, interest rates dramatically increase, or there are market shocks such as terrorist attacks or threats, the outbreak of war or geopolitical uncertainties, the housing market could be negatively impacted. Over the past several decades, the national residential real estate market has demonstrated significant growth, with annual existing home sales volume growing from 1.6 million in 1970 to over 6.0 million in 2003 and median existing home sales prices increasing every year during that period. During that period, the volume of existing home sales has declined for at least two consecutive years only twice, namely 1979 through 1982 and 1989 through 1990. The declines in sales volumes in the 1979 through 1982 period occurred while interest rates were at historic highs, with long-term U.S. Treasury rates exceeding 10%. With rates remaining at similarly high levels, housing activity expanded during the period from 1983 through 1986. Average interest rates were lower during the second period of consecutive year declines, 1989 through 1990, than in 1988. Many factors influence an individual s decision to buy or sell a home, and we believe that no one factor alone determines the health of the residential real estate market. For example, while a rise in interest rates could lead to lower demand for housing or put downward pressure on prices, it is our experience that lifestyle influences, such as job relocation, changes in family dynamics or a desire to change neighborhoods, significantly impact the demand for residential real estate. In addition, periods of interest rate increases are often characterized by improving economic fundamentals, which can create jobs, increase incomes and bolster consumer confidence, all of which are factors that positively influence housing demand. It is difficult to predict which influences will be strongest, and ultimately whether the housing market will be affected positively or negatively when faced with numerous influences. While we do not believe that increasing interest rates will necessarily have a negative impact on the housing market, increasing interest rates may lead to a lower demand for housing or put downward pressure on prices. Higher interest rates could increase monthly housing payments or reduce the amount an individual can pay, which may have an adverse effect on pricing and affordability. It is also Table of Contents Management s discussion and analysis of financial condition and results of operations possible that home ownership rates, which reached an all time high in 2003 during the recent period of record low interest rates, could drop as a result of fewer first-time buyers being able to afford homes. Should overall transaction activity or sales prices decline, overall commissions generated in the industry could decline as well, potentially causing the roughly $60 billion in annual commissions generated in 2003 to decline. However, should the addressable market for our services decline somewhat due to decreasing sales volume or prices, we believe the overall size of the market on an absolute basis will remain very large, providing ample addressable opportunity for us to continue to grow our business through increasing our market share. CRITICAL ACCOUNTING POLICIES Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Accordingly, our actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies are described in Note 1 of the notes to our financial statements, and of those policies, we believe that the following accounting policies involve the greatest degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to understand and evaluate our financial condition and results of operations. Revenue recognition We derive the substantial majority of our revenues from commissions earned as agents for buyers and sellers in residential real estate transactions. We recognize commission revenues upon closing of a sale and purchase transaction, net of any rebate or commission discount, as evidenced by the closure of the escrow or similar account and the transfer of these funds to all appropriate parties. We recognize non-commission revenues from our other business relationships, such as our E-LOAN marketing relationship, as the fees are earned from the other party. Revenues are recognized when there is persuasive evidence of an arrangement, the price is fixed or determinable, collectibility is reasonably assured and the transaction has been completed. Allowance for doubtful accounts We maintain an allowance for doubtful accounts for specific estimated losses resulting from the failure of an escrow company, attorney, broker or other party to make required payments. Determination of collectibility of accounts receivable and the establishment of allowances requires judgment on the part of management and includes ongoing assessment of specific receivables exposure and history of collections. Internal-use software and web site development costs We account for internal-use software and web site development costs, including the development of our ZipAgent Platform, in accordance with the guidance set forth in Statement of Position 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use and Emerging Task Force Issue No. 00-02, Accounting for Web Site Development Costs. We capitalize the payroll and direct payroll-related costs of employees who devote time to the development of internal-use software. We amortize these costs over their estimated useful lives, which is generally 15 months. Our judgment is required in determining the point at which various projects enter the stages at which costs may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the estimated useful lives over which the costs are amortized. The estimated life is based on management s judgment as to the product life cycle. Table of Contents Management s discussion and analysis of financial condition and results of operations Deferred stock-based compensation We account for employee stock-based compensation in accordance with provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation an Interpretation of APB No. 25, and comply with the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, or SFAS 123, and related Statement of Financial Accounting Standard No. 148, Accounting for Stock-Based Compensation Transaction and Disclosure. Under APB 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of our stock and the exercise price of the option. We amortize deferred stock-based compensation using the straight-line method over the vesting period. We account for equity instruments issued to non-employees in accordance with the provisions of SFAS 123 and Emerging Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. The accounting for and disclosure of employee and non-employee equity instruments, primarily stock options and preferred and common stock warrants, requires judgment by management on a number of assumptions, including the fair value of the underlying instrument, estimated lives of the outstanding instruments, and the instrument s volatility. Changes in key assumptions will impact the valuation of such instruments. Because there has been no public market for our stock, our board of directors has determined the fair value of our common and preferred stock based on several factors, including, but not limited to, our operating and financial performance, recent sales of convertible debt instruments and internal valuation analyses considering key terms and rights of the related instruments. We have issued warrants primarily in relation to our convertible debt arrangements, and to a lesser degree, to certain service providers. Amounts recorded in conjunction with our convertible debt arrangements are generally amortized to interest expense over the expected life of the debt using the effective interest method. Our board of directors estimated the fair value of common stock for options granted during the 12-month period ended September 30, 2004, with input from our management, using the market approach described below. Contemporaneous valuations by an unrelated party were not obtained because we continued to focus financial and management resources on expanding our business and moving towards profitability, and we believed our board of directors had considerable experience in the valuation of emerging companies, both in the pre- and post-initial public offering stage. In addition, until earlier this year we did not believe a liquidity event such as an initial public offering would occur until late in 2005. As we prepared our financial statements over time and as we prepared for our initial public offering, we performed retrospective assessments of the fair value of common stock and compared such assessments to the initial estimate of fair value as determined by the board of directors. We did not use unrelated valuation specialists to assist in this process as we felt our board of directors and management had sufficient experience in this area. In addition, as we have been approaching the date of our potential initial public offering, we have obtained relevant input from experienced investment banking firms on the value of our common stock based on relative market value. We have recorded deferred stock-based employee compensation for those grants where our retrospective reassessment of fair value exceeds the initial grant exercise price, as determined by our board of directors. Significant factors, assumptions and methodologies used in determining fair value. Determining the fair value of our stock requires making complex and subjective judgments. At each stock option grant, the board of directors determined the value of our common stock utilizing the market approach, based primarily on six key factors. These factors and the input of investment banking firms were also Table of Contents Management s discussion and analysis of financial condition and results of operations considered in our retrospective reassessment of fair value. The assumptions underlying our estimates are consistent with our business plan. There is inherent uncertainty in these estimates. These key factors are: comparable values of similar companies and the pricing of recent rounds of financing; revenue growth and profitability milestones achieved and as measured to budget; continued growth in experience of our management team; marketplace activity and competition; barriers to entry; and status of capital markets. Significant factors contributing to the difference between fair value as of the date of each grant and estimated IPO price. As disclosed more fully in Note 9 to the financial statements included in this prospectus, we granted stock options with exercise prices ranging from $2.25 to $11.25 per share during the twelve month period ended September 30, 2004. During this period, we determined the fair value of our common stock increased from $4.11 to $11.25 per share. We have recorded deferred stock-based compensation for any difference between the initial exercise price of options granted and our retrospective assessment of fair value. The more significant reasons for the difference between the range of fair value used in estimating deferred stock-based compensation during this 12-month period and an estimated initial public offering price of $11.00 per share, are as follows: Several factors influenced the fair value estimates of our common stock, including: these stock options were generally subject to vesting over a four-year period, there has been no public market for the shares issuable upon exercise of these options, all of the shares were subject to a right of first refusal held by us, and in the event of a sale of our company there existed a substantial preferred stock liquidation preference in front of the common stock in excess of $90.0 million. Over the past 12 months, we have attempted to logically increase the fair value of our common stock as our performance and prospects for a successful initial public offering, and hence deemed valuation, have improved. During the last quarter of 2003, we were only marginally profitable and the equity capital markets environment did not appear receptive to a company of our stage of development and scale. Further, based upon the building of our future revenue pipeline during the final quarter of 2003, it was not clear whether or not we would be able to achieve profitability during the first quarter of 2004. Consequently, at that time we believed that the probability of completing an initial public offering was low, and that a future sale of our company represented the most likely ultimate liquidity event. Given the substantial liquidation preferences of our mandatorily redeemable convertible preferred stock applicable in a sale, the fair value of our common stock was considerably lower than the fair value of our preferred stock. During the first quarter of 2004, while we did not achieve profitability, our client activity and future revenue pipeline began to improve significantly and we believed that our prospects were much improved for the balance of the year. We also concluded at this time that we had reached significant scale to deliver sustainable profitability, a key consideration in evaluating the viability of a potential initial public offering. As a result of the significant improvements in both the equity markets and our performance, toward the end of the first quarter we began to explore the possibility of a potential initial public offering with several investment banks. During this quarter, due to the increased likelihood of an eventual initial public offering rather than a future company sale scenario, our board of directors significantly increased the fair value assumption of our common stock, recognizing the reduced risk of the liquidation preferences for our preferred stock diluting the value of our common stock. Table of Contents Management s discussion and analysis of financial condition and results of operations In April 2004, we engaged investment bankers and held our organizational meeting as an initial step in the initial public offering process. We believed at the time that while we had made substantial progress, several things needed to transpire before we could execute an initial public offering, including delivering consistently profitable results and increasing our revenue run rate. Should we not have achieved these milestones, we concluded that completing a successful offering in the fourth quarter of 2004 would not have been viable. Consequently, we believed that the fair value of our common stock at the time of filing of our registration statement in May 2004, given the milestones yet to be achieved prior to enabling us to successfully execute an offering, should represent some level of discount relative to the anticipated initial public offering price. The option grants our board of directors made in June 2004, which were the first grants subsequent to the filing of our registration statement, were priced at $10.50, which represented approximately 95% of the value of the then anticipated, and current actual, offering price range. The most recent option grants made by our board of directors, in August and October 2004, were made at $11.25 per share, a value slightly in excess of the mid-point of the range on the cover of this prospectus. We believe that the fair values we have assumed are appropriate given our steadily improving prospects, and hence our valuation, as we have progressed towards a planned initial public offering. Based on an assumed price per share in this offering of $11.00, the intrinsic value of options exercisable for our common stock outstanding at September 30, 2004 was $22.1 million, of which $13.4 million was attributable to vested options and $8.7 million was attributable to unvested options. Although it is reasonable to expect that the completion of our initial public offering will add value to the shares because they will have increased liquidity and marketability, the amount of additional value can be measured with neither precision nor certainty. Income taxes Deferred tax assets and liabilities arise from the differences between the tax basis of an asset or liability and its reported amount in the financial statements as well as from net operating loss and tax credit carry forwards. Deferred tax amounts are determined by using the tax rates expected to be in effect when the taxes will actually be paid or refunds received, as provided under current tax law. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense or benefit is the tax payable or refundable, respectively, for the period plus or minus the change during the period in deferred tax assets and liabilities. We have recorded a full valuation allowance against our deferred tax assets, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of net operating loss carryforwards, before they expire. We regularly review deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. If we conclude that it is more likely than not that we will realize the benefit of all or some of our deferred tax assets, we will reduce or eliminate the valuation allowance and will record a significant benefit to our results of operations. We have incurred annual losses for both financial and income tax reporting purposes since inception. At December 31, 2003, we had federal and state net operating loss carryforwards of approximately $49.0 million and $34.3 million, respectively, available to offset future taxable income. If not utilized, the federal and state net operating losses will begin to expire in 2019 for federal and 2009 for state tax purposes, respectively. Table of Contents Management s discussion and analysis of financial condition and results of operations The Tax Reform Act of 1986 limits the use of net operating loss and tax credit carryforwards in certain situations where there are significant changes in the ownership of a company s stock. We have not yet determined the amount of such limitation, if any, applicable to us. The difference between our effective income tax rate and the federal statutory rate is primarily a function of the valuation allowance provided against the net deferred tax assets and permanent differences. Our future effective income tax rate will depend on various factors, such as changes in our valuation allowance, pending or future tax law changes including rate changes and the tax benefit from research and development credits, potential limitations on the use of federal and state net operating losses, and state taxes. RESULTS OF OPERATIONS The following table summarizes certain financial data related to our operations: Nine months ended Year ended December 31, September 30, Net revenues 3,963 17,163 33,807 24,527 44,741 Total operating expenses 17,725 29,922 36,198 27,053 42,493 Income (loss) from operations (13,762 ) (12,759 ) (2,391 ) (2,526 ) 2,248 Net income (loss) $ (13,792 ) $ (14,765 ) $ (4,583 ) $ (4,756 ) $ 2,296 Table of Contents Management s discussion and analysis of financial condition and results of operations The following table presents our historical operating results as a percentage of net revenues for the periods indicated: Statements of operations data 2001 2002 2003 2003 Nine months ended Year ended December 31, September 30, (unaudited Net transaction revenues 98.6 % 97.9 % 96.7 % 96.3 % 97.6 % Referral and other revenues 1.4 2.1 3.3 3.7 2.4 Net revenues 100.0 100.0 100.0 100.0 100.0 Operating expenses: Cost of revenues 175.9 78.4 58.9 60.0 54.5 Product development 47.9 9.1 5.1 5.6 3.7 Marketing and business development 81.4 25.9 14.8 15.4 14.1 General and administrative 137.4 60.5 28.0 29.1 22.4 Stock-based compensation 4.7 0.5 0.3 0.2 0.3 Total operating expenses 447.3 174.4 107.1 110.3 95.0 Income (loss) from operations (347.3 ) (74.4 ) (7.1 ) (10.3 ) 5.0 Other income (expense): Interest expense (5.7 ) (12.3 ) (6.7 ) (9.3 ) Interest income 4.9 0.7 0.2 0.2 0.2 Other income (expense) 0.1 (0.1 ) 0.1 Total other income (expense), net (0.7 ) (11.7 ) (6.4 ) (9.1 ) 0.2 Income (loss) before income taxes (348.0 ) (86.1 ) (13.5 ) (19.4 ) 5.2 Provision for income taxes 0.1 Net income (loss) (348.0 )% (86.1 )% (13.5 )% (19.4 )% 5.1 % Comparison of the nine months ended September 30, 2004 and September 30, 2003 Net revenues Nine months ended September 30, (in thousands) Net revenues $24,527 $ 44,741 $ 20,214 82.4% The substantial increase in our net revenues for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 was primarily due to increased transaction volume and an increase in average net revenue per transaction. Transaction volume increased by 54% and contributed $12.8 million resulting from 6,163 transactions closed in 2004 compared to 3,992 transactions closed in 2003. Our transaction volume increased as we added additional ZipAgents in our existing markets which allowed us to attract and service new clients. We had 782 ZipAgents at September 30, 2004 compared to 425 at September 30, 2003. Average net revenue per transaction increased by 20% and contributed $7.2 million resulting primarily from representing buyers and sellers in transactions for higher priced homes in 2004 and as a result of two consumer rebate reductions. Of the 20% increase in average net revenue per transaction, approximately 15% and $5.6 million were due to higher home prices, and 5% and $1.6 million were due to our consumer rebate reductions. In September 2002, we lowered the rebate we paid to our buyer clients from 33.3% of our commission to 25% of our commission; the phase in of this reduction was completed in early Table of Contents Management s discussion and analysis of financial condition and results of operations 2003. In March 2004, we further lowered the rebate from 25% to 20%; the phase in of this reduction was completed by the end of the second quarter of 2004. The increase in referral and other revenues was not significant. Cost of revenues Nine months ended September 30, (in thousands) Cost of revenues $ 14,710 $ 24,389 $ 9,679 65.8% Our cost of revenues consists of commissions, related payroll taxes, benefits and expense allowances paid to our ZipAgents, and the amortization of internal-use software and web site development costs which relate primarily to our ZAP technology. The increase in cost of revenues for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 was due primarily to an increase in commissions, related payroll costs and expense allowances of approximately $9.6 million related to our growth in net transaction revenues. As a percentage of net revenues, cost of revenues decreased by 5.5 percentage points due primarily to the ZipAgent compensation changes we implemented from late 2002 through 2003. We expect our cost of revenues to increase in 2004 in absolute dollars as we continue to grow our business, but to remain relatively consistent as a percentage of net revenues. Product development Nine months ended September 30, (in thousands Product development $1,363 $ 1,639 $ 276 20.3% Product development expenses include our information technology costs, primarily compensation and benefits for our product development personnel, depreciation of equipment, communications expenses and other operating costs relating to the maintenance of our web site and our proprietary technology systems. The increase in product development expenses for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 was due to increases in salaries, benefits, consulting and communications costs of approximately $0.3 million. As a percentage of net revenues, product development expenses decreased 1.9 percentage points in the period due primarily to the significant growth in our net revenues. We expect our product development expenses to increase in 2004 in absolute dollars as we continue to grow our business but to continue to decrease as a percentage of net revenues. Marketing and business development Nine months ended September 30, (in thousands Marketing and business development $3,782 $ 6,325 $ 2,543 67.2% Table of Contents Management s discussion and analysis of financial condition and results of operations Marketing and business development expenses include compensation and benefits of our marketing and business development personnel and costs relating to our marketing, advertising and client acquisition activities. The increase in marketing and business development expenses in the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 was due to growth in our business and consisted primarily of increased lead generation spending of approximately $1.4 million necessary to support the increase in the number of ZipAgents and an increase of approximately $1.0 million in marketing and advertising as we commenced a print and radio campaign in the second quarter of 2004 in connection with our redesigned logo and branding effort. As a percentage of net revenues, marketing and business development expenses decreased 1.3 percentage points in the period due primarily to the significant growth in our net revenue. We expect our marketing and business development expenses to increase in 2004 in absolute dollars, but to remain flat or to modestly increase as a percentage of net revenues, as we acquire more leads for our expanding ZipAgent force and expand offline marketing and advertising campaigns to enhance our brand and expand geographically. General and administrative Nine months ended September 30, (in thousands) General and administrative $ 7,141 $ 10,014 $ 2,873 40.2% General and administrative expenses consist of compensation and benefits costs of our corporate employees, field support and management personnel, occupancy costs, legal and accounting fees, and other general operating support costs. The increase in general and administrative expenses in the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 was due to growth in our business and consisted primarily of approximately $1.8 million related to increased compensation, benefits, travel and related operating costs of our additional management and support personnel in our district sales offices and approximately $0.4 million related to recruiting and training our expanding ZipAgent force. Additionally corporate office expenses increased due to approximately $0.4 million of salaries, benefits and operating costs and approximately $0.2 million of outside accounting and other professional costs. As a percentage of net revenues, general and administrative expenses decreased 6.7 percentage points in the period due primarily to the significant growth in our net revenues. As we expand our business and incur additional costs associated with being a public company, we expect our general and administrative expenses to increase in absolute dollars and decrease as a percentage of net revenues. Stock-based compensation Nine months ended September 30, Table of Contents Management s discussion and analysis of financial condition and results of operations of grant. We amortize deferred stock-based compensation expense over the vesting periods of the individual options on the straight-line method. Outstanding options will continue to vest over future periods so long as the optionee continues in service to us. At September 30, 2004, we had approximately $0.5 million in deferred employee stock-based compensation on our balance sheet. Future compensation expense from options granted through September 30, 2004 is estimated to be approximately $0.1 million in the remainder of 2004, $0.2 million in 2005, $0.2 million in 2006 and $0.1 million in 2007. These amounts may decrease if stock options for which deferred stock-based expense has been recorded are forfeited through cancellation or repurchase prior to vesting. Interest expense Nine months ended September 30, (in thousands) Interest expense $ (2,271 ) $ $ (2,271) (100.0)% Interest expense consists of interest payments on our convertible debt, non-cash interest charges for the amortization of debt issuance and discount costs related to such debt and related warrants. Interest expense for 2003 was attributable to interest payable on our Series E and Series F convertible notes which were converted together with accrued interest to Series E and Series F mandatorily redeemable convertible preferred stock in June 2003. No convertible notes or other indebtedness was outstanding in the nine months ended September 30, 2004, and therefore we incurred no interest expense. Interest income Nine months ended September 30, (in thousands) Interest income $ 44 $ 95 $ 51 117.7% Interest income relates to interest we earn on our money market deposits. Interest income will fluctuate as our cash balances change and applicable interest rates increase or decrease. The amount of interest income was not significant in either period. Other income (expense), net Nine months ended September 30, (in thousands) Other income (expense), net $ (3 ) $ $ (3) (81.9)% Other income (expense), net consists of non-operating items, which have not been significant to date. Provision for income taxes Nine months ended September 30, Table of Contents Management s discussion and analysis of financial condition and results of operations Comparison of the years ended December 31, 2003 and December 31, 2002 Net revenues Year ended December 31, (in thousands) Net revenues $ 17,163 $ 33,807 $ 16,644 97.0% The substantial increase in our net revenues in the year ended December 31, 2003 as compared to the year ended December 31, 2002 was primarily due to increased transaction volume and an increase in average net revenue per transaction. Transaction volume increased by 59% and contributed approximately $9.8 million resulting from 5,387 transactions closed in 2003 compared to 3,379 transactions closed in 2002. Our transaction volume increased as we added additional ZipAgents and increased lead generation to attract new clients; we had 440 ZipAgents at December 31, 2003 compared to 279 at December 31, 2002. Average net revenue per transaction increased by 24% and contributed $6.3 million resulting primarily from representing buyers and sellers in transactions for higher priced homes in 2003 than in 2002 and as a result of our consumer rebate reduction in early 2003 which lowered the rebate we paid to our buyer clients from 33.3% of our commission to 25% of our commission in September 2002. Cost of revenues Year ended December 31, (in thousands) Cost of revenues $ 13,450 $ 19,929 $ 6,479 48.2% The increase in cost of revenues in 2003 as compared to 2002 was due primarily to an increase in commissions, related payroll costs and expense allowances of approximately $6.4 million related to our growth in net revenues. As a percentage of net revenues, cost of revenues declined 19.5 percentage points in 2003 due primarily to ZipAgent compensation changes we implemented from late 2002 through 2003. Product development Year ended December 31, Table of Contents Management s discussion and analysis of financial condition and results of operations Marketing and business development Year ended December 31, (in thousands) Marketing and business development $ 4,451 $ 5,003 $ 552 12.4% The increase in marketing and business development expenses in 2003 compared to 2002 was due to growth in our business and consisted primarily of increased lead generation spending of approximately $0.4 million necessary to support the increase in number of ZipAgents and an increase of approximately $0.2 million in compensation and benefits. As a percentage of net revenues, marketing and business development expenses decreased 11.1 percentage points in 2003 due primarily to the significant growth in our net revenues. General and administrative Year ended December 31, (in thousands) General and administrative $ 10,378 $ 9,464 $ (914 ) (8.8)% The decrease in general and administrative expenses in 2003 compared to 2002 was due to cost control measures resulting in approximately $0.7 million related to compensation, benefits and related travel and entertainment expenses and operating expenses of $0.3 million partially offset by increases in recruiting and training expenses of approximately $0.1 million, professional fees of approximately $0.1 million and occupancy costs of approximately $0.2 million. Additionally, depreciation expense decreased by approximately $0.3 million as older equipment became fully depreciated and no significant new equipment was acquired. As a percentage of net revenues, general and administrative expenses decreased 32.5 percentage points for the year due primarily due to the significant growth in our net revenues. Stock-based compensation Year ended December 31, (in thousands) Stock-based compensation $ 84 $ 85 $ 1 1.9% Our stock-based compensation expense remained relatively flat from 2002 to 2003. Interest expense Year ended December 31, Table of Contents Management s discussion and analysis of financial condition and results of operations notes payable issued in February 2003; these notes with accrued interest were converted to Series E and Series F mandatorily redeemable convertible preferred stock in June 2003. Interest income Year ended December 31, (in thousands) Interest income $ 126 $ 60 $ (66 ) (52.4)% The decrease in interest income from 2002 to 2003 was principally due to decreased interest rates on our deposits. Other income (expense), net Year ended December 31, (in thousands) Net transaction revenues $ 5,320 $ 8,325 $ 9,969 $ 9,065 $ 10,660 $ 15,902 $ 17,108 Referral and other revenues 273 308 332 215 239 368 (in thousands) Other income (expense), net $ (14 ) $ 21 $ (35 ) (242.7)% Other income (expense), net consists of non-operating items, which have not been significant to date. Comparison of the years ended December 31, 2002 and December 31, 2001 Net revenues Year ended December 31, (in thousands) Net revenues $ 3,963 $ 17,163 $ 13,200 333.1% The substantial increase in our net revenues in the year ended December 31, 2002 as compared to the year ended December 31, 2001 was primarily due to increase transaction volume and an increase in average net revenue per transaction. Transaction volume increased by 300% and contributed approximately $11.7 million resulting from 3,379 transactions closed in 2002 compared to 844 transactions closed in 2001. Our transaction volume increased as we added additional ZipAgents and increased lead generation to attract new clients; we had 279 ZipAgents at December 31, 2002 compared to 162 at December 31, 2001. Average net revenue per transaction increased by 7% and contributed $1.2 million resulting primarily from representing buyers and sellers in transactions for higher priced homes in 2002 than in 2001. Cost of revenues Year ended December 31, (in thousands) Cost of revenues $ 6,969 $ 13,450 $ 6,481 93.0% The increase in cost of revenues in 2002 as compared to 2001 was due primarily to an increase in commissions, related payroll costs and expense allowances of approximately $6.3 million related to our growth in net revenues and an increase in amortization of internal-use software and web site Table of Contents Management s discussion and analysis of financial condition and results of operations development costs of approximately $0.2 million as we continued to invest in our ZAP technology. As a percentage of net revenues, cost of revenues declined 97.5 percentage points in 2002 due primarily to the ZipAgent compensation changes we implemented during 2002 as well as achieving net revenues volume sufficient to cover fixed cost elements of the ZipAgent compensation structure in effect during 2001. Product development Year ended December 31, (in thousands) Product development $ 1,899 $ 1,559 $ (340 ) (17.9)% The decrease in product development expenses in 2002 as compared to 2001 was primarily due to cost control measures resulting in decreased consulting and operating costs of approximately $0.1 million and an increase in capitalized internal use software of approximately $0.1 million. In addition, depreciation expense decreased by approximately $0.1 million as older equipment became fully depreciated and no significant new equipment was acquired. As a percentage of net revenues, product development expenses decreased 38.8 percentage points in 2002 due primarily to these cost decreases and the significant growth in our net revenues. Marketing and business development Year ended December 31, (in thousands) Marketing and business development $ 3,225 $ 4,451 $ 1,226 38.0% The increase in marketing and business development expenses in 2002 compared to 2001 was due to growth in our business and consisted primarily of increased lead generation spending of approximately $1.0 million necessary to support the increase in our number of ZipAgents, and an increase in advertising expenses of $0.4 million offset by a decrease in consulting and public relations fees of approximately $0.2 million. As a percentage of net revenues, marketing and business development expenses decreased 55.5 percentage points in 2002 due primarily to the significant growth in our net revenues. General and administrative Year ended December 31, (in thousands) General and administrative $ 5,447 $ 10,378 $ 4,931 90.5% The increase in general and administrative expenses in 2002 compared to 2001 was primarily due to reestablishing executive and administrative functions following a significant reduction in work force in early 2001 resulting in approximately $4.0 million related to increased compensation, benefits and related travel and entertainment costs, increased general operating expense of approximately $0.6 million and increased recruiting and training expenses of approximately $0.1 million. As a percentage of net revenues, general and administrative expenses decreased 76.9 percentage points for the year due primarily to the significant growth in our net revenues. Table of Contents Management s discussion and analysis of financial condition and results of operations Stock-based compensation Year ended December 31, (in thousands) Stock-based compensation $ 185 $ 84 $ (101) (54.7)% Our stock-based compensation expense decreased in 2002 from 2001 primarily due to an accelerated vesting charge in 2001. Interest expense Year ended December 31, (in thousands) Interest expense $ (226 ) $ (2,118 ) $ 1,892 836.3% The substantial increase in interest expense for 2002 was attributable to the issuance of $19.5 million of our Series E and Series F convertible notes payable, issued in February 2002, April 2002 and December 2002, as well as interest payable on interim bridge loans issued in September and October 2002. Interest expense for 2001 consisted primarily of interest on capitalized leases. Interest income Year ended December 31, (in thousands) Interest income $ 193 $ 126 $ (67) (34.6)% Interest income was relatively flat in dollar terms from 2001 to 2002. Other income (expense), net Year ended December 31, (in thousands) Other income (expense), net $ 3 $ (14 ) $ (17) (647.5)% Other income (expense), net consists of non-operating items, which have not been significant to date. Quarterly results of operations The following table sets forth our selected unaudited quarterly operating information for each of the seven quarters ended September 30, 2004. This information has been prepared on the same basis as the audited financial statements contained elsewhere in this prospectus and includes all normal recurring adjustments necessary for the fair presentation of the information for the periods presented, when read together with our financial statements and related notes. Our future operating results are difficult to predict and may vary significantly. Results for any fiscal quarter are not necessarily indicative of results for the full year or for any future quarter. Table of Contents Management s discussion and analysis of financial condition and results of operations Three months ended Total operating expenses 7,692 9,501 9,860 9,145 11,026 15,103 16,365 (1) General and administrative expenses for the three months ended June 30 and September 30, 2004 included approximately $0.2 million and $0.1 million, respectively, of outside accounting costs related to the review of quarterly financial statements for inclusion in this prospectus. After experiencing consistent losses since inception, we experienced our first two profitable quarters in the second half of 2003. Although we experienced a significant seasonal slowdown in business, including web site and client activity and the number of signed purchase contracts in the fourth quarter of 2003, the seasonal impact which traditionally depresses first quarter revenues was masked by an unusually strong January and February 2004 in terms of new transactions which both originated and closed in the first quarter of 2004. Consequently, while we did incur a small loss in the first quarter of 2004, it was considerably smaller than anticipated due to higher than expected net revenues. We returned to profitability in the second and third quarters of 2004 as a result of strong revenues due to increased transaction volume and an increase in net revenue per transaction. We increased marketing and business development expenditures during these quarters to support our growing ZipAgent force and, additionally, increased our general and administrative expenses by adding to our field management and support infrastructure as we grow our business. LIQUIDITY AND CAPITAL RESOURCES We have funded our operations primarily through the sale of preferred stock and convertible notes which have provided us with aggregate net proceeds as of September 30, 2004 of approximately Table of Contents Management s discussion and analysis of financial condition and results of operations $65.8 million. As of September 30, 2004, we had cash and cash equivalents of $21.5 million and had no bank debt, line of credit or equipment facilities. Operating activities Our operating activities used cash in the amount of $11.8 million, $10.4 million, $0.2 million and $1.2 million in the years ended December 31, 2001, 2002 and 2003 and the nine months ended September 30, 2003, respectively. Our operating activities generated cash in the amount of $4.0 million in the nine months ended September 30, 2004. Uses of cash were primarily to fund net losses and changes in working capital. Cash generated in the nine months ended September 30, 2004 was due to achieving profitability for the period plus net changes in working capital and non-cash items. Our primary source of operating cash flow is the collection of our commission income from escrow companies or similar intermediaries in the real estate transaction closing process. Due to the structure of our commission arrangements, our accounts receivable are converted to cash on a short-term basis and our accounts receivable balances at period end have historically been significantly less than one month s net revenues. Our operating cash flows will be impacted in the future by the timing of payments to our vendors for accounts payable, which are generally paid within the invoice terms and conditions. Our cash outflows are also impacted by the timing of the payment of our accrued liabilities relating to commissions and related compensation costs and client acquisition costs. A number of non-cash items have been charged to expense and increased our net loss or decreased our net income. These items include depreciation and amortization of property and equipment, amortization of debt discounts and non-cash interest expense relating to our debt arrangements, and amortization of deferred employee stock-based compensation expense and other stock-based charges. To the extent these non-cash items increase or decrease in amount and increase or decrease our future operating results, there will be no corresponding impact on our cash flows. Investing activities Our investing activities used cash in the amount of $0.6 million, $0.6 million and $0.3 million in 2001, 2002 and 2003, respectively. Our investing activities used cash in the amount of $0.2 million and $1.1 million in the nine months ended September 30, 2003 and 2004, respectively. Uses of cash for investing activities were primarily related to purchases and sales of property and equipment and changes in restricted cash collateralizing our office and automobile leases. We primarily invest our cash in money market funds and other highly liquid securities with maturities of less than 90 days. Currently, we expect our 2004 capital expenditures to be approximately $1.4 million. In the future, our ability to make significant capital investments may depend on our ability to generate cash flow from operations and to obtain adequate financing, if necessary and available. Financing activities Our financing activities provided cash in the amount of $7.3 million, $19.1 million, $1.9 million, $2.0 million and $8.3 million in the years ended December 31, 2001, 2002 and 2003 and the nine months ended September 30, 2003 and 2004, respectively. Sources of cash from financing activities primarily represented proceeds from the issuance of our convertible preferred stock, notes convertible into our preferred stock or preferred stock warrant exercises. Uses of cash through 2003 were primarily related to repayment on capital lease obligations. At September 30, 2004, we no longer had any capital lease obligations. As of September 30, 2004 we had warrants outstanding for the purchase of an aggregate of 4,912,729 shares of our common stock at a weighted average exercise price of $3.93 per share. All of Table of Contents Management s discussion and analysis of financial condition and results of operations these warrants are currently exercisable at the option of the holders. If all or a portion of these warrants were exercised for cash, we could receive significant proceeds at that time. Future needs We believe that cash flows from operations and our current cash and cash equivalents will be sufficient to fund our operations for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of growth into new geographic markets, our level of investment in technology and advertising initiatives. Although we are currently not a party to any agreement or letter of intent with respect in investments in, or acquisitions of, complementary businesses, products or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. We currently have no bank debt or line of credit facilities. In the event that additional financing is required, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operations and results will likely suffer. CONTRACTUAL OBLIGATIONS AND COMMITMENTS We lease office space and equipment under non-cancelable operating leases with various expiration dates through January 2007. The following table provides summary information concerning our future contractual obligations and commitments at December 31, 2003. Payments due by period Less than More than 1 year 1 to 3 years 3 to 5 years 5 years Total (in thousands) Operating lease commitments $ 553 $ 1,153 $ 49 $ $ 1,755 OFF-BALANCE SHEET ARRANGEMENTS We do not have any off balance-sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases. EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity, if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB issued FIN 46-R (revised December 2003), Consolidation of Variable Interest Entities, to address certain FIN 46 implementation issues. The effective dates and impact of FIN 46 and FIN 46-R are as follows: Special-purpose entities, or SPEs, created prior to February 1, 2003. We must apply either the provisions of FIN 46 or early adopt the provisions of FIN 46-R at the end of the first interim or annual reporting period ending after December 15, 2003. Non-SPEs created prior to February 1, 2003. We are required to adopt FIN 46-R at the end of the first interim or annual reporting period ending after March 15, 2004. All entities, regardless of whether an SPE, created subsequent to January 31, 2003. The provisions of FIN 46 were applicable for variable interests in entities obtained after January 31, 2003. Table of Contents Management s discussion and analysis of financial condition and results of operations The adoption of the provisions applicable to SPEs and all other variable interests obtained after January 31, 2003 did not have a material impact our financial position, results of operations, or liquidity. We believe that the adoption of FIN 46-R will not have a material impact on our financial position or results of operations because we have no subsidiaries or other consolidated entities and have no other arrangements which we believe meet the definition of a variable interest entity. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts. SFAS No. 149 clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying to conform it to language used in FASB Interpretation, or FIN, No. 45, and amends certain other existing pronouncements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. All provisions of the Statement, except those related to forward purchases or sales of when-issued securities, should be applied prospectively. We do not currently have any instruments that meet the definition of a derivative, and therefore, the adoption of this Statement has had no effect on our financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting For Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. Many of these instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on our financial position or results of operations. In November 2003, the EITF issued EITF No. 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128, which provides for a two-class method of calculating earnings per share computations that relate to certain preferred stock that would be considered to be participating in conjunction with certain common stock rights. This guidance became applicable to us starting with the second quarter beginning April 1, 2004. We have adopted the provisions of this pronouncement as of April 1, 2004. Prior period earnings per share amounts presented have been restated to conform with EITF No. 03-6. In December 2003, the SEC released Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition. SAB 104 revises or rescinds portions of the interpretative guidance related to revenue recognition included in Topic 13 of the codification of the staff accounting bulletins. We have assessed the impact of SAB 104 and concluded that our adoption of SAB 104 did not have a material impact on our financial position or results of operations. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest rate sensitivity We do not have any debt and thus do not have any related interest rate exposure. Our investment policy requires us to invest funds in excess of current operating requirements. The principal objectives of our investment activities are to preserve principal, provide liquidity and maximize income consistent with minimizing risk of material loss. Table of Contents Management s discussion and analysis of financial condition and results of operations As of September 30, 2004, our cash and cash equivalents consisted primarily of money market funds. The recorded carrying amounts of cash and cash equivalents approximate fair value due to their short maturities. Our interest income is sensitive to changes in the general level of interest rates in the United States, particularly since the majority of our investments are short-term in nature. Due to the nature of our short-term investments, we have concluded that we do not have material market risk exposure. Exchange rate sensitivity We consider our exposure to foreign currency exchange rate fluctuations to be minimal, as we do not have any sales denominated in foreign currencies. We have not engaged in any hedging or other derivative transactions to date. Table of Contents Management s discussion and analysis of financial condition and results of operations Business OVERVIEW We are a full-service residential real estate brokerage firm, using the Internet, proprietary technology and efficient business processes to provide home buyers and sellers with high-quality service and value. Our solution includes a client-centric business approach, a sophisticated web site that empowers home buyers and sellers with relevant information, a proprietary business management technology platform and significant financial savings for consumers. With operations in 12 major metropolitan areas, we employ over 750 sales agents, known as ZipAgents, all of whom are licensed in their local markets, are members of the National Association of REALTORS and work for us on an exclusive, full-time basis. We believe that this unique employee-based model in an industry characterized almost exclusively by independent contractors provides us with a distinct competitive advantage in being able to consistently deliver outstanding service to our clients. Through our web site, registered users can access a broad range of current information and powerful tools to research and commence the process of buying or selling a home, including direct access to comprehensive local Multiple Listing Service(s) home listings data, such as asking prices, home layouts and other features. Each MLS is a database of available homes listed for sale by participating member agents to facilitate broker cooperation. We also provide information in addition to MLS data, including neighborhood attributes, school district information, comparable home sales data, maps and driving directions. We attract users to our web site through a variety of marketing channels, including online advertising, word-of-mouth and advertisements in traditional media. Our proprietary ZipAgent Platform automatically matches registered users with our local ZipAgents who market and provide our comprehensive real estate brokerage services, including showing properties to our buyers and listing and marketing properties on behalf of our sellers, as well as negotiating, advisory, transaction processing and closing services. Our ZAP technology also includes a customer relationship management system that identifies and analyzes user behavior on our web site allowing us to provide more relevant information and service to clients and a business management system that allows our managers to monitor the activities of our ZipAgents to ensure a high level of client service. According to a 2004 survey by the California Association of REALTORS , 88% of home buyers who used the Internet as an important part of their home buying and selection process were very satisfied with their agent experience, compared to only 30% for traditional home buyers who did not use the Internet as an important part of their process. Our business was founded in 1999 and has grown rapidly since inception. We generate revenues principally from earning brokerage commissions in connection with representing buyers and sellers of residential real estate. In 2003, we generated $33.8 million in net revenues, compared to $17.2 million in 2002 and $4.0 million in 2001. As of September 30, 2004, we had over 400,000 active registered users who had accessed our web site within the last nine months, and since our inception we had closed over 16,100 real estate transactions with an aggregate transaction value of approximately $5.0 billion. We currently have operations in Atlanta, Baltimore/ Washington D.C./Northern Virginia, Boston, Chicago, Dallas, Los Angeles, Orange County, Phoenix/ Scottsdale, Sacramento, San Diego, the San Francisco Bay Area and Seattle. INDUSTRY BACKGROUND The U.S. residential real estate market The residential real estate industry is one of the largest in the United States. According to REAL Trends, an industry research firm, residential real estate sales totaled over $1.5 trillion in 2003. Also according to REAL Trends, sales of existing homes comprise the vast majority of the residential real Table of Contents Business estate market, accounting for $1.3 trillion of 2003 total home sales. Additionally, REAL Trends reported that total residential real estate brokerage commissions and fees, which are primarily derived from existing home sales, were approximately $60 billion in 2003. We believe that favorable demographic, cultural and economic trends have contributed to consistent long-term growth in the residential real estate industry. From 1983 to 2003, the residential real estate industry grew at a compound annual growth rate of 9% in terms of aggregate sales volume. The residential real estate brokerage market is highly fragmented. According to REAL Trends, the 10 largest brokerage firms accounted for approximately 10% of all brokered residential real estate transaction volume in 2003, and the single largest firm accounted for less than 5% of total transaction volume. According to NAR, there are in excess of one million members of NAR and an estimated 70,000 residential real estate brokerage firms in the United States. Some brokerage firms are affiliated with national franchise brands, such as Century 21, Coldwell Banker, Prudential and RE/ MAX. The franchise brands typically do not directly own and operate brokerage firms, but rather license their brand names and trademarks and provide other marketing support to franchisee brokerage firms. These brokerage firms typically engage agents to work for them as independent contractors and as a result franchisors and franchisees have limited direct influence over the client relationship or the quality of client service. Brokerage firms associated with the eight largest brands accounted for approximately 50% of total brokered transaction volume in 2003 according to REAL Trends. Traditional real estate transaction process The traditional real estate transaction process centers on real estate agents, who act as the principal intermediary between home buyers and sellers and control the flow of information to both. Prior to the relatively recent influence of the Internet, prospective home buyers and sellers would typically rely on their agents, word of mouth, newspapers and local publications for information regarding homes available for sale. Information presented in traditional media has historically been limited, often consisting of only a single photo and a brief description. In order to gain access to a broader range of information, prospective home buyers would typically engage an agent. One of the primary benefits traditionally offered by an agent is access to MLS home listings data and the ability to search and filter that data based upon specified criteria. Because consumers have not traditionally had direct access to this data, the agent has primary control over the process of searching and filtering the MLS data under this system. Consequently, consumers cannot be assured of access to comprehensive and relevant information. Prospective home buyers rely on the agent to identify and show them relevant properties and typically spend a great deal of time physically viewing these properties. Therefore consumers may spend unnecessary time visiting homes that they would have decided not to visit, and may fail to visit homes that would have been of interest, if they had access to more comprehensive information. Traditionally, prospective home sellers have had similarly limited opportunities to investigate the current market or to efficiently and effectively market and sell their homes. Sellers would typically call a local agent to list their home for sale and would rely on that agent to give them guidance on the market value of the home and the most effective manner to successfully market and sell the home. The agent would then enter into an exclusive listing agreement with the seller and post the property for sale in the local MLS. Commissions vary from market to market, but generally range from 5% to 6% of the total sales price of the home. Many agents and brokerages are reluctant to compete on price and instead rely on historical market commission percentages to set their rates. The commission is paid by the seller at the closing and is typically split between the buyer s agent and the seller s agent. Table of Contents Business Increasing use of the Internet in the residential real estate transaction process Consumers are increasingly using the Internet as a key source of information in buying or selling a home. Currently, more than 70% of home buyers use the Internet in their home search, up from 41% in 2001, as reported by Business Week in May 2004. The Internet provides a highly effective means for consumers to research information about homes in an industry that is data intensive yet historically has suffered from a lack of broad access to comprehensive and timely property listings information for consumers. The interactivity of the Internet also allows consumers to better conduct targeted searches and research relevant data about desired homes or areas. The ability to provide multiple images and rich media makes the Internet a highly effective means for brokerage firms to market and consumers to research homes. Challenges and limitations of the traditional residential real estate process We believe that the traditional residential real estate industry is characterized by a number of challenges and limitations, including: Challenges for home buyers and sellers. We believe that the traditional residential real estate industry is characterized by low levels of client satisfaction. Some contributing factors include: limited access to, and transparency of, information; high commissions; lack of client control over the process; and low levels of agent responsiveness and accountability. Challenges for agents. Agents often have difficulty generating consistent transaction volume, resulting in inconsistent earnings. Some contributing factors include: need to spend considerable personal time and money generating potential clients; limited resources to properly manage client relationships and transaction processes; and responsibility for other business expenses and personal benefits. Challenges for brokerage firms. Traditional brokerage firms have difficulty differentiating their services and effectively managing agents and ensuring client satisfaction. Some contributing factors include: independent contractor nature of agent relationship limits accountability and managerial effectiveness; ownership and management of client relationships resides with the agents; and low levels of client and agent loyalty. OUR BUSINESS MODEL We are a full service residential real estate brokerage firm using the Internet, proprietary technology and efficient business processes to provide home buyers and sellers with high-quality service and value. We believe that we have developed a unique client-centric approach to the residential real estate brokerage process. The key attributes of our solution include: Addressing challenges for home buyers and sellers We use the Internet to empower consumers. Through our web site, we empower our registered users with comprehensive, free and unrestricted access to all currently available home listings posted on the MLSs in our markets and the ability to research and compare homes. Our MLS data is updated at least once per day in each of our markets. We also provide valuable information and services to Table of Contents Business potential home buyers through our web site, such as home and neighborhood content, automated screenings and notifications of available homes that meet specified criteria, the ability to schedule home viewing appointments or make offers online and financing pre-approval. We offer home sellers online comparative marketing tools and virtual tours, as well as broad marketing distribution through the Internet and traditional media. We focus on delivering high-quality service with a client-centric approach. Our solution is built around the client, not the agent. We acquire a majority of our client leads and provide ongoing value-added services through the Internet, allowing us, rather than the agent, to control the client relationship. With our employee model, we hold our agents accountable for consistently delivering a high level of client service and satisfaction. We monitor each of our ZipAgents through our ZAP technology to ensure a high level of responsiveness and enable us to quickly address any potential issues. To back up our commitment to client service, we offer our clients a $250 cash refund if they are unsatisfied with our services. In addition, our clients can influence the commission paid to their ZipAgent based upon the results of a client satisfaction survey. We offer a compelling consumer value proposition. Our use of the Internet, proprietary technologies and efficient business processes allow us to offer significant cash rebates to our buyers and reduced commissions to our sellers. We presently pay each of our home buyers an amount equal to 20% of our commission in cash upon closing and offer our home sellers up to a 25% discount off of standard commissions in their particular market. Addressing challenges for agents and brokerage firms We use proprietary business management technologies and processes to increase operational efficiency and provide excellent client service. Our proprietary ZAP technology utilizes the interactivity, broad availability and efficiencies of the Internet to allow us to increase ZipAgent productivity. After a new client completes the registration process, our ZAP technology automatically monitors the client s searching behavior from the initial search session and assigns that client to a ZipAgent who specializes in the specific territories most frequently searched by that client during that initial session. Only leads that are qualified, meaning that the client has completed the registration process and has conducted at least one home search in an area in which we do business, are assigned to our ZipAgents, allowing our agents a steady flow of clients who are searching in the territories in which they specialize. Our ZAP technology also provides a system for organizing and prioritizing these leads, valuable customer relationship management, or CRM, tools and visibility into client web site behavior. Our ZAP technology also allows our managers to observe and manage how our ZipAgents are servicing our clients. We also have proprietary transaction support tools and a dedicated group of service professionals to help our ZipAgents close transactions more efficiently. We believe our integrated consumer web site and ZAP technology are difficult to replicate and allow us to manage employees effectively, rapidly scale our business to meet client needs, and provide outstanding client service. We offer a compelling value proposition to agents. We believe our employee-based model and ZAP technology offer a unique and attractive proposition to agents compared with that found at traditional brokerages, including the ability to work more efficiently and close more transactions. We design, implement and bear the cost of all marketing programs for our ZipAgents, including the delivery of a steady flow of client leads, allowing them to focus on serving clients rather than generating new business. Additionally, all of our ZipAgents receive comprehensive initial training and participate in various ongoing training activities. All of our ZipAgents are full-time ZipRealty employees and are eligible for employee benefits including company-sponsored health, welfare, retirement and equity Table of Contents Business incentive plans. We believe that a number of factors contribute to our ZipAgents ability to close more transactions than is typically achieved in the industry, in particular: our ZipAgents receive a steady flow of qualified leads without individual marketing efforts, allowing them to rapidly develop a good pipeline of clients; our ZAP technology, with its proprietary CRM tools, allows our ZipAgents to remain organized and communicate and sell effectively with numerous clients at the same time; and our system includes closing support infrastructure that allows our ZipAgents to spend less time on closing tasks and more time on new clients than they would otherwise be able to without this support in place. Our ZipAgent productivity has consistently exceeded that typically achieved by agents in the industry. According to an annual ranking in Realtor Magazine, the number of monthly transaction sides per agent for the largest 10 brokerages in the United States averaged approximately 0.8 in 2002 and 2003. We are not aware of the methodology used by Realtor Magazine to calculate these productivity levels. For 2002, 2003 and the nine months ended September 30, 2004, the average monthly productivity of our ZipAgents ranged from 1.21 to 1.29 transactions per ZipAgent. We calculate the average monthly productivity of our ZipAgents during a quarter by dividing the average monthly number of transactions closed during the quarter by the number of ZipAgents employed at the beginning of the quarter. We do not adjust the denominator for ZipAgents hired during the quarter, because closing transactions in the first three months of joining us is difficult given the time lags involved in the real estate closing process. The productivity level of our ZipAgents who have been with us in excess of three full months is considerably higher than the average level achieved by all our ZipAgents. We also do not adjust the denominator for ZipAgents who leave us during the quarter. OUR STRATEGY Our objective is to become one of the most recognized, respected and successful companies in the residential real estate industry. The key elements of our strategy include: Broaden and deepen our presence in existing markets We plan to increase our presence and market share in existing markets by expanding our number of ZipAgents, continuing to improve ZipAgent productivity and growing our home listings business. While our focus historically has been on buyers, we intend to grow our home listings business in a number of ways, such as by developing more web site tools for sellers, implementing a referral system that encourages ZipAgents and clients to refer home listings and using dedicated listing specialists. We also intend to increase our penetration into the higher-priced home segment. Enhance the ZipRealty brand We believe that enhancing the ZipRealty brand will heighten awareness of our company and increase the number of home buyers and sellers who use our services and ultimately increase the number of transactions that we close. We recently redesigned our logo and reinitiated advertising campaigns on offline media such as radio, outdoor and print to promote this new branding effort. We also plan to advertise through television media to further promote our brand. In addition, we believe that we can enhance our brand by continuing to focus on client service, with the objective of creating lifelong relationships with our clients. Continue to invest in technology and our people to increase operational efficiency We plan to continue improving our proprietary technology platform to increase ZipAgent productivity and provide consistently high levels of client service and satisfaction. We intend to continue to design tools that help our ZipAgents better qualify and prioritize leads and identify levels of client Table of Contents Business responsiveness and implement communication services that allow our ZipAgents to be more responsive and productive. In addition to enhancing our technology, we intend to continue to refine our recruiting and training programs and provide our ZipAgents with additional field support in an effort to continue increasing ZipAgent productivity. Our centralized infrastructure is designed to enable us to rapidly expand our business and take advantage of economies of scale. Expand operations into new geographic markets We believe that there is a significant opportunity to expand our services into new geographic markets represented by over 250 U.S. metropolitan statistical areas, or MSAs. We currently operate in 12 major metropolitan areas, including 11 of the top 25 U.S. MSAs, and we are currently evaluating the relative attractiveness of these markets and developing entry strategies and timelines. In determining which markets we intend to expand into and in what order, we consider a variety of criteria, including demographics, business climate, housing market, competition, technology fit and regulatory environment. Currently, several states prohibit sharing any commissions with, or providing rebates to, clients who are not licensed real estate agents. In addition, other states may limit or restrict our cash rebate program as currently structured. Should we decide to expand into any of these states, we may have to adjust our pricing structure or refrain from offering rebates to buyers in these states. Continue to improve the client experience We believe that ongoing client satisfaction is critical to our continued success and future growth. As a result, we continually focus on improving the client experience on our web site and with our ZipAgents. In addition to enhancing the functionality of our web site, we plan to provide additional information to home buyers and sellers, including transaction documentation, improved personalization and search features such as comparison and market analysis tools, additional seller tools to improve our listings business and enhanced image capabilities. We also plan to provide clients with the ability to monitor the transaction process and view documentation online. OUR CONSUMER WEB SITE AND SERVICES Our real estate services enable consumers to control the home buying or selling process from the comfort of their home or office. Consumers enjoy an Internet-enabled, easy-to-use approach to the real estate process and have access to a team of local ZipAgents. Our ZipAgents typically have extensive market knowledge of the metropolitan areas they serve and are required to be active members of their local, state and national real estate and MLS associations. In addition, our web site, www.ziprealty.com, provides a step-by-step approach to guide clients through the home buying and selling process. Our web site and agent platform software is proprietary to us. We enhance our web site by including information such as home listings, neighborhoods and recent home sales that we obtain from local MLSs and other third party providers. Comprehensive MLS access for home listings data We offer individuals who register on our web site access to comprehensive available home listings data, including pictures, from the local MLSs in the markets in which we operate. As active members of the MLSs in the markets we serve, we organize the data from each MLS database and provide it directly to consumers on our web site. Unlike many real estate web sites, we show listings from all broker participants in the MLSs, not just our own listings. We update this data frequently, often multiple times daily. Our web site is password protected, so only individuals who provide basic registration information, agree to our terms of use and then return to our site to input a code which we email to them at the time of their registration, are able to access comprehensive home listings data. Consumers can search for homes based upon numerous criteria, including location, price, square footage, number of bedrooms and bathrooms, and other characteristics and amenities such as lot size, whether it has a Table of Contents Business fireplace or central air, and numerous other features. We do not show information from the MLS databases that is marked as confidential, such as information relating to home security. ZipNotify One of our most popular consumer web site tools is called ZipNotify, which allows consumers to receive an automatic email notification each time a property which meets their desired search criteria is listed on the local MLSs. Since we update our listings information at least once per day in each market, our registered users are able to learn about new listings in a very timely manner. In markets that are characterized by short supply, this tool provides our clients a competitive advantage over other consumers who might have to wait for their agent to learn about the listing and then contact them with the information. The ZipNotify tool is also interactive, so with one click the consumer can login to see more detailed information on the home, schedule a visit with one of our ZipAgents to see the home, or send an email to one of our ZipAgents requesting more information about the property. Our number of ZipNotify messages has grown steadily, and averaged over 6.7 million per month in the third quarter of 2004 compared to 2.9 million per month in the third quarter of 2003. Neighborhood data and related information Our system is designed to provide consumers with access to a broad range of information in addition to the MLS data about their potential home without having to rely on an agent or other party to provide that information for them. Consequently our web site includes several tools to help our clients educate themselves during the process, including relevant neighborhood data such as population, comparable home sales, average income, education level, occupation mix, cost of living, crime statistics, weather, school district information, maps and driving directions. Online images and virtual tours We believe that one of the principal attractions of the Internet for consumers researching homes is the ability for consumers to view images of available homes. For our seller clients, we offer virtual home tours and photos of our home listings at no additional cost. For our buyer clients, in addition to the customary single photo, in select markets we have the ability to post multiple property photos from the local MLSs, giving clients a more robust search experience. This enables home buyers to better research homes before deciding whether to visit them. Schedule visits We try to make it as easy and convenient as possible for our buyer clients to schedule visits of properties they would like to see. All a client has to do is click on a button when viewing information about a home on our web site and enter in their phone number and what day(s) and time(s) they would prefer to see the home. We then contact the listing agent and organize the visit for our client. Alternatively, our clients can contact their ZipAgent by telephone or fax to schedule a visit. Home offers While the vast majority of clients prefer to make offers through their ZipAgent, some clients like the convenience and speed of submitting their offers online. We provide this capability through our web site by allowing clients to input all of the relevant information into our offer form. We then fill out the appropriate paperwork and obtain signatures from, and submit the offer on behalf of, our client. Financing pre-approval Obtaining pre-approval for a home purchase prior to submitting an offer can greatly strengthen the quality of an offer for our buyers. Therefore, we offer our clients a pre-approval option on our web site through the ZipRealty Mortgage Center, which is provided by E-LOAN, Inc. Clients input all of the required data into the online form, and the pre-approval process can be completed in a matter of Table of Contents Business minutes. Clients can conveniently print out their own pre-approval letters from E-LOAN to submit with offers. Clients can also call E-LOAN through our mortgage center for additional assistance. ZIPAGENT PLATFORM Our ZipAgent Platform is our proprietary web-based system that systematically integrates and records all consumer contact information and web site behavior, ZipAgent behavior and transaction information into a common Oracle-based platform. ZAP records relevant consumer behavior such as logon frequency and times, specific homes viewed and printed, searches made by clients, requested visits to view a home and online offers. The system also records and organizes all relevant ZipAgent activities, such as frequency and length of ZipAgent logins, automatically captures and stores all email communications, organized by client, and requires ZipAgents to input summary information about all client phone calls, visits conducted and offers submitted and accepted. We use the data collected by ZAP to more effectively manage our ZipAgents to ensure each is working diligently, productively and in our clients best interests. The system also incorporates proprietary CRM tools that allow ZipAgents to manage their databases of clients. For example, one tool uses predictive behavior to help our ZipAgents identify those clients who are likely to need their services in the near term. ZAP also has an array of real-time management reports which gives our management detailed visibility into daily business activity. Finally, ZAP includes automated closing checklists and tools that allow our ZipAgents and district coordinators who assist our ZipAgents in the closing process to efficiently handle the closing of multiple transactions. We believe that ZAP enables our ZipAgents to be more productive and enhances the level of service we provide our clients. ZIPAGENTS We believe that we are one of the few residential real estate brokerages that engages its agents as full-time employees rather than as independent contractors. Independent contractors work for themselves, not a brokerage, and consequently have a tremendous degree of independence in how they spend their time, when they work and how well they service clients. In contrast, our employee-based model allows us to actively manage and train our ZipAgents and hold them accountable for their activities and client service levels. We believe that by actively managing and training our employee ZipAgents we can both enhance the client experience and increase ZipAgent productivity. Compensation structure We offer our ZipAgents a compensation package that we believe is attractive compared to that offered by traditional brokerage firms. We believe that our compensation package leads to a higher degree of ZipAgent loyalty and a consistently high level of client service. Our compensation package includes: Commissions. As is customary in the real estate brokerage industry, ZipAgents earn a portion of the commissions they generate for us, which is known as their split. Industry commission splits vary widely, but frequently range from 70% to 80% to the agent and the balance to the brokerage firm. Our commission splits to ZipAgents vary from as low as 40% to as high as 75% of our net revenues, after deducting certain other items. Expense allowance. All ZipAgents receive an expense allowance of $750 to $1,500 per month, depending on their level of productivity. This allowance is designed to allow ZipAgents to cover many expenses typically related to their business, such as automobile, cell phone and Internet connectivity. Company-paid expenses. In the traditional independent contractor model, agents are typically responsible for covering all of their own expenses, including the cost of lead generation, advertising and marketing costs associated with selling homes, production of collateral materials and Table of Contents Business transaction coordination costs if those services are desired. In our model, we cover these costs for all of our ZipAgents who meet certain levels of productivity. For those ZipAgents who do not meet this threshold, we charge a client acquisition fee of $750 per month. Benefits. One of the advantages of our employee-based model for our ZipAgents is that we provide them with a broad array of benefits that are uncommon in the real estate brokerage industry, including company-sponsored health, welfare and 401(k) plans. In addition, ZipAgents have the ability to earn stock options in connection with annual performance reviews and in some cases based upon transaction volume. Recruiting and training At September 30, 2004, we employed a staff of 15 full-time recruiters who are solely dedicated to identifying and qualifying prospective ZipAgents. We offer extensive training programs both for new ZipAgents as they join us, as well as for existing ZipAgents on an on-going basis. New ZipAgents currently receive a week of orientation and initial training on how to use ZAP in one of our two regional training facilities. ZipAgents then enter their respective local markets and are required to complete a series of training modules with their manager and other local resources during their first several weeks. On an on-going basis, ZipAgents are presented with training content through multiple channels, including webcasts, interactive web training modules and live presentations during their weekly sales meetings. New ZipAgents are also frequently paired with seasoned ZipAgents for their first few transactions to accelerate their training. CLIENT ACQUISITION Lead generation We want our ZipAgents to focus on providing high-quality client service, rather than finding their next client. Accordingly, we provide ZipAgents with leads of clients who are actively searching on our web site for properties in their sales territories. We attract these clients principally by using two types of lead sources. First, we retain hosts of other web sites to provide links to our web site. Those hosts are typically businesses that are lead generators or that are involved in the real estate or financial services industries. Second, we actively advertise in key locations on the Web where consumers gather or conduct searches for real estate information. We currently have contractual relationships with over 40 lead sources of either type. In the first nine months of 2004 there were three independent lead sources that each generated in excess of 10% of our leads during that period: Commission Junction, our Yahoo! co-branded initiative in four of our markets, and Homegain, Inc. These lead sources generated approximately 15%, 14% and 22% of our leads during this period, respectively. The Yahoo! co-branded initiative ended on July 31, 2004, and our strategy includes replacing the Yahoo! leads with a smaller number of leads from other sources that we believe, based upon our historical conversion data, will continue to provide ample deal flow for our ZipAgents in these markets to allow them to be successful. Our largest lead source during the first nine months of 2004, Homegain, competes with us for on-line customer acquisition. In addition to paid lead sources, in the first nine months of 2004 we attracted approximately 26% of our leads directly to our web site, which involved no direct acquisition costs. The majority of our lead source agreements are in the form of non-exclusive, short-term agreements (six months or less) that are generally terminable on little or no notice (60 days or less) and with no penalties. These agreements typically are priced on a cost-per-click, or CPC, cost-per-lead, or CPL, or cost-per-impression, or CPM, basis, with a majority being on a CPC and CPL basis. Under our CPC agreements, we pay a fixed amount each time a potential client clicks on one of our advertisements and is directed to our web site. Under our CPL agreements, we pay a fee for each lead we generate from that source. We define a lead as a client who has registered on our web site, confirmed an email address, searched for homes in an area where we have operations, and has been assigned to one of our Table of Contents Business ZipAgents. Under our CPM agreements, we are charged a fee each time a potential client views one of our advertisements. We have found that localized content is a key to driving qualified leads to our site. Once a client visits our web site, we are able to track significant information about the client, including which web site and link the consumer clicked on, how frequently they visit our web site, what activities they perform while on our web site and whether they ultimately transact with us. By using this data, we believe we can optimize our lead generation expenses based on the most productive sources and continually refine the ways in which we advertise our services. Offline marketing We recently redesigned our logo and reinitiated advertising campaigns on offline media such as radio, outdoor and print to promote this new branding effort. Our media plan, which over time we anticipate will include additional media such as television, focuses on heightening awareness of our company and increasing the number of home buyers and sellers who use our services and ultimately transact with us. Beginning with a limited number of test markets, we plan to gauge the effectiveness of the advertising before rolling it out on a broader scale. Finally, we believe that we will enhance our brand by continuing to focus on client service, with the objective of encouraging word-of-mouth referrals and creating lifelong relationships with our clients. PRODUCT DEVELOPMENT AND ENGINEERING At September 30, 2004, our technology team was comprised of 21 employees, including a product development team, software engineers, database and data center engineers and a data acquisition team. Our technology team focuses on enhancing and improving our existing technology as well as developing new proprietary tools. Our technology team is responsible for maintaining property listings data through our over 30 MLS memberships. In order to ensure we provide the most comprehensive and timely data available, we download MLS data seven days a week, and for most MLSs, multiple times per day. Currently, we provide information on more than 400,000 homes in our searchable database in the markets we serve. To provide our consumers with a more complete understanding of homes and neighborhoods, we combine data from the MLSs with additional local information from other data sources which we license on a non-exclusive basis. Our product development team is responsible for fulfilling all product requirements on both our consumer web site and the ZipAgent Platform. This team generally internally releases software updates approximately once per quarter. As part of our development process, the product development team works with users to identify feature enhancements that will provide a better consumer experience, increase ZipAgent productivity and enhance management oversight capabilities. Our system is not dependent on a client s computer configuration, working with all principal Internet service providers and Internet browsers. Our system is Java-based and uses commercially available hardware and proprietary database technology based on an Oracle platform, making it highly scalable. Our application server is compliant with relevant industry standards. We serve our clients from a third party co-location facility located in Sunnyvale, California, operated by Qwest Communications. The facility is secured by around-the-clock guards and biometric access screening and is equipped with back-up generators, redundant HVAC and Internet connectivity. We regularly rotate back-up tapes to another location for safekeeping. Table of Contents Business REGULATORY MATTERS The real estate industry is highly regulated. In the conduct of our business, we must monitor and comply with a wide variety of applicable laws and regulations of both the government and private organizations. Government regulation The most extensive regulations applicable to our business are at the state level and are typically overseen by state agencies dedicated to real estate matters. However, the residential real estate industry is also regulated by federal and local authorities. State regulation. Real estate licensing laws vary from state to state, but generally all individuals and entities acting as real estate brokers or salespersons must be licensed in the state in which they conduct business. A person licensed as a broker may either work independently or may work for another broker in the role of an associate broker, conducting business on behalf of the sponsoring broker. A person licensed as a salesperson must be affiliated with a broker in order to engage in licensed real estate brokerage activities. Generally, a corporation engaged in the real estate brokerage business must obtain a corporate real estate broker license. In order to obtain this license, most jurisdictions require that an officer of the corporation be licensed individually as a real estate broker in that jurisdiction. If applicable, this officer-broker is responsible for supervising the licensees and the corporation s real estate brokerage activities within the state. Real estate licensees, whether they are brokers, salespersons, individuals or entities, must follow the state s real estate licensing laws and regulations. These laws and regulations generally prescribe minimum duties and obligations of these licensees to their clients and the public, as well as standards for the conduct of business, including contract and disclosure requirements, record keeping requirements, requirements for local offices, trust fund handling, agency representation, advertising regulations and fair housing requirements. Although payment of rebates or credits to real estate purchasers of the type we offer are permitted in most states, some states either do not permit these rebates or credits, or do not permit them in the form that we currently provide them. In each of the nine states and the District of Columbia where we currently have operations, we have designated one of our officers as the individually licensed broker and, where applicable, we hold a corporate real estate broker s license. Federal regulation. In addition to state regulations, there are federal laws and regulations that govern the real estate brokerage business. The applicable federal regulations include the Real Estate Settlement Procedures Act of 1974, as amended, or RESPA, and federal fair housing laws. RESPA, as applicable to us, is intended to provide for more effective advance disclosures to home buyers and sellers of settlement costs and the elimination of kickbacks or referral fees that tend to increase unnecessarily the costs of certain settlement services. While RESPA has broad-reaching impact on a variety of services associated with the purchase or sale of real estate, including lending, title insurance and settlement services, its principal application to the real estate brokerage business is to limit payment of referral fees or the inappropriate splitting of fees, and to require additional consumer disclosures. Generally, it is illegal under RESPA to pay or receive a referral fee or other fee, kickback or anything of value in a real estate transaction involving a federally related mortgage loan for the referral of business. RESPA limits the type of business relationships that we can enter into for acquiring client leads or otherwise, as well as the referral of clients to other service providers. RESPA also limits the manner in which we can provide other services to our customers. Federal fair housing laws generally make it illegal to discriminate against protected classes of individuals in housing or brokerage services. Other federal regulations protect the privacy rights of consumers, and affect our opportunities to solicit new clients. Local regulation. Local regulations also govern the conduct of the real estate brokerage business. Local regulations generally require additional disclosures by the parties to a real estate transaction or Table of Contents Business their agents, or the receipt of reports or certifications, often from the local governmental authority, prior to the closing or settlement of a real estate transaction. Federal and state labor regulation. In addition to the real estate regulations discussed above, we are also subject to federal and state regulation of our employment practices including the compensation of ZipAgents. ZipAgents are exempt from the overtime and minimum wage provisions of the federal Fair Labor Standards Act because their duties selling residential real estate and the commission-based method of compensation are designed to qualify for the outside sales exemption under the terms of the Fair Labor Standards Act and the U.S. Department of Labor s regulations. The outside sales exemption is applied on a case-by-case basis and is considered in light of the specific duties performed by an individual ZipAgent. Accordingly, as to any individual ZipAgent, in the event his or her duties become different than those currently assigned and contemplated, it might be determined that the exemption is inapplicable. In that event, we could be subject to penalties and damages including back pay and attorneys fees for the failure to pay the individual in accordance with his or her actual duties. Further, the Department of Labor s regulations are subject to interpretation by the Department of Labor and the courts and are subject to change. New regulations were promulgated in final form on April 23, 2004 and went into effect August 23, 2004. Accordingly, there is neither precedent or guidance regarding the interpretation and application of the new regulations nor any assurance how long these regulations will remain in place. In the event it appears the legal standard for the outside exemption changes, it may be necessary to modify the ZipAgent compensation structure. Individual states also sometimes elect to adopt overtime and minimum wage laws providing greater benefits to employees than the Fair Labor Standards Act. The ZipAgent job is designed to qualify for exemption from such laws, to the extent applicable, in the states in which we currently employ ZipAgents. Like the federal law, these state laws are applied on a case-by-case basis considering the duties of specific individuals and are subject to judicial and agency interpretation and legislative change. New interpretations or changes in state law, or expansion of operations to states that do not recognize an outside sales exemption comparable to the federal exemption, may require modification of the ZipAgent compensation structure. Third-party regulation In addition to governmental regulations, we are subject to rules and regulations established by private real estate trade organizations, including, among others, local MLSs, NAR, state Associations of REALTORS , and local Associations of REALTORS . The rules and regulations of the various MLSs to which we belong vary, and specify, among other things, how we as a broker member can use MLS listing data, including specifying, in some cases, the use and display of this data on our web site. Additionally, NAR has recently adopted a mandatory policy for NAR-affiliated MLSs regarding the use and display of MLS listings data on virtual office web sites, or VOWs. We operate a VOW, which is a password protected web site which allows us to show comprehensive MLS data directly to consumers without their having to visit an agent. Individual MLSs affiliated with NAR, which includes the vast majority of MLSs in the United States, will be required to implement their own individual VOW policies consistent with the NAR policy by July 1, 2005. NAR has extended the deadline for the implementation of its rules at least three times during an investigation by the antitrust division of the U.S. Department of Justice into NAR s policy that dictates how brokers can display other brokers property listings on their web sites. We presently do not know whether or when the NAR rules will be implemented in their current form or in a revised form, if at all. Once these individual MLS VOW policies are implemented, the NAR policy currently provides that member brokerages will have up to six months to comply with the policy. Table of Contents Business The NAR policy is designed to provide structure to the individual MLS VOW policies, subject to a number of areas in which the individual MLSs may tailor the policy to meet their local needs. One NAR policy provision with which the individual MLSs must adhere, once required to be implemented, is known as an opt-out. This provision creates a mechanism for individual brokers to prevent their listings data from being displayed on certain competitors VOWs. MLS members and participants, including individual brokers, could exercise a blanket opt-out, which would not allow their listings to be displayed on any competing VOW, or a selective opt-out, in which they could selectively prevent certain competing VOWs from displaying their listings, while allowing other VOWs to do so. A few of the MLSs of which we are a member, as well as at least one of the state Association of REALTORS of which we are a member, have adopted VOW policies with opt-out provisions, apparently in anticipation of their required implementation of the NAR policy. To our knowledge, to date no members or participants of any of those MLSs have exercised such an opt-out right. Should any such right be exercised, it could restrict our ability to display comprehensive MLS home listings data to our clients, which is a key part of our business model. Should our ability to display MLS listings information on our web site be significantly restricted, it may reduce demand for our services and materially harm our earnings and results from operations, as well as increase our costs of ensuring compliance with such restrictions. NAR, as well as the state and local Associations of REALTORS , also have codes of ethics, rules and regulations governing the actions of members in dealings with other members, clients and the public. We are bound to abide by these codes of ethics, rules and regulations by virtue of our membership in these organizations. COMPETITION The market for residential real estate brokerage services is highly fragmented at the national level, with no individual brokerage holding more than a 5% share, and the 10 largest brokerages holding less than 10% collectively, according to REAL Trends. However, the eight largest national brands that brokerages work under via franchise affiliations currently have approximately a 50% U.S. market share, according to REAL Trends, providing the potential for significant national and local influence. We compete with these brokerages at the local level to represent home buyers or sellers. Some of those competitors are large national brokerage firms or franchisors, such as Prudential Financial, Inc., RE/MAX International Inc. and Cendant Corporation, which owns the Century 21, Coldwell Banker and ERA franchise brands, a large corporate relocation business and NRT Incorporated, the largest brokerage in the United States. NRT owns and operates brokerages that are typically affiliated with one of the franchise brands owned by Cendant. We are also subject to competition from local or regional firms, as well as individual real estate agents. We also compete or may in the future compete with various online services, such as InterActiveCorp/ IAC and its LendingTree unit, HouseValues, Inc., HomeGain, Inc., Homestore, Inc. and its Realtor.com affiliate and Yahoo! Inc. that also look to attract and service home buyers and sellers using the Internet. Homestore is affiliated with NAR, NAHB, a number of major MLSs and Cendant, which may provide Homestore with preferred access to listing information and other competitive advantages. While these online services companies are intermediaries providing lead referrals and are not full-service brokerages like us, we compete with these companies to attract consumers to our web site. There is also a growing number of discount firms that cater exclusively to clients who are looking for reduced service levels as well as for sale by owner services. We believe that the key competitive factors in the residential real estate segment include the following: quality of the home data available to clients; quality of the agents; Table of Contents Business level of client responsiveness; level of commissions charged sellers or incentives provided to buyers; local knowledge; ease of product usability; and overall client service. We believe that our Internet-enabled, employee-based model positions us well relative to our competition to address these competitive factors in our industry. INTELLECTUAL PROPERTY We rely on a combination of trademark, copyright, trade secret and patent laws in the United States as well as confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We currently have trademarks registered or pending in the United States for our name and certain words and phrases that we use in our business. We also rely on copyright laws to protect computer programs relating to our web site, our proprietary database and ZAP. We have registered numerous Internet domain names related to our business in order to protect our proprietary interests, and we hold a patent issued in the United States that covers certain processes and methodologies related to transacting residential real estate on the Internet. We also enter into confidentiality and invention assignment agreements with our employees and consultants and confidentiality agreements with other third parties, and we strictly control access to our proprietary technology. From time to time, we may encounter disputes over rights and obligations concerning intellectual property. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business, our brand and reputation, or our ability to compete. Also, protecting our intellectual property rights could be costly and time consuming. EMPLOYEES At September 30, 2004, we had 919 employees. Of this total, 782 were licensed ZipAgents, 64 were district directors or field support personnel and 73 were corporate employees. We consider our employee relations to be good. LEGAL MATTERS We are not currently subject to any material legal proceedings. From time to time we have been, and we currently are, a party to litigation and subject to claims incident to the ordinary course of our business. The amounts in dispute in these matters are not material to us, and we believe that the resolution of these proceedings will not have a material adverse effect on our business or financial results. FACILITIES Our principal executive offices are located in a leased facility in Emeryville, California, consisting of approximately 15,825 square feet of office space, under a five-year lease that expires in 2007. This facility accommodates our principal administrative and finance operations. We occupy a leased facility in each of our operating districts to accommodate offices for our district director and support staff. We generally do not provide office space for our ZipAgent force. We do not own any real property. We believe that our leased facilities are adequate to meet our current needs and that additional facilities will be available for lease to meet our future needs. Table of Contents Business Management EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information about our executive officers and directors: Name Age Position (1) Member of the Audit Committee. (2) Member of the Compensation Committee. (3) Member of the Corporate Governance and Nominating Committee. Eric A. Danziger has served as our President, Chief Executive Officer and a member of our board of directors since June 2001. Prior to joining us, from February 1998 to June 2001, Mr. Danziger served as President and Chief Operating Officer of Carlson Hotels Worldwide, a hotel and resort management company including the hospitality brands Radisson Hotels Worldwide, Regent International, and Country Inns and Suites. From May 1996 to February 1998, Mr. Danziger served as President and Chief Executive Officer of Starwood Hotels and Resorts Worldwide, Inc., and from September 1990 to May 1996, he served as President of Wyndham Hotels and Resorts. Gary M. Beasley has served as our Executive Vice President since February 2004 and our Chief Financial Officer since November 2001. Mr. Beasley previously served as our Senior Vice President from October 2002 to February 2004 and as our Vice President from November 2001 to October 2002. Prior to joining us, from June 1995 to November 2001, Mr. Beasley served in various executive positions with KSL Recreation Corporation, a resort and leisure sector company, most recently as Vice President of Business Development and Acquisitions. Mr. Beasley holds a Masters of Business Administration degree from the Stanford University Graduate School of Business and a Bachelor of Arts degree in economics from Northwestern University. William Scott Kucirek, one of our founders, has served as our Executive Vice President of New Market Development since January 2003 and as a member of our board of directors since January 1999. From June 2001 to December 2002, Mr. Kucirek served as our Executive Vice President of People and Culture, from February 1999 to May 2001, he served as our Chief Financial Officer, and from July 1999 to June 2001, he also served as our President. Mr. Kucirek holds a Masters of Business Table of Contents Management Administration degree from the Haas School of Business at the University of California at Berkeley and a Bachelor of Science degree in bioengineering from the University of California at Berkeley. William C. Sinclair has served as our Senior Vice President of Sales and Operations since September 2002. Prior to joining us, from October 1998 to September 2002, Mr. Sinclair served as Executive Vice President and Chief Operating Officer for the Asia Pacific division of Radisson Hotels and Resorts Worldwide. From December 1997 to October 1998, Mr. Sinclair served as Vice President of New Business Development for Promus Hotel Corporation. Mr. Sinclair holds a Bachelor of Arts degree in business from Washington State University. Alain J. An has served as our Vice President of Human Resources since November 2002. From April 1998 to September 2002, Mr. An served as Vice President of Human Resources of Starwood Hotels and Resorts Worldwide, Inc. Mr. An holds a Masters of Arts degree in applied psychology from The Catholic University of America and a Bachelor of Arts degree in psychology from The George Washington University. Joseph Patrick Lashinsky has served as our Vice President of Marketing and Business Development since February 2000. Prior to joining us, from March 1999 to February 2000, Mr. Lashinsky served as Group Marketing Manager at Del Monte Foods Company. Mr. Lashinsky holds a Masters of Business Administration degree from the University of California at Los Angeles and a Bachelor of Arts degree in political economies of industrialized societies from the University of California at Berkeley. David A. Rector has served as our Vice President, Controller and Chief Accounting Officer since May 2004, as our Vice President and Corporate Controller from October 2002 to May 2004 and as our Corporate Controller from April 2002 to September 2002. Prior to joining us, from June 1999 to January 2002, Mr. Rector worked in various financial positions for several companies as a consultant for Resources Connection Inc., a consulting firm. Prior to that, he held senior financial positions at various companies, including commercial real estate companies Allegiance Realty Group and Fox Carskadon Financial Corporation and served as an audit manager at Price Waterhouse. Mr. Rector is a Certified Public Accountant and holds a Bachelor of Science degree in business administration from the University of California at Los Angeles. Karen B. Seto has served as our Vice President, General Counsel and Secretary since June 2004. From August 2000 to June 2004, Ms. Seto practiced corporate and securities law at Wilson Sonsini Goodrich Rosati, P.C., most recently as Special Counsel. From October 1994 to May 2000, Ms. Seto was an attorney with Fried, Frank, Harris, Shriver Jacobson LLP in Los Angeles. Ms. Seto holds a Juris Doctor degree from the University of California at Los Angeles and a Bachelor of Science in Economics degree cum laude from the Wharton School of the University of Pennsylvania. Joseph P. Trifoglio has served as our Vice President of Technology since April 2000 and previously served as our Director of Data Acquisition from January 2000 to March 2000. Prior to joining us, from March 1994 to November 1999, Mr. Trifoglio served in various positions at K/ P Corporation, an international graphics communications firm, most recently as Chief Information Officer. Ronald C. Brown has served on our board of directors since March 2004. Mr. Brown is currently a private investor. From January 2004 to June 2004, Mr. Brown was Executive Vice President of Strategy of Starwood Hotels and Resorts Worldwide, Inc., a global hotel company. From June 1995 to December 2003, Mr. Brown was Chief Financial Officer of Starwood. Mr. Brown holds an LL.M. degree from the London School of Economics and an LL.B. degree from Osgoode Hall Law School, Toronto, Canada. Marc L. Cellier has served on our board of directors since May 2001. Mr. Cellier has been a founding managing member of Pyramid Technology Ventures since its founding in January 2000. Since April 1998, Mr. Cellier has also been a general partner at GC Technology Ventures. Mr. Cellier holds Table of Contents Management a Masters of Business Administration degree from the University of St. Thomas and a Bachelor of Arts degree in finance from Institut Superieur de Gestion. Matthew E. Crisp has served on our board of directors since December 2002. Mr. Crisp has been a Partner of Venture Strategy Partners since February 2000 and previously was an Entrepreneur in Residence there from August 1999 to February 2000. Mr. Crisp holds a Masters of Science degree in management information systems and a Bachelor of Science degree in marketing finance from the University of Virginia. Robert C. Kagle has served on our board of directors since November 1999. Mr. Kagle has been a General Partner of Benchmark Capital Management Co., LLC, since its founding in May 1995 and a General Partner of Technology Venture Investors since January 1984. Mr. Kagle also serves on the boards of directors of eBay Inc. and E-LOAN, Inc. Mr. Kagle holds a Masters of Business Administration degree from the Stanford University Graduate School of Business and a Bachelor of Science degree in electrical and mechanical engineering from the General Motors Institute (renamed Kettering University in January 1998). Stanley M. Koonce, Jr. has served on our board of directors since May 2004. Mr. Koonce has been the Executive Vice President and Chief Operating Officer of Big Brothers Big Sisters of America since June 2002. From April 2001 to April 2002, Mr. Koonce was President and Chief Executive Officer of Venue Ticket Exchange, a sports ticketing company. From September 2000 to May 2002, Mr. Koonce was Chairman of AIVIA, a software and web development company. Mr. Koonce holds a Masters of Business Administration degree and a Bachelor of Science degree in mathematics from the University of North Carolina at Chapel Hill. Juan F. Mini, one of our founders, has served on our board of directors since January 1999. Since January 2003, Mr. Mini has been Managing Director of Constructora Apolo, a real estate development company. From June 2001 to December 2002, Mr. Mini served as our Executive Vice President of Market Expansion. From July 1999 to June 2001, Mr. Mini served as our Chief Executive Officer, and from February 1999 to July 1999, he served as our President. Mr. Mini holds a Masters of Business Administration degree from the Haas School of Business at the University of California at Berkeley, a Masters of Science degree in engineering from Stanford University and a Bachelor of Science degree in engineering from Cornell University. Donald F. Wood has served on our board of directors since July 1999. Since February 1998, Mr. Wood has been a Managing Member of Vanguard Ventures. Mr. Wood holds a Masters of Business Administration degree from the Stanford University Graduate School of Business and a Bachelor of Arts degree in economics from Stanford University. BOARD OF DIRECTORS Our board of directors currently consists of nine members. Upon completion of this offering, our certificate of incorporation will provide for a classified board of directors consisting of three classes of directors, each serving staggered three-year terms. As a result, a portion of our board of directors will be elected each year. To implement the classified structure, prior to the consummation of the offering, three of the nominees to the board will be appointed to one-year terms, three will be appointed to two-year terms and three will be appointed to three-year terms. Thereafter, directors will be elected for three-year terms. Our Class I directors, whose terms will expire at the 2005 annual meeting of stockholders, will be Mr. Crisp, Mr. Mini and Mr. Wood. Our Class II directors, whose terms will expire at the 2006 annual meeting of stockholders, will be Mr. Cellier, Mr. Kagle and Mr. Kucirek. Our Class III directors, whose terms will expire at the 2007 annual meeting of stockholders, will be Mr. Brown, Mr. Danziger and Mr. Koonce. Table of Contents Management BOARD COMMITTEES Our board of directors has established three committees: the audit committee, the compensation committee and the corporate governance and nominating committee. Audit committee Our audit committee consists of Ronald C. Brown, Stanley M. Koonce, Jr. and Donald F. Wood, each of whom our board of directors has determined is independent within the meaning of the Securities and Exchange Commission and the Nasdaq Stock Market, Inc. independent director standards. This committee s main function is to oversee our accounting and financial reporting processes, internal systems of control, independent auditor relationships and the audits of our financial statements. This committee s responsibilities include: selecting and hiring our independent auditors; evaluating and providing guidance with respect to the external audit and qualifications, independence and performance of our independent auditors; pre-approving the audit and non-audit services to be performed by our independent auditors; reviewing management s report on its assessment of the effectiveness of our internal controls and our significant accounting policies; overseeing and monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or accounting matters; preparing the report that the SEC requires in our annual proxy statement; and reviewing and monitoring compliance with our code of conduct and ethics. Compensation committee Our compensation committee consists of Marc L. Cellier, Matthew E. Crisp and Robert C. Kagle, each of whom our board of directors has determined is independent within the meaning of the Nasdaq Stock Market, Inc. independent director standards. This committee s purpose is to assist our board of directors in determining the development plans and compensation for our senior management and directors and recommend these plans to our board. This committee s responsibilities include: reviewing and recommending compensation and benefit plans for our executive officers; setting performance goals for our officers and reviewing their performance against these goals; evaluating the competitiveness of our executive compensation plans; reviewing and recommending compensation for members of our board of directors and committees thereof; and preparing the report that the SEC requires in our annual proxy statement. Corporate governance and nominating committee Our corporate governance and nominating committee consists of Ronald C. Brown, Robert C. Kagle and Donald F. Wood, each of whom our board of directors has determined is independent within the meaning of the Nasdaq Stock Market, Inc. independent director standards. This committee s purpose is to assist our board by identifying individuals qualified to become members of our board of directors, Table of Contents Management consistent with criteria set by our board, and to develop our corporate governance principles. This committee s responsibilities include: evaluating the composition, size and governance of our board of directors and its committees and making recommendations regarding future planning and the appointment of directors to our committees; administering our policy for considering stockholder nominees for election to our board of directors; evaluating and recommending candidates for election to our board of directors; overseeing our board of directors performance and evaluation process; reviewing our corporate governance principles and providing recommendations to the board regarding possible changes; periodically reviewing executive succession plans; and reviewing and approving any related party transactions. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Prior to establishing the compensation committee, the board of directors as a whole performed the functions delegated to the compensation committee. None of the members of our compensation committee is one of our officers or employees. No member of the board of directors or the compensation committee serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee. DIRECTOR COMPENSATION After the completion of this offering, we plan to reimburse our non-employee directors for their reasonable expenses incurred in connection with attending board and committee meetings. We currently reimburse Messrs. Brown and Koonce for these expenses. In March 2004, our board granted Mr. Brown an option to purchase 25,000 shares of common stock at an exercise price of $7.50 per share. In May 2004, our board granted Mr. Koonce an option to purchase 16,666 shares of common stock at an exercise price of $9.00 per share. Both of these option grants vest as to 25% of the total number of shares after one year from the date of grant, and in equal monthly installments over the subsequent three year period. Following this offering, each of our non-employee directors will receive an annual retainer of $7,500. The non-employee directors serving as the chairpersons of our audit committee, compensation committee and corporate governance and nominating committee will receive additional annual retainers of $10,000, $5,000 and $5,000, respectively. The non-employee directors serving as members but not as chairpersons of those committees will receive an additional annual retainer of $2,500 for each such committee membership. We will pay these retainers on a quarterly basis. Each non-employee director who joins our board following this offering will receive a nondiscretionary, automatic grant of an option to purchase 16,666 shares of our common stock upon joining our board, which will vest over three years in equal annual installments. In addition, each non-employee director will receive an annual nondiscretionary, automatic grant of an option to purchase 6,666 shares of our common stock, pursuant to our 2004 Equity Incentive Plan, which will vest one year from the date of grant. Table of Contents Management EXECUTIVE COMPENSATION The following table summarizes the compensation that we paid to our Chief Executive Officer and each of our four other most highly compensated executive officers during the year ended December 31, 2003. We refer to these officers in this prospectus as our named executive officers. Summary compensation table 2003 annual compensation All other Name and principal position Salary($) Bonus($) compensation($) Eric A. Danziger $275,000 $20,000 President and Chief Executive Officer Gary M. Beasley 150,000 4,000 Executive Vice President and Chief Financial Officer William Scott Kucirek 150,000 4,000 Executive Vice President of New Market Development William C. Sinclair 150,000 3,500 $ 3,634 (1) Senior Vice President of Sales and Operations Joseph Patrick Lashinsky 132,000 3,500 Vice President of Marketing and Business Development (1) Represents payments for temporary housing in connection with relocation to the San Francisco Bay Area. Option grants in last fiscal year We did not grant any options to purchase common stock to any of our named executive officers during the year ended December 31, 2003. However, in March 2004 our board of directors granted Mr. Danziger an option to purchase 250,000 shares of common stock, Mr. Beasley an option to purchase 20,000 shares of common stock, Mr. Kucirek an option to purchase 25,000 shares of common stock, Mr. Sinclair an option to purchase 16,666 shares of common stock and Mr. Lashinsky an option to purchase 10,000 shares of common stock. These options each have an exercise price of $7.50 per share and vest ratably over four years from the date of grant. Aggregate option exercises and option values None of our named executive officers exercised options during 2003. The following table describes for the named executive officers the number and value of securities underlying exercisable and unexercisable options held by them as of December 31, 2003. The value realized and the value of unexercised in-the-money options at December 31, 2003 are based on the assumed initial public offering price of $11.00 per share, the mid-point of the range on the cover of this prospectus, less the per share exercise price, multiplied by the number of shares issued or Table of Contents Management issuable, as the case may be, upon exercise of the option. All options were granted under our 1999 Stock Plan. Number of securities underlying unexercised Value of unexercised options at in-the-money options at December 31, 2003 December 31, 2003 Name Exercisable Unexercisable Exercisable Unexercisable Eric A. Danziger 562,499 437,500 $5,630,615 $4,379,375 Gary M. Beasley 74,295 84,410 743,693 844,944 William Scott Kucirek William C. Sinclair 26,042 57,291 260,680 573,483 Joseph Patrick Lashinsky 67,422 43,670 674,894 437,137 BENEFIT PLANS 1999 Stock Plan Our 1999 Stock Plan was adopted by our board of directors and approved by our stockholders in February 1999. Our 1999 Stock Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code, to our employees, and for the grant of nonstatutory stock options to our employees, directors and consultants. As of September 30, 2004, options to purchase 2,894,657 shares of common stock were outstanding and 255,263 shares were available for future grant under this plan. We will not grant any additional awards under our 1999 Stock Plan following this offering. Instead we will grant options under our 2004 Equity Incentive Plan. Our 1999 Stock Plan provides that in the event of our merger with or into another corporation or a sale of substantially all of our assets, the successor corporation will assume or substitute each award. If the outstanding awards are not assumed or substituted, the administrator will provide notice to the optionee that he or she has the right to exercise the award as to all of the shares subject to the award, including shares that would not otherwise be exercisable, for a period of 15 days from the date of notice. The award will terminate upon the expiration of the 15-day period. 2004 Equity Incentive Plan Our board of directors adopted our 2004 Equity Incentive Plan in June 2004 and our stockholders approved it in August 2004. Our 2004 Equity Incentive Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code, to our employees and our parent and subsidiary corporations employees, and for the grant of nonstatutory stock options, restricted stock, stock appreciation rights, performance units and performance shares to our employees, directors and consultants and our parent and subsidiary corporations employees and consultants. We have reserved a total of 1,000,000 shares of our common stock for issuance pursuant to the 2004 Equity Incentive Plan plus (a) any shares which have been reserved but not issued under our 1999 Stock Plan as of the effective date of this offering and (b) any shares returned to our 1999 Stock Plan on or after the effective date of this offering as a result of termination of options or the repurchase of unvested shares issued under the 1999 Stock Plan. In addition, our 2004 Equity Incentive Plan provides for annual increases in the number of shares available for issuance thereunder on the first day of each fiscal year, beginning with our fiscal year 2006, equal to the least of: 4% of the outstanding shares of our common stock on the first day of the fiscal year; 1,666,666 shares; and such other amount as our board of directors may determine. Table of Contents Management Our board of directors or a committee of our board administers our 2004 Equity Incentive Plan. In the case of options intended to qualify as performance-based compensation within the meaning of Section 162(m) of the Internal Revenue Code, the committee will consist of two or more outside directors within the meaning of Section 162(m) of the Code. The administrator has the power to determine the terms of the awards, including the exercise price, the number of shares subject to each such award, the exercisability of the awards and the form of consideration, if any, payable upon exercise. The administrator also has the authority to institute an exchange program whereby the exercise prices of outstanding awards may be reduced or outstanding awards may be surrendered in exchange for awards with a different exercise price. The administrator determines the exercise price of options granted under our 2004 Equity Incentive Plan, but with respect to nonstatutory stock options intended to qualify as performance-based compensation within the meaning of Section 162(m) of the Code and all incentive stock options, the exercise price must at least be equal to the fair market value of our common stock on the date of grant. The term of an incentive stock option may not exceed ten years, except that with respect to any participant who owns 10% of the voting power of all classes of our outstanding stock, the term must not exceed five years and the exercise price must equal at least 110% of the fair market value on the grant date. The administrator determines the term of all other options. No optionee may be granted an option to purchase more than 666,666 shares in any fiscal year. However, in connection with his or her initial service, an optionee may be granted an additional option to purchase up to 1,000,000 shares. After termination of an employee, director or consultant, he or she may exercise his or her option for the period of time as the administrator may determine. Generally, if termination is due to death or disability, the option will remain exercisable for 12 months. In all other cases, the option will generally remain exercisable for three months. However, an option generally may not be exercised later than the expiration of its term. Stock appreciation rights may be granted under our 2004 Equity Incentive Plan. Stock appreciation rights allow the recipient to receive the appreciation in the fair market value of our common stock between the exercise date and the date of grant. The administrator determines the terms of stock appreciation rights, including when such rights become exercisable and whether to pay the increased appreciation in cash or with shares of our common stock, or a combination thereof. Restricted stock may be granted under our 2004 Equity Incentive Plan. Restricted stock awards are shares of our common stock that vest in accordance with terms and conditions established by the administrator. The administrator will determine the number of shares of restricted stock granted to any employee. The administrator may impose whatever conditions to vesting it determines to be appropriate. For example, the administrator may set restrictions based on the achievement of specific performance goals. Shares of restricted stock that do not vest are subject to our right of repurchase or forfeiture. Performance units and performance shares may be granted under our 2004 Equity Incentive Plan. Performance units and performance shares are awards that will result in a payment to a participant only if performance goals established by the administrator are achieved or the awards otherwise vest. The administrator will establish organizational or individual performance goals in its discretion, which, depending on the extent to which they are met, will determine the number and/or the value of performance units and performance shares to be paid out to participants. Performance units will have an initial dollar value as the administrator establishes prior to the grant date. Performance shares will have an initial value equal to the fair market value of our common stock on the grant date. Table of Contents Management Our 2004 Equity Incentive Plan also provides for the automatic grant of options to our non-employee directors. Each non-employee director appointed to the board after the completion of this offering will receive an initial option to purchase 16,666 shares upon such appointment except for those directors who become non-employee directors by ceasing to be employee directors. In addition, beginning in 2005, non-employee directors who have been directors for at least six months will receive a subsequent option to purchase 6,666 shares immediately following each annual meeting of our stockholders. All options granted under the automatic grant provisions have a term of ten years and an exercise price equal to fair market value on the date of grant. Each initial option vests and becomes exercisable as to one-third of the shares on each anniversary of the date of grant. Each annual option becomes exercisable in full on the first anniversary of the date of grant. Unless the administrator provides otherwise, our 2004 Equity Incentive Plan does not allow for the transfer of awards and only the recipient of an award may exercise an award during his or her lifetime. Our 2004 Equity Incentive Plan provides that in the event of our change in control, the successor corporation or its parent or subsidiary will assume or substitute an equivalent award for each outstanding award. If there is no assumption or substitution of outstanding awards, the administrator will provide notice to the recipient that he or she has the right to exercise the option and stock appreciation right as to all of the shares subject to the award, all restrictions on restricted stock will lapse, and, with respect to performance shares and units, all performance goals or other vesting requirements will be deemed achieved and all other terms and conditions met. The award will terminate upon the expiration of the period of time the administrator provides in the notice. In the event the service of an outside director is terminated on or following a change in control, other than pursuant to a voluntary resignation, his or her options will fully vest and become immediately exercisable. Our 2004 Equity Incentive Plan will automatically terminate in 2014, unless we terminate it sooner. In addition, our board of directors has the authority to amend, suspend or terminate the 2004 Equity Incentive Plan provided such action does not impair the rights of any participant. 401(k) plan We maintain a 401(k) retirement savings plan. Each participant may contribute to the 401(k) plan, through payroll deductions, up to a statutorily prescribed annual limit of $13,000 in 2004, subject to statutory limitations imposed by the Internal Revenue Service. All amounts contributed by employee participants and earnings on these contributions are fully vested at all times and are not taxable to participants until withdrawn. Employee participants may elect to invest their contributions in various established funds. We do not currently make matching or other contributions on behalf of plan participants. Table of Contents Management CHANGE OF CONTROL ARRANGEMENTS In June 2004, our board of directors authorized a form of change of control agreement for each of our current and future officers of a level of Vice President and above. The change of control agreement provides that in the event the employee is terminated without cause, or is constructively terminated, within 12 months of a change of control of ZipRealty (including a merger or sale of assets), 50% of all unvested stock rights as of such date shall become fully vested on the termination date. For purposes of this agreement, stock rights means all options or rights to acquire shares of our common stock, stock appreciation rights, performance units and performance shares, and includes all options issued from our 1999 Stock Plan and 2004 Equity Incentive Plan. We intend for each of our current and future officers of a level of Vice President and above to enter into a change of control agreement with these terms prior to the closing of this offering or at the time such person is hired, as applicable. In addition, with respect to a stock option awarded to Eric A. Danziger in June 2001 to purchase 666,666 shares of our common stock, upon a change of control of ZipRealty 50% of the then unvested shares underlying this option shall become fully vested. Table of Contents Related party transactions We describe below transactions and series of similar transactions, during our last three fiscal years, to which we were a party or will be a party, in which: the amounts involved exceeded or will exceed $60,000; and a director, executive officer, holder of more than 5% of our common stock or any member of their immediate family had or will have a direct or indirect material interest. We also describe below certain other transactions with our directors, executive officers and stockholders. PREFERRED STOCK, CONVERTIBLE NOTE AND WARRANT ISSUANCES Since January 1, 2001, we have issued our securities in the following financing transactions: In May and August 2001, we issued an aggregate of 1,991,091 shares of our Series D preferred stock to the investors listed in the table below in a private placement for a purchase price of $3.93 per share; In February, March and April 2002, we issued senior secured convertible promissory notes in an aggregate principal amount of approximately $7.5 million, convertible into shares of our Series E preferred stock at a conversion price of $3.93 per share, and warrants to purchase an aggregate of 4,208,656 shares of our Series E-1 preferred stock to the investors listed in the table below; In October 2002, we issued senior secured convertible promissory notes in an aggregate principal amount of approximately $3.1 million, convertible into future convertible promissory notes, and warrants to purchase an aggregate of 582,060 shares of our Series F preferred stock to the investors listed in the table below; In December 2002 and February 2003, we issued senior secured convertible promissory notes in an aggregate principal amount of approximately $12.6 million, convertible into shares of our Series F preferred stock at a conversion price of $3.93 per share, and warrants to purchase an aggregate of 1,600,748 shares of our Series F preferred stock to the investors listed in the table below; and In June 2003, we issued warrants to purchase an aggregate of 127,016 shares of Series E-1 preferred stock and 193,241 shares of Series F preferred stock to the investors listed in the table below, in connection with the conversion of such investors then outstanding senior secured convertible promissory notes. In connection with the issuance of the senior secured convertible promissory notes described above, we granted to the note holders security interests on all of our property pursuant to security agreements. These security agreements, and related security interests, terminated in June 2003 in connection with the conversion of the notes into Series E and Series F preferred stock. Table of Contents Related party transactions The following table sets forth the aggregate securities acquired by the listed directors, executive officers and holders of more than 5% of our common stock: Series D Series E Warrants to Series F Warrants to preferred stock preferred stock purchase Series E-1 preferred stock purchase Series F Investor purchased purchased(1) preferred stock purchased(2) preferred stock Benchmark Capital Partners IV, L.P.(3) 508,906 695,800 1,297,685 735,099 547,957 Pyramid Technology Ventures I, L.P.(4) 763,358 556,639 1,038,145 1,292,842 1,080,488 Vanguard Ventures(5) 318,065 278,319 519,075 131,116 118,680 Venture Strategy Partners(6) 1,050,141 564,693 Lamoreaux Partners 417,480 778,610 Iverson Financial Corporation(7) 254,453 125,243 233,583 105,014 56,468 Barrington Partners 81,425 168,415 315,078 Eric A. Danziger 63,612 70,249 130,138 Gary M. Beasley(8) 2,801 5,190 William C. Sinclair 13,126 7,058 Joseph Patrick Lashinsky 1,392 2,596 David A. Rector 1,312 705 Joseph P. Trifoglio 1,272 Donald F. Wood 8,348 15,572 (1) Represents shares of Series E preferred stock issued in June 2003 at a price of $3.93 per share, upon conversion of the principal amount of, and accrued interest on, senior secured convertible promissory notes originally issued between February and April 2002. (2) Represents shares of Series F preferred stock issued in June 2003 at a price of $3.93 per share, upon conversion of the principal amount of, and accrued interest on, senior secured convertible promissory notes originally issued in December 2002 and February 2003. (3) Our director, Robert C. Kagle, is a managing member of the general partner of this entity. (4) Our director, Marc L. Cellier, is a managing member of the general partner of this entity. (5) Our director, Donald F. Wood, is a managing member of the general partner of funds related to this entity. (6) Our director, Matthew E. Crisp, is a managing member of the general partner of funds related to this entity. (7) Our director, Juan F. Mini, is a director of this entity. (8) All shares held by the Beasley Family Revocable Trust. INVESTOR RIGHTS AGREEMENT We have entered into an agreement with purchasers of our preferred stock and holders of warrants to purchase our capital stock that provides for certain rights relating to the registration of their shares of common stock issuable upon conversion of their preferred stock or exercise of their warrants. These rights will continue following this offering and will terminate five years following the completion of this offering, or for any particular holder with registration rights, at such time following this offering when all securities held by that stockholder subject to registration rights may be sold pursuant to Rule 144 under the Securities Act during any 90-day period. All holders of preferred stock, including the directors, executive officers and holders of 5% of our capital stock listed in the above table, are parties to this agreement. See Description of capital stock Registration Rights for additional information. INDEMNIFICATION AGREEMENTS OF OFFICERS AND DIRECTORS Our amended and restated certificate of incorporation and our bylaws provide that we will indemnify each of our directors and officers to the fullest extent permitted by the Delaware General Corporation Law. Further, we have entered into indemnification agreements with each of our directors and officers. For further information, see Description of capital stock Limitations of Liability and Indemnification Matters. Table of Contents Principal stockholders The following table sets forth information about the beneficial ownership of our common stock at September 30, 2004, and as adjusted to reflect the sale of the shares of common stock in this offering, for: each person known to us to be the beneficial owner of more than 5% of our common stock; each named executive officer; each of our directors; and all of our executive officers and directors as a group. Unless otherwise noted below, the address of each beneficial owner listed on the table is c/o ZipRealty, Inc., 2000 Powell Street, Suite 1555, Emeryville, California 94608. We have determined beneficial ownership in accordance with the rules of the Securities and Exchange Commission. Except as indicated by the footnotes below, we believe, based on the information furnished to us, that the persons and entities named in the table below have sole voting and investment power with respect to all shares of common stock that they beneficially own, subject to applicable community property laws. We have based our calculation of the percentage of beneficial ownership on 14,504,856 shares of common stock outstanding on September 30, 2004 and 19,054,856 shares of common stock outstanding upon completion of this offering. Table of Contents Principal stockholders In computing the number of shares of common stock beneficially owned by a person and the percentage ownership of that person, we deemed outstanding shares of common stock subject to options or warrants held by that person that are currently exercisable or exercisable within 60 days of September 30, 2004. We did not deem these shares outstanding, however, for the purpose of computing the percentage ownership of any other person. Beneficial ownership representing less than 1% is denoted with an asterisk (*). Percentage of shares outstanding Number of shares Beneficial owner beneficially owned Before offering After offering 5% Stockholders: Benchmark Capital Partners(1) 5,007,851 31.9 % 24.7% Pyramid Technology Ventures(2) 4,731,472 29.4 22.9 Vanguard Ventures(3) 2,416,139 16.2 12.4 Venture Strategy Partners(4) 1,614,834 10.7 8.2 Lamoreaux Partners(5) 1,196,090 8.0 6.1 Iverson Financial Corporation(6) 894,769 6.1 4.7 Barrington Partners(7) 842,078 5.7 4.4 Directors and named executive officers: Eric A. Danziger(8) 1,075,266 7.0 5.4 Gary M. Beasley(9) 121,989 * * William Scott Kucirek(10) 670,833 4.6 3.5 William C. Sinclair(11) 68,101 * * Joseph Patrick Lashinsky(12) 92,286 * * Ronald C. Brown Marc L. Cellier(13) 4,732,530 29.4 22.9 Matthew E. Crisp(14) Robert C. Kagle(1) 5,007,851 31.9 24.7 Stanley M. Koonce, Jr. Juan F. Mini(15) 1,561,435 10.6 8.1 Donald F. Wood(16) 2,440,059 16.4 12.5 All directors and executive officers as a group (16 people)(17) 15,875,845 82.9 % 67.0% (1) Includes 3,792,043 shares held by Benchmark Capital Partners IV, L.P., as nominee for Benchmark Capital Partners IV, L.P., Benchmark Founders Fund IV, L.P., Benchmark Founders Fund IV-A, L.P., Benchmark Founders Fund IV-B, L.P., Benchmark Founders Fund IV-X, L.P. and related individuals, also known as the Benchmark Funds and 1,215,808 shares issuable upon exercise of warrants held by the same fund that are exercisable within 60 days of September 30, 2004. Mr. Kagle, one of our directors, is a managing member of Benchmark Capital Management Co. IV, L.L.C., which is the general partner of Benchmark Capital Partners IV, L.P. Mr. Kagle disclaims beneficial ownership of the shares held by this fund except with respect to 47,103 issued shares and 15,514 shares issuable upon exercise of warrants that are exercisable within 60 days of September 30, 2004, and to the extent of his pecuniary interest therein. The address of this fund and Mr. Kagle is c/o Benchmark Capital Partners, 2480 Sand Hill Road, Suite 200, Menlo Park, CA 94025. (2) Includes 1,614,767 shares issuable upon exercise of warrants that are exercisable within 60 days of September 30, 2004. The address of this fund is c/o Pyramid Technology Ventures, P.O. Box 10723, Zephyr Cove, NV 89448. (3) Includes 1,887,492 shares held by Vanguard VI, L.P., 78,062 shares held by Vanguard VI Affiliates Fund, L.P. and 64,764 shares held by Vanguard VI Annex Fund, L.P. Also includes 336,608 shares issuable upon exercise of warrants held by Vanguard VI, L.P., 35,292 shares issuable upon exercise of warrants held by Vanguard VI Annex Fund, L.P. and 13,921 shares issuable upon exercise of warrants held by Vanguard VI Affiliates Fund, L.P., in each case that are exercisable within 60 days of September 30, 2004. The address of these funds is c/o Vanguard Ventures, 525 University Ave., Suite 1200, Palo Alto, CA 94301. Table of Contents Principal stockholders (4) Includes 982,407 shares held by Venture Strategy Partners II LP and 67,734 shares held by Venture Strategy Affiliates Fund LP. Also includes 528,271 shares issuable upon exercise of warrants held by Venture Strategy Partners II LP and 36,422 shares issuable upon exercise of warrants held by Venture Strategy Affiliates Fund LP, in each case that are exercisable within 60 days of September 30, 2004. Joanna Rees Gallanter, the executive managing member of the general partner of these funds, may be deemed to be the beneficial owner of the shares held by these funds. Ms. Gallanter disclaims beneficial ownership of the shares held by these funds except to the extent of her pecuniary interest therein. The address of these funds is c/o Venture Strategy Partners, 140 Geary Street, Suite 600, San Francisco, CA 94108. (5) Includes 400,710 shares issuable upon exercise of warrants that are exercisable within 60 days of September 30, 2004. The address of Lamoreaux Partners is 1505 Bridgeway, Suite 125, Sausalito, CA 94965. (6) Includes 176,681 shares issuable upon exercise of warrants that are exercisable within 60 days of September 30, 2004. The address of Iverson Financial Corporation is 881 Ocean Drive, Apt. 26-H, Key Biscayne, FL 33149. (7) Includes 321,339 shares held by Barrington ZRE III Limited Partnership, 81,425 shares held by Barrington ZRE II Limited Partnership, 135,011 shares held by Barrington Partners Venture Fund II, L.P., 92,505 shares held by Barrington Partners, LLC and 46,258 shares held by Barrington ZRE Partners. Also includes 162,154 shares issuable upon exercise of warrants held by Barrington ZRE III Limited Partnership and 3,386 shares issuable upon exercise of a warrant held by Barrington Partners, LLC, in each case that are exercisable within 60 days of September 30, 2004. The address of these funds is c/o Barrington Partners, 866 Dorchester Ave., Boston, MA 02125. (8) Includes 66,975 shares issuable upon exercise of warrants and 833,332 shares issuable upon exercise of options that are exercisable within 60 days of September 30, 2004. Also includes 31,806 shares held by the Eric A. Danziger Grantor Retained Annuity Trust and 31,806 shares held by the Jennifer L. Danziger Grantor Retained Annuity Trust. (9) Includes 30,320 shares held by the Beasley Family Revocable Trust and 2,671 shares issuable upon exercise of warrants held by this entity that are exercisable within 60 days of September 30, 2004. Also includes 88,998 shares issuable upon exercise of options that are exercisable within 60 days of September 30, 2004. (10) Includes 4,167 shares issuable upon exercise of options that are exercisable within 60 days of September 30, 2004. (11) Includes 7,058 shares issuable upon exercise of warrants and 47,917 shares issuable upon exercise of options that are exercisable within 60 days of September 30, 2004. (12) Includes 1,336 shares issuable upon exercise of warrants and 88,298 shares issuable upon exercise of options that are exercisable within 60 days of September 30, 2004. (13) Includes 1,058 shares held by Mr. Cellier individually, 3,116,705 shares held by Pyramid Technology Ventures I, L.P. and 1,614,767 shares issuable upon exercise of warrants held by the same fund that are exercisable within 60 days of September 30, 2004. Mr. Cellier, one of our directors, is a managing member of the general partner of Pyramid Technology Ventures I, L.P. Mr. Cellier disclaims beneficial ownership of the shares held by this fund except to the extent of his pecuniary interest therein. Mr. Cellier s address is c/o Pyramid Technology Ventures, P.O. Box 10723, Zephyr Cove, NV 89448. (14) Excludes shares held by Venture Strategy Partners II LP and Venture Strategy Affiliates Fund LP as described in footnote 4. Mr. Crisp, one of our directors, is a managing member of the general partner of these funds. However, Mr. Crisp neither has shares nor voting or dispositive authority over the shares held by these funds and, accordingly, is not deemed to beneficially own the shares held by these funds. The address of Mr. Crisp is c/o Venture Strategy Partners, 140 Geary Street, Suite 600, San Francisco, CA 94108. (15) Includes 666,666 shares held by Mr. Mini individually, 718,088 shares held by Iverson Financial Corp. and 176,681 shares issuable upon exercise of warrants held by this entity that are exercisable within 60 days of September 30, 2004. Mr. Mini is a director of Iverson Financial Corporation, which is controlled by members of his family. Mr. Mini s address is 881 Ocean Drive, Apt. 26-H, Key Biscayne, FL 33149. (16) Includes 8,348 shares held by Mr. Wood individually, 1,887,492 shares held by Vanguard VI, L.P., 78,062 shares held by Vanguard VI Affiliates Fund, L.P. and 64,764 shares held by Vanguard VI Annex Fund, L.P. Also includes 15,572 shares issuable upon exercise of warrants held by Mr. Wood, 336,608 shares issuable upon exercise of warrants held by Vanguard VI, L.P., 35,292 shares issuable upon exercise of warrants held by Vanguard VI Annex Fund, L.P. and 13,921 shares issuable upon exercise of warrants held by Vanguard VI Affiliates Fund, L.P., in each case that are exercisable within 60 days of September 30, 2004. Mr. Wood, one of our directors, is a managing member of the general partner of each of Vanguard VI, L.P., Vanguard VI Affiliates Fund, L.P. and Vanguard VI Annex Fund, L.P. Mr. Wood disclaims beneficial ownership of the shares held by these funds except to the extent of his pecuniary interest therein. Mr. Wood s address is c/o Vanguard Ventures, 525 University Ave., Suite 1200, Palo Alto, CA 94301. (17) Includes 3,487,394 shares issuable upon exercise of warrants and 1,164,918 shares issuable upon exercise of options that are exercisable within 60 days of September 30, 2004. Table of Contents Description of capital stock Upon the closing of this offering, our authorized capital stock will consist of 100,000,000 shares of common stock, $0.001 par value per share, and 5,000,000 shares of preferred stock, $0.001 par value per share. The following description summarizes the material terms of our capital stock. Because it is only a summary, it does not contain all the information that may be important to you. For a complete description you should refer to our certificate of incorporation and bylaws, copies of which have been filed as exhibits to the registration statement of which the prospectus is a part. COMMON STOCK On September 30, 2004, there were 14,504,856 shares of common stock outstanding, held of record by 131 stockholders. After this offering, there will be 19,054,856 shares of our common stock outstanding, or 19,737,356 shares if the underwriters exercise their over-allotment option in full. The holders of our common stock are entitled to one vote for each share held of record on all matters submitted to a vote of the stockholders, including the election of directors, and do not have cumulative voting rights. Accordingly, the holders of a majority of the shares of common stock entitled to vote in any election of directors can elect all of the directors standing for election, if they so choose. Subject to preferences that may be applicable to any then outstanding preferred stock, holders of common stock are entitled to receive ratably those dividends, if any, as may be declared by the board of directors out of legally available funds. Upon our liquidation, dissolution or winding up, the holders of common stock will be entitled to share ratably in the net assets legally available for distribution to stockholders after the payment of all of our debts and other liabilities of our company, subject to the prior rights of any preferred stock then outstanding. Holders of common stock have no preemptive or conversion rights or other subscription rights and there are no redemption or sinking funds provisions applicable to the common stock. All outstanding shares of common stock are, and the common stock to be outstanding upon completion of this offering will be, fully paid and nonassessable. PREFERRED STOCK Our board of directors will have the authority, without any action by the stockholders, to issue from time to time the preferred stock in one or more series and to fix the number of shares, designations, preferences, powers, and relative, participating, optional or other special rights and the qualifications or restrictions thereof. The preferences, powers, rights and restrictions of different series of preferred stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund provisions, and purchase funds and other matters. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of common stock or adversely affect the rights and powers, including voting rights, of the holders of common stock, and may have the effect of delaying, deferring or preventing a change in control of our company. The existence of authorized but unissued preferred stock may enable the board of directors to render more difficult or to discourage an attempt to obtain control of us by means of a merger, tender offer, proxy contest or otherwise. For example, if in the due exercise of its fiduciary obligations, the board of directors were to determine that a takeover proposal is not in our best interests, the board of directors could cause shares of preferred stock to be issued without stockholder approval in one or more private offerings or other transactions that might dilute the voting or other rights of the proposed acquirer or insurgent stockholder or stockholder group. Table of Contents Description of capital stock WARRANTS In November 1999, we issued a warrant to purchase 3,386 shares of Series B preferred stock at an exercise price of $9.45 per share. This warrant expires in November 2004. After the completion of this offering this warrant will remain outstanding and will become exercisable for 3,386 shares of our common stock. In August 2000, we issued a warrant to purchase 6,349 shares of Series C preferred stock and 3,284 shares of Series C preferred stock at an exercise price of $9.45 and $18.27, respectively. These warrants expire in August 2010. After the completion of this offering, these warrants will remain outstanding and will become exercisable for an aggregate of 9,633 shares of our common stock. From February 2002 through April 2002, and in June 2003, we issued warrants to purchase an aggregate of 4,600,135 shares of Series E-1 preferred stock at an exercise price of $3.93 per share, of which warrants to purchase an aggregate of 2,455,173 shares of Series E-1 preferred stock remained outstanding as of September 30, 2004. These warrants expire five years from their date of issuance. In the event of a merger with or sale of all or substantially all of our assets to a public company, all of these warrants will automatically exercise in full. After the completion of this offering, these warrants will remain outstanding and will become exercisable for an aggregate of 2,455,173 shares of our common stock. In October 2002, we issued a warrant to purchase 19,083 shares of common stock at an exercise price of $0.99 per share. This warrant expires in October 2012, or at such earlier date as may be determined by our board of directors in connection with the occurrence of certain corporate events. After the completion of this offering, this warrant will remain outstanding. From December 2002 through February 2003, and in June 2003, we issued warrants to purchase an aggregate of 2,425,454 shares of Series F preferred stock at an exercise price of $3.93 per share. These warrants expire five years from their date of issuance. In the event of a merger with or sale of all or substantially all of our assets to a public company, all of these warrants will automatically exercise in full. After the completion of this offering, these warrants will remain outstanding and will become exercisable for an aggregate 2,425,454 shares of our common stock. In lieu of payment of the exercise price in cash, any of these warrants may be exercised by subtracting the value of a portion of the warrant that is equal to the number of shares issuable under the warrant being exercised multiplied by the fair market value of the securities receivable upon exercise of the warrant from the aggregate exercise price of the shares being exercised. REGISTRATION RIGHTS After this offering, the holders of approximately 12,927,786 shares of common stock and warrants to acquire 4,893,646 shares of common stock will be entitled to rights with respect to the registration of these shares under the Securities Act. These shares are referred to as registrable securities. Under the terms of the agreement between us and the holders of the registrable securities, if we propose to register any of our securities under the Securities Act, these holders are entitled to notice of such registration and are entitled to include their shares of registrable securities in our registration. Certain of these holders are also entitled to demand registration rights, pursuant to which they may require us to use our commercially reasonable efforts to register their registrable securities under the Securities Act at our expense, up to a maximum of two registrations. Holders of registrable securities may also require us to file an unlimited number of additional registration statements on Form S-3 at our expense so long as the holders propose to sell registrable securities with a value of at least $1.0 million. All of these registration rights are subject to certain conditions and limitations, among them the right of the underwriters of an offering to limit the number of shares included in such Table of Contents Description of capital stock registration and our right not to effect a requested registration 60 days prior to or 180 days after a registered offering of our securities, including the offering made here. These registration rights have been waived with respect to this offering. ANTI-TAKEOVER EFFECTS OF PROVISIONS OF OUR AMENDED AND RESTATED CERTIFICATE OF INCORPORATION, OUR BYLAWS AND DELAWARE LAW Some provisions of Delaware law, our amended and restated certificate of incorporation and our bylaws could make the following transactions more difficult: acquisition of us by means of a tender offer; acquisition of us by means of a proxy contest or otherwise; or removal of our incumbent officers and directors. These provisions, summarized below, are expected to discourage coercive takeover practices and inadequate takeover bids. These provisions are also designed to encourage persons seeking to acquire control of us to first negotiate with our board of directors. We believe that the benefits of increased protection of our potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure us outweigh the disadvantages of discouraging these proposals because negotiation of these proposals could result in an improvement of their terms. Undesignated preferred stock The ability to authorize undesignated preferred stock makes it possible for our board of directors to issue preferred stock without stockholder approval with voting or other rights or preferences that could impede the success of any attempt to change control of us. Stockholder meetings Our charter documents provide that a special meeting of stockholders may be called only by our chief executive officer, president or chairperson of the board of directors, or a resolution adopted by a majority of our board of directors. Requirements for advance notification of stockholder nominations and proposals Our bylaws establish advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors, other than nominations made by or at the direction of the board of directors or a committee of the board of directors. Elimination of stockholder action by written consent Our certificate of incorporation eliminates the right of stockholders to act by written consent without a meeting. This limit on the ability of our stockholders to act by written consent may lengthen the amount of time required to take stockholder actions. As a result, a holder controlling a majority of our capital stock would not be able to amend our bylaws or remove directors without a stockholder meeting. Election and removal of directors Our board of directors is divided into three classes. The directors in each class will serve for a three-year term, one class being elected each year by our stockholders. For more information on the classified board, see Management Board of Directors. This system of electing and removing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of us, because it generally makes it more difficult and takes longer for stockholders to replace a majority of the directors. Table of Contents Description of capital stock Delaware anti-takeover statute We are subject to Section 203 of the Delaware General Corporation Law which prohibits persons deemed interested stockholders from engaging in a business combination with a Delaware corporation for three years following the date these persons become interested stockholders. Generally, an interested stockholder is a person who, together with affiliates and associates, owns, or within three years prior to the determination of interested stockholder status did own, 15% or more of a corporation s voting stock. Generally, a business combination includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. The existence of this provision may have an anti-takeover effect with respect to transactions not approved in advance by the board of directors. Amendment of charter provisions The amendment of any of the above provisions, except for the provision making it possible for our board of directors to issue preferred stock, would require approval by holders of at least 66 2/3% of our then outstanding common stock. The provisions of Delaware law, our amended and restated certificate of incorporation and our bylaws could have the effect of discouraging others from attempting hostile takeovers and, as a consequence, they may also inhibit temporary fluctuations in the market price of our common stock that often result from actual or rumored hostile takeover attempts. These provisions may also have the effect of preventing changes in our management. It is possible that these provisions could make it more difficult to accomplish transactions that stockholders may otherwise deem to be in their best interests. LIMITATIONS OF LIABILITY AND INDEMNIFICATION MATTERS We have adopted provisions in our amended and restated certificate of incorporation that limit the liability of our directors for monetary damages for breach of their fiduciary duties, except for liability that cannot be eliminated under the Delaware General Corporation Law. Delaware law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for any of the following: any breach of their duty of loyalty to the corporation or its stockholders; acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law; or any transaction from which the director derived an improper personal benefit. This limitation of liability does not apply to liabilities arising under the federal securities laws and does not affect the availability of equitable remedies such as injunctive relief or rescission. Our amended and restated certificate of incorporation and our bylaws also provide that we shall indemnify our directors and executive officers and may indemnify our other officers and employees and other agents to the fullest extent permitted by law. We believe that indemnification under our bylaws covers at least negligence and gross negligence on the part of indemnified parties. Our bylaws also permit us to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in this capacity, regardless of whether our bylaws would permit indemnification. We have entered into separate indemnification agreements with our directors and officers, in addition to indemnification provided for in our charter documents. These agreements, among other things, provide for indemnification of each of our directors and officers for expenses, judgments, fines and settlement amounts incurred by this person in any action or proceeding arising out of this person s Table of Contents Description of capital stock services as a director or officer or at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and officers. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock is American Stock Transfer and Trust Company. Its address is 59 Maiden Lane, Plaza Level, New York, New York 10038, and its telephone number is (800) 937-5449. LISTING The Nasdaq National Market has approved our common stock for quotation under the symbol ZIPR subject to notice of issuance. Table of Contents Shares eligible for future sale Prior to this offering there has been no public market for our common stock, and a significant public market for our common stock may never develop or be sustained after this offering. We cannot predict the effect, if any, that market sales of shares or the availability of shares for sale will have on the market price prevailing from time to time. As described below, only a limited number of shares will be available for sale shortly after this offering due to contractual and legal restrictions on resale. However, sales of our common stock in the public market after the restrictions lapse, or the perception that these sales may occur, could cause the market price of our common stock to decline. Upon completion of this offering, we will have an aggregate of 19,054,856 outstanding shares of common stock, or 19,737,356 shares if the underwriters exercise the over-allotment option in full. As of September 30, 2004, we had outstanding stock options held by employees, consultants and directors for the purchase of an aggregate of 2,894,657 shares of common stock. The 4,550,000 shares of common stock being sold in this offering will be freely tradable without restriction or further registration under the Securities Act of 1933, as amended, unless the shares are purchased by our affiliates, as that term is defined in Rule 144 of the Securities Act of 1933, as amended. All remaining shares were issued and sold by us in private transactions and are eligible for public sale if registered under the Securities Act of 1933, as amended, or sold in accordance with Rule 144 or Rule 701 thereunder, in each case subject to the termination of the lock-up agreements described below. LOCK-UP AGREEMENTS Each of our officers and directors and substantially all of our current securityholders have signed lock-up agreements under which they have agreed not to offer, sell, contract to sell, hedge or otherwise dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exercisable or exchangeable for shares of common stock, for a period of 180 days after the date of this prospectus, subject to certain exceptions. In addition, the 180-day lock-up period may be extended for up to 37 additional days under certain circumstances where we announce or pre-announce earnings or a material event within approximately 18 days prior to, or approximately 16 days after, the termination of the 180-day period. UBS Securities LLC and Deutsche Bank Securities Inc., in their sole discretion, may release some or all of these shares before the lock-up period ends. Shares purchased by our officers, directors, stockholders or optionholders in the directed share program, if any, will not be subject to these lock-up agreements unless the purchaser is subject to the reporting requirements of Section 16 of the Securities Exchange Act of 1934 as result of the purchaser s relationship with us. Following the expiration of the lock-up period, 14,259,827 shares of common stock, including shares issuable upon the exercise of vested options after the lock-up period ends, will be available for sale in the public market, subject in some cases to the volume and other restrictions of Rule 144, Rule 144(k) or Rule 701. ELIGIBILITY OF RESTRICTED SHARES FOR SALE IN THE PUBLIC MARKET Rule 144 In general, under Rule 144, a person or persons whose shares are aggregated who has beneficially owned restricted securities for at least one year, including the holding period of any holder who is not an affiliate, and who files a Form 144 with respect to this sale, is entitled to sell within any three- Table of Contents Shares eligible for future sale month period commencing 90 days after the date of this prospectus a number of shares of common stock that does not exceed the greater of: 1% of the then outstanding shares of our common stock, or approximately 190,549 shares immediately after this offering; or the average weekly trading volume during the four calendar weeks preceding the sale. Sales under Rule 144 are also subject to restrictions relating to manner of sale, notice and the availability of current public information about us. Rule 144(k) A person who is not deemed to have been our affiliate at any time during the 90 days immediately preceding a sale and who has beneficially owned his or her shares for at least two years, including the holding period of any prior owner who is not an affiliate, is entitled to sell these shares of common stock pursuant to Rule 144(k) without regard to the volume limitations, manner of sale provisions, public information or notice requirements of Rule 144. Affiliates must always sell pursuant to Rule 144, even after the applicable holding periods have been satisfied. Rule 701 Rule 701 may be relied upon with respect to the resale of securities originally purchased from us by our employees, directors, officers, consultants or advisers prior to the closing of this offering and pursuant to written compensatory benefit plans or written contracts relating to the compensation of these persons. In addition, the SEC has indicated that Rule 701 will apply to stock options granted by us before this offering, along with the shares acquired upon exercise of these options. Securities issued in reliance on Rule 701 are deemed to be restricted shares and, beginning 90 days after the date of this prospectus, may be sold by persons other than affiliates subject only to the manner of sale provisions of Rule 144 and by affiliates under Rule 144 without compliance with the holding period requirements. As of September 30, 2004, 212,039 of our outstanding shares of common stock had been issued in reliance on Rule 701 as a result of exercise of stock options. STOCK OPTIONS We intend to file a registration statement under the Securities Act of 1933, as amended, covering approximately 4,149,920 shares of common stock reserved for issuance under our 1999 Stock Plan and 2004 Equity Incentive Plan. We expect to file this registration statement as soon as practicable after the date of this prospectus. Accordingly, shares registered under this registration statement will be available for sale in the open market, unless these shares are subject to vesting restrictions with us or are otherwise subject to the contractual restrictions described above. REGISTRATION RIGHTS In addition, after this offering, the holders of 12,927,786 shares of common stock and 4,893,646 shares of common stock issuable upon exercise of outstanding warrants may demand that we register their shares under the Securities Act of 1933, as amended, or if we file another registration statement under the Securities Act, these stockholders may elect to include their shares in such registration. If these shares are registered, they will be freely tradable without restriction under the Securities Act. For more information, see Description of capital stock Registration Rights. Table of Contents Underwriting We and the underwriters named below have entered into an underwriting agreement concerning the shares we are offering. Subject to conditions, each underwriter has severally agreed to purchase the number of shares indicated in the following table at the public offering price less the underwriting discounts and commissions set forth on the cover page of this prospectus. UBS Securities LLC, Deutsche Bank Securities Inc., Thomas Weisel Partners LLC and Pacific Growth Equities, LLC are the representatives of the underwriters, with UBS Securities LLC and Deutsche Bank Securities Inc. serving as joint book-running managers. Underwriters Number of shares UBS Securities LLC Deutsche Bank Securities Inc. Thomas Weisel Partners LLC Pacific Growth Equities, LLC Total 4,550,000 The underwriting agreement provides that the underwriters obligations to purchase the shares of common stock offered by this prospectus depend upon the satisfaction of the conditions contained in the underwriting agreement. The conditions contained in the underwriting agreement include, among others, the condition that all the representations and warranties made by us to the underwriters are true, that there has been no material adverse change in our condition, that the registration statement of which this prospectus is a part shall have been declared effective by the SEC and that we deliver to the underwriters certain legal opinions and other customary closing documents. In addition, the underwriting agreement may be terminated by the underwriters based on their assessment of the state of the financial markets. The underwriters will purchase all of the shares of common stock offered by this prospectus, other than those covered by the over-allotment option described below, if any of these shares are purchased. If the underwriters sell more shares than the total number set forth in the table above, the underwriters have a 30-day option to buy from us up to an additional 682,500 shares at the initial public offering price less the underwriting discounts and commissions and estimated offering expenses to cover these sales. If any shares are purchased under this option, the underwriters will severally purchase shares in approximately the same proportion as set forth in the table above. We will be obligated, pursuant to the option, to sell these additional shares of common stock to the underwriters to the extent the option is exercised. The underwriting discounts and commissions per share are equal to the public offering price per share of common stock less the amount paid by the underwriters to us per share of common stock. The following table shows the per share and total underwriting discounts and commissions we will pay to the underwriters. These amounts are shown assuming both no exercise and full exercise of the underwriters option to purchase up to an additional 682,500 shares. No exercise Full exercise Per share $ $ Total $ $ We estimate that the total expenses of the offering payable by us, excluding underwriting discounts and commissions, will be approximately $2.0 million. Expenses include the Securities and Exchange Commission and NASD filing fees, Nasdaq National Market listing fee, printing, legal, accounting and transfer agent and registrar fees and other miscellaneous fees and expenses. Table of Contents Underwriting Shares sold by the underwriters to the public will initially be offered at the initial public offering price set forth on the cover of this prospectus. Any shares sold by the underwriters to securities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any of these securities dealers may resell any shares purchased from the underwriters to other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial public offering price, the representatives may change the offering price and the other selling terms. Sales of shares made outside of the United States may be made by affiliates of the underwriters. Upon execution of the underwriting agreement, the underwriters will be obligated to purchase the shares at the prices and upon the terms stated therein and, as a result, will thereafter bear any risk associated with changing the offering price to the public or other selling terms. The underwriters have informed us that they do not expect discretionary sales to exceed 5% of the shares of common stock to be offered. Our company and each of our directors and executive officers and substantially all of our current securityholders have agreed with the underwriters or us not to offer, sell, contract to sell, hedge or otherwise dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exchangeable for shares of common stock until after the date that is 180 days after the date of this prospectus, without the prior written consent of UBS Securities LLC and Deutsche Bank Securities Inc. In addition, the 180-day lock-up period may be extended for up to 37 additional days under certain circumstances where we announce or pre-announce earnings or a material event within approximately 18 days prior to, or approximately 16 days after, the termination of the 180-day period. This agreement does not generally apply to the exercise of options under our employee benefits plans. Generally, shares purchased in the directed share program described below will not be subject to these lock-up agreements unless the purchaser is subject to the reporting requirements of Section 16 of the Securities Exchange Act of 1934. Although they have advised us that they have no intent or understanding to do so, UBS Securities LLC and Deutsche Bank Securities Inc., in their sole discretion, may permit early release of the shares of our common stock subject to the restrictions detailed above prior to the expiration of the lock-up period. At our request, the underwriters have reserved up to 5% of the common stock being offered by this prospectus for sale at the initial public offering price to both employees who were employed with us as of September 30, 2004 and who remained employed as of October 25, 2004, and to non-employee clients who have purchased or sold a home with us prior to September 30, 2004. We presently estimate that the number of potential participants in this program will be approximately 15,000; however, we do not know whether these persons will choose to purchase all or any portion of these reserved shares. Each participant will be offered the opportunity to purchase between a minimum and a maximum number of shares, and the total shares made available for purchase by any particular participant will be subject to a potential cut back depending on the overall interest in this program. The number of shares available for sale to the general public in the offering will be reduced to the extent these reserved shares are purchased in the directed share program. The purchasers of these shares will not be subject to a lock-up except to the extent they are otherwise subject to a lock-up agreement with the underwriters as described above. Any reserved shares not purchased in the directed share program will be offered by the underwriters to the general public on the same basis as the other shares in this offering. Prior to this offering, there has been no public market for our common stock. The initial public offering price will be determined by negotiation by us and the representatives of the underwriters. The principal factors to be considered in determining the initial public offering price include: the information set forth in this prospectus and otherwise available to the representatives; the history and the prospects for the industry in which we compete; the ability of our management; Table of Contents Underwriting our prospects for future earnings, the present state of our development, and our current financial position; the general condition of the securities markets at the time of this offering; and the recent market prices of, and the demand for, publicly traded common stock of generally comparable companies. In connection with the offering, the underwriters may purchase and sell shares of common stock in the open market. These transactions may include stabilizing transactions. Stabilizing transactions consist of bids or purchases made for the purpose of preventing or retarding a decline in the market price of the common stock while the offering is in progress. These transactions may also include short sales and purchases to cover positions created by short sales. Short sales involve the sale by the underwriters of a greater number of shares than they are required to purchase in the offering. Short sales may be either covered short sales or naked short sales. Covered short sales are sales made in an amount not greater than the underwriters over-allotment option to purchase additional shares in the offering. The underwriters may close out any covered short position by either exercising their over-allotment option or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. Naked short sales are in excess of the over-allotment option. The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering. A stabilizing bid is a bid for, or the purchase of, shares of common stock on behalf of the underwriters for the purpose of fixing or maintaining the price of our common stock. The underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the underwriters a portion of the underwriting discount received by it because the representatives have repurchased shares sold by or for the account of that underwriter in stabilizing or short covering transactions. These activities by the underwriters may stabilize, maintain or otherwise affect the market price of the common stock. As a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriters at any time. These transactions may be effected on the Nasdaq National Market, in the over-the-counter market or otherwise. We have agreed to indemnify the several underwriters against certain liabilities, including liabilities under the Securities Act, and to contribute to payments that the underwriters may be required to make in respect thereof. A prospectus in electronic format is being made available on Internet web sites maintained by one or more of the lead underwriters of this offering and may be made available on web sites maintained by other underwriters. Other than the prospectus in electronic format, the information on any underwriter s web site and any information contained in any other web site maintained by an underwriter is not part of the prospectus or the registration statement of which the prospectus forms a part. The Nasdaq National Market has approved our common stock for quotation under the symbol ZIPR subject to notice of issuance. Table of Contents Legal matters The validity of the common stock offered by this prospectus will be passed upon for us by Wilson Sonsini Goodrich Rosati, Professional Corporation, Palo Alto, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by O Melveny Myers LLP, Menlo Park, California. Certain members of, and investment partnerships comprised of members of, and persons associated with, Wilson Sonsini Goodrich Rosati own an aggregate of 42,567 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001143714_corus_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001143714_corus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..65f8d473334adcdbc653eb18bdd98b401bb29ea8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001143714_corus_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered by this prospectus will be passed upon for Corus by Orrick, Herrington & Sutcliffe LLP, Seattle, Washington. Entities affiliated with Orrick, Herrington & Sutcliffe LLP own an aggregate of 41,213 shares of our common stock and a partner of Orrick, Herrington & Sutcliffe LLP owns an aggregate of 17,176 shares of our common stock. Certain legal matters in connection with this offering will be passed upon for the underwriters by Heller Ehrman White & McAuliffe LLP, Seattle, Washington. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001145404_cornerston_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001145404_cornerston_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..effae7b2d9883af4cc22df6ae3d7d64fd94135fb --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001145404_cornerston_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock we are offering will be passed upon for us by Hale and Dorr LLP, Boston, Massachusetts. Partners of Hale and Dorr LLP beneficially own 71,328 shares of our series B convertible preferred stock, which will automatically convert into 19,020 shares of common stock on the closing of this offering. Legal matters in connection with this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001145750_seven_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001145750_seven_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6108308cfcd24f454500f68ea0f80d1711c0e4b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001145750_seven_legal_matters.txt @@ -0,0 +1 @@ +95 % 93 % 72 % 100 % 94 % 98 % 93 % Loss before provision for income taxes (14,142 ) (18,825 ) (12,598 ) (3,522 ) (3,109 ) Provision for income taxes (1 ) (28 ) (343 ) (23 ) (82 ) (restated) (restated) (in thousands, except percentages) Stock-based compensation $ Net loss $ (14,143 ) $ (18,853 ) $ (12,941 ) $ (3,545 ) $ (3,191 ) Basic and diluted net loss per share $ (5.29 ) $ (3.52 ) $ (1.89 ) $ (0.56 ) $ (0.40 ) Shares used in computing basic and diluted net loss per share 2,676 5,358 6,851 6,350 7,893 (1) As described in Note 2 of the consolidated financial statements, we have restated our financial statements as of December 31, 2002, and for each of the years in the two-year period ended December 31, 2002 to account for stock-based compensation matters. Year ended December 31, Three months ended March 31, Table of Contents The following table presents our summary consolidated balance sheet data as of March 31, 2004 both on an actual basis and on an as adjusted basis. The as adjusted data gives effect to the sale of shares of common stock that we are offering under this prospectus at an assumed initial public offering price of $ per share, generating proceeds to us of million. After deducting the estimated underwriting discounts and commission of $ million, estimated offering expenses payable by us of $ , the offering is expected to generate net proceeds to us of $ million. As of March 31, 2004 Balance sheet data: Actual As adjusted Table of Contents Risk factors This offering involves a high degree of risk. We have described below the most significant risks related to our business and industry and to your ownership to our common stock, and you should carefully consider each of these risks and uncertainties described below and all of the other information in this prospectus, including the consolidated financial statements and the related notes appearing at the end of this prospectus, before deciding to invest in shares of our common stock. If any of the following risks or uncertainties actually occurs, our business, prospects, financial condition and operating results could be harmed. In such an event, the trading price of our common stock could decline and you may lose all or part of your investment. RISKS THAT RELATE TO OUR BUSINESS AND INDUSTRY We have been sued for alleged patent infringement. An adverse outcome in this lawsuit could require us to pay significant damages and restrict the sale or use of our products and services. We have been sued for alleged patent infringement. In September 2003, we were served with a complaint filed by Visto Corporation ( Visto ) in the United States District Court for the Eastern District of Texas, Marshall Division ( District Court ), alleging that all System SEVEN messaging products and services (the Accused Products ) infringe two United States patents held by Visto. Visto s complaint seeks to enjoin the sale of the Accused Products in the United States. Visto also seeks an unspecified amount of lost profits and/or other damages, interest, attorneys fees, treble damages and litigation costs and also asks that we be ordered to destroy all the Accused Products within our possession, custody, and control. Visto s motion for a preliminary injunction seeks to enjoin us from selling the Accused Products in the United States pending the outcome of the litigation. The Court has not yet set a date for a hearing on Visto s preliminary injunction. A case scheduling conference will be held on May 18, 2004 in the District Court. It is likely that the District Court will address the timing of the preliminary injunction motion hearing date and other important pre-trial dates at that time, including the setting of a trial date. Although the District Court has tentatively proposed that the case be tried on April 4, 2005, a preliminary injunction hearing could be held at any time. On April 27, 2004, Visto filed a motion in the District Court seeking to amend its complaint to add allegations claiming that SEVEN infringes four additional patents controlled by Visto. As with its initial complaint, Visto continues to allege that the Accused Products infringe the two patents asserted in its original complaint as well as the four additional patents alleged in its proposed amendment to the complaint. We believe we have meritorious defenses to Visto s original and amended claims of patent infringement and plan to continue our vigorous defense against Visto s claims. Despite our defense in this regard, we cannot assure you that we will be successful in opposing these claims. If we are unable to oppose Visto s motion for preliminary injunction successfully, then we may be barred from selling, marketing, advertising, manufacturing or using the Accused Products in the United States or elsewhere during the course of the litigation. Sales of the Accused Products in the United States represented approximately 31% of our total revenues in 2003, 55% of our total revenues in the three months ended March 31, 2004 and are expected to represent a substantial portion of revenue in the future. If we are not successful in defending this litigation, we will very likely be required to pay Visto damages, including a possible trebling of damages awarded by the District Court, lost profits, interest, royalties and attorney s fees and litigation costs in an indeterminate amount and to indemnify our wireless operator customers for damages incurred by them as a result of such infringement. If a permanent injunction were issued after an adverse verdict at trial, then we could be barred from selling, marketing, advertising, manufacturing or using the Accused Products in the United States or elsewhere, unless we are able to negotiate a license from Visto at that time. Such a license may not be available to us at a reasonable cost or at all. If the Table of Contents Risk factors District Court orders a preliminary or permanent injunction restricting the sale of the Accused Products in the United States and a license from Visto is not available to us, then we likely would have to terminate contractual arrangements with our customers in the United States, and we could be subject to additional claims for any losses they incur as a result. If these unfavorable events occurred, we might be able to restructure our business to focus on our operations in markets outside the United States. However, we might not be successful in doing so. We might also face further legal challenges from Visto regarding our foreign operations and related activities, including the use of the Accused Products by third parties. In addition, we may be required to expend a significant amount of cash and other resources to defend ourselves against this lawsuit. This litigation could also result in delays by new or existing customers in entering into or renewing agreements to license our software. As a result of the foregoing, the Visto litigation could have a material adverse effect on our business, operating results and financial condition. We have a limited operating history that makes an evaluation of our business difficult. We were incorporated in May 2000 and began to offer our software and services to wireless operators in the third quarter of 2001. Our limited operating history makes evaluation of our business and prospects difficult. Companies at an early stage of development frequently encounter heightened risks as well as unexpected expenses and difficulties. For us, these risks include: the limited number of wireless operators that offer wireless data services incorporating our software; the limited number of current subscribers for these services; our unproven long-term use of monthly per-subscriber-based license agreements with our customers; our ability to protect our intellectual property rights and defend against claims that we infringe the intellectual property rights of others; our dependence on wireless operators to introduce, promote and market these services directly to subscribers; our dependence on wireless device manufacturers to design and develop compelling devices incorporating our software; our ability to compete in a highly competitive and rapidly evolving market; potential declines in our gross margin resulting from competition, cost increases, reductions in rates charged for wireless data services or other factors; and our ability to develop and introduce new software and services. We have a history of net losses and may not be profitable in the future. As of March 31, 2004, we had an accumulated deficit of $50.8 million. Our ability to generate profits and positive cash flow from operating activities will depend in large part on our ability to increase our revenues, particularly revenues from software licenses and subscription fees, and to manage the increasing costs of growing our business. If we cannot achieve operating profitability or positive cash flow from operations in the future, our business, financial condition and operating results will be adversely affected. Our quarterly revenues and operating results may vary significantly from quarter to quarter and may not be a good indication of our future performance. Our quarterly revenues and operating results have varied in the past and are likely to vary significantly from quarter to quarter in the future. In particular, many of our contracts have historically provided for significant up-front perpetual license fees that do not recur on a quarterly basis or otherwise. As a result, Table of Contents Risk factors if we are unable to generate recurring revenues under these contracts or additional revenues under new contracts, our future revenues in any quarter may not increase and could decline. At least in the near term, we expect to derive substantially all of our revenues from a limited number of wireless operators. Further, our revenues in any quarter may fluctuate significantly to the extent we do not recognize anticipated revenues from one or more of those wireless operators in that quarter. Finally, we have significant deferred revenue, including a substantial amount from a single wireless operator, and our revenues could fluctuate significantly in any particular quarter depending on when we recognize those revenues. For these and other reasons, we believe that period to period comparisons of our operating results are not a good indication of our future performance. A number of other factors are likely to cause variations in our quarterly results, including: the development of the wireless telecommunications market; fluctuations in demand for our software and services; the timing of the introduction and promotion of products and services based on our software by wireless operators and wireless device manufacturers; acceptance of products and services incorporating our technology by subscribers of wireless operators and wireless device manufacturers; the level of subscriber turnover experienced by our wireless operator customers; introductions of new products by us and our competitors and changes in our pricing policies or the pricing policies of our competitors; our ability to manage costs, including personnel and support services costs, and costs of deploying and supporting existing and new wireless operators; and delays of customer purchases caused by announcements of new technology or otherwise. Moreover, because our expenses are relatively fixed in the near term, any shortfall from anticipated revenue could result in losses for the quarter. In 2003, we recognized 98% of our revenues from four customers and the loss of one or more customers could cause our revenues to decline significantly. We currently derive, and we expect to continue to derive, a significant portion of our revenues from a small number of wireless operators. In 2003, we recognized approximately 98% of our total revenues from four of our customers: Cingular Wireless, NTT DoCoMo, Orange and Sprint PCS. In addition, for the three months ended March 31, 2004, we recognized approximately 86% of our total revenues from these same four customers. Sprint PCS and Orange accounted for approximately 41% and 18% of our total revenues for the three months ended March 31, 2004, respectively. We expect that we will continue to be dependent upon a limited number of customers for a significant portion of our revenues for the foreseeable future, although these customers may vary from period to period. As a result, if we fail to successfully offer our software and services to one or more customers in any particular period, or if any one of our customers purchases less of our software or services than anticipated, defers or cancels an order with us, our revenues could decline significantly and our business, operating results and financial condition could be materially and adversely effected. Moreover, our current customer agreements generally have two- to three-year terms and automatically renew for additional one-year terms unless terminated in advance. In 2004, our license agreements with Cingular Wireless, Orange and mmO2 will be up for renewal. In 2005, our license agreements with NTT DoCoMo and KDDI Corp will be up for renewal. Also, some of these agreements allow the wireless operators to terminate their commitments Table of Contents Risk factors prior to the end of the specified term. Our revenues may not grow as expected or may even decline if any one of our customers terminates its relationship with us. Our success and continued revenue growth depends on significantly increasing the number of subscribers that regularly use wireless data services incorporating our software. To date, only a relatively limited number of subscribers use wireless data services incorporating our software. Our near-term results depend heavily on achieving significant use of wireless data services by subscribers of our existing wireless operator customers. Over the longer term, our results also depend on achieving widespread deployment of our software by additional large wireless operators. The use of wireless data services incorporating our software will depend on the quality of those services and subscriber expectations for those services, which may vary by market, as well as the level of subscriber turnover experienced by our wireless operator customers. If we are not successful in maintaining relationships with existing customers, or establishing relationships with additional customers, and in significantly increasing the number of subscribers that use wireless data services incorporating our software, our revenue will not grow as expected and may even decline. Our success depends on a number of factors outside our control, including the introduction, marketing and promotion by large wireless operators of wireless data services that incorporate our software. None of our wireless operator customers is contractually obligated to introduce, market or promote products and services incorporating our software. Moreover, our customer agreements do not prevent our wireless operator customers from offering wireless data services supported by one or more of our competitors. As a result, if wireless operators do not introduce, market and promote wireless data services that incorporate our software, our software will not achieve widespread acceptance and we may not be able to grow as fast as anticipated, if at all. More generally, our success depends on a number of factors that are outside of our control, including: the widespread adoption of wireless data services; the extent to which wireless operators offer and promote competing products; the addition and retention by wireless operators of subscribers using wireless data services based on our software; the extent to which subscribers desire to purchase wireless data services directly from third parties other than wireless operators; the availability of wireless handheld devices that are compatible with our software; changes in the terms, particularly significant rate reductions, that wireless operators offer their subscribers for wireless data services that incorporate our software; the accessibility and prominence of System SEVEN features on wireless handheld devices; the quality and coverage area of voice and data services offered by wireless operators; the extent and timeliness of testing of our products on wireless operator networks; continued investments by wireless operators in evolving network technologies, such as third generation, or 3G , network capability with increased bandwidth; and continued support and distribution of our products and services, even though claims of patent infringement involving our products have been, and may continue to be, filed against us or third parties using our software. Table of Contents Risk factors If we are unable to successfully transition our customers from prepaid perpetual license agreements to per-subscriber-based license agreements, our revenues may not grow as expected and could fluctuate significantly from quarter to quarter. Historically, our license arrangements with our wireless operator customers have typically provided for fixed up-front payments for a specified number of perpetual licenses. These wireless operators may then use these perpetual licenses to provide wireless data services to their subscribers using our software, provided that the total number of subscribers at any one time may not exceed the number of perpetual licenses purchased by the wireless operator. In 2002 and 2003 and the three months ended March 31, 2004, these perpetual licenses represented 100% of all license revenues. However, in May 2003 we began entering into agreements with our wireless operator customers to purchase licenses with a specified term on a per-subscriber basis. These per-subscriber-based agreements generally have limited up-front payments and require wireless operators to pay us a fixed monthly fee for each of their subscribers using our software to access wireless data services. Although we believe the use of these new per-subscriber-based license agreements should result in a more stable revenue stream and may result in increased revenues over the life of each respective agreement, our existing and any additional wireless operator customers may not adopt per-subscriber-based pricing terms. Moreover, the use of per-subscriber-based agreements is unproven and we may not be able to maintain satisfactory pricing or volume levels. If we are unable to successfully transition our customers from prepaid perpetual license agreements to per-subscriber-based license agreements or if our use of per-subscriber-based license agreements is not successful, our revenues may not grow as expected and could fluctuate significantly from quarter to quarter. In 2003, our international operations accounted for approximately 69% of our total revenues. The administration of our foreign operations may increase our costs and divert management s attention, and the licensing of our software in foreign jurisdictions subjects our business to additional risks. Revenues outside the United States represented approximately 81% and 69% of our revenues in 2002 and 2003, respectively. For the three months ended March 31, 2004, approximately 45% of our revenues were derived from customers outside of the United States. We continue to pursue growth opportunities in the international market, which could result in increased international revenue contribution. Accordingly, we have committed, and may continue to commit, significant resources to our international operations and sales and marketing activities. We maintain offices in the United States and Japan and also have a limited physical presence in Europe. The additional complexities associated with administering our international operations, including compliance with import and export laws and attention to international trading and investment policies and potential adverse tax consequences, may increase our costs and require significant management attention. In addition, we are subject to a number of risks as a result of licensing our products in foreign jurisdictions, including: lengthened sales cycles; compliance with, and unexpected changes in, foreign regulatory requirements; difficulties in collecting accounts receivable; and uncertainties of laws and enforcement relating to the protection of intellectual property. In addition, governmental regulation of imports or exports or our failure to obtain any required export approval of our technologies, particularly our encryption technologies, could impede our international sales. Particularly, in light of recent terrorist activity, governments could enact additional regulation or restrictions on the use, import or export of encryption technologies. Additional regulation of encryption technology could delay or prevent the acceptance and use of our software. Gross profit (loss) 195 4,287 (542 ) (154 ) 223 1,831 1,444 Table of Contents Risk factors If wireless handheld device manufacturers do not design, manufacture or market products that are compatible with our software, or if these products do not achieve widespread market adoption, we may not be able to sustain or grow our business. We do not manufacture wireless handheld devices. Accordingly, our success will depend on, among other things, wireless handheld device manufacturers introducing new products that are compatible with our software and which provide subscribers with a compelling user experience for voice and data applications. Relative to the number of wireless handheld devices available to date, only a limited number of these devices are suitable for providing wireless data services. Any failure or delay in the introduction or acceptance of affordable wireless handheld devices that effectively enable wireless data services will slow the growth of our business. Our lengthy sales cycle makes it difficult for us to forecast revenue and increases the variability of quarterly fluctuations, which makes our business more difficult to evaluate and predict. We have a lengthy and complex sales process and many of our prospective wireless operator customers could spend a substantial amount of time performing internal evaluations before purchasing our software. Even after an initial decision to purchase our software is made, our wireless operator customers are likely to spend several months testing our software before deploying and implementing it into their networks. Because of this lengthy cycle, we may experience delays from the time we begin the sales process and incur increased operating expenses to obtain a new wireless operator customer until the time we generate revenue from the sale of our software. These delays could cause our operating results to vary significantly from quarter to quarter. If we are unable to develop enhancements to our software that keep pace with technological and market developments, or if we fail to release our software in a timely manner, the demand for our software may decline. The market for wireless data services is emerging and is characterized by rapid technological change and frequent new product introductions. Our inability, for technological or other reasons, to develop, deliver, introduce or enhance our software in a timely manner, or at all, in response to changing market conditions, enterprise technologies or customer requirements could have a material adverse effect on our operating results or could result in our software becoming obsolete. Development and delivery schedules for our products are difficult to predict. If new releases of our software are delayed, wireless operators may curtail their efforts to market and promote products and services incorporating our software and subscribers may cancel their existing subscriptions, any of which would result in a delay or loss of revenues and could seriously harm our business. Our ability to compete successfully will depend in large measure on our ability to maintain a technically skilled research and development staff and to adapt to technological changes and advances in the industry, including providing for the continued compatibility of our products with evolving industry standards and protocols. Defects in our software can be difficult to detect. If defects occur, they could damage our reputation and result in product liability or warranty claims or lost revenues. Our software is highly complex and may contain design defects that are difficult to detect and correct. In the past, we have experienced delays in new releases of our software due to defects, and we may experience similar delays in the future. In addition, if releases of our software contain defects, our customers may delay the introduction and promotion of our software to their subscribers. Despite testing by us, defects and errors may still be found in our current software or in new software releases, potentially resulting in delayed or lost revenues, loss of customers, failure to achieve acceptance, diversion of development resources and harm to our reputation. Our software is integrated into our customers networks and equipment. The sale and support of our software entails the risk of product liability or warranty claims based on damage to such networks and Table of Contents Risk factors equipment. In addition, the failure of our products or services to perform to customer expectations could give rise to warranty claims or lost revenues. If our software platform does not scale as anticipated, we may not be able to support a significant number of additional customers and subscribers and grow our business as expected. Despite frequent testing of our software s scalability in a laboratory environment, the ability of our software platform to support and manage a significant number of additional subscribers in an actual deployment is unproven. If our software platform does not efficiently scale to support and manage a significant number of additional subscribers while maintaining a high level of performance, we may not be able to support a significant number of additional customers and subscribers and grow our business as expected. The occurrence or perception of a security breach or an inappropriate disclosure of confidential information could seriously harm our business. Our software is often used to transmit personal, private and confidential information. If there is a security breach or if there is an inappropriate disclosure of any of these types of information, we could be exposed to litigation and possible liability. Even if we were not held liable, a security breach or inappropriate disclosure of personal, private or confidential information could harm our reputation and our relationships with current and potential customers, and even the perception of a security risk could inhibit market acceptance of our products and services. In addition, we may be required to invest additional resources to protect us against damages caused by any actual or perceived disruptions or security breaches. Any of these developments could result in increased costs or lost revenues which could seriously harm our business. Products and services that incorporate our software may contain errors or defects, which could damage our reputation and result in increased costs or lost revenues. We cannot control the business and quality standards of our wireless operator customers and wireless device manufacturers, and we are unable to monitor the distribution of wireless data services based on our software. We cannot guarantee that the products and services provided by our customers are free from errors or defects. If errors or defects occur in products and services that use our software, it could result in the rejection of these products and services by wireless operators or their subscribers, damage to our reputation, increased customer service and support costs, lost revenues and diverted development resources. We operate in a highly competitive industry and if we do not compete effectively to retain our existing customers and attract new customers, our revenues may not grow as expected or may even decline. The wireless data services market is highly competitive. With the introduction of new technologies and market entrants, we expect competition to intensify in the future. Our direct competitors include those companies that provide consumers and businesses with access to personal and business information over wireless handheld devices such as Research In Motion Limited (RIM), which markets the Blackberry solution. In addition, we compete with a number of privately held companies. We believe our competitors could also include wireless hardware manufacturers, application and software providers, such as IBM and Microsoft, network infrastructure providers and wireless operators that developed their own competing solutions. Our current and potential competitors may have greater name recognition, larger customer bases and significantly greater financial, technical, marketing, public relations, sales, distribution and other resources than we do. We cannot assure you that we will be able to compete effectively with these companies. For example, our competitors could adopt our strategy of providing software that is compatible with a wide variety of hardware and software platforms and thereby harm our competitive position. Competition could result in price reductions, including competing solutions that are provided at Table of Contents Risk factors little or no cost as part of a bundled product offering, fewer customer orders and reduced gross margins. In addition, rates charged by wireless operators for wireless data services could significantly decline. These pricing pressures could result in reduced margins that would harm our operating results. If we are unable to compete effectively to retain our existing customers and attract new customers and increase subscriber adoption of our software, our revenues may not grow as expected or may even decline and our business would be seriously harmed. We may experience declines in our gross profit percentage that have a material adverse effect on our operating results and financial condition. We may experience declines in our gross profit percentage. For example, competition could result in price reductions, including competing solutions that are provided at little or no cost as part of a bundled offering. In addition, rates charged by wireless operators for wireless data services could decline significantly, resulting in pricing pressures that reduce our gross profit percentage. Moreover, we may experience cost increases. A decline in our gross profit percentage for any reason could have a material adverse effect on our operating results and financial condition. The success of our business and continued growth in our revenues are dependent on the continued growth in the market for wireless data services. Growth in the market for wireless data services may not develop as we anticipate and may be inhibited for a number of reasons, including ease of access and use, regulatory initiatives or lack of necessary increases in bandwidth availability. Further, subscribers may not be satisfied with the cost or quality of wireless data services or the functionality of the wireless devices on which these services are delivered. Wireless operators may not promote wireless data services or they may promote wireless data services that do not use our software. If the market for wireless data services does not grow as expected for these or other reasons, our revenues may not grow as expected. If we infringe on the intellectual property rights of others, we may be required to pay monetary damages or we may be prohibited from selling or marketing our products and services unless we are able to obtain a license to use such intellectual property. Our commercial success depends, in part, upon us not infringing intellectual property rights owned by others. For example, the industry in which we compete has many participants that may own, or claim to own, intellectual property. We cannot determine with certainty whether any existing or future third-party intellectual property rights would require us to alter our technologies, obtain licenses or cease certain activities. We have received, and may in the future receive, claims from third parties asserting infringement and other related claims. Litigation has been and may continue to be necessary to determine the scope, enforceability and validity of third-party proprietary rights or to establish our proprietary rights. Some of our competitors may have substantially greater resources than we do and may be able to sustain the costs of complex intellectual property litigation to a greater degree and for longer periods of time than we could. Regardless of whether claims that we are infringing patents or other intellectual property rights have any merit, those claims could: adversely affect our relationships with our current or future wireless operator customers, their subscribers, wireless data handheld device manufacturers and system integrators; be time-consuming and costly to evaluate and defend; cause product shipment delays or stoppages; divert management s attention and resources; Table of Contents Risk factors subject us to significant liabilities; require us to enter into royalty or licensing agreements; and require us to cease certain activities. In addition to liability for monetary damages against us or, in certain circumstances, our customers or their subscribers, we may be prohibited from developing or commercializing certain of our technologies and products unless we obtain a license from the holder of the patent or other intellectual property rights. We cannot assure you that we will be able to obtain any such license on commercially favorable terms, or at all. If we do not obtain such a license, our business, operating results and financial condition could be materially adversely affected and we could, for example, be required to cease related business operations in some markets and restructure our business to focus on our continuing operations in other markets. Our limited ability to protect our intellectual property and proprietary rights may harm our competitiveness. We rely primarily on a combination of trademark laws, copyright laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary technology. In addition, we have two patent applications pending in the U.S. Patent & Trademark Office that are directed to core elements of our software, and have filed two corresponding international applications pursuant to the Patent Cooperation Treaty. Patents may not be issued from these or any future applications. Even if they are issued, these patents may not survive a legal challenge to their validity or provide significant protection for us. The steps we have taken to protect our proprietary rights may not be adequate to prevent misappropriation of our proprietary information. For instance, while we have filed an application to register the name SEVEN with the European Communities Trade Mark Association, several oppositions to our application have been filed and we are currently aware of at least one third party that is currently using this mark in several European countries. Further, we may not be able to detect unauthorized use of, or take appropriate steps to enforce, our intellectual property rights. Our competitors may also independently develop similar technology. In addition, the laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Any failure by us to meaningfully protect our intellectual property could result in competitors offering products that incorporate our most technologically advanced features, which could seriously reduce demand for our products and services. Failure to manage our growth could seriously harm our ability to deliver our software in a timely fashion, fulfill existing customer commitments or attract and retain new customers. Our rapid growth has placed, and is expected to continue to place, a significant strain on our managerial, operational and financial resources. Our future success will depend, in part, upon the ability of our senior management to manage growth effectively. This will require us to implement additional management information systems; to further develop our operating, administrative, financial and accounting systems and controls; to hire additional personnel; to develop additional levels of management within the corporation; to locate additional office space in the United States as well as internationally; and to maintain close coordination among our development, accounting, finance, sales and marketing, consulting services and customer service and support organizations. Moreover, as our sales increase, we may be required to concurrently deploy our software at multiple locations or provide increased levels of customization. As a result, we and our systems integrator partners may lack the resources to deploy our software on a timely and cost-effective basis. Failure to accomplish any of these requirements could seriously harm our ability to deliver our software in a timely fashion, fulfill existing customer commitments or attract and retain new customers. Table of Contents Risk factors We depend on the services of key personnel to implement our strategy. If we lose the services of our key personnel or are unable to attract and retain other qualified personnel, we may be unable to implement our strategy. Our ability to manage our growth depends, in part, on our ability to identify, hire and retain additional qualified employees. Our business depends on the services of a small number of key management and operating personnel, in particular, Bill Nguyen, a founder, Chairman of the Board of Directors and Co-Chief Executive Officer; Kent Thexton, President and Co-Chief Executive Officer; Gary Schofield, Vice President of Worldwide Sales; and Kazuhiko Ishii, Vice President and General Manager, Japan. Recently, we offered employment to Thomas Hoster, who has accepted our offer and is expected to join us as our Chief Financial Officer on May 10, 2004. We have at-will employment relationships with all of our management and other employees, except for Mr. Ishii with whom we have entered into an employment agreement which, as required under Japanese law, provides that Mr. Ishii can only be terminated for cause. We do not maintain key man life insurance policies on any members of management or any other employees. The loss of members of our key management and certain other members of our operating personnel could adversely affect our business. If we are unsuccessful in attracting and retaining these key personnel, our ability to operate our business effectively would be negatively impacted and our business would be adversely affected. If we fail to effectively integrate new members of our management team into our organization, the management of our business and the future development and marketing of our products and services may suffer. Kent Thexton, our President and Co-Chief Executive Officer, joined us in April 2004, and Thomas Hoster is expected to join us in May 2004 as our Chief Financial Officer. In addition, we are in the process of recruiting, hiring and integrating other members of our management. As a result, our executive team has not worked together as a group for a significant period of time. Our future performance will depend, in part, on our ability to successfully integrate our newly-hired executive officers into our management team and our ability to develop an effective working relationship among senior management. Our failure to integrate these individuals and create effective working relationships among them and other members of management could result in inefficiencies in the development and marketing of our products and services and the overall management of our business. We rely on third parties to implement our System SEVEN software. We currently rely on our systems integrator partners, NEC and Hewlett-Packard, to implement our System SEVEN software with our wireless operator customers, and in the future we expect to increasingly rely on third parties for implementation. Our relationships with these parties do not ensure that they will provide implementation services when needed and we cannot control the quality of service they provide. If we do not receive adequate support from these third parties, we may be required to internally implement our software and services. This could significantly limit our ability to meet our customers needs and could increase our operating costs. Also, if the number of System SEVEN software implementations increases, we will need to develop new relationships with additional partners in order to meet implementation demands. If we are unable to establish and maintain effective, long-term relationships with implementation partners, or if these implementation partners do not meet the needs or expectations of our customers, we may not be able to grow our business as expected. Future acquisitions may strain our business and resources and may result in dilution to our stockholders. While we are not currently a party to any agreements or commitments and have no understandings with respect to any acquisitions, we may find it necessary to acquire additional businesses, products or technologies in the future in order to remain competitive. In the event that we identify an appropriate Table of Contents Risk factors acquisition candidate, we may not be able to negotiate the terms of any such acquisition successfully, finance such acquisition or integrate such acquired business, products or technologies into our existing business and operations. Further, the negotiation of potential acquisitions, as well as the integration of an acquired business, could cause significant diversions of management time and resources. Any potential acquisition, whether or not consummated, could seriously harm our business, operating results and financial condition. If we consummate one or more significant acquisitions in which the consideration consists of stock or other securities, our stockholders could suffer significant dilution of their interests in us. If we were to proceed with one or more significant acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash to consummate any such acquisition. Acquisition financing may not be available on favorable terms, or at all. In addition, we may be required to impair significant amounts of goodwill and other intangible assets in connection with future acquisitions, which may seriously harm our operating results. We will incur increased costs as a result of being a public company. As a public company following this offering, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Stock Market, Inc., have required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. For example, in anticipation of becoming a public company, among other things, we have created additional board committees and adopted corporate governance guidelines and a code of business conduct. In addition, we will incur additional costs associated with our public company reporting requirements. We also expect these new rules and regulations to make it more difficult and more expensive for us to obtain and maintain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers. We cannot predict or estimate the amount of additional costs we may incur as a result of these new rules or the timing of such costs. We are exposed to fluctuations in foreign currencies as a result of our international operations. A significant portion of our current and potential future customers are based outside the United States. As of March 31, 2004, two of our agreements with our wireless operator customers had provisions to collect our fees in a foreign currency, one in Japanese Yen and the other in British Pounds, and we are exposed to foreign exchange risk in connection with these agreements. For the three months ended March 31, 2004, approximately 18% of our revenue and approximately 11% of our operating costs were denominated in currencies other than the U.S. Dollar. Although we currently do not engage in any hedging activities, we monitor our foreign exchange exposures and, in certain circumstances, maintain net monetary asset and/or liability balances in foreign currencies. These activities are designed to mitigate, but do not eliminate, our exposure to exchange rate fluctuations. If the Japanese Yen, the British Pound or other currencies in which we may transact depreciate relative to the U.S. Dollar, our foreign currency denominated revenue will decrease when translated to U.S. Dollars for financial reporting purposes. As a result, exchange rate fluctuations may materially adversely affect our operating results in future periods. Our headquarters and data centers, and a number of our major customers, are located in areas that are particularly susceptible to earthquakes. Our headquarters and data centers are located in California and some of our wireless operator customers are concentrated in Asia and elsewhere in the Pacific Rim, areas subject to significant earthquake risks. Table of Contents Risk factors Any damage to our headquarters or disruption to the networks of these customers or our data centers resulting from earthquakes or other natural disasters could significantly harm our business. Reduced spending by our customers or reduced demand for our products due to the uncertainty of economic and geopolitical conditions may cause an overall decline in our revenues or cause our revenues to grow less quickly than anticipated. Economic and geopolitical uncertainties may directly affect wireless operators and enterprises using our software. Some wireless operators and enterprises have reduced capital spending on technology products. Current and future conditions in the domestic and global economies remain uncertain. A slowdown in capital spending by wireless operators and enterprises utilizing our software, coupled with existing economic and geopolitical uncertainties, has created uncertainty for market demand and may affect our revenues. It is difficult to estimate the level of growth for the economy as a whole. The prevailing economic uncertainties make it difficult to estimate the demand for our software and, as a result, our future income and expenditures. The future direction of the overall domestic and global economies will have an impact on our overall performance. Economic conditions in the United States, Japan, Asia-Pacific, Europe and elsewhere affecting the wireless data communication industry in which we compete, are beyond our control. If these economic conditions fail to improve, we may not experience the anticipated demand for our products and we may be subject to adverse pricing pressures, either of which could cause our revenues to decline or grow less quickly than anticipated and harm our operating results. In addition, acts of terrorism and the outbreak of hostilities and armed conflicts between countries have created uncertainties that may affect the global economy and could further impact the demand for our products. RISKS THAT RELATE TO YOUR OWNERSHIP OF OUR COMMON STOCK Our existing executive officers, directors and principal stockholders will control approximately % of our common stock after this offering and, as a result, will be able to influence the outcome of director elections and other transactions requiring stockholder approval. Upon completion of this offering: our executive officers, directors and principal stockholders will beneficially own, in the aggregate, approximately % of our outstanding common stock; Bill Nguyen, our Chairman of the Board of Directors and Co-Chief Executive Officer, will own approximately % of our outstanding common stock; Ignition, LLC and its affiliates will own approximately % of our outstanding common stock; Greylock X Limited Partnership and its affiliates will own approximately % of our outstanding common stock; SOFTBANK Asia Infrastructure Fund will own approximately % of our outstanding common stock; and Saints Capital III, L.P. and its affiliates will own approximately % of our outstanding common stock. As a result, these stockholders will be able to exercise control over significant matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which may have the effect of delaying or preventing a third party from acquiring control over us. These transactions may include those that other stockholders deem to be in their best interests Table of Contents Risk factors and in which those other stockholders might otherwise receive a premium for their shares over their current prices. Our stock price may be particularly volatile because we are a technology company in the wireless data services industry. The stock market in general has recently experienced extreme price and volume fluctuations. In addition, the trading prices of securities of technology companies, and in particular companies in the wireless data services industry, have been volatile, and have experienced fluctuations that have often been unrelated to or disproportionate to the operating performance of such companies. These broad market fluctuations could adversely affect the price of our common stock. If securities or industry analysts do not publish research or reports about our business, if they change their recommendations regarding our stock adversely or if our operating results do not meet their expectations, our stock price and trading volume could decline. The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or more of the analysts who cover us downgrade our stock or if our operating results do not meet their expectations, our stock price could decline. Our ability to raise capital in the future may be limited and our failure to raise capital when needed could prevent us from executing our growth strategy. We believe that our existing cash, cash equivalents, marketable securities, and cash provided by operating activities will be sufficient to meet our anticipated cash needs for at least the next 12 months. The timing and amount of our working capital and capital expenditure requirements may vary significantly depending on numerous factors, including: market acceptance of our software and services; the need to adapt to changing technologies and technical requirements; and the existence of opportunities for expansion. If our capital resources are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity securities or debt securities or obtain debt financing. The sale of additional equity securities or convertible debt securities would result in additional dilution to our stockholders. The incurrence of debt could result in increased expenses and would likely result in covenants that could restrict our operations. We have not made arrangements to obtain additional financing and there is no assurance that financing, if required, will be available in amounts or on terms acceptable to us, if at all. Provisions in our charter documents and Delaware law may make it difficult for a third party to acquire us and could depress the price of our common stock. Delaware corporate law and our restated certificate of incorporation and bylaws contain provisions that could delay, defer or prevent a change in control of us or our management. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. As a result, these provisions could limit the price that investors are willing to pay in the future for shares of our common stock. These provisions include: creating a classified board of directors; authorizing the board of directors to issue preferred stock without stockholder approval; Table of Contents Risk factors prohibiting cumulative voting in the election of directors; limiting the persons who may call special meetings of stockholders; prohibiting stockholder action by written consent; and establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings. We are also subject to certain provisions of Delaware law which could delay, deter or prevent us from entering into an acquisition, including Section 203 of the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in a business combination with an interested stockholder unless specific conditions are met. You will experience immediate and substantial dilution by investing in our common stock. The initial public offering price will be substantially higher than the net tangible book value of each outstanding share of our common stock immediately following the offering. Purchasers of common stock in this offering will suffer immediate and substantial dilution. Any common stock you purchase in this offering will have a post-offering net tangible book value per share of $ less than the initial public offering price of $ per share. Future sales or issuances of our common stock could lower our share price and dilute your voting power and may reduce our earnings per share. We may sell additional shares of our common stock in subsequent offerings. We may also issue additional shares of our common stock to finance future acquisitions. We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of our common stock will have on the trading price of our common stock. Sales or issuances of substantial amounts of common stock, or the perception that such sales could occur, may adversely affect prevailing trading prices for our common stock. Any additional sale or issuance of our common stock will result in dilution to your voting power and may reduce our earnings per share. The trading price of our common stock could be affected by the substantial number of shares that are eligible for future sale. Many of our existing stockholders will have an opportunity to sell their stock following this offering. Also, many of our employees and directors may exercise their stock options in order to sell the underlying stock in the market following this offering. Upon completion of this offering, we will have approximately shares of common stock outstanding, assuming no exercise of options and warrants outstanding as of March 31, 2004 and the conversion of all outstanding shares of preferred stock. In addition, as of March 31, 2004, 4,114,625 shares of our common stock are issuable upon the exercise of outstanding stock options, of which 933,961 shares were then vested and exercisable. The shares sold in this offering will be freely transferable without restriction or registration under the Securities Act, except for any shares purchased by one of our existing affiliates, as that term is defined in Rule 144 under the Securities Act. An additional shares outstanding after this offering will also be freely transferable without restriction or registration under the Securities Act, except for any shares held by our existing affiliates. The remaining shares of our common stock outstanding after this offering will be restricted shares as defined in Rule 144 under the Securities Act and may be sold in the public market only if registered or if they qualify for an exemption from registration under the Securities Act, including exemptions contained in Rule 144. However, of these restricted shares, Table of Contents Risk factors shares have been held for more than two years and, except for any shares held by one of our existing affiliates, may be resold in the public market without regard to the volume or manner of sale restrictions of Rule 144. Our officers, directors, option holders and all of our stockholders have agreed that, subject to limited exceptions, they will not sell their shares for a period of 180 days. Thus, upon the expiration of the 180-day lock-up period, shares of our common stock held by those stockholders will be available for immediate resale, subject to the restrictions imposed by the securities laws. We have entered into an agreement with some of our stockholders that provides for registration rights. Under circumstances described in that agreement, these stockholders can demand that we register the 27,551,064 shares of our common stock held by them for sale to the public market. In addition, we may be required to include those shares if we register additional shares for sale to the public market. There is no existing market for our common stock so the share price for our common stock may fluctuate significantly. Prior to the offering, there has been no public market for our common stock. We cannot assure you that an active trading market will develop upon completion of the offering or, if it does develop, that it will be sustained. If a market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at an attractive price, or at all. The initial public offering price of our common stock was determined by negotiation among us, the selling stockholders and the representatives of the underwriters and may not be representative of the price that will prevail in the open market after the offering. The trading price of our common stock after this offering may be significantly affected by factors such as quarterly variations in our results of operations, results of existing or potential litigation involving us, including developments in the Visto litigation, announcements by us regarding new contracts or new products and services, our trading volume, differences between our actual financial and operating results and those expected by investors and analysts and changes in analysts recommendations or projections regarding SEVEN. In addition, our share price may be affected by factors such as announcements by or results of our competitors, changes in government regulations, general market trends for technology companies, changes in general economic conditions, volatility in the financial markets and other factors. We have broad discretion to use the offering proceeds and our investment of those proceeds may not yield a favorable return. Our management has broad discretion over the use of net proceeds from this offering. We intend to use the net proceeds of this offering to increase our research and development capabilities, to develop and implement marketing programs to drive adoption of our software and for working capital and general corporate purposes. In addition, we may use a portion of the net proceeds to acquire or invest in one or more new technologies, products or businesses that expand, complement or are otherwise related to our current business and products. You will not have the opportunity to evaluate the economic, financial or other information on which we base our decisions on how to use the net proceeds we receive from this offering. We cannot assure you that management will apply these funds effectively, nor can we assure you that the net proceeds from this offering will be invested to yield a favorable return. Table of Contents Special note regarding forward-looking statements Some of the statements made under Prospectus summary, Risk factors, Management s discussion and analysis of financial condition and results of operations, Business, and elsewhere in this prospectus constitute forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expects, plans, anticipates, believes, estimated, predicts, potential, or continue, or the negative of these terms or other comparable terminology. These statements are only predictions and are subject to known and unknown risks, uncertainties, and other factors that may cause our or our industry s actual results, levels of activity, performance, or achievements to be materially different from those anticipate by the forward-looking statements. These factors include, among other things, those listed under Risk factors and elsewhere in this prospectus. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of the forward-looking statements after the date of this prospectus to conform forward-looking statements to actual results. Table of Contents Use of proceeds We estimate that the net proceeds to us from the sale of the shares of common stock that we are offering will be approximately $ million based on the public offering price of $ per share and after deducting underwriting discounts and commissions and estimated offering expenses. We will not receive any proceeds from the sale of shares by the selling stockholders. The primary purposes of this offering are to obtain additional equity capital, create a public market for our common stock and facilitate future access to public markets. We expect to use the net proceeds we receive from this offering, together with our remaining cash, to increase our research and development capabilities, to develop and implement marketing programs to drive adoption of our software and for working capital and general corporate purposes. Although we may use a portion of the net proceeds to acquire technology or businesses that are complementary to our business, we are not currently a party to any agreements or commitments and we have no understandings with respect to any acquisitions. Accordingly, our management will have broad discretion in applying the net proceeds of this offering. Pending such uses, we plan to invest the net proceeds in short-term, interest-bearing, investment grade securities. Dividend policy We have never declared or paid any dividends on our common stock, and we do not currently anticipate paying dividends on our common stock in the foreseeable future. Our current policy is to retain earnings to finance the expansion of our operations. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant. Table of Contents Capitalization The following table sets forth our capitalization as of March 31, 2004: on an actual basis; and on as adjusted basis to reflect the conversion of all of our outstanding convertible preferred stock into 27,551,064 shares of common stock, which will occur upon the closing of this offering; and the sale of the shares of common stock offered in this offering at an assumed initial public offering price of $ per share after deducting the underwriting discount and estimated offering expenses of $ . You should read this information in connection with our consolidated financial statements and the notes to those statements appearing elsewhere in this prospectus. As of March 31, 2004 Gross profit (loss) (198 ) 3,787 3,681 Actual As adjusted Gross profit (loss) (198 ) 3,787 3,681 Gross profit $ (unaudited) Cash, cash equivalents and short-term and long-term investments $ 11,573,727 $ Stockholders equity: Convertible preferred stock, $0.000067 par value, 27,749,126 shares authorized, issuable in series: Series 1 preferred stock, 7,500,000 shares designated, issued and outstanding $ 503 $ Series A preferred stock, 8,116,070 shares designated issued and outstanding 544 Series A1 preferred stock, 4,183,056 shares designated, issued and outstanding 280 Series B preferred stock, 7,950,000 shares designated; 7,751,938 shares issued and outstanding; aggregate liquidation preference of $30,000,000 519 Common stock, $0.000067 par value, 44,000,000 shares authorized, 8,696,469 shares issued and outstanding on an actual basis; and shares issued and shares outstanding on an as adjusted basis 582 Additional paid-in capital 65,736,167 Notes receivable from stockholders (220,876 ) (220,876 ) Deferred stock-based compensation (7,260,011 ) (7,260,011 ) Accumulated other comprehensive income 30,589 30,589 Accumulated deficit (50,809,588 ) (50,809,588 ) Total stockholders equity $ 7,748,709 $ (restated) (in thousands, except percentages) Stock-based compensation $ 1,177 $ (unaudited) Commercial paper $ 3,679,431 23 (98 ) 3,679,356 Market auction preferred stock 275,227 275,227 U.S. Treasury and Agency securities 511,620 1,084 512,704 Corporate debt securities 4,397,821 1,467 (752 ) 4,398,536 Foreign debt securities 742,084 Shares of common stock to be outstanding after the offering do not include: 4,114,625 shares of common stock issuable upon exercise of stock options outstanding at a weighted average exercise price of $0.39 per share; 60,000 shares of common stock issuable upon exercise of a warrant outstanding as of March 31, 2004; 5,059,064 shares reserved as of March 31, 2004 for future stock option grants and purchases under our equity compensation plans; and an additional 1,250,000 reserved for future stock option grants and purchases under our equity compensation plans, as approved by our board of directors in April 2004. See Management 2004 Equity Incentive Plan and Employee Stock Purchase Plan and note 12 of the notes to our consolidated financial statements. Table of Contents Dilution The net tangible book value of our common stock as of March 31, 2004 was $7.7 million, or approximately $0.89 per share. Net tangible book value per share represents the amount of stockholders equity divided by 8,696,469 shares of common stock outstanding at that date. On completion of this offering, all outstanding shares of convertible preferred stock will convert into common stock. Assuming the offering was completed at March 31, 2004, the 27,551,064 shares of convertible preferred stock outstanding at that date would have converted into an estimated 27,551,064 shares of common stock, decreasing net tangible book value per share by $ to $ . There have been no issuances of convertible preferred stock subsequent to March 31, 2004. Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of common stock in this offering and the pro forma net tangible book value per share of common stock immediately after completion of this offering. After giving effect to our sale of shares of common stock in this offering, after deducting the underwriting discounts and estimated offering expenses, our pro forma net tangible book value as of March 31, 2004 would have been $ per share. This represents an immediate increase in net tangible book value of $ per share to existing stockholders and an immediate dilution in net tangible book value of $ per share to purchasers of common stock in this offering, as illustrated in the following table: Assumed initial public offering price per share $ Net tangible book value per share as of March 31, 2004 $ Decrease per share attributable to conversion of convertible preferred stock $ Increase per share attributable to new investors $ Pro forma net tangible book value per share at March 31, 2004 after giving effect to the offering $ Dilution per share to new investors $ The following table summarizes, on a pro forma as adjusted basis, as of March 31, 2004, the difference between the number of shares of common stock purchased from us, the total consideration paid to us, and the average price per share paid by existing stockholders and by new investors at an assumed initial public offering price of $ per share, before deducting underwriting discounts and estimated offering expenses. Shares Purchased Total Consideration Average Price Per Share Number % Amount % (in thousands, except percentages) Interest income and other expenses, net $ 784 $ Existing stockholders % $ % $ New investors % % $ Total 100.0 % 100.0 % Deferred tax assets: Net operating loss carryforwards $ 12,761,786 16,778,574 Research and development credit carryforwards 746,130 1,032,153 Depreciation and amortization 184,054 402,457 Reserves and accruals 138,345 536,804 Other 1,063 The discussion and the tables above assume no exercise of stock options or warrants outstanding on March 31, 2004, and no issuance of shares reserved for future issuance under our equity compensation plans. As of March 31, 2004, there were: 60,000 shares of common stock issuable upon exercise of an outstanding warrant; 4,114,625 shares of common stock issuable upon exercise of outstanding options with a weighted average exercise price of $0.39 per share; and an additional 2,609,064 shares reserved for future stock option grants and purchases under our existing equity compensation plans. Table of Contents Selected historical consolidated financial data The following table sets forth our selected historical consolidated financial data which should be read in conjunction with the section entitled Management s discussion and analysis of financial condition and results of operations following this section and our consolidated financial statements, the related notes and other financial data included elsewhere in this prospectus. As described in Note 2 of notes to our consolidated financial statements, we have restated our financial statements as of December 31, 2002, and for each of the years in the two-year period ended December 31, 2002 to account for stock-based compensation matters. The selected historical consolidated financial data for the years ended December 31, 2001, 2002 and 2003 and as of December 31, 2002 and 2003 are derived from our audited consolidated financial statements included in this prospectus. The selected historical consolidated financial data for the period from our inception (May 5, 2000) to December 31, 2000 and as of December 31, 2000 and 2001 are derived from our audited consolidated financial statements not included in this prospectus. The selected historical consolidated financial data for the three months ended March 31, 2003 and March 31, 2004 and as of March 31, 2004 are derived from the unaudited consolidated financial statements included elsewhere in this prospectus. The historical results are not necessarily indicative of results to be expected in any future period. Statements of operations data: Year ended December 31, Three months ended March 31, (in thousands, except percentages) Cost of revenues: License $ $ % Support, maintenance and hosting 3,312 2,125 (35.9 ) Professional services Total operating expenses 2,077 15,143 23,396 16,537 3,844 4,306 (in thousands, except percentages) Provision for income taxes $ 28 $ (unaudited, in thousands, except percentages) Restructuring $ Loss before provision for income taxes (1,681 ) (14,142 ) (18,825 ) (12,598 ) (3,522 ) (3,109 ) Net loss $ (1,681 ) $ (14,143 ) $ (18,853 ) $ (12,941 ) $ (3,545 ) $ (3,191 ) (unaudited, in thousands, except percentages) General and administrative $ 453 $ (unaudited, in thousands, except percentages) Cost of revenues: License $ 6 $ 4 (31.0 )% Support, maintenance and hosting 579 705 21.8 Professional services 314 Total revenues 694 4,751 259 509 1,122 2,728 2,215 839 2,277 Cost of revenues: License 6 6 6 6 4 Support, maintenance and hosting 499 447 634 545 579 521 626 646 705 Professional services 17 167 118 314 370 139 3 Basic and diluted net loss per share $ (1.05 ) $ (5.29 ) $ (3.52 ) $ (1.89 ) $ (0.56 ) $ (0.40 ) Shares used in computing basic and diluted net loss per share 1,604 2,676 5,358 6,851 6,350 7,893 (footnotes on the following page) Table of Contents Statements of cash flows data: Year ended December 31, Three months ended March 31, As of March 31, (restated)(1) (restated)(1) (unaudited) (in thousands) Cash, cash equivalents and short-term investments $ 19,867 $ 31,979 $ 15,796 $ 6,682 $ 6,859 Long-term investments 7,815 7,393 6,856 4,715 Accounts receivable 125 576 1,273 1,747 Total assets 24,196 45,722 29,161 18,539 17,394 Deferred revenue 4,869 5,011 6,296 6,579 Net working capital 19,550 26,738 10,226 786 1,029 Accumulated deficit (1,681 ) (15,824 ) (34,677 ) (47,619 ) (50,810 ) Total stockholders equity 23,770 39,839 22,301 9,839 7,749 (1) See Note 2 of notes to consolidated financial statements. Year ended December 31, Three months ended March 31, Table of Contents Management s discussion and analysis of financial condition and results of operations The following discussion and analysis of our financial condition and results of operations for the three years ended December 31, 2003 and for the three months ended March 31, 2003 and March 31, 2004 should be read in conjunction with our Selected historical consolidated financial data and our consolidated financial statements and related notes that appear in this prospectus. As described in Note 2 of notes to our consolidated financial statements, we have restated our financial statements as of December 31, 2002, and for each of the years in the two-year period ended December 31, 2002, to account for stock-based compensation matters. The discussion outlines our historical results of operations and other factors that are expected to affect our prospective financial condition. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in Risk factors. OVERVIEW We are a global provider of software that enables wireless operators to offer secure, affordable and real-time wireless data services to their business and individual subscribers. Our software allows access to e-mail as well as other business and personal information on a wide variety of wireless handheld devices or access points such as Internet browsers. We license our System SEVEN software to wireless operators who embed it into their existing networks and systems. We believe this operator-centric approach allows operators to offer their subscribers bundled, branded and differentiated wireless services at a relatively low cost in order to enhance customer loyalty and increase revenues. As of March 31, 2004, our customers consisted of the following wireless operators: Cingular Wireless and Sprint PCS in the United States; KDDI Corp and NTT DoCoMo in Japan; SingTel group, consisting of Globe Telecom, Optus and SingTel, in Asia-Pacific; and mmO2 and Orange in Europe. Our customers license our software either directly or through our distribution and systems integrator partners, NEC and Hewlett-Packard. For example, pursuant to a strategic value added reseller and distribution agreement with us, NEC sublicenses our software to NTT DoCoMo and KDDI Corp. We were founded in May 2000 as Leap Corporation and in December 2000 changed our name to Seven Networks, Inc. Since our inception, we have financed our operations through the sale of our capital stock and revenues generated from our wireless operator customers. In 2000, we raised $25.4 million in our initial venture financing. In July 2001, we raised $29.9 million in our second venture financing. Our investors include Ignition, LLC, Greylock, Saints Capital and SOFTBANK Asian Infrastructure Fund. To date, we have experienced significant operating losses as we have made substantial investments in research and development, sales and marketing and our overall infrastructure. We expect to continue to make substantial investments in these areas in the future to expand our market presence by adding new wireless operator customers and by increasing subscriber adoption of wireless data services based on our software. Our ability to generate profits and positive cash flow from operations will depend primarily on increasing revenues to offset anticipated increases in operating expenses. Even if we are able to achieve profitability in any period, we may not be able to increase or sustain profitability on a quarterly or annual basis. For the foreseeable future, we plan to invest cash in our operations, particularly in sales and marketing, and research and development. Table of Contents Management s discussion and analysis of financial condition and results of operations SOURCES AND COSTS OF REVENUES We have derived, and we expect to continue to derive, at least in the near term, a significant portion of our revenues from a limited number of wireless operator customers. For the three months ended March 31, 2004, we recognized approximately 86% of our total revenues from four of our customers: Cingular Wireless, NTT DoCoMo, Orange and Sprint PCS. Sprint PCS and Orange accounted for approximately 41% and 18% of these revenues, respectively. In 2003, we recognized approximately 98% of our total revenues from these same four customers. NTT DoCoMo and Orange accounted for approximately 43% and 24% of these revenues, respectively. In 2002, mmO2 and Cingular Wireless accounted for approximately 75% and 19% of total revenues, respectively. In order to increase our revenues, we will need to substantially increase the number of wireless operator customers and subscribers who use our software. We classify our revenues into three main categories: License. License revenues accounted for 92.7% of our total revenues in 2001, 32.2% in 2002 and 43.5% in 2003. License revenues for the three months ended March 31, 2004 accounted for 34.2% of our total revenues. Historically, we have granted wireless operators a specified number of perpetual licenses to offer wireless data services using our software in exchange for an up-front fee. These wireless operators may then use the perpetual licenses to provide wireless data services, provided that the total number of subscribers at any one time may not exceed the number of perpetual licenses purchased by the wireless operator. Wireless operators may purchase additional perpetual licenses at negotiated rates as needed to support additional subscribers. We have recognized license revenue under these arrangements upon acceptance of our software by our wireless operator customers, assuming all other revenue recognition criteria have been met. As a result, our license revenues have fluctuated significantly, depending on the timing of the delivery of our software and satisfaction of revenue recognition criteria. Commencing in May 2003, we began to enter into agreements with some of our wireless operator customers to purchase licenses with a specified term on a per-subscriber basis. For example, our per-subscriber-based agreements may have limited up-front fees and require a wireless operator to pay a monthly fee for each of its subscribers using our software to access wireless data services. The initial up-front fee is recognized ratably over the period that the Company expects to provide maintenance. The monthly per-subscriber fees are recognized at the time a reliable estimate can be made of the actual usage that has occurred, provided collectibility is probable. As we renegotiate agreements and enter into new agreements, we will seek to convert our existing perpetual license agreements to agreements where revenue is generated and recognized monthly on a per-subscriber basis. We believe that, as a result of entering into per-subscriber-based agreements with a specified term, revenues earned from these agreements will be more predictable and exceed those recognized under comparable perpetual license arrangements. If we are unsuccessful in negotiating contracts using these terms, our revenues may continue to fluctuate significantly and our revenue growth could decline, depending on when we recognize up-front fees pursuant to our perpetual license agreements. Our perpetual and per subscriber-based license agreements typically have terms that set the pricing for two to three years and are non-cancelable, though customers typically have the right to terminate their contracts for cause if our software fails to perform as described. For perpetual license agreements, we generally invoice the license fee upon execution of the license agreement but in certain situations a portion of the license fee is due upon acceptance of our software. For per-subscriber-based agreements, we typically invoice in monthly installments or invoice in advance of the subscription service period. Typical payment terms provide that our customers pay us within 30 to 45 days of invoice. Table of Contents Management s discussion and analysis of financial condition and results of operations At March 31, 2004, we had deferred revenue of $6.6 million, including $4.3 million in deferred revenue from a single customer. Our deferred revenue consists of amounts deferred for ongoing support and maintenance and other amounts deferred pending the delivery of specific upgrades or acceptance of our software by our customers. Our revenues may fluctuate significantly in any given quarter pending satisfaction of our revenue recognition policies. Support, maintenance and hosting. Support, maintenance and hosting revenues accounted for 7.3%, 52.2% and 41.7% of our total revenues in 2001, 2002 and 2003, respectively. Support, maintenance and hosting revenues for the three months ended March 31, 2004 accounted for 42.1% of our total revenues. Concurrent with entering into either a perpetual or per-subscriber-based license agreement, we enter into support and maintenance agreements with a wireless operator customer for a specified term, typically two to three years. Support and maintenance include the right to unspecified upgrades and ongoing support. Support and maintenance revenues are billed either on a fixed fee basis or as a percentage of the license fee and are deferred and recognized ratably as services are provided over the support and maintenance period. Additional support fees are typically due when the number of subscribers who use our software exceeds a specified number. We generally invoice our customers for support and maintenance in annual or quarterly installments and typical payment terms provide that our customers pay us within 30 to 45 days of invoice. Though support and maintenance is anticipated to increase in absolute dollars, revenues are anticipated to decline as a percent of total revenues as license revenues increase. Hosting is provided on a monthly basis to wireless operators who require these services. The duration and expiration of a hosting contract is usually determined by wireless operators choosing to transition the hosting of our software to their own facilities. Hosting is billed on a fixed fee basis and recognized over the hosting period. Professional services. Professional services revenues, consisting of fees associated with customization and implementation of our software and training, accounted for 0.0%, 15.6% and 14.8% of our total revenues in 2001, 2002 and 2003, respectively. Professional services revenues for the three months ended March 31, 2004 accounted for 23.7% of our total revenues. Our customization, implementation and training engagements are billed either on time and materials or a fixed fee basis. Our cost of revenues includes the following: License. Cost of license revenues consists of royalties on third party software that has been incorporated in our software since 2003. Support, maintenance and hosting. Cost of support, maintenance and hosting revenues primarily consists of employee-related costs to host our service and provide support, depreciation expense associated with computer equipment and allocated overhead. We allocate overhead such as rent and occupancy charges, employee benefit costs and depreciation expense to all departments based on headcount. As such, general overhead expenses are reflected in each operating expense category and cost of revenue, excluding cost of license. The delivery of hosting services requires significant capital expenditures to develop or expand hosting centers and related infrastructure. Because of these capital expenditures and related personnel requirements, gross profit percentages from hosting services are generally lower than from software licenses. Professional services. Cost of professional services revenues consists primarily of employee-related costs associated with the customization and implementation of our software and allocated overhead. OPERATING EXPENSES Research and development. Research and development expenses consist primarily of salaries and related overhead expenses for development and engineering personnel, fees paid to outside contractors Table of Contents Management s discussion and analysis of financial condition and results of operations and consultants and allocated overhead. We have historically focused our engineering efforts on increasing the functionality and enhancing the ease of use of our software. We expense our research and development costs as they occur. Sales and marketing. Sales and marketing expenses consist primarily of salaries and related expenses, including commissions, marketing programs, corporate communications expenses, product marketing expenses and allocated overhead. General and administrative. General and administrative expenses consist of salaries and related expenses for executive, finance and accounting, legal and human resources personnel, professional fees, other corporate expenses and allocated overhead. Restructuring. In September 2002 and January 2003, we downsized our operations and implemented cost-reduction plans to reduce ongoing operating expenses and to focus on key areas of our business. These plans resulted in restructuring charges related to employee severance, termination of an equipment lease and consolidation of excess facilities. Stock-based compensation. Stock-based compensation expenses are related to option grants to employees in situations where the exercise price was less than the deemed fair value of our common stock at the date of grant. These charges have been significant and are reflected in our historical financial results. SUMMARY OF RESULTS OF OPERATIONS AND CURRENT OUTLOOK Since inception through 2003, our revenues have grown primarily as a result of licensing our software to wireless operators and systems integrator partners. We licensed our software to our first customer in June 2001. We anticipate continuing to focus our sales efforts on adding wireless operator customers and systems integrator partners in 2004. A significant portion of our revenues in 2002 and 2003 were non-recurring, up-front license fees. As we seek to renegotiate certain existing contracts and enter into new contracts, we plan to structure these agreements so that wireless operators pay us a monthly fee based on the number of their subscribers using wireless data services based on our software. Additionally, in 2004 we will seek to renew or renegotiate the terms of our customer agreements with Cingular Wireless, Orange and mmO2. A relatively small number of subscribers use wireless data services based on our software at the present time. We will seek to grow subscriber adoption in 2004 by investing more in sales and marketing. A key element of this strategy is to promote our software as a low cost solution that makes wireless data services attractive to a broader segment of subscribers as more data-enabled wireless handheld devices enter the market. During 2003, our operating expenses declined by $6.9 million compared to 2002, primarily as a result of cost savings realized from restructurings in September 2002 and January 2003. We reduced headcount in all areas of our company resulting in a reduction in salaries of $3.1 million and a decrease in stock-based compensation of $0.9 million, closed certain sales offices in Germany, France and Singapore contributing savings of $0.8 million, and refocused our engineering efforts on our core software offerings. Our general and administrative expenses declined $1.3 million in 2003 compared to 2002. As the benefit of our restructurings were realized in 2003, we anticipate growth in operating expenses in 2004 to support additional wireless operators and to increase our sales and marketing efforts. Although we anticipate revenue growth in 2004, we expect to operate at a loss throughout the year. Table of Contents Management s discussion and analysis of financial condition and results of operations RESULTS OF OPERATIONS The following tables set forth financial data as a percentage of operating revenues and in dollars for the years ended December 31, 2001, 2002 and 2003 and for the three months ended March 31, 2003 and 2004. As described in Note 2 of the consolidated financial statements, we have restated our financial statements as of December 31, 2002, and for each of the years in the two-year period ended December 31, 2002 to account for stock-based compensation matters. Year ended December 31, Three months ended March 31, (restated) (restated) (unaudited) Revenues: License 92.7 % 32.2 % 43.5 % 23.4 % 34.2 % Support, maintenance and hosting 7.3 52.2 41.7 44.5 42.1 Professional services 15.6 14.8 32.1 23.7 State $ 800 1,610 1,752 Foreign Total revenues 100.0 100.0 100.0 100.0 100.0 Cost of revenues 106.4 39.0 46.7 80.1 48.9 Gross profit (loss) (6.4 ) 61.0 53.3 19.9 51.1 Operating expenses: Research and development 259.3 172.7 119.2 181.0 81.5 Sales and marketing 127.5 105.9 68.1 120.2 55.3 General and administrative 95.8 48.9 24.8 40.4 17.4 Restructuring 30.1 24.0 32.7 Stock-based compensation 3.6 19.0 3.4 (31.6 ) 34.9 Total operating expenses 486.2 376.6 239.5 342.7 189.1 Operating loss (492.6 ) (315.6 ) (186.2 ) (322.8 ) (138.0 ) Interest income and other expenses, net 38.5 12.7 3.8 8.9 1.5 (unaudited, in thousands, except percentages) Revenues by category: License $ 263 23.4 % $ 778 34.2 % 196.4 % Support, maintenance and hosting 499 44.5 960 42.1 92.4 Professional services 360 32.1 (restated)(1) (restated)(1) (restated)(1) (restated)(1) (unaudited, in thousands) Revenues: License $ $ 2,000 $ $ $ 263 $ 1,541 $ 1,180 $ 22 $ 778 Support, maintenance and hosting 594 2,229 251 167 499 782 791 807 960 Professional services 100 522 8 342 360 405 244 10 Net loss before provision for income taxes (454.0 ) (302.9 ) (182.4 ) (313.9 ) (136.5 ) Provision for income taxes (0.1 ) (0.5 ) (5.0 ) (2.1 ) (3.6 ) Net loss (454.1 )% (303.4 )% (187.4 )% (316.0 )% (140.1 )% Three months ended March 31, 2004 compared to three months ended March 31, 2003 Revenues Three months ended March 31, Total revenues $ 1,122 100.0 % $ 2,277 100.0 % 103.0 % Accounts receivable $ 125 $ Table of Contents Management s discussion and analysis of financial condition and results of operations Three months ended March 31, Total revenues $ 1,122 100.0 % $ 2,277 100.0 % 103.0 % Our license revenues increased $0.5 million, or 196%, for the three months ended March 31, 2004 compared to the three months ended March 31, 2003. For the three months ended March 31, 2004, our license revenue was comprised of the recognition of a portion of previously deferred revenue due to the renegotiation of our contract with Sprint PCS and license revenues associated with the commercial availability of our software with KDDI Corp. For the three months ended March 31, 2003, our license revenue was comprised solely of up-front license fees from Orange. The increase in support, maintenance and hosting revenues in 2004 compared to 2003 for the three months ended March 31, 2004 compared to the three months ended March 31, 2003 was primarily due to increased support and maintenance revenues from KDDI Corp and Sprint PCS. Professional services revenues for the three months ended March 31, 2004 consisted of installation and customization fees earned from new customer implementations with KDDI Corp in Japan and customization projects with existing customers in Europe and Japan. In 2003, professional services revenues consisted primarily of installation and customization fees earned from our contract with Orange. The increase in revenues in Japan for the three months ended March 31, 2004 compared to the three months ended March 31, 2003 was the result of our ongoing strategic efforts to license our software to wireless operators in areas with the greatest concentration of wireless data subscribers. In March 2004, KDDI Corp launched their Keitai Office service using our technology. In addition we recognized ongoing support and maintenance and professional services revenue from NTT DoCoMo. Revenues in Europe declined for the three months ended March 31, 2004 compared to the three months ended March 31, 2003 due to recognition of up-front license and professional services revenues associated with the initial launch of Orange in Europe in 2003. In comparison, our revenues for the three months ended March 31, 2004 are comprised of ongoing support, maintenance and hosting services for our software from our existing customers. For the remainder of 2004, we will seek to generate additional revenues by adding new wireless operator customers in key regions and by increasing the number of active subscribers who use wireless data services based on our software. We intend to accomplish this through additional direct sales and through the efforts of our systems integrator partners, NEC and Hewlett-Packard. While we currently have only a small direct sales force, we anticipate hiring a number of additional sales representatives in North America, Europe and Asia-Pacific following this offering. In addition, we expect to devote additional sales and marketing resources to assist our wireless operator customers in deploying and promoting services supported by our software within their subscriber base, and we expect to use a portion of the net proceeds from this offering to develop and implement marketing programs to further assist our wireless operator customers in increasing the number of their subscribers using our software. Table of Contents Management s discussion and analysis of financial condition and results of operations Cost of revenues and gross profit Three months ended March 31, Gross profit % 19.9 % 51.1 % The increased cost of revenues for the three months ended March 31, 2004 compared to the three months ended March 31, 2003 resulted from an increase in support, maintenance and professional services expenses required to support new and existing wireless operator customers in 2004. For the three months ended March 31, 2004, we supported our software at nine wireless operator customers as compared to seven customers for the three months ended March 31, 2003. To the extent our customer base grows, we may need to invest additional resources in our hosting and support and professional services infrastructure. The timing of these additional expenses could affect our cost of revenues, both in terms of absolute dollars and as a percentage of revenues, especially in a particular quarterly period. As the number of wireless operators we support grows, we plan to increase the number of employees who are fully dedicated to support services. Gross profit increased by $0.9 million for the three months ended March 31, 2004 compared to the three months ended March 31, 2003, reflecting $0.5, $0.3 and $0.1 million increases in gross profit from licensing; support, maintenance and hosting; and professional services revenues, respectively. As our costs to provide hosting services tend to be relatively fixed over the short run, the decline in gross profit from support, maintenance and hosting revenues reflects a decline in hosting revenues during this period. The decline in gross profit percentage from professional services reflects a significant increase in labor costs resulting from the increased complexity of deploying our software with international wireless operators. Because license revenues have higher gross profit percentages than support, maintenance and licensing and professional service revenues, we anticipate that gross profit may increase on both an absolute and percentage basis if we are successful in increasing license revenues. Research and development Three months ended March 31, (unaudited, in thousands, except percentages) Research and development $ 2,031 $ 1,856 (8.6 )% % of total revenues 181.0 % 81.5 % Total cost of revenues 499 464 801 663 899 897 771 The decrease in research and development expenses of $0.2 million, or 8.6%, for the three months ended March 31, 2004 compared to the three months ended March 31, 2003 was primarily due to lower salary and related benefit costs of $0.1 million as average headcount decreased to 42 for the three months ended March 31, 2004 from 49 for the three months ended March 31, 2003. The decrease in research and development salary costs is attributed to additional engineering resources being allocated to our Table of Contents Management s discussion and analysis of financial condition and results of operations professional services projects and the outsourcing of a portion of our quality assurance and product development functions. As we upgrade and extend our service offerings, enter new markets and strive to meet the ongoing requirements of our wireless operator customers, we expect that research and development expenses will increase in absolute dollars. However, we anticipate that to the extent our revenues increase, these research and development expenses will decrease as a percentage of our total revenue. Sales and marketing Three months ended March 31, (unaudited, in thousands, except percentages) Sales and marketing $ 1,348 $ 1,259 (6.7 )% % of total revenues 120.2 % 55.3 % The decrease in sales and marketing expenses of $0.1 million, or 6.7%, for the three months ended March 31, 2004 as compared to the three months ended March 31, 2003 was primarily due to lower outside marketing costs of approximately $40,000 which did not recur in the first quarter of 2004 and lower travel costs of approximately $35,000 as a result of ongoing cost containment plans. We anticipate that sales and marketing expenses will increase as we add additional sales and marketing personnel in order to increase adoption by subscribers of wireless data services based on our software and broaden our reseller and wireless handset manufacturer relationships. We also expect to expand our domestic and international sales and marketing activities. We anticipate that sales and marketing expenses will increase in absolute dollars in 2004 and will continue to represent a substantial percentage of total revenues. General and administrative Three months ended March 31, % of total revenues 40.4 % 17.4 % The decrease in general and administrative expenses of $0.1 million, or 12.4%, for the three months ended March 31, 2004 compared to the three months ended March 31, 2003 was primarily attributable to a decrease of $0.1 million in total occupancy expenses as we entered into a sublease to a third party effective on January 1, 2004. This increase was partially offset by an increase of $0.1 million in legal expenses incurred primarily to defend our outstanding litigation. We expect that in the future, general and administrative expenses may increase in absolute dollars as we add personnel and incur additional professional fees and insurance costs related to the growth of our business and to our operations as a public company as well as legal costs in defense of outstanding litigation. However, to the extent our revenues increase, these expenses may decrease as a percentage of our total revenue. Restructuring Three months ended March 31, % of total revenues 32.7 % 0.0 % Table of Contents Management s discussion and analysis of financial condition and results of operations In the three months ended March 31, 2003, we recorded a restructuring charge of $0.4 million, or 32.7% of total revenues, comprised of employee severance costs to reduce our workforce at our headquarters and at our sales office in Singapore. We had no restructuring charges in the three months ended March 31, 2004. Stock-based compensation Three months ended March 31, % of total revenues (31.6 )% 34.9 % The increase in stock-based compensation of $1.1 million, or 323.3%, for the three months ended March 31, 2004 compared to the three months ended March 31, 2003 is a result of granting options below the deemed fair value at the date of grant in the first quarter of 2004. Our negative expense for the three months ended March 31, 2003 resulted from the cancellation of unvested options as we decreased our headcount in early 2003. Deferred stock-based compensation, which stems principally from the grant of employee stock options with exercise prices below the deemed fair value of the underlying common stock on the date of the grant, is being amortized over the vesting period using the accelerated method described in FASB Interpretation (FIN) No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans an interpretation of APB Opinions No. 15 and 25. We expect stock-based compensation expenses to continue to increase in 2004 and 2005 as a result of options granted below the deemed fair value at the date of grant in the first and second quarters of 2004. From January 1, 2004 through March 31, 2004, we recorded an additional $6.8 million in deferred stock-based compensation, which will be amortized to expense through 2008. Interest income and other expenses, net Three months ended March 31, % of total revenues 8.9 % 1.5 % Interest income and other expenses, net decreased by $65,000, or 66.2%, for the three months ended March 31, 2004 compared to the three months ended March 31, 2003, primarily due to decreases in interest income related to lower balances of cash, cash equivalents and short-term and long-term investments. Our balance of cash, cash equivalents and short-term and long-term investments was $11.6 million and $19.3 million at March 31, 2004 and March 31, 2003, respectively. Provision for income taxes Three months ended March 31, % of total revenues 2.1 % 3.6 % Table of Contents Management s discussion and analysis of financial condition and results of operations Our tax provisions for the three months ended March 31, 2004 and 2003 were primarily comprised of withholding taxes on software license revenues from customers in Japan of approximately $80,000 and $20,000, respectively. As we continue licensing our software to international wireless operators, we anticipate that we will continue to pay withholding taxes and incur income taxes at our foreign subsidiaries. Domestically, we anticipate incurring operating losses for at least the next year and do not expect to have any significant federal or state income tax liability. Year ended December 31, 2003 compared to year ended December 31, 2002 Revenues Year ended December 31, Total revenues $ 6,213 100.0 % $ 6,904 100.0 % 11.1 % Year ended December 31, (in thousands, except percentages) Interest income and other expenses, net $ 1,199 $ Total revenues $ 6,213 100.0 % $ 6,904 100.0 % 11.1 % Operating expenses: Research and development 8,076 10,729 8,230 2,031 1,856 Sales and marketing 3,970 6,581 4,698 1,348 1,259 General and administrative 2,984 3,037 1,715 453 397 Restructuring 1,872 1,657 367 Stock-based compensation(2) 113 1,177 237 (355 ) $ 113 $ 1,177 $ 237 $ (355 ) $ Operating expenses: Research and development 621 8,076 10,729 8,230 2,031 1,856 Sales and marketing 413 3,970 6,581 4,698 1,348 1,259 General and administrative 1,043 2,984 3,037 1,715 453 397 Restructuring 1,872 1,657 367 Stock-based compensation(2) 113 1,177 237 (355 ) $ $ 113 $ 1,177 $ 237 $ (355 ) $ (unaudited, in thousands, except percentages) Stock-based compensation $ (355 ) $ Operating expenses: Research and development 2,819 3,059 2,671 2,180 2,031 1,803 2,218 2,178 1,856 Sales and marketing 1,280 1,456 2,078 1,767 1,348 1,166 1,026 1,158 1,259 General and administrative 529 848 910 749 453 535 276 451 397 Restructuring 1,065 14 500 293 367 42 1,249 Stock-based compensation 92 281 445 359 (355 ) 141 207 244 The increase in license revenues of $1.0 million, or 50%, in 2003 compared to 2002 was primarily due to our continued expansion into international markets. During 2003, we licensed our software to NTT DoCoMo in Japan; SingTel group, consisting of Globe Telecom, Optus and SingTel, in Asia-Pacific; and to Orange in Europe. The decrease in support, maintenance and hosting revenues in 2003 compared to 2002 was primarily due to a decrease in hosting revenues of $0.5 million due to a completion of a large hosting arrangement from an existing wireless operator customer in Europe. In 2003, hosting revenues were $1.7 million compared to $2.2 million in 2002. The decrease in hosting revenues was partially offset by an increase in support and maintenance revenues of $0.1 million, as three new wireless operator customers launched services based on our software. Professional services revenues in 2003 consisted primarily of installation and customization fees earned from new customer implementations. In 2002, professional services revenues consisted solely of customization fees earned from existing customers. The increase in revenues in Japan in 2003 compared to 2002 was the result of our strategic efforts to license our software to wireless operators in areas with the greatest concentration of wireless data subscribers. In July 2003, NTT DoCoMo launched services based on our software. Revenues in Europe declined in 2003 compared to 2002 due to the completion of a large licensing and hosting arrangement Table of Contents Management s discussion and analysis of financial condition and results of operations in 2002 with an existing wireless operator customer. In 2002, our European based revenues were derived solely from this one contract. This decrease was offset in part by the addition of a licensing agreement with a new wireless operator customer in Europe in 2003. Cost of revenues and gross profit Year ended December 31, Supplemental disclosures of cash flow information: Cash paid during the year for income taxes $ Total cost of revenues $ 2,426 $ 3,223 32.8 % Gross profit $ 3,787 $ 3,681 (2.8 )% Gross profit % 61.0 % 53.3 % (in thousands, except percentages) Cost of revenues: License $ $ 24 nm Support, maintenance and hosting 2,125 2,373 11.7 Professional services 301 The increased cost of revenues in 2003 compared to 2002 resulted from an increase in support, maintenance and professional services expenses required to support three new wireless operator customers in 2003. To the extent our customer base grows, we may need to invest additional resources in our hosting and support and professional services infrastructure. The timing of these additional expenses could affect our cost of revenues, both in terms of absolute dollars and as a percentage of revenues, especially in a particular quarterly period. As the number of wireless operators we support grows, we plan to increase the number of employees who are fully dedicated to support services. Gross profit declined by $0.1 million from 2002 to 2003, reflecting a $1.0 million increase in gross profit from licensing revenues that was offset by decreases in gross profit from support, maintenance and hosting and professional services revenues of $0.6 million and $0.5 million, respectively. The decline in gross profit from support, maintenance and hosting revenues reflects a decline in hosting revenues that was not offset by a corresponding decline in cost of hosting revenues, which tend to be relatively fixed over the short run. The decline in gross profit from professional services reflects a significant increase in labor costs resulting from the increased complexity of deploying our software with an international wireless operator. Because license revenues have higher gross profit percentages than support, maintenance and licensing and professional service revenues, we anticipate that gross profit may increase on both an absolute and percentage basis if we are successful in increasing license revenues. Research and development Year ended December 31, (in thousands, except percentages) Research and development $ 10,729 $ 8,230 (23.3 )% % of total revenues 172.7 % 119.2 % The decrease in research and development expenses of $2.5 million, or 23.3%, in 2003 compared to 2002 was primarily due to reduced average headcount and the reduction of overhead costs, resulting from our restructurings in 2002. Our research and development headcount decreased to 49 at December 31, 2003 from a high of 69 at June 30, 2002, which resulted in lower salary and related costs Table of Contents Management s discussion and analysis of financial condition and results of operations of $2.3 million. As our products commercially launched, our engineering efforts shifted from research and development to the enhancement of our products. As we upgrade and extend our service offerings, enter new markets and strive to meet the ongoing requirements of our wireless operator customers, we expect that research and development expenses will increase in absolute dollars. However, we anticipate that to the extent our revenues increase, these research and development expenses will decrease as a percentage of our total revenue. Sales and marketing Year ended December 31, (in thousands, except percentages) Sales and marketing $ 6,581 $ 4,698 (28.6 )% % of total revenues 105.9 % 68.1 % The decrease in sales and marketing expenses of $1.9 million, or 28.6%, in 2003 as compared to 2002 was primarily due to a reduction in our domestic sales force in late 2002 and in the beginning of 2003, resulting in a decrease in salary and salary-related expenses of $1.1 million in 2003 compared to 2002. Our total sales and marketing headcount at December 31, 2003 was 18, compared to a high of 25 at June 30, 2002. Additionally, we closed or downsized sales offices in Germany, France and the United Kingdom in the second half of 2002. As a result, the total expenses to run these operations decreased $0.8 million in 2003 compared to 2002. We expect to increase sales and marketing personnel in order to add new customers, increase adoption by subscribers of wireless data services based on our software and broaden our reseller and handset manufacturer relationships. We also expect to expand our domestic and international sales and marketing activities. We anticipate that sales and marketing expenses will increase in absolute dollars in 2004 and will continue to represent a substantial percentage of total revenues. General and administrative Year ended December 31, (in thousands, except percentages) General and administrative $ 3,037 $ 1,715 (43.5 )% % of total revenues 48.9 % 24.8 % The decrease in general and administrative expenses of $1.3 million, or 43.5%, in 2003 compared to 2002 was primarily due to the renegotiation of the lease for our headquarters and reduction in headcount in early 2003. In May 2002, we renegotiated our headquarters lease to extend the lease term and to lease additional space in exchange for a reduction in our overall rent. As a result, our facility expenses decreased $0.6 million in 2003 from 2002. Additionally, our general and administrative headcount decreased to seven at December 31, 2003 from a high of 13 at June 30, 2002, which resulted in a decrease in salary and related expenses of $0.3 million. We expect that in the future, general and administrative expenses may increase in absolute dollars as we add personnel and incur additional professional fees and insurance costs related to the growth of our business and to our operations as a public company. However, to the extent our revenues increase, these expenses may decrease as a percentage of our total revenue. Table of Contents Management s discussion and analysis of financial condition and results of operations Restructuring Year ended December 31, (in thousands, except percentages) Restructuring $ 1,872 $ 1,657 (11.5 )% % of total revenues 30.1 % 24.0 % In 2003, we recorded a restructuring charge of $1.7 million, or 24.0% of total revenues, including $0.4 million of employee severance and related costs. In December 2003, we subleased a portion of unused space at our headquarters in Redwood City and recorded a $1.0 million charge pertaining to the estimated future obligations under the non-cancelable lease offset by the estimated contractual sublease income to be received over the sublease term and an impairment of related leasehold improvements of $0.2 million. In 2002, we recorded a restructuring charge of $1.0 million, or 30.1% of total revenues, comprised of employee severance costs to reduce our sales and marketing resources in Europe and the size of our workforce at our headquarters. Additionally, we paid $0.9 million to terminate an equipment lease. Stock-based compensation Year ended December 31, % of total revenues 19.0 % 3.4 % (restated)(1) (restated)(1) (unaudited) (dollars in thousands, except per share data) Revenues $ 3,115 $ 6,213 $ 6,904 $ 1,122 $ 2,277 Cost of revenues 3,313 2,426 3,223 (restated)(1) (restated)(1) (unaudited) (in thousands, except per share data) Revenues $ $ 3,115 $ 6,213 $ 6,904 $ 1,122 $ 2,277 Cost of revenues 3,313 2,426 3,223 Total cost of revenues $ The decrease in stock-based compensation of $0.9 million, or 79.9% in 2003 compared to 2002 primarily resulted from the cancellation of unvested options as we decreased our headcount in early 2003. Deferred stock-based compensation, which stems principally from the grant of employee stock options with exercise prices below the deemed fair value of the underlying common stock on the date of the grant, is being amortized over the vesting period using the accelerated method described in FIN No. 28. We expect stock-based compensation expenses to increase in 2004 and 2005 as a result of granting options below the deemed fair value at the date of grant in the first quarter of 2004. See Note 2 of notes to our consolidated financial statements for information about the restatement of our stock-based compensation expense. Interest income and other expenses, net Year ended December 31, % of total revenues 12.7 % 3.8 % Interest income and other expenses, net decreased by $0.5 million, or 67.1%, in 2003 compared to 2002, primarily due to decreases in interest income related to lower balances of cash, cash equivalents and short-term and long-term investments and a general decline in interest rates in 2003 compared to 2002. Table of Contents Management s discussion and analysis of financial condition and results of operations Provision for income taxes Year ended December 31, % of total revenues 0.5 % 5.0 % Our tax provision in 2003 was primarily comprised of withholding taxes on software license revenues from customers in Japan of $0.3 million and income taxes paid in international jurisdictions of $0.1 million. As we continue licensing our software to international wireless operators, we anticipate that we will continue to pay withholding taxes and incur income taxes at our foreign subsidiaries. Domestically, we anticipate incurring operating losses for at least the next year and do not expect to have any significant federal or state income tax liability. Year ended December 31, 2002 compared to year ended December 31, 2001 Revenues Year ended December 31, (in thousands) (unaudited) Cash and cash equivalents $ 17,000 $ 13,596 $ 6,181 $ 5,920 Short-term investments 14,979 2,200 501 Total revenues $ 3,115 100.0 % $ 6,213 100.0 % 99.5 % Year ended December 31, Total revenues $ 3,115 100.0 % $ 6,213 100.0 % 99.5 % (in thousands, except percentages) Revenues by category: License $ 2,000 32.2 % $ 3,006 43.5 % 50.3 % Support, maintenance and hosting 3,241 52.2 2,879 41.7 (11.2 ) Professional services (in thousands, except percentages) Revenues by category: License $ 2,888 92.7 % $ 2,000 32.2 % (30.7 )% Support, maintenance and hosting 227 7.3 3,241 52.2 1,327.3 Professional services Even though the number of wireless operator customers increased in 2002 compared to 2001, license revenues decreased by $0.9 million, or 30.7%, in 2002 compared to 2001, primarily due to deferral of license revenues from one customer. The increase in hosting and maintenance revenues in 2002 compared to 2001 was primarily due to an increase in the total number of customers that license our software. Professional services revenues were $1.0 million during 2002 and were primarily comprised of customization fees earned from existing customers. In 2001, we had no professional services revenues due to the early stage of our products. Revenues in the United States in 2001 were recognized solely from one customer. Revenues in Europe in 2002 were recognized solely from one customer. Table of Contents Management s discussion and analysis of financial condition and results of operations Cost of revenues and gross profit (loss) Year ended December 31, Total cost of revenues $ 3,312 $ 2,426 (26.8 )% Gross profit (loss) $ (198 ) $ 3,787 2,014.0 % Gross profit (loss) % (6.4 %) 61.0 % The decrease in cost of revenues of $0.9 million, or 26.8%, in 2002 compared to 2001 was primarily due to a reduction in third party rental costs in 2002 resulting from termination of an equipment lease in the first quarter of 2002. The increase in gross profit of $4.0 million in fiscal 2002 compared to fiscal 2001 reflects increases in gross profit from support, maintenance and hosting and professional services revenues of $4.2 million and $0.7 million, respectively, that was partly offset by a $0.9 million decline in gross profit from license revenues. Research and development Year ended December 31, (in thousands, except percentages) Research and development $ 8,076 $ 10,729 32.9 % % of total revenues 259.3 % 172.7 % The increase in research and development expenses of $2.7 million, or 32.9%, in 2002 compared to fiscal 2001 was primarily due to additional headcount needed to support our research and development efforts to enhance our software and adapt our software for international deployment. Sales and marketing Year ended December 31, (in thousands, except percentages) Sales and marketing $ 3,970 $ 6,581 65.8 % % of total revenues 127.5 % 105.9 % Sales and marketing expenses increased in 2002 compared to 2001 by $2.6 million, or 65.8%, primarily as a result of our expansion into international markets. During 2002, we opened new sales offices in Japan, Germany, Singapore and France and added additional headcount in the United Kingdom. This expansion increased our sales and marketing expenses by $1.9 million in 2002 from 2001. Additionally, we expanded our product marketing headcount at our headquarters, which contributed to the remainder of the increased expenses from 2001 to 2002. Our marketing and sales headcount increased from 13 as of December 31, 2001 to 21 as of December 31, 2002. Table of Contents Management s discussion and analysis of financial condition and results of operations General and administrative Year ended December 31, (in thousands, except percentages) General and administrative $ 2,984 $ 3,037 1.8 % % of total revenues 95.8 % 48.9 % The increase in general and administrative expenses in fiscal 2002 compared to fiscal 2001 of $0.1 million, or 1.8%, was due to increased headcount to support our growth in revenues and international expansion partially offset by lower rent as we renegotiated our operating lease in May 2002 for our headquarters. Restructuring Year ended December 31, (in thousands, except percentages) Restructuring $ $ 1,872 nm % of total revenues % 30.1 % In 2002, we took a restructuring charge of $1.0 million for employee severance costs to reduce our sales and marketing resources in Europe and reduce the size of our workforce at our headquarters. Additionally, we paid $0.9 million to terminate an equipment lease. Stock-based compensation Year ended December 31, % of total revenues 3.6 % 19.0 % Stock-based compensation increased $1.1 million, or 940.6%, in 2002 compared to 2001 due to an increase in the number of options granted where the deemed fair value on the date of grant exceeded the exercise price. The increase was attributable to our continued headcount growth to support our operations. Interest income and other expenses, net Year ended December 31, % of total revenues 38.5 % 12.7 % Table of Contents Management s discussion and analysis of financial condition and results of operations Interest income and other expenses, net decreased $0.4 million, or 34.6%, in 2002 compared to 2001 primarily due to lower interest income related to a decline in balances of cash, cash equivalents and short-term and long-term investments and a general decrease in interest rates in 2002 compared to 2001. QUARTERLY RESULTS OF OPERATIONS The following table sets forth selected unaudited quarterly consolidated statement of operations data for our nine most recently completed fiscal quarters through March 31, 2004. The information for each of these quarters has been prepared on the same basis as the audited consolidated financial statements included in this prospectus and, in the opinion of management, includes all adjustments necessary for the fair presentation of the results of operations for such periods. This data should be read in conjunction with the audited consolidated financial statements and the related notes included in this prospectus. Our revenues and related gross profit have fluctuated significantly from quarter to quarter. Our costs of revenues and operating expenses are fixed based on headcount and fixed overhead expenses. Our quarterly operating results may fluctuate significantly in future quarters due to the development of the wireless telecommunications market; fluctuations in demand for our software and services; the timing of the introduction and promotion of products and services based on our software by wireless operators and wireless device manufacturers; the timing of recognizing revenues, particularly up-front license fees; acceptance of products and services incorporating our technology by customers of wireless operators and wireless device manufacturers; the level of subscriber turnover experienced by our customers; introductions of new products by us and our competitors and changes in our pricing policies or the pricing policies of our competitors; our ability to manage costs, including personnel and support services costs; and delays of customer purchases caused by announcements of new technology or otherwise. Table of Contents Management s discussion and analysis of financial condition and results of operations The occurrence of one or more of these factors might cause our operating results to vary widely. As such, we believe that quarter-to-quarter comparisons of our revenues and operating results may not be meaningful and should not be relied upon as an indication of future performance. Three months ended Net loss before provision for income taxes (5,389 ) (1,226 ) (6,953 ) (5,257 ) (3,522 ) (1,773 ) (2,229 ) (5,074 ) (3,109 ) Provision for income taxes (28 ) (23 ) (119 ) (116 ) (85 ) (82 ) Net loss $ (5,389 ) $ (1,226 ) $ (6,953 ) $ (5,285 ) $ (3,545 ) $ (1,892 ) $ (2,345 ) $ (5,159 ) $ (3,191 ) (1) See Note 2 of notes to consolidated financial statements. The operating results for the quarters ended March 31, June 30, September 30 and December 31, 2002 have been restated to reflect (i) an increase in stock-based compensation expense of $0.1 million, $0.3 million, $0.4 million and $0.3 million, respectively, as a result of amortizing the remeasured deferred stock-based compensation for employee awards over the appropriate vesting periods and (ii) an immaterial increase in general and administrative expenses related to restricted stock, options and warrants issued to non-employees for the 2002 quarters presented. Table of Contents Management s discussion and analysis of financial condition and results of operations LIQUIDITY AND CAPITAL RESOURCES The table shown below presents our liquidity position as of December 31, 2001, 2002 and 2003 and March 31, 2004: As of December 31, Total $ 39,794 $ 23,189 $ 13,538 $ 11,574 Since our inception, we have financed our operations primarily through the sale of our capital stock and revenues generated by sales to our wireless operators customers. We raised $25.4 million in venture financing in 2000 and $29.9 million in venture financing in 2001, for total net proceeds of $55.4 million. Our principal sources of liquidity as of March 31, 2004 were cash and cash equivalents, short-term and long-term investments totaling $11.6 million and accounts receivable of $1.7 million. The decline in cash, cash equivalents and investments from December 31, 2001 to March 31, 2004 is primarily due to net cash used in operations. Net cash used in operating activities was $9.8 million in 2003, $14.8 million in 2002 and $8.0 million in 2001. The decrease in cash used in operating activities from 2002 to 2003 was primarily due to a reduction in our net loss from $18.9 million in 2002 to $12.9 million in 2003, resulting primarily from a decline in operating expenses after our restructuring and to a lesser extent from a $0.7 million increase in revenues in 2003 compared to 2002. The increase in net cash used in operating activities from 2001 to 2002 was primarily due to an increase in our net loss from $14.1 million in 2001 to $18.9 million in 2002, reflecting significant increases in operating expenses that were partly offset by a $3.1 million increase in revenues. In 2002, we opened new sales offices in Japan, Singapore, France and Germany. For the three months ended March 31, 2003 and 2004, net cash used in operating activities was $3.7 million and $2.1 million, respectively. The decrease in cash used in operating activities resulted primarily from a $1.2 million increase in revenues for the three months ended March 31, 2004 compared to the three months ended March 31, 2003 and a decline in operating expenses as a result of our restructuring, excluding non-cash items including depreciation and stock-based compensation. Historically, net cash used in operating activities has been affected by (i) changes in working capital accounts, particularly increases in deferred revenue, and (ii) adjustments for non-cash expenses, particularly depreciation and amortization and stock-based compensation. Our deferred revenue increased by $4.9 million, $0.1 million, $1.3 million and $0.3 million in 2001, 2002 and 2003 and as of March 31, 2004, respectively. At December 31, 2003, $4.7 million of deferred revenue was from a single customer. Net cash provided by investing activities was $2.3 million in 2003 and $11.2 million in 2002. Net cash used in investing activities was $14.0 million in 2001. For the three months ended March 31, 2003 and 2004, net cash provided by investing activities was $1.3 million and $1.8 million, respectively. These amounts primarily related to changes in our portfolio of marketable securities to manage our operating Table of Contents Management s discussion and analysis of financial condition and results of operations needs and capital expenditures. Our capital expenditures were $2.5 million, $2.8 million and $42,000 in 2001, 2002 and 2003, respectively. For the three months ended March 31, 2003 and 2004, our capital expenditures were not material. The large expenditures in 2001 and 2002 resulted from significant investments to build and expand hosting capacity and to enhance our research and development infrastructure. As we increase the number of wireless operator customers and the number of subscribers using our software, we may need to increase capital expenditures to increase the capacity of our hosting infrastructure. Net cash provided by financing activities was $30.0 million in 2001, consisting primarily of $29.9 million from a private placement of preferred stock, and $0.2 million in 2002. Net cash used in financing activities in 2003 and in the three months ended March 31, 2003 and 2004 was immaterial. During 2000, we established a $2.0 million letter of credit in favor of the lessor of our headquarters facility. As of March 31, 2004, the funds available for withdrawal on this letter of credit were reduced to $0.9 million. This letter of credit is collateralized by $1.1 million in cash and investments maintained at the granting financial institution. We have reflected these investments as restricted cash on our consolidated balance sheet. As of March 31, 2004, no amounts have been drawn against the letter of credit. The letter of credit renews annually and expires on September 30, 2008, concurrent with expiration of our lease. We believe our existing cash and cash equivalents and investments as well as cash generated from operations will be sufficient to meet our working capital and capital expenditure needs over at least the next 12 months. Our future capital requirements will depend on many factors, including the level of our revenues, the expansion of our sales and marketing activities, the timing and extent of spending to support product development efforts and expansion into key geographic regions, the timing of introductions of new services and enhancements to existing services and the continuing market acceptance of our services. To the extent that funds generated by this offering, together with existing cash and investments and cash generated from operations, are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. Although we are not currently considering any investments in, or acquisitions of, complementary businesses, services or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. Capital expenditures Since our inception, we have spent approximately $5.7 million in capital expenditures for our data centers, network infrastructure, research and development and other operations. We expect to spend approximately $0.3 million in capital expenditures in 2004. We will have to increase our capital expenditures, if we are required to expand our hosting capacity beyond planned levels, We believe our cash on hand and anticipated cash flows from operations will be sufficient to fund our planned and potential additional capital expenditures in 2004. Table of Contents Management s discussion and analysis of financial condition and results of operations Contractual obligations Our primary contractual obligation arises under the operating lease for our headquarters facility. The term of our lease began in December 2000 and extends through September 2008. Future minimum rental payments required under our operating lease as of March 31, 2004 are as follows: Year ending December 31, (in thousands) Operating lease obligations $ 1,467 $ 2,013 $ 2,083 $ 2,144 $ 1,646 Other arrangements Other than our $0.9 million letter of credit and the contractual obligations under our operating lease described above, we do not have commercial commitments under lines of credit, standby repurchase obligations or other such debt arrangements. We have no off-balance sheet arrangements or transactions with unconsolidated limited purpose entities, nor do we have any undisclosed material transactions or commitments involving related persons or entities. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. See our consolidated financial statements and related notes thereto included elsewhere in this prospectus, which contain accounting policies and other disclosures required by accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions. We believe that the following critical accounting policies represent areas where significant judgments and estimates have been used in the preparation of our consolidated financial statements. Revenue recognition We make significant judgments related to revenue recognition. Specifically, in connection with each software transaction, we must evaluate whether: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) our fee is fixed or determinable, (iv) collectibility is probable and (v) if professional services are included in the arrangement, whether the services are essential to the functionality of the software. We apply these criteria as discussed below. Persuasive Evidence of an Arrangement Exists. We require a written contract, signed by both the customer and us prior to recognizing revenue on an arrangement. Delivery Has Occurred. We deliver software to our customers electronically. Delivery occurs when we provide the customer access codes or keys that allow the customer to take immediate possession of the software on its hardware. If the contract contains substantive acceptance provisions, such as successful commercial launch by our customers of wireless data services based on our software, delivery is not considered to have occurred, and revenue is deferred, until such time as the acceptance has been received from the customer, as we do not have adequate experience providing these services through acceptance. Table of Contents Management s discussion and analysis of financial condition and results of operations Under perpetual license agreements, we recognized license revenue at the time of acceptance of our software, assuming all other revenue recognition criteria have been met. Under per subscriber-based license agreements, the initial up-front fee, if any, is recognized ratably over the period that the Company expects to provide maintenance. The per-subscriber fees are recognized at the time a reliable estimate can be made of the actual usage that has occurred, provided collectibility is probable. The Fee is Fixed or Determinable. Our standard payment terms are net 30 to 45 days from the invoice date. When an arrangement includes standard payment terms, we regard the fee as fixed or determinable, and we recognize revenue upon delivery, assuming other revenue recognition criteria are met. If the payment terms do not meet this standard, which we refer to as extended payment terms, we do not consider the fee to be fixed or determinable and recognize revenue when customer installments are due and payable. Collectibility is Probable. To recognize revenue, we must judge collectibility of the fees due from the customer, which we do on a customer-by-customer basis pursuant to our credit review policy. For a new customer, we evaluate the customer s financial position and ability to pay. If we determine that collectibility is not probable based upon our credit review process or the customer s payment history, we recognize revenue on a cash-collected basis. Services Essential to the Functionality. Arrangements that include professional services are evaluated to determine whether those services are essential to the functionality of other elements of the arrangement. To date, professional services, including installation and integration services, that are sold together with the initial software license have been considered essential to the functionality of the software due to the following factors: (1) customers to date have relied on us for integration assistance; (2) our software is not shrink-wrapped and must be modified/integrated into the wireless operator s network; and (3) payment for the service element is often not due until installation and integration is complete. If we provide professional services that are considered essential to the functionality of our software products, both the software license revenue and the service revenue are recognized under contact accounting in accordance with the provisions of SOP No. 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Because these arrangements also have substantive acceptance provisions, often tied to the customer s commercial service launch, and the unique nature of each customer integration effort, we have not been able to reasonably estimate completion status and the completed-contract method has been used. Arrangements where services have not been considered essential to the functionality of our software have been limited to follow-on professional services arrangements. For fixed-fee arrangements, when services are not considered essential to the functionality, professional services revenue is recognized as services are performed based on the ratio of direct labor hours incurred to date to total projected labor costs. Where completion status cannot be reasonably estimated, revenue is recognized when all of the professional services have been delivered. For time-and-materials billing arrangements, we recognize revenue as services are performed. For contracts with multiple elements (e.g., license, maintenance, hosting, and other services), revenue is allocated to each component of the contract based on vendor-specific objective evidence (VSOE) of its fair value, which is the price charged when the elements are sold separately. Since VSOE has not been established for license elements, the residual method is used to allocate revenue to the license portion of muliple-element transactions. The fair value of hosting and maintenance services in a bundled arrangement is determined by reference to contractual renewal rates in the sales agreements. The fair value of professional services is determined based on the price charged when the services are sold separately. Table of Contents Management s discussion and analysis of financial condition and results of operations Accounting for stock-based awards We record deferred stock-based compensation charges in the amount by which the exercise price of an option is less than the deemed fair value of our common stock at the date of grant. We granted stock options with exercise prices of $0.20 to $0.40 during the three-year period ending December 31, 2003. During this period, we determined that the fair value of our common stock increased from $0.20 to $2.00. We granted stock options with exercise prices of $0.40 to $1.32 during the three-month period ending March 31, 2004. During this period, we determined that the fair value of our common stock increased from $2.00 to $4.81. In the absence of a public trading market for our common stock, we considered numerous objective and subjective factors in determining the fair value of the common stock for the granting of options. These factors included, but were not limited to: our financial and operating performance, with specific focus on revenues and customer wins; our progress in implementing our business plan and achieving our performance targets; assessment of future business risks, including successful development of our products and our pending litigation with Visto; timing of our product release and market acceptance for our products; and degree of market penetration by competitors; and the likelihood of achieving a liquidity event, such as an initial public offering (IPO). In addition to these general factors, we also considered specific factors such as the sale of our preferred stock to third parties in 2000 and July 2001 and the engagement of bankers to initiate the process of our IPO in February 2004; the initial filing of our registration statement on Form S-1 in March 2004; the hiring and commencement of employment of Kent Thexton as the Company s President and Co-Chief Executive Officer and the hiring of Thomas Hoster as Chief Financial Officer; the completion of the renegotiation of a major contract with Sprint PCS; the search for an additional outside director to serve as chairman of the audit committee; and progress toward completion of a significant new version our software. The value of our common stock cannot be ascertained with precision or certainty until after the IPO occurs and a market is established for the shares. Furthermore, the IPO price is only an estimate of the fair value of a share, which will not be known with certainty until the price volatility often associated with the period immediately following an IPO ceases. Legal contingencies We are subject to various claims and legal actions, including the Visto litigation. See Business Legal Proceedings. We have accrued for estimated losses in accordance with GAAP for those matters where we believe that the likelihood that a loss has occurred is probable and the amount of loss is reasonably estimable. Although we believe we have properly accrued for estimable and probable losses regarding the outcome of outstanding legal proceedings, claims and litigation involving us, litigation is inherently uncertain, and there can be no assurance that existing or future litigation will not have a material adverse effect on our business, results of operations or financial condition or that the current amount of accrued losses is sufficient for any actual losses that may be incurred. We had no accrued claims liability at March 31, 2004. RECENT ACCOUNTING PRONOUNCEMENTS In November 2002, the Emerging Issues Task Force ( EITF ) reached a consensus on Issue No. 00-21, Revenue arrangements with Multiple Deliverables. Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of Issue No 00-21 applies to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of Issue No 00-21 did not have a material effect on consolidated financial position, results of operations or cash flows. Table of Contents Management s discussion and analysis of financial condition and results of operations In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies accounting and reporting for derivative instruments, including certain derivatives imbedded in other contracts and for hedging activities under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS 149 did not have a material impact on our consolidated financial position, results of operations or cash flows. In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. SFAS 150 is implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption. The adoption of SFAS 150 did not have a significant impact to our consolidated financial position, results of operations or cash flows. In December 2003, the FASB issued (FIN) Interpretation No. 46R (revised December 2003), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, which addresses how a business enterprise should evaluate whether it has a controlling interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN No. 46R replaces FASB Interpretation FIN No. 46, which was issued in January 2003. As of the effective date of FIN No. 46R, an enterprise must evaluate its involvement with all entities or legal structures created before February 1, 2003, to determine whether consolidation requirements of FIN No. 46R apply to those entities. There is no grandfathering of existing entities. The adoption of FIN No. 46 did not have a significant impact on our consolidated financial position, results of operations or cash flows. In December 2003, the SEC issued Staff Accounting Bulletin (SAB) 104, Revenue Recognition. SAB 104 revises or rescinds portions of interpretative guidance included in Topic 13 of the codification of staff accounting bulletins in order to make this guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The adoption of SAB 104 did not have a material effect on our consolidated financial position, results of operations or cash flows. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest rate risk We are exposed to market risk from changes in interest rates. Our exposure to interest rate risk relates primarily to our investment portfolio. We intend to protect the safety and preservation of our invested principal funds by limiting default risks, market risk and reinvestment risk. To minimize this risk, we maintain our portfolio of cash equivalents, short-term investments and long term investments in a variety of securities including commercial paper, money market funds, market auction preferred stock, and government and non-government debt securities. All investments are classified as either cash equivalents, short-term investments or long-term investments and are carried at fair value. We have no derivative financial instruments outstanding to hedge interest rate risk. If market rates were to increase immediately and uniformly by 10% from levels at March 31, 2004, the decline in fair value of the portfolio would not be material. Table of Contents Management s discussion and analysis of financial condition and results of operations Foreign currency exchange risk Although we pay a portion of our salaries and operating expenses that are fixed in Japanese Yen to our employees based in Japan, and to a lesser degree salary and operating expenses in British Pounds to our employee in the United Kingdom, to date our exposure to foreign currency rate fluctuations has not been significant. At March 31, 2004, two of our contracts have provisions to collect our fees in foreign currency, one in Japanese Yen and the other in British Pounds. At March 31, 2004, 16.4% of our accounts receivable and 17.7% of our revenues for the three months ended March 31, 2004 were transacted in British Pounds. To date, we have not used derivative financial instruments for speculative trading purposes, nor do we hedge any foreign currency exposure in a manner that entirely offsets the effects of changes in foreign exchange rates. We believe that a hypothetical change of 10% in the foreign currency exchange rates would not have a material impact on our consolidated financial position or results of operations. Table of Contents Business OVERVIEW We are a global provider of software that enables wireless operators to offer secure, affordable and real-time wireless data services to their subscribers on a wide variety of wireless handheld devices. Wireless data services allow subscribers to use wireless handheld devices to access business and personal information such as e-mail, calendar, contacts, corporate directories and documents. Our objective is to provide software that drives the mass market adoption of affordable wireless data services by making information portable, ubiquitous and easy to access. We license our System SEVEN software to wireless operators who embed it into their existing networks and systems. We believe this operator-centric approach allows operators to offer their subscribers bundled, branded and differentiated wireless data services at a relatively low cost in order to enhance customer loyalty and increase revenues. As of March 31, 2004, our customers consisted of Cingular Wireless and Sprint PCS in the United States; KDDI Corp and NTT DoCoMo in Japan; Globe Telecom, Optus and SingTel in Asia-Pacific; and mmO2 and Orange in Europe. Our customers license our software either directly or through our distribution and systems integrator partners, NEC and Hewlett-Packard. Currently, our System SEVEN software is compatible with wireless handheld devices manufactured by Hitachi, HTC, Motorola, palmOne, Samsung, Sanyo, Sony Ericsson and Toshiba. Currently, our software also supports the following software platforms: BREW, J2ME, Microsoft Pocket PC and Smartphone, Palm OS and Symbian OS, as well as enterprise and consumer e-mail servers such as Microsoft Exchange, Lotus Domino and IMAP4/POP3. THE MARKET FOR WIRELESS DATA SERVICES Worldwide use of wireless voice and data services has grown rapidly, as cellular and other mobile communications technologies have become more widely available and affordable to the mass business and consumer markets. IDC, an independent research firm, estimates that worldwide there were 1.2 billion wireless voice subscribers at the end of 2003, with that number expected to reach 1.6 billion by 2007. Furthermore, IDC estimates that wireless voice services will generate approximately $317 billion in revenue in 2003 and $381 billion in revenue by 2007. In addition, the wireless data market has been growing faster than the wireless voice market and IDC estimates that wireless data revenues will increase at a compound annual growth rate of approximately 30% from $47 billion in 2003 to $135 billion in 2007. Key factors driving the growth of the wireless data services market include: Established revenue opportunity. Facing increased competition, wireless operators have sought to offer customized, branded, bundled voice and data communications services to increase revenues and enhance customer loyalty. According to IDC, wireless data revenues worldwide were approximately 13% of total wireless operator revenues in 2003, and are expected to grow to approximately 26% of total wireless operator revenues in 2007. In Japan, an advanced wireless data services market, Gartner, an independent research firm, estimates that approximately 24% of total wireless operator revenues in 2003 were generated from wireless data services such as NTT DoCoMo s i-mode service, representing $12.5 billion in wireless data revenues. Large mobile workforce. Enterprises have sought to extend their existing remote access service (RAS) to increase the productivity of their workforce by enabling a larger number of their employees to remain connected outside the workplace. According to IDC, this trend will cause an increase in the number of U.S. and European mobile workers from 171 million in 2003 to 188 million in 2006. Table of Contents Business Ubiquity of e-mail. Professionals and consumers have become increasingly dependent on e-mail as a form of communication, driving demand for affordable solutions that provide mobile e-mail access. E-mail is rapidly becoming one of the most compelling wireless data applications. Ovum, an independent research firm, forecasts that the number of worldwide wireless e-mail messages will increase from 6.1 billion in 2003 to 40.3 billion in 2005, representing a compound annual growth rate of approximately 157%. Next generation devices. Wireless device manufacturers have begun to introduce advanced converged devices that combine voice services with enhanced data functionality on a single, portable device. We expect the appeal of these devices to continue to improve as they become more affordable and functional. According to Gartner, the number of advanced converged wireless handheld devices shipped worldwide is expected to grow from 10 million in 2003 to 93 million in 2007, representing a compound annual growth rate of approximately 73% and accounting for approximately 18% of all wireless handheld devices expected to be shipped in 2007. We believe that the proliferation of compelling, easy to use and more functional converged devices will be a key factor in increasing the adoption rate of wireless data services, much like improvements in traditional voice wireless handsets helped drive the growth of wireless voice services. Next generation wireless networks. Most major wireless operators have made significant investments to acquire additional spectrum and to upgrade their networks to offer next generation wireless data services. To date, these upgrades have consisted primarily of packet overlay networks that enable the delivery of basic wireless data services over existing voice networks. These are commonly referred to as 2.5G networks. One such technology is general packet radio service (GPRS), which operates over global system for mobile communications (GSM) networks. Another technology used in 2.5G networks is single carrier radio transmission technology (1xRTT), which operates over code-division multiple access (CDMA) networks. In addition, advanced 3G data networks, which combine voice and data transmission over packet-switched, or Internet Protocol (IP) networks such as next generation CDMA-based technologies, CDMA2000 and W-CDMA, have been deployed in a few countries, such as Japan. Completion of wireless network upgrades is enabling wireless operators to offer differentiated and value-added wireless data services to their subscribers in a cost-effective manner. LIMITATIONS OF EXISTING WIRELESS DATA SOLUTIONS Despite recent growth in the wireless data market, we believe that the market for advanced wireless data services remains significantly underpenetrated. We also believe that the growth of this market has been restrained due to key limitations of existing wireless data solutions, including: High cost and complexity. We believe the wireless data solutions most widely used today are priced at levels that have limited their adoption to high-end users. These solutions generally require high up-front fees and expenses to install and integrate software and hardware into an enterprise network; the acquisition of an expensive proprietary wireless handheld device; and, as currently priced, average recurring monthly fees of approximately $30-$40 per subscriber for wireless data services only. These solutions are also complex because of required device and network integration, data synchronization and ongoing technical support. Limited choice of devices. Many wireless data solutions available today operate only on specific wireless handheld devices provided by the vendor of the solution. Although new devices are continuously being introduced, they are generally not compatible with these solutions. Moreover, these solutions generally operate only with the specific software platform provided by the vendor. Table of Contents Business Limited flexibility for wireless operators. We believe wireless operators are seeking differentiated wireless data solutions that they can control, customize, brand and bundle as an add-on feature to their core wireless voice offerings. However, vendors of most currently available wireless data solutions provide only a standalone solution that does not provide this level of flexibility for the wireless operators, and we believe that this has limited the adoption of these solutions. OUR SOLUTION Our System SEVEN software enables wireless operators to offer their subscribers secure, affordable and real-time wireless data services on a wide variety of wireless handheld devices. These services include access to e-mail, calendar, corporate directories and documents as well as the ability to view, send or fax e-mail attachments. We have developed customized editions of our solution designed for the different needs of individuals, small/medium-sized enterprises and large enterprises. We believe our System SEVEN software offers a number of key advantages over competing wireless data solutions, including the following: Low cost and easy to use and manage. We believe our solution reduces the need for high up-front costs for the subscriber or enterprise and can be offered by wireless operators as an inexpensive, add-on feature to wireless voice. Relative to comparable offerings of our competitors, our wireless operator customers may offer wireless data services using our System SEVEN software to their subscribers for an additional fee ranging from $15-$20 per month. We believe that our software is comparatively easy to install and integrate with existing systems, does not require cradle synchronization, and requires relatively limited support infrastructure at the customer s premises. Our System SEVEN software is delivered as a network service by wireless operators, eliminating the added complexity associated with device and network integration, application rendering and other technical issues. Subscribers and enterprises not only benefit from the advantage of low cost and rapid deployment, but also from the bundling and subsidy strategies of the wireless operator. Wide choice of devices, software platforms and access points. While our competitors generally support only a small number of wireless handheld devices and operating systems, our System SEVEN software currently works on wireless handheld devices from manufacturers that include Table of Contents Business Hitachi, HTC, Motorola, palmOne, Samsung, Sanyo, Sony Ericsson and Toshiba. Our System SEVEN software is also compatible with the following software platforms: binary runtime environment for wireless (BREW), Java 2 platform micro edition (J2ME), Microsoft Pocket PC and Smartphone, Palm OS and Symbian OS. We believe that the market for converged wireless voice and data services will evolve in a similar fashion to the PC industry, with the proliferation of one or more open system architectures that may allow hardware and software to inter-operate more effectively and provide users with a greater choice of functional and affordable devices. In contrast to most competing wireless data solutions, our System SEVEN software allows access to wireless data services either remotely from a wide variety of wireless handheld devices or directly through an Internet access point. Network-integrated, operator-centric approach. We do not compete with wireless operators by selling wireless data services and software to their customers. We license our software to wireless operators, who embed the software into their existing networks and systems. We believe this enables wireless operators to offer subscribers a low cost, customized, branded and bundled voice and data service on a single wireless handheld device with one consolidated bill. In addition, the subscriber benefits from the reliability, scalability, service and customer support of the wireless operator. OUR STRATEGY Our objective is to provide software that drives the mass market adoption of wireless data services by making information portable, ubiquitous and easy to access on a single device at a low cost. The following are key elements of our business strategy: Further penetrate the subscriber base of our existing customers. Although our nine existing wireless operator customers have reported approximately 144 million wireless subscribers of voice services as of December 31, 2003, only a small fraction of these subscribers also use wireless data services based on our software. We intend to continue to improve our software and services and to strengthen our partner sales and marketing programs to increase the percentage of these subscribers who use wireless data services based on our software. Grow our customer base in key geographic regions. We intend to focus our sales and marketing efforts on adding wireless operator customers in key geographic regions with market characteristics that are favorable for accelerated growth in wireless data services. Maintain technology leadership. We believe that SEVEN is currently recognized as an innovator in the wireless data services industry. By continuing to invest in research and development, we intend to establish our carrier class, operator-centric, low cost solution as the industry-leading device- and platform-agnostic standard for delivering mass market wireless data services. In addition, we intend to continue to actively manage and protect our intellectual property rights. Leverage relationships with leading strategic partners. We have developed key alliances and relationships with channel partners, systems integrators, major device manufacturers, wireless technology innovators and developers. We have existing strategic distribution and systems integrator relationships with NEC and Hewlett-Packard, which allow us to efficiently deploy and market our solutions. We intend to continue to strengthen and develop these relationships and enter into similar relationships in order to maintain an efficient cost structure, integrate complementary technologies with our software, ensure access to emerging standards, and increase our access to potential new customers. Table of Contents Business PRODUCTS AND SERVICES Our System SEVEN software allows subscribers to use wireless handheld devices to access business and personal information such as e-mail, calendar, contacts, corporate directories and documents. We currently offer three editions of our software: SEVEN Personal Edition targets individual subscribers seeking a self-provisioned and easy to use solution. SEVEN Server Edition targets enterprises seeking a behind-the-firewall solution that can be managed by the enterprise IT staff. SEVEN Enterprise Edition targets enterprises looking for an operator-hosted, yet IT-managed solution. System SEVEN Product Line Table of Contents Business SYSTEM SEVEN SOFTWARE ARCHITECTURE Our System SEVEN software has been developed using a flexible, open architecture. We believe that our network, platform and device-agnostic approach increases the applicability and utility of our software to wireless operators and their subscribers. Our System SEVEN software is compatible with: Major international network standards, including CDMA2000/1xRTT, FOMA (a 3G technology developed by NTT DoCoMo), GSM/GPRS and universal mobile telecommunications system (UMTS); Major wireless local area network technologies, including Bluetooth and Wi-Fi; Leading security protocols, including advanced encryption standard (AES) and 128-bit secure socket layer (SSL); A wide variety of enterprise servers, including Microsoft Exchange, Lotus Domino, internet message access protocol version 4/post office protocol version 3 (IMAP4/POP3) and lightweight directory access protocol (LDAP) directories; Corporate directories and PC file systems that store documents; Major device operating systems and platforms, including BREW, J2ME, Microsoft Pocket PC and Smartphone, Palm OS and Symbian OS; and A variety of wireless handheld devices from manufacturers, such as Hitachi, HTC, Motorola, palmOne, Samsung, Sanyo, Sony Ericsson and Toshiba. Table of Contents Business System SEVEN As shown in the above diagram, depending on the deployment method used, the key components of a System SEVEN software implementation could include: A Mobile Services Environment that includes a browser or proxy server, an authentication and routing server, and a service management module for provisioning and billing. The Mobile Services Environment can be hosted by the wireless operator, a systems integrator partner or SEVEN; A SEVEN Connector for access to e-mail servers, network file systems and PC file systems. We use three deployment models: a SEVEN Enterprise Server installed behind the corporate IT firewall (SEVEN Server Edition); a trust network relationship between the operator Mobile Services Environment and the e-mail server using virtual private networks or SSL encryption (SEVEN Enterprise Edition); or a SEVEN PC Desktop Connector installed on the PCs of subscribers behind the corporate IT firewall (SEVEN Personal Edition); and Mobile Client Software installed on the wireless handheld devices provides the interface to the Mobile Services Environment. Alternatively, subscribers may connect to the Mobile Services Environment using a web browser. Currently available competing solutions typically employ a store and forward architecture where copies of e-mails and personal and business information are stored in multiple locations along the message delivery path, causing data duplication and inconsistencies. In contrast, our System SEVEN software uses a real-time architecture to deliver information over-the-air. Our System SEVEN software routes each user or server transaction as it arrives to the appropriate data destination or access point. With our System SEVEN software, enterprise data and applications remain securely stored behind the corporate firewall or within the wireless handheld device. Wireless handheld devices that have SEVEN s software installed send and receive data using an AES-encrypted TCP/IP connection that provides state- of-the-art security for confidential information. Our System SEVEN software also provides management Table of Contents Business capabilities that control the security and privacy of all information on wireless handheld devices. For example, a misplaced device can be instantly disconnected from enterprise systems and the information on the device remotely erased to mitigate security risks. In addition, our System SEVEN software allows enterprise IT organizations to use server-based or web-based management tools to extend their organization s existing access rights and authentication policies to the wireless environment. Our System SEVEN software integrates with user management infrastructures, such as Active Directory and Lotus Notes Address Book, eliminating the need for redundant wireless subscriber management systems. By using this integrated approach, all subscriber and application policies including password protection and user permissions can be conveniently enforced in the wireless environment. Our System SEVEN software platform has been designed to be highly scalable. We believe that our software platform, as it is currently designed, is capable of scaling to meet the foreseeable needs of our existing and prospective wireless operator customers. SALES AND MARKETING Our sales and marketing efforts rely on direct sales and on our systems integrator partners, which currently consist of NEC and Hewlett-Packard, to promote the sale of our software to wireless operators. While we currently have only a small direct sales force, we anticipate hiring a number of additional sales representatives in North America, Europe and Asia-Pacific following this offering. When we enter into contracts directly with wireless operators, we grant them license rights to use and distribute our software to their subscribers. When we sell through our systems integrator partners, we enter into license agreements with the systems integrator and grant them license rights to use and sublicense our software. For example, NEC is our systems integrator for NTT DoCoMo and KDDI Corp. In the case of these two wireless operators, we do not have direct contractual relationships with the wireless operators other than professional services engagements that are entered into from time to time. We do not sell directly to subscribers nor have we historically deployed direct marketing programs targeted at subscribers of wireless operators using our System SEVEN software. Instead, we leverage the brands, expertise and sales and marketing resources of wireless operators to market wireless data services to their subscribers. In the future, we also expect to devote additional sales and marketing resources to assist our wireless operator customers in promoting and deploying services supported by our software within their subscriber base. In addition, we expect to use a portion of the net proceeds from this offering to develop and implement marketing programs to further assist our wireless operator customers in increasing the number of their subscribers using our software. CUSTOMERS AND ALLIANCES Our customers include some of the largest wireless operators in the United States, Europe, Japan and Asia-Pacific. Historically, we have granted our customers a specified number of perpetual licenses to use our software in exchange for an up-front fee. Customers may then use these perpetual licenses to provide wireless data services to their subscribers using our software, provided that the total number of subscribers using our software at any one time may not exceed the number of perpetual licenses purchased by the customer. Wireless operator customers may purchase additional perpetual licenses at negotiated rates as needed to support additional subscribers. Commencing in May 2003, we began to enter into agreements with some of our wireless operator customers to purchase licenses with a specified term on a per-subscriber basis. For example, our per-subscriber-based agreements may have limited up- front fees and require a wireless operator to pay a monthly fee for each of its subscribers using our Table of Contents Business software to access wireless data services. As we renegotiate our existing agreements and enter into new agreements with wireless operators, we will seek to convert our existing perpetual license agreements to agreements where revenue is generated monthly on a per-subscriber basis. We intend to continue to develop and maintain long-term relationships with our wireless operator customers both through the renewal of our existing agreements and by entering into new agreements as we bring new products and services to market. Our current customer agreements generally have two- to three-year terms and will automatically renew for additional one-year terms unless terminated in advance. In 2004, our license agreements with Cingular Wireless, Orange and mmO2 will be up for renewal. In 2005, our license agreements with NTT DoCoMo and KDDI Corp will be up for renewal. Also, some of these agreements allow the wireless operators to terminate their commitments prior to the end of the specified term. SEVEN Customer Profile(1) (1) Subscriber figures and regional market position are estimates as reported by wireless operators as of December 31, 2003. Only a small fraction of these subscribers currently use wireless data services based on our software. Table of Contents Business Our systems integrator partners, NEC and Hewlett-Packard, manage the deployment, customization, support and integration of our System SEVEN software with some of our wireless operator customers, including NTT DoCoMo and KDDI Corp. We also engage in joint efforts with wireless operators and wireless handheld device manufacturers to provide us early insight into the capabilities and features of future wireless handheld devices, allowing us to better design and integrate software with these devices. Through such efforts, we intend to increase the number of wireless handheld devices that come pre-enabled for with our System SEVEN software. For example, Treo 600 devices sold by Sprint PCS and XDA devices sold by mmO2 allow the subscriber to download our software and use wireless data services immediately upon activation of service by the wireless operator, which further helps to drive subscriber adoption of wireless data services. RESEARCH AND DEVELOPMENT Our research and development efforts have focused on the following key areas of technological advancement: Building a carrier-class infrastructure for the delivery of wireless data services. Our software enables secure enterprise connectivity, network routing and transport and application services across multiple networks and a variety of wireless handheld devices. Integrating with wireless technologies. We have invested in integrating our technology with the infrastructure of our wireless operators. By leveraging the wireless operator network, our technology increases the functionality, security, and robustness of wireless data services. This integration also streamlines the service management of wireless data services including provisioning, billing, and customer care. Enabling mobility of enterprise applications. We have spent significant resources developing applications that enable subscribers to access e-mail and personal and business information using their wireless handheld devices. Our wireless applications include access to email, calendar, contacts, and corporate directories as well as documents stored in enterprise network drives and PC file systems. Extending our technology. We have invested in a number of application programming interfaces (APIs), device access libraries and tool kits that increase the extensibility and applicability of our technology to our wireless operators and systems integrators, enabling them to deliver advanced wireless data services more effectively. Since inception, we have spent approximately $29 million on research and development, including approximately $8.1 million in 2001, $10.7 million in 2002 and $8.2 million in 2003. COMPETITION The market for SEVEN s products and services is evolving rapidly and is highly competitive. The wireless data services market is relatively new and is characterized by frequent product introductions, changing protocols and rapidly developing technology. As handheld wireless devices continue to improve and become a major component of business and personal information management, we expect new competitors to enter the market and existing competitors to allocate more resources to develop more comprehensive wireless data solutions. As a result, we expect competition in these markets to intensify. Our direct competitors include those companies that provide subscribers with access to business and personal information over wireless handheld devices, the most significant being RIM, which markets the Table of Contents Business Blackberry solution. In addition, we compete with a number of privately held companies. We believe our competitors could also include wireless hardware manufacturers, application and software providers, such as IBM and Microsoft, network infrastructure providers and wireless operators that develop their own competing solutions. Our current and potential competitors may have substantially greater financial, technical, marketing and distribution resources, customer relationships and other significant competitive advantages in comparison to us. In addition, these companies may have greater name recognition and more established relationships with our target customers. Furthermore, these competitors may be able to adopt more aggressive pricing policies and offer customers more attractive terms, including potentially providing a competing solution at little or no cost as part of a bundled product offering. INTELLECTUAL PROPERTY We seek to protect its proprietary rights and its other intellectual property through a combination of copyrights, trademarks and patents, as well as through trade secret and contractual protections. The SEVEN name is a registered trademark in the United States. We have two patent applications pending in the U.S. Patent & Trademark Office which are directed to core elements of our System SEVEN software and have filed two corresponding international applications pursuant to the Patent Cooperation Treaty. In addition, we utilize internal and external controls such as proprietary invention assignment agreements, routine patent disclosure meetings to identify new patentable material, code segregation and security schemes, as well as aggressive use of confidentiality agreements with its customers, partners, and vendors. However, we cannot guarantee that the steps we have taken to protect our proprietary rights will be adequate to deter misappropriation of our proprietary information, and we may not be able to detect unauthorized use and take appropriate steps to enforce our intellectual property rights. REGULATORY MATTERS Our products are governed by the United States Bureau of Export Administration because of the encryption contained within the products. We have received a qualified license exception for our System SEVEN software which has been classified by the U.S. Bureau of Export Administration as ECCN 5D002 ENC and subject to U.S. Export Control Restrictions. EMPLOYEES As of March 31, 2004, we had a total of 81 employees, including 33 in engineering, 24 in field operations, 11 in application services, seven in finance and administration and six in marketing. Of these employees, 72 were located in the United States, and nine were located outside the United States. None of our employees is represented by a collective bargaining agreement. We have never experienced a work stoppage, and we consider our relations with our employees to be good. FACILITIES We sublease approximately 50,000 square feet of office space for our headquarters in Redwood City, California. In addition, we also lease two office suites for a sales and support office in Tokyo, Japan, under a month-to-month leasing arrangement. Table of Contents Business LEGAL PROCEEDINGS From time to time, we are involved in legal proceedings and litigation arising in the ordinary course of business. As of the date of this prospectus, except as described below, we are not a party to any litigation or other legal proceeding that, in out opinion, could severely harm our business. In September 2003, we were served with a complaint filed by Visto Corporation in the United States District Court for the Eastern District of Texas, Marshall Division, alleging that our System SEVEN products (the Accused Products ) infringe on two United States patents held by Visto. Visto s complaint seeks to permanently enjoin our sale, manufacture and distribution of the Accused Products in the United States in addition to the payment of an unspecified amount of lost profits and/or other damages, interest, attorney s fees, treble damages and litigation costs. The day after filing its complaint, Visto also filed a motion for a preliminary injunction seeking to enjoin us from selling the Accused Products pending the outcome of this litigation. We have answered Visto s complaint and have filed a counterclaim for declaratory relief seeking a declaration of non-infringement and the establishment of other defenses. The parties have also began, but not completed, the process of making mandatory disclosures of documents and other items required under the Federal Rules of Civil Procedure. Visto also filed motions challenging the legal sufficiency of certain defenses and claims pleaded in SEVEN s answer and counterclaim, but those motions have now been resolved in SEVEN s favor. On February 10, 2004, the District Court issued a scheduling order governing Visto s motion for a preliminary injunction. SEVEN took discovery related to Visto s motion for a preliminary injunction and the time to complete such discovery has now expired. SEVEN s opposition brief and Visto s reply brief have been filed with the District Court. No date for a hearing on the preliminary injunction has been set. On April 27, 2004, Visto filed a motion in the District Court seeking to amend its complaint to add allegations claiming that SEVEN infringes four additional patents controlled by Visto. As with its initial complaint, Visto continues to allege that the Accused Products infringe the two patents asserted in its original complaint as well as the four additional patents alleged in its proposed amendment to the complaint. A case scheduling conference will be held before the District Court on May 18, 2004. At that time we anticipate the District Court will address scheduling issues concerning the preliminary injunction motion and other important pre-trial scheduling issues and also will likely set a trial date. Although the District Court has tentatively proposed that the case be tried on April 4, 2005, a preliminary injunction hearing date could be held at any time. We believe we have meritorious defenses to Visto s original and amended claims of patent infringement, and we plan to continue our vigorous defense of this matter. We cannot, however, assure you that we will be successful in opposing either Visto s motion for preliminary injunction or its claims of patent infringement if this matter proceeds to trial. If we are unable to oppose Visto s motion for a preliminary injunction successfully, then we may be barred from selling, marketing, advertising, manufacturing or using the Accused Products in the United States or elsewhere during the course of the litigation. While the scope of any restraint imposed upon us by a preliminary injunction would depend upon the precise language of the order issued by the District Court, Visto s motion seeks to bar us from selling, marketing, advertising, manufacturing or using the Accused Products in the United States or elsewhere during the course of the litigation. Sales of the Accused Products in the United States represented approximately 31% of our total revenues in 2003, 55% of our total revenues in the three months ended March 31, 2004 and are expected to represent a substantial portion of revenue in the future. If we are not successful in defending this litigation at trial, we will very likely be required to pay Visto damages, including a possible trebling of any damages awarded by the District Court, lost profits, interest, royalties and Table of Contents Business attorneys fees and litigation costs in an indeterminate amount and to indemnify our wireless operator customers for damages incurred by them as a result of such infringement. If a permanent injunction were issued after an adverse verdict at trial then we could be permanently barred from selling, marketing, advertising, manufacturing or using the Accused Products in the United States or elsewhere unless we are able to negotiate a license from Visto at that time. Such a license may not be available to us at a reasonable cost or at all. If the District Court orders a preliminary or permanent injunction and a license from Visto is not available to us, then depending on the precise language of the District Court s injunctive relief order(s) or judgment, we likely would have to terminate contractual arrangements with our customers and resellers in the United States, and we could be subject to additional claims for any losses they incur as a result. If these unfavorable events occurred, we might be able to restructure our business to focus on our operations in markets outside the United States. However, we might not be successful in doing so. We might also face further legal challenges from Visto alleging that our offshore operations and activities related to those operations, including the use of the Accused Products by third parties, was in continued violation of the United States patent laws, a cause of further damage to Visto and also in violation of any injunctions issued by the District Court. Any of these developments would have a material adverse effect on our business, operating results and financial condition. Table of Contents Management EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth information regarding our executive officers and directors, their ages and the positions they held as of April 30, 2004. Name Age Position (1) Member of the stock option committee as of the closing of the offering. (2) Effective as of May 10, 2004. (3) Member of the audit committee as of the closing of the offering. (4) Member of the compensation committee as of the closing of the offering. (5) Member of the nominating/corporate governance committee as of the closing of the offering. Provided below are biographies for each of the executive officers and directors listed in the table above. Bill Nguyen founded SEVEN in May 2000 and currently serves on the board of directors and as Co-Chief Executive Officer. Before founding SEVEN, Mr. Nguyen served as a founder of Onebox.com from 1999 to 2000. Onebox was eventually acquired by Phone.com, now Openwave Systems. During 1998 and prior to starting Onebox, Mr. Nguyen served as Vice President of Products for Tioga Systems (now Support.com). Mr. Nguyen served as Vice President of Products for FreeLoader and headed business development and product management at the ForeFront Group. Kent Thexton joined SEVEN in April 2004 and currently serves on the board of directors and as Co-Chief Executive Officer and President. Prior to joining SEVEN, Mr. Thexton was Chief Data and Marketing Officer at mmO2 from November 2001 to March 2004. From 1998 until November 2001, Mr. Thexton was President of the Genie division of British Telecom and became Sales and Marketing Director of BTCellnet in 1990. Prior to British Telecom, Mr. Thexton held various positions at Rogers Cantel, including Executive Vice President and Chief Operating Officer. Mr. Thexton also serves on the Board of Directors of Photochannel Networks, Inc. Thomas C. Hoster is expected to become our Chief Financial Officer effective on or about May 10, 2004. Previously, Mr. Hoster served as Senior Vice President, Finance and Administration and Chief Financial Officer of At Road, a mobile resource management company, from November 1999 to May Table of Contents Management 2004. From May 1998 to March 1999, Mr. Hoster was Senior Vice President and Chief Financial Officer of GetSmart, an on-line provider of consumer financial services. From June 1996 to May 1998, Mr. Hoster was Chief Financial Officer of ClickAction, a provider of e-mail marketing services, formerly known as MySoftware Company. Prior to that, Mr. Hoster held several finance and administration positions at Octel Communications, a voice messaging company, from December 1989 to June 1996. Andrew K. Urushima joined the Company in October 2001 and currently serves as our Vice President, Finance and Interim Chief Financial Officer. Prior to joining the Company, Mr. Urushima served as Senior Vice President and Controller of InsWeb Corporation from May 1999 to September 2001. Mr. Urushima has also held financial management and accounting positions at Electronic Arts during 1996 to 1999 and Deloitte and Touche, LLP during 1985 to 1995, respectively. Mr. Urushima has qualified as a Certified Public Accountant in the state of California. Gary A. Schofield joined the Company in December 2000 and currently serves as Vice President, Worldwide Sales. Prior to joining the Company, Mr. Schofield was Vice President, Worldwide Application Sales at Openwave Systems (previously Phone.com). He joined Phone.com through the acquisition of Onebox.com where he was Vice President of Worldwide Sales from December 1999 until February 2000. Mr. Schofield was a regional sales manager for Oracle Corporation between 1995 and 1999, and was an account executive for IBM during 1992 and 1995. Kazuhiko Ishii has served as Vice President and General Manager, Japan since April 2002. Previously, Mr. Ishii held various positions including Vice President of Sales at Openwave System s (formerly Phone.com) Japan operation from January 1999 to April 2002. Prior to joining Phone.com Inc., Mr. Ishii held various senior executive positions with Nihon Vienna Systems K.K., Nihon Cisco Systems K.K. and Hewlett-Packard Japan, from 1985 through 1998. Atif Hussein currently serves as our Vice President, Field Services. Mr. Hussein served as a Sales Consultant to the Company from January 2001 to October 2001 and as the Company s Director of Sales Engineering from November 2001 to January 2003. Prior to joining the Company, he was Vice President of Marketing of iTheo from January 1999 until September 2000. Prior to iTheo, Mr. Hussein was in product marketing at Alphablox Corporation during 1998. Prior to Alphablox Corporation, he spent seven years at Oracle Corporation in various positions that included technical sales and software development in their consulting organization from 1990 through 1997. William A. Alvarado currently serves as our Vice President, Products. Mr. Alvarado served as a Product Manager of the Company from October 2000 to February 2003 and as the Company s Director of Product Management from February 2003 to May 2003. Prior to joining the Company, Mr. Alvarado was a consultant at Strategic Decisions Group from June 1999 through September 1999. Prior to joining Strategic Decisions Group, Mr. Alvarado worked as a senior business analyst at America One, a wholly owned telecommunications subsidiary of Capital One Financial Corporation, from December 1997 until July 1998. Prior to America One, Mr. Alvarado worked as a Senior Operations Analyst for Capital One Financial Corporation from 1995 until 1996. In addition, Mr. Alvarado has held consulting positions at a number of Internet startups. Kate A. O Sullivan has served as Vice President, Corporate Marketing and Communications since October 2000. Prior to joining the Company, Ms. O Sullivan held various positions at Ogilvy Public Relations Worldwide from 1994 to October 2000, including Vice President and Managing Director at its Silicon Valley office and Vice President, Account Supervisor and Account Manager at its San Francisco office. Table of Contents Management Harvey J. Anderson, II has served as Vice President, General Counsel since February 2003. Prior to joining the Company, he was Chief Operating Officer for Flywheel Communications, Inc., from January 2000 until October 2001. Mr. Anderson was Senior Vice President, General Counsel and Chief Operating Officer for Medscape (formerly MedicaLogic) from May 1999 until January 2000. From 1996 to 1999, Mr. Anderson held various positions at Netscape Communications, Corp. including Assistant General Counsel. Prior to Netscape, Mr. Anderson practiced law at McCutchen Doyle Brown & Enersen. Dr. Ross A. Bott has been one of our directors since February 2003. Dr. Bott became a partner, start-up advisor and consultant for Vision Capital in February 2003 and for BrainHeart Capital in September 2003. Mr. Bott has also been a venture partner and consultant at Redpoint Ventures since March 2001. Prior to joining Redpoint Ventures in March 2001, Dr. Bott was Chief Operating Officer at Phone.com in 2000 and Senior Vice President at Openwave Systems (formerly Phone.com) in 2001. Prior to Openwave, Dr. Bott became Chief Executive Officer of Onebox.com in September 1998. Prior to Onebox, Dr. Bott served as Executive Vice President, Product Divisions at Adobe Systems, Senior Vice President of Enterprise Technologies at Silicon Graphics and Chief Technical Officer and Vice President of Advanced Development at Pyramid Technology Corp. Eric Hsia has been one of our directors since March 2004. Mr. Hsia is a Managing Director of SOFTBANK Asia Infrastructure Fund, L.P. ( SAIF ). Prior to joining SAIF in February 2001, was an Associate Partner with SOFTBANK Venture Capital from February 1999 to February 2001. Mr. Hsia was a founding member of Merrill Lynch s Technology Investment Banking Group and held various positions from September 1994 to January 1999 and worked as a consultant with The LEK/Alcar Consulting Group from 1993 to 1994. Cameron D. Myhrvold has been one of our directors since September 2000. Since co-founding Ignition, LLC in February 2000, Mr. Myhrvold has served as a board member of Ignition, LLC and Managing Director of Ignition Partners, LLC, the management company for Ignition, LLC. Prior to co-founding Ignition, LLC, Mr. Myhrvold worked in various capacities at Microsoft Corporation from 1986 to 1998, most recently as Vice President of the Internet Customer Unit. He was co-founder of Dynamical Systems Inc., which was acquired by Microsoft Corporation in 1986. Brad A. Silverberg has been one of our directors since September 2000. Since co-founding Ignition, LLC in February 2000, Mr. Silverberg has served as a board member of Ignition, LLC and Managing Director of Ignition Partners, LLC, the management company for Ignition LLC. Prior to co-founding Ignition, LLC, Mr. Silverberg was a Senior Vice President at Microsoft Corporation from March 1990 to October 1999, where he also served as a member of the Executive Committee. David L. M. Sze has been one of our directors since October 2000, and is a General Partner at Greylock. Prior to joining Greylock in January 2000, Mr. Sze served various capacities at Excite@Home from March 1996 to January 2000, most recently as Senior Vice President of Product Strategy from May 1999 to January 2000. Mr. Sze worked for Electronic Arts and Crystal Dynamics from 1993 until 1996. BOARD OF DIRECTORS Following the closing of this offering, we anticipate that our board of directors will consist of Dr. Bott and Messrs. Myhrvold, Nguyen, Sze, Thexton and , and there will be one vacancy. There are no family relationships between any of our directors or executive officers. Table of Contents Management VOTING AGREEMENT Several of our current directors were elected pursuant to a voting agreement that we entered into with certain holders of our common and preferred stock. Specifically, the voting agreement provides that the parties thereto shall vote in favor of the following nominees in any election of directors: (i) two nominees of Ignition, LLC to serve as the directors elected by the holders of Series A preferred stock, which directors are currently Brad Silverberg and Cameron Myhrvold; (ii) one nominee of Greylock X Limited Partnership to serve as the director elected by the holders of Series A1 preferred stock, which director is currently David Sze; (iii) one nominee of SOFTBANK Asia Infrastructure Fund, L.P. to serve as the director elected by the holders of Series B preferred stock, which director is currently Eric Hsia; (iv) one nominee of the holders of a majority in interest of the shares of our common stock to serve as a director elected by all stockholders, which director is currently Bill Nguyen; and (v) two nominees mutually agreed upon by the holders of a majority in interest of our common stock and the holders of a majority in interest of our preferred stock to serve as directors elected by all stockholders, which directors are currently Ross Bott and Kent Thexton. The right to elect directors under this voting agreement will terminate upon consummation of this offering. CLASSIFIED BOARD Immediately after the consummation of this offering, our amended and restated certificate of incorporation will provide for a classified board of directors consisting of three classes of directors, each serving a staggered three-year term. As a result, a portion of our board of directors will be elected each year. To implement the classified structure, immediately after consummation of this offering, two of the nominees to the board will be elected to one-year terms, two will be elected to two-year terms and two will be elected to three-year terms. Thereafter, directors will be elected for three-year terms. Messrs. Myhrvold and Sze have been designated Class I directors whose term expires at the 2005 annual meeting of stockholders. Dr. Bott and Mr. Thexton have been designated Class II directors whose term expires at the 2006 annual meeting of stockholders. Messrs. Nguyen and have been designated Class III directors whose term expires at the 2007 annual meeting of stockholders. Our bylaws provide that the number of authorized directors may be changed only by resolution of the board of directors. Any additional directorships resulting from an increase in the number of authorized directors will be distributed among the three classes so that, as nearly as reasonably possible, each class will consist of one-third of the directors. The classification of the board of directors may have the effect of delaying or preventing changes in control of our company. COMMITTEES OF THE BOARD OF DIRECTORS Our board currently has four committees: the audit committee, the compensation committee, the nominating/corporate governance committee and the stock option committee. The information set forth below assumes the completion of the proposed offering. Audit Committee. The members of our audit committee are Messrs. Sze, and Dr. Bott. chairs the audit committee and is our audit committee financial expert (as is currently defined under the SEC rules implementing Section 407 of the Sarbanes-Oxley Act of 2002). Our audit committee, among other things: appoints a firm to serve as independent accountants to audit our financial statements; discusses the scope and results of the audit with the independent accountants, and reviews with management and the independent accountants our interim and year-end operating results; Table of Contents Management considers the adequacy of our internal accounting controls and audit procedures; and approves (or, as permitted, pre-approves) all audit and non-audit services to be performed by the independent accountants. The audit committee has the sole and direct responsibility for appointing, evaluating and retaining our independent auditors and for overseeing their work. All audit services to be provided to us and all permissible non-audit services, other than de minimis non-audit services, to be provided to us by our independent auditors must be approved in advance by our audit committee. We believe that the composition of our audit committee meets the requirements for independence under the current Nasdaq National Market and SEC rules and regulations. Compensation Committee. The members of our compensation committee are Dr. Bott and Mr. Myhrvold. Mr. Myhrvold chairs the compensation committee. The purpose of our compensation committee is to discharge the responsibilities of our board of directors relating to compensation of our executive officers. Specific responsibilities of our compensation committee include: reviewing and determining the compensation of our executive officers; administering our stock incentive and employee stock purchase plans; and reviewing and making recommendations to our board with respect to incentive compensation and equity plans. Nominating/Corporate Governance Committee. The members of our nominating/corporate governance committee are Messrs. Myhrvold and Sze. Mr. Sze chairs the nominating/governing committee. Our nominating/corporate governance committee identifies, evaluates and recommends nominees to our board of directors and committees of our board of directors, conducts searches for appropriate directors, and evaluates the performance of our board of directors and of individual directors. The nominating/corporate governance committee is also responsible for reviewing developments in corporate governance practices, evaluating the adequacy of our corporate governance practices and reporting and making recommendations to the board concerning corporate governance matters. Stock Option Committee. Our stock option committee consists of Mr. Nguyen. Our stock option committee administers the 2004 Equity Incentive Plan with respect to individuals who are not officers and is authorized to make stock option grants to employees and consultants of the company who are not officers in accordance with guidelines established by the compensation committee from time to time. All option grants to officers and all option grants in excess of the share limit imposed by the compensation committee must be submitted for approval to the compensation committee. COMPENSATION OF DIRECTORS Our directors historically have not received cash fees as compensation for their services. Directors are reimbursed for their reasonable out-of-pocket travel expenditures. Our directors are also eligible to participate in our 2004 Equity Incentive Plan, which contains an automatic option grant program under which each non-employee director who first joins our board on or after the effective date of this offering will receive an initial option grant for 25,000 shares when the director first joins our board of directors, and each non-employee director will receive an annual option grant for 10,000 shares at each annual stockholders meeting. Each option grant vests in equal monthly installments, with the initial grant vesting over four years and each of the annual grants vesting over one year of service. For further information see Management 2004 Equity Incentive Plan. In February 2003, in consideration for his Table of Contents Management service as a member of the board of directors, Dr. Bott received an option for 325,000 shares of our common stock at an exercise price per share of $0.40 that vests with respect to 25% of the shares upon the completion of 12 months of continuous service from the vesting commencement date and with respect to 1/48th of the shares upon the completion of each of the next 36 months of continuous service. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION In fiscal 2003, the board of directors as a whole approved matters concerning executive officer compensation, and Mr. Nguyen participated in these deliberations. None of our executive officers serve as a member of the board of directors or compensation committee of any entity that has one or more executive officers who serve on our board of directors or compensation committee. EXECUTIVE COMPENSATION The following table provides compensation information for our chief executive officer, former chief executive officer and the four most highly compensated other executive officers whose total annual salary and bonus exceeded $100,000 for all services rendered to us in 2003. We use the term named executive officers to refer to these people later in this prospectus. Summary compensation table Annual Compensation Long-Term Compensation All Other Compensation Name and Title Salary Bonus(1) Securities Underlying Options(2) Bill Nguyen President and Chief Executive Officer $ 104,050 Harvey J. Anderson II Vice President, General Counsel 153,980 $ 20,000 100,000 Atif Hussein Vice President, Field Services 167,215 30,000 32,500 Kazuhiko Ishii Vice President and General Manager, Japan 186,599 60,953 Kate A. O Sullivan Vice President, Corporate Marketing and Communications 171,100 Mark Biestman Former Chief Executive Officer 18,557 $ 200,000 (3) (1) Mr. Anderson received a signing bonus in connection with the commencement of his employment. Mr. Hussein received a bonus for achieving certain performance milestones. Mr. Ishii received an amount that represents commissions from sales of our products. (2) All options are exercisable for shares of our common stock. In February 2004, the following number of option shares were granted to the following named executive officers: 50,000 to Mr. Anderson, 100,000 to Mr. Hussein, 180,000 to Mr. Ishii and 100,000 to Ms. O Sullivan. (3) Mr. Biestman s employment ceased on January 27, 2003, and this amount represents a severance payment. Table of Contents Management Option grants in last fiscal year The following table contains information about stock option awards made to the named executive officers during 2003. No stock appreciation rights have been granted to these individuals. Individual Grants Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term(5) Name Number of Securities Underlying Options Granted Percent of Total Options Granted To Employees in Fiscal 2003(3) Exercise Price(4) Expiration Date 5% 10% Bill Nguyen Harvey J. Anderson II 100,000 (1) 3.8 % $ 0.40 February 4, 2013 $ $ Atif Hussein 32,500 (2) 1.5 0.40 May 5, 2013 Kazuhiko Ishii Kate A. O Sullivan Mark Biestman (1) Mr. Anderson s option vests as to 25% of the shares upon the completion of 12 months of service and as to 1/48th of the shares upon the completion of each of the next 36 months of service, and this option is immediately exercisable, and any unvested shares purchased under this option will be subject to repurchase by us, at the original exercise price paid per share, upon Mr. Anderson s cessation of service with us, prior to the vesting in such shares. (2) Mr. Hussein s option vests as to 1/48th of the shares upon the completion of each month of service following the vesting commencement date. (3) Percentages shown under Percent of Total Options Granted to Employees in Fiscal 2003 are based on options for an aggregate of 2,169,500 shares granted to our employees during 2003. (4) The exercise price of each option granted was equal to the fair market value of our common stock, as determined by our board of directors on the date of grant. Because there was no public market for our stock prior to this offering, our board of directors determined the fair market value of our common stock by considering a number of factors, including, but not limited to, previous valuations, status of product development, our financial condition and prospects for future growth. The exercise price may be paid in cash, in shares of our common stock valued at fair market value on the exercise date or through a cashless exercise procedure involving a same-day sale of the purchased shares. (5) The potential realizable value is calculated based on the ten-year term of the option at the time of grant. Stock price appreciation of 5% and 10% is assumed according to rules promulgated by the Securities and Exchange Commission and does not represent our prediction of our stock price performance. The potential realizable value at 5% and 10% appreciation is calculated by: Multiplying the number of shares of stock subject to a given stock option by the assumed initial public offering price per share of $ ; Assuming that the aggregate stock value derived from that calculation compounds at the annual 5% or 10% rate shown in the table until the expiration of the option; and Subtracting from that result the aggregate option exercise price. Table of Contents Management Option exercises and fiscal year-end values The following table sets forth the number of shares covered by both exercisable and unexercisable options as of December 31, 2003 and the year-end value of unexercised options as of December 31, 2003 for the named executive officers. No options or stock appreciation rights were exercised by our named executive officers in 2003, and no stock appreciation rights were outstanding at the end of that year. Shares Acquired on Exercise Value Realized Number of Securities Underlying Unexercised Options at December 31, 2003 Value of Unexercised in-the-Money Options at December 31, 2003(1) Name Exercisable Unexercisable Exercisable Unexercisable Bill Nguyen Harvey J. Anderson II 100,000 (2) $ Atif Hussein 4,740 27,760 Kazuhiko Ishii 50,000 70,000 Kate A. O Sullivan Mark Biestman (1) Amounts presented under the caption Value of Unexercised In-the-Money Options at December 31, 2003 are based on an assumed initial public offering price of $ per share minus the exercise price, multiplied by the number of shares subject to the stock option, without taking into account any taxes that might be payable in connection with the transaction. (2) All options held by Mr. Anderson are immediately exercisable, and any shares purchased under unvested options will be subject to repurchase by us, at the original exercise price paid per share, upon Mr. Anderson s cessation of service with us, prior to the vesting in such shares. Employment agreements and offer letters We have entered into an employment contract with Mr. Ishii. The agreement provides for a monthly base salary of 1,800,000 yen, or approximately US$17,000 based on exchange rates as of April 15, 2004, and states that Mr. Ishii is eligible to participate in an annual commission plan. The agreement requires that for a period of two years following his departure date from the company, Mr. Ishii will not provide service to another firm that manufactures or sells products or services that could compete with those of the company will not persuade or attempt to persuade certain employees of the company to leave the company and will not hire such individuals. Pursuant to the requirements under Japanese law, this employment contract provides that we may terminate Mr. Ishii s employment for cause. We have entered into an offer letter with Mr. Kent Thexton, our President and Co-Chief Executive Officer. The offer letter provides for an annual base salary of $200,000 and an option for 1,850,000 shares of our common stock that is subject to a four-year vesting schedule. We have entered into an offer letter with Mr. Thomas C. Hoster, who has agreed to become our Chief Financial Officer effective on or about May 10, 2004. The offer letter provides for an annual base salary of $200,000, an option for 125,000 shares of our common stock that becomes fully vested upon the effective date of this offering and an option for 375,000 shares of our common stock that is subject to a four-year vesting schedule. Change of control arrangements and severance If we terminate Mr. Anderson s employment for any reason other than cause, then he will be paid three months of his base salary. If we are subject to a change in control before his service ceases, he becomes vested in an additional number of option shares equal to 50% of all of his option grants, and if his employment is terminated other than for cause or as a result of a constructive termination following a change in control, all remaining unvested option shares become fully vested. Table of Contents Management If we are subject to a change in control before Mr. Hussein s service ceases, of the 67,500 shares that he acquired by exercising an option and with respect to his option covering 100,000 shares, he will become vested in an additional number of shares equal to 25% of these option grants, and for his option covering 32,500 shares, he will become vested in an additional number of shares equal to 50% of this option grant. If we are subject to a change in control before Mr. Ishii s service ceases, he will become vested in an additional number of option shares equal to 25% of all of his option grants. If we are subject to a change in control before Ms. O Sullivan s service ceases, of the 300,000 shares that she acquired by exercising an option and with respect to her option covering 100,000 shares, she will become vested in an additional number of shares equal to 25% of these option grants. The compensation committee of the board of directors, as plan administrator of the 2004 Equity Incentive Plan, has the authority to provide for accelerated vesting of the shares of common stock subject to outstanding options held by the named executive officers and any other person in connection with a change in control. We entered into a severance agreement with Mr. Biestman, our former Chief Executive Officer, pursuant to which he received $200,000 and additional vesting acceleration of 535,657 option shares in consideration for his execution of a general release of claims. Mr. Biestman did not exercise any of his vested options, and they have expired. If we are subject to a change in control before Mr. Thexton s service ceases, he will become vested in an additional number of option shares equal to 25% of his total option grant. In addition, if his employment with us ends as a result of a constructive termination within 12 months following the change in control, all remaining unvested option shares will become fully vested. If we are subject to a change in control before Mr. Hoster s service ceases, he will become vested in an additional number of option shares equal to 25% of the total shares subject to each option. In addition, if his employment with us ends as a result of a constructive termination within 12 months following the change in control, all remaining unvested option shares will become fully vested. 2004 Equity Incentive Plan Our 2004 Equity Incentive Plan was adopted by our board of directors in March 2004 and was approved by our stockholders in April 2004. Our 2004 Equity Incentive Plan will become effective contingent upon this offering. The following summary of our 2004 Equity Incentive Plan is qualified in its entirety by the specific language contained in our 2004 Equity Incentive Plan. Purpose. The purpose of our 2004 Equity Incentive Plan is to promote the long-term success of our company and the creation of stockholder value by (a) encouraging employees, non-employee directors and consultants to focus on critical long-range objectives, (b) encouraging the attraction and retention of employees, non-employee directors and consultants with exceptional qualifications and (c) linking employees, non-employee directors and consultants directly to stockholder interests through increased stock ownership. Share Reserve. We have reserved 2,000,000 shares of our common stock for issuance under the 2004 Equity Incentive Plan, plus the number of shares of our common stock remaining available for grant under our 2000 Stock Plan upon this offering. In general, if options or shares awarded under our 2000 Table of Contents Management Stock Plan or 2004 Equity Incentive Plan are forfeited or repurchased, then those options or shares will again become available for awards under our 2004 Equity Incentive Plan. In addition, as of January 1 of each year, starting in 2005, the number of shares of our common stock reserved under our 2004 Equity Incentive Plan will automatically increase by the lesser of (a) 1,000,000 shares and (b) 1.0% of the total number of shares of our common stock then outstanding. Administration. The compensation committee of our board of directors administers our 2004 Equity Incentive Plan. The committee has the complete discretion to make all decisions relating to our 2004 Equity Incentive Plan. The compensation committee may also reprice outstanding options and modify outstanding awards in other ways. Our stock option committee administers the 2004 Equity Incentive Plan with respect to individuals who are not officers and is authorized to make stock option grants to employees and consultants of the company who are not officers in accordance with guidelines established by the compensation committee from time to time. Eligibility. Employees, non-employee members of our board of directors and consultants are eligible to participate in our 2004 Equity Incentive Plan. Types of Award. Our 2004 Equity Incentive Plan provides for the following types of awards: incentive and nonstatutory stock options to purchase shares of our common stock; stock appreciation rights; restricted shares of our common stock; and stock units. Options and Stock Appreciation Rights. The exercise price for incentive stock options and nonstatutory stock options granted under our 2004 Equity Incentive Plan may not be less than 100% and 85%, respectively, of the fair market value of our common stock on the option grant date. A stock option agreement may provide that a new option will be granted automatically to an optionee when he or she exercises a prior option and pays the exercise price with shares of our common stock already owned by such optionee. Optionees may pay the exercise price by using cash, shares of our common stock that the optionee already owns, a full-recourse promissory note, an immediate sale of the option shares through a broker designated by us or a loan from a broker designated by us, secured by the option shares. Incentive stock options may be granted only to our employees. The aggregate fair market value, determined at the time of option grant, of shares of our common stock subject to incentive stock options that are exercisable for the first time by an optionee during any calendar year may not exceed $100,000. No incentive stock option may be granted to any person who, at the time of the grant, owns or is deemed to own stock possessing more than 10% of our total combined voting power or of any of our affiliates unless the following conditions are satisfied: (a) the option exercise price is at least 110% of the fair market value of the stock subject to the option on the date of grant; and (b) the term of the incentive stock option does not exceed five years from the date of grant. A participant who exercises a stock appreciation right receives the increase in value of our common stock over the base price. The base price for stock appreciation rights granted under our 2004 Equity Incentive Plan shall be determined by our compensation committee. The settlement value of the stock appreciation right may be paid in cash or shares of our common stock or a combination of both. Options and stock appreciation rights vest at the times determined by our compensation committee. In most cases, our options and stock appreciation rights will vest over a four-year period following the date of grant. Table of Contents Management Options and stock appreciation rights generally expire 10 years after they are granted but generally expire earlier if the participant s service terminates earlier. No participant may receive options or stock appreciation rights under our 2004 Equity Incentive Plan covering more than 500,000 shares in one fiscal year, except that a newly hired employee may receive options or stock appreciation rights covering up to 2,000,000 shares in the first year of employment. Restricted Shares and Stock Units. Restricted shares may be awarded under our 2004 Equity Incentive Plan in return for cash, a full-recourse promissory note, services already provided to us and in the case of treasury shares only, services to be provided to us in the future. Restricted shares vest at the times determined by our compensation committee. Stock units may be awarded under our 2004 Equity Incentive Plan. No cash consideration shall be required of the award recipients. Stock units may be granted in consideration of a reduction in the recipient s other compensation or in consideration of services rendered. Each award of stock units may or may not be subject to vesting and vesting, if any, shall occur upon satisfaction of the conditions specified by our compensation committee. Settlement of vested stock units may be made in the form of cash, shares of our common stock or a combination of both. No participant may receive restricted shares or stock units with performance-based vesting under our 2004 Equity Incentive Plan covering more than 500,000 shares in one fiscal year, except that a newly hired employee may receive such restricted shares or stock units covering up to 2,000,000 shares in the first year of employment. In addition, no participant may receive stock units of more than $2,000,000 in value in a single year. Adjustments. If there is a subdivision of our outstanding shares of common stock, a dividend declared in stock or a combination or consolidation of our outstanding shares of common stock into a lesser number of shares, corresponding adjustments will be automatically made in each of the following: (a) the number of shares of our common stock available for future awards under our 2004 Equity Incentive Plan; (b) any limitation on the maximum number of shares of our common stock that may be subject to awards in a fiscal year; (c) the number of shares of our common stock covered by each outstanding option or stock appreciation right, as well as the exercise price under each such award; (d) the number of shares of our common stock covered by the options to be granted under the automatic option grant program; or (e) the number of stock units included in any prior award that has not yet been settled. Change in Control. If we are merged or consolidated with another company, and such merger or consolidation results in a change in control of SEVEN, an option or award under our 2004 Equity Incentive Plan will be subject to the terms of the merger agreement, which may provide that the option or award continues, is assumed or substituted, fully vests or is cancelled in exchange for a cash payment equal to the spread between the exercise price and the value of our common stock on the closing date of the change in control transaction. Automatic Option Grant Program. In March 2004, our board of directors approved a program of automatic option grants for non-employee directors under our 2004 Equity Incentive Plan on the terms specified below: Each non-employee director who first joins our board after this offering, such director referred to herein as a new director, will receive an initial option for 25,000 shares of our common stock. The initial grant of this option will occur when the director takes office. Starting in the year after the year in which a new director joins our board, each new director will automatically be granted an annual option for 10,000 shares of our common stock at each of our stockholder meetings. A non-employee director who joined our board before the effectiveness of the registration statement related to this offering is also eligible to receive this annual option grant at each of our stockholder meetings. Table of Contents Management Each initial option grant vests in 48 equal monthly installments following the date of grant, and each annual option grant vests in 12 equal monthly installments following the date of grant. A non-employee director s option granted under this automatic option grant program will become fully vested upon a change in control of SEVEN or the director s death, total and permanent disability or retirement at or after age 65. The exercise price of each non-employee director s option will be equal to the fair market value of our common stock on the date of grant. A director may pay the exercise price by using cash, shares of our common stock that the director already owns, or an immediate sale of the option shares through a broker designated by us. Each non-employee director s option granted under this automatic option grant program has a 10-year term, except that the option expires 12 months after the director leaves our board of directors for any reason. Amendments or Termination. Our board of directors may amend or terminate our 2004 Equity Incentive Plan at any time. If our board of directors amends our 2004 Equity Incentive Plan, it does not need to seek stockholder approval of the amendment unless applicable law requires it. Our 2004 Equity Incentive Plan will continue until March 11, 2014, unless our board of directors decides to terminate this plan earlier. 2000 Stock Plan Our 2000 Stock Plan was adopted by our board of directors in August 2000 and has been approved by our stockholders. No further option grants will be made under our 2000 Stock Plan after the effectiveness of the registration statement related to this offering. The options granted under the 2000 Stock Plan that are outstanding after this offering will continue to be governed by their existing terms. Share Reserve. As of March 31, 2004, we had reserved 9,735,140 shares of our common stock for issuance under our 2000 Stock Plan. After this offering, if options or shares awarded under our 2000 Stock Plan are forfeited or repurchased, then those options or shares will again become available for awards under our 2004 Equity Incentive Plan. As of March 31, 2004, 2,609,064 shares of our common stock remained available for grant under our 2000 Stock Plan. In addition, in April 2004 our board of directors authorized an additional 1,250,000 shares of our common stock for issuance under our 2000 Stock Plan. Administration. Our board of directors has administered our 2000 Stock Plan and has complete discretion to make all decisions relating to our 2000 Stock Plan. Our board may also reprice outstanding options and modify outstanding awards in other ways. Eligibility. Employees, non-employee members of our board of directors and consultants are eligible to participate in our 2000 Stock Plan. Types of Awards. Our 2000 Stock Plan provides for incentive and nonstatutory stock options to purchase shares of our common stock and restricted shares of our common stock. The exercise price for incentive stock options and nonstatutory stock options granted under our 2000 Stock Plan may not be less than 100% and 85%, respectively, of the fair market value of our common stock on the date of grant. Optionees may pay the exercise price by using cash, shares of our common stock that the optionee already owns, a full-recourse promissory note, an immediate sale of the option shares through a broker designated by us or a loan from a broker designated by us, secured by the option shares. In most cases, our options vest over a four-year period following the date of grant and generally expire 10 years after they are granted, unless the optionee ceases service with us. Restricted shares may be awarded under our Table of Contents Management 2000 Stock Plan in return for cash, a full-recourse promissory note or services already provided to us. Restricted shares vest at the times determined by our board of directors. Change in Control. If a change in control of SEVEN occurs, options outstanding under our 2000 Stock Plan will become fully vested and exercisable if the options do not remain outstanding following the change in control and the surviving corporation or its parent does not assume the options or substitute them with options that have substantially the same terms. In addition, unless otherwise provided in the applicable stock option agreement, upon a change in control of SEVEN, the vesting and exercisability of options granted under our 2000 Stock Plan will accelerate, as if the optionees provided an additional 12 months of service. A change in control includes (i) a merger or consolidation of SEVEN with or into another entity or any other corporate reorganization, if persons who were not stockholders of SEVEN immediately before such merger, consolidation or other reorganization own immediately after such merger, consolidation or other reorganization 50% or more of the voting power of SEVEN or (ii) the consummation of a sale or other disposition of all, or substantially all, of our assets. Amendments or Termination. Our board of directors may amend or terminate our 2000 Stock Plan at any time. If our board of directors amends our 2000 Stock Plan, it does not need to seek stockholder approval of the amendment unless the number of shares reserved under our 2000 Stock Plan increases or the class of persons eligible for the grant of incentive stock options materially changes. Our 2000 Stock Plan will automatically terminate 10 years after its adoption by our board of directors. Employee Stock Purchase Plan Our Employee Stock Purchase Plan was adopted by our board of directors in March 2004 and was approved by our stockholders in April 2004. Our Employee Stock Purchase Plan will become effective upon the effectiveness of the registration statement related to this offering. Our Employee Stock Purchase Plan is intended to qualify under Section 423 of the Internal Revenue Code. Share Reserve. We have reserved 450,000 shares of our common stock for issuance under our Employee Stock Purchase Plan. In addition, on January 1 of each year, starting with the year 2006, the number of shares of our common stock in the reserve will automatically increase by the lesser of (i) 0.3% of the total number of shares of our common stock that are outstanding at that time or (ii) 200,000 shares. Administration. The compensation committee of our board of directors will administer our Employee Stock Purchase Plan. Eligibility. All of our employees are eligible to participate if we employ them for more than 20 hours per week and their customary employment is for more than five months per year. Eligible employees may begin participating in the Employee Stock Purchase Plan at the start of any offering period. Offering Periods. Each offering period lasts a maximum of 12 months, and a new offering period begins every six months, as determined by our board of directors. Overlapping offering periods generally start on May 10 and November 10 of each year. However, the first offering period will start on the effective date of the registration statement related to this offering and end no more than 12 months later. Amount of Contributions. Our Employee Stock Purchase Plan permits each eligible employee to purchase our common stock through payroll deductions. Each employee s payroll deductions may not exceed 15% of the employee s cash compensation. Purchases of our common stock will generally occur on May 9 and November 9 of each year. Each participant may purchase up to the number of shares determined by our board of directors on any purchase date, not to exceed 750 shares. The value of the shares of our common stock purchased in any calendar year may not exceed $25,000. Table of Contents Management Purchase Price. The price of each share of common stock purchased under our Employee Stock Purchase Plan will not be less than 85% of the lower of: the fair market value per share of our common stock on the date immediately before the first day of the applicable offering period (except that for the first offering period, we will use the initial public offering price), and the fair market value per share of our common stock on the purchase date. Adjustments. The total number of shares of our common stock offered under our Employee Stock Purchase Plan, the 750-share limitation on each purchase date and the price of shares of our common stock that any participant has elected to purchase will be adjusted proportionately for any increase or decrease in the number of outstanding shares of our common stock resulting from a subdivision or consolidation of shares or the payment of a stock dividend, any other increase or decrease in such shares effected without receipt or payment of consideration by us, the distribution of the shares of a subsidiary to our stockholders or a similar event. Other Provisions. Employees may end their participation in our Employee Stock Purchase Plan at any time. Participation ends automatically upon termination of employment with SEVEN. If a change in control of SEVEN occurs, our Employee Stock Purchase Plan will end and shares will be purchased with the payroll deductions accumulated to date by participating employees. Our board of directors may amend or terminate our Employee Stock Purchase Plan at any time. If our board of directors increases the number of shares of our common stock reserved for issuance under our Employee Stock Purchase Plan, except for the automatic increases described above, it must seek the approval of our stockholders. 401(k) plan We maintain a profit sharing/401(k) plan, which is intended to qualify under Sections 401(a) and 401(k) of the Internal Revenue Code. This plan allows each participant to contribute up to 60% of his or her pre-tax compensation, up to a statutory limit, which is $13,000 in calendar year 2004. Under the plan, each employee is fully vested in his or her deferred salary contributions. The plan also permits us to make discretionary contributions and matching contributions. To date, we have not made any discretionary or matching contributions to the plan on behalf of participating employees. LIMITATION OF LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS As of the closing of this offering, we will adopt and file a new amended and restated certificate of incorporation and adopt new amended and restated bylaws. Our new amended and restated certificate of incorporation and amended and restated bylaws provide that we will indemnify our directors and officers to the fullest extent permitted by Delaware law, as it now exists or may in the future be amended, against all expenses and liabilities reasonably incurred in connection with their service for or on behalf of us. In addition, the new amended and restated certificate of incorporation provides that our directors will not be personally liable for monetary damages to us for breaches of their fiduciary duty as directors, unless they violated their duty of loyalty to us or our stockholders, acted in bad faith, knowingly or intentionally violated the law, authorized illegal dividends or redemptions or derived an improper personal benefit from their action as directors. Prior to the closing of this offering, we anticipate that we will obtain liability insurance which will insure our directors and officers against certain losses and which will insure us against our obligations to indemnify our directors and officers. In addition, we are in the process of entering into indemnification agreements with each of our directors and officers. These agreements, among other things, require us to indemnify each director and officer to Table of Contents Management the fullest extent permitted by Delaware law, including indemnification of expenses such as attorneys fees, judgments, fines and settlement amounts incurred by the director or officer in any action or proceeding, including any action or proceeding by or in right of us, arising out of the person s services as a director or officer. At present, we are not aware of any pending or threatened litigation or proceeding involving any of our directors, officer, employees or agents in which indemnification would be required or permitted. We believe provisions in our new amended and restated certificate of incorporation and indemnification agreements are necessary to attract and retain qualified persons as directors and officers. Table of Contents Related party transactions THIRD AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT We have granted registration rights to our preferred stockholders and certain common stockholders pursuant to an investor rights agreement. See Description of Capital Stock Registration Rights. EMPLOYMENT AGREEMENTS We have entered into offer letters or employment agreements with each of our named executive officers. For more information regarding these arrangements. See Management Executive Compensation. STOCK OPTION GRANTS We have granted options to purchase shares of our common stock to our executive officers and directors. See Management Compensation of Directors and Management Executive Compensation. In October 2000, we granted an option to purchase 75,000 shares of our common stock to Kent Thexton in connection with his services as an advisor. This option was subsequently rescinded. INDEMNIFICATION AGREEMENTS We are in the process of entering into separate indemnification agreements with our directors and executive officers, in addition to the indemnification provided for in our amended and restated bylaws. See Management Limitation of Liability and Indemnification of Officers and Directors. LOANS TO EXECUTIVE OFFICERS On October 18, 2000, we loaned $55,800 to Ms. O Sullivan in connection with her exercise of an option to purchase 200,000 shares of our common stock. Ms. O Sullivan issued a promissory note to us bearing interest at the rate of 6.09% per annum, compounded annually, which note is secured by a pledge of the shares acquired and is payable in full on October 18, 2004. The outstanding principal and interest on this loan was approximately $68,000 as of March 31, 2004. RELATIONSHIPS WITH CUSTOMERS Kent Thexton joined us as our President and Co-Chief Executive Officer and as a member of our board of directors on April 1, 2004. Prior to joining SEVEN, Mr. Thexton was the Chief Data and Marketing Officer of mmO2, one of our wireless operator customers. In 2003, we recognized less than five percent of our total revenues from our agreement with mmO2. Table of Contents Principal and selling stockholders The following table sets forth information regarding beneficial ownership of our common stock as of April 30, 2004, as adjusted to reflect the sale of the shares of common stock offered in this offering and held by the following persons: each person known by us to be the beneficial owner of more than five percent of our outstanding voting capital stock; each of our named executive officers; each of our directors; all of our executive officers and directors as a group; and the selling stockholders. A total of shares of our common stock are being offered for sale by the selling stockholders. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Except as noted by footnote, and subject to community property laws where applicable, the persons named in the table below have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. The percentage of beneficial ownership is based on shares of common stock outstanding after completion of the offering. Fractional shares have been rounded to the nearest whole number. This table lists applicable percentage ownership based on 36,436,075 shares of common stock outstanding as of April 30, 2004, assuming the conversion of all outstanding preferred stock to common stock, and also lists applicable percentage ownership based on shares of common stock outstanding after the closing of the offering. Options and warrants to purchase shares of our common stock that are exercisable within 60 days of April 30, 2004, are deemed to be beneficially owned by the persons holding these options for the purpose of computing percentage ownership of that person, but are not treated as outstanding for the purpose of computing any other persons ownership percentage. A total of shares of our common stock are being offered for sale by the selling stockholders listed below. We will not receive any of the proceeds from the sale of common stock by the selling stockholders. The selling stockholders include certain members of our board of directors. The following table assumes the underwriters do not exercise their over-allotment option. If the over-allotment option is exercised in full, the selling stockholders will sell up to an aggregate of additional shares of common stock. Unless otherwise indicated, the address for each beneficial owner is c/o Seven Networks, Inc., 901 Marshall Street, Redwood City, California 94063. Table of Contents Principal and selling stockholders Beneficial ownership as of April 30, 2004 Shares Offered Beneficial ownership after offering Name and address of beneficial owner Shares Percent(1) Shares Percent(1) 5% Stockholders Greylock X Limited Partnership(2)(3) 3,740,728 10.3 % % Ignition, LLC(4) 9,194,098 25.2 Bill Nguyen 11,672,250 32.0 Saints Capital III, L.P.(5) 2,842,377 7.8 SOFTBANK Asia Infrastructure Fund(6) 3,875,969 10.6 Named Executive Officers and Directors Bill Nguyen 11,672,250 29.5 % % Kent Thexton(7) 1,850,000 4.8 Kazuhiko Ishii(8) 83,750 * * Atif Hussein(9) 176,302 * * Kate A. O Sullivan(10) 400,000 1.1 * Harvey J. Anderson II(11) 150,000 * Dr. Ross Bott(12) 325,000 * * Eric Hsia(13) 3,875,969 10.6 Cameron D. Myhrvold(14) 9,194,098 25.2 Brad A. Silverberg(15) 9,194,098 25.2 David L. M. Sze(16) 3,740,728 10.3 Mark Biestman All executive officers and directors as a group (14 persons) 32,153,484 81.2 Other Selling Stockholders * Represents beneficial ownership of less than one percent of our outstanding common stock. (1) For the purpose of computing the percentage ownership of each beneficial owner, any securities which were not outstanding but which were subject to options, warrants, rights or conversion privileges held by such beneficial owner exercisable within 60 days from April 30, 2004 were deemed to be outstanding in determining the percentage owned by such person, but were not deemed outstanding in determining the percentage owned by any other person. (2) Includes 3,126,343 shares held of record by Greylock X Limited Partnership and 240,313 shares held of record by Greylock X-A Limited Partnership. The address of Greylock X Limited Partnership and Greylock X-A Limited Partnership is 880 Winter Street, Suite 300, Waltham, Massachusetts 02451. (3) Includes 748 shares held of record by David B. Aronoff, 16,833 shares held of record by Aneel Bhusri, 24,315 shares held of record by Charles Chi and Renee van Dieen as Tenants in Common, 65,463 shares held of record by Howard E. Cox, Jr., 16,833 shares held of record by Charles M. Hazard, Jr., 33,292 shares held of record by William W. Helman, 33,292 shares held of record by William S. Kaiser, 37,876 shares held of record by Mapache Investments L.P. u/a/d 05/31/99, 65,463 shares held of record by McCance Family Limited Partnership, 12,624 shares held of record by David N. Strohm, 16,833 shares held of record by David Sze, and 50,500 shares held of record by The Roger L. Evans Revocable Trust dated 12/16/99. Each disclaims beneficial ownership of aforementioned shares and shares held by Greylock X Limited Partnership and Greylock X-A Limited Partnership, except to the extent of his pecuniary interest therein. (4) The address of Ignition, LLC is 11400 SE 6th, Suite 100, Bellevue, Washington 98004. (5) The address of Saints Capital III, L.P., is 475 Sansome Street, Suite 1850, San Francisco, California 94111. (6) The address of SOFTBANK Asia Infrastructure Fund is Two Palo Alto Square, Suite 500, 3000 El Camino Real, Palo Alto, California 94306. (7) This number includes 1,850,000 shares issuable upon exercise of options under our 2000 Stock Plan. If all outstanding options are exercised, 1,850,000 of these shares can be repurchased by SEVEN at cost within 60 days of April 30, 2004 in the event of termination of Mr. Thexton s employment with SEVEN. (8) This number includes 83,750 shares issuable upon exercise of options under our 2000 Stock Plan. (footnotes continued on following page) Table of Contents Principal and selling stockholders (9) This number includes 176,302 shares issued or issuable upon exercise of options under our 2000 Stock Plan. If all outstanding options are exercised, 99,427 of these shares can be repurchased by SEVEN at cost within 60 days of April 30, 2004 in the event of termination of Mr. Hussein s employment with SEVEN. (10) This number includes 400,000 shares issued or issuable upon exercise of options under our 2000 Stock Plan. If all outstanding options are exercised, 114,583 of these shares can be repurchased by SEVEN at cost within 60 days of April 30, 2004 in the event of termination of Ms. O Sullivan s employment with SEVEN. (11) This number includes 150,000 shares issuable upon exercise of options under our 2000 Stock Plan. If all outstanding options are exercised, 102,500 of these shares can be repurchased by SEVEN at cost within 60 days of April 30, 2004 in the event of termination of Mr. Anderson s employment with SEVEN. (12) The address of Dr. Bott is c/o Seven Networks, 901 Marshall Street, Redwood City, California 94063. Includes 325,000 shares issuable upon exercise of options under our 2000 Stock Plan. If all outstanding options are exercised, 220,536 of these shares can be repurchased by SEVEN at cost within 60 days of April 30, 2004 in the event of Dr. Bott s resignation from the Board of Directors of SEVEN. (13) The address of Mr. Hsia is Two Palo Alto Square, Suite 500, 3000 El Camino Real, Palo Alto, California 94306. Includes 3,875,969 shares held of record by SOFTBANK Asia Infrastructure Fund. Mr. Hsia is Managing Director of SOFTBANK Asia Infrastructure Fund. SOFTBANK Asia Infrastructure Fund is affiliated with SOFTBANK Capital Partners, which owns a six percent interest in Ignition Partners, LLC. Mr. Hsia disclaims beneficial ownership of aforementioned shares, except to the extent of his pecuniary interest therein. (14) The address of Mr. Myhrvold is 11400 SE 6th, Suite 100, Bellevue, Washington 98004. Includes 9,194,098 shares held of record by Ignition, LLC. Mr. Myhrvold is a board member of Ignition, LLC and a Managing Director of Ignition Partners, LLC. Mr. Myhrvold disclaims beneficial ownership of aforementioned shares, except to the extent of his pecuniary interest therein. (15) The address of Mr. Silverberg is 11400 SE 6th, Suite 100, Bellevue, Washington 98004. Includes 9,194,098 shares held of record by Ignition, LLC. Mr. Silverberg is a board member of Ignition, LLC and a Managing Director of Ignition Partners, LLC. Mr. Silverberg disclaims beneficial ownership of aforementioned shares, except to the extent of his pecuniary interest therein. (16) The address of Mr. Sze is 880 Winter Street, Suite 300, Waltham, Massachusetts 02451. Includes 3,126,343 shares held of record by Greylock X Limited Partnership, 240,313 shares held of record by Greylock X-A Limited Partnership, 748 shares held of record by David B. Aronoff, 16,833 shares held of record by Aneel Bhusri, 24,315 shares held of record by Charles Chi and Renee van Dieen as Tenants in Common, 65,463 shares held of record by Howard E. Cox, Jr., 16,833 shares held of record by Charles M. Hazard, Jr., 33,292 shares held of record by William W. Helman, 33,292 shares held of record by William S. Kaiser, 37,876 shares held of record by Mapache Investments L.P. u/a/d 05/31/99, 65,463 shares held of record by McCance Family Limited Partnership, 12,624 shares held of record by David N. Strohm, 16,833 shares held of record by David Sze, and 50,500 shares held of record by The Roger L. Evans Revocable Trust dated 12/16/99. Mr. Sze is a General Partner of Greylock Partners. Mr. Sze disclaims beneficial ownership of aforementioned shares, except to the extent of his pecuniary interest therein. Table of Contents Description of capital stock The following summary description of our capital stock is subject to and qualified in its entirety by the provisions of our amended and restated certificated of incorporation, as amended to effect our -for- reverse stock split, and our amended and restated bylaws, which are included as exhibits to the registration statement of which this prospectus forms a part, and the provisions of applicable law. This description gives effect to the conversion of all outstanding shares of preferred stock into common stock, which will automatically occur upon the closing of this offering. AUTHORIZED CAPITAL STOCK Immediately after consummation of this offering, we will be authorized to issue 200,000,000 shares of common stock, $0.0001 par value, and 10,000,000 shares of preferred stock, $0.0001 par value. These shares of preferred stock will not have been designated as to series and will be available for issuance from time to time in one or more series at the discretion of our board of directors. While we have no present intention to issue shares of preferred stock, any such issuance could be used to discourage, delay or make more difficult a change in control of SEVEN. COMMON STOCK As of March 31, 2004, after giving effect to the conversion of all outstanding of all shares of preferred stock, we had 36,247,533 shares of common stock outstanding, held of record by approximately 95 stockholders. In addition, as of March 31, 2004, there were 4,114,625 shares of common stock subject to outstanding options. When this offering is completed, there will be shares of common stock outstanding, assuming no exercise of the underwriter s over-allotment option or additional exercise of options or warrants outstanding as of March 31, 2004 and assuming the conversion of all preferred stock to common stock. Subject to the rights and preferences that may be applicable to any preferred stock outstanding at the time, the holders of outstanding shares of common stock have the rights and preferences set forth below. Voting rights The holders of common stock are entitled to one vote per share on all matters to be voted upon by stockholders. Dividends Subject to preferences that may be applicable to any outstanding preferred stock, holders of common stock are entitled to receive ratably any dividends that may be declared by the Board of Directors out of funds legally available for that purpose. Liquidation rights In the event of our liquidation, dissolution or winding up, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preference of any outstanding preferred stock. Table of Contents Description of capital stock Other The common stock has no preemptive or conversion rights, other subscription rights, or redemption or sinking fund provisions. All outstanding shares of common stock are fully paid and non-assessable, and the shares of common stock to be issued upon completion of this offering will be fully paid and non-assessable. PREFERRED STOCK Immediately after consummation of this offering, the Board of Directors will have the authority, without further action by the stockholders, to issue up to 10,000,000 shares of preferred stock in one or more series, to establish from time to time the number of shares to be included in each such series, to fix the rights, preferences and privileges of the shares of each wholly unissued series and any qualifications, limitations or restrictions thereon, and to increase or decrease the number of shares of any such series (but not below the number of shares of such series then outstanding). The Board of Directors may authorize the issuance of preferred stock with voting or conversion rights that could adversely affect the voting power or other rights of the holders of the common stock. Although we have no present intention to issue shares of preferred stock, any such issuance, while providing flexibility in connection with possible acquisitions and other corporate purposes, could, among other things, have the effect of delaying, deferring or preventing a change in control of SEVEN and may adversely affect the trading price of the common stock and the voting and other rights of the holders of common stock. WARRANTS In August 2003, we issued a warrant to purchase 60,000 shares of our common stock with an exercise price of $4.00 per share. This warrant expires upon the closing of this offering. REGISTRATION RIGHTS The holders of 27,611,064 shares of common stock, or the registrable securities, are entitled to have their shares registered by us under the Securities Act under the terms of an agreement between us and the holders of these registrable securities. Subject to limitations specified in the agreement, these registration rights include the following: The holders of at least 2,500,000 of the then outstanding registrable securities may require, on three occasions beginning six months after the date of this prospectus, that we use our reasonable efforts to register the registrable securities for public resale. If we register any common stock, either for our own account or for the account of other security holders, the holders of registrable securities (including an additional 5,535,000 shares held by some of our present and former officers and other common holders) are entitled to include their shares of common stock in the registration, subject to the ability of the underwriters to limit the number of shares included in the offering in view of market conditions. The holders or any holder of the then outstanding registrable securities may require us to use our reasonable efforts to register all or a portion of their registrable securities on Form S-3 when use of that form becomes available to us, provided that the proposed aggregate selling price is at least $1,000,000. Table of Contents Description of capital stock We will bear all registration expenses other than underwriting discounts and commissions. All registration rights terminate on the date three years following the closing of this offering, or, with respect to each individual holder, such earlier time at which all registrable securities held by the holder (and any affiliate of the holder with whom such holder must aggregate its sales under Rule 144) can be sold each day of any three-month period without registration in compliance with Rule 144. DELAWARE ANTI-TAKEOVER LAW AND OUR CERTIFICATE OF INCORPORATION AND BYLAW PROVISIONS Provisions of Delaware law and our certificate of incorporation and bylaws could make more difficult our acquisition by a third party and the removal of our incumbent officers and directors. These provisions, summarized below, are expected to discourage coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of SEVEN to first negotiate with us. We believe that the benefits of increased protection of our ability to negotiate with the proponent of an unfriendly or unsolicited acquisition proposal outweigh the disadvantages of discouraging such proposals because, among other things, negotiation could result in an improvement of their terms. We are subject to Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions. In general, Section 203 prohibits a Delaware corporation from engaging in a business combination with an interested stockholder for a period of three years following the date the person became an interested stockholder, unless: the board of directors approved the transaction in which such stockholder became an interested stockholder prior to the date the interested stockholder attained such status; upon consummation of the transaction that resulted in the stockholder s becoming an interested stockholder, he or she owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding shares owned by persons who are directors and also officers; or on or subsequent to such date the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders. A business combination generally includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. In general, an interested stockholder is a person who, together with affiliates and associates, owns, or within three years prior to the determination of interested stockholder status, did own, 15% or more of a corporation s voting stock. Our amended and restated certificate of incorporation and bylaws to be filed upon the closing of this offering do not provide for the right of stockholders to act by written consent without a meeting or for cumulative voting in the election of directors. In addition, our amended and restated bylaws to be filed upon the closing of this offering provide that special meetings of the stockholders can only be called by the chairman of the board, the chief executive officer or the board of directors. Our Certificate of Incorporation to be in effect following the offering provides for the board of directors to be divided into three classes, each with staggered three-year terms. As a result, only one class of directors will be elected at each annual meeting of stockholders, and each of the two other classes of directors will continue to serve for the remainder of its respective three-year term. These provisions, which require the vote of stockholders holding at least a majority of the outstanding common stock to amend, may have the effect of deterring hostile takeovers or delaying changes in our management. Table of Contents Description of capital stock CLASSIFIED BOARD Immediately after the closing of this offering, our amended and restated certificate of incorporation will provide for a classified board of directors consisting of three classes of directors, each serving a staggered three-year term. The classification of our board of directors may have the effect of delaying or preventing changes in control of our company. See Management Classified Board. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock is EquiServe. Table of Contents Shares eligible for future sale Prior to this offering, there has been no public market for our common stock. Sales of substantial amounts of our common stock in the public market, or the perception that such sales may occur, could adversely affect the prevailing trading price of our common stock and could impair our ability to raise equity capital in the future. Upon completion of the offering, shares of our common stock will be outstanding, assuming no exercise of options and warrants outstanding as of March 31, 2004 and the conversion of all outstanding shares of preferred stock. Of these shares, the shares sold in this offering will be freely tradable without restrictions or further registration under the Securities Act, unless one of our existing affiliates as that term is defined in Rule 144 under the Securities Act purchases such shares. The remaining shares of our common stock held by existing stockholders are restricted shares or are restricted by the contractual provisions described below. Restricted shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144, 144(k) or 701 of the Securities Act, which are summarized below. Of these restricted shares, shares will be available for resale in the public market in reliance on Rule 144(k), of which shares are restricted by the terms of the lock-up agreements described below. An additional shares will be available for resale in the public market in reliance on Rule 144, of which shares are restricted by the terms of the lock-up agreements. The remaining shares become eligible for resale in the public market at various dates thereafter, all of which shares are restricted by the terms of the lock-up agreements. The table below sets forth the approximate number of shares eligible for future sale: Days after Date of this Prospectus Approximate Additional Number of Shares Becoming Eligible for Future Sale Comment On Effectiveness Freely tradable shares sold in offering; shares salable under Rule 144(k) that are not locked up 90 Days Shares eligible on effectiveness; vested options for shares salable under Rule 144 and 701 that are not locked up 180 Days Lock-up released; shares and vested options for shares salable under Rule 144, 144(k) and 701 Thereafter Restricted securities held for 1 year or less LOCK-UP AGREEMENTS Except for sales of common stock to the underwriters in accordance with the terms of the underwriting agreement, we and our executive officers, directors and substantially all of our stockholders and optionholders have agreed not to sell or otherwise dispose of, directly or indirectly, any shares of our common stock (or any security convertible into or exchangeable or exercisable for common stock) without the prior written consent of UBS Securities LLC for a period of 180 days from the date of this prospectus. In addition, for a period of 180 days from the date of this prospectus, except as required by law, we have agreed that our board of directors will not consent to any offer for sale, sale or other disposition, or any transaction which is designed or could be expected to result in the disposition by any person, directly or indirectly, of any shares of our common stock without the prior written consent of UBS Securities LLC, in its sole discretion, at any time or from time to time and without notice, may release for sale in the public market all or any portion of the shares restricted by the terms of the lock-up agreements. Table of Contents Shares eligible for future sale RULE 144 Under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned restricted shares for at least one year and has complied with the requirements described below would be entitled to sell some of its shares within any three-month period. That number of shares cannot exceed the greater of one percent of the number of shares of our common stock then outstanding, which will equal approximately shares immediately after this offering, or the average weekly trading volume of our common stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a notice on Form 144 reporting the sale. Sales under Rule 144 are also restricted by manner of sale provisions, notice requirements and the availability of current public information about our company. Rule 144 also provides that our affiliates who are selling shares of our common stock that are not restricted shares must nonetheless comply with the same restrictions applicable to restricted shares with the exception of the holding period requirement. RULE 144(k) Under Rule 144(k), a person who is not deemed to have been one of our affiliates at any time during the 90 days preceding a sale and who has beneficially owned the shares proposed to be sold for at least two years is entitled to sell those shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Accordingly, unless otherwise restricted, these shares may be sold immediately upon the completion of this offering. RULE 701 Rule 701 provides that the shares of common stock acquired upon the exercise of currently outstanding options or other rights granted under our equity plans may be resold, to the extent not restricted by the terms of the lock-up agreements, by persons, other than affiliates, beginning 90 days after the date of this prospectus, restricted only by the manner of sale provisions of Rule 144, and by affiliates in accordance with Rule 144, without compliance with its one-year minimum holding period. As of March 31, 2004, shares will be available for resale in the public market in reliance on Rule 701, all of which shares are restricted by the terms of the lock-up agreements. As of March 31, 2004, our board of directors had authorized an aggregate of up to 9,735,140 shares of common stock for issuance under our existing equity plans. In addition, in April 2004 our board of directors authorized an additional 1,250,000 shares of common stock for issuance under our existing equity plans. As of March 31, 2004 options to purchase a total of 4,114,625 shares of common stock were outstanding, all of which options are exercisable but restricted by our right to repurchase unvested shares upon the termination of an optionee s business relationship with us. Of these options, shares are no longer restricted by our right of repurchase and will be eligible for sale, if not restricted by the terms of the lock-up agreements, in the public market in accordance with Rule 701 under the Securities Act beginning 90 days after the date of this prospectus. All of the shares issuable upon exercise of these options are restricted by the terms of the lock-up agreements. We intend to file one or more registration statements on Form S-8 under the Securities Act following this offering to register all shares of our common stock which have been issued or are issuable upon exercise of outstanding stock options or other rights granted under our equity plans. These registration statements are expected to become effective upon filing. Shares covered by these registration statements will thereupon be eligible for sale in the public market, upon the expiration or release from the terms of the lock-up agreements, to the extent applicable, or subject in certain cases to vesting of such shares. Table of Contents United States federal income tax consequences to non-United States holders The following is a summary of the material United States federal income tax consequences of the ownership and disposition of our common stock to non-United States holders (as described below), but does not purport to be a complete analysis of all the potential tax considerations relating thereto. This discussion does not address tax consequences of the purchase, ownership, or disposition of the common stock to holders of the common stock other than those holders who acquired their beneficial ownership in the common stock in this offering. This summary is based upon the provisions of the Internal Revenue Code of 1986, as amended, or the Code, Treasury regulations promulgated thereunder, administrative rulings and judicial decisions, all as of the date hereof. These authorities may be changed, possibly retroactively, so as to result in United States federal income tax consequences different from those set forth below. We have not sought any ruling from the Internal Revenue Service, or IRS, with respect to the statements made and the conclusions reached in the following summary, and there can be no assurance that the IRS will agree with such statements and conclusions. This summary also does not address estate tax considerations or the tax considerations arising under the laws of any foreign, state, local or other tax jurisdiction. In addition, except where noted this discussion addresses only those holders who hold the common stock as capital assets and does not address tax considerations applicable to an investor s particular circumstances or to investors that may be subject to special tax rules, including, without limitation: banks, insurance companies, or other financial institutions; persons subject to the alternative minimum tax; tax-exempt organizations or government entities; brokers or dealers in securities or currencies; traders in securities that elect to use a mark-to-market method of accounting for their securities holdings; persons that own, or are deemed to own, more than five percent of our Company; certain former citizens or long-term residents of the United States; certain foreign entities that are owned by U.S. persons, including controlled foreign corporations, passive foreign investment companies, and foreign personal holding companies ; persons who hold our common stock as a position in a hedging transaction, straddle, conversion transaction or other risk reduction transaction; persons deemed to sell our common stock under the constructive sale provisions of the Code; or persons who hold our common stock through partnerships or entities taxable as partnerships. In addition, if a partnership holds our common stock, the tax treatment of a partner generally will depend on the status of the partner and upon the activities of the partnership. Accordingly, partnerships which hold our common stock and partners in such partnerships should consult their tax advisors. YOU ARE URGED TO CONSULT YOUR TAX ADVISOR WITH RESPECT TO THE APPLICATION OF THE UNITED STATES FEDERAL INCOME TAX LAWS TO YOUR PARTICULAR SITUATION, AS WELL AS ANY TAX CONSEQUENCES OF THE PURCHASE, Table of Contents United States federal income tax consequences to non-United States holders OWNERSHIP AND DISPOSITION OF OUR COMMON STOCK ARISING UNDER THE UNITED STATES FEDERAL ESTATE OR GIFT TAX RULES OR UNDER THE LAWS OF ANY STATE, LOCAL, FOREIGN OR OTHER TAXING JURISDICTION OR UNDER ANY APPLICABLE TAX TREATY. NON-UNITED STATES HOLDER DEFINED For purposes of this discussion, you are a non-United States holder if you are a holder that, for United States federal income tax purposes, is not a United States person. For purposes of this discussion, you are a United States person if you are: an individual citizen or resident of the United States; a corporation or other entity taxable as a corporation created or organized in the United States or under the laws of the United States or any political subdivision thereof; an estate whose income is subject to United States federal income tax regardless of its source; or a trust (1) whose administration is subject to the primary supervision of a United States court and which has one or more United States persons who have the authority to control all substantial decisions of the trust or (2) which has made an election to be treated as a United States person. DISTRIBUTIONS We have not made any distributions on our common stock, and we do not plan to make any distributions for the foreseeable future. However, if we do make distributions on our common stock, those payments will constitute dividends for United States tax purposes to the extent paid from our current or accumulated earnings and profits, as determined under United States federal income tax principles. To the extent those distributions exceed our current and accumulated earnings and profits, they will constitute a return of capital and will first reduce your basis in our common stock, but not below zero, and then will be treated as gain from the sale of stock. Subject to the discussion below under Income or Gain Effectively Connected with a U.S. Trade or Business, any dividend paid to you generally will be subject to United States withholding tax either at a rate of 30% of the gross amount of the dividend or such lower rate as may be specified by an applicable tax treaty. In order to receive a reduced treaty rate, you must provide us with an IRS Form W-8BEN or other appropriate version of IRS Form W-8 certifying qualification for the reduced rate. If a non-United States holder holds the common stock through a foreign intermediary, a reduced rate of withholding may be obtained if the foreign intermediary provides a properly executed IRS Form W-8IMY, stating that such holder of the common stock is holding the common stock on behalf of non-United States holders and attaching properly executed IRS Form W-8BENs of such non-United States holders (unless such intermediary is a qualified intermediary) to the Form W-8IMY. In all situations, the applicable form must be delivered pursuant to applicable procedures and must be promptly transmitted to the U.S. paying/withholding agent. If you are eligible for a reduced rate of withholding tax pursuant to a tax treaty, you may obtain a refund of any excess amounts currently withheld if you file an appropriate claim for refund with the IRS. Table of Contents United States federal income tax consequences to non-United States holders GAIN ON DISPOSITION OF COMMON STOCK You generally will not be required to pay United States federal income tax on any gain realized upon the sale or other disposition of our common stock unless: the gain is effectively connected with your conduct of a United States trade or business (or if a tax treaty applies, such gain is attributable to a permanent establishment of the non-United States holder) (in either case, see the discussion below under Income or Gain Effectively Connected with a U.S. Trade or Business); you are an individual who holds our common stock as a capital asset (generally, an asset held for investment purposes) and who is present in the United States for a period or periods aggregating 183 days or more during the calendar year in which the sale or disposition occurs and certain other conditions are met; or our common stock constitutes a United States real property interest by reason of our status as a United States real property holding corporation for United States federal income tax purposes at any time within the shorter of the five-year period preceding the disposition or your holding period for our common stock. Unless an applicable treaty provides otherwise, if you are an individual non-United States holder described in the second arrow above, you will be required to pay a flat 30% tax on the gain derived from the sale, which tax may be offset by United States source capital losses (even though you are not considered a resident of the United States). With respect to the third arrow above, a U.S. real property holding corporation is defined to include any U.S. corporation if, at any time during the applicable time set forth in the third bullet, the fair market value of the U.S. real property interests (USRPIs) it owns equals or exceeds 50% of the sum of the U.S. corporation s (1) business assets, (2) USRPIs, and (3) foreign real property interests. Notwithstanding this fact, if any class of stock of a U.S. corporation is regularly traded on an established securities market, stock of such class shall not be treated as a U.S. real property holding corporation unless the non-United States holder beneficially owns, actually as well as through constructive attribution, more than 5% of such class of stock at any time within a five-year period preceding the disposition or the non-United States holder s holding period, whichever period is shorter. Our common stock will be treated as regularly traded on an established securities market during any period in which it is listed on a registered securities exchange or any over-the-counter market, including the Nasdaq National Market. INCOME OR GAIN EFFECTIVELY CONNECTED WITH A U.S. TRADE OR BUSINESS If a non-United States holder is engaged in a trade or business in the U.S. (for this purpose a non-United States holder will be deemed to be engaged in a trade or business in the U.S. and be deemed to receive income effectively connected with that trade or business if it sells stock that constitutes a United States real property interest as described above or receives dividends on stock that constitutes a United States real property interest) and if dividends on the common stock or gain realized on the sale or other disposition of the common stock is effectively connected with the non-United States holder s conduct of such trade or business (and, if an applicable tax treaty requires, is attributable to a U.S. permanent establishment maintained by the non-United States holder in the United States), the non-United States holder will generally be subject to U.S. federal income tax on such dividends or gain on a net income basis in the same manner as if it were a U.S. taxpayer, although the non-United States holder will be exempt from U.S. withholding tax if it delivers, pursuant to applicable procedures, a properly executed IRS Form W-8ECI to the U.S. paying/withholding agent. In addition, if such non-United States holder is a foreign corporation, it may be subject to a branch profits tax equal to 30% (or such lower rate Table of Contents United States federal income tax consequences to non-United States holders provided by an applicable U.S. income tax treaty) of a portion of its effectively connected earnings and profits for the taxable year. BACKUP WITHHOLDING AND INFORMATION REPORTING Generally, we must report annually to the IRS the amount of dividends paid to you, your name and address, and the amount of tax withheld, if any. A similar report is sent to you. Pursuant to tax treaties or other agreements, the IRS may make its reports available to tax authorities in your country of residence. Payments of dividends or of proceeds on the disposition of stock made to you may be subject to information reporting and backup withholding unless you establish an exemption, for example by properly certifying your non-United States status on a IRS Form W-8BEN or another appropriate version of IRS Form W-8. Notwithstanding the foregoing, backup withholding and information reporting may apply if either we or our paying agent has actual knowledge, or reason to know, that you are a United States person. Backup withholding is currently imposed at a rate of 28%; however, it is not an additional tax. Rather, the United States income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund or credit may be obtained, provided that the required information is furnished to the IRS. Table of Contents Underwriting We and the selling stockholders are offering the shares of our common stock described in this prospectus through the underwriters named below. UBS Securities LLC and Needham & Company, Inc. are the representatives of the underwriters. We and the selling stockholders have entered into an underwriting agreement with the representatives. Subject to the terms and conditions of the underwriting agreement, each of the underwriters has severally agreed to purchase, the number of shares of common stock listed next to its name in the following table: Underwriters Number of Shares UBS Securities LLC Needham & Company, Inc Total The underwriting agreement provides that the underwriters must buy all of the shares if they buy any of them. However, the underwriters are not required to take or pay for the shares covered by the underwriters over-allotment option described below. Our common stock and the common stock of the selling stockholders is offered subject to a number of conditions, including: receipt and acceptance of our common stock by the underwriters, and the underwriters right to reject orders in whole or in part. We have been advised by the representatives that the underwriters intend to make a market in our common stock, but that they are not obligated to do so and may discontinue making a market at any time without notice. In connection with this offering, certain of the underwriters or securities dealers may distribute prospectuses electronically. OVER-ALLOTMENT OPTION The selling stockholders have granted the underwriters an option to buy up to additional shares of our common stock. The underwriters may exercise this option solely for the purpose of covering over-allotments, if any, made in connection with this offering. The underwriters have 30 days from the date of this prospectus to exercise this option. If the underwriters exercise this option, they will each purchase additional shares approximately in proportion to the amounts specified in the table above. COMMISSIONS AND DISCOUNTS Shares sold by the underwriters to the public will initially be offered at the initial offering price set forth on the cover of this prospectus. Any shares sold by the underwriters to securities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any of these securities dealers may resell any shares purchased from the underwriters to other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial public offering price, the representatives may change the offering price and the other selling terms. Sales of Table of Contents Underwriting shares made outside of the United States may be made by affiliates of the underwriters. Upon execution of the underwriting agreement, the underwriters will be obligated to purchase the shares at the prices and upon the terms stated therein, and, as a result, will thereafter bear any risk associated with changing the offering price to the public or other selling terms. The underwriters have informed us that they do not expect discretionary sales to exceed % of the shares of common stock to be offered. The following table shows the per share and total underwriting discounts and commissions we will pay to the underwriters assuming both no exercise and full exercise of the underwriters option to purchase up to an additional shares. Paid by us Paid by Selling Stockholders Total No Exercise Full Exercise No Exercise Full Exercise No Exercise Full Exercise Per Share $ $ $ $ $ $ Total $ $ $ $ $ $ We estimate that the total expenses of this offering payable by us, not including the underwriting discounts and commissions, will be approximately $ million. NO SALES OF SIMILAR SECURITIES We, our executive officers and directors and substantially all of our existing stockholders have entered into lock-up agreements with the underwriters. Under these agreements, we and each of these persons may not, without the prior written approval of UBS Securities LLC, offer, sell, contact to sell or otherwise dispose of or hedge our common stock or securities convertible into or exchangeable for our common stock. These restrictions will be in effect for a period of 180 days after the date of this prospectus. At any time and without public notice, UBS Securities LLC may in their sole discretion, release all or some of the securities from these lock-up agreements. We and the selling stockholders have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act. If we are unable to provide this indemnification, we will contribute to payments the underwriters may be required to make in respect of those liabilities. NASDAQ NATIONAL MARKET QUOTATION We have applied to have our common stock approved for quotation on the Nasdaq National Market under the trading symbol SEVN. PRICE STABILIZATION AND SHORT POSITIONS In connection with this offering, the underwriters may engage in activities that stabilize, maintain or otherwise affect the price of our common stock including: stabilizing transactions; short sales; purchases to cover positions created by short sales; imposition of penalty bids; and syndicate covering transactions. Table of Contents Underwriting Stabilizing transactions consist of bids or purchases made for the purpose of preventing or retarding a decline in the trading price of our common stock while this offering is in progress. These transactions may also include making short sales of our common stock, which involves the sale by the underwriters of a greater number of shares of common stock than they are required to purchase in this offering, and purchasing shares of common stock on the open market to cover positions created by short sales. Short sales may be covered shorts, which are short positions in an amount not greater than the underwriters over allotment option referred to above, or may be naked shorts, which are short positions in excess of that amount. The underwriters may close out any covered short position by either exercising their over allotment option, in whole or in part, or by purchasing shares in the open market. In making this determination, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. Naked short sales are in excess of the over-allotment option. The underwriters must close out any naked short position, by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market that could adversely affect investors who purchased in this offering. The underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the underwriters a portion of the underwriting discount received by it because the representatives have repurchased shares sold by or for the account of that underwriter in stabilizing or short covering transactions. As a result of these activities, the price of our common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriters at any time. The underwriters may carry out these transactions on the Nasdaq National Market, in the over-the-counter market or otherwise. Prior to this offering, there has been no public market for our common stock. The initial public offering price will be determined by negotiation by us, the selling stockholders and the representatives of the underwriters. The principal factors to be considered in determining the initial public offering price include: the information set forth in this prospectus and otherwise available to representatives; our history and prospects, and the history and prospects of the industry in which we compete; our past and present financial performance and an assessment of our management; our prospects for future earnings, the present state of our development; the general condition of the securities markets at the time of this offering; the recent trading prices of, and demand for, public traded common stock of generally comparable companies; and other factors deemed relevant by the underwriters and us. The underwriters and their affiliates have provided and may provide certain commercial banking, financial advisory and investment banking services for us for which they receive customary fees. The underwriters and their affiliates may from time to time in the future engage in transactions with us and perform services for us in the ordinary course of their business. Table of Contents Legal matters Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP, Menlo Park, California, will pass upon the validity of the common stock offered by this prospectus. Members of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP participating in the consideration of legal matters related to the common stock offered by us in this offering are the beneficial owners of 214,939 shares of our common stock. Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California, will pass upon certain legal matters for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001156934_oasis_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001156934_oasis_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..cd072c14f034a8caf6801ce19a6b29a08bf0f42a --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001156934_oasis_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock we are offering will be passed upon for us by Hale and Dorr LLP, Boston, Massachusetts. Legal matters in connection with this offering will be passed upon for the underwriters by Testa, Hurwitz & Thibeault, LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001162461_cutera-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001162461_cutera-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ff74887c73893c3c64e9d9441c4973a17bf6a161 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001162461_cutera-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby has been passed upon for Cutera by Wilson Sonsini Goodrich & Rosati, Palo Alto, California. Certain members of Wilson Sonsini Goodrich & Rosati, Palo Alto, California maintain beneficial ownership of 114,000 shares of our common stock. Latham & Watkins LLP, Menlo Park, California, is counsel for the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001163345_partners_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001163345_partners_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a1c1a958a4c685765e83a426f69af0b055645072 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001163345_partners_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters as to U.S. law in connection with this offering will be passed upon for us by Hogan & Hartson L.L.P., Washington, D.C. Certain legal matters in connection with this offering will be passed upon for the underwriters by Muldoon Murphy Faucette & Aguggia LLP, Washington, D.C. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001164050_radio_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001164050_radio_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001164050_radio_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001164056_diagnostic_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001164056_diagnostic_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001164056_diagnostic_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001169238_texas_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001169238_texas_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8db4114a441e5cc61ec53506df30135bfd3ec8be --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001169238_texas_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the validity of the shares of our common stock offered by this prospectus will be passed upon for by us by Bracewell Patterson, L.L.P., Houston, Texas. Certain legal matters with respect to the common stock offered by this prospectus will be passed upon for the underwriters by Lewis, Rice Fingersh, LC, St. Louis, Missouri. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001169749_morgan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001169749_morgan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ee02ca78391538fd179468950a6d626ea9d2ab34 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001169749_morgan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters in connection with the units being offered hereby, including the discussion of the material federal income tax considerations relating to the acquisition, ownership, and disposition of units, have been passed upon for each partnership and the general partner by Cadwalader, Wickersham & Taft LLP, 100 Maiden Lane, New York, New York 10038. Cadwalader, Wickersham & Taft LLP also has acted as counsel for Morgan Stanley DW in connection with the offering of units. Cadwalader, Wickersham & Taft LLP may advise the general partner with respect to its responsibilities as general partner of, and with respect to matters relating to, the partnerships. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001170593_primus_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001170593_primus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e11dc928824ea35025c0b8a7f998a3d0c39f5ccb --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001170593_primus_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the common shares offered by this prospectus and Bermuda tax consequences has been passed upon by Conyers Dill & Pearman, Hamilton, Bermuda, special Bermuda counsel to Primus Guaranty, Ltd. Morgan, Lewis & Bockius LLP, New York, New York, has passed upon the registration of the common shares offered by this prospectus under the Securities Act together with the United States tax matters related to this offering. Certain United States securities laws matters will be passed upon for the underwriters by Davis Polk & Wardwell, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001171032_bakers_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001171032_bakers_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3015f1e7b4311fa28b8ecfcf43a3db17e26ded3e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001171032_bakers_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby and certain legal matters in connection with the offering will be passed upon for us by Bryan Cave LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001172480_santarus_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001172480_santarus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b4e48657494174d9abd5d7c21713d02e77783cd1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001172480_santarus_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS" --> LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Latham Watkins LLP, San Diego, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by Sullivan Cromwell LLP, Los Angeles, California. As of the date of this prospectus, attorneys with Latham Watkins LLP own in the aggregate less than one percent of the outstanding shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001172754_maple_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001172754_maple_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001172754_maple_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001172755_b-g-foods_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001172755_b-g-foods_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001172755_b-g-foods_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001172758_bloch_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001172758_bloch_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001172758_bloch_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001172767_william_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001172767_william_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..706e3844992f309686b5d3f34fb5e734308d0a37 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001172767_william_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EISs and the shares of our Class A common stock and senior subordinated notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and Massachusetts subsidiary guarantors, will be passed upon for us by Dechert LLP, New York, New York. The validity of the issuance of the subsidiary guarantee by the Vermont subsidiary guarantor will be passed upon for us by Lisman, Webster, Kirkpatrick & Leckerling, P.C., Burlington, Vermont. Debevoise & Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001174527_citadel_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001174527_citadel_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..cff72897c02089a9c063d54e9f2220a7da0361e6 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001174527_citadel_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered by this prospectus will be passed upon for us by Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York. Fried, Frank, Harris, Shriver & Jacobson LLP has in the past provided, and may continue to provide, legal services to Forstmann Little & Co. and its affiliates. Leventhal, Senter & Lerman P.L.L.C., Washington, D.C., will pass upon legal matters regarding FCC issues for Citadel. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001174620_celerity_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001174620_celerity_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b4814f6bf1d568b89438f9fa33ff98bc543199d8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001174620_celerity_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fenwick West LLP, Mountain View, California, will pass upon the validity of the issuance of the shares of common stock offered by this prospectus. Wilson Sonsini Goodrich Rosati, Professional Corporation, Palo Alto, California is acting as counsel to the underwriters in connection with the offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001174874_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001174874_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001174874_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175295_xyratex_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175295_xyratex_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41b8790957a17ddd0536ac9376bdae8fdecde2db --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175295_xyratex_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS 16 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175359_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175359_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175359_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175360_new_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175360_new_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175360_new_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175361_hadley_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175361_hadley_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175361_hadley_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175362_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175362_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175362_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175363_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175363_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175363_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175364_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175364_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175364_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175365_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175365_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175365_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175366_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175366_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175366_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175367_ocean_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175367_ocean_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175367_ocean_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175368_northern_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175368_northern_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175368_northern_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175369_northern_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175369_northern_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175369_northern_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175370_northern_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175370_northern_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175370_northern_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175371_katie-ann_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175371_katie-ann_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175371_katie-ann_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001175829_h-s_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001175829_h-s_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ad804c3dbb24bf5870e85773c6d997ff401671ce --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001175829_h-s_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Weil, Gotshal & Manges LLP, New York, New York has passed upon the validity of the registered securities on our behalf. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001177257_h-e_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001177257_h-e_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..86582fa6e9cf106098b94f60979ed3a0d866a1b8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001177257_h-e_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed on for us by Kirkland & Ellis LLP, New York, New York. Certain matters under Louisiana law will be passed upon by Taylor, Porter, Brooks & Phillips, LLP. Certain matters under Washington and Montana law will be passed upon by Garlington, Lohn & Robinson, LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001177258_h-e_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001177258_h-e_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..86582fa6e9cf106098b94f60979ed3a0d866a1b8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001177258_h-e_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed on for us by Kirkland & Ellis LLP, New York, New York. Certain matters under Louisiana law will be passed upon by Taylor, Porter, Brooks & Phillips, LLP. Certain matters under Washington and Montana law will be passed upon by Garlington, Lohn & Robinson, LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001177259_gne_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001177259_gne_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..86582fa6e9cf106098b94f60979ed3a0d866a1b8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001177259_gne_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed on for us by Kirkland & Ellis LLP, New York, New York. Certain matters under Louisiana law will be passed upon by Taylor, Porter, Brooks & Phillips, LLP. Certain matters under Washington and Montana law will be passed upon by Garlington, Lohn & Robinson, LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001177260_great_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001177260_great_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..86582fa6e9cf106098b94f60979ed3a0d866a1b8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001177260_great_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed on for us by Kirkland & Ellis LLP, New York, New York. Certain matters under Louisiana law will be passed upon by Taylor, Porter, Brooks & Phillips, LLP. Certain matters under Washington and Montana law will be passed upon by Garlington, Lohn & Robinson, LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001177317_noveon_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001177317_noveon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..41a53cd0cd69dd22f6d90ea21e10b60ef38fcd02 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001177317_noveon_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York. Latham & Watkins LLP, New York, New York will pass upon certain legal matters in connection with this offering for the underwriters. Fried, Frank, Harris, Shriver & Jacobson LLP has in the past provided, and may continue to provide, legal services to AEA Investors LLC and its affiliates. Fried, Frank, Harris, Shriver & Jacobson LLP, on behalf of its partners, is a limited partner in PMD Investors I LP, which indirectly owns an interest in our common stock. A partner of Fried, Frank, Harris, Shriver & Jacobson LLP, is a managing director and general counsel of AEA Investors LLC. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178056_palmsource_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178056_palmsource_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d26d784a77b424f2b6ec1089f8a9e2dfadf3a5b9 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178056_palmsource_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered will be passed upon for us by Howard, Rice, Nemerovski, Canady, Falk & Rabkin, A Professional Corporation, San Francisco, California. O Melveny & Myers LLP, Menlo Park, California, is acting as counsel for the underwriters in connection with selected legal matters relating to the shares of common stock offered by this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178347_ym_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178347_ym_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..69507eae58f882be38361797adb9e0dda91f856b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178347_ym_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters in connection with the offering of the common shares in the United States will be passed upon by Torys LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178519_distinctiv_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178519_distinctiv_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178519_distinctiv_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178521_home-town_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178521_home-town_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178521_home-town_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178522_ocb_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178522_ocb_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178522_ocb_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178523_ocb_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178523_ocb_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178523_ocb_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178586_415_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178586_415_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3a8d97c0ef98c514d422d88a993e11ea7756a153 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178586_415_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock and the notes offered hereby will be passed upon for our company by Day, Berry & Howard LLP, Stamford, CT 06901. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178587_415_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178587_415_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3a8d97c0ef98c514d422d88a993e11ea7756a153 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178587_415_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock and the notes offered hereby will be passed upon for our company by Day, Berry & Howard LLP, Stamford, CT 06901. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001178588_415_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001178588_415_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3a8d97c0ef98c514d422d88a993e11ea7756a153 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001178588_415_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock and the notes offered hereby will be passed upon for our company by Day, Berry & Howard LLP, Stamford, CT 06901. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001179755_endurance_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001179755_endurance_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5a869b3f69a681013072648f829e5b9ad30bdea4 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001179755_endurance_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York is representing us in connection with this offering. Skadden, Arps is also representing the Putnam Investors, which are selling shareholders in this offering. The validity under Bermuda law of the ordinary shares being offered will be passed upon by Appleby Spurling & Kempe, Hamilton, Bermuda. LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York, will act as counsel for the underwriters. LeBoeuf, Lamb, Greene & MacRae, L.L.P. has in the past performed, and continues to perform, legal services for us. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001182129_auxilium_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001182129_auxilium_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e5c53422d385760ad29b5b75e4d3efd3c081661 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001182129_auxilium_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the validity of the shares of common stock offered hereby will be passed upon for us by Morgan, Lewis & Bockius LLP, Philadelphia, Pennsylvania. Pillsbury Winthrop LLP, New York, New York, has acted as counsel for the underwriters in connection with certain legal matters related to this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001184172_tmm_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001184172_tmm_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a38e5392c7e8c9197d72d06f4e59a9d9c597a1b1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001184172_tmm_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Senior Secured Notes has been passed upon as to Mexican law by Haynes & Boone, S.C., as our Mexican counsel, Mexico City, Mexico, and as to New York law by Milbank, Tweed, Hadley & McCloy LLP, New York, New York, as our special U.S. counsel. Ortiz, Sainz y Erreguerena, S.C. has rendered an opinion regarding the Mexican tax consequences of the sale of the Notes referred to in "Material Mexican Federal Income Tax Considerations." \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001192305_lecg-corp_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001192305_lecg-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..acb6e617aebc5c2d11d20e150dea17baa3841908 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001192305_lecg-corp_legal_matters.txt @@ -0,0 +1,12861 @@ +LEGAL MATTERS + +We have a dispute with Navigant Consulting arising out of our management led buyout of certain of the assets and liabilities of LECG, Inc. In the management led buyout, +we acquired substantially all of the assets and assumed certain liabilities of LECG, Inc. pursuant to an asset purchase agreement dated +September 29, 2000. Under the asset purchase agreement up to $5.0 million of the purchase price was deferred contingent upon whether specific individuals listed on a schedule to the +asset purchase agreement had an employment, consulting, contracting or other relationship with us on September 29, 2001. + +Navigant +Consulting contends that it is entitled to a payment of approximately $4.9 million plus interest with respect to this contingent purchase price amount. We have advised Navigant +Consulting that a number of the individuals listed on the schedule to the asset purchase agreement did not have an employment, consulting, contracting or other relationship with us on +September 29, 2001. If Navigant Consulting initiates legal proceedings regarding this dispute, a decision against us could harm our financial results and financial position. + +In +June 2004, National Economic Research Associates, Inc., or NERA, and its parent company, Marsh & McLennan Companies, Inc., filed a complaint against us and one of our +experts in the Superior Court Department of the Trial Court Business Litigation Session, Suffolk County, Commonwealth of Massachusetts. This action arises out of our hiring of professionals in +March 2004 who were formerly employed by NERA in the United States and Europe. The complaint alleges that during and after his employment with NERA, this expert violated contractual commitments +and fiduciary duties to NERA. The complaint further alleges that we interfered with NERA's contractual relations and advantageous business relationship, misappropriated confidential business +information and goodwill, and engaged in unfair and deceptive trade practices. The complaint asks for unspecified damages and disgorgement of wrongful gain, invalidation of an indemnification +agreement provided to this expert by us and contains a demand for a jury trial. In August 2004, we served a motion to dismiss the complaint with respect to the breach of contract, tortious +interference with contractual relations and the unfair and deceptive trade practices counts, which motion the parties are currently briefing. We also filed our answer to the complaint. A decision +against us in this case could harm our financial results and financial position. + +Our +projects typically involve complex analysis and the exercise of professional judgment. Many of our engagements involve matters that could have a severe impact on the client's business, cause the +client to gain or lose significant amounts of money, or assist or prevent the client from pursuing desirable business opportunities. If a client questions the quality of our work, the client could +threaten or bring a lawsuit to recover damages against us. We carry professional liability insurance to cover most of these types of claims, but the policy limits and the breadth of coverage may be +inadequate to cover any particular claim or all claims plus the cost of legal defense. For example, we provide services on engagements in which the amounts in controversy or the impact on a client may +substantially + + 50 + + + +exceed the limits of our errors and omissions insurance coverage. If we are found to have professional liability with respect to work performed on such an engagement, we may not have sufficient +insurance to cover the entire liability. + +We +are a party to certain legal proceedings arising out of the ordinary course of business, the outcomes of which individually or in the aggregate, in the opinion of management, would not have a +material adverse effect on our business, financial position or results of operations. + +FACILITIES + +Our principal executive offices are located in a leased facility in Emeryville, California, consisting of approximately 41,000 square feet of office space, under an +8-year lease that expires in July 2010. This facility accommodates our principal administrative and finance operations. We also have a major office in Washington, D.C., where we +lease approximately 55,000 square feet of office space, under a 10-year lease that expires in May 2011, and a major office in London, where we lease approximately 17,000 square feet +of office space, under a 15-year lease that expires in March 2019. We occupy leased facilities in a total of 19 locations throughout the United States and in 10 locations in Canada, the United +Kingdom, Belgium, Spain, France, South Korea, Australia, New Zealand and Argentina. We do not own any real property. We believe that our leased facilities are adequate to meet our current needs and +that additional facilities are available for lease to meet future needs. + + 51 + + + + + + +Management + +EXECUTIVE OFFICERS AND DIRECTORS + +The following table sets forth our directors and executive officers. The table also sets forth their ages as of September 30, 2004. + +Name + + + +Age + + + +Position + + +David J. Teece + +56 + +Chairman of the Board of Directors + +David P. Kaplan + +49 + +President and Director + +John C. Burke + +66 + +Chief Financial Officer + +Gary S. Yellin + +53 + +Chief Accounting Officer + +J. Geoffrey Colton + +57 + +Director of Finance and Assistant Secretary + +Marvin A. Tenenbaum + +53 + +Vice President, General Counsel and Secretary + +Tina M. Bussone + +32 + +Director of Administration + +Michael R. Gaulke + +58 + +Director(1)(2) + +Michael J. Jeffery + +57 + +Director(1)(2)(3) + +William W. Liebeck + +49 + +Director(2)(3) + +Ruth M. Richardson + +53 + +Director(2)(3) + +David T. Scheffman + +60 + +Director + +William J. Spencer + +74 + +Director(1)(2) + +Walter H.A. Vandaele + +59 + +Director + +(1) Member of the Audit Committee. + + (2) Member of the Compensation Committee. + + (3) Member of the Corporate Governance Committee. + +David J. Teece co-founded our business in 1988. He has served as our Chairman of the Board of Directors from the +date of the management buyout of our business in September 2000. Dr. Teece served as the Chairman of LECG, Inc., our predecessor company, from its founding until it was acquired by Navigant +Consulting, Inc. in August 1998. Dr. Teece has performed economic, business and financial consulting services in the capacity of an expert for our firm since the inception of our business, and +he has been an economic, business and financial consultant for 30 years. Since 1982, Dr. Teece has been a Professor of Business Administration at the Haas School of Business at the University +of California at Berkeley, where since 1994 he has directed the Institute of Management, Innovation and Organization. Dr. Teece has had teaching and research positions at Stanford University +and Oxford University. He has authored over 150 publications in economics, business and technology strategy and has testified before Congress and government agencies on regulatory policy and +competition policy. Dr. Teece has a PhD in Economics from the University of Pennsylvania. He also serves on the board of directors of the Atlas Family of Mutual Funds, the Atlas Insurance +Trusts, Canterbury Limited and several other private entities. + +David P. Kaplan has served as our President and a member of the Board of Directors since September 2000. From August 1998 to August 2000, +Mr. Kaplan was employed by Navigant Consulting/LECG performing economic, business and financial consulting services. From 1985 to 1998, Mr. Kaplan was president of Capital Economics, an +economic consulting firm he helped establish. Mr. Kaplan specializes in antitrust economics, including the analysis of numerous mergers, damage assessment in intellectual property matters, +including, for example, those involving patents and trade secrets, and the analysis of damage issues related to general commercial litigation. He also is experienced in analyzing economic issues in +matters involving possible class certification. Mr. Kaplan has testified as an + + 52 + + + +economic expert in federal and state courts, before arbitration panels and before regulatory agencies including the Department of Justice, the Federal Trade Commission and the International Trade +Commission. Mr. Kaplan also has testified before Congress on antitrust and competitive policy issues. Mr. Kaplan has served as a consultant to the Federal Trade Commission (Bureau of +Economics), the Department of Justice and the Senate Judiciary Committee. He has published in the field of economics and teaches in the MBA program at Johns Hopkins University. He also has served as a +Lecturer in Economics at George Mason University. Mr. Kaplan has a BA and MA in Economics from The George Washington University and a JD from The George Washington University National Law +Center. + +John C. Burke has served as our Chief Financial Officer since January 2003. Prior to joining us, Mr. Burke served as the Chief Financial Officer and +Treasurer of Braun Consulting Inc. for approximately six years. Prior to his service at Braun Consulting, Mr. Burke served as a member of senior management of the public accounting firm of +Grant Thornton LLP for twenty years holding the positions of Chairman of the firm for three years and Chicago Area Managing Partner for seven years. He is a Certified Public Accountant and has a BS in +Accounting from the University of Notre Dame. + +Gary S. Yellin has served as our Chief Accounting Officer since January 2003. Prior to joining us as an employee, Mr. Yellin consulted for us in +a management capacity overseeing our accounting function from April 2002 through December 2002. Mr. Yellin performed similar duties in a consulting capacity for companies beginning in October +1997 through April 2002, as well as accounting litigation analysis from May 1999 through August 2002 with the law firm of Morrison & Foerster, LLP. Mr. Yellin has taught Accounting at +California State University at Hayward. He is a Certified Public Accountant and has a BA in Mathematics from the State University of New York at Binghamton and an MBA from California State University +at Hayward. + +J. Geoffrey Colton has served as our Director of Finance and Assistant Secretary since February 2003 and served as our Chief Financial Officer, Vice +President and Secretary from June 2000 until January 2003. Prior to joining us, Mr. Colton served as Chief Financial Officer of T.Y. Lin International from April 1998 until March 2000. +Mr. Colton also served as the Vice President of Finance for Kleinfelder, Inc. from October 1987 until March 1998. He has a BA in Political Science from San Francisco State University and an MBA +from Golden Gate University. + +Marvin A. Tenenbaum has served as our Secretary since February 2003 and our General Counsel and Vice President since January 2001. Prior to joining us, +Mr. Tenenbaum was of counsel at the law firm of Sachnoff & Weaver from March 2000 to January 2001. From August 1998 until January 2000, Mr. Tenenbaum was the General Counsel of +Operations at Navigant Consulting, Inc. and from October 1993 until August 1998, he was the General Counsel at Peterson Consulting LLC. Mr. Tenenbaum has a BA in Economics and a JD from +Northwestern University. + +Tina M. Bussone has served as our Director of Administration since April 2003. From September 2000 until this time, Ms. Bussone worked as our +Manager of Administrative Operations. From September +1999 until August 2000, she was a Regional Operations Manager at Navigant Consulting, Inc., and from August 1998 until September 1999, she was the Office Coordinator of our Washington, D.C. office. +Prior to joining us in August 1998, Ms. Bussone worked for a law firm in Washington, D.C. Ms. Bussone has a BS in Russian Area Studies from Georgetown University and a MBA from George +Washington University. + +Michael R. Gaulke has served on our Board of Directors since June 2003. Since June 1996, Mr. Gaulke has been the President and Chief Executive +Officer of Exponent, Inc. (formerly known as Failure Analysis Associates), a publicly traded consulting firm of engineers and scientists which is best known in the litigation support marketplace for +its expertise in products liability matters and for investigating accidents and failures. Mr. Gaulke has also served on the board of directors of Exponent, + + 53 + + + +Inc. since 1994. Mr. Gaulke is a member of the Board of Trustees of the Palo Alto Medical Foundation and a director of Cymer, Inc. He has a BS in Electrical Engineering from Oregon State +University and an MBA from the Stanford Graduate School of Business. + +Michael J. Jeffery has served on our Board of Directors since June 2003. Mr. Jeffery, presently retired, was the Treasurer and Head of the +Markets Division for the Western Hemisphere and a member of the senior executive committee of Standard Chartered Bank from 1994 until 2001. Prior to his service at Standard Chartered Bank, +Mr. Jeffery held senior executive financial and board of directors positions with Nikko Bank, Scandinavian Bank Group, and Finacorp SA New York. He has extensive, global experience in business +and financial management, trading, sales and administration, including past service on the board of directors of Banque Scandinave en Suisse, the Private Capital Group, Banco Scandinavian Sul America +and Scandinavian Pacific Limited. + +William W. Liebeck has served on our Board of Directors since September 2000. Mr. Liebeck has been a partner of Thoma Cressey Equity Partners, +Inc., a private equity investment firm, since June 1997. From June 1990 to July 1996, Mr. Liebeck was a partner at the private equity firm of Equivest Partners, Inc. Prior to that, he was a +partner at Golder Thoma & Co., also a private equity firm. Mr. Liebeck currently serves as a director of several private companies. He has a BA in Economics from the University of California at +Berkeley and an MBA from the Stanford Graduate School of Business. + +Ruth M. Richardson has served on our Board of Directors since September 2003. The Honourable Ruth Richardson has been an international strategic and +economic policy consultant since 1994. From 1990 to 1993, Ms. Richardson served as New Zealand's Minister of Finance. Miss Richardson was a member of the New Zealand Parliament from 1981 to +1994. She currently serves as a director of several private companies, including Jade Software Corporation. Ms. Richardson has also served as a member of the board of the Reserve Bank of New +Zealand from 1999 to February 2004. She has extensive, global experience in business and financial management, corporate governance, privatizations and public sector and social policy reforms. She has +lectured widely and has advised governments and governmental agencies throughout the world. She has an LLB in Law from Canterbury University in New Zealand. + +David T. Scheffman has served on our Board of Directors since September 2003 and previously served on our Board of Directors from September 2000 until +June 2001, when he joined the Federal Trade Commission as Director of the Bureau of Economics. Dr. Scheffman has also been an expert and consultant at LECG since September 2003 and was +previously employed as an expert and consultant with LECG from September 2000 until June 2001. From June 2001 until August 2003, Dr. Scheffman served as the Director of the Bureau of Economics +at the Federal Trade Commission, and he previously served in a number of positions in the Bureau of Economics at the Federal Trade Commission from 1979 through 1988, including serving as its Director +from 1985 through 1988. From August 1998 to September 2000, Dr. Scheffman was affiliated with LECG, through which he performed economic, business and financial consulting services. +Dr. Scheffman is an adjunct Professor at the Owen Graduate School of Management at Vanderbilt University. Dr. Scheffman has authored many articles and books in industrial organization +and antitrust economics, law and economics, and marketing and business strategy. Dr. Scheffman has a BA in Mathematics and Economics from the University of Minnesota and a PhD in Economics from +Massachusetts Institute of Technology. + +William J. Spencer has served on our Board of Directors since November 2002. He has been Chairman Emeritus of the International SEMATECH, a consortium +of twelve semiconductor manufacturing companies from seven countries, since November 2000. From October 1997 to October 2000, Dr. Spencer was Chairman of the Board of SEMATECH. He also served +as President and Chief + + 54 + + + +Executive Officer of SEMATECH from November 1990 to October 1997. Dr. Spencer is a director of Capital Group ICA, a privately held corporation, a member of the National Academy of Engineering, +a Fellow of the Institute of Electrical and Electronics Engineers and serves on many advisory groups. Dr. Spencer held teaching positions at the University of California at Berkeley and the +University of New Mexico. During 1997 and 1998, he was a member of the board of directors of LECG, Inc. prior to its acquisition by Navigant Consulting. Dr. Spencer has an MS in Mathematics and +a PhD in Physics from Kansas State University. + +Walter H.A. Vandaele has served on our Board of Directors since June 2001 and has been an expert with us since November 2000. From August 1998 to +October 2000, Dr. Vandaele was a Senior Vice President of PHB Hagler Bailly, Inc., a subsidiary of Hagler Bailly, Inc. Dr. Vandaele also performed economic, business and financial +consulting services at Putnam, Hayes & Bartlett, Inc. from June 1988 to August 1998. He has a Licentiaat in the Handels-en Financi le Wetenschappen from the University of Antwerp +(University Faculties Saint Ignatius) (Belgium), a Doctorandus in Economics, University of Tilburg (the Netherlands) and a PhD and an MBA from the Graduate School of Business, University of Chicago. + +BOARD OF DIRECTORS + +Our board of directors currently consists of nine members. + +There +are no family relationships among any of our directors and executive officers. + +BOARD COMMITTEES + +Our audit committee consists of Michael R. Gaulke, Michael J. Jeffery and William J. Spencer. The audit committee reviews and monitors our financial statements and internal +accounting procedures, selects independent accountants and consults with and reviews the services provided by our independent accountants. + +Our +compensation committee consists of Michael R. Gaulke, Michael J. Jeffery, William W. Liebeck, Ruth M. Richardson and William J. Spencer. The compensation committee determines +the compensation and benefits of our executive officers and administers our stock incentive plans and employee benefit plans. + +Our +corporate governance committee consists of Michael J. Jeffery, William W. Liebeck and Ruth M. Richardson. The corporate governance committee recommends prospective director +nominees to the board of directors for the next annual meeting of stockholders, develops and recommends to the board of directors governance principles applicable to us, oversees the evaluation of the +board of directors and management and recommends to the board of directors nominees for each committee. + +COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION + +Prior to establishing the compensation committee, the board of directors as a whole performed the functions delegated to the compensation committee. None of our executive +officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation +committee. + + 55 + + + +DIRECTOR COMPENSATION + +We reimburse our non-employee directors for their expenses incurred in connection with attending board and committee meetings, and these directors, except for +William W. Liebeck, receive a quarterly retainer of $4,000, an additional $2,000 for each regularly scheduled quarterly meeting of the board attended and $1,000 for each meeting of a committee +attended. In addition, each of these directors receives $1,000 for each special meeting of the board attended, and the chairperson of each committee receives an additional $1,000 for each committee +meeting attended. Each non-employee director who joins our board will receive a nondiscretionary, automatic grant of an option to purchase 15,625 shares of our common stock upon joining +our board. In addition, each non-employee director, other than William W. Liebeck, will receive a yearly nondiscretionary, automatic grant of an option to purchase 4,688 shares of +our common stock, which vest one year after grant, pursuant to our 2003 Stock Option Plan. Certain directors also act in an expert capacity for us and receive compensation for their work as experts. +See "Related party transactions." + +EXECUTIVE COMPENSATION + +The following table summarizes the compensation earned for services rendered to us in all capacities for the years indicated by our Chairman of the Board (acting in a capacity +similar to a chief executive officer) and our four other most highly paid executive officers whose salary and bonus exceeded $100,000 in 2003. These executives are referred to as the named executive +officers elsewhere in this prospectus: + +Summary compensation table + + + + + + + + + + + + + + +Long-term compensation + + + + + + + + + + + + +Annual + +compensation + + + + + + + + + + + + +Securities + +underlying options + + + +All other compensation + + + + +Name and principal position + + + +Year + + + +Salary + + + +Bonus + + + + + + +David J. Teece + +Chairman of the Board + +2003 + +2002 + +$200,000 + +125,000 + +$ + +354,840 + +100,000 + +46,875 + + + +$ + +1,850,385 + +1,508,607 +(1)(3) + +(1) + +David P. Kaplan + +President + +2003 + +2002 + +$200,000 + +125,000 + +$ + +354,840 + +100,000 + +46,875 + + + +$ + +2,236,336 + +2,451,058 +(1)(3) + +(1) + +Marvin A. Tenenbaum + +General Counsel, Vice President and Secretary + +2003 + +2002 + +$300,000 + +270,000 + +$ + +100,000 + +45,000 + +15,625 + + + + + + + + + +John C. Burke + +Chief Financial Officer + +2003 + +$240,545 + +$ +150,000 + +68,750 + + + + + +Gary S. Yellin + +Chief Accounting Officer + +2003 + +$190,000 + +$ +75,000 + +31,250 + +$ +13,625 +(2) + +(1) Represents amounts paid to the named executive officer in his or her capacity as an expert and for a percentage of the professional fees on projects secured by this +named executive officer, for services provided in the years indicated and prior periods, provided these services were billed and collected by us. (2) Represents fees +paid to Mr. Yellin in his capacity as a consultant. (3) Includes $50,000 for Dr. Teece and $25,000 for Mr. Kaplan for interest earned in 2003 for +deferred compensation payable to them. + + + 56 + + + +Option grants in last fiscal year + +The following table sets forth each grant of stock options granted to each named executive officer during 2003, including the potential realizable value over the +10-year term of the options, based on assumed rates of stock appreciation of 5% and 10%, compounded annually. These assumed rates of appreciation comply with the rules of the Securities +and Exchange Commission and do not represent our estimate of future stock price. Actual gains, if any, on stock option exercises depend on the future performance of our common stock. The assumed 5% +and 10% rates of stock appreciation are based on the closing price on December 31, 2003 of $22.89 per share. + + + + +Individual grants + + + + + + + + + + + + + +Percent of total options granted pursuant to option plan(1) + + + + + + + + + + + + + + + + + + + + + + + + + + +Potential realizable value at assumed annual rates of stock price appreciation + +for option term + + + + + + + + + +Exercise price per share + + + + + + + + +Number of securities underlying + +options granted + + + + + +Name + + + +Expiration date + + + +5% + + + +10% + + +David J. Teece + +46,875 + +5.27% + +$16.00 + +10/12/2013 + +$ +997,753 + +$ +2,033,005 + +David P. Kaplan + +46,875 + +5.27% + +$16.00 + +10/12/2013 + +$ +997,753 + +$ +2,033,005 + +Marvin A. Tenenbaum + +9,375 + +1.05% + +$16.00 + +2/14/2013 + +$ +199,551 + +$ +406,601 + + + +6,250 + +0.70% + +$16.00 + +10/12/2013 + +$ +133,034 + +$ +271,067 + +John C. Burke + +46,875 + +5.27% + +$16.00 + +1/31/2013 + +$ +997,753 + +$ +2,033,005 + + + +12,500 + +1.41% + +$16.00 + +10/12/2013 + +$ +266,067 + +$ +542,135 + + + +9,375 + +1.05% + +$20.65 + +11/24/2013 + +$ +155,863 + +$ +362,913 + +Gary S. Yellin + +15,625 + +1.76% + +$16.00 + +1/31/2013 + +$ +332,584 + +$ +677,668 + + + +15,625 + +1.76% + +$16.00 + +10/12/2013 + +$ +332,584 + +$ +677,668 + +(1) Percentages represent options granted to the named executive officers as a percent of all options granted pursuant to our 2000 Incentive Plan and 2003 Stock Option Plan +during fiscal 2003. + +In 2003, we granted options to purchase up to an aggregate of 888,923 shares to employees, directors and consultants. Other than option shares received by our +non-employee directors, option shares generally vest over four to eight years. + +Aggregate option exercises and option values + +The following table describes for the named executive officers the number and value of securities underlying exercisable and unexercisable options held by them as of +December 31, 2003. + +The +value realized is based on a fair value of the underlying stock at the time of exercise of $14.40 per share, less the per share exercise price, multiplied by the number of shares issued. The value +of unexercised in-the-money options at December 31, 2003 is based on the closing price at December 31, 2003 of $22.89 per share, less the per share exercise +price, multiplied by the number of shares + + 57 + + + +issuable. All options were granted under our 2000 Incentive Plan except for 9,375 options issued under our 2003 Stock Option Plan. + + + + + + + + + + +Number of securities + +underlying unexercised + +options at + +December 31, 2003 + + + + + + + + + + + + + + + + +Value of unexercised + +in-the-money options at + +December 31, 2003 + + + + + +Number of shares acquired on exercise + + + + + +Name + + + +Value realized + + + +Exercisable + + + +Unexercisable + + + +Exercisable + + + +Unexercisable + + +David J. Teece + +140,625 + +$1,593,000 + +468,750 + +46,875 + +$ +8,228,750 + +$322,875 + +David P. Kaplan + + + + + +577,148 + +55,664 + +$ +10,376,773 + +$497,039 + +Marvin A. Tenenbaum + + + + + +31,250 + +31,250 + +$ +619,250 + +$417,250 + +John C. Burke + + + + + +13,021 + +55,729 + +$ +89,688 + +$340,175 + +Gary S. Yellin + + + + + + + +31,250 + + + + +$215,250 + +EMPLOYMENT CONTRACTS AND SEVERANCE PAYMENTS + +David J. Teece is entitled to receive severance payments for a period of six months at a rate equal to his then current base salary in the event he is terminated without cause +pursuant to a senior management agreement with us. These severance payments may be extended by an additional six months in exchange for the extension of the non-competition covenants of +Dr. Teece for an additional six months. + +David +P. Kaplan is entitled to receive severance payments totaling $250,000 payable over twelve months in the event he is terminated without cause pursuant to a senior management agreement with us. +These senior management agreements are described in the section of this prospectus entitled "Related party transactions." + +John +C. Burke is entitled to receive severance payments for a period of four months at a rate equal to his then current base salary and prior year's bonus payable over four months in the event he is +terminated without cause pursuant to his employment offer letter with us. We must also provide Mr. Burke with 60 days prior written notice of any such termination without cause. + +BENEFIT PLANS + +2000 Incentive Plan + +Our 2000 Incentive Plan was adopted by our board of directors and our stockholders in September 2000. Our 2000 Incentive Plan provides for the grant of nonstatutory +stock options to our employees, directors and consultants. As of September 30, 2004, 755,953 shares of common stock had been issued pursuant to the exercise of options, and options to +purchase 3,975,473 shares were outstanding under the 2000 Incentive Plan. Following our initial public offering, the 2000 Incentive Plan terminated, and we do not grant any additional stock +options under our 2000 Incentive Plan. + + >Administration of the 2000 Incentive Plan. Our board of directors administers the +2000 Incentive Plan. The board of directors has the power to determine the terms of the options granted, including the exercise price, the number of shares subject to each option, the exercisability +of the options and the form of consideration payable upon exercise. + + >Exercisability of options following termination. After termination of one of our +employees, directors or consultants, he or she may exercise his or her option for the period of time stated in the option agreement. Generally, if termination is due to death or disability, the option +will remain + + 58 + + + +exercisable +for 12 months. In all other cases, the option will generally remain exercisable for 30 to 90 days. However, an option may never be exercised later than the expiration of its +ten-year term. + + >Effect of changes in capitalization. The number of shares of common stock +reserved under our 2000 Incentive Plan will be proportionately increased or decreased for any increase or decrease in the number of shares in any recapitalization, reclassification, split, +combination, dividend or other distribution payable in stock. + + >Adjustments upon a change of control. If a successor corporation refuses to +assume or substitute for outstanding options in a change of control, then the 2000 Incentive Plan provides that either all outstanding options shall immediately vest and become exercisable for a +period of 15 days preceding the change of control or the board of directors may elect, in its sole discretion, to cancel any outstanding options and cause us to pay the holder of such options +an amount in cash or securities equal to price paid to the holders of common stock in the change of control less the exercise price. + +2003 Stock Option Plan + +Our board of directors approved the 2003 Stock Option Plan in September 2003, and our stockholders approved the 2003 Stock Option Plan in November 2003. As of +September 30, 2004, no shares of common stock had been issued pursuant to the exercise of options, options to purchase 2,116,725 shares were outstanding, and 383,275 shares +were available for future grant under the 2003 Stock Option Plan. Our 2003 Stock Option Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal +Revenue Code of 1986, as amended, or the Code, to our employees, and for the grant of nonstatutory stock options and stock purchase rights to our employees, directors and consultants. + + >Number of shares of common stock available under the 2003 Stock Option Plan. Our +2003 Stock Option Plan provides for annual increases in the number of shares available for issuance under our 2003 Stock Option Plan on the first day of each fiscal year, beginning with our fiscal +year 2004, equal to the lesser of: + + >4% +of the outstanding shares of common stock on the first day of our fiscal year; + + >1,250,000 +shares; or + + >a +lesser amount as our board of directors may determine. + + >Administration of the 2003 Stock Option Plan. Our board of directors or a +committee of our board administers the 2003 Stock Option Plan. In the case of options intended to qualify as "performance-based compensation" within the meaning of Section 162(m) of the Code, +the committee will be our compensation committee. The administrator has the power to determine the terms of the options or stock purchase rights granted, including the exercise price, the number of +shares subject to each option or stock purchase right, the exercisability of the options and the form of consideration payable upon exercise. + + >Options. The administrator determines the exercise price of options granted under +the 2003 Stock Option Plan, but with respect to nonstatutory stock options intended to qualify as "performance-based compensation" within the meaning of Section 162(m) of the Code and all +incentive stock options, the exercise price must at least be equal to the fair market value of our common stock on the date of grant. The term of an incentive stock option may not exceed ten years, +except that with respect to any participant who owns 10% of the voting power of all classes of our outstanding capital stock, the term must not exceed five years and the exercise price must equal at +least 110% + + 59 + + + +of +the fair market value on the grant date. The administrator determines the term of all other options. + +No +optionee may be granted an option to purchase more than 1,000,000 shares in any fiscal year. In connection with his or her initial service, an optionee may be granted additional options to purchase +up to 1,000,000 shares. + +After +termination of one of our employees, directors or consultants, he or she may exercise his or her option for the period of time stated in the option agreement. Generally, if termination is due to +death or disability, the option will remain exercisable for 12 months. In all other cases, the option will generally remain exercisable for one to three months. However, an option may never be +exercised later than the expiration of its term. + + >Stock purchase rights. Stock purchase rights, which represent the right to +purchase our common stock, may be issued under our 2003 Stock Option Plan. The administrator determines the purchase price of stock purchase rights granted under our 2003 Stock Option Plan. Unless the +administrator determines otherwise, a restricted stock purchase agreement, an agreement between us and the recipient which governs the terms of stock purchase rights, will grant us a repurchase option +that we may exercise upon the termination of the purchaser's service with us for any reason, including death or disability. The purchase price for shares we repurchase will generally be the original +price paid by the purchaser and may be paid by cancellation of any indebtedness of the purchaser to us. The administrator determines the rate at which our repurchase option will lapse. + + >Transferability of options and stock purchase rights. Our 2003 Stock Option Plan +generally does not allow for the transfer of options or stock purchase rights, and only the optionee may exercise an option and stock purchase right during his or her lifetime. + + >Adjustments upon merger, asset sale or other change in control. Our 2003 Stock +Option Plan provides that in the event of our merger with or into another corporation, a sale of substantially all of our assets or other change of control (as defined in the 2003 Stock Option Plan), +the successor corporation will assume or substitute an equivalent option or right for each outstanding option or stock purchase right. If there is no assumption or substitution of outstanding options +or stock purchase rights, all options and stock purchase rights shall immediately vest and the administrator will provide notice to the optionee that he or she has the right to exercise the option or +stock purchase right as to all of the shares subject to the option or stock purchase right, including shares which would not otherwise be exercisable, for a period of 15 days from the date of +the notice. The option or stock purchase right will terminate upon the expiration of the 15-day period. + + >Amendment and termination of our 2003 Stock Option Plan. Our 2003 Stock Option +Plan will automatically terminate in 2013, unless we terminate it sooner. In addition, our board of directors has the authority to amend, suspend or terminate the 2003 Stock Option Plan provided it +does not adversely affect any option or stock purchase right previously granted under it. Amendments will be subject to stockholder approval to the extent required by law. + +2003 Employee Stock Purchase Plan + +Our board of directors approved the 2003 Employee Stock Purchase Plan in September 2003, and our stockholders approved the Purchase Plan in November 2003. A total of +950,000 shares of our common stock has been reserved for issuance under the purchase plan, 76,771 shares of which have been issued as of September 30, 2004. + + >Number of shares of common stock available under the 2003 Employee Stock Purchase +Plan. Our 2003 Employee Stock Purchase Plan provides for annual increases in the number of + + 60 + + + +shares +available for issuance under the 2003 Employee Stock Purchase Plan on the first day of each fiscal year, beginning with our fiscal year 2004, equal to the lesser of: + + >1.5% +of the outstanding shares of our common stock on the first day of the fiscal year; + + >500,000 +shares; or + + >a +lesser amount as our board of directors may determine. + + >Administration of the 2003 Employee Stock Purchase Plan. Our board of directors +or a committee of our board administers the 2003 Employee Stock Purchase Plan. Our board of directors or its committee has full and exclusive authority to interpret the terms of the 2003 Employee +Stock Purchase Plan and determine eligibility. + + >Eligibility to participate. All of our employees and employees of designated +subsidiaries are eligible to participate in the 2003 Employee Stock Purchase Plan if they are customarily employed for at least 20 hours per week and more than five months in any calendar year. +However, an employee may not be granted an option to purchase stock under the 2003 Employee Stock Purchase Plan if that employee: + + >immediately +after grant owns stock possessing 5% or more of the total combined voting power or value of all classes of our capital stock; or + + >accrues +rights to purchase stock under all of our employee stock purchase plans at a rate that exceeds $25,000 worth of stock for each calendar year. + + >Offering periods and contributions. Our 2003 Employee Stock Purchase Plan is +intended to qualify under Section 423 of the Code and contains consecutive, overlapping 24-month offering periods. Each offering period consists of four 6-month purchase +periods. The offering periods generally start on the first trading day on or after May 1 and November 1 of each year, except for the first such offering period which commenced on +November 14, 2003 and will end on the first trading day on or after November 1, 2005. + +Our +Employee Stock Purchase Plan permits participants to purchase common stock through payroll deductions of up to 15% of their eligible compensation which includes only a participant's base salary, +wages, commissions, shift premium and overtime but excludes all other compensation. A participant may purchase a maximum of 10,000 shares during a six-month purchase period. + + >Purchase of shares. Amounts deducted and accumulated by the participant are used +to purchase shares of our common stock at the end of each six-month purchase period. The price is 85% of the lower of the fair market value of our common stock at the beginning of an +offering period or on the last day of a purchase period. If the fair market value on the last day of a purchase period is less than the fair market value at the beginning of the offering period, +participants will be withdrawn from the current offering period following their purchase of shares on +the purchase date and will be automatically re-enrolled in a new offering period. Participants may end their participation at any time during an offering period, and will be returned their +payroll deductions to date. Participation ends automatically after termination of employment with us; however, a participant's accumulated payroll deductions at the time of termination will be used to +purchase shares on the next purchase date provided such purchase date is within three months of such participant's termination of employment. + + >Transferability of rights. A participant may not transfer rights granted under +the 2003 Employee Stock Purchase Plan other than by will, the laws of descent and distribution or as otherwise provided under the Purchase Plan. + + 61 + + + + >Adjustments upon merger or change in control. In the event of a merger with or +into another corporation or change in control, a successor corporation may assume or substitute each outstanding purchase option. If the successor corporation refuses to assume or substitute for the +outstanding purchase options, the offering periods then in progress will be shortened, and a new exercise date will be set. In this event, the administrator will provide notice of the new exercise +date to each participant at least 10 business days before the new exercise date. + + >Amendment and termination of the purchase plan. The administrator has the +authority to amend or terminate our 2003 Employee Stock Purchase Plan, except that, subject to certain exceptions described in the 2003 Employee Stock Purchase Plan, no action may adversely affect any +outstanding rights to purchase stock under our 2003 Employee Stock Purchase Plan. Amendments will be subject to stockholder approval to the extent required by law. + +401(k) Plan + +We maintain a 401(k) retirement savings plan. Each participant may contribute to the 401(k) Plan, through payroll deductions, up to a statutorily prescribed annual limit of +$13,000 in 2004, subject to statutory limitations imposed by the Internal Revenue Service. Through 2003, we generally matched contributions of participants up to $6,000 per year. All amounts +contributed by employee participants and earnings on these contributions are fully vested at all times. Employee participants may elect to invest their contributions in various established funds. + +Deferred Compensation Plan + +We have adopted a deferred compensation plan pursuant to which participants may elect to defer receipt of a portion of their cash or equity compensation. Under such a deferred +compensation plan, participants may defer a portion of their project origination fees, expert fees, base annual salaries, bonuses, qualifying stock option gains and/or other compensation. + +Deferred +amounts would be credited or debited based on the return of mutual funds made available under the deferred compensation plan and selected by the participant or in the context of deferred +qualifying stock option gains, deferred amounts would be credited or debited based on the return from our Stock Unit Fund. We do not match amounts that participants have elected to defer under the +deferred compensation plan. + +Deferred +payments, including amounts credited or debited, would generally be payable beginning: + + >upon +termination of service; + + >upon +death, payable to one or more designated beneficiaries; or + + >upon +retirement, as defined in the deferred compensation plan. + +Participants +whose employment is terminated ordinarily would receive their deferred payment in a lump sum, but the committee administering the deferred compensation plan may elect to pay such deferred +payments in annual installments for up to five years. In the case of terminations following a change of control of us, however, such participants would receive their deferred payments in a lump sum. +Beneficiaries of participants who die would receive their deferred payment in a lump sum. Participants who retire may elect to receive their deferred payment in a lump sum or in annual installments +for up to 15 years. + +Participants +may also elect to receive their deferred payments earlier through an in-service distribution, an elective withdrawal or a designated distribution, pursuant to the terms of the deferred +compensation plan. + + 62 + + + + + + +Related party transactions + +We describe below transactions and series of similar transactions, during our last three fiscal years, to which we were a party or will be a party, in which: + + >the +amounts involved exceeded or will exceed $60,000; and + + >a +director, executive officer, holder of more than 5% of our common stock or any member of their immediate family had or will have a direct or indirect material +interest. + +We +also describe below certain other transactions with our directors, executive officers and stockholders. + +GENERAL + +In our ordinary course of business, we enter into transactions with some of our directors and officers. We believe that each of these transactions has been on terms no less +favorable for us than we could have obtained in a transaction with an independent third party. + +EXPERT AND SENIOR MANAGEMENT AGREEMENTS + +We are party to expert agreements with Walter H.A. Vandaele, a director, David T. Scheffman, a director, David J. Teece, our Chairman of the Board of +Directors, and David P. Kaplan, a director and our President. These agreements are terminable at will by either party and do not contain restrictions on competition after termination. Pursuant +to these agreements, these experts provide expert services on our behalf in consideration for a cash payment generally equal to the sum of the amount of fees collected by us for the hours billed by +this person and a percentage (up to 14%) of staff fees collected by us on projects secured by this person. We are also required to pay to Mr. Kaplan $58,333 per month, and collected fees for +billings and projects secured by Mr. Kaplan will be deducted against this amount; we are required to pay to Dr. Vandaele $41,666 per month, and collected fees for billings and projects +secured by Dr. Vandaele are deducted against this amount; and we are required to pay Dr. Scheffman $20,000 per month, and collected fees for billings and projects secured by +Dr. Scheffman are deducted against this amount. In addition, Dr. Scheffman received a $1.0 million sign-on bonus that was paid in two installments in September 2003 and +February 2004. + +In +September 2000, we entered into a senior management agreement with David J. Teece, our Chairman of the Board of Directors, providing for among other things, Dr. Teece's compensation +as an expert and our Chairman of the Board of Directors. Dr. Teece's base annualized salary as our Chairman of the Board of Directors was $175,000 for the six month period starting +January 1, 2003 and ending June 30, 2003 and increased to $225,000 for the six month period starting July 1, 2003 and ending December 31, 2003. Effective January 1, +2004, Dr. Teece's annual salary is $225,000. In addition, Dr. Teece met the criteria for a performance bonus of $354,840 based on LECG achieving specified revenue and earnings before +equity-based compensation charges, interest, taxes, depreciation and amortization, or Adjusted EBITDA, targets for 2003. Dr. Teece's agreement recognizes that his time availability and +commitment to us must accommodate his position as a part-time faculty member at the University of California at Berkeley, and the University's regulations regarding conflict of commitment. +Dr. Teece is not required to spend more than 50% of his business or professional time on our affairs or provide services on engagements. In addition, Dr. Teece is entitled to $500,000 +related to services he rendered in connection with our September 29, 2000 management buyout. Such amount has been earned by Dr. Teece and is not contingent on his continued employment with +LECG. Accordingly, $500,000 was expensed in the fiscal period ended December 31, 2000. Such amount was + + 63 + + + +paid in February 2004, as the criteria of achieving at least $20.0 million of Adjusted EBITDA in any fiscal year was met in 2003. The $500,000 due to Dr. Teece had been accruing interest at a +rate of +10% per year since September 29, 2000 until paid. We are obligated to provide him with two executive assistants at our expense. The senior management agreement does not have a specified term and is +terminable at will. + +If +Dr. Teece's services as the Chairman of the Board of Directors are terminated by us without cause, Dr. Teece will be entitled to severance payments for a six-month period following +termination at his then annual base salary rate, which period may be extended by an additional six months in exchange for a six-month extension of the non-competition covenants of Dr. Teece. +Dr. Teece is generally prohibited from managing or controlling a competitive business to ours that has annual revenues greater than $5.0 million during the twelve-month period following his +termination, which period is reduced to six months in the event he is terminated by us without cause; however, Dr. Teece may act as an expert in a non-managerial control position. In addition, +Dr. Teece is prohibited from soliciting certain of our clients and staff during the twelve-month period following his termination. + +In +September 2000, we entered into a senior management agreement with David P. Kaplan, our President. In September 2003, we entered into an amended and restated senior management agreement with +Mr. Kaplan, providing for among other things, Mr. Kaplan's compensation as an expert, as previously described, and as our President. Mr. Kaplan's base annualized salary as our +President was $175,000 for the six-month period starting January 1, 2003 and ending June 30, 2003 and increased to $225,000 for the six-month period starting July 1, 2003 and ending December +31, 2003. Effective January 1, 2004, Mr. Kaplan's annual salary is $225,000. In addition, Mr. Kaplan met the criteria for a performance bonuses of $354,840 based on LECG achieving +specified Adjusted EBITDA targets for 2003. In addition, Mr. Kaplan is entitled to $250,000 related to services he rendered in connection with our September 29, 2000 management buyout. +Such amount has been earned by Mr. Kaplan and is not contingent on his continued employment with LECG. Accordingly, $250,000 was expensed in the fiscal period ended December 31, 2000. +Such amount was paid in February 2004, as the criteria of achieving at least $20.0 million of Adjusted EBITDA in any fiscal year was met in 2003. The $250,000 due to Mr. Kaplan had been +accruing interest at a rate of 10% per year since September 29, 2000 until paid. Mr. Kaplan is also eligible for benefits generally available to our other executive and managerial +employees, and we are obligated to provide him with one executive assistant at our expense. The senior management agreement does not have a specified term and is terminable at will. If +Mr. Kaplan's services as the President are terminated by us without cause, Mr. Kaplan will be entitled to severance payments totaling $250,000 payable over a 12-month period following +termination. Mr. Kaplan is generally prohibited from managing or controlling a competitive business to ours that has annual revenues greater than $5.0 million during the twelve-month period +following his termination; however, Mr. Kaplan may act as an expert in a non-managerial control position. In addition, Mr. Kaplan is prohibited from soliciting certain of our clients and +staff during the twelve-month period following his termination. + +Pursuant +to their respective agreements, during 2001, we paid Dr. Teece, Mr. Kaplan and Dr. Vandaele, each of whom is a director and in the case of Dr. Teece and +Mr. Kaplan, executive officers, $2,329,172, $1,832,146, and $1,224,263, respectively, for expert services and project origination fees. During 2002, we paid Dr. Teece, Mr. Kaplan +and Dr. Vandaele, $1,508,607, $2,451,058 and $2,068,500 respectively, pursuant to these agreements for expert services and project origination fees. During 2003, we paid Dr. Teece, +Mr. Kaplan, Dr. Vandaele and Dr. Scheffman, one of our directors, $1,800,385, $2,211,336, $1,647,026 and $191,308, respectively, for expert services and project origination fees. + + 64 + + + +OTHER AGREEMENTS + +Pursuant to an agreement with David Teece, our Chairman of the Board, we pay the project origination fees otherwise owing to Dr. Teece to Enterprise +Research, Inc., a corporation in which Dr. Teece has a 40% equity position. In identifying the compensation paid to Dr. Teece, we have included the $721,609 and $1,008,188 amounts +paid to this corporation for project origination fees in 2002 and 2003, respectively, representing the contractual percentage (typically 14%) applied to professional staff revenue recognized on +engagements secured by the expert. + +COMMON STOCK ISSUANCES PURSUANT TO BUY-SELL AGREEMENT + +We +and some of our stockholders are parties to a buy-sell agreement, effective as of September 29, 2000, which provides, in part, that we as well as certain stockholders have the right to repurchase +the unvested shares of restricted common stock issued under the buy-sell agreement at original cost if one or more specified conditions are met. The repurchase provision with respect to vested shares +was terminated upon the conversion from an LLC to a C corporation and the completion of the initial public offering. The vesting restrictions on the common stock issued under the buy-sell agreement +and the repurchase provision for unvested shares remain in effect. The following directors and executive officers are parties to the buy-sell agreement: David J. Teece, David P. Kaplan, +J. Geoffrey Colton, Marvin A. Tenenbaum and Walter H. A. Vandaele. + +In +October 2000, we issued to each of David J. Teece, our Chairman of the Board of Directors, and David P. Kaplan, our President, 525,000 shares of restricted common stock at a price of $0.01 +per share. The shares of restricted common stock issued to Dr. Teece and Mr. Kaplan are subject to the buy-sell agreement. The buy-sell agreement provides that the shares owned by +Dr. Teece and Mr. Kaplan are subject to a right of repurchase in our favor, which lapses (i) at a rate of 25% per year commencing on September 29, 2001 and on the next three +anniversary dates thereafter subject to the continued services to us by Dr. Teece and Mr. Kaplan, with respect to 50% of the shares of common stock subject to the agreement, +(ii) at a rate of 25% per year commencing on December 31, 2001 based upon the achievement of individual billing goals with respect to 25% of the shares subject to the agreement, and +(iii) at a rate of 25% per year commencing on December 31, 2001, in the event we achieve our goals as stated in our annual business plan. In December 2002, our Board of Directors +accelerated the vesting of 1,025,679 restricted common shares. Included in such acceleration was 328,125 shares for each of +Dr. Teece and Mr. Kaplan. All 525,000 shares owned by each of Dr. Teece and Mr. Kaplan are fully vested and no shares remain subject to our right of repurchase. + +In +October 2000, we issued J. Geoffrey Colton, our Director of Finance, 23,438 shares of restricted common stock at a price of $0.01 per share. The shares of restricted common stock issued to +Mr. Colton are subject to the buy-sell agreement. The buy-sell agreement provides that the shares owned by Mr. Colton are subject to a right of repurchase in our favor, which lapses at a +rate of 25% per year commencing on September 30, 2001 and on the next three anniversary dates thereafter, subject to Mr. Colton's continued services to us on these dates. All 23,438 shares +owned by Mr. Colton are fully vested and no shares remain subject to our right of repurchase. + +In +October 2000, we issued Walter H.A. Vandaele, a director, 37,500 shares of restricted common stock at a price of $0.01 per share. The shares of restricted common stock issued to +Dr. Vandaele are subject to the buy-sell agreement. The buy-sell agreement provides that the shares owned by Dr. Vandaele are subject to a right of repurchase in our favor, which lapses +at a rate of 25% per year commencing on September 30, 2001 and on the next three anniversary dates thereafter, subject to + + 65 + + + +Dr. Vandaele's continued services to us on these dates. All 37,500 shares owned by Dr. Vandaele are fully vested and no shares remain subject to our right of repurchase. + +The +stockholders that are a party to the buy-sell agreement, including the foregoing directors and named executive officers, are entitled to certain registration rights. See "Shares +eligible for future sale Registration rights." + +PERFORMANCE STOCK OPTION ISSUANCES + +In October 2001, we issued David J. Teece, our Chairman of the Board of Directors, and David P. Kaplan, our President, options to purchase 468,750 shares of our +common stock, respectively, at an exercise price of $5.33 per share. The options have a 7-year cliff vesting period subject to acceleration upon the occurrence of certain events. Specifically, the +options fully vest and become immediately exercisable before the 7th year anniversary of the grant date if the holders of our Redeemable Class A preferred units achieve the minimum return +threshold, which is equal to four times the aggregate purchase price paid by the holders of our Redeemable Class A preferred units for both Redeemable Class A preferred units and common +units that were originally issued in September and October 2000. The holders of our Redeemable Class A preferred units will have achieved the minimum return threshold if any of the following +occurs: the total amount of all dividends on the Redeemable Class A preferred units that have accrued at a rate of 8% per annum, compounded quarterly, from the date of issuance together with +any dividends on the common units and other distributions to common unitholders equals the minimum return threshold; or the total amount received by the holders of Redeemable Class A preferred +units in a sale or exchange of the Redeemable Class A preferred units and common units equals the minimum return threshold; or the sum of (i) the amount received by the + +holders of Redeemable Class A preferred units pursuant to a mandatory redemption of the Redeemable Class A preferred units in connection with and immediately following an initial public +offering, plus (ii) the average closing price of our common stock over a period of twenty consecutive trading days following an initial public offering multiplied by the total number of shares +of common stock held by the holders of Redeemable Class A preferred units equals the minimum return threshold; or the combined value of (i) the dividends and distributions, and +(ii) the amount received in a sale or exchange and/or the amount received in an initial public offering as described above, equals the minimum return threshold. Pursuant to the terms of these +options, each such option became fully vested and immediately exercisable in December 2003. + + + +Pursuant to our employment offer letter to John C. Burke, our Chief Financial Officer, Mr. Burke is entitled to receive an option to purchase 15,625 shares of our common stock upon the +successful completion of a public offering by us subsequent to our initial public offering. The exercise price of this option would be set at the fair market value of our common stock on the date of +grant. We anticipate that if the underwriter exercises its over-allotment option in full and we sell shares of common stock in this offering, Mr. Burke will be entitled to this option grant. + + + +OTHER RECENT STOCK OPTION GRANTS + +In May 2004, the board of directors granted non-qualified stock options to purchase 750,000 shares of our common stock at an exercise price of $21.85 per share, to each of +Dr. Teece and Mr. Kaplan. The options have a 8 2/3-year cliff vesting period from the date of grant, subject to pro-rata acceleration upon the occurrence of death or disability. + +In +2004, each of our non-employee directors, other than Mr. Liebeck, received an option to purchase 7,500 shares of our common stock, which cliff vest one year from the date of grant. + + 66 + + + +ACCELERATED VESTING OF STOCK OPTIONS AND SHARES OF RESTRICTED STOCK + +In December 2002, the board of directors authorized the acceleration of the vesting of 846,792 stock options held by 45 experts, including 82,031, 49,805 and 13,673 +stock options held by Dr. Teece, Mr. Kaplan and Dr. Vandaele, respectively. In December 2002, the board of directors authorized the acceleration of the vesting of 1,025,679 +shares of restricted stock held by 17 experts, including 328,125 and 328,125 shares of restricted stock held by Dr. Teece and Mr. Kaplan, respectively. These accelerated options and +restricted shares are subject to a lock-up agreement under which the shares +underlying the options and the restricted shares cannot be sold until such time as the options and restricted shares would have otherwise vested absent the acceleration. + +COMMON UNIT AND PREFERRED UNIT ISSUANCES + +Prior to our initial public offering, there was a series of integrated reorganization transactions, including an equity exchange transaction by the members of LECG Holding +Company, LLC. Upon the effectiveness of the equity exchange transaction, each Redeemable Class A preferred unit was redeemed subsequent to the initial public offering at the rate of $1,000 per +unit, which is the original stated value of each such unit, plus cumulative dividends that had accrued through the date of the initial public offering at a rate of 8% per annum, compounded quarterly, +pursuant to the terms established on the date of issuance. The participants in these transactions included persons who at that time were executive officers, directors or as a result of the transaction +became holders of more than 5% of our securities and their affiliated entities. + +PREFERRED CLASS A REDEMPTION AND PAYMENT OF PREVIOUSLY TAXED EARNINGS OF LECG HOLDING COMPANY, LLC + +Following our initial public offering, we used $40.7 million of the proceeds of the offering to redeem all preferred Class A units, $14.1 million to pay +previously taxed earnings ("PTI") and $1.3 million to pay estimated taxes for the period ending November 13, 2003 of LECG Holding Company, LLC. The following represents amounts paid to +executive officers, directors and affiliates to redeem their preferred shares and for their portions of PTI and estimated taxes: + +Investor + + + +Redeemable Class A + +preferred units + +including accrued + +dividend shares + + + +Redemption + +payment + + + +PTI payment + + + +Estimated + +LLC taxes + + +Thoma Cressey Fund VII, L.P. and Thoma Cressey Friends Fund VII, L.P. + +19,776.984 + +$ +19,776,984 + +$ +5,453,420 + +$ +577,630 + +David J. Teece + +3,946.917 + +$ +3,946,917 + +$ +1,811,265 + +$ +154,517 + +David P. Kaplan + +1,274.750 + +$ +1,274,750 + +$ +865,023 + +$ +84,249 + +J. Geoffrey Colton + +110.416 + +$ +110,416 + +$ +55,812 + +$ +8,167 + +Walter H.A. Vandaele + +1,275.933 + +$ +1,275,933 + +$ +392,428 + +$ +45,172 + +Marvin A. Tenenbaum + +63.796 + +$ +63,796 + +$ +17,591 + +$ +1,862 + + + + + + +Total paid to officers, directors and affiliates + + + +$ +26,448,796 + +$ +8,595,539 + +$ +871,597 + + + + + + +INDEMNIFICATION AGREEMENTS OF OFFICERS AND DIRECTORS + +Our amended and restated certificate of incorporation and our bylaws provide that we will indemnify each of our directors and officers to the fullest extent permitted by the +Delaware General Corporation + + 67 + + + +Law. Further, we have indemnification agreements for our directors and officers. For further information, see "Description of capital stock Limitations of liability and indemnification +matters." + +LOAN GUARANTY + +In June 2002, we entered into an amendment to our credit agreement with our lenders and borrowed an additional $5.0 million under our existing term loan. Thoma Cressey +Fund VII, L.P., our largest stockholder, guaranteed our obligations up to $5.0 million for the benefit of our lenders and the administrative agent under the loan with respect to our borrowing +of an additional $5.0 million. Dr. Teece, our Chairman of the Board of Directors, guaranteed our obligations up to $2.5 million, for the benefit of Thoma Cressey Fund VII, L.P. +with respect to our borrowing of an additional $5.0 million. We reimbursed Thoma Cressey Fund VII, L.P. and Dr. Teece $37,000 for all legal expenses incurred by them associated with the +guarantees and the related transactions. In addition, we paid a commitment fee of $400,000 to Thoma Cressey Fund VII, L.P., of which $200,000 was required to be paid to Dr. Teece by Thoma +Cressey Fund VII, L.P. In March 2003, we amended and restated our credit facilities with our lenders, and the guarantees are no longer in effect. + +LOANS FROM MANAGEMENT + +In August 2002, David J. Teece, our Chairman, and Walter H.A. Vandaele, a director, loaned us $200,000 and $500,000, respectively, and in September 2002, +Dr. Teece and Dr. Vandaele loaned us $2.0 million and $500,000, respectively. We repaid all amounts loaned to us by Drs. Teece and +Vandaele within a few days of the making of such loans. In November 2002, Dr. Teece also committed to provide us up to $2.0 million through March 31, 2003, at an interest +rate of prime rate plus 3.5% for any borrowed amounts. No borrowings were made by us from Dr. Teece under this commitment. + +REIMBURSEMENT OF LEGAL FEES AND COSTS + +We have agreed to reimburse Thoma Cressey Fund VII, L.P., our largest stockholder, for the reasonable legal fees and costs it incurs in matters related to us and the +transactions we consummate. We reimbursed TCEP/LECG Funding Corporation, which at the time was an affiliate of Thoma Cressey Fund VII, L.P., $65,612, $51,852 and $0 for legal fees and costs +incurred by them in 2002, 2003 and the nine months ended September 30, 2004, respectively. + +Pursuant +to the terms of our Registration Rights Agreement, we have agreed to pay certain fees and expenses, including legal fees, incurred by our selling stockholders in connection with this +offering. We expect these reimbursed fees and expenses to be approximately $100,000. + + 68 + + + + + + +Principal and selling stockholders + +The following table sets forth information about the beneficial ownership of our common stock on September 30, 2004, and as adjusted to reflect the sale +of the shares of common stock in this offering, by: + + >each +person known to us to be the beneficial owner of more than 5% of our common stock; + + >each +named executive officer; + + >each +of our directors; + + >all +of our executive officers and directors as a group; and + + >each +stockholder that is selling shares in this offering. + +Unless +otherwise noted below, the address of each beneficial owner listed on the tables is c/o LECG Corporation, 2000 Powell Street, Suite 600, Emeryville, California 94608. We have determined +beneficial ownership in accordance with the rules of the Securities and Exchange Commission. Except as indicated by the footnotes below, we believe, based on the information furnished to us, that the +persons and entities named in the tables below have sole voting and investment power with respect to all shares of common stock that they beneficially own, subject to applicable community property +laws. We have based our calculation of the percentage of beneficial ownership on 22,439,134 shares of common stock outstanding on September 30, 2004. + + 69 + + + +In +computing the number of shares of common stock beneficially owned by a person and the percentage ownership of that person, we deemed outstanding shares of common stock subject to options held by +that person that are currently exercisable or exercisable within 60 days of September 30, 2004. We did not deem these shares outstanding, however, for the purpose of computing the +percentage ownership of any other person. + + + + +Shares beneficially owned + +prior to the offering + + + + +Shares beneficially owned + +after the offering + + + + + +Shares + +offered + + + + +Beneficial owner + + + +Number + + + +Percent + + + +Number + + + +Percent + + + + + + +5% Stockholders + + + + + + + + + + + + +Thoma Cressey Fund VII, L.P. and Thoma Cressey Friends Fund VII, L.P.(1)(25) + +5,037,500 + +22.4 +% +2,611,375 + +2,426,125 + +10.8 +% + +Ronald Baron and affiliated entities(2) + +2,326,000 + +10.4 +% + + +2,326,000 + +10.4 +% + +T. Rowe Price Associates, Inc.(3) + +1,753,500 + +7.8 +% + + +1,753,500 + +7.8 +% + +Westfield Capital Management Company LLC(4) + +1,534,650 + +6.8 +% + + +1,534,650 + +6.8 +% + +Wasatch Advisors, Inc.(5) + +1,390,065 + +6.2 +% + + +1,390,065 + +6.2 +% + +Other Selling Stockholders + + + + + + + + + + + + + + + + + + + + + + + +Marco Hellman(6) + +33,000 + +* + +13,000 + +20,000 + +* + + +i-cap private equity fund plc(7) + +50,625 + +* + +50,625 + + + + + + +Directors and Named Executive Officers + + + + + + + + + + + + + + + + + + + + + + + +David J. Teece(8)(9) + +1,863,656 + +8.1 +% +75,000(10) + +1,788,656 + +7.8 +% + +David P. Kaplan(9)(11)(25) + +1,398,044 + +6.1 +% +250,000 + +1,148,044 + +5.0 +% + +J. Geoffrey Colton(12) + +62,317 + +* + + + +62,317 + +* + + +Marvin A. Tenenbaum(13) + +63,209 + +* + + + +63,209 + +* + + +Walter H.A. Vandaele(14) + +412,427 + +1.8 +% + + +412,427 + +1.8 +% + +John C. Burke(15) + +32,984 + +* + + + +32,984 + +* + + +Gary S. Yellin(16) + +11,294 + +* + + + +11,294 + +* + + +Tina M. Bussone(17) + +5,255 + +* + + + +5,255 + +* + + +Michael R. Gaulke(18) + +7,782 + +* + + + +7,782 + +* + + +Michael J. Jeffery(19) + +4,882 + +* + + + +4,882 + +* + + +William J. Spencer(20) + +4,882 + +* + + + +4,882 + +* + + +Ruth M. Richardson(21) + +4,231 + +* + + + +4,231 + +* + + +William W. Liebeck(22) + +5,043,400 + +22.5 +% +2,611,375 + +2,432,025 + +10.8 +% + +David T. Scheffman(23) + +58,593 + +* + + + +58,593 + +* + + +All directors and executive officers as a group (14 people)(24)(25) + +8,972,956 + +37.8 +% +2,936,375 + +6,036,581 + +25.4 +% + +*Less than one percent + +(1)Thoma Cressey Fund VII, L.P. ("Fund VII") holds directly 4,960,023 shares of our common stock and Thoma Cressey Friends Fund VII, L.P. ("Friends +Fund VII") holds directly 77,477 shares of our common stock, and the shares offered hereby will be offered and sold ratably in accordance with their respective stock ownership levels. TC Partners VII, +L.P. ("TC Partners"), as the general partner to both Fund VII and Friends Fund VII, may, for purposes of Rule 13d-3 under the Securities Exchange Act of 1934, as amended, be deemed +to own beneficially the shares held by Fund VII and Friends Fund VII. Thoma Cressey Equity Partners, Inc. ("Partners, Inc."), as the general partner of TC Partners, may, for purposes of +Rule 13d-3, be deemed to own beneficially the shares held by Fund VII and Friends Fund VII. Carl D. Thoma is the sole stockholder of Partners, Inc. and accordingly possesses +voting and dispositive power over all of the shares owned by the + + 70 + + + + Thoma Cressey entities. The address for Mr. Thoma and the Thoma Cressey entities is One Embarcadero Center, Suite 2930, San Francisco, California 94111. + +(2)Ronald Baron owns a controlling interest in Baron Capital Group, Inc. ("BCG"). BAMCO, Inc. ("BAMCO") and Baron Capital +Management, Inc. ("BCM") are subsidiaries of BCG. Ronald Baron, BCG, BAMCO and BCM beneficially own an aggregate of 2,326,000 shares of our common stock. Ronald Baron and BCG, each, +beneficially own 2,326,000 shares of our common stock, BAMCO beneficially owns 2,319,500 shares of our common stock and BCM beneficially owns 6,500 shares of our common stock. Ronald Baron and BCG +disclaim beneficial ownership of shares held by their controlled entities (or the investment advisory clients thereof) to the extent such shares are held by persons other than Ronald Baron and BCG. +BAMCO and BCM disclaim beneficial ownership of shares held by their investment advisory clients to the extent such shares are held by persons other than BAMCO, BCM and their affiliates. The address +for Ronald Baron, BCG, BAMCO and BCM is 767 Fifth Avenue, New York, New York 10153. + +(3)The address of T. Rowe Price Associates, Inc. is 100 East Pratt Street, Baltimore, Maryland 21202. + +(4)The address of Westfield Capital Management Company LLC is One Financial Center, Boston, Massachusetts 002111-2690. + +(5)The address for Wasatch Advisors Inc. is 150 Social Hall Avenue, Salt Lake City, Utah 84111. + +(6)The address of Mr. Hellman is 310 Palm Avenue, Kentfield, California 94904. + +(7)The address of i-cap private equity fund plc is Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland. + +(8)Includes 325,000 shares held by the Teece Irrevocable Trust No. 3 U/A/D 10/14/97, 148,829 shares of common stock held by the Teece Family +Millennium Trust, 123,047 shares of common stock held by the Flex Trust u/t/d February 5, 2003 and 16,625 shares of common stock held by the Teece Family Foundation. + + + The sole trustee of the Teece Irrevocable Trust No. 3 U/A/D 10/14/97 is Norman J. Laboe. The beneficiaries of the Teece Irrevocable Trust No. 3 U/A/D 10/14/97 are the four minor children +of Dr. Teece. The co-trustees of the Teece Family Millennium Trust are Norman J. Laboe and U.S. Trust Company of Delaware. The beneficiaries of the Teece Family Millennium Trust are +the four minor children of Dr. Teece, the grandchildren and more remote descendants of Dr. Teece, and the Teece Family Foundation, a private charitable foundation. + + + The sole trustee of the Flex Trust u/t/d February 5, 2003 is Norman J. Laboe. The beneficiaries of the Flex Trust u/t/d February 5, 2003 are Dr. Teece, the descendants of +Dr. Teece and the Teece Family Foundation, a private charitable foundation. + + + The board of directors of the Teece Family Foundation consists of Dr. Teece, his spouse, Leigh Teece, and one other individual, who collectively possess voting and dispositive power over all of +the shares owned by the Teece Family Foundation. + + + Dr. Teece disclaims beneficial ownership of the shares referenced above in this footnote 8, except to the extent of his pecuniary interest therein. + + + Also includes 10,156 shares subject to options exercisable within 60 days of September 30, 2004. + +(9)Includes 468,750 shares of common stock underlying the performance options granted to each of Dr. Teece and Mr. Kaplan in +October 2001 that became fully vested and exercisable in December 2003. See "Certain Relationships and Related Transactions Performance Stock Option Issuances." + +(10)Represents shares held by the Teece Family Millennium Trust. + +(11)Includes 127,344 shares subject to options exercisable within 60 days of September 30, 2004. + +(12)Includes 16,015 shares subject to options exercisable within 60 days of September 30, 2004. + +(13)Shares of our common stock are held by Marvin A. Tenenbaum and Lynn Tenenbaum, as joint tenants. Includes 46,959 shares subject to options +exercisable within 60 days of September 30, 2004. + +(14)Includes 43,306 shares subject to options exercisable within 60 days of September 30, 2004. + +(15)Includes 31,925 shares subject to options exercisable within 60 days of September 30, 2004. + +(16)Includes 10,220 shares subject to options exercisable within 60 days of September 30, 2004. + + 71 + + + +(17)Includes 5,103 shares subject to options exercisable within 60 days of September 30, 2004. + +(18)Shares of our common stock are held by the Gaulke Family Trust, of which Mr. Gaulke and Judith A. Gaulke are trustees. Includes 4,882 +shares subject to options exercisable within 60 days of September 30, 2004. + +(19)Includes 4,882 shares subject to options exercisable within 60 days of September 30, 2004. + +(20)Includes 4,882 shares subject to options exercisable within 60 days of September 30, 2004. + +(21)Includes 4,231 shares subject to options exercisable within 60 days of September 30, 2004. + +(22)Includes 5,900 shares owned individually by Mr. Liebeck. Mr. Liebeck is a partner of Partners, Inc., the general partner of +TC Partners, the general partner of both Fund VII and Friends Fund VII. Of the shares attributed to Mr. Liebeck, 4,960,023 are held directly by Fund VII and 77,477 are held directly by Friends +Fund VII. Mr. Liebeck disclaims beneficial ownership of these shares except to the extent of his pecuniary interest therein. Mr. Liebeck's address is c/o Thoma Cressey Equity +Partners, Inc., One Embarcadero Center, Suite 2930, San Francisco, California 94111. + +(23)Includes 58,593 shares subject to options exercisable within 60 days of September 30, 2004. + +(24)Includes 1,305,998 shares subject to options exercisable within 60 days of September 30, 2004. + +(25)In the event that the underwriter's over-allotment option is exercised in full, Fund VII and Friends Fund VII will sell an +aggregate of an additional 25,000 shares of common stock, David P. Kaplan, our President, will sell an additional 175,000 shares of common stock, and we will sell 250,000 shares of common +stock. As a result, after the offering, the percentage of our shares beneficially owned by these Thoma Cressey entities would be 10.6%, the percentage owned by Mr. Kaplan would be 4.1% and the +percentage owned by all directors and executive officers as a group would be 24.3%. + + 72 + + + + + + +Description of capital stock + +Our authorized capital stock consists of 200,000,000 shares of common stock, $0.001 par value per share, and 5,000,000 shares of preferred stock, $0.001 par +value per share. The following description summarizes some of the terms of our capital stock. Because it is only a summary, it does not contain all the information that may be important to you. For a +complete description you should refer to our amended and restated certificate of incorporation and bylaws, copies of which have been filed as exhibits to the registration statement of which the +prospectus is a part. + +COMMON STOCK + +On September 30, 2004, there were 22,439,134 shares of common stock outstanding, held of record by approximately 82 stockholders. + +The +holders of our common stock are entitled to one vote for each share held of record on all matters submitted to a vote of the stockholders, including the election of directors, and do not have +cumulative +voting rights. Accordingly, the holders of a majority of the shares of common stock entitled to vote in any election of directors can elect all of the directors standing for election, if they so +choose. Subject to preferences that may be applicable to any then outstanding preferred stock, holders of common stock are entitled to receive ratably those dividends, if any, as may be declared by +the board of directors out of legally available funds. Upon our liquidation, dissolution or winding up, the holders of common stock will be entitled to share ratably in the net assets legally +available for distribution to stockholders after the payment of all of our debts and other liabilities of our company, subject to the prior rights of any preferred stock then outstanding. Holders of +common stock have no preemptive or conversion rights or other subscription rights and there are no redemption or sinking funds provisions applicable to the common stock. All outstanding shares of +common stock are, and the common stock to be outstanding upon completion of this offering will be, fully paid and nonassessable. + +PREFERRED STOCK + +The board of directors will have the authority, without any action by the stockholders, to issue from time to time the preferred stock in one or more series and to fix the +number of shares, designations, preferences, powers, and relative, participating, optional or other special rights and the qualifications or restrictions thereof. The preferences, powers, rights and +restrictions of different series of preferred stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund +provisions, and purchase funds and other matters. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of common stock or adversely +affect the rights and powers, including voting rights, of the holders of common stock, and may have the effect of delaying, deferring or preventing a change in control of our company. The existence of +authorized but unissued preferred stock may enable the board of directors to render more difficult or to discourage an attempt to obtain control of us by means of a merger, tender offer, proxy contest +or otherwise. For example, if in the due exercise of its fiduciary obligations, the board of directors were to determine that a takeover proposal is not in our best interests, the board of directors +could cause shares of preferred stock to be issued without stockholder approval in one or more private offerings or other transactions that might dilute the voting or other rights of the proposed +acquirer or insurgent stockholder or stockholder group. + + 73 + + + +ANTI-TAKEOVER EFFECTS OF PROVISIONS OF OUR AMENDED AND RESTATED CERTIFICATE OF INCORPORATION, OUR BYLAWS AND DELAWARE LAW + +Some provisions of Delaware law, our amended and restated certificate of incorporation and our bylaws contain provisions that could make the following transactions more +difficult: + + >acquisition +of us by means of a tender offer; + + >acquisition +of us by means of a proxy contest or otherwise; or + + >removal +of our incumbent officers and directors. + +These +provisions, summarized below, are expected to discourage coercive takeover practices and inadequate takeover bids. These provisions are also designed to encourage persons seeking to acquire +control of us to first negotiate with our board of directors. We believe that the benefits of increased protection of our potential ability to negotiate with the proponent of an unfriendly or +unsolicited proposal to acquire or restructure us outweigh the disadvantages of discouraging these proposals because negotiation of these proposals could result in an improvement of their terms. + +Undesignated preferred stock + +We have authorized undesignated preferred stock which makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that +could impede the success of any attempt to change control of us. These and other provisions may have the effect of deferring hostile takeovers or delaying changes in control or management of our +company. + +Stockholder meetings + +Our charter documents provide that a special meeting of stockholders may be called only by the chairman of the board, the chief executive officer or the president of our +company, or by a resolution adopted by a majority of our board of directors. + +Requirements for advance notification of stockholder nominations and proposals + +Our bylaws establish advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors, other than nominations made by +or at the direction of the board of directors or a committee of the board of directors. + +Elimination of stockholder action by written consent + +Our certificate of incorporation eliminates the right of stockholders to act by written consent without a meeting. + +Delaware anti-takeover statute + +We are subject to Section 203 of the Delaware General Corporation Law which prohibits persons deemed "interested stockholders" from engaging in a "business combination" +with a Delaware corporation for three years following the date these persons become interested stockholders. Generally, an "interested stockholder" is a person who, together with affiliates and +associates, owns, or within three years prior to the determination of interested stockholder status did own, 15% or more of a corporation's voting stock. Generally, a "business combination" includes a +merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. The existence of this provision may have an anti-takeover effect with +respect to transactions not approved in advance by the board of directors. + + 74 + + + +Amendment of charter provisions + +The amendment of any of the above provisions, except for the provision making it possible for our board of directors to issue preferred stock, would require approval by holders +of at least 662/3% of our then outstanding common stock. + +The +provisions of Delaware law, our amended and restated certificate of incorporation and our bylaws could have the effect of discouraging others from attempting hostile takeovers and, as a +consequence, +they may also inhibit temporary fluctuations in the market price of our common stock that often result from actual or rumored hostile takeover attempts. These provisions may also have the effect of +preventing changes in our management. It is possible that these provisions could make it more difficult to accomplish transactions that stockholders may otherwise deem to be in their best interests. + +LIMITATIONS OF LIABILITY AND INDEMNIFICATION MATTERS + +We have adopted provisions in our amended and restated certificate of incorporation that limit the liability of our directors for monetary damages for breach of their fiduciary +duties, except for liability that cannot be eliminated under the Delaware General Corporation Law. Delaware law provides that directors of a corporation will not be personally liable for monetary +damages for breach of their fiduciary duties as directors, except liability for any of the following: + + >any +breach of their duty of loyalty to the corporation or the stockholder; + + >acts +or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; + + >unlawful +payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law; or + + >any +transaction from which the director derived an improper personal benefit. + +This +limitation of liability does not apply to liabilities arising under the federal securities laws and does not affect the availability of equitable remedies such as injunctive relief or rescission. + +Our +amended and restated certificate of incorporation and our bylaws also provide that we shall indemnify our directors and executive officers and may indemnify our other officers and employees and +other agents to the fullest extent permitted by law. We believe that indemnification under our bylaws covers at least negligence and gross negligence on the part of indemnified parties. Our bylaws +also permit us to secure insurance on behalf of any officer, director, employee or other agent for any +liability arising out of his or her actions in this capacity, regardless of whether our bylaws would permit indemnification. + +We +have entered into separate indemnification agreements with our directors and executive officers, in addition to indemnification provided for in our charter documents. These agreements among other +things, provide for indemnification of our directors and executive officers for expenses, judgments, fines and settlement amounts incurred by this person in any action or proceeding arising out of +this person's services as a director or executive officer or at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and +executive officers. + +TRANSFER AGENT AND REGISTRAR + +The transfer agent and registrar for our common stock is LaSalle Bank N.A. Its address is 135 S. LaSalle Street, Chicago, Illinois 60603. + +LISTING + +Our common stock is quoted on the Nasdaq National Market under the symbol "XPRT." + + 75 + + + + + + +Shares eligible for future sale + +A significant public market for our common stock may not be sustained after this offering. We cannot predict the effect, if any, that market sales of shares or +the availability of shares for sale will have on the market price prevailing from time to time. As described below, a number of shares will not be available for sale for a period of time after this +offering due to contractual and legal restrictions on resale. However, sales of our common stock in the public market after the restrictions lapse, or the perception that these sales may occur, could +cause the market price of our common stock to decline. + +Upon +completion of this offering, we will have an aggregate of 22,439,134 outstanding shares of common stock, based on this number of shares being outstanding as of September 30, 2004. As of +September 30, 2004, we had outstanding stock options held by employees, consultants and directors for the purchase of an aggregate of 6,092,198 shares of common stock. + +The +3,000,000 shares of common stock being sold in this offering will be, and the 8,625,000 shares previously sold in our initial public offering are, freely tradable without restriction or further +registration under the Securities Act of 1933, as amended, unless the shares are purchased by affiliates of our company, as that term is defined in Rule 144 of the Securities Act of 1933, as +amended. All remaining shares were issued and sold by us in private transactions or issued by us in reliance on +Rule 701, and are eligible for public sale if registered under the Securities Act of 1933, as amended, or sold in accordance with Rule 144 thereunder. + +LOCK-UP AGREEMENTS + +Each of our directors, executive officers and the selling stockholders have signed lock-up agreements under which, subject to certain exceptions noted below, they will agree +not to offer, sell, contract to sell, hedge or otherwise dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exercisable or exchangeable for shares of +common stock, for a period of 90 days after the date of this prospectus, without the prior written consent of UBS Securities LLC. Approximately 5,535,296 shares of common stock +beneficially owned by these parties as of September 30, 2004, including shares issuable upon the exercise of vested options 90 days after the date of this prospectus, are subject to the +foregoing restrictions under these lock-up agreements. In addition, each holder of securities registrable under our registration rights agreement has agreed not to effect any public sale or +distribution, subject to certain exceptions noted below, of any of our equity securities or any securities convertible into or exchangeable or exercisable for our equity securities for a period of +90 days after the date of this prospectus, without the prior consent of UBS Securities LLC. Approximately 5,160,731 shares of common stock (in addition to those shares subject to the +lock-up agreements above) beneficially owned by these parties as of September 30, 2004, including shares issuable upon the exercise of vested options 90 days after the date of this +prospectus, are subject to the lock-up provision of our registration rights agreement. All shares issued pursuant to our Employee Stock Purchase Plan, consisting of 132,593 total shares, are not +subject to the foregoing lock-up restrictions, including 7,906 shares held by directors, officers and selling stockholders. In addition, 598,479 shares subject to Rule 10b5-1 plans in +effect as of November 10, 2004 also are not subject to the foregoing lock-up restrictions, including 75,500 shares held by directors, officers and selling stockholders, but excluding +234,000 shares previously subject to a Rule 10b5-1 plan for David P. Kaplan, our President, that has been terminated. Furthermore, David J. Teece, our Chairman, recently adopted a +Rule 10b5-1 plan with respect to 257,500 shares that will not take effect until 90 days after the date of this prospectus. In addition, UBS Securities LLC, in its sole discretion, may +release some or all of these shares before the 90-day lock-up period ends. + + + + 76 + + + +Following +the expiration of the lock-up period noted above, 90 days after the date of this prospectus, these shares of common stock will be available for sale in the public market, subject in some +cases to the vesting of restricted common stock and to the volume and other restrictions of compliance with Rule 144, Rule 144(k) or Rule 701. + +ELIGIBILITY OF RESTRICTED SHARES FOR SALE IN THE PUBLIC MARKET + +Rule 144 + +In general, under Rule 144, a person or persons whose shares are aggregated who has beneficially owned restricted securities for at least one year, including the holding +period of any holder who is not an affiliate, and who files a Form 144 with respect to the sale, is entitled to sell within any three-month period a number of shares of common stock that does +not exceed the greater of: + + >1% +of the then outstanding shares of our common stock, or approximately 224,391 shares immediately after this offering; or + + >the +average weekly trading volume during the four calendar weeks preceding the sale. + +Sales +under Rule 144 are also subject to restrictions relating to manner of sale, notice and the availability of current public information about us. + +Rule 144(k) + +A person who is not deemed to have been our affiliate at any time during the three-month period immediately preceding a sale and who has beneficially owned his or her shares +for at least two years, including the holding period of any prior owner who is not an affiliate, is entitled to sell these shares of common stock pursuant to Rule 144(k) without regard to the +volume limitations, manner of sale provisions, public information or notice requirements of Rule 144. Affiliates must always sell pursuant to Rule 144, even after the applicable holding +periods have been satisfied. + +Rule 701 + +Securities issued in reliance on Rule 701 are deemed to be restricted securities and may be sold by persons other than affiliates subject only to the manner of sale +provisions of Rule 144 and by affiliates under Rule 144 without compliance with the holding period requirements. As of September 30, 2004, 185,112 of our outstanding shares of +common stock had been issued in reliance on Rule 701 as a result of the exercise of stock options. + +STOCK OPTIONS + +We have filed registration statements under the Securities Act of 1933, as amended, covering approximately 8,031,887 shares of common stock reserved for issuance under +our 2000 Incentive Plan, 2003 Stock Option Plan and 2003 Employee Stock Purchase Plan. Shares registered under this registration statement are available for sale in the open market, unless these +shares are subject to vesting restrictions with us or are otherwise subject to the contractual or legal restrictions described above. + +REGISTRATION RIGHTS + +In addition, assuming completion of this offering the holders of approximately 9,307,996 shares of common stock will be entitled to rights with respect to the registration of +these shares under the + + + + 77 + + + +Securities Act of 1933, as amended. These shares are referred to as registrable securities. Under the terms of the agreement between us and the holders of the registrable securities, if we propose to +register any of our securities under the Securities Act of 1933, as amended, these holders are entitled to notice of such registration and are entitled to include their shares of registrable +securities in our registration. Certain of these holders also are entitled to demand registration rights, pursuant to which they may require us to prepare and file a registration statement +under the Securities Act of 1933, as amended, in certain cases at our expense, covering all or a portion of their registrable securities, subject to specific conditions and limitations. Under these +demand registration rights, we are required to use our best efforts to effect the registration and sale of the shares requested to be registered, subject to customary conditions and limitations. +Certain holders of registrable securities also may require us to register all or a portion of their securities on a registration statement on Form S-3, subject to specific +conditions and limitations. Registration rights terminate no later than five years after our initial public offering. Registration of these shares under the Securities Act of 1933, as amended, would +result in these shares, other than shares purchased by our affiliates, becoming freely tradable without restriction under the Securities Act of 1933, as amended. + + 78 + + + + + + +Underwriting + +We, the selling stockholders and UBS Securities LLC, the underwriter, have entered into an underwriting agreement concerning the shares of our common stock +being offered. Subject to the terms and conditions set forth in the underwriting agreement, the underwriter has agreed to purchase 3,000,000 shares of our common stock from the selling stockholders. + +If +the underwriter sells more than 3,000,000 shares, the underwriter has a 30-day option to buy from us and/or certain selling stockholders up to an additional 450,000 shares at the public +offering price less the underwriting discounts and commissions. + +The +following table shows the per share and total underwriting discounts and commissions the selling stockholders and we will pay to the underwriter. These amounts are shown assuming both no exercise +and full exercise of the underwriter's option to purchase up to an additional 450,000 shares. + + + + +Paid by the selling stockholders + +Paid by us + + + + +No + +exercise + +Full + +exercise + +No + +exercise + +Full + +exercise + +Per share + +$ + + +$ + + +$ + + +$ + + +Total + +$ + + +$ + + +$ + + +$ + + +We estimate that the total expenses of the offering payable by us, excluding underwriting discounts and commissions, will be approximately $500,000. + +Shares +sold by the underwriter to the public will initially be offered at the offering price set forth on the cover of this prospectus. Any shares sold by the underwriter to securities dealers may be +sold at a discount of up to $ per share from the offering price. Any of these securities dealers may resell any shares purchased from the underwriter to other brokers or +dealers at a +discount of up to $ per share from the offering price. If all the shares are not sold at the offering price, the underwriter may change the offering price and the other +selling terms. +Sales of shares made outside of the United States may be made by affiliates of the underwriter. Upon execution of the underwriting agreement, subject to the conditions set forth therein, the +underwriter will be obligated to purchase the shares at the prices and upon the terms stated therein, and, as a result, will thereafter bear any risk associated with changing the offering price to the +public or other selling terms. + +Our +company and each of our directors, executive officers and the selling stockholders have agreed with the underwriter not to offer, sell, contract to sell, hedge or otherwise dispose of, directly or +indirectly, subject to certain exceptions noted below, any shares of our common stock or securities convertible into or exercisable or exchangeable for shares of common stock until after the date that +is 90 days after the date of this prospectus, without the prior written consent of the underwriter. All shares issued pursuant to our Employee Stock Purchase Plan, consisting of 132,593 total +shares, are not subject to the foregoing lock-up restrictions, including 7,906 shares held by directors, officers and +selling stockholders. In addition, 598,479 shares subject to Rule 10b5-1 plans in effect as of November 10, 2004 also are not subject to the foregoing lock-up restrictions, +including 75,500 shares held by directors, officers and selling stockholders, but excluding 234,000 shares previously subject to a Rule 10b5-1 plan for David P. Kaplan, our +President, that has been terminated. Furthermore, David J. Teece, our Chairman, recently adopted a Rule 10b5-1 plan with respect to 257,500 shares that will not take effect until +90 days after the date of this prospectus. Although it has advised us that it has no intent or understanding to do so, the underwriter, in its sole discretion, may permit early + + 79 + + + +release of the shares of our common stock subject to the restrictions detailed above prior to the expiration of the 90-day lock-up period. + +In +connection with this offering, the underwriter may engage in passive market making transactions in the common stock on the Nasdaq National Market prior to the pricing and completion of this +offering. Passive market making consists of displaying bids on the Nasdaq National Market no higher than the bid prices of independent market makers and making purchases no higher than these +independent bids in response to order flow. Net purchases by a passive market maker on each day are limited to a specified percentage of the passive market maker's average daily trading volume in the +common stock during a specified period and must be discontinued when such limit is reached. Passive market making may cause the price of the common stock to be higher than the price that would +otherwise exist in the open market in the absence of such transactions. If passive market making is commenced, it may be discontinued at any time. + +In +connection with the offering, the underwriter may purchase and sell shares of common stock in the open market. These transactions may include stabilizing transactions. Stabilizing transactions +consist of bids or purchases made for the purpose of preventing or retarding a decline in the market price of the common stock while the offering is in progress. These transactions may also include +short sales and purchases to cover positions created by short sales. Short sales involve the sale by the underwriter of a greater number of shares than it is required to purchase in the offering. +Short sales may be either "covered short sales" or "naked short shares." Covered short sales are sales made in an amount not greater than the underwriter's over-allotment option to +purchase additional shares in the offering. The underwriter may close out any covered short position by either exercising its over-allotment option or purchasing shares in the open market. +In determining the source of shares to close out the covered short position, the underwriter will consider, among other things, the price of shares available for purchase in the open market as +compared to the price at which it may purchase shares through the over-allotment option. Naked short sales are in excess of the over-allotment option. The underwriter must +close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriter is concerned that there may be downward pressure on +the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering. + +These +activities by the underwriter may stabilize, maintain or otherwise affect the market price of the common stock. As a result, the price of the common stock may be higher than the price that +otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriter at any time. These transactions may be effected on the Nasdaq National Market, +in the over-the-counter market or otherwise. + +We +and the selling stockholders have agreed in the underwriting agreement to indemnify the underwriter against certain liabilities, including liabilities under the Securities Act of 1933, as amended, +and to contribute to payments that the underwriter may be required to make in respect thereof. + + 80 + + + + + + +Legal matters + +Various legal matters with respect to the validity of the common stock offered by this prospectus will be passed upon for us by Wilson Sonsini Goodrich & +Rosati, Professional Corporation, Palo Alto, California. The validity of the common stock will be passed upon for the underwriter by Sullivan & Cromwell LLP, Los Angeles, California. + + + + +Experts + +The consolidated financial statements of LECG Corporation (formerly LECG Holding Company, LLC) and subsidiary as of December 31, 2003 and 2002 and for +each of the three years in the period ended December 31, 2003 included in this prospectus have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as +stated in their report appearing herein (which report expresses an unqualified opinion and contains an explanatory paragraph relating to the adoption of a new accounting standard), and have been so +included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. + + + + +Where you can find more information + +We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission, or SEC. The SEC maintains a +website that contains the annual, quarterly and special reports, proxy statements and other information we file with the SEC. The address of the SEC website is http://www.sec.gov. You may also read +and copy any document we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the Public Reference Room by +calling the SEC at 1-800-SEC-0330. + +We +have filed with the SEC a registration statement on Form S-1 under the Securities Act of 1933, as amended, with respect to the shares of common stock offered hereby. This +prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules thereto. Some items are omitted in accordance with the rules and regulations +of the SEC. For further information with respect to us and the common stock offered hereby, we refer you to the registration statement and the exhibits and schedules filed therewith. Statements +contained in this prospectus as to the contents of any contract, agreement or any other document are summaries of the material terms of this contract, agreement or other document. With respect to each +of these contracts, agreements or other documents filed as an exhibit to the registration statement, reference is made to the exhibits for a more complete description of the matter involved. You may +obtain a copy of the registration statement, and the exhibits and schedules thereto, from the SEC. + + 81 + + + + + + +Index to financial statements + +Audited Consolidated Financial Statements: + + + + +Report of Independent Registered Public Accounting Firm + +F-2 + + +Consolidated Balance Sheets as of December 31, 2002 and 2003 + +F-3 + + +Consolidated Statements of Operations for the Years Ended December 31, 2001, 2002 and 2003 + +F-4 + + +Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2001, 2002 and 2003 + +F-5 + + +Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2002 and 2003 + +F-7 + + +Notes to Consolidated Financial Statements + +F-8 + +Unaudited Interim Condensed Consolidated Financial Statements: + + + + + + +Condensed Consolidated Balance Sheets as of December 31, 2003 and September 30, 2004 + +F-28 + + +Condensed Consolidated Statements of Income for the Nine Months Ended September 30, 2003 and 2004 + +F-29 + + +Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2004 + +F-30 + + +Condensed Consolidated Statement of Stockholders' Equity for the Nine Months Ended September 30, 2004 + +F-31 + + +Notes to Unaudited Interim Condensed Consolidated Financial Statements + +F-32 + + F-1 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + + +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM + +To the Board of Directors and Shareholders + +LECG Corporation: + +We +have audited the consolidated balance sheets of LECG Corporation and subsidiary, as of December 31, 2002 and 2003 and the related consolidated statements of operations, shareholders' equity, +and cash flows for each of the three years in the period ended December 31, 2003. 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. + +We +conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). 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 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. + +In +our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of LECG Corporation and subsidiary as of December 31, 2002 and 2003, and +the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United +States of America. + +As +discussed in Note 2 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and other intangible assets to conform to Statement of +Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. + +/s/ +DELOITTE & TOUCHE LLP + +San +Francisco, California + +March 22, +2004 + + F-2 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + CONSOLIDATED BALANCE SHEETS + +(dollars in thousands, except per share data) + + + + + +December 31, + + + + + +2002 + + + +2003 + + + + + + +Assets + + + + + + + + +Current assets: + + + + + + + + + +Cash and cash equivalents + +$ +2,576 + +$ +67,177 + + + +Accounts receivable, net of allowance of $315 and $482 respectively + + +35,833 + + +46,708 + + + +Prepaid expenses + + +1,817 + + +2,708 + + + +Deferred taxes + + + + + +9,802 + + + +Current portion of signing bonuses and other + + +2,392 + + +3,868 + + + + + + + + + + + +Total current assets + + +42,618 + + +130,263 + + +Property and equipment, net + + +6,137 + + +4,506 + + +Goodwill + + +22,542 + + +23,976 + + +Other intangible assets + + +1,150 + + +533 + + +Signing bonuses and other assets + + +3,249 + + +3,864 + + + + + + + + + +Total assets + +$ +75,696 + +$ +163,142 + + + + + + + + + +Liabilities and shareholders' equity + + + + + + + + + + + + + + + +Current liabilities: + + + + + + + + + +Accounts payable and other accrued liabilities + +$ +4,624 + +$ +5,733 + + + +Accrued compensation + + +24,270 + + +29,270 + + + +Revolving credit facility + + +1,500 + + + + + + +Current portion of long-term debt + + +3,750 + + + + + + +Deferred revenue + + +1,193 + + +732 + + + +Distributions payable + + + + + +3,398 + + + + + + + + + + + +Total current liabilities + + +35,337 + + +39,133 + + +Long-term debt + + +15,050 + + + + + +Other long-term liabilities + + +941 + + +22 + + +Redeemable Class A preferred units, no par value; 38,001 and 0 units + +authorized, issued and outstanding at December 31, 2002 + +and 2003, respectively + + +33,000 + + + + + +Preferred stock, $.001 par value, 5,000,000 shares authorized, none outstanding + + + + + + + + +Shareholders' equity (deficit): + + + + + + + + + + + + + + + +Common units, no par value, 12,775,030 units authorized, issued + +and outstanding at December 31, 2002 + + +31,228 + + + + + +Common stock, $.001 par value, 200,000,000 shares authorized, + +21,693,156 shares issued and outstanding at December 31, 2003 + + + + + +22 + + +Additional paid-in capital + + + + + +113,326 + + +Receivable from shareholder + + +(290 +) + +(290 +) + +Deferred equity compensation + + +(1,280 +) + +(2,193 +) + +Accumulated other comprehensive gain (loss) + + +(129 +) + +510 + + +Retained earnings (accumulated deficit) + + +(38,161 +) + +12,612 + + + + + + + + + + + +Total shareholders' equity (deficit) + + +(8,632 +) + +123,987 + + + + + + + + + +Total liabilities and shareholders' equity + +$ +75,696 + +$ +163,142 + + + + + + + + + +See notes to consolidated financial statements + + F-3 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + CONSOLIDATED STATEMENTS OF OPERATIONS + (dollars in thousands, except per share data) + + + + + +Year ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + + + + + +Revenues + +$ +100,735 + +$ +133,704 + +$ +165,594 + + +Cost of services: + + + + + + + + + + + + +Compensation and project costs + + +(69,032 +) + +(90,083 +) + +(110,634 +) + + +Equity-based compensation + + +(6,735 +) + +(16,645 +) + +(1,754 +) + + + + + + + + + + + +Total cost of services + + +(75,767 +) + +(106,728 +) + +(112,388 +) + + + + + + + + + + +Gross profit + + +24,968 + + +26,976 + + +53,206 + + +Operating expenses: + + + + + + + + + + + + +General and administrative expenses + + +(22,953 +) + +(28,914 +) + +(29,292 +) + + +Depreciation and amortization + + +(7,802 +) + +(3,737 +) + +(4,801 +) + + +Costs of postponed equity offering + + + + + +(3,500 +) + + + + + + + + + + + + + +Operating income (loss) + + +(5,787 +) + +(9,175 +) + +19,113 + + +Interest income + + +125 + + +42 + + +103 + + +Interest expense + + +(2,372 +) + +(3,188 +) + +(2,620 +) + +Other income (expense), net + + +(384 +) + +257 + + +466 + + + + + + + + + + + +Income before income tax benefit + + +(8,418 +) + +(12,064 +) + +17,062 + + +Income tax benefit + + + + + + + + +9,613 + + + + + + + + + + + +Net income (loss) + + +(8,418 +) + +(12,064 +) + +26,675 + + +Accrued preferred dividends and accretion of preferred units + + +(3,251 +) + +(3,692 +) + +(7,712 +) + + + + + + + + + + +Net income (loss) attributable to common shares + +$ +(11,669 +) +$ +(15,756 +) +$ +18,963 + + + + + + + + + + + +Net income (loss) per share: + + + + + + + + + + + + +Basic + +$ +(1.11 +) +$ +(1.41 +) +$ +1.39 + + + +Diluted + +$ +(1.11 +) +$ +(1.41 +) +$ +1.17 + + +Shares used in calculating net income (loss) per share: + + + + + + + + + + + + +Basic + + +10,477,660 + + +11,168,563 + + +13,673,875 + + + +Diluted + + +10,477,660 + + +11,168,563 + + +16,261,216 + + +See notes to consolidated financial statements + + F-4 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY + (dollars in thousands) + + + + + +Common Units + + + + +Receivable + +from + +unitholders + + + +Deferred + +equity + +compensation + + + +Accumulated + +other + +comprehensive + +income (loss) + + + +Total + +shareholders' + +deficit + + + +Total + +comprehensive + +income (loss) + + + + + + + + +Accumulated + +Deficit + + + + + + + + +Units + + + +Amount + + + + + + + + +Balance at December 31, 2000 + +12,835,987 + +$ +7,049 + +$ +(7,675 +) +$ +(19 +) +$ +(667 +) +$ +5 + +$ +(1,307 +) + + + + + +Decrease in receivable from unitholder + + + + + + + + + + +5 + + + + + + + + +5 + + + + + + +Deferred equity compensation + + + + +688 + + + + + + + + +(688 +) + + + + + + + + + + + +Equity compensation + + + + +6,430 + + + + + + + + +207 + + + + + +6,637 + + + + + + +Preferred dividends + + + + + + + +(2,609 +) + + + + + + + + + + +(2,609 +) + + + + + +Accretion of preferred units + + + + + + + +(642 +) + + + + + + + + + + +(642 +) + + + + + +Distribution to common unitholders + + + + + + + +(200 +) + + + + + + + + + + +(200 +) + + + + + +Repurchase of units + +(154,219 +) + +(28 +) + + + + + + + + + + + + + +(28 +) + + + + + +Interest receivable on unitholder loans + + + + +60 + + + + + +(60 +) + + + + + + + + + + + + + + +Net loss + + + + + + + +(8,418 +) + + + + + + + + + + +(8,418 +) +$ +(8,418 +) + + +SFAS 133 transition adjustment + + + + + + + + + + + + + + + + +(257 +) + +(257 +) + + + + + +Amortization of transition adjustment + + + + + + + + + + + + + + + + +93 + + +93 + + + + + + +Foreign currency translation adjustment + + + + + + + + + + + + + + + + +(40 +) + +(40 +) + +(40 +) + + + + + + + + + + + + + + + + + + + + + + +Total comprehensive loss + + + + + + + + + + + + + + + + + + + + + +$ +(8,458 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Balance at December 31, 2001 + +12,681,768 + + +14,199 + + +(19,544 +) + +(74 +) + +(1,148 +) + +(199 +) + +(6,766 +) + + + + + +Decrease (increase) in receivable from unitholder + + + + + + + + + + +(166 +) + + + + + + + +(166 +) + + + + + +Issuance of restricted units + +62,500 + + +280 + + + + + + + + + + + + + + +280 + + + + + + +Exercise of options + +30,762 + + + + + + + + + + + + + + + + + + + + + + + + +Cancel unvested options + + + + + + + + + + + + + + + + + + + + + + + + + + +Deferred equity compensation + + + + +4,753 + + + + + + + + +(4,753 +) + + + + + + + + + + + +Equity compensation + + + + +11,949 + + +77 + + + + + +4,619 + + + + + +16,645 + + + + + + +Preferred dividends + + + + + + + +(2,894 +) + + + + + + + + + + +(2,894 +) + + + + + +Accretion of preferred units + + + + + + + +(875 +) + + + + + + + + + + +(875 +) + + + + + +Distribution to common unitholders + + + + + + + +(2,861 +) + + + + + + + + + + +(2,861 +) + + + + + +Interest receivable on unitholder loans + + + + +50 + + + + + +(50 +) + + + + + + + + + + + + + + +Other + + + + +(3 +) + + + + + + + +2 + + + + + +(1 +) + + + + + +Net loss + + + + + + + +(12,064 +) + + + + + + + + + + +(12,064 +) +$ +(12,064 +) + + +Amortization of transition adjustment + + + + + + + + + + + + + + + + +93 + + +93 + + + + + + +Foreign currency translation adjustment + + + + + + + + + + + + + + + + +(23 +) + +(23 +) + +(23 +) + + + + + + + + + + + + + + + + + + + + + + +Total comprehensive loss + + + + + + + + + + + + + + + + + + + + + +$ +(12,087 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + F-5 + + + + + + + + + + + + + + +Common Stock + + + + + + + + + + + + + + + + + + + + + + +Common Units + + + + + + + + + + +Additional + +Paid In + +Capital + + + + + + +Receivable + +from + +shareholder + + + +Deferred + +equity + +compensation + + + +Accumulated + +other + +comprehensive + +income (loss) + + + +Total + +Shareholders' + +equity + + + +Total + +comprehensive + +income (loss) + + + + + + + +Accumulated + +Deficit + + + + + + + + + +Retained + +earnings + + + + + + +Units + + + +Amount + + + +Shares + + + +Par Value + + + + + + +Balance at December 31, 2002 +12,775,030 + + +31,228 + + +(38,161 +) + + + + + + + + + + + + +(290 +) + +(1,280 +) + +(129 +) + +(8,632 +) + + + + +Deferred equity compensation +140,625 + + +2,025 + + + + + + + + + + + + + + + + + + + +(2,025 +) + + + + + + + + + + +Equity compensation and other +(1,875 +) + +67 + + + + + + + + + + +598 + + + + + +(13 +) + +1,112 + + + + + +1,764 + + + + + +Exercise of options +154,376 + + +505 + + + + + + + + + + + + + + + + + + + + + + + + + +505 + + + + + +Preferred dividends + + + + + + +(2,712 +) + + + + + + + + + + + + + + + + + + + + + +(2,712 +) + + + + +Preferred accretion + + + + + + +(5,001 +) + + + + + + + + + + + + + + + + + + + + + +(5,001 +) + + + + +Distributions to common unitholders + + + + + + +(23,383 +) + + + + + + + + + + + + + + + + + + + + + +(23,383 +) + + + + +Net income through November 13, 2003 + + + + + + +14,063 + + + + + + + + + + + + + + + + + + + + + + +14,063 + +$ +14,063 + + +Conversion to C corporation +(13,068,156 +) + +(33,825 +) + +55,194 + +13,068,156 + + +13 + + +(21,382 +) + + + + + + + + + + + + + + + + + + + +Proceeds from initial public offering, net + + + + + + + + +8,625,000 + + +9 + + +134,110 + + + + + + + + + + + + + + +134,119 + + + + + +Decrease in shareholder receivable + + + + + + + + + + + + + + + + + + + + +13 + + + + + + + + +13 + + + + + +Net income from November 13, 2003 to December 31, 2003 + + + + + + + + + + + + + + + + + +12,612 + + + + + + + + + + + +12,612 + + +12,612 + + +Amortization of transition adjustment + + + + + + + + + + + + + + + + + + + + + + + + + + +70 + + +70 + + + + + +Foreign currency translation adjustment + + + + + + + + + + + + + + + + + + + + + + + + + + +569 + + +569 + + +569 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Total comprehensive income + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +$ +27,244 + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Balance at December 31, 2003 + + +$ + + +$ + + +21,693,156 + +$ +22 + +$ +113,326 + +$ +12,612 + +$ +(290 +) +$ +(2,193 +) +$ +510 + +$ +123,987 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +See notes to consolidated financial statements + + F-6 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + CONSOLIDATED STATEMENTS OF CASH FLOWS + (dollars in thousands) + + + + + +Year ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + + + + + +Cash flows from operating activities + + + + + + + + + + + +Net income (loss) + +$ +(8,418 +) +$ +(12,064 +) +$ +26,675 + + +Adjustments to reconcile net income (loss) to net cash provided by operating activities: + + + + + + + + + + + + +Deferred taxes + + + + + + + + +(10,095 +) + + +Bad debt expense + + +150 + + +315 + + +482 + + + +Depreciation and amortization of property and equipment + + +2,122 + + +2,742 + + +2,945 + + + +Amortization of goodwill and other intangibles + + +5,692 + + +650 + + +1,316 + + + +Amortization of signing bonuses + + +1,956 + + +1,947 + + +1,622 + + + +Equity based compensation + + +6,735 + + +16,645 + + +1,754 + + + +Equity investment loss + + + + + + + + +51 + + + +Loss (gain) on sale of property and equipment + + +(32 +) + +6 + + +123 + + + +Interest rate swap expense (income) + + +396 + + +(218 +) + +(435 +) + + +Amortization of transition adjustment + + +(164 +) + +93 + + +70 + + + +Deferred rent + + +156 + + +411 + + +565 + + + +Changes in assets and liabilities: + + + + + + + + + + + + + + +Accounts receivable + + +(4,556 +) + +(5,956 +) + +(11,388 +) + + + + +Other current assets + + +(69 +) + +(131 +) + +(1,924 +) + + + + +Accounts payable and other accrued liabilities + + +774 + + +148 + + +(468 +) + + + + +Accrued compensation + + +2,538 + + +3,824 + + +5,502 + + + + + +Deferred revenue + + +203 + + +278 + + +(193 +) + + + + +Signing bonuses and other assets + + +(1,950 +) + +(4,339 +) + +(1,926 +) + + + + +Other liabilities + + +75 + + +75 + + + + + + + + + + + + + + + + + + +Net cash provided by (used in) operating activities + + +5,608 + + +4,426 + + +14,626 + + + + + + + + + + + +Cash flows from investing activities + + + + + + + + + + + + +Business acquisitions + + +(2,852 +) + +(2,863 +) + +(2,498 +) + + +Purchase of property and equipment + + +(3,196 +) + +(2,102 +) + +(1,349 +) + + +Proceeds on sale of property and equipment + + +100 + + +1 + + +2 + + + +Collection (payment) of security deposits on operating leases, + + +228 + + +(121 +) + +1 + + + +Other + + + + + + + + +(87 +) + + + + + + + + + + + + + + +Net cash used in investing activities + + +(5,720 +) + +(5,085 +) + +(3,931 +) + + + + + + + + + + +Cash flows from financing activities + + + + + + + + + + + + +Net proceeds from initial public offering net of acquisition costs + + + + + + + + +134,132 + + + +Repurchases of common units + + +(29 +) + + + + +(3 +) + + +Borrowings under long-term debt agreements + + + + + +5,000 + + + + + + +Borrowings under revolving credit facility + + + + + +19,700 + + +41,400 + + + +Repayments of long-term debt + + +(4,000 +) + +(4,200 +) + +(18,800 +) + + +Repayments under revolving credit facility + + + + + +(18,200 +) + +(42,900 +) + + +Payment of loan fees + + + + + +(129 +) + +(892 +) + + +Exercise of options + + + + + + + + +505 + + + +Redemption of preferred units + + + + + + + + +(40,713 +) + + +Receivables from unitholders + + +7 + + +863 + + +14 + + + +Distributions to common unitholders + + +(200 +) + +(2,861 +) + +(19,407 +) + + +Other + + + + + +(1 +) + + + + + + + + + + + + + + + + + +Net cash provided by (used in) financing activities + + +(4,222 +) + +172 + + +53,336 + + + + + + + + + + + +Effect of exchange rates on changes in cash + + +(40 +) + +(23 +) + +570 + + + + + + + + + + + +Increase (decrease) in cash and cash equivalents + + +(4,374 +) + +(510 +) + +64,601 + + +Cash and cash equivalents, beginning of year + + +7,460 + + +3,086 + + +2,576 + + + + + + + + + + + +Cash and cash equivalents, end of year + +$ +3,086 + +$ +2,576 + +$ +67,177 + + + + + + + + + + + +Supplemental disclosure + + + + + + + + + + + +Cash paid for interest + +$ +2,198 + +$ +1,958 + +$ +1,984 + + + + + + + + + + + +Cash paid for income taxes + +$ +22 + +$ +45 + +$ +153 + + + + + + + + + + + +See notes to consolidated financial statements + + F-7 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + + +1. Basis of Presentation and Operations + +The accompanying consolidated financial statements include the accounts of LECG Corporation (formerly "LECG Holding Company, LLC") and its wholly owned subsidiary, LECG, LLC, +(collectively, the "Company", "Companies" or "LECG"). The Companies were formed as a California limited liability company concurrent with the management buyout on September 29, 2000 of +substantially all of the assets and certain assumed liabilities of LECG, Inc., a wholly owned subsidiary of Navigant Consulting Inc. In November 2003, the Company completed a +merger and exchange transaction immediately prior to completing its initial public offering, in which ownership of LECG, LLC was transferred from LECG Holding Company, LLC to LECG Corporation. + +The +Company provides expert services, including economic and financial analysis, expert testimony, litigation support and strategic management consulting to a broad range of public and private +enterprises. The Company's experts may be either employees of the Company or independent contractors. Services are provided by academics, recognized industry leaders and former high-level +government officials (collectively, "experts") with the assistance of a professional support staff. These services are provided primarily in the United States from the +Company's headquarters in Emeryville, California and its 16 other offices across the country. The Company also has international offices in Argentina, Australia, Canada, New Zealand, South Korea and +the United Kingdom. + +Reclassifications + +Certain amounts have been reclassified to the current period presentation. + +2. Summary of Significant Accounting Policies + +Principles of consolidation + +The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All material intercompany transactions and balances have +been eliminated. + +Use of estimates + +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and +assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and +expenses during the reporting period. Actual results could differ materially from those estimates. + +Fair value + +The carrying amount of cash, accounts receivable and accounts payable approximate their estimated fair values because of the short maturity of these financial instruments. The +estimated fair value of the Company's long-term debt approximates its fair value due to the variable interest rate on the debt. + +Cash and cash equivalents + +Cash and cash equivalents consist principally of money market funds. + +Property and equipment + +Property and equipment is stated at cost, net of accumulated depreciation and amortization and includes costs of improvements to leased properties. Depreciation and +amortization is computed using the straight-line method over the assets estimated useful life or the lesser of the estimated useful life or related lease term. Estimated useful lives +generally range from 3-5 years for computer and + + F-8 + + + +telecommunication equipment, 5 years for furniture, fixtures and other equipment and 3 years for software. + +The +Company's policy is to evaluate its property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. +Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If such asset +is considered to be impaired, the impairment to be recognized would be measured as the difference between the related carrying amount and fair value. No such impairment has been recognized. + +Goodwill + +Goodwill relates to the Company's business acquisitions, reflecting the excess of purchase price over fair value of identifiable net assets acquired. In June 2001, the +Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and +SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, +2001 be accounted for under the purchase method of accounting and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS +No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination whether acquired individually or with a group of other assets. SFAS +No. 142 also addresses the recognition and measurement of goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that goodwill and intangible assets +with indefinite lives will not be amortized, but will be required to be tested at least annually for impairment. + +The +Company adopted the transition provisions of SFAS No. 141 on January 1, 2002. We determined that no amounts previously recognized as goodwill should be reallocated to intangible +assets. Such determination was based upon the fact that the goodwill represented the intellectual capital of the acquired workforce and an acquired workforce may not be recognized as an intangible +asset apart from goodwill. We also adopted SFAS No. 142 on January 1, 2002, with no goodwill impairment indicated. At that date, the Company stopped the amortization of goodwill, with +net carrying value of $21,479,495, that had resulted from the purchases completed prior to the effective date of SFAS No. 142. + +The +Company determined that it has one reporting unit based on the similarity of operations throughout its individual offices. The business acquisitions have been integrated within the structure of +the organization, are not separately distinguishable and do not represent separate reporting units. The Company performs its goodwill impairment test annually as of October 1 by using both a +discounted cash flow approach as well as a market valuation based approach applying certain multiples derived from enterprise values of publicly traded comparable companies. It adopted +October 1 as its date for performing its annual goodwill impairment test to allow sufficient time to schedule and perform the required valuation analysis and record any necessary goodwill +impairment charges prior to its year-end. Based on the results of the test performed as of October 1, 2003, the Company concluded that goodwill was not impaired. + + F-9 + + + +The +changes in the carrying amount of goodwill are as follows: + + + + +Year ended December 31, + + + + + +2002 + + + +2003 + + + + + + +Balance at beginning of year + +$ +21,479,495 + + +22,542,191 + + +Goodwill acquired (see Note 3) + + +1,062,696 + + +1,702,184 + + +Other changes + + + + + +(268,188 +) + +Goodwill amortization + + + + + + + + + + + + + + + +Balance at end of year + +$ +22,542,191 + +$ +23,976,187 + + + + + + + + + +Other changes represent the finalization of initial estimates related to certain assumed liabilities. + +The +following table presents a reconciliation of net income (loss) had goodwill not been amortized pursuant to SFAS No. 142 (in thousands, except per unit information): + + + + +Year ended December 31, + + + + +2001 + + + +2002 + + + +2003 + + +Net income (loss) available to common shares as reported + +$ +(11,669 +) +$ +(15,756 +) +$ +18,963 + +Elimination of goodwill amortization + + +5,503 + + + + + + + + + + + + + + + +Adjusted net income (loss) + +$ +(6,166 +) +$ +(15,756 +) +$ +18,963 + + + + + + + + +Basic earnings (loss) per share: + + + + + + + + + + + +Reported net income (loss) attributable to common shares + +$ +(1.11 +) +$ +(1.41 +) +$ +1.39 + + +Goodwill amortization + + +0.52 + + + + + + + + + + + + + + + +Adjusted basic net income (loss) attributable to common shares + +$ +(0.59 +) +$ +(1.41 +) +$ +1.39 + + + + + + + + +Diluted earnings (loss) per share: + + + + + + + + + + + +Reported net income (loss) attributable to common shares + +$ +(1.11 +) +$ +(1.41 +) +$ +1.17 + + +Goodwill amortization + + +0.52 + + + + + + + + + + + + + + + +Adjusted diluted net income (loss) attributable to common shares + +$ +(0.59 +) +$ +(1.41 +) +$ +1.17 + + + + + + + + +Revenue recognition + +Revenue includes all amounts that are billed or billable to clients, including out-of-pocket costs such as travel and subsistence. Revenues generated by +experts who are employees and those who are independent contractors are presented on a gross basis. + +Revenues +primarily arise from time and material contracts, which are recognized in the period in which the services are performed. The Company also enters into certain performance-based contracts for +which performance fees are dependent upon a successful outcome, as defined by the consulting engagement. Revenues related to performance-based fee contracts are recognized in the period when the +earnings process is complete and collectibility is reasonably assured, generally when our client has received payment as a result of services we performed under the contract. Costs incurred on +contingent contracts are expensed in the period incurred. Revenues are also generated from fixed price contracts which are recognized as the agreed upon services are performed. Such revenues are not a +material component of total revenues. + +Expert +revenues consist of revenues generated by experts who are our employees and revenues generated by experts who are independent contractors. There is no operating, business or other + + F-10 + + + +substantive distinction between our employee experts and our exclusive independent contractor experts. Revenues from independent contractor experts were approximately 11%, 9% and 7% in 2001, 2002 and +2003, respectively. + +A +significant portion of the Company's revenues is generated by a small number of experts. Five experts accounted for approximately 28%, 24% and 19% of revenues in 2001, 2002 and 2003, respectively. + +Deferred revenue + +Deferred revenue consists of retainers paid by customers to the Company. The amounts are recorded as revenue as services are rendered. + +Cost of services + +Costs of services consists of compensation to experts, compensation of professional staff, project costs including reimbursable expenses and fees charged for outside services, +equity-based compensation and signing bonuses. + +The +majority of our experts' compensation is comprised of expert fees and project origination fees. Expert fees represent amounts earned by the experts based on their contractual percentage applied to +revenues generated by their direct work in the period. Project origination fees represent the contractual percentage applied to professional staff revenue recognized on engagements secured by such +experts. Expert fees and project origination fees are accrued in the period in which the associated revenue is recognized. Experts who are compensated under our variable compensation expert model also +may receive a discretionary bonus each quarter. Such bonus is determined based upon 5% of such expert's total compensation each quarter, up to a maximum of $50,000 annually for each expert. The +decision as to whether to pay this discretionary bonus is made on a quarterly basis. Our Board of Directors has delegated this quarterly decision to Dr. Teece, our Chairman and +Mr. Kaplan, our President. Such discretionary bonuses included in costs of services were $1,516,226, $519,234 and $0 in 2001, 2002 and 2003, respectively. The remaining experts' compensation +consists of salary and bonus. Signing bonuses, which represent supplemental payments to attract and retain certain key experts are deferred and amortized over the period for which they are recoverable +from the individual expert, generally two to five years. Deferred signing bonuses included in current assets and other assets were $3,516,860 and $4,140,117 at December 31, 2002 and 2003, +respectively. + +Income taxes + +In connection with the Company's initial public offering, the Company became a C corporation subject to federal and state income taxes. The Company accounts for income taxes in +accordance with SFAS 109 Accounting for Income Taxes, under which deferred assets and liabilities were recognized based upon anticipated future +tax consequences attributable to differences between financial statement carrying values of assets and liabilities and their respective tax bases. A valuation allowance is established to reduce the +carrying value of deferred tax assets if it is considered more likely than not that such assets will not be realized. + +Prior +to the merger on November 13, 2003 of LECG Holdings, LLC operated as a limited liability company ("LLC"). As an LLC, LECG's income or losses were "passed through" to its owners who were +liable for any related income taxes. LECG was subject to an $800 minimum tax and a tax based on total revenues of the Company by the State of California and also certain income taxes related to +foreign jurisdictions. Accordingly, general and administrative expenses include $22,487 and $45,174 of California taxes in the accompanying consolidated financial statements for 2001 and 2002, + + F-11 + + + +respectively. For 2001, 2002 and 2003, the Company distributed $200,000, $2,861,000 and $8,283,000, respectively, to common unitholders towards the payment of tax obligations. + +Concentration of credit risk + +The Company's accounts receivable base consists of a broad range of clients in a variety of industries located throughout the United States and in other countries. The Company +performs a credit evaluation of each of its clients to minimize its collectibility risk and has not required collateral or other security from its clients. + +The +Company provides an allowance for doubtful accounts as follows (in thousands): + + + + +Year ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + + + + + +Balance at beginning of year + +$ +379 + +$ +150 + +$ +315 + + +Charged to costs and expenses + + +150 + + +315 + + +482 + + +Amounts written off + + +(379 +) + +(150 +) + +(315 +) + + + + + + + + + + +Balance at end of year + +$ +150 + +$ +315 + +$ +482 + + + + + + + + + + + +Equity-based compensation + +The Company uses the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to +Employees, for options granted to employees. Accordingly, compensation cost related to option grants to employees is measured as the excess, if any, of the fair value of the +Company's shares at the date of the grant over the option exercise price and such cost is charged to operations over the related option vesting period. SFAS No. 123, Accounting for Stock-Based Compensation, requires that companies record compensation cost for equity-based compensation to non-employees +based on fair values. Accordingly, the Company records compensation cost for options granted to non-employees using a fair value based method over the related option vesting period. + +SFAS +No. 123 requires the disclosure of pro forma net income (loss) and earnings (loss) per share had the Company adopted the fair value method since the Company's inception. Under SFAS +No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely +tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. If the computed values of the Company's stock-based awards to +employees had been + + F-12 + + + +amortized to expense over the vesting period of the awards, net loss (based upon the weighted average assumptions described in Note 7) would have been (in thousands, except per unit +information): + + + + +Year ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + + + + + +Net income (loss) attributed to common shareholders as reported + +$ +(11,669 +) +$ +(15,756 +) +$ +18,963 + + +Add: equity-based employee compensation expense included in net loss + + +34 + + +2,085 + + +1,754 + + +Deduct: total equity-based employee compensation expense determined under fair value based method for all awards + + +(146 +) + +(5,043 +) + +(7,491 +) + + + + + + + + + + +Pro forma net income (loss) + +$ +(11,781 +) +$ +(18,714 +) +$ +13,226 + + + + + + + + + + + +Basic earnings (loss) per unit: + + + + + + + + + + + + +Net income (loss) attributable to common shares as reported + +$ +(1.11 +) +$ +(1.41 +) +$ +1.39 + + + +Net adjustment for fair value based method + + +(0.01 +) + +(0.27 +) + +(0.42 +) + + + + + + + + + + + +Net income (loss) attributable to common shares pro forma + +$ +(1.12 +) +$ +(1.68 +) +$ +0.97 + + +Diluted earnings (loss) per unit: + + + + + + + + + + + + +Net income (loss) attributable to common shares as reported + +$ +(1.11 +) +$ +(1.41 +) +$ +1.17 + + + +Net adjustment for fair value based method + + +(0.01 +) + +(0.27 +) + +(0.36 +) + + +Net income (loss) attributable to common shares pro forma + +$ +(1.12 +) +$ +(1.68 +) +$ +0.81 + + +Net income (loss) per share and share amounts + +Basic net income (loss) per common share is computed by dividing the net income (loss) attributable to common shareholders for the period by the weighted average number of +common shares outstanding during the period. Diluted net income (loss) per common share is computed by dividing the net income (loss) attributable to common shareholders for the period by the weighted +average number of common and common equivalent shares outstanding during the period. Common equivalent shares, composed +of common shares issuable upon the exercise of options, are included in the diluted net income (loss) per common share calculation to the extent these shares are dilutive. + +The +following is a reconciliation of net income (loss) and the number of shares used in the basic and diluted earnings per share computations: + + + + +Year ended December 31, + + + + +2001 + + + +2002 + + + +2003 + + +Net income (loss) attributable to common unitholders + +$ +(11,669 +) +$ +(15,756 +) +$ +18,963 + +Weighted average shares outstanding: + + + + + + + + + + + +Basic + + +10,477,660 + + +11,168,563 + + +13,673,875 + + +Effect of dilutive stock options + + + + + + + + +2,587,341 + + + + + + + + + +Diluted + + +10,477,660 + + +11,168,563 + + +16,261,216 + +Net income (loss) per share: + + + + + + + + + + + +Basic + +$ +(1.11 +) +$ +(1.41 +) +$ +1.39 + + +Diluted + +$ +(1.11 +) +$ +(1.41 +) +$ +1.17 + +The following shares were excluded from the calculation of diluted net income (loss) per share for 2001, 2002 and 2003, as these shares were antidilutive; +2.6 million, 4.1 million and 0.7 million, respectively. + + F-13 + + + +Foreign currency translation + +Assets and liabilities of the Company's non-US subsidiaries that operate in a local currency environment are translated to U.S. dollars at year-end +exchange rates. Income and expense items are translated at weighted-average rates of exchange prevailing during the year. Translation adjustments are recorded in accumulated other comprehensive income +(loss) within Common shareholders' equity. Foreign currency transaction gains and losses are a result of the effect of exchange rate changes on transactions denominated in currencies other than the +functional currency, including U.S. dollars. Gains and losses on those foreign currency transactions are included in determining net income (loss) for the period in which exchange rates change. + +Comprehensive income (loss) + +Comprehensive income (loss) represents net income (loss) plus other comprehensive income (loss) resulting from changes in foreign currency translation. + +Derivative instruments + +Under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, derivatives are recorded on the balance +sheet at fair value. The Company had an $11,000,000 principal interest rate swap that expired on September 30, 2003 (see Note 5). Such swap was entered into to convert variable interest +payments to fixed payments at 6.64%, thus protecting the Company against interest rate increases. The swap was not designated as a hedge because the documentation requirements were not met. The +Company does not hold or issue derivative financial instruments for trading purposes. + +The +estimated fair value of the interest rate swap is based on quoted market prices. The estimated fair value at January 1, 2001, a liability of $256,965, was recorded as a transition +adjustment to other comprehensive income and is amortized into expense over the life of the related debt. Changes in the fair value of the interest rate swap are included in other income (expense). +The fair value of the interest rate swap agreement included in accounts payable and other accrued liabilities at December 31, 2002 was $434,789. + +Segment reporting + +SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes annual and interim +reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas and major customers. The Company operates as one business segment. +Revenues attributable to international activities are $5,085,603, $6,825,850 and $15,158,712 for the years ended December 31, 2001, 2002 and 2003, respectively. Total long-lived +assets of our non-US subsidiaries is not significant. + +3. Business Acquisitions + +Goodwill recognized as a result of our LECG, Inc. (see Note 1) and other acquisitions was attributable to the intellectual capital of the respective acquired +workforce. The acquired businesses consisted almost entirely of experts and professional staff having specialized knowledge of specific markets, regulations and industries. Each of the acquired +businesses is fundamentally dependent on the qualifications, expertise and reputation of the individuals. Therefore, in each acquisition, the excess of purchase price over the net tangible and +intangible assets acquired was attributed to the value of the acquired assembled workforce. The acquired assembled workforce is treated as goodwill under SFAS No. 141. The goodwill was +considered to be "enterprise" goodwill, as the Company determined there was only one reporting unit for the Company. + + F-14 + + + +In +March 2001, the Company acquired 10 experts and 22 professional staff from an unrelated consulting firm for its environmental consulting group in exchange for a $2,000,000 payment and a +promise to pay an additional amount based on the number of such employees retained as of June 30, 2002. Additional payments totaling approximately $845,000 were made in 2002. The total purchase +price of $2,845,000 was recorded as goodwill as of December 31, 2001. + +In +June 2002, the Company acquired 10 experts and 25 professional staff who were formerly partners or employees of Arthur Andersen LLP for its environmental claims consulting group. In +connection with this transaction, the Company paid Arthur Andersen LLP $2,863,000; $1,063,000 was allocated to goodwill and $1,800,000 was allocated to an intangible asset representing Arthur Andersen +LLP's agreement to release its claims to any future payments received by the Company for various ongoing projects. The intangible asset is being amortized over an 18-month period; $650,000 +was amortized in 2002 and $1,150,000 was amortized in 2003. In addition, the Company paid or committed to pay $597,000 in signing bonuses to the recruited group. The signing bonuses are being +amortized over the period during which they could be recovered from the employee if he or she left LECG, which resulted in amortization of $87,000 and $145,000 in 2002 and 2003, respectively, and is +expected to result in amortization of $136,750 in each of 2004, 2005 and $57,188 in 2006. + +In +August 2003, the Company acquired the business and certain assets formerly owned by the Center for Forensic Economic Studies ("CFES"). Four of the five experts (shareholders) and 10 +professional staff, have become employees of the Company. The purchase price was as follows: + + >$2,400,000 +in cash at closing; and + + >$1,600,000 +in annual cash payments in 2004 through 2007, based upon achievement of certain revenue and earnings targets. + +The +net purchase price, including transaction costs of approximately $98,000, was allocated to tangible and intangible assets. The excess of the aggregate purchase price over the estimated fair value +of the net assets acquired was recognized as goodwill. The allocation of the purchase price of $2,498,000 resulted in property and equipment of $96,000, customer-related intangible assets of $600,000 +(18-month amortization), rights to license software under development of $100,000 and goodwill of $1,702,000. + +Additional +goodwill will be recorded in subsequent years if the performance targets are met. + +In +addition, in connection with the acquisition, the Company agreed to: + + >make +annual cash payments of $500,000 in 2004 through 2007 based upon achievement of certain revenue and earnings targets, subject to continued employment of the +four experts; and + + >issue +140,625 restricted shares (valued at a fair market value of $14.40 per share) that vest over 5 years, subject to continued employment of the four +experts. + +The +Company will record compensation expense, in future years, based upon continued employment of the individuals when earned. + + F-15 + + 4. Property and Equipment + +Property and equipment consists of the following (in thousands): + + + + +December 31, + + + + + +2002 + + + +2003 + + + + + + +Computer and telecommunication equipment + +$ +4,660 + +$ +4,878 + + +Furniture, fixtures and other equipment + + +3,870 + + +4,396 + + +Software + + +1,722 + + +2,091 + + +Leasehold improvements + + +1,205 + + +1,255 + + + + + + + + + + +Total + + +11,457 + + +12,620 + + +Less: accumulated depreciation and amortization + + +(5,320 +) + +(8,114 +) + + + + + + + + + +Total + +$ +6,137 + +$ +4,506 + + + + + + + + + +5. Borrowing Arrangements + +Revolving credit facility + +As of December 31, 2003, the Company's revolving credit facility provides for maximum borrowings of $18,000,000, of which $2,000,000 are available for letters of credit. +Borrowings and letters of credit under this facility are limited to 80% of eligible receivables. The revolving credit facility is due March 31, 2006. As of December 31, 2003, the Company +had no outstanding borrowings on this facility. The Company has a letter of credit outstanding in the amount of $426,780. The rate in effect for the revolving credit facility at December 31, +2003 was 4.75%. + +Borrowings +under the revolving credit facility are collateralized by substantially all of the assets of the Company. Interest is due quarterly at the banks' Base Rates or LIBOR, plus an Applicable +Margin, as defined and the revolving credit facility contains certain restrictive covenants including the maintenance of minimum financial ratios and restrictions related to levels of capital +expenditures, acquisitions and distributions to unitholders. + +The Company repaid the outstanding balance of $15,500,000 of its term loan in November 2003. Consequently, $412,000 of unamortized loan fees were recognized as interest expense. + +As +of December 31, 2002, the Company had a Credit Agreement with a lender group comprised of two banks. This agreement included a revolving credit facility, a letter of credit facility, and a +term loan facility as described below. + +Revolving credit facility + +The revolving credit facility provided for maximum revolving credit borrowings of $5,000,000, subject to certain levels of letter of credit commitments. The balance outstanding +on this revolving credit +facility was $1,500,000 at December 31, 2002. The rate in effect for the revolving credit facility at December 31, 2002 was 6.00%. All amounts under this facility were repaid on +March 13, 2003. + +Letter of credit facility + +The letter of credit facility provided for letters of credit to a maximum of $500,000 limited to the extent such letters of credit would not cause the Company to exceed the +limits of its revolving credit facility. The Company had a letter of credit outstanding as of December 31, 2002 in the amount of $426,780 in lieu of a deposit for the rental of office space. + + F-16 + + + +Term loan facility + +The term loan facility, as amended, provided for total borrowings of $27,000,000. The balance as of December 31, 2002 was $18,800,000. Borrowings under these facilities +were collateralized by substantially all of the assets of the Company with interest due quarterly at the banks' Base Rates or LIBOR, plus an Applicable Margin, as defined. The rate in effect for the +term borrowings as of December 31, 2002 (except as described below) was 6.00%. All amounts under this facility were repaid on November 19, 2003. + +Interest rate swap + +The Company entered into an $11,000,000 principal interest rate swap that effectively converted the floating rate LIBOR based payments to fixed payments at 6.64%. This +agreement expired in September 2003. + +Debt covenants + +Under the Credit Agreement, the Company was required to comply with certain restrictive covenants including the maintenance of certain financial ratios and levels of earnings +and restrictions related to levels of capital expenditures, acquisitions and distributions to shareholders. The Company was in compliance with the financial covenants in 2002. + +6. Redeemable Class A Preferred Units and Common Shares + +Redemption of preferred units + +In 2000, the Company sold investment units, each consisting of a combination of Redeemable Class A Preferred ("Preferred") and Common units of ownership interest at a +ratio of 326.1 Common units for each unit of Preferred. In total, the Company realized related proceeds of $31,102,873 (net of $805,229 of equity issuance costs) and issued 31,797 Preferred and +10,370,128 Common units. On a per unit basis, the Preferred and Common units were issued with stated values of $1,000 and $0.01, respectively and were recorded at their estimated fair values of $815 +and $0.58, respectively. The Company was accreting the Preferred units to their stated value with corresponding reductions in accumulated deficit over the period ending December 31, 2005. When +combined with the preferred unit 8% cumulative annual dividend, this accretion results in an effective annual preferred unit yield of 12.6%. In November 2003, following the Company's initial +public offering and in accordance with the redemption terms of the Preferred units, the Company paid $40,712,619 to Preferred unitholders to redeem all of the outstanding and accrued Preferred units. + +Distributions to unitholders + +The Company also paid $11,123,723 in 2003 of previously taxed income ("PTI") of LECG Holdings LLC to common unitholders of record on November 13, 2003. The final PTI +distribution of approximately $3.0 million is expected to be paid in 2004, as well as an additional $1.3 million for estimated taxes of the LLC for the period from January 1 to +November 13, 2003. + +Common shareholders + +Common shareholders have voting rights entitling them to one vote for each share held of record on all matters submitted to a vote of the shareholders. + + F-17 + + + +7. Equity-Based Compensation + +Equity-based compensation expense + +The Company records equity-based compensation related to certain restricted common shares and non-qualified options, both of which have vesting criteria based on +either time, +performance or both, as well as common shares issued in exchange for non-recourse notes. Equity-based compensation expense was as follows (in thousands): + + + + +Year ended December 31, + + + + +2001 + + + +2002 + + + +2003 + + +Options + + + + + + + + + + + +Employees time and performance vesting + +$ +34 + +$ +806 + +$ +315 + + +Employees accelerated vesting + + + + + +986 + + +585 + + +Non-employees time and performance vesting + + +1,659 + + +2,432 + + +25 + + +Non-Employees accelerated vesting + + + + + +2,264 + + + + +Restricted common shares: + + + + + + + + + + + +Employees time and performance vesting + + +172 + + +1,058 + + +242 + + +Employees accelerated vesting + + + + + +1,981 + + + + + +Non-employees time and performance vesting + + +3,298 + + +2,817 + + +5 + + +Non-Employees accelerated vesting + + + + + +2,337 + + + + + +Common shares issued in exchange for non-recourse notes + + +1,572 + + +1,964 + + +582 + + + + + + + + + +Total equity based compensation expense + +$ +6,735 + +$ +16,645 + +$ +1,754 + + + + + + + + +The Company accounted for the December 2002 acceleration of vesting of options granted to employees and restricted shares issued to employees subject to +vesting, discussed below, in accordance with APB 25, which provides that any measured compensation cost from an award should be recognized as an expense over the periods in which the employee performs +the services to earn the award. Accordingly, the effect of the acceleration was to expense in December 2002 the unamortized deferred compensation related to the options and restricted shares, +since no further services will be required to earn the award. + +In +addition, in accordance with FIN 44, "Accounting for Certain Transactions involving Stock Compensation," the modification to accelerate the vesting +of a fixed award effectively results in the renewal for that award if, after the modification, an employee is able to exercise an award that, under the original terms, would have expired +unexercisable. Accordingly, in the event that an employee terminates prior to the time that the options or restricted units would have vested under the original terms, the Company will incur +additional compensation expense based on the intrinsic value at the time of the acceleration of vesting, reduced by the amounts previously expensed as a result of the acceleration. As of +December 31, 2003, there were no terminations that would have resulted in additional equity-based compensation. + +The +Company accounted for the December 2002 acceleration of vesting of options granted to non employees and restricted stock issued to non employees subject to vesting, discussed below, in +accordance with SFAS 123 and EITF 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with +Selling, Goods or Services." The acceleration established the measurement date for previously unvested awards and units as the non employees' performance was complete and no +additional services were required. The Company recorded compensation expense in December 2002, based on the then fair value of the award on the + + F-18 + + + +acceleration date less the cumulative compensation for the award that had been previously recorded. There will be no further accounting in subsequent periods related to whether the award would have +vested under the original terms. + +2000 Incentive Plan + +The Company's 2000 Incentive Plan was replaced by the 2003 Stock Option Plan in November 2003 following the completion of the Company's initial public offering. Under +the 2000 Incentive Plan, options to purchase common stock were granted to employee and non-employee. Compensation cost related to option grants to employees is measured as the excess, if +any, of the fair value of the underlying unit at the date of grant over the exercise price, and is amortized on a straight-line basis over the vesting period. Compensation cost for +employee grants was $34,496, $806,127 and $314,969 for 2001, 2002 and 2003, respectively. + +Compensation +cost related to option grants to non-employees is measured based upon the fair value as determined by the Black-Scholes method (using the assumptions in the table at the end +of Note 7), and is amortized on a graded-vesting basis over the vesting period. Compensation cost related to non-employee grants was $1,658,848, $2,431,940 and $24,978 for 2001, +2002 and 2003, respectively. The awards are treated as nonqualified stock options and are generally granted with 10-year terms and 4-year vesting periods. + +In +December 2002, the Company accelerated the vesting for 846,792 nonqualified options. The options are subject to lock-up agreements that prohibit the common units that would be +issued as the result of the exercise of options, to be sold at a date earlier than what would have been allowed had the vesting of the restricted units or the options not been accelerated. Total +compensation expense recognized in 2002 associated with the acceleration of vesting for the options was $3,249,342. In the event that an employee terminates prior to the time that the options would +have vested under the original terms, the Company would incur additional expense based on the fair value of the underlying units at the time of the accelerated vesting reduced by amounts previously +recognized as expense. As of December 31, 2003, there were no terminations that would have resulted in additional equity-based compensation. + +In +December 2003, the vesting for 937,500 options issued in October 2001 to two officer directors was accelerated, in accordance with the terms of the option agreements, as described +later in this footnote. As a result of the acceleration, the Company recognized equity-based compensation of $585,052. + +2003 Stock Option Plan + +The Company has a 2003 Stock Option Plan (the "Stock Option Plan"), under which options may be granted to employees and non-employee experts to purchase, in the +aggregate, up to 2,500,000 common shares. The Stock Option Plan provides for increases in the number of shares available for issuance on the first day of each year beginning with fiscal year 2004, +equal to the lesser of: + + >4% +of the outstanding shares of common stock on the first day of the fiscal year; + + >1,250,000 +shares; or + + >a +lesser amount as may be determined by the Board of Directors. + +The +Board of Directors determined there will be no increases to the shares available for issuance for fiscal year 2004. There were 2,490,625 shares available to be issued under the Stock Option Plan +as of December 31, 2003. + + F-19 + + + +The +Company had the following option activity under the Incentive Plan and Stock Option Plan: + + + + +Options + + + +Weighted + +average + +exercise price + + +Outstanding at January 1, 2001 + +927,673 + +$ +2.83 + +Granted in 2001: + + + + + + + +Granted with exercise price greater than fair market value (weighted average fair value of $0.70 per share) + +389,179 + +$ +3.07 + + +Granted with exercise price less than fair market value (weighted average fair value of $3.68 per share) + +1,404,844 + +$ +4.58 + + +Canceled + +(77,868 +) +$ +3.07 + + + + + + + + + +Outstanding at December 31, 2001 + +2,643,828 + +$ +3.79 + + + + + + + + +Granted in 2002: + + + + + + + +Granted with exercise price greater than fair market value (weighted average fair value of $5.29 per share) + +675,000 + +$ +15.81 + + +Granted with exercise price less than fair market value (weighted average fair value of $5.29 per share) + +656,312 + +$ +7.55 + + +Canceled + +(24,055 +) +$ +3.07 + + +Exercised + +(30,762 +) +$ +0.02 + + + + + + + + + +Outstanding at December 31, 2002 + +3,920,323 + +$ +6.53 + + + + + + + + +Granted in 2003: + + + + + + + +Granted with exercise price greater than fair market value (weighted average fair value of $8.40 per share) + +879,548 + +$ +15.97 + + +Granted with exercise price equal to fair market value (weighted average fair value of $13.23 per share) + +9,375 + +$ +20.66 + + +Canceled + +(70,425 +) +$ +9.08 + + +Exercised + +(154,350 +) +$ +3.07 + + + + + + + + + +Outstanding at December 31, 2003 + +4,584,471 + +$ +8.44 + + + + + + + + +Options available for future grants at December 31, 2003 were 2,490,625. + +The +following table summarizes information as of December 31, 2003 concerning currently outstanding and exercisable options: + +Options outstanding + + + + + + + +Options exercisable + +Range of + +exercise + +prices + + + + + + +Weighted average + +remaining + +contractual life + +(years) + + + + + + +Number + +outstanding + + + +Weighted average + +exercise price + + + +Number + +exercisable + + + +Weighted average + +exercise price + + +$0.01 + +39,551 + +6.75 + +$ +0.01 + +39,551 + +$ +0.01 + +$3.07 + +1,497,373 + +6.75 + +$ +3.07 + +1,257,976 + +$ +3.07 + +$5.33 + +937,500 + +7.83 + +$ +5.33 + +937,500 + +$ +5.33 + +$8.00 + +588,468 + +8.28 + +$ +8.00 + +448,788 + +$ +8.00 + +$13.50 to 20.66 + +1,521,579 + +9.16 + +$ +16.01 + +286,380 + +$ +15.98 + + + + + + + + + + + + + + + + + +4,584,471 + +8.14 + +$ +8.44 + +2,970,195 + +$ +5.46 + + + + + + + + + + + + + + + + F-20 + + + +There were 261,956 and 1,596,603 options exercisable with weighted average exercise prices of $2.82 and $5.68 at December 31, 2001 and 2002, +respectively. + +Included +in the option tables above are 937,500 options for common shares granted in October 2001 to two officer directors of the Company. The options vested in December 2003 in +accordance with the terms of the respective options agreements that called for the acceleration of vesting upon an initial public offering of the Company's securities that resulted in the preferred +unitholders achieving a return on their investment in excess of a defined threshold, the options would fully vest. + +Restricted common shares + +In accordance with a Buy Sell Agreement between the Company's shareholders dated September 29, 2000, the Company issued restricted common units to employees and +non-employees during the period from October 1, 2000 through December 31, 2001 at a price of $0.01 per share. Restricted common shares vest over four years. Vested and +unvested restricted units are subject to repurchase by the Company in the event of the termination of the shareholder's employment or consulting relationship with the Company, with the exception that +vested units will not be subject to repurchase following an initial public offering of the Company's equity securities under the Securities Act of 1933. Unvested units are subject to repurchase at +$0.01 and vested units are subject to repurchase at the estimated fair market value. + +In +August 2003, the Company issued 140,625 restricted shares at a fair market value of $14.40 per unit, in conjunction with its acquisition of CFES (see Note 3.) The Company recorded +deferred equity compensation of $2,025,000, which will be amortized over a 5-year vesting period. + +Restricted +common shares issued to employees are subject to fixed plan accounting. The Company records deferred compensation at the time the units are issued based on the intrinsic value of the unit. +Deferred compensation is amortized to expense on a straight-line basis through 2004. The Company amortized $172,335, $1,058,327 and $242,159 in 2001, 2002 and 2003, respectively. + +The +vesting of the restricted common shares issued to non-employees was accelerated in December 2002. For 2001 and 2002, compensation expense relating to restricted common shares +issued to non-employees that are subject to time vesting only is calculated on a graded-vesting basis. Compensation expense relating to restricted common shares issued to +non-employees that are subject to time and performance vesting is recorded using variable plan accounting. Both approaches use the fair value of the shares as determined by the Black- +Scholes method (using the weighted average assumptions appearing in the table at the end of this note.) The Company incurred expenses relating to restricted common shares held by +non-employees of $3,297,289, $2,817,458 and $4,498 in 2001, 2002 and 2003, respectively. + +In +December 2002, the Company's Board of Directors accelerated the vesting for 1,025,679 restricted common shares. The shares are subject to lock-up agreements that prohibit the +sale of such shares at a date earlier than what would have been allowed had the vesting of the shares not been accelerated. Total compensation expense recognized in 2002 associated with the +acceleration of vesting for the restricted common shares was $4,318,347. In the event that an employee terminates prior to the time that the restricted common shares would have vested under the +original terms, the Company would incur additional expense based on the fair value of the underlying shares at the time of the accelerated vesting reduced by amounts previously recognized as expense. + + F-21 + + + +The +Company had the following restricted common share activity: + +Outstanding at January 1, 2001 + +2,465,859 + + +Repurchased at $3.07 per share + +(8,965 +) + +Repurchased at $0.01 per share + +(145,254 +) + + + + + + +Outstanding at December 31, 2001 + +2,311,640 + + +Issued at $4.48 per share + +62,500 + + + + + + + +Outstanding at December 31, 2002 (2,065,393 shares vested) + +2,374,140 + + +Issued at $14.40 per share + +140,625 + + +Repurchased at $0.01 per share + +(1,874 +) + + + + + + +Outstanding at December 31, 2003 (2,217,949 shares vested) + +2,512,891 + + + + + + + +Receivables from shareholders + +In 2000, two members of the Company's Board of Directors borrowed on a non-recourse basis a total of $750,000 from the Company in order to purchase preferred and +common shares. The loans were repaid in 2002. In 2002, a shareholder borrowed $280,000 on a non-recourse basis in order to purchase restricted common shares. This note is outstanding as of +December 31, 2003. The non-recourse nature of these notes resulted in equity compensation subject to variable plan accounting throughout the period that the notes were outstanding. +The Company incurred $1,572,392, $1,963,505 and $581,966 of equity compensation associated with the non-recourse notes for 2001, 2002 and 2003, respectively + +The +following weighted average assumptions are used in conjunction with the Black-Scholes method to determine compensation expense for options and restricted shares issued to non-employees +and for the pro forma effect of applying FAS 123 to measure compensation expense for options and restricted shares issued to employees: + + + + +Year ended December 31, + + + + + +2001 + + + +2002 + + + +2003 + + + + + + +Dividend yield + +None + +None + +None + + +Volatility + +60.0 +% +70.0 +% +70.0 +% + +Risk-free interest rate + +4.6 +% +2.8 +% +2.8 +% + +Expected term, in years + +5.0 + +5.0 + +5.0 + + +2003 Employee Stock Purchase Plan + +In November 2003, the Company established an employee stock purchase plan ("ESPP") under which eligible employees may purchase a limited number of shares of the +Company's common stock at a discount of up to 15% of the market value at certain plan-defined dates. The board of directors authorized 950,000 shares of common stock for issuance under the +ESPP, which also provides for annual increases in the number of shares available for issuance on the first day of each fiscal year, equal to the lesser of: (1) 1.5% of the outstanding shares of +our common stock on the first day of the fiscal year; (2) 500,000 shares; or (3) a lesser amount as determined by the board of directors. No shares were issued under the ESPP in 2003. + + F-22 + + 8. Commitments and Contingencies + +The Company leases its office facilities and certain equipment under non-cancelable operating lease arrangements expiring on various dates through 2010. Such leases +include fixed or minimum payments plus, in some cases, scheduled base rent increases over the term of the lease and additional rents based on the Consumer Price Index. Certain leases provide for +monthly payments of real estate taxes, insurance and other operating expenses applicable to the property. Future minimum annual lease payments are as follows (in thousands): + +Year ending December 31, + + + + +2004 + +$ +7,712 + +2005 + + +7,179 + +2006 + + +6,854 + +2007 + + +6,569 + +2008 + + +5,753 + +Thereafter + + +10,044 + + + + + +Total + +$ +44,111 + + + + +Rent expense was $5,573,559, $7,447,891 and $7,358,864 for 2001, 2002, and 2003, respectively, + +On +September 29, 2000, the Company executed an Asset Purchase Agreement (the "Agreement") with Navigant Consulting, Inc. ("Navigant"). Pursuant to the Agreement, the Company could be +contingently liable for certain additional purchase price amounts. The two contingent purchase price amounts aggregate to a maximum of $10,000,000. The first such contingent amount was measured at +September 29, 2001 and equaled the excess of $5,000,000 over the sum of (i) certain Excluded Expert Fees, as defined and (ii) the aggregate of each individual value amount +assigned to specific LECG personnel, to the extent such individuals who did not have an employment, consulting, contracting or other relationship with the Company, leave the Company before +September 29, 2001. Navigant asserts that substantially the entire first contingent amount is to be paid by the Company. Based on the actual number of such individuals who did not have such a +relationship with the Company on September 29, 2001, management believes that Navigant's assertion is without merit. Amounts paid, if any, would increase the purchase price and result in +additional goodwill. + +The +second contingent purchase price amount, to a maximum of $5,000,000, was potentially payable at any time prior to September 29, 2003, if certain specified individuals become employees or +are otherwise retained by or affiliated with the Company as an employee, officer, independent contractor or agent before that date without complying with the terms of the Agreement. Management did not +hire these individuals nor does it expect to be liable for the contingent payment. Amounts paid, if any, would increase the purchase price and result in additional goodwill. + +In +March 2002, Navigant asserted that the Company failed to comply with certain terms of the Agreement pertaining to employing certain former employees of Navigant. Management believes that +Navigant's assertion is without merit. + +In +addition, if the Company had consummated or entered into a written agreement, letter of intent or written understanding for an asset sale, an IPO or similar transaction prior to +September 29, 2001 (a "Transaction"), the Company would be required to pay an amount to Navigant equal to the excess of "Buyer Value", as defined in the Agreement, over the purchase price paid +to Navigant by the Company. There is no restriction on the Company's ability to engage in discussions regarding a Transaction so long as no written agreement, letter of intent or understanding is +entered into or + + F-23 + + + +reached. In March 2002, Navigant advised the Company that it was reserving all rights with respect to this provision of the Agreement. The Company did not enter into a written agreement, +letter of intent or written understanding for a Transaction prior to September 29, 2001 and therefore does not expect that the Company will be liable for any amounts under this provision. +Amounts paid, if any, would increase the purchase price and result in additional goodwill. + +The +Company is a party to certain legal proceedings arising out of the ordinary course of business, the outcomes of which individually or in the aggregate, in the opinion of management, would not have +a material adverse effect on our business, financial position or results of operations. + +9. Income taxes + +As a result of our conversion from a nontaxable limited liability corporation to a taxable C corporation as of the November 13, 2003 initial public offering, and +in accordance with Statement of Financial Accounting Standards No. 109, the Company established beginning balances in its deferred tax assets and liabilities. Accordingly, the Company +recognized a tax benefit of $10.1 million, offset by $500,000 provision for foreign income taxes for the year ended December 31, 2003. The components of the benefit for income taxes for +2003 are as follows (in thousands): + +Current: + + + + + +Federal + +$ + + + +State + + + + + +Foreign + + +482 + + + + + + + + +Total current provision + + +482 + + +Deferred: + + + + + +Federal + + +(8,033 +) + +State + + +(2,050 +) + +Foreign + + +(12 +) + + + + + + + +Total deferred benefit + + +(10,095 +) + + + + + + +Total benefit for income taxes + +$ +(9,613 +) + + + + + + +A reconciliation of the statutory federal income tax rate to the Company's effective tax rate for 2003 is as follows: + +Tax at U.S. statutory rate + +35.0 +% + +Earnings from nontaxable limited liability company through November 13, 2003 + +(29.6 +) + +Foreign earnings + +2.1 + + +State tax expense + +1.2 + + +Benefit from conversion from a nontaxable limited liability company to a taxable C corporation + +(65.1 +) + + + + + + +Effective tax rate + +(56.4 +)% + + + + + + + F-24 + + + +At December 31, components of deferred tax assets and liabilities are as follows (in thousands): + +Deferred tax assets: + + + + + +Accrued compensation and related expenses + +$ +2,293 + + +Equity-based compensation + + +4,340 + + +Net operating losses + + +3,612 + + +Depreciation and amortization + + +478 + + +Foreign tax credit + + +90 + + + + + + + + + + +10,813 + + +Deferred tax liabilities: + + + + + +State taxes + + +(718 +) + + + + + + +Net deferred tax asset + +$ +10,095 + + + + + + + +The Company has not provided any valuation allowance as it believes the realization of its deferred tax assets is more likely than not. This determination is +primarily based upon our expectation that future operations will be sufficiently profitable to utilize the operating loss carryforwards and other deferred tax assets. As of December 31, 2003, +the Company had net operating losses of approximately $8.5 million for federal, which expire in 2024, and $7.4 million for state tax reporting purposes, which expire in 2014. As of +December 31, 2003, the Company had tax credits of approximately $90,000, which expire in 2009. + +10. 401(k) Plan + +The Company has a 401(k) Plan under which all employees are immediately eligible. Company matching contributions are at the discretion of management. The Company contributed +$685,787, $831,961 and $767,967 to the 401(k) Plan for 2001, 2002, and 2003, respectively. + +11. Related Party Transactions + +The Company entered into agreements on September 29, 2000 with two officer directors entitling them to $750,000, in the aggregate, of compensation related to services +rendered in connection with our management buyout. Such amount has been earned and is not contingent on continued employment with LECG. Accordingly, $750,000 was expensed in the fiscal period ended +December 31, 2000. Such amount is not payable until permitted under our credit facility and we have achieved operating cash flows (defined as earnings before interest, taxes, depreciation and +amortization) of at least $20 million in any fiscal year. The amount due is subordinate to any amounts owed to any senior or secondary lenders and accrues interest at the rate of 10% per annum +until paid. The amount due including interest due to the executives, included in other long-term liabilities at December 31, 2002, was $918,750, and included in current liabilities +at December 31, 2003 was $993,750. In February 2004, we paid Dr. Teece and Mr. Kaplan $669,109 and $334,555, respectively, to satisfy this obligation. + +The +Company periodically borrowed funds from an officer director at varying amounts up to $2,000,000 during 2002. One other member of the Board of Directors also loaned the Company $500,000 during +fiscal 2002. There were no amounts due on these commitments at December 31, 2002. + +The +Company entered into expert agreements with Walter H.A. Vandaele, a director, David Scheffman, a director, David J. Teece, the Chairman of the Board, and David P. Kaplan, the President and a +director. Pursuant to such agreements, each individual provides expert services on the Company's + + F-25 + + + +behalf in consideration for cash payment. Pursuant to these agreements, the Company paid David J. Teece, David P. Kaplan and Walter H.A. Vandaele $2,329,172, $1,832,146 and $1,224,263, respectively, +during 2001, for expert services and project origination fees. During 2002, the Company +paid David J. Teece, David P. Kaplan and Walter H.A. Vandaele $1,508,607, $2,451,058 and $2,068,500, respectively, pursuant to these agreements for expert services and project origination fees. During +2003, the Company paid David J. Teece, David P. Kaplan, David Scheffman and Walter H.A. Vandaele $1,800,385, $2,211,336, $191,308 and $1,647,026, respectively, pursuant to these agreements for expert +services and project origination fees. + +12. Subsequent Events + +On March 8, 2004, we acquired the business (including certain assets, five experts, who were equity owners and professional staff) of Economic Analysis, LLC, a company +providing expert services involving complex business litigation and regulatory matters. The purchase price was comprised of $15.4 million paid in cash, and the issuance of 50,819 shares of +common stock with a fair market value of $1.0 million. The allocation of purchase price to net assets, intangibles and goodwill has not yet been determined. In addition, based upon achievement +of certain revenue and profitability targets, the Company is required to make earn out payments of up to $2.6 million per year for three years and additional payments of up to +$2.0 million if certain revenue targets are met. Additional purchase price will be recorded in subsequent years, if the performance targets are met. + +In +March 2004, we entered into a 15-year lease for office space for our London UK operations. Average annual lease payments are approximately $1.3 million. Lease payments are +subject to increase based on periodic market value assessments. We have the option to terminate the lease agreement after 10 years with no penalty. + + F-26 + + + +13. Quarterly Results of Operations (Unaudited) + +The following table sets forth selected unaudited quarterly operating information for each of the eight quarters during the period from January 1, 2002 to +December 31, 2003. Results for any fiscal quarter are not necessarily indicative of results for the full year or for any future quarter. The comparability of results for 2002 and 2003 is +impacted by the Company's initial public offering and conversion to a C corporation in November 2003, significant equity-based compensation in 2002 due to the acceleration of vesting of +certain options and restricted stock and costs of the postponed offering in 2002. + +Consolidated statement of operations data + +(dollars in thousands, except per share data) + + + + +Quarter ended + + + + + +March 31 + + + +June 30 + + + +September 30 + + + +December 31 + + + + + + +Fiscal year 2003 + + + + + + + + + + + + + + +Revenues + +$ +38,800 + +$ +41,432 + +$ +41,551 + +$ +43,811 + + +Gross profit + + +12,527 + + +12,940 + + +14,193 + + +13,546 + + +Operating income + + +3,586 + + +4,880 + + +5,605 + + +5,042 + + +Income before income tax benefit + + +2,839 + + +4,465 + + +5,001 + + +4,757 + + +Net income + + +2,839 + + +4,465 + + +5,001 + + +14,370 +(1) + +Accrued preferred dividends and accretion of preferred units + + +1,014 + + +1,045 + + +1,076 + + +4,577 + + +Net income attributable to common shares + +$ +1,825 + +$ +3,420 + +$ +3,925 + +$ +9,793 + + +Net income per share + + + + + + + + + + + + + + + +Basic + +$ +0.15 + +$ +0.27 + +$ +0.31 + +$ +0.57 + + + +Diluted + +$ +0.12 + +$ +0.23 + +$ +0.26 + +$ +0.49 + + +Fiscal year 2002 + + + + + + + + + + + + + + + + + + + + + + + + + + + +Revenues + +$ +28,569 + +$ +32,285 + +$ +34,758 + +$ +38,092 + + +Gross profit + + +6,645 + + +7,174 + + +8,575 + + +4,582 + + +Operating income (loss) + + +(225 +) + +(1,832 +) + +(1,701 +) + +(5,416 +) + +Net income + + +(500 +) + +(2,457 +) + +(2,616 +) + +(6,491 +) + +Accrued preferred dividends and accretion of preferred units + + +874 + + +900 + + +934 + + +984 + + +Net income (loss) attributable to common shares + +$ +(1,374 +) +$ +(3,357 +) +$ +(3,350 +) +$ +(7,475 +) + +Net income (loss) per share + + + + + + + + + + + + + + + +Basic + +$ +(0.13 +) +$ +(0.31 +) +$ +(0.30 +) +$ +(0.64 +) + + +Diluted + +$ +(0.13 +) +$ +(0.31 +) +$ +(0.30 +) +$ +(0.64 +) + +(1) Includes income tax benefit of $9,613 from conversion from nontaxable LLC to taxable C corporation in connection with the November 13, 2003 initial public +offering. + + F-27 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + CONDENSED CONSOLIDATED BALANCE SHEETS + (dollars in thousands, except share data) + + + + + +December 31, + +2003 + + + +September 30, + +2004 + + + + + + + + + +(unaudited) + + + + +Assets + + + + + + + + +Current assets: + + + + + + + + + +Cash and cash equivalents + +$ +67,177 + +$ +24,142 + + + +Accounts receivable, net of allowance of $482 and $370 + + +46,708 + + +72,774 + + + +Prepaid expenses + + +2,708 + + +3,290 + + + +Deferred tax assets + + +9,802 + + +8,803 + + + +Current portion of signing bonuses and other current assets + + +3,868 + + +10,390 + + + + + + + + + + + +Total current assets + + +130,263 + + +119,399 + + +Property and equipment, net + + +4,506 + + +6,231 + + +Goodwill + + +23,976 + + +53,397 + + +Other intangible assets + + +533 + + +836 + + +Long-term portion of signing bonuses and other assets + + +3,864 + + +17,221 + + + + + + + + + +Total assets + +$ +163,142 + +$ +197,084 + + + + + + + + + +Liabilities and stockholders' equity + + + + + + + + + + + + + + + +Current liabilities: + + + + + + + + + +Accounts payable and other accrued liabilities + +$ +5,733 + +$ +10,773 + + + +Accrued compensation + + +29,270 + + +33,134 + + + +Amounts due for business acquisitions current portion + + + + + +2,980 + + + +Deferred revenue + + +732 + + +1,241 + + + +Distributions payable + + +3,398 + + + + + + + + + + + + + + +Total current liabilities + + +39,133 + + +48,128 + + +Amounts due for business acquisitions long-term + + + + + +2,000 + + +Other long-term liabilities + + +22 + + +3,859 + + +Stockholders' equity: + + + + + + + + + + + + + + + +Common stock, $.001 par value, 200,000,000 shares authorized, 21,693,156 shares outstanding at December 31, 2003 and 22,439,134 shares outstanding at September 30, 2004 + + +22 + + +22 + + +Additional paid-in capital + + +113,326 + + +119,751 + + +Receivable from stockholder + + +(290 +) + + + + +Deferred equity compensation + + +(2,193 +) + +(1,727 +) + +Accumulated other comprehensive income + + +510 + + +465 + + +Retained earnings + + +12,612 + + +24,586 + + + + + + + + + + + +Total stockholders' equity + + +123,987 + + +143,097 + + + + + + + + + +Total liabilities and stockholders' equity + +$ +163,142 + +$ +197,084 + + + + + + + + + +See notes to interim condensed consolidated financial statements + + F-28 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + CONDENSED CONSOLIDATED STATEMENTS OF INCOME + (in thousands, except per share data) + + + + + +Nine months ended September 30, + + + + + +2003 + + + +2004 + + + + + + + + + +(unaudited) + + + + +Revenues + +$ +121,783 + +$ +152,847 + + +Cost of services: + + + + + + + + + +Compensation and project costs + + +(81,725 +) + +(101,121 +) + + +Equity-based compensation (expense) income + + +(398 +) + +73 + + + + + + + + + +Total cost of services + + +(82,123 +) + +(101,048 +) + + + + + + + + +Gross profit + + +39,660 + + +51,799 + + +Operating expenses: + + + + + + + + + +General and administrative expenses + + +(22,360 +) + +(29,005 +) + + +Depreciation and amortization + + +(3,229 +) + +(2,677 +) + + + + + + + + +Operating income + + +14,071 + + +20,117 + + + +Interest income + + +30 + + +251 + + + +Interest expense + + +(1,942 +) + +(183 +) + + +Other income (expense), net + + +146 + + +(27 +) + + + + + + + + +Income before income tax + + +12,305 + + +20,158 + + +Provision for income taxes + + + + + +(8,184 +) + + + + + + + + +Net income + + +12,305 + + +11,974 + + +Accrued preferred dividends and accretion of preferred stock + + +(3,135 +) + + + + + + + + + + + +Net income available to common shares + +$ +9,170 + +$ +11,974 + + + + + + + + + +Net income per share: + + + + + + + + + + + + + + + + +Basic + +$ +0.73 + +$ +0.55 + + + +Diluted + +$ +0.61 + +$ +0.51 + + +Share amounts: + + + + + + + + + +Basic + + +12,492 + + +21,725 + + + +Diluted + + +15,034 + + +23,333 + + +See notes to interim condensed consolidated financial statements + + F-29 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS + (dollars in thousands) + + + + + +Nine months ended September 30, + + + + + +2003 + + + +2004 + + + + + + + + + +(unaudited) + + + + +Cash flows from operating activities + + + + + + + + +Net income + +$ +12,305 + +$ +11,974 + + + +Adjustments to reconcile net income to net cash provided by (used in) operating activities: + + + + + + + + + +Bad debt expense + + + + + +165 + + + +Depreciation and amortization of property and equipment + + +2,329 + + +1,834 + + + +Amortization of intangible assets + + +900 + + +843 + + + +Amortization of signing bonuses + + +1,080 + + +2,812 + + + +Equity-based compensation + + +398 + + +(73 +) + + +Tax benefit of stock option plans + + + + + +2,718 + + + +Deferred rent expense + + +490 + + +801 + + + +Other non-cash (income) expense + + +(213 +) + +58 + + + +Changes in assets and liabilities, net of effect of acquisitions: + + + + + + + + + + +Accounts receivable + + +(11,728 +) + +(23,318 +) + + + +Prepaid and other current assets + + +(1,856 +) + +(3,009 +) + + + +Accounts payable and other accrued liabilities + + +(21 +) + +4,505 + + + + +Accrued compensation + + +2,837 + + +2,198 + + + + +Signing bonuses and other assets + + +(1,429 +) + +(18,341 +) + + + +Other liabilities, net + + +56 + + +1,889 + + + + + + + + + + + + +Net cash provided by (used in) operating activities + + +5,148 + + +(14,944 +) + + + + + + + + +Cash flows from investing activities + + + + + + + + + +Payments for business acquisitions, net of cash acquired + + +(2,455 +) + +(24,996 +) + + +Purchase of property and equipment + + +(796 +) + +(2,781 +) + + +Other + + +(62 +) + +(51 +) + + + + + + + + + + + +Net cash used in investing activities + + +(3,313 +) + +(27,828 +) + + + + + + + + +Cash flows from financing activities + + + + + + + + + +Proceeds from issuance of common stock employee stock plan + + + + + +1,109 + + + +Exercise of stock options + + +432 + + +2,604 + + + +Receivable from stockholder + + +14 + + +295 + + + +Borrowings under long-term debt agreements + + +1,250 + + + + + + +Borrowings under revolving credit facility + + +37,400 + + + + + + +Repayments of long term debt + + +(4,550 +) + + + + + +Repayments under revolving credit facility + + +(27,100 +) + + + + + +Payment of loan fees + + +(871 +) + + + + + +Distributions to common stockholders + + +(7,964 +) + +(4,235 +) + + +Other + + +(3 +) + + + + + + + + + + + + + + +Net cash used in financing activities + + +(1,392 +) + +(227 +) + + + + + + + + +Effect of exchange rates on changes in cash and cash equivalents + + +279 + + +(36 +) + + + + + + + + +Increase (decrease) in cash and cash equivalents + + +722 + + +(43,035 +) + +Cash and cash equivalents, beginning of period + + +2,576 + + +67,177 + + + + + + + + + +Cash and cash equivalents, end of period + +$ +3,298 + +$ +24,142 + + + + + + + + + +Supplemental disclosure: + + + + + + + + + +Cash paid for interest + +$ +1,827 + +$ +288 + + + + + + + + + + +Cash paid for income taxes + +$ +150 + +$ +655 + + + + + + + + + +Non-cash investing activites: + + + + + + + + + +Common stock issued for business acquisitions + + + + +$ +1,959 + + + + + + + + + + +Amounts due for business acquisitions + + + + +$ +4,980 + + + + + + + + + +See notes to interim condensed consolidated financial statements + + F-30 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY + +(dollars in thousands) + + + + + +Common Stock + +Additional + +paid in + +capital + + + + + + +Receivable + +from + +stockholder + + + +Deferred + +equity + +compensation + + + +Accumulated + +other + +comprehensive + +income (loss) + + + +Total + +stockholders' + +equity + + + +Total + +comprehensive + +income (loss) + + + + + + + +Retained + +earnings + + + + + + + +Shares + + + +Par value + + + + + + +Balance at December 31, 2003 + +21,693,156 + +$ +22 + +$ +113,326 + +$ +12,612 + +$ +(290 +) +$ +(2,193 +) +$ +510 + +$ +123,987 + + + + + +Decrease in receivable from stockholder + + + + + + + +4 + + + + + +290 + + +1 + + + + + +295 + + + + + +Proceeds from sale of stock + +76,771 + + + + + +1,109 + + + + + + + + + + + + + + +1,109 + + + + + +Issuance of resricted shares + +107,741 + + + + + +1,958 + + + + + + + + + + + + + + +1,958 + + + + + +Exercise of options + +570,841 + + + + + +2,604 + + + + + + + + + + + + + + +2,604 + + + + + +Equity compensation + + + + + + + +(537 +) + + + + + + + +464 + + + + + +(73 +) + + + + +Repurchase of restricted shares + +(9,375 +) + + + + +(1 +) + + + + + + + +1 + + + + + + + + + + + +Distributions to common stockholder + + + + + + + +(431 +) + + + + + + + + + + + + + +(431 +) + + + + +Tax benefit of option exercises + + + + + + + +1,719 + + + + + + + + + + + + + + +1,719 + + + + + +Net income + + + + + + + + + + +11,974 + + + + + + + + + + + +11,974 + +$ +11,974 + + +Foreign currency translation adjustment + + + + + + + + + + + + + + + + + + + +(45 +) + +(45 +) + +(45 +) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Total comprehensive income + + + + + + + + + + + + + + + + + + + + + + + + +$ +11,929 + + + + + + + + + + + + + + + + + + + + + + + +Balance at September 30, 2004 + +22,439,134 + +$ +22 + +$ +119,751 + +$ +24,586 + +$ + + +$ +(1,727 +) +$ +465 + +$ +143,097 + + + + + + + + + + + + + + + + + + + + + + + + + + + +See notes to interim condensed consolidated financial statements + + F-31 + + + + + LECG Corporation (formerly LECG Holding Company, LLC) and Subsidiary + + + NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) + + + +1. Basis of Presentation and Operations + +The accompanying consolidated financial statements include the accounts of LECG Corporation and its wholly owned subsidiary, LECG, LLC, (collectively, the "Company", +"Companies" or "LECG"). + +The +Company provides expert services, including economic and financial analysis, expert testimony, litigation support and strategic management consulting to a broad range of public and private +enterprises. The Company's experts may be either employees of the Company or independent contractors. Services are provided by academics, recognized industry leaders and former high-level +government officials (collectively, "experts") with the assistance of a professional support staff. These services are provided primarily in the United States from the Company's headquarters in +Emeryville, California and its 18 other offices across the country. The Company also has international offices in Argentina, Australia, Canada, New Zealand, South Korea, Spain, Belgium, France and the +United Kingdom. + +The +consolidated statements of income for the nine months ended September 30, 2003 and 2004, the consolidated balance sheet as of September 30, 2004 and the consolidated statements of +cash flows for the nine months ended September 30, 2003 and 2004 are unaudited. In the opinion of management, these statements include all adjustments, consisting only of normal recurring +adjustments, necessary for a fair presentation of LECG's consolidated financial position, results of operations and cash flows. The December 31, 2003 balance sheet is derived from LECG's +audited financial statements included in its Annual Report on Form 10-K as of that date. The results of operations for the nine months ended September 30, 2004 are not +necessarily indicative of the results that may be expected for the year. + +Reclassifications + +Certain prior period amounts have been reclassified to conform to the current period presentation. + +2. Significant Accounting Policies + +Revenue recognition + +Revenue includes all amounts earned that are billed or billable to clients, including out-of-pocket costs such as travel and subsistence, and have been +reduced for amounts related to work performed that are estimated to be uncollectible. + +Revenues +primarily arise from time and material contracts, which are recognized in the period in which the services are performed. The Company also enters into certain performance-based contracts for +which performance fees are dependent upon a successful outcome, as defined by the consulting engagement. Revenues related to performance-based fee contracts are recognized in the period when the +earnings process is complete, generally when we have received payment as a result of services we performed under the contract. Costs incurred on performance-based contracts are expensed in the period +incurred. Revenues are also generated from fixed price contracts, which are recognized as the agreed upon services are performed. Such revenues do not represent a material component of total revenues. + +Expert +revenues consist of revenues generated by experts who are our employees and revenues generated by experts who are independent contractors. There is no operating, business or other substantive +distinction between our employee experts and our exclusive independent contractor experts. + + F-32 + + + +Income taxes + +The Company accounts for income taxes in accordance with SFAS 109 Accounting for Income Taxes, under which deferred +assets and liabilities are recognized based upon anticipated future tax consequences attributable to differences between financial statement carrying values of assets and liabilities and their +respective tax bases. In accordance with SFAS 109, a valuation allowance is established to reduce the carrying value of deferred tax assets if it is considered more likely than not that such +assets will not be realized. Significant management judgment is required in determining if it is more likely than not that the Company will be able to utilize the potential tax benefit represented by +its deferred tax assets. Consideration is given to evidence such as the history of prior year taxable income, expiration periods for net operating losses and the Company's projections. No valuation +allowance was recorded at September 30, 2004 and December 31, 2003. We expect that our 2004 effective income tax rate will be approximately 40.6%. The Company's effective tax rate is +determined based on estimated worldwide pre-tax income, permanent differences and credits, and is reviewed quarterly to determine if actual results require modifying the effective tax +rate. Prior to November 13, 2003, the Company operated as a limited liability company and income taxes were passed through to and were the responsibility of the owners. Accordingly, no income +taxes are provided for the nine months ended September 30, 2003. + +Use of estimates + +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and +assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and +expenses during the reporting period. The Company's financial statements contain various estimates including, but not limited to, estimates for unrealizable revenue, valuation allowance on deferred +tax assets, bonus compensation, contingent payments for businesses acquired and costs recoverable from non-salaried experts. Actual results could differ from those estimates. + +3. Net Income Per Share and Share Amounts + +Basic net income per common share is computed by dividing the net income available to common stockholders for the period by the weighted average number of common shares +outstanding during the period. Diluted net income per common share is computed by dividing the net income available to common stockholders for the period by the weighted average number of common and +common equivalent shares outstanding during the period. Common equivalent shares, comprised of unvested restricted stock and common shares issuable upon the exercise of options, are included in the +diluted net income per common share calculation to the extent these shares are dilutive. + +The +following items impact the comparability of our financial results for the nine months ended September 30, 2004 as compared to the same periods in 2003. + + >Prior +to November 13, 2003, no income taxes were recorded or paid at the corporate level. In prior periods the Company operated as a limited liability company +and taxes were paid at the individual stockholder level not by the Company. + + >Prior +to November 13, 2003, the Company incurred preferred stock accretion and dividends in conjunction with its outstanding preferred units. Those preferred +units were redeemed in full in connection with the Company's initial public offering; however, they impacted the calculation of earnings per share. + + F-33 + + + + >Basic +and diluted earnings per share for the nine months ended September 30, 2004 include the impact of 8,625,000 shares sold in our initial public offering +on November 13, 2003. + +The +following is a reconciliation of net income and the number of shares used in the basic and diluted earnings per share computations (in thousands, except per share amounts). + + + + +Nine months ended September 30, + + + + +2003 + + + +2004 + + +Net income available to common shares + +$ +9,170 + +$ +11,974 + + + + + + + + + Weighted average shares outstanding: + + + + + + + + + + + + + + + +Basic + + +12,492 + + +21,725 + + + +Effect of dilutive stock options and unvested restricted stock + + +2,542 + + +1,608 + + + + + + + + +Diluted + + +15,034 + + +23,333 + + + + + + + + + Net income per share + + + + + + + + + + + + + + + +Basic + +$ +0.73 + +$ +0.55 + + + +Diluted + +$ +0.61 + +$ +0.51 + +The following common stock equivalents were excluded from the calculation of diluted net income per share, as these shares were antidilutive: 1.2 million +options, for the nine months ended September 30, 2003 and 1.6 million options for the nine months ended September 30, 2004. + +4. Equity-Based Compensation + +The Company uses the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to +Employees, for options granted to employees. Accordingly, compensation cost related to option grants to employees is measured as the excess, if any, of the fair value of the +Company's common stock at the date of the grant over the option exercise price and such cost is charged to operations over the related option vesting period. SFAS No. 123, Accounting for Stock-Based +Compensation, requires that companies record compensation cost for equity-based compensation to non-employees +based on fair values. Accordingly, the Company records compensation cost for options granted to non-employees using a fair value based method over the related option vesting period. + +SFAS +No. 123 requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method since the Company's inception. Under SFAS No. 123, the +fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully +transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. If the computed values of the Company's stock-based awards to employees had been + + F-34 + + + +amortized to expense over the vesting period of the awards, net income would have been the following (in thousands, except per share information): + + + + +Nine months ended September 30, + + + + + +2003 + + + +2004 + + + + + + +Net income available to common shares as reported + +$ +9,170 + +$ +11,974 + + +Add (subtract): equity-based employee compensation expense (income), as reported + + +305 + + +(73 +) + +Deduct: total equity-based employee compensation expense determined under fair value based method for all awards + + + + + +(2,613 + +) + + + +(3,517 + +) + + + + + + + + +Net income available to common shares pro forma + +$ +6,862 + +$ +8,384 + + + + + + + + + +Basic earnings per share: + + + + + + + + + + + + + + + + +Net income available to common shares as reported + +$ +0.73 + +$ +0.55 + + + +Net adjustment for fair value based method + + +(0.18 +) + +(0.17 +) + + + + + + + + + +Net income available to common shares pro forma + +$ +0.55 + +$ +0.38 + + + + + + + + + +Diluted earnings per share: + + + + + + + + + + + + + + + + +Net income available to common shares as reported + +$ +0.61 + +$ +0.51 + + + +Net adjustment for fair value based method + + +(0.15 +) + +(0.15 +) + + + + + + + + + +Net income available to common shares pro forma + +$ +0.46 + +$ +0.36 + + + + + + + + + +The following weighted average assumptions are used in conjunction with the Black-Scholes method to determine compensation expense for the pro forma effect of +applying FAS 123 to measure compensation expense for options issued to employees: + + + + +Nine months ended September 30, + + + + + +2003 + + + +2004 + + + + + + +Dividend yield + +0 +% +0 +% + +Volatility + +70 +% +51 +% + +Risk-free interest rate + +2.8 +% +4.2 +% + +Expected term, in years + +5.0 + +7.0 + + +5. Comprehensive Income + +Comprehensive income represents net income plus other comprehensive income resulting from changes in foreign currency translation and amortization of interest rate swap +transition adjustment. The + + F-35 + + + +reconciliation of LECG's comprehensive income for the nine months ended September 30, 2003 and 2004 is as follows (in thousands): + + + + +Nine months ended September 30, + + + + + +2003 + + + +2004 + + + + + + +Net income + +$ +12,305 + +$ +11,974 + + +Foreign currency translation adjustment + + +283 + + +(45 +) + +Amortization of transition adjustment + + +70 + + + + + + + + + + + + +Comprehensive income + +$ +12,658 + +$ +11,929 + + + + + + + + + +6. Business Acquisitions + +In August 2004, the Company acquired all of the outstanding shares of Silicon Valley Expert Witness Group, Inc. ("SVEWG"), a company providing expert services +involving complex technologies and intellectual property disputes. The purchase price of $9.0 million was comprised of $5.0 million paid in cash at closing, the issuance of 56,850 +unregistered shares of common stock with a fair market value of $958,000, and $3.0 million of additional payments to be made no later than 2009. The purchase price was allocated as follows: +$7.7 million to goodwill, $100,000 to contract rights (10-month amortization) and $1.2 million to net current assets and property and equipment. The allocation of the +purchase price to assets acquired and liabilities assumed is based on preliminary estimates and certain assumptions that the Company believes are reasonable. In addition, if specified revenue and +operating margin targets are achieved, the Company will make additional payments of up to $3.0 million over a five-year-period. Additional goodwill will be recorded in +subsequent years if these performance targets are met. + +In +March 2004, the Company acquired the business (including certain assets and liabilities, five experts, who were equity owners, and professional staff) of Economic Analysis, LLC, a company +providing expert services involving complex business litigation and regulatory matters. The purchase price was comprised of $15.4 million paid in cash, and the issuance of 50,891 unregistered +shares of common stock with a fair market value of $1.0 million, of which $15.0 million was allocated to goodwill, $900,000 was allocated to contract rights (12-month +amortization) and $500,000 to property and equipment and other assets. In addition, if specified revenue and profitability targets are +achieved, the Company will make additional payments of up to $2.6 million per year for three years, and additional payments of up to $2.0 million if certain revenue targets are met. +Additional goodwill will be recorded in subsequent years, if the performance targets are met. + +In +March 2004, the Company acquired the business (including certain assets and liabilities, five experts, four of whom were equity owners and professional staff) of Low Rosen Taylor Soriano +("LRTS"), an expert services firm located in Toronto, Canada, providing expert services in the areas of business valuation and damages quantification. The purchase price was $3.8 million paid +in cash, of which $3.1 million was allocated to goodwill, $145,000 was allocated to contract rights (12-month amortization) and $570,000 was allocated primarily to property and +equipment and other assets. In addition, if specified profitability targets are achieved, the Company will make additional payments of up to $4.2 million over a four-year period. As +a result of achieving certain profitability targets through September 30, 2004, the Company recorded additional goodwill of $245,000 as of September 30, 2004. Additional goodwill will be +recorded in subsequent years, if the performance targets are met. + + F-36 + + + +In +accordance with the terms of the Center for Forensic Economic Studies ("CFES") Purchase Agreement dated August 1, 2003, and as a result of achieving certain performance targets set forth in +the agreement, the Company recognized $1.6 and $1.7 million of additional goodwill as of June 30, 2004 and September 30, 2004, respectively, of which $1.6 million has been +paid and $1.7 million is payable in August 2005. + +7. Goodwill and Identifiable Intangible Assets + +Goodwill relates to the Company's business acquisitions, reflecting the excess of purchase price over fair value of identifiable net assets acquired. Goodwill and intangible +assets with indefinite lives are not amortized, but are required to be tested at least annually for impairment. + +The +Company determined that it has one reporting unit based on the similarity of operations throughout its individual offices. Business acquisitions have been integrated within the structure of the +organization and all the individual offices share similar economic characteristics and do not represent separate reporting units. The Company performs its goodwill impairment test annually as of +October 1 by using the quoted market price of LECG's common stock and comparing the fair value of the Company to its recorded book value. The Company adopted October 1 as its date for +performing its annual goodwill impairment test to allow sufficient time to schedule and perform the required valuation analysis and record any necessary goodwill impairment charges prior to its +year-end. Based on the results of the test performed as of October 1, 2004, the Company concluded that goodwill was not impaired. The balance in goodwill as of September 30, +2004 and changes in goodwill for the nine months ended September 30, 2004 are as follows: + +Balance at December 31, 2003 + +$ +23,976 + + +SVEWG + + +7,663 + + +Economic Analysis, LLC + + +15,037 + + +LRTS + + +3,329 + + +CFES + + +3,392 + + + + +Balance at September 30, 2004 + +$ +53,397 + + + + +Other intangible assets include customer contracts with useful lives of 10 to 12 months, and rights to license software under development, for which +amortization will begin when the software is available for general release to customers. These intangible assets continue to be amortized on a straight-line basis over their useful lives. + +As +of September 30, 2004, other intangible assets consisted of the following (in thousands): + + + + +Gross + +Accumulated + +amortization + +Net + +Customer contracts + +$ +1,745 + +$ +(1,009 +) +$ +736 + +Rights to license software under development + +$ +100 + +$ +0 + +$ +100 + + + + + + + + +Total + +$ +1,845 + +$ +(1,009 +) +$ +836 + + + + + + + + + F-37 + + + +The estimated future amortization expense of other intangible assets as of September 30, 2004 is as follows (in thousands): + +2004 + +$ +394 + +2005 + + +342 + +Thereafter + + +100 + + + + +Total + +$ +836 + + + + +8. Deferred Compensation Plan + +In March 2004, the Company adopted a deferred compensation plan under which highly compensated employees are eligible to defer up to 15% of their bonuses, salary, expert +fees, project origination fees and qualifying stock option gains. The cash compensation deferred under this plan is credited with earnings or losses measured by the mirrored rate of return on +investments elected by plan participants. The qualifying stock option gains deferred under this plan are credited or debited based on changes in an LECG stock measurement fund. Each plan participant +is fully vested in all compensation deferred under the plan, other than signing bonuses and other employer contributions subject to vesting, and the earnings credited to his or her account. Signing +bonuses and other employer contributions deferred under the plan vest ratably over a specified forfeiture period. Employee deferrals are invested through a trust. + +9. Common Stock, Restricted Stock and Stock Options + +Common stock + +On August 2, 2004, the Company issued 56,850 unregistered shares of LECG common stock in connection with its acquisition of all of the outstanding shares of Silicon +Valley Expert Witness Group, Inc. See Note 6. + +On +March 1, 2004, the Company issued 50,891 unregistered shares of LECG common stock in connection with its acquisition of Economic Analysis, LLC. See Note 6. + +In +November 2003, the Company adopted an Employee Stock Purchase Plan ("ESPP") under which eligible United States and New Zealand employees may purchase newly issued shares of common stock of +the Company at 85% of the lower of the closing price of the Company's common stock on the first and last day of the six-month offering periods, which end in April and November 2004. +Employees pay for their shares through payroll deductions at a rate equal to any whole percentage from 1% to 15% of their gross wages. There were 76,771 common shares issued under the ESPP in +April 2004 at $14.45 per share. + +The +Board of Directors authorized 950,000 shares of common stock for issuance under the ESPP, which also provides for annual increases in the number of shares available for issuance on the first day +of each fiscal year, equal to the lesser of: (1) 1.5% of the outstanding shares of our common stock on the first day of the fiscal year; (2) 500,000 shares; or (3) a lesser amount +as determined by the board of directors. The Board of Directors determined not to provide for this annual increase to the ESPP for fiscal 2004. As of September 30, 2004, there are 873,229 +shares available for issuance under the plan. + + F-38 + + + +Restricted stock + +The following table shows the activity under the restricted stock program: + + + + +Number of + +vested shares + +Number of + +unvested shares + +Total + + +Balance at December 31, 2003 + +2,217,949 + +294,941 + +2,512,890 + + +Vested + +128,535 + +(128,535 +) + + + +Repurchased + + + +(9,375 +) +(9,375 +) + + + + + + + + + + +Balance at September 30, 2004 + +2,346,484 + +157,031 + +2,503,515 + + + + + + + + + + + +The +Company has a total of 157,031 shares of outstanding common stock that are subject to a right of repurchase or cancellation in favor of the Company under certain circumstances. The fair value of +all unvested restricted shares is included in the financial statements as deferred compensation and is being amortized ratably over the applicable vesting periods. Of these 157,031 restricted shares, +there are 16,406 restricted shares that were issued in 2000 and that are subject to repurchase at $0.01 in the event of the termination of the stockholder' employment or consulting relationship with +the Company for any reason prior to January 16, 2005. The right of repurchase of these 16,406 restricted shares will expire on either (i) December 31, 2004 if each of the +stockholders achieve certain individual performance criteria, or (ii) January 16, 2005 regardless of performance. The remaining 140,625 restricted shares were issued in +August 2003 and are subject to vesting over time. Of these restricted shares, 112,500 will vest on August 1, 2007, and the remaining 28,125 will vest on August 1, 2008, provided +that the stockholders have not resigned or been terminated for cause as of those vesting dates. + +Stock option plans + +The Company granted 231,250 and 2,107,350 non-qualified options to purchase common shares in the quarter and nine months ended September 30, 2004, +respectively. Included in the 2004 option grants were 750,000 non-qualified options to purchase shares of common stock, at an exercise price of $21.85 per share, issued to each of +Dr. David Teece, Chairman and +Mr. David Kaplan, President. The options issued to Dr. Teece and Mr. Kaplan cliff-vest 82/3 years following the date of grant and expire in +May 2013. The Company issued 22,500 options to three independent members of its Board of Directors that will vest in August 2005. During their tenure as members of the Board of +Directors, independent directors receive annual grants of options to purchase common stock on or after the date of the Company's annual stockholder meeting, subject to approval by the Compensation +Committee. The remaining options were granted to employees, have five to seven year vesting periods and were issued at exercise prices equal to the fair market value of the Company's stock on the date +of grant. + +During +the nine months ended September 30, 2004, pursuant to terms of the Company's 2000 Stock Option Plan, the Company cancelled unvested options to purchase 28,824 shares of common stock. + +At +September 30, 2004, there were 383,275 options available for future grants under the 2003 Stock Option Plan. + + F-39 + + + +10. Commitments and Contingencies + +Legal proceedings + +In June 2004, National Economic Research Associates, Inc. ("NERA") and its parent company, Marsh & McLennan Companies, Inc., filed a complaint against LECG +and one of its experts in the Superior Court Department of the Trial Court Business Litigation Session, Suffolk County, Commonwealth of Massachusetts. This action arises out of LECG's hiring of +professionals in March 2004 who were formerly employed by NERA in the United States and Europe. The complaint alleges that during and after his employment with NERA, this expert violated +contractual commitments and fiduciary duties to NERA. The complaint further alleges that LECG interfered with NERA's contractual relations and advantageous business relationships, misappropriated +confidential business information and goodwill, and engaged in unfair and deceptive trade practices. The complaint asks for unspecified damages and disgorgement of wrongful gain, invalidation of an +indemnification agreement provided to this expert by LECG and contains a demand for a jury trial. + +In +August 2004, we served a motion to dismiss the complaint with respect to the breach of contract, tortious interference with contractual relations and the unfair and deceptive trade practices +counts, which motion the parties are currently briefing. We also filed our answer to the complaint. + +LECG +is not able to determine the outcome or resolution of the complaint, or to estimate the amount or potential range of loss with respect to this complaint. + +LECG +is also a party to certain legal proceedings arising out of the ordinary course of business, the outcomes of which individually or in the aggregate, in the opinion of LECG's management, would not +have a material adverse effect on LECG's business, financial position or results of operations. + +Business acquisitions and expert hires + +We have made commitments in connection with our acquisitions and certain expert agreements that will require us to make additional payments and bonus compensation payments if +various performance goals are met. + +In +August 2004, LECG purchased the business of Silicon Valley Expert Witness Group, Inc. The initial purchase price of $9.0 million, paid in cash and shares of common stock, +included $3.0 million of additional payments to be made no later than September 2009. In addition, if specified revenue and operating margin targets are achieved, LECG will make +additional payments of up to $3.0 million over a five-year period. See Note 6. + +In +March 2004, LECG acquired the business of Economic Analysis, LLC. In addition to the initial purchase price of $16.4 million paid in cash and shares of LECG common stock, if specified +revenue and profitability targets are achieved, LECG will make additional payments of up to $2.6 million per year for three years. Additional payments of up to $2.0 million will also be +made if certain revenue targets are met. See Note 6. + +In +March 2004, LECG acquired the business of Low Rosen Taylor Soriano. In addition to the initial purchase price of $3.8 million paid in cash, if specified profitability targets are +achieved, LECG will make additional payments of up to $4.2 million over a four-year period. See Note 6. + +In +connection with the acquisition in August 2003 of CFES, if certain specified revenue and profitability targets are met, LECG will make additional payments ranging from $1.7 to +$1.9 million per year for four years. In August 2004, LECG made the first of such payments in the amount of + + F-40 + + + +$1.7 million that was recorded to goodwill. In addition, based on an evaluation of results through September 2004, the Company estimated that the performance targets for 2004 will be +met, and consequently has recognized additional goodwill of $1.7 million to be paid in August 2005. In addition, if certain performance targets are met, the Company will also pay bonus +compensation ranging from +$520,000 to $580,000 per year. The Company recognizes compensation expense on a quarterly basis since it believes it is probable that the performance targets will be achieved. + +In +August 2004, LECG entered into employment agreements with certain experts, whereby if certain performance targets are met, LECG will make payments of up to $500,000 per year for the next +four years. Payments will be subject to amortization over five years. + +In +connection with the hiring of certain experts and professional staff in March 2004, LECG has agreed to pay performance bonuses of up to $5.7 million per year in 2006 and 2007, +provided certain significant revenue and gross margin targets are achieved. Bonus payments will be subject to amortization over a seven-year period. + +LECG +currently has outstanding letters of credit for $1.0 million under our revolving credit facility, which expires in March 2006, at which time all outstanding borrowings, if any, are +required to be repaid. In August 2004, the Company's lender agreed to amend the Company's credit agreement, effective as of July 30, 2004, to allow the Company to make business +acquisitions without the lender's prior consent, provided certain financial conditions are met. + +11. Subsequent Events + +On October 8, 2004, the Company acquired substantially all of the assets of Washington Advisory Group, LLC, a privately held expert services firm specializing in +technology assessment and policy, and research development strategy. The purchase price consists of an initial payment of approximately $660,000 and a minimum guaranteed payment of $400,000 payable by +February 15, 2007. Additional payments of up to $2.1 million will be made if specific growth and profitability targets are met. + +Effective +October 31, 2004, the Company issued 68,979 shares of its common stock at a weighted average price of $14.54 in connection with its Employee Stock Purchase Plan for proceeds of +$1,003,246. + + F-41 + + + + + + + + +Part II + +INFORMATION NOT REQUIRED IN PROSPECTUS + + + Item 13. Other Expenses of Issuance and Distribution + + +The following table sets forth the fees and expenses, other than underwriting discounts and commissions, payable in connection with the registration of the common stock +hereunder. All such fees and expenses, other than underwriting discounts and commissions, will be borne by us. All amounts +are estimates except the SEC registration fee, the NASD filing fee and the Nasdaq National Market listing fee. + + + + +Amount to be paid + +SEC Registration Fee + +$ +8,763 + +NASD Filing Fee + + +7,417 + +Legal Fees and Expenses + + +250,000 + +Accounting Fees and Expenses + + +100,000 + +Printing and Engraving Expenses + + +70,000 + +Blue Sky Fees and Expenses + + +5,000 + +Transfer Agent and Registrar Fees + + +10,000 + +Miscellaneous Expenses + + +48,820 + + + + + +Total + +$ +500,000 + + + + + + + +Item 14. Indemnification of Directors and Officers + + +Section 145 of the Delaware General Corporation Law permits a corporation to include in its charter documents, and in agreements between the corporation and its +directors and officers, provisions expanding the scope of indemnification beyond that specifically provided by the current law. + +Article VIII +of our amended and restated certificate of incorporation provides for the indemnification of directors to the fullest extent permissible under Delaware law. + +Article VI +of our bylaws provides for the indemnification of officers, directors and third parties acting on our behalf if this person acted in good faith and in a manner reasonably believed to +be in and not opposed to our best interest, and, with respect to any criminal action or proceeding, the indemnified party had no reason to believe his or her conduct was unlawful. + +We +are entering into indemnification agreements with our directors and executive officers, in addition to indemnification provided for in our charter documents, and we intend to enter into +indemnification agreements with any new directors and executive officers in the future. + +The +underwriting agreement (Exhibit 1.1 hereto) provides for indemnification by the underwriter of us, our executive officers and directors and the selling stockholders, and indemnification of +the underwriter by us and the selling stockholders for certain liabilities, including liabilities arising under the Securities Act of 1933, as amended, in connection with matters specifically provided +in writing by the underwriter for inclusion in the registration statement. + +We +intend to purchase and maintain insurance on behalf of any person who is or was a director or officer against any loss arising from any claim asserted against him or her and incurred by him or her +in that capacity, subject to certain exclusions and limits of the amount of coverage. + + II-1 + + + + + + +Item 15. Recent Sales of Unregistered Securities + + + (a) Within +the last three years, we have issued and sold the following unregistered securities: + + >On +May 1, 2002, we sold 62,500 common units at a purchase price of $4.48 per unit to one of our experts pursuant to a buy-sell agreement. The foregoing +purchase and sale was exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof on the basis that the transaction did not involve a public offering. + + >On +August 1, 2003, we issued 140,625 common units at a purchase price of $14.40 per unit to four accredited experts in connection with our acquisition of the +business and certain assets of BLDS, LLC, which business and assets were formerly owned by the Center for Forensic Economic Studies. The foregoing purchase and sale was exempt from registration under +the Securities Act of 1933, as amended, pursuant to Rule 701 thereof on the basis that the transactions were pursuant to compensatory benefit plans and contracts relating to compensation as +provided under Rule 701. + + >On +March 1, 2004, we sold 50,891 shares of our common stock at an effective purchase price of $19.65 per share to 5 accredited experts in connection with our +acquisition of the business and certain assets of Economic Analysis, LLC. The foregoing purchase and sale was exempt from registration under the Securities Act of 1933, as amended, pursuant to Section +4(2) thereof on the basis that the transaction did not involve a public offering. + + >On +August 2, 2004, we sold 56,850 shares of our common stock at an effective purchase price of $17.59 per share to certain accredited investors in +connection with our acquisition of Silicon Valley Expert Witness Group, Inc. The foregoing purchase and sale was exempt from registration under the Securities Act of 1933, as amended, pursuant +to Section 4(2) thereof on the basis that the transaction did not involve a public offering. + + (b) Since +September 29, 2000, we granted options to purchase common stock to employees, directors and consultants under our 2000 Incentive Plan at exercise prices +ranging from $0.01 to $16.00 per share. Of the 4,932,598 options granted, 3,975,473 remain outstanding, 755,953 shares have been issued pursuant to the exercise of options and 201,172 options +have been cancelled. The foregoing grants and exercises were exempt from registration under the Securities Act of 1933, as amended, pursuant to Rule 701 thereof on the basis that the +transactions were pursuant to compensatory benefit plans and contracts relating to compensation as provided under Rule 701. + +The +sales and issuances of securities in the transactions described above were deemed to be exempt from registration under the Securities Act of 1933, as amended, in reliance upon Section 4(2) +of the Securities Act of 1933, as amended, Regulation D promulgated thereunder or Rule 701 promulgated under Section 3(b) of the Securities Act of 1933, as amended, as +transactions by an issuer not involving any public offering or transactions pursuant to compensatory benefit plans and contracts relating to compensation as provided under Rule 701. The +recipients of securities in each transaction represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof +and appropriate legends were affixed to the securities issued in these transactions. All recipients had adequate access, through their relationship with LECG, to information about us. + + (c) There +were no underwritten offerings employed in connection with any of the transactions set forth in Item 15(a) and (b). + + II-2 + + + + + + +Item 16. Exhibits and Financial Statement Schedules + + +(a)Exhibits + + + +Exhibit Number + + +Description + +1.1 + +Form of Underwriting Agreement + +**2.1 + +Asset Purchase Agreement entered into as of March 1, 2004 by and among LECG Corporation, LECG, LLC, Economic Analysis, the members of Economic Analysis and other related parties identified +therein + +**2.2 + +First Amendment to Asset Purchase Agreement entered into on March 17, 2004 by and among LECG Corporation, LECG, LLC, Economic Analysis, the members of Economic Analysis, and other related parties +identified therein + +* 2.3 + +Stock Purchase Agreement entered into effective as of August 2, 2004 by and among LECG, LLC, LECG Corporation, The Summers 1992 Trust, U/T/A 1/27/92, the Richard & Sylvia McCloskey Living +Trust Dated 6/14/93, Dr. Richard A. Blanchard, Diana Trujillo, Gary J. Summers and Richard McCloskey + +*3.1(a) + +Amended and Restated Certificate of Incorporation of LECG Corporation, as currently in effect + +*3.2 + +Bylaws of LECG Corporation + +*3.3 + +Articles of Organization of LECG Holding Company, LLC, a California limited liability company, as currently in effect + +*3.4 + +Articles of Organization of LECG, LLC, a California limited liability company, as currently in effect + +*3.5 + +Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, as currently in effect + +*3.5(a) + +First Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece +and David Kaplan dated October 29, 2001 + +*3.5(b) + +Second Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. +Teece and David Kaplan dated December 7, 2001 + +*3.5(c) + +Third Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece +and David Kaplan dated March 27, 2003 + +*3.5(d) + +Fourth Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. +Teece and David Kaplan dated August 1, 2003 + +*3.5(e) + +Fifth Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece +and David Kaplan dated October 14, 2003. + +*3.6 + +Operating Agreement of LECG, LLC, a California limited liability company, as currently in effect + +*4.1 + +Form of the Registrant's Common Stock Certificate + +#5.1 + +Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation + +*10.1 + +Form of Director and Executive Officer Indemnification Agreement + + II-3 + + + +*10.2 + +2000 Incentive Plan and forms of agreements thereunder + +*10.2(a) + +First Amendment to 2000 Incentive Plan dated October 29, 2001 + +*10.2(b) + +Second Amendment to 2000 Incentive Plan dated February 2, 2002 + +*10.2(c) + +Third Amendment to 2000 Incentive Plan dated June 7, 2002 + +*10.2(d) + +Fourth Amendment to 2000 Incentive Plan dated May 30, 2003 + +*10.3 + +2003 Stock Option Plan and forms of agreements thereunder + +*10.4 + +2003 Employee Stock Purchase Plan and forms of agreement thereunder + +*10.5 + +Asset Purchase Agreement between Navigant Consulting, Inc., LECG, Inc., LECG Holding Company, LLC and LECG, LLC dated September 29, 2000 + +*10.6 + +Loan Agreement between LECG Holding Company, LLC and David P. Kaplan dated September 29, 2000 and Secured Non-Recourse Promissory Note issued thereunder + +*10.7 + +Office Lease Agreement between LECG, LLC and EOP-Emeryville Properties, L.L.C. dated December 17, 2001 + +*10.8 + +Lease Agreement between LECG, LLC and Farragut Center LLC dated December 27, 2000 + +*10.9 + +Expert Agreement between LECG, LLC and Walter Vandaele dated October 13, 2000 + +*10.9(a) + +First Amendment to Employment Letter between LECG, LLC and Walter Vandaele dated June 13, 2003 + +*10.9(b) + +Second Amendment to Employment Letter between LECG, LLC and Walter Vandaele dated September 9, 2003 + +*10.10 + +Convertible Promissory Note made by LECG, LLC to Thoma Cressey Fund VII, L.P. for up to $5.0 million dated June 13, 2002 + +*10.11 + +Expert Agreement between LECG, LLC and David Teece dated October 27, 1997 + +*10.12 + +Expert Agreement between LECG, LLC and David Kaplan dated April 27, 1998 + +*10.13 + +Loan Agreement between LECG Holding Company, LLC and Mukesh Bajaj dated November 1, 2000 and Secured Non-Recourse Promissory Note issued thereunder + +*10.14 + +Guaranty Agreement by Thoma Cressey Fund VII, L.P. in favor of Wachovia Bank, National Association (formerly known as First Union National Bank) dated June 13, 2002 + +*10.15 + +Guaranty Agreement by David J. Teece in favor of Thoma Cressey Fund VII, L.P. dated June 12, 2002 + +*10.16 + +Agreement between LECG, LLC and PA Consulting Group, Inc. and PA Holdings Limited dated March 19, 2001 + +*10.17 + +Letter Agreement between LECG, LLC and Arthur Andersen LLP dated June 12, 2002 + +*10.18 + +Registration Rights Agreement between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece, David Kaplan, Frog & Peach Investors, LLC and other persons dated September 29, +2000 + +#10.18(a) + +Amendment No. 1 to the Registration Rights Agreement by and among Thoma Cressey Fund VII, L.P., Thoma Cressey Friends Fund VII, L.P. and LECG Corporation dated November 9, 2004 + +*10.19 + +Buy Sell Agreement between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece, David Kaplan, Frog & Peach Investors, LLC and other persons dated September 29, 2000 + + II-4 + + + +*10.19(a) + +First Amendment to Buy Sell Agreement between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece, David Kaplan, Frog & Peach Investors, LLC and other persons dated December 2, +2002 + +*10.20 + +Senior Management Agreement among LECG Holding Company, LLC, LECG, LLC and David J. Teece dated September 29, 2000 + +*10.21 + +Senior Management Agreement among LECG Holding Company, LLC, LECG, LLC and David P. Kaplan dated September 29, 2000 + +*10.22 + +Letter Agreement among LECG Holding Company, LLC, LECG, LLC, Thoma Cressey Fund VII, L.P., and David J. Teece dated June 13, 2002 + +*10.23 + +Joint Venture Agreement dated July 19, 2003 between LECG, LLC, LECG Korea, LLC, a Korean limited liability company, Hong-Choo Hyun, Kye-Sung Chung and Chun-Wook Hyun + +*10.24 + +Share Subscription Agreement dated July 19, 2003 between LECG, LLC, LECG Korea, LLC, a Korean limited liability company, Hong-Choo Hyun, Kye-Sung Chung and Chun-Wook Hyun + +*10.25 + +Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto, U.S. Bank National Association and LaSalle Bank National +Association dated March 31, 2003 + +*10.26 + +Revolving Promissory Note issued by LECG, LLC, to U.S. Bank National Association dated March 31, 2003 + +*10.27 + +Revolving Promissory Note issued by LECG, LLC to LaSalle Bank National Association dated March 31, 2003 + +*10.28 + +Term Note issued by LECG, LLC to U.S. Bank National Association dated March 31, 2003 + +*10.29 + +Term Note issued by LECG, LLC to LaSalle Bank National Association dated March 31, 2003 + +*10.30 + +Amended and Restated Security Agreement between LECG Holding Company, LLC and U.S. Bank National Association dated March 31, 2003 + +*10.31 + +Amended and Restated Security Agreement between LECG, LLC and U.S. Bank National Association dated March 31, 2003 + +*10.32 + +Guaranty given by LECG Holding Company, LLC in favor of U.S. Bank National Association dated March 31, 2003 + +*10.33 + +First Amendment to Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto and U.S. Bank National Association, dated +August 19, 2003 + +*10.34 + +Revolving Promissory Note issued by LECG, LLC to U.S. Bank National Association dated August 19, 2003 + +*10.35 + +Revolving Promissory Note issued by LECG, LLC to LaSalle Bank National Association dated August 19, 2003 + +*10.36 + +Reaffirmation of Guaranty and Security Agreement given by LECG Holding Company, LLC in favor of U.S. Bank National Association dated August 19, 2003 + +*10.37 + +Asset Purchase Agreement between LECG, LLC, LECG Holding Company, LLC, BLDS, LLC, Dr. Bernard R. Siskin, Dr. Leonard A. Cupingood, Dr. David W. Griffin and +Dr. Samuel J. Kursh dated August 1, 2003 + + II-5 + + + +*10.37(a) + +First Amendment to Asset Purchase Agreement between LECG, LLC, LECG Holding Company, LLC, BLDS, LLC, Dr. Bernard R. Siskin, Dr. Leonard A. Cupingood, Dr. David W. Griffin and +Dr. Samuel J. Kursh dated November 11, 2003 + +*10.38 + +Director Practice Purchase Agreement between LECG, LLC, LECG Holding Company, LLC, Dr. Bernard R. Siskin, Dr. Leonard A. Cupingood, Dr. David W. Griffin and +Dr. Samuel J. Kursh dated August 1, 2003 + +*10.39 + +Business Development Agreement between LECG, LLC and Enterprise Research, Inc. dated December 10, 2002 + +*10.39(a) + +First Amendment to Business Development Agreement between LECG, LLC and Enterprise Research dated September 29, 2003 + +*10.40 + +First Amendment to Employment Agreement between LECG Holding Company, LLC, LECG, LLC and David J. Teece dated August 5, 2002 + +*10.40(a) + +Second Amendment to Employment Agreement between LECG, LLC and David J. Teece dated September 30, 2003 + + 10.40(b) + +Third Amendment to Employment Agreement between LECG, LCC and David J. Teece dated October 1, 2004 + +*10.41 + +Amended and Restated Senior Management Agreement between LECG Holding Company, LLC, LECG, LLC and David P. Kaplan dated September 29, 2003 + + 10.41(a) + +First Amendment to Amended and Resated Senior Management Agreement between LECG, LLC, LECG Corporation, successor in interest to LECG Holding Company, LLC, and David Kaplan dated October 1, +2004 + +*10.42 + +Loan Commitment Letter from David J. Teece to LECG, LLC dated September 5, 2002 + +*10.43 + +Loan Commitment Letter from David J. Teece to LECG, LLC dated November 12, 2002 + +*10.44 + +Expert Agreement between LECG, LLC and David T. Scheffman dated August 29, 2003 + +*10.45 + +First Amendment to Employment Letter between LECG, LLC and David T. Scheffman dated August 29, 2003 + +*10.46 + +Form of Omnibus Plan of Reorganization between LECG Holding Company, LLC, LECG Corporation, TCEP/LECG Funding Corporation, Thoma Cressey Fund VII, L.P. and Thoma Cressey Friends Fund VII, L.P., +David J. Teece and David Kaplan + +*10.47 + +Form of Transfer Agreement between LECG Corporation, Thoma Cressey Fund VII, L.P., Thoma Cressey Friends Fund VII, L.P. and TCEP/LECG Funding Corporation + +*10.48 + +Form of Agreement and Plan of Merger between LECG Holding Company, LLC, TCEP/LECG Funding Corporation and LECG Corporation + +*10.49 + +Form of Assignment and Assumption Agreement between LECG Holding Company, LLC and LECG Corporation + +*10.50 + +Second Amendment to Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto and U.S. Bank National Association, dated +November 12, 2003 + + 10.51 + +Amended and Restated Deferred Compensation Plan + +* 10.52 + +Third Amendment to Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto and U.S. Bank National Association, +dated April 15, 2004 + + II-6 + + + +* 10.53 + +Lease between Derwent Valley Central Limited, LECG Limited UK and LECG Corporation, dated March 15, 2004 for Third Floor of the Davidson Building 5 Southampton Street, London WC2 + +* 10.54 + +Lease between Derwent Valley Central Limited, LECG Limited UK and LECG Corporation, dated March 15, 2004 for Fourth Floor of the Davidson Building 5 Southampton Street, +London WC2 + +* 10.55 + +Lease between Derwent Valley Central Limited, LECG Limited UK and LECG Corporation, dated March 15, 2004 for Fifth Floor of the Davidson Building 5 Southampton Street, London WC2 + +* 10.56 + +Fourth Amendment to Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto and U.S. Bank National Association, dated +August 12, 2004 + +10.57 + +Employment Letter between LECG, LLC and John C. Burke dated January 15, 2003 + +#21.1 + +Subsidiaries of Registrant + +23.1 + +Consent of Deloitte & Touche LLP, independent registered public accounting firm + +#23.2 + +Consent of Counsel (included in exhibit 5.1) + +#24.1 + +Power of Attorney + +#24.2 + +Power of Attorney of Michael J. Jeffery + +*Incorporated +by reference to the same number exhibit filed with Registrant's Registration Statement on Form S-1 (File No. 333-108189), as amended. + +**Incorporated +by reference to the same number exhibit filed with Registrant's Current Report on Form 8-K filed April 1, 2004. + + Incorporated +by reference to the same number exhibit filed with Registrant's Current Report on Form 8-K filed October 6, 2004. + + Incorporated +by reference to the same number exhibit filed with Registrant's Current Report on Form 8-K filed November 3, 2004. + +* Incorporated +by reference to the same number exhibit filed with Registrant's Quarterly Report on Form 10-Q filed November 9, 2004. + +#Previously +filed. + +(b)Financial +Statement Schedules + +Schedules +not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto. + + + + +Item 17. Undertakings + + +Insofar as indemnification by LECG for liabilities arising under the Securities Act of 1933, as amended, may be permitted to our directors, officers and controlling persons of +us, we have been advised that in the opinion of the Securities and Exchange Commission, this indemnification is against public policy as expressed in the Securities Act of 1933, as amended, and is, +therefore, unenforceable. In the event that a claim for indemnification against these liabilities (other than the payment by us of expenses incurred or paid by any of our directors, officers or +controlling persons in the successful defense of any action, suit or proceeding) is asserted by a director, officer or controlling person in connection with the securities being registered, we will, +unless in the opinion of our counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of + + II-7 + + + +whether this indemnification is against public policy as expressed in the Securities Act of 1933, as amended, and will be governed by the final adjudication of this issue. + +We +hereby undertake that: + + (a) For +purposes of determining any liability under the Securities Act of 1933, as amended, the information omitted from a form of prospectus filed as part of this +registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by us pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act of 1933, +as amended, shall be deemed to be part of this registration statement as of the time it was declared effective. + + (b) For +the purpose of determining any liability under the Securities Act of 1933, as amended, each post-effective amendment that contains a form of prospectus +shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering +thereof. + + II-8 + + + + + + +Signatures + +Pursuant to the requirements of the Securities Act of 1933, as amended, LECG Corporation has duly caused this Amendment No. 2 to the Registration +Statement on Form S-1 to be signed on its behalf by the undersigned, thereunto duly authorized, in Emeryville, California on the 8th day of December, 2004. + + + + + +LECG CORPORATION + + + + + +By: + +/s/ DAVID J. TEECE David J. Teece + Chairman of the Board + +Pursuant to the requirements of the Securities Act of 1933, as amended, this Amendment No. 2 to the Registration Statement on Form S-1 has been signed by the following +persons in the capacities and on the dates indicated. + + + +Signature + + + + +Title + + + + +Date + + +/s/ DAVID J. TEECE David J. Teece + +Chairman of the Board of Directors and Director (Principal Executive Officer) + +December 8, 2004 + +* DAVID P. KAPLAN David P. Kaplan + + + +President and Director + + + +December 8, 2004 + +/s/ JOHN C. BURKE John C. Burke + + + +Chief Financial Officer (Principal Financial Officer) + + + +December 8, 2004 + +/s/ GARY S. YELLIN Gary S. Yellin + + + +Chief Accounting Officer (Principal Accounting Officer) + + + +December 8, 2004 + +* MICHAEL R. GAULKE Michael R. Gaulke + + + +Director + + + +December 8, 2004 + +* MICHAEL J. JEFFERY Michael J. Jeffery + + + +Director + + + +December 8, 2004 + +* WILLIAM W. LIEBECK William W. Liebeck + + + +Director + + + +December 8, 2004 + +* WILLIAM J. SPENCER William J. Spencer + + + +Director + + + +December 8, 2004 + +* WALTER H.A. VANDAELE Walter H.A. Vandaele + + + +Director + + + +December 8, 2004 + +* RUTH M. RICHARDSON Ruth M. Richardson + + + +Director + + + +December 8, 2004 + +* DAVID T. SCHEFFMAN David T. Scheffman + + + +Director + + + +December 8, 2004 + +*By: + + + +/s/ DAVID J. TEECE David J. Teece + Attorney-in-Fact + + + + + + + + + + II-9 + + + + +Exhibit Index + +Exhibit Number + + +Description + +1.1 + +Form of Underwriting Agreement + +**2.1 + +Asset Purchase Agreement entered into as of March 1, 2004 by and among LECG Corporation, LECG, LLC, Economic Analysis, the members of Economic Analysis and other related parties identified +therein + +**2.2 + +First Amendment to Asset Purchase Agreement entered into on March 17, 2004 by and among LECG Corporation, LECG, LLC, Economic Analysis, the members of Economic Analysis, and other related parties +identified therein + +* 2.3 + +Stock Purchase Agreement entered into effective as of August 2, 2004 by and among LECG, LLC, LECG Corporation, The Summers 1992 Trust, U/T/A 1/27/92, the Richard & Sylvia McCloskey Living +Trust Dated 6/14/93, Dr. Richard A. Blanchard, Diana Trujillo, Gary J. Summers and Richard McCloskey + +*3.1(a) + +Amended and Restated Certificate of Incorporation of LECG Corporation, as currently in effect + +*3.2 + +Bylaws of LECG Corporation + +*3.3 + +Articles of Organization of LECG Holding Company, LLC, a California limited liability company, as currently in effect + +*3.4 + +Articles of Organization of LECG, LLC, a California limited liability company, as currently in effect + +*3.5 + +Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, as currently in effect + +*3.5(a) + +First Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece +and David Kaplan dated October 29, 2001 + +*3.5(b) + +Second Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. +Teece and David Kaplan dated December 7, 2001 + +*3.5(c) + +Third Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece +and David Kaplan dated March 27, 2003 + +*3.5(d) + +Fourth Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. +Teece and David Kaplan dated August 1, 2003 + +*3.5(e) + +Fifth Amendment to Limited Liability Company Agreement of LECG Holding Company, LLC, a California limited liability company, between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece +and David Kaplan dated October 14, 2003. + +*3.6 + +Operating Agreement of LECG, LLC, a California limited liability company, as currently in effect + +*4.1 + +Form of the Registrant's Common Stock Certificate + +#5.1 + +Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation + +*10.1 + +Form of Director and Executive Officer Indemnification Agreement + +*10.2 + +2000 Incentive Plan and forms of agreements thereunder + +*10.2(a) + +First Amendment to 2000 Incentive Plan dated October 29, 2001 + +*10.2(b) + +Second Amendment to 2000 Incentive Plan dated February 2, 2002 + +*10.2(c) + +Third Amendment to 2000 Incentive Plan dated June 7, 2002 + +*10.2(d) + +Fourth Amendment to 2000 Incentive Plan dated May 30, 2003 + +*10.3 + +2003 Stock Option Plan and forms of agreements thereunder + +*10.4 + +2003 Employee Stock Purchase Plan and forms of agreement thereunder + +*10.5 + +Asset Purchase Agreement between Navigant Consulting, Inc., LECG, Inc., LECG Holding Company, LLC and LECG, LLC dated September 29, 2000 + +*10.6 + +Loan Agreement between LECG Holding Company, LLC and David P. Kaplan dated September 29, 2000 and Secured Non-Recourse Promissory Note issued thereunder + +*10.7 + +Office Lease Agreement between LECG, LLC and EOP-Emeryville Properties, L.L.C. dated December 17, 2001 + +*10.8 + +Lease Agreement between LECG, LLC and Farragut Center LLC dated December 27, 2000 + +*10.9 + +Expert Agreement between LECG, LLC and Walter Vandaele dated October 13, 2000 + +*10.9(a) + +First Amendment to Employment Letter between LECG, LLC and Walter Vandaele dated June 13, 2003 + +*10.9(b) + +Second Amendment to Employment Letter between LECG, LLC and Walter Vandaele dated September 9, 2003 + +*10.10 + +Convertible Promissory Note made by LECG, LLC to Thoma Cressey Fund VII, L.P. for up to $5.0 million dated June 13, 2002 + +*10.11 + +Expert Agreement between LECG, LLC and David Teece dated October 27, 1997 + +*10.12 + +Expert Agreement between LECG, LLC and David Kaplan dated April 27, 1998 + +*10.13 + +Loan Agreement between LECG Holding Company, LLC and Mukesh Bajaj dated November 1, 2000 and Secured Non-Recourse Promissory Note issued thereunder + +*10.14 + +Guaranty Agreement by Thoma Cressey Fund VII, L.P. in favor of Wachovia Bank, National Association (formerly known as First Union National Bank) dated June 13, 2002 + +*10.15 + +Guaranty Agreement by David J. Teece in favor of Thoma Cressey Fund VII, L.P. dated June 12, 2002 + +*10.16 + +Agreement between LECG, LLC and PA Consulting Group, Inc. and PA Holdings Limited dated March 19, 2001 + +*10.17 + +Letter Agreement between LECG, LLC and Arthur Andersen LLP dated June 12, 2002 + +*10.18 + +Registration Rights Agreement between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece, David Kaplan, Frog & Peach Investors, LLC and other persons dated September 29, +2000 + +#10.18(a) + +Amendment No. 1 to the Registration Rights Agreement by and among Thoma Cressey Fund VII, L.P., Thoma Cressey Friends Fund VII, L.P. and LECG Corporation dated November 9, 2004 + +*10.19 + +Buy Sell Agreement between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece, David Kaplan, Frog & Peach Investors, LLC and other persons dated September 29, 2000 + +*10.19(a) + +First Amendment to Buy Sell Agreement between LECG Holding Company, LLC, TCEP/LECG Funding Corporation, David J. Teece, David Kaplan, Frog & Peach Investors, LLC and other persons dated December 2, +2002 + +*10.20 + +Senior Management Agreement among LECG Holding Company, LLC, LECG, LLC and David J. Teece dated September 29, 2000 + +*10.21 + +Senior Management Agreement among LECG Holding Company, LLC, LECG, LLC and David P. Kaplan dated September 29, 2000 + +*10.22 + +Letter Agreement among LECG Holding Company, LLC, LECG, LLC, Thoma Cressey Fund VII, L.P., and David J. Teece dated June 13, 2002 + +*10.23 + +Joint Venture Agreement dated July 19, 2003 between LECG, LLC, LECG Korea, LLC, a Korean limited liability company, Hong-Choo Hyun, Kye-Sung Chung and Chun-Wook Hyun + +*10.24 + +Share Subscription Agreement dated July 19, 2003 between LECG, LLC, LECG Korea, LLC, a Korean limited liability company, Hong-Choo Hyun, Kye-Sung Chung and Chun-Wook Hyun + +*10.25 + +Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto, U.S. Bank National Association and LaSalle Bank National +Association dated March 31, 2003 + +*10.26 + +Revolving Promissory Note issued by LECG, LLC, to U.S. Bank National Association dated March 31, 2003 + +*10.27 + +Revolving Promissory Note issued by LECG, LLC to LaSalle Bank National Association dated March 31, 2003 + +*10.28 + +Term Note issued by LECG, LLC to U.S. Bank National Association dated March 31, 2003 + +*10.29 + +Term Note issued by LECG, LLC to LaSalle Bank National Association dated March 31, 2003 + +*10.30 + +Amended and Restated Security Agreement between LECG Holding Company, LLC and U.S. Bank National Association dated March 31, 2003 + +*10.31 + +Amended and Restated Security Agreement between LECG, LLC and U.S. Bank National Association dated March 31, 2003 + +*10.32 + +Guaranty given by LECG Holding Company, LLC in favor of U.S. Bank National Association dated March 31, 2003 + +*10.33 + +First Amendment to Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto and U.S. Bank National Association, dated +August 19, 2003 + +*10.34 + +Revolving Promissory Note issued by LECG, LLC to U.S. Bank National Association dated August 19, 2003 + +*10.35 + +Revolving Promissory Note issued by LECG, LLC to LaSalle Bank National Association dated August 19, 2003 + +*10.36 + +Reaffirmation of Guaranty and Security Agreement given by LECG Holding Company, LLC in favor of U.S. Bank National Association dated August 19, 2003 + +*10.37 + +Asset Purchase Agreement between LECG, LLC, LECG Holding Company, LLC, BLDS, LLC, Dr. Bernard R. Siskin, Dr. Leonard A. Cupingood, Dr. David W. Griffin and +Dr. Samuel J. Kursh dated August 1, 2003 + +*10.37(a) + +First Amendment to Asset Purchase Agreement between LECG, LLC, LECG Holding Company, LLC, BLDS, LLC, Dr. Bernard R. Siskin, Dr. Leonard A. Cupingood, Dr. David W. Griffin and +Dr. Samuel J. Kursh dated November 11, 2003 + +*10.38 + +Director Practice Purchase Agreement between LECG, LLC, LECG Holding Company, LLC, Dr. Bernard R. Siskin, Dr. Leonard A. Cupingood, Dr. David W. Griffin and +Dr. Samuel J. Kursh dated August 1, 2003 + +*10.39 + +Business Development Agreement between LECG, LLC and Enterprise Research, Inc. dated December 10, 2002 + +*10.39(a) + +First Amendment to Business Development Agreement between LECG, LLC and Enterprise Research dated September 29, 2003 + +*10.40 + +First Amendment to Employment Agreement between LECG Holding Company, LLC, LECG, LLC and David J. Teece dated August 5, 2002 + +*10.40(a) + +Second Amendment to Employment Agreement between LECG, LLC and David J. Teece dated September 30, 2003 + + 10.40(b) + +Third Amendment to Employment Agreement between LECG, LCC and David J. Teece dated October 1, 2004 + +*10.41 + +Amended and Restated Senior Management Agreement between LECG Holding Company, LLC, LECG, LLC and David P. Kaplan dated September 29, 2003 + + 10.41(a) + +First Amendment to Amended and Resated Senior Management Agreement between LECG, LLC, LECG Corporation, successor in interest to LECG Holding Company, LLC, and David Kaplan dated October 1, +2004 + +*10.42 + +Loan Commitment Letter from David J. Teece to LECG, LLC dated September 5, 2002 + +*10.43 + +Loan Commitment Letter from David J. Teece to LECG, LLC dated November 12, 2002 + +*10.44 + +Expert Agreement between LECG, LLC and David T. Scheffman dated August 29, 2003 + +*10.45 + +First Amendment to Employment Letter between LECG, LLC and David T. Scheffman dated August 29, 2003 + +*10.46 + +Form of Omnibus Plan of Reorganization between LECG Holding Company, LLC, LECG Corporation, TCEP/LECG Funding Corporation, Thoma Cressey Fund VII, L.P. and Thoma Cressey Friends Fund VII, L.P., +David J. Teece and David Kaplan + +*10.47 + +Form of Transfer Agreement between LECG Corporation, Thoma Cressey Fund VII, L.P., Thoma Cressey Friends Fund VII, L.P. and TCEP/LECG Funding Corporation + +*10.48 + +Form of Agreement and Plan of Merger between LECG Holding Company, LLC, TCEP/LECG Funding Corporation and LECG Corporation + +*10.49 + +Form of Assignment and Assumption Agreement between LECG Holding Company, LLC and LECG Corporation + +*10.50 + +Second Amendment to Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto and U.S. Bank National Association, dated +November 12, 2003 + + 10.51 + +Amended and Restated Deferred Compensation Plan + +* 10.52 + +Third Amendment to Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto and U.S. Bank National Association, +dated April 15, 2004 + +* 10.53 + +Lease between Derwent Valley Central Limited, LECG Limited UK and LECG Corporation, dated March 15, 2004 for Third Floor of the Davidson Building 5 Southampton Street, London WC2 + +* 10.54 + +Lease between Derwent Valley Central Limited, LECG Limited UK and LECG Corporation, dated March 15, 2004 for Fourth Floor of the Davidson Building 5 Southampton Street, +London WC2 + +* 10.55 + +Lease between Derwent Valley Central Limited, LECG Limited UK and LECG Corporation, dated March 15, 2004 for Fifth Floor of the Davidson Building 5 Southampton Street, London WC2 + +* 10.56 + +Fourth Amendment to Amended and Restated Credit Agreement between LECG, LLC, a California limited liability company, the Banks which are signatories thereto and U.S. Bank National Association, dated +August 12, 2004 + +10.57 + +Employment Letter between LECG, LLC and John C. Burke dated January 15, 2003 + +#21.1 + +Subsidiaries of Registrant + +23.1 + +Consent of Deloitte & Touche LLP, independent registered public accounting firm + +#23.2 + +Consent of Counsel (included in exhibit 5.1) + +#24.1 + +Power of Attorney + +#24.2 + +Power of Attorney of Michael J. Jeffery + +*Incorporated +by reference to the same number exhibit filed with Registrant's Registration Statement on Form S-1 (File No. 333-108189), as amended. + +**Incorporated +by reference to the same number exhibit filed with Registrant's Current Report on Form 8-K filed April 1, 2004. + + Incorporated +by reference to the same number exhibit filed with Registrant's Current Report on Form 8-K filed October 6, 2004. + + Incorporated +by reference to the same number exhibit filed with Registrant's Current Report on Form 8-K filed November 3, 2004. + +* Incorporated +by reference to the same number exhibit filed with Registrant's Quarterly Report on Form 10-Q filed November 9, 2004. + +#Previously +filed. + + + +QuickLinks \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001202444_golfsmith_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001202444_golfsmith_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ed94fd0f269e651751855dc169cd397800dfa342 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001202444_golfsmith_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes and the guarantees will be passed upon for us by King & Spalding LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001203866_pharmion_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001203866_pharmion_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..50228c4a0d1581093f01fe2045197fef765e7ee2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001203866_pharmion_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the common stock offered by this prospectus and certain other legal matters are being passed upon for us by our counsel, Willkie Farr Gallagher LLP, New York, New York. The underwriters will be represented by Davis Polk Wardwell, Menlo Park, California. Peter H. Jakes, a partner at Willkie Farr Gallagher LLP, owns 9,202 shares of our common stock, as a joint tenant with his spouse. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001207070_franklin_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001207070_franklin_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b2084448935203c95ce2c3d964285094a5716543 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001207070_franklin_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered for sale in this offering will be passed upon by Wachtell, Lipton, Rosen & Katz, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001211351_rtw_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001211351_rtw_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f8526d114106198ee72743f01c059bdb4f3128c4 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001211351_rtw_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares offered hereby will be passed on for us by Kirkland & Ellis LLP, New York, New York. Certain partners at Kirkland & Ellis LLP indirectly own 168,240 of our shares through investment partnerships. The validity of the shares offered hereby will be passed upon for the underwriters by Latham & Watkins LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001217688_foxhollow_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001217688_foxhollow_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2b34982aa4c37da566cb45143344f209fc225cb --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001217688_foxhollow_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby has been passed upon for us by Wilson Sonsini Goodrich & Rosati, P.C., Palo Alto, California. Certain members of, and investment partnerships comprised of members of, and persons associated with, Wilson Sonsini Goodrich & Rosati, P.C. own an interest representing less than 0.3% of the shares our common stock. Latham & Watkins LLP, Menlo Park, California, is counsel for the underwriters in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001229505_ardent_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001229505_ardent_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001229505_ardent_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001231129_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001231129_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001231129_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001235010_momenta_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001235010_momenta_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1d2081dad5c32ef4c9d3c7df1adb666cffab5514 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001235010_momenta_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the validity of the shares of common stock offered hereby will be passed upon for us by Wilmer Cutler Pickering Hale and Dorr LLP, Boston, Massachusetts. Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. has acted as counsel for the underwriters in connection with certain legal matters related to this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001239672_entourage_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001239672_entourage_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..af5a500252360ac7e8ea1317bee893a0721266e7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001239672_entourage_legal_matters.txt @@ -0,0 +1,3275 @@ +LEGAL MATTERS + +Certain legal matters in connection with the common shares offered by this prospectus and certain tax matters will be passed upon for us by Conrad C. Lysiak, Attorney and Counselor at Law, 601 West First Avenue, Suite 503, Spokane, Washington, our United States counsel. + +EXPERTS + +The consolidated financial statements of Entourage Mining as at and for the fiscal years ended December 31, 2000, 2001 and 2002, have been included in this prospectus in reliance upon the report of Morgan & Company, Chartered Accountant, 700 West Georgia Street, Suite 1488, Vancouver, British Columbia, Canada V7Y 1A1, independent chartered accountants, upon their authority as experts in accounting and auditing. + +AUDITOR, TRANSFER AGENT AND REGISTRAR + +Our auditor is Morgan & Company, Chartered Accountant, 700 West Georgia Street, Suite 1488, Vancouver, British Columbia, Canada V7Y 1A1. Our stock transfer agent for our securities is Computershare Trust Company of Canada, 510 Burrard Street, Vancouver, British Columbia, Canada V6C 3B9 and its telephone number is (604) 661-9400. + +WHERE YOU CAN FIND MORE INFORMATION + +We have filed with the SEC a registration statement on Form F-1 under the Securities Act with respect to the common shares offered hereby. This prospectus does not contain all of the information set forth in the registration statement and the exhibits thereto, to which reference is hereby made. With respect to each contract, agreement or other document filed as an exhibit to the registration statement, reference is made to such exhibit for a more complete description of the matter involved. The registration statement and the exhibits thereto filed by us with the SEC may be inspected at the public reference facility of the SEC listed below. + +The registration statement, reports and other information filed or to be filed with the SEC by us can be inspected and copied at the public reference facilities maintained by the SEC at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the SEC using its EDGAR system. + + + + + + - 55 - + +As a foreign private issuer, we are exempt from the rules under the Securities Exchange Act of 1934 prescribing the furnishing and content of proxy statements, and our executive officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Securities Exchange Act. + +Copies of documents referred to in this prospectus may be arranged to be inspected at our offices at 675 West Hastings Street, Suite 306, Vancouver, British Columbia V6B 1N2. Our telephone number is (604) 684-7227. + +INDEX TO FINANCIAL STATEMENTS + +No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date. + +BALANCE SHEET + +STATEMENTS OF OPERATIONS + +STATEMENT OF CHANGES IN CASH FLOW + +F-1 + +F-2 + +F-3 + +NOTES TO FINANCIAL STATEMENTS + +F-4 F-6 + +AUDITORS REPORT + +F-7 + +BALANCE SHEET + +STATEMENTS OF OPERATIONS + +STATEMENT OF CHANGES IN CASH FLOW + +STATEMENT OF STOCKHOLDERS' EQUITY + +F-8 + +F-9 + +F-10 + +F-11 + +NOTES TO FINANCIAL STATEMENTS + +F-12 + + + + + + + + + + + + + + + + + + - 56 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +BALANCE SHEET + +(Unaudited) + +(Stated in Canadian Dollars) + +SEPTEMBER + +30 + + DECEMBER 31 + +2003 + +2002 + + + + + + + +ASSETS + + + + + + + + + + + +Current + + + + + +Cash + +$ + +592 + +$ + +- + + + + + + + +Mineral Property Option (Note 3) + + +- + +- + +592 + +- + + + + + + + + + + + +LIABILITIES + + + + + + + + + + + +Current + + + + + +Accounts payable + +$ + +211,460 + +$ + +52,632 + +Accounts payable to related parties + + +174,167 + +109,167 + + + + + +385,627 + +161,799 + + + + + + + + + + + +SHAREHOLDERS' DEFICIENCY + + + + + + + + + + + +Capital Stock (Note 4) + + + + + +Authorized: + + + + + +100,000,000 common voting shares without par value + + + + + +Issued: + + + + + +15,130,005 common voting shares at September 30, 2003 and + + + + + +9,130,005 common voting shares at December 31, 2002 (of + + + + + +which 3,750,000 are held in escrow at September 30, 2002 + + + + + +and December 31, 2002) + + +336,501 + +276,501 + + + + + + + +Contributed Capital + + +200,671 + + +200,671 + + + + + + + +Deficit Accumulated During The Exploration Stage + + +(922,207) + +(638,971) + + + + + +(385,035) + +(161,799) + + + + + + + + + + + +$ + +592 + +$ + +- + + + +F-1 + + + + - 57 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +STATEMENT OF OPERATIONS AND DEFICIT + +(Unaudited) + +(Stated in Canadian Dollars) + + + + + + + +INCEPTION + + + + + +JUNE 16 + + + +THREE MONTHS ENDED + +NINE MONTHS ENDED + +1995 TO + + + +SEPTEMBER 30 + +SEPTEMBER 30 + +SEPTEMBER 30 + +2003 + +2002 + +2003 + +2002 + +2003 + + + + + + + + + + + + + + + + + + + + + +Revenue + +$ + +- + +$ + +- + +$ + +- + +$ + +- + +$ + +- + + + + + + + + + + + + + + + + + + + + + +Expenses + + + + + + + + + + + +Accounting and legal + + +- + + +- + + +- + + +- + + +22,500 + +Bank charges + + + 24 + + +- + + + 24 + + +- + + +24 + +Consulting + + +3,000 + + +- + + + 3,000 + + +- + + +3,000 + +Option payments and exploration costs + + +164,259 + + +- + + +224,259 + + +- + + +367,142 + +Interest expense + + +- + + +- + + +- + + +- + + +5,808 + +Management fees + + +- + + +7,500 + + +- + + +22,500 + + +225,000 + +Office and sundry + + +2,204 + + +- + + +5,065 + + +- + + +6,428 + +Professional fees + + +14,032 + + +- + + +43,625 + + +- + + +105,042 + +Rent + + +- + + +6,000 + + +- + + +18,000 + + +180,000 + +Travel + +7,263 + +- + +7,263 + +- + +7,263 + + + + + + + + + + + + + + + + + + + + + + + +Loss For The Period + + +190,782 + + + +13,500 + + +283,236 + + +40,500 + +$ + +922,207 + + + + + + + + + + + + + + + + + + + + + + + +Deficit, Beginning Of Period + +731,425 + +606,543 + +638,971 + +579,543 + + + + + + + + + + + + + + + + + + + + + + + + + +Deficit, End Of Period + +$ + +922,207 + +$ + +620,043 + +$ + +922,207 + +$ + +620,043 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Basic And Diluted Loss Per Share + +$ + +0.02 + +$ + +0.01 + +$ + +0.03 + +$ + +0.01 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Weighted Average Number Of Shares Outstanding + +11,380,005 + +5,380,005 + +8,390,994 + +5,380,005 + + + + + + + + + + + +F-2 + + + + - 58 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +STATEMENT OF CASH FLOWS + +(Unaudited) + +(Stated in Canadian Dollars) + + + + + +INCEPTION + + + + + +JUNE 16 + + + +THREE MONTHS ENDED + +SIX MONTHS ENDED + +1995 TO + + + +SEPTEMBER 30 + +SEPTEMBER 30 + +SEP. 30 + +2003 + +2002 + +2003 + +2002 + +2003 + + + + + + + + + + + + + + + + + + + + + +Cash Flows From Operating Activities + + + + + + + + + + + +Net loss for the period + +$ + +(190,782) + +$ + +(13,500) + +$ + +(283,236) + +$ + +(40,500) + +$ + +(922,207) + + + + + + + + + + + + + +Adjustment To Reconcile Net Loss To + + + + + + + + + + + +Net Cash Used By Operating Activities + + + + + + + + + + + +Mineral property option payment paid + + + + + + + + + + + +with stock + + +- + + +- + + +60,000 + + +- + + +60,000 + +Increase in accounts payable + + +126,374 + + +- + + +158,828 + + +- + + +211,460 + +Increase in accounts payable to related + + + + + + + + + + + +parties + +65,000 + +13,500 + +65,000 + +40,500 + +374,838 + + + +- + +- + +283,828 + +- + +(275,909) + + + + + + + + + + + + + + + + + + + + + + + +Cash Flows From Financing Activity + + + + + + + + + + + +Issue of capital stock + +- + +- + +- + +- + +276,501 + + + + + + + + + + + + + + + + + + + + + + + +Net Change In Cash + + +592 + + +- + + +592 + + +- + + +592 + + + + + + + + + + + + + +Cash, Beginning Of Period + +- + +8 + +- + +8 + +- + + + + + + + + + + + + + + + + + + + + + + + +Cash, End Of Period + +$ + +592 + +$ + +8 + +$ + +592 + +$ + +8 + +$ + +592 + +SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES: + +During the period ended September 30, 2003, the Company issued 6,000,000 common shares at a fair value of $60,000 in connection with the mineral property option agreement referred to in Note 3. + + + + + +F-3 + + + + - 59 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +SEPTEMBER 30, 2003 + +(Unaudited) + +(Stated in Canadian Dollars) + +1. BASIS OF PRESENTATION + +The unaudited financial statements as of September 30, 2003 included herein have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. It is suggested that these financial statements be read in conjunction with the December 31, 2002 audited financial statements and notes thereto. + +2. SIGNIFICANT ACCOUNTING POLICIES + +The financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States. Because a precise determination of many assets and liabilities is dependent upon future events, the preparation of financial statements for a period necessarily involves the use of estimates which have been made using careful judgement. + +The financial statements have, in management's opinion, been properly prepared within reasonable limits of materiality and within the framework of the significant accounting policies summarized below: + +a) Option Payments and Exploration Costs + +The Company expenses all costs related to the maintenance and exploration of mineral claims in which it has secured exploration rights prior to establishment of proven and probable reserves. To date, the Company has not established the commercial feasibility of its exploration prospects, therefore, all costs are being expensed. + + + + + + + + + +F-4 + + + + - 60 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +SEPTEMBER 30, 2003 + +(Unaudited) + +(Stated in Canadian Dollars) + + + +2. SIGNIFICANT ACCOUNTING POLICIES (Continued) + +b) Stock Based Compensation + +The Company will account for stock based employee and director compensation arrangements in accordance with provisions of Accounting Principles Board ("APB") Opinion No. 25 - "Accounting for Stock Issued to Employees", and related interpretations, and complies with the disclosure provisions of SFAS No. 123 - "Accounting for Stock Based Compensation". Under APB No. 25, compensation expense is based on the difference, if any, on the date the number of shares receivable is determined, between the estimated fair value of the Company's stock and the exercise price of options to purchase that stock. Stock based compensation arrangements for others are recorded at their fair value as the services are provided and the compensation earned. + +c) Earnings (Loss) Per Share + +Basic earnings (loss) per common share is computed in accordance with SFAS No. 128 - "Earnings Per Share" by dividing income and losses by the weighted average number of common shares outstanding for the year. Diluted per share amounts reflect the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted to common shares. In computing diluted earnings (loss) per share, no shares were added to the weighted average number of common shares outstanding during the years ended December 31, 2002, 2001 and 2000 for the dilutive effect of employee stock options and warrants as no options, warrants or other convertible securities were outstanding. No adjustments were required to reported earnings (loss) from operations in computing diluted per share amounts. + +d) Exploration Stage Company + +The Company is an exploration stage company as defined in the Statements of Financial Standards No. 7. The Company is devoting substantially all of its present efforts to establish a new business and none of its planned principal operations have commenced. All losses accumulated since inception have been considered as part of the Company's exploration stage activities. + + + +F-5 + + + + - 61 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +SEPTEMBER 30, 2003 + +(Unaudited) + +(Stated in Canadian Dollars) + +3. MINERAL PROPERTY OPTION + +By an assignment agreement dated March 17, 2003, as amended May 17, 2003, the Company holds an option to acquire a 60% interest, subject to a 3% gross overriding royalty, in two groups of mineral claims located in the Yukon Territory. As consideration for the assignment, the Company has agreed to pay, to the assignor, the sum of $60,000 once the Company has been financed, and to issue 6,000,000 common shares (issued). Under the terms of the option agreement, the Company must incur a total of $500,000 in exploration expenditures, and make additional cash payments totalling $80,000 through November 1, 2007. + +4. RELATED PARTY TRANSACTIONS + +a) During the period ended September 30, 2003, the Company incurred $Nil (2002 - $15,000) for management fees, and $Nil (2002 - $12,000) for rent with a related company. + +b) Included in accounts payable at September 30, 2003 is $174,167 (2002 - $286,007) owing to a director and a company controlled by the same director. + +c) During the period ended September 30, 2003, the Company paid $1,000 (2002 - $Nil) for consulting fees to a Director of the Company. + + + + + + + + + +F-6 + + + + - 62 - + +AUDITORS' REPORT + +To the Stockholders of + +Entourage Mining Ltd. + +(An exploration stage company) + +We have audited the balance sheets of Entourage Mining Ltd. (an exploration stage company) as at December 31, 2002 and 2001, and the statements of operations, cash flows, and stockholders' equity for the years ended December 31, 2002, 2001 and 2000. 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. + +We conducted our audits in accordance with United States and Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance 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. + +In our opinion, these financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2002 and 2001, and the results of its operations and cash flows for the years ended December 31, 2002, 2001 and 2000 in accordance with United States generally accepted accounting principles applied on a consistent basis. + +The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered net losses and negative cash flows from operations since its inception that raise substantial doubt about its ability to continue as a going concern. Management plans as to this matter are discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. + +Vancouver, Canada + +February 6, 2003 + +/s/ Morgan & Company + +Chartered Accountants + + + +F-7 + + + + - 63 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +BALANCE SHEETS + +(Stated in Canadian Dollars) + + + +DECEMBER 31 + +2002 + +2001 + + + + + + + + + + + +ASSETS + + + + + + + + + + + +Current + + + + + +Cash + +$ + +- + +$ + +8 + +Goods and Services Tax recoverable + +- + +3,978 + +$ + +- + +$ + +3,986 + +LIABILITIES + + + + + +Current + + + + + +Accounts payable and accrued liabilities + +$ + +52,632 + +$ + +48,021 + +Account payable to related parties + +109,167 + +259,007 + + + +161,799 + +307,028 + +SHAREHOLDERS' Deficiency + + + + + +Capital Stock (Note 4) + + + + + +Authorized: + + + + + +100,000,000 common voting shares without par value + + + + + +Issued: + + + + + +9,130,005 common voting shares (of which 3,750,000 are held in escrow) + + +276,501 + + +276,501 + +Contributed Capital + + +200,671 + + +- + +Deficit Accumulated During The Exploration Stage + +(638,971) + +(579,543) + +(161,799) + +(303,042) + +$ + +- + +$ + +3,986 + +See accompanying notes to the financial statements + +F-8 + + + + - 64 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +STATEMENTS OF OPERATIONS + +(Stated in Canadian Dollars) + + + + + + + + + +INCEPTION + + + + + + +JUNE 16 + + + + + + +1995 TO + + + +YEARS ENDED DECEMBER 31 + +DECEMBER 31 + +2002 + +2001 + +2000 + +2002 + +Revenue + +$ + +- + +$ + +- + +$ + +- + +$ + +- + + + + + + + + + + + + + + + + + + + +Expenses + + + + + + + + + +Accounting and legal + + +4,855 + + +3,645 + + +9,000 + + +22,500 + +Exploration costs + + +- + + +- + + +- + + +142,883 + +Interest expense + + +541 + + +1,062 + + +1,355 + + +5,808 + +Management fees + + +30,000 + + +30,000 + + +30,000 + + +225,000 + +Office and sundry + + +32 + + +42 + + +700 + + +1,363 + +Professional fees + + +- + + +- + + +1,800 + + +61,417 + +Rent + +24,000 + +24,000 + +24,000 + +180,000 + + + + + + + + + + + + + + + + + + + +Loss For The Year + +$ + +(59,428) + +$ + +(58,749) + +$ + +(66,855) + +$ + +(638,971) + + + + + + + + + + + + + + + + + + + +Comprehensive Income (Loss) For The Year + +$ + +(59,428) + +$ + +(58,749) + +$ + +(66,855) + + + + + + + + + + + + + + + + + + + + + +Earnings (Loss) Per Share, basic and diluted + +$ + +(0.01) + +$ + +(0.03) + +$ + +(0.01) + + + + + + + + + + + + + + + + + + + + + +Weighted Average Number Of Shares Outstanding, + +5,380,005 + +5,380,005 + +5,380,005 + + + +See accompanying notes to the financial statements + +F-9 + + + + - 65 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +STATEMENTS OF CASH FLOWS + +(Stated in Canadian Dollars) + + + + + + + + + +INCEPTION + + + + + + +JUNE 16 + + + + + + +1995 TO + + + +YEARS ENDED DECEMBER 31 + +DECEMBER 31 + +2002 + +2001 + +2000 + +2002 + + + + + + + + + + + + + + + + + + + +Cash Flows From Operating Activities + + + + + + + + + +Loss for the year + +$ + +(59,428) + +$ + +(58,749) + +$ + +(66,855) + +$ + +(638,971) + + + + + + + + + + + + + + + + + + + +Adjustments To Reconcile Loss To Net Cash Used By Operating Activities + + + + + + + + + +Change in Goods and Services Tax refundable + + +3,978 + + +(217) + + +(1,806) + + +- + +Change In prepaid expenses + + +- + + +- + + +700 + + +- + +Change in accounts payable and accrued liabilities + + +4,611 + + +58,865 + + +67,896 + + +52,632 + +Change in accounts payable to related parties + +50,831 + +- + +- + +309,838 + +Total Adjustments + +59,420 + +58,648 + +66,790 + +362,470 + +(8) + +(101) + +(65) + +(276,501) + + + + + + + + + + + + + + + + + + + +Cash Flows From Financing Activity + + + + + + + + + +Issue of capital stock + +- + +- + +- + +276,501 + + + + + + + + + + + + + + + + + + + +Increase (Decrease) In Cash + + +(8) + + +(101) + + +(65) + + +- + + + + + + + + + + + +Cash, Beginning Of Year + +8 + +109 + +174 + +- + + + + + + + + + + + + + + + + + + + +Cash, End Of Year + +$ + +- + +$ + +8 + +$ + +109 + +$ + +- + +See accompanying notes to the financial statements + +F-10 + + + + - 66 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +STATEMENT OF STOCKHOLDERS' EQUITY + +DECEMBER 31, 2002 + +(Stated in Canadian Dollars) + +DEFICIT + + + + + + + + +ACCUMULATED + + + + + +NUMBER + + + + + +DURING THE + + + + + +OF + + + +CONTRIBUTED + +EXPLORATION + + + +SHARES + +AMOUNT + +CAPITAL + +STAGE + +TOTAL + + + + + + + + + + + + + + + + + + + + + +Share issued for cash + +5 + +$ + +1 + +$ + +- + +$ + +- + +$ + +1 + +Loss for the period + +- + +- + +(38,624) + + +(38,624) + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 1995 + +5 + + +1 + + +- + + +(38,624) + + +(38,623) + + + + + + + + + + + + +Shares issued for cash + +9,130,000 + + +276,500 + + +- + + +- + + +276,500 + +Loss for the year + +- + + +- + + +- + + +(210,592) + + +(210,592) + + + + + + + + + + + + + + + + + + + + + +Balance, December 31,1996 + +9,130,005 + + +276,501 + + +- + + +(249,216) + + +27,285 + + + + + + + + + + + + +Loss for the year + +- + + +- + + +- + + +(74,529) + + +(74,529) + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 1997 + +9,130,005 + + +276,501 + + +- + + +(323,745) + + +(47,244) + + + + + + + + + + + + +Loss for the year + +- + + +- + + +- + + +(60,148) + + +(60,148) + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 1998 + +9,130,005 + + +276,501 + + +- + + +(383,893) + + +(107,392) + + + + + + + + + + + + +Loss for the year + +- + + +- + + +- + + +(70,046) + + +(70,046) + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 1999 + +9,130,005 + + +276,501 + + +- + + +(453,939) + + +(177,438) + + + + + + + + + + + + +Loss for the year + +- + + +- + + +- + + +(66,855) + + +(66,855) + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 2000 + +9,130,005 + + +276,501 + + +- + + +(520,794) + + +(244,293) + + + + + + + + + + + + +Loss for the year + +- + + +- + + +- + + +(58,749) + + +(58,749) + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 2001 + +9,130,005 + + +276,501 + + +- + + +(579,543) + + +(303,042) + + + + + + + + + + + + +Forgiveness of amounts due to related party + +- + + +- + + +200,671 + + +- + + +200,671 + + + + + + + + + + + + +Loss for the year + +- + + +- + + +- + + +(59,428) + + +(59,428) + + + + + + + + + + + + + + + + + + + + + +Balance, December 31, 2002 + +9,130,005 + +$ + +276,501 + +$ + +200,671 + +$ + +(638,971) + +$ + +(161,799) + +See accompanying notes to the financial statements + +F-11 + + + + - 67 - + +ENTOURAGE MINING LTD. + + (An Exploration Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +DECEMBER 31, 2002, 2001 AND 2000 + +(Stated in Canadian Dollars) + +1. NATURE AND CONTINUANCE OF OPERATIONS + +The Company is incorporated in the Province of British Columbia, Canada, and its principal business activity is the acquisition, exploration and development of mineral properties. + +These financial statements have been prepared in accordance with generally accepted accounting principles applicable to a going concern which assume that the Company will realize its assets and discharge its liabilities in the normal course of business. Realization values may be substantially difference from the carrying values shown in the financial statements should the Company be unable to continue as a going concern. + +The Company has experienced significant operating losses and, at December 31, 2002, has a working capital deficiency of $161,799, and has an accumulated deficit of $638,971. The recurring losses and lack of working capital raise substantial doubt about the Company's ability to continue as a going concern. + +The Company's ability to meet its obligations and maintain operations is contingent upon successful completion of additional financing arrangements and the continuing support of its creditors. Management is working to obtain sufficient working capital from external sources in order to continue operations, as well as identifying new business opportunities. There is, however, no assurance that the aforementioned events, including the receipt of additional funding, will occur or be successful. + +2. SIGNIFICANT ACCOUNTING POLICIES + +The financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States. Because a precise determination of many assets and liabilities is dependent upon future events, the preparation of financial statements for a period necessarily involves the use of estimates which have been made using careful judgement. + +The financial statements have, in management's opinion, been properly prepared within reasonable limits of materiality and within the framework of the significant accounting policies summarized below: + +a) Option Payments and Exploration Costs + +The Company expenses all costs related to the maintenance and exploration of mineral claims in which it has secured exploration rights prior to establishment of proven and probable reserves. To date, the Company has not established the commercial feasibility of its exploration prospects, therefore, all costs are being expensed. + +F-12 + + + + - 68 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +DECEMBER 31, 2002, 2001 AND 2000 + +(Stated in Canadian Dollars) + +2. SIGNIFICANT ACCOUNTING POLICIES (Continued) + +b) Use of Estimates + +The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses for the periods reported. Actual results could differ from these estimates. + +c) Financial Instruments + +The Company's financial instruments consist of cash, Goods and Services Tax recoverable, accounts payable and accrued liabilities. + +Unless otherwise noted, it is management's opinion that this Company is not exposed to significant interest or credit risks arising from these financial instruments. The fair value of these financial instruments approximate their carrying values, unless otherwise noted. + +d) Income Taxes + +The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 109 - "Accounting for Income Taxes" (SFAS 109). This standard requires the use of the asset and liability approach for accounting and reporting on income taxes. Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. 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. To the extent that it is not more likely than not that a deferred tax asset will be realized, a valuation allowance is provided. + +F-13 + + + + - 69 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +DECEMBER 31, 2002, 2001 AND 2000 + +(Stated in Canadian Dollars) + +2. SIGNIFICANT ACCOUNTING POLICIES (Continued) + +e) Stock Based Compensation + +The Company accounts for stock based employee and director compensation arrangements in accordance with provisions of Accounting Principles Board ("APB") Opinion No. 25 - "Accounting for Stock Issued to Employees", and related interpretations, and complies with the disclosure provisions of SFAS No. 123 - "Accounting for Stock Based Compensation". Under APB No. 25, compensation expense is based on the difference, if any, on the date the number of shares receivable is determined, between the estimated fair value of the Company's stock and the exercise price of options to purchase that stock. Stock based compensation arrangements for others are recorded at their fair value as the services are provided and the compensation earned. + +f) Earnings (Loss) Per Share + +Basic earnings (loss) per common share is computed in accordance with SFAS No. 128 - "Earnings Per Share" by dividing income and losses by the weighted average number of common shares outstanding for the year. Diluted per share amounts reflect the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted to common shares. In computing diluted earnings (loss) per share, no shares were added to the weighted average number of common shares outstanding during the years ended December 31, 2002, 2001 and 2000 for the dilutive effect of employee stock options and warrants as no options, warrants or other convertible securities were outstanding. No adjustments were required to reported earnings (loss) from operations in computing diluted per share amounts. + +g) Exploration Stage Company + +The Company is an exploration stage company as defined in the Statements of Financial Standards No. 7. The Company is devoting substantially all of its present efforts to establish a new business and none of its planned principal operations have commenced. All losses accumulated since inception have been considered as part of the Company's exploration stage activities. + +3. MINERAL PROPERTY + +Lion Mineral Claims + +By an agreement dated August 15, 1996, the Company was granted an option to acquire a 65% interest in four mineral claims located in the Toodoggone area of British Columbia. + +F-14 + + + + - 70 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +DECEMBER 31, 2002, 2001 AND 2000 + +(Stated in Canadian Dollars) + +3. MINERAL PROPERTY (Continued) + +Lion Mineral Claims (Continued) + +In order to earn its interest, the Company must incur exploration expenditures and issue shares from its treasury as follows: + + + +- + +a total of $200,000 in exploration expenditures, $100,000 of which must be incurred by December 31, 2000, with an additional $100,000 to be incurred by December 31, 2001; + + + +- + +a total of 200,000 shares in 50,000 share intervals as work progresses on the property, the results of which give rise to recommendations for further exploration expenditures. + +During the year ended December 31, 2001, the Company abandoned its interest in the Lion Mineral Claims. + +4. SHARE CAPITAL + +a) During the year ended December 31, 2002, the Company increased its authorized and issued common shares on the basis of five common shares for every common share held. Concurrently, the Company increased its authorized common shares to 100,000,000 common shares with no par value. All per share amounts and number of shares issued have been adjusted in these financial statements to reflect the share split. + +b) Of the Company's issued and outstanding shares, 3,750,000 are held in escrow, their release being subject to the approval of the regulatory authorities. As the escrow shares are considered to be contingently issuable shares, they have been excluded from the weighted average common shares outstanding for both basic and diluted earnings and loss per share calculations. + +5. RELATED PARTY TRANSACTIONS + +a) During the year ended December 31, 2002, the Company incurred $30,000 (2001 - $30,000; 2000 - $30,000) for management fees, and $24,000 (2001 - $24,000; 2000 - $24,000) for rent with a company controlled by a director. + +b) Included in accounts payable at December 31, 2002 is $109,167 (2001 - $259,007; 2000 - $205,007) owing to a director and to a company controlled by the same director. During the year ended December 31, 2002, the related company controlled by a director forgave $200,671 of accounts payable owed to it by the Company. + +F-15 + + + + - 71 - + +ENTOURAGE MINING LTD. + +(An Exploration Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +DECEMBER 31, 2002, 2001 AND 2000 + +(Stated in Canadian Dollars) + +6. INCOME TAXES + +A reconciliation of income taxes at statutory rates to the Company's effective income tax expense is as follows: + + + +2002 + +2001 + +2000 + + + + + + + + + + + + + + + +Loss for the year + +$ + +(59,428) + +$ + +(158,970) + +$ + +(66,855) + +Statutory tax rate + + +39.6% + + +44.6% + + +45.6% + +Expected income tax provision + +$ + +(23,533) + +$ + +(70,901) + +$ + +(30,486) + +Non-deductible differences + +$ + +79,465 + +$ + +44,699 + +$ + +- + +Unrecognized tax losses + +$ + +(55,932) + +$ + +26,202 + +$ + +30,486 + + + + + + + + + + + + + + + +Income tax provision + +$ + +- + +$ + +- + +$ + +- + +Details of future income tax assets are as follows: + + + +2002 + +2001 + +2000 + + + + + + + + + + + + + + + +Mineral properties + +$ + +36,782 + +$ + +41,428 + +$ + +42,355 + +Loss available for future periods + + +116,985 + + +194,750 + + +172,327 + +Valuation allowance + + +(153,767) + + +(236,178) + + +(214,682) + + + + + + + + + + + + + + + +Net future income tax asset + +$ + +- + +$ + +- + +$ + +- + +The Company has non-capital losses for income tax purposes of $295,417 which may be available to reduce taxable income in future years. The potential benefit of these losses has been recognized as a future income tax benefit but has been reduced by a valuation allowance, as currently these amounts are less than likely to be realized. These losses expire as follows: + +2005 + +$ + +55,348 + +2006 + + +114,465 + +2007 + + +66,855 + +2008 + + +58,749 + + + +$ + +295,417 + +The Company also has Canadian resource deductions totalling $92,883 with no specified expiry date. + +F-16 + + + + - 72 - + +TABLE OF CONTENTS + + + + + + +Page \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001246704_madison_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001246704_madison_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2214505b99cd645711710ef42c3ad9b6395feca --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001246704_madison_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered and certain other legal matters will be passed upon by our counsel, Yvonne Rebatta. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001246709_madison_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001246709_madison_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2214505b99cd645711710ef42c3ad9b6395feca --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001246709_madison_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered and certain other legal matters will be passed upon by our counsel, Yvonne Rebatta. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001246713_madison_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001246713_madison_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2214505b99cd645711710ef42c3ad9b6395feca --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001246713_madison_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered and certain other legal matters will be passed upon by our counsel, Yvonne Rebatta. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001246715_madison_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001246715_madison_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2214505b99cd645711710ef42c3ad9b6395feca --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001246715_madison_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered and certain other legal matters will be passed upon by our counsel, Yvonne Rebatta. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001246718_madison_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001246718_madison_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2214505b99cd645711710ef42c3ad9b6395feca --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001246718_madison_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered and certain other legal matters will be passed upon by our counsel, Yvonne Rebatta. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001246720_madison_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001246720_madison_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2214505b99cd645711710ef42c3ad9b6395feca --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001246720_madison_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of our common stock offered and certain other legal matters will be passed upon by our counsel, Yvonne Rebatta. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001252300_southern_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001252300_southern_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001252300_southern_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001252301_southern_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001252301_southern_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001252301_southern_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001252304_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001252304_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f8dc3ed4a22ad90a14cf4c6f3aaab71874f12a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001252304_american_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes and guarantees offered hereby will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by five of the subsidiary guarantors will be passed upon for us by Mundt MacGregor LLP, Seattle, Washington. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001253347_commonweal_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001253347_commonweal_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..366a0c003877e8570bf5c9efaea9b7fcc429fb3d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001253347_commonweal_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS In connection with the units offered hereby Reed Smith LLP, Philadelphia, Pennsylvania, counsel to the dealer manager, the general partner and CIGF5, will pass upon legal matters for CIGF5 and the general partner regarding the valid issuance of the units, and the United States federal income tax consequences of an investment in the units. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001255145_lightfirst_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001255145_lightfirst_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..048819aae57503c99dc2cb490c0268846d46b445 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001255145_lightfirst_legal_matters.txt @@ -0,0 +1,7053 @@ +LEGAL MATTERS + + +Vedder, Price, Kaufman +Kammholz, P.C., Chicago, Illinois, will pass upon the +validity of the issuance of the shares of common stock offered +by this prospectus. + +EXPERTS + + +The financial statements for the years ended +December 31, 2001, 2002 and 2003 included in this +prospectus have been so included in reliance on the report of +Mengel, Metzger, Barr Co. LLP, Rochester, New York, an +independent registered public accounting firm, given on their +authority as experts in auditing and accounting. + +74 + +Table of Contents + +WHERE YOU CAN FIND MORE INFORMATION + + +We have filed a registration statement on +Form S-1 with the Securities and Exchange Commission under +the Securities Act of 1933, as amended, with respect to the +common stock offered by this prospectus. This prospectus does +not contain all of the information in the registration statement +and its exhibits and schedules. For further information with +respect to our common stock, and us please see the registration +statement and the exhibits and schedules filed with the +registration statement. Statements contained in this prospectus +concerning the contents of any contract or other document +referred to are not necessarily complete. Please refer to the +copies of these contracts or other documents filed as an exhibit +to the registration statement. Each of these statements is +qualified in all respects by this reference. The registration +statement, including its exhibits and schedules, may be +inspected without charge at the principal office of the +Securities and Exchange Commission in Washington, D.C. Copies of +all or any part of the registration statement may be inspected +and copied at the public reference room maintained by the +Securities and Exchange Commission at 450 Fifth Street, N.W., +Room 1024, Washington, D.C. 20549. Copies of this material +may be obtained at prescribed rates by mail from the public +reference section of the Securities and Exchange Commission at +450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain +information on the operation of the Securities and Exchange +Commission s public reference room by calling the +Securities and Exchange Commission at 1-800-SEC-0330. In +addition, the Securities and Exchange Commission maintains an +Internet site at http://www.sec.gov that contains reports, proxy +and information statements and other information regarding +registrants, including us, that file electronically. + +75 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +FINANCIAL STATEMENTS + +AND + +INDEPENDENT AUDITORS REPORT + +DECEMBER 31, 2003, 2002 AND +2001 + +F-1 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +INDEX TO FINANCIAL STATEMENTS + + + + + + + + + + + Page + + + + + + + + FINANCIAL STATEMENTS + + + + + + + + + + + + Independent Auditors Report + + + + + + F-3 + + + + + + Balance Sheets + + + + + + F-4 + + + + + + Statements of Operations + + + + + + F-5 + + + + + + Statements of Shareholders Deficiency + + + + + + F-6 + + + + + + Statements of Cash Flows + + + + + + F-7 + + + + + + Notes to Financial Statements + + + + + + F-9 + + +F-2 + +Table of Contents + +INDEPENDENT AUDITORS REPORT + +Board of Directors + +LightFirst Inc. + + +We have audited the accompanying balance sheets +of LightFirst Inc. (a development stage company) as of +December 31, 2003 and 2002, and the related statements of +operations, shareholders deficiency, and cash flows for +the years then ended, for the period from inception +(April 11, 2001) to December 31, 2001 and for the +period from inception (April 11, 2001) to December 31, +2003. 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. + + +We conducted our audits in accordance with +auditing standards generally accepted in the United States of +America. 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. + + +In our opinion, the financial statements referred +to above present fairly, in all material respects, the financial +position of LightFirst Inc. as of December 31, 2003 and +2002, and the results of its operations and its cash flows for +the years then ended, for the period from inception +(April 11, 2001) to December 31, 2001 and for the +period from inception (April 11, 2001) to December 31, +2003, in conformity with accounting principles generally +accepted in the United States of America. + + +The accompanying financial statements have been +prepared assuming that the Company will continue as a going +concern. As discussed in Note N to the financial statements, the +Company is in the development stage as of December 31, +2003, has incurred significant losses since inception and has a +working capital and shareholders deficiency. Recovery of +the Company s assets and satisfaction of liabilities is +dependent upon future events, the outcome of which is +indeterminable. In addition, successful completion of the +Company s development program and its transition, +ultimately, to attaining profitable operations is dependent upon +obtaining adequate capital and financing to complete its +development activities and to achieve a level of revenues +adequate to support the Company s cost structure. These +conditions raise substantial doubt about the Company s +ability to continue as a going concern. Management s plans +in regard to these matters are also described in Note N. The +financial statements do not include any adjustments that might +result from the outcome of this uncertainty. + + + + + + + /s/ Mengel, Metzger, Barr Co. 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issuance of common stock to + minority shareholders + + + + + $ + 655,250 + + + $ + + + + $ + + + + $ + 655,250 + + + $ + + + + $ + 508,200 + + + $ + 147,050 + + + + + + Proceeds from issuance of common stock to + founding shareholder + + + + + + 100 + + + + + + + + + + + + 100 + + + + + + + + + + + + 100 + + + + + + Proceeds from line of credit payable to + shareholder + + + + + + 2,449,986 + + + + 564,999 + + + + 645,265 + + + + 1,884,987 + + + + 1,195,987 + + + + 689,000 + + + + + + + + + + Deferred offering costs + + + + + + (291,516 + ) + + + (86,663 + ) + + + (124,928 + ) + + + (204,853 + ) + + + (184,315 + ) + + + (20,538 + ) + + + + + + + + + Due (from) to officer/shareholder + + + + + + 4,927 + + + + 3,246 + + + + 16,917 + + + + 1,681 + + + + 18,598 + + + + (52,787 + ) + + + 35,870 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + NET CASH PROVIDED FROM FINANCING ACTIVITIES + + + + + + 2,818,747 + + + + 481,582 + + + + 537,254 + + + + 2,337,165 + + + + 1,030,270 + + + + 1,123,875 + + + + 183,020 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + NET INCREASE (DECREASE) IN CASH + + + + + + 18,852 + + + + 9,207 + + + + 21,300 + + + + 9,645 + + + + 5,037 + + + + (10,624 + ) + + + 15,232 + + + + + Cash at beginning of period + + + + + + + + + + 9,645 + + + + 4,608 + + + + + + + + 4,608 + + + + 15,232 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + CASH AT END OF PERIOD + + + + + $ + 18,852 + + + $ + 18,852 + + + $ + 25,908 + + + $ + 9,645 + + + $ + 9,645 + + + $ + 4,608 + + + $ + 15,232 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + NON-CASH OPERATING, INVESTING AND FINANCING + ACTIVITIES + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Investments received as consideration for sale of + common stock + + + + + $ + 544,800 + + + $ + + + + $ + + + + $ + 544,800 + + + $ + + + + $ + + + + $ + 544,800 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Acquisition of customer list offset by deferred + revenue + + + + + $ + 148,907 + + + $ + + + + $ + + + + $ + 148,907 + + + $ + + + + $ + + + + $ + 148,907 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Issuance of common stock in exchange for services + + + + + $ + 190,000 + + + $ + + + + $ + + + + $ + 190,000 + + + $ + 190,000 + + + $ + + + + $ + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +See notes to financial statements. + +F-8 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS + +December 31, 2003, 2002 and 2001 + +Note A: The +Company and Summary of Significant Accounting Policies + + + + + + + + + The Company + + +LightFirst Inc. (the Company) was incorporated on +April 11, 2001, for the purpose of developing electronic +bill presentation services. The Company currently derives its +revenue primarily from providing dial-up Internet access and +electronic mail access to a customer base that is primarily +comprised of teachers and other individual users in the Chicago, +Illinois area. The Company reports one segment based upon +Statement of Financial Accounting Standard +(SFAS) No. 131, Disclosures about Segments of an +Enterprise and Related Information . + + +Since April 11, 2001 (date of inception), +the Company s efforts have been devoted primarily to +developing the Company s software systems, developing +markets for its products, and to raising capital. The Company +has not generated significant revenues from its services as of +December 31, 2003. Accordingly, through the date of these +financial statements, the Company is considered to be in the +development stage and the accompanying financial statements +represent those of a development stage enterprise. + + + + + + + + + Unaudited interim financial + information + + +The accompanying interim balance sheet as of +June 30, 2004, the statements of operations and cash flows +for the six months ended June 30, 2004 and 2003 and the +statement of shareholders deficiency for the six months +ended June 30, 2004 are unaudited. The unaudited interim +financial statements have been prepared in accordance with +accounting principles generally accepted in the United States of +America. In the opinion of the Company s management, the +unaudited interim financial statements have been prepared on the +same basis as the audited financial statements and include all +adjustments, consisting only of normal recurring adjustments, +necessary for the fair presentation of the Company s +results of operations and its cash flows for the six months +ended June 30, 2004 and 2003. The results for the six +months ended June 30, 2004 are not necessarily indicative +of the results to be expected for the year ended +December 31, 2004. + + +The accompanying interim financial statements +cited above should be read in conjunction with the financial +statements and related notes presented in the Company s +Annual Report on Form 10-K for the year ended +December 31, 2003. + + +The accompanying unaudited financial statements +have been prepared in accordance with accounting principles +generally accepted in the United States of America, which +contemplates the realization of assets and the satisfaction of +liabilities in the normal course of business as a going concern. +The Company has been in the development stage since its +inception on April 11, 2001. + + +The Company incurred a net loss of approximately +$1,180,000 for the six months ended June 30, 2004. Further, +the Company has incurred aggregate net losses since its +inception (April 11, 2001) through June 30, 2004 of +approximately $6,753,000. In addition, at June 30, 2004, +the Company s current liabilities exceeded its current +assets by approximately $4,700,000 and its total liabilities +exceeded its total assets by approximately $5,363,225. The +Company has substantial liquidity issues, and at June 30, +2004 had a balance of approximately $1,830,000 outstanding on +its $3,000,000 line of credit. As more fully described in Note +N, the Company has a limited operating history and its future +prospects are subject to the risks, expenses and uncertainties +frequently encountered by companies in the new and rapidly +evolving markets for Internet based products and services. These +risks include the failure to develop and protect the +Company s online brands, the failure of vendors and +third-party providers to supply hardware and software products +and services, systems and online security failure, the rejection +of the Company s services by + +F-9 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +Internet consumers, vendors and advertisers, the +inability of the Company to maintain and increase their customer +base in levels sufficient to generate profitable operations, as +well as other risks and uncertainties. The success of the +Company also depends on the continued growth of the Internet as +a viable commercial marketplace. + + +On August 6, 2004, the Company filed a +Registration Statement on Form S-1 with the Securities and +Exchange Commission ( SEC ). The purpose of this +filing is to give the Company the ability to go to the public +markets for additional equity capital. There are no assurances +that shares of common stock will be sold in connection with the +Registration Statement. In the event the Company is not able to +raise additional equity capital or obtain additional amounts of +debt financing, there is uncertainty as to the Company s +ability to continue as a going concern. + + +Management is currently devoting substantial +efforts to sell its common shares in connection with its initial +public offering. Should the public offering be consummated, +management believes the Company will be better able to execute +its business plan and begin their revenue producing activities +related to electronic bill presentation and related services. + + + + + + + + + Cash + + +The Company maintains its cash balances at two +financial institutions located in the Chicago, Illinois area. +Accounts at these institutions are insured by the Federal +Deposit Insurance Corporation up to $100,000. There were no +uninsured balances at December 31, 2003. + + + + + + + + + Property + + +Property is recorded at cost. Depreciation is +provided using the straight-line method over the estimated +useful lives of the related assets, which approximate three +years. Major renewals and betterments are capitalized, while +repairs and maintenance are charged to operations as incurred. +Upon sale or retirement, the cost and accumulated depreciation +is removed from the accounts and the related gain or loss is +reflected in operations. + + + + + + + + + Deferred offering costs + + +The Company has incurred costs in connection with +raising additional capital through the sale of its common stock. +These costs have been capitalized and will be charged against +additional paid-in capital should common stock be issued. If +there is no issuance of common stock, the costs incurred will be +charged to operations. + + + + + + + + + Valuation of long-lived + assets + + +In accordance with SFAS No. 144, the +Company evaluates the carrying value of long-lived assets to be +held and used whenever events or changes in circumstances +indicate that the carrying amount may not be recoverable. The +carrying value of a long-lived asset is considered impaired when +the projected undiscounted future cash flows are less than its +carrying value. The Company measures impairment based on the +amount by which the carrying value exceeds the fair market +value. Fair market value is determined primarily using the +projected future cash flows discounted at a rate commensurate +with the risk involved. Losses on long-lived assets to be +disposed of are determined in a similar manner, except that fair +market values are reduced for the cost to dispose. + +F-10 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + + + + + + + + + Revenue recognition + + +Revenues are recorded when earned (i.e., at the +time services are provided). Deferred revenue consists of +amounts collected for services to be provided in future periods +of one year or less. + + + + + + + + + Income Taxes + + +Deferred income tax assets and liabilities arise +from temporary differences associated with differences between +the financial statement and tax basis of assets and liabilities, +as measured by the enacted tax rates which are expected to be in +effect when these differences reverse. Deferred tax assets and +liabilities are classified as current or non-current, depending +on the classification of the assets or liabilities to which they +relate. Deferred tax assets and liabilities not related to an +asset or liability are classified as current or non-current +depending on the periods in which the temporary differences are +expected to reverse. The temporary differences between assets +and liabilities for financial statement and tax return purposes +are set forth in Note H. + + + + + + + + + Stock-based compensation + costs + + +The Company adopted the disclosure provisions of +Statement of Financial Accounting Standards ( SFAS or + Statement ) No. 148, Accounting for +Stock-Based Compensation Transition and Disclosure , which +amends SFAS No. 123, Accounting for Stock-Based +Compensation . SFAS No. 148 provides alternative +methods of transition for a voluntary change to the fair value +based method of accounting for stock-based employee +compensation, which was originally provided under +SFAS No. 123. The Statement also improves the +timeliness of disclosure by requiring the information be +included in interim, as well as annual, financial statements. +The adoption of these disclosure provisions did not have a +material effect on the Company s financial statements. + + +SFAS No. 123 encourages, but does not +require, companies to record compensation cost for stock-based +employee compensation plans at fair value. The Company has +chosen to continue to account for stock-based compensation using +the intrinsic value method prescribed in Accounting Principles +Board Opinion No. 25, Accounting for Stock Issued to +Employees , and related Interpretations. Accordingly, +compensation cost for stock options is measured as the excess, +if any, of the market price of the Company s stock at the +date of the grant over the amount an employee must pay to +acquire the stock. The option price of all the Company s +stock options is at least equal to the market value of the stock +at the grant date. As such, no compensation expense is recorded +in the accompanying financial statements. For purposes of +pro-forma disclosure, the Company believes there would not have +been any additional stock-based compensation expense to disclose +had the fair value recognition provision of +SFAS No. 123 been applied. + + + + + + + + + Earnings per share + + +Basic net (loss) income per share is determined +by dividing net (loss) income by the weighted average number of +common shares outstanding. There were no dilutive potential +common shares for all periods presented in the accompanying +statements of operations. + + + + + + + + + New accounting pronouncements + + +In June 2001, the Financial Accounting Standards +Board (FASB) issued SFAS No. 141, Business +Combinations , and No. 142, Goodwill and Other +Intangible Assets . SFAS No. 141 applies to all +business combinations with a closing date after June 30, +2001. SFAS No. 141 also further clarifies the criteria +for recognition of intangible assets separately from goodwill. +There was no material effect to the + +F-11 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +Company s financial statements upon adoption +of SFAS No. 141. SFAS No. 142 addresses the +recognition and measurement of goodwill and other intangible +assets subsequent to a business combination. The Company adopted +this standard effective January 1, 2002 and it did not have +a material effect on the Company s financial statements. + + +In June 2001, the FASB issued +SFAS No. 143, Accounting for Asset Retirement +Obligations , which requires companies to record a +liability at fair value for asset retirement obligations for the +period in which they are incurred. The associated asset +retirement costs are capitalized as part of the carrying amount +of the long-lived asset. The Company adopted this standard +effective January 1, 2003 and it did not have a material +effect on the Company s financial statements. + + +In October 2001, the FASB issued +SFAS No. 144, Accounting for the Impairment or +Disposal of Long-Lived Assets . SFAS No. 144 +supercedes SFAS No. 121, Accounting for the +Impairment or Disposal of Long-Lived Assets and for Long-Lived +Assets to be Disposed Of and replaces the accounting and +reporting provisions of APB Opinion No. 30, Reporting +Results of Operations Reporting the Effects of +Disposal of a Segment of a Business and Extraordinary, Unusual +and Infrequently Occurring Events and Transactions , as it +relates to the disposal of a segment of business. +SFAS No. 144 requires the use of a single accounting +model for long-lived assets to be disposed of by sale. +SFAS No. 144 retains the fundamental provisions of +SFAS No. 121 for recognition and measurement of the +impairment of long-lived assets to be held and used and +measurement of long-lived assets to be disposed of by sale. The +Company adopted this standard effective January 1, 2002 and +it did not have a material effect on the Company s +financial statements. + + +In July 2002, the FASB issued +SFAS No. 146, Accounting for Costs associated +with Exit or Disposal Activities , which is effective for +exit or disposal activities initiated after December 31, +2002. SFAS No. 146 requires companies to recognize +costs associated with exit or disposal activities when they are +incurred rather than at the date of a commitment to an exit or +disposal plan. The Company adopted this standard on +January 1, 2003 and it did not have a material effect on +the Company s financial statements. + + +In November 2002, the FASB issued Interpretation +No. 45, Guarantor s Accounting and Disclosure +Requirements for Guarantees, including Indirect Guarantees of +Indebtedness of Others ( FIN 45 ). This +Interpretation elaborates on the disclosures to be made by a +guarantor in its interim and annual financial statements about +its obligations under certain issued guarantees. Under the +provision of FIN 45, at the time a guarantee is issued, the +Company will recognize a liability for the fair value or market +value of the obligation it assumes. The initial measurement and +recognition provisions of this interpretation are applicable on +a prospective basis for guarantees issued or modified after +December 31, 2002, and the disclosure requirements of this +Interpretation are effective for interim or annual financial +statements issued after December 15, 2002. The Company +adopted FIN 45 as required and it did not have a material +effect on the Company s financial statements. + + +In December 2002, the FASB issued +SFAS No. 148, Accounting for Stock-Based +Compensation Transition and Disclosure . +SFAS No. 148 amends SFAS No. 123, + Accounting for Stock-Based Compensation , to provide +alternative methods of transition for a voluntary change to the +fair value based method of accounting for stock-based +compensation. In addition, SFAS No. 148 amends the +disclosure requirements of SFAS No. 123 to require +prominent disclosures in both annual and interim financial +statements about the method of accounting for stock-based +employee compensation and the effect of the method used on +reported results. The transition guidance and annual disclosure +provisions of SFAS No. 148 are effective for the +Company s fiscal year ended December 31, 2003. The +Company continues to account for stock-based compensation using +the intrinsic value method in accordance with the provisions of +APB Opinion No. 25, Accounting for Stock Issued to +Employees , as allowed by + +F-12 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +SFAS No. 123. The adoption of +SFAS No. 148 did not have any impact on the +Company s financial statements. + + +SFAS No. 149, Amendment of +Statement 133 on Derivative Instruments and Hedging +Activities was issued in April 2003 and its effective for +all derivative contracts entered into or modified after +June 30, 2003. The Company has had no derivative contracts +since its inception. This standard is not expected to have a +material effect on the Company s financial statements. + + +In May 2003, the FASB issued +SFAS No. 150, Accounting for Certain Financial +Instruments with Characteristics of both Liabilities and +Equity , which changes the accounting for certain financial +instruments that, under previous guidance, could be classified +as equity, by now requiring those instruments to be classified +as liabilities (or assets in some circumstances) in the +statement of financial position. Further, SFAS No. 150 +requires disclosure regarding the terms of those instruments and +settlement alternatives. The guidance in SFAS No. 150 +is generally effective for all financial instruments entered +into or modified after May 31, 2003, and is otherwise +effective at the beginning of the first interim period beginning +after June 15, 2003. The Company adopted +SFAS No. 150 in the second quarter of 2003. The +adoption of SFAS No. 150 did not have a material +impact on the Company s financial statements. + + +In January 2003, the FASB issued FIN No. 46, + Consolidation of Variable Interest Entities and in +December 2003, a revised interpretation was issued (FIN +No. 46, as revised) which addresses consolidation by +business enterprises of variable interest entities that have +certain characteristics. In general, FIN No. 46, as +revised, requires a variable interest entity to be consolidated +by a company if that company is subject to a majority of the +risk of loss from the variable interest entity s activities +or is entitled to receive a majority of the entity s +residual returns or both. An entity that meets this definition +is considered the primary beneficiary . FIN +No. 46, as revised, requires disclosures about variable +interest entities by the primary beneficiary and an enterprise +that holds significant variable interests in a variable interest +entity but is not the primary beneficiary. FIN No. 46, as +revised, provides for exceptions to the scope of this +interpretation including transfers to qualifying special purpose +entities subject to the reporting of SFAS No. 140, +which would not be consolidated. FIN No. 46, as revised, +applies immediately to variable interest entities created after +January 31, 2003 and to variable interest entities in which +an enterprise obtains an interest after January 31, 2003. +FIN No. 46, as revised, applies in the first fiscal year, +or interim period, beginning after December 15, 2003 to +variable interests entities in which an enterprise holds a +variable interest that it acquired before February 1, 2003. +This statement did not have a material impact on the +Company s financial statements. + + + + + + + + + Estimates + + +The preparation of financial statements in +conformity with accounting principles generally accepted in the +United States of America requires management to make estimates +and assumptions that affect the reported amounts of assets and +liabilities and disclosure of contingent assets and liabilities +at the date of the financial statements and the reported amounts +of revenues and expenses during the reporting period. Actual +results could differ from those estimates. + +Note B: Customer +List + + +In April 2001, the Company purchased the right, +title and interest in a current base of subscribers, including +service agreements, from Avenew.com, Inc., a related party (also +see Note J). An officer/shareholder of Avenew.com, Inc. is +also the founding shareholder and an officer of the Company. +Under the terms of the agreement, the Company assumed the +obligation to provide Internet access services to the above +cited subscribers for contract periods already paid for by the +subscribers. The remaining contract periods ranged from less +than one month to one year. The obligation for future services + +F-13 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +to be provided for these contract periods +amounted to $148,907. As additional consideration for the +customer list, the Company was also required to pay Avenew.com +for the cash received from the customer base for services during +the six month period following the acquisition, which amounted +to $112,409. The total consideration for the customer list +amounted to $261,316, and is being amortized on a straight-line +basis over a thirty-six month period. + + +At the time of the purchase, the Company s +president and chief executive officer owned 100% of the +outstanding common stock of LightFirst Inc. and 23% (on a fully +diluted basis) of the outstanding common stock of Avenew.com, +Inc. Such stock holdings made the Company s president and +chief executive officer the controlling shareholder of both +companies at the date of the above-cited transaction. + +Note C: Due +From/ to Officer/ Shareholder + + +The Company has an amount due to an +officer/shareholder of $1,681 at December 31, 2003 and an +amount due from an officer/shareholder of $16,917 at +December 31, 2002. The amounts bear interest at a rate of +6%. The amount due from an officer/shareholder was collected +during 2003. + +Note D: Line +of Credit Payable to Shareholder + + +The Company has a line of credit arrangement +available with a shareholder of the Company, which provides for +interest at a rate of 9%. The arrangement provides for +borrowings of up to $1,500,000 through its expiration date of +December 31, 2004. The arrangement is secured by all assets +of the Company. At December 31, 2003 and 2002, there was +$1,264,987 and $69,000, respectively, outstanding under this +arrangement. + +Note E: Accrued +Payroll + + +The Company has entered into written agreements +with several employees, whereby the employees have agreed to +defer receiving certain amounts of compensation. Such +compensation will be payable at the earlier of ten days +following the successful completion and closing of the +Company s initial public offering (see Note N) or +January 2, 2005. The total accrued payroll related to these +agreements amounted to approximately $703,000 and $450,000 at +December 31, 2003 and 2002, respectively. + +Note F: Accrued +Payroll Taxes and Related Penalties + + +The Company has a liability for payroll taxes not +remitted to various Federal and State taxing authorities, +amounting to approximately $753,000 and $539,000 at +December 31, 2003 and 2002, respectively. In addition, the +Company has recorded a liability of approximately $399,000 and +$221,000 for the estimated tax penalties associated with the +non-payment of the above-cited payroll taxes at +December 31, 2003 and 2002, respectively. + +Note G: Notes +Payable to Shareholder + + +The Company has two notes payable to a +shareholder in the amounts of $200,000 and $420,000. The notes +were originally due in February 2003 and April 2003, +respectively; however, during 2003 the due dates for each note +were extended until the earlier of the successful completion of +the Company s initial public offering or January 1, +2005. The notes bear interest at a rate of 10%. Principal and +interest for both notes are due in full on January 1, 2005. +Principal plus accrued interest on these notes approximated +$708,000 and $641,000 at December 31, 2003 and 2002, +respectively. These notes are secured by certain real property +owned by the majority shareholder as well as his personal +guarantee. In addition, the + +F-14 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +$420,000 note described above is also secured by +certain real property owned by another shareholder of the +Company as well as this shareholder s personal guarantee. + +Note H: Income +Taxes + + +Deferred taxes resulting from temporary +differences are as follows: + + + + + + + + + + + + + + + + + + Asset + + + + + + + + + + + + December 31, + + + + + + + + 2003 + + 2002 + + + + + + + + + + Net operating loss carryforward + + + + + $ + 1,260,000 + + + $ + 753,700 + + + + + Deferred compensation + + + + + + 210,000 + + + + 135,000 + + + + + Customer list + + + + + + 51,000 + + + + 30,500 + + + + + + + + + + + + + + + + 1,521,000 + + + + 919,200 + + + + + Less valuation allowance + + + + + + 1,521,000 + + + + 919,200 + + + + + + + + + + + + + + + $ + + + + $ + + + + + + + + + + + + + + +As of December 31, 2003, the Company has a +net operating loss carryforward for tax purposes of +approximately $3,750,000. This loss carryforward may be used to +offset future taxable income and expires at various dates +through 2023. + + +Because of the uncertainty surrounding the future +utilization of the net operating loss carryforward, future +deferred compensation deductions and the tax deductions +associated with the customer list, the Company has recorded a +valuation allowance of $1,521,000 and $919,200 at +December 31, 2003 and 2002, respectively, to completely +offset the deferred tax asset which may have otherwise been +recorded. + +Note I: Common +Stock Agreements + + +The Company had common stock agreements to sell +and issue a total of 1,200,000 shares of the Company s +common stock for an aggregate price of $1,200,000. At +December 31, 2001, a total of 691,800 shares of stock +had been issued in exchange for $544,800 of marketable +securities and $147,000 of cash. The additional +508,200 shares of stock were issued in July 2002 upon +receipt of $508,200 of cash. + +Note J: Avenew.com +Agreement + + +The Company had an agreement with Avenew.com +whereby Avenew.com provided customer support, billing +management, and software development services to the Company for +a charge of $1.50 per customer per month, with a minimum +charge of $22,000 per month. This agreement expired in May +2002. In connection with this agreement, the Company incurred +expenses of approximately $110,000 and $163,000 for the year +ended December 31, 2002 and for the period from +April 11, 2001 (date of inception) through +December 31, 2001, respectively. Subsequent to the +expiration of this agreement, the Company began performing these +services. + +Note K: Network +Services and Co-Location Agreements + + +In September 2003, the Company entered into an +agreement with a service provider for co-location services. This +agreement provides for monthly payments of $8,300, through its +expiration in September 2004. + + +In November 2003, the Company entered into an +agreement with a service provider to purchase telecommunication +services for the interconnection of the Company s end users +with the internet and to + +F-15 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +have access to Internet bandwidth. This agreement +provides for monthly payments of approximately $25,000 through +its expiration in October 2008. + + +In January 2002, the Company entered into +agreements with two service providers to purchase +telecommunication services for the interconnection of the +Company s end users with the internet, rent space to house +telecommunications equipment, and have access to Internet +bandwidth. These agreements provided for aggregate monthly +payments of approximately $31,000, depending on usage. These +agreements expired in December 2003. + + +Prior to January 2002, the Company obtained +services similar to those cited above from a different service +provider under agreements which were terminated effective +December 31, 2001. + + +The total cost of these agreements amounted to +approximately $501,000 and $342,000 for the years ended +December 31, 2003 and 2002, respectively and approximately +$223,000 for the period from April 11, 2001 (date of +inception) through December 31, 2001. These costs have been +included in the accompanying statements of operations as cost of +revenues. + +Note L: Commitments + + + + + + + + + Lease agreements + + +The Company entered into a month to month lease +agreement in May 2003 for its operating facilities which +requires monthly payments of $13,421. The Company was previously +committed under a sublease agreement for the same space which +required monthly payments of $11,929 through July 2003. During +September 2003, the Company settled a claim against it for +disputed rent in connection with this sub-lease agreement. As a +result of the settlement, the Company was able to extinguish +approximately $50,000 of previously recorded rent. Accordingly, +the Company has recorded a reduction of their rent expense in +the accompanying statement of operations for the year ended +December 31, 2003. Total rent expense, net of this +reduction, amounted to $116,611 and $79,659 for the years ended +December 31, 2003 and 2002, respectively and $26,233 from +the period April 11, 2001 (date of inception) through +December 31, 2001. + + + + + + + + + Employment agreement + + +The Company entered into an employment agreement +with its majority shareholder, effective January 1, 2003, +to serve as the President and Chief Executive Office of the +Company. The agreement covers a three year period (unless +terminated earlier in accordance with terms provided in the +agreement) and provides for an annual base salary of $1.00 plus +bonuses for the achievement of certain subscriber acquisition +goals. + +Note M: Stock +Option Plan + + +On January 5, 2002, the Company s Board +of Directors approved the LightFirst Inc. 2002 Stock Option Plan +(the Plan ). The Plan is designed to attract and +retain key employees, directors, or consultants of the Company +and to encourage them to contribute to the Company s +success by providing the opportunity for stock ownership. The +Plan provides for annual grants of incentive stock options and +non-statutory stock options to key employees, directors and +consultants of the Company to purchase up to 10% of the +outstanding common stock of the Company as of January +1st of each year. In addition, until the Plan terminates, +there shall also be available for the grant of options pursuant +to the Plan a total of 250,000 shares of common stock. The +Plan is administered by a Stock Option Committee, which is +authorized to determine the recipients of options, the type of +options granted, the number of shares subject to each option, +the term of each option, exercise prices and other option +features. The exercise price for incentive stock options granted +under the Plan shall not be less than 100% of the fair market +value of the + +F-16 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +shares subject to the option. The option price +for non-qualified stock options granted under the Plan shall not +be less than 85% of the fair market value (determined as of the +day the option is granted). Stock option grants will have a +contractual life of no more than ten years from the grant date +and are subject to early termination as provided for in the Plan. + + +On January 5, 2002, the Company granted +non-qualified stock options to purchase 88,750 shares +of the Company s common stock. The awards had exercise +dates of January 5, 2003 (covering 59,500 shares) and +January 5, 2004 (covering 29,250 shares). The +expiration date for the exercise of all of the above-cited +awards is January 5, 2007. The exercise price for the +shares subject to options of the Company s common stock is +at least equal to the fair market value on the date of the grant. + + +Information relating to stock options outstanding +is as follows: + + + + + + + + + + + + + + + Number + + Exercise + + + + of + + Price per + + + + Shares + + Share + + + + + + + + + + Shares under option at January 1, 2002 + + + + + + + + + $ + + + + + + + Granted on January 5, 2002 + + + + + + 88,750 + + + + 2.50 + + + + + + Exercised + + + + + + + + + + + + + + + + + + + + + + + + + Shares under option at December 31, 2002 + + + + + + 88,750 + + + + 2.50 + + + + + + Granted + + + + + + + + + + + + + + + + Exercised + + + + + + + + + + + + + + + + + + + + + + + + + Shares under option at December 31, 2003 + + + + + + 88,750 + + + $ + 2.50 + + + + + + + + + + + + + + + + + + Note N: + + Going Concern Uncertainty and + Management s Plans + + +The accompanying financial statements have been +prepared in accordance with accounting principles generally +accepted in the United States of America, which contemplates the +realization of assets and the satisfaction of liabilities in the +normal course of business as a going concern. As discussed in +Note A, the Company has been in the development stage since +its inception on April 11, 2001. + + +The Company has a limited operating history and +its future prospects are subject to the risks, expenses and +uncertainties frequently encountered by companies in the new and +rapidly evolving markets for Internet based products and +services. These risks include the failure to develop and protect +the Company s online brands, the failure of vendors and +third-party providers to supply hardware and software products +and services, systems and online security failure, the rejection +of the Company s services by Internet consumers, vendors +and advertisers, the inability of the Company to maintain and +increase their customer base in levels sufficient to generate +profitable operations, as well as other risks and uncertainties. +The success of the Company also depends on the continued growth +of the Internet as a viable commercial marketplace. + + +In February 2004, a Registration Statement filed +on Form S-1 with the Securities and Exchange Commission +( SEC ) was approved. The purpose of this filing is to +give the Company the ability to go to the public markets for +additional equity capital. There are no assurances that shares +of common stock will be sold in connection with the Registration +Statement. In the event the Company is not able to raise +additional equity capital or obtain additional amounts of debt +financing, there is uncertainty as to the Company s ability +to continue as a going concern. + + +Management is currently devoting substantial +efforts to sell its common shares in connection with its initial +public offering. Should the public offering be consummated, +management believes the Company will + +F-17 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +be better able to execute its business plan and +begin their revenue producing activities related to electronic +bill presentation and related services. + + + + + + + Note O: + + Subsequent Event + + +In March 2004, the borrowings available under the +line of credit arrangement described in Note D were +increased from $1,500,000 to $3,000,000 and the maturity date +was extended until January 1, 2005. The maturity of the +credit line is subject to acceleration upon the occurrence of +certain acceleration events, including the successful completion +of a public offering of securities by the Company. All other +terms and conditions of the arrangement remained the same as +described in Note D. Management believes that the +shareholder cited in Note D will be able to fund requested +draws by the Company on this line of credit arrangement up to +the maximum available amount. + +Note P: Quarterly +Financial Data (Unaudited) + + +The Company s unaudited quarterly results +for the years ended December 31, 2003 and 2002 were as +follows: + + + + + + + + + + + + + + + + + + + + + + + + + + First + + Second + + Third + + Fourth + + + + 2003 + + Quarter + + Quarter + + Quarter + + Quarter + + Total + + + + + + + + + + + + + + + + Revenues + + + + + $ + 124,664 + + + $ + 122,506 + + + $ + 120,800 + + + $ + 118,190 + + + $ + 486,160 + + + + + + + + + + + + + + + + + + + + + + + + + + + Gross profit (loss) + + + + + $ + (1,152 + ) + + $ + 14,179 + + + $ + 14,929 + + + $ + (43,261 + ) + + $ + (15,305 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + Loss from operations + + + + + $ + (527,049 + ) + + $ + (725,702 + ) + + $ + (365,267 + ) + + $ + (548,621 + ) + + $ + (2,166,639 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + Net loss + + + + + $ + (547,841 + ) + + $ + (756,175 + ) + + $ + (401,196 + ) + + $ + (592,878 + ) + + $ + (2,298,090 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + Net loss per share basic and diluted + + + + + $ + (0.09 + ) + + $ + (0.09 + ) + + $ + (0.09 + ) + + $ + (0.09 + ) + + $ + (0.36 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + 2002 + + + + + + + + + + + + + + + + + + + + + + + + + + Revenues + + + + + $ + 102,680 + + + $ + 90,500 + + + $ + 108,116 + + + $ + 119,000 + + + $ + 420,296 + + + + + + + + + + + + + + + + + + + + + + + + + + + Gross profit + + + + + $ + 26,558 + + + $ + 33,768 + + + $ + 4,264 + + + $ + 14,173 + + + $ + 78,763 + + + + + + + + + + + + + + + + + + + + + + + + + + + Loss from operations + + + + + $ + (564,739 + ) + + $ + (523,247 + ) + + $ + (574,700 + ) + + $ + (782,102 + ) + + $ + (2,444,788 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + Net loss + + + + + $ + (571,255 + ) + + $ + (523,247 + ) + + $ + (582,122 + ) + + $ + (795,846 + ) + + $ + (2,472,470 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + Net loss per share basic and diluted + + + + + $ + (0.10 + ) + + $ + (0.09 + ) + + $ + (0.09 + ) + + $ + (0.12 + ) + + $ + (0.40 + ) + + + + + + + + + + + + + + + + + + + + + + + +F-18 + +Table of Contents + +LIGHTFIRST INC. + +(A Development Stage Company) + +NOTES TO FINANCIAL STATEMENTS +(Continued) + +LIGHTFIRST INC. + +STOCK ORDER FORM + +(Instructions on page iii) + + + + + + + DEADLINE AND DELIVERY + + + FOR INTERNAL USE + + + + + EXPIRATION DATE: 5:00 p.m., Chicago time, + on . + This original Stock Order Form, properly executed and with full + payment, must be received (not postmarked) by our Escrow Agent + by this deadline. Stock Order Forms received after this deadline + will not be honored. Delivery will be accepted by the return + envelope provided, or by overnight delivery to the address on + page v. + + + + Date Rec d Batch + No. ---------------------- + + + + Order No. + + +YOU MUST PRINT CLEARLY AND COMPLETE ALL +APPLICABLE AREAS. + + + + + (1) + + SHARES REQUESTED + (100 share minimum) + + + + + + + + + + + + + Number of Shares + + + + Price per Share + + + + Amount Due + + + + + X + + + + $10.00 + + + + = + + + + + + + + + + + + + + + + + + + (2) + + METHOD OF PAYMENT + (Cash and wires will not be accepted) + + + + + + + + PAYMENT MUST BE MADE BY CHECK OR MONEY ORDER AND + MUST ACCOMPANY THIS ORDER FORM. Enclosed is/are personal + check(s), bank check(s) or money order(s) payable to + JPMorgan Chase Trust totaling: + $ + + + + + + (3) + + PURCHASER + INFORMATION (CHECK ONLY ONE BOX) + + +Note: If more than one category applies, mark +the box beside the category that is shown earliest in the +list. + + + + + + + City Manager or Community Associate + You are a participant in the LightFirst Associate Program, have + electronically or physically executed a LightFirst Independent + Agent Agreement, and that Agreement is currently in effect. + + + + + + + Independent Contractor You are an + independent contractor or a member of the immediate family of an + independent contractor working on a part-time basis for + LightFirst as part of the Student Internship Program, Call + Center Program, or Internet Trainer Program. If you are not the + independent contractor, but an immediate family member, write + the independent contractor s name and your relationship to + that person in the spaces below: + + + + + + + + Independent Contractor s + Name: + + + + + + + Relationship: I am the independent + contractor s + + + + + + + Customer + You have an active LightFirst Internet access account. + + + + + + + Primary Account Log-in + Name: + + + + + + + + + + Business Relationships You are the + owner or an employee of a business with which we maintain a + relationship, including a business that participates in our + Community Directory program: + + + + + + + + Name of + Business: + + + + + + + Your position/relationship to Business (circle + one): A. Owner B. Employee + + + + + + + + Community Member Your primary + residence in located in one of the following Illinois counties: + Cook, DuPage, Kane, Kendall, Lake, McHenry, Will. + + + All +Others + + + + + (4) + + LIGHTFIRST DIRECTORS, EXECUTIVE OFFICERS, + ASSOCIATES + + Check +here if you are a LightFirst director or executive officer. + + + + + + + Check here if you are a member of the immediate + family of a LightFirst director or executive officer. (See + definition on reverse side of this Form.) + + +i + +Table of Contents + +(5) FORM OF STOCK OWNERSHIP +(Check One See Ownership +Definitions on pages iii-iv). + + + + + + + + Individual + + + + + + Corporation + + + + + Joint + Tenants + + + + + + Partnership + + + + + Tenants + in Common + + + + + + Uniform + Transfers to Minors + + + + + Trust + (Under Agreement Dated ------------) + + + + + + Other + + +FOR BROKER USE +ONLY: IRA + +Social Security # of Beneficial +Owner: + + + + + (6) + + STOCK REGISTRATION + (PRINT clearly and provide all + information, which will be used for stock certificate delivery + and future mailings). + + + + + + + + + (First Name, Middle Initial, + Last Name) + + + + + + ----------------------------------------------------- + + (Social Security No./Tax ID No., + + certificate will show only this number) + + + + + + + (First Name, Middle Initial, + Last Name) + + + + + + ----------------------------------------------------- + + (Social Security No./Tax ID No.) + + + + + + + (Street Address) + + + + + + ----------------------------------------------------- + + (Daytime Phone Number) + + + + + + + (City, State, Zip Code) + + + + + + ----------------------------------------------------- + + (Evening Phone Number) + + + + + + (7) + + NATIONAL ASSOCIATION OF SECURITIES DEALERS + ( NASD ) AFFILIATION + +(CHECK ONLY IF APPLICABLE) + + + + + + + Check here if you are a member of the NASD or a + person affiliated with an NASD member or a member of the + immediate family of any such person to whose support such person + contributes directly or indirectly, or if you have an account in + which an NASD member, or person associated with an NASD member, + has a beneficial interest. + + +I agree 1) not to sell, transfer or +hypothecate the stock for period of three months following +issuance; and 2) to report this subscription in writing to +the applicable NASD member within one day of payment for the +stock. + +(8) ACKNOWLEDGEMENT AND +SIGNATURE + +I acknowledge receipt of the Prospectus dated +August , 2004 and that I have read it +thoroughly, including the section titled \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001255474_whiting_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001255474_whiting_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8e54b389b36fee23cb6f8bf2bea7967137c9df30 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001255474_whiting_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock to be sold in the offering will be passed upon for us by the law firm of Foley & Lardner LLP. Welborn Sullivan Meck & Tooley, P.C. will pass on certain legal matters relating to us and our subsidiaries for us in connection with this offering. Certain legal matters will be passed upon for the underwriters by the law firm of Vinson & Elkins L.L.P. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001257803_telvent_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001257803_telvent_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..30ce5eda0148207f9351b3d17e2bd233a5715400 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001257803_telvent_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS" --> LEGAL MATTERS The validity of the ordinary shares being offered by this prospectus and other legal matters with respect to Spanish, U.S. federal and New York laws in connection with this offering will be passed upon for us and the selling shareholders by Squire, Sanders Dempsey L.L.P. Squire, Sanders Dempsey L.L.P. represents Abengoa and Inversi n Corporativa in connection with certain legal matters. Certain legal matters with respect to U.S. federal and New York laws in connection with this offering will be passed upon for the underwriters by Fried, Frank, Harris, Shriver Jacobson LLP. Certain legal matters with respect to Spanish law in connection with this offering will be passed upon for the underwriters by Ur a, Men ndez y Cia, Abogados, S.C., Madrid, Spain. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001257945_sig_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001257945_sig_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a1ba2697ee8cd4b628848af3ab5b9c56e67773ed --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001257945_sig_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters, including the validity of ABC BIGS, will be passed upon for SIG Indices, LLLP, the initial depositor in connection with the offering of ABC BIGS, by Drinker Biddle & Reath LLP, Philadelphia, Pennsylvania. Drinker Biddle & Reath LLP, as special U.S. tax counsel to the trust, will also render an opinion regarding the material U.S. federal income tax consequences relating to ABC BIGS. WHERE YOU CAN FIND MORE INFORMATION SIG Indices, LLLP has filed a registration statement on Form S-1, of which this prospectus is a part, with the SEC covering ABC BIGS. While this prospectus is a part of the registration statement, it does not contain all the exhibits filed as part of the registration statement. You should consider reviewing the full text of those exhibits. The registration statement is available over the Internet at the SEC's Web site at http://www.sec.gov. You may also read and copy the registration statement at the SEC's public reference rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for more information on the public reference rooms and their copy charges. SIG Indices, LLLP will not file any reports pursuant to the Exchange Act. The trust will file modified reports pursuant to the Exchange Act. - 26 - BECAUSE THE UNDERLYING COMPANY SECURITIES ARE REGISTERED UNDER THE EXCHANGE ACT, THE COMPANY IS REQUIRED TO FILE PERIODICALLY FINANCIAL AND OTHER INFORMATION SPECIFIED BY THE SEC UNDER FEDERAL LAW. INFORMATION PROVIDED TO OR FILED WITH THE SEC BY THE COMPANY WITH RESPECT TO ITS REGISTERED SECURITIES CAN BE INSPECTED AT THE SEC'S PUBLIC REFERENCE FACILITIES OR ACCESSED THROUGH THE SEC'S WEBSITE AT HTTP://WWW.SEC.GOV. YOU SHOULD REVIEW THE COMPANY'S PUBLIC FILINGS ON THE SEC'S WEBSITE CAREFULLY, BECAUSE IT WILL GIVE YOU MORE INFORMATION ABOUT THE COMPANY, ITS SECURITIES AND THE RISKS INVOLVED IN OWNING THOSE SECURITIES. THOSE RISKS ARE IMPORTANT BECAUSE RISKS APPLICABLE TO THE UNDERLYING COMPANY SECURITIES ARE ALSO APPLICABLE TO ABC BIGS. IN ADDITION, INFORMATION REGARDING THE COMPANY MAY BE OBTAINED FROM OTHER SOURCES INCLUDING, BUT NOT LIMITED TO, PRESS RELEASES, NEWSPAPER ARTICLES AND OTHER PUBLICLY DISSEMINATED INFORMATION. The trust and its affiliates are not affiliated with the Company, and the Company has no obligations with respect to ABC BIGS. This prospectus relates only to ABC BIGS and does not relate to the underlying Company securities. The information in this prospectus regarding the Company has been derived from the publicly available documents described in the preceding paragraph. We have not participated in the preparation of these documents or made any due diligence inquiries with respect to the underlying Company securities in connection with ABC BIGS. We make no representation that these publicly available documents or any other publicly available information regarding the underlying Company securities are accurate or complete. Furthermore, we cannot assure you that all events occurring prior to the date of this prospectus, including events that would affect the accuracy or completeness of the publicly available documents described in the preceding paragraph, that would affect the trading price of the underlying Company securities, and therefore the offering and trading prices of ABC BIGS, have been publicly disclosed. - 27 - LOGO 10,000,000 Depositary Receipts ABC BIGS _______________________________ PROSPECTUS ________________________________ [_________], 2004 Until [________], 2004 (25 days after the date of this prospectus), all dealers effecting transactions in the offered ABC BIGS, whether or not participating in this distribution, may be required to deliver a prospectus. This requirement is in addition to the obligations of dealers to deliver a prospectus when acting as underwriters and with respect to unsold allotments and subscriptions. PART II. INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses of Issuance and Distribution. ----------------------------------------------------- The expenses expected to be incurred in connection with the issuance and distribution of the securities being registered are as set forth below. Except for the registration fee payable to the Securities and Exchange Commission, all such expenses are estimated: Securities and Exchange Commission registration fee..............$64.00 Printing and engraving expenses...............................$5,000.00 Legal fees and expenses.....................................$250,000.00 Miscellaneous................................................$20,000.00 ----------------------------- Total................................................................$275,064.00 Item 14. Indemnification of Directors and Officers. --------------------------------------------------- Section 108 of the Delaware Revised Uniform Limited Partnership Act, as amended, provides that a limited partnership shall have the power to indemnify and hold harmless any partner or other person from and against any and all claims and demands whatsoever, subject to standards and restrictions, if any, set forth in its partnership agreement. Section 145 of the General Corporation Law of the State of Delaware, as amended, provides that under certain circumstances a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that such person is or was a director, officer, employee or agent of the corporation or is or was serving at its request in such capacity in another corporation or business association, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe such person's conduct was unlawful. Article IX, Section 9.1 of the Bylaws, as amended, of SIG Index Holdings, Inc., the general partner of the initial depositor SIG Indices, LLLP, provides in effect that SIG Index Holdings, Inc. shall indemnify any of its directors and officers where such person was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding other than an action by or in the right of the corporation if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interest of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his II-1 conduct was unlawful. Article IX, Section 9.2 of the Bylaws, as amended, provides in effect that SIG Index Holdings, Inc. shall indemnify any of its directors and officers where such person was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation, except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity. Item 15. Recent Sales of Unregistered Securities. ------------------------------------------------- On November 22, 2002, SIG Indices, LLLP issued partnership interests in the amount of 1% to the general partner, SIG Index Holdings, Inc., and 99% to the limited partner, SIG Index Partners, LLLP, pursuant to the organization of the partnership. SIG Index Holdings, Inc. made a capital contribution of $1.00 as consideration for the partnership interest received. SIG Index Partners, LLLP made a capital contribution of $99.00 as consideration for the partnership interest received. SIG Indices, LLLP issued the partnership interests in an exempt offering pursuant to Regulation D under the Securities Act of 1933. Item 16. Exhibits. ------------------ See Exhibit Index. Item 17. Undertakings. ---------------------- The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933. (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of the prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. II-2 (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (4) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (5) For purposes of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (6) Insofar 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 Item 14 of this registration statement, 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 Act 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. II-3 SIGNATURES AND POWER OF ATTORNEY Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities indicated on December 7, 2004. SIG INDICES, LLLP as Initial Depositor, by its general partner SIG Index Holdings, Inc. on behalf of ABC BIGS Trust I By: /s/ Jamie Farmer --------------------------------- Jamie Farmer Chief Executive Officer and Director Signature Title Date --------- ----- ---- * Chief Executive Officer and December 7, 2004 ----------------------- Director Jamie Farmer /s/ Brian Sullivan Chief Financial Officer and December 7, 2004 ----------------------- Chief Accounting Officer Brian Sullivan * Director December 7, 2004 ----------------------- Todd Silverberg * Director December 7, 2004 ----------------------- Eric Noll * By: /s/ Jamie Farmer, pursuant to power of attorney ------------------------------------------------ Jamie Farmer Chief Executive Officer and Director II-4 INDEX TO EXHIBITS Exhibits 4.1 Form of Standard Terms for Depositary Trust Agreement between SIG Indices, LLLP, as initial depositor, and The Bank of New York, as trustee, and included as exhibits thereto, form of Depositary Trust Agreement and form of BIGS (previously filed). 5.1* Opinion of Drinker Biddle & Reath LLP regarding the validity of BIGS. 8.1 Form of opinion of Drinker Biddle & Reath LLP, as special U.S. tax counsel regarding the material federal income tax consequences (previously filed). 23.1 Consent of Drinker Biddle & Reath LLP (included in Exhibit 5.1). 24.1 Power of Attorney (previously filed). * To be filed by amendment. II-5 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260167_travelport_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260167_travelport_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260167_travelport_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260618_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260618_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260618_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260619_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260619_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260619_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260620_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260620_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260620_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260621_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260621_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260621_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260623_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260623_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260623_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260624_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260624_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260624_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260627_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260627_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260627_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260630_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260630_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260630_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260631_worldspan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260631_worldspan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260631_worldspan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001260632_ws_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001260632_ws_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8dd2d280e15afa4aedebc6cf2a9fc818912de199 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001260632_ws_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and the binding effect of the notes offered hereby will be passed upon for us by Dechert LLP, Philadelphia, Pennsylvania. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001261694_tessera_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001261694_tessera_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..cfedfd896c22a706d8da543ad9cfb438092873df --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001261694_tessera_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Latham & Watkins LLP, Menlo Park, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001261888_chinacast_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001261888_chinacast_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ef1c0f8611fbc20ab6e337b129dfb46f0367267c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001261888_chinacast_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered in this prospectus are being passed upon for us by Graubard Miller, New York, New York. Littman Krooks LLP, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001263756_provide_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001263756_provide_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b3fb7e085b2e2422d4ec45b7217d5e02e2b20ac1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001263756_provide_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Latham & Watkins LLP, San Diego, California and for the underwriters by O Melveny & Myers LLP, Newport Beach, California. A partner of Latham & Watkins LLP beneficially owns as of the date hereof an aggregate of 3,112 shares of our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001264006_north_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001264006_north_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..cfd5d967aad3ebe5f1da11131911242cde24dcba --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001264006_north_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and binding nature of the obligations of the exchange notes and the guarantees and other legal matters will be passed upon on our behalf by Kirkland & Ellis LLP, Chicago, Illinois (a limited liability partnership that includes professional corporations). Certain partners of Kirkland & Ellis LLP are partners in a partnership that owns 43,439.9 Preferred Units and 43,416.2 Class A Common Units of NSP Holdings. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001264008_north_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001264008_north_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..cfd5d967aad3ebe5f1da11131911242cde24dcba --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001264008_north_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and binding nature of the obligations of the exchange notes and the guarantees and other legal matters will be passed upon on our behalf by Kirkland & Ellis LLP, Chicago, Illinois (a limited liability partnership that includes professional corporations). Certain partners of Kirkland & Ellis LLP are partners in a partnership that owns 43,439.9 Preferred Units and 43,416.2 Class A Common Units of NSP Holdings. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001264010_norcross_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001264010_norcross_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..cfd5d967aad3ebe5f1da11131911242cde24dcba --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001264010_norcross_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and binding nature of the obligations of the exchange notes and the guarantees and other legal matters will be passed upon on our behalf by Kirkland & Ellis LLP, Chicago, Illinois (a limited liability partnership that includes professional corporations). Certain partners of Kirkland & Ellis LLP are partners in a partnership that owns 43,439.9 Preferred Units and 43,416.2 Class A Common Units of NSP Holdings. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001264012_morning_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001264012_morning_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..cfd5d967aad3ebe5f1da11131911242cde24dcba --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001264012_morning_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and binding nature of the obligations of the exchange notes and the guarantees and other legal matters will be passed upon on our behalf by Kirkland & Ellis LLP, Chicago, Illinois (a limited liability partnership that includes professional corporations). Certain partners of Kirkland & Ellis LLP are partners in a partnership that owns 43,439.9 Preferred Units and 43,416.2 Class A Common Units of NSP Holdings. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001264017_norcross_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001264017_norcross_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..cfd5d967aad3ebe5f1da11131911242cde24dcba --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001264017_norcross_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and binding nature of the obligations of the exchange notes and the guarantees and other legal matters will be passed upon on our behalf by Kirkland & Ellis LLP, Chicago, Illinois (a limited liability partnership that includes professional corporations). Certain partners of Kirkland & Ellis LLP are partners in a partnership that owns 43,439.9 Preferred Units and 43,416.2 Class A Common Units of NSP Holdings. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266439_acs-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266439_acs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266439_acs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266444_acs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266444_acs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266444_acs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266445_acs-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266445_acs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266445_acs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266446_acs-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266446_acs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266446_acs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266448_acs-long_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266448_acs-long_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266448_acs-long_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266450_acs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266450_acs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266450_acs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266451_acs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266451_acs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266451_acs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266452_acs-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266452_acs-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266452_acs-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266453_acs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266453_acs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266453_acs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266660_acs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266660_acs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5d1d0d9bb7c31e116358f469e4fd27041cd52b5b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266660_acs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby, including the shares of our Class A common stock and notes represented thereby, and the separate notes as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantors, will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Alaska subsidiary guarantors will be passed upon for us by Birch, Horton, Bittner and Cherot. Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman & Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266914_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266914_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266914_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266916_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266916_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266916_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266918_cumberland_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266918_cumberland_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266918_cumberland_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266919_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266919_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266919_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266920_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266920_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266920_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266921_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266921_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266921_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266922_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266922_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266922_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266923_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266923_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266923_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266924_ahs-new_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266924_ahs-new_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266924_ahs-new_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266925_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266925_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266925_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266926_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266926_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266926_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266927_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266927_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266927_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266928_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266928_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266928_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266929_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266929_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266929_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266930_valle_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266930_valle_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266930_valle_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266931_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266931_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266931_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266932_bloomingto_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266932_bloomingto_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266932_bloomingto_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266933_columbus_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266933_columbus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266933_columbus_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266934_indiana_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266934_indiana_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266934_indiana_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266937_lebanon_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266937_lebanon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266937_lebanon_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266939_mesilla_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266939_mesilla_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266939_mesilla_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266941_mesilla_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266941_mesilla_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266941_mesilla_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266942_northern_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266942_northern_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266942_northern_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266943_valle_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266943_valle_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266943_valle_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266956_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266956_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266956_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266957_ardent_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266957_ardent_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266957_ardent_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266959_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266959_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266959_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266972_ahs-sed_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266972_ahs-sed_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266972_ahs-sed_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266975_ahs_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266975_ahs_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266975_ahs_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266979_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266979_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266979_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266981_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266981_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266981_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266984_bhc-cedar_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266984_bhc-cedar_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266984_bhc-cedar_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266988_columbus_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266988_columbus_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266988_columbus_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266989_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266989_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266989_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266992_bhc-fox_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266992_bhc-fox_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266992_bhc-fox_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001266995_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001266995_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001266995_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267000_bhc-gulf_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267000_bhc-gulf_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267000_bhc-gulf_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267003_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267003_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267003_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267005_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267005_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267005_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267007_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267007_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267007_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267012_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267012_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267012_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267014_lebanon_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267014_lebanon_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267014_lebanon_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267015_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267015_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267015_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267019_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267019_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267019_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267020_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267020_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267020_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267029_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267029_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267029_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267032_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267032_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267032_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267033_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267033_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267033_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267035_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267035_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267035_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267037_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267037_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267037_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267038_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267038_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267038_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267039_bhc-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267039_bhc-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267039_bhc-of_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267040_northern_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267040_northern_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267040_northern_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267041_bhc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267041_bhc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267041_bhc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267130_cabelas_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267130_cabelas_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d45ff79d5ff635bfba200da5d9effe1ca1bb5b32 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267130_cabelas_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Koley Jessen P.C., A Limited Liability Organization, Omaha, Nebraska. Certain legal matters in connection with this offering will be passed upon for us by Sidley Austin Brown & Wood LLP, Chicago, Illinois. Dewey Ballantine LLP, New York, New York will act as counsel for the underwriters. Paul C. Jessen, a shareholder of Koley Jessen P.C., A Limited Liability Organization owns an aggregate of 49,545 shares of our common stock and options to purchase 7,340 shares of common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001267482_semiconduc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001267482_semiconduc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..94d242d4df1392890ee6f721fae8fedb7fde55eb --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001267482_semiconduc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the ADSs and certain legal matters as to United States and New York law will be passed upon for us by Shearman & Sterling LLP, Menlo Park, California. Certain legal matters as to United States and New York law will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP. The validity of the ordinary shares and certain other legal matters as to Cayman Islands law will be passed upon for us by Maples and Calder Asia. Certain legal matters as to Hong Kong law will be passed upon for us by Slaughter and May, Hong Kong, and for the underwriters by Freshfields Bruckhaus Deringer, Hong Kong. Certain legal matters as to PRC law will be passed upon for us by Jingtian & Gongcheng and Fangda Partners and for the underwriters by Haiwen & Partners. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001268904_etrials_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001268904_etrials_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c48da0e88f9b04a9319f0661d367584d5b513b79 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001268904_etrials_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the securities offered in this prospectus are being passed upon for us by Graubard Miller, New York, New York. Bingham McCutchen LLP, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001270400_virgin_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001270400_virgin_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..985af8632e533352418d2eb1a1ed866e8b39e749 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001270400_virgin_legal_matters.txt @@ -0,0 +1,513 @@ +LEGAL MATTERS + + Certain legal +matters with respect to US law, including the validity of Telewest common stock hereby registered, will be passed upon by Fried, Frank, Harris, Shriver & Jacobson (London) LLP. + + + 127 + +Table of Contents + + +INDEX TO CONSOLIDATED FINANCIAL STATEMENT +S + + + + + +Page + + Telewest Global, Inc. + + + + + Audited Consolidated Financial Statements: + + + + + +Report of Independent Registered Public Accounting Firm to the Board and Shareholder of Telewest Global, Inc. KPMG Audit plc + + +F-2 + + +Consolidated Statement of Operations for the period November 12, 2003 to December 31, 2003 + + +F-3 + + +Consolidated Balance Sheet as of December 31, 2003 + + +F-4 + + +Consolidated Statement of Cash Flows for the period November 12, 2003 to December 31, 2003 + + +F-5 + + +Consolidated Statement of Shareholder s Equity/(Deficit) and Comprehensive Income for the period November 12, 2003 to December 31, 2003 + + +F-6 + + +Notes to the Consolidated Financial Statements + + +F-7 + + Unaudited Interim Consolidated Financial Statements: + + + + + +Unaudited Consolidated Statement of Operations for the three months ended March 31, 2004 + + +F-8 + + +Unaudited Consolidated Balance Sheets as of December 31, 2003 and March 31, 2004 + + +F-9 + + +Unaudited Consolidated Statements of Cash Flows for the three months ended March 31, 2004 + + +F-10 + + +Unaudited Consolidated Statements of Shareholders Equity/(Deficit) and Comprehensive Income for the three months ended March 31, 2004 and for the period November 12, 2003 to December 31, +2003 + + +F-11 + + +Notes to the Unaudited Interim Consolidated Financial Statements + + +F-12 + + Telewest Communications plc + + + + + Audited Consolidated Financial Statements: + + + + + +Report of Independent Registered Public Accounting Firm to the Board and Shareholders of Telewest Communications plc KPMG Audit plc + + +F-14 + + +Consolidated Statements of Operations for the years ended December 31, 2001, December 31, 2002 and December 31, 2003 + + +F-15 + + +Consolidated Balance Sheets as of December 31, 2002 and December 31, 2003 + + +F-16 + + +Consolidated Statements of Cash Flows for the years ended December 31, 2001, December 31, 2002 and December 31, 2003 + + +F-17 + + +Consolidated Statements of Shareholders Equity/(Deficit) and Comprehensive Loss for the years ended December 31, 2001, December 31, 2002 and December 31, 2003 + + +F-18 + + +Notes to the Consolidated Financial Statements + + +F-19 + + Unaudited Interim Condensed Consolidated Financial Statements: + + + + + +Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2003 and March 31, 2004 + + +F-50 + + +Unaudited Condensed Consolidated Balance Sheets as of December 31, 2003 and March 31, 2004 + + +F-51 + + +Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and March 31, 2004 + + +F-52 + + +Notes to the Unaudited Condensed Consolidated Financial Statements + + +F-53 + + + + F-1 + +Table of Contents + + Telewest Global, Inc. + +Audited Consolidated Financial Statements + + Report of Independent Registered Public Accounting Firm + to the Board of Directors and Shareholder of Telewest Global, Inc. + + + We have audited the +accompanying consolidated balance sheet of Telewest Global, Inc. and subsidiary as of December 31, 2003 and the related consolidated statement of operations, shareholders equity/(deficit) and comprehensive income, and cash flow for the period +then ended. 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 audit. + + We conducted our audit in accordance the standards of the Public Company Accounting +Oversight Board (United States). 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. + + In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Telewest Global, Inc. and subsidiary as of December 31, 2003 and the results +of its operations and its cash flows for the period then ended in conformity with accounting principles generally accepted in the United States of America. + + +/s/ KPMG Audit Plc + KPMG Audit Plc + London, England + March 23, 2004 + + + F-2 + +Table of Contents + + Telewest Global, Inc. + +Consolidated Statement of Operations + for the period November 12, 2003 to December 31, 2003 + + + + +$ + + + Revenue + + + + + + Operating costs and expenses + + +(337,655 +) + + Operating loss + + +(337,655 +) + + Other expenses + + + + + + Loss before income taxes + + +(337,655 +) + + Income tax + + + + + + Net loss + + +(337,655 +) + + + See +accompanying notes to the consolidated financial statements. + + + F-3 + +Table of Contents + + Telewest Global, Inc. + +Consolidated Balance Sheet + December 31, 2003 + + + + +$ + + + Assets + + + + + + Other receivables + + +10 + + + Total assets + + +10 + + + Liabilities and shareholder s deficit + + + + + + Other liabilities + + +337,655 + + + Total liabilities + + +337,655 + + + Shareholder s deficit + + + + + + Preferred stock $0.01 par value; authorized 5,000,000 shares, issued none + + + + + + Common stock $0.01 par value; authorized 1,000,000,000 shares, issued 1 + + + + + + Additional paid-in capital + + +10 + + + Accumulated deficit + + +(337,655 +) + + Total shareholder s deficit + + +(337,645 +) + + + + + + + Total liabilities and shareholder s deficit + + +10 + + + + See +accompanying notes to the consolidated financial statements. + + + F-4 + +Table of Contents + + +Telewest Global, Inc. + +Consolidated Statement of Cash Flows + for the period November 12, 2003 to December 31, 2003 + + There were no cash flows in the period and consequently no +statement of cash flows has been presented. + + See accompanying notes to the +consolidated financial statements. + + + F-5 + +Table of Contents + + Telewest Global, Inc. + +Consolidated Statement of Shareholder s Equity/(Deficit) and + Comprehensive Income + for the period November 12, 2003 to December 31, 2003 + + + + +Common +stock +$ + +Additional +paid-in +capital +$ + + Other +comprehensive +income + $ + + + Accumulated + + deficit + $ + + + + Total + $ + + + + Common stock issued ($0.01 par value) + + + + +10 + + + + + + +10 + + + Net loss + + + + + + + + +(337,655 +) + +(337,655 +) + + Balance at December 31, 2003 + + + + +10 + + + +(337,655 +) + +(337,645 +) + + + There was no other comprehensive +income in the period November 12, 2003 to December 31, 2003. + + See accompanying +notes to the financial statements. + + + F-6 + +Table of Contents + + Telewest Global, Inc. + +Notes to Consolidated Financial Statements + period ended December 31, 2003 + + 1 ORGANIZATION AND HISTORY + + Telewest Global, Inc. ( the Company ) was incorporated in the US state of Delaware +on November 12, 2003, as a wholly owned subsidiary of Telewest Communications plc. As a result of the planned financial restructuring of Telewest Communications plc and its subsidiaries, the Company is expected to become the ultimate holding company +for the operating companies that currently carry on the business of the Telewest group. The Telewest Global, Inc. group has no assets other than shares of Telewest UK Limited, a subsidiary newly formed under the laws of England and Wales. Telewest +UK Limited currently has no assets. Neither the Company nor Telewest UK Limited have any operating history. + + 2 BASIS OF PREPARATION + + The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America ( US GAAP ). + + The consolidated financial statements are prepared on a going concern basis, which the directors believe to be appropriate for the following +reasons: + + Telewest Communications plc currently provides financial support to +the Telewest Global, Inc. Group ensuring that liabilities can be met as they fall due. Such financial support will continue until the successful completion of the planned financial restructuring, which will provide for the transfer of the +subsidiaries of Telewest Communications plc to Telewest UK Limited. + + 3 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001270484_lipman_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001270484_lipman_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..44c3320ada9b5f91d290be0339a86a42d184618e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001270484_lipman_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the ordinary shares being offered by this prospectus and other legal matters concerning this offering relating to Israeli law will be passed upon for us by Shnitzer, Gotlieb, Sharon & Co., Ramat-Gan, Israel. Some legal matters concerning this offering relating to United States law will be passed upon for us by Fulbright & Jaworski L.L.P., New York, New York. On matters of Israeli law, Fulbright & Jaworski L.L.P. is relying upon the opinion of Shnitzer, Gotlieb, Sharon & Co. In connection with this offering, Naschitz, Brandes & Co., Tel Aviv, Israel have advised the underwriters with respect to certain Israeli law matters and Weil, Gotshal & Manges LLP, New York, New York have advised the underwriters with respect to certain United States law matters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001270532_linktone_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001270532_linktone_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f6deed43c55555da0c701f6e88d348f7f306f687 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001270532_linktone_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the ADSs and certain other legal matters with respect to U.S. federal and New York law will be passed upon for us by Morrison Foerster LLP. Certain legal matters with respect to U.S. federal and New York law in connection with this offering will be passed upon for the underwriters by Simpson Thacher Bartlett LLP. The validity of our ordinary shares represented by the ADSs offered in this offering will be passed upon for us by Maples and Calder Asia. Legal matters as to Chinese law will be passed upon for us by Commerce Finance Law Offices and for the underwriters by Haiwen Partners. Morrison Foerster LLP may rely upon Maples and Calder Asia with respect to matters governed by Cayman Islands law and upon Commerce Finance Law Offices with respect to matters governed by Chinese law. Simpson Thacher Bartlett LLP may rely upon Maples and Calder Asia with respect to matters governed by Cayman Islands law and Haiwen Partners with respect to matters governed by Chinese law. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001270597_merisant_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001270597_merisant_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7015e196a9bb33aab56930b49beba39aabfb6d5e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001270597_merisant_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs, the shares of our Class A common stock and senior subordinated notes and guarantees offered hereby will be passed upon for us by Sidley Austin Brown & Wood LLP, Chicago, Illinois. Certain legal matters relating to this offering will be passed upon for the underwriters by Akin Gump Strauss Hauer & Feld LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001271193_superior_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001271193_superior_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d9e2f38461a70e10067d35b0b33797a7933a9144 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001271193_superior_legal_matters.txt @@ -0,0 +1 @@ +Legal matters Certain legal matters with regard to the validity of the common stock will be passed upon for us by Proskauer Rose LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001271245_fremont_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001271245_fremont_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6ffebd43f76e974ac9fa4fae6502f1eb125b8cb3 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001271245_fremont_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the common stock being offered by this prospectus will be passed on for us by Siebers Mohney, PLC, Grand Rapids, Michigan. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001272209_gregg_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001272209_gregg_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffb0286449b70809740b5958da2f7a0c2f5f7ed2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001272209_gregg_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters relating to Wisconsin law will be passed upon for us by Foley & Lardner LLP. Certain matters relating to Ohio law will be passed upon for us by Taft, Stettinius & Hollister LLP. Certain matters relating to Indiana law will be passed upon for us by Hackman Hulett & Cracaft, LLP. Certain matters relating to Pensylvannia law will be passed on for us by Dechert LLP. Certain matters with respect to Nebraska law will be passed on for us by Baird, Holm, Hulett & Cracraft. Certain matters relating to New York law, the General Corporation Law of the State of Delaware and California law will be passed upon for us by Kirkland & Ellis LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001272663_messilla_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001272663_messilla_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..73bfba8eda910643f4624bf4aeb46ecfbb7bb629 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001272663_messilla_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the exchange notes and the guarantees has been passed upon for us by Ropes Gray LLP, New York, New York. As to certain matters of local law, Ropes Gray LLP relied upon the opinions of Boult, Cummings, Conners Berry PLC, Nashville, Tennessee; Greenebaum Doll McDonald, PLLC, Lexington, Kentucky; Lionel Sawyer Collins, Las Vegas, Nevada; Montgomery Andrews, P.A., Santa Fe, New Mexico; Thelen Reid Priest LLP, San Francisco, California; Troutman Sanders LLP, Richmond, Virginia; and Walter Haverfield LLP, Cleveland, Ohio. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001272957_bristol_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001272957_bristol_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b31045118aa9ac20cdc52296e63b4fd7390d3b07 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001272957_bristol_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of common stock to be sold in the offering will be passed upon for us by our counsel, Simpson Thacher & Bartlett LLP, New York, New York. Certain legal matters in connection with the issuance of the common stock to be sold in the offering will be passed upon for the underwriters by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001273584_gracechurc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001273584_gracechurc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..906bba9d4f4d4f692f531ca74f0b68217bd405bb --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001273584_gracechurc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Matters of English law relating to the validity of the issuance of the notes and matters of U.S. law will be passed upon for the issuer by Clifford Chance Limited Liability Partnership, London, England. Weil, Gotshal & Manges has acted as counsel to the underwriters with respect to the offering of the notes pursuant to this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001274032_simply-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001274032_simply-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..94325c15d2a217bf736e63634066a16116d568ac --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001274032_simply-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Patton Boggs LLP, Denver, Colorado, has acted as our counsel in connection with this offering, including with respect to the validity of the issuance of the securities offered in this prospectus. Attorneys at Patton Boggs LLP beneficially own 12,000 shares of our common stock. Certain matters have been passed upon on behalf of the underwriters by Loeb & Loeb LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001274081_lydian_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001274081_lydian_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..555487d729a037765cedf736c6c41fa1b73bc5d2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001274081_lydian_legal_matters.txt @@ -0,0 +1,43 @@ +LEGAL MATTERS + + + The validity of the shares of common stock offered in this offering will be passed upon for us by Elias, Matz, Tiernan & Herrick L.L.P., Washington, D.C. +and for the underwriters by Sullivan & Cromwell LLP, New York, New York. + + + + +EXPERTS + + + The consolidated financial statements of the Company as of December 31, 2003 and 2002 and for each of the three years in the period ended +December 31, 2003 included in this prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, independent certified public accountants, given on the authority of +said firm as experts in auditing and accounting. + + + + + + +WHERE YOU CAN FIND MORE INFORMATION + + + We have filed with the SEC a registration statement on Form S-1 under the Securities Act of 1933 with respect to the shares of common stock +offered by this prospectus. This prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules to that registration statement. For further +information with respect to us and our common stock, we refer you to such registration statement, exhibits and schedules. Statements contained in this prospectus as to the contents of any contract or +other document are not necessarily complete, and, in each instance, reference is made to the copy of that contract or document filed as an exhibit to the registration statement, each of these +statements being qualified in all respects by that reference. You may read and copy the registration statement, including exhibits to the registration statement, at the SEC's public reference room at +450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our filings with the SEC +are also available to the public through the SEC's internet site at http://www.sec.gov. + + Upon +completion of this offering, we will be subject to the informational requirements of the Securities Exchange Act of 1934 and, in accordance with those requirements, will file +reports, proxy and information statements with the SEC. You will be able to inspect and copy these reports, proxy and information statements and other information at the addresses set forth above. + + We +intend to furnish to our stockholders annual reports containing consolidated financial statements audited by our independent certified public accountants and quarterly reports +containing unaudited consolidated financial statements for each of the first three quarters of each fiscal year. + +121 + + Legal matters Certain legal matters with respect to U.S. federal law, including federal tax law, and New York law in connection with this offering will be passed upon for us by Paul, Hastings, Janofsky Walker LLP, our United States counsel. Certain legal matters with respect to the laws of the Cayman Islands in connection with this offering will be passed upon for us by Conyers Dill Pearman, Cayman, our Cayman Islands counsel. Certain legal matters with respect to PRC law in connection with this offering will be passed upon for us by Commerce Finance Law Offices, our PRC counsel. Certain legal matters with respect to U.S. federal and New York law in connection with this offering will be passed upon for the underwriters by Simpson Thacher Bartlett LLP. Certain legal matters with respect to PRC law in connection with this offering will be passed upon for the underwriters by Haiwen Partners. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001285736_iowa_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001285736_iowa_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..21745067889cff25290f333b053f688e971041a2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001285736_iowa_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the issuance of the notes represented by the IDSs and notes sold separately (not represented by IDSs) and the issuance of the subsidiary guarantees will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. The validity of the issuance of the shares of our Class A common stock represented by IDSs will be passed upon for us by Dorsey & Whitney LLP, Des Moines, Iowa. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001285738_iowa_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001285738_iowa_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..21745067889cff25290f333b053f688e971041a2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001285738_iowa_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the issuance of the notes represented by the IDSs and notes sold separately (not represented by IDSs) and the issuance of the subsidiary guarantees will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. The validity of the issuance of the shares of our Class A common stock represented by IDSs will be passed upon for us by Dorsey & Whitney LLP, Des Moines, Iowa. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001285739_iowa_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001285739_iowa_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..21745067889cff25290f333b053f688e971041a2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001285739_iowa_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the issuance of the notes represented by the IDSs and notes sold separately (not represented by IDSs) and the issuance of the subsidiary guarantees will be passed upon for us by Debevoise & Plimpton LLP, New York, New York. The validity of the issuance of the shares of our Class A common stock represented by IDSs will be passed upon for us by Dorsey & Whitney LLP, Des Moines, Iowa. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286603_synetics_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286603_synetics_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8cee922a846dfba052b2f5d6954a850d2d3b1362 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286603_synetics_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered by this prospectus will be passed upon for us by Stoel Rives LLP, Portland, Oregon. Legal matters will be passed upon for the underwriters by Perkins Coie LLP, Portland, Oregon. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286686_collegiate_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286686_collegiate_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..97e605944703e331fbc2a0fc963cb31df260110d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286686_collegiate_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of common stock to be sold in this offering will be passed upon for us by Simpson Thacher Bartlett LLP, New York, New York. Legal matters in connection with this offering are being passed upon for the underwriters by Davis Polk Wardwell, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286692_mulberry_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286692_mulberry_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4adbaedeb1f969c57cfdb2bc91bda61c3a0cd06e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286692_mulberry_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes offered hereby will be passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. Partners of Simpson Thacher & Bartlett LLP, members of their families, related persons and others have an indirect interest, through limited partnerships, which are investors in an affiliate of KLC Associates, L.P., in less than 1% of the common stock underlying the IDSs. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286693_kc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286693_kc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4adbaedeb1f969c57cfdb2bc91bda61c3a0cd06e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286693_kc_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes offered hereby will be passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. Partners of Simpson Thacher & Bartlett LLP, members of their families, related persons and others have an indirect interest, through limited partnerships, which are investors in an affiliate of KLC Associates, L.P., in less than 1% of the common stock underlying the IDSs. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286694_kindercare_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286694_kindercare_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..4adbaedeb1f969c57cfdb2bc91bda61c3a0cd06e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286694_kindercare_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs, our shares of Class A common stock and notes offered hereby will be passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. Partners of Simpson Thacher & Bartlett LLP, members of their families, related persons and others have an indirect interest, through limited partnerships, which are investors in an affiliate of KLC Associates, L.P., in less than 1% of the common stock underlying the IDSs. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286698_alliance_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286698_alliance_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d20579cbdebccc31e23c9e46deee4027072de645 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286698_alliance_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantee by the subsidiary guarantor, will be passed upon for us by Kirkland Ellis LLP, New York, New York. Certain partners of Kirkland Ellis LLP are also members of Randolph Street Partners II which will own 15,893 IDSs and 9,030 shares of Class B common stock upon completion of the reorganization and this offering. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286733_memec-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286733_memec-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6965dd7c3426a68635a5ee95cdaec57ff93a2bbb --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286733_memec-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Clifford Chance US LLP, San Diego, California. Certain legal matters will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, Palo Alto, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286743_grand_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286743_grand_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6f2dc3f944b567a0b05577a2b9de5a4dda8274d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286743_grand_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs, the Class A common stock, the notes and the guarantees offered hereby will be passed upon for us by Mayer, Brown, Rowe Maw LLP, New York, New York. Certain legal matters relating to the offerings will be passed upon for the underwriters by Cahill Gordon Reindel LLP, New York, New York. Two members of Mayer, Brown, Rowe Maw LLP own approximately 1,035,000 common units of Holdings as of September 30, 2004. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286744_super_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286744_super_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6f2dc3f944b567a0b05577a2b9de5a4dda8274d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286744_super_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs, the Class A common stock, the notes and the guarantees offered hereby will be passed upon for us by Mayer, Brown, Rowe Maw LLP, New York, New York. Certain legal matters relating to the offerings will be passed upon for the underwriters by Cahill Gordon Reindel LLP, New York, New York. Two members of Mayer, Brown, Rowe Maw LLP own approximately 1,035,000 common units of Holdings as of September 30, 2004. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286745_american_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286745_american_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6f2dc3f944b567a0b05577a2b9de5a4dda8274d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286745_american_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs, the Class A common stock, the notes and the guarantees offered hereby will be passed upon for us by Mayer, Brown, Rowe Maw LLP, New York, New York. Certain legal matters relating to the offerings will be passed upon for the underwriters by Cahill Gordon Reindel LLP, New York, New York. Two members of Mayer, Brown, Rowe Maw LLP own approximately 1,035,000 common units of Holdings as of September 30, 2004. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001286746_appliance_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001286746_appliance_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6f2dc3f944b567a0b05577a2b9de5a4dda8274d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001286746_appliance_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs, the Class A common stock, the notes and the guarantees offered hereby will be passed upon for us by Mayer, Brown, Rowe Maw LLP, New York, New York. Certain legal matters relating to the offerings will be passed upon for the underwriters by Cahill Gordon Reindel LLP, New York, New York. Two members of Mayer, Brown, Rowe Maw LLP own approximately 1,035,000 common units of Holdings as of September 30, 2004. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287152_xerium-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287152_xerium-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287152_xerium-inc_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287156_xerium_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287156_xerium_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287156_xerium_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287158_xerium-iv_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287158_xerium-iv_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287158_xerium-iv_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287159_xerium-v_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287159_xerium-v_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287159_xerium-v_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287161_stowe_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287161_stowe_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287161_stowe_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287163_weavexx_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287163_weavexx_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287163_weavexx_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287164_xerium-i_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287164_xerium-i_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287164_xerium-i_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287166_huyck_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287166_huyck_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287166_huyck_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287168_huyck_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287168_huyck_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287168_huyck_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287170_stowe_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287170_stowe_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287170_stowe_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287172_huyck_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287172_huyck_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..15015ebe634f8aa9ab703c4311641b0825eeff44 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287172_huyck_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Argentina law, Australia law, Mexico law and United Kingdom law, on the opinion of Steward McKelvey Stirling Scales as to matters of Canada law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japan law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287173_huyck_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287173_huyck_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287173_huyck_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287174_stowe_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287174_stowe_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287174_stowe_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287175_stowe_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287175_stowe_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287175_stowe_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287176_weavexx_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287176_weavexx_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287176_weavexx_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287177_huyck_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287177_huyck_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287177_huyck_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287178_huyck-ltd_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287178_huyck-ltd_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287178_huyck-ltd_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287180_huyck-ltd_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287180_huyck-ltd_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287180_huyck-ltd_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287181_stowe_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287181_stowe_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287181_stowe_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287258_planetout_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287258_planetout_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..301352da4db2bc637ee8532b396fd93a97604076 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287258_planetout_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered will be passed upon for us by Howard Rice Nemerovski Canady Falk Rabkin, A Professional Corporation, San Francisco, California. O Melveny Myers LLP, New York, New York, is acting as counsel for the underwriters in connection with selected legal matters relating to the shares of common stock offered by this prospectus. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287503_ecost-com_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287503_ecost-com_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d63f227a90813a60af92a96797c73ee4932a8775 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287503_ecost-com_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Morrison & Foerster LLP, Irvine, California, will pass upon the validity of the common stock offered hereby for us. Sonnenschein Nath & Rosenthal LLP, Chicago, Illinois, will pass upon certain legal matters in connection with this offering for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287808_hill_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287808_hill_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..876a71bbdd082fd58f4634bec8c1119c8c81f846 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287808_hill_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered in this prospectus are being passed upon for us by Graubard Miller, New York, New York. Bingham McCutchen LLP, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287868_ecca_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287868_ecca_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287868_ecca_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287869_eye-care_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287869_eye-care_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287869_eye-care_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287870_enclave_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287870_enclave_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287870_enclave_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287872_ecca_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287872_ecca_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287872_ecca_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287874_ecca_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287874_ecca_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287874_ecca_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287875_ecca_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287875_ecca_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287875_ecca_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287876_eyemasters_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287876_eyemasters_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287876_eyemasters_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287878_eyemasters_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287878_eyemasters_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287878_eyemasters_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287880_stein_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287880_stein_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287880_stein_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287881_vision_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287881_vision_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287881_vision_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287882_eye-drx_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287882_eye-drx_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287882_eye-drx_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287885_metropolit_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287885_metropolit_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287885_metropolit_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287886_hour-eyes_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287886_hour-eyes_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287886_hour-eyes_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287888_ecca_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287888_ecca_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287888_ecca_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287889_eyemasters_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287889_eyemasters_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287889_eyemasters_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287890_visionary_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287890_visionary_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287890_visionary_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287891_visionary_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287891_visionary_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287891_visionary_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287892_eyemasters_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287892_eyemasters_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287892_eyemasters_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287894_ecca_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287894_ecca_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287894_ecca_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287898_ecca_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287898_ecca_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287898_ecca_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287901_visionary_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287901_visionary_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287901_visionary_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287905_visionary_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287905_visionary_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287905_visionary_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287906_ecca_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287906_ecca_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287906_ecca_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287907_visionary_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287907_visionary_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287907_visionary_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287956_fabtek_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287956_fabtek_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287956_fabtek_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001287957_windsor_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001287957_windsor_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0444591ba79160514bd47869fb88dc80e0c13925 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001287957_windsor_legal_matters.txt @@ -0,0 +1 @@ +[D] LEGAL MATTERS Certain legal matters with respect to the issuance of the notes offered hereby, including the validity of the notes, will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. [E] LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Cravath, Swaine & Moore LLP, New York, New York. The underwriters have been represented by Milbank, Tweed, Hadley & McCloy LLP, New York, New York in connection with this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288351_blountsvil_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288351_blountsvil_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288351_blountsvil_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288353_page_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288353_page_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288353_page_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288354_brindlee_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288354_brindlee_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288354_brindlee_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288355_brindlee_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288355_brindlee_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288355_brindlee_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288357_otelco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288357_otelco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288357_otelco_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288358_otelco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288358_otelco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288358_otelco_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288359_otelco-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288359_otelco-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288359_otelco-inc_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288361_hopper_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288361_hopper_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288361_hopper_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288362_hopper_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288362_hopper_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3dfba5f667717950ca4603664136279dbc96204 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288362_hopper_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the IDSs offered hereby and the shares of our Class A common stock and senior subordinated notes represented thereby, the validity of the senior subordinated notes (not in the form of IDSs) and the validity of the subsidiary guarantees will be passed upon for us by O'Melveny & Myers LLP, New York, New York. Certain legal matters relating to the validity of the subsidiary guarantees by the Alabama subsidiary guarantors will be passed upon for us by Wilkerson & Bryan, P.C., Montgomery, Alabama. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288379_new-river_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288379_new-river_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..99deba9530c1645ca8b8fe63b70274dd56d29acc --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288379_new-river_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Various legal matters with respect to the validity of the common stock offered by this prospectus will be passed upon for us by Hunton & Williams LLP. Morrison & Foerster LLP is counsel for the underwriters in connection with the offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288496_edgewave_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288496_edgewave_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..24785153d81a4fa9b254efaacfa58436f392369e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288496_edgewave_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the securities offered in this prospectus are being passed upon for us by Jenkens & Gilchrist, a professional corporation. Dilworth Paxson LLP is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288633_china_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288633_china_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1675aad6396bf300f226babc33d631a7c3407c0c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288633_china_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered in this prospectus are being passed upon for us by Loeb & Loeb LLP, New York, New York. Littman Krooks LLP, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288741_mccormick_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288741_mccormick_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..60216be9556488cec42e7ee4592107a9b44337bd --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288741_mccormick_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered in this prospectus will be passed upon for us by Stoel Rives LLP, Portland, Oregon. Shearman & Sterling LLP, New York, New York, will pass upon certain legal matters in connection with this offering for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288776_google-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288776_google-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b8d921b92fb07ae05848ec534aa680a362725b90 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288776_google-inc_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock that we are offering to repurchase hereby will be passed upon for us by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. Certain members of, and investment partnerships comprised of members of, and persons associated with, Wilson Sonsini Goodrich & Rosati beneficially hold an aggregate of 197,132 shares of our common stock, which represents less than 0.1% of our outstanding shares of common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001288834_visionwork_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001288834_visionwork_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..1a2518b28021f5e084e5be965a0c942c31ca21a7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001288834_visionwork_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IUs offered hereby and the shares of our class A common stock and senior subordinated notes represented thereby and the separate senior subordinated notes, as well as the validity of the issuance of the subsidiary guarantees by the Delaware, Texas and Florida subsidiary guarantors, will be passed upon for us by Weil, Gotshal Manges LLP. The validity of the issuance of the subsidiary guarantees by the Maryland and Virginia subsidiary guarantors, will be passed upon for us by . Certain legal matters relating to this offering will be passed upon for the underwriters by Shearman Sterling LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001289141_mimis_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001289141_mimis_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..5589ef4eb4f402e3cbae616cd57eeb2a37a9212f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001289141_mimis_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of common stock offered hereby will be passed upon for us by Stradling Yocca Carlson & Rauth, a Professional Corporation, Newport Beach, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by Fried, Frank, Harris, Shriver & Jacobson LLP, a Delaware limited liability partnership, Los Angeles, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001289244_assured_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001289244_assured_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..42916c5e02a6d467ce51f0b7234e1cb10fac8b8a --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001289244_assured_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain matters as to U.S. law in connection with this offering will be passed upon for the issuer and the guarantor by Mayer, Brown, Rowe & Maw LLP, Chicago, Illinois. Certain legal matters under Bermuda law will be passed upon for the guarantor by Conyers Dill & Pearman, Hamilton, Bermuda. Certain legal matters in connection with this offering will be passed upon for the underwriters by LeBoeuf, Lamb, Greene & MacRae, L.L.P., a limited liability partnership including professional corporations, New York, New York. LeBoeuf, Lamb, Greene & MacRae, L.L.P. has in the past performed, and continues to perform, services for us. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001289632_trinity_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001289632_trinity_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..64b274eff30c66a1946944ad83bb1b63e96e7c41 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001289632_trinity_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered in this prospectus are being passed upon for us by Sonnenschein Nath & Rosenthal LLP, New York, New York. Graubard Miller, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001289634_homeland_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001289634_homeland_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..95ae4c6eee81398e851c4cbef328d092efb7b9d9 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001289634_homeland_legal_matters.txt @@ -0,0 +1 @@ +(CDN$) (CDN$) Bruce 2003 Nil Nil Nil Nil Nil Nil Nil Johnstone President, CEO, CFO, and Director We do not anticipate paying any salaries in 2004. Options & SARs Granted to Named Executive Officers No options or SARs have been granted to any executive officers or directors and there are no options or SARs outstanding. Equity Compensation Plans We have no equity compensation plans. - 19 - Stock Option Plans and Long-Term Incentive Plan Awards We do not have any stock option plans or long-term incentive plans that provide compensation intended to serve as incentive for performance. Compensation of Directors We have has no standard arrangement pursuant with which our directors are compensated by us for their services in their capacity as directors other than the unissued treasury shares reserved for the grant of directors' stock options. There has been no other arrangement pursuant to which our directors are compensated by us in their capacity as directors since our inception on April 28, 2003 through our accounting year ended March 31, 2004. No executive officer, director or employee compensation plans have been established nor are any such plans contemplated pursuant to which cash or non-cash compensation will be paid to our executive officers, directors or employees other than as referred to herein. PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth, as of the date of this prospectus, the total number of shares owned beneficially by each of our directors, officers and key employees, individually and as a group, and the present owners of 5% or more of our total outstanding shares. The stockholders listed below have direct ownership of the shares and possess sole voting and dispositive power with respect to the shares. Percent of Name of owner Number of Shares Position Class Bruce E. Johnstone 1,500,100 President, CEO, 33.24% 102 Donaghy Avenue Secretary, Treasurer North Vancouver, BC CFO, and Director Canada V7P 2L5 ALL OFFICERS AND 1,500,100 33.24% DIRECTORS AS A GROUP (1 Person) There are no outstanding options to purchase shares of our common stock. The shares were not issued to our sole officer and director as part of a compensation plan. Selling Shareholders At the present time our shares of common stock are not traded anywhere and there is no assurance that our shares will ever by listed for trading anywhere. The following holders of our common shares will sell their common shares as set forth in the table below. The percentage of beneficial ownership before the offering is based on 4,512,600 common shares outstanding as of April 14, 2004. The percentage of beneficial ownership after the offering reflects the 4,512,600 common shares offered by this prospectus. - 20 - Name and Address of Beneficial Owner Number of Shares Beneficially Owned Before Offering Number of Shares Being Offered(1) Number of Shares Beneficially Owned After Offering Percentage of Shares Beneficially Owned Before Offering After Offering Bruce E. Johnstone 1,500,100 1,500,100 0 33.24% 0 102 Donaghy Avenue, North Vancouver, B.C. V7P 2L5 Catherine Johnstone 4,000 4,000 0 0.09% 0 727 Kilkeel Place, North Vancouver, B.C. V7N 2X2 John Bellamy 130,000 130,000 0 2.88% 0 19933 - 46A Avenue Langley, B.C. V3A 5Z4 Penny Bellamy 70,000 70,000 0 1.55% 0 19933 - 46A Avenue Langley, B.C. V3A 5Z4 Jennifer Bigler 500 500 0 0.01% 0 4630 Eastridge Road, North Vancouver, B.C. V7G 1K4 Milo Bigler 500 500 0 0.01% 0 4630 Eastridge Road, North Vancouver, B.C. V7G 1K4 Ann Bird 90,000 90,000 0 1.99% 0 3380 Thompson Crescent, West Vancouver, B.C. V7V 3E7 Clive Bird 110,000 110,000 0 2.44% 0 3380 Thompson Crescent, West Vancouver, B.C. V7V 3E7 John Fox 2,000 2,000 0 0.04% 0 4802 Strathcona Rd. North Vancouver, B.C. V7G 1V8 - 21 - Warren Foster 80,000 80,000 0 1.77% 0 P.O. Box 91315, West Vancouver, B.C. V7V 3N9 Wendy Foster 120,000 120,000 0 2.66% 0 3370 Thompson Crescent, West Vancouver, B.C. V7V 3E7 Paul Graham 150,000 150,000 0 3.32% 0 #23-2236 Folkstone Way, West Vancouver, B.C. V7S 2X7 Patti Graham 50,000 50,000 0 1.11% 0 #23-2236 Folkstone Way, West Vancouver, B.C. V7S 2X7 Deborah (Jane) Holden 60,000 60,000 0 1.33% 0 2240 Kings Avenue, West Vancouver, B.C. V7S 2C2 Mark Holden 140,000 140,000 0 3.10% 0 2240 Kings Avenue, West Vancouver, B.C. V7S 2C2 Greg Kneller 70,000 70,000 0 1.55% 0 445 Southborough Avenue West Vancouver, B.C. V7S 1M3 Arleigh Kurucz 200,000 200,000 0 4.43% 0 4802 Strathcona Rd. North Vancouver, B.C. V7G 1V8 Jill Kurucz 200,000 200,000 0 4.43% 0 2397 Lawson Avenue, West Vancouver, B.C. V7V 2E5 David Langley 115,000 115,000 0 2.55% 0 1090 Pigeon Avenue Williams Lake, B.C. V2G 2B9 Karla Langley 65,000 65,000 0 1.44% 0 1090 Pigeon Avenue Williams Lake, B.C. V2G 2B9 - 22 - Nathan Langley 20,000 20,000 0 0.44% 0 Suite 424 1641 Lonsdale Avenue North Vancouver, B.C. V7M 2J5 Ed Lindahl 160,000 160,000 0 3.55% 0 2528 Haywood Avenue West Vancouver, B.C. V7V 1Y4 Lori Lindahl 40,000 40,000 0 0.89% 0 2528 Haywood Avenue West Vancouver, B.C. V7V 1Y4 Paul McKay 1,500 1,500 0 0.03% 0 2341 Larson Road North Vancouver, B.C. V7M 3A5 Susan McKay 1,000 1,000 0 0.02% 0 2341 Larson Road North Vancouver, B.C. V7M 3A5 Peter Marshall 125,000 125,000 0 2.77% 0 P.O. Box 664, Lions Bay, B.C. V0N 2E0 Betty Martin 500 500 0 0.01% 0 2066-131st Street, Surrey, B.C. V4A 8M1 Tony Martin 500 500 0 0.01% 0 Unit 112, 8310-130th Street, Surrey, B.C. V3W 8J9 Karen Matheson 1,000 1,000 0 0.02% 0 2316 Mathers Avenue West Vancouver, B.C. V7V 2H6 Peter Morris 150,000 150,000 0 3.32% 0 6501 Lakes Road Duncan, B.C. V9L 5V7 Wendy Morris 50,000 50,000 0 1.11% 0 6501 Lakes Road Duncan, B.C. V9L 5V7 - 23 - Margaret Ramsdale 130,000 130,000 0 2.88% 0 445 Southborough Avenue West Vancouver, B.C. V7S 1M3 Ivan Sauv 135,000 135,000 0 2.99% 0 #121-2979 Panorama Drive Coquitlam, B.C. V3E 2W8 Monica Sauv 65,000 65,000 0 1.44% 0 #121-2979 Panorama Drive Coquitlam, B.C. V3E 2W8 Colin Seddon 110,000 110,000 0 2.44% 0 Unit #1, 19299 - 94th Avenue Surrey, B.C. V4N 4E6 Charlene Seddon 90,000 90,000 0 1.99% 0 1435 Inglewood Avenue, West Vancouver, B.C. V7T 1Z2 Lea Thorson 75,000 75,000 0 1.66% 0 P.O. Box 104, Knutsford, Kamploops, B.C. V0E 2A0 Graham Young 150,000 150,000 0 3.32% 0 4703 Woodley Drive, West Vancouver, B.C. V7S 3A1 Alexandra Young 50,000 50,000 0 1.11% 0 4703 Woodley Drive, West Vancouver, B.C. V7S 3A1 Walter Walmesley 1,000 1,000 0 0.02% 0 704-2222 Bellevue Avenue West Vancouver, B.C. V7V 1C7 Total 4,512,600 4,512,600 0 100% 0% RELATED PARTY TRANSACTIONS Other than as disclosed herein, our officer, director and principal shareholders, or any of our associates or affiliates, have not participated in and have no other interest, direct or indirect, in any material transactions in which we have participated, or in any proposed transaction which has materially affected or will materially affect our company since our inception and through April 14, 2004. - 24 - There are no additional interests of management in transactions involving our company except for those stated in the Notes to the Financial Statements. DESCRIPTION OF SECURITIES Common Stock Our authorized common stock consists of 100,000,000 shares, no par value per share. The holders of our common stock: * have equal ratable rights to dividends from funds legally available if and when declared by our board of directors; * are entitled to share ratably in all of our assets available for distribution to holders of common stock upon liquidation, dissolution or winding up of our affairs; * do not have preemptive, subscription or conversion rights and there are no redemption or sinking fund provisions or rights; and * are entitled to one non-cumulative vote per share on all matters on which stockholders may vote. All shares of common stock, now outstanding, are fully paid for and non-assessable and all shares of common stock will be fully paid for and non-assessable. We refer you to our articles of incorporation, bylaws and the applicable statutes of the laws of British Columbia for a more complete description of the rights and liabilities of holders of our securities. Non-cumulative voting Holders of shares of our common stock do not have cumulative voting rights, which means that the holders of more than 50% of the outstanding shares, voting for the election of directors, can elect all of the directors to be elected, if they so choose, and, in that event, the holders of the remaining shares will not be able to elect any of our directors. Cash dividends As of the date of this registration statement, we have not paid any cash dividends to our stockholders. The declaration of any future cash dividend will be at the discretion of our board of directors and will depend upon our earnings, if any, our capital requirements and financial position, our general economic conditions, and other pertinent conditions. It is our present intention not to pay any cash dividends in the foreseeable future, but rather to reinvest earnings, if any, in our business operations. - 25 - Preferred Stock We are authorized to issue up to 20,000,000 shares of preferred stock, no par value. No preferred shares are outstanding. Anti-takeover provisions There are no British Columbia anti-takeover provisions that may have the effect of delaying or preventing a change in control. Dividends Holders of the common stock are entitled to share equally in dividends when, as and if declared by our board of directors, out of funds legally available therefore. No dividend has been paid on the common stock since inception, and none is contemplated in the foreseeable future. Reports After we complete this offering, we will not be required to furnish you with an annual report. Further, we will not voluntarily send you an annual report. We will be required to file reports with the SEC under section 15(d) of the Securities Act. The reports will be filed electronically. The reports we will be required to file are Forms 10-KSB, 10-QSB, and 8-K. You may read copies of any materials we file with the SEC at the SECs Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that will contain copies of the reports we file electronically. The address for the Internet site is www.sec.gov. Stock transfer agent Our stock transfer agent for our securities is Holladay Stock Transfer, Inc., 2939 North 67th Place, Scottsdale, Arizona 85251 and its telephone number is (480) 481-3940. UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS U.S. federal income tax considerations describes the material U.S. federal income tax matters expected to be relevant to U.S. Holders (as defined below) who hold our common shares as a capital asset. This discussion is based upon, as of the date hereof, the applicable provisions of the U.S. Internal Revenue Code of 1986, as amended (the"Code"), Treasury Regulations promulgated or proposed thereunder, and administrative and judicial interpretation thereof, all of which are subject to change either prospectively or retroactively, or are subject to different interpretations. We did not obtain, nor do we intend to obtain, a ruling from the Internal Revenue Service as to any United States federal income tax consequences discussed below and there can be no assurances that the Internal Revenue Service will not take contrary positions. As used herein, the term "U.S. Holder" means a beneficial owner of common shares that is for United States federal income tax purposes: - 26 - * a citizen or resident of the United States; * a corporation, or other entity taxed as a corporation for United States federal income tax purposes, created or organized in or under the laws of the United States or any political subdivision thereof; * an estate, the income of which is subject to United States federal income taxation regardless of its source; or a trust, if both (a) a United States court is able to exercise primary supervision over the administration of the trust, and (b) one or more United States persons have the authority to control all substantial decisions of the trust. The discussion below does not address all of the United States federal income tax consequences that may be relevant to U.S. Holders in light of their particular circumstances, nor does it address the tax consequences to U.S. Holders subject to special treatment under the United States federal income tax laws, such as: * certain financial institutions; * insurance companies; * traders in securities that elect to mark-to-market; * securities dealers; * partnerships or other entities classified as partnerships for United States federal income tax purposes; * tax-exempt organizations; * persons that hold the common shares as part of an integrated investment (including a straddle); * persons owning, directly, indirectly or constructively, 10% or more of your voting stock; * persons whose "functional currency" is not the U.S. dollar. The discussion also does not address the tax consequences arising under the laws of any foreign, state or local jurisdiction. - 27 - Prospective investors are urged to consult their own tax advisors as to the federal, state and other tax consequences of acquiring, holding and disposing of our common shares. General Distributions Subject to the discussion under "Special Tax Provisions" below, distributions of cash or property made by us with respect to the common shares will constitute dividends to U.S. Holders, to the extent that the distributions are made out of our current or accumulated earnings and profits of us (as determined for United States federal income tax purposes). Dividends paid by us are includible in a U.S. Holder's gross income and are taxable as ordinary income. If a portion of a distribution made by us with respect to the common shares exceeds its current and accumulated earnings and profits, that portion will be treated as nontaxable return of capital, which will reduce the U.S. Holder's adjusted basis in the common shares (but not below zero). To the extent a distribution exceeds the U.S. Holder's adjusted basis in the common shares, the distribution will constitute capital gain. Dividends received by a corporate U.S. Holder from us generally will not be eligible for the dividends received deduction. For United States foreign tax credit purposes, a distribution treated as a dividend for United States federal income tax purposes will constitute income from sources outside the United States. In the case of U.S. Holders who are not residents of Canada, the Canada-United States Income Tax Convention (1980), as amended (the "Convention"), provides that dividends received in respect of the common shares generally will be subject to a 15% Canadian withholding tax. Subject to limitations set forth in the Code, as modified by the Convention, including certain minimal holding periods, U.S. Holders may elect to claim a foreign tax credit against their U.S. federal income tax liability for Canadian tax withheld from dividends paid in respect of common shares. The limitation on foreign taxes eligible for the foreign tax credit is calculated separately with respect to specific classes of income. For this purpose, dividends paid by us generally will constitute "passive income," or in the case of certain U.S. Holders, "financial services income." The rules relating to the United States foreign tax credit are extremely complex and the availability of the foreign tax credit depends on numerous factors. If a dividend is paid in a currency other than the U.S. dollar, the amount includible in a U.S. Holder's gross income will be the U.S. dollar value of the dividend, calculated by reference to the exchange rate in effect on the date the U.S. Holder receives the dividend, regardless of whether the payment actually is converted into U.S. dollars. Gain or loss, if any, that a U.S. Holder realizes as a result of currency exchange fluctuations during the period from the date the U.S. Holder includes the dividend in gross income to the date the U.S. Holder converts the payment into U.S. dollars will be treated as ordinary income or loss for United States federal income tax purposes. This gain or loss generally will be from sources within the United States for United States foreign tax credit purposes. - 28 - Dispositions Generally, subject to the discussion of "Special Tax Provisions" immediately below, upon a sale or other taxable disposition of the common shares, a U.S. Holder will recognize taxable gain or loss in an amount equal to the difference between the amount of cash and the fair market value of other property that the U.S. Holder receives in the sale or other taxable disposition (the "amount realized") and the U.S. Holder's adjusted tax basis in the common shares. Subject to the passive foreign investment company rules discussed below, the U.S. Holder's gain or loss will be capital gain or loss. The gain or loss will be long-term capital gain or loss if the common shares were held by the U.S. Holder for more than one year. Long-term capital gains recognized by certain non-corporate U.S. Holders (including individuals) are eligible for preferential United States federal income taxation rates. Any gain or loss recognized by U.S. Holders on a sale or other taxable disposition of the common shares generally will be treated as derived from U.S. sources for United States foreign tax credit purposes. The deduction of capital losses is subject to certain limitations under the Code. A capital loss realized by a non-corporate U.S. Holder is allowable as an offset against capital gain and up to $3,000 of ordinary income. Any capital loss not utilized in any taxable year by a non-corporate U.S. Holder may be carried forward indefinitely and used to offset capital gain and up to $3,000 of ordinary income in any future taxable year of the non-corporate U.S. Holder. A capital loss realized by a corporate U.S. Holder is allowable as an offset only against capital gain. Any capital loss not utilized by a corporate U.S. Holder first must be carried back and applied against capital gain in the three years preceding the year of the sale or other taxable disposition giving rise to the capital loss, and then may be carried forward to the five taxable years subsequent to the year of the sale or other taxable disposition. The amount that a corporate U.S. Holder generally may carry back is limited, however, to an amount that does not increase or produce a net operating loss in the carryback year. Backup Withholding and Information Reporting Backup withholding and information reporting requirements may apply to distributions made by us to a U.S. Holder with respect to the common shares, or to the proceeds of a sale, redemption or other disposition of the common shares. Under the backup withholding rules, a paying agent may be required to withhold tax from a U.S. Holder's distributions or proceeds, if the U.S. Holder fails to furnish a correct taxpayer identification number and comply with certain certification procedures, or otherwise fails to comply with the applicable requirements of the backup withholding rules. Some U.S. Holders (including, among others, corporations) are exempt from the backup withholding requirements. Any amounts withheld under the backup withholding rules generally may be claimed by a U.S. Holder as a credit against the U.S. Holder's United States federal income tax liability and the U.S. Holder may be entitled to receive a refund, provided that the required information is furnished to the Internal Revenue Service. Special Tax Provisions Some provisions of the Code specifically deal with the United States federal income tax treatment of investments by U.S. persons in foreign corporations and may alter the United States federal income tax consequences described above or propose special rules for United States foreign tax credit purposes. - 29 - Passive Foreign Investment Company U.S. persons owning shares of a "passive foreign investment company" ("PFIC") are subject to a special United States federal income tax regime with respect to specified distributions received from the PFIC and gain from the sale or disposition of PFIC stock. A foreign corporation generally will be classified as a PFIC for United States federal income tax purposes in any taxable year in which, after applying relevant look-through rules with respect to the income and assets of subsidiaries, either: * at least 75% of its gross income is "passive income;" or * on average at least 50% of the gross value of its assets is attributable to assets that produce passive income or are held for the production of passive income. For this purpose, passive income generally includes, among other things, dividends, interest, rents, royalties, gains from the disposition of passive assets and gains from commodities transactions, other than gains derived from "qualified active sales" of commodities and "qualified hedging transactions" involving commodities, within the meaning of applicable Treasury Regulations. Based on certain estimates of the gross income and gross assets, we do not believe that we are currently a PFIC, nor do we anticipate becoming a PFIC in the foreseeable future. However, since PFIC status will be determined by us on an annual basis and PFIC status depends upon the composition of our income and assets (including, among others, less than 25% owned equity investments), and the nature of its activities, from time to time, there can be no assurance that we will not be considered a PFIC for any taxable year. In addition, we will not obtain an opinion of counsel, and no ruling will be sought from the Internal Revenue Service, regarding our characterization as a PFIC for United States federal income tax purposes. If we are treated as a PFIC for any taxable year during which a U.S. Holder held common shares, some adverse consequences could apply to the U.S. Holder (see discussion below). For this reason, if we are treated as a PFIC for any taxable year, a U.S. Holder may desire to make an election to treat us as a "qualified electing fund" (a "QEF") with respect to the electing U.S. Holder. Generally, a QEF election should be made on or before the due date for filing the electing U.S. Holder's United States federal income tax return for the first taxable year in which the common shares are held by the U.S. Holder and we are treated as a PFIC. If a timely QEF election is made, whether or not distributed by us, the electing U.S. Holder will be required to annually include in gross income (a) as ordinary income, a pro-rata share of our ordinary earnings and (b) as long-term capital gain, a pro-rata share of our net capital gain. An electing corporate U.S. Holder will not be eligible for the dividends received deduction with respect to the income or gain included in gross income under this rule. In addition, in the event that we incur a net loss for a taxable year, the loss will not be available as a deduction to an electing U.S. Holder, and may not be carried forward or back in computing our ordinary earnings and net capital gain in other taxable years. In some cases in which a QEF does not distribute all of its earnings in a taxable year, electing U.S. Holders may be permitted to elect to defer the payment of some or all of their United States federal income taxes on the QEF's undistributed earnings, subject to an interest charge on the deferred tax amount. - 30 - If we are treated as a PFIC for any taxable year during which a U.S. Holder held common shares, we will provide to a U.S. Holder, upon written request, all information and documentation that the U.S. Holder is required to obtain in connection with making a QEF election for United States federal income tax purposes. In general, if a U.S. Holder fails to make a timely QEF election (or mark-to-market election, see discussion below) for any taxable year that we are treated as a PFIC, the United States federal income tax consequences to the U.S. Holder will be determined under the so-called "interest charge" method. Under the interest charge regime: * any gain derived from the disposition of PFIC stock (possibly including a gift, an exchange in a corporate reorganization, or a grant as security for a loan), as well as any "excess distribution" that is received from the PFIC (i.e., a distribution that exceeds 125% of the average distributions from the shorter of the prior three years, or the U.S. Holder's holding period for the stock), will be treated as ordinary income that was earned ratably over each day in the U.S. Holder's holding period for the PFIC stock; * the portion of the gain or distribution that is allocable to prior taxable years, other than any year before we became a PFIC, will be subject to United States federal income tax at the highest rate applicable to ordinary income for the relevant taxable years, regardless of the tax rate otherwise applicable to the U.S. Holder; and * an interest charge will be imposed on the resulting United States federal income tax liability as if such liability represented a tax deficiency for the past taxable years, other than any year before we became a PFIC. In addition, a step-up in the tax basis of the PFIC stock may not be available upon the death of a non-corporate U.S. Holder. In many cases, application of the interest charge regime will have substantially more onerous United States federal income tax consequences than would result if a timely QEF election is made by a U.S. holder. Accordingly, if we are treated as a PFIC for any taxable year, U.S. holders are urged to carefully consider whether to make a QEF election and the consequences of not making the election. As an alternative to the QEF election, a U.S. Holder of "marketable stock" in a PFIC may make a "mark-to-market" election, provided the PFIC stock is regularly traded on a "qualified exchange". Under applicable Treasury Regulations, a "qualified exchange" includes a national securities exchange that is registered with the SEC or the national market system established under the Securities Exchange Act of 1934. Under applicable Treasury Regulations, PFIC stock traded on a qualified exchange is regularly traded on the exchange for any calendar year during which the stock is traded, other than in de minimis quantities, on at least 15 days during each calendar quarter. We cannot assure U.S. Holders that the common stock will be treated as regularly traded on a qualified exchange. - 31 - If a valid mark-to-market election is made, the electing U.S. Holder generally would (a) include in gross income, entirely as ordinary income, an amount equal to the difference between the fair market value of the PFIC stock as of the close of the taxable year and the U.S. Holder's adjusted basis in the PFIC stock, and (b) deduct as an ordinary loss the excess, if any, of the adjusted tax basis of the PFIC stock over its fair market value at the end of the taxable year, but only to the extent of the amount previously included in income as a result of the mark-to-market election. Foreign Personal Holding Company U.S. persons owning, directly or indirectly (on the last day of the corporation's taxable year), shares of a foreign corporation that is a "foreign personal holding company" ("FPHC") are required to include in their gross income a pro rata share of the FPHC's "foreign personal holding company income" that has not been distributed by the corporation to its shareholders during its taxable year. A foreign corporation will constitute a FPHC if more than 50% of its stock (by vote or value) is owned (directly or indirectly) by five or fewer individuals who are U.S. citizens or residents and at least 60% (50% in certain years following the year in which the corporation becomes a FPHC) of its gross income consists of "foreign personal holding company income." "Foreign personal holding company income" includes interest, dividends, royalties, certain rents, and gain from the sale of stock or securities. Based upon the expected size and distribution of common shares in the offering and among current holders, we do not expect to meet the FPHC stock ownership test immediately after the offering and, therefore, will not be a FPHC at such time. We do not expect to meet the income test immediately after the offering and, therefore, will not qualify as a FPHC based upon our income. However, future changes of ownership and income could cause us to become a FPHC. CANADIAN FEDERAL INCOME TAX CONSIDERATIONS The following summary is a general description of the principal Canadian federal income tax considerations generally applicable to the holders of common shares acquired pursuant to this registration statement who at all relevant times hold such common shares as capital property, deal at arm's length with us, and are not affiliated with us, all within the meaning of the Income Tax Act (Canada) (the "Canadian Tax Act"). The common shares will generally be considered to be capital property to you unless held in the course of carrying on a business, in an adventure in the nature of trade, or as "mark-to-market property" for purposes of the Canadian Tax Act. Shareholders who will not hold their common shares as capital property should consult their own tax advisors regarding their particular circumstances, as this summary does not apply to these holders. This summary does not take into account the potential application to certain "financial institutions," as defined in the Canadian Tax Act, of the "mark-to-market" rules. This summary is based on the current provisions of the Canadian Tax Act, the regulations thereunder, and counsel's understanding of the current published administrative practices and policies of the Canada Customs and Revenue Agency, all in effect as of the date of this document. This summary takes into account all specific proposals to amend the Canadian Tax Act or the regulations publicly announced by the Minister of Finance (Canada) prior to the date of this document, although no assurances can be given that the proposed amendments will be enacted in the form proposed, or at all. This summary does not take into account or anticipate any other changes in law, whether by judicial, governmental or legislative action or decision, nor does it take into account provincial, territorial or foreign income tax legislation or considerations, which may differ from the Canadian federal income tax considerations described herein. - 32 - This summary should not be construed to be legal or tax advice to any particular holder of common shares. Accordingly, prospective investors are urged to consult their own tax advisors for advice with respect to the tax consequences to them of acquiring, holding and disposing of our common shares. Holders Resident in Canada The following section of this summary applies to a holder of our common shares who, for purposes of the Canadian Tax Act and any applicable tax treaty or convention, is or is deemed to be resident in Canada at all relevant times (referred to in this summary as a "Canadian holder"). A Canadian holder whose common shares might not otherwise qualify as capital property may be entitled to obtain such qualification in certain circumstances by making an irrevocable election permitted by subsection 39(4) of the Canadian Tax Act. Taxation of Dividends In the case of a Canadian holder who is an individual, dividends received or deemed to be received by the holder on our common shares will be included in computing the holder's income and will be subject to the gross-up and dividend tax credit rules normally applicable to taxable dividends received from taxable Canadian corporations. Dividends received by a corporation on our common shares must be included in computing the corporation's income but generally will be deductible in computing its taxable income. A "private corporation" (as defined in the Canadian Tax Act) or any other corporation resident in Canada and controlled or deemed to be controlled by or for the benefit of an individual or a related group of individuals, generally will be liable under Part IV of the Canadian Tax Act to pay a refundable tax of 33 1/3% of dividends received or deemed to be received on our common shares to the extent that such dividends are deductible in computing its taxable income. Disposition of Common Shares A disposition or deemed disposition of our common shares by a Canadian holder will generally result in a capital gain (or capital loss) equal to the amount by which the proceeds of disposition, net of any reasonable costs of disposition, exceed (or are less than) the adjusted cost base to the Canadian holder of such shares immediately before the disposition. Under the provisions of the Canadian Tax Act, one-half of any capital gain realized by a Canadian holder will be required to be included as a taxable capital gain in computing income for the year of disposition. One-half of any capital loss (an "allowable capital loss") realized by a Canadian holder may be deducted against taxable capital gains realized in the year of disposition. Subject to detailed rules contained in the Canadian Tax Act, any excess of allowable capital losses over taxable capital gains may be carried back up to three taxation years or forward indefinitely and deducted against net taxable capital gains of those other taxation years. - 33 - Capital gains realized by an individual or trust (other than certain specified trusts) may be subject to alternative minimum tax under the Canadian Tax Act. If the Canadian holder of common shares is a corporation, the amount of any capital loss realized on the disposition or deemed disposition of a common share may be reduced by the amount of dividends received or deemed to have been received by it on such common share to the extent and under the circumstances prescribed by the Canadian Tax Act. Similar rules may apply where a corporation is a member of a partnership or beneficiary of a trust that owns common shares or that is itself a member of a partnership or a beneficiary of a trust that owns common shares. A Canadian-controlled private corporation (as defined in the Canadian Tax Act), may also be liable to pay a 6 2/3% refundable tax on certain investment income, including taxable capital gains. Holders Not Resident In Canada The following portion of the summary is generally applicable to a shareholder: * who, at all relevant times, is neither a resident nor deemed to be a resident of Canada for purposes of the Canadian Tax Act and any applicable tax treaty or convention; * who does not use or hold (and will not use or hold) and is not deemed to use or hold our common shares in, or in the course of, carrying on a business in Canada; and * to whom the our common shares do not constitute "taxable Canadian property" for purposes of the Canadian Tax Act (referred to in this summary as a "Non-Resident Shareholder"). Special rules which are not discussed in this summary apply to a non-resident that carries on an insurance business in Canada or elsewhere. Generally, our common shares will not be taxable Canadian property to a Non-Resident Shareholder at a particular time provided that such shares are listed on a prescribed stock exchange (which includes the New York Stock Exchange and the Nasdaq National Market) at that time, and the holder, persons with whom the holder does not deal at arm's length, or the holder together with all such persons has not owned 25% or more of the issued shares of any class or series in our capital at any time during the 60-month period that ends at the particular time. For this purpose, it is the position of the Canada Customs and Revenue Agency that holders of an interest in or option to acquire our common shares will be considered to hold the common shares to which such interest or option relates. Common shares can be deemed to be taxable Canadian property in certain circumstances set out in the Canadian Tax Act. - 34 - Taxation of Dividends Dividends on our common shares paid or credited or deemed under the Canadian Tax Act to be paid or credited to a Non-Resident Shareholder generally will be subject to Canadian withholding tax at the rate of 25%, subject to any applicable reduction in the rate of withholding in any applicable tax treaty where the holder is a resident of a country with which Canada has an income tax treaty. If the Non-Resident Shareholder is a United States resident entitled to benefits under the Canada-United States Income Tax Convention, dividends on our common shares generally will be subject to Canadian withholding tax at the rate of 15%. Disposition of Common Shares A Non-Resident Shareholder will not be subject to tax under the Canadian Tax Act in respect of any capital gain realized on the disposition of our common shares. SHARES ELIGIBLE FOR FUTURE SALE U.S. Eligibility for Future Sales We have 4,512,600 shares of common stock outstanding. All 4,512,600 common shares offered for sale by this prospectus will be freely tradable without restriction in the United States under the Securities Act of 1933 unless purchased by our affiliates. Common shares issued by us in the future may be sold in the public market in the United States only if registered or if they qualify for an exemption from registration, including the exemptions described below under Rules 144, 144(k) or 701 promulgated under the Securities Act. Rule 144 In general, under Rule 144, a person, or group of persons whose shares are aggregated, that has beneficially owned any of our common shares that are restricted securities, as defined in Rule 144, for at least one year, is entitled to sell in the United States within any three-month period commencing 90 days after the date of this prospectus a number of shares that does not exceed the greater of: * 1% of our common shares then outstanding, which will be approximately 140,440 shares immediately after this offering, or * the average weekly trading volume of our common shares in the public market during the four calendar weeks immediately before the sale. Sales under Rule 144 are also subject to certain requirements as to the manner of sale, notice and availability of current public information about us. - 35 - Rule 144(k). Under Rule 144(k), a person who is not deemed to have been one of our affiliates at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, including the holding period of any prior owner who is not one of our affiliates, is entitled to sell these shares in the United States without complying with the manner of sale provisions, availability of current public information requirement, volume limitations or notice requirements of Rule 144. Rule 701. In general under Rule 701, any of our employees, officers, directors, consultants or advisors who purchased or received shares from us before this offering under a compensatory stock or option plan or written agreement will be eligible to resell their shares in the United States in reliance on Rule 144. Non-affiliates will be able to sell their shares in the United States subject only to the manner of sale provisions of Rule 144. Affiliates are subject to all of the provisions of Rule 144 except that they will be able to sell their shares without compliance with the holding period requirement of Rule 144. PLAN OF DISTRIBUTION; TERMS OF THE OFFERING There are 40 selling shareholders. They may sell some or all of their common stock in one or more transactions, including block transactions: 1. On such public markets or exchanges as the common stock may from time to time be trading; 2. In privately negotiated transactions; 3. Through the writing of options on the common stock; 4. In short sales; or 5. In any combination of these methods of distribution. The sales price to the public is fixed at US$0.01 per share until such time as the shares of our common stock become traded on the Bulletin Board operated by the National Association of Securities Dealers, Inc. or another exchange. If our common stock becomes quoted on the Bulletin Board or another exchange, then the sales price to the public will vary according to the selling decisions of each selling shareholder and the market for our stock at the time of resale. In these circumstances, the sales price to the public may be: - 36 - 1. The market price of our common stock prevailing at the time of sale; 2. A price related to such prevailing market price of our common stock; or 3. Such other price as the selling shareholders determine from time to time. The shares may also be sold in compliance with the Securities and Exchange Commission's Rule 144. The selling shareholders may also sell their shares directly to market makers acting as principals or brokers or dealers, who may act as agent or acquire the common stock as a principal. Any broker or dealer participating in such transactions as agent may receive a commission from the selling shareholders, or, if they act as agent for the purchaser of such common stock, from such purchaser. The selling shareholders will likely pay the usual and customary brokerage fees for such services. Brokers or dealers may agree with the selling shareholders to sell a specified number of shares at a stipulated price per share and, to the extent such broker or dealer is unable to do so acting as agent for the selling shareholders, to purchase, as principal, any unsold shares at the price required to fulfill the respective broker's or dealer's commitment to the selling shareholders. Brokers or dealers who acquire shares as principals may thereafter resell such shares from time to time in transactions in a market or on an exchange, in negotiated transactions or otherwise, at market prices prevailing at the time of sale or at negotiated prices, and in connection with such re-sales may pay or receive commissions to or from the purchasers of such shares. These transactions may involve cross and block transactions that may involve sales to and through other brokers or dealers. We can provide no assurance that all or any of the common stock offered will be sold by the selling shareholders. We are bearing all costs relating to the registration of the common stock, estimated to be US$25,000.00. The selling shareholders, however, will pay commissions or other fees payable to brokers or dealers in connection with any sale of the common stock. The selling shareholders must comply with the requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934 in the offer and sale of the common stock. In particular, during such times as the selling shareholders may be deemed to be engaged in a distribution of the common stock, and therefore be considered to be an underwriter, they must comply with applicable law and may, among other things: 1. Not engage in any stabilization activities in connection with our common stock; 2. Furnish each broker or dealer through which common stock may be offered, such copies of this prospectus, as amended from time to time, as may be required by such broker or dealer; and 3. Not bid for or purchase any of our securities or attempt to induce any person to purchase any of our securities other than as permitted under the Securities Exchange Act of 1934. - 37 - There is no assurance that any of the selling shareholders will sell any or all of the shares offered by them. Under the securities laws of certain states, the shares may be sold in such states only through registered or licensed brokers or dealers. In addition, in certain states the shares may not be sold unless they have been registered or qualified for sale in that state or an exemption from registration or qualification is available and is met. There are no pre-existing contractual agreements for any person to purchase the shares. Of the 4,512,600 shares of common stock outstanding as of April 14, 2004, 1,500,100 shares were owned by our sole officer and director and may only be resold pursuant to this registration statement or in compliance with Rule 144 of the Securities Act of 1933 . At April 14, 2004, there were 40 holders of record. The price of the shares has been determined by the sole member of our board of directors. We selected the $0.01 for the shares of common stock. Currently there is no market for the shares and we wanted to give our shareholders the ability to sell their shares. If our shares are listed for trading on the Bulletin Board, the price of the shares will be established by the market. We have not declared any cash dividends, nor do we intend to do so. We are not subject to any legal restrictions respecting the payment of dividends, except that they may not be paid to render us insolvent. Dividend policy will be based on our cash resources and needs and it is anticipated that all available cash will be needed for our operations in the foreseeable future. Section 15(g) of the Exchange Act Our shares are covered by section 15(g) of the Securities Exchange Act of 1934, as amended, and Rules 15g-1 through 15g-6 promulgated thereunder. They impose additional sales practice requirements on broker/dealers who sell our securities to persons other than established customers and accredited investors (generally institutions with assets in excess of $5,000,000 or individuals with net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouses). While Section 15g and Rules 15g-1 through 15g-6 apply to broker/dealers, they do not apply to us. Rule 15g-1 exempts a number of specific transactions from the scope of the penny stock rules. Rule 15g-2 declares unlawful broker/dealer transactions in penny stocks unless the broker/dealer has first provided to the customer a standardized disclosure document. Rule 15g-3 provides that it is unlawful for a broker/dealer to engage in a penny stock transaction unless the broker/dealer first discloses and subsequently confirms to the customer current quotation prices or similar market information concerning the penny stock in question. Rule 15g-4 prohibits broker/dealers from completing penny stock transactions for a customer unless the broker/dealer first discloses to the customer the amount of compensation or other remuneration received as a result of the penny stock transaction. - 38 - Rule 15g-5 requires that a broker/dealer executing a penny stock transaction, other than one exempt under Rule 15g-1, disclose to its customer, at the time of or prior to the transaction, information about the sales persons compensation. Rule 15g-6 requires broker/dealers selling penny stocks to provide their customers with monthly account statements. Again, the foregoing rules apply to broker/dealers. They do not apply to us in any manner whatsoever. The application of the penny stock rules may affect your ability to resell your shares. Offering Period and Expiration Date This offering will start on the date of this prospectus and continue for a period of 270 days. LEGAL MATTERS Certain legal matters in connection with the common shares offered by this prospectus and certain tax matters will be passed upon for us by Conrad C. Lysiak, Attorney and Counselor at Law, 601 West First Avenue, Suite 503, Spokane, Washington 99201, our United States counsel. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290075_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290075_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290075_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290077_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290077_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290077_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290085_paper_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290085_paper_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290085_paper_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290087_nalco-co_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290087_nalco-co_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290087_nalco-co_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290090_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290090_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290090_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290091_nalco-co_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290091_nalco-co_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290091_nalco-co_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290097_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290097_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290097_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290100_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290100_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290100_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290105_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290105_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290105_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290106_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290106_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290106_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290114_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290114_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290114_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290117_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290117_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290117_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290119_nalco-ft_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290119_nalco-ft_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290119_nalco-ft_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290120_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290120_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290120_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290122_ones-west_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290122_ones-west_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290122_ones-west_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290128_visco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290128_visco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290128_visco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290135_pure-chem_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290135_pure-chem_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290135_pure-chem_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290156_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290156_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290156_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290168_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290168_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290168_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290176_nalco-pws_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290176_nalco-pws_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290176_nalco-pws_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290182_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290182_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290182_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290233_nalco-u-s_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290233_nalco-u-s_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290233_nalco-u-s_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290234_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290234_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290234_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290236_nalgreen_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290236_nalgreen_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290236_nalgreen_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290238_naltech_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290238_naltech_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290238_naltech_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290245_board_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290245_board_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290245_board_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290246_adx-corp_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290246_adx-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..793e6e639e665f64398cc6e41cd45ac0089769f7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290246_adx-corp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes and the guarantees have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. In rendering its opinion, Simpson Thacher & Bartlett LLP relied upon the opinions of Mayer, Brown, Rowe & Maw LLP as to all matters governed by the laws of the States of California and Texas and the opinion of Barnes & Thornburg LLP as to all matters governed by the laws of the State of Michigan. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290729_rio_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290729_rio_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0fb3b9ddc7f14918cb4300249c40512db5a145ad --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290729_rio_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with regard to the warrants and shares of common stock offered by this prospectus will be passed upon for us by Hogan & Hartson L.L.P., Washington, D.C. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001290903_elong-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001290903_elong-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..68b86bfcd82763a3b2b58ac07f04200d00dc7776 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001290903_elong-inc_legal_matters.txt @@ -0,0 +1,545 @@ +Legal Matters + +Experts + +Expenses Related to this Offering + +Where You Can Find More Information + +Index to Financial Statements + + +100 +113 +124 +130 +145 +154 +158 +162 +163 +171 +171 +171 +172 +F-1 + + + + + + + Until + , 2004 (25 days after the date of this prospectus), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to +deliver a prospectus. This is in addition to the dealer s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions. + +Table of Contents + + PART II + + +Item 6. + +Indemnification of Directors and Officers + + Our Articles of Association provide that our directors and officers shall be indemnified out of our assets for and against all actions, costs, charges, losses, +damages and expenses that such persons shall or may incur or sustain by or by reason of any act done or omitted in or about the execution of their duties in their respective offices or trusts, and none of such persons shall be answerable for the +acts, receipts, neglects or defaults of the other or others of such persons provided that the indemnity does not extend to any matter in respect of any willful neglect or intentional malfeasance which may attach to such persons. In addition, certain +of our directors who were nominated by IAC may be indemnified under IAC s director and officers insurance policy and under the bylaws of an IAC affiliate. + + We plan to obtain a directors and officers liability policy prior to the completion of this offering. At present, there is no pending +litigation or proceeding involving any of our directors, officers or employees for which indemnification from us is sought. In addition, we are not aware of any threatened litigation or proceeding against any of our directors, officers or employees +that may result in a claim for indemnification. + + The proposed form of the +Underwriting Agreement provides for indemnification under certain circumstances by the underwriters of the Registrant and the Registrant s directors and certain officers for certain liabilities arising under the Securities Act. + + Reference is made to the Underwriting Agreement, and the Articles of Association filed +as exhibits to this Registration Statement regarding relevant indemnification provisions described above and elsewhere herein. + + Insofar as indemnification for liabilities arising under Securities Act of 1933, as amended, or the Securities Act, may be permitted to directors, officers or +persons controlling the Registrant under the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore +unenforceable. + + +Item 7. + +Recent Sales of Unregistered Securities + + During the past three years, the Registrant has issued and sold the securities listed below without registering the securities under the Securities Act. None of +these transactions involved any underwriters underwriting discounts or commissions, or any public offering. The Registrant believes that each of the following issuances was exempt from registration under the Securities Act in reliance on +Regulation D, Regulation S or Rule 701 under the Securities Act or pursuant to Section 4(2) of the Securities Act regarding transactions not involving a public offering. + + On August 26, 2003, we increased the number of ordinary shares authorized to be issued under our stock option plan to 5,500,000. In +2003, options for 490,000 ordinary shares were granted to certain of our executives at an exercise price of US$1.53 per share. The options have a ten-year term and vest over a four-year period from the date of the grant. + + On August 26, 2003, we issued warrants to purchase 600,000 ordinary shares at an +exercise price of US$0.75 per share to Broadband Capital Management LLC, an investment banking and financial advisory firm, and two outside consultants, Peter Lerner and Liu Hao in consideration for investment banking services provided to us in +connection with a private placement of Series A preferred shares. We also paid Broadband Capital Management LLC US$250,000 for these services. + + + II-1 + +Table of Contents + + On August 29, 2003, we received US$15,000,000 from four investors Tiger Technology Private Investment +Partners, L.P., Tiger Technology II, L.P., Blue Ridge Limited Partnership, and RMG Holdings, LLC, in exchange for 9,787,494 shares of Series A preferred shares, the issuance of which stock was exempt from registration under Regulation D or +Regulation S of the Securities Act of 1933. + + On December 15, 2003, we +issued 50,000 ordinary shares to Peter Lerner upon his exercise of the warrants granted to him. + + On January 1, 2004, we granted options for 689,400 ordinary shares to certain of our employees at an exercise price of US$1.53 per share. The options have a +ten-year term and vest over a three- or four-year period from the date of the grant. + + On April 20, 2004, we granted options for 300,000 ordinary shares to a senior management employee at an exercise price of US$1.53 per share. The options have a ten-year term and vest over a four-year period from the date of the +grant. + + On July 23, 2004, we granted options for 1,660,000 ordinary +shares to certain of our employees at an exercise price of US$5.25 per share. The options have a ten-year term and vest over a four-year period from the date of the grant. + + On July 23, 2004 we entered into an agreement to issue 11,188,570 Series B preferred shares to IAC in exchange for US$58,690,062. + + + On August 4, 2004, we granted to IAC an option to purchase up to 711,429 +ordinary shares at a purchase price of US$5.25 per share. + + On August 4, +2004, we issued a warrant to IAC to purchase the number of our high-vote ordinary shares which, if exercised, would cause IAC to hold 51% of our outstanding ordinary shares on a fully-diluted basis after giving effect to our repurchase, in +connection with the warrant exercise, from certain of our existing shareholders of a number of ordinary shares equal to one-half of the shares IAC purchases upon exercise of the warrant. Assuming the completion of this offering, the exercise price +per share purchased by IAC under the warrant will be equal to the lower of (a) the initial public offering price for this offering or (b)(1) US$205 million, minus our indebtedness, plus our cash and cash equivalents, plus the pro forma consideration +that would be received in connection with the exercise of all vested or unvested in-the-money options, warrants or other convertible securities of our company, in each case at the time of exercise, divided by (2) the total number of our outstanding +ordinary shares on a fully-diluted basis at the time of exercise (but excluding out-of-the-money options or securities). If it exercises the warrant, IAC would deposit 12.5% of the aggregate purchase price into escrow as security for its +indemnification rights. + + On October 1, 2004, we granted options to +purchase an aggregate of 250,000 ordinary shares to two members of senior management at an exercise price of US$5.25 per share. The options have a ten-year term and vest over a four-year period from the date of the grant. We also granted to IAC an +option to purchase 260,204 shares at an exercise price of US$5.25 per share. + + + II-2 + +Table of Contents + +Item 8. + +Exhibits and Financial Statement Schedules + + (a) Exhibits. + + +Exhibit +No. + + + Description of Exhibit + +1.1 + + Form of Underwriting Agreement. + +3.1 + + The Second Amended and Restated Memorandum of Association of the Registrant + +3.2 + + The Second Amended and Restated Articles of Association of the Registrant. + +4.1 + + Form of Ordinary Share Certificate. + +4.2 + + The Amended and Restated Articles of Association of the Registrant (Filed as Exhibit 3.2 hereto). + +4.3 + + Form of Deposit Agreement between the Registrant and JPMorgan Chase Bank, as depositary. + +4.4 + + Form of American depositary receipt evidencing American depositary shares. + +4.5 + + Investors Rights Agreement dated August 29, 2003 among the Registrant and Series A Preferred Share Investors. + +4.6 + + Investors Agreement dated July 23, 2004 among Registrant, IACT Asia Pacific Limited and the other parties named +therein. + +4.7 + + Warrant Agreement dated August 22, 2003 between Registrant and Broadband Capital Management LLC. + +4.8 + + Warrant Agreement dated August 26, 2003 between Registrant and Liu Hao. + +4.9 + + Warrant Agreement dated July 23, 2004 among Registrant and IACT Asia Pacific Limited. + +4.10 + + Stock Option Agreement dated July 23, 2004 between Registrant and IACT Asia Pacific Limited. + +4.11 + + Stock Option Agreement dated October 1, 2004 between Registrant and IACT Asia Pacific Limited. + +4.12 + + Letter Agreement dated October 1, 2004 between Registrant and IACT Asia Pacific Limited. + +4.13 + + eLong, Inc. Stock Option Plan dated April 18, 2001 + +4.14 + + eLong, Inc. Stock and Annual Incentive Plan dated July 23, 2004 + +4.15 + + Letter Agreement dated October 27, 2004 between Registrant and IACT Asia Pacific Limited + +5.1 + + Opinion of Conyers Dill & Pearman, Cayman regarding the validity of the issuance of ordinary shares being +registered. + +8.1 + + Opinion of Skadden, Arps, Slate, Meagher & Flom LLP, U.S. counsel to the Registrant, regarding certain U.S. tax +matters. + +8.2 + + Opinion of Conyers Dill & Pearman, Cayman, Cayman Islands counsel to the Registrant, regarding certain Cayman Islands tax +matters. + +10.1 + + Employment Agreement dated July 23, 2004 between Registrant, InterActiveCorp and Justin Tang. + +10.2 + + Employment Agreement dated July 23, 2004 between Registrant, InterActiveCorp and Derek Palaschuk. + +10.3 + + Employment Agreement dated July 23, 2004 between Registrant, InterActiveCorp and Richard Chen. + +10.4 + + Employment Agreement dated July 23, 2004 between Registrant, InterActiveCorp and Richard Xue. + +10.5 + + Employment Agreement dated July 23, 2004 between Registrant, InterActiveCorp and Frank Zheng. + +10.6 + + Amended and Restated Technical Services Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and Beijing +eLong Information Technology Co., Ltd. + + + + II-3 + +Table of Contents + +Exhibit +No. + + + Description of Exhibit + +10.7 + + Amended and Restated Loan Agreement dated July 20, 2004 among the Registrant, Justin Tang and Qu Zhi regarding Beijing eLong Information +Technology Co., Ltd. + +10.8 + + Amended and Restated Equity Interest Pledge Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and +Justin Tang regarding Beijing eLong Information Technology Co., Ltd. + +10.9 + + Amended and Restated Equity Interest Pledge Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and Qu +Zhi regarding Beijing eLong Information Technology Co., Ltd. + +10.10 + + Amended and Restated Trademark License Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and Beijing +eLong Information Technology Co., Ltd. + +10.11 + + Amended and Restated Domain Name License Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and Beijing +eLong Information Technology Co., Ltd. + +10.12 + + Amended and Restated Cooperative Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and Beijing eLong +Information Technology Co., Ltd. + +10.13 + + Amended and Restated Business Operation Agreement dated July 20, 2004 among eLongNet Information Technology (Beijing) Co., Ltd., Beijing eLong +Information Technology Co., Ltd., Justin Tang and Qu Zhi. + +10.14 + + Amended and Restated Loan Agreement dated July 20, 2004 among the Registrant, Inc., Justin Tang and Qu Zhi regarding Beijing Asia Media +Interactive Advertising Co., Ltd. + +10.15 + + Amended and Restated Exclusive Purchase Right Agreement dated July 20, 2004 among the Registrant, eLongNet Information Technology (Beijing) +Co., Ltd., Justin Tang and Beijing eLong Information Technology Co., Ltd. + +10.16 + + Amended and Restated Exclusive Purchase Right Agreement dated July 20, 2004 among the Registrant, eLongNet Information Technology (Beijing) +Co., Ltd., Qu Zhi and Beijing eLong Information Technology Co., Ltd. + +10.17 + + Cooperative Agreement dated July 20, 2004 between Beijing Asia Media Interactive Advertising Co., Ltd. and Beijing eLong Information Technology +Co., Ltd. + +10.18 + + Trademark License Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd and Beijing Asia Media Interactive +Advertising Co., Ltd. + +10.19 + + Amended and Restated Advertising Technical Consulting and Services Agreement dated July 20, 2004 between eLongNet Information Technology +(Beijing) Co., Ltd. and Beijing Asia Media Interactive Advertising Co., Ltd. + +10.20 + + Amended and Restated Equity Interest Pledge Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and +Justin Tang regarding Beijing Asia Media Interactive Advertising Co., Ltd. + +10.21 + + Amended and Restated Equity Interest Pledge Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and Qu +Zhi regarding Beijing Asia Media Interactive Advertising Co., Ltd. + + + + II-4 + +Table of Contents + +Exhibit +No. + + + Description of Exhibit + +10.22 + + Amended and Restated Business Operation Agreement dated July 20, 2004 among eLongNet Information Technology (Beijing) Co., Ltd., Justin Tang, +Qu Zhi and Beijing Asia Media Interactive Advertising Co., Ltd. + +10.23 + + Amended and Restated Exclusive Purchase Right Agreement dated July 20, 2004 among the Registrant, eLongNet Information Technology (Beijing) +Co., Ltd., Justin Tang and Beijing Asia Media Interactive Advertising Co., Ltd. + +10.24 + + Amended and Restated Exclusive Purchase Right Agreement dated July 20, 2004 among the Registrant, eLongNet Information Technology (Beijing) +Co., Ltd., Qu Zhi and Beijing Asia Media Interactive Advertising Co., Ltd. + +10.25 + + Amended and Restated Technical Consulting and Services Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) +Co., Ltd. and Beijing eLong Airline Service Co., Ltd. + +10.26 + + Amended and Restated Equity Pledge Interest Agreement dated July 20, 2004 among eLongNet Information Technology (Beijing) Co., Ltd., Beijing +eLong Information Technology Co., Ltd. and Beijing Asia Media Interactive Advertising Co., Ltd. regarding Beijing eLong Airline Service Co., Ltd. + +10.27 + + Amended and Restated Business Operation Agreement dated July 20, 2004 among eLongNet Information Technology (Beijing) Co., Ltd., Beijing eLong +Airline Service Co., Ltd., Beijing eLong Information Technology Co., Ltd., and Beijing Asia Media Interactive Advertising Co., Ltd. + +10.28 + + Amended and Restated Cooperative Agreement dated July 20, 2004 between Beijing eLong Information Technology Co., Ltd and Beijing eLong +Airline Service Co., Ltd. + +10.29 + + Trademark License Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and Beijing eLong Airline Service +Co., Ltd. + +10.30 + + Amended and Restated Technical Consulting and Services Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) +Co., Ltd. and General Chinese Reservation Network, Ltd. + +10.31 + + Amended and Restated Equity Interest Pledge Agreement dated July 20, 2004 among eLongNet Information Technology (Beijing) Co., Ltd., Beijing +eLong Information Technology Co., Ltd. and Beijing eLong Airline Service Co., Ltd. + +10.32 + + Amended and Restated Business Operation Agreement dated July 20, 2004 among eLongNet Information Technology (Beijing) Co., Ltd., General +Chinese Reservation Network, Ltd., Beijing eLong Information Technology Co., Ltd., and Beijing eLong Airlines Service Co., Ltd. + +10.33 + + Amended and Restated Cooperative Agreement dated July 20, 2004 between Beijing eLong Information Technology Co., Ltd. and General Chinese +Reservation Network, Ltd. + +10.34 + + Trademark License Agreement dated July 20, 2004 between eLongNet Information Technology (Beijing) Co., Ltd. and General Chinese Reservation +Network, Ltd. + +10.35 + + Transaction Agreement dated July 23, 2004 by and among Registrant, eLongNet Information Technology (Beijing) Co., Ltd., eLong Hi-Tech +(Beijing) Co., Ltd., InterActive Corp and IACT Asia Pacific Limited. + +10.36 + + Transfer and Escrow Contribution Agreement dated July 23, 2004 by and among Registrant, IACT Asia Pacific Limited and the selling shareholders +listed therein. + +10.37 + + Series A Preferred Shares Purchase Agreement dated August 29, 2003 by and among the Registrant and Series A preferred share +investors. + + + + II-5 + +Table of Contents + +Exhibit +No. + + + Description of Exhibit + +21.1 + + Subsidiaries of Registrant. + +23.1 + + Consent of KPMG. + +23.2 + + Consent of Conyers Dill & Pearman, Cayman (see Exhibit 5.1). + +23.3 + + Consent of Commerce & Finance Law Offices (see Exhibits 99.1, 99.2, 99.3 and 99.4). + +23.4 + + Consent of Skadden, Arps, Slate, Meagher & Flom LLP (see Exhibit 8.1). + +24.1 + + Powers of Attorney. + +99.1 + + Opinion of Commerce & Finance Law Offices, the People s Republic of China, Counsel to the Registrant, as to the legality of the +corporate structure of Beijing eLong Information Technology Co., Ltd. + +99.2 + + Opinion of Commerce & Finance Law Offices, the People s Republic of China, Counsel to the Registrant, as to the legality of the +corporate structure of Beijing Airline Services Co., Ltd. + +99.3 + + Opinion of Commerce & Finance Law Offices, the People s Republic of China, Counsel to the Registrant, as to the legality of the +corporate structure of Beijing Asia Media Interactive Advertising Co., Ltd. + +99.4 + + Opinion of Commerce & Finance Law Offices, the People s Republic of China, Counsel to the Registrant, as to the legality of the +corporate structure of General Chinese Hotel Reservation Network, Ltd. + +99.5 + + Consent of Mr. Thomas Gurnee dated October 8, 2004 + + + + + +Filed previously. + + + +Filed herewith. + + + +Amended version filed herewith + + (b) Financial Statement Schedules. + + All supplemental schedules are omitted because of the absence of conditions under which they are required or because the information is shown in the financial +statements or notes thereto. + + +Item 9. + +Undertakings + + The undersigned Registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreements certificates in such denominations and registered in such names as required by the underwriters +to permit prompt delivery to each purchaser. + + Insofar as indemnification +for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described in Item 14, or otherwise, we have been advised that in the opinion of the +Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than 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 of whether such indemnification by it is against +public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. + + + II-6 + +Table of Contents + + The undersigned Registrant hereby undertakes that: + + (1) For purposes of determining any liability under the Securities Act, the information omitted +from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to +be part of this Registration Statement as of the time it was declared effective. + + (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form +of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. + + + II-7 + +Table of Contents + + SIGNATURES + + Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant certifies that it has reasonable grounds to believe that it meets all of the +requirements for filing on \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001291000_mueller_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001291000_mueller_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a556f3afe1634291f7feedbb84a03211fe22737f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001291000_mueller_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes offered hereby will be passed upon for us by Davis Polk & Wardwell, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001291080_fidelity_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001291080_fidelity_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c9f613c94ece49be56c6058d93b3c384a38ff8a5 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001291080_fidelity_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by LeBoeuf, Lamb, Greene MacRae, L.L.P., a limited liability partnership including professional corporations, and for the underwriters by Davis Polk Wardwell, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001291124_portola_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001291124_portola_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6b43d15d99f6ef1518ff2df754cee4e555af970f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001291124_portola_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fenwick West LLP, Mountain View, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001291138_portola_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001291138_portola_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6b43d15d99f6ef1518ff2df754cee4e555af970f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001291138_portola_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fenwick West LLP, Mountain View, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001291147_portola_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001291147_portola_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6b43d15d99f6ef1518ff2df754cee4e555af970f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001291147_portola_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fenwick West LLP, Mountain View, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001291148_portola_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001291148_portola_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6b43d15d99f6ef1518ff2df754cee4e555af970f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001291148_portola_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fenwick West LLP, Mountain View, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001291149_tech_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001291149_tech_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6b43d15d99f6ef1518ff2df754cee4e555af970f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001291149_tech_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fenwick West LLP, Mountain View, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001291239_portola_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001291239_portola_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6b43d15d99f6ef1518ff2df754cee4e555af970f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001291239_portola_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the notes will be passed upon for us by Fenwick West LLP, Mountain View, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292215_pilgrim-s_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292215_pilgrim-s_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2ffdbe43f9eed65b15d9f08db308d8fc549b8a3 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292215_pilgrim-s_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The legality of the shares of New Gold Kist common stock to be issued in this offering has been passed upon by Alston & Bird LLP, Atlanta, Georgia. The underwriters are being represented in connection with this offering by Cravath, Swaine & Moore LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292429_tp_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292429_tp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292429_tp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292430_t-c_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292430_t-c_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292430_t-c_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292431_texas_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292431_texas_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292431_texas_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292432_cabana_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292432_cabana_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292432_cabana_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292433_get-real_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292433_get-real_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292433_get-real_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292434_tc-lease_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292434_tc-lease_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292434_tc-lease_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292435_tc-bevco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292435_tc-bevco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292435_tc-bevco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292614_cabana_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292614_cabana_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..36902fb36032ffb88d6aea5ff70eb5f9bac4d77d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292614_cabana_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs offered hereby and the shares of our Class A common stock and notes represented thereby and the issuance of the separate notes hereby, as well as the validity of the issuance of the subsidiary guarantees by the Delaware and New York subsidiary guarantors, will be passed upon for us by Katten Muchin Zavis Rosenman, New York, New York. The validity of the issuance of the subsidiary guarantees by the Florida subsidiary guarantors will be passed upon for us by , , Florida. The validity of the issuance of the subsidiary guarantees by the Texas subsidiary guarantors will be passed upon for us by , , Texas. Certain legal matters relating to this offering will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001292731_buffets_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001292731_buffets_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001292731_buffets_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293139_egenera_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293139_egenera_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..28a6007cec62df582c1187b0bdbe1a046868ed75 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293139_egenera_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock we are offering will be passed upon for us by Wilmer Cutler Pickering Hale and Dorr LLP, Boston, Massachusetts. The underwriters have been represented by Cravath, Swaine Moore LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293153_homex_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293153_homex_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e0141220ccdef97645db86388ae45343e2575824 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293153_homex_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Common Shares under Mexican law will be passed upon for us and the selling shareholders by Mijares, Angoitia, Cort s y Fuentes, S.C., Mexico City, Mexico, and for the underwriters by Ritch, Heather y Mueller, S.C., Mexico City, Mexico. The validity of the ADSs under New York law and certain legal matters of United States and New York law will be passed upon for us and the selling shareholders by Mayer, Brown, Rowe Maw LLP, Chicago, Illinois. Certain legal matters of United States and New York law relating to the international offering will be passed upon for the underwriters by Milbank, Tweed, Hadley McCloy LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293257_hutchison_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293257_hutchison_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2e651cf7a8957146f2e01f267925cd02857d0f7a --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293257_hutchison_legal_matters.txt @@ -0,0 +1 @@ +Table of Contents As of December 31, 2003 there were approximately 1.0 million fixed-line and mobile telecommunications subscribers in Ghana, which represents a penetration rate of approximately 4.8%, of which approximately 1.4% is attributable to fixed-line telecommunications operations and approximately 3.4% is attributable to mobile telecommunications operations. Subscriber numbers are not publicly available and those in the table below are our best estimate only as of December 31, 2003. Operator Technology Coverage Number of subscribers Table of Contents Capture synergies through integration. We will seek to realize further synergies through integration of our existing businesses and to leverage our experience for future investments and acquisitions. The management teams of our various operating companies are familiar with the range of technology in the market and we will share technology expertise and a global procurement strategy for network expansion and upgrades among our businesses to reduce costs and capital expenditure. We will seek to continue pursuing these activities as a means of further enhancing the efficiency and profitability of our businesses. Management We employ a small team at the holding company level to manage our business. We rely on the managers of our operating companies to run the day-to-day business, to make important policy decisions in their respective markets and to advise our senior management on strategic issues. Many of the managers of our operating companies have been with our group for a number of years in various telecommunications positions. The following table sets forth certain information concerning the senior management of our operating companies: Name Age Position Table of Contents Stephen Wing Fai SUN, 56, was appointed the president and chief executive officer of Hutchison CAT Wireless MultiMedia Limited in 2001 having been with the Hutchison Whampoa group since 2000. Mr. Sun holds a Bachelor of Science degree and an MBA from the California State University, Sacramento, the United States. Stephen Kim Ying NGAN, 40, was appointed the chief operating officer of Hutchison CAT Wireless MultiMedia Limited in 2002, having been with the Hutchison Whampoa group for over 11 years. Mr. Ngan first joined the Hutchison Whampoa group in 1988 until May 1992, and then rejoined in March 1997. Mr. Ngan holds an Honors Diploma in Communication from the Hong Kong Baptist University. Antony SAULT, 31, was appointed the controller of Hutchison CAT Wireless MultiMedia Limited in August 2004, having been with the Hutchison Whampoa group since 2000. Mr. Sault holds a Bachelor of Business degree (Majors in Management and Accounting) from Monash University in Australia. Thirukumar NADARASA, 41, was appointed the chief executive officer of Hutchison Telecommunications Lanka (Private) Limited in 2002, having been with the Hutchison Whampoa group since 1994. Mr. Nadarasa holds a Master of Science in Management Science from Imperial College of Science and Technology, University of London and a Master of Science in Telecommunications Technology from the University of Aston in Birmingham, England and a Bachelor of Science in Electrical and Electronic Engineering from Loughborough University of Technology, England. Rogerio ANTUNES, 33, was appointed the general manager of Hutchison Telecommunications Paraguay S.A. in 2002, having been with the Hutchison Whampoa group since 1997. Mr. Antunes holds a Bachelor degree in Business Administration from the Funda o Getulio Vargas, S o Paulo, Brazil. Robert PALITZ, 51, was appointed the managing director of Kasapa Telecom Limited in 2000, having been with the Hutchison Whampoa group since 1990. Mr. Palitz studied at the California Institute of Technology. Employees As of June 30, 2004, we had 41 full-time employees, of whom nine had been seconded to our subsidiaries. The following table sets forth the number of our employees by their functions as of June 30, 2004: Our employees Number % of Total Table of Contents As of June 30, 2004, our subsidiaries had 10,340 full-time employees. The table below sets forth the number of employees by function employed by our subsidiaries as of June 30, 2004: Our subsidiaries employees Number % of Total Total 10,340 100.0 % The following table sets out the number of employees for our business segments as of the dates indicated: As of December 31, As of June 30, Total 8,242 8,487 9,803 11,684 As at 31 December As at 31 December Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 7 INTEREST AND OTHER FINANCE COSTS Year ended 31 December Six months ended 30 June Guarantee and other finance fees included fees paid to related companies amounting to approximately HK$77 million for the six months ended 30 June 2004 (year ended 31 December 2003 HK$126 million, six months ended 30 June 2003 HK$54 million, year ended 31 December 2002 HK$53 million, year ended 31 December 2001 nil). The capitalisation rate applied to funds borrowed for the funding of fixed assets is between 1.94% to 5.43% per annum. Following the capitalisation of the long term amounts due to related companies as part of the Restructuring detailed in Note 1, interest on amounts due to related companies has subsequently ceased. 8 DIRECTORS EMOLUMENTS Directors emoluments comprise payments to the Directors of the Company in connection with the management of the affairs of the Group. The emoluments of the Directors of the Company are as follows: Year ended 31 December Six months ended 30 June Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The carrying values of all fixed assets are stated at cost less accumulated depreciation and accumulated impairment losses. For the year ended 31 December 2001, the Group made a provision for impairment losses of approximately HK$1,535 million on certain network equipment after assessment of impairment. Other assets includes motor vehicles, office furniture and equipment, leasehold improvements and computer equipment. As at 31 December Jointly controlled entities as at 31 December 2001 were interests in Hutchison Global Communications Investment Holdings Limited, the holding company of the Group s fixed-line business, and Hazelwood Green Limited, the holding company of the Group s data centre business. The Group increased its shareholdings from 50% to 100% in 2002, and these companies were accounted for as subsidiary companies subsequent to the increase. As at 31 December Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Year ended 31 December Six months ended 30 June Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The changes in the valuation allowance for the years ended December 31, 2001, 2002, and 2003, are as follows: At December 31: 2003 NIS 4.379 178.58 points 2002 NIS 4.737 182.01 points 2001 NIS 4.416 170.91 points 2000 NIS 4.041 168.53 points Increase (decrease) during the year: 2003 (7.6 %) (1.9 %) 2002 7.3 % 6.5 % Table of Contents APPENDIX B PROPERTY VALUATIONS The following is the text of the letter, a summary of valuations and an extract of the valuation certificate received from DTZ Debenham Tie Leung Limited, an independent property valuer, prepared for the purpose for incorporation in this prospectus, in connection with their valuation of the property interests (excluding leased and licensed cell sites) held by the Group as at 31 July 2004. 30 September 2004 The Directors Hutchison Telecommunications International Limited 22/F, Hutchison House 10 Harcourt Road Hong Kong Dear Sirs, In accordance with your instructions to us to value the property interests held by Hutchison Telecommunications International Limited (the Company ) and/or its subsidiaries (hereinafter together referred to as the Group ) in Hong Kong, the People s Republic of China (the PRC ), Macau, India, Sri Lanka, Paraguay, Ghana, Thailand, Malaysia, the Philippines, Singapore, Taiwan and the United States, we confirm that we have made relevant enquiries and searches and obtained such further information as we consider necessary for the purpose of providing you with our opinion of the open market values of the property interests as at 31 July 2004 (the date of valuation ). Our valuation of each of the property interests represents its open market value which we would define as intended to mean an opinion of the best price at which the sale of an interest in property would have been completed unconditionally for cash consideration on the date of valuation, assuming:- (a) a willing seller; (b) that, prior to the date of valuation, there had been a reasonable period (having regard to the nature of the property and the state of the market) for the proper marketing of the interest, for the agreement of the price and terms and for the completion of the sale; (c) that the state of the market, level of values and other circumstances were, on any earlier assumed date of exchange of contracts, the same as on the date of valuation; (d) that no account is taken of any additional bid by a prospective purchaser with a special interest; and (e) that both parties to the transaction had acted knowledgeably, prudently and without compulsion . Our valuations have been made on the assumption that the Group sells the property interests on the open market without the benefit of deferred term contracts, leasebacks, joint ventures, Condensed Consolidated Balance Sheet Table of Contents management agreements or any similar arrangements which could serve to affect the values of the property interests. We have valued property nos. 3 to 10 in Group I, property nos. 11 to 18 in Group II, property nos. 19 to 20 in Group III, property no. 21 in Group IV, property nos. 22 to 32 in Group V, and property nos. 35 to 48 in Group VIII which are held by the Group in Hong Kong, the PRC, Macau, Paraguay, India, and Thailand respectively by Direct Comparison Method by making reference to comparable transactions as available in the relevant market. Due to the specific nature of the buildings and structures of property nos. 1 and 2 in Group I, property no. 33 in Group VI and property no. 34 in Group VII, we have adopted the Depreciated Replacement Costs (the DRC ) approach. A DRC approach requires an estimate of the open market value of the land in its existing use and an estimate of the new replacement cost of the buildings and structures, from which deductions are made to allow for the age, condition and functional obsolescence. The properties in Groups IX, X, XI, XII, XIII, XIV, XV, XVI, XVII, XVIII, XIX, XX and XXI, which are leased to the Group in Hong Kong, the PRC, Macau, Paraguay, India, Sri Lanka, Ghana, Thailand, Malaysia, the Philippines, Singapore, Taiwan and the United States respectively, have no commercial value due to prohibition against assignment or lack of substantial profit rent. In valuing property nos. 5, 7 and 10 in Hong Kong the Government Leases of which expired before 30 June 1997, we have taken into account that under the provisions contained in Annex III of the Joint Declaration of the Government of the United Kingdom and the Government of the PRC on the Question of Hong Kong as well as in the New Territories Leases (Extension) Ordinance, such leases have been extended without premium until 30 June 2047 and rents of three per cent. of the rateable value are charged per annum from the date of extension. Unless otherwise stated, in the course of our valuation of the properties situated in the PRC, India, Sri Lanka, Paraguay, Ghana and Thailand, we have assumed that transferable land use rights in respect of the properties for specific terms at nominal annual land use fees have been granted and that, any premia payable have already been fully paid. We have also assumed that the grantees or the users of the properties have free and uninterrupted rights to use or to assign the properties for the whole of the unexpired terms as granted. We have relied on the advice given by the Group and the Group s legal adviser Commerce & Finance Law Offices on PRC Law, regarding the title to each of the property interests and the Group s interests in the properties in the PRC. We have been provided with extract copies of documents in relation to the title to the properties situated in the PRC, India, Sri Lanka, Paraguay, Ghana and Thailand and we have caused searches to be made at the appropriate Land Registries in respect of the properties in Hong Kong and Macau. However, we have not searched the original documents to ascertain ownership or to verify any amendments which may not appear on the copies handed to us. We have relied to a very considerable extent on the information given by the Group and its legal adviser on PRC law. We have accepted advice given to us on such matters as planning approvals, statutory notices, easements, tenures, identification of properties, particulars of occupancy, tenancy details, site and floor plans, site and floor areas and all other relevant matters. Dimensions and measurements are based on the copies of documents or other information provided to us by the Group and are therefore only approximations. Unless otherwise stated, no on-site measurement has been carried out. We have had no reason to doubt the truth and accuracy of the information provided to us by the Group which are material to the valuations. We were also advised by the Group that no material facts have been omitted from the information supplied. Table of Contents Hong Kong, India, Israel and Thailand are the geographical markets that currently account for substantially all of our turnover and operating profit (loss). The following table lists the relative contributions of these markets to our turnover and operating profit (loss) for 2003 and for the six months ended June 30, 2004: December 31, Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Variable interest entities To comply with Indian and Thai regulations that restrict majority direct foreign ownership or voting control of companies that provide telecommunications services, the Group conducts its operations in India and Thailand through entities in which the Company does not have voting control or a majority of the direct equity interest. For the entities in India, in addition to its minority direct interest in each of the entities, the Group also has indirect interests of varying percentages ranging from 0.3% to 25% in the Indian operating entities. The Group has also established an entity to facilitate the sale and leaseback transaction described in Note (g) above. Under Hong Kong GAAP, these entities are included as subsidiary companies for the reasons described in Note 3A. Under US GAAP, these entities are variable interest entities as defined in Financial Accounting Standards Board Interpretation No. 46 ( FIN 46 ). As a result of the direct and indirect ownership interests and other financing arrangements, the Group has determined that it was the primary beneficiary, as defined in FIN 46, for these entities from the date of acquisition or incorporation and, accordingly, has included the financial statements of these entities in the Group s consolidated financial statements. FIN 46 has been applied for all periods presented. The following entities are variable interest entities in which the Group is the primary beneficiary: Total Assets as at 31 December Revenue for the year ended 31 December 4.00 Number outstanding at December 31, Number exercisable at December 31, Table of Contents We have inspected the exterior and, wherever possible, the interior of the properties. However, no structural survey has been made, but in the course of our inspections, we did not note any serious defects. We are not, however, able to report whether the properties are free of rot, infestation or any other structural defects. No tests were carried out on any of the services. No allowance has been made in our valuations for any charges, mortgages or amounts owing on the property interests nor any expenses or taxation which may be incurred in effecting a sale. Unless otherwise stated, it is assumed that the property interests are free from encumbrances, restrictions and outgoings of any onerous nature which could affect their values. As advised by the Group, up to 31 July 2004, there were in total approximately 2,886 leased cell sites situated in seven jurisdictions including 312 in Hong Kong, 69 in Macau, 1,095 in India, 89 in Sri Lanka, 105 in Paraguay, 45 in Ghana and 1,171 in Thailand. In addition, there were in total approximately 4,583 licensed cell sites situated in Hong Kong, Macau and India. A waiver has been granted by the Stock Exchange from compliance with Rules 5.01 and 5.06(1) to (3) and Practice Note 16 of the Listing Rules and an exemption has been granted by the SFC pursuant to 342A of the Companies Ordinance from compliance with Section 342(1)(b) and Paragraph 34(2) of Part II of the Third Schedule to the Companies Ordinance in respect of the Group s leased and licensed cell sites. As further advised by the Group, another waiver has been granted by the Stock Exchange from strict compliance with Practice Note 12 of the Listing Rules in respect of the requirement for our property valuation report to include a statement summarising the material information regarding title and other matters contained in any legal opinion relating to the 64 property interests owned by the Group in Thailand, India, Paraguay, Sri Lanka and Ghana and for the provision of such legal opinions. Unless otherwise stated, all sums stated in our valuation certificates are in Hong Kong dollars. The exchange rates adopted in our valuations as at 31 July 2004 are US$1=HK$7.8, RMB1.06=HK$1, MOP1.03=HK$1, PYG758.4=HK$1, INR5.94=HK$1, LKR13.28=HK$1, GHC1,141.16=HK$1 and THB5.3=HK$1 which were approximately the prevailing exchange rates as at the date of valuation and the date of this letter. We enclose herewith a summary of valuations and our valuation certificate for your attention. Yours faithfully, for and on behalf of DTZ Debenham Tie Leung Limited K.B. Wong Registered Professional Surveyor (General Practice Division) M.H.K.I.S., M.R.I.C.S. Director Note: Mr. K.B. Wong has been a Chartered Surveyor since 1986 and has extensive valuation experience in valuation of properties in Hong Kong, the PRC, Macau, the Asia-Pacific Region and many other countries. December 31, December 31, December 31, December 31, Six months ended June 30, As of June 30, As of June 30, As of August 31, As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 31 December As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June As at 30 June Total Assets as at 30 June Group I Property interests held by the Group in Hong Kong 1. Portions of 2nd and 3rd Floors and one Car Parking Space on the Ground Floor of the Telephone Exchange building, No. 1 Chun Ming Road, Hong Kong International Airport, Lantau Island, New Territories, Hong Kong 17,000,000 2. Portions of 2nd and 3rd Floors, Telephone Exchange, No. 12 Cheung Tung Road, Tung Chung, Lantau Island, New Territories, Hong Kong 14,300,000 3. Godowns B2 and C on 12th Floor, Ever Gain Centre, No. 28 On Muk Street, Shatin, New Territories, Hong Kong 15,000,000 4. Unit B on 1st Floor and Flat Roof, Wang Yip Centre, No. 18 Wang Yip Street East, Yuen Long, New Territories, Hong Kong 2,070,000 5. Units 7 to 12 with Portions of Corridor and Flat Roofs appertaining to Units 7 and 10 on 1st Floor, Block 3, Nan Fung Industrial City, No. 18 Tin Hau Road, Tuen Mun, New Territories, Hong Kong 2,520,000 June 30, June 30, June 30, June 30, 6 month period ended June 30, 3 month period ended June 30, 6 month period ended June 30, 6 month period ended June 30, 3 month period ended June 30, Sub-total: 54,780,000 Group II Property interests held by the Group in the PRC 11. Units E and F on 17th Level, SIIC Building, No. 18 Caoxi North Road, Minhang District, Shanghai, the PRC 5,530,000 12. Unit No. 4 (now renamed as Unit Nos. 3 and 4) on 26th Level, Minxing Financial Tower, No. 88 Tedu Street, Qingyang District, Chengdu, Sichuan Province, the PRC 3,300,000 Sub-total: 32,670,000 Sub-total: 692,326 Group V Property interests held by the Group in India 22. 11/5, Sarat Bose Road, Kolkata 700020, India 875,758 23. Unit No. 5 on 4th Floor, Block B, Shyam Apartment, Samarpally, Krishnapur, Calcutta 700059, India 77,441 24. Unit No. 402 on 4th Floor, Unit Nos. 601 to 616 on 6th Floor, and Unit Nos. 701, 702, 707, 715 and 716 on 7th Floor, Sakar II, Ashram Road, Ellisbridge, Ahmedabad, India 8,155,498 25. Unit No. 904, Chandraka Tower, Anandwan, Baroda, India 107,239 HK$ millions HK$ millions HK$ millions HK$ millions 2003 15 15 2004 11 11 12 12 2005 86 85 90 87 2006 98 96 102 99 2007 369 389 378 In thousands Year ended December 31: 2004 140,028 31,977 2005 78,256 17,871 2006 40,779 9,312 2007 28,718 6,558 Sub-total: 17,969,157 Sub-total: 3,675,324 Group VIII Property interests held by the Group in Thailand 35. No. 166 Khuanthani Road, Nai Muang Sub-district, Muang Ubonratchathani District, Ubonratchathani Province, Thailand 377,358 36. No. 59/13 Borom Trai Lokkanant Road, Nai Muang Sub-district, Muang District, Phitsanulok Province, Thailand 377,358 37. No. 750, Si Chan Road, Nai Muang Sub-district, Muang District, Khonkaen Province, Thailand 603,774 38. No. 10/27 Raksakchamul Road (Highway No. 316), Tha Chang Sub-district, Muang District, Chanthaburi Province, Thailand 339,623 39. No. 42, Chuti-Uthit 3 Road, Hatyai Sub-district, Hatyai District, Songkhla Province, Thailand 754,717 40. No. 44, Chuti-Uthit 3 Road, Hatyai Sub-district, Hatyai District, Songkhla Province, Thailand 754,717 41. No. 310/6 Prachak Road, Mak Kheang Sub-district, Muang District, Udonthani Province, Thailand 698,113 Group IX Property interests leased to the Group in Hong Kong 49. 124 leased properties in Hong Kong No commercial value Group X Property interests leased to the Group in the PRC 50. 15 leased properties in the PRC No commercial value Group XI Property interests leased to the Group in Macau 51. 133 leased properties in Macau No commercial value Group XII Property interests leased to the Group in Paraguay 52. 5 leased properties in Paraguay No commercial value Group XIII Property interests leased to the Group in India 53. 266 leased properties in India No commercial value Group XIV Property interests leased to the Group in Sri Lanka 54. 3 leased properties in Sri Lanka No commercial value Group XV Property interests leased to the Group in Ghana 55. 11 leased properties in Ghana No commercial value Group XVI Property interests leased to the Group in Thailand 56. 54 leased properties in Thailand No commercial value Group XVII Property interests leased to the Group in Malaysia 57. 2 leased properties in Malaysia No commercial value Group XVIII Property interests leased to the Group in the Philippines 58. 2 leased properties in the Philippines No commercial value Group XIX Property interests leased to the Group in Singapore 59. 2 leased properties in Singapore No commercial value Group XX Property interest leased to the Group in Taiwan 60. 1 leased property in Taiwan No commercial value Group XXI Property interest leased to the Group in the United States 61 1 leased property in the United States No commercial value 1. Portions of 2nd and 3rd Floors and one Car Parking Space on the Ground Floor of the Telephone Exchange building, No. 1 Chun Ming Road, Hong Kong International Airport, Lantau Island, New Territories, Hong Kong A portion of the Remaining Portion of Chek Lap Kok Lot No. 1 and the Extension thereto The property comprises portions of the 2nd and 3rd floors and one car parking space of a 4-storey telephone exchange building completed in 1998. The property has a gross floor area of approximately 586.691 sq.m. (6,315 sq.ft.), excluding the car parking space. The land of the property is held by the Airport Authority from the Government for a term of years from 1 December 1995 to 30 June 2047. The term of sub-lease of the telephone exchange is from 3 February 1997 to 2 December 2028. The current annual Government Rent payable for the property is an amount equal to 3% of the rateable value for the time being of the property. The property is occupied by the Group for installation of tele-communication equipment. HK$17,000,000 Notes: (1) A portion of the Remaining Portion of Chek Lap Kok Lot No.1 and the Extension thereto having an area of approximately 1,701 square meters (the land ) is leased by the Airport Authority to Hong Kong Telephone Company Limited (now known as PCCW-HKT Telephone Limited), Hutchison Communications Limited (now known as Hutchison Global Communications Limited) and New World Telephone Limited (now known as New World Telecommunications Limited) (as tenants in common in the following shares: namely as to 57/100th parts or shares in Hong Kong Telephone Company Limited, as to 28/100th parts or shares in Hutchison Communications Limited and as to 15/100th parts or shares in New World Telephone Limited (as Lessee) under a sub-lease dated 3 February 1997 and registered in the Islands New Territories Land Registry by Memorial No. 242390. (2) The sub-lease of the land prohibits assignment of the property. In the event that the Lessee desires to assign the property at any time during the term of the sub-lease, the Lessee shall obtain the consent from the Airport Authority. (3) Hutchison Communications Limited (now known as Hutchison Global Communications Limited) is entitled to have exclusive right to hold use and occupy the property under and by virtue of a Deed of Mutual Covenant and Management Agreement dated 3 December 1998 and registered in the Islands New Territories Land Registry by Memorial No. 278343. (4) At the time of our title search, we are not aware of any mortgage registered against the property under the name of Hong Kong Telephone Company Limited, Hutchison Communications Limited, New World Telephone Limited, PCCW-HKT Telephone Limited, Hutchison Global Communications Limited or New World Telecommunications Limited. (5) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. Table of Contents Licenses Introduction Hutchison Essar Telecom Limited, Hutchison Max Telecom Private Limited, Hutchison Telecom East Limited, Fascel Limited, Aircel Digilink India Limited and Hutchison Essar South Limited, collectively referred to herein as Hutch India, have 11 cellular mobile telecommunications service licenses and two unified access licenses to provide mobile services in 13 service areas and unified access services in two service areas, the details of which are given below: State 2. Portions of 2nd and 3rd Floors, Telephone Exchange, No. 12 Cheung Tung Road, Tung Chung, Lantau Island, New Territories, Hong Kong A portion of Tung Chung Town Lot No. 8 The property comprises portions of the 2nd and 3rd floors of a 4-storey telephone exchange building completed in 1998. The property has a gross floor area of approximately 413.027 sq.m. (4,446 sq.ft.). The property is held from the Government for a term of years from 16 May 1998 to 30 June 2025. The current annual Government Rent payable for the property is an amount equal to 3% of the rateable value for the time being of the property. The property is occupied by the Group for installation of tele-communication equipment. HK$14,300,000 Notes: (1) The registered owners of the whole of Tung Chung Town Lot No. 8 are Hong Kong Telephone Company Limited (now known as PCCW-HKT Telephone Limited), Hutchison Communications Limited (now known as Hutchison Global Communications Limited) and New World Telephone Limited (now known as New World Telecommunications Limited) holding as tenants in common in the following shares: namely as to 5,850/10,000th parts or shares in Hong Kong Telephone Company Limited, as to 1,869/10,000th parts or shares in Hutchison Communications Limited and as to 2,281/10,000th parts or shares in New World Telephone Limited. (2) At the time of our title search, we are not aware of any mortgage registered against the property under the name of Hong Kong Telephone Company Limited, Hutchison Communications Limited, New World Telephone Limited, PCCW-HKT Telephone Limited, Hutchison Global Communications Limited or New World Telecommunications Limited. (3) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. Service Area 3. Godowns B2 and C on 12th Floor, Ever Gain Centre, No. 28 On Muk Street, Shatin, New Territories, Hong Kong 177/5720th parts or shares of and in Sha Tin Town Lot No. 402 The property comprises two godown units on the 12th floor of a 20-storey godown building completed in 1993. The property has a saleable area of approximately 1,637.68 sq.m. (17,628 sq.ft.). The property is held from the Government for a term of years from 4 May 1992 to 30 June 2047. The current annual Government Rent payable for the property is an amount equal to 3% of the rateable value for the time being of the property. The property is occupied by the Group for installation of tele-communication equipment. HK$15,000,000 Notes: (1) The registered owner of the property is Hutchison Global Crossing Limited (now known as Hutchison Global Communications Limited). (2) The property is subject to a temporary waiver letter dated 15 April 2002 and issued by District Lands Officer, Sha Tin to permit the use of the property for the purpose of information technology and telecommunications industries for the life time of the existing building. (3) At the time of our title search, we are not aware of any mortgage registered against the property. (4) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. Name of Licensee 4. Unit B on 1st Floor and Flat Roof, Wang Yip Centre, No. 18 Wang Yip Street East, Yuen Long, New Territories, Hong Kong 44/1380th parts or shares of and in Yuen Long Town Lot No. 385 The property comprises an industrial unit together with its flat roof on the 1st floor of a 9-storey industrial building completed in 1992. The property has a gross floor area of approximately 411.46 sq.m. (4,429 sq.ft.) plus a flat roof area of approximately 136.29 sq.m. (1,467 sq.ft.). The property is held from the Government for a term of years from 23 January 1990 to 30 June 2047. The current annual Government Rent payable for the property is an amount equal to 3% of the rateable value for the time being of the property. The property is occupied by the Group for installation of tele-communication equipment. HK$2,070,000 Notes: (1) The registered owner of the property is Hutchison Global Crossing Limited (now known as Hutchison Global Communications Limited). (2) At the time of our title search, we are not aware of any mortgage registered against the property. (3) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. (4) According to the Group, the registered owner is in the process of applying for a waiver from the Government to permit the property to be used for information technology and telecommunications industries. In the event that the waiver is not granted, the Group will cease to use the property for installation of telecommunications equipment and relocate such equipment to other properties owned by or leased to the Group or owned by other third parties. The Group has also confirmed that non-compliance with the permitted use of the property pending the grant of the waiver will not have a material impact on the Group s operations and its trading and financial position. 5. Units 7 to 12 with Portions of Corridor and Flat Roofs appertaining to Units 7 and 10 on 1st Floor, Block 3, Nan Fung Industrial City, No. 18 Tin Hau Road, Tuen Mun, New Territories, Hong Kong 157590/26992290th parts or shares of and in Tuen Mun Town Lot No. 233 The property comprises six industrial units on the 1st floor together with flat roofs appertaining to units 7 and 10 and portions of the corridor of a 16-storey industrial building completed in 1989. The property has a total gross floor area of approximately 1,374.30 sq.m. (14,793 sq.ft.) plus a total flat roof area of approximately 89.74 sq.m. (966 sq.ft.). The property is held from the Government for a term of 99 years from 1 July 1898 less the last three days and was statutorily extended to 30 June 2047. The current annual Government Rent payable for the property is an amount equal to 3% of the rateable value for the time being of the property. The property is occupied by the Group for installation of tele-communication equipment. HK$2,520,000 Notes: (1) The registered owner of the property is Hutchison Global Crossing Limited (now known as Hutchison Global Communications Limited). (2) At the time of our title search, we are not aware of any mortgage registered against the property. (3) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. (4) According to the Group, the registered owner is in the process of applying for a waiver from the Government to permit the property to be used for information technology and telecommunications industries. In the event that the waiver is not granted, the Group will cease to use the property for installation of telecommunications equipment and relocate such equipment to other properties owned by or leased to the Group or owned by other third parties. The Group has also confirmed that non-compliance with the permitted use of the property pending the grant of the waiver will not have a material impact on the Group s operations and its trading and financial position. 6. Workshop 14 on 2nd Floor, Hong Leong Plaza, No. 33 Lok Yip Road, Fanling, New Territories, Hong Kong 188/21231st parts or shares of and in Fanling Sheung Shui Town Lot No. 106 The property comprises an industrial unit on the 2nd floor of a 6-storey industrial building completed in 1992. The property has a gross floor area of approximately 187.85 sq.m. (2,022 sq.ft.). The property is held from the Government for a term of years from 14 November 1990 to 30 June 2047. The current annual Government Rent payable for the property is an amount equal to 3% of the rateable value for the time being of the property. The property is occupied by the Group for installation of tele-communication equipment. HK$680,000 Notes: (1) The registered owner of the property is Hutchison Global Crossing Limited (now known as Hutchison Global Communications Limited). (2) At the time of our title search, we are not aware of any mortgage registered against the property. (3) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. (4) According to the Group, the registered owner is in the process of applying for a waiver from the Government to permit the property to be used for information technology and telecommunications industries. In the event that the waiver is not granted, the Group will cease to use the property for installation of telecommunications equipment and relocate such equipment to other properties owned by or leased to the Group or owned by other third parties. The Group has also confirmed that non-compliance with the permitted use of the property pending the grant of the waiver will not have a material impact on the Group s operations and its trading and financial position. 7. Workshop 16 on 11th Floor, Block A, Vigor Industrial Building, Nos. 14-20 Cheung Tat Road, Tsing Yi, New Territories, Hong Kong 7/4000th parts or shares of and in Tsing Yi Town Lot No. 86 The property comprises a workshop unit on the 11th floor of an 18-storey industrial building completed in 1986. The property has a saleable area of approximately 126.07 sq.m. (1,357 sq.ft.). The property is held from the Government for a term of 99 years less the last three days from 1 July 1898 which has been statutorily extended to 30 June 2047. The current Government Rent payable for the property is an amount equal to 3 per cent. of the rateable value for the time being of the property per annum. The property was previously leased for a term of 2 years from 26 August 2002 to 25 August 2004 at a monthly rent of HK$6,000, inclusive of rates and management fees and is currently vacant. HK$410,000 Note: (1) The registered owner of the property is Vanda Instrument & Equipment Company Limited. 8. Office Nos. 2, 3 and 4 on 18th Floor, Kenbo Commercial Building, Nos. 335-339 Queen s Road West, Sai Ying Pun, Hong Kong 148/10703rd parts or shares of and in Section B and the Remaining Portion of Inland Lot No. 1270 The property comprises three office units on the 18th floor of a 23-storey commercial building completed in 1982. The property has a total gross floor area of approximately 95.88 sq.m. (1,032 sq.ft.). The property is held from the Government for a term of 999 years from 1 October 1855. The current Government Rent payable for the Remaining Portion of Inland Lot No. 1270 is HK$22 per annum. The property is currently occupied by the Group for installation of tele-communication equipment. HK$700,000 Notes: (1) The registered owner of the property is Hutchison Radio Telephone Limited (now known as Hutchison Telephone Company Limited). (2) At the time of our title search, we are not aware of any mortgage registered against the property. (3) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. 9. Flat A2 on 19th Floor, Block A, Ka On Building, No. 65 Catchick Street, Kennedy Town, Hong Kong 6/646th parts or shares of and in the Remaining Portion of Section D of Marine Lot No. 245 The property comprises a residential unit on the 19th floor of a 24-storey residential block erected over a commercial podium completed in 1988. The property has a gross floor area of approximately 60.83 sq.m. (655 sq.ft.). The property is held from the Government for a term of 999 years from 24 June 1892. The current Government Rent payable for the lot is HK$88 per annum. The property is currently occupied by the Group as staff quarter. HK$1,500,000 Notes: (1) The registered owner of the property is Hutchison Telephone Company Limited. (2) At the time of our title search, we are not aware of any mortgage registered against the property. 10. Flat C on 17th Floor, Kam Fu Building, Nos. 2-8 On Fu Road, Tai Po, New Territories, Hong Kong 5/594th parts or shares of and in Sections A, B, C, D and E of Lot No. 826 in Demarcation District No. 6 The property comprises a residential unit on the 17th floor of a 23-storey composite building completed in 1976. The property has a gross floor area of approximately 45.24 sq.m. (487 sq.ft.). The property is held from the Government for a term of 75 years from 1 July 1898 renewed for a further term of 24 years and was statutorily extended to 30 June 2047. The current annual Government Rent payable for the property is an amount equal to 3% of the rateable value for the time being of the property. The property is currently leased for a term of two years from 19 May 2004 to 18 May 2006 at a monthly rent of HK$3,300 inclusive of rates and management fees. HK$600,000 Notes: (1) The registered owner of the property is Hutchison Telephone Company Limited. (2) At the time of our title search, we are not aware of any mortgage registered against the property. 11. Units E and F on 17th Level, SIIC Building, No. 18 Caoxi North Road, Minhang District, Shanghai, the PRC The property comprises 2 office units on the 17th level of a 40-storey office building erected on an 8-storey podium plus 2 levels of basement carpark completed in 1996. The property has a total gross floor area of approximately 337.76 sq.m. (3,636 sq.ft.). The land use rights of the property have been granted for a term expiring on 28 November 2044 for office use. The property is currently occupied by the Group as offices. HK$5,530,000 Notes: (1) According to Real Estate Title Certificate Nos. (1997) 005660 and (1997) 005661 both issued by Shanghai Housing and Land Administrative Bureau dated 26 November 1997, the property comprising a gross floor area of 215.25 sq.m. and 122.51 sq.m. for Units E and F respectively, have been granted to Janeper Development Limited for a term expiring on 28 November 2044 for office use. (2) According to two Pre-sale Contracts of Overseas Sale Commodity Housing both entered into between Shanghai SIIC Development Co. Ltd (Party A) and Janeper Development Limited (Party B), Party B purchased the property comprising a gross floor area of 215.25 sq.m. for Unit E and 122.51 sq.m. for Unit F at a total consideration of US$678,120 from Party A. (3) The opinion of the Group s PRC legal adviser states that: (i) The Land Use Rights of the property have been granted to Janeper Development Limited for a term from 27 August 1997 to 28 November 2044 and 5 August 1997 to 28 November 2044 for Units E and F respectively; (ii) The Building Ownership of the property is held by Janeper Development Limited; (iii) The property is not subject to any mortgage; and (iv) Janeper Development Limited is entitled to transfer, lease and mortgage the property. (4) We have prepared our valuation on the following assumptions: (i) Janeper Development Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use rights at no extra land premium or other onerous payment payable to the government; (ii) all considerations have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (5) The status of title and grant of major approvals and licences in accordance with the information provided to us by the Group and the aforesaid legal opinion are as follows:- Real Estate Title Certificates Yes Pre-sale Contracts of Overseas Sale Commodity Housing Yes Business Licence N/A 12. Unit No. 4 (now renamed as Unit Nos. 3 and 4) on 26th Level, Minxing Financial Tower, No. 88 Tedu Street, Qingyang District, Chengdu, Sichuan Province, the PRC The property comprises an office unit on the 26th level of a 32-storey office tower erected upon a 6-storey commercial podium plus 4 levels of basement completed in 1998. The property is currently partitioned into two portions and has a total gross floor area of approximately 425.37 sq.m. (4,579 sq.ft.). The land use rights of the property have been granted for a term expiring on 22 May 2044. Unit No. 2604 of the property comprising a gross floor area of approximately 201 sq.m. (2,164 sq.ft.) is currently leased to a tenant for a term from 15 January 2004 to 14 January 2006 at a monthly rent of RMB11,055, exclusive of management fees and utilities charges. Unit No. 2604A property comprising a gross floor area of approximately 224.37 sq.m. (2,415 sq.ft.) is currently leased to a tenant for a term from 18 April 2003 to 17 June 2006 at a monthly rent of RMB11,250, exclusive of management fees and utilities charges. HK$3,300,000 Notes: (1) According to Certificate for the Use of State-owned Land No. (2003) 015 issued by Chengdu Lands Bureau dated 8 January 2003, the land use rights of Minxing Financial Tower comprising a total site area of 4,437.87 sq.m. have been granted to Sichuan Minxing Construction Company Limited for a term expiring on 22 May 2034 and 22 May 2044 for commercial portion and composite portion respectively. (2) According to Building Ownership Certificate No. 0629748 issued by Chengdu Real Estate Administrative Bureau on 26 July 2001, the building ownership of the property comprising a gross floor area of 425.37 sq.m. is held by Janeper Development Limited . (3) According to Sale and Purchase Agreement of Minxing Financial Tower entered into between Sichuan Minxing Construction Company Limited (Party A) and Janeper Development Limited (Party B), Party B has agreed to purchase the property comprising a gross floor area of 413 sq.m. from Party A at a consideration of RMB5,286,400. (4) The opinion of the Group s PRC legal adviser states that: (i) The Land Use Rights of the property have been granted to Janeper Development Limited for a term expiring on 22 May 2044; (ii) The Building Ownership of the property is held by Janeper Development Limited; (iii) The property is not subject to any mortgage; and (iv) Janeper Development Limited is entitled to transfer, lease and mortgage the property. (5) We have prepared our valuation on the following assumptions:- (i) Janeper Development Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use rights at no extra land premium or other onerous payment payable to the government; (ii) all considerations have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. Table of Contents VALUATION CERTIFICATE (6) The status of title and grant of major approvals and licences in accordance with the information provided to us by the Group and the aforesaid legal opinion are as follows: Certificate for the Use of State-owned Land Yes Building Ownership Certificate Yes Sale and Purchase Agreement Yes Business Licence N/A 13. Unit No. 3304, Taihe Plaza, No. 72 Wusheng Road, Qiaokou District, Wuhan, Hubei Province, the PRC The property comprises an office unit on the 33rd level of a 45-storey office building completed in 1996. The property has a gross floor area of approximately 225.58 sq.m. (2,428 sq.ft.). The Land Use Rights of the property have been granted for a term expiring on 1 August 2042. The property is currently occupied by the Group as an office. HK$1,350,000 Notes: (1) According to Certificate for the Use of State-owned Land No. (2004) 1880 issued in May 2004, the land use rights of the property comprising an apportioned area of 10.65 sq.m. have been granted to Janeper Development Limited for a term expiring on 1 August 2042. (2) According to Building Ownership Certificate No. 003-00473 issued by Wuhan Real Estate Administrative Bureau on 12 June 1998, the building ownership of the property comprising a gross floor area of 225.58 sq.m. is held by Janeper Development Limited. (3) According to Sale Contract of Commodity Housing entered into between Wuhan Taihe Real Estate Development Company Limited (Party A) and Janeper Development Limited (Party B), Party B purchased the property, comprising a gross floor area of 202 sq.m., at a consideration of RMB1,747,300 from Party A. The land use rights of the property have been granted to Party A for a term of 50 years from 1 August 1992 to 1 August 2042. (4) The opinion of the Group s PRC legal adviser states that: (i) The Land Use Rights of the property have been granted to Janeper Development Limited for a term expiring on 1 August 2042; (ii) The Building Ownership of the property is held by Janeper Development Limited; (iii) The property is not subject to any mortgage; and (iv) Janeper Development Limited is entitled to transfer, lease and mortgage the property. (5) We have prepared our valuation on the following assumptions:- (i) Janeper Development Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use rights at no extra land premium or other onerous payment payable to the government; (ii) all considerations have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (6) The status of title and grant of major approvals and licences in accordance with the information provided to us by the Group and the aforesaid legal opinion are as follows: Certificate for the Use of State-owned Land No Building Ownership Certificate Yes Sale Contracts of Commodity Housing Yes Business Licence N/A 14. Unit Nos. A901 to A912 on 9th Level, Block A, Vantone New World Plaza, Nos. 2-8 Fuchengmenwai Avenue, Xicheng District, Beijing, the PRC The property comprises the whole 9th level of a 20-storey office tower (Block A) of an office/ commercial composite complex named Vantone New World Plaza. The development was completed in 1996. The property is currently partitioned into various portions and has a total floor area of approximately 1,441.60 sq.m. (15,517 sq.ft.). The land use rights of the property have been granted for a term from 13 August 2001 to 2 November 2043 for composits uses. The property is currently leased to three tenants for terms from 1 September 2002 to 31 August 2005, 5 January 2003 to 4 January 2005 and 1 December 2002 to 30 November 2004 with monthly rents of RMB66,572.33, RMB31,645 and RMB20,079 respectively. All monthly rents are exclusive of management fees and utilities charges. HK$19,000,000 Notes: (1) According to 12 Real Estate Title Certificates Nos. JFQZSXGATZ 1770017 to 1770022 and 1770024 to 1770029 all issued by Beijing Land Resources and Building Administrative Bureau , the land use terms and the building ownership of the property comprising a total gross floor area of 1,441.60 sq.m. are held by Vanda Computer & Equipment Company Limited . (2) According to Sale Contract of Real Estate entered into between Vanda Investment International Co. Limited (Party A) and Vanda Computer & Equipment Company Limited (Party B) on 22 February 2001, Party B purchased Unit Nos. A901 to A906 on the 9th Level in Block A of Vantone New World Plaza, comprising a total gross floor area of 720.86 sq.m., at a total consideration of US$1,831,000 from Party A. According to 6 Presale Contracts of Real Estate all entered into between Beijing Vantone Plaza Real Estate Company Limited (Party A) and Vanda Computer & Equipment Company Limited on 8 March 1994, Party B agreed to purchase Unit Nos. A907 to A912 on the 9th Level in Block A of Vantone New World Plaza, comprising a total gross floor area of 647.74 sq.m., at a total consideration of US$1,594,691.80 from Party A. (3) The opinion of the Group s PRC legal adviser states that: (i) The Land Use Rights of the property have been granted to Vanda Computer & Equipment Company Limited for a term from 13 August 2001 to 2 November 2043; (ii) The Building Ownership of the property is held by Vanda Computer & Equipment Company Limited; and (iii) The property is subject to a mortgage in favour of Beijing City Commercial Bank Co., Ltd. Table of Contents VALUATION CERTIFICATE (4) We have prepared our valuation on the following assumptions: (i) Vanda Computer & Equipment Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use rights at no extra land premium or other onerous payment payable to the government; (ii) all considerations have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (5) The status of title and grant of major approvals and licences in accordance with the information provided to us by the Group and the aforesaid legal opinion are as follows: Real Estate Title Certificates Yes Presale/ Sale Contracts of Real Estate Yes Business Licence N/A 15. Unit Nos. D, E, F and G on 22nd Level, New Times Square, No. 42 Wenwu Road, Xinhua Avenue, Qingyang District, Chengdu, Sichuan Province, the PRC The property comprises 4 office units on the 22nd level of a 28-storey office building completed in 1996. The property has a total gross floor area of approximately 382.93 sq.m. (4,122 sq.ft.). The land use rights of property have been granted for a term expiring on 30 October 2045 for office use. Unit nos. D and E are currently leased to a tenant for a term of 1 year from 25 January 2004 to 25 January 2005 at a monthly rent of RMB7,738.5, exclusive of rates and management fees. The remaining portion of the property is currently occupied by the Group as an office. HK$2,900,000 Notes: (1) According to Certificate for the Use of State-owned Land No. (2003) 018596 issued by Chengdu Qingyang District Land Resources Bureau on 13 April 2003, the land use rights of the property have been granted to Vanda Computer & Equipment Company Limited for a term expiring on 30 October 2045 for office use. (2) According to Building Ownership Certificate No. 0849826 issued by Chengdu Real Estate Administrative Bureau on 27 February 2003, the building ownership of the property comprising a gross floor area of 382.93 sq.m. is held by Vanda Computer & Equipment Company Limited. (3) According to Sale and Purchase Agreement of New Times Square entered into between Sichuan New Times Enterprise Co., Ltd. and (Party A) and Vanda Computer & Equipment Company Limited (Party B), Party B purchased the property, comprising a gross floor area of 382.93 sq.m., at a consideration of RMB3,025,147 from Party A. (4) The opinion of the Group s PRC legal adviser states that: (i) The Land Use Rights of the property have been granted to Vanda Computer & Equipment Company Limited for a term expiring on 30 October 2045; (ii) The Building Ownership of the property is held by Vanda Computer & Equipment Company Limited; (iii) The property is not subject to any mortgage; and (iv) Vanda Computer & Equipment Company Limited is entitled to transfer, lease, mortgage and dispose of the property by any other legal means. (5) We have prepared our valuation on the following assumptions: (i) Vanda Computer & Equipment Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use rights at no extra land premium or other onerous payment payable to the government; (ii) all considerations have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. Table of Contents VALUATION CERTIFICATE (6) The status of title and grant of major approvals and licences in accordance with the information provided to us by the Group and the aforesaid legal opinion are as follows: Certificate for the Use of State-owned Land Yes Building Ownership Certificate Yes Sale and Purchase Agreement Yes Business Licence N/A 16. Unit No. B807 on 8th Level, Block B, Yinhai Building, No. 250 Caoxi North Road, Xuhui District, Shanghai, the PRC The property comprises an office unit on the 8th level of a 12-storey office building plus a bicycle parking basement completed in 1992. The property has a gross floor area of approximately 92.84 sq.m. (999 sq.ft.). The land use rights of the property have been granted for a term expiring on 13 October 2043. The property is currently vacant. HK$590,000 Notes: (1) According to Real Estate Title Certificate No. (2004)019076 dated 24 May 2004 issued by Shanghai Xuhui Real Estate Registration Bureau , the land use terms and building ownership of the property comprising a gross floor area of 92.84 sq.m. are held by Vanda Computer & Equipment Company Limited for a term expiring on 13 October 2043. (2) According to Sale Contract of Overseas Sale Commodity Housing entered into between Shanghai Zhongnongxin Real Estate Company Limited (Party A) and Vanda Computer & Equipment Company Limited (Party B), Party B has agreed to purchase the property comprising a gross floor area of 92.84 sq.m. from Party A at a consideration of US$204,923. (3) The opinion of the Group s PRC legal adviser states that: (i) The Land Use Rights of the property have been granted to Vanda Computer & Equipment Company Limited for a term expiring on 13 October 2043; (ii) The Building Ownership of the property is held by Vanda Computer & Equipment Company Limited; (iii) The property is not subject to any mortgage; and (iv) Vanda Computer & Equipment Company Limited is entitled to transfer, lease and mortgage the property. (4) We have prepared our valuation on the following assumptions: (i) Vanda Computer & Equipment Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use rights at no extra land premium or other onerous payment payable to the government; (ii) all considerations have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (5) The status of title and grant of major approvals and licences in accordance with the information provided to us by the Group and the aforesaid legal opinion are as follows: Real Estate Title Certificate Yes Sale Contract Yes Business Licence N/A 17. Various residential units in Buildings B7, C2, C3 and C4 situated in Shenzhen High-Tech Industrial Park, Shennan Avenue, Nanshan District, Shenzhen, the PRC The property comprises 20 residential units in 2 multi-storey buildings completed in 1997. The property has a total gross floor area of approximately 903.50 sq.m. (9,725 sq.ft.). The land use rights of the property have been granted for a term of 50 years from 28 January 1996 to 27 January 2046 for residential use. Portion of the property is currently leased whilst the remaining portion is currently occupied by the Group as staff quarters. No commercial value Notes: (1) The property comprises the following units: Building C2: 2303 and 2304 Building C3: 2401, 2402, 2403 and 2404 Building C4: 2501, 2502, 2503 and 2504 Building B7: 301, 302, 303, 304, 305, 306, 307, 308, 309 and 310 (2) According to the opinion of the PRC legal adviser, Vanda Computer Systems Integration (Shenzhen) Co., Ltd. is not entitled to freely transfer, mortgage and lease the property, we have therefore not assigned value to the property. (3) According to 20 Real Estate Title Certificate Nos. 4000019814 to 4000019833 all dated 6 April 1999, the land use rights of the property comprising a total gross floor area of 903.50 sq.m. have been granted to Vanda Computer Systems Integration (Shenzhen) Co., Ltd. for a term of 50 years from 28 January 1996 to 27 January 2046 for residential use. The property was purchased at a total consideration was RMB2,502,695. (4) According to Business Licence No. 304191 dated 9 March 2004, Vanda Computer Systems Integration (Shenzhen) Co., Ltd. has been incorporated with a registered capital of US$2,100,000 for a valid operation period from 23 December 1995 to 23 December 2045. (5) The opinion of the Group s PRC legal adviser states that: (i) The Land Use Rights of the property have been granted to Vanda Computer Systems Integration (Shenzhen) Co., Ltd. for a term from 28 January 1996 to 27 January 2046; (ii) The Building Ownership of the property is held by Vanda Computer Systems Integration (Shenzhen) Co., Ltd.; (iii) The property is not subject to any mortgage; and (iv) Vanda Computer Systems Integration (Shenzhen) Co., Ltd. is not entitled to freely transfer, mortgage and lease the property. (6) The status of title and grant of major approvals and licences in accordance with the information provided to us by the Group and the aforesaid legal opinion are as follows: Real Estate Title Certificates Yes Business Licence Yes 18. Levels A2, A3 and AF3 of Block R3, Shenzhen High-Tech Industrial Estate, Shennan Avenue, Nanshan District, Shenzhen, the PRC The property comprises the 2nd and 3rd levels of a 6-storey industrial building completed in 1997. The property has a total gross floor area of approximately 2,686.39 sq.m. (28,916 sq.ft.). The land use rights of the property have been granted for a term of 50 years from 28 July 1995 to 27 July 2045 for industrial use. Level AF3 of the property comprising a gross floor area of approximately 393.53 sq.m. (4,236 sq.ft.) is currently leased to a tenant for a term from 1 August 2004 to 31 July 2005 at a monthly rent of RMB19,676.50, exclusive of management fees and utilities charges. The remaining portion of the property comprising a gross floor area of 2,292.86 sq.m. (24,680 sq.ft.) is currently occupied by the Group. No commercial value Notes: (1) According to the opinion of the PRC legal adviser, Vanda Computer Systems Integration (Shenzhen) Co., Ltd. is not entitled to freely transfer, mortgage and lease the property, we have therefore not assigned value to the property. (2) According to 3 Real Estate Title Certificate Nos. 4000054012, 4000054013 and 4000054014 all dated 8 October 2001, the land use rights of property comprising a total gross floor area of 2,686.39 sq.m. have been granted to Vanda Computer Systems Integration (Shenzhen) Co., Ltd for a term of 50 years from 28 July 1995 to 27 July 2045 for industrial use. The property was purchased at a total consideration was RMB7,568,877. (3) According to Business Licence No. 304191 dated 9 March 2004, Vanda Computer Systems Integration (Shenzhen) Co., Ltd. has been incorporated with a registered capital of US$2,100,000 for a valid operation period from 23 December 1995 to 23 December 2045. (4) The opinion of the Group s PRC legal adviser states that: (i) The Land Use Rights of the property have been granted to Vanda Computer Systems Integration (Shenzhen) Co., Ltd. for a term from 28 July 1995 to 27 July 2045; (ii) The Building Ownership of the property is held by Vanda Computer Systems Integration (Shenzhen) Co., Ltd.; (iii) The property is subject to a mortgage in favour of Shenzhen Commercial Bank Company Limited; and (iv) Vanda Computer Systems Integration (Shenzhen) Co., Ltd. is not entitled to freely transfer, mortgage and lease the property. (5) The status of title and grant of major approvals and licences in accordance with the information provided to us by the Group and the aforesaid legal opinion are as follows: Real Estate Title Certificates Yes Business Licence Yes Table of Contents MANAGEMENT General Our board currently consists of three executive directors, three non-executive directors and three independent non-executive directors. Directors and Executive Officers The following table sets forth certain information concerning our current directors, executive officers, company secretary, chief technology officer and qualified accountant. The business address of each of our directors and executive officers is 18/F, Two HarbourFront, 22 Tak Fung Street, Hunghom, Kowloon, Hong Kong. Name 19. Shop A on Ground Floor and Unit A on Mezzanine Floor, Edf. Lin Seng, Estrada de Coelbo do Amaral No. 161-163C, Macau The property comprises a shop unit on the ground floor and a residential unit on the mezzanine floor of a 21-storey composite building completed in about 1987. The property has a total saleable area of approximately 380.90 sq.m. (4,100 sq.ft.) plus patio area of approximately 10.96 sq.m. (118 sq.ft.). The property is held from the Macau Government for a term expiring on 11 March 2009. The current annual Government Rent payable for the whole building is MOP31,956. The ground floor of the property is currently occupied by the Group as retail shop whilst the mezzanine floor of the property is vacant. HK$3,400,000 Notes: (1) The registered owner of the property is Telecontacto Union Limitada (also known as Union Telecom Limited). (2) At the time of our title search, we are not aware of any mortgage registered against the property. Age 20. 1st Floor, Blocks A, B, I, J, L, M and N, Edf. Iau Luen, Rua de Ferreira do Amaral No. 13B-15E, Macau The property comprises seven office units on the first floor of a 24-storey (including basement floor) composite building completed in 1987. The property has a total saleable area of approximately 414.25 sq.m. (4,459 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$2,200,000 Notes: (1) The registered owner of the property is Telecontacto Union Limitada (also known as Union Telecom Limited). (2) At the time of our title search, we are not aware of any mortgage registered against the property. Position 21. Nine cell sites in Paraguay The property comprises nine cell sites in different locations in Paraguay. The property has a total site area of approximately 13,937.57 sq.m. (150,024 sq.ft.). There is a single-storey office building having an area of approximately 123.50 sq.m. (1,329 sq.ft.) erected on one of the sites. The property is held under freehold ownership. Except for two sites which are currently vacant, the property is currently occupied by the Group as cell sites for installation of tele-communication equipment. HK$692,326 (PYG525,060,000) Notes: (1) The registered owner of the property (except the cell site at Ciudad del Este) is Comunicaciones Personales S.A. (now known as Hutchison Telecommunications Paraguay S.A.). (2) The registered owner of the cell site at Ciudad del Este is Hutchison Telecommunications Paraguay S.A. (3) The nine cell sites are situated in the following locations: San Lorenzo Presidente Franco Ciudad del Este Aregu Luque Hernandarias (2 sites) Mariano Roque Alonso and Limpio (4) We have prepared our valuation on the following assumptions: (i) Comunicaciones Personales S.A. is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (5) As advised by the Group, the property is not subject to any mortgage. (6) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. 22. 11/5, Sarat Bose Road, Kolkata 700020, India The property comprises a shop on the ground floor and a car parking space of a 5-storey plus basement commercial building completed in about 1995. The property has an area of approximately 111.02 sq.m. (1,195 sq.ft.), excluding the car parking space. The property is held under freehold ownership. The property is occupied by the Group as a shop. HK$875,758 (INR5,202,000) Notes: (1) The registered owner of the property is Usha Martin Telekom Limited (now known as Hutchison Telecom East Limited). (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecom East Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 23. Unit No. 5 on 4th Floor, Block B, Shyam Apartment, Samarpally, Krishnapur, Calcutta 700059, India The property comprises a unit on the 4th floor of a 5-storey residential building completed in about 1996. The property has an area of approximately 69.68 sq.m. (750 sq.ft.). The property is held under freehold ownership. The property is occupied by the Group as a warehouse, technical store and equipment room for a cell site. HK$77,441 (INR460,000) Notes: (1) The registered owner of the property is Usha Martin Telekom Limited (now known as Hutchison Telecom East Limited). (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecom East Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 24. Unit No. 402 on 4th Floor, Unit Nos. 601 to 616 on 6th Floor, and Unit Nos. 701, 702, 707, 715 and 716 on 7th Floor, Sakar II, Ashram Road, Ellisbridge, Ahmedabad, India The property comprises 22 office units and 14 car parking spaces on various floors of an 11-storey plus 2 basements commercial building completed in about 1992. The property has a total area of approximately 2,970.46 sq.m. (31,974 sq.ft.), excluding the car parking spaces. The property is held under freehold ownership. The property is occupied by the Group as offices. HK$8,155,498 (INR48,443,660) Notes: (1) The registered owner of the property is Fascel Limited. (2) We have prepared our valuation on the following assumptions: (i) Fascel Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) The property is subject to mortgages in favour of The Hongkong and Shanghai Banking Corporation Limited and Standard Chartered Bank. 25. Unit No. 904, Chandraka Tower, Anandwan, Baroda, India The property comprises a domestic unit on the 9th floor of an 11-storey composite building completed in about 1987 to 1988. The property has an area of approximately 92.90 sq.m. (1,000 sq.ft.). The property is held under freehold ownership. The property is occupied by the Group for storage purpose. HK$107,239 (INR637,000) Notes: (1) The registered owner of the property is Fascel Limited. (2) We have prepared our valuation on the following assumptions: (i) Fascel Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) The property is subject to mortgages in favour of The Hongkong and Shanghai Banking Corporation Limited and Standard Chartered Bank. 26. Office No. ABS-1 on 1st Floor, Bomabay Market Annexie Building, Umarwada, Surat, India The property comprises an office unit on the 1st floor of a 3-storey commercial building completed in the early 1980 s. The property has an area of approximately 501.67 sq.m. (5,400 sq.ft.). The property is held under freehold ownership. The property is occupied by the Group as an office and switch site. HK$1,093,636 (INR6,496,200) Notes: (1) The registered owner of the property is Fascel Limited. (2) We have prepared our valuation on the following assumptions: (i) Fascel Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) The property is subject to mortgages in favour of The Hongkong and Shanghai Banking Corporation Limited and Standard Chartered Bank. 27. 4th Floor, Jay Tower 1, Main Silvassa Road, Vapi, Dist. Valsad, India The property comprises an office unit on the 4th floor of a 10-storey composite building completed in the early 1990 s. The property has an area of approximately 130.06 sq.m. (1,400 sq.ft.). The property is held under freehold ownership. The property is occupied by the Group as an office. HK$151,549 (INR900,200) Notes: (1) The registered owner of the property is Fascel Limited. (2) We have prepared our valuation on the following assumptions: (i) Fascel Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) The property is subject to mortgages in favour of The Hongkong and Shanghai Banking Corporation Limited and Standard Chartered Bank. 28. Gaurav Towers I, Basement, Ground and 1st Floors, Malviya Nagar, Jaipur, Rajasthan 302 013, India The property comprises the basement, ground and 1st floors of a 6-storey plus basement commercial building completed in about 1998. The property has a total area of approximately 722.32 sq.m. (7,775 sq.ft.). The property is held for a term of 99 years from 6 November 1996 to 5 November 2095. The property is occupied by the Group as a shop, an office and a warehouse. HK$2,418,182 (INR14,364,000) Notes: (1) The registered owner of the property is Aircel Digilink India Limited. (2) We have prepared our valuation on the following assumptions: (i) Aircel Digilink India Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) The properly is subject to a mortgage in favour of Global Trust Bank. 29. Basement and 1st Floor, Essar House, Opposite Randhir Cinema, Kunjpura Road, Karnal, Haryana 132 001, India The property comprises the basement and 1st floor of a 3-storey plus basement commercial building completed in about 1994. The property has a total area of approximately 944.72 sq.m. (10,169 sq.ft.). The property is held under freehold ownership. The property is occupied by the Group as an office. HK$1,061,411 (INR6,304,780) Notes: (1) The registered owner of the property is Aircel Digilink India Limited. (2) We have prepared our valuation on the following assumptions: (i) Aircel Digilink India Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) The property is subject to a mortgage in favour of Global Trust Bank. Table of Contents 30. Basement, Sangam Place, Civil Lines, Allahabad, UP, India The property comprises the basement of a 12-storey commercial building completed in about 1996. The property has an area of approximately 40 sq.m. (431 sq.ft.). The property is held for a term of 99 years from 23 October 1997 to 22 October 2096. The property is occupied by the Group as a warehouse. HK$101,010 (INR600,000) Notes: (1) The registered owner of the property is Aircel Digilink India Limited. (2) We have prepared our valuation on the following assumptions: (i) Aircel Digilink India Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 31. Basement and Ground Floor, Chintels House, 16 Station Road, Lucknow, U.P 226 001, India The property comprises the basement and ground floor of a 5-storey plus basement commercial building completed in about 1987. The property has a total area of approximately 826.83 sq.m. (8,900 sq.ft.). The property is held under freehold ownership. The property is occupied by the Group as an office. HK$2,959,596 (INR17,580,000) Notes: (1) The registered owner of the property is Sterling Cellular Limited (now known as Hutchison Essar Telecom Limited). (2) We have prepared our valuation on the following assumptions: (i) Hutchison Essar Telecom Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) The property is subject to a mortgage in favour of Industrial Development Bank of India. 32. Nineteen cell sites in India The property comprises nineteen cell sites in different locations in India. The property has a total area of approximately 7,581.66 sq.m. (81,609 sq.ft.). 17 cell sites are held under freehold ownership. The remaining 2 cell sites are held for terms for 99 years expiring on 8 December 2096 and 25 September 2098 respectively. The property is currently occupied by the Group mainly as cell sites for installation of tele-communication equipment. HK$1,026,308 (INR6,096,270) Notes: (1) The registered owner of eighteen cell sites of the property is Fascel Limited and the registered owner of the remaining cell site is Aircel Digilink India Limited. (2) The nineteen cell sites are situated in the following locations: Kheda, Ahmedabad-Baroda Taluka Karjan Taluka Bharuch Taluka Mehsana Taluka Gandhinagar Ambawadi, Ahmedabad Kalol Taluka Surat Taluka Sanand Amreli Panchmahal Bhavnagar Rajkot (2 sites) Bhuj Taluka Dang Bopal, Ahmedabad Vasna, Ahmedabad and Barabanki (3) We have prepared our valuation on the following assumptions: (i) Fascel Limited and Aircel Digilink India Limited are in possession of a proper legal title to the property and are entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (4) Except for one cell site in Barabanki which is not subject to any mortgage, the property is subject to a mortgage in favour of The Hongkong and Shanghai Banking Corporation Limited and Standard Chartered Bank. (5) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. 33. Eleven cell sites in Sri Lanka The property comprises eleven cell sites in different locations in Sri Lanka. The property has a total site area of approximately 46,612 sq.m. (501,732 sq.ft.). The property is held under freehold ownership. The property is currently occupied by the Group mainly as cell sites for installation of telecommunication equipment. HK$17,969,157 (LKR238,630,400) Notes: (1) The owner of the property is Hutchison Telecommunications Lanka (Private) Limited. (2) The eleven cell sites are situated in the following locations: Aluthgama Belungala Chilaw Habaraduwa Hikkaduwa Hantana Kalutara Lunuwila Panadura Warakapola and Walpola (3) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications Lanka (Private) Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (4) As advised by the Group, the property is not subject to any mortgage. (5) The valuation excludes the telecommunication equipment and all plant and machinery installed in the property. Table of Contents press announcement as soon as it becomes aware that Hutchison Whampoa has taken a decision to inject any part of the excluded business if such injection constitutes a connected transaction of ours, requiring compliance with such disclosure requirement under the listing rules of the Hong Kong Stock Exchange prevailing at such time. Independence from the Hutchison Whampoa group Our board of directors is satisfied that we can carry on business independently of the Hutchison Whampoa group and its associates after we are listed on the Hong Kong Stock Exchange, as justified by the following factors: Independence of boards and management: Our board of directors and Hutchison Whampoa s board of directors will function independently of each other. The following table illustrates the degree to which our directors will have continuing roles in the Hutchison Whampoa group: Our directors 34. Plot Nos. 78 and 79, Old Town Section A, Kumasi, Ghana The property comprises a 3-storey commercial building erected upon a site of approximately 2,063.88 sq.m. (22,216 sq.ft.) and was completed in mid 1980 s. The property has a total area of approximately 2,393.63 sq.m. (25,765 sq.ft.). The property is held from the Government for a term of 50 years from 1 February 1994. The property is currently vacant. HK$3,675,324 (GHC4,194,132,800) Notes: (1) The owner of the property is Celltel Limited (now known as Kasapa Telecom Limited). (2) We have prepared our valuation on the following assumptions: (i) Celltel Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. Our directors with continuing roles in Hutchison Whampoa 35. No. 166 Khuanthani Road, Nai Muang Sub-district, Muang Ubonratchathani District, Ubonratchathani Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 61.2 sq.m. (659 sq.ft.) and was completed in about 1990. The property has an area of approximately 144 sq.m. (1,550 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$377,358 (THB2,000,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 36. No. 59/13 Borom Trai Lokkanant Road, Nai Muang Sub-district, Muang District, Phitsanulok Province, Thailand The property comprises a 3-storey plus penthouse commercial building erected upon a site of approximately 55.2 sq.m. (594 sq.ft.) and was completed in about 1990. The property has an area of approximately 135 sq.m. (1,453 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$377,358 (THB2,000,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 37. No. 750, Si Chan Road, Nai Muang Sub-district, Muang District, Khonkaen Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 80 sq.m. (861 sq.ft.) and was completed in about 1989. The property has an area of approximately 236 sq.m. (2,540 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$603,774 (THB3,200,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 38. No. 10/27 Raksakchamul Road (Highway No. 316), Tha Chang Sub-district, Muang District, Chanthaburi Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 151.2 sq.m. (1,628 sq.ft.) and was completed in about 1994. The property has an area of approximately 216 sq.m. (2,325 sq.ft.). The property is held under freehold ownership. The property is currently occupied by the Group as a shop. HK$339,623 (THB1,800,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 39. No. 42, Chuti-Uthit 3 Road, Hatyai Sub-district, Hatyai District, Songkhla Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 100 sq.m. (1,076 sq.ft.) and was completed in about 1990. The property has an area of approximately 230 sq.m. (2,476 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$754,717 (THB4,000,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 40. No. 44, Chuti-Uthit 3 Road, Hatyai Sub-district, Hatyai District, Songkhla Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 100 sq.m. (1,076 sq.ft.) and was completed in about 1990. The property has an area of approximately 230 sq.m. (2,476 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$754,717 (THB4,000,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 41. No. 310/6 Prachak Road, Mak Kheang Sub-district, Muang District, Udonthani Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 88 sq.m. (947 sq.ft.) and was completed in about 1989. The property has an area of approximately 208 sq.m. (2,239 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$698,113 (THB3,700,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 42. No. 199/11 Chang Klan Road, Chang Klan Sub-district, Muang District, Chiangmai Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 63.20 sq.m. (680 sq.ft.) and was completed in about 1989. The property has an area of approximately 152 sq.m. (1,636 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$849,057 (THB4,500,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 43. No. 68/12, Atthakawee Road, Paknumpho Sub-district, Muang Nakhonsawan District, Nakhonsawan Province, Thailand The property comprises a 3-storey commercial building erected upon two sites with a total site area of approximately 71.6 sq.m. (771 sq.ft.) and was completed in about 1993. The property has an area of approximately 164 sq.m. (1,765 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$792,453 (THB4,200,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. 44. No. 166 Gor/19 unnamed Soi, Chang Klan Road, Chang Klan Sub-district, Muang District, Chiangmai Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 57.2 sq.m. (616 sq.ft.) and was completed in about 1991. The property has an area of approximately 172 sq.m. (1,851 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$377,358 (THB2,000,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. Table of Contents operators subscribers to a new entrant telecommunications operator that offers high-value services. The risk profile is a function of the significant investment required in order to build the infrastructure to offer this type of service, in a large market, in competition with entrenched incumbent telecommunications operators and without the benefit of an existing revenue stream. The executive management teams within the Hutchison Whampoa group with responsibility for the mobile telecommunications businesses in Western Europe and Australia are not part of our executive management and will continue to be separate from the executive management team responsible for our international operations. Argentina falls outside the delineation principles set out above. In the wake of the Argentine economic collapse in 2002, and given the current differences in the business strategies of the Argentine operations and our group, which are the primary reasons for Hutchison Whampoa s decision to exclude the Argentine operations from our company, Hutchison Whampoa is evaluating its options in Argentina. We will, however, have an option to acquire the Hutchison Whampoa group s interest in Hutchison Telecommunications Argentina S.A. See Option Agreement. Going forward, our company s and the Hutchison Whampoa group s activities will be limited to specific jurisdictions. The basis for the delineation between the Hutchison Whampoa group s exclusive territory and our company s exclusive territory is the same as the basis for the delineation between the Hutchison Whampoa group s existing businesses and our company s existing businesses. The Hutchison Whampoa group s exclusive territory will be in the member countries of the European Union (prior to its enlargement in 2004), Vatican City, San Marino, the Channel Islands, Monaco, Switzerland, Norway, Greenland, Liechtenstein, Australia, New Zealand, the United States, Canada and, unless and until such time as we exercise our option to acquire the Hutchison Whampoa group s interest in Hutchison Telecommunications Argentina S.A., Argentina. Our exclusive territory will cover all the remaining countries of the world. In respect of those mobile telecommunications countries which are subject to the non-competition agreement, there is no single country in which both we and the Hutchison Whampoa group have competing operations. We have entered into the non-competition agreement with Hutchison Whampoa, as described in Non-Competition Agreement above, to maintain a clear delineation of our respective businesses going forward. Independence of administrative capability: Certain non-management administrative functions will be outsourced by us to the Hutchison Whampoa group, as described in Certain Relationships and Related Party Transactions. However, all essential administrative functions will be carried out by us without requiring the support of the Hutchison Whampoa group. In particular, we will have our own capabilities, performing all essential administrative functions such as finance and accounting, administration and operations, information technology, human resources and compliance functions. Independent financial viability: The following table presents bank loans and other interest-bearing borrowings and debentures which were guaranteed by Hutchison Whampoa and other members of the Hutchison Whampoa group as of August 31, 2004: As of August 31, 2004 45. No. 658/22 Namuang Road, Talad Sub-district, Muang District, Suratthani Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 121.6 sq.m. (1,309 sq.ft.) and was completed in about 1990. The property has an area of approximately 205 sq.m. (2,207 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$509,434 (THB2,700,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. Due in 1 year 46. No. 20/187 Moo 10 off South Pattaya Road, Nongplue Sub-district, Banglamung District, Cholburi Province, Thailand The property comprises a 4-storey commercial building erected upon a site of approximately 73.60 sq.m. (792 sq.ft.) and was completed in about 1989. The property has an area of approximately 208 sq.m. (2,239 sq.ft.). The property is held under freehold ownership. The property is occupied by the Group as a shop. HK$1,226,415 (THB6,500,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. Due in 1-3 years 47. No. 896 Borom Trai Lokkanant Road, Nai Muang Sub-district, Muang District, Phitsanulok Province, Thailand The property comprises a 4-storey commercial building erected upon a site of approximately 80 sq.m. (861 sq.ft.) and was completed in about 1995. The property has an area of approximately 212 sq.m. (2,282 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$339,623 (THB1,800,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. Due in 3-5 years 48. No. 12 Phang Nga Road, Taladyai Sub-district, Muang District, Phuket Province, Thailand The property comprises a 3-storey commercial building erected upon a site of approximately 85.2 sq.m. (917 sq.ft.) and was completed in about 1991. The property has an area of approximately 224 sq.m. (2,411 sq.ft.). The property is held under freehold ownership. The property is currently vacant. HK$471,698 (THB2,500,000) Notes: (1) The registered owner of the property is Hutchison Telecommunications (Thailand) Company Limited. (2) We have prepared our valuation on the following assumptions: (i) Hutchison Telecommunications (Thailand) Company Limited is in possession of a proper legal title to the property and is entitled to transfer the property together with the residual term of its land use right at no extra land premium or other onerous payment payable to the government; (ii) all land premium and costs of ancillary facilities have been fully settled; (iii) the design and construction of the property are in compliance with the local planning regulations and have been approved by the relevant government authorities; and (iv) the property may be freely disposed of to other parties. (3) As advised by the Group, the property is not subject to any mortgage. Due after 5 years Total Table of Contents PRINCIPAL AND SELLING SHAREHOLDERS All of the ADSs being offered in this offering are being offered by Hutchison Telecommunications Investment Holdings Limited, our immediate parent company and the selling shareholder. As of the date of this prospectus, the selling shareholder owns 4,500,000,000 ordinary shares, which represent all of our issued and outstanding ordinary shares. Following the global offering, assuming that the underwriters option to purchase additional ADSs is exercised in full, the selling shareholder will own 3,171,750,000 ordinary shares, which will represent approximately 70.48% of our issued and outstanding ordinary shares without taking account of any ordinary shares that will be transferred to NTT DoCoMo pursuant to its agreement with Hutchison Whampoa. See Relationship with Hutchison Whampoa Transaction with NTT DoCoMo involving our shares. The table below sets forth information with respect to the beneficial ownership, within the meaning of Section 13(d)(3) of the U.S. Securities Exchange Act of 1934, as amended, or the Exchange Act, of our ordinary shares, as of the date of this prospectus, as adjusted to reflect the sale of our ADSs offered in this global offering for: each person whom we know owns beneficially more than 5% of our ordinary shares; each of our directors; each of our executive officers; and all of our directors and executive officers as a group. Ordinary shares beneficially owned prior to the global offering(4) Ordinary shares beneficially owned after the global offering(1)(4) Name of beneficial owner Number Percent Number Percent Hutchison Telecommunications Investment Holdings Limited 4,500,000,000 100 % 3,345,000,000 74.33 % Hutchison Whampoa 4,500,000,000 100 % 3,345,000,000 74.33 % Cheung Kong (Holdings) Limited(2) 2,248,435,083 49.97 % 1,699,739,448 37.77 %(3) Table of Contents The depositary will only vote or attempt to vote as you instruct or as described in the preceding sentence or in the deposit agreement. Moreover, our articles of association provide that if any person directly or indirectly has or acquires an interest in a number of our ordinary or preference shares, including ordinary shares underlying our ADSs, that would or may, in the opinion of our directors, require a review or approval under, or which would or may result in any subsidiary or affiliate of the company being in default or in breach of, any applicable law, regulation, or license, permit, consent or privilege held or enjoyed by any such subsidiary or affiliate, or of any requirement of any governmental or regulatory authority, the directors may suspend certain of the voting rights attached to those shares. For further details of this right under our articles of association, see Description of Share Capital Voting Rights Attaching to Our Shares. Fees and Charges As an ADS holder, you will be required to pay the following service fees to the depositary bank: Service Fees Table of Contents UNDERWRITING We, the selling shareholder and the underwriters named below have entered into an underwriting agreement with respect to the ADSs being offered by this prospectus. Subject to certain conditions, each underwriter has severally agreed to purchase the number of ADSs indicated in the following table. Goldman Sachs (Asia) L.L.C., Cheung Kong Center, 2 Queen s Road Central, Hong Kong, is the representative of the underwriters. Underwriters Number of ADSs Goldman Sachs (Asia) L.L.C. ABN AMRO Bank N.V. Citigroup Global Markets Limited Daiwa Securities SMBC Hong Kong Limited The Hongkong and Shanghai Banking Corporation Limited J.P. Morgan Limited Merrill Lynch, Pierce, Fenner & Smith Incorporated First Shanghai Securities Limited Kotak Mahindra (International) Limited. Morgan Stanley & Co. International Limited Total 69,300,000 If the underwriters sell more ADSs than the total number set forth in the table above, the underwriters have the option to purchase up to 11,550,000 additional ADSs from the selling shareholder. They may exercise this option within 30 days of the date of commencement of trading of our ordinary shares on the Hong Kong Stock Exchange. If any ADSs are purchased pursuant to this option, the underwriters will severally purchase ADSs in approximately the same proportion as set forth in the table above. The following table shows the per ADS and total underwriting discounts and commissions to be paid to the underwriters by the selling shareholder. Such amounts are shown assuming both no exercise and full exercise of the underwriters option to purchase additional ADSs. Paid by us No exercise Full exercise Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED COMBINED PROFIT AND LOSS ACCOUNTS Year ended 31 December Six months ended 30 June Note Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED COMBINED BALANCE SHEETS As at 31 December Note Total non-current assets 19,889 25,625 31,067 33,715 Net current liabilities (2,508 ) (6,017 ) (6,250 ) (5,484 ) Total assets less current liabilities 17,381 19,608 24,817 28,231 Total non-current liabilities 22,446 25,353 30,449 32,705 Net liabilities (4,929 ) (6,072 ) (6,375 ) (5,376 ) Shareholders deficits(1) (4,929 ) (6,072 ) (6,375 ) (5,376 ) Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED COMBINED CASH FLOW STATEMENTS Year ended 31 December Six months ended 30 June Note Investing activities Purchases of fixed assets (2,248 ) (4,240 ) (5,573 ) (2,478 ) (2,706 ) Purchases of telecommunications licences (767 ) (52 ) (343 ) (25 ) (142 ) Additions to telecommunications customer acquisition costs (490 ) (18 ) (377 ) Reduction of long term deposits 11 13 6 7 Purchases of subsidiary companies, net of cash acquired 26(b) (909 ) (726 ) (89 ) 69 Purchases of associated companies (1 ) (522 ) (63 ) Advances to jointly controlled entities (254 ) Repayments from jointly controlled entities 561 Proceeds on disposal of fixed assets 131 22 63 4 94 Proceeds on disposal of partial interest in subsidiary company 1,578 Cash flows from investing activities (3,487 ) (5,507 ) (6,482 ) (2,511 ) (1,477 ) Analysis of net debts Total cash and cash equivalents 510 2,859 1,993 1,930 2,336 Bank and other interest bearing borrowings 21,25 7,838 12,906 12,972 13,308 14,820 Net debts 7,328 10,047 10,979 11,378 12,484 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED COMBINED STATEMENTS OF CHANGES IN EQUITY Share capital Accumulated losses Exchange reserve Total At 1 January 2002 (4,941 ) 12 (4,929 ) Company and subsidiary companies loss for the year (1,002 ) (1,002 ) Share of results of associated companies 53 53 Share of results of jointly controlled entities (37 ) (37 ) Exchange translation differences (157 ) (157 ) At 31 December 2002 (5,927 ) (145 ) (6,072 ) At 31 December 2003 (6,141 ) (234 ) (6,375 ) At 30 June 2003 (6,190 ) (118 ) (6,308 ) At 30 June 2004 (5,222 ) (154 ) (5,376 ) Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 4 BUSINESS COMBINATIONS (a) Acquisition of Hutchison Global Communications Holdings Limited ( HGC ) Effective 8 May 2002, the Group increased its shareholding in HGC from 50% to 100% for a cash consideration of HK$936 million. After this date, the Group had the majority of the voting interest in HGC and the results of the operations from the acquisition date have been included in the Group s combined accounts. The acquisition was accounted for as a purchase business combination. The fair value of identifiable assets and liabilities of HGC at the date of acquisition is as follows: HK$ millions Fixed assets 4,348 Other assets 2,063 Goodwill 70 Liabilities assumed (2,757 ) The excess of the purchase price over the Group s share of identifiable assets acquired and liabilities assumed was recorded as goodwill and is related to the Hong Kong fixed-line telecommunications segment. The following pro forma results of the Group have been prepared assuming the acquisition has taken place on 1 January 2001 and are for information purposes only and do not purport to be indicative of what operating results would have been and may not be indicative of future operating results. Year ended 31 December HK$ millions (Unaudited) Turnover 7,324 8,048 Operating profit (loss) (1,835 ) 269 Loss attributable to shareholders (2,036 ) (1,023 ) (b) Acquisition of Aircel Digilink India Limited ( ADIL ) Effective 27 August 2003, the Group acquired from a minority shareholder of one of its subsidiary companies over 99% of the equity ownership interest in ADIL in exchange for 33% of the equity of Hutchison Telecom East Limited. The acquisition was valued at HK$319 million on 27 August 2003, the date of completion. The acquisition was accounted for as a purchase business combination. The estimated fair value of identifiable assets and liabilities of ADIL at the date of acquisition was recorded as of 31 December 2003 as follows: HK$ millions Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The following pro forma results of the Group have been prepared assuming the acquisition took place on 1 January 2002 and are for information purposes only and do not purport to be indicative of what operating results would have been and may not be indicative of future operating results. Year ended 31 December Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Since the Group retains a 53% ownership in HGC through its 53% ownership in HGCH, the Group has treated this transaction as a disposal of 47% of HGC. The consideration received by the Group on disposal of 47% of HGC was an increased ownership in HGCH of 16%, convertible notes with a face value of HK$3,200 million and cash of HK$1,578 million. The estimated fair value of the net identifiable assets of HGCH acquired and the other consideration received was approximately HK$2,851 million. As of the transaction date, the Group s book value of the 47% of HGC disposed of was HK$1,551 million. Thus, a gain of HK$1,300 million was recorded on the disposal. The convertible notes are due in March 2009 and are convertible into shares of HGCH at any time prior to the maturity date and after March 2005 at a conversion price of HK$0.96 per share. The notes bear interest at 1% per annum. The convertible notes and the fair value of the identifiable assets and liabilities are based upon preliminary valuation assessments. The final valuation amounts may differ from these amounts and, accordingly, the gain recorded on disposal of 47% of HGC or the amounts consolidated for HGCH may differ from these amounts once the valuation is finalized. 5 TURNOVER Turnover comprises revenues from the provision of mobile telecommunications services and handset and accessory sales in both Hong Kong and outside Hong Kong and fixed telecommunications services in Hong Kong. An analysis of turnover of the Company and subsidiary companies is as follows: Year ended 31 December Six months ended 30 June 6,226 7,654 10,104 4,532 6,891 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 6 SEGMENT INFORMATION Segmental information is provided on the basis of primary geographical regions which is the basis on which the Group manages its world-wide interests. The Hong Kong and Macau region is further subdivided based upon its business segments. Management of the Group measures the performance of its segments based upon operating profit (loss). Turnover Operating profit (loss) Year ended 31 December Six months ended 30 June Year ended 31 December Six months ended 30 June Depreciation and amortisation Capital expenditures Year ended 31 December Six months ended 30 June Year ended 31 December Six months ended 30 June 1,283 1,696 2,262 1,030 1,504 2,364 4,870 5,546 2,062 2,209 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Total assets Total assets 22,413 30,698 36,243 40,032 Segment assets comprise fixed assets, other non-current assets, goodwill, amounts due from related companies, long term deposits, cash and cash equivalents, restricted cash and other current assets. Total liabilities HK$ millions HK$ millions HK$ millions HK$ millions Segment liabilities of Company and subsidiary companies Hong Kong and Macau Mobile telecommunications 11,517 12,472 11,825 12,585 Fixed telecommunications 4,090 7,655 8,419 9,084 India 9,316 11,068 12,398 12,928 Thailand 1,508 3,058 6,874 7,362 Others (note a) 1,047 2,189 2,284 2,427 Total liabilities 27,478 36,443 41,875 44,506 Segment liabilities comprise bank and other loans, debentures, other current liabilities, long term loans, amounts due to related companies and pension obligations. 777 879 954 454 461 Less: interest capitalised (48 ) (90 ) (154 ) (60 ) (19 ) Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The independent non-executive directors of the Company have been appointed subsequent to June 2004 and therefore no emoluments have been paid to them during any of the periods presented. The emoluments of the Directors fall within the following bands: Year ended 31 December Six months ended 30 June HK$ Number of directors Number of directors Number of directors Number of directors Number of directors 500,001 1,000,000 1 1,000,001 1,500,000 1 1 1,500,001 2,000,000 1 1 4,000,001 4,500,000 1 1 1 5,000,001 5,500,000 1 9,000,001 9,500,000 1 10,000,001 10,500,000 1 No emoluments were paid to any directors as inducements to join or upon joining the Group or as compensation for loss of office during the Relevant Period. The five individuals whose emoluments were the highest for both six months ended 30 June 2003 and 2004 were two (2003 two, 2002 two, 2001 two) directors of the Company and three (2003 three, 2002 three, 2001 three) directors of subsidiary companies of the Company. The aggregate remuneration paid by the respective subsidiary companies to these highest paid individuals is as follows: Year ended 31 December Six months ended 30 June The emoluments of the above mentioned three individuals with the highest emoluments fall within the following bands: Year ended 31 December Six months ended 30 June Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 9 TAXATION Current taxation Deferred taxation Year ended 31 December 2001 Total Current taxation Deferred taxation Year ended 31 December 2002 Total Current taxation Deferred taxation Year ended 31 December 2003 Total HK$ millions HK$ millions HK$ millions HK$ millions HK$ millions HK$ millions HK$ millions HK$ millions HK$ millions Hong Kong Subsidiary companies (230 ) (230 ) 105 105 88 88 Associated companies 1 1 Outside Hong Kong Subsidiary companies (176 ) (176 ) 6 51 57 21 201 222 Associated companies (484 ) (484 ) Current taxation Deferred taxation Six months ended 30 June 2003 Total Current taxation Deferred taxation Six months ended 30 June 2004 Total Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The differences between the Group s expected tax charge (credit) at respective domestic tax rate and the Group s tax charge (credit) for the Relevant Periods were as follows: Year ended 31 December Six months ended 30 June Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 10 OPERATING PROFIT (LOSS) Operating profit (loss) is shown after charging/(crediting) the following items: Year ended 31 December Six months ended 30 June Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 13 FIXED ASSETS Properties Telecom- munications and network equipment Construction in progress Other assets Total Accumulated Depreciation and Accumulated Impairment Losses At 1 January 2001 5 2,298 1,603 3,906 Exchange translation differences (2 ) (10 ) (12 ) Charge for the year 1 574 279 854 Impairment recognised 1,535 1,535 Disposals (28 ) (65 ) (93 ) CONDENSED CONSOLIDATED FINANCIAL STATEMENTS IN NOMINAL NEW ISRAELI SHEKELS (NIS): Balance Sheets June 30, 2004 and December 31, 2003 C-2 Statements of Operations Six and Three Months Ended June 30, 2004 and 2003 C-4 Statement of Changes in Shareholders Equity Six Months Ended June 30, 2004 C-5 Statements of Cash Flows Six Months Ended June 30, 2004 and 2003 C-6 Notes to Financial Statements June 30, 2004 C-7 The amounts are stated in New Israeli Shekels (NIS) in thousands. The accompanying notes are an integral part of these condensed financial statements. The accompanying notes are an integral part of these condensed financial statements. The accompanying notes are an integral part of these condensed financial statements. Supplementary information on investing activities not involving cash flows At June 30, 2004 and 2003, trade payables include NIS 120,070,000 ($ 26,700,000) (unaudited) and NIS 56,468,000 (unaudited), respectively, in respect of acquisition of fixed assets. These balances are recognized in these statements upon payment. The accompanying notes are an integral part of these condensed financial statements. % % Six months ended June 30, 2004 2.7 1.4 2003 (9.0 ) (0.5 ) Three months ended June 30: 2004 (0.7 ) 1.5 2003 (8.0 ) (1.3 ) Year ended December 31, 2003 (7.6 ) (1.9 ) The Nominal NIS figures at June 30, 2004 and December 31, 2003 and for the six and three month periods ended at June 30, 2004 have been translated into U.S. dollars using the representative exchange rate of the U.S. dollar at June 30, 2004 ($ 1 = NIS 4.497). The translation was made solely for convenience. The translated U.S. dollar figures should not be construed as a representation that the Israeli currency amounts actually represent, or could be converted into, U.S. dollars. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) JUNE 30, 2004 (Unaudited) 4. Recent accounting pronouncement FAS 132 (revised 2003) In December 2003, the FASB issued FAS No. 132 (revised 2003), Employers Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB Statement No. 132 ( FAS 132 (revised 2003) ). This Statement revises employers disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans. The new rules require additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. Part of the new disclosures provisions were effective for 2003 calendar year-end financial statements and accordingly have been applied by the Company in the 2003 annual consolidated financial statements. The rest of the provisions of this Statement, which have a later effective date, are currently being evaluated by the Company. 5. Contingencies: a) On October 28, 1999, an Israeli consumer organization lodged a claim against the Company, alleging a variety of consumer complaints and requested that this claim be recognized as a class action. On March 20, 2002, the Haifa District Court decided to strike the claim, because the consumer organization lost, on December 31, 2001, a special status required under Israeli law for consumer organizations to file class action claims. Another claim, involving a substantial amount, which was filed by a private consumer who had previously asked to join the above class action, has been brought again before the court. The court had previously frozen the proceedings of the private consumer s claim, until a decision was made in the case filed by the consumer organization. On May 25, 2003, the private consumer filed a request to amend his motion to file a class action claim and a proposed amended motion and claim. The motion to amend was granted. The Company has submitted its response. According to a procedural agreement between the parties, both the private consumer and the Company have submitted written summations and responses. While the amount of the claim is substantial, the ultimate liability cannot be determined because of the considerable uncertainties that exist. At this stage, unless and until the claim is certified as class action, the Company and its legal council are unable to evaluate the probability of success of such claim and therefore no provision has been made. In addition, the Company and its legal advisers are of the opinion that in light of the facts known at this early stage, the chances that a material amount would be ordered in favor of the plaintiffs are low. b) On July 8, 2001, a claim was filed against the Company for alleged violation of supplier s exclusivity agreement. For filing purposes, the claim was set at NIS 18 million; however, this amount can be increased by the claimant. At his stage, since preliminary proceedings between the parties are yet to take place, and the parties are holding negotiations and the claim concerns a contract interpretation issue, the At 1 January 2002 6 4,377 1,807 6,190 Exchange translation differences 6 6 16 28 Charge for the year 4 884 297 1,185 Disposals (6 ) (24 ) (281 ) (311 ) Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) JUNE 30, 2004 (Unaudited) Company and its legal counsel are unable to evaluate the probability of success of the said litigation, and therefore no provision has been made. c) On April 8, 2002, a claim was filed against the Company, together with a motion to certify this claim as a class action, alleging a variety of consumer complaints. The amount of the claim against the Company is estimated at approximately NIS 545 million plus additional significant amounts relating to other alleged damages. Only preliminary hearings have taken place and the parties await a decision by the court with regards to a preliminary motion to dismiss, which was submitted by the Company. At this stage, and until the claim is certified as a class action, the Company and its legal council are unable to evaluate the probability of success of such claim, and therefore no provision has been made. In addition the Company and its legal council are of the opinion that even if the request to approve this claim as a class action is granted, and even if the plaintiff s arguments are accepted, the outcome of the claim will be significantly lower than the abovementioned amount. d) On April 13, 2003, a claim was filed against the Company and other cellular telecommunication companies, together with a request to approve this claim as a class action, for alleged violation of antitrust law, alleging that no fee should have been collected for incoming SMS messages or alternatively, that the fee collected is excessive and that it is a result of illegal co-operation between the defendants. The amount of the claim against all the defendants is estimated at approximately NIS 90 million. The Company has filed its response on October 1, 2003. At this stage, no hearings have taken place and unless and until the claim is certified as a class action, the Company and its legal council are unable to evaluate the probability of success of such claim, and therefore no provision has been made. e) The Company does not have building permits for many of its cell sites and as a result is involved in numerous legal actions (including criminal proceedings against officers and directors) relating to this issue. Most of these proceedings have been settled under plea bargain arrangements, whereby the Company has paid fines of insignificant amounts. Management, based upon current experience and the opinion of legal counsel, does not believe that these legal actions will result in significant costs to the Company. The accounts do not include a provision in respect thereof. f) The Company is a party to various claims arising in the ordinary course of its operations. Management, based upon the opinion of its legal counsel, is of the opinion that the ultimate resolution of these claims will not have a material effect on the financial position of the Company. The accounts do not include a provision in respect thereof. g) On July 15, 2003, the Ministry of Communications decided to decrease the deduction rate in respect of payments that Bezeq The Israel Communication Corp. Limited fails to collect from its customers for using the Company s network to 1.1% from 2.5%. The decision is effective retroactively for the period from October 2, 2000 and through August 31, 2003. As from September 1, 2003 the deduction rate was cancelled altogether. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) JUNE 30, 2004 (Unaudited) Bezeq has lodged an appeal with the Jerusalem District Court against the Minister s decision. On January 6, 2004, the Supreme Court within the framework of Partner s appeal against the District Court s verdict in respect of previous case between the parties, that related to Bezeq s failure to collect payments from its customers for using the Company s network for calls from fixed lines to mobile lines ruled that the Minister s decision concerning the aforementioned deduction of 1.1% shall also apply to the period from March 1, 2000 to October 2, 2000, and that this deduction rate shall remain in effect or shall be amended in accordance with the outcome of the appeal lodged by Bezeq against the aforesaid decision of the Minister. At this stage, the Company and its legal counsel are unable to evaluate the probability of success of the appeal, therefore the effect of the Ministry of Communication s decision on the Company s results (income of approximately NIS 19.5 million), was not recognized. 6. On March 15, 2004, the Company signed a Memorandum Of Agreement ( MOA ) with Matav Cable Systems Media Ltd. ( Matav ) and its shareholders, Dankner Investments Ltd. and Delek Investments Ltd.-, which are all considered related parties of the Company. Matav is an Israeli cable television provider and its shares are registered both in the US and Israel. The MOA has since expired and the Company has discontinued negotiations regarding this transaction. 7. On June 29, 2004, the Israeli Parliament passed the Income Tax Ordinance Amendment (No. 140 and Ad Hoc Provision) Law, 2004 (hereafter the Amendment), which provides for the gradual reduction commencing from January 1, 2004 in the rate of corporate tax from 36% to 30%, in the following manner: the rate for 2004 will be 35%, in 2005 34%, in 2006 32%, and in 2007 and thereafter 30%. The Amendment was signed at the beginning of July 2004 by the officials authorized by the State of Israel to approve it, and was published in the Official Gazette of the Government of Israel on July 11, 2004. In accordance with FAS 109 ( Accounting for income taxes ) the measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law at balance sheet date. Since, as at June 30, 2004, the Amendment had not yet been enacted , as defined in FAS 109, the measurement of the current and deferred taxes for the three months and six months ended June 30, 2004 is made without taking the aforementioned Amendment into consideration. The effect of the Amendment will be included in the financial statements for the period of the three months ended September 30, 2004, resulting in an increase in the Company s income tax expenses (current and deferred) for that period by NIS 34.5 million. 8. On July 28, 2004, the Board of Directors of the Company approved the permanent reduction of the long-term bank facility by an aggregate of approximately $100 million. The reduction shall occur in steps by the end of the year. At 1 January 2003 10 5,243 1,839 7,092 Exchange translation differences 5 38 13 56 Charge for the year 5 1,185 407 1,597 Disposals (294 ) (50 ) (344 ) Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 14 OTHER NON-CURRENT ASSETS As at 31 December At end of year/period 2,165 2,131 2,489 2,526 At end of year/period 1,288 1,278 1,256 2,363 3,617 4,075 4,397 15 GOODWILL As at December HK$ millions HK$ millions HK$ millions HK$ millions Cost At beginning of year/period 7,131 7,906 7,864 8,400 Exchange translation differences (8 ) Additional goodwill recognized 30 Relating to subsidiaries acquired 775 70 544 Relating to a subsidiary partially disposed of (112 ) (33 ) At end of year/period 7,906 7,864 8,400 8,397 At end of year/period 1,440 1,834 2,232 2,436 Net book value at end of year/period 6,466 6,030 6,168 5,961 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 16 ASSOCIATED COMPANIES As at 31 December The market value of the listed investments at 30 June 2004 was HK$4,803 million (2003 HK$5,329 million, 2002 HK$2,133 million, 2001 HK$3,346 million). Details of the Group s principal associated companies are as follows: Percentage of equity attributable to the Group Company name Place of incorporation/ operation Principal activity Nominal value of share capital Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 17 JOINTLY CONTROLLED ENTITIES As at 31 December HK$ millions HK$ millions HK$ millions HK$ millions Unlisted shares 2,935 Share of undistributed post acquisition reserves (282 ) Investments in jointly controlled entities 2,653 Amounts due to jointly controlled entities (45 ) 2,608 HK$ millions Summarised financial information of Hutchison Global Communications Investment Holding Limited Current assets 291 Non-current assets 5,665 Current liabilities (772 ) Non current liabilities (1,550 ) Net revenues 1,075 Net loss (225 ) 18 LONG-TERM DEPOSITS Long-term deposits are pledged to a bank as collateral to secure a subsidiary company s obligations under the defeasance of finance leases. 19 CURRENT ASSETS As at 31 December 2,524 5,073 5,176 6,317 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The Group has established credit policies for customers. The credit period granted for trade receivables ranges from 30 to 45 days. As at 31 December 20 OTHER CURRENT LIABILITIES As at 31 December 2,726 4,736 5,943 6,380 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The short-term amounts due to related companies are non-financing in nature and arose during the ordinary course of business. As at 30 June 2004, included in amounts due to related companies is accrued interest payable amounting to nil (2003 HK$37 million, 2002 HK$41 million, 2001 nil). 21 LONG-TERM LOANS The following table presents the outstanding bank loans and other interest bearing borrowings as at 31 December 2001, 2002 and 2003 and 30 June 2004, as well as information regarding maturity of such loans: As at 31 December 4,116 5,920 7,111 9,215 5,528 6,548 7,485 9,395 The long-term loans are repayable as follows: As at 31 December 5,528 6,548 7,485 9,395 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Long-term loans of the Group, including interest rates and maturities, are summarised as follows: As at 31 December Maturity date Total long-term loans, including current maturities 7,834 12,902 12,968 14,816 Current maturities of long-term loans (2,306 ) (6,354 ) (5,483 ) (5,421 ) Total long-term loans 5,528 6,548 7,485 9,395 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 23 DEFERRED TAXATION The deferred tax assets and liabilities are offset when there is a legally enforceable right to set off and when the deferred income taxes relate to the same fiscal authority. The following amounts, determined after appropriate offsetting, are shown in the combined balance sheet: As at 31 December Analysis of net deferred tax assets (liabilities): Tax losses 1,527 1,455 1,771 1,542 Accelerated depreciation allowances (234 ) (316 ) (907 ) (910 ) The potential deferred tax assets which have not been recognised in the accounts are as follows: Arising from unused tax losses 306 573 1,153 1,538 Arising from accelerated depreciation allowances (111 ) (210 ) (435 ) (459 ) The utilisation of unused tax losses depends on future taxable profits in excess of the profits arising from the reversal of existing taxable temporary differences. Out of the total unrecognised tax losses of HK$7,048 million (2003 HK$5,916 million, 2002 HK$3,074 million, 2001 HK$1,731 million) carried forward, an amount of HK$4,607 million (2003 HK$3,984 million, 2002 HK$2,498 million, 2001 HK$1,521 million) can be carried forward indefinitely. The remaining HK$2,441 million (2003 1,932 million, 2002 HK$576 million, 2001 HK$210 million) will expire in the following years: As at 31 December Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 24 PENSION OBLIGATIONS As at 31 December The Group operates a number of defined benefit and defined contribution plans, the assets of which are held independently of the Group s assets in trustee administered funds. (a) Defined Benefit Plans The Group s major defined benefit plans are in Hong Kong and India. The plans are mainly contributory final salary pension plans. The Group s major plans in Hong Kong were valued by Watson Wyatt Hong Kong Limited, and in India by Arpan N. Thanawala, qualified actuaries as at 31 December 2002 and 31 December 2003, respectively, using the projected unit credit method to account for the Group s pension accounting costs. The principal actuarial assumptions used for accounting purposes are as follows: As at 31 December Discount rate applied to defined benefit plan obligations 8.0%-10.5% 4.75%-9.5% 4.5%-9.5% 4.5%-7.0% Expected return on plan assets 8.0% 8.0% 8.0% 8.0% Future salary increases 6.0%-7.0% 5.0%-7.0% 3.0%-7.0% 3.0%-7.0% Interest credited on plan accounts nil nil-6.0% nil-6.0% nil-6.0% As at 31 December Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Year ended 31 December Six months ended 30 June Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS payment to vested employees at retirement or termination of employment based on the respective employee s salary and years of employment with the Group. The benefit vests to employees on completion of 5 years of service. The Group provides for the Gratuity Plan on the basis of an external actuarial valuation. (b) Defined Contribution Plans All employees of subsidiary companies in India are entitled to receive benefits from a provident fund, which is a defined contribution plan. The employee and the employer both make monthly contributions to the plan at a predetermined rate (presently at 12%) of the employee s basic salary. The Group has no further obligations under the plan beyond its monthly contributions. The Fund is administered and managed by the Government of India. The Group s monthly contributions are expensed as incurred. 25 MINORITY INTERESTS As at 31 December Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 26 NOTES TO COMBINED CASH FLOW STATEMENT Year ended 31 December Six months ended 30 June 927 3,514 89 (55 ) Less: Investments amount held prior to purchase (18 ) (2,788 ) (14 ) Discharged by: Cash payment 915 936 151 Less : Cash and cash equivalents purchased (6 ) (210 ) (62 ) (69 ) Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The effect of the acquisition of subsidiaries on the Group s results is immaterial to the Relevant Periods. (c) Analysis of changes in financing during the year/period Amounts due to related companies Bank, other loans and debentures Minority interests Total HK$ millions HK$ millions HK$ millions HK$ millions At 1 January 2001 14,658 5,381 402 20,441 New loans 2,258 4,864 7,122 Repayment of loans (2,339 ) (47 ) (2,386 ) Net cash flows from financing activities 2,258 2,525 (47 ) 4,736 Minority interests in loss (402 ) (402 ) Exchange translation differences (72 ) (44 ) (116 ) Relating to subsidiary companies acquired (45 ) (45 ) At 31 December 2001 16,916 7,834 (136 ) 24,614 Net cash flows from financing activities 1,889 3,052 784 5,725 Minority interests in profit 43 43 Exchange translation differences 16 36 52 Relating to subsidiary companies disposed of (400 ) (400 ) Relating to subsidiary companies acquired 2,000 2,000 At 1 January 2003 18,805 12,902 327 32,034 New loans 463 4,063 4,526 Repayment of loans (3,848 ) (3,848 ) At 1 January 2004 22,903 12,968 743 36,614 New loans 479 5,539 6,018 Repayment of loans (3,775 ) (3,775 ) Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 27 SHARE CAPITAL The share capital presented in the combined balance sheets as at 31 December 2001, 2002 and 2003 and 30 June 2004 represents the aggregated issued capital of the Group s intermediate holding companies: As at 31 December 2,685 2,685 2,685 2,685 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS As at 31 December Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 33 INTERESTS IN SUBSIDIARY COMPANIES Particulars of the principal subsidiary companies are as at 30 June 2004 and the date of this report as follows: Place of incorporation / registration and operation Currency Nominal value of issued ordinary share capital / registered capital Percentage of beneficial interest attributable to the Group Principal activities Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Place of incorporation / registration and operation Currency Nominal value of issued ordinary share capital / registered capital Percentage of beneficial interest attributable to the Group Principal activities Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 34 RECONCILIATION TO US GAAP The Group s combined financial statements have been prepared in accordance with Hong Kong GAAP which differs in some respects from US GAAP. The effect on income (loss) attributable to shareholders and shareholders funds of significant differences between Hong Kong GAAP and US GAAP is as follows: As of or year ended 31 December As of or six months ended 30 June Shareholders equity under US GAAP 11,167 13,139 13,925 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Financial Statements and other US GAAP disclosures As at 31 December As at 30 June 2004 Total assets 32,934 38,121 39,973 Total liabilities 21,767 24,982 26,048 Shareholders Equity Share capital (Authorized: 10,000,000,000 ordinary shares of HK$0.25 each, issued and fully paid: 4,500,000,000 ordinary shares) 1,125 1,125 1,125 Additional paid in capital 16,969 19,417 19,455 Retained deficits (6,782 ) (7,140 ) (6,493 ) Cumulative translation adjustment (145 ) (263 ) (162 ) Total shareholders equity 11,167 13,139 13,925 Total liabilities and shareholders equity 32,934 38,121 39,973 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Condensed Consolidated Income Statement Year ended 31 December Six months ended 30 June 7,634 10,013 4,289 7,105 Operating income (loss) 15 87 248 (189 ) Interest income 63 56 30 9 Share of income from equity investees 314 591 236 356 Interest and other finance costs (1,022 ) (985 ) (381 ) (513 ) Gain on partial disposal of subsidiary 1,300 (Loss) income per share, basic and diluted (HK dollars) (0.19 ) (0.08 ) (0.03 ) 0.14 Condensed Consolidated Statement of Changes in Shareholders Equity Year ended 31 December Six months ended 30 June 2004 Balance, end of period 16,969 19,417 19,455 Balance, end of period (6,782 ) (7,140 ) (6,493 ) Balance, end of period (145 ) (263 ) (162 ) Total shareholders equity 11,167 13,139 13,925 Revenue for the six months ended 30 June 2004 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The following entities are variable interest entities in which the Group holds a variable interest, but is not the primary beneficiary: Vanda Systems & Communications Holdings Limited (subsequently renamed Hutchison Global Communications Holdings Limited HGCH ) Hutchison Telecommunications Argentina S.A. Balances and results as at and for the year ended 31 December 2003 HK$ millions HK$ millions Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders of Partner Communications Company Ltd. We have audited the consolidated balance sheets of Partner Communications Company Ltd. and its subsidiary (collectively the Company ) as of December 31, 2002 and 2003 and the related consolidated statements of operations, changes in shareholders equity (capital deficiency) and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company s Board of Directors and management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of Public Company Accounting Oversight Board (United States), and auditing standards generally accepted in Israel, including those prescribed by the Israeli Auditors (Mode of Performance) Regulations, 1973. Those standards require that we plan and perform the audits 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. In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2002 and 2003 and the consolidated results of operations, changes in shareholders equity (capital deficiency) and cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Tel-Aviv, Israel March 30, 2004 /s/ Kesselman & Kesselman Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONSOLIDATED BALANCE SHEETS December 31 New Israeli shekels Convenience translation into US $ (note 1a) In thousands Assets CURRENT ASSETS: Cash and cash equivalents 1,360 3,774 862 Security deposit 107,794 Accounts receivable (note 13): Trade 518,768 482,141 110,103 Other 50,986 56,543 12,912 Inventories 137,508 102,861 23,490 Deferred income taxes (note 10) 220,000 50,240 Total current assets 816,416 865,319 197,607 INVESTMENTS AND LONG-TERM RECEIVABLES: Non-marketable securities (note 2) 3,530 Accounts receivable trade (note 13) 13,906 3,176 Funds in respect of employee rights upon retirement (note 7) 42,461 58,724 13,410 45,991 72,630 16,586 FIXED ASSETS, net of accumulated depreciation and amortization (note 3) 1,864,511 1,694,584 386,980 LICENSE AND DEFERRED CHARGES, net of accumulated amortization (note 4) 1,269,348 1,325,948 302,797 DEFERRED INCOME TAXES (note 10) 413,752 94,486 Total assets 3,996,266 4,372,233 998,456 (Continued) /s/ Amikam Cohen /s/ Alan Gelman /s/ Ben-Zion Zilberfarb Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONSOLIDATED BALANCE SHEETS (Continued) December 31 New Israeli shekels Convenience translation into US $ (note 1a) In thousands Liabilities and shareholders equity (net of capital deficiency) Current Liabilities: Current maturities of long-term bank loans (note 5) 119,853 27,370 Accounts payable and accruals: Trade 532,987 387,818 88,563 Other (note 13) 202,166 252,585 57,681 Total current liabilities 735,153 760,256 173,614 Long-Term Liabilities: Bank loans, net of current maturities (note 5) 2,467,556 1,687,215 385,297 Notes payable (note 6) 828,975 766,325 175,000 Liability for employee rights upon retirement (note 7) 60,966 76,506 17,471 Asset retirement obligations (note 13) 6,367 1,454 Total long-term liabilities 3,357,497 2,536,413 579,222 Commitments And Contingencies (note 8) Total liabilities 4,092,650 3,296,669 752,836 Shareholders Equity (Capital Deficiency) (note 9): Share capital ordinary shares of NIS 0.01 par value: authorized December 31, 2002 and 2003 235,000,000 shares; issued and outstanding December 31, 2002 181,595,222 shares and December 31, 2003 182,695,574 shares 1,816 1,827 417 Less receivable in respect of shares (4,374 ) (999 ) Capital surplus 2,293,270 2,303,055 525,933 Deferred compensation (6,385 ) (2,509 ) (573 ) Accumulated deficit (2,385,085 ) (1,222,435 ) (279,158 ) Total shareholders equity (capital deficiency) (96,384 ) 1,075,564 245,620 3,996,266 4,372,233 998,456 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31 New Israeli Shekels Convenience translation into US $ (Note 1a) In Thousands (Except Per Share Data) Revenues net: Services 2,972,079 3,766,584 4,117,887 940,371 Equipment 277,270 287,979 349,832 79,889 3,249,349 4,054,563 4,467,719 1,020,260 Cost of Revenues: Services 2,187,612 2,499,534 2,586,707 590,707 Equipment 531,551 569,924 549,749 125,542 2,719,163 3,069,458 3,136,456 716,249 Gross Profit 530,186 985,105 1,331,263 304,011 Selling and Marketing Expenses 292,960 308,079 314,008 71,708 General and Administrative Expenses 134,282 143,594 162,387 37,083 Income (Loss) Before Tax Benefit (306,845 ) 84,198 529,628 120,947 Tax Benefit (note 10) 633,022 144,559 Income (Loss) Before Cumulative Effect of a Change in Accounting Principles (306,845 ) 84,198 1,162,650 265,506 Cumulative Effect, at Beginning of Year, of a Change in Accounting Principles (note 1p) 3,483 Net Income (Loss) for the Year (303,362 ) 84,198 1,162,650 265,506 Earnings (Loss) Per Share ( EPS ): Basic: Before cumulative effect (1.72 ) 0.47 6.39 1.46 Cumulative effect 0.02 (1.70 ) 0.47 6.39 1.46 Diluted: Before cumulative effect (1.72 ) 0.46 6.34 1.45 Cumulative effect 0.02 (1.70 ) 0.46 6.34 1.45 Weighted Average Number of Shares Outstanding Basic 178,909,274 179,984,090 181,930,803 181,930,803 Diluted 178,909,274 183,069,394 183,243,157 183,243,157 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (CAPITAL DEFICIENCY) Share capital Receivables in respect of shares issued Capital surplus Deferred compensation Accumulated deficit Total Number of shares Amount (In thousands) New Israeli Shekels Balance at December 31, 2000 178,888,888 1,789 2,317,993 (65,021 ) (2,165,921 ) 88,840 Changes During the Year Ended December 31, 2001: Exercise of options granted to employees 35,697 * 47 47 Amortization of deferred compensation related to employee stock option grants net of deferred compensation with respect to stock options forfeited (19,960 ) 40,659 20,699 Loss (303,362 ) (303,362 ) Balance at December 31, 2001 178,924,585 1,789 2,298,080 (24,362 ) (2,469,283 ) (193,776 ) Changes During the Year Ended December 31, 2002: Exercise of options granted to employees 2,670,637 27 4,210 4,237 Amortization of deferred compensation related to employee stock option grants net of deferred compensation with respect to stock options forfeited (9,020 ) 17,977 8,957 Net income 84,198 84,198 Balance at December 31, 2002 181,595,222 1,816 2,293,270 (6,385 ) (2,385,085 ) (96,384 ) (Continued) Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (CAPITAL DEFICIENCY) (Continued) Share capital Receivables in respect of shares issued Capital surplus Deferred compensation Accumulated deficit Total Number of shares Amount (In thousands) Changes During the Year Ended December 31, 2003: Exercise of options granted to employees 1,100,352 11 (4,374 ) 7,754 3,391 Income tax benefit in respect of exercise of options granted to employees 730 730 Deferred compensation related to employee stock option grants 2,666 (2,666 ) Amortization of deferred compensation related to employee stock option grants net of deferred compensation with respect to stock options forfeited (1,365 ) 6,542 5,177 Net income 1,162,650 1,162,650 Balance at December 31, 2003 182,695,574 1,827 (4,374 ) 2,303,055 (2,509 ) (1,222,435 ) 1,075,564 Convenience translation into US dollars (note 1a): Balance at January 1, 2003 181,595,222 414 523,698 (1,458 ) (544,664 ) (22,010 ) Changes during the Year Ended December 31, 2003: Exercise of options granted to employees 1,100,352 3 (999 ) 1,771 775 Income tax benefit in respect of exercise of options granted to employees 167 167 Deferred compensation related to employee stock option grants 609 (609 ) Amortization of deferred compensation related to employee stock option grants net of deferred compensation with respect to stock options forfeited (312 ) 1,494 1,182 Net income 265,506 265,506 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31 New Israeli Shekels Convenience translation into US $ (note 1a) Net cash provided by operating activities 422,548 682,191 1,031,492 235,554 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Year ended December 31 New Israeli Shekels Convenience translation into U.S. $ (note 1a) In thousands Cash Flows From Financing Activities: Proceeds from exercise of stock options granted to employees 47 4,237 3,391 775 Long-term bank loans received 1,111,869 1,349,326 240,000 54,806 Repayment of long-term bank loans (901,000 ) (1,223,698 ) (895,700 ) (204,544 ) Net cash provided by (used in) financing activities 210,916 129,865 (652,309 ) (148,963 ) Supplementary Disclosure of Cash Flow Information Cash Paid During the Year: Interest 285,465 323,841 287,629 65,684 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4) Assets are depreciated by the straight-line method, on basis of their estimated useful life. Annual rates of depreciation are as follows: % Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table illustrates the effect on net income (loss) and EPS assuming the Company had applied the fair value recognition provisions of FAS 123 to its stock based employee compensation: Year ended December 31, NIS Convenience translation into dollars In thousands, except per share data Net income (loss), as reported (303,362 ) 84,198 1,162,650 265,506 Add: stock based employee compensation expense net, included in reported net income (loss) (2003 net of income taxes) 20,699 8,957 3,313 757 Deduct: stock based employee compensation expense net, determined under fair value method for all awards (2003 net of income taxes) (59,476 ) (30,029 ) (12,225 ) (2,792 ) Pro-forma net income (loss) (342,139 ) 63,126 1,153,738 263,471 Earning (loss) per share Basic as reported: before cumulative effect (1.72 ) 0.47 6.39 1.46 cumulative effect 0.02 net income (loss) (1.70 ) 0.47 6.39 1.46 Basic pro forma: before cumulative effect (1.93 ) 0.35 6.34 1.45 cumulative effect 0.02 net income (loss) (1.91 ) 0.35 6.34 1.45 Diluted as reported: before cumulative effect (1.72 ) 0.46 6.34 1.45 cumulative effect 0.02 net income (loss) (1.70 ) 0.46 6.34 1.45 Diluted pro-forma: before cumulative effect (1.93 ) 0.34 6.31 1.44 cumulative effect 0.02 net income (loss) (1.91 ) 0.34 6.31 1.44 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company has currently no variable interests in any VIE. Accordingly, the Company believes that the adoption of FIN 46 and FIN 46-R will not have any impact on its financial position, results of operations and cash flows. NOTE 2 INVESTMENTS IN NON-MARKETABLE SECURITIES The Company and its subsidiary have entered into agreements with a number of technological companies in the early stages of development of cellular products (hereafter the start-up companies). Under the agreements, the Group is to supply infrastructure and support services which the start-up companies need to develop their products, in consideration of options and shares in those companies. In some cases, the Group is also entitled to royalties on future sales of the products of the start-up companies. Based on the financial position of the companies, management is in the opinion that the fair value of the securities granted to the Group, on the grant date and as of December 31, 2003 is not material. The Group s holdings in the start-up companies (current and fully diluted) do not exceed 15% of the share capital of any one of them and does not give the Group significant influence over any one of them. Therefore, the investments therein are presented on a cost basis. During 2003, the Company recorded an impairment loss of approximately NIS 3.5 million (approximately $ 0.8 million) (2001 and 2002 approximately NIS 8.9 million and approximately NIS 4.1 million, respectively) in respect of the above investments. As of December 31, 2003, the balance of these investments was fully impaired. NOTE 3 FIXED ASSETS: u. Composition of fixed assets net, is as follows: December 31 NIS Convenience translation into dollars In thousands Communications network 2,398,907 2,553,982 582,764 Computers, hardware and software for information systems 471,079 548,700 125,303 Vehicles 24,955 2,697 616 Office furniture and equipment 31,641 35,934 8,206 Leasehold improvements 140,376 146,431 38,677 Cellular telephones base stock 6,309 6,309 1,441 3,073,267 3,294,053 757,007 Communications network construction in progress (see note 1a(2)) 11,507 2,628 3,073,267 3,305,560 759,635 Less accumulated depreciation and amortization 1,208,756 1,610,976 372,655 1,864,511 1,694,584 386,980 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Depreciation and amortization in respect of fixed assets totaled NIS 361,265,000, NIS 446,970,000 and NIS 469,205,000 ($107,149,000) for the years ended December 31, 2001, 2002 and 2003, respectively. v. Fixed assets include interest expenses, direct consultation and supervision costs and other direct costs of establishing the cellular communications network and information systems, which were capitalized (before commencing full commercial operations) in respect of: December 31 NIS Convenience translation into dollars In thousands Communications network 69,858 69,858 15,953 Computers, hardware and software for information systems 15,566 15,566 3,555 85,424 85,424 19,508 Less accumulated depreciation 51,752 63,775 14,564 Depreciated balance 33,672 21,649 4,944 w. As to pledges on the fixed assets see note 11. NOTE 4 LICENSE AND DEFERRED CHARGES: December 31 NIS Convenience translation into dollars In thousands License (note 1a(2))* 1,792,714 1,916,980 437,767 Less accumulated amortization 571,485 629,893 143,844 1,221,229 1,287,087 293,923 Deferred charges in respect of: Obtaining long-term credit lines 55,996 55,996 12,787 Notes payable 22,017 22,017 5,028 78,013 78,013 17,815 Less accumulated amortization 29,894 39,152 8,941 48,119 38,861 8,874 1,269,348 1,325,948 302,797 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS on deferred charges for the years ended December 31, 2001, 2002 and 2003 totaled NIS 7,309,000, NIS 7,187,000 and NIS 9,258,000 ($2,114,000), respectively. The expected license amortization expenses for the next five years are as follows: NIS Convenience Translation into dollars In thousands Year ended December 31: 2004 67,051 15,312 2005 71,424 16,310 2006 71,424 16,310 2007 71,424 16,310 2008 71,424 16,310 NOTE 5 LONG-TERM BANK LOANS In December 2002, the Company entered into an Amending Agreement in connection with its primary secured bank credit facility, with Bank Leumi B.M., Bank Hapoalim B.M., Israel Discount Bank Ltd., The First International Bank of Israel Ltd., United Mizrahi Bank Ltd., Mercantile Discount Bank Ltd. and Citibank N.A., which amends the bank facility agreement dated August 1998 between the Company and the above mentioned banks, as amended from time to time. The amended facility is divided into three tranches: A multi-currency term loan facility of $410 million ( Facility A ), a revolving multi-currency loan facility of $150 million ( Facility B ) and a fixed-term NIS loan facility of $150 million ( Facility C ). Facility A was available to be drawn through March 31, 2003, from the said amount, $ 383 million have been drawn. The amount drawn from facility A is to be repaid in quarterly installments with a final maturity of June 30, 2008. Facility B may be drawn and repaid until June 30, 2008. Facility C may be drawn through December 31, 2004 and is to be repaid until June 30, 2009. The bank facility is a dollar denominated facility and it may be drawn in different currencies, see c. below. a. Status of the facility at December 31, 2003 is as follows: The total facility Amounts drawn Amounts available for drawing Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS b. The amounts outstanding, classified by linkage terms and interest rates, are as follows: December 31, December 31 Weighted average interest rates Amount % NIS Convenience Translation into dollars In thousands In NIS linked to the Israeli consumer price index (CPI) (1) 5.8 % 629,056 364,268 83,185 In NIS unlinked (2) 6.5 % 1,838,500 1,442,800 329,482 2,467,556 1,807,068 *412,667 Less current maturities 119,853 27,370 2,467,556 1,687,215 385,297 (1) Linkage terms apply both to principal and interest. (2) The loans bear interest at the on-call rate (a varying inter-bank rate in Israel), prime rate or fixed unlinked rate. * The amounts outstanding differ from the amounts drawn, due to differing linkage terms. c. Facilities A and B, may be drawn in NIS, US dollars or Euros, provided that not less than 60% of the outstanding Facilities A and B shall, at any time, be in NIS. Facility C, may be drawn only in NIS. d. There is a range of options as to how interest is calculated on borrowings under the amended facility. These options include rates based on LIBOR, the bond rate, fixed linked rate, fixed unlinked rate, on-call rate and prime rate. The margin for facility A and B is 0.90% per annum and can be reduced to 0.45% on fulfillment of some terms specified in the agreement. The margin for facility C is 1.25% per annum and cannot be reduced. e. The total commitments under the Facilities will be reduced during each of the following years to the following amounts: Dollars in millions A B Total Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS amended facility. Under the amended facility, the Company has undertaken not to transfer any amounts, including dividends, to its shareholders, except in cases specified in the Agreement. g. As to pledges to secure loans and liabilities and other restrictions placed with respect thereto, see note 11. NOTE 6 NOTES PAYABLE On August 10, 2000, the Company completed an offering of $175 million of unsecured Senior Subordinated Notes due 2010, which have been issued at their dollar par value. The Notes have been registered under the U.S. Securities Act of 1933. The net proceeds from the offering (approximately $170.5 million after deducting commissions and offering expenses) were used mainly to repay a portion of the indebtedness under the credit facility. The Notes bear dollar interest at the rate of 13% per annum which are payable semi-annually on each February 15 and August 15, commencing February 15, 2001. The Company may redeem 100% of the aggregate principal amount of the Notes beginning August 15, 2005, at the following redemption price: Redemption price Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (e) The minimum projected rental payments (based upon agreements in force as of December 31, 2003) for the next five years, at rates in effect at December 31, 2003, are as follows: NIS Convenience translation into dollars 354,415 80,934 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the employees in connection with the benefit arising from the options will be reduced; in exchange, the Company will defer the deduction of such taxable income as an expense, for a period of 4 years from the date it commences paying income taxes. The agreement applies only to employees who have joined the agreement, and relate to (1) options that were exercised by December 31, 2002; and/or (2) options that vest by December 31, 2003 and are exercised by March 31, 2004. In each case, the Section 102 trustee must have held the options for a period of 24 months from the date on which they were granted. 2) Following is a summary of the status of the plans as of December 31, 2001, 2002 and 2003 and the changes therein during the years ended on those dates: Year ended December 31 Weighted average exercise price* Weighted average exercise price* Weighted average exercise price* Number Number Number NIS NIS NIS Balance outstanding at beginning of year 8,541,669 12.296 8,962,235 12.746 6,611,110 18.001 Changes during the year: Granted** 1,063,708 19.286 768,000 20.976 195,000 20.450 Exercised (32,314 ) 1.440 (2,670,637 ) 1.591 (1,100,352 ) 7.057 Forfeited (610,828 ) 19.286 (448,488 ) 16.747 (304,538 ) 23.025 Expired (60,250 ) 26.284 Balance outstanding at end of year 8,962,235 12.746 6,611,110 18.001 5,340,970 19.945 Options exercisable at end of year 3,501,109 7.386 2,728,806 17.740 3,504,914 19.351 * Includes options under the 1998 Plan, the exercise price of which is weighted based on the applicable date s NIS dollar exchange rate. ** 2001 and 2002 at market value, 2003 below market value. The following table summarizes information about options outstanding at December 31, 2003: Options outstanding Options exercisable Range of exercise prices NIS Weighted average remaining contractual life Weighted average exercise price Weighted average exercise price Years NIS NIS 1.502 1,049,595 2.81 1.502 899,143 1.502 17.25-22.23 1,752,208 6.77 20.261 679,104 20.288 27.35 2,539,167 5.83 27.35 1,926,667 27.350 1.502-27.35 5,340,970 5.54 19.945 3,504,914 19.351 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS c. Dividends As to restrictions with respect to cash dividend distributions, see note 5f. NOTE 10 TAXES ON INCOME: a. Measurement of results for tax purposes under the Income Tax (Inflationary Adjustments) Law, 1985 Under this law, results for tax purposes are measured in real terms, having regard to the changes in the Israeli CPI. The Company and its subsidiary are taxed under this law. b. Tax rates applicable to income of the Company and its subsidiary The income of the Company and its subsidiary are taxed at the regular rate of 36%. c. Losses carried forward to future years At December 31, 2003, the Group had carryforward losses of approximately NIS 1,300 million (approximately $ 297 million). The carryforward tax losses are linked to the Israeli CPI and can be utilized indefinitely. d. Deferred income taxes The major components of the net deferred tax asset, current and non-current, in respect of the balances of temporary differences and the related valuation allowance as of December 31, 2002 and 2003, are as follows: December 31 NIS Convenience Translation into dollars In thousands In respect of carryforward tax losses (see c. above) 721,405 508,916 116,217 Subscriber acquisition costs 49,833 47,766 10,908 Allowance for doubtful accounts 27,404 27,826 6,354 Provisions for employee rights 13,910 14,011 3,200 Depreciable fixed assets (18,087 ) (45,048 ) (10,287 ) Amortized license 66,149 15,106 Options granted to employees 28,607 17,051 3,895 Other 5,636 1,287 823,072 642,307 146,680 Valuation allowance in respect of carryforward tax losses and deductions that may not be utilized (823,072 ) (8,555 ) (1,954 ) -,- 633,752 144,726 NIS Convenience translation into dollars In thousands Balance at beginning of year 568,052 745,703 823,072 187,959 Utilization during the year (30,410 ) (161,541 ) (36,890 ) Change during the year 177,651 107,779 (652,976 ) (149,115 ) Balance at end of year 745,703 823,072 8,555 1,954 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS e. The difference between the theoretical tax expenses, assuming all income is taxed at the statutory tax rate applicable to the Company (see b. above), and the actual tax expenses as reported in the statement of operations for the year ended December 31, 2003 results almost entirely from changes in the valuation allowance. f. Tax assessments: 1) The Company has received final assessment through the year ended December 31, 2001. 2) The subsidiary has not been assessed for tax purposes since incorporation. NOTE 11 LIABILITIES SECURED BY PLEDGES AND RESTRICTIONS PLACED IN RESPECT OF LIABILITIES At December 31, 2003, balances of liabilities of the Company in the amount of NIS 1,807 million ($413 million), are secured by fixed charges on the fixed assets (including leasehold rights), share capital and insurance rights, and by floating charges on the assets. The Company has also undertaken under the facility agreement not to register any further charges on its assets, with certain exceptions (see also note 5). NOTE 12 FINANCIAL INSTRUMENTS AND RISK MANAGEMENT a. Linkage of monetary balances: 1) As follows: December 31, 2003 In/or linked to foreign currencies (mainly dollars) Linked to the Israeli CPI Unlinked In thousands NIS: Assets 1,443 18,309 519,009 Liabilities 907,545 365,995 1,902,022 Liabilities 207,249 83,580 434,351 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2) Data regarding the dollar exchange rate and the Israeli CPI: Exchange rate of one dollar Israeli CPI* * Based on the index for the month ending on each balance sheet date, on the basis of 1993 average = 100. b. Derivative financial instrument foreign exchange risk management The Company enters into foreign currency forward transactions and purchases and writes foreign currency options in order to protect itself against the risk that the eventual dollar cash flows resulting from the existing assets and liabilities will be affected by changes in exchange rates. The writing of such options is part of a comprehensive hedging strategy and is designed to effectively swap the currencies relating to existing assets and liabilities. Each of the options written is combined with purchase of an option for the same period and the same notional amount. The Company does not hold or issue derivative financial instruments for trading purposes. The transactions are mainly designated to hedge the cash flows related to payments of dollar interest on notes payable as well as those related to anticipated payments in respect of purchases of handsets and capital expenditures in foreign currency. However, these contracts do not qualify for hedge accounting under FAS 133. As the counterparties to the foreign currency options and forward transactions are Israeli banks, the Company considers the inherent credit risks remote. The notional amounts of foreign currency derivatives as of December 31, 2002 and 2003 are as follows: December 31 NIS Convenience translation into dollars Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The derivatives financial instruments are for a period of up to one year. As of December 31, 2003, the remaining contractual lives are for periods up to one year. c. Fair value of financial instruments The financial instruments of the Company as of December 31, 2003 consist mainly of non-derivative assets and liabilities (items included in working capital and long-term liabilities); the Company also has some derivatives, which are presented at their fair value. In view of their nature, the fair value of the financial instruments included in working capital is usually identical or close to their carrying value. The fair value of long-term loans approximates the carrying value, since they bear interest at rates close to the prevailing market rates. Regarding the fair value of Notes payable see note 6. The fair value of derivatives as of December 31, 2003, is a liability of approximately NIS 11.5 million (approximately $ 2.6 million) (December 31, 2002 approximately NIS 2 million). NOTE 13 SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION: a. Accounts receivable: December 31 NIS Convenience translation into dollars In thousands 1) Trade (current and long-term) The item is presented after the deduction of: (a) Deferred interest income* (1,040 ) (3,183 ) (727 ) (b) Allowance for doubtful accounts (74,622 ) (77,295 ) (17,651 ) Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2) Other: December 31 NIS Convenience translation into dollars In thousands Government institutions 12,144 19,396 4,429 Prepaid expenses 24,040 17,603 4,020 Sundry 14,802 19,544 4,463 50,986 56,543 12,912 b. Accounts payable and accruals other: December 31 NIS Convenience translation into dollars 202,166 252,585 57,681 c. Asset retirement obligations the changes in the asset retirement obligations for the year ended December 31, 2003, are as follows: NIS Convenience translation into dollars Balance at December 31, 2003 6,367 1,454 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS d. Financial expenses, net: Year ended December 31 NIS Convenience translation into dollars In thousands Financial income (9,879 ) (5,052 ) (1,952 ) (446 ) Financial expenses 306,724 350,377 320,771 73,252 Derivatives instruments (169 ) (8,302 ) 59,580 13,606 Exchange rate differences 73,352 69,797 (59,168 ) (13,512 ) CPI Linkage differences 21,893 35,723 (4,554 ) (1,040 ) Factoring costs 9,006 9,614 17,111 3,908 Less capitalized interest (6,977 ) (10,078 ) (2,301 ) 400,927 445,180 321,710 73,467 e. Diluted EPS Following are data relating to the net income (loss) and the weighted average number of shares that were taken into account in computing the basic and diluted EPS (the effect of the inclusion of the options for the year 2001 is anti-dilutive): Year ended December 31 NIS Convenience Translation into dollars In thousands Net income (loss) used for the computation of basic and diluted EPS (in thousands) (303,362 ) 84,198 1,162,650 265,506 Weighted average number of shares used in computation of basic EPS 178,909,274 179,984,090 181,930,803 181,930,803 Add net additional shares from assumed exercise of employee stock options 4,593,060 3,085,304 1,312,354 1,312,354 Weighted average number of shares used in computation of diluted EPS 183,502,334 183,069,394 183,243,157 183,243,157 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 14 TRANSACTIONS AND BALANCES WITH RELATED PARTIES: a. Transactions with related parties: Year ended December 31 The Cayman Islands NIS Convenience translation into dollars In thousands Acquisition of handsets from related party 300,024 185,237 203,675 46,512 Financial expenses, net 60,202 81,212 67,906 15,507 Selling commissions and maintenance expenses 26,807 20,624 7,458 1,703 b. Balances with related parties: December 31 NIS Convenience translation into dollars Current liabilities 7,200 19,066 4,354 Long-term liabilities 692,572 491,987 112,351 Table of Contents SUMMARY OF VALUATIONS Property Capital value in existing state as at 31 July 2004 HK$ Table of Contents Property Capital value in existing state as at 31 July 2004 HK$ 6. Workshop 14 on 2nd Floor, Hong Leong Plaza, No. 33 Lok Yip Road, Fanling, New Territories, Hong Kong 680,000 7. Workshop 16 on 11th Floor, Block A, Vigor Industrial Building, Nos. 14-20 Cheung Tat Road, Tsing Yi, New Territories, Hong Kong 410,000 8. Office Nos. 2, 3 and 4 on 18th Floor, Kenbo Commercial Building, Nos. 335-339 Queen s Road West, Sai Ying Pun, Hong Kong 700,000 9. Flat A2 on 19th Floor, Block A, Ka On Building, No. 65 Catchick Street, Kennedy Town, Hong Kong 1,500,000 10. Flat C on 17th Floor, Kam Fu Building, Nos. 2-8 On Fu Road, Tai Po, New Territories, Hong Kong 600,000 Table of Contents Property Capital value in existing state as at 31 July 2004 HK$ 13. Unit No. 3304, Taihe Plaza, No. 72 Wusheng Road, Qiaokou District, Wuhan, Hubei Province, the PRC 1,350,000 14. Unit Nos. A901 to A912 on 9th Level, Block A, Vantone New World Plaza, Nos. 2-8 Fuchengmenwai Avenue, Xicheng District, Beijing, the PRC 19,000,000 15. Unit Nos. D, E, F and G on 22nd Level, New Times Square, No. 42 Wenwu Road, Xinhua Avenue, Qingyang District, Chengdu, Sichuan Province, the PRC 2,900,000 16. Unit No. B807 on 8th Level, Block B, Yinhai Building, No. 250 Caoxi North Road, Xuhui District, Shanghai, the PRC 590,000 17. Various residential units in Buildings B7, C2, C3 and C4 situated in Shenzhen High-Tech Industrial Park, Shennan Avenue, Nanshan District, Shenzhen, the PRC No commercial value 18. Levels A2, A3 and AF3 of Block R3, Shenzhen High-Tech Industrial Estate, Shennan Avenue, Nanshan District, Shenzhen, the PRC No commercial value Table of Contents Property Capital value in existing state as at 31 July 2004 HK$ Group III Property interests held by the Group in Macau 19. Shop A on Ground Floor and Unit A on Mezzanine Floor, Edf. Lin Seng, Estrada de Coelbo do Amaral No. 161-163C, Macau 3,400,000 20. 1st Floor, Blocks A, B, I, J, L, M and N, Edf. Iau Luen, Rua de Ferreira do Amaral No. 13B-15E, Macau 2,200,000 Sub-total: 5,600,000 Group IV Property interest held by the Group in Paraguay 21. Nine cell sites in Paraguay 692,326 Table of Contents Property Capital value in existing state as at 31 July 2004 HK$ 26. Office No. ABS-1 on 1st Floor, Bomabay Market Annexie Building, Umarwada, Surat, India 1,093,636 27. 4th Floor, Jay Tower 1, Main Silvassa Road, Vapi, Dist. Valsad, India 151,549 28. Gaurav Towers I, Basement, Ground and 1st Floors, Malviya Nagar, Jaipur, Rajasthan 302 013, India 2,418,182 29. Basement and 1st Floor, Essar House, Opposite Randhir Cinema, Kunjpura Road, Karnal, Haryana 132 001, India 1,061,411 30. Basement, Sangam Place, Civil Lines, Allahabad, UP, India 101,010 31. Basement and Ground Floor, Chintels House, 16 Station Road, Lucknow, U.P 226 001, India 2,959,596 32. Nineteen cell sites in India 1,026,308 Sub-total: 18,027,628 Group VI Property interest held by the Group in Sri Lanka 33. Eleven cell sites in Sri Lanka 17,969,157 Table of Contents Property Capital value in existing state as at 31 July 2004 HK$ Group VII Property interest held by the Group in Ghana 34. Plot Nos. 78 and 79, Old Town Section A, Kumasi, Ghana 3,675,324 Table of Contents Property Capital value in existing state as at 31 July 2004 HK$ 42. No. 199/11 Chang Klan Road, Chang Klan Sub-district, Muang District, Chiangmai Province, Thailand 849,057 43. No. 68/12, Atthakawee Road, Paknumpho Sub-district, Muang Nakhonsawan District, Nakhonsawan Province, Thailand 792,453 44. No. 166 Gor/19 unnamed Soi, Chang Klan Road, Chang Klan Sub-district, Muang District, Chiangmai Province, Thailand 377,358 45. No. 658/22 Namuang Road, Talad Sub-district, Muang District, Suratthani Province, Thailand 509,434 46. No. 20/187 Moo 10 off South Pattaya Road, Nongplue Sub-district, Banglamung District, Cholburi Province, Thailand 1,226,415 47. No. 896 Borom Trai Lokkanant Road, Nai Muang Sub-district, Muang District, Phitsanulok Province, Thailand 339,623 48. No. 12 Phang Nga Road, Taladyai Sub-district, Muang District, Phuket Province, Thailand 471,698 Sub-total: 8,471,698 Grand Total: 141,886,133 Table of Contents Property Capital value in existing state as at 31 July 2004 HK$ Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group I Property interests held by the Group in Hong Kong Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group II Property interests held by the Group in the PRC Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group II Property interests held by the Group in the PRC Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group II Property interests held by the Group in the PRC Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group II Property interests held by the Group in the PRC Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group II Property interests held by the Group in the PRC Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group II Property interests held by the Group in the PRC Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group II Property interests held by the Group in the PRC Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group III Property interests held by the Group in Macau Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group III Property interests held by the Group in Macau Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group IV Property interest held by the Group in Paraguay Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group V Property interests held by the Group in India Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VI Property interest held by the Group in Sri Lanka Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VII Property interest held by the Group in Ghana Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interest held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents VALUATION CERTIFICATE Group VIII Property interests held by the Group in Thailand Property Description and tenure Particulars of occupancy Capital value in existing state as at 31 July 2004 Table of Contents APPENDICES SUPPLEMENTAL INFORMATION APPENDIX C PARTNER COMMUNICATIONS INTERIM FINANCIAL STATEMENTS FOR THE SIX MONTH PERIOD ENDED JUNE 30, 2004 The following has been extracted from the Form 6-K filed by Partner Communications Company Ltd. with the United States Securities and Exchange Commission on July 28, 2004. PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) INTERIM FINANCIAL STATEMENTS AT JUNE 30, 2004 (Unaudited) TABLE OF CONTENTS Page Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONDENSED CONSOLIDATED BALANCE SHEETS New Israeli shekels Convenience translation into U.S. dollars (see note 2b) (Unaudited) (Audited) (Unaudited) (Audited) In thousands A s s e t s CURRENT ASSETS: Cash and cash equivalents 4,954 3,774 1,102 839 Accounts receivable: Trade 551,131 482,141 122,555 107,214 Other 58,012 56,543 12,900 12,573 Inventories 154,761 102,861 34,414 22,873 Deferred income taxes 211,859 220,000 47,111 48,922 Total current assets 980,717 865,319 218,082 192,421 INVESTMENTS AND LONG-TERM RECEIVABLES: Accounts receivables trade 46,285 13,906 10,292 3,092 Funds in respect of employee rights upon retirement 67,262 58,724 14,957 13,059 113,547 72,630 25,249 16,151 FIXED ASSETS, net of accumulated depreciation and amortization 1,771,920 1,694,584 394,023 376,826 LICENSE AND DEFERRED CHARGES, net of amortization 1,355,515 1,325,948 301,427 294,852 DEFERRED INCOME TAXES 301,172 413,752 66,972 92,006 4,522,871 4,372,233 1,005,753 972,256 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONDENSED CONSOLIDATED BALANCE SHEETS New Israeli shekels Convenience translation into U.S. dollars (see note 2b) (Unaudited) (Audited) (Unaudited) (Audited) In thousands Liabilities and shareholders equity CURRENT LIABILITIES: Current maturities of long-term bank loans 119,853 26,652 Accounts payable and accruals: Trade 519,765 387,818 115,580 86,239 Other 232,212 252,585 51,637 56,167 Total current liabilities 751,977 760,256 167,217 169,058 LONG-TERM LIABILITIES: Bank loans, net of current maturities 1,570,728 1,687,215 349,283 375,187 Notes payable 786,975 766,325 175,000 170,408 Liability for employee rights upon retirement 86,597 76,506 19,257 17,013 Asset retirement obligations 6,803 6,367 1,513 1,416 Total long-term liabilities 2,451,103 2,536,413 545,053 564,024 Total liabilities 3,203,080 3,296,669 712,270 733,082 SHAREHOLDERS EQUITY: Share capital ordinary shares of NIS 0.01 par value: authorized December 31, 2003 and June 30, 2004 235,000,000 shares; issued and outstanding December 31, 2003 182,695,574 shares and June 30, 2004 183,461,591 shares 1,835 1,827 408 406 Less receivable in respect of shares (852 ) (4,374 ) (189 ) (972 ) Capital surplus 2,317,188 2,303,055 515,274 512,131 Deferred compensation (1,179 ) (2,509 ) (262 ) (558 ) Accumulated deficit (997,201 ) (1,222,435 ) (221,748 ) (271,833 ) Total shareholders equity 1,319,791 1,075,564 293,483 239,174 4,522,871 4,372,233 1,005,753 972,256 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS New Israeli shekels Convenience translation into U.S. dollars (see note 2b) 6 month period ended June 30, 3 month period ended June 30, (Unaudited) In thousands (except per share data) REVENUES net: Services 2,233,864 1,943,108 1,138,254 1,003,137 496,745 253,114 Equipment 239,362 165,397 116,326 74,102 53,227 25,867 2,473,226 2,108,505 1,254,580 1,077,239 549,972 278,981 COST OF REVENUES: Services 1,393,048 1,240,561 709,562 618,002 309,773 157,785 Equipment 326,341 279,582 154,161 121,829 72,568 34,281 1,719,389 1,520,143 863,723 739,831 382,341 192,066 GROSS PROFIT 753,837 588,362 390,857 337,408 167,631 86,915 SELLING AND MARKETING EXPENSES 168,228 159,574 76,504 81,282 37,409 17,012 GENERAL AND ADMINISTRATIVE EXPENSES 84,494 80,453 48,553 38,099 18,789 10,797 OPERATING PROFIT 501,115 348,335 265,800 218,027 111,433 59,106 FINANCIAL EXPENSES net 153,039 158,414 66,011 62,926 34,031 14,679 INCOME BEFORE TAXES ON INCOME 348,076 189,921 199,789 155,101 77,402 44,427 TAXES ON INCOME 122,842 66,374 27,317 14,759 NET INCOME FOR THE PERIOD 225,234 189,921 133,415 155,101 50,085 29,668 EARNINGS PER SHARE ( EPS ): Basic 1.23 1.05 0.73 0.85 0.27 0.16 Diluted 1.22 1.04 0.72 0.85 0.27 0.16 WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING: Basic 183,143,256 181,704,757 183,308,290 181,759,051 183,143,256 183,308,290 Diluted 184,852,967 183,316,602 184,912,233 181,803,143 184,852,967 184,912,233 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY Share capital Receivables in respect of shares issued Capital surplus Deferred compensation Accumulated deficit Total In thousands New Israeli shekels (note 2b) BALANCE AT JANUARY 1, 2004 (audited) 1,827 (4,374 ) 2,303,055 (2,509 ) (1,222,435 ) 1,075,564 CHANGES DURING THE 6 MONTHS ENDED JUNE 30, 2004 (unaudited): Exercise of options granted to employees 8 3,522 12,711 16,241 Income tax benefit in respect of exercise of options granted to employees 2,121 2,121 Amortization of deferred compensation related to employee stock option grants, net of deferred compensation with respect to employee stock options Forfeited (699 ) 1,330 631 Net income 225,234 225,234 BALANCE AT JUNE 30, 2004 (unaudited) 1,835 (852 ) 2,317,188 (1,179 ) (997,201 ) 1,319,791 Convenience translation into U.S. dollars (note 2b) BALANCE AT JANUARY 1, 2004 (audited) 406 (972 ) 512,131 (558 ) (271,833 ) 239,174 CHANGES DURING THE 6 MONTHS ENDED JUNE 30, 2004 (unaudited): Exercise of options granted to employees 2 783 2,827 3,612 Income tax benefit in respect of exercise of options granted to employees 472 472 Amortization of deferred compensation related to employee stock option grants, net of deferred compensation with respect to employee stock options forfeited (156 ) 296 140 Net income 50,085 50,085 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS New Israeli shekels Convenience translation into U.S. dollars (see note 2b) 6 month period ended June 30 Net cash provided by operating activities 541,504 389,549 120,415 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of fixed assets (260,229 ) (199,643 ) (57,868 ) Proceeds from sale of fixed assets 552 7,466 123 Purchase of additional spectrum (48,850 ) (34,977 ) (10,863 ) Funds in respect of employee rights upon retirement (8,538 ) (8,108 ) (1,899 ) Net cash used in investing activities (317,065 ) (235,262 ) (70,507 ) Net cash used in financing activities (223,259 ) (150,227 ) (49,645 ) CASH AND CASH EQUIVALENTS AT END OF PERIOD 4,954 5,420 1,102 Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2004 (Unaudited) 1. Nature of operations: Partner Communications Company Ltd. ( the Company ) operates a mobile telecommunications network based upon the Global System for Mobile Communications ( GSM ) Standard in Israel. 2. Basis of presentation: a. The condensed consolidated interim financial statements at June 30, 2004 and for the six and three month period then ended ( the interim financial statements ) have been prepared in condensed form, in accordance with accounting principles generally accepted in the United States for interim financial statements. The generally accepted accounting principles applied in preparation of the interim statements are consistent with those applied in preparation of the annual financial statements; nevertheless, the interim financial statements do not include all the information and notes required for annual financial statements. In management s opinion, interim financial statements reflect all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the financial information, in accordance with generally accepted accounting principles in the United States, for the period presented. Results for interim periods are not necessarily indicative of the results to be expected for the entire year. b. The financial statements have been prepared on the basis of historical cost of Israeli currency. All figures in the interim financial statements are presented in nominal new Israeli shekels ( NIS ). The changes in the exchange rate of the U.S. dollar and the Israeli CPI are: Exchange rate of the U.S. dollar Israeli CPI Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) JUNE 30, 2004 (Unaudited) 3. Stock based compensation The Company accounts for its employee stock option plans using the treatment prescribed by APB No. 25, Accounting for Stock Issued to Employees and related interpretations. Under APB 25, compensation cost for employee stock option plans is charged to shareholders equity, on the date of grant of the options, under deferred compensation costs and is then amortized over the vesting period using the accelerated method of amortization. FAS No. 123 Accounting for Stock-Based Compensation , establishes a fair value based method of accounting for employee stock options or similar equity instruments, and encourages adoption of such method for stock compensation plans. However, it also allows companies to continue to account for those plans using the accounting treatment prescribed by APB 25. The Company has elected to continue accounting for employee stock option plans according to APB 25, and accordingly discloses pro forma data assuming the Company had accounted for employee stock option grants using the fair value based method as defined in FAS 123. No options were granted during the six-months period ended June 30, 2004 and 2003. The following table illustrates the effect on net income and EPS assuming the Company had applied the fair value recognition provisions of FAS 123 to its stock based employee compensation Convenience translation into U.S. dollars (see note 2b) New Israeli shekels 6 month period ended June 30, 3 month period ended June 30, (Unaudited) In thousands (except EPS data) Net income for the period, as reported 225,234 189,921 133,415 155,101 50,085 29,668 Add: stock based employee compensation expense, included in reported net income (2004 net of income taxes) 404 2,786 160 1,838 90 36 Deduct: stock based employee compensation expense determined under fair value method for all awards (2004 net of income taxes) (2,425 ) (7,437 ) (1,526 ) (3,153 ) (539 ) (339 ) Pro-forma net income 223,213 185,270 132,049 153,786 49,636 29,365 EPS: Basic as reported 1.23 1.05 0.73 0.85 0.27 0.16 Basic pro forma 1.22 1.02 0.72 0.85 0.27 0.16 Diluted as reported 1.22 1.04 0.72 0.85 0.27 0.16 Diluted pro-forma 1.21 1.01 0.71 0.85 0.27 0.16 Table of Contents You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the ADSs offered by this prospectus, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date. No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. TABLE OF CONTENTS Presentation of Financial and Other Information i Prospectus Summary 1 Risk Factors 14 Forward-Looking Statements 36 Use of Proceeds 38 Dividend Policy 38 Exchange Rates 39 Capitalization 40 Dilution 41 Selected Combined Financial Data 43 Management s Discussion and Analysis of Financial Condition and Results of Operations 46 Selected Overview of the Telecommunications Industry 97 Business 114 Regulation 194 Management 232 The Restructuring 239 Relationship with Hutchison Whampoa 241 Certain Relationships and Related Party Transactions 249 Principal and Selling Shareholders 274 Description of Share Capital 276 Description of American Depositary Shares 289 Shares Eligible for Future Sale 299 Taxation 301 Underwriting 305 Validity of Securities 312 Experts 313 Enforcement of Civil Liabilities 314 Where You Can Find Additional Information 315 Index to Financial Statements F-1 Appendices Additional Information Disclosed in the Hong Kong Public Offering Appendix A Statement of Business Objectives and Strategies A-1 Appendix B Property Valuations B-1 Supplemental Information Appendix C Partner Communications Interim Financial Statements for the Six Month Period Ended June 30, 2004 C-1 Through and including , 2004 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription. Hutchison Telecommunications International Limited 69,300,000 American Depositary Shares Representing 1,039,500,000 Ordinary Shares Goldman Sachs (Asia) L.L.C. ABN AMRO Rothschild Citigroup Daiwa Securities SMBC Hong Kong The Hongkong and Shanghai Banking Corporation Limited JPMorgan Merrill Lynch & Co. Kotak Investment Banking Morgan Stanley Table of Contents PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 6. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Reference is made to the underwriting agreement, the proposed form of which is filed as Exhibit 1.1, which contains certain provisions for the indemnification by the underwriters of the Registrant and the Registrant s directors and officers who signed the registration statement against certain civil liabilities under the Securities Act. Reference is also made to the articles of association, the draft form of which is filed as Exhibit 3.1, which indemnifies the Registrant s officers and directors from and against all actions, costs, charges, losses, damages and expenses they may incur or sustain by reason of any act done or omitted in their respective offices or trusts, provided that the indemnity does not extend in any respect to any fraud or dishonesty which may attach to the directors and officers. ITEM 7. RECENT SALES OF UNREGISTERED SECURITIES. The information below sets forth the date of sale and title and amount of securities sold within the last three years that were not registered under the Securities Act of 1933. All such securities were issued outside the United States to individuals or entities who were not citizens or residents of the United States, in reliance upon Section 4(2) of, and Regulation S promulgated under, the Securities Act of 1933. Accordingly, the offering and issuance of such securities were not subject to the registration requirements of the Securities Act of 1933. On March 25, 2004, the Registrant issued one ordinary share, par value US$1.00, to Hutchison Telecommunications Investment Holdings Limited for cash at par. On September 3, 2004, the Registrant issued four ordinary shares, par value US$1.00 each, to Hutchison Telecommunications Investment Holdings Limited for cash at par. On September 22, 2004, the Registrant issued 804,917,650 ordinary shares, par value HK$0.25 each, to Hutchison Telecommunications Investment Holdings Limited for a consideration of HK$6,975,953,205.54. On September 22, 2004, the Registrant issued 3,695,082,194 ordinary shares, par value HK$0.25 each, to Hutchison Telecommunications Investment Holdings Limited as consideration for the Registrant s acquisition of the entire issued share capital of Hutchison Telecommunications International (Cayman) Holdings Limited and for the capitalization of the loans extended to Hutchison Telecommunications International (Cayman) Holdings Limited by Hutchison Whampoa Limited. II-1 Table of Contents ITEM 8. EXHIBITS. The following documents are exhibits to the registration statement. Exhibit Number Description of Exhibit 1.1 Form of Underwriting Agreement 3.1 Amended and Restated Memorandum of Association 3.2 Articles of Association 4.1 Form of American Depositary Receipt 4.2 Amended and Restated Memorandum of Association (filed as Exhibit 3.1 hereof) 4.3 Articles of Association (filed as Exhibit 3.2 hereof) 4.4 Form of Deposit Agreement among the Registrant, Citibank, N.A., as depositary, and Holders and Beneficial Holders from time to time of American Depositary Shares evidenced by American Depositary Receipts issued thereunder, including the form of American Depositary Receipt (incorporated by reference to the Depositary s Registration Statement on Form F-6 (File No. 333-119242), filed with the Securities and Exchange Commission on September 24, 2004 with respect to the American Depositary Receipts) 5.1 Opinion of Conyers Dill & Pearman, Cayman, Cayman Islands counsel to the Registrant, as to the validity of the ordinary shares 5.2 Form of opinion of Skadden, Arps, Slate, Meagher & Flom LLP, counsel to the depositary, as to the validity of the American Depositary Receipts (incorporated by reference to the Depositary s Registration Statement on Form F-6 (File No. 333-119242), filed with the Securities and Exchange Commission on September 24, 2004 with respect to the American Depositary Receipts) 10.1 Sale and Purchase Agreement dated June 21, 2004 between Hutchison Telecommunications Lanka (Private) Limited (formerly called Lanka Cellular Services (Pvt.) Ltd.) and Hutchison 3G Italy Investments S. r.l, relating to the restructuring 10.2 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold one share in Hutchison Telecommunications (HK) Holdings Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.3 Loan Agreement dated September 17, 2004 between Hutchison Telecommunications International (Cayman) Holdings Limited and Hutchison Telecommunications Investment Holdings Limited, relating to the restructuring 10.4 Loan Agreement dated September 17, 2004 between Hutchison Telecommunications International (HK) Limited and Hutchison International Limited, relating to the restructuring 10.5 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed by Whampoa Holdings Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.6 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison Telephone Company Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring II-2 Table of Contents Exhibit Number Description of Exhibit 10.7 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison Telecommunication Services Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.8 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison 3G HK Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.9 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison Telecommunications (Hong Kong) Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.10 Loan Agreement dated September 20, 2004 between Hutchison Global Communications Investment Holding Limited and Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.11 Sale and Purchase Agreement dated September 17, 2004 between Hutchison International Limited and Hutchison Global Communications Investment Holding Limited, relating to the restructuring 10.12 Loan Agreement dated September 20, 2004 between HTI (BVI) Holdings Limited and Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.13 Sale and Purchase Agreement dated September 20, 2004 under which Hutchison Telecommunications Limited sold shares in Hutchison Global Communications Investment Holding Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.14 Loan Assignment Agreement dated September 20, 2004 under which Hutchison International Limited transferred a loan facility owed to it by Hutchison Global Communications Holdings Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.15 Loan Assignment Agreement dated September 20, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison Global Communications Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.16 Transfer Agreement dated September 20, 2004 under which Mangere International Limited transferred a note issued by Hutchison Global Communications Holdings Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.17 Loan Assignment Agreement dated September 20, 2004 under which Mangere International Limited transferred a debt owed to Hutchison Global Communications Investment Holding Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.18 Transfer Agreement dated September 20, 2004 under which Hutchison International Limited transferred a deposit deposited to it by Hutchison Global Communications Investment Holding Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.19 Loan Agreement dated September 17, 2004 under which Hutchison Telecommunications International (Thailand) Holdings Limited borrowed an amount designated in US dollars from Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring II-3 Table of Contents Exhibit Number Description of Exhibit 10.20 Sale and Purchase Agreement dated September 17, 2004 between Hutchison Telecommunications (Malaysia) Limited and Hutchison Telecommunications International (Thailand) Holdings Limited, relating to the restructuring 10.21 Loan Agreement dated September 17, 2004 under which Hutchison Telecommunications International (Thailand) Holdings Limited borrowed an amount designated in Thai baht from Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.22 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications (Malaysia) Limited transferred a debt owed to it by Hutchison Multimedia Services (Thailand) Limited to Hutchison Telecommunications International (Thailand) Holdings Limited, relating to the restructuring 10.23 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications (Malaysia) Limited transferred a debt owed to it by Hutchison Telecommunications (Thailand) Co. Limited to Hutchison Telecommunications International (Thailand) Holdings Limited, relating to the restructuring 10.24 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold one share in CGP Investments (Holdings) Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.25 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by CGP Investments (Holdings) Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.26 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Hutchison Telecommunications Investment Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.27 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold one share in Fairglass Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.28 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Fairglass Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.29 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Hutchison Telecommunications Lanka (Private) Limited (formerly called Lanka Cellular Services (Pvt.) Ltd.) to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.30 Sale and Purchase Agreement dated July 16, 2004 between Essar Telecom India Holdings Limited and HTI (BVI) Holdings Limited, relating to the restructuring 10.31 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold 6 A shares in Hutchison Telecommunications (India) Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.32 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Hutchison Telecommunications (India) Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring II-4 Table of Contents Exhibit Number Description of Exhibit 10.33 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by CGP Investments (Holdings) Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.34 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold one share in Kuwata Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.35 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Certwell Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.36 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Kasapa Telecom Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.37 Sale and Purchase Agreement dated September 18, 2004 under which Hutchison Telecommunications Limited sold one share in Pearl Charm Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.38 Loan Agreement dated September 18, 2004 between Widcombe Limited and Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.39 Acknowledgement of Debt and Advances Assignment Agreement dated September 18, 2004 under which Hutchison Telecommunications Limited acknowledged a debt owed to it by Widcombe Limited and transferred a debt owed to it by Hutchison Telecommunications Paraguay S.A. to Widcombe Limited, relating to the restructuring 10.40 Loan Assignment Agreement dated September 18, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Widcombe Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.41 Loan Assignment Agreement dated September 18, 2004 under which HTI (1993) Holdings Limited transferred a debt owed to it by Wellington Gardens Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.42 Loan Assignment Agreement dated September 18, 2004 under which HTI (1993) Holdings Limited transferred a debt owed to it by Widcombe Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.43 Loan Assignment Agreement dated September 18, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Pearl Charm Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.44 Loan Agreement dated September 17, 2004 between Advent Investments Pte Limited and Hutchison OMF Limited, relating to the restructuring 10.45 Instrument of Transfer dated September 17, 2004 between Hutchison Telecommunications (Amsterdam) B.V. and Advent Investments Pte Limited, relating to the restructuring 10.46 Loan Agreement dated September 17, 2004 between Hutchison Telecommunications (Cyprus) Limited and Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring II-5 Table of Contents Exhibit Number Description of Exhibit 10.47 Loan Agreement dated September 17, 2004 between Hutchison Telecommunications International (Netherlands) B.V. and Hutchison Telecommunications (Cyprus) Limited, relating to the restructuring 10.48 Instrument of Transfer dated September 17, 2004 between Advent Investments Pte. Ltd. and Hutchison Telecommunications International (Netherlands) B.V., relating to the restructuring 10.49 Instrument of Transfer dated June 18, 2004 between Colonial Nominees Limited and Advent Investments Pte. Ltd., relating to the restructuring 10.50 Deposit Transfer Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred deposits deposited with it by Advent Investments Pte and Amber International Holdings Inc. to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.51 Sale and Purchase Agreement dated September 22, 2004 under which Hutchison Telecommunications Limited sold 10 shares in Amber International Holdings Inc. to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.52 Loan Agreement dated September 22, 2004 between Hutchison Telecommunications International (HK) Limited and the Registrant, relating to the restructuring 10.53 Sale and Purchase Agreement dated September 22, 2004 under which Hutchison Telecommunications Investment Holdings Limited sold two shares in Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.54 Share Purchase and Loan Transfer Agreement dated September 22, 2004 under which Hutchison Telecommunications Investment Holdings Limited (1) sold one share in Hutchison Telecommunications International (Cayman) Holdings Limited and (2) transferred loans to Hutchison Telecommunications International (Cayman) Holdings Limited to the Registrant, relating to the restructuring 10.55 Sale and Purchase Agreement dated September 17, 2004 under which HTHK Limited sold one share in Hutchison Mobile Communications Limited to Hutchison Telecommunications Limited, relating to the restructuring 10.56 Sale and Purchase Agreement dated September 17, 2004 under which HTHK Limited sold one share in Tegor Limited to Hutchison Telecommunications Limited, relating to the restructuring 10.57 The Transfer and Declaration of Trust Deed dated September 17, 2004 whereby Whampoa Holdings Limited transferred its beneficial interest in the Argentine Title, Rights and Obligations, relating to the restructuring 10.58 Sale and Purchase Agreement dated September 17, 2004 between Array Holdings Limited and Hutchison Telecommunications Limited, relating to the restructuring 10.59 Tax Indemnity Deed dated September September 24, 2004 between Hutchison Telecommunications Limited and the Registrant 10.60 Non-Competition Agreement dated September 24, 2004 between the Registrant and Hutchison Whampoa Limited 10.61 IPR Framework Agreement dated September 24, 2004 between Hutchison International Limited and the Registrant II-6 Table of Contents Exhibit Number Description of Exhibit 10.62 Registration Rights Agreement dated September 24, 2004 among Hutchison Telecommunications Investment Holdings Limited, Cheung Kong (Holdings) Limited and the Registrant 10.63 Counter-Indemnity Agreement dated September 24, 2004 between Hutchison Whampoa Limited and the Registrant 10.64 Share Option Scheme dated September 17, 2004 of the Registrant and its group members 10.65 Acquisition Agreement dated January 28, 2004 among Hutchison Global Communications Holdings Limited, Vanda Systems & Communications Holdings Limited and Hutchison International Limited 10.66 Shareholders Agreement dated April 23, 1998 between Max Telecom Ventures Limited and Hutchison Telecommunications (India) Limited and Telecom Investments India Private Limited and Hutchison Max Telecom Limited 10.67# Shareholders Agreement dated May 2, 2000 among Essar Teleholdings Limited, CGP India Investments Limited, Mobilvest, CCII (Mauritius) Inc., Prime Metals Ltd., Euro Pacific Securities Ltd., Jaykay Finholdings (India) Private Limited and Sterling Cellular Limited 10.68# Shareholders Agreement dated May 31, 2002 among Indusind Telecom Network Limited, Hamko Financial Services Limited, Kotak Mahindra Finance Limited, Trans Crystal Limited, Usha Martin Telematics Limited and Fascel Limited 10.69 Shareholders Agreement dated April 9, 2004 between Multifaced Finstock Private Limited and CGP India Investments Limited and Telecom Investments (India) Private Limited 10.70 Shareholders Agreement dated April 9, 2004 between Asian Telecommunication Investments (Mauritius) Limited and UMT Investments Limited and Usha Martin Telematics Limited 10.71 [Intentionally left blank] 10.72 ETH Pass-Through Agreement dated September 24, 2004 between HTI (1993) Holdings Limited, Hutchison Whampoa Limited and Hutchison Telecom (BVI) Limited 10.73 [Intentionally left blank] 10.74# Marketing Service Agreement dated August 14, 1996 (as amended on April 1, 1997, October 16, 2000 and August 11, 2003) between the Communications Authority of Thailand and Hutchison CAT Wireless Multimedia Company Limited 10.75# Lease Agreement dated October 16, 2000 among Communications Authority of Thailand, BFKT (Thailand) Limited and Hutchison CAT Wireless Multimedia Company Limited 10.76 Hutchison Wireless Shareholders Agreement dated October 16, 2000 between Hutchison Telecommunications Investment Limited, GMRP (Thailand) Limited, Tawan Telecom Company Limited, Mr. Prayong Boonsong, Mr. Virat Ovararint and i-Mobile Holdings Company Limited 10.77 Hutchison CAT Shareholders Agreement dated October 14, 1999 and amended October 16, 2000 between Hutchison CAT Wireless Multimedia Company Limited and Communications Authority of Thailand Telecom 10.78 PKNS (Thailand) Limited Shareholders Agreement dated October 16, 2000 between Light Power Telecommunications Limited and DPBB (Thailand) Limited 10.79 Partner Relationship Agreement dated October 10, 1999 (incorporated by reference to Partner s registration statement on Form F-1 (No. 333-10992)) II-7 Table of Contents Exhibit Number Description of Exhibit 10.80 Amendment to Partner Relationship Agreement dated April 23, 2002 (incorporated by reference to Partner s annual report on Form 20-F (No. 001-14968) for the fiscal year ended December 31, 2001) 10.81 Amended and Restated Share Pledge dated September 10, 1998 between Advent Investments Pte. Ltd. and Bank Leumi 10.82 Amended and Restated Share Pledge dated October 24, 1999 between Advent Investments Pte. Ltd. and Bank Leumi 10.83 Share Pledge dated June 23, 2004 between Advent Investments Pte. Ltd. and Bank Leumi 10.84 Hong Kong Underwriting Agreement 21.1 List of subsidiaries of the Registrant 23.1 Consent of PricewaterhouseCoopers, independent registered public accounting firm 23.2 Consent of Kesselman and Kesselman, independent registered public accounting firm 23.3 Consent of Conyers Dill & Pearman, Cayman (included in Exhibit 5.1) 23.4 Consent of Skadden, Arps, Slate, Meagher & Flom LLP (included in Exhibit 5.2) (incorporated by reference to the Depositary s Registration Statement on Form F-6 (File No. 333-119242), filed with the Securities and Exchange Commission on September 24, 2004 with respect to the American Depositary Receipts) 23.5 Consent of Baker & McKenzie Limited 23.6 Consent of DTZ Debenham Tie Leung Limited 24.1 Powers of Attorney (included in signature pages in registration statement) # Confidential treatment has been requested. Confidential material has been redacted and separately filed with the Securities and Exchange Commission. Previously filed. II-8 Table of Contents SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form F-1 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Hong Kong, on October 4, 2004. HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED By: /s/ Chan Ting Yu Name: Chan Ting Yu Title: Executive Director Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities indicated below on October 4, 2004. Signature Title /s/ * FOK Kin-ning, Canning Chairman and Non-Executive Director /s/ * Dennis Pok Man LUI Executive Director and Chief Executive Officer /s/ Chan Ting Yu CHAN Ting Yu Executive Director /s/ * Tim Lincoln PENNINGTON Executive Director and Chief Financial and Accounting Officer /s/ * CHOW WOO Mo Fong, Susan Non-Executive Director Frank John SIXT Non-Executive Director KWAN Kai Cheong Independent Non-Executive Director John W. STANTON Independent Non-Executive Director Kevin WESTLEY Independent Non-Executive Director *By: /s/ Chan Ting Yu Chan Ting Yu Attorney-in-fact II-9 Table of Contents SIGNATURE OF AUTHORIZED REPRESENTATIVE OF Hutchison Telecommunications International Limited Pursuant to the Securities Act of 1933, as amended, the undersigned, the duly authorized representative in the United States of Hutchison Telecommunications International Limited, has signed this Registration Statement or amendment thereto in the United States, on October 4, 2004. Hutchison Telecommunications International Limited By: /s/ Donald J. Puglisi Name: Donald J. Puglisi Title: Authorized Representative II-10 Table of Contents Exhibit Index Exhibit Number Description of Exhibit 1.1 Form of Underwriting Agreement 3.1 Amended and Restated Memorandum of Association 3.2 Articles of Association 4.1 Form of American Depositary Receipt 4.2 Amended and Restated Memorandum of Association (filed as Exhibit 3.1 hereof) 4.3 Articles of Association (filed as Exhibit 3.2 hereof) 4.4 Form of Deposit Agreement among the Registrant, Citibank, N.A., as depositary, and Holders and Beneficial Holders from time to time of American Depositary Shares evidenced by American Depositary Receipts issued thereunder, including the form of American Depositary Receipt (incorporated by reference to the Depositary s Registration Statement on Form F-6 (File No. 333-119242), filed with the Securities and Exchange Commission on September 24, 2004 with respect to the American Depositary Receipts) 5.1 Opinion of Conyers Dill & Pearman, Cayman, Cayman Islands counsel to the Registrant, as to the validity of the ordinary shares 5.2 Form of opinion of Skadden, Arps, Slate, Meagher & Flom LLP, counsel to the depositary, as to the validity of the American Depositary Receipts (incorporated by reference to the Depositary s Registration Statement on Form F-6 (File No. 333-119242), filed with the Securities and Exchange Commission on September 24, 2004 with respect to the American Depositary Receipts) 10.1 Sale and Purchase Agreement dated June 21, 2004 between Hutchison Telecommunications Lanka (Private) Limited (formerly called Lanka Cellular Services (Pvt.) Ltd.) and Hutchison 3G Italy Investments S. r.l, relating to the restructuring 10.2 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold one share in Hutchison Telecommunications (HK) Holdings Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.3 Loan Agreement dated September 17, 2004 between Hutchison Telecommunications International (Cayman) Holdings Limited and Hutchison Telecommunications Investment Holdings Limited, relating to the restructuring 10.4 Loan Agreement dated September 17, 2004 between Hutchison Telecommunications International (HK) Limited and Hutchison International Limited, relating to the restructuring 10.5 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed by Whampoa Holdings Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.6 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison Telephone Company Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.7 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison Telecommunication Services Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring Table of Contents Exhibit Number Description of Exhibit 10.8 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison 3G HK Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.9 Loan Assignment Agreement dated September 17, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison Telecommunications (Hong Kong) Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.10 Loan Agreement dated September 20, 2004 between Hutchison Global Communications Investment Holding Limited and Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.11 Sale and Purchase Agreement dated September 17, 2004 between Hutchison International Limited and Hutchison Global Communications Investment Holding Limited, relating to the restructuring 10.12 Loan Agreement dated September 20, 2004 between HTI (BVI) Holdings Limited and Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.13 Sale and Purchase Agreement dated September 20, 2004 under which Hutchison Telecommunications Limited sold shares in Hutchison Global Communications Investment Holdings Limited to HTI (BVI) Holding Limited, relating to the restructuring 10.14 Loan Assignment Agreement dated September 20, 2004 under which Hutchison International Limited transferred a loan facility owed to it by Hutchison Global Communications Holdings Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.15 Loan Assignment Agreement dated September 20, 2004 under which Hutchison International Limited transferred a debt owed to it by Hutchison Global Communications Limited to Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.16 Transfer Agreement dated September 20, 2004 under which Mangere International Limited transferred a note issued by Hutchison Global Communications Holdings Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.17 Loan Assignment Agreement dated September 20, 2004 under which Mangere International Limited transferred a debt owed to Hutchison Global Communications Investment Holding Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.18 Transfer Agreement dated September 20, 2004 under which Hutchison International Limited transferred a deposit deposited to it by Hutchison Global Communications Investment Holding Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.19 Loan Agreement dated September 17, 2004 under which Hutchison Telecommunications International (Thailand) Holdings Limited borrowed an amount designated in US dollars from Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.20 Sale and Purchase Agreement dated September 17, 2004 between Hutchison Telecommunications (Malaysia) Limited and Hutchison Telecommunications International (Thailand) Holdings Limited, relating to the restructuring Table of Contents Exhibit Number Description of Exhibit 10.21 Loan Agreement dated September 17, 2004 under which Hutchison Telecommunications International (Thailand) Holdings Limited borrowed an amount designated in Thai baht from Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.22 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications (Malaysia) Limited transferred a debt owed to it by Hutchison Multimedia Services (Thailand) Limited to Hutchison Telecommunications International (Thailand) Holdings Limited, relating to the restructuring 10.23 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications (Malaysia) Limited transferred a debt owed to it by Hutchison Telecommunications (Thailand) Co. Limited to Hutchison Telecommunications International (Thailand) Holdings Limited, relating to the restructuring 10.24 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold one share in CGP Investments (Holdings) Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.25 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by CGP Investments (Holdings) Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.26 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Hutchison Telecommunications Investment Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.27 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold one share in Fairglass Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.28 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Fairglass Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.29 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Hutchison Telecommunications Lanka (Private) Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.30 Sale and Purchase Agreement dated July 16, 2004 between Essar Telecom India Holdings Limited and HTI (BVI) Holdings Limited, relating to the restructuring 10.31 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold 6 A shares in Hutchison Telecommunications (India) Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.32 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Hutchison Telecommunications (India) Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.33 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by CGP Investments (Holdings) Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring Table of Contents Exhibit Number Description of Exhibit 10.34 Sale and Purchase Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited sold one share in Kuwata Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.35 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Certwell Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.36 Loan Assignment Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Kasapa Telecom Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.37 Sale and Purchase Agreement dated September 18, 2004 under which Hutchison Telecommunications Limited sold one share in Pearl Charm Limited to HTI (BVI) Holdings Limited, relating to the restructuring 10.38 Loan Agreement dated September 18, 2004 between Widcombe Limited and Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.39 Acknowledgement of Debt and Advances Assignment Agreement dated September 18, 2004 under which Hutchison Telecommunications Limited acknowledged a debt of owed to it by Widcombe Limited and transferred a debt owed to it by Hutchison Telecommunications Paraguay S.A. to Widcombe Limited, relating to the restructuring 10.40 Loan Assignment Agreement dated September 18, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Widcombe Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.41 Loan Assignment Agreement dated September 18, 2004 under which HTI (1993) Holdings Limited transferred a debt owed to it by Wellington Gardens Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.42 Loan Assignment Agreement dated September 18, 2004 under which HTI (1993) Holdings Limited transferred a debt owed to it by Widcombe Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.43 Loan Assignment Agreement dated September 18, 2004 under which Hutchison Telecommunications Limited transferred a debt owed to it by Pearl Charm Limited to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.44 Loan Agreement dated September 17, 2004 between Advent Investments Pte Limited and Hutchison OMF Limited, relating to the restructuring 10.45 Instrument of Transfer dated September 17, 2004 between Hutchison Telecommunications (Amsterdam) B.V. and Advent Investments Pte Limited, relating to the restructuring 10.46 Loan Agreement dated September 17, 2004 between Hutchison Telecommunications (Cyprus) Limited and Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.47 Loan Agreement dated September 17, 2004 between Hutchison Telecommunications International (Netherlands) B.V. and Hutchison Telecommunications (Cyprus) Limited, relating to the restructuring Table of Contents Exhibit Number Description of Exhibit 10.48 Instrument of Transfer dated September 17, 2004 between Advent Investments Pte. Ltd. and Hutchison Telecommunications International (Netherlands) B.V., relating to the restructuring 10.49 Instrument of Transfer dated June 18, 2004 between Colonial Nominees Limited and Advent Investments Pte. Ltd., relating to the restructuring 10.50 Deposit Transfer Agreement dated September 17, 2004 under which Hutchison Telecommunications Limited transferred deposits deposited with it by Advent Investments Pte and Amber International Holdings Inc. to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.51 Sale and Purchase Agreement dated September 22, 2004 under which Hutchison Telecommunications Limited sold 10 shares in Amber International Holdings Inc. to Hutchison Telecommunications International (Cayman) Holdings Limited, relating to the restructuring 10.52 Loan Agreement dated September 22, 2004 between Hutchison Telecommunications International (HK) Limited and the Registrant, relating to the restructuring 10.53 Sale and Purchase Agreement dated September 22, 2004 under which Hutchison Telecommunications Investment Holdings Limited sold two shares in Hutchison Telecommunications International (HK) Limited, relating to the restructuring 10.54 Share Purchase and Loan Transfer Agreement dated September 22, 2004 under which Hutchison Telecommunications Investment Holdings Limited (1) sold one share in Hutchison Telecommunications International (Cayman) Holdings Limited and (2) transferred loans to Hutchison Telecommunications International (Cayman) Holdings Limited to the Registrant, relating to the restructuring 10.55 Sale and Purchase Agreement dated September 17, 2004 under which HTHK Limited sold one share in Hutchison Mobile Communications Limited to Hutchison Telecommunications Limited, relating to the restructuring 10.56 Sale and Purchase Agreement dated September 17, 2004 under which HTHK Limited sold one share in Tegor Limited to Hutchison Telecommunications Limited, relating to the restructuring 10.57 The Transfer and Declaration of Trust Deed dated September 17, 2004 whereby Whampoa Holdings Limited transferred its beneficial interest in the Argentine Title, Rights and Obligations, relating to the restructuring 10.58 Sale and Purchase Agreement dated September 17, 2004 between Array Holdings Limited and Hutchison Telecommunications Limited, relating to the restructuring 10.59 Tax Indemnity Deed dated September 24, 2004 between Hutchison Telecommunications Limited and the Registrant 10.60 Non-Competition Agreement dated September 24, 2004 between the Registrant and Hutchison Whampoa Limited 10.61 IPR Framework Agreement dated September 24, 2004 between Hutchison International Limited and the Registrant 10.62 Registration Rights Agreement dated September 24, 2004 among Hutchison Telecommunications Investment Holdings Limited, Cheung Kong (Holdings) Limited and the Registrant 10.63 Counter-Indemnity Agreement dated September 24, 2004 between Hutchison Whampoa Limited and the Registrant Table of Contents Exhibit Number Description of Exhibit 10.64 Share Option Scheme dated September 17, 2004 of the Registrant and its group members 10.65 Acquisition Agreement dated January 28, 2004 among Hutchison Global Communications Holdings Limited, Vanda Systems & Communications Holdings Limited and Hutchison International Limited 10.66 Shareholders Agreement dated April 23, 1998 between Max Telecom Ventures Limited and Hutchison Telecommunications (India) Limited and Telecom Investments India Private Limited and Hutchison Max Telecom Limited 10.67# Shareholders Agreement dated May 2, 2000 among Essar Teleholdings Limited, CGP India Investments Limited, Mobilvest, CCII (Mauritius) Inc., Prime Metals Ltd., Euro Pacific Securities Ltd., Jaykay Finholdings (India) Private Limited and Sterling Cellular Limited 10.68# Shareholders Agreement dated May 31, 2002 among Indusind Telecom Network Limited, Hamko Financial Services Limited, Kotak Mahindra Finance Limited, Trans Crystal Limited, Usha Martin Telematics Limited and Fascel Limited 10.69 Shareholders Agreement dated April 9, 2004 between Multifaced Finstock Private Limited and CGP India Investments Limited and Telecom Investments (India) Private Limited 10.70 Shareholders Agreement dated April 9, 2004 between Asian Telecommunication Investments (Mauritius) Limited and UMT Investments Limited and Usha Martin Telematics Limited 10.71 [Intentionally left blank] 10.72 ETH Pass-Through Agreement dated September 24, 2004 between HTI (1993) Holdings Limited, Hutchison Whampoa Limited and Hutchison Telecom (BVI) Limited 10.73 [Intentionally left blank] 10.74# Marketing Service Agreement dated August 14, 1996 (as amended on April 1, 1997, October 16, 2000 and August 11, 2003) between the Communications Authority of Thailand and Hutchison CAT Wireless Multimedia Company Limited 10.75# Lease Agreement dated October 16, 2000 among Communications Authority of Thailand, BFKT (Thailand) Limited and Hutchison CAT Wireless Multimedia Company Limited 10.76 Hutchison Wireless Shareholders Agreement dated October 16, 2000 between Hutchison Telecommunications Investment Limited, GMRP (Thailand) Limited, Tawan Telecom Company Limited, Mr. Prayong Boonsong, Mr. Virat Ovararint and i-Mobile Holdings Company Limited 10.77 Hutchison CAT Shareholders Agreement dated October 14, 1999 and amended October 16, 2000 between Hutchison CAT Wireless Multimedia Company Limited and Communications Authority of Thailand Telecom 10.78 PKNS (Thailand) Limited Shareholders Agreement dated October 16, 2000 between Light Power Telecommunications Limited and DPBB (Thailand) Limited 10.79 Partner Relationship Agreement dated October 10, 1999 (incorporated by reference to Partner s registration statement on Form F-1 (No. 333-10992)) 10.80 Amendment to Partner Relationship Agreement dated April 23, 2002 (incorporated by reference to Partner s annual report on Form 20-F (No. 001-14968) for the fiscal year ended December 31, 2001) Table of Contents Exhibit Number Description of Exhibit 10.81 Amended and Restated Share Pledge dated September 10, 1998 between Advent Investments Pte. Ltd. and Bank Leumi 10.82 Amended and Restated Share Pledge dated October 24, 1999 between Advent Investments Pte. Ltd. and Bank Leumi 10.83 Share Pledge dated June 23, 2004 between Advent Investments Pte. Ltd. and Bank Leumi 10.84 Hong Kong Underwriting Agreement 21.1 List of subsidiaries of the Registrant 23.1 Consent of PricewaterhouseCoopers, independent registered public accounting firm 23.2 Consent of Kesselman and Kesselman, independent registered public accounting firm 23.3 Consent of Conyers Dill & Pearman, Cayman (included in Exhibit 5.1) 23.4 Consent of Skadden, Arps, Slate, Meagher & Flom LLP (included in Exhibit 5.2) (incorporated by reference to the Depositary s Registration Statement on Form F-6 (File No. 333-119242), filed with the Securities and Exchange Commission on September 24, 2004 with respect to the American Depositary Receipts) 23.5 Consent of Baker & McKenzie Limited 23.6 Consent of DTZ Debenham Tie Leung Limited 24.1 Powers of Attorney (included in signature pages in registration statement) # Confidential treatment has been requested. Confidential material has been redacted and separately filed with the Securities and Exchange Commission. Previously filed. Table of Contents INDEX TO FINANCIAL STATEMENTS Hutchison Telecommunications International Limited Report of Independent Registered Public Accounting Firm F-2 Combined Profit and Loss Accounts for the Years ended December 31, 2001, 2002 and 2003 and the Six-Month Periods ended June 30, 2003 and 2004 F-3 Combined Balance Sheets as of December 31, 2001, 2002 and 2003 and June 30, 2004 F-4 Combined Cash Flows Statements for the Years ended December 31, 2001, 2002 and 2003 and the Six-Month Periods ended June 30, 2003 and 2004 F-5 Combined Statements of Changes in Equity for the Years ended December 31, 2001, 2002 and 2003 and the Six-Month Periods ended June 30, 2003 and 2004 F-6 Notes to the Combined Accounts F-7 Partner Communications Company Ltd. Report of Independent Registered Public Accounting Firm F-61 Consolidated Balance Sheets at December 31, 2002 and 2003 F-62 Consolidated Statements of Operations for the Years ended December 31, 2001, 2002 and 2003 F-64 Consolidated Statements of Changes in Shareholders Equity (Capital Deficiency) for the Years ended December 31, 2001, 2002 and 2003 F-65 Consolidated Statements of Cash Flows for the Years ended December 31, 2001, 2002 and 2003 F-67 Notes to Consolidated Financial Statements F-69 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To Board of Directors and Shareholders of Hutchison Telecommunications International Limited: In our opinion, the accompanying combined balance sheets and the related combined profit and loss accounts, cash flow statements, and statements of changes in equity present fairly, in all material respects, the financial position of Hutchison Telecommunications International Limited and its subsidiary companies (collectively referred to as the Group ) at 31 December 2001, 2002 and 2003, and 30 June 2004, and the results of their operations and their cash flows for the years then ended, and the six month periods ended 30 June 2003 and 2004, in conformity with accounting principles which, as described in Note 3, are generally accepted in Hong Kong. These financial statements are the responsibility of the Group s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States) and auditing standards generally accepted in Hong Kong. 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. Accounting principles generally accepted in Hong Kong vary in certain significant respects from accounting principles generally accepted in the United States of America ( US GAAP ). The application of the latter would have affected the amount of net loss attributable to shareholders, expressed in Hong Kong dollars, for the two years ended 31 December 2003 and the six month periods ended 30 June, 2003 and 2004 and the determination of combined shareholders deficits, expressed in Hong Kong dollars, as of 31 December 2002 and 2003 and 30 June 2004 to the extent summarised in Note 34 to the combined accounts. /s/ PricewaterhouseCoopers Hong Kong 17 August 2004, except for Note 1 and Note 34, as to which the date is 30 September 2004. The accompanying notes are an integral part of the combined accounts. (1) As part of the Restructuring described in Note 1, substantially all of the amounts due to related companies, as at 30 June 2004 amounting to approximately HK$20,869 million, were capitalised. The accompanying notes are an integral part of the combined accounts. The accompanying notes are an integral part of the combined accounts. The accumulated losses of the Group include accumulated losses of HK$282 million retained by jointly controlled entities as at 31 December 2001 and retained profits of HK$935 million retained by associated companies as at 30 June 2004 (as at 31 December 2003 - retained profits of HK$743 million, as at 30 June 2003 - retained profit of HK$54 million, as at 31 December 2002 - accumulated losses of HK$67 million and as at 31 December 2001 - accumulated losses of HK$104 million). The accompanying notes are an integral part of the combined accounts. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 1 RESTRUCTURING AND NATURE OF OPERATIONS Hutchison Telecommunications International Limited (the Company ) was incorporated in the Cayman Islands on 17 March 2004 as a company with limited liability. It is a wholly owned subsidiary company of Hutchison Whampoa Limited ( HWL ), a conglomerate based in Hong Kong and listed on the Main Board of The Stock Exchange of Hong Kong Limited ( Hong Kong Stock Exchange ). HWL operates five core business divisions in 42 countries. The five divisions are: (1) ports and related services; (2) telecommunications; (3) property and hotels; (4) retail and manufacturing; and (5) infrastructure, energy, finance and investments. The Restructuring In September 2004, the Company and HWL consummated a restructuring (the Restructuring ) in contemplation of a listing of the Company on the Hong Kong Stock Exchange and the New York Stock Exchange ( NYSE ), whereby HWL transferred to the Company the operations and related assets and liabilities of its mobile telecommunications and related businesses in Hong Kong, India, Israel, Thailand, Sri Lanka, Paraguay, Ghana and Macau, including HWL s third-generation ( 3G ) mobile and fixed-line telecommunications businesses in Hong Kong. The Company and its subsidiary companies are collectively referred to as the Group. The direct and indirect subsidiary companies of HWL outside the Group are collectively referred to as related companies . Following the Restructuring, HWL continues to operate its existing second-generation ( 2G ) mobile telecommunications businesses in Australia and Argentina and its 3G mobile telecommunications businesses in Western Europe and Australia through other subsidiary companies and affiliates. As part of the Restructuring, the Company entered into a non-competition agreement with HWL, whereby the Group has the right, exclusive of HWL and related companies, to engage in the telecommunications business in Asia, Eastern Europe, the Middle East, Africa and South America (except Argentina). The Company has been granted an option by Hutchison Telecommunications Limited ( HTL ), a wholly-owned subsidiary of HWL, to acquire HWL s mobile telecommunications related interests in Argentina at HWL s investment cost plus interest. The option expires three years after the date of the Restructuring with a further right of first refusal thereafter. As part of the Restructuring, the Company and HWL entered into an administrative services agreement pursuant to which HWL continues to provide certain administrative services, including company secretarial, legal, financial, information technology, tax and other supporting services to the Group in connection with the operation of its business. The fees for services provided are based upon the level of services to be provided by HWL and time incurred by its related companies employees. In addition, a loan facility of HK$1 billion granted by a related company to the Group in 2004 continues to be available on the same terms. Historically, the Group received loans and advances from HWL or other related companies to finance its operations, in most cases interest free. Following the Restructuring, the Company has an authorised share capital of 10 billion ordinary shares of par value of HK$0.25 each, totalling approximately HK$2.5 billion, and an issued and fully paid share capital of 4.5 billion ordinary shares of par value of HK$0.25 each, totalling approximately HK$1.125 billion. All of these ordinary shares were issued to HWL in exchange for transfer of the operating businesses and capitalisation of the net long-term amount due to related companies (being HK$20,869 million as at 30 June 2004). Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Nature of Operations The Group is engaged in mobile telecommunications and related businesses in Hong Kong, India, Israel, Thailand, Sri Lanka, Paraguay, Ghana and Macau, including 2G and 3G mobile and fixed-line telecommunications businesses in Hong Kong. 2 BASIS OF PREPARATION The Restructuring has been accounted for as a reorganisation of businesses under common control in a manner similar to a pooling of interests. The accompanying combined profit and loss accounts and combined cash flow statements include the results of operations and cash flows of the companies now comprising the Group as if the current group structure had been in existence throughout the years ended 31 December 2001, 2002 and 2003, and six months periods ended 30 June 2003 and 2004 or since their respective dates of incorporation or acquisition. The accompanying combined balance sheets have been prepared to present the financial position of the Group as at 31 December 2001, 2002, 2003 and 30 June 2004 as if the current group structure had been in existence as of these dates. All significant intra-group transactions and balances have been eliminated on combination. Minority interests, representing the interest of outside shareholders in the operating results and net assets of the companies now comprising the Group, have been accounted for in arriving at the Group s net profit or loss attributable to shareholders and net liabilities. On this basis, the combined accounts of the Group include the accounts for each of the three years ended 31 December 2001, 2002 and 2003, and for the six months ended 30 June 2003 and 2004 (the Relevant Periods ), of the Company and its subsidiary companies and also incorporate the Group s interest in associated companies and jointly controlled entities on the basis set out in Notes 3D and 3E below. Results of subsidiary and associated companies and jointly controlled entities acquired or disposed of during the relevant year are included as from their effective dates of acquisition to 31 December or up to the dates of disposal as the case may be. At 31 December 2001, 2002, 2003 and 30 June 2004, the Group has net liabilities and net current liabilities. While the Group s operations have generated cash in each of these periods, investments in the Group s businesses have consumed cash in excess of amounts generated from operations. The consequent financing requirement has been met by bank and other loans and support from HWL and related companies, mainly through advances and guarantees of bank and other third party loans extended to the Group. 3 PRINCIPAL ACCOUNTING POLICIES The combined accounts have been prepared in accordance with generally accepted accounting principles in Hong Kong and comply with the accounting standards issued by the Hong Kong Institute of Certified Public Accountants and are prepared under the historical cost convention. A Subsidiary companies A company is a subsidiary company if the Group, directly or indirectly, has more than 50% of the voting control or otherwise has governing power, or by virtue of the Group s funding or financing arrangements bears the majority of the economic risks and is entitled to the majority of the rewards of that company on a long term basis. The particulars of the Group s principal subsidiary companies as at 30 June 2004 are shown in Note 33 to the combined accounts. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS B Partnership A partnership is an entity in which the Group has the decision-making powers to control or to obtain control of the partnership or its assets. The results of the partnership acquired or disposed of during the year are included in the combined profit and loss accounts from the effective date of acquisition or up to the effective date of disposal, as appropriate. C Minority Interests Recognition of minority interests share of losses of subsidiary companies is generally limited to the amount of such minority interests portion of the common equity of those subsidiary companies. Minority interests share of losses is generally not recognised once the minority holders of common equity of subsidiary companies have their investment value reduced to zero as such amounts do not represent a receivable by the Group and the minority holders are not obligated to provide additional funding. D Associated Companies An investee company or a joint venture is classified as an associated company if significant influence is exercised over its management but there is no contractual agreement between the shareholders to establish the Group s control or joint control over the economic activities of the entity. Results of the associated companies are incorporated in the accounts to the extent of the Group s share of the post acquisition results. Investments in associated companies represent the Group s share of their net assets, after attributing fair values to their net assets as at the date of acquisition, less provision for impairment in value. The particulars of the Group s principal associated companies as at 30 June 2004 are shown in Note 16 to the combined accounts. E Jointly Controlled Entities An investment in a joint venture is classified as a jointly controlled entity if it is held as a long term investment and a contractual arrangement between the shareholders establishes joint control over the economic activities of the joint venture. Results of the jointly controlled entities are incorporated in the accounts to the extent of the Group s share of the post acquisition results. Investments in jointly controlled entities represent the Group s share of their net assets, after attributing fair values to their net assets at the date of acquisition, less provision for impairment in value. The particulars of the Group s jointly controlled entities are shown in Note 17 to the combined accounts. F Fixed Assets Fixed assets are stated at cost less accumulated depreciation and accumulated impairment losses. The cost of an asset comprises its purchase price and any directly attributable costs of bringing Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS the asset to its working condition and location for its intended use. Fixed assets are depreciated on a straight-line basis, at rates sufficient to write off their costs over their estimated useful lives. Buildings 20-50 years Telecommunications and network equipment 10-35 years Motor vehicles 20-25% Office furniture & equipment and computer equipment 15-20% Leasehold improvements Over the unexpired period of the lease or 15%, whichever is the greater During the six month period ended 30 June 2004, the Directors re-assessed the useful lives of certain of the Group s telecommunications and network equipment in relation to the Group s fixed line business. As a result of this re-assessment the Directors concluded that the useful lives of these assets should be extended from 6.67 - 25 years to 20 - 35 years. The Directors consider this to be a change in accounting estimate and have therefore accounted for the change prospectively from 1 January 2004. The effect of this change in accounting estimate is to decrease depreciation charged for the six months ended 30 June 2004 by HK$27 million. Leasehold land is amortised over the remaining period of the lease. The period of the lease includes the period for which a right of renewal is attached at nil or a de mimimis additional cost. The cost of maintenance and repairs is charged to operations as incurred. Expenditures, which extend the useful life of the asset or increase the capacity or quality of output or standard of performance, are capitalised and depreciated at the applicable depreciation rates. Construction in progress is stated at cost, which includes borrowing costs incurred to finance the construction, and is proportionally attributed to the qualifying assets. G Cash and Cash Equivalents Cash and cash equivalents represent cash on hand and in banks and all demand deposits placed with banks with original maturities of three months or less from the date of placement or acquisition. H Restricted Cash Restricted cash represents cash deposited with banks as collateral for the Group s banking facilities. I Trade and Other Receivables Trade and other receivables are recorded net of provision for doubtful debts, based upon a review of the collectibility of the outstanding amounts at the end of the year/period. Accounts are written off as bad debt during the period in which they are determined not to be collectible. J Internal-use Software The Group capitalises direct costs incurred during the application development stage and the implementation stage for developing, purchasing or otherwise acquiring software for internal use. These costs are amortised over the estimated useful lives of the software, generally 5 years. All costs incurred during the preliminary project stage, including project scoping, identification and testing of alternatives, are expensed as incurred. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS K Leased Assets Assets acquired pursuant to finance leases and hire purchase contracts that transfer to the Group substantially all the rewards and risks of ownership are accounted for as if purchased. Finance leases are capitalised at the inception of the leases at the lower of the fair value of the leased assets or the present value of the minimum lease payments. Lease payments are treated as consisting of capital and interest elements. The capital element of the leasing commitment is included as a liability and the interest element is charged to the combined profit and loss accounts. All other leases are accounted for as operating leases and the rental payments are charged to the combined profit and loss accounts on an accrual basis. L Other Non-current Assets Licences granted to the Group by the government in each of the countries where the Group does business include the right to use spectrum. The methods of payment for these rights vary from country to country and include fixed upfront payments, fixed periodic payments with variable periodic payments in subsequent years and variable only payments. Payments prior to commercial launch of services are recorded at cost and included in other non-current assets and amortised from the date of first commercial launch over the remaining licence period. Upfront payments and fixed periodic payments made subsequent to the commercial launch of services are recognised in the profit and loss account on a straight-line basis over the period of the related licence. Variable periodic payments are recognised in the profit and loss account as incurred. Costs to acquire a mobile telecommunications customer are capitalised and amortised over the estimated customer relationship period. In the event that a customer leaves the network, any unamortised acquisition costs are written off. Prepaid capacity and maintenance is telecommunications capacity leased on an indefeasible right of use ( IRU ) basis and related maintenance services. Prepaid capacity and maintenance is stated at cost and amortised on a straight line basis from the date that the related capacity is activated over the shorter of the term of the IRU agreement or estimated useful life. M Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group s share of the net assets of the acquired subsidiary company, associated company or jointly controlled entity at the date of its acquisition. Goodwill on acquisitions is reported in the balance sheet as a separate asset or, as applicable, included within investments in associated companies and jointly controlled entities, and is amortised using the straight line method over its estimated useful life. N Contingent Liabilities and Contingent Assets A contingent liability is a possible obligation that arises from past events and whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Group. It can also be a present obligation arising from past events that Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS is not recognised because it is not probable that an outflow of economic resources will be required or the amount of the obligation cannot be measured reliably. A contingent liability is not recognised but is disclosed in the notes to the accounts. When a change in the probability of an outflow occurs so that the outflow is probable, it will then be recognised as a provision. A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain events not wholly within the control of the Group. A contingent asset is not recognised but is disclosed in the accounts when the inflow of economic benefit has become probable and is recognised when the inflow has become virtually certain. O Asset Impairment Intangible and tangible assets are tested for impairment when an event that might affect asset carrying value has occurred. A provision for impairment in value is recognised to the extent that the carrying amount cannot be recovered either by selling the asset or from the discounted future earnings from operating the asset. Such provision is recognised in the combined profit and loss accounts. P Borrowing Costs Borrowing costs are accounted for on the accrual basis and charged to the combined profit and loss accounts in the year/period incurred, except for certain costs related to funding of fixed assets which are capitalised as part of the cost of that asset up to the date of commencement of its operations. Fees paid for the arrangement of syndicated loan facilities and debt securities are deferred and amortised on a straight line basis over the period of the loans. Q Advertising Expenses Advertising expenses are charged to the combined profit and loss accounts as incurred. R Stocks Stocks consist of handsets and phone accessories and are valued using the weighted average cost method. Stocks are stated at the lower of cost and net realisable value. Net realisable value is determined on the basis of anticipated sales proceeds less estimated selling expense. S Deferred Taxation Deferred taxation is provided, using the liability method, for temporary differences arising between the tax bases of assets and liabilities and their carrying values in the accounts. Deferred tax liabilities are provided in full on all taxable temporary differences while deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which the deductible temporary differences (including tax losses) can be utilised. Deferred taxation is provided on temporary differences arising on investments in subsidiary and associated companies and jointly controlled entities, except when the timing of the reversal of the Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS temporary difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future. T Pension Plans Pension plans are classified into defined benefit and defined contribution plans. From 1 January 2002, pension accounting costs for defined benefit plans are assessed using the projected unit credit method. Under this method, the cost of providing pensions is charged to the combined profit and loss account so as to spread the regular cost over the service lives of employees in accordance with the advice of the actuaries who carry out a full valuation of the plans each year. The pension obligation is measured as the present value of the estimated future cash outflows using interest rates determined by reference to market yields at the balance sheet date based on high quality corporate bonds with currency and term similar to the estimated term of benefit obligations. Cumulative unrecognised net actuarial gains and losses at the previous financial year end to the extent of the amount in excess of 10% of the greater of the present value of plan obligations and the fair value of plan assets at that date are recognised over the average remaining service lives of employees. In accordance with transitional provisions, transitional liabilities at 1 January 2002 are recognised as an expense on a straight line basis over a period of less than five years from 1 January 2002. The Group s contributions to the defined contribution plans are charged to the combined profit and loss account in the year/period incurred. Pension costs are included in the combined profit and loss account within staff costs. The pension plans are generally funded by the relevant Group companies taking into account the recommendations of independent qualified actuaries and by payments from employees for contributory plans. U Foreign Exchange The reporting currency of the Group is Hong Kong dollars. Transactions in foreign currencies are converted at the rates of exchange ruling at the transaction dates. Monetary assets and liabilities are translated at the rates of exchange ruling at the balance sheet date. Exchange differences are included in the determination of operating profit. The accounts of overseas subsidiary and associated companies and jointly controlled entities are translated into Hong Kong dollars using the year/period end rates of exchange for the balance sheet items and the average rates of exchange for the year/period for the profit and loss account items. Exchange differences are dealt with as a movement in reserves. The Group endeavours to hedge its foreign currency positions with the appropriate level of borrowings in the same currencies. For transactions directly related to the underlying businesses, forward foreign exchange contracts and interest and currency swaps are utilised when suitable opportunities arise and, when considered appropriate, to hedge against currency exposures as well as assist in managing the Group s interest rate exposures. Fees paid for the arrangement of the forward foreign exchange contracts and interest and currency swaps are deferred and amortised on a straight line basis over the period of the relevant contract. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS V Revenue Recognition The Group recognises revenue on the following bases: a. Installation and connection fees are recognised in turnover on connection of the service. b. Sales of handsets are recognised upon delivery to the distributors, dealers or directly to customers. c. Revenues from usage charges are recognised when services are rendered and collectibility can be reasonably assured. d. Revenues from pre-paid calling cards are recognised upon customer s usage of the cards or upon the expiry of the service period. e. Revenues for monthly fees and value added services are recognised on a time proportional basis, taking into account customers usage of the services. f. Network interconnection with international carriers and roaming revenues are recognised as rendered/incurred and are presented on a gross basis. W Interest Income Interest income is recognised on a time proportion basis, taking into account the principal amounts outstanding and the interest rates applicable. X Use of Estimates The preparation of the combined accounts in conformity with Hong Kong generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts that are reported in the combined accounts and accompanying disclosures. Although these estimates are based on management s best knowledge of current events and actions that the company may undertake in the future, actual results may be different from the estimates. Y Dilution of Interest in Subsidiary and Associated Companies or Jointly Controlled Entities Changes in the Group s proportionate share of the underlying equity of a subsidiary or associated company or jointly controlled entity, which result from the issuance of additional equity by the entity, are recognised as gains or losses as incurred. Fixed assets 27 Licences 158 Other assets 423 Goodwill 415 Liabilities assumed (1,023 ) The excess of the purchase price over the Group s share of identifiable assets acquired and liabilities assumed was recorded as goodwill and is related to the India segment. The Group has finalized its valuation during the six months ended 30 June 2004 and recorded additional goodwill of HK$30 million. HK$ millions (Unaudited) Turnover 7,845 10,354 Operating profit 116 986 Loss attributable to shareholders (1,119 ) (173 ) (c) Acquisition of Fascel Limited ( FASCEL ) To further increase its shareholding percentage, one of the subsidiary companies acquired an additional 7.8% and 11% interest in FASCEL in 2001 and 2003, respectively. Goodwill of HK$297 million was recorded as a result of the acquisitions. (d) Acquisition of Hutchison Essar South Limited ( HESL ) In 2002, to further increase its shareholding percentage, one of the subsidiary companies acquired an additional 29.7% interest in HESL. After the acquisition, the subsidiary company had an effective 74.1% beneficial ownership interest in HESL. (e) Acquisition of Hutchison Telecom East Limited ( HTEL ) In 2001, to further increase its shareholding percentage, one of the subsidiary companies acquired an additional 2.5% interest in HTEL. After the acquisition, the subsidiary company had an effective 89.1% beneficial ownership interest in HTEL. (f) Acquisition of an additional 18.7% in Hutchison Telephone Company Limited ( HTCL ) In 2001, one of the subsidiary companies acquired an additional 25.1% in HTCL for US$120 million. Subsequently, it sold 6.4% to the minority shareholders at the same acquisition price (US$30.4 million). g) Acquisition of an additional 16% in Hutchison Global Communications Holdings ( HGCH , formerly known as Vanda Systems and Communications Limited ( Vanda )) In March 2004, the Group s 37% held associated company, HGCH, purchased a wholly-owned subsidiary company of the Group, Hutchison Global Communications Limited ( HGC ), operating fixed-line telecommunications and related businesses, in exchange for an issue of new shares and convertible notes of HGCH. The Group s stake in HGCH increased to 79% of the enlarged share capital of HGCH. In a subsequent transaction completed on the same date, the Group sold approximately 26% of its new HGCH shares for cash of HK$1,578 million by way of a share placement, and as a result, after that transaction the Group owns approximately 53% of HGCH. The Group has accounted for these transactions as a single transaction and as a business combination in which the Group is the acquirer of an additional 16% interest in HGCH. Note: (a) Others includes Paraguay, Sri Lanka and Ghana. Note (a) Others includes Sri Lanka, Paraguay and Ghana. HK$ Number of directors Number of directors Number of directors Number of directors Number of directors 1,000,001 1,500,000 3 3 4,000,001 4,500,000 1 1 5,000,001 5,500,000 1 1 5,500,001 6,000,000 1 6,000,001 6,500,000 1 1 7,000,001 7,500,000 1 1 No emoluments were paid to any of the five highest paid individuals as an inducement to join or upon joining the Group or as compensation for loss of office during the Relevant Periods. Hong Kong profits tax has been provided for at the rate of 17.5% (2003 17.5%, 2002 16%, 2001 16%) on the estimated assessable profits less available tax losses. In 2003, The Government of the Hong Kong Special Administrative Region enacted a change in the profits tax rate from 16% to 17.5% for the fiscal year 2003/2004. Taxation outside Hong Kong has been provided for at the applicable rate on the estimated assessable profits less available tax losses. Thailand 30 % India 35.88 % Sri Lanka 30 % Paraguay 30 % Ghana 32.5 % The Indian entities benefit from certain tax incentives provided to the telecommunications industry under Indian tax laws. These incentives provide a deduction from taxable income of an amount equal to (a) 100% of profits derived from telecommunication business for the first 5 assessment years commencing at the choice of the Company, at any time during the Benefit Period defined below and (b) 30% of the profits for a further 5 assessment years. The deduction may be claimed, at the option of the Company, for any 10 consecutive assessment years out of 15 years beginning from the year in which the Company starts providing telecommunications service ( Benefit Period ). Note (a) The profit on partial disposal of a subsidiary company of HK$1,300 million for the six months ended 30 June 2004 arose from the disposal of a portion of shares of Hutchison Global Communications Holding Limited by way of a share placement. 11 EARNINGS PER SHARE No earnings per share is presented as this would be hypothetical. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS 12 DIVIDENDS The Group did not declare any dividends for the years ended 31 December 2001, 2002 and 2003 and the six months ended 30 June 2003 and 2004. Except as permitted under the Companies Law and the common law of the Cayman Islands, the Company is not permitted to distribute dividends unless it has a profit, realised or unrealised, or a reserve set aside from profits which the directors of the Company determine is no longer needed. As at 30 June 2004, the Group had combined accumulated losses of HK$5,222 million, representing accumulated losses in a majority of the Company s subsidiaries. In a HK$8 billion credit facility with ABN Amro Bank N.V., the Company has agreed to not pay dividends to shareholders for so long as any amounts under that credit facility are outstanding. As at 30 June 2004, there were no outstanding amounts under that facility. Certain of the Company s subsidiaries in Hong Kong, India and Thailand have entered into loan agreements or credit facilities that restrict their ability to pay dividends or make loans or advances to the Company, conditional either on obtaining prior approval or on meeting certain financial thresholds. Certain of the Company s subsidiaries in Hong Kong, India and Thailand are also parties or subject to shareholder agreements with non-affiliated shareholders that require the non-affiliated shareholder to approve dividend distributions, advances or loans to the Company. India also restricts the transfer of assets from a member of the Group in that country to a foreign entity such as the Company under certain circumstances. These restrictions could limit the Company s ability to pay dividends in the future. At 30 June 2004, telecommunications and network equipment includes assets held under defeased finance leases at a cost of HK$3,222 million (2003 HK$3,222 million, 2002 HK$3,222 million, 2001 HK$3,222 million) and accumulated depreciation and impairment losses of HK$2,358 million (2003 HK$2,298 million, 2002 HK$2,179 million, 2001 HK$2,053 million). Depreciation for the six months ended 30 June 2004 amounted to HK$60 million (six months ended 30 June 2003 HK$60 million, year ended 31 December 2003 HK$119 million, year ended 31 December 2002 HK$126 million, year ended 31 December 2001 HK$212 million). (a) Partner Communications Company Ltd. Israel Mobile telecommunications services 35% 43% 43% 43% NIS 1,826,956 (b) Vanda Systems & Communications Holdings Limited (Subsequently renamed Hutchison Global Communications Holdings Limited ) Bermuda/ Hong Kong System integration & application solution services N/A N/A 37% HK$ 690,169,396 As of 30 June 2004, certain shares held in Partner Communications Company Ltd. ( Partner ) were pledged as security for a US$583 million bank credit facility to Partner from various banks. Such facility contains certain events of default, including in the event that the Group ceases to control at least 30% of the voting rights of Partner. As of 30 June 2004, US$348 million remained outstanding under this facility. This facility is not guaranteed by HWL or other related companies. In March 2004, Vanda Systems & Communications Holdings Limited ( Vanda ) (subsequently renamed Hutchison Global Communications Holdings Limited, HGCH ) acquired 100% of the Group s fixed-line and data center businesses. The Group s stake in Vanda increased to 79% of the enlarged share capital of HGCH as a result of HGCH s acquisition of the fixed-line and data centre businesses. Thereafter, Vanda was accounted for as a subsidiary company of the Group. Subsequently, following a placement of HWL s shares in HGCH, the Group s stake in HGCH decreased to 52.5%. The gain on disposal of the HGCH shares of approximately HK$1.3 billion is recognised in the combined profit and loss account for the six months ended 30 June 2004. At 30 June 2004, the aggregate principal amounts of long-term loans scheduled for repayment for the next five years were: HK$ millions 2005 5,421 2006 7,175 2007 2,073 2008 41 2009 58 2010 and thereafter 48 In September 2001, the Hong Kong fixed-line business was granted a long-term syndicated loan facility amounting to HK$4.4 billion, secured by, inter alia, mortgages of its shares and shares of its subsidiary companies and debentures over the Hong Kong fixed line business and its subsidiaries undertakings and assets including real property, certain tangible movable properties and certain material contracts. Amounts drawn down at 31 December 2001 and 2002 were HK$1,550 million and HK$2,530 million, respectively. In July 2003, the loan was fully repaid. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS In 2000, the Hong Kong mobile business was granted a HK$4 billion secured credit facility with various banks, maturing in 2006 and bearing interest at the Hong Kong interbank offered rate ( HIBOR ) plus 1.1% to 1.3% per annum. The facility is secured in part by pledges of the Group s and certain other shareholders shares in the borrower. Under the terms of the facility, the borrower is required to meet certain financial covenants including debt to liquidity and debt service coverage ratios. The facility also contains certain events of default, including a decrease in HWL s direct or indirect equity ownership in the borrower to below 35% in the case of an initial public offering. In May 2004, the Hong Kong mobile business was granted a HK$1.1 billion committed short-term term loan facility (which was amended in August 2004 and increased to HK$2 billion) with an international commercial bank, to refinance the remaining balance of the HK$4 billion secured credit facility. The facility contains certain negative pledges and events of default, including in the event that Hutchison International Limited s ( HIL ) direct or indirect shareholding in the borrower falls to less than 65%, or after the listing of the Company, HIL s direct or indirect shareholding in the Company falls to 50% or less, or the Company s direct or indirect shareholding in the borrower falls to less than 65%. The facility (as amended) is supported by a letter of comfort from HIL containing the same ownership requirements. As of 30 June 2004, HK$1.1 billion was outstanding under this facility, which will mature on 17 May 2005, with an option to further extend to 31 December 2005 (as amended). In 2002, the Hong Kong 3G business was granted committed short-term revolving credit facilities amounting to HK$2 billion, which were subsequently increased to HK$3 billion and HK$4 billion in 2003 and 2004, respectively, bearing interest at HIBOR plus 0.75% per annum. These facilities contain the same shareholding covenants as the HK$2 billion facility in the above paragraph and are supported by letters of comfort from HIL on the same terms. Amounts drawn down at 31 December 2002 and 2003 and 30 June 2004 were HK$1.3 billion, HK$2.3 billion and HK$3.0 billion, respectively. At 30 June 2004, the outstanding loan balances of the Group consist of the following foreign currency denominated loans: HK$3,955 million denominated in Indian Rupees HK$2,384 million denominated in Thai Baht HK$861 million denominated in US dollars HK$3,338 million denominated in Japanese Yen HK$41 million denominated in Singapore dollars HK$13 million denominated in Malaysia Ringgit HK$17 million denominated in Renminbi The remaining HK$4,207 million is denominated in Hong Kong dollars. As of 30 June 2004, total borrowings of HK$10,516 million are guaranteed by HWL and other related companies. Premature release of guarantees given by HWL and other related parties will not occur upon listing of the Company on the Hong Kong Stock Exchange and NYSE. Instead, the Company intends to refinance the relevant facilities as the relevant facilities mature without the benefit of a further guarantee by HWL or other related companies. Under the terms of a credit support agreement between the Company and HWL, the Company will pay a guarantee fee charged at normal commercial rates and will provide a counter-indemnity in favour of HWL and other related companies in respect of guarantees provided by them for so long as they are not discharged. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS In December 2003, bank and other loans of HK$4,113 million due in 2004 were refinanced to extend the repayment dates to 2005. As a result, an amount of HK$4,113 million has been reclassified as long-term as of 31 December 2003. As at 30 June 2004, fixed assets and current assets of certain subsidiary companies amounting to HK$5,076 million and HK$1,389 million, respectively, were used as collateral for certain of the borrowings. The current portion of bank and other loans and debentures of the Group is secured to the extent of HK$757 million (2003 HK$1,422 million, 2002 HK$3,176 million, 2001 HK$1,701 million). The long-term portion of bank and other loans and debentures of the Group is secured to the extent of HK$1,881 million (2003 HK$2,135 million, 2002 HK$ 4,382 million, 2001 HK$ 3,662 million). The Group has entered into a currency and interest rate swap arrangement with a bank to swap floating rate US dollar borrowings of HK$623 million (2003 HK$623 million, 2002 nil, 2001 nil) into fixed rate Indian Rupees borrowings at 4.3% per annum (2003 4.3% per annum, 2002 nil, 2001 nil) to match currency and interest rate exposure of the underlying businesses. The Group has entered into currency swap arrangements with banks to swap Japanese Yen borrowings of HK$3,338 million (2003 HK$2,292 million, 2002 HK$560 million, 2001 HK$101 million) and US dollar borrowings of HK$237 million (2003 HK$263 million, 2002 nil, 2001 nil) into Thai Baht borrowings to match currency exposure of the underlying businesses. 22 AMOUNTS DUE FROM (TO) RELATED COMPANIES The related companies are HWL and its direct and indirect subsidiary companies outside the Group. Amounts due from and to related companies are unsecured and have no fixed repayment terms. At 30 June 2004, HK$12,491 million (2003 HK$15,727 million, 2002 HK$14,755 million, 2001 HK$13,277 million) of the amounts due to related companies is interest free and HK$10,745 million (2003 HK$7,176 million, 2002 HK$4,050 million, 2001 HK$3,639 million) carries interest at Hong Kong prime lending rate and variable rates based on interbank offered rates. The average interest rates were approximately 2.2%, 3.4%, 4.9% and 8.8% per annum for the six months ended 30 June 2004 and the years ended 31 December 2003, 2002 and 2001, respectively. At 30 June 2004, HK$2,056 million (2003 HK$543 million, 2002 HK$526 million, 2001 HK$313 million) of the amounts due from related companies is interest free. There were no outstanding interest bearing amounts due from related companies as at 30 June 2004 and 31 December 2003. As at 31 December 2002 and 2001, HK$34 million and HK$1,102 million, respectively, carries interest at variable rates based on interbank offered rates. The maximum interest bearing amounts outstanding during the six months ended 30 June 2004 was HK$3,400 million (2003 HK$52 million, 2002 HK$1,217 million, 2001 HK$1,408 million). As part of the Restructuring, the net amounts due to related companies of HK$20,869 million were capitalised as shareholders funds. The gain (loss) on plan assets during the six months ended 30 June 2004 was a loss of HK$1 million (six months ended 30 June 2003 a gain of HK$13 million, year ended 31 December 2003 gain of HK$32 million, year ended 31 December, 2002 loss of HK$22 million, year ended 31 December 2001 nil). There is no immediate requirement for the Group to fund the deficit between the fair value of defined benefit plan assets and the present value of the defined benefit plan obligations disclosed as at 31 December 2003. Contributions to fund the obligations are based upon the recommendations of independent qualified actuaries for each of the Group s pension plans to fully fund the relevant schemes on an ongoing basis. The realisation of the deficit is contingent upon the realisation of the actuarial assumptions made which is dependent upon a number of factors including the market performance of plan assets. Funding requirements of the Group s major defined benefit plans are detailed below. The Group operates two principal plans in Hong Kong. One plan, which has been closed to new entrants since 1994, provides benefits based on the greater of the aggregate of the employee and employer vested contributions plus a minimum interest thereon of 6% per annum, and a benefit derived by a formula based on the final salary and years of service. A formal independent actuarial valuation, undertaken for funding purposes under the provision of Hong Kong s Occupational Retirement Schemes Ordinance ( ORSO ), at 29 February 2004 reported a funding level of 99% of the accrued actuarial liabilities on an ongoing basis. The employers annual contributions were adjusted to fully fund the plan as advised by the independent actuaries. The valuation used the aggregate cost method and the main assumptions in the valuation are an investment return of 6.0% per annum and salary increases of 4.0%. The valuation was performed by Tian Keat Aun, a Fellow of The Institute of Actuaries, of Watson Wyatt Hong Kong Limited. The funding of the plan will be reassessed based upon the results of next formal actuarial valuation to be completed by 28 February 2007 in accordance with the requirements of ORSO. The second plan provides benefits equal to the employer vested contributions plus a minimum interest thereon of 5% per annum. As at 30 June 2004, this plan is fully funded for the funding of vested benefits in accordance with the ORSO funding requirements. The Group operates certain defined benefit pension plans for its mobile operations in India. In accordance with Indian law, the Group also provides for gratuity obligations through a defined benefit retirement plan (the Gratuity Plan ) covering all employees. The Gratuity Plan provides a lump sum The loans are unsecured and have no fixed terms of repayment. Note: The aggregate issued capital of all other intermediate holding companies is less than HK$3,000. The combined share capital was rounded down to zero and not presented in the combined balance sheets. 28 CONTINGENT LIABILITIES At 30 June 2004, the Group had contingent liabilities in respect of performance guarantees amounting to HK$432 million (2003 HK$456 million, 2002 HK$542 million, 2001 HK$601 million). In addition, the Group had contingent liabilities in respect of sales taxes payable on revenues earned from airtime, activation fees and/or monthly rentals. The claims to date amount to HK$223 million (2003 HK$91 million, 2002 HK$38 million, 2001 HK$36 million). The Group has been successful in obtaining court orders restraining any further action by the sales tax authorities pending a final ruling on this matter by the Supreme Court of India. However, if the sales tax authorities were successful in obtaining a favourable ruling that sales tax was payable on all the aforementioned revenues streams, it is possible that this ruling may be applied retrospectively and in this situation the Group estimates the maximum aggregate amount payable to be approximately HK$468 million. No amounts have been recognised in respect of the contingent liabilities as it is expected that the Group will meet the requisite performance criteria and will be successful in its defence against the claims. 29 COMMITMENTS Outstanding Group commitments not provided for in the accounts at 30 June 2004 are as follows: Capital commitments 1. Contracted for: i. Telecommunications, mobile network HK$2,291 million (2003 HK$1,987 million, 2002 HK$1,445 million, 2001 HK$2,071 million). Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS ii. Telecommunications, fixed network HK$738 million (2003 HK$1,129 million, 2002 HK$1,470 million, 2001 nil). 2. Authorised but not contracted for: The Group, as part of its annual budgeting process, estimates future capital expenditures and these budgeted amounts are shown below. These estimates are subject to a rigorous authorisation process before the expenditure is committed. i. Telecommunications, mobile network HK$7,299 million (2003 HK$9,284 million, 2002 HK$8,974 million, 2001 HK$9,749 million). ii. Telecommunications, fixed network HK$1,097 million (2003 HK$1,102 million, 2002 HK$895 million, 2001 nil). Operating Lease Commitments - future aggregate minimum lease payments for land and Buildings 1. In the first year HK$370 million (2003 HK$376 million, 2002 HK$ 398 million, 2001 HK$310 million). 2. In the second to fifth years inclusive HK$612 million (2003 HK$490 million, 2002 HK$514 million, 2001 HK$340 million). 3. After the fifth year HK$703 million (2003 HK$596 million, 2002 HK$428 million, 2001 HK$208 million). Operating Lease Commitments - future aggregate minimum lease payments for other assets 1. In the first year HK$234 million (2003 HK$278 million, 2002 HK$249 million, 2001 HK$200 million). 2. In the second to fifth years inclusive HK$72 million (2003 HK$98 million, 2002 HK$128 million, 2001 HK$145 million). 3. After the fifth year HK$1 million (2003 HK$2 million, 2002 HK$5 million, 2001 HK$2 million). Commitments - fixed periodic payments for the right to use spectrum 1. In the first year HK$50 million (2003 HK$50 million, 2002 HK$50 million, 2001 HK$50 million). 2. In the second to fifth years inclusive HK$230 million (2003 HK$230 million, 2002 HK$210 million, 2001 HK$200 million). 3. After the fifth year HK$926 million (2003 HK$926 million, 2002 HK$997 million, 2001 HK$1,057 million). Funding Commitments The Group has agreed to provide or arrange necessary funding for its Thailand operations and one of its Indian operating companies in the event additional equity funding is to be contributed. The Group holds call options, both directly and indirectly, which, if exercised, would entitle the Group to additional equity interests in its operating and investment holding companies in India, in each case subject to the Indian government s foreign ownership regulation. Conversely, some Indian shareholders hold put options that could, again subject to the foreign ownership restrictions, require the Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Group to purchase additional equity interests in the operating companies or investment holding companies through which the Group holds indirect interests in the operating companies. The call and put options are exercisable at fair market value to be determined at the time of exercise by the parties agreements. Also, one of the Indian shareholders, has a call option that could, in certain circumstances, dilute to some extent the Group s indirect minority holdings in the Indian operating companies. GMRP (Thailand) Limited ( GMRP ) has granted a call option to the Group and the Group has granted a put option to GMRP in respect of up to all of the shares in Hutchison Wireless MultiMedia Holdings Limited ( HWMHL ), the holding company of Hutchison CAT Wireless MultiMedia Limited, held by GMRP. HWMHL has granted an option to the Communications Authority of Thailand ( CAT Telecom ) to swap the shares which CAT Telecom holds in Hutchison CAT Wireless MultiMedia Limited with the shares of HWMHL or BFKT (Thailand) Limited. DPBB (Thailand) Limited ( DPBB ) has granted a call option to the Group and the Group has granted a put option to DPBB in respect of up to all the preference shares in the share capital of PKNS (Thailand) Limited, the holding company of BFKT (Thailand) Limited held by DPBB. The Group holds an option to acquire the Hutchison Group s mobile telecommunications related interests in Hutchison Telecommunications Argentina S.A. 30 RELATED PARTY TRANSACTIONS In addition to interest on amounts due to related companies and guarantee fee paid to related companies disclosed in Note 7 and interest on amounts due from related companies disclosed in Note 10 in this report, the Group has entered into other transactions, which in the opinion of the Directors are on normal commercial terms and the ordinary and usual course of the Group s business, with Hutchison Group and other shareholders and joint venture partners of the Group s operating companies who exercise significant influence, together with other Group companies. The transactions and balances of the following related party groups have been narrated below: Related Party Group: (1) Hutchison Group HWL together with its direct and indirect subsidiary companies outside the Group. (2) Other shareholders and joint venture partners: (a) NEC Group (b) KM Group Kotak Mahindra Finance Ltd together with subsidiary and associated companies. (c) Essar Group (d) Hinduja Group (e) CAT Telecom (f) Kludjeson International Limited (g) Asia Global Crossing Limited HK$ millions HK$ millions HK$ millions HK$ millions HK$ millions Transactions during the Relevant Periods: (a) HWL Group Fixed telecommunications services 21 30 33 19 30 Mobile telecommunications services income 11 10 11 5 7 Rental expenses on lease arrangements 77 88 83 42 50 Bill collection services fee expenses 1 5 2 3 Roaming arrangement fee income 1 2 8 2 5 Sharing of services arrangements 26 38 39 6 4 Dealership services fee expenses 24 10 8 4 4 Global Procurement services arrangements 145 99 53 27 Provision of data center services 15 16 8 8 (b) NEC Group Purchase of handsets 21 11 335 (c) KM Group Mobile telecommunications services income 1 Customary fee and commission expenses 13 14 22 12 11 Interest expense 5 3 (d) Essar Group Mobile telecommunications services income 2 2 3 2 2 Roaming arrangement fee income 2 3 1 1 1 Roaming cost 2 3 4 2 2 Rental income 2 1 1 1 1 Sale of sim cards 1 (e) Hinduja Group Interest expense 8 5 (f) CAT Telecom Share of revenue from mobile phone services 14 10 67 10 102 Network operating expenses 14 10 23 10 11 (g) Kludjeson International Limited Purchases of goods and services 1 (h) Asia Global Crossing Limited Fixed telecommunications services 52 33 Interest expense 11 HK$ millions HK$ millions HK$ millions HK$ millions Balances outstanding at end of the year/periods: (a) KM Group Payable outstanding at end of year/period 31 (b) Essar Group Receivables outstanding at end of year/period 8 9 (c) Hinduja Group Payable outstanding at end of year/period 80 (d) CAT Telecom Payable outstanding at end of year/period 114 108 30 128 (e) Kludjeson International Limited Loan outstanding as at end of year/period 4 4 4 4 Effective 27 August 2003, the Group acquired from Essar Group over 59% of the ownership interest in Aircel Digilink India Limited in exchange for 33% of the equity of Hutchison Telecom East Limited, valued at HK$319 million. Pursuant to an agreement entered into in July 2003 with Essar Group, HWL agreed to continue to provide guarantees amounting to HK$1,842 million for loans to Essar Group. In 2004, the Company had provided a counter-indemnity to HWL for the guarantees it has given in favour of Essar Group. Transactions disclosed under Notes (a), (b) and (f) above, the customary fee and commission expenses disclosed under Note (c) above, the mobile telecommunications services income disclosed under Notes (c) and (d) above, and the loan disclosed under Note (g) above will continue after the Listing of the Company on the Hong Kong Stock Exchange and NYSE. 31 LEGAL PROCEEDINGS Save as disclosed in Note 28 in respect of the claims against the Group for sales taxes, the Group is not engaged in any material litigation or arbitration proceeding, and no material litigation or claim is known by the Group to be pending or threatened against it. 32 SUBSEQUENT EVENTS (a) AIRCEL Acquisition Aircel Digilink India Limited (part of Hutch India) entered into a preliminary agreement on 19 June 2004 to acquire 100% equity interest of Aircel Limited and Aircel Cellular Limited (collectively referred to as Aircel ). Completion of the acquisition is subject to various conditions including obtaining the approval of the Department of Telecommunications. If such conditions are not satisfied or waived by 1 November 2004, then either party may terminate the preliminary agreement. The total consideration that would be payable in connection with the Aircel acquisition would be INR16.3 billion (approximately HK$2.8 billion) (including assumed debt of approximately INR4.3 billion (approximately HK$0.7 billion)). Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS (b) Business Cooperation Contract in Vietnam On 12 July 2004, Hutchison Telecommunications (Vietnam) S. r.l., an indirect wholly owned subsidiary of the Company, and Hanoi Telecommunications Joint Stock Company ( HTC ) entered into a Business Cooperation Contract ( BCC ) for the joint development of a CDMA-based mobile telecommunications network in Vietnam. The BCC will not become effective until receipt from Vietnam s Ministry of Planning and Investment of an investment licence authorising the project to proceed. The issue of such licence is pending as at the date of this report. Aircel Digilink India Limited (Notes 1, 2) India INR 1,011,000,000 59 % Mobile telecommunications services BFKT (Thailand) Limited (Note 3) Thailand THB 5,000,000 49 % Network leasing Fascel Limited (Notes 1, 2) India INR 5,000,000,000 66 % Mobile telecommunications services HCL Network Partnership Hong Kong HK$ 10,000 52.55 % Telecommunications network equipment leasing and provision of ancillary services Hutchison 3G HK Limited Hong Kong HK$ 2 71 % 3G network services Hutchison 3G Services (HK) Limited Hong Kong HK$ 2 71 % 3G mobile multimedia services Hutchison CAT Wireless MultiMedia Limited (formerly known as Tawan Mobile Telecom Company Limited) (Note 3) Thailand THB 950,000,000 36 % Marketing of mobile telecommunications services Hutchison Essar South Limited (formerly known as Barakhamba Sales & Services Limited) (Notes 1, 2) India INR 5,396,075,000 74 % Mobile telecommunications services Hutchison Essar Telecom Limited (formerly known as Sterling Cellular Limited) (Note 2) India INR 1,997,164,690 49 % Mobile telecommunications services Hutchison Global Communications Limited Hong Kong HK$ 20 52.55 % Fixed line communications Hutchison GlobalCentre Limited (formerly known as Pretty Skill Limited) Hong Kong HK$ 2 52.55 % Data centre facilities services Hutchison-Management of Telecommunication Services, Limited Macau MOP 10,000 100 % Call centre operation Hutchison Max Telecom Private Limited (Note 2) India INR 1,084,388,190 49 % Mobile telecommunications services Hutchison MultiMedia Services Limited Hong Kong HK$ 20 52.55 % Provision of internet services Hutchison MultiMedia Services (Thailand) Limited (formerly known as Loxley Pagephone Company Limited) Thailand THB 230,000,000 100 % Provision of call centre and distribution channel Hutchison Telecom East Limited (formerly known as Usha Martin Telekom Limited) (Notes 1, 2) India INR 1,934,416,370 59 % Mobile telecommunications services Hutchison Telecommunications (Hong Kong) Limited Hong Kong HK$ 20 100 % Provision of management services Hutchison Telecommunications Information Technology (Shenzhen) Limited China HK$ 5,370,000 100 % Provision of information technology services Hutchison Telecommunications Paraguay S.A. Paraguay PYG 500,000,000 95 % Mobile telecommunications services Hutchison Telecommunication Services Limited (formerly known as Hutchison Telecommunications Retail Services Limited) Hong Kong HK$ 20 100 % Mobile telecommunications retail operations Hutchison Telephone Company Limited Hong Kong HK$ 1,258,120 71 % Mobile telecommunications services Hutchison Telephone (Macau) Company Limited Macau MOP 10,000,000 71 % Mobile telecommunications services Hutchison Teleservices Overseas Limited (formerly known as Hutchison Teleservices (BVI) Limited) British Virgin Islands US$ 15,000 100 % Call centre operation Hutchison Teleservices (HK) Limited Hong Kong HK$ 20 100 % Call centre operation Kasapa Telecom Limited (formerly known as Celltel Limited) Ghana GHC 13,165,886,000 80 % Mobile telecommunications services Hutchison Telecommunications Lanka (Private) Limited (formerly known as Lanka Cellular Services (Private) Limited) Sri Lanka LKR 875,000,000 100 % Mobile telecommunications services Telecom Investment India Private Limited (Note 2) India INR 40,455,000 49 % Investment holding Union Telecom Limited Macau MOP 200,000 80 % Paging operation Usha Martin Telematics Limited (Notes 1, 2) India INR 162,162,520 79 % Investment holding Vanda Systems & Communications Holdings Limited (renamed Hutchison Global Communications Holdings Limited) Bermuda/Hong Kong HK$ 690,169,396 52.55 % Provision of information technology services and trading of computers products Wizdom Technology Limited China US$ 100,000 100 % Provision of information technology services The accounts of the subsidiary company have been audited by KPMG Phoomchai Audit Ltd. The accounts of the subsidiary company have been audited by Guangzhou Yangcheng Certified Public Accountants Company Limited. Note 1: The Group holds 49% or less of direct equity interest in each of these companies. The percentages disclosed above include the Group s indirect equity interests. Note 2: The Company is a subsidiary company as the Group, by virtue of its funding or financing arrangement, bears the majority of the economic risks and is entitled to the majority of its rewards on a long term basis from a combination of some of the following factors: The Group s direct and indirect economic shareholdings which results in the Group holding in some cases more than 50% of the economic interest in the operation. Non-voting preference shareholdings with redemption premium features that provides the Group with additional economic rewards. The Group s sole counter-indemnity to HWL Group for the guarantees it has solely provided to the Group s non-wholly owned Indian operating businesses disproportionate to the Group s economic interest in these businesses. Commitment to provide financial support for third party shareholders of the operating companies. Note 3: In addition to the Group s 49.0% and 36.2% beneficial interest in each of BFKT (Thailand) Limited and Hutchison CAT Wireless MultiMedia Limited respectively as disclosed above, the Group also holds call options over 51.0% and 30.3% beneficial interest in each of BFKT (Thailand) Limited and Hutchison CAT Wireless MultiMedia Limited, respectively. Exchange translation adjustment (k) 4 (29 ) 12 Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS The increases or decreases noted above refer to the following differences between Hong Kong GAAP and US GAAP: (a) Revenue Recognition Under Hong Kong GAAP, revenues from sales of handsets are recognised when the handsets are delivered to dealers or to customers on dealer or corporate and retail sales, respectively. When customer acquisition costs are capitalised, the Group does not recognise any revenue relating to the sale of handsets. Proceeds from the sale of these handsets are netted against the direct costs of acquiring the customers. Under US GAAP, when the sales of handsets do not constitute a separate earnings process, the revenue in excess of cost is recorded as deferred revenue and recognised in income over the expected customer relationship period. Under Hong Kong GAAP, connection and installation fees are recognised when the installation or connection takes place. Under US GAAP, revenues from connection and installation fees and any other up-front fees are deferred and recognised over the expected customer relationship period. EITF 00-21 on Revenue Arrangements with Multiple Deliverables addresses the accounting, by a vendor, for contractual arrangements in which multiple revenue-generating activities will be performed by the vendor. It is effective prospectively for all arrangements entered into fiscal periods beginning after 15 June 2003. EITF 00-21 addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. The Group adopted EITF 00-21 in the year ended 31 December 2003 and it had no impact on its financial position and results of operations. (b) Customer Acquisition Costs Under Hong Kong GAAP, as described in Note 3L, certain telecommunications customer acquisition costs, net of related revenue, are capitalised over the average estimated customer relationship period. In the event a customer ends its relationship before the costs have been fully amortised, the unamortised acquisition costs are written off. Under US GAAP, direct incremental customer acquisition costs are deferred and amortised over the average customer relationship period to the extent of deferred revenue with any excess costs expensed as incurred. (c) Capitalisation of Interest Expense For Hong Kong GAAP, as described in Note 3P, interest costs incurred prior to the date the related asset is available for use are capitalised as construction in progress for borrowings identified as being related to the acquisition of the assets. Under US GAAP, the interest cost incurred prior to the asset being ready for its intended use that could have been avoided if the expenditures for the fixed asset had not been made are capitalised as construction in progress. (d) Telecommunication Spectrum Licences Under Hong Kong GAAP, licence fee payments prior to commercial launch of services are recorded at cost and included in other non-current assets and amortised from the date of first commercial launch over the remaining licence period. Upfront payments and fixed periodic payments made subsequent to the commercial launch of services are recognised in the profit and loss account on a straight-line basis over the period of the related licence. Variable periodic payments are recognised in the profit and loss account as incurred. As described in Notes 3L and 3O, licences are evaluated for impairments when an event occurs that might affect its value. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS Under US GAAP, licence fee payments, the discounted value of the fixed annual fees to be paid over the licence period, and certain other direct costs incurred prior to the date the asset is ready for its intended use are capitalised. Capitalised licence fees are amortised from the date the asset is ready for its intended use until the expiration of the licence. Interest is accreted on the fixed annual fees and charged to interest expense. Variable licence fees are recognised as period costs. The impairment review of licences first compares the future undiscounted cash flows expected to be generated from continual use and ultimate disposition of the licences with their book value. If these cash flows are not sufficient, an impairment charge is recorded to reduce the licence carrying cost to the estimated discounted future cash flows. (e) Business Combinations Under Hong Kong GAAP, the excess of the cost of acquisition over the fair value of the Group s share of net assets of the acquired subsidiary company, associated company and joint venture entity is recognised as goodwill. Goodwill is capitalised and amortised over its estimated useful economic life, a period of no longer than 20 years. An identifiable intangible asset acquired in a business combination have been limited to those assets that can be identified and controlled and for which future economic benefits attributable to the asset will probably flow to the entity. In the event the criteria cannot be met, intangibles are not recognised and the corresponding amount will be classified as part of goodwill. Under US GAAP, the cost of the acquisition is allocated to fair value of acquired assets and liabilities, including separately identifiable intangibles if it satisfies either the contractual-legal or separability criterion. Any excess cost of the acquisition is recognised as goodwill. Intangibles are amortised over their estimated useful lives. Under US GAAP, prior to 1 January 2002, goodwill was amortised over its estimated useful life, not to exceed 40 years. Subsequent to this date, goodwill is no longer amortised, but tested for impairment, at least annually. (f) Impairment of Goodwill Under Hong Kong GAAP, the Group will perform an impairment review to ensure its assets, including goodwill, are carried at no more than their recoverable amount if there is an indication of impairment. The recoverable amount of an asset is the higher of its net selling price and its value in use, based on present value calculations. The value in use test is performed for each cash-generating unit identified. A cash-generating unit is the smallest identifiable group of assets that generate cash inflows largely independent of the cash inflows from other assets or groups of assets. The cash generating unit can be a level or levels above the reporting unit, the reporting unit, or a level or levels below the reporting unit. Under US GAAP, the Group performs an annual impairment test for goodwill based on the fair value of the operating segment or one reporting level below the operating segment. The fair value of the reporting unit is allocated to its assets and liabilities, including any unrecognised intangible assets. The remaining fair value for the reporting unit is the implied fair value of the goodwill. This implied fair value of goodwill is compared to its carrying amount on an annual basis to determine if there is a potential impairment. If the implied fair value of the goodwill is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value is less than its carrying value. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS (g) Sale and leaseback transaction In 1998, the Group entered into a sale and leaseback transaction for certain of its mobile telecommunication assets. Under Hong Kong GAAP, this transaction was accounted for as a defeased lease and, thus, the assets subject to the sale and leaseback arrangement have been accounted for as a financing lease and the related financial assets transferred to a third party in exchange for payment of liabilities have been removed from the balance sheet along with the related liabilities. Under US GAAP, the mobile telecommunication assets and related depreciation expense subject to this arrangement are recorded at their historical cost. Further, the related financial assets transferred to a third party under the defeased lease agreements have not met all of the criteria for treatment of a sale under SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities , thus, the financial assets and related liabilities are included in the Group s US GAAP balance sheet. (h) Derivatives The principal financial risks arising from the Group s activities are interest risk, currency risk and counterparty risk. The Group manages these risks by a variety of methods, including the use of a number of financial instruments. All transactions in derivative financial instruments are undertaken for risk management purposes only. No instruments are held by the Group for trading purposes. The Group accounts for all its derivative financial instruments in accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities ( SFAS 133 ). Derivative financial instruments are recorded as assets or liabilities and are measured at fair value. When available, quoted market prices are used in determining fair value; however, if quoted market prices are not available, the Group estimates fair value using either quoted market prices of financial instruments with similar characteristics or other valuation techniques. The Group uses swaps to reduce the effects of fluctuations in foreign currency exchange rates and interest rates. Changes in the fair value of instruments that are designated as cash flow hedges and that qualify for hedge accounting under the provisions of SFAS 133 are accumulated in equity as other comprehensive income (loss) and are recognised in earnings when the hedged transaction occurs. Gains or losses on non-qualifying derivatives are recognized in earnings immediately. Gains or losses on fair value hedges and on the underlying item being hedged are also recorded in earnings. The Group did not meet the restrictive documentation, designation and effectiveness assessments required under SFAS 133 for its cross currency and interest rate swap contracts to qualify as hedge accounting. As a result, the changes in fair value of the currency and interest rate swap contracts are recognized in earnings as finance gains or losses. The fair values of the derivative financial instruments have been recorded in the condensed combined balance sheet as other long-term liabilities. The effects of the currency swap of Yen32.6 billion and US$32.4 million term loan in Baht and the currency and interest rate swap for the US$80 million term loan into Indian Rupees are HK$25 million loss and HK$16 million loss for the year ended 31 December 2002 and 2003, respectively. The effect of the currency swap of Yen46.6 billion and US$32.5 term loan in Baht and the currency and interest rate swap for the US$80 million term loan into Indian Rupees is HK$73 million gain for the six months ended 30 June 2004. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS (i) Deferred Income Tax Hong Kong GAAP and US GAAP are substantially the same with respect to deferred income tax expense or benefit that affects the Group. The amounts included in the reconciliation show the income tax effects of the differences between Hong Kong GAAP and US GAAP as described above. (j) Deferred financing fee Under Hong Kong GAAP, finance costs incurred prior to 2000 relating to the arrangement of loan facilities were recorded as expenses at the inception of the arrangements. Under US GAAP, these amounts are deferred and amortised over the term of the loan on a straight-line basis under which the amortised amount approximates the result obtained from the interest method. (k) Exchange translation adjustment Hong Kong GAAP and US GAAP are substantially the same with respect to calculating the currency translation adjustment for the Group. The amounts included in the reconciliation show the effect on the shareholders deficits of the differences between Hong Kong GAAP and US GAAP described above. (l) Capitalisation of loans net of related interest Upon consummation of the Restructuring described in Note 1, US GAAP requires that the Restructuring be accounted for as if it had been consummated as of the beginning of the periods presented. This resulted in the share capital of the Group when reconciled to US GAAP being retroactively restated for the effect of the capitalisation of the long-term amounts due to related companies in exchange for the shares in the Company issued to HWL. Pursuant to the Restructuring, HK$20,869 million of the net amount due to related companies as of 30 June 2004 was capitalised which comprised of both amounts payable included in amounts due to related companies and amounts receivable included in amounts due from related companies on the balance sheet under Hong Kong GAAP. In addition to this amount, retroactive effect has also been given to the interest expense related to the net amounts due to related companies for the periods presented. Thus, under US GAAP, the related interest expense has been debited against additional paid in capital. Under Hong Kong GAAP, this interest expense has been included in the combined profit and loss accounts. Additionally, loss per share in accordance with SFAS 128, Computation of Earnings per Share, has been disclosed as if the shares had been outstanding for all periods presented. Under Hong Kong GAAP, the Restructuring will be given retroactive treatment only after the financial statements are prepared for the period in which the Restructuring has occurred. HK$ millions HK$ millions HK$ millions HK$ millions Aircel Digilink India Limited 846 92 1,080 275 Fascel Limited 1,405 847 1,308 578 Hutchison CAT Wireless MultiMedia Limited 2,654 348 3,248 602 Hutchison Essar South Limited 2,214 367 2,744 392 Hutchison Essar Telecom Limited 1,605 1,145 1,655 749 Hutchison Max Telecom Private Limited 1,246 1,586 1,394 919 Hutchison Telecom East Limited 1,025 460 931 289 Telecom Investments India Private Limited 963 961 Usha Martin Telematics Limited 357 1 203 Pacific Leasing Limited 2,440 2,329 (1) During March 2004, the Group s ownership of HGCH increased to approximately 53%. Subsequent to that date, HGCH has been included in the combined financial statements of the Group. Fair value of financial instruments The carrying value of the Group s financial assets including cash and cash equivalents, restricted assets, accounts receivable, other receivables, amounts due from affiliates and financial liabilities including trade accounts payable, other payables and accrued liabilities, current amounts due to affiliates, current portion of capital lease obligations, and current portions of debt approximate their fair values due to their short maturities. The carrying value of the long term loans approximates their fair values due to their variable interest rates. The estimated fair value of the long term loans is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for debt with similar terms. The Group has put and call options to acquire certain minority interests in its variable interest entities in India and Thailand. For entities in India, the put and call options are exercisable at anytime at fair value. For the entities in Thailand, the put and call options are exercisable at anytime at a nominal value. Comprehensive income US GAAP requires that all items that are required to be recognised as components of comprehensive income be reported in a separate financial statement. There are no material Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS differences between total recognised gains and losses for the years ended 31 December 2002 and 2003 and for the six months ended 30 June 2004 shown in the Combined Statements of Changes in Equity presented under Hong Kong GAAP and the Consolidated Statements of Changes in Equity presented under US GAAP, except for the differences between Hong Kong and US GAAP profit attributable to shareholders shown above. Risk and Uncertainties The relevant telecommunications governing authorities have retained the right, to a certain extent, to modify the terms and conditions of licence agreements at any time if in its opinion it is necessary or expedient to do so in the interest of the general public or for the proper operation of the telecommunications sector. This includes the right to permit additional telecommunications operators to enter the telecommunications sector at any time the governing authorities see fit. Further, the Group is exposed to the following types of market risk: (i) Credit risk The carrying amount of accounts receivable included in the balance sheet represents the Group s exposure to credit risk in relation to its financial assets. The Group s receivables are unsecured to the extent they are not covered by security deposits. The Group believes that adequate provision for uncollectible accounts receivable has been made. (ii) Interest rate risk The Group is exposed to changes in interest rates due to its long-term debt obligations. The Group enters into debt obligations to support general corporate purposes including capital expenditures, acquisitions, and working capital needs. The Group has entered into certain interest swap arrangements as described in Note 21. (iii) Foreign currency risk The Group has assets and liabilities that are subject to fluctuations in foreign currency exchange rates. The Group has entered into certain foreign currency swap instruments as described in Note 21 to reduce its economic exposure to changes in the exchange rates related to debt obligations in Thailand and India. The Group also had non-HK$ denominated bank balances amounting to HK$719 million and HK$765 million as of 31 December 2003 and 30 June 2004, respectively. The Group has foreign currency denominated bank loans, the details of which are disclosed in Note 21. Pensions The Group s major pension plans are in Hong Kong and India. The Group s subsidiary companies in Hong Kong participate in two employer plans, as established by HWL (multiemployer plans). The allocation to the annual pension cost to the companies and contributions to the plan have been determined on actuarial basis. In addition, all employees of the subsidiary companies in India are entitled to receive benefits from a provident fund. The employee and the employer both make monthly contributions to the plan. The Group s monthly contributions are expensed as incurred. Table of Contents HUTCHISON TELECOMMUNICATIONS INTERNATIONAL LIMITED NOTES TO THE COMBINED ACCOUNTS (Loss) income per share In accordance with SFAS No. 128, Computation of Earnings per Share , basic (loss) income per share for the years ended 31 December 2002 and 2003 and for the six months ended 30 June 2003 and 2004 is based upon the net loss attributable to shareholders of HK$844 million, HK$358 million, HK$135 million, and net income attributable to shareholders of HK$647 million, respectively, and the weighted average of 4.5 billion ordinary shares issued upon the Restructuring subsequent to 30 June, 2004, as described in Note 1 as if such shares had been outstanding for all periods presented. The amount of diluted earnings (loss) per share is equal to basic earnings (loss) per share as there were no potential dilutive ordinary shares in existence for the periods presented. Kesselman & Kesselman Certified Public Accountants (Israel) Amikam Cohen Alan Gelman Ben-Zion Zilberfarb Chief Executive Officer Chief Financial Officer Director The accompanying notes are an integral part of the financial statements. (Concluded) The accompanying notes are an integral part of the financial statements. The accompanying notes are an integral part of the financial statements. * Representing an amount less than NIS 1,000. The accompanying notes are an integral part of the financial statements. * Representing an amount less than NIS 1,000. The accompanying notes are an integral part of the financial statements. Cash Flows From Investing Activities: Purchase of fixed assets (601,050 ) (599,769 ) (350,344 ) (80,005 ) Proceeds from sale of fixed assets 1,771 5,737 12,309 2,811 Investment in non-marketable securities (16,446 ) Withdrawal of security deposit 98,917 22,589 Purchase of additional spectrum (207,635 ) (121,388 ) (27,720 ) Funds in respect of employee rights upon retirement (13,336 ) (14,301 ) (16,263 ) (3,714 ) Net cash used in investing activities (629,061 ) (815,968 ) (376,769 ) (86,039 ) (Continued) The accompanying notes are an integral part of the financial statements. (Concluded) Supplementary information on investing activities not involving cash flows At December 31, 2001, 2002 and 2003, trade payables include NIS 148,276,000, NIS 117,406,000 and NIS 65,681,000 ($14,999,000), respectively, in respect of acquisition of fixed assets. In addition, at December 31, 2002, trade payables include NIS 7.2 million in respect of acquisition of additional spectrum and at December 31, 2003, shareholders equity include NIS 4.4 million receivable in respect of shares issued. These balances are recognized in the cash flow statements upon payment. The accompanying notes are an integral part of the financial statements. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 SIGNIFICANT ACCOUNTING POLICIES a. General: Nature of operations: 1) Partner Communications Company Ltd. ( the Company ) operates a mobile telecommunications network based upon the Global System for Mobile Communications ( GSM ) Standard in Israel. 2) The Company was incorporated on September 29, 1997. The Company operates under a license granted by the Ministry of Communications to operate a cellular telephone network for a period of 10 years beginning April 7, 1998. At the beginning of January 1999, the Company commenced full commercial operations. The Company paid a one-time license fee of approximately new Israeli shekels (NIS) 1.6 billion which is presented under license and deferred charges . The Company is entitled to request extension of the license for an additional period of six years and then renewal for one or more further six year periods. Should the license not be renewed, the new license-holder is obliged to purchase the communications network and all the rights and obligations of the subscribers for a fair price, as agreed between the parties or as determined by an arbitrator. In December 2001, the Company was awarded additional spectrum (2G band (1800MHz) and third generation (3G) UMTS band (1900MHz and 2100MHz)). Following the award of the above spectrum, the Company s license was amended and extended through 2017. During June 2002, the Minister of Communications amended and further extended the license through 2022. As to the change in estimate of the useful life of the license see also note f(1) below. In consideration for the above additional spectrum the Company paid NIS 180 million ($41 million) for the 2G spectrum, and is committed to pay NIS 220 million ($50 million) for the 3G spectrum in six installments through 2006. Out of this amount, approximately NIS 130 million (approximately $30 million) was paid as of December 31, 2003. Under the terms of the amended license, the Company has provided a guarantee in NIS equivalent of $ 10 million to the State of Israel to secure the Company s adherence to the terms of the license. 3) The Company will incur substantial capital expenditures in building out the 3G network. The Company estimates that capital expenditures in connection with building out the 3G network will be approximately $250 million over the next three years from the beginning of the network build-out, see also note 8a(3). Use of estimates in the preparation of financial statements The preparation of financial statements in conformity with generally accepted accounting principles ( GAAP ) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting years. Actual results could differ from those estimates. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Functional currency and reporting currency The functional currency of the Company and its subsidiary is the local currency New Israeli Shekels NIS. The consolidated financial statements have been drawn up on the basis of the historical cost of Israeli currency and are presented in NIS. Convenience translation into U.S. dollars ( dollars or $ ) The NIS figures at December 31, 2003 and for the year then ended have been translated into dollars using the representative exchange rate of the dollar at December 31, 2003 ($1 = NIS 4.379). The translation was made solely for convenience. The translated dollar figures should not be construed as a representation that the Israeli currency amounts actually represent, or could be converted into, dollars. Accounting principles The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). b. Principles of consolidation: 1) The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary (together the Group). 2) Intercompany balances between the Company and its subsidiary have been eliminated. c. Inventories Inventories of cellular telephones (handsets) and accessories are stated at the lower of cost or estimated net realizable value. Cost is determined on the first-in, first-out basis. d. Non-marketable securities These investments are stated at cost, less provision for impairment losses, see also note 2. e. Fixed assets: 1) These assets are stated at cost, handsets for use abroad by subscribers are carried by the base stock method. 2) Direct consultation and supervision costs and other direct costs relating to setting up the Company s communications network and information systems for recording and billing calls are capitalized to cost of the assets. 3) Interest costs in respect of loans and credit which served to finance the construction or acquisition of fixed assets incurred until installation of the fixed assets is completed are capitalized to cost of such assets. Communications network 10-20 (mainly 15) Computers, hardware and software for information systems 15-33 Vehicles 20 Office furniture and equipment 7-15 Leasehold improvements are amortized by the straight-line method over the term of the lease, or the estimated useful life of the improvements, whichever is shorter. The Company terminated the lease agreement for one of its headquarter buildings in March 2003, in favor of a new building (see note 8a(2)b) and abandoned part of its leasehold improvements. Following the decision to abandon the leasehold improvements, in October 2002, the unamortized balance of the existing leasehold improvements was amortized on a straight-line basis as of October 1, 2002 over the period of 6 months ending March 31, 2003. 5) Computer Software Costs The cost of internal-use software is capitalized in accordance with Statement of Position (SOP) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software to perform a task it previously did not perform. Software maintenance and training costs are expensed in the period in which they are incurred. Capitalized computer software costs are amortized using the straight-line method over a period of 5 to 7 years. f. License and deferred charges: 1) License: The license (see also 1a(2) above) is stated at cost and is amortized by the straight-line method over the utilization period of the license starting January 1, 1999. Through the period ended December 31, 2001 the license was amortized over 9.25 years. Following the extensions of the license (as described in note 1a(2) above) the unamortized balance of the Company s existing license as well as the cost of the additional spectrum put into service are amortized on a straight-line basis as follows: as of January 1, 2002 over the period ending in 2017; as of April 1, 2002 over the period ending in 2022. The costs relating to the 3G band are not amortized since the utilization period has not yet commenced. As a result of the above extensions, in 2002, and 2003 license amortization expenses (included in cost of services revenues ) decreased by approximately NIS 113 million and NIS 117 million, (approximately $27 million), respectively, net income increased by approximately NIS 113 million and NIS 75 million ($17 million), respectively, and earnings per share increased by NIS 0.63 and NIS 0.41 ($0.09), respectively compared to the figures computed based on the amortization rates used prior to the changes in the estimated useful life. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Interest expenses which served to finance the license fee incurred until the commencement of utilization of the license are capitalized to cost of the license. During the year 2002 and 2003 NIS 7 million and NIS 10 million ($2 million) interest costs were capitalized to the cost of the license, respectively. 2) Deferred charges: a) Costs relating to the obtaining of long-term credit lines are amortized using the effective interest rate stipulated for the borrowing transactions. b) Issuance costs relating to Notes payable (see note 6) are amortized using the effective interest rate stipulated for the Notes. g. Impairment of long-lived assets The Company has adopted Statement of Financial Accounting Standards No. 144 (FAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets effective January 1, 2002. FAS 144 requires that long-lived assets, to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Under FAS 144, if the sum of the expected future cash flows (undiscounted and without interest charges) of the long-lived assets is less than the carrying amount of such assets, an impairment loss would be recognized, and the assets written down to their estimated fair values. The adoption of FAS 144, on January 1, 2002, did not have any impact on the consolidated financial position and results of operations. h. Cash equivalents The Company considers all highly liquid investments, which include short-term bank deposits (up to 3 months from date of deposit) that are not restricted as to withdrawal or use, to be cash equivalents. i. Comprehensive income The Company has no comprehensive income components other than net income (loss). j. Revenue recognition Service revenues are based on usage and recognized at the time the service is provided, net of credits and adjustments for service discounts. Sales of equipment, primarily handsets and wireless data devices, are recognized upon delivery to the customer. Prepaid calling cards revenues are deferred until service is provided. Emerging Issues Task Force ( EITF ) Issue 00-21, Revenue Arrangements with Multiple Deliverables addresses the accounting, by a vendor, for contractual arrangements in which multiple revenue-generating activities will be performed by the vendor. It is effective prospectively for all arrangements entered into in fiscal periods beginning after June 15, 2003. EITF Issue 00-21 addresses when and, if so, how an arrangement involving multiple deliverables should be Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS divided into separate units of accounting. The Company adopted EITF Issue 00-21 in the year ended December 31, 2003 and it had no impact on its financial position and results of operations. k. Concentration of credit risks allowance for doubtful accounts The Company s revenues are derived from a large number of customers. Accordingly, the Company s trade balances do not represent a substantial concentration of credit risk. An appropriate provision for doubtful accounts is included in the accounts of the Company. The allowance charged to expenses (including bad debts), determined as a percentage of specific debts doubtful of collection for the years ended December 31, 2001, 2002 and 2003 totaled NIS 15,399,000, NIS 17,752,000 and NIS 15,601,000 ($ 3,563,000) (see also note 13a), respectively. The cash and cash equivalents as of December 31, 2003 are deposited mainly with leading Israeli banks. Therefore, in the opinion of the Company, the credit risk inherent in these balances is remote. The Company factors most of its long-term trade receivables resulting from sales of handsets. The factoring is made through clearing companies, on a non-recourse basis. The sale of accounts receivable was recorded by the Company as a sales transaction under the provisions of Statement of Financial Accounting Standards No.140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities . The resulting costs are charged to financial expenses-net , as incurred. During the years ended December 31, 2001, 2002 and 2003, the Company factored NIS 180,302,000, NIS 209,568,000 and NIS 295,827,000 ($67,556,000), respectively, from long-term trade receivables. l. Handsets warranty obligations Until the year 2002 provision for warranty was not provided for, as the Company s liability was covered by the handsets suppliers warranty. As of 2002, the Company has entered into several agreements under which the supplier does not provide any warranty but rather provides additional handsets to satisfy its warranty obligation. In these cases, the Company provides for warranty costs at the same time as the revenues are recognized. The annual provision is calculated at the rate of 1.5%-3.5% of the cost of the handsets sold. As of December 31, 2002 and 2003, the provision for warranty totaled NIS 2,589,000 and NIS 2,053,000 ($469,000), respectively. Additional warranty liability incurred for the year ended December 31, 2003 totaled NIS 4,215,000 ($963,000). Warranty expenses for the years ended December 31, 2002 and 2003 totaled NIS 2,589,000 and NIS 4,751,000 ($1,085,000), respectively. m. Advertising expenses Advertising expenses are charged to the statement of operations as incurred. Advertising expenses for the years ended December 31, 2001, 2002 and 2003 totaled NIS 91,681,000, NIS 96,061,000 and NIS 99,061,000 ($ 22,622,000), respectively. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS n. Deferred income taxes Deferred taxes are determined utilizing the asset and liability method, based on the differences between the amounts presented in these financial statements and those taken into account for tax purposes, in accordance with the applicable tax laws. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized (see also note 10d). Deferred tax assets and liabilities are presented as current or long-term items in accordance with the nature of assets or liabilities to which they relate. Deferred tax assets in respect of carryforward tax losses are presented as current or long-term assets, according to their expected utilization date. o. Foreign currency transactions and balances Balances in, or linked to, foreign currency are stated on the basis of the exchange rates prevailing at balance sheet dates. For foreign currency transactions included in the statements of operations, the exchange rates at transaction dates are used. Transaction gains or losses arising from changes in the exchange rates used in the translation of such balances are carried to financial income or expenses. p. Derivative financial instruments ( derivatives ) The Company has adopted FAS 133 as of January 1, 2001. FAS 133, as amended, establishes accounting and reporting standards for derivatives, including certain derivatives embedded in other contracts, and for hedging activities. Under FAS 133, all derivatives are recognized on the balance sheet at their fair value. On the date that the Company enters into a derivative contract, it designates the derivative, for accounting purposes, as: (1) hedging instrument, or (2) non-hedging instrument. Any changes in fair value are to be reflected as current gains or losses or other comprehensive gains or losses, depending upon whether the derivative is designated as a hedge and what type of hedging relationship exists. Changes in fair value of non-hedging instruments are carried to financial expenses net on a current basis. To date, the Company did not have any contracts that qualify for hedge accounting under FAS 133. The Company occasionally enters into commercial (foreign currency) contracts in which a derivative instrument is embedded . This embedded derivative is separated from the host contract and carried at fair value when (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract and (2) a separate, stand-alone instrument with the same terms would qualify as a derivative instrument. The adoption of FAS 133 resulted in recording additional income of approximately NIS 3.5 million included in the statement of operations of 2001 under cumulative effect, at beginning of year, of a change in accounting principles , which was recorded against an asset in the balance sheet, of the same amount. This cumulative effect reflects the fair value of embedded derivatives (see also note 12b.) as of that date. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS q. Earning (loss) Per Share (EPS) Basic EPS is computed by dividing net income (loss) by the weighted average number of shares outstanding during the years. Diluted EPS reflects the increase in the weighted average number of shares outstanding that would result from the assumed exercise of employee stock options, calculated using the treasury-stock-method (in 2001, such effect was not included since it would have been anti-dilutive). r. Stock based compensation The Company accounts for its employee stock option plans using the treatment prescribed by APB No. 25, Accounting for Stock Issued to Employees and related interpretations. Under APB 25, compensation cost for employee stock option plans is charged to shareholders equity, on the date of grant of the options, under deferred compensation costs and is then amortized over the vesting period using the accelerated method of amortization. FAS No. 123 Accounting for Stock-Based Compensation , establishes a fair value based method of accounting for employee stock options or similar equity instruments, and encourages adoption of such method for stock compensation plans. However, it also allows companies to continue to account for those plans using the accounting treatment prescribed by APB 25. The Company has elected to continue accounting for employee stock option plans according to APB 25, and accordingly discloses pro forma data assuming the Company had accounted for employee stock option grants using the fair value based method as defined in FAS 123. The weighted average fair value of options granted using the Black & Scholes option-pricing model during 2001, 2002 and 2003 is NIS 18.08, NIS 16.68 and NIS 26.96 ($6.16), respectively. The fair value of each option granted is estimated on the date of grant based on the following weighted average assumptions: weighted average dividend yield of 0%; expected volatility of 83%, 69% and 62%, respectively; risk-free interest rate in NIS terms: 2001 6.9%, 2002 7.7%, 2003 4.5 %; weighted expected life: the 1998 plan 2002 9 years, 2001 8 years; the 2000 plan 9 years. s. Accounting for asset retirement obligations The Company has adopted as of January 1, 2003 FAS 143 Accounting for Asset Retirement Obligations ( FAS 143 ). FAS 143 requires that an asset retirement obligation (ARO) associated with the retirement of a tangible long lived asset be recognized as a liability in the period in which it is incurred and becomes determinable (as defined by the standard), with an offsetting increase in the carrying amount of the associated asset. The cost of the tangible asset, including the initially recognized ARO, is depreciated such that the cost of the ARO is recognized over the useful life of the asset. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The ARO is recorded at fair value, and the accretion expense will be recognized over time as the discounted liability is accreted to its expected settlement value. The fair value of the ARO is measured using expected future cash out flows discounted at the Company s credit-adjusted risk-free interest rate. The Company is subject to asset retirement obligations associated with its cell sites operating leases. These lease agreements contain clauses requiring restoration of the leased site at the end of the lease term, creating asset retirement obligations, see also note 13c. t. Recently issued accounting pronouncements: 1) FAS 132 (revised 2003) In December 2003, the FASB issued FAS No. 132 (revised 2003), Employers Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB Statement No. 132 ( FAS 132 (revised 2003) ) . This Statement revises employers disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans. The new rules require additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. Part of the new disclosures provisions are effective for 2003 calendar year-end financial statements, and accordingly have been applied by the Company in these consolidated financial statements. The rest of the provisions of this Statement, which have a later effective date, are currently being evaluated by the Company. 2) FIN 46 In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). Under FIN 46, entities are separated into two populations: (1) those for which voting interests are used to determine consolidation (this is the most common situation) and (2) those for which variable interests are used to determine consolidation. FIN 46 explains how to identify Variable Interest Entities (VIEs) and how to determine when a business enterprise should include the assets, liabilities, noncontrolling interests, and results of activities of a VIE in its consolidated financial statements. Since issuing FIN 46, the FASB has proposed various amendments to the Interpretation and has deferred its effective dates. Most recently, in December 2003, the FASB issued a revised version of FIN 46 (FIN 46-R), which also provides for a partial deferral of FIN 46. This partial deferral established the effective dates for public entities to apply FIN 46 and FIN 46-R based on the nature of the variable interest entity and the date upon which the public company became involved with the variable interest entity. In general, the deferral provides that (i) for variable interest entities created before February 1, 2003, a public entity must apply FIN 46-R at the end of the first interim or annual period ending after March 15, 2004, and may be required to apply FIN 46 at the end of the first interim or annual period ending after December 15, 2003, If the variable interest entity is a special purpose entity, and (ii) for variable interest entities created after January 31, 2003, a public company must apply FIN 46 at the end of the first interim or annual period ending after December 15, 2003, as previously required, and then apply FIN 46-R at the end of the first interim or annual reporting period ending after March 15, 2004. * As of December 31, 2003 NIS 153,773,000 ($35,116,000) (December 31, 2002 NIS 106,719,000) in respect of 3G band spectrum are not amortized, see also note 1f(1). License amortization expenses for the years ended December 31, 2001, 2002 and 2003 totaled NIS 169,693,000, NIS 62,042,000 and NIS 58,408,000 ($13,338,000), respectively. Amortization expenses December 31, 2003 383 150 150 683 2004 356 150 150 656 2005 266 150 141 557 2006 172 150 114 436 2007 62 150 84 296 2008 0 0 72 72 June 30, 2009 0 0 0 0 f. Under the amended facility the Company is required, inter alia, to fulfill certain operational conditions and to maintain certain financial ratios. If the Company defaults on the covenants, the banks are entitled to demand early repayment of the credit facility in whole or in part. The Company believes that it is in compliance with all covenants stipulated by the August 15: 2005 106.500 % 2006 104.333 % 2007 102.167 % 2008 and thereafter 100.000 % On December 31, 2003, the Notes closing price was 119 points. Commission fees and offering expenses in respect of the Notes totaled approximately NIS 22 million. These expenses are presented as deferred charges and the amortization in respect thereof is included in financial expenses, net . The Company was obligated to keep a restricted deposit in the amount of one year of interest payment until December 31, 2003, which was deposited and was presented in the balance sheet under security deposit . On December 31, 2003, the deposit was withdrawn. NOTE 7 LIABILITY FOR EMPLOYEE RIGHTS UPON RETIREMENT: a. Israeli labor laws and agreements require payment of severance pay upon dismissal of an employee or upon termination of employment in certain other circumstances. The Company s severance pay liability to its employees, mainly based upon length of service and the latest monthly salary (one month s salary for each year worked), is reflected by the balance sheet accrual under the liability for employee rights upon retirement . The Company records the liability as if it was payable at each balance sheet date on an undiscounted basis. The liability is partly funded by purchase of insurance policies and the amounts funded are included in the balance sheet under investments and long-term receivables, as funds in respect of employee rights upon retirement . The policies are the Company s assets and under labor agreements, subject to certain limitations, they may be transferred to the ownership of the beneficiary employees. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS b. The severance pay expenses for the years ended December 31, 2001, 2002 and 2003 were approximately NIS 21,113,000, NIS 24,094,000 and NIS 19,723,000 (approximately $4,333,000), respectively. c. The Company expects to contribute in 2004, NIS 68,500,000 ($15,643,000) in respect of its severance pay and retirement obligation. NOTE 8 COMMITMENTS AND CONTINGENCIES: a. Commitments: 1) Royalty Commitments The Company is committed to pay royalties to the Government of Israel on its income from cellular services as defined in the Regulations (see below), which includes all kinds of turnover of the licensee from the granting of Bezeq services under the license including airtime, roaming services and non-recurring connection fees, but excluding: bad debts, income transferred to another holder of a communications license or payments to another communication licensee in respect of interconnection, payments for roaming services to foreign operators and expenses related to the sale of equipment. On June 18, 2001, the Knesset s Finance Committee approved the Telecommunications (Royalties) Regulations, 2001 (hereafter the Regulations). The principal change to the old regulations was the reduction of the percentage of royalties payable by mobile phone companies from 8% to 5% in 2001, 4.5% in 2002 , 4% in 2003 and 3.5% in 2004 and thereafter. In addition, the basis in respect of which the royalties are paid has been expanded (as described above). The amendment is effective as from January 1, 2001. The royalty expenses for the years ended December 31, 2001, 2002 and 2003 were approximately NIS 112,201,000, NIS 117,281,000 and NIS 119,387,000 (approximately $27,264,000), respectively, and are included under cost of services revenues . 2) Operating leases The Company has entered into operating lease agreements as follows: (a) Lease agreements for its headquarters facility in Rosh Ha ayin for a fifteen year period (until 2018). The Company has an option to shorten the lease periods by 3.5 to 8.5 years. The rental payments are linked to the Israeli CPI. (b) Lease agreements for service centers and retail stores for a period of two to five years. The Company has an option to extend the lease periods for up to twenty additional years (including the original lease periods). The rental payments are linked partly to the dollar and partly to the Israeli CPI. (c) Lease agreements in respect of cell sites throughout Israel are for periods of two to three years. The Company has an option to extend the lease periods up to ten additional years (including the original lease periods). The rental payments fees are partly linked to the dollar and are partly linked to the Israeli CPI. (d) Operating lease agreements in respect of vehicles are for periods of three years. The rental payments are linked to the Israeli CPI. (f) The rental expenses for the years ended December 31, 2001, 2002 and 2003 were approximately NIS 93 million, NIS 113 million, and NIS 163 million (approximately $37 million), respectively. 3) During November 2003, the Company entered into an agreement with Nortel Networks Israel (Sales and Marketing) Ltd. ( Nortel ) for the supply, maintenance and support of a 3G system and the provision of related services, see also note 1a(3). The Agreement is divided into two phases: (a) First phase scheduled for the year 2004: For the sum of approximately $15 million. Payment is due only after Nortel meets certain milestones in accordance with the project plan and other applicable terms, provisions and requirements as defined in the agreement. The payment is subject to an Acceptance Tests Procedure ( ATP ), during which the equipment and the system delivered during the first phase undergo a series of specific and detailed acceptance tests. (b) Second phase: The agreement serves as a framework agreement, under which the Company may purchase, from time to time, any equipment and services on a purchase order basis. The payments in respect of this phase are also subject to the ATP as described above. According to Company s current purchase forecasts the second phase is scheduled for the years 2004-2007 for the total sum of approximately $78 million. 4) At December 31, 2003, the Company is committed to acquire fixed assets (including the first phase of the Nortel agreement), as described above, for approximately NIS 160 million (approximately $ 36 million). 5) At December 31, 2003, the Company is committed to acquire handsets for approximately NIS 162 million (approximately $ 37 million). Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6) As to the Company s commitment to pay NIS 107 million (approximately $ 23 million) regarding the award of the new spectrum, see note 1a. b. Contingencies: 1) On October 28, 1999, an Israeli consumer organization lodged a claim against the Company, alleging a variety of consumer complaints and requested that this claim be recognized as a class action. On March 20, 2002, the Haifa District Court decided to strike the claim, because the consumer organization lost, on December 31, 2001, a special status required under Israeli law for consumer organizations to file class action claims. Another claim, involving a substantial amount, which was filed by a private consumer who had previously asked to join the above class action, has been brought again before the court. The court had previously frozen the proceedings of the private consumer s claim, until a decision was made in the case filed by the consumer organization. On May 25, 2003, the private consumer filed a request to amend his motion to file a class action claim and the proposed claim itself, and also a draft of the proposed amended motion and claim. The motion to amend was granted and on January 21, 2004, the Company has submitted its response to the certification motion. While the amount of the claim is substantial, the ultimate liability cannot be determined because of the considerable uncertainties that exist. At this stage, unless and until the claim is certified as class action, the Company and its legal council are unable to evaluate the probability of success of such claim and therefore no provision has been made. In addition, the Company and its legal advisers are of the opinion that in light of the facts known at this early stage, the chances that a material amount would be ordered in favor of the plaintiffs are low. 2) On July 8, 2001, a claim was filed against the Company for alleged violation of supplier s exclusivity agreement. For filing purposes, the claim was set at NIS 18 million; however, this amount can be increased by the claimant. At this stage, since preliminary proceedings between the parties are yet to take place, and the claim concerns a contract interpretation issue, the Company and its legal counsel are unable to evaluate the probability of success of the said litigation, and therefore no provision has been made. 3) On April 8, 2002, a claim was filed against the Company, together with a motion to certify this claim as a class action, alleging a variety of consumer complaints. The amount of the claim against the Company is estimated at approximately NIS 545 million plus additional significant amounts relating to other alleged damages. Only a preliminary hearing has taken place and another preliminary hearing is set for March 28, 2004. At this stage, and until the claim is certified as a class action, the Company and its legal council are unable to evaluate the probability of success of such claim, and therefore no provision has been made. In addition the Company and its legal council are of the opinion that even if the request to approve this claim as a class action is granted, and even if the plaintiff s arguments are Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS accepted, the outcome of the claim will be significantly lower than the abovementioned amount. 4) On April 13, 2003 a claim was filed against the Company and other cellular telecommunication companies, together with a request to approve this claim as a class action, for alleged violation of antitrust law, alleging that no fee should have been collected for incoming SMS messages or alternatively, that the fee collected is excessive and that it is a result of illegal co-operation between the defendants. The amount of the claim against all the defendants is estimated at approximately NIS 90 million. The Company has filed its response on October 1, 2003. At this stage, no hearings have taken place and unless and until the claim is certified as a class action, the Company and its legal council are unable to evaluate the probability of success of such claim, and therefore no provision has been made. 5) The Company does not have building permits for many of its cell sites and as a result is involved in numerous legal actions (including criminal proceedings against officers and directors) relating to this issue. Most of these proceedings have been settled under plea bargain arrangements, whereby the Company has paid fines of insignificant amounts. Management, based upon current experience and the opinion of legal counsel, does not believe that these legal actions will result in significant costs to the Company. The accounts do not include a provision in respect thereof. 6) The Company is a party to various claims arising in the ordinary course of its operations. Management, based upon the opinion of its legal counsel, is of the opinion that the ultimate resolution of these claims will not have a material effect on the financial position of the Company. The accounts do not include a provision in respect thereof. 7) On July 15, 2003, the Ministry of Communications decided to decrease the deduction rate in respect of payments that Bezeq The Israel Communication Corp. Limited fails to collect from its customers for using the Company s network to 1.1% from 2.5%. The decision is effective retroactively for the period from October 2, 2000 and through August 31, 2003. As from September 1, 2003 the deduction rate was cancelled altogether. Bezeq has lodged an appeal with the Jerusalem District Court against the Minister s decision. On January 6, 2004, the Supreme Court within the framework of Partner s appeal against the District Court s verdict in respect of previous case between the parties, that related to Bezeq s failure to collect payments from its customers for using the Company s network for calls from fixed lines to mobile lines ruled that the Minister s decision concerning the aforementioned deduction of 1.1% shall also apply to the period from March 1, 2000 to October 2, 2000, and that this deduction rate shall remain in effect or shall be amended in accordance with the outcome of the appeal lodged by Bezeq against the aforesaid decision of the Minister. At this stage, since preliminary proceedings are yet to take place, the Company and its legal counsel are unable to evaluate the probability of success of the appeal, therefore the effect of the Ministry of Communication s decision on the Company s results (income of approximately NIS 19.5 million), was not recognized. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 SHAREHOLDERS EQUITY (CAPITAL DEFICIENCY): a. Share capital: The Company s shares are traded on the Tel-Aviv stock exchange (TASE), on the London Stock Exchange ( LSE ) and, in the form of American Depository Receipts ( ADRs ), each represent one ordinary share, on the NASDAQ National Market ( Nasdaq NM ). During 2001, the Company listed its shares in the according to the dual listing regulations. On December 31, 2003, the closing price per ADR on the Nasdaq NM was $7.84; the Company s shares were quoted on that date on the LSE at $7.70, and on the TASE at NIS 34.46 ($7.87). Under the provisions of the license granted to the Company (note 1a(2)), restrictions are placed on transfer of Company shares and placing liens thereon. The restrictions include the requirement that the advance written consent of the Minister of Communications be received prior to transfer of 10% or more of the Company s shares to a third party. On December 26, 2001, the Company filed a shelf registration statement on Form F-3 with the United States Securities and Exchange Commission for future offerings of its securities. Under the shelf registration, the Company can raise up to $400 million from the issue of ordinary shares and debt securities. b. Employee stock option plans: 1) a. On March 3, 1999, the Company s Board of Directors approved an employee stock option plan (hereafter the 1998 Plan ), pursuant to which 5,833,333 ordinary shares were reserved for issuance upon the exercise of 5,833,333 options to be granted to key employees without consideration, of which 729,166 options were later cancelled. Through December 31, 2003 5,505,557 options have been granted pursuant to the 1998 Plan, of which 3,538,436 options have been exercised and 590,373 options have been forfeited (options forfeited are available for subsequent grants). The options vest in five equal annual batches over a period of five years from the beginning of employment of each employee, unless otherwise provided in the grant instrument, provided the employee is still in the Company s employ. An option not exercised within 8 years from the date of its allotment shall expire. The exercise price per share of the options granted through December 31, 2000, which is denominated in dollars, is $ 0.343. During 2002, the Company granted options under the 1998 Plan in accordance with the terms of the 2000 plan, including the exercise price, vesting schedule and expiration date (see b. below). As of December 31, 2003 188,983 options of the 1998 Plan remain ungranted. b. In October 2000, the Company s Board of Directors approved an employee stock option plan (hereafter the 2000 Plan ), pursuant to which 4,472,222 ordinary shares were reserved for issuance upon the exercise of 4,472,222 options to be granted to employees without consideration. The options vest in four equal annual batches over a period of four years from the date of grant of the option, provided the employee is still in the Company s employ. The option holder may exercise all or part of his options at any time after the date Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of vesting but no later than the expiration of the exercise period, which will fixed by the Employee Stock Option Committee and will not exceed ten years from the date of option grant. The NIS denominated exercise price per share of the options, is equal to the market price of the Company s shares on the date on which the options are granted. During November 2003, 419,930 options of this plan were transferred to options under the 2003 amendment Plan (see c. below). Through December 31, 2003 5,317,555 options were granted pursuant to the 2000 Plan, of which 268,250 options have been exercised, 1,219,833 options have been forfeited and 60,250 expired (options forfeited are available for subsequent grants). As of December 31, 2003 14,820 options of the 2000 Plan remain ungranted. c. On November 13, 2003, the Company s Board of Directors approved an amendment to the terms and provision of the 2000 Plan, in order to adjust the terms of the 2000 Plan to comply with new tax legislation that came into force in January 2003. On December 2003, the Company offers the employees, who received options under the 2000 plan, to exchange their unvested options, with the same amount of identical options, under the amended plan and to benefit from the capital gain s tax route pursuant to Section 102(b)(2) of the Israeli Income Tax Ordinance. Employees holding options to purchase 962,104 ordinary shares accepted this offer. On December 30, 2003, the Company s Board of Directors approved the grant of 195,000 options, under the 2003 amended Plan with an exercise price of NIS 20.45 which was less than the market price on the date of grant. As of December 31, 2003 224,930 options of the 2003 amended Plan remain ungranted. d. The ordinary shares derived from the exercise of the options confer the same rights as the other ordinary shares of the Company. e. The plans are subject to the terms stipulated by Section 102 of the Israeli Income Tax Ordinance. Inter alia, these terms provide that the Company will be allowed to claim, as an expense for tax purposes, the amounts credited to the employees as a benefit in respect of shares or options granted under the plans, as follows: Through December 31, 2003, the amount that the Company will be allowed to claim as an expense for tax purposes will be the amount of the benefit taxable in the hands of the employee. From January 1, 2004, the amount that the Company will be allowed to claim as an expense for tax purposes, will be the amount of the benefit taxable as work income in the hands of the employee, while that part of the benefit that is taxable as capital gains in the hands of the employee shall not be allowable. All the above is subject to the restrictions specified in Section 102 of the Income Tax Ordinance. The aforementioned expense for tax purposes will be recognized in the tax year that the employee is taxed, except as described below. In December 2002, the Company signed an agreement with the tax authorities concerning the tax liabilities of its employees regarding the benefit arising from the options granted to them. According to the agreement, the individual tax rate on the taxable income received by The Company analyzes its deferred tax asset with regard to potential realization. The Company s determination of the realizability of its net deferred tax asset involves considering all available evidence, both positive and negative, regarding the likelihood of sufficient future income. The methodology used involves estimates of future income, which assumes ongoing profitability of its business. These estimates of future income are projected through the life of the deferred tax asset using assumptions which management believes to be reasonable. As of December 31, 2002, the Company had carryforward tax losses of approximately NIS 2,000 million and timing differences of approximately NIS 300 million. The Company did not have a substantial record of utilization of the carryforward tax losses (the Company had its first net income during 2002), and the Company had not been assessed for tax purposes since incorporation. Consequently, management s assessment was, that a full valuation allowance should be established. Based on the methodology described above, the Company s updated estimates of its future earnings and profitability, assessments relating to the cellular market and trends, and the receipt of final tax assessments for the tax years through December 31, 2001, which validated the amount of the carryforward tax losses, the Company concluded that a valuation allowance is no longer necessary. Accordingly, a valuation allowance of approximately NIS 653 million (approximately $149 million) was reversed during 2003. The carryforward tax losses are linked to the Israeli CPI and can be utilized indefinitely. During the year 2003, the Company utilized NIS 450 million ($103 million) of its carryforward tax losses. As of December 31, 2003, the Company would require approximately NIS 1,760 million of future taxable income in order to fully realize the related deferred tax assets. A full valuation allowance was provided in respect of the wholly-owned subsidiary, as it is more likely than not that its deferred tax assets will not be realized. A valuation allowance was provided in respect the portion of tax benefits arising from options granted to employees, which will not be realized. * Long-term trade receivables (including current maturities) as of December 31, 2002 and 2003 in the amount of NIS 4,561,000 and NIS 26,275,000 ($6,000,000), respectively, bear no interest. These balances are in respect of handsets sold in installments (mostly 36 monthly payments). Income in respect of deferred interest is the difference between the original and the present value of the trade receivable. The current amount is computed on the basis of the interest rate relevant to the date of the transaction (6.3% 10%). c. Cost sharing agreement The Company has entered into a Cost Sharing Agreement (the Agreement ) with Hutchison Telecommunications Limited, or HTL, and certain of its subsidiaries (hereafter the Hutchison group ). The principal purpose of the Agreement is to regulate the sharing of costs associated with various joint procurement and development activities relating to the roll out and operation of a 3G Business. The Agreement sets out the basis upon which expenses and liabilities are paid or discharged by the Hutchison group companies in connection with the joint procurement or development activities. Under the Agreement, the Company has the right to decide, and give notice of, which of the joint projects it wishes to participate in. As of December 31, 2003, the Company had given notice of its participation in six projects. The Company s expected share in these projects in financial terms (including its share of joint expenses and liabilities) is not material. Table of Contents PARTNER COMMUNICATIONS COMPANY LTD. (An Israeli Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 15 SUBSEQUENT EVENT On March 15, 2004, the Company signed a Memorandum Of Agreement ( MOA ) with Matav Cable Systems Media Ltd. ( Matav ) and its shareholders, Dankner Investments Ltd. and Delek Investments Ltd. , which are all considered related parties of the Company. Matav is one of Israel s three cable television providers and its shares are registered both in the US and Israel. The MOA sets out the principles for a transaction, under which the Company will purchase up to 40% of the shareholding of Matav in consideration for up to $137 million in cash, and receive control in Matav for a period of two years from the closing date. The transaction is subject to a number of conditions precedent, including, inter-alia, the approval of the parties respective boards of directors, as stipulated in the MOA, and other necessary corporate approvals. As of March 30, 2004, these conditions have not been met yet. The Company is examining a number of options to finance the transaction. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293314_snb_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293314_snb_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..38ab0e0ce7c2b98f2601b4af2c1c333254dc3c1c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293314_snb_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the validity of the shares of our common stock offered by this prospectus will be passed upon for by us by Bracewell Patterson, L.L.P., Houston, Texas. Certain legal matters with respect to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, Houston, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293330_net_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293330_net_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a96ac6b9b7f7a94295f0e12b38e5bca937f72386 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293330_net_legal_matters.txt @@ -0,0 +1 @@ +Table of Contents Tax treatment of the Distribution to the U.S. holders of Ener1 common stock as of the Ener1 Record Date This section summarizes certain U.S. federal income tax consequences of the distribution to U.S. holders. The term U.S. holder means the beneficial owner of Ener1 common stock that is: a citizen or resident of the United States, as defined for U.S. federal income tax purposes; a corporation created or organized in or under the laws of the United States or of any State; an estate the income of which is subject to U.S. federal income taxation regardless of its source; or a trust if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more United States persons have the authority to control all substantial decisions of the trust, or certain electing trusts that were in existence on August 20, 1996, and were treated as domestic trusts on the previous day. We and Ener1 are not aware of any authority directly on point indicating how the IRS will characterize the Distribution for federal income tax purposes. Ener1 intends to take the position that the Distribution will be treated as a distribution in respect of Ener1 common stock for federal income tax purposes. If the Distribution is so treated by the IRS, then the Distribution will be taxable to Ener1 shareholders to the extent of Ener1 s current or accumulated earnings or profits for the year in which the Distribution occurs. Ener1 has no historic cumulative earnings and profits and does not anticipate having any earnings and profits for 2004, the year in which Ener1 expects the Distribution to occur. If Ener1 has no current or accumulated earnings and profits for the year in which the Distribution occurs, then the Distribution would first reduce a U.S. holder s tax basis in its shares of Ener1 to the extent of the fair market value of the Splinex shares received, and after the basis is reduced to zero, would be taxable to the U.S. holder as capital gain. Any gain recognized would generally be treated as long-term capital gain if the U.S. holder held its Ener1 shares for more than one year as of the date of the Distribution. Non-corporate U.S. holders would generally be eligible for the 15% U.S. federal income tax rate in respect of long-term capital gains. A U.S. holder s basis in the shares of our common stock received would be equal to the fair market value of the Splinex shares received. If Ener1 has current or accumulated earnings and profits in the year the Distribution occurs, the Distribution would be taxable to the U.S. holders as a dividend based on the fair market value of the shares of our common stock received, but only to the extent of Ener1 s current or accumulated earnings and profits. If the fair market value of the shares of our common stock received in the Distribution exceeded Ener1 s current or accumulated earnings and profits, the excess would first reduce a U.S. holder s tax basis in its shares of Ener1 common stock and after the basis is reduced to zero, would be taxable as capital gains as described above. It is possible that the IRS may disagree with the characterization of the Distribution as a distribution in respect of Ener1 common stock for federal income tax purposes. While the tax consequences are uncertain, it is possible that, under these circumstances, the U.S. holders would be required to recognize ordinary income equal to the fair market value of our common stock received as a result of the Distribution. Tax treatment of the Distribution of our common stock to the non-U.S. holders of Ener1 common stock This section summarizes the U.S. federal income and consequences of the Distribution to a holder that is not a U.S. holder (a non-U.S. holder ). If, as anticipated, Ener1 has no current or accumulated earnings and profits during the year the Distribution occurs, the tax consequences of the Distribution to non-U.S. holders will be similar to that of U.S. holders in that the Distribution and would reduce a non-U.S. holder s tax basis in its shares of Ener1 common stock to the extent of the fair market value of the Splinex shares received. However, non-U.S. holders would not be subject to U.S. income tax if the fair market value of the Splinex shares received exceeded the basis of the non-U.S. holder s basis in its Ener1 shares. A non-U.S. holder s basis in the shares of our common stock received would be equal to the fair market value of the Splinex shares received. Pro forma net loss per basic and fully diluted share $ (822.85 ) $ (0.01 ) Table of Contents If Ener1 has either current or accumulated earnings and profits for the year in which the Distribution occurs, the Distribution would be treated as a taxable dividend to the extent of Ener1 s current and accumulated earnings and profits for federal income tax purposes. Non-U.S. holders would be subject to withholding of U.S. federal income tax at a 30% rate, unless the rate was reduced by an applicable income tax treaty. In general, to claim the benefit of a tax treaty or to claim exemption from withholding because the income is U.S. trade or business income, a non-U.S. holder must provide a properly executed IRS Form W-8BEN for treaty benefits or Form W-8ECI for U.S. trade or business income, in either case prior to the payment of dividends. Non-U.S. holders may obtain a refund of any excess amounts withheld by timely filing an appropriate claim for refund with the IRS. Non-U.S. holders should consult their tax advisors with respect to their entitlement to benefits under a relevant income tax treaty. If the IRS disagrees with the characterization of the Distribution as a distribution in respect of Ener1 common stock for federal income tax purposes, it is possible that under some circumstances, a non-U.S. holder would be subject to withholding of U.S. federal income tax at a 30% rate, unless this rate was reduced by an applicable income tax treaty as described above. Backup withholding of U.S. federal income tax The Distribution may, under some circumstances, be subject to backup withholding at a rate of 28%. To avoid backup withholding, each Ener1 shareholder as of the Ener1 Record Date must provide the Distribution Agent for the Distribution with either proof of an applicable exemption or its correct taxpayer identification number. Any amount withheld under the backup withholding rules is not an additional tax. Rather, the tax liability of an Ener1 shareholders subject to withholding will be reduced by the amount of the tax withheld. Some Ener1 shareholders (including, among others, all U.S. corporations) are not subject to these backup withholding and reporting requirements. LEGAL MATTERS The validity of the shares of common stock to which this prospectus relates will be passed upon for us by Curtis Wolfe, our general counsel and by Gibson, Dunn Croucher, LLP. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293331_transcore_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293331_transcore_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293331_transcore_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293334_transcore_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293334_transcore_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293334_transcore_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293335_tlp_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293335_tlp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293335_tlp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293336_transcore_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293336_transcore_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293336_transcore_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293337_transcore_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293337_transcore_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293337_transcore_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293338_transcore_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293338_transcore_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293338_transcore_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293340_viastar_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293340_viastar_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293340_viastar_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293341_amtech_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293341_amtech_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293341_amtech_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293342_viastar_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293342_viastar_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293342_viastar_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293343_amtech_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293343_amtech_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293343_amtech_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293344_transcore_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293344_transcore_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293344_transcore_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293345_transcore_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293345_transcore_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..787f93bab4f55dcc44a60e8f0ccc45826ec91751 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293345_transcore_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the EYSs, the shares of class A common stock and notes offered hereby, as well as the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Blank Rome LLP, Philadelphia, Pennsylvania. Certain legal matters relating to the validity of the issuance of the subsidiary guarantees by two of the subsidiary guarantors will be passed upon for us by Locke Liddell Sapp LLP, Dallas, Texas. Debevoise Plimpton LLP, New York, New York is acting as counsel for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293385_insight_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293385_insight_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293385_insight_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293398_comprehens_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293398_comprehens_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293398_comprehens_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293401_comprehens_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293401_comprehens_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293401_comprehens_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293403_comprehens_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293403_comprehens_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293403_comprehens_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293404_comprehens_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293404_comprehens_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293404_comprehens_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293405_comprehens_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293405_comprehens_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293405_comprehens_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293407_imi-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293407_imi-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293407_imi-of_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293410_imi-of_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293410_imi-of_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293410_imi-of_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293411_comprehens_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293411_comprehens_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ba66abf1e6c5f553a09ef957a985b8d1ae4f942e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293411_comprehens_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby and the shares of our common stock and senior subordinated notes represented thereby, the validity of the separate issuance of senior subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kaye Scholer LLP, New York, New York. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293892_spic-span_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293892_spic-span_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293892_spic-span_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293893_prestige_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293893_prestige_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293893_prestige_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293894_prestige_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293894_prestige_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293894_prestige_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293896_prestige_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293896_prestige_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293896_prestige_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293897_pecos_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293897_pecos_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293897_pecos_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293898_medtech_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293898_medtech_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293898_medtech_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293899_medtech_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293899_medtech_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293899_medtech_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293901_cutex-co_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293901_cutex-co_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293901_cutex-co_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293902_comet_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293902_comet_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293902_comet_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001293903_prestige_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001293903_prestige_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001293903_prestige_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001294154_lease_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001294154_lease_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..edf3541698075717b853c17d18225ec2bebffdbb --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001294154_lease_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Kunzman & Bollinger, Inc., 5100 N. Brookline, Suite 600, Oklahoma City, OK 73112, has issued its opinion to our general partner regarding the validity and due issuance of our units including assessibility, and its opinion on material federal income tax consequences to individual typical investors in us. However, the factual statements in this prospectus are our statements or those of our general partner, and counsel has not given any opinions with respect to any of the tax or other legal aspects of this offering except as expressly set forth above. 73 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001294171_woodforest_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001294171_woodforest_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0fbef656bb598e62a2299714b1c955f49a8ad3c3 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001294171_woodforest_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters, including the validity of the shares of our common stock offered by this prospectus will be passed upon for by us by Bracewell & Patterson, L.L.P., Houston, Texas. Certain legal matters will be passed upon for the underwriters by Fulbright & Jaworski L.L.P., Houston, Texas. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001294248_china_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001294248_china_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a9e35badbb2821608b9089777de10fac969fce78 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001294248_china_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered in this prospectus are being passed upon for us by Graubard Miller, New York, New York. Davis & Gilbert LLP, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001294250_rand_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001294250_rand_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..876a71bbdd082fd58f4634bec8c1119c8c81f846 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001294250_rand_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered in this prospectus are being passed upon for us by Graubard Miller, New York, New York. Bingham McCutchen LLP, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001294875_matchnet_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001294875_matchnet_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..29d8eef3e91334c6d4e69ddaee9533c9352deaef --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001294875_matchnet_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Kirkpatrick Lockhart LLP, Los Angeles, California, will pass for us on the validity of the shares of common stock offered hereby. Latham Watkins LLP, Los Angeles, California is acting as counsel for the underwriters in connection with selected legal matters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001295334_valley_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001295334_valley_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..c041cc2386e8d5acfb38246a22fee654710cd72b --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001295334_valley_legal_matters.txt @@ -0,0 +1 @@ +CERTAIN LEGAL MATTERS Graham Dunn, P.C., Seattle, Washington, has advised us in connection with certain banking and securities law aspects of this offering. Stephens, Gourley Bywater, Las Vegas, Nevada, has advised us in connection with certain matters related to Nevada law in connection with this offering, and will pass upon the validity of our common stock offered by this prospectus. The validity of the common stock offered by this prospectus will be passed upon for the underwriter by Manatt, Phelps Phillips, Los Angeles, California. Manatt, Phelps Phillips will rely as to all matters of Nevada law upon the opinion of Stephens, Gourley Bywater. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001295477_prestige_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001295477_prestige_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..17270abe7856889701439435c0fc9a720439fbf1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001295477_prestige_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of our common stock and subordinated notes represented thereby, the validity of the separate issuance of subordinated notes not represented by IDSs and the validity of the issuance of the subsidiary guarantees by the subsidiary guarantors, will be passed upon for us by Kirkland & Ellis LLP, a limited liability partnership that includes professional corporations, Chicago, Illinois. Certain partners of Kirkland & Ellis LLP are members of a limited liability company that is an investor in GTCR Fund VIII, L.P. and GTCR Fund VIII/B, L.P., each of which owns equity interests in Prestige Holdings. Certain partners of Kirkland & Ellis LLP are members in a partnership that is an investor in GTCR Co-Invest II, L.P., which also owns equity interests in Prestige Holdings. Kirkland & Ellis LLP has from time to time represented, and may continue to represent, GTCR Golder Rauner, LLC and certain of its affiliates in connection with certain legal matters. Certain matters of Virginia law will be passed upon by Kelley Drye & Warren LLP. The underwriters are represented by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001295484_51job-inc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001295484_51job-inc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ae069cb294440e60b88f2e98022d63a4ce4e000c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001295484_51job-inc_legal_matters.txt @@ -0,0 +1 @@ +legal matters that may have a material impact on us and any material reports or inquiries from regulatory or governmental agencies; and establishing procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls, auditing matters or potential violations of law, and the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters or potential violations of law. Nominating and corporate governance committee Our nominating and corporate governance committee assists the board of directors in identifying individuals qualified to become members of our board of directors and in determining the composition of the board and its committees. Our board of directors has determined that all members of our nominating and corporate governance committee are independent directors within the meaning of Nasdaq Marketplace Rule 4200(a)(15) and meet the criteria for independence set forth in Section 10A(m)(3)(B)(i) of the Exchange Act. The current members of our nominating and corporate governance committee are Shan Li, who acts as the chairman of our nominating and corporate governance committee, and Charles E. Phillips, Jr. Our nominating and corporate governance committee will be responsible for, among other things: identifying and recommending to the board nominees for election or re-election to the board, or for appointment to fill any vacancy; reviewing annually with the board the current composition of the board in light of the characteristics of independence, age, skills, experience and availability of service to us; reviewing the continued board membership of a director upon a significant change in such director s principal occupation; Table of Contents WHERE YOU CAN FIND MORE INFORMATION We have filed with the SEC a registration statement on Form F-1 under the Securities Act in connection with this offering of our shares and ADSs. A related registration statement on Form F-6 has also been filed with the SEC to register the ADSs as evidenced by the ADRs. This prospectus, which forms a part of the registration statement on Form F-1, does not contain all of the information set forth in these registration statements, and the exhibits and schedules thereto. We have omitted certain portions of these registration statements from the prospectus in accordance with the rules and regulations of the SEC. You should refer to these registration statements for further information. Statements contained in this prospectus as to the contents of any contract or other document that is filed as an exhibit to the registration statements are not necessarily complete, and each such statement is qualified in all respects by reference to the full text of such contract or document. Upon declaration by the SEC of the effectiveness of the registration statements, we will become subject to the periodic reporting and other informational requirements of the Exchange Act applicable to a foreign private issuer. Under the Exchange Act, we will file annual reports on Form 20-F within six months of our fiscal year end, and we will submit other reports and information under cover of Form 6-K with the SEC. Copies of the registration statements, their accompanying exhibits, as well as such reports and other information, when so filed, may be inspected without charge and may be obtained at prescribed rates at the SEC s Public Reference Room located at 450 Fifth Street, N.W., Room 1200, Washington, D.C. 20549. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the SEC at 1-800-SEC-0330 or by contacting the SEC at its website at www.sec.gov. As a foreign private issuer, we are exempt under the Exchange Act from, among other things, the rules prescribing the furnishing and content of proxy statements, and our executive officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. In addition, we will not be required under the Exchange Act to file periodic reports and financial statements with the SEC as frequently or as promptly as U.S. companies whose securities are registered under the Exchange Act. However, we intend to furnish the depositary with our annual reports, which will include a review of operations and annual audited financial statements prepared in conformity with U.S. GAAP, and all notices of shareholders meetings and other reports and communications that are made generally available to our shareholders. The depositary will make such notices, reports and communications available to holders of ADSs and, upon our request, will mail to all record holders of ADSs the information contained in any notice of a shareholders meeting received by the depositary from us. We also intend to furnish to the SEC under Form 6-K semi-annual and quarterly reports containing certain unaudited financial information. RMB US$(1) RMB US$(1) RMB US$(1) Shareholders equity: Common shares US$0.0001 par value; 57,000,000 shares authorized; 29,035,513 shares issued and outstanding(2) 24,033 2,904 35,679 4,311 44,369 5,361 Series A preference shares US$0.0001 par value; 15,000,000 shares authorized; 14,058,466 shares issued and outstanding 11,646 1,407 Additional paid-in capital common shares 115,267,461 13,926,910 234,908,119 28,382,200 706,668,641 85,381,514 Additional paid-in capital preference shares 119,640,658 14,455,290 Deferred share-based compensation share option (49,791,893 ) (6,015,984 ) (49,791,893 ) (6,015,984 ) (49,791,893 ) (6,015,984 ) Statutory reserves 14,478,441 1,749,322 14,478,441 1,749,322 14,478,441 1,749,322 Other comprehensive loss (661,711 ) (79,948 ) (661,711 ) (79,948 ) (661,711 ) (79,948 ) Accumulated deficit (26,325,619 ) (3,180,731 ) (26,325,619 ) (3,180,731 ) (26,325,619 ) (3,180,731 ) Total shareholders equity 172,643,016 20,859,170 172,643,016 20,859,170 644,412,228 77,859,534 Total capitalization 172,643,016 20,859,170 172,643,016 20,859,170 644,412,228 77,859,534 Table of Contents DILUTION If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and the pro forma net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per common share of our ADSs is substantially in excess of the book value per common share attributable to the existing shareholders for our presently outstanding common shares. Our net tangible book value as of June 30, 2004 was US$20,036,271, or US$0.69 per common share and US$1.38 per ADS. Our pro forma net tangible book value as of June 30, 2004 was US$20,036,271, or US$0.46 per common share and US$0.93 per ADS. Pro forma net tangible book value per common share represents the amount of total tangible assets less total liabilities, divided by the number of common shares outstanding after giving effect to the automatic conversion of all of our outstanding Series A preference shares into our common shares. After giving effect to our sale of 5,250,000 ADSs in this offering at the initial public offering price of US$12 per ADS (the midpoint of the estimated range of the initial public offering price) and after deducting estimated underwriting discounts and commissions and estimated offering expenses, our pro forma net tangible book value as of June 30, 2004 would have been US$77,036,636, or US$1.44 per common share and US$2.88 per ADS. This represents an immediate increase in pro forma net tangible book value of US$0.98 per common share, or US$1.96 per ADS, to existing shareholders and an immediate dilution in pro forma net tangible book value of US$4.56 per common share, or US$9.12 per ADS, to investors purchasing ADSs in this offering. The following table illustrates this dilution on a per common share and per ADS basis: Assumed initial public offering price per common share US$ 6.00 Net tangible book value per common share as of June 30, 2004 US$ 0.69 Pro forma net tangible book value per common share as of June 30, 2004 US$ 0.46 Increase in pro forma net tangible book value per common share attributable to this offering US$ 0.98 Pro forma net tangible book value per common share after this offering US$ 1.44 Dilution in pro forma net tangible book value per common share to new investors in this offering US$ 4.56 Dilution in pro forma net tangible book value per ADS to new investors in this offering US$ 9.12 Table of Contents The following table summarizes, on a pro forma basis as of June 30, 2004, the differences between existing shareholders and the new investors with respect to the number of common shares purchased from us, the total consideration paid and the average price per share paid. Total consideration paid by existing shareholders represents total cash consideration paid for the issuance of common and preferred shares in each of the periods since our incorporation. Common Total Average Average shares purchased consideration price price per per Number Percent Amount Percent share ADS US$ US$ US$ Existing shareholders 43,093,979 80.4 % 14,672,745 18.9 % 0.34 0.68 New investors 10,500,000 19.6 63,000,000 81.1 6.00 12.00 Sales and account management 534 744 Marketing and merchandising 396 474 Technology and online operations 145 218 Customer service and production 166 216 Search and training consultants 106 115 General and administrative 134 Total 53,593,979 100.0 % 77,672,745 100.0 % 1.45 2.90 Table of Contents Internet content provider services, and plan to continue to streamline our ownership structure and operations as and when permitted by PRC laws and regulations. Group Ownership Structure The chart below sets forth our current ownership structure.(1) Table of Contents For the year ended December 31, For the six months ended June 30, RMB RMB RMB US$(1) RMB RMB US$(1) Selected Consolidated Statement of Operations Data: Revenues: Print advertising 90,940,220 116,989,356 182,606,297 22,062,960 77,220,871 149,259,709 18,033,940 Online recruitment services 22,586,591 28,938,327 76,960,121 9,298,519 33,390,914 50,849,355 6,143,749 Executive search 9,126,842 9,726,300 15,748,331 1,902,754 6,061,669 10,833,165 1,308,891 Other human resource related revenues 5,305,068 9,895,734 18,019,611 2,177,176 6,528,835 17,077,298 2,063,322 Total revenues 127,958,721 165,549,717 293,334,360 35,441,409 123,202,289 228,019,527 27,549,902 Net revenues 121,970,723 158,039,700 280,118,941 33,844,688 117,795,821 217,107,617 26,231,497 Cost of services (84,208,642 ) (92,220,940 ) (151,477,142 ) (18,301,856 ) (66,322,816 ) (107,765,129 ) (13,020,459 ) Gross profit 37,762,081 65,818,760 128,641,799 15,542,832 51,473,005 109,342,488 13,211,038 Operating expenses: Sales and marketing (18,503,675 ) (24,356,157 ) (38,619,523 ) (4,666,110 ) (17,598,601 ) (29,490,147 ) (3,563,075 ) General and administrative (33,732,311 ) (30,382,850 ) (38,135,612 ) (4,607,642 ) (18,075,208 ) (27,380,253 ) (3,308,152 ) Share-based compensation share option(2) (13,482,546 ) (1,628,996 ) (11,182,533 ) (12,044,768 ) (1,455,280 ) Share-based compensation founder shares(3) (8,808,931 ) (8,808,931 ) (4,622,466 ) (558,498 ) (3,195,928 ) Total operating expenses (61,044,917 ) (63,547,938 ) (94,860,147 ) (11,461,246 ) (50,052,270 ) (68,915,168 ) (8,326,507 ) Income (loss) from operations (23,282,836 ) 2,270,822 33,781,652 4,081,586 1,420,735 40,427,320 4,884,531 Income (loss) before income tax provision (22,957,650 ) 2,686,608 35,792,274 4,324,513 2,010,583 41,381,649 4,999,835 Income tax benefit (expense) 1,259,194 (3,192,011 ) (385,667 ) (179,307 ) (15,387,952 ) (1,859,212 ) Net income (loss) (22,957,650 ) 3,945,802 32,600,263 3,938,846 1,831,276 25,993,697 3,140,623 Earnings (loss) per share: Basic (1.72 ) 0.09 0.83 0.10 0.05 0.61 0.07 Diluted(4) (1.72 ) 0.07 0.75 0.09 0.04 0.57 0.07 Earnings (loss) per ADS:(5) Basic (3.44 ) 0.18 1.65 0.20 0.10 1.21 0.15 Diluted(4) (3.44 ) 0.15 1.50 0.18 0.08 1.14 0.14 Other Financial Information: Aggregate share-based compensation expense(6) (8,808,931 ) (8,808,931 ) (18,701,563 ) (2,259,571 ) (14,679,347 ) (13,010,393 ) (1,571,937 ) As of December 31, As of June 30, RMB RMB RMB US$(1) RMB US$(1) Selected Consolidated Balance Sheet Data: Assets: Cash 30,339,579 68,637,760 115,084,572 13,904,812 152,668,574 18,445,808 Total current assets 39,661,081 79,635,683 145,573,376 17,588,546 205,602,323 24,841,398 Total non-current assets 20,509,537 24,025,881 39,830,903 4,812,471 43,045,475 5,200,866 Total assets 60,170,618 103,661,564 185,404,279 22,401,017 248,647,798 30,042,264 Liabilities: Total current liabilities 19,806,795 26,025,436 56,096,191 6,777,685 76,004,782 9,183,094 Total non-current liabilities 849,621 32,080 23,533 2,843 Total liabilities 20,656,416 26,057,516 56,119,724 6,780,528 76,004,782 9,183,094 Total shareholders equity 39,514,202 77,604,048 129,284,555 15,620,489 172,643,016 20,859,170 Total liabilities and shareholders equity 60,170,618 103,661,564 185,404,279 22,401,017 248,647,798 30,042,264 Table of Contents The following table sets forth the revenues from our principal lines of business as a percentage of our total revenues for the periods indicated. For the six For the year ended months ended December 31, June 30, Revenues: Print advertising 71.1 % 70.7 % 62.3 % 62.7 % 65.5 % Online recruitment services 17.7 17.5 26.2 27.1 22.3 Executive search 7.1 5.9 5.4 4.9 4.8 Other human resource related revenues 4.1 5.9 6.1 5.3 7.4 Total revenues 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % The following table sets forth our revenue growth rates by business line for the periods indicated. Percentage increase for the six months ended Percentage increase for June 30, 2004 Table of Contents of the candidate s annual compensation, partially in the form of a minimum upfront retainer. While we believe that we have been able to develop this business through effective sales and marketing efforts, our ability to expand this business will depend, to a significant extent, on an increase in the acceptance of executive search by employers in China as an effective recruitment tool. We intend to continue to develop this business, but we do not expect that this business will contribute significantly to our revenues in the foreseeable future. Consequently, as our recruitment advertising businesses expand, executive search service revenues may continue to decline as a percentage of our overall revenues. Other human resource related revenues We generate revenues from our other human resource related services in the form of attendance fees from our training services, and revenues from providing our salary survey studies, our eHR software product, our business processing outsourcing services and our personnel assessment services. We have developed, and will continue to develop, additional human resource related services and products. While these businesses currently represent a relatively small component of our total revenues, we believe that, by providing these products and services, we can provide a one-stop human resource package to our clients. We believe that this should contribute to the growth of our higher revenue recruitment products as well as allow us to successfully develop additional human resource related products and services. We also provide stationery and office supplies to our business customers. Our ability to generate revenues from other human resource related services depends on our ability to successfully develop and introduce new types of products and services for China s developing human resource services market. As this industry is still emerging and as many of our services are currently under development, we are unable to determine the extent to which these businesses will contribute to our revenues in the future. Net revenues and business tax Our net revenues reflect business taxes and related surcharges which are levied on our total revenues. We are subject to a PRC business tax at a rate of 5% on our revenues, after certain deductible expenses, generated from services provided in China. We deduct these amounts from our revenues to arrive at our net revenues. A portion of the business taxes that we had previously paid was refunded in 2002, 2003 and the six months ended June 30, 2004 as a result of local government financial incentives. These refunds are not material and are recognized as other income in our statement of operations. Costs We operate and manage our various businesses as a single segment. We do not account for our results of operations on a geographical or other basis, and we are unable to allocate costs among our various businesses. The following table sets forth our cost of services and total operating expenses as a percentage of our net revenues for the periods indicated. For the six For the year ended months ended December 31, June 30, Table of Contents across various markets. As a result, we have been able to achieve economies of scale as we have realized a higher level of revenues relative to our sales and marketing and other customer acquisition costs. In addition, while our online recruitment services contribute substantially to our total revenues, the growth of these operations requires limited additional fixed costs and allows us to further improve our overall efficiency. We believe that we realize higher profit margins with respect to our online recruitment services than our other recruitment related businesses as a result of the lower costs associated with our operation of our online services. We believe that we have also been able to improve operating efficiencies primarily by increasing the productivity of our infrastructure and staff. We remain focused on identifying and exploiting economies of scale and operating efficiencies in our businesses, and believe that our cost of services and total operating expenses should continue to decline as a percentage of our net revenues as a result of these factors. However, our continuing ability to achieve economies of scale and operating efficiencies is subject to significant uncertainties. Consequently, we cannot assure you that these costs and expenses will continue to decline as a percentage of our net revenues. Cost of services Our cost of services primarily consists of printing related expenses, employee compensation and depreciation. Printing related costs, which primarily consist of printing, publishing and distribution expenses that we pay to our newspaper contractors, constitute the majority of our cost of services. Our printing related costs have tended not to increase or decrease to the same extent as the increases or decreases in our print advertising revenues. As a result, we have been able to expand our print advertising businesses while incurring lower printing related costs relative to our print advertising revenues. We continuously seek to lower our total printing related costs. In addition, to a significant extent, we have been able to use our existing infrastructure to expand our online recruitment services, which has allowed us to lower our cost of providing these services relative to the corresponding revenues that we receive. As a result, we have been able to realize increased economies of scale and operating efficiencies in both of these businesses. The majority of our employee, depreciation and other costs of services are largely shared across our various business lines. Operating expenses Our operating expenses consist of sales and marketing expenses, general and administrative expenses, and share-based compensation. The following table sets forth our operating expenses as a percentage of our net revenues for the periods indicated. For the six For the year ended months ended December 31, June 30, Operating expenses: Sales and marketing (15.2% ) (15.4% ) (13.8% ) (15.0% ) (13.6% ) General and administrative (27.6) (19.2) (13.6) (15.3) (12.6) Share-based compensation share option (4.8) (9.5) (5.5) Share-based compensation founder shares (7.2) (5.6) (1.7) (2.7) Table of Contents Results of Operations The following table sets forth selected data from our consolidated statements of operations as a percentage of our net revenues for the periods indicated. For the six For the year ended months ended December 31, June 30, Total revenues 104.9% 104.8% 104.7% 104.6% 105.0% Less: Business and related tax (4.9) (4.8) (4.7) (4.6) (5.0) Net revenues 100.0 100.0 100.0 100.0 100.0 Loss from operations (8,884,884 ) (19,085,436 ) (2,305,952 ) Equity in profit (loss) of subsidiary companies, net 1 12,827,317 51,682,719 6,244,438 Other income (expense) 3,369 2,980 Cost of services (69.0) (58.4) (54.1) (56.3) (49.6) Gross profit 31.0 41.6 45.9 43.7 50.4 Total operating expenses (50.0) (40.2) (33.9) (42.5) (31.7) Income (loss) from operations (19.0) 1.4 12.1 1.2 18.7 Interest and investment income 0.0 0.3 0.3 0.4 0.2 Other income (expense) 0.2 (0.0) 0.4 0.1 0.2 Income (loss) before provision for income tax (18.8) 1.7 12.8 1.7 19.1 Income tax benefit (expense) 0.8 (1.1) (0.2) (7.1) Net income (loss) (18.8% ) 2.5% 11.7% 1.5% 12.0% Table of Contents For the three months ended RMB RMB RMB RMB RMB RMB Revenues: Print advertising 38,236,552 38,984,319 48,613,392 56,772,034 75,342,560 73,917,149 Online recruitment services 15,767,046 17,623,868 20,179,328 23,389,879 24,060,419 26,788,936 Executive search 2,018,280 4,043,389 4,864,655 4,822,007 3,519,745 7,313,420 Other human resource related revenues 2,961,538 3,567,297 5,129,168 6,361,608 7,024,741 10,052,557 Total revenues 58,983,416 64,218,873 78,786,543 91,345,528 109,947,465 118,072,062 Net revenues 56,397,193 61,398,628 75,392,331 86,930,789 104,855,738 112,251,879 Cost of services (32,235,133 ) (34,087,683 ) (41,789,398 ) (43,364,928 ) (53,611,580 ) (54,153,549 ) Gross profit 24,162,060 27,310,945 33,602,933 43,565,861 51,244,158 58,098,330 Operating expenses: Sales and marketing (8,266,901 ) (9,331,700 ) (9,186,956 ) (11,833,966 ) (13,603,702 ) (15,886,445 ) General and administrative (9,220,988 ) (8,854,220 ) (9,354,693 ) (10,705,711 ) (15,170,955 ) (12,209,298 ) Share-based compensation share option (9,609,771 ) (1,572,762 ) (1,159,758 ) (1,140,255 ) (8,755,475 ) (3,289,293 ) Share-based compensation founder shares (1,769,390 ) (1,426,538 ) (1,426,538 ) Total operating expenses (28,867,050 ) (21,185,220 ) (21,127,945 ) (23,679,932 ) (37,530,132 ) (31,385,036 ) Income (loss) from operations (4,704,990 ) 6,125,725 12,474,988 19,885,929 13,714,026 26,713,294 Income (loss) before income tax provision (4,317,627 ) 6,328,210 12,736,033 21,045,658 14,029,366 27,352,283 Income tax benefit (expense) 385,053 (564,360 ) (1,135,819 ) (1,876,885 ) (5,216,883 ) (10,171,069 ) Net income (loss) (3,932,574 ) 5,763,850 11,600,214 19,168,773 8,812,483 17,181,214 Other Financial Information: Aggregate share-based compensation expense(1) (11,379,161 ) (3,300,186 ) (2,713,818 ) (1,308,398 ) (9,258,698 ) (3,751,695 ) Table of Contents General and administrative expenses. Our general and administrative expenses decreased 9.9% to RMB30.4 million in 2002 from RMB33.7 million in 2001. This decline primarily reflected a non-recurring expense relating to office relocation in 2001 and a reduction in bad debt provision in 2002. Share-based compensation. Our share-based compensation expense included in operating expenses was RMB8.8 million in 2002 and RMB8.8 million in 2001 and consisted of share-based compensation expense recognized in connection with the issuance of restricted common shares to our founders in 2000. Interest and investment income. Our interest and investment income increased 546% to RMB0.5 million in 2002 from RMB0.07 million in 2001, primarily reflecting an increase in cash generated from operations which we deposited in interest bearing accounts at banks in China and Hong Kong. Income tax benefit. We recorded an income tax benefit of RMB1.3 million in 2002. We did not record income tax benefit or expense in 2001. Net income (loss). As a result of the above factors, our net income was RMB3.9 million in 2002 compared to our net loss of RMB23.0 million in 2001. Liquidity and Capital Resources We believe that our current cash and cash equivalents, cash flow from operations and the proceeds from this offering will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures, for the foreseeable future. We may, however, require additional cash resources due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. Liquidity Our liquidity has been principally affected by our significant increases in net cash from operating activities, our net cash inflow from the sale of Series A preference shares in 2001 and 2002 and our purchases of property, equipment and software. The following table sets forth a summary of our cash flows for the periods indicated. For the year ended December 31, For the six months ended June 30, Table of Contents June 30, 2004, partially offset by an increase in prepayments and other current assets, and a reduction in advances from customers. In addition, our net cash provided by operating activities for the six months ended June 30, 2003 and for the six months ended June 30, 2004 also reflected adjustments of RMB14.7 million and RMB13.0 million (US$1.6 million), respectively, for share-based compensation expense. Cash flows from investing activities. Our net cash used in investing activities from 2001 to 2003 reflected purchases of property, equipment, software and other intellectual property rights in these years in connection with the general growth of our businesses and the opening of offices in new cities. In addition, our net cash used in investing activities in 2003 reflected our investment of RMB10.7 million (US$1.3 million) of our excess cash in an interest bearing bank deposit. Our net cash used in investing activities for the six months ended June 30, 2004 was RMB9.4 million (US$1.1 million), as compared to RMB13.6 million for the six months ended June 30, 2003. This difference primarily reflected the establishment of operations in three new cities, Changsha, Hefei and Ningbo, during the six months ended June 30, 2004, as well as continued upgrades of our technology and systems. Cash flows from financing activities. Our net cash provided by financing activities has been primarily affected by the sale of Series A preference shares in 2001 and 2002. In each of 2001 and 2002, we received net proceeds of RMB25.8 million from the sale of 2,999,904 Series A preference shares, for aggregate net proceeds of RMB51.6 million. Our net cash provided by financing activities in 2003 consisted of proceeds from the exercise of stock options by certain directors and executive officers. Our net cash provided by financing activities for the six months ended June 30, 2004 of RMB6.3 million (US$0.8 million) consisted of proceeds from the exercise of warrants to purchase Series A preference shares by one of our principal shareholders and from the exercise of options by certain directors and officers. Contractual cash obligations. Our contractual cash obligations consist largely of obligations under property lease agreements for office premises. Our other contractual cash obligations consist primarily of operating leases for computers. Payments made under operating leases, net of any incentive discounts that we receive from the leasing company, are charged to our income statement on a straight-line basis over the lease periods. We have entered into non-cancelable agreements with initial or remaining terms in excess of one year for the publication of Career Post Weekly, the lease of office premises, and the lease of computers and other equipment. The following table sets forth our future minimum payments with respect to such agreements through the years indicated, as of December 31, 2003: Publication Office fees premises Others Total 67,022,682 27,676,114 648,522 95,347,318 Table of Contents Future minimum payments with respect to these agreements as of June 30, 2004 are as follows: Publication Office fees premises Others Total 38,696,708 27,973,843 244,800 66,915,351 Table of Contents continuing to improve our proprietary software and develop new software to take advantage of new technologies and new business opportunities; and launching and expanding alternative distribution channels and methods of accessing our services. Our Business We provide a range of human resource services in the following categories: recruitment related services, including print advertising, online recruitment and executive search services; and other human resource related services, such as training, software, web-based applications and business process outsourcing. Recruitment related services Print advertising Career Post Weekly. Career Post Weekly is a city-specific recruitment advertising publication which is published once a week and is distributed as an insert in local newspapers and/or on a stand-alone basis. Career Post Weekly was published in 19 major cities in China as of June 30, 2004. We established operations in the cities of Changsha in January 2004, Hefei in March 2004 and Ningbo in May 2004. The 19 cities where Career Post Weekly is published and our newspaper contractor in each city are as follows: City Newspaper contractor(1) Beijing China Trade News Changsha Sanxiang Metropolitan News Chengdu Hua Xi Metropolitan News Chongqing Chongqing Business Daily Guangzhou Guangzhou Youth Daily Dalian Dalian Evening News Hangzhou Daily Business News Harbin Harbin Lifestyle Daily Hefei Hefei Evening News Jinan Jinan Times Kunming Chuncheng Evening News Nanjing Modern Express Ningbo Modern Golden News Qingdao Qingdao Financial Times Shanghai China Trade News Shenyang Liaoshen Evening News Shenzhen Nan Fang Metropolitan News Wuhan News Information Daily Xian China Merchant News Table of Contents In China, entities engaged in publishing activities are required by the government to have a publishing license. Since we do not have any publishing licenses, we have established a relationship with a local newspaper in each market where Career Post Weekly is produced. These newspapers provide us with printing and publishing services on a contractual basis, generally for a term of two years. These newspapers also generally provide us with distribution and marketing support in our local markets, although we sometimes undertake marketing independently. Career Post Weekly is distributed as an insert in our contractor s newspaper in an effort to increase our circulation and help us establish our brand name. As an insert in these newspapers, Career Post Weekly is sold at newsstands, kiosks, convenience stores, supermarkets and other venues. We provide vendors with marketing materials such as posters, display racks and other promotional items. We also circulate Career Post Weekly independently through our direct marketing campaigns. Our direct marketing includes offering free copies of Career Post Weekly at self-help kiosks at job fairs, in the lobbies of major office buildings, at post offices, on university campuses and in other public areas where the public circulation of newspapers is permitted. We have entered into exclusive marketing arrangements to offer free copies of Career Post Weekly in subway stations in certain cities. We change our newspaper contractor in a city when we are able to obtain more favorable terms or higher quality service from a different newspaper contractor. Since inception, we have changed our newspaper contractor in five of the 19 cities in which we currently have a contract with local newspapers. See Risk Factors Risk Related to Our Business We are dependent on local newspaper contractors in each of our geographic markets to publish and distribute Career Post Weekly. The advertising fees that we charge depend on a variety of factors, including the size, placement, format, and use of color and graphics in the advertisement, the length of time the advertisement is to appear, and the market in which the advertisement is placed. As we grow in our existing markets and expand into new cities, we increase our client base and the number of advertising pages that we produce. Our print advertising revenues are primarily affected by the number of print advertising pages and the fees that we charge. Pricing for specific products can vary significantly from city to city. The following table sets forth the estimated number of print advertising pages we generated and the cities where Career Post Weekly was published for the periods and as of the dates indicated. As of and for As of and for the year the six ended December 31, months ended Table of Contents in terms of the number of registered job user accounts and posted job seeker resum s, with approximately 6.9 million user accounts established since the launch of our website in 1999 and approximately 4.6 million resum s posted online as of June 30, 2004. For 2003, we estimate that more than 25,000 unique employers contracted with us to place advertisements on our website. We believe that www.51job.com is perceived as a destination site by job seekers because of its large volume of advertisements and the job search, training and general career management and advisory content available on the website. We believe that www.51job.com provides employers with a cost-effective means of reaching their target audience. As our website contains nationwide recruitment advertisements, employers can access a large pool of potential candidates from a wide geographic area. Certain employers post advertisements solely online when they consider the demographics of their target audience to favor the use of the Internet for recruitment advertising. As a result, www.51job.com includes a higher number of technology related positions than Career Post Weekly as well as recruitment advertisements targeted at younger job seekers that are more likely to use the Internet. We generally update the advertisements on our website hourly, which allows employers to receive responses more rapidly than is generally possible using print advertisements. Employers also use our website as a marketing tool, placing advertising banners, trademarks, logos, website hyperlinks and other devices to promote their image for a fee that varies depending on the size and graphics in their presentation. We believe that certain employers view this image promotion as a significant means of attracting online job seekers to their recruitment advertisements on our website. As a result, we believe that our ability to offer these devices is an important element in our ability to attract online recruitment advertising business, which generates a material portion of our revenues. However, in the event of any adverse change in the actual or perceived effectiveness of online image promotion, or online advertising in general, our online recruitment advertising business may be adversely affected. See Risk Factors Risks Related to Our Business If the Internet, and online advertising in particular, does not achieve broad acceptance in China as a medium for recruitment, our online recruitment services business may be adversely affected. Employers can use our eHire web-based platform to search our job candidate database and download resum s for a fee. In addition, eHire contains other tools that enable employers to manage, organize and streamline the recruitment and hiring process. We also offer website design as an additional value-added service and marketing tool for corporate customers. We can build customized private label recruitment websites with the look and feel of a dedicated website. We design these sites in-house to client specifications and operate and maintain these sites for our clients. These client sites, together with our www.51job.com website, are hosted by China Telecom, China s principal telecommunications and Internet service provider. The following table sets forth the estimated number of unique employers who used our online recruitment services for the periods indicated. For the year ended For the six December 31, months ended Table of Contents Event marketing. We organize customer events such as recruiting workshops and product information seminars as well as networking social events to provide our sales team an opportunity to interact with employers and better understand their needs. To attract potential job seekers, we provide complimentary copies of Career Post Weekly at job fairs, at office buildings, in subway stations in select cities and in other public and commercial areas. We believe that offering complimentary copies of Career Post Weekly to job seekers is also a highly effective means to cross-promote our www.51job.com website. Mass media advertising. We use traditional mass media advertising on a selective basis to increase our visibility and profile. We advertise using various media, including television, radio, and outdoor advertising on billboards, bus stops and buses. In addition, we advertise on print media such as newspapers, magazines and industry publications and telephone directories. Online marketing. We use Internet advertising, including banners, keyword and hyperlink purchases and paid listings, to promote our brand names. We also conduct online promotion campaigns such as prize drawings and giveaways with the goal of attracting traffic to our website and enhancing the loyalty of job seekers. Cross-marketing. We cross-market our brand names, services and products in Career Post Weekly, on www.51job.com and in Human Capital. We also establish cross-marketing relationships with a variety of partners. We believe that we also benefit from recommendations and referrals by our large existing base of Career Post Weekly and www.51job.com job seekers and employers. Media promotions. We produce studies on job market trends that are regularly featured and published in magazines, in newspapers and online. We believe this exposure heightens our profile among both employers and job seekers, and attracts interest and generates sales inquiries for our services. Employees We had 706 employees, 893 employees, 1,481 employees and 1,937 employees as of December 31, 2001, 2002 and 2003, and June 30, 2004, respectively. The following table sets forth the number of our employees categorized by function as of the dates indicated. As of As of December 31, 2003 June 30, 2004 Total(1) 1,481 1,937 Table of Contents MANAGEMENT Directors and Executive Officers Members of our board of directors are elected by our shareholders. Effective upon the closing of this offering, our board of directors will consist of five directors. Our executive officers are appointed by, and serve at the discretion of, our board of directors. The following table sets forth information concerning our directors and executive officers. The business address of each of our directors and executive officers listed below is 21st Floor, Wen Xin Plaza, 755 Wei Hai Road, Shanghai 200041, People s Republic of China. Name Age Positions Table of Contents Stock options granted under the 2000 stock option plan may be incentive stock options, or ISOs, which are intended to qualify for favorable U.S. federal income tax treatment under the provisions of Section 422 of the U.S. Internal Revenue Code of 1986, as amended, or non-qualified stock options, or NSOs, which do not so qualify. The compensation committee of our board of directors administers the plan. Subject to the provisions of the plan and, in the case of a committee, the specific duties delegated by the board of directors to such committee, and subject to the approval of any relevant authorities, the board of directors or the committee so appointed has the authority in its discretion to determine, among other things, the fair market value of the common shares, select optionees, determine the number of common shares to be covered by each award granted under the plan, and the terms and conditions of any options or stock purchase rights granted under the plan. Stock options granted under the plan become exercisable at a rate of not less than 20% per year over five years from the date of the option grant. In the event of the termination of service of an optionee, the unvested portion of a stock option is forfeited and the vested portion terminates within the period of time as specified in the option agreement and, in the absence of a specified time in the option agreement, within twelve months following the optionee s termination in the case of the optionee s disability or death, and three months following the optionee s termination in all other cases. In the event of a merger of our company, each outstanding stock option may be assumed or an equivalent option or right may be substituted by the successor corporation. In the event the successor corporation refuses to assume or substitute for the stock option, the outstanding stock options will automatically vest and become exercisable for a period of 15 days, after which the stock options will terminate. The following table summarizes the options granted to our directors, executive officers and other employees under our 2000 stock option plan during the periods indicated. Common shares underlying options Exercise granted price Date of grant Date of expiration US$ Granted in 2001 David K. Chao 100,267 0.15 March 1, 2001 February 28, 2007 David Weimin Jin 10,000 0.15 September 1, 2001 May 31, 2007 Other employees 227,430 0.15 March 1, 2001 February 28, 2007 to March 28, 2007 190,650 0.15 September 1, 2001 May 31, 2007 to August 31, 2007 Total 528,347 Common shares underlying options Exercise granted price Date of grant Date of expiration US$ Granted in 2002 Other employees 75,800 0.15 March 1, 2002 November 30, 2007 to February 29, 2008 18,100 0.15 March 15, 2002 November 30, 2007 to February 28, 2008 Total 93,900 Table of Contents Common shares underlying options Exercise granted price Date of grant Date of expiration US$ Granted in 2003 Kathleen Chien 200,000 0.15 April 1, 2003 March 31, 2009 460,882 0.50 December 15, 2003 December 14, 2009 David Weimin Jin 65,000 0.15 April 1, 2003 March 31, 2009 Other employees 250,900 0.15 April 1, 2003 March 31, 2009 5,000 0.15 September 1, 2003 August 31, 2009 364,450 0.50 December 15, 2003 December 14, 2009 Total 1,346,232 Common shares underlying options Exercise granted price Date of grant Date of expiration US$ Granted in the six months ended June 30, 2004 Donald L. Lucas 92,176 1.00 February 17, 2004 February 16, 2010 Donald L. Lucas 138,264 * 1.00 February 28, 2004 Not applicable Shan Li 92,176 1.00 February 28, 2004 February 27, 2010 Charles E. Phillips, Jr. 92,176 3.25 May 20, 2004 May 19, 2010 Other employees 53,400 1.00 February 28, 2004 February 27, 2010 Total 468,192 Table of Contents Stock option activity during the periods indicated is as follows: Number Weighted average of shares exercise price Table of Contents PRINCIPAL SHAREHOLDERS The following table sets forth information with respect to the beneficial ownership, within the meaning of Section 13(d)(3) of the Exchange Act, of our common shares, on a fully diluted basis assuming conversion of all of our Series A preference shares as of June 30, 2004, and as adjusted to reflect the sale of our ADSs in this offering by: each of our directors and executive officers; and each person known to us to own beneficially more than 5% of our common shares. Common shares beneficially owned Shares beneficially prior to this owned after this offering offering(1) Number(2) %(3) Number(2) %(3) Directors and executive officers Rick Yan 17,316,000 37.5 17,316,000 30.6 David K. Chao(4) 14,381,854 31.2 14,381,854 25.4 Michael Lei Feng 5,927,021 12.8 5,927,021 10.5 Norman Lui 3,696,000 8.0 3,696,000 6.5 Kathleen Chien(5) 2,101,842 4.6 2,101,842 3.7 Tao Wang 601,660 1.3 601,660 1.1 Donald L. Lucas 230,440 * 230,440 * Shan Li 92,176 * 92,176 * Charles E. Phillips, Jr. 92,176 * 92,176 * David Weimin Jin 80,000 * 80,000 * All directors and executive officers as a group 44,519,169 96.5 44,519,169 78.6 Principal shareholders Rick Yan 17,316,000 37.5 17,316,000 30.6 Entities affiliated with Doll Capital Management(6) 13,980,787 30.3 13,980,787 24.7 Michael Lei Feng 5,927,021 12.8 5,927,021 10.5 Norman Lui 3,696,000 8.0 3,696,000 6.5 Table of Contents DESCRIPTION OF SHARE CAPITAL We were incorporated in the Cayman Islands in March 2000 under the name of 51net.com Cayman Islands Inc. as an exempted limited liability company. We changed our corporate name to 51job, Inc. in April 2004. We are governed by the Companies Law (2004 Revision) of the Cayman Islands, which is referred to as the Companies Law below. An exempted company under Cayman Islands law is a company that carries on its business mainly outside the Cayman Islands, is exempt from certain requirements of the Companies Law, including a filing of an annual return of its shareholders with the Registrar of Companies, does not have to make its register of shareholders open to inspection and may obtain an undertaking against the imposition of certain future taxes. Upon the closing of this offering, we will adopt our fifth amended and restated memorandum and articles of association. The following are summaries of (1) material provisions of our fifth amended and restated memorandum and articles of association and (2) the Companies Law, insofar as they relate to the material terms of our common shares. This offering consists solely of an offering of ADSs representing common shares. Consequently, the following discussion primarily concerns common shares and the rights of holders of common shares. The holders of ADSs will not be treated as our shareholders and will be required to surrender their ADSs for cancellation and withdrawal from the depository facility in which the common shares are held in order to exercise shareholders rights in respect of common shares. The depositary will agree, so far as it is practical, to vote or cause to be voted the amount of common shares represented by ADSs in accordance with the nondiscretionary written instructions of the holders of such ADSs. See Description of American Depositary Shares Voting Rights. Objects of Our Company Under our fifth amended and restated memorandum and articles of association, the objects of our company are unrestricted and we have the full power and authority to carry out any object not prohibited by the law of the Cayman Islands. Common Shares Upon the closing of this offering, our fifth amended and restated memorandum and articles of association will become effective and our authorized share capital will consist of 500,000,000 common shares, par value US$0.0001 per share. Certificates representing the common shares are issued in registered form. Our shareholders may freely hold and vote their shares. Series A Preference Shares Between June 2000 and August 2002, we issued and sold Series A preference shares in reliance upon Section 4(2) of the Securities Act. Upon closing of this offering, all of our outstanding Series A preference shares will convert into common shares. Consequently, no preferred shares will be outstanding immediately after the closing of this offering. Our fifth amended and restated memorandum and articles of association provide for the issuance of preferred shares. See Directors Power to Issue Shares. As of June 30, 2004, there were 29,657,694 common shares and 14,058,466 Series A preference shares issued and outstanding. All of our outstanding common shares are fully paid and non-assessable. The following tables set forth a reconciliation of the numbers of our common shares and Series A preference shares outstanding as of the dates indicated: Common shares(1) January 1, 2003 28,382,481 Common shares issued under stock option exercise 666,067 December 31, 2003 29,048,548 Common shares issued under stock option exercise 609,146 June 30, 2004 29,657,694 Table of Contents (1) Includes early exercise of options. Prior to vesting, the common shares so acquired are subject to our repurchase right in the event that any holder of these common shares ceases to be an officer, director or employee of our company. Holders of these shares are eligible for dividends and their voting rights are not affected. Series A preference shares Table of Contents UNDERWRITERS Under the terms and subject to the conditions contained in an underwriting agreement dated the date of this prospectus, the underwriters named below, for whom Morgan Stanley Dean Witter (Asia) Limited, 27th Floor, Three Exchange Square, Hong Kong is acting as representative, have severally agreed to purchase, and we have agreed to sell to them the number of ADSs indicated below: Number of Name ADSs Morgan Stanley Co. International Limited 25 Cabot Square, Canary Wharf, London E14 4QA, England UBS Securities LLC 677 Washington Boulevard, Stamford, CT 06901, USA Piper Jaffray Co. 800 Nicollet Mall, Suite 800, Minneapolis, MN 55402, USA CLSA Limited 18th Floor, One Pacific Place, 88 Queensway, Hong Kong Total 5,250,000 Table of Contents LEGAL MATTERS The validity of the ADSs and certain legal matters as to United States federal and New York law will be passed upon for us by Shearman Sterling LLP. Certain legal matters as to United States federal and New York law will be passed upon for the underwriters by Davis Polk Wardwell. The validity of the common shares represented by the ADSs offered in this offering and certain other legal matters as to Cayman Islands law will be passed upon for us by Maples and Calder Asia. Certain legal matters as to PRC law will be passed upon for us by Jun He Law Offices and for the underwriters by Commerce Finance Law Offices. Carmen Chang, a partner at Shearman Sterling LLP, holds 4,800 of our Series A preference shares which will convert into 4,800 common shares of our company upon the closing of this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001295825_smartbarga_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001295825_smartbarga_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0e970bc1df8292b0bcfeeb06c15c3b54e5b65896 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001295825_smartbarga_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by SmartBargains will be passed upon for SmartBargains by Wilmer Cutler Pickering Hale and Dorr LLP, Boston, Massachusetts. Various legal matters related to the sale of the common stock offered hereby will be passed upon for the underwriters by Sidley Austin Brown Wood LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001296251_xti-llc_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001296251_xti-llc_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001296251_xti-llc_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001296252_xerium_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001296252_xerium_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bfb4cbe47778617b7c816c13eede49e66955d10 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001296252_xerium_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the issuance of the IDSs offered hereby, the shares of our Class A common stock and our notes, and our notes sold separately (not represented by IDSs), as well as the validity of the issuance of the subsidiary guarantees will be passed upon for us by Ropes & Gray LLP, New York, New York. Ropes & Gray LLP will rely on the opinions of Baker & McKenzie as to matters of Australian law, Mexican law and United Kingdom law, on the opinion of Torys as to matters of Canadian law and on the opinion of Tokyo Aoyama Aoki Law Office as to matters of Japanese law. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001297830_china_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001297830_china_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9c492069f918e86022a34d1d9cfec25cead3b5d7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001297830_china_legal_matters.txt @@ -0,0 +1 @@ +Legal matters" --> Legal matters We are being represented by O Melveny Myers LLP with respect to matters of United States Federal securities and New York State law. Certain legal matters in connection with this offering will be passed upon for the underwriters by Simpson Thacher Bartlett LLP. The validity of the ordinary shares represented by the ADSs offered in this offering will be passed upon for us by O Melveny Myers, Hong Kong. Legal matters in connection with Hong Kong taxation will be passed upon for us by Lovells. Legal matters as to Chinese law will be passed upon for us by Jincheng and Tongda Law Firm and for the underwriters by Jun He Law Offices. O Melveny Myers, Hong Kong, and O Melveny Myers LLP may rely upon Jincheng and Tongda Law Firm with respect to matters governed by Chinese law. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001298004_kenan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001298004_kenan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2704b6ee8098fc0219a5824e44a6d4dae5655737 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001298004_kenan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Fulbright & Jaworski L.L.P., New York, New York. The underwriters have been represented by Cravath, Swaine & Moore LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001298339_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001298339_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d7511c122d89c53af0885958a278ce58902fc813 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001298339_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001298340_nalco_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001298340_nalco_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..d7511c122d89c53af0885958a278ce58902fc813 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001298340_nalco_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity and enforceability of the notes have been passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. An investment vehicle comprised of selected partners of Simpson Thacher & Bartlett LLP, members of their families, related parties and others owns an interest representing less than 1% of the capital commitments of funds controlled by one of our Sponsors, The Blackstone Group. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001298978_market_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001298978_market_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..98ea638ab0d75c338d134e18a2507425bca24be8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001298978_market_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Perkins Coie LLP, Seattle, Washington, will pass upon the validity of our common stock. The underwriters are being represented by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Seattle, Washington. TWB Investment Partnership and TWB Investment Partnership L.P., entities affiliated with Perkins Coie LLP, beneficially own 192,629 shares of our common stock and 100,000 shares of our Series A convertible preferred stock respectively. TWB Investment Partnership is selling 81,728 shares of common stock in this offering and TWB Investment Partnership L.P. is selling 42,428 shares of common stock issuable on conversion of the Series A convertible preferred stock in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001298980_integris_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001298980_integris_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88e87413fe631a406d3a2a0d6d1b2a5bac1fe6a8 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001298980_integris_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock being offered will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York. Certain legal matters will be passed upon for the underwriters by Simpson Thacher & Bartlett LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001299033_calamos_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001299033_calamos_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..9068fb906d3f99b53d71479d530cda19d36e4a98 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001299033_calamos_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Shearman Sterling LLP, New York, New York, will pass upon certain legal matters for us. The underwriters have been represented by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001299146_medex_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001299146_medex_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..65d5e22c8f72f2333f7e177a95edf7c32d16f5c6 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001299146_medex_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Winston & Strawn LLP, Chicago, Illinois. Certain legal matters with respect to this offering will be passed upon for the underwriters by Clifford Chance US LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001299407_ibasis_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001299407_ibasis_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a7ab4cb35bf14d6f70fde27f9d5f46a391f08fa4 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001299407_ibasis_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities has been passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001299408_ibasis_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001299408_ibasis_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a7ab4cb35bf14d6f70fde27f9d5f46a391f08fa4 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001299408_ibasis_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities has been passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001299409_ibasis_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001299409_ibasis_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a7ab4cb35bf14d6f70fde27f9d5f46a391f08fa4 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001299409_ibasis_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities has been passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001299704_advance_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001299704_advance_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..e750b4acbac17ef79943e3b2c5e701734b655197 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001299704_advance_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the common stock offered by this prospectus will be passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York, and Chambliss, Bahner & Stophel, P.C., Chattanooga, Tennessee, for the selling stockholders by Bell, Boyd & Lloyd LLC, Chicago, Illinois, and for the underwriters by Cravath, Swaine & Moore LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001301388_tahoe_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001301388_tahoe_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001301388_tahoe_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001301389_tahoe_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001301389_tahoe_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001301389_tahoe_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001301642_hometown_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001301642_hometown_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001301642_hometown_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001301643_ocb_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001301643_ocb_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001301643_ocb_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001301646_buffets_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001301646_buffets_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88fc531e8cbf0d8de505d4b6f139765722f37ff7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001301646_buffets_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the IDSs offered hereby and the shares of Class A common stock and senior subordinated notes (including the senior subordinated notes sold separately from the IDSs), as well as the validity of the issuance of the subsidiary guarantees by the Delaware subsidiary guarantor, will be passed upon for us by Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York. The validity of the issuance of the subsidiary guarantees by the Minnesota subsidiary guarantors will be passed upon for us by Faegre Benson LLP, Minneapolis, Minnesota. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher Flom LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001302369_hometown_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001302369_hometown_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..b3ddcf7c9f273b77f4451fe88455b61481ab3be2 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001302369_hometown_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of the common stock will be passed upon for us by Morris Manning & Martin LLP, Atlanta, Georgia. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303023_volkswagen_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303023_volkswagen_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0c519f24aa756ff91e5440887959274c646cb3fe --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303023_volkswagen_legal_matters.txt @@ -0,0 +1,21 @@ +LEGAL MATTERS + + +Certain legal matters relating to the notes will +be passed upon for the servicer and the transferor by Allen L. +Strang, Esq., Attorney for VW Credit. Certain other legal +matters with respect to the notes, including federal income tax +matters, will be passed upon for the servicer, the transferor +and the Underwriters by Mayer, Brown, Rowe Maw LLP. +Mayer, Brown, Rowe Maw LLP has from time to time +represented VW Credit and its affiliates in other transactions. + +90 + +Table of Contents + +AVAILABLE INFORMATION + + +The transferor, VW Credit, the origination trust +and \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303056_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303056_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303056_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303057_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303057_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303057_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303058_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303058_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303058_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303059_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303059_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303059_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303060_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303060_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303060_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303061_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303061_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303061_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303062_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303062_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303062_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303063_autocam_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303063_autocam_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303063_autocam_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001303066_titan_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001303066_titan_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..37f071ac06157ff0071ea767f29a77fba6e81a54 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001303066_titan_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, will pass upon the validity of the notes. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001304366_community_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001304366_community_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..8982ee37f974e355b1fa6810259d9273463a587f --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001304366_community_legal_matters.txt @@ -0,0 +1 @@ +CERTAIN LEGAL MATTERS Reitner Stuart, San Luis Obispo, California, has advised us in connection with certain federal banking and securities law aspects of this offering. Santoro, Driggs, Walch, Kearney, Johnson Thompson, Ltd., Las Vegas, Nevada, has advised us in connection with certain matters related to Nevada law in connection with this offering, and will pass upon the validity of our common stock offered by this prospectus. The validity of the common stock offered by this prospectus will be passed upon for the underwriter by Manatt, Phelps Phillips, LLP, Los Angeles, California. Manatt, Phelps Phillips, LLP will rely as to matters of Nevada law upon the opinion of Santoro, Driggs, Walch, Kearney, Johnson Thompson, Ltd. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001304562_millstream_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001304562_millstream_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..876a71bbdd082fd58f4634bec8c1119c8c81f846 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001304562_millstream_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the securities offered in this prospectus are being passed upon for us by Graubard Miller, New York, New York. Bingham McCutchen LLP, New York, New York, is acting as counsel for the underwriters in this offering. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001305507_arlington_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001305507_arlington_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..57a801ee052346c25d4d4d90131b82167093e58d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001305507_arlington_legal_matters.txt @@ -0,0 +1 @@ +legal matters in connection with the sale of the shares offered hereby are being passed upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York, as to matters of United States and New York law and by Conyers Dill & Pearman, Hamilton, Bermuda, as to matters of Bermuda law. Certain matters will be passed upon for the underwriters by Seward & Kissel LLP, New York, New York, and Appleby Spurling Hunter, Hamilton, Bermuda. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001305627_prestiga_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001305627_prestiga_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0a9903ffbe2ff4d966a1a1c37534575cf4f79800 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001305627_prestiga_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters Litigation And Claims Within the past 5 years of the date of this prospectus, there have been no material administrative, civil or criminal actions against either managing member, the commodity trading advisors, the futures commission merchant, the selling agent, or any principal or affiliate of any of them. This includes any actions pending, on appeal, concluded, threatened, or otherwise known to them. Legal Opinion M&A Counselors and Fiduciaries, LLC, 21 Cummings Park, Suite 200, Woburn, MA 01801, bhoilman@macounselors.com, is special securities counsel to advise the Fund and the managing member with respect to: * the offering of membership interests * the preparation of this prospectus * the legality of the membership interests offered, and * the classification of the Fund as a partnership for tax purposes. From time to time, the Fund will also advise the Fund regarding the maintenance of the Fund's tax status, the legality of any subsequent offers, and the legality of any transfers by members. The managing member may add, delete, and change legal counsel to the Fund at any time for any reason. The managing member has granted the Firm the right to employ other law firms to help in matters that relate to the sale of membership interests or our operation The Firm will not give you or any persons affiliated with you legal advice. You should seek investment, legal, and tax advice from your own legal counsel and other professionals of your choice. Experts The managing member has employed financial experts to perform services for the Fund. These experts currently are: Larry D. Liberfarb, P. C., 11 Vanderbilt Avenue, Suite 220, Norwood, MA 02062, 781-255-8800 is our accounting and auditing expert, and is responsible for auditing the books and records of both the Fund and Prestiga Capital Management, Inc. Liberfarb has audited the financial statements in this prospectus and prepares our tax returns. The corporate managing member serves as our tax matters partner. The managing member is required by the rules and regulations of the Commodity Futures Trading Commission to send you unaudited monthly account statements and annual financial statements audited by an independent certified public accountant. The managing member may add, delete and change the experts selected experts to perform services for the Fund at any time for any reason. We will send you the unaudited monthly account statements as soon as practicable after the end of each month, and will send you the audited annual financial statements within 90 days after the end of each calendar year. Additional Information By our managing member, we have filed a registration statement on Form S-1 with the Securities and Exchange Commission under the Securities Act of 1933 to allow us to issue and sell our membership interests. This prospectus does not contain all of the information in the Form S-1 filing, for example, the Selling Agreement and the futures commission merchant's Customer Agreements that established the Fund accounts. The descriptions in this prospectus of these exhibits are summaries. For further information regarding the Fund and the membership interests offered, you may inspect and copy, without charge, our complete filings, including this prospectus, the exhibits and periodic reports, at the public reference facilities of the Securities and Exchange Commission at 450 Fifth Street, NW, Washington, D.C. 20549. Also, the Securities and Exchange Commission offices will send you copies of all or any part of this filing by mail, upon payment of the prescribed rates. This prospectus and other electronic filings made through the Electronic Data Gathering, Analysis and Retrieval (EDGAR) system are publicly available through the Commission's Internet site, http://www.sec.gov. In addition, our books and records will be maintained for six years at the office of the corporate managing member Prestiga Capital Management, Inc., 4 Pheasant Hill Street, P.O. Box 409, Westwood, MA 02090. You are invited to review any materials available to the managing member relating to: * this Fund * our operations * this offering * the commodity experience and trading history of: * the commodity trading advisor * the managing member * the futures commission merchant, and * their respective officers, directors and affiliates * the Advisory Agreement between us and the commodity trading advisor * the Customer Agreement between us and the futures commission merchant * the commodity trading advisor's disclosure document * the forms filed with the National Futures Association for any registered entity or person related to this Fund, and * any other matters relating to the laws applicable to this offering or this Fund. The officer and staff of the managing member will answer all reasonable inquiries you may have. All the above materials will be made available at any mutually convenient location at any reasonable hour after reasonable prior notice. The managing member will allow you to obtain any additional information from third parties necessary to verify any representations or information in this prospectus and its exhibits, assuming the managing member possesses such information or has a right to acquire it with reasonable effort and expense. However, your review is limited by the proprietary and confidential nature of the commodity trading advisor's trading systems and by the confidentiality of personal information relating to other investors. [The balance of this page has been intentionally left blank.] ******************************************************************************* PRESTIGA FUND, LLC (A Development Stage Enterprise) OCTOBER 8, 2004 LARRY D. LIBERFARB, P. C. CERTIFIED PUBLIC ACCOUNTANTS 11 VANDERBILT AVENUE, SUITE 220 NORWOOD, MA 02062 781-255-8800 INDEPENDENT AUDITORS' REPORT To the Members Prestiga Fund, LLC Westwood, MA We have audited the accompanying balance sheet of PRESTIGA FUND, LLC (a development stage enterprise) as of October 8, 2004, and the related statements of operations and cash flows for the initial period October 4, 2004 through October 8, 2004. 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. 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. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of PRESTIGA FUND, LLC as of October 8, 2004, and the results of its operations and its cash flows for the initial period October 4, 2004 through October 8, 2004, in conformity with accounting principles generally accepted in the United States of America. October 8, 2004 Norwood, MA PRESTIGA FUND, LLC (A Development Stage Enterprise) BALANCE SHEET October 8, 2004 ASSETS Cash $ 2,000 Total Assets $ 2,000 LIABILITIES AND MEMBERS' CAPITAL Members' Capital - Member (1 unit) Initial capital contribution 1,000 Managing Member (1 unit) Initial capital contribution 1,000 Total Members' Capital 2,000 Total Liabilities and Members' Capital $ 2,000 The accompanying notes are an integral part of these financial statements. PRESTIGA FUND, LLC (A Development Stage Enterprise) STATEMENT OF OPERATIONS For The Period October 4 to October 8, 2004 REVENUES $ - Total Revenues - EXPENSES - Total Expenses - NET INCOME $ - The accompanying notes are an integral part of these financial statements. PRESTIGA FUND, LLC (A Development Stage Enterprise) STATEMENT OF MEMBERS' CAPITAL For The Period October 4 to October 8, 2004 Total Members Managing Members Members' Capital Amount Units Amount Units Amount Units Initial member contributions $1,000 1 $1,000 1 $2,000 2 Net income Oct 1, 2004 to Oct 8, 2004 - - - Balance - Oct 8, 2004 $1,000 1 $1,000 1 $2,000 2 The accompanying notes are an integral part of these financial statements. PRESTIGA FUND, LLC (A Development Stage Enterprise) STATEMENT OF CASH FLOWS For The Period October 4 to October 8, 2004 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ - Adjustments to reconcile net income to net cash used in operating activities- - Net Cash Used In Operating Activities - CASH FLOWS FROM INVESTING ACTIVITIES Initial member contributions 2,000 NET INCREASE IN CASH 2,000 CASH - Beginning of period - End of period $ 2,000 The accompanying notes are an integral part of these financial statements. PRESTIGA FUND, LLC (A Development Stage Enterprise) NOTES TO FINANCIAL STATEMENTS OCTOBER 8, 2004 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Prestiga Fund, LLC (the Company or Fund) was formed on October 4, 2004 under the laws of the State of Delaware. The Fund expects to engage in high risk, speculative and hedge trading of futures and forward contracts, options on futures and forward contracts, and other instruments selected by the commodity trading advisors (CTA's). However, the Fund will not commence business until at least $900,000 worth of units of membership interests (the Units) are sold. The maximum offering is $100,000,000. Prestiga Capital Management, Inc. is the Managing Member and commodity pool operator (CPO) of the Fund. The initial CTA is expected to be Worth Capital Management, Inc., which will have the authority to trade as much of the Fund's equity as is allocated to it by the Managing Member. The selling agent is MHA Financial Corp (MHA). The Company is in the development stage and its efforts through October 8, 2004 have been principally devoted to organizational activities. Regulation - The Fund is a registrant applicant with the Securities and Exchange Commission (SEC) pursuant to the Securities and Exchange Act of 1934 (the Act). The Fund will be subject to the regulations of the SEC and the reporting requirements of the Act. The Fund will also be subject to the regulations of the Commodities Futures Trading Commission (CFTC), an agency of the U.S. government which regulates most aspects of the commodity futures industry, the rules of the National Futures Association (NFA) and the requirements of various commodity exchanges where the Fund executes transactions. Additionally, the Fund will be subject to the requirements of futures commission merchants and interbank market makers through which the Fund trades. Offering Expenses and Organizational Costs - Contingent upon the sale of at least $900,000 of Units, offering costs of approximately $50,000 will be paid from the gross proceeds contributed and charged to the Members' capital accounts after the thirteenth month of operation of the Fund. Subject to the above contingency and deferral of payment, organizational costs are charged to expense after deferment of thirteen months. Through October 8, 2004, approximately $25,000 in offering costs have been paid by an affiliate. Registration Costs - Costs incurred for the initial filings with SEC, CFTC, NFA and the states where the offering is expected to be made are accumulated, deferred for thirteen months and charged against the Fund. Recurring registration costs, if any, will be charged as incurred; provided however, the managing member has the right, but not the obligation, to defer the charges for those costs to the Fund for thirteen months from the date they are incurred. PRESTIGA FUND, LLC (A Development Stage Enterprise) NOTES TO FINANCIAL STATEMENTS OCTOBER 8, 2004 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Revenue Recognition - Forward contracts, futures and other investments are recorded on the trade date and will be reflected in the statement of operations at the difference between the original contract amount and the market value on the last business day of the reporting period. Market value of forward contracts, futures and other investments is based upon exchange or other applicable closing quotations related to the specific positions. Use of Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Income Taxes - The Fund is not required to provide a provision for income taxes. Income tax attributes that arise from its operations are passed directly to the individual Members. The Fund may be subject to state and local taxes in jurisdictions in which it operates. Statement of Cash Flows - For purposes of the Statement of Cash Flows, the Fund will consider only money market funds to be cash equivalents. Net cash provided by operating activities includes no cash payments for interest or income taxes as of October 8, 2004. 2. MANAGING MEMBER DUTIES The responsibilities of the Managing Member, in addition to directing the trading and investment activity of the Fund, including suspending all trading, includes executing and filing all necessary legal documents, statements and certificates of the Fund, retaining independent public accountants to audit the Fund, employing attorneys to represent the Fund, reviewing the brokerage commission rates to determine reasonableness, maintaining the tax status of the Fund as a partnership, maintaining a current list of the names, addresses and numbers of units owned by each Member and taking such other actions as deemed necessary or desirable to manage the business of the Company. The Managing Member has contributed $1,000 in cash for deposit to the capital of the Fund for a non-trading Managing Membership interest in the Company. The Managing Member and all other Managing Members' combined contribution to the Managing Member account in the Fund will, at all times, be equal to or greater than one percent (1%) of all capital contributions, including the Managing Membership accounts, to the Fund or at such other level as may be required by law. PRESTIGA FUND, LLC (A Development Stage Enterprise) NOTES TO FINANCIAL STATEMENTS OCTOBER 8, 2004 2. MANAGING MEMBER DUTIES(CONTINUED) If the net unit value of the Company falls to less than 50% of the greater of the original $1,000 selling price, less commissions and other charges or such higher value earned through trading, then the Managing Member will immediately suspend all trading, provide all Members with notice of the reduction in net unit value and give all Members the opportunity, for fifteen days after such notice, to redeem Units. No trading shall commence until after the lapse of such fifteen day period. 3. THE LLC OPERATING AGREEMENT The LLC Operating Agreement provides, among other things, that: Capital Account - A capital account shall be established for each Member. The initial balance of each Member's capital account shall be the amount of the initial contributions to the Company. Monthly Allocations - Any increase or decrease in the Company's net asset value as of the end of a month shall be credited or charged to the capital account of each Member in the ratio that the balance of each account bears to the total balance of all accounts. Any distribution from profits or Members' capital will be made solely at the discretion of the Managing Member. Federal Income Tax Allocations - As of the end of each fiscal year, the Company's realized capital gain or loss and ordinary income or loss shall be allocated among the Members, after having given effect to the fees and expenses of the Fund. Subscriptions - Investors must submit subscription agreements and funds at least five business days prior to month end. Subscriptions must be accepted or rejected by the Managing Member within five business days. The investor also has five business days to withdraw his subscription. Funds are deposited into an interest bearing depository account and will be transferred to the Fund's account on the first business day of the month after the subscription is accepted. Interest earned on the funds while on deposit at the depository will accrue to the account of the investor. Redemptions - A Member may request any or all of his investment be redeemed at the net asset value as of the end of a month. The written request must be received by the Managing Member no less than ten business days prior to a month end. Redemptions will generally be paid within twenty days of the effective month end. However, in various circumstances due to liquidity, etc. the Managing Member may be unable to comply with the request on a timely basis. There are no fees for redemption. PRESTIGA FUND, LLC (A Development Stage Enterprise) NOTES TO FINANCIAL STATEMENTS OCTOBER8, 2004 4. FEES The Fund will be charged the following fees on a monthly basis as of the commencement of trading. The Fund will pay the Managing Member a monthly management fee of 1% (annual rate). The Fund will pay the Managing Member a $20 per round turn brokerage commission, from which the Managing Member will pay the round turn commissions to the futures commission merchant. A quarterly incentive fee of 5% of "new trading profits" will be paid to the CTA and a 20% quarterly incentive fee will be paid to the Managing Member. "New trading profits" includes all income earned by a CTA and expense allocated to his activity. In the event that trading produces a loss for a CTA, no incentive fees will be paid and all losses will be carried over to the following months until profits from trading exceed the loss. It is possible for one CTA to be paid an incentive fee during a quarter or a year when the Fund experienced a loss. After the Fund commences trading, the Fund will pay the selling agent who sold the units a one time 6% selling commission and an annual 4% continuing service fee during each year the investment is in the Fund. The Managing Member has reserved the right to change the management fee and the incentive fee at its sole discretion. The total incentive fees may be increased to 27% if the management fee is eliminated. The Fund may also increase the management fees paid to the CTA and Managing Member to 6% if the total incentive fees are decreased to 15%. 5. RELATED PARTY TRANSACTIONS The sole shareholder of the Managing Member has made an initial Member capital contribution in the Fund of $1,000. He is also an owner of MHA Financial Corp, the selling agent, which has temporarily funded the syndication costs incurred by the Fund to date. Management does not believe that a variable interest entity relationship exists between MHA, the Managing Member and the Fund. PRESTIGA FUND, LLC (A Development Stage Enterprise) NOTES TO FINANCIAL STATEMENTS OCTOBER 8, 2004 5. RELATED PARTY TRANSACTIONS (CONTINUED) Financial Accounting Standards Board Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, identifies certain disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. In the normal course of business, the Fund has provided general indemnifications to the Managing Member, its CTA and others when they act, in good faith, in the best interests of the Fund. The Fund is unable to develop an estimate for future payments resulting from hypothetical claims, but expects the risk of having to make any payments under these indemnifications to be remote. 6. CONCENTRATIONS The Fund will maintain all of its subscription deposits with a commercial financial institution. In the event of the financial institution's insolvency, recovery of Fund deposits may be limited to account insurance or other protection afforded deposits. ******************************************************************************* PRESTIGA CAPITAL MANAGEMENT, INC. FINANCIAL STATEMENTS OCTOBER 8, 2004 LARRY D. LIBERFARB, P. C. CERTIFIED PUBLIC ACCOUNTANTS 11 Vanderbilt Avenue, Suite 220 Norwood, MA 02062 INDEPENDENT AUDITORS' REPORT To The Board of Directors of Prestiga Capital Management, Inc. Westwood, MA We have audited the accompanying balance sheet of PRESTIGA CAPITAL MANAGEMENT, INC., a Delaware corporation, as of October 8, 2004, and the related statements of operations and cash flows for the initial period October 1, 2004 (date of inception) through October 8, 2004. 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. 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. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of PRESTIGA CAPITAL MANAGEMENT, INC. as of October 8, 2004, and the results of its operations and its cash flows for the initial period October 1, 2004 through October 8, 2004, in conformity with accounting principles generally accepted in the United States of America. October 8, 2004 Norwood, MA PRESTIGA CAPITAL MANAGEMENT, INC. BALANCE SHEET OCTOBER 8, 2004 ASSETS CURRENT ASSETS Cash $ 2,000 Investment in Prestiga Fund, LLC 1,000 Total Assets $ 3,000 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Advance from stockholder $ 2,000 STOCKHOLDERS' EQUITY Common stock, no par value 1,500 shares authorized; 10 shares issued 1,000 Total Liabilities and Stockholders' Equity $ 3,000 The accompanying notes are an integral part of these financial statements PRESTIGA CAPITAL MANAGEMENT, INC. STATEMENTS OF INCOME AND RETAINED EARNINGS FOR THE PERIOD OCTOBER 1, 2004 (DATE OF INCORPORATION) TO OCTOBER 8, 2004 REVENUES $ 0 EXPENSES 0 Total Expenses 0 NET INCOME 0 RETAINED EARNINGS, beginning of period 0 RETAINED EARNINGS, End of period $ 0 The accompanying notes are an integral part of these financial statements PRESTIGA CAPITAL MANAGEMENT, INC. STATEMENTS OF CASH FLOWS FOR THE PERIOD OCTOBER 1, 2004 (DATE OF INCORPORATION) TO OCTOBER 8, 2004 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 0 Adjustments to reconcile net income to net cash provided by operating activities - Changes in operating assets and liabilities 0 Net Cash Used in Operating Activities 0 CASH FLOWS USED FOR INVESTING ACTIVITIES Investment in Prestiga Fund, LLC (1,000) Net Cash Used In Investing Activities (1,000) CASH FLOWS FROM FINANCING ACTIVITIES Common stock issued 1,000 Advance from stockholder 2,000 Net Cash Provided by Financing Activities 3,000 INCREASE IN CASH 2,000 Cash at beginning of period 0 Cash at end of period $ 2,000 The accompanying notes are an integral part of these financial statements. PRESTIGA CAPITAL MANAGEMENT, INC. NOTES TO FINANCIAL STATEMENTS FOR THE PERIOD OCTOBER 1, 2004 (DATE OF INCORPORATION) TO OCTOBER 8, 2004 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Prestiga Capital Management, Inc. (the Company) was formed primarily to act as managing member of the Prestiga Fund, LLC (the Fund). Purchasers of Units in the Fund will not acquire or otherwise have any interest in this Company. The responsibilities of the Managing Member, in addition to the selection of trading advisors and other investment activity of the Fund, include executing and filing all necessary legal documents, statements and certificates of the Fund, retaining independent public accountants to audit the Fund, employing attorneys to represent the Fund, reviewing the brokerage commission rates to determine reasonableness, maintaining the tax status of the Fund as a limited partnership, maintaining a current list of the names, addresses and number of units owned by each Member and taking such other actions as deemed necessary or desirable to manage the business of the Fund. Revenue Recognition - After the commencement of trading by the Fund, the Company will earn fixed brokerage commissions (from which it will pay commissions to the introducing broker) and incentive fees on "new trading profits". Use of Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Principle of Consolidation - The Company is currently a 50% member in the Fund. However, this substantial ownership interest is expected to be temporary since the Fund intends to solicit over $1,000,000 in membership interests which will reduce the Company's investment to a fractional ownership interest. In addition, to date, the Fund has no revenue and has incurred no expenses. Considering the temporary nature of this substantial ownership interest, the financial records of the Fund and the Company have not been consolidated. Statement of Cash Flows - Net cash provided by operating activities includes no cash payments for interest nor income taxes for the initial period from October 1, 2004 through October 8 2004. PRESTIGA CAPITAL MANAGEMENT, INC. NOTES TO FINANCIAL STATEMENTS THE PERIOD OCTOBER 1, 2004 (DATE OF INCORPORATION) TO OCTOBER 8, 2004 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Income tax status- For Federal income tax purposes, the Company has not elected S-Corporation status and therefore pays Federal income taxes on income and carries forward losses in excess of income earned. 2. CORPORATE AFFILIATIONS The Company's sole shareholder has made an initial member capital contribution in the Fund of $1,000. He is also owner of MHA Financial Corp, which is the principal selling agent for the Fund. The Company purchased an interest as the managing member in the Fund with an initial investment of $1,000 representing a 50% membership interest in the Fund. The investment is accounted for under the equity method. The sole shareholder of the Company has been incurring the organization and offering costs of Prestiga Fund, LLC, which as of October 7, 2004, total approximately $25,000. This receivable is not collateralized and bears no interest. The sole shareholder of the Company has agreed to defer reimbursement of all Fund and Company organization and offering expenses until after the thirteenth month following the commencement of business which is contingent upon the Fund selling $900,000 in face amount of Shares to investors. ******************************************************************************* Part II Statement of Additional Information Prestiga Fund, LLC This Statement of Additional Information is the second part of a two-part document and should be read in conjunction with Part I of Prestiga Fund, LLC's disclosure document dated October ____, 2004, both of which are combined in this single prospectus. Table of Contents Appendix I - Commodity Terms And Definitions; State Regulatory Glossary Appendix II - Privacy Statement Exhibit A - LLC Operating Agreement Exhibit B - Request For Redemption Exhibit C - Suitability Information Exhibit D - Subscription Agreement And Power Of Attorney Exhibit E - Depository Agreement Exhibit F - Investment Advisory Contract The date of this Statement of Additional Information is October ____, 2004 ******************************************************************************* APPENDIX I Commodity Terms And Definitions Identification of the parties and knowledge of various terms and concepts relating to trading in futures and forward contracts and this offering are necessary for a potential investor to identify the risks of investment in the Fund. 1256 Contract. See Taxation - Section 1256 Contract. Additional Sellers. See definition of Selling Agent. Associated Persons. The persons registered pursuant to the Commodity Exchange Act with the futures commission merchant, the selling agent, additional sellers, or the introducing broker who are eligible to service the Fund, the members and to receive continuing service fees. Average Price System. The method approved by the Commodity Futures Trading Commission to permit the commodity trading advisor to place positions sold or purchased in a block to the numerous accounts managed by the advisor. See The Commodity Trading Advisor in the main body of the prospectus. Best Efforts. The term to describe that the party is liable only in the event they intentionally fail or are grossly negligent in the performance of the task described. Broker. See definitions of Futures Commission Merchant and Introducing Broker. Capital means cash invested in the Fund by any member and placed at risk for the business of the Fund. Commodity Futures trading Commission (CFTC). Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW, Washington, D.C., 20581. An independent regulatory commission of the United States government empowered to regulate commodity futures transactions under the Commodity Exchange Act. Commodity. Goods, wares, merchandise, produce, currencies, and stock indices that are traded on and off United States and foreign commercial exchanges. Traded commodities on U. S. Exchanges are sold according to uniform established grade standards, in convenient predetermined lots and quantities such as bushels, pounds or bales, are fungible and, with a few exceptions, are storable over periods of time. Commodity Broker. See definitions of Futures Commission Merchant and Introducing Broker. Commodity Exchange Act. The statute providing the regulatory scheme for trading in commodity futures and options contracts in the United States under the administration of the Commodity Futures Trading Commission which will provide the opportunity for reparations and other redress for claims. Commodity Pool Operator (CPO). Prestiga Capital Management, Inc., 4 Pheasant Hill Street, P.O. Box 409, Westwood, MA 02090, (781) 769-8066. A person that raises capital through the sale of interests in an investment trust, partnership, corporation, syndicate or similar form of enterprise, and uses that capital to invest either entirely or partially in futures contracts. Commodity Trading Advisor (CTA). A person or entity that renders advice about commodities or about the trading of commodities, as part of a regular business, for profit. Particularly, those who will be responsible for the analysis and placement of trades for the Fund. Continuing Service Fee. A percentage of the Capital of the Fund paid to the selling agents who will pay their individual associated persons who work for them who have either sold the membership interests to the members or are providing services to the managing member or the other members. The Fund will pay these fees to the principal selling agent, MHA Financial, which will pay a share these fees to those who sell the membership interests. Daily Price Limit. The maximum permitted movement in a single direction (imposed by an exchange and approved by the CFTC) in the price of a commodity futures contract for a given commodity that can occur on a commodity exchange on a given day in relation to the previous day's settlement price, which is subject to change, from time to time, by the exchange (with CFTC approval). Depository Agent and Depository Account. A segregated account held in the name of the corporate managing member at EBank Financial Services Inc., 2410 Paces Ferry Road, Suite 400, Atlanta, GA 30339 that will hold all the subscription proceeds until such time as either the minimum is sold, the subscription is accepted or the offering is terminated and all subscriptions returned by the Bank directly to the subscriber without deduction for any expenses or fees. Exchange for Physicals (EFP). A practice whereby positions in futures contracts may be initiated or liquidated by first executing the transaction in the appropriate cash market and then arbitraging the position into the futures market (simultaneously buying the cash position and selling the futures position, or vice versa). Fixed Brokerage Commission. The percentage of equity charged to clear the domestic round turn trades entered for the Fund account at the futures commission merchant. Actual commissions are charged to the Fund by the futures commission merchant for trades made on foreign exchanges and forward markets, if any. The entity charging the fixed commission takes the risk that the number of trades entered will not exceed the costs on a round turn basis in exchange for the retention in the difference between the round turn costs and the percentage charged. The percentage is usually expressed at an annual rate but paid monthly. Form K-1. The section of the Federal Income Tax Return filed by the Fund which identifies the amount of investment in the Fund, the gains and losses for the tax year, and the amount of such gains and losses reportable by a member on the member's tax return. Fully Committed Position. Each commodity trading advisor has an objective percentage of equity to be placed at risk. In addition, the CFTC places limits upon the number of positions a single commodity trading advisor may have in commodities. When either the objective percentage of equity is placed at risk or the commodity trading advisor reaches the limit in number of positions, the account or accounts have a fully committed position. Futures Commission Merchant (FCM). The person that solicits or accepts orders for the purchase or sale of any commodity for future delivery subject to the rules of any contract market and in connection with such solicitation or acceptance of orders, accepts money or other assets to margin, guarantee, or secure any trades or contracts that result from such orders for a commission. The corporate managing member is responsible for the negotiation and payment of the commission to the futures commission merchant. Futures Contract. A contract providing for (1) the delivery or receipt at a future date of a specified amount and grade of a traded Commodity at a specified price and delivery point, or (2) cash settlement of the change in the value of the contract. The terms of these contracts are standardized for each commodity traded on each exchange and vary only with respect to price and delivery months. A futures contract should be distinguished from the actual physical commodity, which is termed a cash commodity. Trading in futures contracts involves trading in contracts for future delivery of commodities and not the buying and selling of particular physical lots of commodities. A contract to buy or sell may be satisfied either by making or taking delivery of the commodity and payment or acceptance of the entire purchase price therefore, or by offsetting the contractual obligation with a countervailing contract on the same exchange prior to delivery. Gross Profits. The income or loss from all sources, including interest income and profit and loss from non-trading activities, if any. Initial Closing. When the minimum offering amount has been raised and subscriptions are released to the Fund for commencement of trading. Member. Persons who have invested and been admitted as Members without management authority pursuant to the Fund agreement. Limited liability company or Commodity Pool or Pool or Fund. The Prestiga Fund, LLC, evidenced by Exhibit A to this Prospectus, 4 Pheasant Hill Street, P.O. Box 409, Westwood, MA 02090. Managing Member. Prestiga Capital Management, Inc., 4 Pheasant Hill Street, P.O. Box 409, Westwood, MA 02090, (781) 769-8066. It manages the Fund. Margin. A good faith deposit with a broker to assure fulfillment of the terms of a futures contract. Does not limit or define the amount of the risk or loss. Margin Call. A demand for additional monies to hold positions taken to maintain a customer's account in compliance with the requirements of a particular commodity exchange or a futures commission merchant. MHA Financial Corp. The principal selling agent, 4 Pheasant Hill Street, P.O. Box 409, Westwood, MA 02090, (781) 769-8066 Mr. Hoilman is an owner of MHA and also the sole shareholder of the managing member, Prestiga Capital Management, Inc. Minimum Offering/Maximum Offering. The Minimum is the amount required to be invested before trading will commence, and the Maximum is the amount the managing member establishes as the amount that will terminate this offering. The managing member my elect to register additional membership interests or terminate the offering at anytime. National Association of Securities Dealers (NASD). The self-regulatory organization responsible for the legal and fair operation of broker dealers, such as the selling agent and such other matters within the authority granted to it by the SEC pursuant to the Securities Act of 1933.. National Futures Association (NFA). The self regulatory organization that is responsible for the legal and fair operation of commodity pool operators, such as the managing member of the Fund, commodity trading advisors, such as the trader for the Fund, introducing brokers, for futures commission merchants, such as the clearing broker of the Fund, and such other matters within the authority granted to it by the CFTC pursuant to the Commodity Exchange Act. Net Assets or Net Asset Value means the total assets, including all cash and cash equivalents (valued at cost plus accrued interest and earned discount), less total liabilities, of the Fund (each determined on the basis of generally accepted accounting principles, consistently applied under the accrual method of accounting or as required by applicable laws, regulations and rules including those of any authorized self regulatory organization). See Exhibit A, The LLC Operating Agreement. Net Unit Value. The net assets of the Fund divided by the total number of units of membership interests outstanding. Net Gains. The net profit from all sources. New Net Profit. The amount of income earned from trading, less the trading losses and brokerage commissions and fees paid to clear the trades which are incurred or accrued during the then current accounting period. See Charges to the Fund. Net Worth. The excess of total assets over total liabilities as determined by generally accepted accounting principles. Net worth for a prospective investor shall be exclusive of home, home furnishings and automobiles. North American Securities Administrators Association, Inc. (NASAA). The association of securities administrators of the fifty United States that establish guidelines and procedures for the review of the sale of securities within their State. NASAA has established guidelines for the review of commodity pools, such as the Fund. Offering Expenses. The expenses required to register units with the Securities and Exchange Commission, including the preparation of the Form S-1 and the filing with various State securities agencies and the printing of a Prospectus. North American Securities Administrator Association Guidelines for Commodity Pools define offering and organizational expenses to include selling commissions and redemption fees as well; and, for purposes of limitation, the total expenses cannot exceed 15% of capital raised pursuant to the offering. The offering expenses do not include the first year's accounting, legal and other operating costs. Option Contract. An option contract gives the purchaser the right (as opposed to the obligation) to acquire (call) or sell (put) a given quantity of a commodity or a futures contract for a specified period of time at a specified price to the seller of the option contract. The seller has unlimited risk of loss while the loss to a buyer of an option is limited to the amount paid (premium) for the option. Organizational Expenses. The costs to form the Fund and qualify it to do business, which were $5,000, that will be repaid by the Fund to the Managing Member thirteen months after the commencement of business. Members. All managing members and all members in the Fund. Position Limits. The Commodity Futures Trading Commission has established maximum positions that can be taken in some, but not in all commodity markets, to prevent the corner or control of the price or supply of those commodities. These maximums are is called position limits. Round-turn Trade. The initial purchase or sale of a futures or forward contract and the subsequent offsetting sale or purchase of such contract. Round-turn Commission. The brokerage cost for the open and close of a trade in a single contract defined by the exchange or other entity as to contract size and duration of position. Redemption. The right of a member to tender its membership interests to the Fund for surrender at the net unit value. See the LLC Operating Agreement attached as Exhibit A. Scale in Positions. In some situations, the positions desired to be taken on behalf of the Fund and other accounts under management will be too large to be executed at one time. The trading advisor intends to take positions at different prices, at different times and allocate those positions on a ratable basis in accordance with rules established by the Commodity Futures Trading Commission. This procedure is defined as to scale in positions. The same definition and rules apply when the trading advisor elects to exit a position. Securities and Exchange Commission (SEC). The United States regulatory authority that supervises the sale of securities, including the Units to be sold to the public by the Fund. Selling Agent. The National Association of Securities Dealers member broker dealer, MHA Financial Corp, 4 Pheasant Hill Street, P.O. Box 409, Westwood, MA 02090., and any other selling agents selected by it and the managing member to offer the membership interests for sale. See Plan of Distribution. Taxation - Section 1256 Contract is defined to mean: (1) any regulated futures contract (RFC); (2) any foreign currency contract; (3) any non-equity option; and (4) any dealer equity option. The term RFC means a futures contract whether it is traded on or subject to the rules of a national securities exchange which is registered with the Securities and Exchange Commission, a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission or any other board of trade, exchange or other market designated by the Secretary of Treasury (a qualified board of exchange) and which is marked-to-market to determine the amount of margin which must be deposited or may be withdrawn. A "foreign currency contract" is a contract which requires delivery of, or the settlement of, which depends upon the value of foreign currency which is currency in which positions are also entered at arm's length at a price determined by reference to the price in the interbank market. (The Secretary of Treasury is authorized to issue regulations excluding certain currency forward contracts from marked-to-market treatment.) A non-equity option means an option which is treated on a qualified board or exchange and the value of which is not determined directly or indirectly by reference to any stock (or group of stocks) or stock index unless there is in effect a designation by the Commodity Futures Trading Commission of a contract market for a contract bond or such group of stocks or stock index. A dealer equity option means, with respect to an options dealer, only a listed option which is an equity option, is purchased or granted by such options dealer in the normal course of his activity of dealing in options, and is listed on the qualified board or exchange on which such options dealer is registered. See Federal Income Tax Aspects. Trading Advisor. See Commodity Trading Advisor. Taking Positions Ahead of the Fund. The allocation of trades by other than legally accepted methods by the commodity trading advisor or other trader which favors parties who took the position unfairly. Trading Matrix. The dollar value used by a commodity trading advisor to define the number of positions to be taken by the accounts under management. Some commodity trading advisors have different trading matrices for different sized accounts. For example, they may trade all accounts over one million in size differently than accounts under one million. Unit. The term used to describe the initial $1,000 value and subsequent Net Asset Value of general and member interests of the Fund. Unrealized Profit Or Loss. The profit or loss that would be realized on an open position if it were closed at the current settlement price or the most recent appropriate quotation as supplied by the broker or bank through which the transaction is effected. Underwriter. This term is not applicable to this offering. All sales of membership interests will be on a best efforts basis. The price of the units will not be guaranteed, supported or underwritten in any way. See Selling Agent. State Regulatory Glossary The following definitions are supplied by the State securities administrators responsible for the review of public futures fund (commodity pool) offerings made to residents of their respective States. They belong to the North American Securities Administrators Association, Inc. that publish "Guidelines for the Registration of Commodity Pool Programs", such as the Fund, which contain these definitions. The following definitions are from the Guidelines; however, the managing member has made additions to, but no deletions from, some of these definitions to make them more relevant to the consideration of an investment in the Fund. Administrator-The official or agency administering the security laws of a State. This will usually be the State of residence of the Fund or the domicile of the broker or brokerage firm which makes the offer or the residence of the potential investor. Advisor-Any person who, for any consideration, engages in the business of advising others, either directly or indirectly, as to the value, purchase, or sale of commodity contracts or commodity options. This definition applies to the commodity trading advisors and, when it provides such advice, to the managing member. Affiliate-An Affiliate of a Person means: (a) any Person directly or indirectly owning, controlling or holding with power to vote 10% or more of the outstanding voting securities of such Person; (b) any Person 10% or more of whose outstanding voting securities are directly or indirectly owned, controlled or held with power to vote, by such Person; (c) any Person, directly or indirectly, controlling, controlled by, or under common control of such Person; (d) any officer, director or member of such Person; or (e) if such Person is an officer, director or member, any Person for which such Person acts in any such capacity. See "Conflicts". Capital Contributions-The total investment in a Program by a Participant or by all Participants, as the case may be. The purchase price for the membership interests. Commodity Broker-Any Person who engages in the business of effecting transactions in commodity contracts for the account of others or for his own account. See Futures Commission Merchant and Introducing Broker. Commodity Contract-A contract or option thereon providing for the delivery or receipt at a future date of a specified amount and grade of a traded commodity at a specified price and delivery point. Cross Reference Sheet-A compilation of the Guideline sections, referenced to the page of the prospectus, Program agreement, or other exhibits, and justification of any deviation from the Guidelines. This sheet is used by the State Administrator to review this prospectus. Net Assets-The total assets, less total liabilities, of the Program determined on the basis of generally accepted accounting principles. Net Assets shall include any unrealized profits or losses on open positions, and any fee or expense including Net Asset fees accruing to the Program. Net Asset Value Per Program Interest-The Net Assets divided by the number of Program Interests outstanding. Net Worth-The excess of total assets over total liabilities are determined by generally accepted accounting principles. Net Worth shall be determined exclusive of home, home furnishings and automobiles. New Trading Profits-The excess, if any, of Net Assets at the end of the period over Net Assets at the end of the highest previous period or Net Assets at the date trading commences, whichever is higher, and as further adjusted to eliminate the effect on Net Assets resulting from new Capital Contributions, redemptions, or capital distributions, if any, made during the period decreased by interest or other income, not directly related to trading activity, earned on Program assets during the period, whether the assets are held separately or in a margin account. See New Net Profit. Organizational and Offering Expenses-All expenses incurred by the Program in connection with and in preparing a Program for registration and subsequently offering and distributing it to the public, including, but not limited to, total underwriting and brokerage discounts and commissions (including fees of the underwriter's attorneys), expenses for printing, engraving, mailing, salaries of employees while engaged in sales activity, charges of transfer agents, registrars, trustees, escrow holders, depositories, experts, expenses of qualification of the sale of its Program Interest under Federal and State law, including taxes and fees, accountants' and attorneys' fees. Participant-The holder of a Program Interest. A Member in the Fund. Person-Any natural Person, partnership, corporation, association or other legal entity. Pit Brokerage Fee-Pit Brokerage Fee shall include floor brokerage, clearing fees, National Futures Association fees, and exchange fees. The managing member will pay these fees from the fixed brokerage commissions. Program-A limited liability company, joint venture, corporation, trust or other entity formed and operated for the purpose of investing in Commodity Contracts. The Fund. Program Broker-A Commodity Broker that effects trades in Commodity Contracts for the account of a Program. See the Futures Commission Merchant and Introducing Broker. Program Interest-A membership interest or other security representing ownership in a program. The units in the Fund. See Exhibit A, the LLC Operating Agreement. Pyramiding-A method of using all or a part of an unrealized profit in a Commodity Contract position to provide margin for any additional Commodity Contracts of the same or related commodities. Sponsor-Any Person directly or indirectly instrumental in organizing a Program or any Person who will manage or participate in the management of a Program, including a Commodity Broker who pays any portion of the Organizational Expenses of the Program, and the managing member(s) and any other Person who regularly performs or selects the Persons who perform services for the Program. Sponsor does not include wholly independent third parties such as attorneys, accountants, and underwriters whose only compensation is for professional services rendered in connection with the offering of the membership interests. The term Sponsor shall be deemed to include its Affiliates. Valuation Date-The date as of which the Net Assets of the Program are determined. For the Fund, this will be after the close of business on the last business day of each month. Valuation Period-A regular period of time between Valuation Dates. For the Fund, this will be the close of business for each calendar month and each calendar year. [The balance of this page has been intentionally left blank] ******************************************************************************* APPENDIX II PRIVACY STATEMENT PRESTIGA FUND, LLC 4 Pheasant Hill Street P.O. Box 409 Westwood, MA 02090 (781) 769-8066 Prestiga Fund, LLC, is committed to safeguarding the confidential information of its members. We hold all personal information provided to us in the strictest confidence. These records include all personal information that we collect from you. We have never disclosed information to nonaffiliated third parties, except to our selling agents or as directed by you or required by law and we do not anticipate any change in these procedures in the future. If we were to change this disclosure policy, we would not take such action without your written permission. A full statement of our privacy policy with respect to personal information about you is as follows: * We limit employee and independent contractor representatives of ours access to information in your file to only to those persons who have a business or professional reason for knowing. * We limit the delivery of your information to only those nonaffiliated parties who directly service your account such as selling agents, trustees and clearing brokers or as directed by you or as required by law. As examples, Federal regulations permit us to share a limited amount of information about you with a clearing brokerage firm in order to execute securities transactions on your behalf and we have implied permission from you to discuss your financial situation with our selling agents and your accountant or other professional. * We use our best efforts to maintain a secure office and computer environment to ensure that your information is not placed at unreasonable risk. * The categories of nonpublic personal information that we collect from a prospect, member, client and independent third parties depend upon the scope of the client engagement. It will include information about your personal finances, information about your health to the extent that it is needed for the planning process, information about transactions between you and third parties, and information from consumer reporting agencies. * For unaffiliated third parties that require access to your personal information, including financial service companies, consultants, and auditors, we also require strict confidentiality in our agreements with them and expect them to keep this information private. Federal and State regulators also may review firm records as permitted under law. * We do not provide your personally identifiable information to mailing list vendors or solicitors for any purpose. * Personally identifiable information about you will be maintained during the time you are a member or client, and for the required time thereafter that such records are required to be maintained by Federal and State securities laws. After this required period of record retention, all such information is expected to be destroyed. [The balance of this page has been intentionally left blank.] ******************************************************************************* EXHIBIT A TO PRESTIGA FUND DISCLOSURE DOCUMENT PRESTIGA FUND, LLC a Delaware Limited Liability Company LLC OPERATING AGREEMENT THIS OPERATING AGREEMENT is made and entered into as of the 4th day of October, 2004, by and among Prestiga Capital Management, Inc., a Delaware corporation (the "Managing Member"), C. William Hoilman (the "Initial Member"), and each other party who shall execute this Agreement, whether in counterpart, by separate instrument, by grant of a power of attorney, or otherwise, as members (collectively "Members") to govern the operation of Prestiga Fund, LLC (the "Company") RECITALS: WHEREAS, the Company was formed as a Delaware limited liability company by the filing of the Certificate of Formation by the Managing Member and Initial Member; NOW THEREFORE, the parties hereto agree as follows: 1. Certain Defined Terms (a) "Disclosure Document": The Disclosure Document, Prospectus, S-1 Registration Statement, and any other form filed with any regulatory agency relating to the Offering. (b) "Managing Member": Prestiga Capital Management, Inc. (c) "Member": Any bona fide purchaser of Units for value who has been accepted by the Managing Member, as provided in Paragraph 6 hereof, as a Member, who takes no active role in the management of the Fund. (d) "Net Asset Fee Net Asset Value": The Fund's net asset value as of the end of each month (without deduction for the management fee then being calculated or for any fees, including incentive fees or payables then accrued or payable, to the Managing Member) increased by the amount of distributions or redemptions from the Fund in the month for which the management fee is being calculated. (e) "Net Asset Value": The Fund's total assets less total liabilities, determined according to the following principles, and where no principle governs, then on the basis of generally accepted accounting principles, consistently applied: (1) Net Asset Value shall include any unrealized profit or loss on open commodity positions (including forward contracts and options on futures contracts). (2) All open commodity positions shall be valued at their then market value which means the settlement price as determined by the exchange on which the transaction is effected or the most recent appropriate quotation as supplied by the Clearing Broker or banks through which the transaction is effected. If there are no trades on the date of the calculation due to operation of daily price fluctuation limits or due to a closing of the exchange on which the transaction is executed, the contract shall be valued at the nominal settlement price as determined by the exchange. (3) Brokerage commissions on open positions shall be accrued one-half (on a round-turn basis) as a liability of the Fund in the month in which such positions are initiated and one-half in the month in which such positions are closed. Incentive allocations payable to the Managing Member on New Net Profit, as defined herein, shall be accrued monthly for purposes of calculating net asset value only. (f) "Net Asset Value per Unit": Net asset value per Unit means the net asset value of the Fund's Account divided by the number of units of membership (including Managing Member) interests then outstanding. (g) "New Net Profit": New Net Profit (for the purpose of calculating the monthly incentive allocation to be paid to the Managing Member and the CTAs) means the excess (if any) of (a) the Fund's net asset value as of the end of the month, not reduced by the current incentive allocation then being calculated or management fees over (b) the highest value of the Fund's net asset value as of the close of business on the last business day of any previous calendar month (or the commencement of trading if higher), after reduction for incentive allocations, paid or payable as of such date. New Net Profit is adjusted for redemptions and distributions since the previous month-end as of which New Net Profit existed (or the commencement of trading, as the case may be). (h) "Offering": The offering of Units in the Fund described in the Disclosure Document to which a copy of this Agreement is attached as an exhibit. (i) "Fund": Prestiga Fund, LLC, the limited liability company created by this Agreement. (j) "Unit(s)": Membership interests in the Fund, as more fully explained in Paragraph 6(b) of this Agreement and, in addition (where the context so requires), the Managing Member's interests in the Fund on a Unit-equivalent basis. (k) "Undefined Terms": Certain terms not defined herein are used with the respective meanings set forth in the Disclosure Document. 2. Formation and Name. The parties hereby form a limited liability company under the laws and in accordance with the Limited Liability Company Act of the state of Delaware (the "Act"). The name of the limited liability company is Prestiga Fund, LLC. The Managing Member may, without the approval of the Members, change the name of the Company. The Managing Member shall execute and file a Certificate of Formation in accordance with the provisions of the Act and execute, file and record those amendments and other documents as are or become necessary or advisable in connection with the operation of the Fund, as it determines. Each Member undertakes to furnish to the Managing Member, if the Managing Member so requests, a power of attorney which may be filed in such jurisdictions as the Managing Member may deem appropriate with the Certificate of Formation and any amendments and any additional information as is required from the Managing Member to complete any documents, including the Certificate of Formation, amendments and assumed name certificates, and to execute and cooperate in the filing, recording and publishing of those documents at the request of the Managing Member. The Managing Member shall not be required to deliver the Certificate of Formation or a certificate of ownership to each Member. 3. Principal Office. The address of the principal office of the Fund shall be 4 Pheasant Hill Street, P.O. Box 409, Westwood, MA 02090, or such other place as the Managing Member may designate from time to time. 4. Business. The Fund will invest in speculative transactions involving commodity interests, which include commodity futures and forward contracts and other interests in commodities (including without limitation option contracts on futures, and cash commodities and foreign currencies). The objective of the Fund's business is appreciation of its assets through trading in such instruments. 5. Term, Special Redemption, Dissolution and Fiscal Year. (a) Term. The term of the Fund shall end upon the first to occur of the following: (1) receipt by the Managing Member of an election to dissolve the Fund at a specified time by a majority of the Members, notice of which is sent by registered mail to the Managing Member not less than 90 days prior to the effective date of dissolution; (2) withdrawal, insolvency, bankruptcy, legal disability or dissolution of both the Managing Member (unless the Fund is continued pursuant to Paragraph 20(c)); (3) termination of the Fund pursuant to Paragraphs 14 or 17; (4) any event which shall make it unlawful for the existence of the Fund to be continued or which requires termination of the Fund. (b) Special Redemption. As of the close of business of the last day of any month, should there be a decline in the net asset value per Unit to less than 50% of the initial net asset value per Unit on the date the Fund commenced trading operations the following will occur: (i) trading in the Fund will be suspended and all open positions will be closed; (ii) the CTA Advisory Agreements will be terminated; (iii) with the exception of the Managing Member, the capital accounts of all existing Fund Members will be redeemed (following the procedures for redemption defined in this document); (iv) following the redemption of Fund Member accounts, the Managing Member may, at its discretion, enter Advisory Agreements with different CTAs, and new subscriptions may be accepted into the Fund. (c) Dissolution. Upon the occurrence of an event causing the dissolution of the Fund, the Fund shall be dissolved and terminated. Upon dissolution, the Fund will conduct no further business, but will engage only in such activities as are necessary for the winding up of its affairs and the distribution of its assets. Upon dissolution, the Fund's open positions will be closed out in an orderly manner. Dissolution, payment of creditors and of expenses incurred in the liquidation of the Fund and distribution of the Fund assets shall be effected as soon as practicable in accordance with the Act, and the Managing Member and Members (and any assignees) shall share in the assets of the Fund, if any, pro-rata in accordance with their respective capital account balances, less any amount owing by such parties (or their respective assignees) to the Fund. (d) Fiscal Year. The fiscal year of the Fund shall begin on January 1 of each year and end on December 31; provided, however, that the first fiscal year of the Fund shall commence on the date its Certificate of Formation is filed with the Secretary of State of Delaware and shall end on December 31 of such year. 6. Capital Contributions; Units of Limited Liability Company Interest. (a) Capital Contributions. The Managing Member Initial Member have each contributed $1,000 in cash to the capital of the Fund in order to form the Fund. Upon (i) the admission of Members to the Fund, the Managing Member shall maintain an aggregate investment in the Fund equal to the greater of $25,000 or 1% of the positive capital account balances of all the Members. The Managing Member will maintain this required minimum investment as long as it is the sole Managing Member of the Fund. The Managing Member may withdraw any interest it may have as a Managing Member in excess of this requirement and may redeem any portion of its interest as of the then current month-end on the same terms as any Member, provided that no reduction will reduce the Managing Member's interest below the minimum required contribution to the Fund as described above. (b) Units of Membership Interest. The Managing Member and Initial Member have each contributed $1,000 in cash to the capital of the Fund in order to form the Fund. Interests in the Fund shall be one class consisting of one hundred thousand (100,000) Units of Limited Liability Company Interests ("Units" or, individually, a "Unit") of initial value of one thousand dollars $1,000 each. Fractional Units shall be rounded to the nearest ten-thousandth of a Unit for all purposes of this Agreement. The Managing Member shall, on behalf of the Fund and in accordance with the Disclosure Document of the Fund, issue and sell Units to other qualified persons (including the Managing Member and their shareholders, directors, officers and employees) pursuant to the Offering. The Managing Member and its affiliates may purchase additional Units. The Units are being sold pursuant to the Disclosure Document. The Managing Member may in the future offer additional Units for sale, and may offer other classes of Units having different terms. Each person who subscribes for Units ("Subscriber") shall become a Member in the Fund at such time as he has: (i) subscribed and had his subscription accepted by the Managing Member for at least the minimum investment; (ii) contributed to the capital of the Fund for each Unit for which he has subscribed; and (iii) become a party to this Agreement by executing and delivering to the Managing Member such documents as the Managing Member shall require. Upon the acceptance of a Member, the Initial Member shall withdraw from the Fund and his initial capital contribution shall be refunded. After the raise of $1,000,000 (the "Minimum"), business shall commence and all proceeds from subscriptions shall then be available for the trading activities of the Fund and for such other proper Fund purposes as the Managing Member shall determine. The Managing Member may in its sole discretion, terminate the offering of Units at any time. All Units are subscribed for upon receipt by the Managing Member of the Subscriber's completed and properly executed Subscription Agreement and Power of Attorney (in the form attached to the Disclosure Document as Exhibit D) and a check or draft or other good funds of the Subscriber in the full amount of the Subscriber's subscription; provided however, no Unit(s) will be issued to a Subscriber until collection in full of the funds represented by the check or draft. Notwithstanding anything contained in this Agreement to the contrary, the Managing Member, in its discretion, may reject any subscription for Units in whole or in part. Each Subscriber agrees to reimburse the Fund for any expenses or losses incurred in connection with any cancellation of Units issued to him. 7. Power of Managing Member in Connection with the Offering. The Managing Member shall have sole and complete discretion to determine the terms and conditions of the Offering, and the Managing Member is authorized and directed to do, or cause to be done, all things which it deems necessary, desirable or appropriate in connection therewith, including, but not limited to, the execution and filing of all such documents as may be necessary to comply with the Securities Act of 1933, as amended, and all rules issued thereunder and to qualify Units for sale under the securities laws of any of the States of the United States and with any other regulatory agencies and organizations. 8. Allocation of Profits and Losses. (a) Maintenance of Capital Accounts. The Fund shall maintain a capital account for each Member which shall consist of such Member's initial capital contributions increased by (i) additional capital contributions, and (ii) such Member's share of profits allocated pursuant to this Paragraph 8, and decreased by (iii) distributions to each such Member, and (iv) his share of losses allocated pursuant to this Paragraph 8. The foregoing provision is intended to comply with Treasury Regulation Section 1.704-1(b) and shall be interpreted and applied in a manner consistent therewith. (b) Allocation of Profit and Loss for Federal Income Tax Purposes. As of the end of each fiscal year, the Fund's income and expense and capital gain or loss from trading shall be allocated to the Managing Member in an amount equal to the greater of the Managing Member's percentage interest in the Fund as determined by its contribution to the Fund or 1% and the balance shall be allocated to the Members as a class. The profit and loss so allocated to the Members shall be allocated among them pursuant to the following subparagraphs for federal income tax purposes. Allocations shall be pro-rata from short- term capital gain or loss and long-term capital gain or loss and operating income or loss realized and recognized by the Fund. (1) Items of ordinary income, such as expense, such as fees, commissions and administrative expenses, shall be allocated pro-rata among the Members based on their respective capital accounts as of the end of each month in which the items of ordinary income and expense accrue. (2) Capital gain or loss from the Fund trading activities shall be allocated as follows: (A) Each capital account shall be increased by the amount of income allocated to the Member or his assignee pursuant to subparagraph (b)(1) above and subparagraph (4) below. (B) Each capital account shall be decreased by the amount of expense or loss allocated to the Member or his assignee pursuant to subparagraph (b)(1) above and subparagraph (6) below and by the amount of any distribution received by the Member or his assignee with respect to the Unit, other than on redemption of Units. (C) When a Unit is redeemed, the capital account maintained for such redeeming Member shall be decreased by the redemption amount. (3) Capital gain shall be allocated first to each Member who has redeemed a Unit during the fiscal year up to any excess of the amount received upon redemption of the Unit over the amount in his capital account attributable to the redeemed Unit. (4) Capital gain remaining after the allocation in subparagraph (3) shall be allocated among all Members in the ratio that each Member's capital account bears to all Members' capital accounts. (5) Capital loss shall be allocated first to each Member who has redeemed a Unit during a fiscal year up to any excess of the amount in his capital account attributable to the redeemed Unit over the amount received upon redemption of the Unit. (6) Capital loss remaining after the allocation in subparagraph (5) shall be allocated among all Members in the ratio that each Member's capital account bears to all Members' capital accounts. (7) Any gain or loss required to be taken into account in accordance with Section 1256 of the Internal Revenue Code of 1986, as amended (the "Code"), shall be considered a realized capital gain or loss for purposes of this Paragraph 8(b). The allocations of capital gain described above shall be pro-rata between short and long-term capital gain. (8) The tax allocations prescribed by this Paragraph 8(b) shall be made to each holder of a Unit, whether or not the holder is a substituted Member. (9) The foregoing provisions are intended to comply with Treasury Regulation Section 1.704-1(b) and shall be interpreted and applied in a manner consistent with such regulation. (c) Qualified Income Offset. Notwithstanding any other provision in this Agreement, in the event at the end of any Fund taxable year any Member's capital account is adjusted for, or such Member is allocated, or there is distributed to such Member any item described in Treasury Regulation Section 1.704-1(b)(2)(ii)(d)(4), (5) or (6) in an amount not reasonably expected to occur at the end of such year, and such treatment creates a deficit balance in such Member's account, then without regard to any other provision of this Agreement, such Member shall be allocated all items of income and gain of the Fund for such year and for all subsequent taxable years of the Fund until such deficit balance has been eliminated. In the event that any such unexpected adjustments, allocations or distributions create a deficit balance in the capital accounts of more than one Member in any Fund taxable year, all items of income and gain of the Fund for such taxable year and all subsequent years shall be allocated among all such Members in proportion to their respective deficit capital account balances until such deficit balances have been eliminated. (d) Code Section 754 Election. In case of a transfer (as defined in Paragraph 14(a)) of all or part of any Member's interest in the Fund, the Managing Member may but shall not be required to elect, in a timely manner, pursuant to Section 754 of the Internal Revenue Code of 1986, as amended (the "Code") and pursuant to corresponding provisions of the applicable state and local tax laws, to adjust the basis of the assets of the Fund pursuant to Sections 734 and 743 of the Code. (e) Expenses. The Managing Member shall advance all organizational and offering expenses. The Fund shall bear all of its operating liabilities, costs and expenses. Appropriate reserves may be created, accrued and charged against net asset value for contingent liabilities, if any, as of the date any contingent liability becomes known to the Managing Member. Any reserves shall reduce the net asset value per Unit for all purposes, including redemption. (f) Limited Liability of Members. Each Unit, when purchased in accordance with this Agreement, shall be fully paid and non-assessable. Any provisions of this Agreement to the contrary notwithstanding, no Member shall be liable for Fund obligations in excess of the capital contributed by him plus his share of profits remaining in the Fund, if any, and any other amounts he may be liable for pursuant to the Act. (g) Return of Members' Capital Contributions. Except to the extent that a Member shall have the right to withdraw capital in accordance with the terms of this Agreement, no Member shall have any right to demand the return of his Capital Contribution or any profits added thereto, except upon dissolution and termination of the Fund. In no event shall a Member be entitled to demand or receive property other than cash. 9. Compensation to the Managing Member and the Commodity Trading Advisor. (a) The Managing Member shall receive as compensation an incentive fee allocation in the amount 5% of the New Net Profit for each calendar quarter, payable on or before the 30th day of the end of a calendar quarter. (b) The Fund shall pay to the CTAs, an annual net asset fee of the month-end net assets of the equity they trade for the Fund (prior to accruals for such fees). The Fund shall also pay to the CTAs an incentive fee of 20% the New Net Profit for each calendar quarter, payable on or before the 30th day of the end of a calendar quarter. The Managing Member may negotiate and determine the fees to the CTAs individually. 10. Other Fees. (a) Brokerage Commissions . The Fund shall pay a round turn brokerage commission of $20 to the Fund's clearing broker(s) as commissions and costs for each transaction executed. FCM brokerage fees will not exceed the industry-wide limitation of 14% annually of the average net assets of the Fund. (b) Continuing Service Fees. Approximately 4% per annum of the month-end net assets of the Fund (monthly) will be paid as a continuing service fees (also known as trail commissions) to selling agents that are qualified to receive such commissions, who will perform ongoing services to members of the Fund. (c) Selling Commission. The Selling Agent will receive a 6% selling commission of the membership interests it sells upon the sale of the minimum and the commencement of business and, thereafter, upon the admission of each subscriber to which it has sold interests. 11. Management of the Fund. The Managing Member, to the exclusion of all Members, shall determine the policies of and conduct the business of the Fund. The Managing Member shall take such actions and enter into such contracts and agreements on behalf of the Fund as it deems necessary, including, among other things, but not limited to, the prosecution, defense and settlement of any claim, lawsuit or arbitration in which the Fund is involved, the power to enter into contracts with third parties for trading advisory services and brokerage services (which brokerage services may be performed by entities affiliated with the Managing Member but only at rates that at least match the lowest rates which might otherwise be available to the Fund) and with respect to: (a) Retaining or replacing any futures commission merchant or introducing broker to act as the Fund's broker, and materially revising the terms or conditions upon which any futures commission merchant, or introducing broker, shall be retained; (b) Appointing any person, including any person affiliated with the Managing Member, to act as a clearing broker, introducing broker, or otherwise to act on behalf of the Fund in connection with its transactions in commodity interests; (c) Settling claims against the Fund; (d) Retaining attorneys, accountants and management consultants to assist in the organization and operation of the Fund. Notwithstanding anything to the contrary, the Managing Member shall not be able to contract out the fiduciary obligation owed to Fund Members. No Member shall be entitled to any salary, draw or other compensation from the Fund on account of his investment in the Fund. The Managing Member shall have sole discretion in determining what distributions of profits and income, if any, shall be made to the Members (subject to the allocation provisions of this Agreement), shall execute various documents on behalf of the Fund and the Members pursuant to powers of attorney and shall supervise the liquidation of the Fund if any event causing termination of the Fund occurs. In the event the Managing Member has been removed or becomes insolvent or bankrupt, the majority in interest of the Members may propose and approve of, by a majority vote, a representative to supervise the liquidation of the Fund. In order to facilitate the foregoing, each Member shall execute a special power of attorney as described in Paragraph 16. The Managing Member may cause the Fund to directly buy, sell, hold or otherwise acquire or dispose of commodity interests, including futures contracts and options traded on exchanges or otherwise, arbitrage positions, repurchase agreements and other assets. The Managing Member, on behalf of the Fund, is authorized to enter Advisory Agreements with independent CTAs so they may, on behalf of the Fund, buy, sell, hold or otherwise acquire or dispose of commodity interests, including futures contracts and options traded on exchanges or otherwise, arbitrage positions, repurchase agreements and other assets. The Managing Member may engage, and compensate on behalf of the Fund from funds of the Fund, persons, firms or corporations, including the Managing Member and any affiliated person or entity, as in its sole judgment it shall deem advisable for the conduct and operation of the business of the Fund. Any net asset fees paid will not exceed 6% of such net assets annually. The Managing Member is specifically authorized to enter into a clearing agreement, and any other agreement which the Managing Member deems necessary or advisable, and each Member consents to the terms of those agreements (including, in particular, the fees set forth therein). The Managing Member may subdivide or combine the Units in its discretion, provided that no subdivision or combination shall affect the aggregate net asset value of any Member's interest in the Fund. The Managing Member has a fiduciary responsibility with respect to safekeeping of the Fund's assets regardless of whether those assets are in its immediate possession. The Managing Member may keep portions or all of the Fund's assets on deposit with the Fund's commodity or clearing brokers, the entities with which it trades in the forward markets, or any financial institution. The Managing Member shall not permit another to employ those assets in any manner other than for the exclusive benefit of the Fund. The Managing Member shall exercise good faith in carrying out its duties and exercising its powers in regard to, or behalf of, the Fund, and shall devote such time and efforts to the furtherance of the business of the Fund as it, in its sole discretion, deems reasonably necessary and appropriate. No Member, other than the Managing Member, its agents or affiliates, shall take part in the management, control, administration or the business of the Fund or transact any business for the Fund, and no Member shall have power to sign for or bind the Fund. The Managing Member shall keep and retain, at the principal office of the Fund, such books and records relating to the business of the Fund as are required by the Act, by state securities administrators and the Commodity Exchange Act, as amended, and the rules and regulations promulgated thereunder. The Managing Member may engage in other business activities and shall not be required to refrain from any other activity nor forego any profits, fees or other compensation from any such activity, including any activity as a futures commission merchant, commodity broker, a commodity pool operator or a commodity trading advisor of additional commodity pools organized to trade in security or commodity interests. The Managing Member will not allow loans to be made by the Fund to the Managing Member or any related person; will not receive any rebates or giveups nor participate in any reciprocal business arrangements; will not allow any interest entered into by the Fund to exceed a term of one year; and will not allow the Fund to engage in using all or a part of an unrealized profit in a commodity contract position to provide a margin for any additional commodity contracts of the same or related commodities. With exception to the fees described herein, the Managing Member will not utilize Fund funds as compensating balances for its benefit. 12. Trading Policies and Limitations. The Fund shall be subject to the following trading policies and limitations set forth in the Disclosure Document. The Fund will conform in all respects to the rules, regulations and guidelines of the commodity exchanges on which its trades are executed. 13. Audits and Reports to Members; Fund Records. The Fund's books shall be audited annually by an independent certified public accountant. The Managing Member shall, on behalf of the Fund, send to each person who was a Member at any time during the fiscal year then ended (i) within 90 days after the close of each fiscal year, certified financial statements (including a balance sheet and statement of income) of the Fund for the fiscal year then ended and (ii) within 75 days after the close of each fiscal year, such tax information as is necessary for a Member to complete his federal income tax return. The Managing Member, on behalf of the Fund, shall also send to each Member any other annual and monthly information which the CFTC may by regulation require. The Managing Member shall be responsible for and shall cause the preparation of monthly and annual reports to Members. The Managing Member is authorized to expend Fund funds and to utilize the services of employees of the Managing Member, or any of its affiliates, to provide the foregoing information and to notify the Members of other information as the Managing Member may deem appropriate. Proper books of account and records relating to the Fund's business shall be made and kept by the Managing Member at its office as required by state securities administrators and by the Commodity Exchange Act and the rules and regulations promulgated thereunder, including balance sheets as of the end of the Fund's fiscal year and statements of income, members equity and cash flows for the year end; a statement showing total fees, compensation; brokerage commissions and expenses paid by the Fund, segregated by type and stated both in aggregate dollar terms and as a percentage of net assets; the average round turn rate for the fiscal year shall be computed within the scope of the annual audit; and a calculation of the net assets of the fund daily, as well as the net asset value per unit. The Managing Member shall also maintain a current list of the full name and last known address of each Member, separately identifying the Managing Member and the Members in alphabetical order, and setting forth the amount of cash and a description and statement of the agreed value of any property or other services contributed by each Member and which each Member has agreed to contribute in the future, and the date on which each became a Member. Members or their duly authorized representatives may inspect, copy or receive by mail (upon payment of reasonable reproduction costs and mailing costs) such books and records during normal business hours at the principal office of the Managing Member provided that the Member gives the Managing Member reasonable notice and represents, in writing, that the list will not be used for commercial purposes. The Managing Member will preserve all Fund records for at least six (6) years. 14. Assignability of Units; Redemption of Units; Suspension of Trading in Certain Events; Automatic Termination of the Fund. (a) Assignability of Units. As used in this Agreement, the term "assignment" or "assign" shall include any assignment, transfer, mortgage, pledge, gift or hypothecation. (1) General Restrictions on Transferability. Units held by a Member may be assigned only as permitted by law and by the provisions of this Paragraph 14(a). Neither the Fund nor the Members shall be bound by any assignment, nor shall the Fund recognize any assignee as a Unit holder for any purpose, until a counterpart of the instrument of assignment, executed and acknowledged by the parties thereto, is delivered to the Fund. (2) Permissible Transfers. Subject to Paragraph 14(a)(1) above, no Unit holder shall assign all or any part of his Units, whether voluntarily or by operation of law, or at judicial sale or otherwise, to any person; except that a Unit holder may assign (but may not substitute the assignee as a substituted Member in his place) all or a portion of his Units to any person or entity upon written notice to the Managing Member provided that the Managing Member, in its discretion, consents to such transfer. The Managing Member shall withhold such consent only if, in the opinion of counsel designated by the Managing Member, such transfer would more likely than not result in the termination of the Fund (within the meaning of Section 708(b) of the Code) or the termination of its status as a partnership thus causing it to be taxable as a corporation (within the meaning of Section 7704 of the Code). (3) Substitution of Members. No assignee of all or part of the Units of any Member shall have the right to become a substituted Member except in conformity with the Act and without affecting the limited liability of Members and unless and until: (A) his assignor has stated such intention in the instrument of assignment; (B) the assignee has executed a counterpart of this Agreement or an instrument reasonably satisfactory to the Managing Member accepting and adopting the terms and provisions of this Agreement and has authorized the Managing Member to act as such assignee's attorneys-in-fact; (C) in the case of an assignee or transferee who is not otherwise a Member, the Managing Member determines that the assignment complies with the laws of the State of Delaware and is in conformity with the provisions of this Agreement; and, (D) the Managing Member consents in writing (which consent is in its sole and absolute discretion) to such person becoming a substituted Member. The Managing Member shall withhold such consent only if, in the opinion of counsel designated by the Managing Member, such substitution would more likely than not result in the termination of the Fund (within the meaning of Section 708(b) of the Code) or the termination of its status as a partnership thus causing it to be taxable as a corporation (within the meaning of Section 7704 of the Code). (4) No transfer may be made where, after the transfer, either the transferee or the transferor holds less than the minimum number of units equivalent to an initial minimum purchase, except for transfers by gift, inheritance, intrafamily transfers, family dissolutions, and transfers to affiliates. Any necessary amendments to this Agreement or to the Certificate of Formation reflecting the substitution of Members shall be filed promptly in the Office of the Secretary of State of the State of Delaware or in any other office appropriate for such filing pursuant to the Act. The written notice required by this Paragraph 14 shall specify the name and address of the assignee and the date of assignment and shall include a statement by the assignee that he agrees to give the above described written notice to the Managing Member upon any subsequent assignment. If the Managing Member withholds consent, an assignee shall not become a substitute Member and shall not have any of the rights of a Member, except that the assignee shall be entitled to receive that share of capital or profits and shall have the right of redemption to which his assignor would otherwise have been entitled. An assigning Member shall remain liable to the Fund as provided in the Act regardless of whether his assignee becomes a substituted Member. No assignment, transfer or disposition of Units shall be effective against the Fund or the Managing Member until the first day of the month succeeding the month in which the Managing Member receives notice of such assignment, transfer or disposition. The Managing Member may, in its discretion, waive receipt of the above described notice or waive any defect therein. (b) Redemption of Units. A Member may request in writing ("Request for Redemption") to withdraw from the Fund part or all of his capital contribution and undistributed profits. Any such withdrawal is herein referred to as a "Redemption." All Requests for Redemption must specify the name and address of the redeeming Member and the amount of Units sought to be redeemed. The effective date of Redemption (the "Redemption Date") shall be the close of business on the last business day of the then current month; provided that the Managing Member shall be in receipt of the written request on or before the day prior to the close of business of the last business day of the then current month. Each member shall be notified within 10 days after the second to last business day of the month if their interests have been redeemed. Payment shall be made to the Member requesting Redemption within twenty (20) days following the Redemption Date. If the Managing Member has not been in receipt of a Request for Redemption prior the close of business on or before the day prior to the last business day of the then current month, the Redemption Date for such Unit or Units may, in the Managing Member's discretion, be the close of business on the last business day of the immediately following month. Any Request for Redemption shall be mailed or delivered to the office of the Managing Member. A Request for Redemption may be revoked prior to the Redemption Date by signed written instruction to the Managing Member. The Managing Member may also, in its discretion, declare additional Redemption dates for some or all of the Units. Each member shall be notified within 10 days after the second to last business day of the month if their interests have been redeemed. Redemption of any Unit will be based on the net asset value per Unit, calculated as of the close of business (as determined by the Managing Member) on the Redemption Date. The Fund's positions in security and commodity interests will be liquidated to the extent necessary to effect redemptions. There will be no redemption fee. Upon the Managing Member's reasonable conclusion, based on applicable regulations or controlling precedent, that the Fund's assets are "plan assets" as defined by the Department of Labor or otherwise, the Fund may call Units owned by IRAs or certain other qualified retirement plans at the net asset value per Unit of Units so held as of the close of business on the date of the call. In addition to the limits and conditions as set forth above, the right to obtain Redemption shall be contingent upon the Fund's having property sufficient to discharge its liabilities on the date of Redemption. If the Managing Member determines that permitting the number of Redemptions sought would be detrimental to the tax status of the Fund, it may restrict the number of Redemptions to be permitted, and shall select by lot so many Redemptions as will not, in its sole discretion, impair the Fund's tax status. Under special circumstances, including, but not limited to, the inability to liquidate positions in security or commodity interests as of or following the Redemption Date, default or delay in payments due to the Fund from commodity brokers, banks or other persons, the Fund may in turn delay payment to persons requesting Redemption of Units of the proportionate part of net asset value represented by the sums that are the subject to such default or delay. In addition, if, in the Managing Member's sole discretion, it determines Redemptions would impair the Fund's ability to meet its objectives, the Managing Member may temporarily suspend the amount of Units to be redeemed in any month. (c) Automatic Termination of the Fund. The Fund will automatically terminate, as herein provided, if its net asset value per Unit declines to less than 50% of the initial net asset value per Unit, as of the last business day of any month, on the date the Fund commenced trading operations. Such termination shall occur within a reasonable period of time following the date the valuation of the net asset value per Unit, as of the last business day of the month, is made. The Members shall be notified of such termination within seven business days from the date the valuation of the net asset value per Unit, as of the last business day of the month, is made. Upon termination, the Fund's open positions will be closed out in an orderly manner. 15. Admission of Additional Members. Pursuant to Paragraph 14, the Managing Member may consent to and admit any assignee of Units as a substituted Member or may admit additional Members pursuant to Paragraph 6. Additional or substitute Managing Members may be admitted to the Fund pursuant to Paragraph 20(c). Upon the admission of any substitute or additional Managing Member or Managing Members, this Agreement shall be amended (and each Member consents to such amendment) so that the provisions of this Agreement shall apply to such Managing Member or Managing Members in the same manner as now applicable to the Managing Member, to the extent practicable. 16. Special Power of Attorney. Each Member, in connection with his investment in the Fund, understands that by executing this Agreement, whether in counterpart, by separate instrument or otherwise, he irrevocably constitutes and appoints the Managing Member with full power of substitution, as its true and lawful attorneys-in-fact, with full power and authority in its name, place and stead, to admit additional Members to the Fund, to file, prosecute, defend, settle or compromise any litigation, claims or arbitrations on behalf of the Fund and to execute, acknowledge, swear to and deliver (as may be appropriate): (i) all certificates, conveyances and other instruments (including but not limited to articles of organization in various jurisdictions, this Agreement and any amendments hereto, agreements with third parties necessary to carry out the Fund's business, authorized amendments to each of the foregoing and a certificate or certificates of assumed name or of doing business under a fictitious business name) which the Managing Member deems appropriate and in accordance with the terms of this Agreement (including without limitation, to reflect the admission of new Members) or advisable to qualify or continue the Fund as a limited liability company in the jurisdictions in which the Fund may conduct business or which may be required to be filed by the Fund or the Member under the laws of any jurisdiction; (ii) all instruments which the Managing Member deems appropriate to reflect a reorganization or refiling of the Fund in a different jurisdiction, provided that such reorganization or refiling does not result in a material change in the rights of the Members; and (iii) all conveyances and other instruments which the Managing Member deems appropriate to reflect the dissolution and termination of the Fund. Each Member understands that the foregoing grant of authority is a special power of attorney coupled with an interest, is irrevocable, and shall survive the dissolution of a Member. Each Member agrees to be bound by any representation made by the Managing Member and by any successor thereto, acting in good faith pursuant to such Power of Attorney, and each Member hereby waives any and all defenses which may be available to contest, negate or disaffirm the action of the Managing Member, and any successor thereto, taken in good faith under such Power of Attorney. In addition to this Power of Attorney, each Member agrees to execute a special Power of Attorney on a document separate from this Agreement. The form of Power of Attorney to be executed is included in the Subscription Agreement and Power of Attorney attached to the Memorandum. In the event of any conflict between this Agreement and any instruments filed by such attorney pursuant to the Power of Attorney granted in this Paragraph 16, this Agreement shall control. 17. Withdrawal of a Managing Member and/or Member. The Fund shall be dissolved and terminated upon the withdrawal, dissolution, admitted or court decreed insolvency or the removal of the Managing Member unless the Fund is continued pursuant to the terms of Paragraph 20(c). In addition, the Managing Member may withdraw from the Fund at any time upon 120 days prior written notice by first class mail, postage prepaid, to each Member. If the Managing Members withdraws and a majority of the remaining Members elect to continue the Fund, the withdrawing Managing Members shall pay all expenses incurred as a result of their withdrawal. A Member will cease to be a Member upon redemption or assignment of all of such Member's Units. The withdrawal, insolvency or dissolution of a Member shall not terminate or dissolve the Fund, and a Member, or its representative shall have no right to withdraw or demand an accounting of the value of the Member's interest in the Fund except as provided in Paragraph 14. Each Member (and any assignee of a Member's interest) waives on behalf of itself and its successors the furnishing of any inventory, accounting or appraisal of the assets of the Fund and any right to an audit. 18. Indemnification. (a) By the Fund. The Managing Member, and any affiliates of the Managing Member engaged in the performance of services on behalf of the Fund, shall be indemnified for any liability, loss or expense (including attorney's fees, judgments and amounts paid in settlement) suffered by the Managing Member or such affiliates and shall have no liability to the Fund or to any Member for liability or loss suffered by the Fund which arises out of any action or inaction of the Managing Member or such affiliates if (1) the Managing Member has determined, in good faith, that such course of conduct was in the best interests of the Fund and (2) such liability or loss was not the result of negligence, misconduct or the breach of its fiduciary obligations to the members by the Managing Member or such affiliates. Notwithstanding the foregoing, the Managing Member, and any affiliate engaged in the performance of services on behalf of the Fund, shall not be indemnified for any liability imposed by judgment, and costs associated therewith, including attorney's fees, arising from or out of a violation of state or federal securities laws or rules; provided, however, the Managing Member and its affiliates shall be indemnified for settlement and related expenses of lawsuits alleging securities law violations, and for expenses incurred in successfully defending such lawsuits, provided that a court either (1) approves the settlement and finds that indemnification of the settlement and related costs should be made, or (2) approves indemnification of litigation costs if a successful defense is made, provided, however, that the Managing Member must apprise the court of the positions of the Securities and Exchange Commission and other appropriate state securities administrators with respect to indemnification for securities laws violations before seeking court approval for indemnification. Any amounts payable to the Managing Member or its affiliates pursuant to the foregoing are recoverable only out of the assets of the Fund and not from the Members. The Fund shall not incur the cost of that portion of liability insurance which insures the Managing Member and its affiliates for any liability as to which the Managing Member and its affiliates are prohibited from being indemnified. Except with respect to lawsuits involving alleged securities law violations, any indemnification, unless ordered or expressly permitted by a court, shall be made by the Fund only upon a determination by independent legal counsel in a written opinion that the conduct which is the subject matter of a claim, demand or lawsuit with respect to which indemnification is sought meets the applicable standard set forth in this Paragraph 18. Fund funds may be paid to the Managing Member and its affiliates for legal expenses and other costs incurred as a result of legal action initiated against the Managing Member or its affiliates are permissible if the following conditions are satisfied: (1) the legal action relates to the performance of duties or services by the Managing Member or its affiliates on behalf of the Fund; (2) the legal action is initiated by a third party who is not a holder of a Fund interest; (3) the Managing Member or its affiliates undertake to repay the advanced funds, together with the applicable legal rate of interest thereon, to the Fund in cases in which they would not be entitled to indemnification. The Fund may also indemnify and hold harmless any clearing broker, or other party with which it does business to the extent their conduct does not constitute misconduct, negligence, an act or omission due to bad faith, or failure to act in good faith in the reasonable belief that their actions were in, or not opposed to, the best interests of the Fund and in accordance with the Trading Policies and the trading strategies as described in the Disclosure Document. (b) By the Members. In the event the Fund is made a party to any claim, dispute or litigation or otherwise incurs any loss or expense as a result of or in connection with any Member's (or assignee's) actions unrelated to the Fund's business, the Member (or assignees, cumulatively) shall indemnify and reimburse the Fund for all loss and expense incurred, including reasonable attorney's fees. In the event the Fund advances funds on behalf of the Managing Member, and the Managing Member is not entitled to indemnification, the Managing Member will repay the funds together with applicable legal interest. 19. Designation of Tax Matters Partner. The Managing Member is hereby designated as Tax Matters Partner (pursuant to Code Section 6231(a)(7)). In the event that the Managing Member assigns, transfers or conveys its entire interest in the Fund or resigns or withdraws as a Managing Member pursuant to this Agreement, the successor Managing Member will be designated Tax Matters Partner. The Managing Member, in its sole discretion, will have the power to appoint any other Member Tax Matters Partner; provided, however, that no appointment will have the effect of causing the Fund to be classified for Federal income tax purposes as an association taxable as a corporation or will have the effect of causing the Fund to be classified as a general partnership under the laws of Delaware or any jurisdiction in which the Fund is conducting business. The Fund hereby indemnifies and holds harmless the Managing Member from and against any claim, loss, expense, liability, action or, damage resulting from its acting, or its failure to take any action, as the Tax Matters Partner, provided that any such action or failure to act is not due to the fraud, negligence, breach of fiduciary duty, bad faith or misconduct of the Managing Member. (a) Notice. The Tax Matters Partner will notify all Members of the commencement of any Fund tax audit and of a financial Fund administrative adjustment, if any, within 14 days of its receipt of such notices from the Internal Revenue Service (the "Service"). (b) Members Audit Waiver. The Members hereby waive any right to negotiate or enter into a settlement agreement with the Service in any Fund tax audit proceeding. All such negotiations will be conducted solely by the Tax Matters Partner. Any settlement agreement between the Service and a Member, regarding an adjustment of any Fund item, will be null and void unless such Member has obtained the prior written consent of the Tax Matters Partner. (c) Audit Expenses. All expenses incurred by the Tax Matters Partner in participating in any Fund tax audit or contesting any adjustment proposed by the Service will be borne by the Fund. (d) Members Petition Waivers. The Members hereby waive any rights to file a petition for a readjustment of Fund items pursuant to Code Section 6226, unless the Tax Matters Partner, in its sole discretion, does not file such a petition within 90 days of its receipt of a notice of a final Fund administrative adjustment and unless such petition is filed in the appropriate Federal District Court in the State of Delaware. 20. Amendments; Meetings. (a) Amendments with Consent of the Managing Member. If at any time during the term of the Fund the Managing Member deems it necessary or desirable to amend this Operating Agreement, it may proceed to do so, provided that the amendment shall be effective only if embodied in an instrument signed by the Managing Member and by Members owning more than 70% of the Units then owned by the Members and if made in accordance with and to the extent permissible under the Act. The approval of the Members may be obtained by the Managing Member by means of a written notice to the Members requiring each Member to respond to the Managing Member in the negative by a specified time or to be deemed to have approved of the proposed amendment if such negative response is not received by such specified time. Any supplemental or amendatory agreement shall be adhered to and have the same effect from and after its effective date as if the same had originally been embodied in and formed a part of this Agreement; provided, however, that no supplemental or amendatory agreement shall, without the consent of all Members, change or alter this Paragraph 20, extend the term of the Fund, reduce the capital account of any Member or modify the percentage of profits, losses or distributions to which any Member is entitled. In addition, reduction of the capital account of any assignee or modifications of the percentage of profits, losses or distributions to which an assignee is entitled shall not be affected by amendment or supplement to this Agreement without the assignee's consent. No meeting procedure or specified notice period is required in the case of amendments made with the consent of the Managing Member; it being agreed and understood that mere receipt of an adequate number of unrevoked consents (or negative approvals, as provided above) are sufficient. The Managing Member may amend this Agreement without the consent of the Members in order to: (i) clarify any inaccuracy, ambiguity or reconcile any inconsistency (including any inconsistency between this Agreement and the Disclosure Document); (ii) add to the representations, duties or obligations of the Managing Member or surrender any right or power of the Managing Member for the benefit of the Members; (iii) delete or add any provision of this Agreement required to be deleted or added by the staff of the Securities and Exchange Commission or other federal agency or any state securities official or similar official or in order to opt to be governed by any amendment or successor statute to the Act; (iv) change the name of the Fund or the location of the principal place of business of the Fund; (v) change this Agreement in any manner that is appropriate or necessary to qualify or maintain the qualification of the Fund as a limited liability company in which the Members have limited liability under the laws of any state or that is appropriate or necessary to ensure that the Fund will not be treated as an association taxable as a corporation for federal income tax purposes; (vi) change this Agreement in any manner that does not adversely affect the Members in any material respect or that is required or contemplated by other provisions of this Agreement; (vii) make any amendment that is appropriate or necessary, in the opinion of the Managing Member, to conform this Agreement to any requirement of law or to prevent the Fund or the Managing Member or its directors or officers from in any manner being subjected to the provisions of the Investment Company Act of 1940, as amended, the Investment Advisors Act of 1940, as amended, or "plan asset" regulations adopted under the Employee Retirement Income Security Act of 1974, as amended, regardless of whether substantially similar to plan asset regulations currently applied or proposed by the United States Department of Labor; (viii) make any other amendment similar to the foregoing; provided, that no such amendment will be adverse to the interests of the Members; (ix) amend this Agreement to effect the interest of the allocations proposed herein to the maximum extent possible in the event of a change in the Internal Revenue Code or the interpretations thereof affecting such allocations; or (x) make any amendment necessary so that Fund income not be deemed to constitute "unrelated business taxable income" under the Internal Revenue Code. (b) Meetings. Upon receipt of a written request, signed by Members owning at least 10% of the Units then owned by Members, that a meeting of the Fund be called to consider any matter which the Members may vote upon pursuant to this Agreement, the Managing Member shall, by written notice to each Member of record mailed within fifteen (15) days after receipt by the Managing Member of such request, call a meeting of the Fund. The meeting shall be held at least thirty (30) but not more than sixty (60) days after the mailing of the notice, and the notice shall specify the date of, a reasonable place and time for, and the purposes of the meeting. (c) Amendments and Actions without Consent of the Managing Member. At any meeting called by the Managing Member or pursuant to Paragraph 20(b), upon the affirmative vote (which may be in person or by proxy) of the majority of the units then owned by the Members, the following actions may be taken, irrespective of whether the Managing Member concurs: (i) this Agreement may be amended in accordance with and only to the extent permissible under the Act; (ii) the Fund may be dissolved; (iii) the Managing Member may be removed and replaced; (iv) a new Managing Member or Managing Members may (to the extent permitted by the Act) be elected if the Managing Member ceases to be a Managing Member; (v) the sale of all or substantially all of the assets of the Fund may be approved; and (vi) any contracts with the Managing Member or any of its affiliates may be terminated on sixty (60) days notice without penalty. If the Managing Member is removed or withdraws from the Fund, its interest shall be valued on a Unit-equivalent basis and immediately redeemed. In the event of a removal or withdrawal of the Managing Member and there is no remaining Managing Member, the Members may unanimously agree in writing to continue the business of the Fund and appoint one or more Managing Members within 90 days of such withdrawal. (d) In the event the Fund is required to comply with Regulation 14A under the Security Exchange Act of 1934 (the proxy rules) or any successor regulation, the foregoing time periods specified in this Paragraph 20 may be altered by the Managing Member so as not to conflict therewith. 21. Governing Law. The validity and construction of this Agreement shall be determined and governed by the laws of the State of Delaware, without regard to conflict of laws principles. This Agreement is intended to qualify Members for limited liability as provided for under Delaware law, and all of the provisions of this Agreement shall be construed in the light of such intention. 22. Miscellaneous. (a) Priority Among Members. No Member shall be entitled to any priority or preference over any other Member in regard to the affairs of the Fund, except to the extent that this Agreement may be deemed to establish a priority or preference. (b) Notices. All notices under this Agreement shall be in writing and, except as set forth in the following sentence, shall be effective upon personal delivery, or if sent by first class mail, postage prepaid addressed to the last known address of the party to whom the notice is to be given, upon the deposit of the notice in the United States mail. Requests for Redemption and notice of assignment of Units or any interest therein shall be effective upon receipt by the Managing Member. (c) Binding Effect. This Agreement shall inure to and be binding upon all of the parties, their successors and assigns, custodians, heirs and personal representatives. For purposes of determining the rights of any Member or assignee, the Fund and the Managing Member may rely upon the Fund records as to who are Members and assignees and all Members and assignees agree that their rights shall be determined and that they shall be bound thereby, including all rights which they may have under Paragraphs 14 to 20 hereof. (d) Captions. Captions in no way define, limit, extend or describe the scope of this Agreement nor the effect of any of its provisions. (e) Invalidity or Unenforceability. If any provision of this Agreement, or the application of such provision to any person or circumstance, shall be held invalid or unenforceable, the remainder of this Agreement, or the application of such provision to persons or circumstances other than those to which it is held invalid or unenforceable, shall not be affected thereby. (f) Code or Treasury Regulations. Each and every time reference is made in this Agreement to a section of the Code or Treasury Regulations, such reference shall be deemed to apply to such section of the Code or Treasury Regulations as in effect on the date hereof or as the same may be amended from time to time. (g) Counterparts. This Agreement may be executed in multiple counterparts, each of which shall be deemed an original, but all of which shall constitute one instrument. IN WITNESS WHEREOF, the parties have executed this Agreement, as of the day and year first above written, in multiple counterparts, which when taken together, shall constitute one and the same instrument. Managing Member & Commodity Pool Operator: Initial Member: PRESTIGA CAPITAL MANAGEMENT, INC. ______________________________ ________________________________ Steven Worth C. William Hoilman President PRESTIGA FUND, LLC By: PRESTIGA CAPITAL MANAGEMENT, INC. Managing Member By: __________________________ Steven Worth President ******************************************************************************* EXHIBIT B TO PRESTIGA FUND DISCLOSURE DOCUMENT PRESTIGA FUND, LLC REQUEST FOR REDEMPTION To: Prestiga Capital Management, Inc. Managing Member ____________________________ 4 Pheasant Hill Street Our Social Security Number or P.O. Box 409 Taxpayer ID Number Westwood, MA 02090 Dear Managing Member: The undersigned hereby requests redemption ("Redemption"), as defined in and subject to all the terms and conditions disclosed in the Offering Circular (the "Prospectus") delivered to the undersigned at the time of our purchase of membership interests (the "Units") in Prestiga Fund, LLC, (the "Fund"), of _______________Units (insert the number of Units to be Redeemed). This Redemption request must be received by you no later than ten (10) business days prior to the last business day of the month in with the Redemption is to occur. Once this Redemption request is approved and accepted by you as Managing Member, it will be paid at the Net Asset Value per Unit, as described in the Prospectus, as of the close of business at the end of the month following such approval. The undersigned hereby represents and warrants that the undersigned is the true, lawful and beneficial owner of the Units to which this Request is made with full power and authority to request Redemption of such Units. Such Units are not subject to any pledge or otherwise encumbered. United States Taxable Members Only - Under penalty of perjury, the undersigned hereby certifies that the Social Security Number or Taxpayer ID Number indicated on this Request for Redemption is the undersigned's true, cared and complete Social Security Number or Taxpayer ID Number and that the undersigned is not subject to backup withholding under the provisions of section 3406(a)(1)(C) of the Internal Revenue Code. Non United States Members Only - Under penalty of perjury, the undersigned hereby certifies that (a) the undersigned is not a citizen or resident of the United States or (b) (in the case of an investor which is not an individual) the investor is not a United States corporation, partnership, estate or trust. SIGNATURE(S) MUST BE IDENTICAL TO NAME(S) IN WHICH UNITS ARE REGISTERED Please forward a fund check for the Redemption proceeds to the undersigned at: __________________________________________________________________________ Name Street City, State and Zip Code Entity Member Individual Member(s) _________________________________ ________________________________ (Name of Entity) (Signature of Member) By: _____________________________ ________________________________ (Authorized corporate officer, partner, (Signature of Member) custodian or trustee) _____________________________ (Title) ******************************************************************************* EXHIBIT C TO PRESTIGA FUND DISCLOSURE DOCUMENT PRESTIGA FUND, LLC SUBSCRIPTION REQUIREMENTS By executing the Subscription Agreement and Power of Attorney for Prestiga Fund, LLC (the "Fund"), each purchaser ("Purchaser") of Membership Interests (the "Units") in the Fund irrevocably subscribes for Units at a price equal to the Net Asset Value per Unit as of the end of the month in which the subscription is accepted as described in the Fund's Offering Circular dated October ___, 2004 (the "Prospectus"). The minimum subscription is $25,000, however, it may be lowered to not less than $5,000 by the Managing Member; additional Units may be purchased in multiples of $1,000. Subscriptions must be accompanied by a check in the full amount of the subscription and made payable to "EBank for the acct. of Prestiga". Purchaser is also delivering to the Selling Agent an executed Subscription Agreement and Power of Attorney (Exhibit D to the Prospectus). Upon acceptance of Purchaser's Subscription Agreement and Power of Attorney Purchaser agrees to contribute Purchaser's subscription to the Fund and to be bound by the terms of the Fund's LLC Operating Agreement, attached as Exhibit A to the Prospectus, as amended from time to time pursuant to its terms. Thereafter, upon the sale of a minimum of one million ($1,000,000) of Units, the Managing Member will direct the release of funds from the depository account and the commencement of trading by the Fund. Purchaser agrees to reimburse the Fund and the Managing Member for any expense or loss, including legal fees and court costs, incurred as a result of the cancellation of Purchaser's Units due to a failure of Purchaser to deliver good funds in the amount of the subscription price. By execution of the Subscription Agreement and Power of Attorney, pursuant to the terms of the offering, Purchaser shall have executed the LLC Operating Agreement. As an inducement to the Managing Member to accept this subscription, Purchaser (for the Purchaser and, if Purchaser is an entity, on behalf of and with respect to each of Purchaser's shareholders, partners or beneficiaries), by executing and delivering Purchaser's Subscription Agreement and Power of Attorney, represents and warrants to the Managing Member, the Commodity Broker and the Selling Agent who solicited Purchaser's subscription and the Fund, as follows: (a) Purchaser is of legal age to execute the Subscription Agreement and Power of Attorney and is legally competent to do so. Purchaser acknowledges that Purchaser has received a copy of the Prospectus, including the LLC Operating Agreement, prior to subscribing for Units. (b) All information that Purchaser has heretofore furnished to the Managing Member or that is set forth in the Subscription Agreement and Power of Attorney submitted by Purchaser is correct and complete as of the date of such Subscription Agreement and Power of Attorney, and if there should be any change in such information prior to acceptance of Purchaser's subscription, Purchaser will immediately furnish such revised or corrected information to the Managing Member. (c) Unless (d) or (e) below is applicable, Purchaser's subscription is made with Purchaser's funds for Purchaser's own account and not as trustee, custodian or nominee for another. (d) The subscription, if made as custodian for a minor, is a gift Purchaser has made to such minor and is not made with such minor's funds or, if not a gift, the representations as to net worth and annual income set forth below apply only to such minor. (e) If Purchaser is subscribing in a representative capacity, Purchaser has full power and authority to purchase the Units and enter and be bound by the Subscription Agreement and Power of Attorney on behalf of the entity for which he is purchasing the Units, and such entity has full right and power to purchase such Units and enter and be bound by the Subscription Agreement and Power of Attorney and become a Member pursuant to the LLC Operating Agreement which is attached to the Prospectus as Exhibit A. ******************************************************************************* EXHIBIT D TO PRESTIGA FUND DISCLOSURE DOCUMENT PRESTIGA FUND, LLC UNITS OF MEMBERSHIP INTEREST SUBSCRIPTION INSTRUCTIONS Any person considering subscribing for Units should carefully read and review the Prospectus. The Units are speculative and involve a high degree of risk. No person may invest more than 10% of his or her liquid net worth (exclusive of home, furnishings and automobiles) in the Fund. No entity-and, in particular, no ERISA plan-may invest more than 10% of its liquid net worth (readily marketable securities) in the Fund. If a purchaser is allowed to purchase less than $25,000 in Units, then the purchaser must have a minimum annual gross income of $45,000 and a minimum net worth of $45,000 or, in the alternative, a minimum net worth of $150,000. A Subscription Agreement and Power of Attorney Signature Page (the "Signature Page") is attached to these Subscription Instructions and the following Subscription Agreement and Power of Attorney. The Signature Page is the document which you must execute if you wish to subscribe for Units. One copy of such Signature Page should be retained by you for your records and the others delivered to your Registered Representative. FILL IN ALL OF THE INFORMATION ON THE ATTACHED SIGNATURE PAGE, USING BLACK INK ONLY, AS FOLLOWS Item 1 - Enter the dollar amount (no cents) of the purchase. Items 2 - 7 - Enter the Social Security Number or Taxpayer ID Number and check the appropriate box to indicate the type of individual ownership desired or of the entity that is subscribing. In the case of joint ownership, either Social Security Number may be used. The Signature Page is self-explanatory for most ownership types; however, the following specific instructions are provided for certain of the ownership types identified on the Signature Page: Trusts-Enter the trust's name on Line 3 and the trustee's name on Line 4, followed by "Ttee." If applicable, use Line 7 also for the custodian's name. Be sure to furnish the Taxpayer ID Number of the trust. Custodian Under Uniform Gifts to Minors Act-Complete Line 3 with the name of minor followed by "UGMA." On Line 7, enter the custodian's name followed by "Custodian." Be sure to furnish the minor's Social Security Number. Partnership or Corporation-The partnership's or corporation's name is required on Line 4. Enter a partner's or officer's name on Line 4. Be sure to furnish the Taxpayer ID Number of the partnership or corporation. A subscriber who is not an individual must provide a copy of documents evidencing the authority of such entity to invest in the Partnership. Item 8 - The investor(s) must execute the Subscription Agreement and Power of Attorney Signature Page and review the representations relating to backup withholding tax or non-resident alien status underneath the signature and telephone number lines in Item 8. Item 9 - Registered Representative must complete. The Selling Agent's copy of the Subscription Agreement and Power of Attorney Signature Page may be required to be retained in the Branch Office. PRESTIGA FUND, LLC UNITS OF MEMBERSHIP INTEREST BY EXECUTING THIS SUBSCRIPTION AGREEMENT AND POWER OF ATTORNEY SUBSCRIBERS ARE NOT WAIVING ANY RIGHTS UNDER THE SECURITIES ACT OF 1933 OR THE SECURITIES EXCHANGE ACT OF 1934 SUBSCRIPTION AGREEMENT AND POWER OF ATTORNEY Prestiga Capital Management, Inc. Managing Member ____________________________ 4 Pheasant Hill Street Social Security Number or Westwood, MA 02090 Taxpayer ID Number Dear Managing Member: 1. Subscription For Units. I hereby subscribe for the number of Membership Units ("Units") in Prestiga Fund, LLC (the "Fund") set forth below (minimum $25,000) in the Subscription Agreement and Power of Attorney Signature Page, at a price per Unit as set forth in the Fund disclosure document dated October ___, 2004, (the "Prospectus"). I have completed and executed a Subscription Agreement and Power of Attorney Signature Page in the form attached hereto as Exhibit "D", and delivered the executed Subscription Documents to the Sales Agent and executed a check made payable to "EBank for the acct. of Prestiga" to be delivered by the Sales Agent to the Depository Agent within 24 hours after receipt for deposit to the Depository Account. The Managing Member may, in its sole and absolute discretion, accept or reject this subscription, in whole or in part. If this subscription is accepted, I understand subscribers will earn additional Units in lieu of interest earned on the undersigned's subscription during any period of time, if any, such subscription is held in escrow. If this subscription is rejected, all funds remitted by the undersigned will be returned, together with any interest earned from the depository account, if any. 2. Representations and Warranties of Subscriber. I have received, read, and understand the prospectus dated October ___, 2004. I understand that by submitting this Subscription Agreement and Power of Attorney I am making the representations and warranties set forth in "Exhibit C - Subscription Requirements" contained in the Prospectus, including, without limitation, representations and warranties relating to my net worth and annual income. Additionally, I understand that my broker/dealer account application will be forwarded to the Managing Member to review my suitability for this investment. 3. Power of Attorney. In connection with my acceptance of an Interest in the Fund, I do hereby irrevocably constitute and appoint the Managing Member, and its successors and assigns, as my true and lawful Attorney-in-Fact, with full power of substitution, in my name, place and stead, to (i) file, prosecute, defend, settle or compromise litigation, claims or arbitration on behalf of the Fund; and, (ii) make, execute, sign, acknowledge, swear to, deliver, record and file any documents or instruments which may be considered necessary or desirable by the Managing Member to carry out fully the provisions of the LLC Operating Agreement of the Fund, which is attached as Exhibit A to the Prospectus, including, without limitation, the execution of the said Agreement itself and by effecting all amendments permitted by the terms thereof. The Power of Attorney granted hereby shall be deemed to be coupled with an interest and shall be irrevocable and shall survive, and shall not be affected by, my subsequent death, incapacity, disability, insolvency or dissolution or any delivery by me of an assignment of the whole or any portion of my interest in the Fund. 4. Irrevocability; Governing Law. You may revoke your subscription for five business days after you send it to us (the "Revocation Period"). After the lapse of five business days from submission, your subscription will be irrevocable. The Units offered to you are subject to prior sale. I hereby acknowledge and agree that after the Revocation Period I am not entitled to cancel, terminate or revoke this subscription or any of my agreements hereunder and that this subscription and such agreements shall survive my death or disability. This Subscription Agreement and Power of Attorney shall be governed by and interpreted in accordance with the laws of the State of Delaware. 5. Suitability and Acceptance of Risks. In addition to the suitability requirements set forth in Exhibit C, I represent and warrant to the Managing Member and Selling Agent that (i) I have the capacity of understanding the fundamental aspects of the Fund (or, if I do not have such fundamental understanding, I have so advised the Selling Agent of such fact); and, (ii) I understand the fundamental risks and possible financial hazards of an investment in the Fund (disclosed in the Prospectus under "Risk Factors" identified on the face page, in the Summary, and described in the Prospectus at page 6), including, but not limited to, the lack of liquidity of my investment in the Fund, the management and control by the Managing Member, and the tax consequences of the investment. PRESTIGA FUND, LLC Units of Membership Interests Subscription Agreement and Power of Attorney Signature Page The investor named below, by execution and delivery of this Subscription Agreement and Power of Attorney, by payment of the purchase price for Membership Interests (the "Units") in Prestiga Fund, LLC (the "Fund"), and by enclosing a check payable to "EBank for the acct. of Prestiga", hereby subscribes for the purchase of Units, at a price per Unit as set forth in the Prospectus. The named investor further, by signature below, acknowledges (i) receipt and that he has read the Prospectus of the Fund dated October___, 2004; (ii) that such Prospectus includes the Fund's LLC Operating Agreement, the Subscription Requirements, and the Subscription Agreement and Power of Attorney set forth therein, the terms of which govern the investment in the Units being subscribed for hereby; (iii) that this subscription may be revoked within five business days after submission; and, (iv) after the lapse of five business days from submission, this subscription will be irrevocable. By my signature below, I represent that I satisfy the requirements relating to net worth and annual income as set forth in Exhibit C to the Prospectus. 1) Total $ Amount __________________ (minimum of $25,000, unless lowered to less than $25,000 but not less than $5,000 by the Managing Member; $1,000 minimum for investors making an additional investment) 2) Social Security Number _____-___-_____ Taxpayer ID # _____-___-_____ Taxable Investors (check one): O Individual Ownership O Trust other than a Grantor or Revocable Trust O Joint Tenants with Right of Survivorship O Estate O UGMA/UTMA (Minor) O Tenants in Common O Community Property O Partnership O Corporation O Grantor or Other Revocable Trust Non-Taxable Investors (check one): O IRA O Profit Sharing O IRA Rollover O Defined Benefit O Pension O Other (specify) O SEP 3) Investor's Name _________________________________________________________ 4) _________________________________________________________________________ Additional Information (for Estates, Trusts, Partnerships and Corporations) 5) Resident Address of Investor _________________________________________________________________________ Street (P.O. Box not acceptable) City State Zip Code 6) Mailing Address(if different) _________________________________________________________________________ Street City State Zip Code 7) Custodian Name and Mailing Address _________________________________________________________________________ Name Street (P.O. Box not acceptable) City State Zip Code Signature(s) - do not sign without familiarizing yourself with the information in the Prospectus, including: (i) the fundamental risks and financial hazards of this investment, including the risk of losing your entire investment; (ii) that the Fund is the first client account to trade in the Prestiga Fund portfolio; (iii) the Fund's substantial charges; (iv) the Fund's highly leveraged trading activities; (v) the lack of liquidity of the Units; (vi) the existence of actual and potential conflicts of interest in the structure and operation of the Fund; (vii) that Members may not take part in the management of the Fund; and (viii) the tax consequences of the Fund. 8) INVESTOR(S) MUST SIGN X_________________________________________________________ Signature of Investor Date Telephone No. X_________________________________________________________ Signature of Joint Investor (if any) Date Investor must sign individually, or pursuant to a power of attorney; provided, however, that such power of attorney has not been granted to a registered representative of a Selling Agent. Executing and delivering this Subscription Agreement and Power of Attorney shall in no respect be deemed to constitute a waiver of any rights under the Securities Act of 1933 or under the Securities Exchange Act of 1934. UNITED STATES INVESTORS ONLY I have checked the following box if I am subject to backup withholding under the provisions of Section 3406(a)(1)(C) of the Internal Revenue Code: 0. Under the penalties of perjury, by signature above I hereby certify that the Social Security Number or Taxpayer ID Number set forth in Item 2 above is my true, correct and complete Social Security Number of Taxpayer ID Number and that the information given in the immediately preceding sentence is true, correct and complete. NON-UNITED STATES INVESTORS ONLY Under the penalties of perjury, by signature above, I hereby certify that (a) I am not a citizen or resident of the United States or (b) (in the case of an investor which is not an individual) the investor is not a United States corporation, partnership, estate or trust: 0. 9) REGISTERED REPRESENTATIVE MUST SIGN I hereby certify that I have informed the investor of all pertinent facts relating to the: risks; tax consequences; liquidity and marketability; management; and control of the Managing Owner with respect to an investment in the Units, as set forth in the Prospectus. I have also informed the investor of the unlikelihood of a public trading market developing for the Units. I do not have discretionary authority over the account of the investor. I have reasonable grounds to believe, based on information obtained from the investor concerning his/her investment objectives, other investments, financial situation and needs and any other information known by me, that an investment in the Fund is suitable for such investor in light of his/her financial position, net worth and other suitability characteristics. The Registered Representative MUST sign below in order to substantiate compliance with Article III, Section 34 of the NASD's Rules of Fair Practice. X__________________________________________________________ Registered Representative Signature Date X__________________________________________________________ Office Manager Signature Date (if required by Selling Agent procedures) 10) REGISTERED REPRESENTATIVE Name: Address: Tel. Number: Registered Representative Number: 11) SELLING AGENT Name: MHA Financial Corp Address: 4 Pheasant Hill Street, P.O. Box 409 Westwood, MA 02090 Tel. Number: (781) 769-8066 ******************************************************************************* EXHIBIT E TO PRESTIGA FUND, LLC DISCLOSURE DOCUMENT DEPOSITORY AGREEMENT THIS AGREEMENT (the "Agreement") is made and entered into as of the ___ day of October, 2004, is by and among Prestiga Fund, LLC, (the "Fund"), Prestiga Capital Management, Inc., 4 Pheasant Hill Street, P. O. Box 409, Westwood, MA 02090-0409, (the "Managing Member"); MHA Financial Corp, a Massachusetts corporation, 4 Pheasant Hill Street, P. O. Box 409, Westwood, MA 02090-0409, (the "Selling Agent"), and EBank Financial Services Inc., 2410 Paces Ferry Road, Suite 400, Atlanta, GA, a bank unaffiliated with the Fund, Managing Member or Selling Agent and otherwise within the definition of Section 3(a)(6) of the 1934 Act (the "Bank"). 1. Account Opened. The Managing Member establishes and the Depository accepts and opens an account that will be invested in short term bank certificates of deposit titled "EBank for the acct. of Prestiga Fund" to clear proceeds of sale of units of membership interest (the "Units") in a best efforts minimum/maximum offering of the Fund promptly delivered by the Selling Agent from subscribers at an initial offering price of one thousand dollars ($1,000) to be held in said bank account subject to the terms of this Agreement until a total face amount of nine hundred thousand dollars ($900,000) of Units (the "Minimum") are sold and, thereafter to continue to accept proceeds of sale from subscribers sold at the Net Asset Value per Unit computed after the close of business on the last business day of each month and transferred to the Fund as of the open on the first business day of each month. The Selling Agent shall direct all subscribers to make their checks to "EBank for the acct. of Prestiga Fund" Any instrument not so made out shall be promptly returned to the subscriber by the Selling Agent. Any instrument which is dishonored shall be returned by the Bank directly to the subscriber, with notice to the Selling Agent. The Selling Agent will supply Bank with a list of the subscribers to identify their name, address and amount of subscription. The Selling Agent will be solely responsible for the allocation of interest earned among the subscribers. 2. Sale of Minimum Required. The Selling Agent shall promptly transmit all checks and wire transfers for the purchase of Units directly to the Bank. At the time of delivery of the proceeds to the Bank, the Selling Agent shall provide the Bank with the name and address of the subscriber for the Units. Should the Minimum not be sold within twelve months from the effective date of the Offering established by the Securities and Exchange Commission (the "Offering Period") or should the offering terminate for any reason prior to the Offering Period, the Bank shall promptly return the proceeds to each subscriber plus interest as allocated by the Managing Member without deduction for costs or expenses from the amounts paid to the subscribers, and the Bank shall notify the Managing Member and the Selling Agent of its distribution of the funds. The proceeds returned to each subscriber shall be free and clear of any and all claims of the Fund or any of its creditors. The Managing Member is solely responsible for the allocation of the interest earned to the subscribers. Upon the receipt of deposits that total $900,000 to the account before the lapse of or termination of the Offering Period, the Bank shall deliver the proceeds plus interest by check or account transfer to the Fund and at the end of each month thereafter, the Bank shall deliver all proceeds plus interest by check or account transfer to the Fund. In no event will the proceeds be released to the Fund until the Minimum is received by the Bank in collected funds. For purposes of this Agreement, the term "collected funds" shall mean all funds received by the Bank which have cleared normal banking channels and are in the form of cash. 3. No Creditor's Rights. The Selling Agent and the Managing Member, individually and on behalf of the Fund agree that they are not entitled to any funds in the Bank account prior to the sale of the Minimum and no amounts deposited in the Bank Account shall become the property of or be subject to the debts of the Selling Agent, Managing Member, Fund or any other entity or person. 4. Collection Procedure. The Bank is hereby authorized to forward each check for collection and, upon collection of the proceeds of each check, deposit the collected proceeds in the account. As an alternative, the Bank may telephone the bank on which the check is drawn to confirm that the check has been paid. Any check returned unpaid shall be returned by the Bank to the subscriber with notice to the Selling Agent. If the Fund rejects any subscription for which the Bank has already collected funds, the Bank shall promptly issue a refund check to the rejected subscriber. If the Managing Member rejects any subscription for which the Bank has not yet collected funds but has submitted the subscriber's check for collection, the Bank shall promptly issue a check in the amount of the subscriber's check to the rejected subscriber after the Bank has cleared such funds. If the Bank has not yet submitted a rejected subscriber's check for collection, the Bank shall promptly remit the subscriber's check directly to the subscriber. 5. Bank Compensation. As the Bank's total compensation for the performance of its services, Bank shall receive an aggregate fee determined by multiplying the total number of checks received from and issued to subscribers by the Bank by $15.00 (the "Bank Fee"). The Managing Member shall pay the Bank Fee within fifteen (15) days after the sale of the Minimum and, thereafter, after the close of each month. Under no circumstances shall the Bank Fee or any indemnification for any damages incurred by the Bank or any monies whatsoever be paid out of or chargeable to the subscribers' funds or interest earned while on deposit in the Bank Account. 6. Bank Liability Limited. Bank shall have no liability under, or duty to inquire into, the terms and provisions of any other document or instrument utilized in connection with the Offering, and it is agreed that the duties of Bank are purely ministerial in nature, and that Bank shall incur no liability whatsoever under this Agreement, except for acts or omissions of the Bank involving or constituting willful misconduct, fraud, gross negligence or bad faith. 7. Bank May Resign. Bank may, at any time, resign hereunder by giving written notice of its intent to resign to the other parties hereto, at their respective addresses set forth above, at least ten (10) days prior to the date specified for such resignation to take effect, and upon the effective date of such resignation the proceeds, including all accrued interest, shall be delivered by Bank to the person designated in writing by the Selling Agent and the Managing Member or a court of competent jurisdiction, whereupon all of Bank's obligations hereunder shall cease and terminate. Notwithstanding the foregoing, nothing in this paragraph releases Bank or relieves it of any of its obligations that existed prior to the effective date of Bank's resignation including, without limitation, liability for willful misconduct, fraud, gross negligence or bad faith. Notwithstanding the foregoing, nothing in this paragraph releases the Selling Agent or the Managing Member of their obligations under the Securities and Exchange Act including, but not limited to, Rules 15c2-4 and 10b-9. 8. Bank Indemnification. The Selling Agent and the Managing Member agree to indemnify, defend and hold Bank harmless from and against any and all loss, damage, tax, liability and expense that may be incurred by Bank and arising out of or in connection with its acceptance of appointment as Bank hereunder, including reasonable attorneys' fees and other legal costs and expenses of defending itself against any claim or liability in connection with its performance hereunder, except in the case of willful misconduct, fraud, gross negligence or bad faith on the part of Bank. Bank may consult with and rely on its attorneys with respect to any dispute not assumed or defended by the Selling Agent and the Managing Member and this indemnification shall include all reasonable and necessary attorneys' fees of Bank in connection with such consultation. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. PRESTIGA CAPITAL MANAGEMENT, INC. EBANK FINANCIAL SERVICES INC. By: ____________________________ By: ___________________________ Steve Worth Print Name: President Title: MHA FINANCIAL CORP PRESTIGA FUND, LLC By: Prestiga Capital Management, Inc. By: ____________________________ By: ____________________________ C. William Hoilman Steve Worth President President ******************************************************************************* EXHIBIT F TO PRESTIGA FUND DISCLOSURE DOCUMENT INVESTMENT ADVISORY CONTRACT WORTH CAPITAL MANAGEMENT, LLC THIS AGREEMENT is made and entered as of this ____ day of October, 2004, between Prestiga Fund, LLC, (the "Fund") and Worth Capital Management, LLC, a Connecticut limited liability company (the "CTA"). WITNESSETH: In consideration of the agreement of the Fund to use its best efforts to raise and deposit one million dollars ($1,000,000), or more, of equity to Man Financial Inc (the "FCM") to an account to be assigned by the FCM (the "Account") and the grant of the power of attorney on the standard form of the FCM to the CTA to permit the CTA to enter trades for the Fund in the Account and payment of management fees to and the opportunity to earn incentive fees by the CTA, the parties hereto agree as follows: 1. The Fund shall use its best efforts to raise and deposit in the Account with the FCM or some other registered futures commission merchant, in U.S. funds the minimum of one million dollars ($1,000,000), which the CTA agrees to manage pursuant to the terms of this Agreement. Subsequent deposits and accumulation of profits in the Account, less withdrawals and losses, shall also be subject to this Agreement. At its sole discretion, the Fund may add or withdraw funds at any time from the Account by written request to the FCM with a copy to the CTA. 2. The CTA will cause futures contracts, and when deemed advisable, options on futures and forward contracts, to be bought and sold on behalf of the Fund in the Account. The CTA will have the sole authority to issue all necessary instructions to the FCM to effect trading for the Fund's Account. All such transactions shall be for the account and risk of the Fund. The CTA agrees to use its best efforts to exit all futures trades prior to delivery of any commodity that requires storage or other costs. During the term of this agreement, the Fund agrees that it will not place orders in the Account without the prior written consent of the CTA. 3. The CTA's services are not rendered exclusively for the Fund and the Fund agrees that the CTA is free to continue to provide and offer similar services to others. The Managing Member may change or add another FCM for the Account assigned to the CTA at any time upon written direction to the FCM and the CTA, and the FCM and the CTA agree to effect the transfer and sign the forms necessary to complete such change or addition, provided such transfer does not conflict with any prior agreements the CTA has with the FCM. 4. Prestiga Capital Management, Inc. (the "Managing Member") shall charge the Fund round turn brokerage commissions of $20, which includes fees for entry and exit from all trades, pit brokerage, exchange, NFA fees and other clearing expenses arising from the trades placed by the CTA in the Account. 5. The CTA will use its best efforts to obtain an equity run from the FCM before the opening of business the next trading day. Unless authorized in writing by the Managing Member, the CTA will use only the equity in the Account assigned to the CTA by the Managing Member for margins to hold the positions taken by the CTA. No equity in the Account assigned to the CTA will be commingled or margined, for any purpose, with any other account at the FCM. The Managing Member, upon written instruction to the FCM, may terminate, for any reason, the power of attorney and suspend the trading authority of the CTA to enter trades with the FCM. In the event of a termination of the power of attorney, the CTA agrees that the FCM shall accept no further instructions from the CTA but shall place the Account upon liquidation only to be handled in written instructions from the Managing Member to the FCM. 6. The Fund agrees to execute, from time to time, the Acknowledgment of Receipt of Disclosure Document from the CTA. By signing, the Fund agrees that it has received and understands and the CTA represents that it has supplied the most recent copy of the CTA's Risk Disclosure Document. The CTA will promptly review the Fund offering documents submitted by the Fund to it, from time to time, and will furnish its consent, in the form requested by the Fund, to the filing of forms and offering documents with the Federal and State security and commodity regulators. 7. The CTA will be paid an incentive fee of twenty percent (20%), of the New Net Profit earned each calendar quarter. New Net Profit is determined after deduction of the fixed commission; i.e., the CTA must earn back the brokerage commissions before incentive fees are paid. And, New Net Profit excludes interest earned on cash and cash equivalents, such as treasury bills. The Fund accountant will make the incentive fee determination on the close of the last business day of each quarter and submit his calculations to the CTA and Managing Member for approval. Once approved, the invoice for the quarterly incentive fee will be submitted to the futures commission merchant for payment from the Account. 8. The Fund and the CTA agree that they have or will properly execute all necessary forms for opening the Account with the FCM; provided, however, any disputes between the Fund and the CTA will be submitted to arbitration before a single arbitrator selected by the American Arbitration Association, not the National Futures Association, and only upon written agreement of the parties at the time such dispute arises. The terms of this Agreement will supersede, and in the event of conflicts with any other agreement, the terms of this Agreement shall control. This Agreement will be governed by the laws of the State of Massachusetts and any dispute concerning arbitration will be resolved by a Federal or State court of competent jurisdiction located in Boston, Massachusetts. IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement the day and year first above written. Prestiga Fund, LLC Worth Capital Management, LLC By: Prestiga Capital Management, Inc. Managing Member ____________________________________ ________________________________ Steven Worth Steven Worth President President ******************************************************************************* Dealer Prospectus Delivery Obligation Until one year from the date of this prospectus, all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation, if any, to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. [The balance of this page has been intentionally left blank.] ******************************************************************************* FORM S-1 Registration No. ____________ PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses of Issuance and Distribution. (a) The Selling Agreement between MHA Financial Corp and the Registrant contains an indemnification from the Managing Member to the effect that the disclosures in the Prospectus are in compliance with Rule 10b5 and otherwise true and complete. This indemnification speaks from the date of the first offering of the Units through the end of the applicable statute of limitations. The Registrant has assumed no responsibility for any indemnification to MHA and the Managing Member is prohibited by the LLC Operating Agreement from receiving indemnification for breach of any securities laws or for reimbursement for insurance for coverage for any such claims. See Section 15.4 of the LLC Operating Agreement. (b) There are no indemnification agreements which are not contained in the LLC Operating Agreement attached as Exhibit A, the Selling Agreement or the Clearing Agreement. (c) The following reflects all expenses in connection with the issuance and distribution of the securities to be registered, other than underwriting discounts and commissions: Expense Cost Registration fees $ 23,000 Federal taxes 0 States taxes and fees 10,000 Trustees' and transfer agents' fees 0 Costs of printing and engraving 2,000 Legal 10,000 Accounting 5,000 Engineering 0 $50,000 Item 15. Recent Sales of Unregistered Securities. None within three years. Item 16. Exhibits and Financial Statement Schedules. The following documents (unless indicated) are filed herewith and made a part of this Registration Statement: (a) Exhibits. Exhibit Number Description of Document 1.01 Selling Agreement dated October 4, 2004 between the Registrant and MHA Financial Corp, the Selling Agent 2.01 None 3.01 Articles of Incorporation of the Managing Member 3.02 By-Laws of the Managing Member 3.03 Board Resolution of Managing Member to authorize formation of the Registrant, a Delaware Limited Liability Company 3.04 By-Laws of the Registrant 3.05 LLC Operating Agreement of the Registrant (included as Exhibit A to the Prospectus) 3.05 Certificate of Formation of the Registrant 4.01 LLC Operating Agreement of the Registrant (included as Exhibit A to the Prospectus) 5.01 Opinion of M&A Counselors and Fiduciaries, LLC with respect to the legality of the Registrant Units 6.01 Not Applicable 7.01 Not Applicable 8.01 Opinion of M&A Counselors and Fiduciaries, LLC with respect to Federal income tax consequences 9.01 None 10.01 Form of Advisory Agreement between the Registrant and the Commodity Trading Advisor (included as Exhibit F to the Prospectus) 10.02 Form of Subscription Agreement and Power of Attorney (included as Exhibit D to the Prospectus) 10.03 Depository Agreement among Depository, Underwriter, and the Registrant (included as Exhibit E to the Prospectus) 11.01 Not Applicable - start-up business 12.01 Not Applicable 13.01 Not Required 14.01 None 15.01 None 16.01 Not Applicable 17.01 Not Required 18.01 Not Required 19.01 Not Required 20.01 Not Required 21.01 None 22.01 Not Required 23.01 Consent of Larry D. Liberfarb, P. C., Certified Public Accountants 23.02 Consent of M&A Counselors and Fiduciaries, LLC, Legal & Tax Counsel 24.01 None 25.01 None 26.01 None 27.01 Not Applicable 28.01 Not Applicable (b) Financial Statement Schedules. No Financial Schedules are required to be filed herewith. Item 17. Undertakings. (a) (1) The undersigned registrant hereby undertakes to file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post- effective amendment thereof) which, individually or in the aggregate, represents a fundamental: change in the information set forth in the registration statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) The undersigned Registrant hereby undertakes that, for the purpose of determining any liability under the Securities Act of 1933, each post- effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (c) The Managing Member has provided an indemnification to MHA Financial Corp, the best efforts selling agent. The Registrant (issuer) has not made any indemnification to MHA Financial Corp. Insofar as indemnification for liabilities under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant including, but not limited to, the Managing Member pursuant to the provisions described in Item 14 above, or otherwise, the Registrant had 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 such 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. ******************************************************************************* SIGNATURES Pursuant to the requirements of the Securities Act of 1933, in the City of Fairfield in the State of Connecticut on this 7th day of October, 2004, Prestiga Capital Management, Inc., the managing member of the Registrant, has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized. PRESTIGA CAPITAL MANAGEMENT, INC. PRESTIGA GLOBAL FUND, LLC BY PRESTIGA CAPITAL MANAGEMENT, INC. MANAGING MEMBER By: /s/ Steven Worth By: /s/ Steven Worth MR. STEVEN WORTH MR. STEVEN WORTH PRESIDENT PRESIDENT Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following person on behalf of Prestiga Capital Management, Inc., Managing Member of the Registrant in the capacities and on the date indicated. /s/ Steven Worth MR. STEVEN WORTH PRESIDENT Date: October 7, 2004 (Being the principal executive officer, and the principal financial and accounting officer of Prestiga Capital Management, Inc., Managing Member of the Fund) \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001305755_china_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001305755_china_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a74258920d37819f80e7c9affb5095d8ac2a183c --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001305755_china_legal_matters.txt @@ -0,0 +1,30496 @@ +LEGAL MATTERS + + +Certain legal matters of United States and New +York law will be passed upon for us and China Netcom Group by +Skadden, Arps, Slate, Meagher Flom LLP, New York, New +York, and for the underwriters by Shearman Sterling +LLP, New York, New York. Certain legal matters of Hong Kong law, +including the validity of the shares, will be passed upon for us +and China Netcom Group by Linklaters, Hong Kong, and for the +underwriters by Baker McKenzie, Hong Kong. Certain +legal matters of PRC law will be passed upon for us and China +Netcom Group by Haiwen Partners, Beijing, PRC, and +for the underwriters, by Commerce Finance Law +Offices, Beijing, PRC. + +EXPERTS + + +Our consolidated financial statements as of +December 31, 2001, 2002 and 2003 and June 30, 2004 and +for each of the three years in the period ended +December 31, 2003 and the six-month periods ended +June 30, 2003 and 2004 included in this registration +statement have been so included in reliance on the report of +PricewaterhouseCoopers, independent registered public accounting +firm, given on the authority of said firm as experts in auditing +and accounting. PricewaterhouseCoopers have audited our +consolidated financial statements since 2001. The address of +PricewaterhouseCoopers is 22/ F, Prince s Building, +Central, Hong Kong. + + +The valuation report included in this document in +Appendix A has been prepared by Sallmanns (Far East) Ltd., +located at 22/ F, Siu On Centre, 188 Lockhart Road, Wan Chai, +Hong Kong, and has been included with the consent and in +reliance of the valuations given upon the authority of that firm +as experts in valuing property interests in buildings and real +property. + +EXPENSES RELATING TO THE GLOBAL +OFFERING + + +The following table sets forth the main estimated +expenses in connection with the global offering, other than the +underwriting discounts and commissions, that we and the selling +shareholders will be required to pay: + + + + + + + + + + + U.S. Securities and Exchange Commission + registration fee + + + + + US$ + 190,050 + + + + + National Association of Securities Dealers filing + fee + + + + + + 30,500 + + + + + New York Stock Exchange listing fee + + + + + + 200,000 + + + + + Hong Kong Stock Exchange listing fee + + + + + + 80,000 + + + + + Legal fees and expenses + + + + + + 3,400,000 + + + + + Accounting fees and expenses + + + + + + 5,000,000 + + + + + Printing fees + + + + + + 2,000,000 + + + + + Other fees and expenses + + + + + + 19,469,950 + + + + + + + + + + + + Total + + + + + US$ + 30,370,500 + + + + + + + + + +All amounts are estimated, except the +U.S. Securities and Exchange Commission registration fee, +the New York Stock Exchange listing fee and the NASD filing fee. +Expenses will be borne in proportion to the number of shares +sold in the offering by us and the selling shareholders, +respectively. + +197 + +Table of Contents + +WHERE YOU CAN FIND MORE INFORMATION + + +We have filed with the Commission, a registration +statement on Form F-1 (No. 333-119786) under the +Securities Act, with respect to the shares, and the depositary +bank has filed a registration statement on Form F-6 +(No. 333-119970) under the Securities Act with respect to +the ADSs. This document does not contain all of the information +in the registration statements and their exhibits. We have +omitted certain portions of these registration statements from +this document. + + +You may read and copy this information at the +Commission s Public Reference Room at 450 Fifth +Street, N.W., Washington, D.C. 20549. You can also request +copies of the documents we file with the Commission, upon +payment of a duplicating fee, by writing to the Public Reference +Section of the Commission. Please call the Commission at +1-800-SEC-0330 for further information on the operation of the +Public Reference Room. You may also inspect these reports and +other information at the offices of the New York Stock Exchange, +11 Wall Street, New York, New York 10005. These materials may +also be accessed electronically by means of the +Commission s home page on the Internet (http://www.sec.gov). + + +Upon completion of the global offering, we will +become subject to the periodic reporting and other informational +requirements of the U.S. Securities Exchange Act of 1934, +as amended, or the Exchange Act, applicable to a foreign private +issuer. In accordance with these requirements, we will file +annual reports on Form 20-F within six months of our fiscal +year end and we will submit other reports and information under +cover of Form 6-K with the Commission. These reports and +other information can be inspected at the Public Reference Room +at the Commission. You can also obtain copies, upon payment of a +prescribed fee, of such material from the Public Reference Room +and the regional offices, or by calling or writing to the +Commission. That material may also be accessed electronically by +means of the Commission s home page on the Internet +(http://www.sec.gov). As a foreign private issuer, we are exempt +under the Exchange Act from, among other things, the rules +prescribing the furnishing and content of proxy statements and +annual reports to shareholders and requiring reporting of +insider purchases and sales. + + +We will furnish the depositary with our annual +reports in English. Our annual reports will include a review of +operations and annual audited financial statements prepared in +conformity with Hong Kong GAAP, together with a reconciliation +to U.S. GAAP of certain financial information. We will also +furnish the depositary with our semi-annual reports in English, +which will include unaudited interim financial information +prepared in conformity with Hong Kong GAAP. Once the depositary +receives this information and reports, it will promptly, upon +our written request, mail such reports to all holders of record +of ADSs. We also will furnish to the depositary in English all +notices of shareholders meeting and other reports and +communication that are made generally available to our +shareholders. The depositary will make such notices, reports and +communications available to holders of ADSs and, upon our +written request, will mail to all record holders of ADSs the +information contained in any notice of a shareholders +meeting received by the depositary from us. + +198 + +Table of Contents + +INDEX TO CONSOLIDATED FINANCIAL +STATEMENTS + +CHINA NETCOM GROUP CORPORATION (HONG KONG) +LIMITED AND ITS SUBSIDIARIES + + + + + + + + + + Page + + + + + + + + Report of Independent Registered Public + Accounting Firm + + + + + + F-2 + + + + + Consolidated Income Statements for the Years + Ended December 31, 2001, 2002 and 2003 and Six Months + Ended June 30, 2003 and 2004 + + + + + + F-3 + + + + + Consolidated Balance Sheets as at + December 31, 2001, 2002 and 2003 and June 30, 2004 + + + + + + F-4 + + + + + Consolidated Statements of Changes in Equity for + the Years Ended December 31, 2001, 2002 and + 2003 and Six Months Ended June 30, 2004 + + + + + + F-5 + + + + + Consolidated Cash Flow Statements for the Years + Ended December 31, 2001, 2002 and 2003 and Six Months + Ended June 30, 2003 and 2004 + + + + + + F-6 + + + + + Notes to the Consolidated Financial Statements + for the Years Ended December 31, 2001, 2002 and 2003 and + Six Months Ended June 30, 2003 and 2004 + + + + + + F-7 + + +F-1 + +Table of Contents + +Report of Independent Registered Public +Accounting Firm + +To the Board of Directors and Shareholders of +China Netcom Group Corporation (Hong Kong) Limited: + + +In our opinion, the accompanying consolidated +balance sheets and the related consolidated income statements, +cash flows statements and statement of changes in equity present +fairly, in all material respects, the financial position of +China Netcom Group Corporation (Hong Kong) Limited and its +subsidiaries at December 31, 2003, 2002 and 2001, and +June 30, 2004, and the results of their operations and +their cash flows for each of the three years in the period ended +December 31, 2003, and each of the six months ended +June 30, 2003 and 2004, in conformity with accounting +principles generally accepted in Hong Kong. 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. We conducted our +audits of these statements in accordance with the standards of +the Public Company Accounting Oversight Board (United States). +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, assessing the +accounting principles used and significant estimates made by +management, and evaluating the overall financial statement +presentation. We believe that our audits provide a reasonable +basis for our opinion. + + +Accounting principles generally accepted in Hong +Kong vary in certain significant respects from accounting +principles generally accepted in the United States of America. +Information relating to the nature and effect of such +differences is presented in Note 36 to the consolidated +financial statements. + +/s/ PRICEWATERHOUSECOOPERS + +Hong Kong + +September 7, 2004, except for +Note 35(c), as to which the date is October 4, 2004. + +F-2 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Consolidated Income Statements + +(in millions, except per share data) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Years ended December 31, + + Six months ended June 30, + + + + + + + + + + + + Note + + 2001 + + 2002 + + 2003 + + 2003 + + 2003 + + 2004 + + 2004 + + + + + + + + + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + US$ + + RMB 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+ (7 + ) + + + (1 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Net cash inflow from operating activities + + + + + + + + + + 22,874 + + + + 23,928 + + + + 25,332 + + + + 3,061 + + + + 14,017 + + + + 14,075 + + + + 1,700 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Cash flows from investing activities + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Purchase of fixed assets and construction in + progress + + + + + + + + + + (40,163 + ) + + + (25,814 + ) + + + (28,528 + ) + + + (3,446 + ) + + + (11,092 + ) + + + (8,947 + ) + + + (1,081 + ) + + + + + Sales of fixed assets + + + + + + + + + + 1,055 + + + + 768 + + + + 735 + + + + 89 + + + + 234 + + + + 37 + + + + 4 + + + + + + Sales of other investments + + + + + + + + + + 94 + + + + 274 + + + + 1,195 + + + + 144 + + + + 997 + + + + 752 + + + + 91 + + + + + + Net (increase)/ decrease in time deposits with + maturity over three months + + + + + + + + + + 61 + + + + (109 + ) + + + 78 + + + + 9 + + + + 106 + + + + 30 + + + + 4 + + + + + + Investment in Asia Netcom + + + + + + 28 + (c)(i) + + + + + + + + + + + (507 + ) + + + (61 + ) + + + (507 + ) + + + + + + + + + + + + + Purchase of additional interest in Asia Netcom + + + + + + 28 + (c)(ii) + + + + + + + + + + + 55 + + + + 7 + + + + + + + + + + + + + + + + + + Purchase of other investments + + + + + + + + + + (2,508 + ) + + + (1,041 + ) + + + (29 + ) + + + (4 + ) + + + (60 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Net cash outflow from investing activities + + + + + + + + + + (41,461 + ) + + + (25,922 + ) + + + (27,001 + ) + + + (3,262 + ) + + + (10,322 + ) + + + (8,128 + ) + + + (982 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Cash flows from financing activities + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + New bank loans and other loans + + + + + + + + + + 47,314 + + + + 48,495 + + + + 63,033 + + + + 7,616 + + + + 20,950 + + + + 22,411 + + + + 2,708 + + + + + + Repayment of bank loans + + + + + + + + + + (29,612 + ) + + + (43,208 + ) + + + (64,614 + ) + + + (7,808 + ) + + + (22,420 + ) + + + (24,126 + ) + + + (2,915 + ) + + + + + Capital element of finance lease payments + + + + + + + + + + (124 + ) + + + (88 + ) + + + (101 + ) + + + (12 + ) + + + (101 + ) + + + (290 + ) + + + (35 + ) + + + + + Advance from owners + + + + + + + + + + + + + + + + + + 4,750 + + + + 574 + + + + + + + + + + + + + + + + + + Contribution received from owners + + + + + + + + + + 4,920 + + + + 507 + + + + + + + + + + + + + + + + 201 + + + + 24 + + + + + + Payment of distribution to owners + + + + + + + + + + (4,078 + ) + + + (3,972 + ) + + + (1,806 + ) + + + (218 + ) + + + (1,130 + ) + + + (7,310 + ) + + + (883 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Net cash inflow/(outflow) from financing + activities + + + + + + + + + + 18,420 + + + + 1,734 + + + + 1,262 + + + + 152 + + + + (2,701 + ) + + + (9,114 + ) + + + (1,101 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (Decrease)/increase in cash and cash equivalents + + + + + + + + + + (167 + ) + + + (260 + ) + + + (407 + ) + + + (49 + ) + + + 994 + + + + (3,167 + ) + + + (383 + ) + + + + Cash and cash equivalents at beginning of + year/period + + + + + + + + + + 7,117 + + + + 6,950 + + + + 6,690 + + + + 808 + + + + 6,690 + + + + 6,283 + + + + 759 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Cash and cash equivalents at end of year/period + + + + + + 10 + + + + 6,950 + + + + 6,690 + + + + 6,283 + + + + 759 + + + + 7,684 + + + + 3,116 + + + + 376 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +The accompanying notes are an integral part of +these consolidated financial statements. + +F-6 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +1. The Group, its +Reorganisation and Principal Activities + +Background of the Group + + +China Netcom Group Corporation (Hong Kong) +Limited (formerly known as China Netcom Corporation (Hong Kong) +Limited) (the Company ) was incorporated in the Hong +Kong Special Administration Region ( Hong Kong ) of +the People s Republic of China (the PRC ) on +October 22, 1999 as a limited liability company under the +Hong Kong Companies Ordinance. Prior to a reorganisation +conducted for the listing of the shares of the Company (the + Reorganisation ), the Company s ultimate holding +company was China Netcom (Holdings) Company Limited ( China +Netcom Holdings ). + + +China Netcom Holdings was owned by four +state-owned enterprises and became the Company s holding +company in December 2000. The Company through its principal +operating subsidiary, China Netcom (Group) Limited ( CNC +China ) is engaged in the provision of the fixed line +telecommunication services through different regional branch +offices in the PRC. In March 2003, the Company along with two +co-investors through Asia Netcom Corporation Limited ( Asia +Netcom ), being a 51% owned jointly controlled entity of +the Company at that time, acquired the Asia-Pacific submarine +cable assets and related physical network assets and +liabilities, from Asia Global Crossing Ltd. On December 31, +2003, the Company further purchased the remaining 49% interests +in Asia Netcom held by the other co-investors and became the +sole owner of Asia Netcom. + +Reorganisation of the Group + + +In anticipation of the listing of the Company, +China Netcom Holdings and China Network Communications Group +Corporation ( China Netcom Group ), both being state +owned enterprises under the supervision and regulation of the +Ministry of Information Industry ( MII ), underwent +the Reorganisation. Immediately after the Reorganisation, the +ultimate holding company of the Group became China Netcom Group. + + +China Netcom Group, the Group s current +ultimate holding company, was established by the State Council +of the PRC in May 2002. Under a comprehensive industry +restructuring plan relating to the fixed line telecommunication +sector in China approved by the State Council in November 2001, +the fixed line telecommunication businesses originally operated +by China Telecommunication Corporation ( China Telecom +Group ) were split into northern and southern operations. +In May 2002, China Netcom Group took over the northern part +fixed line telecommunication operations in 10 provinces, +municipalities and autonomous regions. In accordance with this +industry restructuring plan, China Netcom Group and China +Telecom Group own 30% and 70%, respectively, of the nationwide +inter-provincial optic fibres and both groups were permitted to +operate nationwide fixed line telecommunications networks and +provide nationwide services. + + +The Reorganisation undertaken in anticipation of +the listing of the Company comprised the following: + + + + + + + (a) + + China Netcom Group acquired the entire interest + in China Netcom Holdings from its four state owners and became + the ultimate holding company of the Group; + + + + + + + + (b) + + The Company s principal operating + subsidiary, namely CNC China, transferred all its assets + and liabilities in the PRC telecommunications operations to + China Netcom Group, and assets and liabilities of the PRC fixed + line telecommunications operations previously owned by both + China Netcom Group and the Company were consolidated in the + respective provinces, municipalities and autonomous regions; + + + + + + + + (c) + + After excluding certain assets and liabilities + which were retained by China Netcom Group as set out in (f) + (i) below, the net assets of the telecommunications + operations of 8 PRC provinces and municipalities, namely Beijing + Municipality, Tianjin Municipality, Hebei Province, Henan + Province, Shandong Province, Liaoning Province, Shanghai + Municipality and Guangdong Province (collectively + + +F-7 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + + + + + + + + referred to as the Eight Service + Regions ), valued at RMB 43,012 million, which + was based on an independent valuation and were injected into the + Company in consideration of approximately 5,442 million + ordinary shares (21,769 million shares before share + consolidation. See Note 33(b) for details) of the Company + (the Asset Injection ). + + + + + + + + (d) + + Certain Asia-Pacific submarine cable assets and + related physical network assets and liabilities were transferred + from Asia Netcom to China Netcom Group. + + + + + + + + (e) + + The Group, immediately after the Reorganisation, + contains the following assets and liabilities related to: + (i) fixed line telecommunication operations in the Eight + Service Regions; and (ii) fixed line telecommunication + operations in the Asia-Pacific region operated by Asia Netcom + (collectively the Restructured Businesses ). + + + + + + + + (f) + + China Netcom Group, immediately after the + Reorganisation, retained or held the following assets and + liabilities: (i) certain assets and liabilities of the + Eight Service Regions including fixed assets, mainly + inter-provincial optic fibers, investments in associated + companies, long-term investments, bank balances and borrowings + and those attributable to certain minor ancillary + telecommunications services; (ii) all assets and + liabilities of the fixed line telecommunication operations + outside the Eight Service Regions; (iii) all non-core + businesses representing businesses other than the principal + communications services operations in the Group s northern + and southern service regions and primarily include procurement + of materials, equipment maintenance services, engineering, + project planing and design and operations of certain social + facilities and (iv) the Asia- Pacific submarine cable + assets and related physical network transferred from Asia Netcom + (collectively the Retained Businesses ). + + + +The above Reorganisation procedures primarily +resulted in a net effect of (i) the transfer from China +Netcom Group to the Company of the assets and liabilities of the +telecommunications operations in the Eight Service Regions, +which were previously owned by China Netcom Group prior to the +Reorganisation; and (ii) the transfer from the Company to +China Netcom Group of certain assets and liabilities of the +telecommunications operations outside the Eight Service Regions +and the Asia-Pacific submarine cable assets and related physical +network, which were previously owned by the Group prior to the +Reorganisation. + +Principal activities + + +After the Reorganisation, the Group is a dominant +provider of fixed line telephone services, broadband, other +Internet-related services, and business and data communications +services in six northern municipalities and provinces, namely +Beijing Municipality, Tianjin Municipality, Hebei Province, +Henan Province, Shandong Province and Liaoning Province in the +PRC. The Group also provides telecommunications services to +selected business and residential customers in two southern +municipality and province, namely Shanghai Municipality and +Guangdong Province in the PRC. The Group is the only +telecommunications company in the PRC that operates an extensive +network and offers international data services throughout the +Asia-Pacific region. + + +After the Reorganisation, the Group s +principal services consist of: + + + + + + + + + fixed line telephone services (including the + personal handy phone system (PHS) services), including: + + + + + + + + + + local, domestic long distance and international + long distance services; + + + + + + + + value-added services, including caller identity, + telephone information services; and + + + + + + + + interconnection services provided to other + domestic telecommunications service providers; + + + + + + + + + + broadband services and other Internet-related + services; + + +F-8 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + + + + + + + + business and data communications services, + including integrated regional data and voice communications + services; and + + + + + + + + international services consisting of + international voice services including international inbound + calls destined for the PRC or transit through the PRC or other + Asia-Pacific countries and regions, and leased line, Internet + access, managed data and other telecommunications services + provided to business and carrier customers located outside the + PRC. + + + +The Group s PRC operations are subject to +the supervision of and regulation by the PRC Government. The +MII, pursuant to the authority delegated by the PRC s State +Council, is responsible for formulating the telecommunications +industry policies and regulations. + + +Under the Telecommunications Regulations, all +telecommunications operators in PRC must obtain a +telecommunications service operating license from the MII or +from the provincial telecommunications administrations. +Providers of value-added services within a single province are +required to obtain licenses from provincial telecommunications +administrations. Providers of basic telecommunications services +and providers of value-added services in two or more provinces, +autonomous regions and municipalities are required to obtain +licenses from the MII. In accordance with the approval of the +MII, CNC China, our principal operating subsidiary in +China, as an indirect subsidiary of China Netcom Group, has the +right to operate our telecommunications business in Eight +Service Regions under the authorization of China Netcom Group, +which holds the license required for operating our +telecommunications businesses in PRC. + + +Following our Reorganization, China Netcom Group +continues to be the holder of the licenses for operating a +telecommunicating network in China, but has, with the consent of +MII, granted CNC China the right to operate under its license, +the assets described above and the related business. The Company +is the holder of licenses that are necessary to own and operate +the assets that are outside PRC described above in such key +countries and regions such as Hong Kong, Japan, Singapore and +Korea. + +2. Basis of +Presentation + + +The Reorganisation was effective for accounting +purposes on June 30, 2004, which is the date on which the +Company and China Netcom Group signed the legally binding +agreements that identified (i) all specific assets and +liabilities under the Asset Injection to be transferred to the +Company from China Netcom Group and (ii) the specific +assets and liabilities to be transferred from Asia Netcom to +China Netcom Group. + + +China Netcom Group and China Telecom Group were +both state owned enterprises under common control and +accordingly, the takeover of the fixed line telecommunication +operations in the 10 northern provinces, municipalities and +autonomous regions by China Netcom Group from China Telecom +Group in accordance with the industry restructuring plan is +construed to have occurred at the beginning of the three years +ended December 31, 2003 for the purpose of the consolidated +financial statements. In accordance with this industry +restructuring plan, the entities in the northern regions and the +entities in the southern regions comprising the Group +respectively transferred to and received from China Telecom +Group 70% and 30% of the inter-provincial optic fibres including +network under construction which were all reflected as a +distribution to and contribution from owners in the consolidated +statement of changes in equity for the year ended +December 31, 2001 (see Note 15 (d)). + + +China Netcom Group and China Netcom Holdings were +both state owned enterprises before and after the +Reorganisation, and the acquisition of China Netcom Holdings by +China Netcom Group was carried out under the directive of the +State Council. Accordingly, the Reorganisation is regarded as a +common control transaction and accounted for under merger +accounting, as permitted by the Hong Kong Statement of Standard +Accounting Practice 2.127 Accounting for group +reconstructions , and the assets and liabilities injected +into the Company by China Netcom Group under +Note 1 (c) above have been stated at historical +amounts. The consolidated financial statements present the +consolidated results and financial position of the + +F-9 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +Group as if China Netcom Holdings and China +Netcom Group had been merged throughout the three years ended +December 31, 2003 and as if the Restructured Businesses +were injected into the Company from China Netcom Group at the +beginning of the earliest period presented or when such +businesses were acquired by the Group or China Netcom Group, +whichever is later. The consolidated financial statements do not +include the results and financial position of businesses prior +to the Reorganisation and previously owned by China Netcom Group +outside the Eight Service Regions that were retained by China +Netcom Group upon the Reorganisation. + + +Prior to the consummation of the Reorganisation, +the assets and liabilities of the PRC telecommunications +operations, both within and outside the Eight Service Regions of +the Company held through CNC China, the Company s principal +operating subsidiary, had been historically under common +management and control. Therefore, the Group s consolidated +income statements for the three years ended December 31, +2003 and the six months ended June 30, 2004 and +consolidated balance sheets as at December 31, 2001, 2002 +and 2003 includes the entire consolidated financial data of the +PRC operations of CNC China although the assets and liabilities +of operations of CNC China outside the Eight Service Regions +have been transferred to China Netcom Group under the +Reorganisation as set out in Note 1 above. In addition, the +consolidated balance sheets as at December 31, 2001, 2002 +and 2003 also include the assets and liabilities of the Eight +Service Regions in the PRC which have been retained by China +Netcom Group under the Reorganisation (see +Note 1 (f) (i) above) and the assets and +liabilities that were transferred from Asia Netcom to China +Netcom Group under the Reorganisation (see +Note 1 (f) (iv) above) as those assets and +liabilities were part of the telecommunication operations and +were not separately managed throughout the three years ended +December 31, 2003 and the six months ended June 30, +2004. The above assets and liabilities retained by, or +transferred to, China Netcom Group but included in the +consolidated financial statements during the three years ended +December 31, 2003 and the amounts of such assets and +liabilities distributed to owners on June 30, 2004 as a +result of the Reorganisation are as follows: + +Assets and liabilities: + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Current assets + + + + + + 1,980 + + + + 1,996 + + + + 2,637 + + + + 1,915 + + + + + Fixed assets, net + + + + + + + + + + + + + + + + + + + + + + + + Land and buildings + + + + + + 9,246 + + + + 9,650 + + + + 10,276 + + + + 10,169 + + + + + + Telecommunications networks + and equipment + + + + + + 2,689 + + + + 2,781 + + + + 7,089 + + + + 6,760 + + + + + + Furniture, fixtures, motor + vehicles and other + equipment + + + + + + 111 + + + + 141 + + + + 216 + + + + 251 + + + + + + 12,046 + + + + 12,572 + + + + 17,581 + + + + 17,180 + + + + + Construction in progress + + + + + + 1,400 + + + + 3,174 + + + + 2,057 + + + + 1,401 + + + + + Interest in associated companies and long-term + investments + + + + + + 217 + + + + 970 + + + + 970 + + + + 969 + + + + + Other non-current assets + + + + + + 145 + + + + 325 + + + + 396 + + + + 281 + + + + + Current liabilities + + + + + + (2,693 + ) + + + (5,492 + ) + + + (7,618 + ) + + + (5,830 + ) + + + + Non-current loans and other borrowings + + + + + + (4,224 + ) + + + (5,044 + ) + + + (4,979 + ) + + + (5,153 + ) + + + + Other non-current liabilities + + + + + + (207 + ) + + + (28 + ) + + + (4,833 + ) + + + (4,716 + ) + + + + + + + + + + + + + + + + + + + + + + Net assets + + + + + + 8,664 + + + + 8,473 + + + + 6,211 + + + + 6,047 + + + + + + + + + + + + + + + + + + + + +F-10 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +The results of the PRC operations of CNC China +that were subsequently retained by China Netcom Group upon +Reorganisation but are included in the consolidated income +statements throughout the three years ended December 31, +2003 and six months ended June 30, 2003 and 2004 are +summarized as follows: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months ended + + + + Years Ended December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + + + Revenues + + + + + + 103 + + + + 433 + + + + 802 + + + + 368 + + + + 479 + + + + + + + + + + + + + + + + + + + + + + + + + + + Operating expenses, mainly comprising: + + + + + + + + + + + + + + + + + + + + + + + + + + + + Depreciation and amortisation + + + + + + (103 + ) + + + (157 + ) + + + (240 + ) + + + (92 + ) + + + (276 + ) + + + + + Networks, operations and support + + + + + + (49 + ) + + + (283 + ) + + + (409 + ) + + + (147 + ) + + + (272 + ) + + + + + Staff costs + + + + + + (46 + ) + + + (112 + ) + + + (65 + ) + + + (60 + ) + + + (64 + ) + + + + + Selling, general and administrative + + + + + + (123 + ) + + + (188 + ) + + + (257 + ) + + + (130 + ) + + + (138 + ) + + + + + Other operating (expenses)/income + + + + + + (10 + ) + + + (52 + ) + + + (71 + ) + + + (15 + ) + + + 28 + + + + + Finance costs + + + + + + (120 + ) + + + (342 + ) + + + (496 + ) + + + (247 + ) + + + (248 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + Loss for the year/period + + + + + + (293 + ) + + + (703 + ) + + + (740 + ) + + + (322 + ) + + + (486 + ) + + + + + + + + + + + + + + + + + + + + + + + + +The directors believe that all historical costs +of operations of the Restructured Businesses have been reflected +in the consolidated financial statements. Expenses that were +specifically attributed to the Restructured Businesses, which +were mainly corporate headquarters administrative expenses +provided to the Restructured Businesses by China Netcom Group +since the establishment of China Netcom Group in 2002, were +allocated based on the revenues of entities within the China +Netcom Group. The amount of corporate administrative expenses +allocated to the Group for the years ended December 31, +2002 and 2003 and six months ended June 30, 2003 and 2004 +amounted to RMB344 million, RMB448 million, +RMB173 million and RMB142 million, respectively. The +directors consider that the method of allocation of corporate +administrative expenses presents a reasonable basis of +estimating what the Group s expenses would have been on a +stand-alone basis in the periods presented. + + +The consolidated financial information has been +prepared in Renminbi ( RMB ), the national currency of +the PRC. Solely for the convenience of the reader, the +consolidated financial statements for the year ended +December 31, 2003 and six months ended June 30, 2004 +have been translated into United States dollars at the noon +buying rate in New York City on June 30, 2004 for capable +transfers in Renminbi as certified for customs purposes by the +Federal Reserve Bank of New York of US$1.00 = RMB8.2766. No +representation is made that the Renminbi amounts could have +been, or could be, converted into United States dollars at those +rates or at any other certain rate, on each of December 31, +2003 and June 30, 2004 or at any other dates. + +3. Principal +accounting policies + + +The consolidated financial statements set out in +this report have been prepared in accordance with Hong Kong +Financial Reporting Standards ( HKFRS ) issued by the +Hong Kong Institute of Certified Public Accountants +( HKICPA ). They have been prepared under the +historical cost convention modified by the revaluation of +certain fixed assets and the marking to fair values of certain +investments as explained in the accounting policies below, and +on a going concern basis. + + +A significant percentage of the Group s +funding requirements is through short term borrowings. +Consequently, the balance sheet indicates a significant working +capital deficit. In the past, a substantial portion of the +Group s short term borrowings have been rolled over upon +maturity. Based on the Group s history of obtaining +finance, its relationships with its bankers and operating +performance, the directors + +F-11 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +consider that the Group will continue to be able +to roll over such short term financing, or will be able to +obtain sufficient alternative sources of financing to enable it +to operate and meet its liabilities as and when they fall due. + + +The principal accounting policies adopted in the +consolidated financial statements are set out below: + +(a) Basis of +consolidation + + +As set out in Note 2 above, the +Reorganisation involving the injection of businesses from the +Group s ultimate holding company, as a result of the +Reorganisation, is accounted for using merger accounting. The +results and financial position of businesses consolidated under +the Reorganisation are included in the consolidated financial +statements as if the businesses were acquired at the beginning +of the earliest period presented or the date that such +businesses were acquired by the Group or China Netcom Group +whichever is later. + + +Acquisitions of subsidiaries from third parties +are accounted for using purchase accounting. The results and +financial positions of such subsidiaries acquired or disposed of +during the year/period are included in the consolidated income +statements from the effective date of acquisition or up to the +effective date of disposal, as appropriate. + + +All significant intercompany transactions and +balances within the Group are eliminated on consolidation. + + +Minority interests represent the interests of +outside shareholders in the operating results and net assets of +subsidiaries. + +(b) Subsidiaries + + +Subsidiaries are those entities in which the +Company, directly or indirectly, controls the composition of the +board of directors, controls more than half the voting power, or +holds more than half of the issued share capital. + +(c) Jointly controlled +entities + + +A jointly controlled entity is a joint venture +which involves the establishment of a corporation, partnership +or other entity in which each venturer has an interest. A joint +venture is a contractual arrangement whereby the Group and other +parties undertake an economic activity which is subject to joint +control and none of the participating parties has unilateral +control over the economic activity. A jointly controlled entity +controls the assets of the joint venture, incurs liabilities and +expenses and earns income. It may enter into contracts in its +own name and raise finance for the purposes of the joint venture +activity. Each venturer is entitled to a share of the results of +the jointly controlled entity under the equity method of +accounting. + + +The consolidated income statements include the +Group s share of the results of jointly controlled entities +under the equity method of accounting. + +(d) Associated companies + + +An associated company is a company, not being a +subsidiary or a jointly controlled entity, in which an equity +interest is held for the long-term and significant influence is +exercised in its management. + + +The consolidated income statements include the +Group s share of the results of associated companies for +the year/period, and the consolidated balance sheets include the +Group s share of the net assets of the associated companies +and unamortised goodwill (net of accumulated amortisation) on +acquisition. + +F-12 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +Equity accounting is discontinued when the +carrying amount of the investment in an associated company +reaches zero, unless the Group has incurred obligations or +guaranteed obligations in respect of the associated company. + +(e) Revenue recognition + + + + + + + (i) + + The Group s revenues are recognised as + follows: + + + + + + + + + + Revenues derived from local, domestic long + distance ( DLD ) and international long distance + ( ILD ) telephone usage, which vary depending on the + day, the time of day, the distance and duration of the call and + the tariffs, are recognised when the services are provided to + customers. + + + + + + + + Upfront connection and installation fees received + are deferred and recognised over the expected customer + relationship period of 10 years. With effect from July 1, + 2001, no further upfront fees for connection were charged to + customers. + + + + + + + + Monthly telephone service fees are recognised in + the month during which the telephone services are provided to + customers. + + + + + + + + Revenues from the sale of prepaid calling cards + are deferred and recognised as the cards are used by customers. + + + + + + + + Revenues from PHS bundled service contracts are + recognized into local, DLD, ILD service fees according to the + usage and on a systematic basis to match the pattern of the + usage of the PHS services by customers. PHS bundled service + contracts comprising provisions of PHS services and handsets to + customers, under which customers either prepay a certain amount + of service fee or commit to spend a minimum monthly service fee + for a designated period in order to receive a free handset. + + + + + + + + Revenues from value-added communication services + such as call waiting, call diverting and caller number display + are recognised when the services are provided to customers. + + + + + + + + Revenues from the provision of broadband and + other Internet-related services and managed data services are + recognised when the services are provided to customers. + + + + + + + + Interconnection fees from domestic and foreign + telecommunications operators are recognised when the services + are rendered as measured by the minutes of traffic processed. + + + + + + + + Lease income from the leasing of lines and + customer-end equipment is recognised over the term of the lease. + Lease income from other domestic telecommunications operators + and business customers for the usage of the Group s fixed + line telecommunications networks is measured by the number of + lines leased and the agreed upon rate per line leased. The lease + arrangements are primarily determined on a year to year basis. + + + + + + + + (ii) + + Interest income + + + + Interest income is recognised on a time +proportion basis, taking into account the principal amounts +outstanding and the interest rates applicable. + + + + + + + (iii) + + Dividend income + + + + Dividend income is recognised when the right to +receive payment is established. + +F-13 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +(f) Interest expenses + + +Interest expenses that are attributable to the +acquisition, construction or production of an asset that +necessarily takes a substantial period of time to get ready for +its intended use or sale are capitalised as part of the cost of +that asset. + + +All other interest expenses are charged to the +consolidated income statement in the year/period in which they +are incurred. + +(g) Interconnection +charges + + +Interconnection charges represent amounts +incurred for the use of other telecommunications operators +networks for facilitating the completion of calls that originate +from the Group s fixed line telecommunications networks. +Interconnection charges are recognised on an accrual basis. For +interconnection charges with domestic operators, they are +accrued based on actual amount, while those with overseas +operators are accrued based on the Group s estimates. + +(h) Translation of foreign +currencies + + +Transactions in foreign currencies are translated +at exchange rates ruling at the transaction dates. Monetary +assets and liabilities expressed in foreign currencies at the +balance sheet dates are translated at rates of exchange ruling +at the balance sheet date. Exchange differences arising in these +cases are dealt with in the consolidated income statements. + + +The balance sheets of subsidiaries and associated +companies expressed in foreign currencies are translated at the +rates of exchange ruling at the balance sheet dates and the +respective income statements accounts are translated at the +average exchange rates for the year/period. Exchange differences +are dealt with as a movement in reserves. + +(i) Cash and cash +equivalents + + +Cash and cash equivalents, comprising cash on +hand, deposits held at call with banks and cash investments with +original maturities of three months or less are carried at cost. + +(j) Accounts receivable + + +Accounts receivable are carried at original +amounts less provisions for doubtful debts. The provision for +doubtful debts is recorded if there is objective evidence that +the Group will not be able to collect all amounts due according +to the original term of the accounts receivable. + +(k) Inventories and +consumables + + +Inventories comprise mainly telephone handsets +and are stated at the lower of cost and net realisable value on +a first-in, first-out basis, after provisions for obsolescence. + + +Consumables consist of materials and supplies +used in maintaining the Group s telecommunication networks +and are charged to the income statement when brought into use. +Consumables are valued at cost less any provision for +obsolescence. + +(l) Fixed assets + + + + + + + + + (i) Construction-in-progress + + +Construction-in-progress represents buildings, +telecommunications network plant, transmission and switching +equipment under construction and pending installation, and is +stated at cost less impairment losses. + +F-14 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +Cost comprises direct costs of construction +including borrowing costs attributable to the construction +during the period of construction. When the asset being +constructed becomes available for use, the +construction-in-progress is transferred to the appropriate +category of fixed assets. + + + + + + + + + (ii) Other fixed assets + + +Fixed assets are initially stated at cost less +accumulated depreciation and accumulated impairment losses. +Major costs incurred in restoring fixed assets to their normal +working condition are charged to the income statements as +incurred. Improvements are capitalised and depreciated over +their expected useful lives. + + +Land and buildings subsequent to initial +recognition are stated at cost less accumulated impairment +losses and depreciated over their expected useful lives. + + +Subsequent to the revaluation carried out as at +December 31, 2003, which was based on depreciated +replacement costs (Note 15), fixed assets other than land +and buildings are carried at their revalued amounts, being the +fair values at the date of revaluation, less subsequent +accumulated depreciation and impairment losses. When an item of +fixed asset is revalued, any accumulated depreciation at the +date of the revaluation is restated proportionately together +with the change in the gross carrying amount of the asset so +that the carrying amount of the asset after revaluation equals +its revalued amount. + + + + + + + + + (iii) Revaluations + + +Revaluations will be performed at intervals of +not more than three years by independent valuers; in each of the +intervening years valuations will be undertaken by executives of +the Group. Increases in valuation are credited to the +revaluation reserve. Decreases in valuation are first set off +against revaluation surplus on earlier valuations in respect of +the same item and thereafter are debited to operating profit. +Any subsequent increases are credited to operating profit up to +the amount previously debited. + + + + + + + + + (iv) Depreciation + + +Fixed assets are depreciated at rates sufficient +to write off their costs or revalued amounts less accumulated +impairment losses and estimated residual values over their +estimated useful lives on a straight-line basis. The principal +useful lives are as follows: + + + + + + + + + + Land + + + + + + 10-50 years + + + + + Buildings + + + + + + 8-30 years + + + + + Telecommunication network and equipment + + + + + + 5-10 years + + + + + Furniture, fixtures, motor vehicles and other + equipment + + + + + + 5-10 years + + + +The useful lives are reviewed periodically to +ensure that the methods and rates of depreciation are consistent +with the expected pattern of economic benefits from fixed assets. + + + + + + + + + (v) Gain or loss on sale of fixed + assets + + +The gain or loss on disposal of a fixed asset is +the difference between the net sales proceeds and the carrying +amount of the relevant asset, and is recognised in the income +statement, except where the fixed asset is carried at valuation, +the relevant portion of the revaluation reserve realised in +respect of previous valuations is transferred to retained +earnings and is shown as a movement in reserves. + +(m) Impairment of assets + + +At each balance sheet date, both internal and +external sources of information are considered to assess whether +there is any indication that assets are impaired. If any such +indication exists, the recoverable amount + +F-15 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +of the asset is estimated and where relevant, an +impairment loss is recognised to reduce the asset to its +recoverable amount. Estimated recoverable amounts are determined +based on estimated discounted future cash flows of the +cash-generating unit at the lowest level to which the asset +belongs. The recoverable amount is the higher of value in use or +net selling price. Such impairment losses are recognised in the +income statement except where the asset is carried at valuation +and the impairment loss does not exceed the revaluation surplus +for that same asset, in which case the impairment loss is +treated as a revaluation decrease and charged to the revaluation +surplus. + +(n) Assets under leases + + + + + + + + + (i) Finance leases + + +Leases that substantially transfer to the Group +all of the risks and rewards of ownership of assets are +accounted for as finance leases. Finance leases are capitalised +at the inception of the lease at the lower of the fair value of +the leased assets or the present value of the minimum lease +payments. Each lease payment is allocated between the capital +and finance charges so as to achieve a constant rate on the +capital balances outstanding. The corresponding rental +obligations, net of finance charges, are included in long-term +liabilities. The finance charges are charged to the income +statement over the lease periods. + + +Assets held under finance leases are depreciated +over the shorter of their estimated useful lives or the lease +periods. + + + + + + + + + (ii) Operating leases + + +Leases where substantially all of the risks and +rewards of ownership of the assets remain with the leasing +company are accounted for as operating leases. Payments made +under operating leases net of any incentives received from the +leasing company are charged to the income statement on a +straight-line basis over the lease periods. + +(o) Intangible assets + + + + + + + + + (i) Goodwill + + +Goodwill represents the excess of the cost of an +acquisition over the fair value of the Group s share of the +net assets of the acquired subsidiary, jointly controlled entity +or associated company, at the date of acquisition. + + +Goodwill on acquisitions is included in +intangible assets and is amortised using the straight-line +method over its estimated useful life of not more than +20 years. + + + + + + + + + (ii) Negative goodwill + + +Negative goodwill represents the excess of the +fair value of the Group s share of the net assets acquired +over the cost of acquisition. Negative goodwill is presented in +the same balance sheet classification as goodwill. Negative +goodwill, not exceeding the fair values of the non-monetary +assets acquired, is recognised in the income statement over the +remaining weighted average useful life of those assets; negative +goodwill in excess of the fair values of those non-monetary +assets is recognised in the income statement immediately. + + + + + + + + + (iii) Purchased software + + +Expenditure on purchased software is capitalised +and amortised using the straight-line method over the expected +useful lives of the software, which vary from three to five +years. + +F-16 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +(p) Investments + + + + + + + + + (i) Long-term investments + + +Long-term investments comprise unlisted +investment securities that are held for long term purposes. Such +investments are stated at cost less any provision for impairment +losses. When a decline that is other than temporary has +occurred, the carrying amount of such investment will be reduced +to its fair value. The carrying amounts of individual +investments are reviewed at each balance sheet date to assess +whether the fair values have declined below the carrying +amounts. The impairment loss is recognised as an expense in the +income statement. This impairment loss is written back to the +income statement when the circumstances and events that led to +the write-downs or write-offs cease to exist and there is +persuasive evidence that the new circumstances and events will +persist for the foreseeable future. + + + + + + + + + (ii) Short-term investments + + +Short-term investments comprise listed securities +held for trading purposes are carried at fair value. At each +balance sheet date, the net unrealised gains or losses arising +from the changes in fair value of short-term investments are +recognised in the income statement. Profits or losses on +disposal of short-term investments, representing the difference +between the net sales proceeds and the carrying amounts, are +recognised in the income statement as they arise. + +(q) Provisions + + +Provisions are recognised when the Group has a +present legal or constructive obligation as a result of past +events, it is probable that an outflow of resources will be +required to settle the obligation, and a reliable estimate of +the amount can be made. Where the Group expects a provision to +be reimbursed, the reimbursement is recognised as a separate +asset but only when the reimbursement is virtually certain. + +(r) Employee benefits + + + + + + + + + (i) Pension obligations + + +The Group makes voluntary payments and +contribution on a monthly basis according to various defined +contribution retirement benefit plans organised by relevant +municipal provincial Governments in the PRC. The Group has no +further obligations for post-retirement benefits beyond these +payments as they fall due. Payments made under these plans are +expensed as incurred. + + + + + + + + + (ii) Early retirement benefits + + +Early retirement benefits are recognised as +expenses when the Group reaches agreements with the relevant +employees for early retirement. + + + + + + + + + (iii) Employee housing benefits + + +Certain staff quarters have been sold to +employees, based on a number of eligibility requirements, at +preferential prices. When staff quarters are identified by +management as being intended for sale, the carrying value of the +staff quarters is written down to the net recoverable amount. +Upon the sale, any difference between sales proceeds and the +carrying amount of the staff quarters is charged to the +consolidated income statement. + + +One-off cash housing subsidies paid to employees +are charged to the consolidated income statement in the year in +which it is determined that the payment of such subsidies is +probable and the amounts can be reasonably estimated (see +Note 26(a)). + +F-17 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +Full-time employees of the Group participate in +various government-sponsored housing funds. The Group +contributes on a monthly basis to these funds based on certain +percentages of the salaries of the employees. The Group s +liability in respect of these funds is limited to the +contributions payable in each period. Contributions to these +housing funds are expensed as incurred. + + + + + + + + + (iv) Share subscription scheme + + +The Company has adopted a share subscription +scheme whereby the Company, at its discretion and subject to the +approval of the Board of Directors, may issue and allot new +shares to the directors or employees of the Group at specified +prices, which may be below fair market value. No charge is +recognised in the income statement in respect of the excess of +the fair market value of shares issued over the net proceeds. +The excess, if any, of the proceeds of shares issued over the +nominal value is credited to the share premium account and +included in other reserves. + +(s) Deferred taxation + + +Deferred taxation is provided in full, using the +liability method, on temporary differences arising between the +tax bases of assets and liabilities and their carrying amounts +in the financial statements. Taxation rates enacted or +substantively enacted at the balance sheet date are used to +determine deferred taxation. Deferred tax assets are recognised +to the extent that it is probable that future taxable profit +will be available against which the temporary differences can be +utilised. + +(t) Deferred costs + + + + + + + + + (i) Deferred installation costs + + +The direct incremental costs associated with the +installation of fixed line services are deferred and amortised +to the income statement over the expected customer relationship +period of 10 years except when the direct incremental costs +exceed the corresponding upfront connection and installation +fees. In such cases, the excess of the direct incremental costs +over the installation fees are recorded immediately as expenses +in the income statement. + + + + + + + + + (ii) Customer acquisition costs + + +The cost of handsets given to customers under +bundled service contracts and related commissions paid to +distributors are deferred as customer acquisition costs and +amortised to the income statement on a systematic basis to match +with the pattern of the customer service income over the +contract period. + + + + + + + + + (iii) Prepaid network + capacities + + +Prepayments for the network capacities purchased +on an indefeasible rights to use ( IRU ) basis are +capitalised and amortised over the corresponding lease period. + + + + + + + + + (iv) Discount on foreign currency + exchange forward contracts + + +The unamortised portion of the discount on +foreign currency exchange forward contracts (see Note(w)) is +recognised as deferred cost. + +(u) Contingent +liabilities + + +A contingent liability is a possible obligation +that arises from past events and whose existence will only be +confirmed by the occurrence or non-occurrence of one or more +uncertain future events not wholly within the control of the +Group. It can also be a present obligation arising from past +events that is not recognised + +F-18 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +because it is not probable that outflow of +economic resources will be required or the amount of obligation +cannot be measured reliably. + + +A contingent liability is not recognised but is +disclosed in the notes to the accounts. When a change in the +probability of an outflow occurs so that the outflow is +probable, the contingent liability will then be recognised as a +provision. + + +A contingent asset is a possible asset that +arises from past events and whose existence will be confirmed +only by the occurrence or non-occurrence of one or more +uncertain events not wholly within the control of the Group. + +(v) Segmental reporting + + +Business segments provide services that are +subject to risks and returns that are different from other +business segments. Geographical segments provide services within +a particular economic environment that is subject to risks and +returns that differ from those of components operating in other +economic environments. For the three years ended +December 31, 2003 and the six months ended June 30, +2003 and 2004, the Group has one business segment, the provision +of fixed line telecommunications services. Less than 10% of the +Group s assets and operations are located outside the PRC. +Accordingly, no business and geographical segment information is +presented. + +(w) Foreign currency exchange forward +contracts + + +A foreign currency exchange forward contract is +an agreement to exchange different currencies at a specified +future date and at a specified rate. A non-speculative foreign +currency exchange forward contract is one which is designated +and effective as a hedge of a net investment in a foreign +entity, of a foreign currency asset, or of a net monetary asset +or liability. All other foreign currency exchange forward +contracts, or parts of foreign currency exchange forward +contracts in excess of the amount hedged, are speculative. + + +Where a foreign currency exchange forward +contract is non-speculative and used as a hedge of a net +monetary asset or liability, the gain or loss on the contract, +being the foreign currency amount of the contract multiplied by +the difference between the spot rate at the balance sheet date +and the spot rate at the date of inception of the contract or at +an intervening balance sheet date, is taken to the income +statements. The discount or premium on the contract, being the +foreign currency amount of the contract multiplied by the +difference between the contracted forward rate and the spot rate +at the date of inception of the contract, is amortised over the +period of the contract. In the balance sheet, unamortised +discounts are recorded within deferred costs and unamortised +premiums are recorded within deferred revenues. + + +Where a foreign currency exchange forward +contract is speculative, the gain or loss, being the foreign +currency amount of the contract multiplied by the difference +between the forward rate for the balance of the contract at the +balance sheet date and either the contracted forward rate or the +forward rate used at an intervening balance sheet date, is +credited or charged to the income statements at each intervening +balance sheet date. + +F-19 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +4. Revenues + + +Revenues represent the turnover of the Group and +are derived from the provision of fixed line telecommunications +and related services, net of the PRC business taxes and +government levies. The Group s revenues by business nature +can be summarised as follows: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months ended + + + + Years Ended December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + + + Revenues + + + + + + + + + + + + + + + + + + + + + + + + + + Local usage fees + + + + + + 16,367 + + + + 17,362 + + + + 18,567 + + + + 9,189 + + + + 9,443 + + + + + Monthly telephone service + + + + + + 9,610 + + + + 11,505 + + + + 12,580 + + + + 6,107 + + + + 6,936 + + + + + Upfront installation fees + + + + + + 806 + + + + 944 + + + + 1,044 + + + + 531 + + + + 641 + + + + + DLD usage fees + + + + + + 7,459 + + + + 8,423 + + + + 8,871 + + + + 4,291 + + + + 4,509 + + + + + ILD usage fees + + + + + + 1,141 + + + + 1,344 + + + + 1,410 + + + + 752 + + + + 734 + + + + + Value-added services + + + + + + 476 + + + + 863 + + + + 1,516 + + + + 644 + + + + 1,019 + + + + + Interconnection fees + + + + + + 2,361 + + + + 2,896 + + + + 3,797 + + + + 1,753 + + + + 2,223 + + + + + Upfront connection fees + + + + + + 4,460 + + + + 4,316 + + + + 3,965 + + + + 2,046 + + + + 1,774 + + + + + Broadband and other Internet-related service + + + + + + 1,384 + + + + 2,190 + + + + 3,507 + + + + 1,622 + + + + 2,599 + + + + + Managed data service + + + + + + 1,057 + + + + 1,178 + + + + 1,279 + + + + 628 + + + + 681 + + + + + Leased line income + + + + + + 1,935 + + + + 2,231 + + + + 2,509 + + + + 1,136 + + + + 1,264 + + + + + Other services + + + + + + 1,576 + + + + 1,191 + + + + 853 + + + + 363 + + + + 675 + + + + + + + + + + + + + + + + + + + + + + + + + + + Total + + + + + + 48,632 + + + + 54,443 + + + + 59,898 + + + + 29,062 + + + + 32,498 + + + + + + + + + + + + + + + + + + + + + + + + +F-20 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +The Group s revenues by geographical +location of the customers can be summarised as follows: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months ended + + + + Years ended December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + + + + + + + RMB + + RMB + + + + RMB + + RMB + + RMB + + million + + million + + + + million + + million + + million + + + + + + + + Domestic telecommunications services + + + + + + + + + + + + + + + + + + + + + + + + + + (Being revenues generated from customers + located in the PRC) + + + + + + + + + + + + + + + + + + + + + + + + + + Local usage fees + + + + + + 16,367 + + + + 17,362 + + + + 18,567 + + + + 9,189 + + + + 9,443 + + + + + Monthly telephone service + + + + + + 9,610 + + + + 11,505 + + + + 12,580 + + + + 6,107 + + + + 6,936 + + + + + Upfront installation fees + + + + + + 806 + + + + 944 + + + + 1,044 + + + + 531 + + + + 641 + + + + + DLD usage fees + + + + + + 7,459 + + + + 8,423 + + + + 8,871 + + + + 4,291 + + + + 4,509 + + + + + ILD usage fees + + + + + + 1,141 + + + + 1,344 + + + + 1,410 + + + + 752 + + + + 673 + + + + + Value-added services + + + + + + 476 + + + + 863 + + + + 1,516 + + + + 644 + + + + 1,019 + + + + + Interconnection fees + + + + + + 2,226 + + + + 2,378 + + + + 2,580 + + + + 1,208 + + + + 1,719 + + + + + Upfront connection fees + + + + + + 4,460 + + + + 4,316 + + + + 3,965 + + + + 2,046 + + + + 1,774 + + + + + Broadband and other Internet-related service + + + + + + 1,384 + + + + 2,189 + + + + 3,493 + + + + 1,619 + + + + 2,428 + + + + + Managed data service + + + + + + 1,057 + + + + 1,177 + + + + 1,215 + + + + 614 + + + + 546 + + + + + Leased line income + + + + + + 1,929 + + + + 2,196 + + + + 2,446 + + + + 1,110 + + + + 1,021 + + + + + Other services + + + + + + 1,539 + + + + 1,174 + + + + 832 + + + + 350 + + + + 514 + + + + + + + + + + + + + + + + + + + + + + + + + + + Subtotal + + + + + + 48,454 + + + + 53,871 + + + + 58,519 + + + + 28,461 + + + + 31,223 + + + + + + + + + + + + + + + + + + + + + + + + + + + International telecommunications + services + + + + + + + + + + + + + + + + + + + + + + + + + (Being revenues generated from customers + located outside the PRC, including Hong Kong, Macau Special + Administrative Region and Taiwan) + + + + + + + + + + + + + + + + + + + + + + + + Interconnection fees + + + + + + 135 + + + + 518 + + + + 1,217 + + + + 545 + + + + 565 + + + + + Broadband and other Internet-related service + + + + + + + + + + 1 + + + + 14 + + + + 3 + + + + 171 + + + + + Managed data service + + + + + + + + + + 1 + + + + 64 + + + + 14 + + + + 135 + + + + + Leased line income + + + + + + 6 + + + + 35 + + + + 63 + + + + 26 + + + + 243 + + + + + Other services + + + + + + 37 + + + + 17 + + + + 21 + + + + 13 + + + + 161 + + + + + + + + + + + + + + + + + + + + + + + + + + + Subtotal + + + + + + 178 + + + + 572 + + + + 1,379 + + + + 601 + + + + 1,275 + + + + + + + + + + + + + + + + + + + + + + + + + + + Total + + + + + + 48,632 + + + + 54,443 + + + + 59,898 + + + + 29,062 + + + + 32,498 + + + + + + + + + + + + + + + + + + + + + + + + +F-21 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +5. Profit/(loss) +from operations + + +Profit/(loss) from operations is stated after +charging and crediting the following: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months ended + + + + Years ended December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + + + Charging + + + + + + + + + + + + + + + + + + + + + + + + + + Deficit on revaluation of certain fixed assets + (Note 15(c)) + + + + + + + + + + + + + + 25,778 + + + + + + + + + + + + + Depreciation: + + + + + + + + + + + + + + + + + + + + + + + + + + + + Owned fixed assets + + + + + + 15,955 + + + + 18,622 + + + + 20,298 + + + + 9,913 + + + + 9,411 + + + + + + Leased fixed assets + + + + + + 140 + + + + 124 + + + + 86 + + + + 18 + + + + 91 + + + + + Loss on disposal of fixed assets (included in + networks operations and support expenses) + + + + + + 1,311 + + + + 1,686 + + + + 1,689 + + + + 495 + + + + 80 + + + + + Amortisation of intangible assets (Note 17) + + + + + + 58 + + + + 62 + + + + 99 + + + + 36 + + + + 50 + + + + + Contributions to pension plans (included in staff + costs) + + + + + + 476 + + + + 622 + + + + 790 + + + + 337 + + + + 418 + + + + + Early retirement benefits (included in staff + costs) + + + + + + 131 + + + + 758 + + + + 132 + + + + 28 + + + + 206 + + + + + Cost of inventories + + + + + + 316 + + + + 414 + + + + 327 + + + + 181 + + + + 180 + + + + + Operating leases: + + + + + + + + + + + + + + + + + + + + + + + + + + + + Land and buildings + + + + + + 107 + + + + 130 + + + + 117 + + + + 74 + + + + 108 + + + + + + Networks and machinery + + + + + + 200 + + + + 689 + + + + 630 + + + + 396 + + + + 720 + + + + + Interconnection charges + + + + + + 898 + + + + 1,129 + + + + 1,874 + + + + 714 + + + + 917 + + + + + Bad debt expense + + + + + + 331 + + + + 357 + + + + 619 + + + + 363 + + + + 478 + + + + + Unrealised loss on short-term investment + + + + + + + + + + + + + + + + + + + + + + 7 + + + + + Unrealised foreign exchange losses + + + + + + + + + + 2 + + + + 142 + + + + + + + + 15 + + + + + + + + + + + + + + + + + + + + + + + + + + + Crediting + + + + + + + + + + + + + + + + + + + + + + + + + + Realised gain on disposal of short-term + investments + + + + + + 5 + + + + 28 + + + + 1 + + + + 1 + + + + + + + + + Unrealised gain on short-term investments + + + + + + 12 + + + + 2 + + + + 7 + + + + 7 + + + + + + + + + Unrealised foreign exchange gains + + + + + + 61 + + + + + + + + + + + + 35 + + + + + + + + + + + + + + + + + + + + + + + + + + + + +F-22 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +6. Finance +costs + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Years ended December 31, + + Six months ended June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + + + Interest expenses on + + + + + + + + + + + + + + + + + + + + + + + + + + + + Bank and other loans wholly + repayable within five years + + + + + + 3,046 + + + + 3,493 + + + + 3,340 + + + + 1,738 + + + + 1,814 + + + + + + Bank and other loans not wholly + repayable within five years + + + + + + 159 + + + + 212 + + + + 125 + + + + 65 + + + + 42 + + + + + + + + + + + + + + + + + + + + + + + + + + + + 3,205 + + + + 3,705 + + + + 3,465 + + + + 1,803 + + + + 1,856 + + + + + Less: Interest expenses capitalised in + construction-in-progress + + + + + + (1,218 + ) + + + (905 + ) + + + (621 + ) + + + (313 + ) + + + (258 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + 1,987 + + + + 2,800 + + + + 2,844 + + + + 1,490 + + + + 1,598 + + + + + Exchange (gain)/loss, net + + + + + + (61 + ) + + + 2 + + + + 142 + + + + 35 + + + + (15 + ) + + + + Bank charges + + + + + + 22 + + + + 21 + + + + 20 + + + + 12 + + + + 12 + + + + + Amortisation of discount on foreign currency + exchange forward contracts + + + + + + 31 + + + + 25 + + + + 20 + + + + 11 + + + + 9 + + + + + + + + + + + + + + + + + + + + + + + + + + + + 1,979 + + + + 2,848 + + + + 3,026 + + + + 1,548 + + + + 1,604 + + + + + + + + + + + + + + + + + + + + + + + + + + + Interest expenses were capitalised in + construction in progress using the following annual interest + rates + + + + + + 4.03%-5.99% + + + + 3.85%-5.86% + + + + 3.68%-5.51% + + + + 3.74%-5.72% + + + + 3.65%-5.45% + + + + + + + + + + + + + + + + + + + + + + + + +7. Taxation + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months + + + + Years ended December 31, + + ended June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + + + PRC enterprise income tax ( EIT ) + + + + + + 1,578 + + + + 1,454 + + + + 940 + + + + 1,293 + + + + 1,389 + + + + + Deferred taxation (Note 27) + + + + + + 990 + + + + 758 + + + + (7,775 + ) + + + 69 + + + + 732 + + + + + Share of taxation attributable to jointly + controlled entity + + + + + + + + + + + + + + 16 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Taxation charges/(credit) + + + + + + 2,568 + + + + 2,212 + + + + (6,819 + ) + + + 1,362 + + + + 2,121 + + + + + + + + + + + + + + + + + + + + + + + + + +The provision for EIT is calculated based on the +statutory income tax rate of 33% on the assessable profit of +each of the entities now comprising the Group in the PRC as +determined in accordance with the relevant income tax rules and +regulations for the years ended December 31, 2001, 2002 and +2003 and for the six months ended June 30, 2003 and 2004. + + +Taxation on profits derived from certain +subsidiaries and the jointly controlled entity outside the PRC +has been calculated on the estimated assessable profit for the +three years ended December 31, 2003 and for the six months +ended June 30, 2003 and 2004 at the rates of taxation +ranging from 17.5% to 30%, prevailing in the countries in which +those entities operates. + +F-23 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +Hong Kong profits tax has not been provided for +as there is no assessable profit derived in Hong Kong for the +periods presented. + + +The reconciliation between the Group s +actual tax charge/(credit) and the amount which is calculated +based on the weighted average statutory tax rate is as follows: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months ended + + + + Years ended December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + + + Profit/(loss) before taxation + + + + + + 9,967 + + + + 8,732 + + + + (17,931 + ) + + + 5,634 + + + + 6,996 + + + + + + + + + + + + + + + + + + + + + + + + + + + Weighted average statutory tax rate + + + + + + 33.0 + % + + + 33.0 + % + + + 33.0 + % + + + 33.0 + % + + + 33.0 + % + + + + Tax calculated at the weighted average statutory + tax rate + + + + + + 3,289 + + + + 2,882 + + + + (5,917 + ) + + + 1,859 + + + + 2,309 + + + + + Non-taxable income (Note below) + + + + + + (1,472 + ) + + + (1,424 + ) + + + (1,309 + ) + + + (677 + ) + + + (587 + ) + + + + Expenses not deductible for tax purposes + + + + + + 320 + + + + 255 + + + + 207 + + + + 185 + + + + 112 + + + + + Tax losses not recognised/(utilized) + + + + + + 291 + + + + 463 + + + + 246 + + + + (27 + ) + + + 231 + + + + + Others + + + + + + 140 + + + + 36 + + + + (46 + ) + + + 22 + + + + 56 + + + + + + + + + + + + + + + + + + + + + + + + + + + Tax charge/(credit) + + + + + + 2,568 + + + + 2,212 + + + + (6,819 + ) + + + 1,362 + + + + 2,121 + + + + + + + + + + + + + + + + + + + + + + + + + +Note: Non-taxable income comprises primarily +upfront connection fees charged to customers and amortised +during the year/period. + +8. Profit +distributions + + +No dividend was declared by the Company during +the three years ended December 31, 2003 and the six months +ended June 30, 2004. + +9. Earnings/(loss) +per share + + +Basic earnings/(loss) per share is computed using +the weighted average number of the ordinary shares outstanding +during the year/period. Diluted earnings/(loss) per share is +computed using the weighted average number of ordinary shares +and potential ordinary shares outstanding during the year/period. + +F-24 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +The following table sets forth the computation of +basic and diluted earnings/(losses) per share for the +year/periods indicated: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Years ended December 31, + + Six months ended June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + + + + + (in RMB millions, except share and per share data) + + + + Numerator: + + + + + + + + + + + + + + + + + + + + + + + + + + + + Profit (loss) for the year/period + + + + + + 7,400 + + + + 6,520 + + + + (11,111 + ) + + + 4,272 + + + + 4,875 + + + + + Denominator: + + + + + + + + + + + + + + + + + + + + + + + + + + + + Weighted average number of ordinary shares + outstanding and shares used in computing basic earnings/(loss) + per share + + + + + + 5,492,091,643 + + + + 5,492,258,218 + + + + 5,492,258,218 + + + + 5,492,258,218 + + + + 5,492,258,218 + + + + + + Weighted average number of potential ordinary + shares: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Convertible preference shares + + + + + + 6,935,788 + + + + 7,741,782 + + + + + + + + 7,741,782 + + + + 7,741,782 + + + + + + + + + + + + + + + + + + + + + + + + + + + + Shares used in computing diluted + earnings/(losses) per share + + + + + + 5,499,027,431 + + + + 5,500,000,000 + + + + 5,492,258,218 + + + + 5,500,000,000 + + + + 5,500,000,000 + + + + + + + + + + + + + + + + + + + + + + + + + + + + Basic earnings/(losses) per share + + + + + + RMB1.35 + + + + RMB1.19 + + + + RMB(2.02 + ) + + + RMB0.78 + + + + RMB0.89 + + + + + + + + + + + + + + + + + + + + + + + + + + + + Diluted earnings/(losses) per share + + + + + + RMB1.35 + + + + RMB1.19 + + + + RMB(2.02 + ) + + + RMB0.78 + + + + RMB0.89 + + + + + + + + + + + + + + + + + + + + + + + + +The diluted loss per share for the year ended +December 31, 2003 is the same as the basic loss per share +as all potential ordinary shares are anti-dilutive. + + +All the number of shares stated above have taken +into consideration the effect of shares consolidation conducted +on September 7, 2004 as set out in note 33(a). + +10. Cash and bank +deposits + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Cash and cash equivalents + + + + + + 6,950 + + + + 6,690 + + + + 6,283 + + + + 3,116 + + + + + Time deposits with original maturities over three + months + + + + + + 2 + + + + 112 + + + + 33 + + + + 3 + + + + + + + + + + + + + + + + + + + + + + + Total cash and bank deposits + + + + + + 6,952 + + + + 6,802 + + + + 6,316 + + + + 3,119 + + + + + + + + + + + + + + + + + + + + + +Included in the cash and bank deposits as at the +end of each of December 31, 2001, 2002 and 2003 and +June 30, 2004 are Renminbi denominated balances kept in the +PRC amounting to RMB 6,890 million, +RMB 6,594 million, RMB 5,631 million and +RMB 2,066 million respectively. The conversion of +Renminbi denominated balances into foreign currencies and the +remittance of bank balances and cash out of the PRC are subject +to the rules and regulation of foreign exchange control +promulgated by the PRC government. + +11. Short-term +investments + + +The Group s short-term investments comprise +primarily investments in listed debt securities. + +12. Accounts +receivable + + +Amounts due from the provision of fixed line +telecommunication services to residential and business customers +are due within 30 days from the date of billing. Customers +who have accounts overdue by more + +F-25 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +than 90 days will have their services +disconnected. Accounts receivable from other telecommunication +operators and customers are due between 30 to 90 days from +the billing date. + + +The ageing analysis of accounts receivable based +on the billing date is as follows: + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + 0-30 days + + + + + + 3,321 + + + + 4,005 + + + + 5,232 + + + + 4,953 + + + + + 31-90 days + + + + + + 421 + + + + 618 + + + + 876 + + + + 1,246 + + + + + Over 90 days + + + + + + 703 + + + + 781 + + + + 1,286 + + + + 1,968 + + + + + + + + + + + + + + + + + + + + + + + Total + + + + + + 4,445 + + + + 5,404 + + + + 7,394 + + + + 8,167 + + + + + Less: Allowance for doubtful debts + + + + + + (538 + ) + + + (629 + ) + + + (1,051 + ) + + + (1,435 + ) + + + + + + + + + + + + + + + + + + + + + + Net carrying amounts + + + + + + 3,907 + + + + 4,775 + + + + 6,343 + + + + 6,732 + + + + + + + + + + + + + + + + + + + + + +The movement of allowance for doubtful debts is +as follows: + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Balance at beginning of year/period + + + + + + 575 + + + + 538 + + + + 629 + + + + 1,051 + + + + + Additional provisions + + + + + + 302 + + + + 355 + + + + 558 + + + + 451 + + + + + Less: Amounts utilised + + + + + + (339 + ) + + + (264 + ) + + + (136 + ) + + + (18 + ) + + + + Distributed to owners in accordance with + Reorganization + + + + + + + + + + + + + + + + + + (49 + ) + + + + + + + + + + + + + + + + + + + + + + Balance at end of year/period + + + + + + 538 + + + + 629 + + + + 1,051 + + + + 1,435 + + + + + + + + + + + + + + + + + + + + +13. Inventories +and consumables + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Consumables, at cost + + + + + + 1,231 + + + + 938 + + + + 993 + + + + 781 + + + + + Telephone handsets and other customer end + products held for resale, at cost + + + + + + 108 + + + + 69 + + + + 245 + + + + 371 + + + + + + + + + + + + + + + + + + + + + + + + 1,339 + + + + 1,007 + + + + 1,238 + + + + 1,152 + + + + + + + + + + + + + + + + + + + + +14. Prepayments +and other receivables + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Prepaid expenses and deposits + + + + + + 1,162 + + + + 730 + + + + 648 + + + + 568 + + + + + Other receivables + + + + + + 889 + + + + 740 + + + + 992 + + + + 578 + + + + + + + + + + + + + + + + + + + + + + + + 2,051 + + + + 1,470 + + + + 1,640 + + + + 1,146 + + + + + + + + + + + + + + + + + + + + +F-26 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +15. Fixed +assets + + + + + + + + + + + + + + + + + + + + + + + + + + Furniture, + + + + + + + + + + fixtures, + + + + + + + + Telecommunications + + motor vehicles + + + + + + Land and + + networks and + + and other + + + + + + buildings + + equipment + + equipment + + Total + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Cost: + + + + + + + + + + + + + + + + + + + + + + + Balance at January 1, 2001 + + + + + + 20,185 + + + + 136,512 + + + + 6,510 + + + + 163,207 + + + + + Additions + + + + + + 493 + + + + 4,873 + + + + 777 + + + + 6,143 + + + + + Transferred from construction in progress + (Note 16) + + + + + + 4,740 + + + + 32,406 + + + + 978 + + + + 38,124 + + + + + Disposals + + + + + + (883 + ) + + + (3,454 + ) + + + (1,006 + ) + + + (5,343 + ) + + + + Assets contributed from owners (note (d)) + + + + + + + + + + 89 + + + + + + + + 89 + + + + + Assets distributed to owners (note (d)) + + + + + + + + + + (530 + ) + + + + + + + (530 + ) + + + + + + + + + + + + + + + + + + + + + + Balance at December 31, 2001 + + + + + + 24,535 + + + + 169,896 + + + + 7,259 + + + + 201,690 + + + + + + + + + + + + + + + + + + + + + + + Accumulated depreciation: + + + + + + + + + + + + + + + + + + + + + + + Balance at January 1, 2001 + + + + + + (3,343 + ) + + + (44,977 + ) + + + (1,930 + ) + + + (50,250 + ) + + + + Charge for the year + + + + + + (762 + ) + + + (14,408 + ) + + + (925 + ) + + + (16,095 + ) + + + + Disposals + + + + + + 126 + + + + 2,391 + + + + 461 + + + + 2,978 + + + + + Assets distributed to owners (note d) + + + + + + + + + + 159 + + + + + + + + 159 + + + + + + + + + + + + + + + + + + + + + + + Balance at December 31, 2001 + + + + + + (3,979 + ) + + + (56,835 + ) + + + (2,394 + ) + + + (63,208 + ) + + + + + + + + + + + + + + + + + + + + + + Net book value at December 31, 2001 + + + + + + 20,556 + + + + 113,061 + + + + 4,865 + + + + 138,482 + + + + + + + + + + + + + + + + + + + + + + + Cost: + + + + + + + + + + + + + + + + + + + + + + + Balance at January 1, 2002 + + + + + + 24,535 + + + + 169,896 + + + + 7,259 + + + + 201,690 + + + + + Additions + + + + + + 206 + + + + 1,032 + + + + 346 + + + + 1,584 + + + + + Transferred from construction in progress + (Note 16) + + + + + + 2,871 + + + + 23,715 + + + + 710 + + + + 27,296 + + + + + Disposals + + + + + + (491 + ) + + + (4,108 + ) + + + (554 + ) + + + (5,153 + ) + + + + + + + + + + + + + + + + + + + + + + Balance at December 31, 2002 + + + + + + 27,121 + + + + 190,535 + + + + 7,761 + + + + 225,417 + + + + + + + + + + + + + + + + + + + + + + + Accumulated depreciation: + + + + + + + + + + + + + + + + + + + + + + + Balance at January 1, 2002 + + + + + + (3,979 + ) + + + (56,835 + ) + + + (2,394 + ) + + + (63,208 + ) + + + + Charge for the year + + + + + + (906 + ) + + + (16,868 + ) + + + (972 + ) + + + (18,746 + ) + + + + Disposals + + + + + + 33 + + + + 2,311 + + + + 357 + + + + 2,701 + + + + + + + + + + + + + + + + + + + + + + + Balance at December 31, 2002 + + + + + + (4,852 + ) + + + (71,392 + ) + + + (3,009 + ) + + + (79,253 + ) + + + + + + + + + + + + + + + + + + + + + + Net book value at December 31, 2002 + + + + + + 22,269 + + + + 119,143 + + + + 4,752 + + + + 146,164 + + + + + + + + + + + + + + + + + + + + + + + Cost/valuation: + + + + + + + + + + + + + + + + + + + + + + + Balance at January 1, 2003 + + + + + + 27,121 + + + + 190,535 + + + + 7,761 + + + + 225,417 + + + + + Additions + + + + + + 393 + + + + 2,381 + + + + 307 + + + + 3,081 + + + + + Acquired through Asia Netcom (Note 28(c) + (ii)) + + + + + + + + + + 3,298 + + + + + + + + 3,298 + + + + + Transferred from construction in progress + (Note 16) + + + + + + 1,892 + + + + 24,062 + + + + 1,286 + + + + 27,240 + + + + + Disposals + + + + + + (408 + ) + + + (5,676 + ) + + + (498 + ) + + + (6,582 + ) + + + + Increase as a result of revaluation + + + + + + + + + + 6,456 + + + + 655 + + + + 7,111 + + + + + Decrease as a result of revaluation + + + + + + + + + + (40,124 + ) + + + (2,034 + ) + + + (42,158 + ) + + + + + + + + + + + + + + + + + + + + + + Balance at December 31, 2003 + + + + + + 28,998 + + + + 180,932 + + + + 7,477 + + + + 217,407 + + + + + + + + + + + + + + + + + + + + +F-27 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + + + + + + + + + + + + + + + + + + + + + + + + + Furniture, + + + + + + + + + + fixtures, + + + + + + + + Telecommunications + + motor vehicles + + + + + + Land and + + networks and + + and other + + + + + + buildings + + equipment + + equipment + + Total + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Accumulated depreciation: + + + + + + + + + + + + + + + + + + + + + + + Balance at January 1, 2003 + + + + + + (4,852 + ) + + + (71,392 + ) + + + (3,009 + ) + + + (79,253 + ) + + + + Charge for the year + + + + + + (716 + ) + + + (18,520 + ) + + + (1,148 + ) + + + (20,384 + ) + + + + Acquired through Asia Netcom (Note 28(c) + (ii)) + + + + + + + + + + (261 + ) + + + + + + + (261 + ) + + + + Disposals + + + + + + 103 + + + + 3,622 + + + + 434 + + + + 4,159 + + + + + Increase as a result of revaluation + + + + + + + + + + (3,693 + ) + + + (436 + ) + + + (4,129 + ) + + + + Decrease as a result of revaluation + + + + + + + + + + 15,696 + + + + 684 + + + + 16,380 + + + + + + + + + + + + + + + + + + + + + + + Balance at December 31, 2003 + + + + + + (5,465 + ) + + + (74,548 + ) + + + (3,475 + ) + + + (83,488 + ) + + + + + + + + + + + + + + + + + + + + + + Net book value at December 31, 2003 + + + + + + 23,533 + + + + 106,384 + + + + 4,002 + + + + 133,919 + + + + + + + + + + + + + + + + + + + + + + + Cost/valuation: + + + + + + + + + + + + + + + + + + + + + + + Balance at January 1, 2004 + + + + + + 28,998 + + + + 180,932 + + + + 7,477 + + + + 217,407 + + + + + Additions + + + + + + 23 + + + + 436 + + + + 158 + + + + 617 + + + + + Transferred from construction in progress (Note + 16) + + + + + + 900 + + + + 7,743 + + + + 511 + + + + 9,154 + + + + + Disposals + + + + + + (46 + ) + + + (279 + ) + + + (34 + ) + + + (359 + ) + + + + Distributed to owners in accordance with + Reorganization on June 30, 2004 + + + + + + (12,827 + ) + + + (9,265 + ) + + + (325 + ) + + + (22,417 + ) + + + + + + + + + + + + + + + + + + + + + + Balance at June 30, 2004 + + + + + + 17,048 + + + + 179,567 + + + + 7,787 + + + + 204,402 + + + + + + + + + + + + + + + + + + + + + + + Accumulated depreciation: + + + + + + + + + + + + + + + + + + + + + + + Balance at January 1, 2004 + + + + + + (5,465 + ) + + + (74,548 + ) + + + (3,475 + ) + + + (83,488 + ) + + + + Charge for the period + + + + + + (483 + ) + + + (8,489 + ) + + + (530 + ) + + + (9,502 + ) + + + + Disposals + + + + + + 2 + + + + 211 + + + + 29 + + + + 242 + + + + + Distributed to owners in accordance with + Reorganization on June 30, 2004 + + + + + + 2,658 + + + + 2,505 + + + + 74 + + + + 5,237 + + + + + + + + + + + + + + + + + + + + + + + Balance at June 30, 2004 + + + + + + (3,288 + ) + + + (80,321 + ) + + + (3,902 + ) + + + (87,511 + ) + + + + + + + + + + + + + + + + + + + + + + Net book value at June 30, 2004 + + + + + + 13,760 + + + + 99,246 + + + + 3,885 + + + + 116,891 + + + + + + + + + + + + + + + + + + + + + +(a) The net book value of assets held under +finance lease is as follows: + + + + + + + + + + + + + + + + + + + + + + + + + + Furniture, + + + + + + + + + + fixtures, + + + + + + + + Telecommunications + + motor vehicles + + + + + + Land and + + networks and + + and other + + + + + + buildings + + equipment + + equipment + + Total + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + At December 31, 2001 + + + + + + + + + + 598 + + + + 4 + + + + 602 + + + + + At December 31, 2002 + + + + + + + + + + 529 + + + + 5 + + + + 534 + + + + + At December 31, 2003 + + + + + + + + + + 715 + + + + 2 + + + + 717 + + + + + At June 30, 2004 + + + + + + + + + + 1,955 + + + + 6 + + + + 1,961 + + + +During the six months ended June 30, 2004, +the Group entered into a finance lease arrangement with a +related party with certain existing fixed assets to obtain +funding of RMB 1,085 million. The net book value + +F-28 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +of such fixed costs included above amounted to +RMB 1,082 million and the corresponding finance lease +obligation amounted to RMB 1,085 million as at +June 30, 2004. + + +(b) The analysis of the cost or revaluation +of the assets of the Group is as follows: + + + + + + + + + + + + + + + + + + + + + + + + + + Furniture, + + + + + + + + + + fixture, + + + + + + + + Telecommunications + + motor vehicles + + + + + + Land and + + networks and + + and other + + + + + + buildings + + equipment + + equipment + + Total + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + At December 31, 2003 + + + + + + + + + + + + + + + + + + + + + + + Cost + + + + + + 28,998 + + + + + + + + + + + + 28,998 + + + + + Valuation + + + + + + + + + + 180,932 + + + + 7,477 + + + + 188,409 + + + + + + + + + + + + + + + + + + + + + + + + 28,998 + + + + 180,932 + + + + 7,477 + + + + 217,407 + + + + + + + + + + + + + + + + + + + + + + + At June 30, 2004 + + + + + + + + + + + + + + + + + + + + + + + Cost + + + + + + 17,048 + + + + 8,179 + + + + 669 + + + + 25,896 + + + + + Valuation + + + + + + + + + + 171,388 + + + + 7,118 + + + + 178,506 + + + + + + + + + + + + + + + + + + + + + + + + 17,048 + + + + 179,567 + + + + 7,787 + + + + 204,402 + + + + + + + + + + + + + + + + + + + + + +The Group s land and buildings are primarily +located in the PRC and held on leases of primarily between 10 to +50 years. + + +(c) As detailed in Note 3(l)(ii), except for +land and buildings, fixed assets were carried at revalued +amounts on December 31, 2003. As required by PRC rules and +regulations relevant to the Reorganisation, each class of fixed +assets in the PRC injected into the Group as at +December 31, 2003, was valued by China Enterprise Appraisal +Co. Ltd. (the PRC valuer ), independent valuers +registered in the PRC, on a depreciated replacement cost basis. +The value of such fixed assets in the PRC injected into the +Group was determined at RMB 122,456 million. The fixed +assets retained by the ultimate holding company, which were +transferred based on their carrying values upon the +Reorganisation, were valued by the Directors at an amount of +RMB 17,581 million as at December 31, 2003. The +impact of the revaluation was a net deficit on revaluation of +the fixed assets, other than land and buildings, totalling +RMB 22,796 million. Such amount will serve as the tax +base for such assets for future years (see Note 27). + + +The respective carrying amount of the +telecommunication networks and equipment and furniture, motor +vehicles and other equipment would have been RMB +128,049 million and RMB 5,133 million as at +December 31, 2003 and RMB 119,335 million and +RMB 4,907 million as at June 30, 2004 had they been +stated at cost less accumulated depreciation. + + +The land and buildings were also revalued and the +result was a net surplus of RMB 6,967 million. Such +revaluation on land and buildings serve as the tax base for land +and buildings for the future years, has not been reflected in +the consolidated financial statements (see Note 27(ii)). + +F-29 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +The historical carrying amounts of the +Group s fixed assets, as at December 31, 2003 and +where applicable the corresponding revalued amounts of these +assets are as follows: + + + + + + + + + + + + + + + + + + + + + + Historical + + + + + + + + + + carrying + + Revaluation + + Revaluation + + Revalued + + + + amount + + surplus + + deficit + + amount + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Land and buildings + + + + + + 23,533 + + + + + + + + + + + + 23,533 + + + + + Telecommunications networks and equipment + + + + + + 128,049 + + + + 2,763 + + + + (24,428 + ) + + + 106,384 + + + + + Furniture, fixture, motor vehicles and other + equipment + + + + + + 5,133 + + + + 219 + + + + (1,350 + ) + + + 4,002 + + + + + + + + + + + + + + + + + + + + + + + + 156,715 + + + + 2,982 + + + + (25,778 + ) + + + 133,919 + + + + + + + + + + + + + + + + + + + + + +The Group s land and buildings injected by +China Netcom Group were valued separately by Sallmanns, +independent qualified valuers in Hong Kong, as at +December 31, 2003 on the basis of their open market value. +The value arrived at by these valuers was consistent with that +arrived at by the PRC valuers. The Group s land and +buildings are carried at their cost less accumulated +depreciation and impairment losses in the consolidated financial +statements. + + +At December 31, 2003 and June 30, 2004, +the net book value of fixed assets pledged as security for the +Group s long term bank and other loans amounted to +RMB 2,668 million and RMB 24 million +respectively. + + +(d) In accordance with the industry +restructuring plan in 2001 as detailed in Note 1, the +entities in the northern service regions comprising the Group +transferred 70% of the Group s interprovincial optic fibres +comprising fixed assets amounting to RMB 371 million and +construction in progress amounting to RMB 435 million +(totaling RMB 806 million) to China Telecom Group while the +Group s entities in the southern service regions received +30% of the said assets comprising fixed assets amounting to +RMB 89 million and construction in progress amounting +to RMB 8 million (totaling RMB 97 million) +from China Telecom Group. These transfers were reflected as +movements in the consolidated statement of changes in equity for +the year ended December 31, 2001. All of the Group s +interprovincial optic fibres are among the assets being +transferred to China Netcom Group upon the Reorganization on +June 30, 2004. + +16. Construction-in-progress + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Balance at beginning of year/period + + + + + + 23,124 + + + + 22,727 + + + + 17,783 + + + + 15,695 + + + + + Additions + + + + + + 38,154 + + + + 22,352 + + + + 25,152 + + + + 9,503 + + + + + Transferred to fixed assets (Note 15) + + + + + + (38,124 + ) + + + (27,296 + ) + + + (27,240 + ) + + + (9,154 + ) + + + + Assets contributed from owners (Note 15(d)) + + + + + + 8 + + + + + + + + + + + + + + + + + Assets distributed to owners (Note 15(d)) + + + + + + (435 + ) + + + + + + + + + + + + + + + + Distributed to owners in accordance with + Reorganisation on June 30, 2004 + + + + + + + + + + + + + + + + + + (1,401 + ) + + + + + + + + + + + + + + + + + + + + + + Balance at end of year/period + + + + + + 22,727 + + + + 17,783 + + + + 15,695 + + + + 14,643 + + + + + + + + + + + + + + + + + + + + +F-30 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +17. Intangible +assets + + + + + + + + + + + + + + + + + + + + Purchased + + + + + + Goodwill + + software + + Total + + + + + + + + + + + + RMB + + RMB + + RMB + + + + million + + million + + million + + + + Cost: + + + + + + + + + + + + + + + + + + + Balance at January 1, 2001 + + + + + + + + + + 399 + + + + 399 + + + + + Additions + + + + + + 3 + + + + 100 + + + + 103 + + + + + + + + + + + + + + + + + + + Balance at December 31, 2001 + + + + + + 3 + + + + 499 + + + + 502 + + + + + + + + + + + + + + + + + + + Accumulated amortisation: + + + + + + + + + + + + + + + + + + + Balance at January 1, 2001 + + + + + + + + + + (270 + ) + + + (270 + ) + + + + Amortisation for the year + + + + + + (2 + ) + + + (56 + ) + + + (58 + ) + + + + + + + + + + + + + + + + + + Balance at December 31, 2001 + + + + + + (2 + ) + + + (326 + ) + + + (328 + ) + + + + + + + + + + + + + + + + + + Net book value at December 31, 2001 + + + + + + 1 + + + + 173 + + + + 174 + + + + + + + + + + + + + + + + + + + Cost: + + + + + + + + + + + + + + + + + + + Balance at January 1, 2002 + + + + + + 3 + + + + 499 + + + + 502 + + + + + Additions + + + + + + + + + + 161 + + + + 161 + + + + + + + + + + + + + + + + + + + Balance at December 31, 2002 + + + + + + 3 + + + + 660 + + + + 663 + + + + + + + + + + + + + + + + + + + Accumulated amortisation: + + + + + + + + + + + + + + + + + + + Balance at January 1, 2002 + + + + + + (2 + ) + + + (326 + ) + + + (328 + ) + + + + Amortisation for the year + + + + + + + + + + (62 + ) + + + (62 + ) + + + + + + + + + + + + + + + + + + Balance at December 31, 2002 + + + + + + (2 + ) + + + (388 + ) + + + (390 + ) + + + + + + + + + + + + + + + + + + Net book value at December 31, 2002 + + + + + + 1 + + + + 272 + + + + 273 + + + + + + + + + + + + + + + + + + + Cost: + + + + + + + + + + + + + + + + + + + Balance at January 1, 2003 + + + + + + 3 + + + + 660 + + + + 663 + + + + + Additions + + + + + + + + + + 191 + + + + 191 + + + + + Negative goodwill on acquisition of certain + entities of Asia Global Crossing through Asia Netcom (See note + below) + + + + + + (296 + ) + + + + + + + (296 + ) + + + + Acquisition of additional 49% interest in Asia + Netcom (Note 28(c)(ii)) + + + + + + 115 + + + + + + + + 115 + + + + + + + + + + + + + + + + + + + Balance at December 31, 2003 + + + + + + (178 + ) + + + 851 + + + + 673 + + + + + + + + + + + + + + + + + + + Accumulated amortisation: + + + + + + + + + + + + + + + + + + + Balance at January 1, 2003 + + + + + + (2 + ) + + + (388 + ) + + + (390 + ) + + + + Amortisation for the year + + + + + + + + + + (99 + ) + + + (99 + ) + + + + + + + + + + + + + + + + + + Balance at December 31, 2003 + + + + + + (2 + ) + + + (487 + ) + + + (489 + ) + + + + + + + + + + + + + + + + + + Net book value at December 31, 2003 + + + + + + (180 + ) + + + 364 + + + + 184 + + + + + + + + + + + + + + + + + + + Cost: + + + + + + + + + + + + + + + + + + + Balance at January 1, 2004 + + + + + + (178 + ) + + + 851 + + + + 673 + + + + + Additions + + + + + + + + + + 25 + + + + 25 + + + + + + + + + + + + + + + + + + + Balance at June 30, 2004 + + + + + + (178 + ) + + + 876 + + + + 698 + + + + + + + + + + + + + + + + + + + Accumulated amortisation: + + + + + + + + + + + + + + + + + + + Balance at January 1, 2004 + + + + + + (2 + ) + + + (487 + ) + + + (489 + ) + + + + Amortisation for the period + + + + + + 8 + + + + (58 + ) + + + (50 + ) + + + + + + + + + + + + + + + + + + Balance at June 30, 2004 + + + + + + 6 + + + + (545 + ) + + + (539 + ) + + + + + + + + + + + + + + + + + + Net book value at June 30, 2004 + + + + + + (172 + ) + + + 331 + + + + 159 + + + + + + + + + + + + + + + + +F-31 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + + + + + + + + + + + + Note: + + + + + + + On March 10, 2003, Asia Netcom, the + Group s 51% jointly controlled entity at that time, + acquired certain entities from Asia Global Crossing (details see + Note 28(c)(i)). The unamortised negative goodwill of + RMB 296 million arising from the aforementioned acquisition + has been consolidated into the Group through Asia Netcom upon + the acquisition of the remaining 49% interest of Asia Netcom, + which became a wholly owned subsidiary of the Group on + December 31, 2003. + + +F-32 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +18. Deferred +costs + + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Balance at beginning of year/period + + + + + + + + + + + + + + + + + + + + + + + + Installation costs + + + + + + 3,394 + + + + 4,110 + + + + 4,408 + + + + 4,708 + + + + + + Customer acquisition costs + + + + + + 15 + + + + 32 + + + + 44 + + + + 1,370 + + + + + + Prepaid network capacities + + + + + + 11 + + + + 235 + + + + 383 + + + + 1,248 + + + + + + Discount on foreign currency + exchange forward contracts + + + + + + 153 + + + + 122 + + + + 97 + + + + 77 + + + + + + Others + + + + + + 133 + + + + 167 + + + + 217 + + + + 469 + + + + + + + + + + + + + + + + + + + + + + + + 3,706 + + + + 4,666 + + + + 5,149 + + + + 7,872 + + + + + + + + + + + + + + + + + + + + + + + Additions for the year/period + + + + + + + + + + + + + + + + + + + + + + + + Installation costs + + + + + + 1,259 + + + + 962 + + + + 1,455 + + + + 520 + + + + + + Customer acquisition costs + + + + + + 43 + + + + 58 + + + + 1,666 + + + + 1,547 + + + + + + Prepaid network capacities + + + + + + + + + + + + + + + + + + + + + + + + + additions + + + + + + 231 + + + + 169 + + + + 16 + + + + 113 + + + + + + + acquired through Asia Netcom (Note + 28(c)(ii)) + + + + + + + + + + + + + + 870 + + + + + + + + + + Discount on foreign currency + exchange forward contracts + + + + + + + + + + + + + + + + + + + + + + + + Others + + + + + + 113 + + + + 177 + + + + 431 + + + + 204 + + + + + + + + + + + + + + + + + + + + + + + + 1,646 + + + + 1,366 + + + + 4,438 + + + + 2,384 + + + + + + + + + + + + + + + + + + + + + + + Charge for the year/period + + + + + + + + + + + + + + + + + + + + + + + + Installation costs + + + + + + (543 + ) + + + (664 + ) + + + (1,155 + ) + + + (537 + ) + + + + + Customer acquisition costs + + + + + + (26 + ) + + + (46 + ) + + + (340 + ) + + + (835 + ) + + + + + Prepaid network capacities + + + + + + + + + + + + + + + + + + + + + + + + + additions + + + + + + (7 + ) + + + (21 + ) + + + (21 + ) + + + (21 + ) + + + + + + acquired through Asia Netcom (Note + 28(c)(ii)) + + + + + + + + + + + + + + + + + + + + + + + + Discount on foreign currency + exchange forward contracts + + + + + + (31 + ) + + + (25 + ) + + + (20 + ) + + + (9 + ) + + + + + Others + + + + + + (79 + ) + + + (127 + ) + + + (179 + ) + + + (123 + ) + + + + + + + + + + + + + + + + + + + + + + + (686 + ) + + + (883 + ) + + + (1,715 + ) + + + (1,525 + ) + + + + + + + + + + + + + + + + + + + + + + Distributed to owners in accordance with + Reorganization on June 30, 2004 + + + + + + + + + + + + + + + + + + + + + + + + Prepaid network capacities + + + + + + + + + + + + + + + + + + (61 + ) + + + + + Others + + + + + + + + + + + + + + + + + + (113 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (174 + ) + + + + + + + + + + + + + + + + + + + + + + Balance at end of year/period + + + + + + + + + + + + + + + + + + + + + + + + Installation costs + + + + + + 4,110 + + + + 4,408 + + + + 4,708 + + + + 4,691 + + + + + + Customer acquisition costs + + + + + + 32 + + + + 44 + + + + 1,370 + + + + 2,082 + + + + + + Prepaid network capacities + + + + + + 235 + + + + 383 + + + + 1,248 + + + + 1,279 + + + + + + Discount on foreign currency + exchange forward contracts + + + + + + 122 + + + + 97 + + + + 77 + + + + 68 + + + + + + Others + + + + + + 167 + + + + 217 + + + + 469 + + + + 437 + + + + + + + + + + + + + + + + + + + + + + + + 4,666 + + + + 5,149 + + + + 7,872 + + + + 8,557 + + + + + + + + + + + + + + + + + + + + +F-33 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +19. Long-term +investment and interests in associated companies + + +Long-term investment and interests in associated +companies are unlisted equity investments, which were +transferred to China Netcom Group upon the Reorganisation on +June 30, 2004. + +20. Foreign +currency exchange forward contracts + + +The Group has entered into certain foreign +currency exchange forward contracts with banks, which are +non-speculative and used as hedges of the Group s certain +borrowings denominated in foreign currencies. The respective +foreign currency exchange forward contract receivable and +payable balances which are included in other non-current assets +and other non-current liabilities are as follows: + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Receivable + + + + + + 391 + + + + 391 + + + + 469 + + + + 426 + + + + + + + + + + + + + + + + + + + + + + + Payable + + + + + + 620 + + + + 564 + + + + 588 + + + + 544 + + + + + + + + + + + + + + + + + + + + +21. Accounts +payables + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + 0-30 days + + + + + + 5,485 + + + + 4,539 + + + + 7,480 + + + + 5,328 + + + + + 31-60 days + + + + + + 1,557 + + + + 1,433 + + + + 554 + + + + 1,226 + + + + + 61-90 days + + + + + + 1,050 + + + + 555 + + + + 414 + + + + 1,914 + + + + + 91-180 days + + + + + + 1,452 + + + + 1,391 + + + + 2,494 + + + + 1,503 + + + + + Over 180 days + + + + + + 4,679 + + + + 5,384 + + + + 3,844 + + + + 4,019 + + + + + + + + + + + + + + + + + + + + + + + + 14,223 + + + + 13,302 + + + + 14,786 + + + + 13,990 + + + + + + + + + + + + + + + + + + + + +22. Accruals and +other payables + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Accrued expenses + + + + + + 1,770 + + + + 1,905 + + + + 2,949 + + + + 2,642 + + + + + Other payables + + + + + + 2,149 + + + + 1,620 + + + + 1,461 + + + + 1,321 + + + + + + + + + + + + + + + + + + + + + + + + 3,919 + + + + 3,525 + + + + 4,410 + + + + 3,963 + + + + + + + + + + + + + + + + + + + + +F-34 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +23. Bank and +other loans + + +(a) The short term bank loans as at +June 30, 2004 were unsecured and comprise: + + + + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + + + As at December 31, + + June 30, + + + + + + + + + + Currency + + Interest rate and final maturity + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + + + million + + million + + million + + million + + + + Renminbi denominated + + + + + + Interest rates ranging from 4.54% to + 6.2% per annum with maturity through June 28, 2005 + + + + 17,837 + + + + 26,234 + + + + 32,098 + + + + 29,625 + + + + + US Dollar denominated + + + + + + Interest rates ranging from 2.59% to + 2.77% per annum with maturity through Nov. 28, 2004 + + + + + + + + 137 + + + + 119 + + + + 119 + + + + + + + + + + + + + + + + + + + + + + + + + + + + 17,837 + + + + 26,371 + + + + 32,217 + + + + 29,744 + + + + + + + + + + + + + + + + + + + + + + + +(b) The Group s long term bank and +other loans comprise: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + + + As at December 31, + + June 30, + + + + + + + + + + + + Note + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + + + million + + million + + million + + million + + + + Bank and other loans + + + + + + (i + ) + + + 46,589 + + + + 43,345 + + + + 37,281 + + + + 27,023 + + + + + Finance lease obligations + + + + + + (ii + ) + + + 263 + + + + 224 + + + + 744 + + + + 1,583 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + 46,852 + + + + 43,569 + + + + 38,025 + + + + 28,606 + + + + + + + + + + + + + + + + + + + + + + + + + + + Less: Current portion + + + + + + + + + + (9,406 + ) + + + (14,089 + ) + + + (15,716 + ) + + + (8,142 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + 37,446 + + + + 29,480 + + + + 22,309 + + + + 20,464 + + + + + + + + + + + + + + + + + + + + + + + + + (i) Long +term bank and other loans + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Loans + + + + + + + + + + + + + + + + + + + + + + + + Unsecured + + + + + + 43,507 + + + + 41,322 + + + + 33,713 + + + + 25,902 + + + + + + Secured + + + + + + 3,082 + + + + 2,023 + + + + 3,568 + + + + 1,121 + + + + + + + + + + + + + + + + + + + + + + + Total + + + + + + 46,589 + + + + 43,345 + + + + 37,281 + + + + 27,023 + + + + + + + + + + + + + + + + + + + + + + + Less: Current portion + + + + + + (9,305 + ) + + + (13,979 + ) + + + (15,426 + ) + + + (7,858 + ) + + + + + + + + + + + + + + + + + + + + + + Long-term loans + + + + + + 37,284 + + + + 29,366 + + + + 21,855 + + + + 19,165 + + + + + + + + + + + + + + + + + + + + +F-35 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + + + + + + The Group s long term bank and other loans + (excluding finance lease liabilities) were repayable as follows: + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Within one year + + + + + + 9,305 + + + + 13,979 + + + + 15,426 + + + + 7,858 + + + + + In the second year + + + + + + 16,546 + + + + 15,590 + + + + 11,513 + + + + 8,394 + + + + + In the third to fifth year + + + + + + 16,129 + + + + 10,279 + + + + 8,644 + + + + 9,335 + + + + + After the fifth year + + + + + + 4,609 + + + + 3,497 + + + + 1,698 + + + + 1,436 + + + + + + + + + + + + + + + + + + + + + + + + 46,589 + + + + 43,345 + + + + 37,281 + + + + 27,023 + + + + + + + + + + + + + + + + + + + + + + + + + + The Group s long term bank and other loans + comprise: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + + + As at December 31, + + June 30, + + + + + + + + + + Currency + + Interest rate and final maturity + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + + + million + + million + + million + + million + + + + Bank loans + + + + + + + + + + + + + + + + + + + + + + + + Renminbi denominated + + + + + + Interest rates ranging from 4.5% to 6.2% per + annum with maturity through Dec. 31, 2032 + + + + 41,202 + + + + 39,410 + + + + 32,870 + + + + 24,129 + + + + + US Dollar denominated + + + + + + Interest rates ranging from 2.1% to 5.5% per + annum with maturity through Dec. 31, 2040 + + + + 3,972 + + + + 2,580 + + + + 1,920 + + + + 1,417 + + + + + Japanese Yen denominated + + + + + + Interest rates ranging from 2.1% to 3.5% per + annum with maturity through Oct. 20, 2022 + + + + 892 + + + + 792 + + + + 877 + + + + 1,120 + + + + + Euro denominated + + + + + + Interest rates ranging from 2% to 5.94% per + annum with maturity through Feb. 28, 2039 + + + + 523 + + + + 563 + + + + 392 + + + + 357 + + + + + + + + + + + + + + + + + + + + + + + + + + + + 46,589 + + + + 43,345 + + + + 36,059 + + + + 27,023 + + + + + + + + + + + + + + + + + + + + + + + + + Other loans + + + + + + + + + + + + + + + + + + + + + + + + US Dollar denominated + + + + + + Interest rate charging at 1% per month with + maturity through Sep. 2006 + + + + + + + + + + + + 1,222 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + 46,589 + + + + 43,345 + + + + 37,281 + + + + 27,023 + + + + + + + + + + + + + + + + + + + + + + +F-36 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + + + + + + As at June 30, 2004 secured loans are bank + loans of RMB 1,121 million which were secured by the + followings: + + + + + + + (i) Certain fixed assets + amounted to RMB 24 million in respect of loan amounting to + RMB 5 million; + + + + + + + (ii) Corporate guarantee granted by + China Netcom Group to the extent of RMB 578 million; + and + + + + + + + (iii) Corporate guarantee granted by third + parties to the extent of RMB 538 million. + + + + + + + Besides, other loans amounting to + RMB 1,222 million at December 31, 2003 represent + finance arrangements with certain vendors, which were secured by + certain cable systems, property and contracts owned by the + Group. Upon the Reorganisation on June 30, 2004, these + vendor loans were all transferred to China Netcom Group. + + + (ii) Finance +lease obligations + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Obligations under finance leases + + + + + + 263 + + + + 224 + + + + 744 + + + + 1,583 + + + + + Less: current portion + + + + + + (101 + ) + + + (110 + ) + + + (290 + ) + + + (284 + ) + + + + + + + + + + + + + + + + + + + + + + + 162 + + + + 114 + + + + 454 + + + + 1,299 + + + + + + + + + + + + + + + + + + + + + + + + + + During the six months ended June 30, 2004, + the Group has entered into a finance lease arrangement with a + related party (see note 15 (a)). The lease obligation + payable to the related party as at June 30, 2004 amounted + to RMB1,085 million. + + + + + + + The Group s liabilities under finance leases + are analysed as follows: + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Within one year + + + + + + 113 + + + + 118 + + + + 305 + + + + 321 + + + + + In the second year + + + + + + 68 + + + + 103 + + + + 211 + + + + 200 + + + + + In the third to fifth year, inclusive + + + + + + 106 + + + + 15 + + + + 250 + + + + 1,166 + + + + + After the fifth year + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + 287 + + + + 236 + + + + 766 + + + + 1,687 + + + + + Less: future finance charges on finance leases + + + + + + (24 + ) + + + (12 + ) + + + (22 + ) + + + (104 + ) + + + + + + + + + + + + + + + + + + + + + + Present value of finance lease liabilities + + + + + + 263 + + + + 224 + + + + 744 + + + + 1,583 + + + + + + + + + + + + + + + + + + + + + + + The present value of finance lease liabilities is + as follows: + + + + + + + + + + + + + + + + + + + + + + + Within one year + + + + + + 101 + + + + 110 + + + + 290 + + + + 284 + + + + + In the second year + + + + + + 60 + + + + 99 + + + + 206 + + + + 163 + + + + + In the third to fifth year, inclusive + + + + + + 102 + + + + 15 + + + + 248 + + + + 1,136 + + + + + After the fifth year + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + 263 + + + + 224 + + + + 744 + + + + 1,583 + + + + + + + + + + + + + + + + + + + + +F-37 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +24. Amount due +from/(to) holding companies and fellow subsidiaries + + + + + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + + + As at December 31, + + June 30, + + + + + + + + + + + + Note + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + + + million + + million + + million + + million + + + + Current + + + + + + + + + + + + + + + + + + + + + + + + Due from intermediate holding company + + + + + + (a) + + + + 620 + + + + 439 + + + + 399 + + + + 7 + + + + + Due from fellow subsidiaries + + + + + + (a) + + + + 193 + + + + 233 + + + + 50 + + + + 51 + + + + + + + + + + + + + + + + + + + + + + + + + + + + 813 + + + + 672 + + + + 449 + + + + 58 + + + + + + + + + + + + + + + + + + + + + + + + + Profits distribution payable to ultimate holding + company + + + + + + (a) + + + + (990 + ) + + + (1,035 + ) + + + (9,002 + ) + + + (7,812 + ) + + + + + + + + + + + + + + + + + + + + + + + + Non-current + + + + + + + + + + + + + + + + + + + + + + + + Due to holding companies + + + + + + + + + + + + + + + + + + + + + + + + + + intermediate holding company + + + + + + (a),(c) + + + + + + + + + + + + (3,000 + ) + + + + + + + + + ultimate holding company + + + + + + (b),(c) + + + + + + + + + + + + (1,750 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (4,750 + ) + + + + + + + + + + + + + + + + + + + + + + + + + +Notes: + + + + + + + + + (a) + + + + These are interest free, unsecured and have no + fixed terms of repayment. + + + + + + (b) + + + + The amount due to ultimate holding company + amounting to RMB1,750 million is unsecured, carries + interest at 4.6% per annum. + + + + + + (c) + + + + These balances were subsequently waived and + recognised into the Group s equity in accordance with the + Reorganisation. + + +F-38 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +25. Deferred +revenues + + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Balance at beginning of year/period + + + + + + + + + + + + + + + + + + + + + + + + upfront connection fees + + + + + + 22,546 + + + + 18,671 + + + + 14,355 + + + + 10,390 + + + + + + upfront installation fees + + + + + + 4,886 + + + + 5,945 + + + + 6,456 + + + + 6,691 + + + + + + advances from network capacity sales + + + + + + + + + + 30 + + + + 27 + + + + 2,050 + + + + + + prepaid telephony services + + + + + + 965 + + + + 2,367 + + + + 1,971 + + + + 2,702 + + + + + + + + + + + + + + + + + + + + + + + + 28,397 + + + + 27,013 + + + + 22,809 + + + + 21,833 + + + + + + + + + + + + + + + + + + + + + + + Additions for the year/period + + + + + + + + + + + + + + + + + + + + + + + + upfront connection fees + + + + + + 585 + + + + + + + + + + + + + + + + + + upfront installation fees + + + + + + 1,865 + + + + 1,456 + + + + 1,279 + + + + 637 + + + + + + advances from network capacity sales + + + + + + + + + + + + + + + + + + + + + + + + + additions + + + + + + 30 + + + + + + + + + + + + 68 + + + + + + + acquired through Asia Netcom + (Note 28(c)(ii)) + + + + + + + + + + + + + + 2,032 + + + + + + + + + + prepaid telephony services + + + + + + 5,163 + + + + 6,127 + + + + 9,790 + + + + 6,793 + + + + + + + + + + + + + + + + + + + + + + + + 7,643 + + + + 7,583 + + + + 13,101 + + + + 7,498 + + + + + + + + + + + + + + + + + + + + + + + Reductions for the year/period + + + + + + + + + + + + + + + + + + + + + + + + upfront connection fees + + + + + + (4,460 + ) + + + (4,316 + ) + + + (3,965 + ) + + + (1,774 + ) + + + + + upfront installation fees + + + + + + (806 + ) + + + (945 + ) + + + (1,044 + ) + + + (641 + ) + + + + + advances from network capacity sales + + + + + + + + + + (3 + ) + + + (9 + ) + + + (59 + ) + + + + + prepaid telephony services + + + + + + (3,761 + ) + + + (6,523 + ) + + + (9,059 + ) + + + (6,631 + ) + + + + + + + + + + + + + + + + + + + + + + + (9,027 + ) + + + (11,787 + ) + + + (14,077 + ) + + + (9,105 + ) + + + + + + + + + + + + + + + + + + + + + + Distributed to owners in accordance with + Reorganization on June 30, 2004 + + + + + + + + + + + + + + + + + + + + + + + + advances from network capacity sales + + + + + + + + + + + + + + + + + + (5 + ) + + + + + prepaid telephony services + + + + + + + + + + + + + + + + + + (44 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (49 + ) + + + + + + + + + + + + + + + + + + + + + + Balance at end of year/period + + + + + + + + + + + + + + + + + + + + + + + + upfront connection fees + + + + + + 18,671 + + + + 14,355 + + + + 10,390 + + + + 8,616 + + + + + + upfront installation fees + + + + + + 5,945 + + + + 6,456 + + + + 6,691 + + + + 6,687 + + + + + + advances from network capacity sales + + + + + + 30 + + + + 27 + + + + 2,050 + + + + 2,054 + + + + + + prepaid telephony services + + + + + + 2,367 + + + + 1,971 + + + + 2,702 + + + + 2,820 + + + + + + + + + + + + + + + + + + + + + + + + 27,013 + + + + 22,809 + + + + 21,833 + + + + 20,177 + + + + + + + + + + + + + + + + + + + + + + + Representing: + + + + + + + + + + + + + + + + + + + + + + + + Current portion + + + + + + 7,658 + + + + 7,028 + + + + 7,229 + + + + 6,783 + + + + + + Non-current portion + + + + + + 19,355 + + + + 15,781 + + + + 14,604 + + + + 13,394 + + + + + + + + + + + + + + + + + + + + + + + + 27,013 + + + + 22,809 + + + + 21,833 + + + + 20,177 + + + + + + + + + + + + + + + + + + + + +F-39 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +26. Provisions + + + + + + + + + + + + + + + + + + Early + + One-off cash + + + + + + retirement + + housing + + + + + + benefits + + subsidies + + Total + + + + + + + + + + + + RMB + + RMB + + RMB + + + + million + + million + + million + + + + Note 3(r)(ii) + + Note (a) + + + + + + At January 1, 2001 + + + + + + 2,753 + + + + 2,818 + + + + 5,571 + + + + + Additional provisions + + + + + + 131 + + + + + + + + 131 + + + + + Payments during the year + + + + + + (339 + ) + + + + + + + (339 + ) + + + + + + + + + + + + + + + + + + At December 31, 2001 + + + + + + 2,545 + + + + 2,818 + + + + 5,363 + + + + + + + + + + + + + + + + + + + Analysis of total provisions: + + + + + + + + + + + + + + + + + + + Current portion + + + + + + 361 + + + + 2,818 + + + + 3,179 + + + + + Non-current portion + + + + + + 2,184 + + + + + + + + 2,184 + + + + + + + + + + + + + + + + + + + + 2,545 + + + + 2,818 + + + + 5,363 + + + + + + + + + + + + + + + + + + + At January 1, 2002 + + + + + + 2,545 + + + + 2,818 + + + + 5,363 + + + + + Additional provisions + + + + + + 758 + + + + + + + + 758 + + + + + Payments during the year + + + + + + (365 + ) + + + (35 + ) + + + (400 + ) + + + + + + + + + + + + + + + + + + At December 31, 2002 + + + + + + 2,938 + + + + 2,783 + + + + 5,721 + + + + + + + + + + + + + + + + + + + Analysis of total provisions: + + + + + + + + + + + + + + + + + + + Current portion + + + + + + 315 + + + + 2,783 + + + + 3,098 + + + + + Non-current portion + + + + + + 2,623 + + + + + + + + 2,623 + + + + + + + + + + + + + + + + + + + + 2,938 + + + + 2,783 + + + + 5,721 + + + + + + + + + + + + + + + + + + + At January 1, 2003 + + + + + + 2,938 + + + + 2,783 + + + + 5,721 + + + + + Additional provisions + + + + + + 132 + + + + + + + + 132 + + + + + Payments during the year + + + + + + (316 + ) + + + (113 + ) + + + (429 + ) + + + + + + + + + + + + + + + + + + At December 31, 2003 + + + + + + 2,754 + + + + 2,670 + + + + 5,424 + + + + + + + + + + + + + + + + + + + Analysis of total provisions: + + + + + + + + + + + + + + + + + + + Current portion + + + + + + 413 + + + + 2,670 + + + + 3,083 + + + + + Non-current portion + + + + + + 2,341 + + + + + + + + 2,341 + + + + + + + + + + + + + + + + + + + + 2,754 + + + + 2,670 + + + + 5,424 + + + + + + + + + + + + + + + + + + + At January 1, 2004 + + + + + + 2,754 + + + + 2,670 + + + + 5,424 + + + + + Additional provisions + + + + + + 206 + + + + + + + + 206 + + + + + Payments during the period + + + + + + (161 + ) + + + (313 + ) + + + (474 + ) + + + + + + + + + + + + + + + + + + At June 30, 2004 + + + + + + 2,799 + + + + 2,357 + + + + 5,156 + + + + + + + + + + + + + + + + + + + Analysis of total provisions: + + + + + + + + + + + + + + + + + + + Current portion + + + + + + 432 + + + + 2,357 + + + + 2,789 + + + + + Non-current portion + + + + + + 2,367 + + + + + + + + 2,367 + + + + + + + + + + + + + + + + + + + + 2,799 + + + + 2,357 + + + + 5,156 + + + + + + + + + + + + + + + + +F-40 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +(a) Certain staff quarters have been sold to +its employees, subject to a number of eligibility requirements, +at preferential prices. In 1998, the State Council of the PRC +issued a circular which stipulated that the sale of quarters to +employees at preferential prices should be terminated. In 2000, +the State Council issued a further circular stating that cash +subsidies should be made to certain eligible employees following +the withdrawal of allocation of staff quarters. However, the +specific timetable and procedures of implementation of these +policies were to be determined by individual provincial or +municipal government based on the particular situation of the +provinces or municipality. + + +Based on the relevant detailed local government +regulations promulgated, certain entities within the Group have +adopted cash housing subsidy plans. In accordance with these +plans, for those eligible employees who had not been allocated +with quarters or who had not been allocated with quarters up to +the prescribed standards before the discounted sales of quarters +were terminated, the Group is required to pay them one-off cash +housing subsidies based on their years of service, positions and +other criteria. Based on the available information, the Group +estimated the required provision for these cash housing +subsidiaries amounting to RMB2,818 million, which was +charged to the consolidated income statement in the year ended +December 31, 2000 when the State Council circular in +respect of cash subsidies was issued. Pursuant to the +Reorganisation, if the actual payments required for these one +off housing subsidies differ from the amount provided as of +June 30, 2004, China Netcom Group will bear any additional +payments required or will be paid the difference if the actual +payments are lower than the amount provided. + +27. Deferred +taxation + + +Movements of the deferred tax assets and +liabilities for the three years ended December 31, 2003 and +the six months ended June 30, 2004 are as follows: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Balance at + + Recognised + + Balance at + + Recognised + + Balance at + + Recognised + + + + January 1, + + in income + + December 31, + + in income + + December 31, + + in income + + + + 2001 + + statement + + 2001 + + statement + + 2002 + + statement + + + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + million + + + + Deferred tax assets + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Current + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Deferred revenue, primarily advances from + customers + + + + + + 280 + + + + 384 + + + + 664 + + + + (80 + ) + + + 584 + + + + (25 + ) + + + + Other temporary differences primarily allowance + for doubtful debts + + + + + + 386 + + + + (119 + ) + + + 267 + + + + 92 + + + + 359 + + + + 106 + + + + + Unrecognized revaluation surplus and deficit + (note (ii)) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Provision for early retirement provision benefits + + + + + + 974 + + + + (69 + ) + + + 905 + + + + 130 + + + + 1,035 + + + + (61 + ) + + + + Disposal of fixed assets + + + + + + 483 + + + + 32 + + + + 515 + + + + 144 + + + + 659 + + + + 44 + + + + + Others + + + + + + 12 + + + + (4 + ) + + + 8 + + + + 7 + + + + 15 + + + + 68 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Balance at end of year/period + + + + + + 2,135 + + + + 224 + + + + 2,359 + + + + 293 + + + + 2,652 + + + + 132 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Deferred tax liabilities + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Revenue recognition + + + + + + (762 + ) + + + (35 + ) + + + (797 + ) + + + (5 + ) + + + (802 + ) + + + 90 + + + + + Fixed assets depreciation + + + + + + (6,963 + ) + + + (1,176 + ) + + + (8,139 + ) + + + (970 + ) + + + (9,109 + ) + + + 7,746 + + + + + Deferred cost + + + + + + (332 + ) + + + 113 + + + + (219 + ) + + + 69 + + + + (150 + ) + + + (95 + ) + + + + Interest capitalisation + + + + + + (510 + ) + + + (94 + ) + + + (604 + ) + + + (126 + ) + + + (730 + ) + + + (102 + ) + + + + Others + + + + + + (40 + ) + + + (22 + ) + + + (62 + ) + + + (19 + ) + + + (81 + ) + + + 4 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Balance at end of year/period + + + + + + (8,607 + ) + + + (1,214 + ) + + + (9,821 + ) + + + (1,051 + ) + + + (10,872 + ) + + + 7,643 + + + + + + + + + + + + + + + + + + + + + + + + + + + + +[Additional columns below] + +[Continued from above table, first column(s) repeated] + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Recognised + + Balance at + + Recognised + + + + + + Balance at + + + + in owner s + + December 31, + + in income + + Recognised + + Recognised + + June 30, + + + + equity + + 2003 + + statement + + in equity + + in equity + + 2004 + + + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + million + + + + Deferred tax assets + + + + + + + + + + + + + + + + + + note (i) + + + note (ii) + + + + + + + + Current + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Deferred revenue, primarily advances from + customers + + + + + + + + + + 559 + + + + (45 + ) + + + (513 + ) + + + + + + + 1 + + + + + Other temporary differences primarily allowance + for doubtful debts + + + + + + + + + + 465 + + + + 201 + + + + (420 + ) + + + + + + + 246 + + + + + Unrecognized revaluation surplus and deficit + (note (ii)) + + + + + + + + + + + + + + (117 + ) + + + + + + + 2,355 + + + + 2,238 + + + + + Provision for early retirement provision benefits + + + + + + + + + + 974 + + + + 15 + + + + (945 + ) + + + + + + + 44 + + + + + Disposal of fixed assets + + + + + + + + + + 703 + + + + (70 + ) + + + (633 + ) + + + + + + + + + + + + Others + + + + + + + + + + 83 + + + + 22 + + + + (69 + ) + + + + + + + 36 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Balance at end of year/period + + + + + + + + + + 2,784 + + + + 6 + + + + (2,580 + ) + + + 2,355 + + + + 2,565 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Deferred tax liabilities + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Revenue recognition + + + + + + + + + + (712 + ) + + + 123 + + + + 579 + + + + + + + + (10 + ) + + + + Fixed assets depreciation + + + + + + (984 + ) + + + (2,347 + ) + + + (856 + ) + + + 2,797 + + + + + + + + (406 + ) + + + + Deferred cost + + + + + + + + + + (245 + ) + + + 23 + + + + 131 + + + + + + + + (91 + ) + + + + Interest capitalisation + + + + + + + + + + (832 + ) + + + (36 + ) + + + (270 + ) + + + + + + + (1,138 + ) + + + + Others + + + + + + + + + + (77 + ) + + + 8 + + + + 52 + + + + + + + + (17 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Balance at end of year/period + + + + + + (984 + ) + + + (4,213 + ) + + + (738 + ) + + + 3,289 + + + + + + + + (1,662 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + +The amounts shown in the consolidated balance +sheet include the following: + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Deferred tax assets to be recovered after more + than 12 months + + + + + + + + + + + + + + 1,428 + + + + + + + + 1,709 + + + + + + + + + + + + 1,760 + + + + + + + + + + + + + + + + 2,318 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Deferred tax liabilities to be settled after more + than 12 months + + + + + + + + + + + + + + (9,024 + ) + + + + + + + (10,070 + ) + + + + + + + + + + + (3,501 + ) + + + + + + + + + + + + + + + (1,652 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +F-41 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +Notes: + + + + + + + + + (i) + + + + As described in Note 15, in connection with + the Reorganisation, certain of the Group s + telecommunications networks and equipment and furniture, + fixture, motor vehicles and other equipment were revalued as at + December 31, 2003. Such revalued amounts will be used to + determine the tax bases for these assets for future years. In + addition, in connection with the Reorganisation, the tax bases + of certain assets and liabilities have been adjusted to the + revalued amounts incorporated as the carrying values in the + balance sheet, except for the item described in Note (ii) + below. As a result, the Group s net deferred tax + liabilities was subsequently reduced by RMB709 million + (comprising deferred tax assets of RMB2,580 million and + deferred tax liabilities of RMB3,289 million), and this + reduction was recorded as a credit to owner s equity upon + the date of the Reorganisation on June 30, 2004. Among the + RMB709 million net reduction of deferred tax liabilities, + RMB846 million, being deferred tax liabilities originated + from the revaluation surplus of fixed assets recorded, was + credited to revaluation reserves and the remaining + RMB137 million deferred tax assets were debited to retained + earnings. + + + + + + (ii) + + + + In addition, the Group s land and buildings + were revalued for PRC tax purposes with a net surplus of + RMB6,967 million as at December 31, 2003 to determine + the tax bases for future years. However, the resulting + revaluations of land and buildings were not incorporated in the + consolidated financial statements. As a result, a deferred tax + asset of RMB2,355 million was subsequently recorded with a + corresponding increase in owner s equity upon the + Reorganisation on June 30, 2004. In the opinion of the + directors, it is more likely than not the Group will realise the + benefits of the deferred tax asset after making reference to the + historical taxable income of the Group. The amount is + transferred to retained earnings upon the corresponding + depreciation of the underlying fixed assets. The amount of + transfer to retained earnings for the six months ended + June 30, 2004 was RMB117 million. + + + + + + + + 28. + + Consolidated cash flow statements + +(a) Reconciliation of profit/(loss) +before taxation to net cash flows generated from +operations + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months + + + + Years ended December 31, + + ended June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + + + Profit/(loss) before taxation + + + + + + 9,967 + + + + 8,732 + + + + (17,931 + ) + + + 5,634 + + + + 6,996 + + + + + Depreciation of fixed assets and amortisation of + intangible assets + + + + + + 16,153 + + + + 18,808 + + + + 20,483 + + + + 9,967 + + + + 9,552 + + + + + Amortisation of deferred revenues + + + + + + (9,027 + ) + + + (12,058 + ) + + + (14,309 + ) + + + (6,881 + ) + + + (9,105 + ) + + + + Deferred costs expensed in the income statements + + + + + + 655 + + + + 1,129 + + + + 1,927 + + + + 589 + + + + 1,516 + + + + + Deficit on revaluation of fixed assets + + + + + + + + + + + + + + 25,778 + + + + + + + + + + + + + Allowance for doubtful debts + + + + + + 331 + + + + 357 + + + + 619 + + + + 363 + + + + 478 + + + + + Loss on disposal of fixed assets + + + + + + 1,311 + + + + 1,686 + + + + 1,689 + + + + 495 + + + + 80 + + + + + Dividend income + + + + + + (181 + ) + + + (78 + ) + + + (45 + ) + + + (31 + ) + + + (7 + ) + + + + Share of profit/(loss) from associated companies + and jointly controlled entities + + + + + + (4 + ) + + + 1 + + + + 416 + + + + 87 + + + + 1 + + + + + Interest income + + + + + + (158 + ) + + + (82 + ) + + + (79 + ) + + + (39 + ) + + + (32 + ) + + + + Interest expense + + + + + + 1,987 + + + + 2,800 + + + + 2,844 + + + + 1,490 + + + + 1,598 + + +F-42 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months + + + + Years ended December 31, + + ended June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + million + + + + Discount on foreign currency exchange forward + contracts + + + + + + 31 + + + + 25 + + + + 20 + + + + 11 + + + + 9 + + + + + Realised gain on disposal of other investments + + + + + + (5 + ) + + + (28 + ) + + + (1 + ) + + + (1 + ) + + + + + + + + Unrealised (gain)/loss on other investments + + + + + + (12 + ) + + + (2 + ) + + + (7 + ) + + + (7 + ) + + + 7 + + + + + Unrealised foreign exchange (gains)/losses + + + + + + (61 + ) + + + 2 + + + + 142 + + + + (35 + ) + + + 15 + + + + + + + + + + + + + + + + + + + + + + + + + + + Operating profit before working capital changes + + + + + + 20,987 + + + + 21,292 + + + + 21,546 + + + + 11,642 + + + + 11,108 + + + + + Decrease/(increase) in accounts receivable + + + + + + 408 + + + + (1,225 + ) + + + (1,779 + ) + + + (1,280 + ) + + + (957 + ) + + + + Decrease/(increase) in inventories and consumables + + + + + + 216 + + + + 332 + + + + (231 + ) + + + (125 + ) + + + (11 + ) + + + + Decrease/(increase) in prepayments and other + receivables + + + + + + 4,330 + + + + 1,391 + + + + 270 + + + + (561 + ) + + + 432 + + + + + Increase in deferred costs and other non-current + assets + + + + + + (1,496 + ) + + + (1,171 + ) + + + (3,494 + ) + + + (879 + ) + + + (2,318 + ) + + + + Increase in accounts payables + + + + + + 1,692 + + + + 186 + + + + 1,883 + + + + 338 + + + + 19 + + + + + (Decrease)/increase in accruals and other payable + + + + + + (7,663 + ) + + + (363 + ) + + + (457 + ) + + + 1,173 + + + + 44 + + + + + Increase in deferred revenues + + + + + + 7,643 + + + + 7,582 + + + + 11,069 + + + + 5,443 + + + + 7,498 + + + + + + + + + + + + + + + + + + + + + + + + + + + Net cash inflow generated from operations + + + + + + 26,117 + + + + 28,024 + + + + 28,807 + + + + 15,751 + + + + 15,815 + + + + + + + + + + + + + + + + + + + + + + + + +(b) Major non-cash +transactions + + +In six months ended June 30, 2004, the Group +entered into finance lease arrangements in respect of newly +acquired fixed assets with a total capital value at the +inception of the lease of RMB 146 million (six months +ended June 30, 2003: RMB 500 million; year ended +December 31, 2003: RMB 276 million; year ended +December 31, 2002: RMB82 million; year ended +December 31, 2001: RMB 561 million). + + + + + + + (c) + + Acquisition of Asia Global Crossing through + Asia Netcom + + +The Group acquired 100% of certain entities +previously controlled by Asia Global Crossing by way of two +acquisitions which were effected as follows: + + +(i) In March 2003 the company invested +RMB 507 million (US$61 million) in an inactive +subsidiary, Asia Netcom, and introduced two new shareholders. +The Group s shareholding in Asia Netcom was reduced to 51% +by the introduction of these two new shareholders. Subsequent to +the introduction of the new shareholders, Asia Netcom became a +jointly controlled entity. + + +On March 10, 2003, Asia Netcom acquired +certain entities previously controlled by Asia Global Crossing +for a total cost of RMB 62 million +(US$7.53 million). The entities acquired from Asia Global +Crossing own and operate an Asia-Pacific region cable network +providing city-to-city connectivity, data communications and +IP-based services. + + +(ii) On December 31, 2003, the Group +acquired the remaining 49% of the equity of Asia Netcom for a +total cost of RMB 525 million (US$63.5 million). + +F-43 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +From March 10, 2003 to December 31, +2003, Asia Netcom was accounted for as a jointly controlled +entity. On December 31, 2003, Asia Netcom became a wholly +owned subsidiary of the Company and was consolidated into the +Group s financial statements. + + +The net assets acquired and the net cash inflow +in respect of the purchase of the remaining 49% interest in Asia +Netcom, which has a group of subsidiaries, is analysed as +follows: + + + + + + + + + + As at + + + + December 31, + + + + 2003 + + + + + + + + RMB million + + + + Net assets acquired at their respective estimated + fair values + + + + + + + + + + + Fixed assets + + + + + + 3,037 + + + + + Deferred costs + + + + + + 870 + + + + + Other non-current assets + + + + + + 157 + + + + + Cash and bank deposits + + + + + + 580 + + + + + Accounts receivables and other current assets + + + + + + 442 + + + + + Accounts payable and other current liabilities + + + + + + (1,207 + ) + + + + Advances from networks capacity sales + + + + + + (2,032 + ) + + + + Bank and other loans + + + + + + (1,011 + ) + + + + + + + + + + Net assets + + + + + + 836 + + + + + + + + + + + 49% of net assets + + + + + + 410 + + + + + Goodwill (Note 17) + + + + + + 115 + + + + + + + + + + + Satisfied by cash + + + + + + 525 + + + + + + + + + + + Cash consideration + + + + + + 525 + + + + + Cash and bank deposits acquired + + + + + + (580 + ) + + + + + + + + + + Net cash outflow in respect of the purchase of + subsidiaries + + + + + + (55 + ) + + + + + + + + + + + + + 29. + + Contingent liabilities + +(a) Guarantees + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Guarantees for US dollar denominated bank + loans of third parties + + + + + + 250 + + + + 188 + + + + 125 + + + + 94 + + + + + + + + + + + + + + + + + + + + + +The Group entered into the above guarantee +arrangement in 2000 and did not make any provision for the above +guarantees during the three years ended December 31, 2003 +and the six months ended June 30, 2004 because the +directors were of the opinion that the possibility for the +guaranteed party to default on the outstanding balance of the +borrowing was remote. + + +On December 8, 2000, a subsidiary of the +Company entered into an agreement to provide a guarantee to a +subsidiary of China Mobile for a foreign currency borrowing. The +guarantee arose from the assumption of responsibilities by both +parties as part of the legacy arrangements of their predecessor +companies commonly controlled by the state government. + +F-44 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +The guarantee obligation is limited to the +outstanding loan and accrued interest amount payable by the +subsidiary of China Mobile which is due to be settled by +September 2005. As at December 31, 2003 and +June 30, 2004, the outstanding balances of the borrowing, +including interest payable, were US$15.1 million +(RMB125 million) and US$11.4 million +(RMB94 million) respectively. + + +The directors are of the opinion that the +possibility of the guaranteed party defaulting on the +outstanding balance of the borrowing was remote, hence no +provisions have been made for the guarantee. + +(b) National Audit Office +( NAO ) audit + + +The NAO is currently performing an audit on the +ultimate holding company, China Netcom Group, including all of +its business operations, assets and liabilities prior to the +Reorganisation. Substantial assets and liabilities currently +comprising the Group were injected by China Netcom Group in +accordance with the Reorganisation. The audit is currently in +progress and NAO has not communicated its preliminary findings +or conclusions, if any, to the Company as of the date of the +approval of those financial statements. The directors are of the +opinion that, to their best knowledge, there is no specific +matter that qualify for further disclosure in the financial +statements in relation to the NAO audit. + + + + + + + 30. + + Banking facilities + + +As at December 31, 2001, 2002 and 2003 and +June 30, 2004, the Group s banking facilities are as +follows: + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Amount utilised + + + + + + 64,426 + + + + 69,716 + + + + 69,498 + + + + 56,767 + + + + + Amount unutilised + + + + + + 7,296 + + + + 8,453 + + + + 10,952 + + + + 11,845 + + + + + + + + + + + + + + + + + + + + + + + Aggregate banking facilities + + + + + + 71,722 + + + + 78,169 + + + + 80,450 + + + + 68,612 + + + + + + + + + + + + + + + + + + + + + + + + + + 31. + + Commitments + +(a) Capital commitments + + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Contracted but not provided for + + + + + + + + + + + + + + + + + + + + + + + + Land and buildings + + + + + + 130 + + + + 130 + + + + 220 + + + + 54 + + + + + + Telecommunications networks and equipment + + + + + + 2,070 + + + + 1,101 + + + + 1,971 + + + + 3,339 + + + + + + + + + + + + + + + + + + + + + + + + 2,200 + + + + 1,231 + + + + 2,191 + + + + 3,393 + + + + + + + + + + + + + + + + + + + + + + + Authorised but not contracted for + + + + + + + + + + + + + + + + + + + + + + + + Land and buildings + + + + + + 152 + + + + 306 + + + + 213 + + + + 12 + + + + + + Telecommunications networks and equipment + + + + + + 1,092 + + + + 4,966 + + + + 4,626 + + + + 4,794 + + + + + + + + + + + + + + + + + + + + + + + + 1,244 + + + + 5,272 + + + + 4,839 + + + + 4,806 + + + + + + + + + + + + + + + + + + + + +F-45 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +(b) Operating lease +commitments + + +The Group had future minimum lease payments under +non-cancellable operating leases in respect of premises and +equipment as follows: + + + + + + + + + + + + + + + + + + + + + + + + As at + + + + As at December 31, + + June 30, + + + + + + + + + + 2001 + + 2002 + + 2003 + + 2004 + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + + + million + + million + + million + + million + + + + Not later than one year + + + + + + 246 + + + + 147 + + + + 463 + + + + 942 + + + + + Later than one year and not later than five years + + + + + + 329 + + + + 371 + + + + 770 + + + + 1,648 + + + + + Later than five years + + + + + + 428 + + + + 539 + + + + 297 + + + + 1,025 + + + + + + + + + + + + + + + + + + + + + + + + 1,003 + + + + 1,057 + + + + 1,530 + + + + 3,615 + + + + + + + + + + + + + + + + + + + + + + + + + + 32. + + Related party transactions + + +Parties are considered to be related if one party +has the ability, directly or indirectly, to control the party or +exercise significant influence over the party in making +financial and operating decisions. Parties are also considered +to be related if they are subject to common control or common +significant influence. + +F-46 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + +The directors consider that the following related +party transactions were carried out in the normal course of +business of the Group and at terms mutually agreed between the +Group and the respective related parties. + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Six months ended + + + + + + Years ended December 31, + + June 30, + + + + + + + + + + + + Note + + 2001 + + 2002 + + 2003 + + 2003 + + 2004 + + + + + + + + + + + + + + + + + + + + RMB + + RMB + + RMB + + RMB + + RMB + + + + + + million + + million + + million + + million + + million + + + + Rental income from properties leased to related + companies + + + + + + (v)a, (v)c + + + + 1 + + + + 1 + + + + 4 + + + + + + + + 2 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Purchase of materials + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + from fellow subsidiaries + + + + + + (v)a, (v)c + + + + (3,874 + ) + + + (2,809 + ) + + + (2,365 + ) + + + (726 + ) + + + (528 + ) + + + + from related companies + + + + + + (v)a, (v)c + + + + (1,288 + ) + + + (1,473 + ) + + + (1,738 + ) + + + (643 + ) + + + (670 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (5,162 + ) + + + (4,282 + ) + + + (4,103 + ) + + + (1,369 + ) + + + (1,198 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Receipt of engineering, project planning, design, + construction and information technology services + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + from fellow subsidiaries + + + + + + (v)a, (v)b + + + + (1,150 + ) + + + (1,377 + ) + + + (1,714 + ) + + + (651 + ) + + + (321 + ) + + + + from related companies + + + + + + (v)a, (v)b + + + + (1,388 + ) + + + (1,562 + ) + + + (1,517 + ) + + + (353 + ) + + + (564 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (2,538 + ) + + + (2,939 + ) + + + (3,231 + ) + + + (1,004 + ) + + + (885 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Ancillary telecommunications support services(i) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + from fellow subsidiaries + + + + + + (v)a, (v)c + + + + (509 + ) + + + (759 + ) + + + (1,021 + ) + + + (364 + ) + + + (207 + ) + + + + from related companies + + + + + + (v)a, (v)c + + + + (435 + ) + + + (543 + ) + + + (767 + ) + + + (241 + ) + + + (232 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (944 + ) + + + (1,302 + ) + + + (1,788 + ) + + + (605 + ) + + + (439 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Payment of operating lease rentals for premises + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + from fellow subsidiaries + + + + + + (v)a, (v)c + + + + (5 + ) + + + (10 + ) + + + (13 + ) + + + (5 + ) + + + (7 + ) + + + + from related companies + + + + + + (v)a, (v)c + + + + (16 + ) + + + (29 + ) + + + (35 + ) + + + (7 + ) + + + (5 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (21 + ) + + + (39 + ) + + + (48 + ) + + + (12 + ) + + + (12 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Support services(ii) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + from fellow subsidiaries + + + + + + (v)a, (v)c + + + + (690 + ) + + + (500 + ) + + + (1,028 + ) + + + (468 + ) + + + (187 + ) + + + + from related companies + + + + + + (v)a, (v)c + + + + (374 + ) + + + (498 + ) + + + (510 + ) + + + (170 + ) + + + (149 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + (1,064 + ) + + + (998 + ) + + + (1,538 + ) + + + (638 + ) + + + (336 + ) + + + + + + + + + + + + + + + + + + + + + + + + + + + +Notes: + + + + + + + + + (i) + + + + Represents provision of ancillary + telecommunications support services to the Group by the fellow + subsidiaries and the related companies. These services include + certain telecommunications pre-sale, on-sale and after-sale + services, certain sales agency services, the printing and + delivery of invoice services, the maintenance of certain + air-conditioning, fire alarm equipment and telephone booths and + other customers services. + + + + + + (ii) + + + + Represents the support services provided to the + Group by the fellow subsidiaries and the related companies. + These support services include equipment leasing services, motor + vehicles services, safety + + +F-47 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + +and security services, conference services, basic +construction agency services, equipment maintenance services, +employee training services, advertising services, printing +services and other support services. + + + + + + + + + (iii) + + + + As at respective balance sheet dates, the Group + had balances with certain related parties, which have been set + out in Notes 23(b)(ii) and 24. + + + + + + (iv) + + + + The related companies represent the investees of + the unlisted fellow subsidiaries. + + + + + + (v) + + + + Transactions with individual related party are + priced based on one of the following three criteria: + + + + + + + + + a) market price; + + + + + + + + + b) prices based on government guidance; and + + + + + + + + + c) cost plus basis. + + + + + + + + 33. + + Share capital + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Authorized + + + + + + + + + + + + + + + + + + Convertible preference shares of + + + + + + Ordinary shares of US$0.04 + + US$0.04 each (note (d)) + + Total + + + + + + + + + + + + + + RMB + + No. of + + + + RMB + + + + RMB + + + + No. of shares + + US$ + + million + + shares + + US$ + + million + + US$ + + million + + + + + + + + + + + + + + + + + + + + + + At January 1, 2001, December 31, 2001, + 2002 and 2003, June 30, 2004 + + + + + + 25,000,000,000 + + + + 1,000,000,000 + + + + 8,277 + + + + 7,741,782 + + + + 309,671 + + + + 3 + + + + 1,000,309,671 + + + + 8,280 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Issued + + + + + + + + + + + + + + + + + + Convertible preference shares of + + + + + + Ordinary shares of US$0.04 + + US$0.04 each + + Total + + + + + + + + + + + + + + RMB + + No. of + + + + RMB + + + + RMB + + + + No. of shares + + US$ + + million + + shares + + US$ + + million + + US$ + + million + + + + + + + + + + + + + + + + + + + + + + At January 1, 2001 (note (b)) + + + + + + 5,490,658,218 + + + + 219,626,329 + + + + 1,815 + + + + + + + + + + + + + + + + 219,626,329 + + + + 1,815 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + Shares issued (note (c)) + + + + + + 1,600,000 + + + + 64,000 + + + + 1 + + + + + + + + + + + + + + + + 64,000 + + + + 1 + + + + + Issue of convertible preference shares + (note (d)) + + + + + + + + + + + + + + + + + + 7,741,782 + + + + 309,671 + + + + 3 + + + + 309,671 + + + + 3 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + At December 31, 2001, 2002 and 2003, + June 30, 2004 + + + + + + 5,492,258,218 + + + + 219,690,329 + + + + 1,816 + + + + 7,741,782 + + + + 309,671 + + + + 3 + + + + 220,000,000 + + + + 1,819 + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +Notes: + + + + + + + + + (a) + + + + Pursuant to an ordinary resolution dated + September 1, 2004, the authorised share capital of the + Company was increased to US$1,000,000,000 by creating additional + 99,600,000,000 shares of US$0.01 each. Pursuant to an ordinary + resolution passed on September 7, 2004, every four issued + and unissued shares of US$0.01 each were consolidated into one + new share of US$0.04 each. Following the creation of + 99,600,000,000 additional shares and the share consolidation, + the authorised share capital of the Company is RMB 8,277 + million divided into 25,000,000,000 shares of US$0.04 each, of + which 5,492,258,218 shares were in issue and fully paid. The + shares after the share consolidation rank pair in all respects + with each other. All references to the share capital of the + Company in this report have been adjusted retrospectively since + beginning of the relevant periods to take into account the + increase in authorised share capital and share consolidation. + Besides, the increase in authorized capital is applied + respectively in connection with presentation of share capital of + the consolidated balance sheets as detailed in notes below. + + +F-48 + +Table of Contents + +China Netcom Group Corporation (Hong Kong) +Limited + +Notes to Consolidated Financial +Statements + + + + + + + + + (b) + + + + The share capital presented in the consolidated + balance sheet at January 1, 2001 represents (i) the + share capital of the Company, including the shares as at + January 1, 2001 totalling 500,000 ordinary shares, + (ii) shares issued for the Asset Injection arising from the + Reorganisation totalling 5,442,258,218 ordinary shares + described in note 1 above, and (iii) shares issued to + CNC Holding, the then ultimate holding company, for the transfer + of entire interest in CNC China to the Company totalling + 47,900,000 ordinary shares in February 2001. + + + + + + + + + The shares described in (ii) and (iii) are deemed + to have been issued throughout the relevant periods presented as + the shares were issued for mergers under common control, which + constitutes the differences between share capital of the Company + and the Group as at each of December 31, 2001, 2002 and + 2003. + + + + + + + + + The difference between the nominal value of the + shares described in (ii) and the value of the net assets + injected into the Company under the Asset Injection, totaling + approximately RMB 31,263 million, is reflected as + share premium as at January 1, 2001. The difference between + the nominal value of the shares described in (iii) and the + net assets of CNC China amounting to approximately + RMB 134 million, is reflected as share premium as at + January 1, 2001. + + + + + + (c) + + + + On February 7, 2001, 1,600,000 ordinary + shares of nominal value of US$0.04 each (taking into + consideration the effect of share consolidation) were issued at + RMB 4.00 each pursuant to the share subscription plan as + detailed in note 34. + + + + + + (d) + + + + On February 7, 2001, + 7,741,782 preference shares (taking into consideration the + effect of share consolidation) were issued for cash totalling + US$325,000,000. The difference between the nominal value of + these preference shares and the value of the cash received, + totalling US$324,690,329, is reflected as share premium on the + same date. The holders of convertible preference shares carry no + voting rights in the general meetings of the Company. Each + preference share is convertible, at the option of the holder, + into one fully paid ordinary share, subject to adjustment for \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CIK0001312731_global_legal_matters.txt b/parsed_sections/legal_matters/2004/CIK0001312731_global_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..631245d9274f61918ef4cef43dd2c1ede2fb743e --- /dev/null +++ b/parsed_sections/legal_matters/2004/CIK0001312731_global_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters in connection with the ordinary shares with respect to Hong Kong law will be passed upon for us by Hastings & Co. our Hong Kong counsel. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CNS_cohen_legal_matters.txt b/parsed_sections/legal_matters/2004/CNS_cohen_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..10f0e5f60de648c4cf62416eaad134256e141133 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CNS_cohen_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock will be passed upon for us by Simpson Thacher & Bartlett LLP, New York, New York. Certain legal matters in connection with this offering will be passed upon for the underwriters by Clifford Chance US LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CNX_cnx_legal_matters.txt b/parsed_sections/legal_matters/2004/CNX_cnx_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..0f117152812da0344948e088a5112f4745664b1d --- /dev/null +++ b/parsed_sections/legal_matters/2004/CNX_cnx_legal_matters.txt @@ -0,0 +1,3739 @@ +LEGAL MATTERS + + The validity of +the common stock that is being offered pursuant to this prospectus will be passed upon by Piper Rudnick LLP, New York, New York. + + + 108 + +Table of Contents + + +EXPERTS + + The financial statements +as of December 31, 2003 and December 31, 2002 and for the years ended December 31, 2003 and December 31, 2002, included in this prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given +on the authority of said firm as experts in auditing and accounting. + + The consolidated financial statements of CONSOL Energy Inc. at December 31, 2001 and for the periods of six months ended December 31, 2001 and the twelve months ended June 30, 2001 appearing in this prospectus and registration statement +have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and +auditing. + + The financial information included in this +prospectus for the year ended December 31, 2003 and December 31, 2002, relating to our total gas supply and our owned gas reserves of Pocahontas Gas Partnership, is derived from reserve reports prepared or reviewed by Ralph E. Davis Associates, +Inc. The financial information included in this prospectus for the year ended December 31, 2003 and December 31, 2002, six months ended December 31, 2001 and for the twelve months ended June 30, 2001, relating to the estimates of reserves from our +oil and gas reserves, is derived from reserve reports prepared or reviewed by Data and Consulting Services, a division of Schlumberger. This information is included in this prospectus in reliance upon these firms as experts in matters contained in +the reports. + + +WHERE YOU CAN FIND MORE INFORMATION + + We are subject to the reporting requirements of the Securities Exchange Act of 1934 and, in accordance with that Act, file annual and quarterly reports, proxy statements and other information with the Securities and Exchange Commission. +These reports, proxy statements and other information may be inspected and copies of these materials may be obtained upon payment of fees at the Public Reference Room maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. +You may obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330. In addition, we are required to file electronic versions of these materials with the Commission through the Commission s +Electronic and Data Gathering, Analysis and Retrieval system. The Commission maintains a World Wide Web site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants that file +electronically with the Commission. Our common stock is listed on the New York Stock Exchange, and reports and other information concerning us may be inspected at the New York Stock Exchange, Inc. at 20 Broad Street, New York, New York 10005. + + + We have filed with the Commission a registration statement on +Form S-1 under the Securities Act of 1933. This prospectus does not contain all of the information set forth in the registration statement and the exhibits thereto. + + + 109 + +Table of Contents + + +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS + + + + +Page + + +Reports of Independent Auditors + + +F-2 + + +Consolidated Statements of Income (Loss) for the Twelve Months Ended December 31, 2003, December 31, 2002, Six Months Ended December 31, 2001 and Twelve Months Ended June 30, 2001 + + +F-4 + + +Consolidated Balance Sheets at December 31, 2003, December 31, 2002 and December 31, 2001 + + +F-5 + + +Consolidated Statements of Stockholders Equity for the Twelve Months Ended December 31, 2003, December 31, 2002, Six Months Ended December 31, 2001 and Twelve Months Ended June 30, 2001 + + +F-6 + + +Consolidated Statements of Cash Flows for the Twelve Months Ended December 31, 2003, December 31, 2002, Six Months Ended December 31, 2001 and Twelve Months Ended June 30, 2001 + + +F-7 + + +Notes to Consolidated Financial Statements + + +F-8 + + + + F-1 + +Table of Contents + + +REPORT OF INDEPENDENT AUDITORS + + To the Board of Directors and Stockholders of + CONSOL Energy Inc. + + In our opinion, the accompanying consolidated balance sheets and the related +consolidated statements of income, stockholders equity and cash flows present fairly, in all material respects, the financial position of CONSOL Energy Inc. and its subsidiaries (the Company) at December 31, 2003 and 2002, and the results of +their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial presentation. We believe that our audits provide a reasonable basis for our opinion. + + As discussed in Note 10 to the consolidated financial statements, the Company +changed the manner in which it accounts for asset retirement costs as of January 1, 2003. + + + + + Pittsburgh, Pennsylvania + February 20, 2004 + + + F-2 + +Table of Contents + + REPORT OF INDEPENDENT AUDITORS + + To the Board of Directors and Stockholders of + CONSOL Energy Inc. + + We have audited the consolidated balance sheets of CONSOL Energy Inc. and subsidiaries (CONSOL Energy) as of December 31, 2001, and the related +consolidated statements of income, stockholders equity and cash flows for the six months ended December 31, 2001 and for the twelve months ended June 30, 2001. These financial statements are the responsibility of CONSOL Energy s +management. Our responsibility is to express an opinion on these financial statements based on our audits. + + We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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. + + + In our opinion, the consolidated financial statements referred +to above present fairly, in all material respects, the consolidated financial position of CONSOL Energy at December 31, 2001 and the consolidated results of their operations and their cash flows for the six months ended December 31, 2001 and for the +twelve months ended June 30, 2001, in conformity with accounting principles generally accepted in the United States. + + + + + Pittsburgh, Pennsylvania + January +16, 2002, + except for the information included in Note 30 and Note 31 + related to the periods December 31, 2001 + and prior as to which the date is March 5, 2004. + + + F-3 + +Table of Contents + + CONSOL ENERGY INC. AND SUBSIDIARIES + + +CONSOLIDATED STATEMENTS OF INCOME + (Dollars in thousands, except per share data) + + + + +For the Twelve Months Ended +December 31, + + + + For the Six +Months Ended +December 31, + 2001 + + + + For the Twelve +Months Ended + June 30, + 2001 + + + + + +2003 + + + +2002 + + + + + + Sales Outside + + +$ +2,041,482 + + +$ +2,002,541 + + +$ +964,460 + + +$ +2,113,914 + + + Sales Related Parties (Note 3) + + + +1,369 + + + +804 + + + + + + + +9,288 + + + Freight Outside + + + +114,020 + + + +133,852 + + + +70,314 + + + +157,037 + + + Freight Related Parties (Note 3) + + + +562 + + + +564 + + + + + + + +3,903 + + + Other Income (Note 4) + + + +65,033 + + + +45,837 + + + +31,223 + + + +70,457 + + + + + + + + + + + + Total Revenue and Other Income + + + +2,222,466 + + + +2,183,598 + + + +1,065,997 + + + +2,354,599 + + + Costs of Goods Sold and Other Operating Charges (exclusive of depreciation, depletion and amortization shown below) + + + +1,624,016 + + + +1,543,189 + + + +761,146 + + + +1,554,867 + + + Freight Expense + + + +114,582 + + + +134,416 + + + +70,314 + + + +160,940 + + + Selling, General and Administrative Expenses + + + +77,571 + + + +65,888 + + + +31,493 + + + +63,043 + + + Depreciation, Depletion and Amortization + + + +242,152 + + + +262,873 + + + +120,039 + + + +243,272 + + + Interest Expense (Note 5) + + + +34,451 + + + +46,213 + + + +16,564 + + + +57,598 + + + Taxes Other Than Income (Note 6) + + + +160,209 + + + +172,479 + + + +80,659 + + + +158,066 + + + Export Sales Excise Tax Resolution (Note 7) + + + +(614 +) + + +(1,037 +) + + +5,402 + + + +(123,522 +) + + Restructuring Costs (Note 8) + + + +3,606 + + + + + + + + + + + + + + + + + + + + + + + + Total Costs + + + +2,255,973 + + + +2,224,021 + + + +1,085,617 + + + +2,114,264 + + + Earnings (Loss) Before Income Taxes + + + +(33,507 +) + + +(40,423 +) + + +(19,620 +) + + +240,335 + + + Income Taxes (Benefits) (Note 9) + + + +(20,941 +) + + +(52,099 +) + + +(20,679 +) + + +56,685 + + + + + + + + + + + + Earnings (Loss) before Cumulative Effect of Change in Accounting Principle + + +$ +(12,566 +) + +$ +11,676 + + +$ +1,059 + + +$ +183,650 + + + + + + + + + + + + Cumulative Effect of Changes in Accounting for Mine Closing, Reclamation and Gas Well Closing Costs, Net of Income Taxes of $3,035 +(Note +10) + + +$ +4,768 + + +$ + + + +$ + + + +$ + + + + + + + + + + + + + Net Income (Loss) + + +$ +(7,798 +) + +$ +11,676 + + +$ +1,059 + + +$ +183,650 + + + + + + + + + + + + Earnings (Loss) per Share (Note 1): + + + + + + + + + + + + + + + + + + + Basic + + +$ +(0.10 +) + +$ +0.15 + + +$ +0.01 + + +$ +2.34 + + + + + + + + + + + + Dilutive + + +$ +(0.10 +) + +$ +0.15 + + +$ +0.01 + + +$ +2.33 + + + + + + + + + + + + Weighted Average Number of Common Shares Outstanding (Note 1): + + + + + + + + + + + + + + + + + + + Basic + + + +81,732,589 + + + +78,728,560 + + + +78,699,732 + + + +78,613,580 + + + + + + + + + + + + Dilutive + + + +82,040,418 + + + +78,834,023 + + + +78,920,046 + + + +78,817,935 + + + + + + + + + + + + Dividends per Share + + +$ +0.56 + + +$ +0.84 + + +$ +0.56 + + +$ +1.12 + + + + + + + + + + + + + + + The accompanying notes are an integral part of these consolidated financial +statements. + + + F-4 + +Table of Contents + + CONSOL ENERGY INC. AND SUBSIDIARIES + + +CONSOLIDATED BALANCE SHEET + (Dollars in thousands, except per share data) + + + + +December 31, + + + + + +2003 + + + +2002 + + + +2001 + + + + ASSETS + + + + + + + + + + + + + + + Current Assets: + + + + + + + + + + + + + + + Cash and Cash Equivalents + + +$ +6,513 + + +$ +11,517 + + +$ +15,582 + + + Accounts and Notes Receivable: + + + + + + + + + + + + + + + Trade + + + +89,971 + + + +205,891 + + + +220,442 + + + Other Receivables + + + +91,401 + + + +127,226 + + + +123,336 + + + Inventories (Note 11) + + + +103,358 + + + +135,621 + + + +113,894 + + + Recoverable Taxes + + + +20,257 + + + +21,935 + + + + + + + Deferred Income Taxes (Note 9) + + + +125,938 + + + +92,236 + + + +54,708 + + + Prepaid Expenses + + + +33,402 + + + +28,411 + + + +42,274 + + + + + + + + + + Total Current Assets + + + +470,840 + + + +622,837 + + + +570,236 + + + Property, Plant and Equipment (Note 13): + + + + + + + + + + + + + + + Property, Plant and Equipment + + + +5,495,096 + + + +5,257,456 + + + +4,965,659 + + + Less Accumulated Depreciation, Depletion and Amortization + + + +2,808,638 + + + +2,651,233 + + + +2,361,052 + + + + + + + + + + Total Property, Plant and Equipment Net + + + +2,686,458 + + + +2,606,223 + + + +2,604,607 + + + Other Assets: + + + + + + + + + + + + + + + Deferred Income Taxes (Note 9) + + + +409,090 + + + +420,718 + + + +520,906 + + + Intangible Assets (Note 14) + + + +375,049 + + + +388,362 + + + +403,347 + + + Restricted Cash + + + +190,918 + + + + + + + + + + + Investment in Affiliates + + + +84,878 + + + +135,362 + + + +77,928 + + + Other + + + +101,745 + + + +119,658 + + + +121,708 + + + + + + + + + + Total Other Assets + + + +1,161,680 + + + +1,064,100 + + + +1,123,889 + + + + + + + + + + TOTAL ASSETS + + +$ +4,318,978 + + +$ +4,293,160 + + +$ +4,298,732 + + + + + + + + + + LIABILITIES AND STOCKHOLDERS EQUITY + + + + + + + + + + + + + + + Current Liabilities: + + + + + + + + + + + + + + + Accounts Payable + + +$ +134,772 + + +$ +151,371 + + +$ +171,923 + + + Short-Term Notes Payable (Note 15) + + + +68,760 + + + +204,545 + + + +77,869 + + + Current Portion of Long-Term Debt and Capital Lease Obligations (Note 17 and 18) + + + +53,330 + + + +8,615 + + + +72,771 + + + Accrued Income Taxes + + + + + + + + + + + +4,799 + + + Other Accrued Liabilities (Note 16) + + + +567,737 + + + +449,902 + + + +313,379 + + + + + + + + + + Total Current Liabilities + + + +824,599 + + + +814,433 + + + +640,741 + + + Long-Term Debt: + + + + + + + + + + + + + + + Long-Term Debt (Note 17) + + + +441,912 + + + +485,535 + + + +464,187 + + + Capital Lease Obligations (Note 18) + + + + + + + +2,896 + + + +8,482 + + + + + + + + + + Total Long-Term Debt + + + +441,912 + + + +488,431 + + + +472,669 + + + Deferred Credits and Other Liabilities: + + + + + + + + + + + + + + + Postretirement Benefits Other Than Pensions (Note 19) + + + +1,494,615 + + + +1,437,987 + + + +1,417,567 + + + Pneumoconiosis Benefits (Note 20) + + + +441,076 + + + +455,436 + + + +459,776 + + + Mine Closing + + + +312,208 + + + +332,920 + + + +333,738 + + + Workers Compensation + + + +255,785 + + + +261,250 + + + +269,075 + + + Deferred Revenue + + + +61,673 + + + +102,400 + + + +227,595 + + + Salary Retirement + + + +79,545 + + + +91,474 + + + +8,633 + + + Reclamation + + + +14,480 + + + +5,812 + + + +13,744 + + + Other + + + +102,448 + + + +140,970 + + + +183,635 + + + + + + + + + + Total Deferred Credits and Other Liabilities + + + +2,761,830 + + + +2,828,249 + + + +2,913,763 + + + + + + + + + + Total Liabilities + + + +4,028,341 + + + +4,131,113 + + + +4,027,173 + + + + + + + + + + Shareholders Equity: + + + + + + + + + + + + + + + Common Stock, $.01 Par Value; 500,000,000 Shares Authorized, 91,267,558 Issued and 89,861,900 Outstanding at December 31, 2003; 80,267,558 +Issued; 78,749,001 Outstanding at December 31, 2002 and 78,705,638 Outstanding at December 31, 2001 + + + +913 + + + +803 + + + +803 + + + Capital in Excess of Par Value + + + +833,675 + + + +643,787 + + + +643,627 + + + Preferred Stock, 15,000,000 Shares Authorized; None Issued and Outstanding + + + + + + + + + + + + + + + Retained Earnings (Deficit) + + + +(425,470 +) + + +(372,017 +) + + +(317,566 +) + + Other Comprehensive Loss (Note 23) + + + +(102,601 +) + + +(93,370 +) + + +(37,659 +) + + Common Stock in Treasury, at Cost 1,405,658 Shares at December 31, 2003, 1,518,557 Shares at December 31, 2002, 1,561,920 Shares at +December 31, 2001 + + + +(15,880 +) + + +(17,156 +) + + +(17,646 +) + + + + + + + + + Total Stockholders Equity + + + +290,637 + + + +162,047 + + + +271,559 + + + + + + + + + + TOTAL LIABILITIES AND STOCKHOLDERS EQUITY + + +$ +4,318,978 + + +$ +4,293,160 + + +$ +4,298,732 + + + + + + + + + + + The accompanying notes +are an integral part of these consolidated financial statements. + + + F-5 + +Table of Contents + + CONSOL ENERGY INC. AND SUBSIDIARIES + + +CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY + (Dollars in thousands, except per share data) + + + + + +Common +Stock + + +Capital +in +Excess +of Par +Value + + +Retained +Earnings +(Deficit) + + + +Other +Comprehensive +Loss + + + +Common +Stock in +Treasury + + + +Total +Stockholders +Equity + + + + Balance at June 30, 2000 + + +$ +803 + +$ +642,947 + +$ +(370,152 +) + +$ +(322 +) + + +(19,097 +) + +$ +254,179 + + + Net Income + + + + + + + + + +183,650 + + + + + + + + + + + +183,650 + + + Minimum Pension Liability (Net of $10 tax) + + + + + + + + + + + + + +(15 +) + + + + + + +(15 +) + + + + + + + + + + + + + + + Comprehensive Income (Loss) + + + + + + + + + +183,650 + + + +(15 +) + + + + + + +183,635 + + + Treasury Stock Issued (118,981 Shares) + + + + + + +539 + + + + + + + + + + +1,345 + + + +1,884 + + + Dividends ($1.12 per Share) + + + + + + + + + +(88,051 +) + + + + + + + + + + +(88,051 +) + + + + + + + + + + + + + + + Balance at June 30, 2001 + + + +803 + + +643,486 + + +(274,553 +) + + +(337 +) + + +(17,752 +) + + +351,647 + + + Net Income + + + + + + + + + +1,059 + + + + + + + + + + + +1,059 + + + Minimum Pension Liability (Net of $23,761 tax) + + + + + + + + + + + + + +(37,322 +) + + + + + + +(37,322 +) + + + + + + + + + + + + + + + Comprehensive Income (Loss) + + + + + + + + + +1,059 + + + +(37,322 +) + + + + + + +(36,263 +) + + Treasury Stock Issued (9,383 shares) + + + + + + +141 + + + + + + + + + + +106 + + + +247 + + + Dividends ($.56 per Share) + + + + + + + + + +(44,072 +) + + + + + + + + + + +(44,072 +) + + + + + + + + + + + + + + + Balance at December 31, 2001 + + + +803 + + +643,627 + + +(317,566 +) + + +(37,659 +) + + +(17,646 +) + + +271,559 + + + Net Income + + + + + + + + + +11,676 + + + + + + + + + + + +11,676 + + + Minimum Pension Liability (Net of $34,438 tax) + + + + + + + + + + + + + +(54,092 +) + + + + + + +(54,092 +) + + Treasury Rate Lock (Net of $476 tax) + + + + + + + + + + + + + +746 + + + + + + + +746 + + + Interest Rate Swap Contract (Net of $338 tax) + + + + + + + + + + + + + +(531 +) + + + + + + +(531 +) + + Gas Cash Flow Hedge (Net of $1,168 tax) + + + + + + + + + + + + + +(1,834 +) + + + + + + +(1,834 +) + + + + + + + + + + + + + + + Comprehensive Income (Loss) + + + + + + + + + +11,676 + + + +(55,711 +) + + + + + + +(44,035 +) + + Treasury Stock Issued (42,729 shares) + + + + + + +160 + + + + + + + + + + +490 + + + +650 + + + Dividends ($.84 per share) + + + + + + + + + +(66,127 +) + + + + + + + + + + +(66,127 +) + + + + + + + + + + + + + + + Balance at December 31, 2002 + + + +803 + + +643,787 + + +(372,017 +) + + +(93,370 +) + + +(17,156 +) + + +162,047 + + + Net Income (Loss) + + + + + + + + + +(7,798 +) + + + + + + + + + + +(7,798 +) + + Issuance of Common Stock + + + +110 + + +189,442 + + + + + + + + + + + + + + +189,552 + + + Minimum Pension Liability (Net of $2,789 tax) + + + + + + + + + + + + + +(5,279 +) + + + + + + +(5,279 +) + + Treasury Rate Lock (Net of $53 Tax) + + + + + + + + + + + + + +(81 +) + + + + + + +(81 +) + + Interest Rate Swap Contract (Net of $176 Tax) + + + + + + + + + + + + + +(276 +) + + + + + + +(276 +) + + Gas Cash Flow Hedge (Net of $2,289 tax) + + + + + + + + + + + + + +(3,595 +) + + + + + + +(3,595 +) + + + + + + + + + + + + + + + Comprehensive Income (Loss) + + + + + + + + + + + + + +(9,231 +) + + + + + + +(9,231 +) + + Treasury Stock Issued (112,899 shares) + + + + + + +446 + + + + + + + + + + +1,276 + + + +1,722 + + + Dividends ($.56 per share) + + + + + + + + + +(45,655 +) + + + + + + + + + + +(45,655 +) + + + + + + + + + + + + + + + Balance at December 31, 2003 + + +$ +913 + +$ +833,675 + +$ +(425,470 +) + +$ +(102,601 +) + +$ +(15,880 +) + +$ +290,637 + + + + + + + + + + + + + + + + + The accompanying notes +are an integral part of these consolidated financial statements. + + + F-6 + +Table of Contents + + CONSOL ENERGY INC. AND SUBSIDIARIES + + +CONSOLIDATED STATEMENTS OF CASH FLOW + (Dollars in thousands, except per share data) + + + + +For the Twelve Months +Ended December 31, + + + +For the Six +Months Ended +December 31, + + + For the Twelve +Months + Ended June 30, + + + + + +2003 + + + +2002 + + + +2001 + + + +2001 + + + + Cash Flows from Operating Activities: + + + + + + + + + + + + + + + + + + + Net Income (Loss) + + +$ +(7,798 +) + +$ +11,676 + + +$ +1,059 + + +$ +183,650 + + + Adjustments to Reconcile Net Income to Net Cash Provided By Operating Activities: + + + + + + + + + + + + + + + + + + + Cumulative Effect of Change in Accounting Principle, net of tax + + + +(4,768 +) + + + + + + + + + + + + + + Depreciation, Depletion and Amortization + + + +242,152 + + + +262,873 + + + +120,039 + + + +243,272 + + + Gain on Sale of Assets + + + +(23,372 +) + + +(13,307 +) + + +(6,857 +) + + +(15,280 +) + + Amortization of Advance Mining Royalties + + + +7,013 + + + +9,946 + + + +5,589 + + + +17,192 + + + Deferred Income Taxes + + + +(18,511 +) + + +(45,557 +) + + +(20,943 +) + + +28,631 + + + Equity in Earnings of Affiliates + + + +8,851 + + + +9,818 + + + +(796 +) + + +(19,437 +) + + Changes in Operating Assets: + + + + + + + + + + + + + + + + + + + Accounts Receivable Securitization + + + +108,000 + + + + + + + + + + + + + + + Accounts and Notes Receivable + + + +40,745 + + + +12,061 + + + +58,677 + + + +(91,489 +) + + Inventories + + + +27,044 + + + +(21,727 +) + + +(10,692 +) + + +61,807 + + + Prepaid Expenses + + + +(8,210 +) + + +13,878 + + + +(14,138 +) + + +(4,247 +) + + Changes in Other Assets + + + +17,168 + + + +8,540 + + + +63,475 + + + +(21,827 +) + + Changes in Operating Liabilities: + + + + + + + + + + + + + + + + + + + Accounts Payable + + + +(5,823 +) + + +(20,552 +) + + +5,188 + + + +787 + + + Other Operating Liabilities + + + +99,096 + + + +164,343 + + + +(135,801 +) + + +27,300 + + + Changes in Other Liabilities + + + +(91,354 +) + + +(61,690 +) + + +30,977 + + + +24,233 + + + Other + + + +(9,106 +) + + +(746 +) + + +(2,693 +) + + +1,247 + + + + + + + + + + + + + + +388,925 + + + +317,880 + + + +92,025 + + + +252,189 + + + + + + + + + + + + Net Cash Provided by Operating Activities + + + +381,127 + + + +329,556 + + + +93,084 + + + +435,839 + + + + + + + + + + + + Cash Flows from Investing Activities: + + + + + + + + + + + + + + + + + + + Capital Expenditures + + + +(290,652 +) + + +(295,025 +) + + +(162,700 +) + + +(213,132 +) + + Additions to Intangible Assets + + + +(10,196 +) + + +(5,155 +) + + +(3,318 +) + + +(6,106 +) + + Proceeds from Sale of Assets + + + +108,904 + + + +28,213 + + + +5,601 + + + +12,875 + + + Acquisitions Net of Cash Acquired (Note 2) + + + + + + + + + + + +162,738 + + + +(39,072 +) + + Investment in Equity Affiliates + + + +(12,670 +) + + +(67,969 +) + + +(13,919 +) + + +12,114 + + + + + + + + + + + + Net Cash Used in Investing Activities + + + +(204,614 +) + + +(339,936 +) + + +(11,598 +) + + +(233,321 +) + + + + + + + + + + + Cash Flows from Financing Activities: + + + + + + + + + + + + + + + + + + + Payments on Commercial Paper + + + +(202,953 +) + + +(119,993 +) + + +(36,564 +) + + +(102,455 +) + + Payments on Long-Term Notes + + + + + + + +(66,000 +) + + + + + + + + + + Proceeds from Short-Term Debt + + + +65,000 + + + + + + + + + + + + + + + Payments on Miscellaneous Borrowings + + + +(22 +) + + +(4,285 +) + + +(1,915 +) + + +(5,227 +) + + Proceeds from Long-Term Notes + + + +1,757 + + + +261,803 + + + + + + + + + + + Proceeds from Treasury Rate Lock + + + + + + + +1,332 + + + + + + + + + + + Payments for Bond Issuance Costs + + + + + + + +(1,065 +) + + + + + + + + + + Dividends Paid + + + +(45,613 +) + + +(66,086 +) + + +(44,050 +) + + +(88,014 +) + + Deposits to Restricted Cash + + + +(190,918 +) + + + + + + + + + + + + + + Proceeds from Issuance of Common Stock, Net of Costs + + + +189,552 + + + + + + + + + + + + + + + Issuance of Treasury Stock + + + +1,680 + + + +609 + + + + + + + +1,622 + + + + + + + + + + + + Net Cash Provided by (Used in) Financing Activities + + + +(181,517 +) + + +6,315 + + + +(82,529 +) + + +(194,074 +) + + Net (Decrease) Increase in Cash and Cash Equivalents + + + +(5,004 +) + + +(4,065 +) + + +(1,043 +) + + +8,444 + + + Cash and Cash Equivalents at Beginning of Period + + + +11,517 + + + +15,582 + + + +16,625 + + + +8,181 + + + + + + + + + + + + Cash and Cash Equivalents at End of Period + + +$ +6,513 + + +$ +11,517 + + +$ +15,582 + + +$ +16,625 + + + + + + + + + + + + + The accompanying notes +are an integral part of these consolidated financial statements. + See Note 25 Supplemental Cash Flow Information + + + F-7 + +Table of Contents + + CONSOL ENERGY INC. AND SUBSIDIARIES + + +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + (Dollars in thousands, except per share data) + + + Note 1 Significant Accounting Policies: + + A summary of the significant accounting policies of CONSOL Energy Inc. and subsidiaries (CONSOL Energy) is presented below. +These, together with the other notes that follow, are an integral part of the consolidated financial statements. + + Basis of Consolidation: + + The consolidated financial statements include the accounts of majority-owned and controlled subsidiaries. Investments in \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/CRM_salesforce_legal_matters.txt b/parsed_sections/legal_matters/2004/CRM_salesforce_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..40e8b8edb2cdd60d87713172d6d792ad8dc17585 --- /dev/null +++ b/parsed_sections/legal_matters/2004/CRM_salesforce_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the common stock offered by this prospectus and certain other legal matters are being passed upon for us by our counsel, Gray Cary Ware & Freidenrich LLP, East Palo Alto, California. Certain legal matters relating to the offering will be passed upon for the underwriters by Fenwick & West LLP, Mountain View, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/GLD_spdr-gold_legal_matters.txt b/parsed_sections/legal_matters/2004/GLD_spdr-gold_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..ffa9ab786c22cd8bdd63525fe8536534ad8de3bc --- /dev/null +++ b/parsed_sections/legal_matters/2004/GLD_spdr-gold_legal_matters.txt @@ -0,0 +1 @@ +Legal Matters The validity of the Shares will be passed upon for the Sponsor by Carter Ledyard & Milburn LLP, New York, New York, who, as special US tax counsel to the Trust, will also render an opinion regarding the material federal income tax consequences relating to the Shares. Gibson, Dunn & Crutcher LLP, New York, New York, will opine on the validity of the Underwritten Shares for the Purchaser. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/GTMAY_grupo-tmm_legal_matters.txt b/parsed_sections/legal_matters/2004/GTMAY_grupo-tmm_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..a38e5392c7e8c9197d72d06f4e59a9d9c597a1b1 --- /dev/null +++ b/parsed_sections/legal_matters/2004/GTMAY_grupo-tmm_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the Senior Secured Notes has been passed upon as to Mexican law by Haynes & Boone, S.C., as our Mexican counsel, Mexico City, Mexico, and as to New York law by Milbank, Tweed, Hadley & McCloy LLP, New York, New York, as our special U.S. counsel. Ortiz, Sainz y Erreguerena, S.C. has rendered an opinion regarding the Mexican tax consequences of the sale of the Notes referred to in "Material Mexican Federal Income Tax Considerations." \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/INVA_innoviva_legal_matters.txt b/parsed_sections/legal_matters/2004/INVA_innoviva_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..6412b4ce5cf259b13ed4a898db847d55dfd76dad --- /dev/null +++ b/parsed_sections/legal_matters/2004/INVA_innoviva_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP, Menlo Park, California, will pass upon the validity of the common stock offered by this prospectus. Members of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP are the beneficial owners of 138,099 shares of our common stock and Robert V. Gunderson, Jr., a partner of the firm, is a member of our board of directors. Davis Polk & Wardwell, Menlo Park, California, will pass upon certain legal matters for the underwriters. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/IWSH_wright_legal_matters.txt b/parsed_sections/legal_matters/2004/IWSH_wright_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..224d87b58f2326fa5aa69f063fa02ea365cdb1d5 --- /dev/null +++ b/parsed_sections/legal_matters/2004/IWSH_wright_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters with respect to the shares of common stock offered by this Prospectus have been passed upon by Andrea D. Kantor, our Vice President and General Counsel. As of the date hereof, Ms. Kantor beneficially owns no shares of National Patent Development common stock and 55,301 shares of the common stock of GP Strategies. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/KLIC_kulicke_legal_matters.txt b/parsed_sections/legal_matters/2004/KLIC_kulicke_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..88aafae28c1dcd7c0a68c88406f6398aa2104ee3 --- /dev/null +++ b/parsed_sections/legal_matters/2004/KLIC_kulicke_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS 83 \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/MKTX_marketaxes_legal_matters.txt b/parsed_sections/legal_matters/2004/MKTX_marketaxes_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..30c929ab28fe0bfb36d107449d4d6170f33d7cb9 --- /dev/null +++ b/parsed_sections/legal_matters/2004/MKTX_marketaxes_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Proskauer Rose LLP, New York, New York. Certain legal matters in connection with this offering will be passed upon for the underwriters by Davis Polk Wardwell, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/MLR_miller_legal_matters.txt b/parsed_sections/legal_matters/2004/MLR_miller_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..3f72c3d911187be45363c030b8cf481c24006abc --- /dev/null +++ b/parsed_sections/legal_matters/2004/MLR_miller_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the issuance of the shares of common stock offered hereby will be passed upon for us by Kilpatrick Stockton LLP, Atlanta, Georgia. As of the date hereof, no attorneys at Kilpatrick Stockton LLP who worked on the preparation of this Prospectus beneficially own a substantial interest in our common stock. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/MOH_molina_legal_matters.txt b/parsed_sections/legal_matters/2004/MOH_molina_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..efa52727fc735a5de8f699137b0ec985044c932b --- /dev/null +++ b/parsed_sections/legal_matters/2004/MOH_molina_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the common stock offered by this prospectus will be passed upon for us by McDermott, Will & Emery, Los Angeles, California. Certain legal matters in connection with the offering will be passed upon for the underwriters by Willkie Farr & Gallagher LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/NTGR_netgear_legal_matters.txt b/parsed_sections/legal_matters/2004/NTGR_netgear_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..f1a9e22ef67d479297636d30413f78bccdf029e7 --- /dev/null +++ b/parsed_sections/legal_matters/2004/NTGR_netgear_legal_matters.txt @@ -0,0 +1 @@ +Table of Contents the consistent and recognizable design of our products. We intend to continue building our brand identity through product design, packaging, public relations, advertising campaigns and other marketing efforts. Enhance operational efficiencies. We believe one of the keys to our success in operating a profitable business within the small business and home networking markets has been our ability to control operational costs while continuing to provide first-to-market, innovative products. We have implemented processes to manage product development efficiency, inventory and channel costs, and overall operating expenses. We plan to continue to invest in personnel, technology and processes to enhance our operational discipline and efficiencies with respect to product development, manufacturing, demand assessment and supply chain and channel inventory management. By focusing on operational efficiencies, we intend to continue to meet the demands of our target markets for affordable, high quality products while maintaining a profitable business model. Products Our extensive product line currently includes approximately 100 different products. These products are available in multiple configurations to address the needs of our customers in each geographic region in which our products are sold. Our Ethernet networking products have historically generated a majority of our net revenue. However, in recent periods, the percentage of our net revenue attributable to broadband and wireless networking products has increased. Our products target the following three major segments within the small business and home markets: Ethernet networking products, including switches, NICs or adapters, bridges and print servers; broadband products, including wired and wireless routers and gateways; and wireless networking products, including access points, wireless NICs or adapters, and media adapters and bridges. Computer equipment $ 2,129 $ 2,722 Furniture, fixtures and leasehold improvements 399 794 Software 2,878 3,236 Machinery 1,032 2,216 Construction in progress Table of Contents We customize our products to meet the specific needs of both the small business and home markets, tailoring various elements of the product design, including component specification, physical characteristics such as casing, design and coloration, and specific hardware and software features to meet the needs of these markets. However, we leverage many of our technological developments, high volume manufacturing, technical support and engineering infrastructure across both markets to maximize business efficiencies. Our small business products are designed with an industrial appearance, including metal cases, and for some product categories, the ability to mount the product within standard data networking racks. These products typically include higher port counts, higher data transfer rates and other performance characteristics designed to meet the needs of a small business user. For example, we offer data transfer rates up to one Gigabit per second for our business products to meet the higher capacity requirements of business users. These products are also designed to support transmission modes such as fiber optic cabling, which is common in more sophisticated business environments. Security requirements within our broadband products include firewall and virtual private network capabilities that allow for secure interactions between remote offices and business headquarter locations. Our wireless product offerings for the small business market include higher transfer rates as well as enhanced security capabilities often required in a business setting. Our current development efforts for Ethernet networking products for the small business market include expanding our network management capabilities such as Layer 3 managed switching functionality, as well as offering higher port counts and densities for Fast Ethernet and Gigabit products to support the needs of growing small business customers. For our broadband products in the small business market, we plan to continue enhancing the capabilities of our routers with advanced firewall and virtual private network capabilities and to permit voice calls over the Internet. We expect that these capabilities will be offered in both traditional copper cabling as well as wireless connectivity modes including 802.11b, dual-mode 802.11b/g and tri-mode 802.11a/b/g. Developments in the wireless networking product area include additional 802.11b/g and tri-mode 802.11a/b/g capabilities for access points and NICs, offering advanced speeds, security and backward compatibility. Our home products are designed with pleasing visual and physical aesthetics that are more desirable in a home environment. For example, products featuring our Platinum series physical designs have a silver/gray coloring and lighter plastic casings to appeal to home users. Our Ethernet products for the home market use a lower cost electrical component design and contain lower port counts to meet the increased price sensitivity and specific data networking requirements of home consumers. Our wireless offerings in the home support sufficient data transfer rates for most home user applications, but at a lower price than higher capacity wireless offerings for the small business market. Our broadband products are available with features such as parental control capabilities and firewall security, to allow for safer, more controlled Internet usage in families with children. Our broadband products designed for the home market also contain advanced installation software that guides a less sophisticated data networking user through the installation process with their broadband service provider, using a graphical user interface and simple point and click operations. Our home product offerings include wall-plug data transmission modes which allow home users to take advantage of their existing electrical wiring infrastructure for transmitting data among network components. We are developing a substantial number of new product offerings for the home market. Our current development efforts for Ethernet networking products include expanding our product lines using in-home power lines to form a network, low cost Gigabit Ethernet NICs, and engineering redesigns to allow for price and cost reductions in our switch line. For our broadband products, we plan to expand our portfolio of wired and wireless gateways with integrated asynchronous DSL and cable modem capabilities, with enhanced ease-of-setup installation and ease-of-use capabilities. We expect these capabilities will be offered in both traditional copper cabling as well as 802.11b, and 802.11g wireless connectivity modes. Our development efforts in the wireless networking product area include expanding our line of 802.11g access points, routers and gateways, NICs and bridges with faster speeds, expanded range and enhanced security. Other developments include a USB disk attachable 108 Mbps 802.11g wireless router to wirelessly share files or remote access while away from home and our recently announced wireless digital music player for streaming digital music from PCs or from the Internet to play on traditional analog stereos in the home. Net income (loss) per share attributable to common stockholders: Basic $ (0.25 ) $ 0.00 $ (0.66 ) $ (0.46 ) $ 0.55 Table of Contents Competitive Strengths Since our inception in 1996, we have been solely focused on the networking needs of the small business and home markets. We provide a broad family of innovative networking products and have shipped over 22 million units worldwide. Over the course of the past seven years, we have built a significant market share in several of the geographic and product markets we serve. We believe that the NETGEAR brand name is widely recognized for quality products that meet the networking needs of small business and home users worldwide. Reliable, Easy-to-Use, Affordable Products. We design quality products, perform rigorous technology evaluation and conduct significant product testing, which we believe allow us to achieve a high degree of customer satisfaction and a low rate of product returns and defects. Our networking products are easy to install, use and maintain and minimize the need for users to perform hardware or software configuration. For example, our proprietary, Internet browser-based Smart Wizard application provides users with simple graphical step-by-step installation instructions, including the automatic detection of their Internet connection type in order to automatically configure their routers or gateways. We also provide comprehensive technical support and customer service. Our products satisfy the budgetary requirements of small businesses and home users. Broad Product Offering. We offer an extensive range of networking products to users within the small business and home markets, including routers, gateways, access points, switches and NICs. Our product line includes approximately 100 products that are available in multiple configurations to serve the geographic region in which they are sold. Our products are designed for a variety of networking environments, including traditional Ethernet cabling and wireless as well as emerging in-home electrical wiring communication. We offer broadband products for a wide range of connection types, such as DSL and cable modems. Our wireless products include wireless LAN and security functionality to address the increasing mobility and security requirements of users. We believe users in the small business and home markets prefer to purchase all of their networking products from one vendor. We therefore believe the breadth of our product line represents a competitive strength due to our ability to meet a wide range of their networking needs. Extensive Global Channel Presence. We sell our products in North America, EMEA and Asia Pacific through an extensive network of sales channels. Our net revenue is well balanced worldwide, with 58% of our net revenue in 2003 being derived from sales in North America and 42% derived from international sales. Our worldwide channel presence enables our end-user customers to purchase our products with the same ease with which they purchase personal computers and software. We currently sell products through traditional retailers with more than 3,700 retail locations in North America, including Best Buy, Circuit City, CompUSA, Costco, Fry s Electronics, MicroCenter, Office Depot and Staples domestically, and over 3,300 international retail locations, such as MediaMarkt (Germany, Austria) and PC World (UK) in Europe, and Harris (Australia) in Asia Pacific. Our broad product offering and sales volume enables us to command substantial shelf space at our traditional retailers worldwide, which we believe is a significant competitive advantage in our target markets. We also sell through online stores such as Amazon.com and Buy.com. We have a significant DMR presence, in both catalog sales and direct marketing channels, including relationships with CDW and PC Connection domestically and Misco Global and Insight Direct both domestically and internationally. We have relationships with thousands of VARs worldwide, including over 8,000 domestically and more than 3,000 internationally, which participate in our Powershift Partner program. This program provides incentives and training to select members who meet quarterly sales goals. In addition, we recently began selling our products through broadband service providers such as Time-Warner Cable and Comcast domestically, and Telstra in Australia and Tele Denmark. History of Product Innovation. The product requirements of small business and home networking users are continually changing with the rapid adoption of new technologies. We believe that our experience, market presence, and global reach enable us to identify trends in product demand and rapidly introduce products to meet that demand. Our corporate headquarters are located in Santa Clara in the heart of the Silicon Valley. From this location we team with a number of leading semiconductor and software companies in order to offer products that incorporate emerging technologies. In addition, our internal research and development efforts focus on designing products that meet the requirements of both the small business and home markets. We believe that the combination of our demand assessment capabilities and our technology collaborations often provides us with * These customers purchase our products directly from us. The remaining customers on this list buy their products through our wholesale distributors. Total 59 % 52 % Table of Contents We are currently developing and enhancing relationships with broadband service providers in North America and internationally and have recently signed agreements with Time-Warner Cable and Comcast to distribute our products to their subscribers. Research and Development As of December 31, 2003, we had 30 employees engaged in research and development. We believe that our success depends on our ability to develop products that meet the changing user needs and to anticipate and proactively respond to evolving technology in a timely and cost-effective basis. Accordingly, we have made investments in our research and development department in order to effectively evaluate new technologies and develop new products. Our research and development employees work closely with our manufacturing partners to bring our products to market in a timely, high quality and cost-efficient manner. We identify and qualify new technologies, and we work closely with our various technology suppliers and manufacturing partners to develop products using one of two manufacturing methodologies as described below. ODM. Under the ODM methodology, which we use for most of our product development activities, we define the product concept and specification and perform the technology selection. We then coordinate with our technology suppliers while they develop the chipsets, software drivers and detailed circuit designs. If additional software is required, we either develop the software in-house, subcontract the development of the software, or purchase it from a third-party vendor. Once prototypes are completed, we work with our ODMs to complete the debugging and systems integration and testing. Our ODMs conduct all of the agency approval processes for electrical safety and electromagnetic interference. After completion of the final tests, agency approvals and product documentation, the product is released for production. OEM. Under the OEM methodology, which we use for a limited number of products, we define the product specification and then purchase the product from OEM suppliers that have existing products fitting our design requirements. Once a technology supplier s product is selected, we work with the OEM supplier to complete the cosmetic changes to fit into our mechanical and packaging design, as well as our documentation standard. If software is involved, the look and feel of the software is modified by the OEM supplier to meet our standards. The OEM supplier completes regulatory approvals on our behalf. When all design verification and regulatory testing is completed, the product is released for production. Our internal research and development efforts focus on improving the industrial design of our products and enhancing their ease-of-use through the development of software such as our proprietary Smart Wizard application. Our total research and development expenses were $4.4 million in 2001, and $7.7 million in 2002 and $8.7 million in 2003. Manufacturing Our primary manufacturing contractors are Ambit Microsystems (recently acquired by Foxconn), Cameo Communications Inc., Delta Electronics, SerComm Corporation and Z-Com, Inc., all of which are headquartered in Taiwan. The actual manufacturing of our products occurs both in Taiwan and mainland China. We distribute our manufacturing among these key suppliers to avoid excessive concentration with a single supplier. Delta Electronics is associated with Delta International Holding Ltd., one of our stockholders. In addition to their responsibility for the manufacturing of our products, our manufacturers purchase all necessary parts and materials to produce complete, finished goods. To maintain quality standards for our suppliers, we have established our own product testing and quality organization based in Hong Kong, which is responsible for auditing and inspecting product quality on the premises of our subcontractors. We obtain other key components, such as connector jacks, plastic casings, physical layer transceivers and switching fabric semiconductors, from limited sources. We currently outsource warehousing and distribution logistics to three third party logistics providers who are responsible for warehousing, customer order fulfillment and distribution of products. In addition, these parties are also responsible for some final packaging of our products including bundling components to form Table of Contents kits, and inserting appropriate documentation and power adapters. APL Logistics Americas Ltd in Walnut, California serves the Americas region, Kerry Logistics Ltd in Hong Kong is our logistics provider serving the Asia Pacific region, and Furness Logistics BV in the Netherlands serves the EMEA regions. Sales and Marketing As of December 31, 2003, we had 85 employees in our sales department and 14 employees in our marketing department. We work directly with our resellers on market development activities, such as co-advertising, in-store promotions and demonstrations, event sponsorship and sales associate training. We also participate in major industry trade shows and marketing events. Our marketing department is comprised of our product marketing and corporate marketing groups. Our product marketing group focuses on product strategy, product development roadmaps, the new product introduction process, product lifecycle management, demand assessment and competitive analysis. The group works closely with our sales and research and development groups to align our product development roadmap to meet key channel technology requirements from a strategic perspective. The group also ensures that product development activities, product launches, channel marketing program activities, and ongoing demand and supply planning occur in a well-managed, timely basis in coordination with our development, manufacturing, and sales groups, as well as our ODM, OEM and sales channel partners. Our corporate marketing group is responsible for defining and building our corporate brand. The group focuses on defining our mission, brand promise and marketing messages on a worldwide basis. This group also defines the marketing approaches in the areas of advertising, public relations, events, channel programs and our web delivery mechanisms. These marketing messages and approaches are customized for both the small business and home markets through a variety of delivery mechanisms designed to effectively reach end users in a cost-efficient manner. The needs of our small business and home customers differ, and therefore our marketing initiatives for each of these segments are distinct. In the small business market, we have focused on emphasizing our product line expansion, such as our introduction of a 24 port smart switch with gigabit ports, performance and reliability, and on channel development, while in the home market we have emphasized our wireless offerings, ease-of-use and aesthetics. In both markets, we have focused on developing the NETGEAR brand name, expanding our advertising programs and increasing public awareness through high visibility in the technical and popular press. We conduct much of our international sales and marketing operations through NETGEAR International, Inc., our domestic subsidiary, as well as through NETGEAR Deutschland GmbH, a German company and wholly-owned subsidiary of NETGEAR International, Inc. Technical Support We provide technical support to our customers through a combination of limited permanent employees and an extensive use of subcontracted, outsourcing resources. Although we design our products to require minimal technical support, if a customer requires assistance, we provide free, high-quality technical advice worldwide over the phone and Internet. We currently subcontract first and second level technical support for our products, and as of December 31, 2003 we are utilizing 279 part-time and full-time individuals to answer customers technical questions. First level technical support represents the first team member a customer will reach with questions; and, typically, these individuals are able to answer routine technical questions. If they are unable to resolve the issue, the first level support member will forward the customer to our more highly trained second level support group. The most difficult or unique questions are forwarded to NETGEAR employees. This eight person in-house staff provides the most sophisticated support when customer issues require escalation. In addition to providing third level technical support, these internal NETGEAR employees design our technical support database and are responsible for training and managing our outsourced sub-contractors. We Table of Contents utilize the information gained from customers by our technical support organization to enhance our current and future products. In North America, the United Kingdom and Australia, the first and second level technical support is provided 24 hours a day, 7 days a week, 365 days a year on toll-free lines. Local language support is also available during local business hours in China, France, Germany, Italy, Japan, Korea, Spain and Sweden. Competition The small business and home networking markets are intensely competitive and subject to rapid technological change. We expect competition to continue to intensify. Our principal competitors include: within the small business networking market, companies such as 3Com, Allied Telesyn, The Linksys division of Cisco Systems, Dell Computer, D-Link, Hewlett-Packard and Nortel Networks; and within the home networking market, companies such as Belkin Corporation, D-Link, The Linksys division of Cisco Systems and Microsoft. Other current competitors include numerous local vendors such as Correga and Melco/ Buffalo Technology in Japan and TP-Link in China. Our potential competitors include consumer electronics vendors who could integrate networking capabilities into their line of products. Many of our existing and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other resources. As a result, they may have more advanced technology, larger distribution channels, stronger brand names, better customer service and access to more customers than we do. For example, Dell Computer has significant brand name recognition and has an advertising presence substantially greater than ours. Similarly, Cisco Systems is well recognized as a leader in providing networking solutions to businesses and has substantially greater financial resources than we do. Several of our competitors, such as Linksys division of Cisco Systems and D-Link, offer a range of products that directly compete with most of our product offerings. Several of our other competitors primarily compete in a more limited manner. For example, Hewlett-Packard sells networking products primarily targeted at larger businesses or enterprises. However, the competitive environment in which we operate changes rapidly. Other large companies with significant resources could become direct competitors, either through acquiring a competitor or through internal efforts. We believe that the principal competitive factors in the small business and home markets for networking products are: product breadth; size and scope of the sales channel; brand name; timeliness of new product introductions; product performance, features, functionality and reliability; price; ease-of-installation, maintenance and use; and customer service and support. We believe that we compete favorably in each of these categories. To remain competitive, we believe we must invest significant resources in developing new products, enhancing our current products, expanding our sales channels and maintaining customer satisfaction worldwide. Diluted $ (0.25 ) $ 0.00 $ (0.66 ) $ (0.46 ) $ 0.49 Table of Contents Intellectual Property We believe that our continued success will depend primarily on the technical expertise, speed of technology implementation, creative skills and management abilities of our officers and key employees, plus ownership of a limited but important set of copyrights, trademarks, trade secrets and patents. We primarily rely on a combination of copyright, trademark and trade secret and patent laws, nondisclosure agreements with employees, consultants and suppliers and other contractual provisions to establish, maintain and protect our proprietary rights. We hold an issued United States design patent relating to our home product design, and currently have at least five pending United States patent applications related to technology and products offered by us. In addition, we rely on third-party licensors for patented hardware and software license rights in technology that are incorporated into and are necessary for the operation and functionality of our products. We typically retain limited exclusivity over intellectual property we jointly develop with our OEM and ODM manufacturers. Our success will depend in part on our continued ability to have access to these technologies. We have trade secret rights for our products, consisting mainly of product design, technical product documentation and software. We also own and use distinctive trademarks on or in connection with our products, including NETGEAR, the GearGuy logo, FirstGear, ProSafe and Web Safe. NETGEAR is a trademark registered in Argentina, Australia, Brazil, Canada, the European Union, Japan, New Zealand and the United States. We have obtained or applied for registration for the Everybody s Connecting trademark in Australia, the European Union, Japan, Korea and the United States. We have registered several Internet domain names that we use for electronic interaction with our customers including dissemination of product information, marketing programs, product registration, sales activities, and other commercial uses. Employees As of December 31, 2003, we had 207 employees, with 107 in sales, marketing and technical support, 30 in research and development, 39 in operations, and 31 in finance, information systems and administration. We have never had a work stoppage among our employees and no personnel are represented under collective bargaining agreements. We consider our relations with our employees to be good. TriNet Employer Group, Inc. provides human resource services to NETGEAR and our employees including payroll, employee relations and certain employee benefit plans. TriNet is an employer services company contracted by us to perform certain employer responsibilities on our behalf, and TriNet is the employer of record for payroll, benefits and other functions involving our employment related administration. Our agreement with TriNet is terminable by either party with 30 days notice. Properties Our principal administrative, sales, marketing and research and development facilities occupy approximately 56,000 square feet in an office complex in Santa Clara, California, under a lease that expires in December 2004. Several of our domestic sales employees perform their duties using leases of individual offices. Our international sales personnel reside in local sales offices in Australia, China, France, Germany, Italy, Japan, Korea, Spain, Sweden, and the United Kingdom. We also have operations personnel using a facility in Hong Kong, which is subleased from our third party logistics provider, Kerry Logistics. We believe our existing facilities are adequate for our current needs. We use third parties to provide warehousing services to us, consisting of facilities in Southern California, Hong Kong and the Netherlands. Legal Proceedings We are not currently a party to any material legal proceedings. We may be subject to various claims and legal actions arising in the ordinary course of business from time to time. (1) Messrs. Ralph E. Faison, Gerald A. Poch and Gregory D. Rossmann are members of the compensation committee. (2) Messrs. A. Timothy Godwin, Linwood A. Lacy, Jr. and Stephen D. Royer are members of the audit committee. Patrick C.S. Lo has served as our Chairman and Chief Executive Officer since March 2002. From September 1999 to March 2002, he served as our President, and since our inception in 1996 to September 1999, he served as Vice President and General Manager. Mr. Lo joined Bay Networks, a networking company, in August 1995 to launch a division targeting the small business and home markets and established the NETGEAR division in January 1996. From 1983 until 1995, Mr. Lo worked at Hewlett-Packard Company, a computer and test equipment company, where he served in various management positions in software sales, technical support, network product management, sales support and marketing in the United States and Asia, most recently as the Asia/Pacific marketing director for Unix servers. Mr. Lo received a B.S. degree in Electrical Engineering from Brown University. Raymond P. Robidoux has served as our President since July 2002. From July 2001 to May 2002, Mr. Robidoux worked at Quantum Corporation, a data technology company, where he served as senior vice president and general manager of the networked attached storage division. From March 1997 to March 2001, Mr. Robidoux was at Compaq Computer, where he served as vice president of its North America consumer business group, focused on sales, marketing and service, from March 1999 to March 2001, and as vice president of business planning and operations from March 1997 to February 1999. Prior to that, he held various management positions in the computer hardware industry, including sales, marketing and product development. Mr. Robidoux received a B.S. degree in Aerospace Engineering from California State Polytechnic University and an M.B.A. from Pepperdine University. Jonathan R. Mather has served as our Executive Vice President and Chief Financial Officer since October 2003 and served as our Vice President and Chief Financial Officer since August 2001. From July 1995 to March 2001, Mr. Mather worked at Applause Inc., a consumer products company, where he served Cost of revenue: Cost of revenue 34,685 41,326 48,188 52,773 49,246 49,889 54,691 61,506 Amortization (recovery) of deferred stock-based compensation 66 20 22 36 (11 ) 42 46 Table of Contents as president and chief executive officer from 1998 to 2001, as chief financial officer and chief operating officer from 1997 to 1998 and as chief financial officer from 1995 to 1997. From 1985 to 1995, Mr. Mather was at Home Fashions Inc., a consumer products company, where he served as chief financial officer from 1992 to 1995, and as vice president, finance of an operating division, Louverdrape, from 1988 to 1992. Prior to that, he spent more than two years at the semiconductor division of Harris Corporation, a communications equipment company, where he served as the finance manager of the offshore manufacturing division. He has also worked in public accounting for four years with Coopers Lybrand (now part of PricewaterhouseCoopers LLP) and for two years with Ernst Young. Mr. Mather is a certified management accountant (CMA) and is also a chartered accountant from the Institute of Chartered Accountants in Sri Lanka, where Mr. Mather received his undergraduate B.A. degree equivalent. Mr. Mather received an M.B.A. from Cornell University, New York. Mark G. Merrill has served as our Chief Technology Officer since January 2003. From September 1999 to January 2003, he served as Vice President of Engineering and served as Director of Engineering from September 1995 to September 1999. From 1987 to 1995, Mr. Merrill worked at SynOptics Communications, a local area networking company, which later merged with Wellfleet to become Bay Networks, where his responsibilities included system design and analog implementations for SynOptic s first 10BASE-T products. Mr. Merrill received both a B.S. degree and an M.S. degree in Electrical Engineering from Stanford University. Michael F. Falcon has served as our Vice President of Operations since November 2002. From September 1999 to November 2002, Mr. Falcon worked at Quantum Corporation, a data technology company, where he served as Vice President of Operations and supply chain management. From April 1999 to September 1999, Mr. Falcon was at Meridian Data, a storage company acquired by Quantum Corporation, where he served as vice president of operations. From February 1989 to April 1999, Mr. Falcon was at Silicon Valley Group, a semiconductor equipment manufacturer, where he served as director of operations, strategic planning and supply chain management. Prior to that, he served in management positions at SCI Systems, an electronics manufacturer, Xerox Imaging Systems, a provider of scanning and text recognition solutions, and Plantronics, Inc., a provider of lightweight communication headsets. Mr. Falcon received a B.A. degree in Economics from the University of California, Santa Cruz and has completed coursework in the M.B.A. program at Santa Clara University. Christopher C. Marshall has served as our Vice President of Finance since November 2003. From January 2000 to June 2003, Mr. Marshall served as Vice President Finance and Chief Accounting Officer at BackWeb Technologies Ltd., a publicly-traded company that is a provider of offline Web software. From October 1998 to November 1999, Mr. Marshall served as Vice President Finance and corporate controller at Supercom Inc., a PC assembly and distribution company. Prior to joining Supercom, from August 1997 to October 1998 Mr. Marshall served as controller for S-Vision, a company focused on lighting technology research for scientific applications. Mr. Marshall has also served over twelve years in various financial management positions at Intel Corp. Mr. Marshall earned a B.Sc. at University College, Cardiff, U.K. a M.B.A. at London Business School and a M.A. at University College London. Mr. Marshall is a Fellow of the Institute of Chartered Accountants. Charles T. Olson has served as our Vice President of Engineering since January 2003. From July 1978 to January 2003, Mr. Olson worked at Hewlett-Packard Company, a computer and test equipment company, where he served as director of research and development for ProCurve networking from 1998 to 2003, as research and development manager for the Enterprise Netserver division from 1997 to 1998, and, prior to that, in various other engineering management roles in Hewlett-Packard s Unix server and personal computer product divisions. Mr. Olson received a B.S. degree in Electrical Engineering from the University of California, Davis and an M.B.A. from Santa Clara University. David Soares has served as our Vice President of Europe, Middle East and Africa (EMEA) Sales since December 2003. Mr. Soares joined us in January 1998, and served as EMEA Managing Director from April 2000 to November 2003, United Kingdom and Nordic Regional Manager from February 1999 to March 2000 and United Kingdom Country Manager from January 1998 to January 1999. Prior to joining us, Mr. Soares Table of Contents was at Hayes Microcomputer Products, a manufacturer of dial-up modems. Mr. Soares attended Ridley College, Ontario Canada. Michael A Werdann has served as our Vice President of American Sales since December 2003. Since joining us in 1998, Mr. Werdann has served as our United States Director of Sales, E-Commerce and DMR from December 2002 to 2003 and as our Eastern regional sales director from October 1998 to December 2002. Prior to joining us, Mr. Werdann worked for three years at Iomega Corporation, a computer hardware company, as a sales director for the value added reseller sector. Mr. Werdann holds a B.S. Degree in Communications from Seton Hall University. Ralph E. Faison has served as one of our directors since August 2003. From February 2003 to the present, Mr. Faison has served as chief executive officer of Andrew Corporation, a public company and a manufacturer of communications equipment and systems, and from June 2002 to the present, Mr. Faison has also served as president and a director of Andrew Corporation. From June 2002 to February 2003, Mr. Faison served as chief operating officer of Andrew Corporation. From June 2001 to June 2002, Mr. Faison served as president and chief executive officer of Celiant Corporation, a manufacturer of power amplifiers and wireless radio frequency systems, which was acquired by Andrew Corporation in June 2002. From October 1997 to June 2001, Mr. Faison was vice president of the New Ventures Group at Lucent Technologies, a communications service provider, and from 1995 to 1997, he was vice president of advertising and brand management at Lucent Technologies. Prior to joining Lucent, Mr. Faison held various positions at AT T, a voice and data communications company, including as vice president and general manager of AT T s wireless business unit and manufacturing vice president for its consumer products unit in Bangkok, Thailand. He is a member of the board of directors of WatchMark Corporation, a telecommunications company and a member of the board of directors of The Chicago Executives Club. Mr. Faison received a B.A. degree in marketing from Georgia State University and a M.S. degree in management as a Sloan Fellow from Stanford University. A. Timothy Godwin has served as one of our directors since August 2003. From July 1989 to January 1997, Mr. Godwin worked at Tech Data Corporation, an information technology products distributor, in various capacities including serving as a member of its board of directors, vice chairman focusing on worldwide finance and administration, president and chief operating officer, chief financial officer and senior vice president of finance. From 1974 to June 1989, Mr. Godwin was employed by Price Waterhouse (now part of PricewaterhouseCoopers LLP), most recently as an audit partner from July 1987 to June 1989. Mr. Godwin is a Certified Public Accountant and received a B.S. degree in Accounting from the University of West Florida. Linwood A. Lacy, Jr. has served as one of our directors since September 2002. From July 1998 to July 2001, Mr. Lacy served as chairman of 4Sure.com, a direct marketer of computer and technology products. From October 1996 to October 1997, Mr. Lacy served as president and chief executive officer of Micro Warehouse Incorporated, a micro computer direct-marketing company. From 1985 to May 1996, he served as the co-chairman and chief executive officer of Ingram Micro, Inc., a microcomputer products distributor and a then wholly-owned subsidiary of Ingram Industries Inc. From April 1996 to May 1996, Mr. Lacy served as vice chairman of Ingram Industries Inc.; from June 1995 to April 1996, he served as its president and chief executive officer; and from December 1993 to June 1995, he served as its president. Mr. Lacy is a director of EarthLink, Inc., a public company, as well as a director of several private companies, including Ingram Industries Inc. Mr. Lacy received both a B.S. degree in Chemical Engineering and an M.B.A from the University of Virginia. Gerald A. Poch has served as one of our directors since March 2000. From January 2000 to the present, Mr. Poch has served as a Managing Director of Pequot Capital Management, Inc. and co-head of Pequot Ventures. Since August 1998, Mr. Poch has been one of the leaders of the venture capital team responsible for the growth and strategic direction of the group. From August 1996 to June 1998, he was the chairman, president and chief executive officer of G.E. Capital Information Technology Solutions, Inc., a technology solutions provider. Prior to that, he served as co-founder, co-chairman and co-president of AmeriData Technologies, Inc. (the predecessor company of G.E. Capital Information Technology Solutions, Inc.), a value- Net income (loss) attributable to common stockholders: $ (6,544 ) $ Net income (loss) attributable to common stockholders $ (6,544 ) $ Table of Contents added reseller and systems integrator of hardware and software systems. Mr. Poch is a director of BriteSmile, Inc., Analex Corp. and Andrew Corporation, which are public companies, as well as a director of several private companies. Mr. Poch received a B.S. degree from the University of Connecticut and a J.D. degree cum laude from Boston University Law School. Gregory J. Rossmann has served as one of our directors since February 2002. From April 2000 to the present, Mr. Rossmann has served as a General Partner of Pequot Private Equity Fund II L.P. From April 1994 to April 2000, Mr. Rossmann served as Managing Director and partner at Broadview International, an investment banking firm. From June 1991 to April 1994, he worked at Dynatech Corporation, a technology holding company, where he served as manager of new business development. Prior to that, he was a co-founder of Telemaster Corporation. Mr. Rossmann is a director of several private companies. Mr. Rossmann received a B.S. degree in Electrical Engineering from the University of Cincinnati and an M.B.A. from Santa Clara University. Stephen D. Royer has served as one of our directors since September 2000. From 1991 to the present, Mr. Royer has been with Shamrock Capital Advisors, Inc., a merchant banking company, where he has served as a Managing Director for more than five years. Mr. Royer is a director of several private companies. Mr. Royer received a B.A. degree in Quantitative Economics from Stanford University and an M.B.A. degree from the University of California in Los Angeles. Board Composition Our board of directors currently consists of seven members, who are Messrs. Lo, Faison, Godwin, Lacy, Poch, Rossmann and Royer. Mr. Lo is the only management member of our board of directors. Our directors hold office until their successors have been elected or qualified or until the earlier of their death, resignation, disqualification or removal. There are no family relationships among any of our directors and executive officers. Director Compensation Our non-employee directors receive $1,000 per meeting and are entitled to reimbursement of business, travel and other related expenses incurred in connection with their attendance at meetings of the board of directors and committee meetings. The chairman of our audit committee receives an additional $1,000 per committee meeting attended and the chairman of the compensation committee receives an additional $500 per meeting attended. In addition, our directors, including non-employee directors, are eligible to receive stock options under our 2003 Stock Option Plan. New non-employee directors who join our board of directors are entitled to receive automatic, non-discretionary initial options to acquire 25,000 shares of our common stock, subject to three-year vesting. Directors who have served at least six months with us receive an annual option of 15,000 shares at each annual meeting starting at our 2004 meeting, which will be subject to one-year vesting, under our 2003 Stock Plan. See Benefit Plans Director Option Program. Board Committees Our board of directors has the authority to appoint committees to perform certain management and administrative functions. Our board of directors currently has an audit committee and a compensation committee. Audit Committee Our audit committee is responsible for annually recommending independent accountants, preparing the reports, statements or charters as may be required by Nasdaq or the securities laws, and reviewing: the adequacy of our system of internal accounting controls; our audited financial statements and reports and discussing the statements and reports with management, including any significant adjustments, management judgments and estimates, new accounting policies and disagreements with management; and (1) Each of our executive s bonus is earned in 2003, subject to the review and approval of our Board, and paid in 2004. (2) All other compensation consists of discretionary matching contributions to our 401(k) plan on behalf of each named executive officer, unless otherwise stated. Excludes prerequisites and personal benefits, securities or property to the extent such benefits do not exceed the lesser of either $50,000 or 10% of the total annual sales, and bonus for the named executive officer. (3) Mr. Mather received other compensation consisting of a $1,500 matching contribution to our 401(k) plan on his behalf and a tax protected housing allowance of $37,569 for the year. (4) Ms. Adams received other compensation consisting of a $41,177 housing allowance, $41,424 moving expenses, $18,193 in bonus payments related to calendar year 2002, and $8,269 in payments resulting from her separation from us. (1) On January 1, 2000, we adopted Emerging Issues Task Force, or EITF, Issue 01-09, Accounting for Consideration Given by a Vendor to a Customer or Reseller of the Vendor s Products, and as a consequence, record cooperative marketing costs as a reduction in net revenue. Prior to January 1, 2000, it was not practical for us to determine the amount of cooperative marketing costs to record as a reduction of net revenue, and such amounts were included as sales and marketing expense. December 31, 2003 Patrick C.S. Lo 996,761 11,442,816 Raymond P. Robidoux 140,264 255,778 1,527,475 2,785,422 Jonathan R. Mather 231,022 165,020 3,396,023 2,425,794 Leslie A. Adams 51,041 123,959 509,900 1,238,350 Mark G. Merrill 562,871 8,236 6,415,174 82,279 Employment Agreements and Change of Control Arrangements We have entered into employment agreements with the following of our named executive officers and current executive officers. Each agreement may be terminated by either us or the executive officer at any time with or without cause. In addition, the employment agreements provide for annual salary and bonus amounts and severance benefits, as may be adjusted from time to time by the board of directors. On December 3, 1999, we entered into an employment agreement with Patrick C.S. Lo, our Chairman and Chief Executive Officer. The agreement provides that if within one year following a change of control of the company, Mr. Lo is terminated without cause or resigns for good reason, he is entitled to full acceleration of any unvested portion of his stock options, and severance payments at his final base salary rate for a period of one year after his termination or resignation. If Mr. Lo is terminated without cause, he is entitled to receive severance payments at his final base salary rate for a period of one year and will continue to have his stock options vest for one year after such termination. On December 9, 1999, we entered into an employment agreement with Mark G. Merrill, our Chief Technology Officer. The agreement provides that if within one year following a change of control of the company, Mr. Merrill is terminated without cause or resigns for good reason, he is entitled to receive two years acceleration of any unvested portion of his stock options. If Mr. Merrill is terminated without cause, he is entitled to receive severance payments at his final base salary rate for 26 weeks and will continue to have his stock options vest for one year after such termination. On July 15, 2002, we entered into an employment agreement with Raymond P. Robidoux, our President and on August 10, 2001, we entered into an employment agreement with Jonathan R. Mather, our Executive Vice President and Chief Financial Officer. The agreements provide that if within one year following a change of control of the company the officer is terminated without cause or resigns for good reason, he is entitled to receive two years acceleration of any unvested portion of his stock options. If the officer is terminated without cause, he is entitled to receive severance payments at his final base salary rate for a period of 39 weeks and will continue to have his stock options vest for one year after such termination. On November 4, 2002, we entered into an employment agreement with Michael F. Falcon, our Vice President of Operations. On January 6, 2003, we entered into an employment agreement with Charles T. Olson, our Vice President of Engineering. On November 3, 2003, we entered into an employment agreement with Michael A. Werdann, our Vice President of America Sales. On November 14, 2003, we entered into an employment agreement with Christopher C. Marshall, our Vice President of Finance. Each of these agreements provide that if within one year following a change of control of NETGEAR, the officer is terminated without cause or resigns for good reason, he is entitled to receive two years acceleration of any Table of Contents unvested portion of his stock options, except that Mr. Falcon is entitled to receive one year acceleration of any unvested portion of his stock options. If the officer is terminated without cause, he is entitled to receive severance payments at his final base salary rate for a period of 26 weeks and will continue to have his stock options vest for one year after such termination, except that Mr. Marshall will continue to have his stock options vest for six months after such termination. Benefit Plans 2000 Stock Option Plan Our 2000 Stock Option Plan, or the 2000 Stock Plan, was adopted by our board of directors in April 2000 and our stockholders initially approved our plan in April 2000. As of February 20, 2004, options to purchase an aggregate of 4,986,747 shares of our common stock were outstanding and remain subject to the terms of the agreements evidencing those options and the terms of the 2000 Stock Plan. Our board of directors determined that upon the closing of our initial public offering, no future options were to be granted under our 2000 Stock Plan, and all remaining authorized options have become issuable under our 2003 Stock Plan. The 2000 Stock Plan provides that in the event of (1) the direct or indirect sale by stockholders of more than 50% of our voting stock, (2) our merger with or into another corporation, (3) the sale of all or substantially all of our assets, or (4) our liquidation or dissolution, the successor corporation may assume or substitute for each option. If the successor corporation does not assume or substitute for the options, the options will become fully vested and exercisable as of ten days prior to the proposed transaction, provided that such options will terminate if not exercised prior to the acquisition or other transaction. 2003 Stock Plan Our board of directors adopted the 2003 Stock Plan in April 2003, and our stockholders approved the plan in July 2003. This plan provides for the grant of incentive stock options to our employees and nonstatutory stock options, stock purchase rights and stock appreciation rights to our employees, directors and consultants. Number of Shares of Common Stock Available Under the 2003 Stock Plan. Approximately 1.6 million shares of our common stock have been reserved for issuance pursuant to our 2003 Stock Plan. As of February 20, 2004, options to purchase an aggregate of 314,875 shares of our common stock were outstanding under the 2003 Plan and 1,305,674 remain available for future grant. If an option, stock purchase right or stock appreciation right expires or becomes unexercisable without having been exercised in full, or is surrendered pursuant to an option exchange program, the unpurchased shares which were subject to such award will become available for future grant or sale under our plan (unless our plan has terminated). However, shares that have actually been issued under our plan, upon exercise of an option, stock purchase right or stock appreciation right, will not be returned to our plan and will not be available for future distribution under our plan, except if shares of restricted stock are repurchased by us at their original price, in which case such shares will be available for future grant under our plan. Administration of the 2003 Stock Plan. Our board of directors, or one or more committees appointed by our board, administers our 2003 Stock Plan. In the case of awards intended to qualify as performance based compensation within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended, the committee will consist of two or more outside directors within the meaning of Section 162(m). The administrator has the power to determine the terms of the options, stock purchase rights or stock appreciation rights granted, including the exercise price (which may be changed by the administrator after the date of grant), the number of shares subject to each award, the exercisability of the awards and the form of consideration payable upon exercise. Options. The administrator will determine the exercise price of options granted under our 2003 Stock Plan. The terms of our 2003 Stock Plan allow the administrator to grant options at exercise prices that are equal to or above fair market value. After termination of one of our employees, directors or consultants, he or Table of Contents she may exercise his or her option for the period of time stated in the option agreement. If termination is due to death or disability, the option will generally remain exercisable for 12 months following such termination. In all other cases, the option will generally remain exercisable for three months. However, an option may never be exercised later than the expiration of its term. The term of an incentive stock option may not exceed ten years, except that with respect to any participant who owns 10% of the voting power of all classes of our outstanding capital stock, the term must not exceed five years and the exercise price must equal at least 110% of the fair market value on the date of grant. The administrator determines the term of all other options. No optionee may be granted options to purchase more than 750,000 shares in any fiscal year. In connection with his or her initial service, an optionee may be granted additional options to purchase up to 750,000 shares. Stock Purchase Rights. Our 2003 Stock Plan allows the administrator to issue stock purchase rights at purchase prices that are equal to or above fair market value of the shares. Unless the administrator determines otherwise, the restricted stock purchase agreement, the agreement between us and an optionee which governs the terms of his or her stock purchase rights, will grant us a repurchase option that we may exercise upon the voluntary or involuntary termination of the optionee s service with us for any reason including death or disability. The purchase price for shares we repurchase will generally be the original price paid by the optionee. The administrator determines the rate at which our repurchase option will lapse. Stock Appreciation Rights. A stock appreciation right is the right to receive the appreciation in the fair market value of our common stock between the exercise date and the date of grant. We may pay the appreciation in either cash or in shares of our common stock. Stock appreciation rights are subject to the terms established by the administrator and become exercisable as specified by the administrator in a notice of grant. Transferability of Awards. Unless the administrator determines otherwise, our 2003 Stock Plan does not allow for the transfer of awards other than by will or by the laws of descent and distribution, and only the participant may exercise an award during his or her lifetime. Adjustments upon Change in Control. Our 2003 Stock Plan provides that in the event of our change in control, including the sale of all or substantially all of our assets, the successor corporation will assume or substitute for each option or right. Any outstanding options or rights not assumed or substituted for will be fully exercisable, including as to shares that would not otherwise have been vested and exercisable, for a period of 15 days from the date of notice to the optionee. The option or right will terminate at the end of the 15-day period. Amendment and Termination of Our 2003 Stock Plan. Our 2003 Stock Plan will automatically terminate in 2013, unless we terminate it sooner. In addition, our board of directors has the authority to amend, suspend or terminate our 2003 Stock Plan provided it does not adversely affect any award previously granted under our plan. Director Option Program The director option program is part of our 2003 Stock Plan and provides for the automatic, periodic grant of nonstatutory stock options to our non-employee directors. Each non-employee director who joins our board receives an initial option to purchase 25,000 shares when such person first becomes a non-employee director, except for those directors who became non-employee directors through the termination of their employment with us. In addition, beginning in 2004, each non-employee director who has been a director for at least six months will receive a subsequent option to purchase 15,000 shares following each annual meeting of our stockholders. All options granted under our director option program have a term of ten years and an exercise price equal to the fair market value of our common stock on the date of grant. Each initial option becomes exercisable as to one-third of the shares subject to the option on each anniversary of the date of grant, provided the individual remains a non-employee director on such dates. Each subsequent option becomes exercisable as to 100% of the shares subject to the option on the first anniversary of the grant date, provided the individual remains a service provider on such date. If an outside director terminates service, he or she may generally exercise his or her options for 12 months following such termination or five years if Table of Contents termination is due to a qualifying retirement. In the event of our change in control, each non-employee director option will vest in full. 2003 Employee Stock Purchase Plan Our board of directors adopted the 2003 Employee Stock Purchase Plan in April 2003, and our stockholders approved the plan in July 2003. Number of Shares of Common Stock Available Under Our Plan. As of December 31, 2003, a total of 500,000 shares of our common stock were available for sale under the 2003 Employee Stock Purchase Plan. Administration of Our Plan. Our board of directors, or any committee appointed by our board, administers our plan and has full and exclusive authority to interpret its terms and to determine eligibility under it. Eligibility to Participate. Our employees and employees of designated subsidiaries are eligible to participate if they are customarily employed by us or any participating subsidiary for at least 20 hours per week and more than five months in any calendar year. However, an employee may not be granted an option to purchase stock under our plan if such employee: immediately after the grant owns stock possessing 5% or more of the total combined voting power or value of all classes of our capital stock; or whose rights to purchase stock under all of our employee stock purchase plans accrue at a rate that exceeds $25,000 worth of stock for each calendar year. Offering Periods and Contributions. Our 2003 Employee Stock Purchase Plan is intended to qualify for preferential tax treatment under Section 423 of the Internal Revenue Code of 1986, as amended, and contains consecutive six-month offering periods. Although the first offering period under this plan started on the effective date of our initial public offering and ended on January 31, 2004, offering periods generally start on the first trading day on or after February 1 and August 1 of each year. Our plan permits participants to purchase shares of our common stock through payroll deductions of up to 10% of their eligible compensation, which includes a participant s base straight time gross earnings, commissions, overtime and shift premiums, but excludes all other compensation paid to our employees. A participant may purchase no more than 10,000 shares during any six-month offering period. Purchase of Shares. Amounts deducted and accumulated by the participant are used to purchase shares of our common stock at the end of each six-month offering period. The price is 85% of the lower of the fair market value of our common stock at the beginning of an offering period or on the last day of the offering period. Participants may end their participation at any time during an offering period, and will be paid their accumulated payroll deductions upon withdrawal. Participation ends automatically three months following termination of employment with us unless terminated earlier at the participants request. Transferability of Rights. A participant may not transfer rights granted under our plan other than by will or the laws of descent and distribution. Adjustments Upon Change in Control. In the event of our change in control, including the sale of all or substantially all of our assets, a successor corporation may assume or substitute for each outstanding option. If the successor corporation does not assume or substitute for the outstanding options, the offering period then in progress will be shortened by setting a new exercise date, any offering period then in progress will end on the new exercise date and participant payroll deductions held by us will be used to purchase shares of our common stock on the new exercise date. Amendment and Termination. The administrator has the authority to amend or terminate our plan, except that, subject to certain exceptions described in our plan, no such action may adversely affect any outstanding rights to purchase stock under our plan. Table of Contents 401(k) Retirement Savings Plan We sponsor a 401(k) retirement savings plan covering our employees who are at least 21 years of age. Our 401(k) retirement savings plan is intended to qualify under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986, as amended. Contributions to the 401(k) retirement savings plan and income earned on such contributions are not taxable to employees until withdrawn from the 401(k) retirement savings plan. Subject to restrictions imposed by the Internal Revenue Code on highly compensated employees, employees may generally defer up to 100% of their pre-tax earnings up to the statutorily prescribed annual limit, which is $13,000 for the 2004 calendar year, and to have the amount contributed to the 401(k) retirement savings plan. The 401(k) retirement savings plan permits, but does not require, additional matching contributions to the plan. To date, we have made limited matching contributions to the 401(k) savings plan up to a maximum of $1,500 per year per person. The 401(k) retirement savings plan may be amended or terminated by us at any time in our sole discretion. Limitation on Liability and Indemnification Matters As permitted by the Delaware General Corporation Law, we have adopted provisions in our certificate of incorporation and bylaws that limit or eliminate the personal liability of our directors. Consequently, a director will not be personally liable to us or our stockholders for monetary damages or breach of fiduciary duty as a director, except for liability for: any breach of the director s duty of loyalty to us or our stockholders; any act or omission not in good faith or that involves intentional misconduct or a knowing violation of law; any unlawful payments related to dividends or unlawful stock repurchases, redemptions or other distributions; or any transaction from which the director derived an improper personal benefit. The limitations of liability do not affect the availability of equitable remedies such as injunctive relief or rescission. If Delaware law is amended to authorize the further elimination or limiting of the liability of a director, then the liability of our directors will be eliminated or limited to the furthest extent permitted by Delaware law as so amended. Our certificate of incorporation allows us to indemnify our officers, directors and other agents to the full extent permitted by Delaware law. Our bylaws permit us to purchase insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in such capacity, regardless of whether Delaware law would permit indemnification, and to provide indemnification in circumstances in which indemnification is otherwise discretionary under Delaware law. Our bylaws specify circumstances in which indemnification for our directors and executive officers is mandatory and when we may be required to advance expenses before final disposition of any litigation. We have entered into indemnification agreements with each of our directors and officers that are, in some cases, broader than the specific indemnification provisions permitted by Delaware law, and that may provide additional procedural protection. The indemnification agreements require us, among other things, to: indemnify officers and directors against certain liabilities that may arise because of their status as officers or directors; advance expenses, as incurred, to officers and directors in connection with a legal proceeding, subject to limited exceptions; and in certain cases obtain directors and officers insurance. At present, there is no pending litigation or proceeding involving any of our directors, officers or employees in which indemnification is sought, nor are we aware of any threatened litigation or proceeding that could result in claims for indemnification. Patrick C.S. Lo, our Chairman and Chief Executive Officer, was a limited partner in The Abernathy Group. In December 2000, The Abernathy Group funds transferred an aggregate of 648,527 shares of our Series A preferred stock held by them to their limited partners, which included an aggregate of 94,192 shares transferred to a trust on behalf of Mr. Lo. Each of the transferees thereby became direct stockholders of NETGEAR. Table of Contents Stephen D. Royer, one of our directors, is managing director of Shamrock Capital Advisors, Inc., which is a related party to Shamrock Capital Growth Fund, L.P. Mr. Royer is also an Executive Vice President of Shamrock Capital Partners, L.L.C., the general partner of Shamrock Capital Growth Fund, L.P. In March 2001, Shamrock Holdings of California, Inc. transferred all shares of our capital stock held by it to Shamrock Capital Growth Fund, L.P. All shares of preferred stock converted into common stock in connection with our initial public offering. Series C Preferred Stock Financing and Repurchase of Series A Preferred Stock Held by Nortel Networks In February 2002, we issued and sold an aggregate of 10,937,408 shares of our Series C preferred stock to our stockholders of record (other than Nortel Networks), on a pro rata basis, for an aggregate purchase price of $5.2 million. As payment for the Series C preferred stock, the stockholders (other than Nortel Networks and Pequot Private Equity Fund, II, L.P.) transferred to us 75% of a contractual liquidation preference right that such stockholders previously obtained from Nortel Networks in connection with their purchase of shares of our Series A preferred stock from Nortel Networks in September 2000. The liquidation preference right required Nortel Networks to, in the event of a liquidation of the company at a price of less than $7.43 per share, pay to all holders of Series A preferred stock (other than Nortel Networks) an amount up to $2.19 per share. Since Pequot Private Equity Fund, II, L.P. did not hold any shares of our Series A preferred stock, Pequot Private Equity Fund, II, L.P. paid us approximately $4.7 million in cash to purchase shares of our Series C preferred stock in the financing. The Series C preferred stock converted into shares of common stock in connection with our initial public offering. We used the cash proceeds from the sale of our Series C preferred stock as partial consideration to repurchase 20,273,918 shares of the our Series A preferred stock held by Nortel Networks. In consideration for the repurchase of the shares, we (1) paid Nortel Networks $4.7 million in cash, (2) issued a $20.0 million subordinated unsecured convertible promissory note and (3) assumed 75% of the contractual liquidation preference obligation previously payable by Nortel Networks as described above. In connection with the stock repurchase, we also entered into a tax matters agreement with Nortel Networks which allocates rights and responsibilities for tax matters between us and Nortel Networks for prior tax years during which we were included in a joint tax return with Nortel Networks. The agreement provides that Nortel Networks will indemnify us for any tax liabilities arising on or before September 6, 2000 and we will indemnify Nortel Networks for any tax liabilities arising from our operations after September 6, 2000. We ceased to be included in Nortel Networks consolidated tax returns on September 6, 2000 for federal and state income tax purposes. We also entered into a letter agreement with Nortel Networks that sets forth the repayment terms of a $4.2 million trade payable obligation that we owed to Nortel Networks, which we have repaid in full. Common Stock Warrant to Shamrock Capital Advisors, Inc. On March 13, 2002, we issued a warrant to Shamrock Capital Advisors, Inc. to purchase 218,750 shares of our common stock at an exercise price of $1.29 per share, for services rendered to us by Shamrock in connection with our February 2002 Series C preferred stock financing. Pursuant to the warrant s net exercise provision, the warrant was exercised in full immediately prior to our initial public offering with Shamrock Capital Advisors, Inc. receiving 198,593 shares of our common stock. Registration Rights Certain of our stockholders are entitled to registration rights. See Description of Capital Stock Registration Rights. Table of Contents Indemnification and Employment Agreements We have entered into indemnification agreements with each of our directors and officers. See Management Limitation on Liability and Indemnification Matters. We have also entered into employment agreements with our officers. See Management Employment Agreements and Change of Control Arrangements. Certain Other Transactions with Executive Officers and Directors A. Timothy Godwin serves as one of our directors and also serves as chairman of the audit committee. From 1989 to March 1997, Mr. Godwin worked at Tech Data Corporation, an information technology products distributor, in various capacities, including as vice chairman, president, chief operating officer and a director of Tech Data from September 1995 to March 1997. A substantial portion of our revenue to date has been derived from a limited number of wholesale distributors, including Tech Data. Linwood A. Lacy, Jr., one of our directors, has been a director of Ingram Industries Inc. since 1991, and from 1985 to May 1996, he served as the co-chairman and chief executive officer of Ingram Micro, Inc., a microcomputer products distributor and a then wholly-owned subsidiary of Ingram Industries Inc. A substantial portion of our revenue to date has been derived from a limited number of wholesale distributors, the largest of which is Ingram Micro. From October 1996 to October 1997, Mr. Lacy also served as president and chief executive officer of Micro Warehouse Incorporated, a micro computer direct-marketing company acquired by CDW, one of our top five direct market resellers. In April 2002, we issued a stand-alone nonstatutory stock option to Michael Ressner, one of our former directors associated with Nortel Networks, to purchase 43,750 shares of our common stock at an exercise price of $3.31 per share. The option is fully vested and expires on April 22, 2006, or earlier in connection with our change in control if not assumed or substituted by the successor company. Mr. Ressner resigned from our board of directors in February 2002 in connection with our repurchase of all of the shares of Series A preferred stock then held by Nortel Networks. We issued the stock option to Mr. Ressner pursuant to a settlement agreement and release in connection with such termination of services. In April 2003, we entered into separation and release agreements with each of Stephen Dix and Arthur J. Smith, two of our former executive officers. Pursuant to the terms of their separation agreements, each officer received 26 weeks of severance pay and benefits and option acceleration and exercise rights pursuant to the terms of their employment agreements with us. On December 21, 2003, we entered into a severance agreement and release with Leslie A. Adams, our former Vice President of Marketing. Pursuant to the terms of her separation agreement, she is receiving 26 weeks of severance pay and benefits and will continue to have her options vest through one-year following her separation from us. In addition, the agreement provides for the monthly payment of a housing allowance to Ms. Adams, payable during the 26-week period following her termination of employment. Ms. Adams has agreed to a one-year non-solicitation period regarding our employees. Stock Option Grants We have granted stock options to purchase shares of our common stock to our executive officers and directors. See Principal Stockholders. Stock Option Exchange Program On October 30, 2002, we completed a stock option exchange program whereby eligible officers and employees of the company had the opportunity to exchange all or part of their then existing stock options for new options pursuant to a six months and a day option exchange program. Mark G. Merrill, our chief technology officer, participated in the option exchange program, pursuant to which he tendered, and we accepted for cancellation, options to purchase 57,750 shares of common stock, with an exercise price of $8.57 per share, which were cancelled on March 15, 2002. We granted Mr. Merrill Table of Contents a new option to purchase 39,501 shares of common stock on October 30, 2002, with an exercise price of $6.00 per share. 45-Day Lock-up Agreement Prior to this offering, we had entered into a 45-day Lock-up Agreement with each of the selling stockholders, which restricted their ability to sell our stock. Those agreements were terminated in connection with each of the selling stockholders entering a lock-up agreement with Lehman Brothers Inc. in connection with this offering. Executive Officers and Directors: Patrick C.S. Lo(6) 1,206,080 3.9 1,206,080 3.9 Raymond P. Robidoux(7) 159,867 * 159,867 * Jonathan R. Mather(8) 64,025 * 64,025 * Mark G. Merrill(9) 485,339 1.6 485,339 1.6 Richard A. Fabiano(10) 218,315 * 218,315 * Michael F. Falcon(11) 18,187 * 18,187 * Christopher C. Marshall Charles T. Olson(12) 22,981 * 22,981 * David Soares(13) 99,859 * 99,859 * Michael A. Werdann(14) 292 * 292 * Ralph E. Faison A. Timothy Godwin 10,415 * 10,415 * Linwood A. Lacy, Jr.(15) 24,244 24,244 * Represents beneficial ownership of less than 1%. (1) Shares beneficially owned by Pequot Capital Management, Inc., the investment manager of Pequot Private Equity Fund II, L.P., represents 6,953,486 shares held of record by Pequot Private Equity Fund II, L.P. Pequot Capital Management, Inc. holds voting and dispositive power for all shares held by Pequot Private Equity Fund II, L.P. Gerald A. Poch is a Managing Director of Pequot Capital Management, Inc. and co-head of Pequot Ventures, and Gregory M. Rossmann is a General Partner of Pequot Private Equity Fund II, L.P. Both Mr. Poch and Mr. Rossmann serve as members of our board of directors and may be deemed to beneficially own the securities held of record by Pequot Private Equity Fund II, L.P. Mr. Poch and Mr. Rossmann disclaim beneficial ownership of these shares except to the extent of their pecuniary interest therein. The address of Pequot Capital Management, Inc. and Pequot Private Equity Fund II, L.P. is 500 Nyala Farm Road, Westport, CT 06880. (2) Shares beneficially owned by Shamrock Capital Growth Fund, L.P. represent 4,597,501 shares held of record by Shamrock Capital Growth Fund, L.P. and 198,593 shares hold of record by Shamrock Capital Advisors, Inc. Stephen D. Royer, one of our directors, is a managing director of Shamrock Capital Advisors, Inc., which is a related party to Shamrock Capital Growth Fund, L.P. Shamrock Capital Partners, L.L.C. holds voting and dispositive power for the shares held of record by Shamrock Capital Growth Fund, L.P. Mr. Royer is also an executive vice president of Shamrock Capital Partners, L.L.C., the general partner of Shamrock Capital Growth Fund, L.P. Mr. Royer disclaims beneficial ownership of these shares except to the extent of his pecuniary interest therein. The address of Shamrock Capital Advisors, Inc. and Shamrock Capital Growth Fund, L.P. is 4444 Lakeside Drive, Second Floor, Burbank, CA 91505. (3) Shares beneficially owned by Blue Ridge Limited Partnership represent 1,951,436 shares held of record by Blue Ridge Limited Partnership, 61,340 shares held of record by Blue Ridge Private Equity Fund, LLC and 527,200 shares of record held by Blue Ridge Offshore Master Limited Partnership. The sole managing member of each of Blue Ridge Private Equity Fund, LLC, JAG Offshore Holdings, LLC and JAG Holdings, LLC is John A. Griffin. JAG Holdings, LLC holds voting and dispositive power for the shares held by Blue Ridge Limited Partnership, JAG Offshore Holdings, LLC holds voting and dispositive power for the shares held by Blue Ridge Offshore Master Limited Partnership and Mr. Griffin holds voting and dispositive power for the shares held by Blue Ridge Private Equity Fund, LLC. Mr. Griffin disclaims beneficial ownership of these shares except to the extent of his pecuniary interest therein, Blue Ridge Offshore Master Limited Partnership disclaims beneficial ownership of the shares held by Blue Ridge Limited Partnership and Blue Ridge Private Equity Fund, LLC and Blue Ridge Limited Partnership disclaims beneficial ownership of the shares held by Blue Ridge Offshore Master Limited Partnership and Blue Ridge Private Equity Fund, LLC. The address of each of Blue Ridge Limited Partnership, Blue Ridge Offshore Master Limited Partnership and Blue Ridge Private Equity Fund, LLC is 660 Madison Avenue, New York, NY 10021. (4) Shares beneficially owned by Halyard Capital Fund, LP represent 2,146,929 shares held of record by Halyard Capital Fund, LP. Its general partner is Halyard Fund GP, LP, which has as its general partner Halyard Advisors, LLC. Halyard Advisors, LLC has as its investment member Halyard Principals, LLC. Each of such entities or persons may be deemed to be the beneficial owner and hold voting and dispositive power for the shares owned by Halyard Capital Fund, LP. The principal business address of Table of Contents each such entity or person is Halyard Capital Fund, LP, 3 Times Square, 29th Floor, New York, NY 10036. (5) Shares beneficially owned by The Abernathy Group represent (1) 1,324,434 shares held of record by Abernathy NETGEAR Holding, LP and (2) 142 shares held of record by Abernathy Financial Services, LLC. Steven Abernathy holds voting and dispositive power for these shares. The address of The Abernathy Group is Wall Street Tower, 38th Floor, Twenty Exchange Place, New York, NY 10005. (6) Shares beneficially owned by Mr. Lo include (1) 199,171 shares held of record by The Patrick and Emily Lo Revocable Living Trust Dated 4-7-99, (2) 5,074 shares held of record by The Daphne T. W. Lo 2002 Irrevocable Education Trust, (3) 5,074 shares held of record by The Kai W. Lo 2002 Irrevocable Education Trust, and 996,761 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (7) Includes 159,867 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (8) Includes 64,025 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (9) Includes 485,339 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (10) Includes 218,315 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (11) Includes 18,187 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (12) Includes 22,981 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (13) Includes 81,958 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (14) Includes 292 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (15) Includes 24,244 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. (16) Shares beneficially owned by all executive officers and directors as a group include 1,971,969 shares issuable pursuant to options exercisable within 60 days of February 20, 2004. Table of Contents DESCRIPTION OF CAPITAL STOCK General Matters Our authorized capital stock consists of 200,000,000 shares of common stock, par value $0.001 per share and 5,000,000 shares of preferred stock, par value $0.001 per share. The following summary of specified provisions of the common stock and the preferred stock does not purport to be complete and is subject to, and qualified in its entirety by, our certificate of incorporation and bylaws, which are filed as exhibits to the registration statement of which this prospectus forms a part, and by the provisions of applicable law. As of February 20, 2004, there were outstanding: 29,654,777 shares of common stock held by 82 stockholders of record; options to purchase an aggregate of 5,301,622 shares of common stock; and no shares of preferred stock. Common Stock Subject to preferences that may be applicable to any preferred stock outstanding at the time, the holders of outstanding shares of common stock are entitled to receive dividends out of assets legally available for distribution at such times and in such amounts as the board of directors from time to time may determine. Holders of common stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders. Our certificate of incorporation and bylaws include provisions that require that certain amendments to the certificate of incorporation and the bylaws require the approval of the holders of at least 66 2/3% of the voting power of all outstanding stock. Cumulative voting for the election of directors is not authorized by our certificate of incorporation, which means that the holders of a majority of the shares voted can elect all of the directors then standing for election. The common stock is not entitled to preemptive rights or sinking fund provisions and is not subject to conversion or redemption. Upon liquidation, dissolution or winding-up of NETGEAR, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation of any preferred stock. Preferred Stock The board of directors is authorized, without action by the stockholders, to designate and issue preferred stock in one or more series. The board of directors can fix the rights, preferences and privileges of the shares of each series and any qualifications, limitations or restrictions thereon. The board of directors may authorize the issuance of preferred stock with voting or conversion rights that could adversely affect the voting power or other rights of the holders of common stock. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes could, under certain circumstances, have the effect of delaying, deferring or preventing a change in control of NETGEAR. We have no current plans to issue any shares of preferred stock. Registration Rights Until August 2006, and after giving effect to this offering, the holders of up to 11,228,480 shares of our common stock that was issued upon conversion of our Series A, Series B and Series C preferred stock have the right to cause us to register those shares under the Securities Act of 1933, as amended, or the Securities Act. Demand Registration Rights; S-3 Registration Rights. Six months following completion of this offering, one or more stockholders holding at least 25% of the registrable shares of our securities has the right to request us to register shares held by them if the shares have an aggregate value of at least $5 million (based on the then current market price or fair value). Piggyback Registration Rights. One or more stockholders holding registrable shares may request us to have their shares registered anytime after our initial public offering if we file a registration Cash paid for interest $ 939 $ 18 $ Table of Contents USE OF PROCEEDS We will not receive any of the proceeds from the sale of the shares of our common stock in this offering other than reimbursement of certain out-of-pocket expenses of the offering. The selling stockholders will receive all of the net proceeds from this offering. We anticipate the selling stockholders will bear substantially all of the out-of-pocket expenses of the offering. MARKET PRICE OF COMMON STOCK Our common stock has been quoted on the Nasdaq National Market under the symbol NTGR since July 31, 2003. Prior to that time, there was no public market for our common stock. The following table sets forth for the indicated periods the high and low sales prices of our common stock on the Nasdaq National Market. High Low Table of Contents statement to register any of our securities for our own account. The underwriters of any underwritten offering will have the right to limit the number of shares having registration rights to be included in the registration statement, but not below 30% of the total number of shares included in the registration statement. Registration of shares of common stock because of the exercise of demand registration rights or piggyback registration rights under the Securities Act would result in the holders being able to trade these shares without restriction under the Securities Act when the applicable registration statement is declared effective. We will pay all registration expenses, other than underwriting discounts, related to any registration. The registration rights terminate upon the earlier of (1) August 5, 2006, (2) with respect to the demand registration rights of an individual holder, when the holder holds less than 175,000 registrable shares, or (3) for an individual holder, when the holder can sell all of the holder s shares in any 90-day period under Rule 144 under the Securities Act. Certain Provisions of our Certificate of Incorporation and Bylaws and Delaware Anti-Takeover Law Certificate of Incorporation and Bylaws Certain provisions of Delaware law and our certificate of incorporation and bylaws could make more difficult the acquisition of NETGEAR by means of a tender offer, a proxy contest, or otherwise, and the removal of incumbent officers and directors. These provisions are expected to discourage certain types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of NETGEAR to first negotiate with us. We believe that the benefits of increased protection of NETGEAR s potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure NETGEAR outweighs the disadvantages of discouraging such proposals, including proposals that are priced above the then current market value of our common stock, because, among other things, negotiation of such proposals could result in an improvement of their terms. Our certificate of incorporation and bylaws include provisions that: allow the board of directors to issue, without further action by the stockholders, up to 5,000,000 shares of undesignated preferred stock; require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent; prohibit cumulative voting in the election of directors; require that special meetings of our stockholders be called only by the board of directors, the chairman of the board, the chief executive officer or the president; establish an advance notice procedure for stockholder proposals to be brought before an annual meeting of our stockholders, including proposed nominations of persons for election to the board of directors; and require that certain amendments to the certificate of incorporation and the bylaws require the approval of the holders of at least 66 2/3% of the voting power of all outstanding stock. The Delaware General Corporation Law We are subject to Section 203 of the Delaware General Corporation Law. This provision generally prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date the stockholder became an interested stockholder, unless: prior to such date, the board of directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation Table of Contents outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned by persons who are directors and also officers and by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or on or subsequent to such date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock that is not owned by the interested stockholder. Section 203 defines a business combination to include: any merger or consolidation involving the corporation and the interested stockholder; any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation involving the interested stockholder; subject to certain exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation. In general, Section 203 defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation and any entity or person affiliated with or controlling or controlled by such entity or person. These provisions are intended to enhance the likelihood of continuity and stability in the composition of the board and in the policies formulated by the board and to discourage certain types of transactions that may involve an actual or threatened change of control of NETGEAR. These provisions are designed to reduce our vulnerability to an unsolicited proposal for a takeover that does not contemplate the acquisition of all of our outstanding shares or an unsolicited proposal for the restructuring or sale of all or part of our company. These provisions, however, could discourage potential acquisition proposals and could complicate, delay or prevent a change in control of NETGEAR. They may also have the effect of preventing changes in our management. We believe that the benefits of increased protection of our potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure us outweighs the disadvantages of discouraging these proposals, including proposals that are priced above the then current market value of our common stock, because, among other things, negotiation of these proposals could result in an improvement of their terms. Transfer Agent and Registrar The transfer agent and registrar for our common stock is Mellon Investor Services LLC. 2003 Third Quarter (beginning July 31, 2003) $ 20.90 $ 14.00 Fourth Quarter $ 18.73 $ 12.86 2004 First Quarter (through March 12, 2004) $ 20.09 $ 13.98 On March 12, 2004, there were approximately 53 stockholders of record. STOCK PERFORMANCE GRAPH The following graph compares the change in the cumulative total stockholder return on NETGEAR s common stock during the period from July 31, 2003, the date on which our stock commenced trading on the Nasdaq National Market, through March 12, 2004, with the cumulative total return on the Nasdaq Market Index and the Nasdaq Computer Index. The comparison assumes reinvestment of dividends, if any. ASSUMES $100 INVESTED ON JULY 31, 2003 ASSUMES DIVIDEND REINVESTED THROUGH FEBRUARY 20, 2004 July 31, 2003 September 28, 2003 December 31, 2003 March 12, 2004 Table of Contents UNITED STATES FEDERAL INCOME TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS The following is a general discussion of the material United States federal income tax consequences of the ownership and disposition of our common stock to a non-United States holder. For the purpose of this discussion, a non-United States holder is any holder that for United States federal income tax purposes is not a United States person. For purposes of this discussion, the term United States person means: an individual citizen or resident of the United States; a corporation or other entity taxable as a corporation or a partnership or entity taxable as a partnership created or organized in the United States or under the laws of the United States or any political subdivision thereof; an estate whose income is subject to United States federal income tax regardless of its source; or a trust (a) whose administration is subject to the primary supervision of a United States court and which has one or more United States persons who have the authority to control all substantial decisions of the trust or (b) which has made an election to be treated as a United States person. If a partnership holds common stock, the tax treatment of a partner will generally depend on the status of the partner and upon the activities of the partnership. Accordingly, partnerships which hold our common stock and partners in such partnerships should consult their tax advisors. This discussion assumes that non-United States holders will hold our common stock issued pursuant to the offering as a capital asset (generally, property held for investment). This discussion does not address all aspects of United States federal income taxation that may be relevant in light of a non-United States holder s special tax status or special tax situations. United States expatriates, life insurance companies, tax-exempt organizations, dealers in securities or currency, banks or other financial institutions, investors whose functional currency is other than the United States dollar, and investors that hold common stock as part of a hedge, straddle or conversion transaction are among those categories of potential investors that are subject to special rules not covered in this discussion. This discussion does not address any tax consequences arising under the laws of any state, local or non-United States taxing jurisdiction. Furthermore, the following discussion is based on current provisions of the Internal Revenue Code of 1986, as amended, and Treasury Regulations and administrative and judicial interpretations thereof, all as in effect on the date hereof, and all of which are subject to change, possibly with retroactive effect. Accordingly, each non-United States Holder should consult a tax advisor regarding the United States federal, state, local and non-United States income and other tax consequences of acquiring, holding and disposing of shares of our common stock. Dividends We have not paid any dividends on our common stock and we do not plan to pay any dividends for the foreseeable future. However if we do pay dividends on our common stock, those payments will constitute dividends for United States tax purposes to the extent paid from our current and accumulated earnings and profits, as determined under United States federal income tax principles. To the extent those dividends exceed our current and accumulated earnings and profits, the dividends will constitute a return of capital and will first reduce a holder s basis, but not below zero, and then will be treated as gain from the sale of stock. Any dividend (out of earnings and profits) paid to a non-United States holder of common stock generally will be subject to United States withholding tax either at a rate of 30% of the gross amount of the dividend or such lower rate as may be specified by an applicable tax treaty. In order to receive a reduced treaty rate, a non-United States holder must provide us with an Internal Revenue Service Form W-8BEN or other appropriate version of Form W-8 certifying qualification for the reduced rate. Dividends received by a non-United States holder that are effectively connected with a United States trade or business conducted by the non-United States holder are exempt from such withholding tax. In order to obtain this exemption, a non-United States holder must provide us with an Internal Revenue Service, or IRS, Form W-8ECI properly certifying such exemption. Such effectively connected dividends, although not Table of Contents subject to withholding tax, are taxed at the same graduated rates applicable to United States persons, net of certain deductions and credits. In addition to the graduated tax described above, dividends received by corporate non-United States holder that are effectively connected with a United States trade or business of the corporate non-United States holder may also be subject to a branch profits tax at a rate of 30% or such lower rate as may be specified by an applicable tax treaty. A non-United States holder of common stock that is eligible for a reduced rate of withholding tax pursuant to a tax treaty may obtain a refund of any excess amounts currently withheld if an appropriate claim for refund is filed with the Internal Revenue Service. Gain on Disposition of Common Stock A non-United States holder generally will not be subject to United States federal income tax on any gain realized upon the sale or other disposition of our common stock unless: the gain is effectively connected with a United States trade or business of the non-United States holder (which gain, in the case of a corporate non-United States holder, must also be taken into account for branch profits tax purposes); the non-United States holder is an individual who holds his or her common stock as a capital asset (generally, an asset held for investment purposes) and who is present in the United States for a period or periods aggregating 183 days or more during the calendar year in which the sale or disposition occurs and certain other conditions are met; or our common stock constitutes a United States real property interest by reason of our status as a United States real property holding corporation for United States federal income tax purposes at any time within the shorter of the five-year period preceding the disposition or the holder s holding period for our common stock. We have determined that we are not and do not believe that we will become a United States real property holding corporation for United States federal income tax purposes. Backup Withholding and Information Reporting Generally, we must report annually to the IRS the amount of dividends paid, the name and address of the recipient, and the amount, if any, of tax withheld. A similar report is sent to the holder. Pursuant to tax treaties or other agreements, the IRS may make its reports available to tax authorities in the recipient s country of residence. Payments of dividends or of proceeds on the disposition of stock made to a non-United States holder may be subject to backup withholding (currently at a rate of 30%) unless the non-United States holder establishes an exemption, for example by properly certifying its non-United States status on a Form W-8BEN or another appropriate version of Form W-8. Notwithstanding the foregoing, backup withholding may apply if either we or our paying agent has actual knowledge, or reason to know, that the holder is a United States person. Backup withholding is not an additional tax. Rather, the United States income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund may be obtained, provided that the required information is furnished to the IRS. Table of Contents SHARES ELIGIBLE FOR FUTURE SALE Sales of Restricted Shares and Lock-Up Agreements All of the shares sold in this offering will be freely tradable without restriction under the Securities Act, except for any shares purchased by our affiliates as that term is defined in Rule 144 under the Securities Act. In addition, the shares sold by us and the selling stockholders in our initial public offering and any shares previously sold by our stockholders pursuant to Rule 144 are freely tradable under the Securities Act, unless they were purchased by our affiliates. Substantially all of the remaining shares of our common stock that will be outstanding after this offering are restricted shares as that term is defined in Rule 144 under the Securities Act. We issued and sold the restricted shares in private transactions in reliance upon exemptions from registration under the Securities Act. Restricted shares may be sold in the public market only if they are registered under the Securities Act or if they qualify for an exemption from registration, such as Rule 144 or 701 under the Securities Act, which are summarized below. In connection with this offering, our directors, executive officers and certain stockholders, including the selling stockholders, have agreed to a 90-day lock-up with respect to approximately 10,756,740 shares, representing substantially all the shares they will beneficially own following this offering. In addition, the lock-up will apply to all shares of our common stock which such persons may acquire during this 90-day period upon exercise of options and warrants to acquire our capital stock. This generally means that they cannot sell these shares during the 90 days following the date of this offering. After the 90-day lock-up period ends, these shares may be sold only in accordance with an available exemption from registration, such as Rule 144 or 701, which are described below. We have filed a registration statement under the Securities Act covering shares of common stock issuable upon the exercise of options or reserved for issuance under our stock plans. The shares registered under this registration statement will, subject to Rule 144 provisions applicable to affiliates, be available for sale in the open market, except to the extent that the shares are subject to vesting restrictions or the lock-up agreements described above. In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned restricted shares for at least one year would be entitled to sell, within any three-month period, up to that number of restricted shares as is equal to the greater of one percent of the number of shares of common stock then outstanding (which will equal approximately 296,548 shares immediately after this offering) or the average weekly trading volume of our common stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a notice on Form 144 with respect to such sale. Sales under Rule 144 are also subject to manner of sale provisions, notice requirements and the availability of current public information about us. Rule 144 also provides that our affiliates who are selling shares of common stock that are not restricted shares must nonetheless comply with the same restrictions applicable to restricted shares with the exception of the holding period requirement. Under Rule 144(k), beginning on the date of this prospectus, a person who is not deemed to have been an affiliate of ours at any time during the 90 days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, is entitled to sell those shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Rule 701 may be relied upon with respect to the resale of shares of common stock originally purchased from us by directors, employees or consultants prior to the date of this prospectus. Shares issued in reliance on Rule 701 are restricted shares and, subject to the lock-up agreements described above, may be sold beginning 90 days after the date of this prospectus by persons other than affiliates, subject only to the manner of sale provisions of Rule 144, and may be sold by affiliates under Rule 144 without compliance with its one-year holding period requirement. Sales under Rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about us. Rule 144 also provides that our affiliates who sell Table of Contents shares of our common stock that are not restricted shares must nonetheless comply with the same restrictions applicable to restricted shares with the exception of the holding period requirement. Rule 144(k) Under Rule 144(k), a person who is not deemed to have been one of our affiliates for purposes of the Securities Act at any time during the 90 days preceding a sale and who has beneficially owned the shares proposed to be sold for at least two years, including the holding period of any prior owner other than an affiliate of us, is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Therefore, unless otherwise restricted, 144(k) shares may be sold immediately upon the completion of this offering. Rule 701 In general, under Rule 701 as currently in effect, any of our employees, consultants or advisors who purchase shares from us in connection with a compensatory stock or option plan or other written agreement will be eligible to resell such shares 90 days after the effective date of this offering in reliance on Rule 144. Registration of Shares in Connection with Compensatory Benefit Plans As of February 20, 2004, options to purchase 5,301,622 shares of common stock were issued and outstanding under our Stock Plans, all of which are freely tradeable under the Securities Act. Other Registration Rights Certain of our stockholders are parties to an agreement which obligates us to register their shares of our capital stock after this offering in specified circumstances. See Description of Capital Stock Registration Rights for additional information. Per share $ $ Total $ $ The underwriters have advised us that they propose to offer the shares of common stock directly to the public at the public offering price presented on the cover page of this prospectus, and to selected dealers, who may include the underwriters, at the public offering price less a selling concession not in excess of $ per share. The underwriters may allow, and the selected dealers may reallow, a concession not in excess of $ per share to brokers and dealers. After the offering, the underwriters may change the offering price and other selling terms. We estimate that the total expenses of this offering, payable by the selling stockholders, including registration, filing and listing fees, printing fees and legal and accounting expenses, but excluding Table of Contents CAPITALIZATION The following table summarizes our capitalization as of December 31, 2003. You should read this table in conjunction with Selected Consolidated Financial Data, Management s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes included elsewhere in this prospectus. As of December 31, 2003 Table of Contents underwriting discounts, will be approximately $500,000. We anticipate the selling stockholders will bear substantially all costs and expenses of this offering. In January 2003, we entered into an agreement with Lehman Brothers Inc. pursuant to which Lehman Brothers Inc. would provide financial advisory services to us. The agreement terminated upon the closing of the initial public offering. Under the terms of the agreement, Lehman Brothers right of first refusal to provide financial advisory services to us survived termination of the agreement for a limited period of time following termination. The National Association of Securities Dealers deemed the right of first refusal to act as our underwriter or placement agent to be compensation to Lehman Brothers Inc. in this offering. Lock-up Agreements We have agreed that, without the prior written consent of Lehman Brothers Inc., we will not, directly or indirectly, offer, sell or dispose of any common stock or any securities which may be converted into or exchanged for any common stock for a period of 90 days from the date of this prospectus. In connection with this offering, our directors, executive officers and certain of our stockholders, including the selling stockholders, have agreed to a 90-day lock-up with respect to approximately 10,756,740 shares, representing substantially all the shares they will beneficially own following this offering. Pursuant to these lock-up agreements they have agreed not to, without the prior written consent of Lehman Brothers Inc., directly or indirectly, offer, sell or otherwise dispose of any common stock or any securities which may be converted into or exchanged or exercised for any common stock that is subject to the lock-up, for a period of 90 days from the date of this prospectus. Quotation on the Nasdaq National Market Our common stock is quoted on the Nasdaq National Market under the symbol NTGR. Indemnification We and the selling stockholders have agreed to indemnify the underwriters against liabilities relating to the offering, including liabilities under the Securities Act and liabilities arising from breaches of the representations and warranties contained in the underwriting agreement, and to contribute to payments that the underwriters may be required to make for these liabilities. Stabilization, Short Positions and Penalty Bids The underwriters may engage in over-allotment, stabilizing transactions, syndicate covering transactions, and penalty bids or purchases for the purpose of pegging, fixing or maintaining the price of our common stock, in accordance with Regulation M under the Securities Exchange Act of 1934: Over-allotment involves sales by the underwriters of shares in excess of the number of shares the underwriters are obligated to purchase, which creates a syndicate short position. The short position may be either a covered short position or a naked short position. In a covered short position, the number of shares over-allotted by the underwriters is not greater than the number of shares that they may purchase in the over-allotment option. In a naked short position, the number of shares involved is greater than the number of shares in the over-allotment option. The underwriters may close out any short position by either exercising their over-allotment option and/or purchasing shares in the open market. Stabilizing transactions permit bids to purchase common stock so long as the stabilizing bids do not exceed a specified maximum. Syndicate covering transactions involve purchases of the common stock in the open market after the distribution has been completed in order to cover syndicate short positions. In determining the source of shares to close out the short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. If the underwriters sell more shares than could be covered by the over-allotment option, creating a naked short position, the position can only be closed out by buying shares in the open market. A naked short position is more likely to be created if the (in thousands, except share and per share data) Cash, cash equivalents and short-term investments $ 73,605 Table of Contents underwriters are concerned that there could be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering. Penalty bids permit the underwriters to reclaim a selling concession from a syndicate member when the common stock originally sold by the syndicate member is purchased in a stabilizing or syndicate covering transaction to cover syndicate short positions. These stabilizing transactions, syndicate covering transactions and penalty bids may raise or maintain the market price of our common stock or prevent or slow a decline in the market price of our common stock. As a result, the price of our common stock may be higher than the price that might otherwise exist in the open market. These transactions may be effected on the Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. Neither we nor any of the underwriters make any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of our common stock. In addition, neither we nor the underwriters make any representation that the underwriters will engage in these stabilizing transactions or that any transaction, once commenced, will not be discontinued without notice. Passive Market Making In connection with this offering, underwriters and selling group members may engage in passive market making transactions in our common stock on the Nasdaq National Market in accordance with Rule 103 of Regulation M under the Exchange Act during the period before the commencement of offers or sales of common stock and extending through the completion of the distribution. A passive market maker must display its bids at a price not in excess of the highest independent bid of the security. However, if all independent bids are lowered below the passive market maker s bid, that bid must be lowered when specified purchase limits are exceeded. Stamp Taxes If you purchase shares of common stock offered in this prospectus, you may be required to pay stamp taxes and other charges under the laws and practices of the country of purchase, in addition to the offering price listed on the cover page of this prospectus. Electronic Distribution A prospectus in electronic format may be made available on Internet sites or through other online services maintained by one or more of the underwriters or selling group members participating in this offering, or by their affiliates. In those cases, prospective investors may view offering terms online and, depending upon the particular underwriter or selling group member, prospective investors may be allowed to place orders online. The underwriters may agree with us to allocate a specific number of shares for sale to online brokerage account holders. Any such allocation for online distributions will be made by the underwriters on the same basis as other allocations. Other than the prospectus in electronic format, information contained in any other web site maintained by an underwriter or selling group member is not part of this prospectus or the registration statement of which this prospectus forms a part, has not been approved or endorsed by us and should not be relied on by investors in deciding whether to purchase any shares of common stock. The underwriters and selling group members are not responsible for information contained in web sites that they do not maintain. Other Relationships Some of the underwriters have performed and may in the future perform investment banking and advisory services for us from time to time for which they have received or may in the future receive customary fees and expenses. The underwriters may, from time to time, engage in transactions with or perform services for us in the ordinary course of their business. Table of Contents Halyard Capital Fund, LP is an affiliate of Harris Nesbitt Corp. and is selling shares of common stock owned by it in this offering. This offering is being made in compliance with the applicable provisions of Rule 2720 of the Conduct Rules of the National Association of Securities Dealers. As a bona fide independent market exists for our common stock, the NASD does not require that we use a qualified independent underwriter for this offering. Total stockholders equity 134,939 Table of Contents NOTICE TO CANADIAN RESIDENTS Offers and Sales in Canada This prospectus is not, and under no circumstances is to be construed as, an advertisement or a public offering of shares in Canada or any province or territory thereof. Any offer or sale of shares in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only by a dealer properly registered under applicable provincial securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made. This prospectus is for the confidential use of only those persons to whom it is delivered by the underwriters in connection with the offering of the shares into Canada. The underwriters reserve the right to reject all or part of any offer to purchase shares for any reason or allocate to any purchaser less than all of the shares for which it has subscribed. Responsibility Except as otherwise expressly required by applicable law or as agreed to in contract, no representation, warranty, or undertaking (express or implied) is made and no responsibilities or liabilities of any kind or nature whatsoever are accepted by any underwriter or dealer as to the accuracy or completeness of the information contained in this prospectus or any other information provided by us or the selling stockholders in connection with the offering of the shares into Canada. Resale Restrictions The distribution of the shares in Canada is being made on a private placement basis only and is exempt from the requirement that we and the selling stockholders prepare and file a prospectus with the relevant Canadian regulatory authorities. Accordingly, any resale of the shares must be made in accordance with applicable securities laws, which will vary depending on the relevant jurisdiction, and which may require resales to be made in accordance with exemptions from registration and prospectus requirements. Canadian purchasers are advised to seek legal advice prior to any resale of the shares. Representations of Purchasers Each Canadian investor who purchases shares will be deemed to have represented to us, the selling stockholders, the underwriters and any dealer who sells shares to such purchaser that: (i) the offering of the shares was not made through an advertisement of the shares in any printed media of general and regular paid circulation, radio, television or telecommunications, including electronic display, or any other form of advertising in Canada; (ii) such purchaser has reviewed the terms referred to above under Resale Restrictions above; (iii) where required by law, such purchaser is purchasing as principal for its own account and not as agent; and (iv) such purchaser or any ultimate purchaser for which such purchaser is acting as agent is entitled under applicable Canadian securities laws to purchase such shares without the benefit of a prospectus qualified under such securities laws, and without limiting the generality of the foregoing: (a) in the case of a purchaser located in a province other than Ontario and Newfoundland and Labrador, without the dealer having to be registered, (b) in the case of a purchaser located in a province other than Ontario or Quebec, such purchaser is an accredited investor as defined in section 1.1 of Multilateral Instrument 45-103 Capital Raising Exemptions, (c) in the case of a purchaser located in Ontario, such purchaser, or any ultimate purchaser for which such purchaser is acting as agent, is an accredited investor , other than an individual, as that term is defined in Ontario Securities Commission Rule 45-501 Exempt Distributions and is a person to which a dealer registered as an international dealer in Ontario may sell shares, and (d) in the case of a purchaser located in Qu bec, such purchaser is a sophisticated purchaser within the meaning of section 44 or 45 of the Securities Act (Qu bec). Total capitalization $ 134,939 Table of Contents Taxation and Eligibility for Investment Any discussion of taxation and related matters contained in this prospectus does not purport to be a comprehensive description of all the tax considerations that may be relevant to a decision to purchase the shares. Canadian purchasers of shares should consult their own legal and tax advisers with respect to the tax consequences of an investment in the shares in their particular circumstances and with respect to the eligibility of the shares for investment by the purchaser under relevant Canadian federal and provincial legislation and regulations. Rights of Action for Damages or Rescission (Ontario) Securities legislation in Ontario provides that every purchaser of shares pursuant to this prospectus shall have a statutory right of action for damages or rescission against us and any selling stockholder in the event this prospectus contains a misrepresentation as defined in the Securities Act (Ontario). Ontario purchasers who purchase shares offered by this prospectus during the period of distribution are deemed to have relied on the misrepresentation if it was a misrepresentation at the time of purchase. Ontario purchasers who elect to exercise a right of rescission against us and any selling stockholder on whose behalf the distribution is made shall have no right of action for damages against us or the selling stockholders. The right of action for rescission or damages conferred by the statute is in addition to, and without derogation from, any other right the purchaser may have at law. Prospective Ontario purchasers should refer to the applicable provisions of Ontario securities legislation and are advised to consult their own legal advisers as to which, or whether any, of such rights or other rights may be available to them. The foregoing summary is subject to the express provisions of the Securities Act (Ontario) and the rules, regulations and other instruments thereunder, and reference is made to the complete text of such provisions contained therein. Such provisions may contain limitations and statutory defences on which we and the selling stockholders may rely. The enforceability of these rights may be limited as described herein under Enforcement of Legal Rights. The rights of action discussed above will be granted to the purchasers to whom such rights are conferred upon acceptance by the relevant dealer of the purchase price for the shares. The rights discussed above are in addition to and without derogation from any other right or remedy which purchasers may have at law. Similar rights may be available to investors in other Canadian provinces. Enforcement of Legal Rights We are organized under the laws of the State of Delaware in the United States of America. All, or substantially all, of our directors and officers, as well as the selling stockholders and the experts named herein, may be located outside of Canada and, as a result, it may not be possible for Canadian purchasers to effect service of process within Canada upon the company or such persons. All or a substantial portion of our assets and such other persons may be located outside of Canada and, as a result, it may not be possible to satisfy a judgment against us or such persons in Canada or to enforce a judgment obtained in Canadian courts against us or such persons outside of Canada. Language of Documents Upon receipt of this document, you hereby confirm that you have expressly requested that all documents evidencing or relating in any way to the sale of the securities described herein (including for greater certainty any purchase confirmation or any notice) be drawn up in the English language only. Par la r ception de ce document, vous confirmez par les pr sentes que vous avez express ment exig que tous les documents faisant foi ou se rapportant de quelque mani re que ce soit la vente des valeurs mobili res d crites aux pr sentes (incluant, pour plus de certitude, toute confirmation d achat ou tout avis) soient r dig s en anglais seulement. Table of Contents LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Wilson, Sonsini, Goodrich Rosati, Professional Corporation, Palo Alto, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by Latham Watkins LLP, Menlo Park, California. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/SFL_sfl-corp_legal_matters.txt b/parsed_sections/legal_matters/2004/SFL_sfl-corp_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..238a86cc334c5d03e7f6d552cf625e7f3b409261 --- /dev/null +++ b/parsed_sections/legal_matters/2004/SFL_sfl-corp_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters in connection with the sale of the common shares offered hereby are being passed upon for the Company by Seward & Kissel LLP, New York, New York, as to matters of United States and New York law and by Mello, Jones & Martin as to matters of Bermuda law. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/SGI_somnigroup_legal_matters.txt b/parsed_sections/legal_matters/2004/SGI_somnigroup_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..39ba4ee8ef9ce7c18fa69e247fd476cb3076553d --- /dev/null +++ b/parsed_sections/legal_matters/2004/SGI_somnigroup_legal_matters.txt @@ -0,0 +1,5059 @@ +LEGAL MATTERS + + The validity of +the common stock offered hereby will be passed upon for us by Bingham McCutchen LLP, Boston, Massachusetts. The underwriters are represented by Weil, Gotshal & Manges LLP, New York, New York. + + + 78 + +Table of Contents + + +EXPERTS + + Ernst & Young LLP, +independent registered public accounting firm, have audited our consolidated financial statements as of and for the year ended December 31, 2003 and as of and for the two months ended December 31, 2002 and the consolidated financial statements of +our predecessor company as of and for the ten months ended October 31, 2002 as set forth in their report. We ve included our consolidated financial statements as of and for the year ended December 31, 2003 and as of and for the two months ended +December 31, 2002 and the consolidated financial statements of our predecessor company for the ten months ended October 31, 2002 in this prospectus and elsewhere in the registration statement in reliance on Ernst & Young LLP s report, given +on their authority as experts in accounting and auditing. + + Arthur Andersen LLP, independent auditors, have audited the consolidated financial statements of our predecessor company at December 31, 2001, and for the year ended December 31, 2001, as set forth in their report. We ve included these +consolidated financial statements of our predecessor company in this prospectus and elsewhere in the registration statement in reliance on Arthur Andersen LLP s report, given on their authority as experts in accounting and auditing. + + + In June 2002, Arthur Andersen LLP was convicted of federal obstruction of +justice charges. As a result of its conviction, Arthur Andersen has ceased operations and is no longer in a position to reissue its audit reports or to provide consent to include financial statements reported on by it in this prospectus. Because +Arthur Andersen has not reissued its reports and because we are not able to obtain a consent from Arthur Andersen, you will be unable to sue Arthur Andersen for material misstatements or omissions, if any, in this prospectus, including the financial +statements covered by its previously issued reports. Even if you have a basis for asserting a remedy against, or seeking recovery from, Arthur Andersen, we believe that it is unlikely that you would be able to recover damages from Arthur Andersen. + + + + 79 + +Table of Contents + + +WHERE YOU CAN FIND MORE INFORMATION + + We have filed with the Securities and Exchange Commission a registration statement on Form S-1, including exhibits and schedules, under the Securities Act with respect to the shares of our common stock to be sold in the offering. This +prospectus does not contain all the information contained in the registration statement. For further information with respect to us and the shares to be sold in the offering, reference is made to the registration statement and the exhibits and +schedules attached to the registration statement. Statements contained in this prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete. When we make such statements, we refer you to the +copies of the contracts or documents that are filed as exhibits to the registration statement because those statements are qualified in all respects by reference to those exhibits. We are subject to the information and reporting requirements of the +Securities Exchange Act of 1934, as amended, and will file annual, quarterly, and current reports, proxy statements, and other information with the Securities and Exchange Commission. + + You may read and copy all or any portion of the registration statement or any reports, statements, or other information that +we file at the Securities and Exchange Commission s Public Reference Room at 450 Fifth Street NW, Washington, D.C. 20549. You can request copies of these documents, upon payment of a duplicating fee, by writing to the Securities and Exchange +Commission. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of the Public Reference Room. The Securities and Exchange Commission maintains an Internet site that contains reports, proxy +and information statements, and other information regarding issuers that file electronically with the Securities and Exchange Commission. Our Securities and Exchange Commission filings are also available at the Securities and Exchange +Commission s web site at http://www.sec.gov. + + You +can obtain a copy of any of our filings, at no cost, by writing to or telephoning us at: + + Tempur-Pedic International Inc. + 1713 Jaggie Fox Way + Lexington, Kentucky 40511 + Attention: Robert B. Trussell, Jr. + 800-878-8889 + + + 80 + +Table of Contents + + + +INDEX TO HISTORICAL FINANCIAL STATEMENTS + + + + Audited Financial Statements + + + + + +Report of Ernst & Young LLP, Independent Registered Public Accounting Firm + + +F-2 + + +Report of Arthur Andersen LLP (previously issued) + + +F-3 + + +Consolidated Balance Sheets as of December 31, 2002 and 2003 + + +F-4 + + +Consolidated Statements of Income for the twelve months ended December 31, 2001, the ten months ended October 31, 2002, the two months ended December 31, 2002 and the twelve months ended December 31, 2003 + + +F-5 + + +Consolidated Statements of Stockholders Equity for the twelve months ended December 31, 2001, the ten months ended October 31, 2002, the two months ended December 31, 2002 and the twelve months ended December 31, +2003 + + +F-6 + + +Consolidated Statements of Cash Flows for the twelve months ended December 31, 2001, the ten months ended October 31, 2002, the two months ended December 31, 2002 and the twelve months ended December 31, +2003 + + +F-7 + + +Notes to Consolidated Financial Statements + + +F-8 + +Interim Unaudited Financial Statements + + + + +Condensed Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003 + + +F-39 + + +Condensed Consolidated Statements of Income for the three months ended September 30, 2004 and 2003 (unaudited) and the nine months ended September 30, 2004 and 2003 (unaudited) + + +F-40 + + +Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 (unaudited) + + +F-41 + + +Notes to Condensed Consolidated Financial Statements + + +F-42 + + + + F-1 + +Table of Contents + + +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM + + To the Board of Directors and Stockholders of + Tempur-Pedic International Inc. and Subsidiaries: + + We have audited the accompanying consolidated balance sheets of Tempur-Pedic +International Inc. and Subsidiaries (the Company) as of December 31, 2002 and 2003, the related consolidated statements of income, stockholders equity and cash flows for the two months ended December 31, 2002 and year ended December 31, 2003 +and the consolidated statements of income, stockholders equity and cash flows of Tempur World, Inc. and Subsidiaries (Predecessor to the Company) for the ten months ended October 31, 2002. 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. The consolidated financial statements of Tempur World, Inc. and Subsidiaries for the year ended December 31, 2001, were +audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their report dated March 8, 2002. + + We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). +Those standards require that we plan and perform the 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. + + In our opinion, +the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tempur-Pedic International Inc. and Subsidiaries as of December 31, 2002 and 2003, and the related consolidated +results of its operations and cash flows for the two months ended December 31, 2002 and year ended December 31, 2003 and the related consolidated results of operations and cash flows of Tempur World, Inc. and Subsidiaries for the ten months ended +October 31, 2002, in conformity with U.S. generally accepted accounting principles. + + As discussed in Note 1(i) to the consolidated financial statements, the Company changed its method of accounting for goodwill. + + +As discussed above, the consolidated financial statements of the Company as of December 31, 2001 and for the year then ended were audited by other +auditors who have ceased operations. As discussed in Note 18 to the consolidated financial statements, those consolidated financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting +Standards (Statement) No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company as of January 1, 2002. Our audit procedures with respect to the disclosures in Note 18 for the December 31, 2001 consolidated financial +statements included (a) agreeing the previously reported net income to the previously issued consolidated financial statements and the adjustments to reported net income to goodwill to the Company s underlying records obtained from management, +and (b) testing the mathematical accuracy of the reconciliation of adjusted net income to reported net income. In our opinion, the disclosure for 2001 in Note 18 is appropriate. However, we were not engaged to audit, review or apply any procedures +to the 2001 consolidated financial statements, and accordingly, we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements taken as a whole. + + ERNST & YOUNG LLP + + Louisville, Kentucky + February 10, 2004 + + + F-2 + +Table of Contents + + +Arthur Andersen LLP Has Not Reissued This Report As Arthur Andersen LLP Ceased Operations In August 2002. The Following Report Is A Copy of the Previously Issued Arthur Andersen LLP Report. + + REPORT OF INDEPENDENT AUDITORS + + To the Board of Directors and Stockholders of + Tempur World, Inc. and Subsidiaries: + + We have audited the accompanying consolidated balance sheets of Tempur World, Inc. (a Delaware corporation) and Subsidiaries +as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders equity and cash flows for the years then ended. 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. + + We conducted our audits in accordance with auditing standards generally accepted in the United States. 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. + + In our opinion, the financial statements referred to above presents fairly, in all material respects, the financial position +of Tempur World, Inc. and Subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. + + + ARTHUR ANDERSEN LLP + + + Louisville, Kentucky + March 8, 2002 + + + F-3 + +Table of Contents + + +TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + CONSOLIDATED BALANCE SHEETS + (In thousands except share and per share amounts) + + + + +December 31, + + + + + +2002 + + + +2003 + + + + ASSETS + + + + + + + + + + + Current Assets: + + + + + + + + + + + Cash and cash equivalents + + +$ +12,654 + + +$ +14,230 + + + Accounts receivable, net + + + +43,799 + + + +60,309 + + + Inventories + + + +36,630 + + + +58,276 + + + Prepaid expenses and other current assets + + + +3,148 + + + +6,937 + + + Deferred income taxes + + + +5,051 + + + +5,692 + + + + + + + + Total current assets + + + +101,282 + + + +145,444 + + + Property, plant and equipment, net + + + +88,286 + + + +114,741 + + + Goodwill + + + +164,644 + + + +208,546 + + + Other intangible assets, net + + + +85,065 + + + +80,000 + + + Restricted cash + + + + + + + +60,243 + + + Deferred financing and other non-current assets, net + + + +9,316 + + + +11,375 + + + + + + + + Total Assets + + +$ +448,593 + + +$ +620,349 + + + + + + + + LIABILITIES AND STOCKHOLDERS EQUITY + + + + + + + + + + + Current Liabilities: + + + + + + + + + + + Accounts payable + + +$ +17,675 + + +$ +25,886 + + + Accrued expenses and other + + + +38,702 + + + +54,078 + + + Current portion of long-term debt + + + +13,565 + + + +10,496 + + + + + + + + Total current liabilities + + + +69,942 + + + +90,460 + + + Long-term debt + + + +182,292 + + + +366,026 + + + Deferred income taxes + + + +42,500 + + + +39,049 + + + Other non-current liabilities + + + +2,253 + + + +2,105 + + + + + + + + Total Liabilities + + + +296,987 + + + +497,640 + + + Commitments and contingencies (see note 10) + + + + + + + + + + + Stockholders Equity: + + + + + + + + + + + Preferred stock, $.01 par value, 94,500,000 and 10,000,000 shares authorized in 2002 and 2003, respectively; 76,893,416 and 0 shares issued +and outstanding in 2002 and 2003, respectively + + + +148,422 + + + + + + + Common stock, $.01 par value, 170,625,000 and 300,000,000 shares authorized in 2002 and 2003, respectively; 7,814,436 and 97,317,669 shares +issued and outstanding in 2002 and 2003, respectively + + + + + + + +973 + + + Additional paid in capital + + + +4,864 + + + +249,946 + + + Class B-1 common stock warrants + + + +2,348 + + + + + + + Notes receivable + + + +(100 +) + + + + + + Deferred stock compensation, net of amortization of $2 and $4,221 as of December 31, 2002 and 2003, respectively + + + +(141 +) + + +(8,935 +) + + Retained deficit + + + +(5,205 +) + + +(127,630 +) + + Accumulated other comprehensive income + + + +1,418 + + + +8,355 + + + + + + + + Total Stockholders Equity + + + +151,606 + + + +122,709 + + + + + + + + Total Liabilities and Stockholders Equity + + +$ +448,593 + + +$ +620,349 + + + + + + + + + The accompanying notes +to consolidated financial statements are an integral part of these statements. + + + F-4 + +Table of Contents + + +TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF INCOME + (In thousands except share and per share amounts) + + + + + +Predecessor + + + + + + + + + Twelve Months + Ended + December 31, + 2001 + + + + Ten Months + Ended + October 31, + 2002 + + + + Two Months + Ended + December 31, + 2002 + + + + Twelve Months + Ended + December 31, + 2003 + + + + Net sales + + +$ +221,514 + + +$ +237,314 + + +$ +60,644 + + +$ +479,135 + + + Cost of sales + + + +107,569 + + + +110,228 + + + +37,812 + + + +223,865 + + + + + + + + + + + + Gross profit + + + +113,945 + + + +127,086 + + + +22,832 + + + +255,270 + + + Selling expenses + + + +52,122 + + + +59,572 + + + +15,322 + + + +106,345 + + + General and administrative expenses + + + +30,189 + + + +26,136 + + + +8,330 + + + +50,356 + + + Research and development expenses + + + +1,263 + + + +985 + + + +163 + + + +1,495 + + + + + + + + + + + + Operating income (loss) + + + +30,371 + + + +40,393 + + + +(983 +) + + +97,074 + + + Other income (expense), net: + + + + + + + + + + + + + + + + + + + Interest expense, net + + + +(6,555 +) + + +(6,292 +) + + +(2,955 +) + + +(20,539 +) + + Loss on debt extinguishment + + + + + + + + + + + + + + + +(13,669 +) + + Other expense, net + + + +(316 +) + + +(1,724 +) + + +1,331 + + + +(1,664 +) + + + + + + + + + + + Total other expense + + + +(6,871 +) + + +(8,016 +) + + +(1,624 +) + + +(35,872 +) + + + + + + + + + + + Income (loss) before income taxes + + + +23,500 + + + +32,377 + + + +(2,607 +) + + +61,202 + + + Income tax provision + + + +11,643 + + + +12,436 + + + +640 + + + +23,627 + + + + + + + + + + + + Net income (loss) + + + +11,857 + + + +19,941 + + + +(3,247 +) + + +37,575 + + + Preferred stock dividends + + + +345 + + + +1,238 + + + +1,958 + + + + + + + Net income (loss) available to common stockholders + + +$ +11,512 + + +$ +18,703 + + +$ +(5,205 +) + +$ +37,575 + + + + + + + + + + + + Basic (loss) earnings per share + + + + + + + + + + +$ +(0.67 +) + +$ +3.32 + + + + + + + + + + + + + + + + Diluted (loss) earnings per share + + + + + + + + + + +$ +(0.67 +) + +$ +0.39 + + + + + + + + + + + + + + + + + + The accompanying notes to consolidated financial statements are an integral part of these statements. + + + F-5 + +Table of Contents + + +TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY + (In thousands except share and per share +amounts) + + + + +Common +Stock + + +Preferred +Stock + + + +Additional +Paid in +Capital + + + +Class B-1 +Common +Stock +Warrants + + + +Notes +Receivable + + + +Treasury +Stock + + + +Deferred +Stock +Compensation + + + +Retained +Earnings/ +(Deficit) + + + +Accumulated +Other +Comprehensive +Income + + + +Total + + + + Predecessor Balance, December 31, 2000 + + +$ +90 + +$ + + + +$ +14,352 + + +$ + + + +$ + + + +$ + + + +$ + + + +$ +24,410 + + +$ +(615 +) + +$ +38,237 + + + Net income + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +11,857 + + + + + + + +11,857 + + + Foreign currency translation adjustments, net of tax + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +(2,741 +) + + +(2,741 +) + + Dividends on preferred stock + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +(345 +) + + + + + + +(345 +) + + Purchases of treasury stock + + + + + + + + + + + + + + + + + + + + + + +(30,314 +) + + + + + + + + + + + + + + +(30,314 +) + + + + + + + + + + + + + + + + + + + + + + + Predecessor Balance, December 31, 2001 + + +$ +90 + +$ + + + +$ +14,352 + + +$ + + + +$ + + + +$ +(30,314 +) + +$ + + + +$ +35,922 + + +$ +(3,356 +) + +$ +16,694 + + + Net income + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +19,941 + + + + + + + +19,941 + + + Foreign currency translation adjustments, net of tax + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +6,833 + + + +6,833 + + + Dividends on preferred stock + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +(1,238 +) + + + + + + +(1,238 +) + + Purchases of treasury stock + + + + + + + + + + + + + + + + + + + + + + +(2,335 +) + + + + + + + + + + + + + + +(2,335 +) + + + + + + + + + + + + + + + + + + + + + + + Predecessor Balance, October 31, 2002 + + +$ +90 + +$ + + + +$ +14,352 + + +$ + + + +$ + + + +$ +(32,649 +) + +$ + + + +$ +54,625 + + +$ +3,477 + + +$ +39,895 + + + + + + + + + + + + + + + + + + + + + + + + Balance, November 1, 2002 + + +$ + + +$ +146,464 + + +$ +4,864 + + +$ +2,348 + + +$ +(100 +) + +$ + + + +$ +(143 +) + +$ + + + +$ + + + +$ +153,433 + + + Net loss + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +(3,247 +) + + + + + + +(3,247 +) + + Foreign currency translation adjustments, net of tax + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +1,418 + + + +1,418 + + + Dividends on preferred stock + + + + + + +1,958 + + + + + + + + + + + + + + + + + + + + + + + +(1,958 +) + + + + + + + + + + Amortization of deferred stock compensation + + + + + + + + + + + + + + + + + + + + + + + + + + +2 + + + + + + + + + + + +2 + + + + + + + + + + + + + + + + + + + + + + + + Balance, December 31, 2002 + + +$ + + +$ +148,422 + + +$ +4,864 + + +$ +2,348 + + +$ +(100 +) + +$ + + + +$ +(141 +) + +$ +(5,205 +) + +$ +1,418 + + +$ +151,606 + + + Net income + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +37,575 + + + + + + + +37,575 + + + Foreign currency translation adjustments, net of tax + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +6,937 + + + +6,937 + + + Dividends paid to stockholders + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + +(160,000 +) + + + + + + +(160,000 +) + + Exercise of stock options + + + + + + + + + + +3,071 + + + + + + + + + + + + + + + + + + + + + + + + + + + +3,071 + + + Conversion to common stock upon IPO + + + +910 + + +(148,422 +) + + +149,860 + + + +(2,348 +) + + + + + + + + + + + + + + + + + + + + + + + + + + IPO transaction costs + + + + + + + + + + +(2,612 +) + + + + + + + + + + + + + + + + + + + + + + + + + + +(2,612 +) + + Issuance of common stock upon IPO + + + +63 + + + + + + +81,750 + + + + + + + + + + + + + + + + + + + + + + + + + + + +81,813 + + + Unearned stock-based compensation + + + + + + + + + + +13,013 + + + + + + + + + + + + + + + +(13,013 +) + + + + + + + + + + + + + + Amortization of unearned stock-based compensation + + + + + + + + + + + + + + + + + + + + + + + + + + +4,219 + + + + + + + + + + + +4,219 + + + Notes receivable repayment + + + + + + + + + + + + + + + + + + +100 + + + + + + + + + + + + + + + + + + + +100 + + + + + + + + + + + + + + + + + + + + + + + + Balance, December 31, 2003 + + +$ +973 + +$ + + + +$ +249,946 + + +$ + + + +$ + + + +$ + + + +$ +(8,935 +) + +$ +(127,630 +) + +$ +8,355 + + +$ +122,709 + + + + + + + + + + + + + + + + + + + + + + + + + The accompanying notes +to consolidated financial statements are an integral part of these statements. + + + F-6 + +Table of Contents + + +TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + CONSOLIDATED STATEMENTS OF CASH FLOWS + (In thousands except share and per share amounts) + + + + + +Predecessor + + + + + + + + + Twelve Months + Ended + December 31, + 2001 + + + + Ten Months + Ended + October 31, + 2002 + + + + Two Months + Ended + December 31, + 2002 + + + + Twelve Months + Ended + December 31, + 2003 + + + + CASH FLOWS FROM OPERATING ACTIVITIES: + + + + + + + + + + + + + + + + + + + Net income (loss) + + +$ +11,857 + + +$ +19,941 + + +$ +(3,247 +) + +$ +37,575 + + + Adjustments to reconcile net income to net cash provided by operating activities: + + + + + + + + + + + + + + + + + + + Depreciation and amortization + + + +10,051 + + + +10,383 + + + +3,306 + + + +19,756 + + + Amortization of deferred financing costs + + + +323 + + + +1,116 + + + +287 + + + +1,986 + + + Write-off of deferred financing fees + + + + + + + + + + + + + + + +7,988 + + + Write-off of original issue discount + + + + + + + + + + + + + + + +1,983 + + + Amortization of original issue discount + + + + + + + + + + + +84 + + + +281 + + + Stock based compensation amortization + + + + + + + + + + + + + + + +4,219 + + + Allowance for doubtful accounts + + + +3,000 + + + +2,776 + + + +501 + + + +2,090 + + + Deferred income taxes + + + +1,692 + + + +(1,138 +) + + +(2,483 +) + + +(4,829 +) + + Foreign currency adjustments + + + +1,582 + + + +(3,887 +) + + +(2,649 +) + + +(4,143 +) + + Loss (Gain) on sale of equipment + + + +(53 +) + + +268 + + + +233 + + + +123 + + + Loss on asset impairment + + + + + + + +1,621 + + + + + + + + + + + Changes in operating assets and liabilities: + + + + + + + + + + + + + + + + + + + Accounts receivable + + + +(10,102 +) + + +(11,664 +) + + +430 + + + +(14,095 +) + + Inventories + + + +(7,543 +) + + +(5,926 +) + + +11,472 + + + +(16,978 +) + + Prepaid expenses and other current assets + + + +(1,092 +) + + +1,151 + + + +(486 +) + + +(3,443 +) + + Accounts payable + + + +(446 +) + + +2,789 + + + +30 + + + +5,303 + + + Accrued expenses and other + + + +10,447 + + + +5,276 + + + +4,907 + + + +9,134 + + + + + + + + + + + + Net cash provided by operating activities + + + +19,716 + + + +22,706 + + + +12,385 + + + +46,950 + + + + + CASH FLOWS FROM INVESTING ACTIVITIES: + + + + + + + + + + + + + + + + + + + Acquisition of businesses, net of cash acquired + + + + + + + +(710 +) + + + + + + + + + + Purchases of property, plant and equipment + + + +(35,241 +) + + +(9,175 +) + + +(1,961 +) + + +(32,597 +) + + Proceeds from sales of property, plant and equipment + + + +379 + + + +5,239 + + + +102 + + + +924 + + + Payments on earn out to former owners + + + + + + + + + + + + + + + +(39,434 +) + + + + + + + + + + + Net cash used by investing activities + + + +(34,862 +) + + +(4,646 +) + + +(1,859 +) + + +(71,107 +) + + + + CASH FLOWS FROM FINANCING ACTIVITIES: + + + + + + + + + + + + + + + + + + + Proceeds from issuance of long-term debt + + + +128,476 + + + +17,538 + + + + + + + +497,175 + + + Repayments of long-term debt + + + +(56,531 +) + + +(35,071 +) + + +(4,671 +) + + +(322,328 +) + + Proceeds (Repayments) from lines of credit + + + +(34,258 +) + + +(280 +) + + +450 + + + + + + + Payments of deferred financing costs + + + +(6,150 +) + + +(2,054 +) + + + + + + +(11,698 +) + + Cash held in trust for repayment of subordinated notes + + + + + + + + + + + + + + + +(60,243 +) + + Proceeds from issuance of preferred stock + + + +11,370 + + + +2,500 + + + + + + + + + + + Proceeds from issuance of common stock + + + + + + + + + + + + + + + +83,668 + + + Payments of dividends to shareholders + + + + + + + + + + + + + + + +(160,000 +) + + Purchases of treasury stock + + + +(30,314 +) + + +(2,335 +) + + + + + + + + + + + + + + + + + + + Net cash provided by(used in) financing activities + + + +12,593 + + + +(19,702 +) + + +(4,221 +) + + +26,574 + + + + + + + + + + + + NET EFFECT OF EXCHANGE RATE CHANGES ON CASH + + + +(481 +) + + +484 + + + +597 + + + +(841 +) + + + + + + + + + + + Increase(Decrease) in cash and cash equivalents + + + +(3,034 +) + + +(1,158 +) + + +6,902 + + + +1,576 + + + + + CASH AND CASH EQUIVALENTS, beginning of period + + + +10,572 + + + +7,538 + + + +5,752 + + + +12,654 + + + + + + + + + + + + CASH AND CASH EQUIVALENTS, end of period + + +$ +7,538 + + +$ +6,380 + + +$ +12,654 + + +$ +14,230 + + + + + + + + + + + + + The accompanying notes +to consolidated financial statements are an integral part of these statements. + + + F-7 + +Table of Contents + + +TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS + (In thousands except share and per share data) + + + (1) Summary of Significant Accounting Policies + + (a) Basis of Presentation and Description of +Business Tempur-Pedic International Inc. (Tempur-Pedic International or the Company) is a US-based multinational corporation incorporated in Delaware. The Company manufactures, markets and sells premium visco-elastic foam products including +pillows, mattresses and other related products. The Company manufactures essentially all of its products at Dan Foam ApS, located in Denmark and Tempur Production USA, Inc., located in the United States. The Company has sales and distribution +companies operating in the US, Europe and Asia Pacific. In addition, the Company has third party distributor arrangements in certain other countries where it does not have distribution companies. The Company sells its products in 54 countries and +extends credit based on the creditworthiness of its customers. The majority of the Company s revenues are derived from sales to retailers and sales to consumers through its direct response businesses. + + On December 23, 2003, the Company closed its initial public offering of +21,562,500 shares of its common stock at an initial offering price of $14.00 per share. Of the 21,562,500 shares offered, the Company sold 6,250,000 shares and certain of the Company s stockholders sold a total of 15,312,500 shares, which +included the exercise in full of the underwriters overallotment option. The shares are traded on the New York Stock Exchange under the symbol TPX . The net proceeds received by the Company were $81,813, before transaction costs of +$2,855. + + On November 1, 2002, Tempur-Pedic International +acquired Tempur World, Inc. (the Tempur Acquisition). The Tempur Acquisition was accounted for using the purchase method of accounting (see Note 2, Business Combinations). As a result of purchase accounting adjustments to the carrying value of the +assets and liabilities, the financial position and results of operations for periods subsequent to the Tempur Acquisition are not comparable to those of Tempur World, Inc. (Tempur World). The accompanying financial statements and notes to +consolidated financial statements present financial information for Tempur-Pedic International and Tempur World (Predecessor). The accompanying financial statements and notes to consolidated financial statements present financial information for +Tempur-Pedic International as of December 31, 2002 and 2003, for the two months ended December 31, 2002 and for the twelve months ended December 31, 2003. These financial statements also include financial information for the Predecessor for the +twelve months ended December 31, 2001 and the ten months ended October 31, 2002. As a result of the foregoing, the consolidated financial statements of the Predecessor and Tempur-Pedic International are not comparable and are separated by a black +line. + + (b) Basis of Consolidation The accompanying +financial statements include the accounts of Tempur-Pedic International and its subsidiaries and Tempur World and its subsidiaries. All subsidiaries are wholly-owned. All material intercompany balances and transactions have been eliminated. Certain +reclassifications have been made to prior periods to conform to the current year presentation. These reclassifications had no effect on net income (loss) for the periods previously reported. + + (c) Management s Use of Estimates The preparation of +financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent +assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. + + (d) Foreign Currency Translation Assets and liabilities of non-US +subsidiaries, whose functional currency is the local currency, are translated at period-end exchange rates. Income and expense items are translated at the + + + + F-8 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + average rates of exchange prevailing during the period. The adjustment resulting from translating the financial statements of such foreign +subsidiaries is reflected as a separate component of consolidated stockholders equity. Foreign currency transaction gains and losses are reported in results of operations. + + (e) Financial Instruments and Hedging Derivative financial instruments are used within the normal course of +business principally to manage foreign currency exchange rate risk. These instruments are generally short term in nature and are subject to fluctuations in foreign exchange rates and credit risk. Credit risk is managed through the selection of sound +financial institutions as counterparties. The changes in fair market value of foreign exchange derivatives are recognized currently in the results of operations. + + The carrying value of cash and cash equivalents, accounts receivable, accounts payable and short-term debt approximate fair +value because of the short-term maturity of those instruments. The fair value of the 10.25% Senior Subordinated Notes due 2010 (Senior Subordinated Notes) of Tempur-Pedic, Inc. and Tempur Production USA, Inc. (Issuers) are based on pricing models +using current market rates. + + The estimated fair value of the +Company s financial instruments is as follows: + + + + +December 31, + + + +2002 + + + +2003 + + + +Carrying +Amount + + + +Estimated +Fair +Market Value + + + +Carrying +Amount + + +Estimated +Fair +Market Value + + Senior Subordinated Notes + + +$ + + +$ + + +$ +150,000 + +$ +165,938 + + Foreign currency contracts + + +(1,964 +) + +(1,964 +) + + +507 + + +507 + + + As of December 31, +2003, the Company had $60,243 in restricted cash for the redemption of the principal amount of $52,500 of Senior Subordinated Notes, the payment of a redemption premium of $5,381 and accrued interest expense of $2,362 to be paid in January 2004. + + + (f) Cash and Cash Equivalents Cash and cash +equivalents consist of all investments with initial maturities of three months or less. + + (g) Inventories Inventories are stated at the lower of cost or market, determined by the first-in, first-out method and consisted of the following: + + + + +December 31, + + + +2002 + + +2003 + + Finished goods + + +$ +21,353 + +$ +35,531 + + Work-in-process + + + +5,198 + + +6,555 + + Raw materials + + + +10,079 + + +16,190 + + + + + + + Total + + +$ +36,630 + +$ +58,276 + + + + + + + + Of the amounts +included in Inventory as of November 1, 2002, $9,780 represents the value of the manufacturing profit earned by Tempur World prior to the Tempur Acquisition and is reflected in Cost of sales for the two months ended December 31, 2002. + + + F-9 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + (h) Property, Plant and Equipment Property, plant and equipment are carried at cost at acquisition date and +depreciated using the straight-line method over their estimated useful lives as follows: + + + + +Estimated Useful Lives + + Buildings + + +25-30 years + + Computer equipment + + +3-5 years + + Leasehold improvements + + +4-7 years + + Machinery equipment + + +3-7 years + + Office furniture and fixtures + + +5-7 years + + Autos + + +3-5 years + + + Leasehold improvements +are amortized over the shorter of the life of the lease or seven years. Equipment held under capital leases is recorded at the fair market value of the equipment at the inception of the leases. Equipment held under capital leases are amortized over +the shorter of their estimated useful lives or the terms of the respective leases. Depreciation expense for Tempur-Pedic International was $2,110 and $14,686 for the two months ended December 31, 2002 and the twelve months ended December 31, 2003, +respectively. Depreciation expense for Tempur World was $8,151 and $9,692 for the twelve months ended December 31, 2001 and the ten months ended October 31, 2002, respectively. + + Long-lived assets are reviewed for impairment in accordance with Statement of Financial Accounting Standards (SFAS) 144, + Accounting for the Impairment or Disposal of Long-Lived Assets, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets is assessed by a +comparison of the carrying amount of the asset to the estimated future net cash flows expected to be generated by the asset. If estimated future undiscounted net cash flows are less than the carrying amount of the asset or group of assets, the asset +is considered impaired and expense is recorded in an amount required to reduce the carrying amount of the asset to its then fair value. + + (i) Goodwill and Other Intangible Assets The Company follows SFAS 141, Business Combinations, (SFAS 141) which requires that the +purchase method of accounting be used for all business combinations. SFAS 141 specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported separately from goodwill. The Company adopted SFAS +142, Goodwill and Other Intangible Assets (SFAS 142), as of January 1, 2002. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually +in accordance with the provisions of SFAS 142. SFAS 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in +accordance with SFAS 144. The Company performs an annual impairment test on all existing goodwill in the fourth quarter of each year. During the fourth quarter of 2003, the Company performed the annual impairment test to all existing goodwill and +concluded that no impairment existed as of December 31, 2003. + + + F-10 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + Consistent with SFAS 141, the Company has used the allocation period to identify and measure the assets acquired and the +liabilities assumed in the Tempur Acquisition. The following table summarizes information about the Company s allocation of Other intangible assets: + + + + +Useful +Lives +(years) + + +As of December 31, 2003 + + + + Gross Carrying + Amount + + +Accumulated +Amortization + + + Net Carrying + Amount + + Unamortized indefinite lived intangible assets: + + + + + + + + + + + + + + Trademarks + + + + +$ +55,000 + +$ + + +$ +55,000 + + Amortized intangible assets: + + + + + + + + + + + + + + Technology + + +10 + +$ +16,000 + +$ +1,867 + +$ +14,133 + + Patents + + +5 + + +5,000 + + +1,167 + + +3,833 + + Customer database + + +5 + + +4,200 + + +980 + + +3,220 + + Foam formula + + +10 + + +3,700 + + +432 + + +3,268 + + Non-competition agreements and other + + +3 + + +2,044 + + +1,498 + + +546 + + + + + + + + + + + Total + + + + +$ +85,944 + +$ +5,944 + +$ +80,000 + + + + + + + + + + + + Amortization expense +relating to intangible assets for Tempur-Pedic International was $1,197 and $5,064 for the two months ended December 31, 2002 and the twelve months ended December 31, 2003, respectively. Amortization expense relating to intangible assets for Tempur +World was $1,900 and $691 for the twelve months ended December 31, 2001 and the ten months ended October 31, 2002, respectively. + + Annual amortization of Other intangible assets is expected to be as follows: + + + Twelve Months Ending December 31, + + + + + + 2004 + + +$ +4,139 + + 2005 + + + +3,825 + + 2006 + + + +3,825 + + 2007 + + + +3,519 + + 2008 + + + +1,985 + + + (j) +Software Preliminary project stage costs incurred are expensed and, thereafter, costs incurred in the developing or obtaining of internal use software are capitalized. Certain costs, such as maintenance and training, are expensed as +incurred. Capitalized costs are amortized over a period of not more than five years and are subject to impairment evaluation in accordance with SFAS 144. Amounts capitalized for software are included in Property, plant and equipment, net. + + + (k) Accrued Sales Returns Estimated sales returns +are provided at the time of sale based on historical sales returns. Tempur-Pedic International allows product returns ranging from 90 to 120 days following a sale. Accrued sales returns are included in Accrued expenses and other. + + Tempur World had the following activity for sales returns for the ten months +ended October 31, 2002: + + + Balance of December 31, 2001 + + +$ +1,919 + + + Amounts accrued + + + +25,206 + + + Returns charged to accrual + + + +(23,488 +) + + + + + Balance as of October 31, 2002 + + +$ +3,637 + + + + + + + + F-11 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + Tempur-Pedic International had the following activity for sales returns for the two months ended December 31, 2002 and +the twelve months ended December 31, 2003, respectively: + + + Balance as of November 1, 2002 + + +$ +3,637 + + + Amounts accrued + + + +5,598 + + + Returns charged to accrual + + + +(5,163 +) + + + + + Balance as of December 31, 2002 + + + +4,072 + + + Amounts accrued + + + +39,700 + + + Returns charged to accrual + + + +(38,316 +) + + + + + Balance as of December 31, 2003 + + +$ +5,456 + + + + + + + (l) +Warranties The Company provides a 20-year warranty for US sales and a 15-year warranty for non-US sales on mattresses, each prorated for the last 10 years. The Company also provides a 2-year to 3-year warranty on pillows. Estimated +future obligations related to these products are provided by charges to operations in the period in which the related revenue is recognized. Warranties are included in Accrued expenses and other. + + Tempur World had the following activity for warranties for the ten months +ended October 31, 2002: + + + Balance of December 31, 2001 + + +$ +3,324 + + + Amounts accrued + + + +2,646 + + + Returns charged to accrual + + + +(3,090 +) + + + + + Balance as of October 31, 2002 + + +$ +2,880 + + + + + + + Tempur-Pedic +International had the following activity for warranties for the two months ended December 31, 2002 and the twelve months ended December 31, 2003, respectively: + + + Balance as of November 1, 2002 + + +$ +2,880 + + + Amounts accrued + + + +256 + + + Warranties charged to accrual + + + +(255 +) + + + + + Balance as of December 31, 2002 + + + +2,881 + + + Amounts accrued + + + +3,382 + + + Warranties charged to accrual + + + +(2,243 +) + + + + + Balance as of December 31, 2003 + + +$ +4,020 + + + + + + + (m) Income +Taxes Deferred tax assets and liabilities are recognized for the future tax impacts attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. +Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities +of a change in tax rates is recognized in the Consolidated Statements of Income in the period that included the enactment date. In accordance with SFAS 5, Accounting for Contingencies, the Company accrues for probable foreign and +domestic tax obligations as required by facts and circumstances in the various regulatory environments. + + (n) Revenue Recognition Sales of products are recognized when the products are shipped to customers and the risks and rewards of ownership are +transferred. No collateral is required on sales made in the normal course + + + + F-12 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + of business. Allowance for doubtful accounts was $2,518 and $4,193 as of December 31, 2002 and 2003, respectively. Deposits made by +customers are recorded as a liability and recognized as a sale when product is shipped. Tempur-Pedic International had $4,202 and $4,639 of deferred revenue included in Accrued expenses and other as of December 31, 2002 and 2003, respectively. + + + Tempur-Pedic International reflects all amounts billed to +customers for shipping and handling in Net sales and the costs incurred from shipping and handling product in Cost of sales. Amounts included in Net sales for shipping and handling were $2,028 and $18,415 for the two months ended December 31, 2002 +and the twelve months ended December 31, 2003, respectively. Amounts included in Cost of sales for shipping and handling were $5,135 and $43,624 for the two months ended December 31, 2002 and the twelve months ended December 31, 2003, respectively. + + + Tempur World reflects all amounts billed to customers for +shipping and handling in Net sales and the costs incurred from shipping and handling product in Cost of sales. Amounts included in Net sales for shipping and handling were $7,900 and $9,553 for the twelve months ended December 31, 2001 and the ten +months ended October 31, 2002, respectively. Amounts included in Cost of sales for shipping and handling were $19,600 and $20,096 for the twelve months ended December 31, 2001 and the ten months ended October 31, 2002, respectively. + + (o) Advertising Costs Tempur-Pedic International expenses +advertising costs as incurred except for production costs and advance payments, which are deferred and expensed when advertisements run for the first time. Direct response advance payments are deferred and amortized over the life of the program. +Advertising costs charged to expense were $8,937 and $65,180 for the two months ended December 31, 2002 and the twelve months ended December 31, 2003, respectively. Advertising costs deferred and included in Prepaid expenses and other current assets +were $1,094 and $4,473 as of December 31, 2002 and 2003, respectively. + + Tempur World expensed all advertising costs as incurred except for production costs and advance payments, which were deferred and expensed when advertisements run for the first time. Direct response advance payments are deferred and +amortized over the life of the program. Advertising costs charged to expense were $31,459 and $37,003 for the twelve months ended December 31, 2001 and the ten months ended October 31, 2002, respectively. + + (p) Research and Development Expenses Research and development +expenses for new products are expensed as they are incurred. + + (q) Stock-Based Compensation The Company has adopted SFAS 123, Accounting for Stock Based Compensation (SFAS 123). In accordance with SFAS 123, the Company has elected to account for employee stock and option +issuances under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Under APB 25, no compensation expense is recognized in the statements of income for stock options granted to employees and +non-employee directors, if the exercise price at least equals the fair value of the underlying stock on the date of grant. + + Certain options granted during the year prior to the Company s initial public offering have exercise prices that are less than the deemed market +value of the underlying common stock at the date of grant. The unearned stock-based compensation will be amortized to compensation expense over the respective vesting term, based on the graded vesting methodology. The Company has +recorded unearned stock-based compensation of $8,935 as of December 31, 2003. The Company recorded $4,078 of compensation expense for the year ended December 31, 2003, which is included in General and Administrative Expenses in the Consolidated +Statements of Income. The future amortization of unearned stock-based compensation costs will be $5,171 in 2004, $2,445 in 2005, $1,105 in 2006 and $214 in 2007. + + + F-13 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + Stock options are granted under various stock compensation programs to employees. For purposes of pro forma disclosures, the +estimated fair value of the options is amortized to expense over the options vesting period. + + During July 2003 and November 2003, the Company s Board of Directors (Board of Directors) authorized the accelerated vesting of options granted to +certain employees under the Company s 2002 Stock Option Plan (Option Plan). This acceleration resulted in the immediate vesting of options granted to certain employees that would otherwise have vested within the next year. Under the original +terms of the Option Plan, unvested options are forfeited upon separation of employment. In accordance with APB 25, the Company has recognized compensation expense based on its estimate of the number of options that the holders ultimately will retain +that otherwise would have been forfeited, absent the notification. + + Pro forma information in accordance with SFAS 123 for Tempur World for the twelve months ended December 31, 2001 and the ten months ended October 31, 2002 and for Tempur-Pedic International for the two months ended December 31, 2002 and the +twelve months ended December 31, 2003, is as follows: + + + + +Predecessor + + + + + + + + + Twelve Months + Ended +December 31, +2001 + + + + Ten Months + Ended +October 31, +2002 + + + + Two Months + Ended +December 31, + 2002 + + + + Twelve Months + Ended +December 31, + 2003 + + + + Net income (loss) as Reported + + +$ +11,857 + + +$ +19,941 + + +$ +(3,247 +) + +$ +37,575 + + + Add: Stock-based employee compensation expense included in reported net income + + + + + + + + + + + + + + + +4,078 + + + Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards + + + +(278 +) + + +(400 +) + + +(1 +) + + +(5,469 +) + + + + + + + + + + + Pro forma net income (loss) + + +$ +11,579 + + +$ +19,541 + + +$ +(3,248 +) + +$ +36,184 + + + + + + + + + + + + (Loss) earnings per share as reported: + + + + + + + + + + + + + + + + + + + Basic + + + + + + + + + + +$ +(0.67 +) + +$ +3.32 + + + + + + + + + + + + + + + + Diluted + + + + + + + + + + +$ +(0.67 +) + +$ +0.39 + + + + + + + + + + + + + + + + Pro forma net (loss) income basic + + + + + + + + + + +$ +(0.67 +) + +$ +3.19 + + + + + + + + + + + + + + + + Pro forma net (loss) income diluted + + + + + + + + + + +$ +(0.67 +) + +$ +0.38 + + + + + + + + + + + + + + + + + The Company has +omitted Tempur World earnings per share, as such information is not meaningful due to the change in capital structure that occurred with the Tempur Acquisition. + + +(2) Business Combinations + + On November 1, 2002, Tempur-Pedic International acquired Tempur World. The total acquisition price of Tempur World as of the Tempur Acquisition closing +date was $268,484 (an additional payment of $39,434 was made in 2003 pursuant to the Merger Agreement), including $14,166 of transaction fees and expenses. The Tempur Acquisition was financed with approximately $146,639 in cash proceeds of newly +issued Series A convertible preferred stock and Class A common stock and $107,679 of incremental senior and mezzanine debt borrowings, net of $5,752 of Tempur World s cash. The Company also refinanced $88,817 of existing debt obligations of +Tempur World. In addition, certain of the former stockholders of Tempur World contributed their shares of common stock of Tempur World to the Company immediately prior to the Tempur Acquisition in + + + + F-14 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + exchange for Class A common stock of the Company. The Company has applied the provisions of Emerging Issues Task Force 88-16, Basis in +Leveraged Buyout Transactions, whereby the carryover equity interests of certain management stockholders from Tempur World were recorded at their historical basis. The application of these provisions reduced Additional paid in capital and +Goodwill by $9,385. + + The following table summarizes the final +aggregate fair values of the assets acquired and liabilities assumed at the date of acquisition: + + + Accounts receivable + + +$ +43,662 + + + Inventories + + + +46,666 + + + Other current assets + + + +4,290 + + + Property, plant and equipment + + + +86,277 + + + Identifiable intangible assets + + + +86,261 + + + Other assets + + + +9,245 + + + Accounts payable + + + +(17,070 +) + + Accrued expenses + + + +(27,515 +) + + Deferred taxes + + + +(42,915 +) + + Other current liabilities + + + +(4,812 +) + + Long term debt + + + +(88,817 +) + + Other non-current liabilities and other + + + +(5,285 +) + + + + + + + +89,987 + + + Adjustment for carryover basis of continuing stockholders + + + +9,385 + + + Goodwill + + + +208,546 + + + + + + Aggregate purchase price + + +$ +307,918 + + + + + + + The Tempur Acquisition +was accounted for as a purchase in accordance with SFAS No. 141, and Tempur-Pedic International has allocated the purchase price based upon the fair values of the net assets acquired and liabilities assumed. The changes in the carrying amount of +Goodwill for the twelve months ended December 31, 2003 are as follows: + + + Balance as of December 31, 2002 + + +$ +164,644 + + + Foreign currency translation adjustments + + + +(180 +) + + Payment on earnout to former owners + + + +39,434 + + + Other purchase accounting adjustments + + + +4,648 + + + + + + Balance as of December 31, 2003 + + +$ +208,546 + + + + + + + Goodwill has been +allocated to the Domestic and International segments as follows: + + + Domestic + + +$ +92,316 + + International + + + +116,230 + + + + + Total + + +$ +208,546 + + + + + + (3) New Accounting Standards + + + In January 2003, the Financial Accounting Standard Board +(FASB) issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). FIN 46 requires an + + + + F-15 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + entity to consolidate a variable interest entity if it is designated as the primary beneficiary of that entity even if the entity does not +have a majority of voting interests. A variable interest entity is generally defined as an entity where its equity is unable to finance its activities or where the owners of the entity lack the risk and rewards of ownership. The provisions of this +statement apply at inception for any entity created after January 31, 2003. In December 2003, the FASB issued FIN 46, as revised, which modified the effective date for implementation. In accordance with this revised standard, the Company plans to +adopt FIN 46 on March 31, 2004 and does not expect its adoption to have a material impact on the consolidated financial statements. + + In April 2002, the FASB issued SFAS 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical +Corrections (SFAS 145). SFAS 145 was effective January 1, 2003. SFAS 145 eliminates the required classification of gain or loss on extinguishment of debt as an extraordinary item of income and states that such gain or loss be evaluated for +extraordinary classification under the criteria of Accounting Principles Board Opinion No. 30, Reporting Results of Operations (APB 30). SFAS 145 also requires sale-leaseback accounting for certain lease modifications that have economic +effects that are similar to sale-leaseback transactions, and makes various other technical corrections to existing pronouncements. The adoption of SFAS 145 did not have a significant impact on our consolidated financial statements. + + In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated +with Exit or Disposal Activities (SFAS 146). This statement nullifies Emerging Issues Task Force Issue (EITF) 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain +Costs Incurred in a Restructuring) (EITF Issue 94-3). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity is recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost +was recognized at the date of an entity s commitment to an exit plan. SFAS 146 had no impact on the Company s consolidated financial statements during 2003. However, future periods could be impacted by qualifying activities. + + In November 2002, the FASB issued Interpretation No. 45, + Guarantor s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others an interpretation of FASB Statements No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34 +(FIN 45). FIN 45 elaborates on the disclosures to be made regarding obligations under certain issued guarantees by a guarantor in interim and annual financial statements. It also clarifies the requirement of a guarantor to recognize a liability at +the inception of the guarantee at the fair value of the obligation. FIN 45 does not provide specific guidance for subsequently measuring the guarantor s recognized liability over the term of the guarantee. The provisions relating to the initial +recognition and measurement of a liability are applicable on a prospective basis for guarantees issued or modified subsequent to December 31, 2002. The disclosure requirements of FIN 45 are effective for interim and annual financial statements for +periods ending after December 15, 2002. This did not have a significant impact on our consolidated financial statements. + + In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based Compensation Transition and Disclosure an Amendment of FASB +Statement 123 (SFAS 148), which was effective on December 31, 2002. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based compensation. In addition, it amends +the disclosure requirements of SFAS 123 to require prominent disclosures about the method of accounting for stock-based compensation and the effect of the method on reported results. The provisions regarding alternative methods of transition do not +apply to the Company, which accounts for stock-based compensation using the intrinsic value method. + + In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS 149). SFAS 149 +amends and clarifies accounting for derivative instruments, + + + + F-16 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. The new guidance amends +SFAS 133, (a) in connection with other Board projects dealing with financial instruments and (b) regarding implementation issues raised in relation to the application of the definition of a derivative that contains financing components. The +amendments set forth in SFAS 149 are generally effective for contracts entered into or modified after June 30, 2003. The guidance is to be applied prospectively. The adoption of SFAS 149 did not have a significant impact on the Company s +consolidated financial statements. + + In May 2003, the FASB +issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (SFAS 150). SFAS 150 improves the accounting for certain financial instruments that, under previous guidance, issuers could +account for as equity. The new guidance requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003. Application of +SFAS 150 to financial instruments that exist on the date of adoption should be reported through a cumulative effect of a change in an accounting principle by measuring those instruments at fair value or as otherwise required by SFAS 150. The +adoption of SFAS 150 did not have a significant impact on the Company s consolidated financial statements. + + (4) Supplemental Cash Flow Information + + Cash paid for interest and cash paid for income taxes was as follows: + + + + +Predecessor + + + + + + + Twelve Months + Ended +December 31, +2001 + + + Ten Months + Ended +October 31, +2002 + + + Two Months + Ended +December 31, +2002 + + + Twelve Months + Ended +December 31, +2003 + + Interest + + +$ +6,465 + +$ +5,382 + +$ +551 + +$ +15,205 + + Income taxes, net of refunds + + +$ +5,257 + +$ +13,769 + +$ +1,843 + +$ +33,146 + + + (5) Property, Plant and Equipment + + + Property, plant and equipment, net consisted of the +following: + + + + +December 31, + + + + + +2002 + + + +2003 + + + + Land and buildings + + +$ +45,519 + + +$ +50,722 + + + Machinery and equipment + + + +43,798 + + + +55,060 + + + Construction in progress + + + +1,079 + + + +26,431 + + + + + + + + + + +90,396 + + + +132,213 + + + Accumulated depreciation + + + +(2,110 +) + + +(17,472 +) + + + + + + + + +$ +88,286 + + +$ +114,741 + + + + + + + + + The amounts above +include capitalized interest costs on self-constructed assets for Tempur-Pedic International of $475 for the twelve months ended December 31, 2003 and for Tempur World of $1,057 for the twelve months ended December 31, 2001. These costs will be +amortized on a straight line basis over the estimated useful life of related assets. + + + F-17 + +Table of Contents + + TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES + + NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) + + (In thousands except share and per share data) + + (6) Long-term Debt + + On August 15, 2003, the Issuers, wholly-owned subsidiaries of Tempur-Pedic International, issued $150,000 of Senior Subordinated Notes as part of a +re \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/TCMFF_telecom_legal_matters.txt b/parsed_sections/legal_matters/2004/TCMFF_telecom_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2815926e20c85fdd1d41d01cade22f22306b1157 --- /dev/null +++ b/parsed_sections/legal_matters/2004/TCMFF_telecom_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Legal matters will be passed upon for us by Marval, O Farrell & Mairal and Estudio Alegria, Buey Fern ndez, Fissore y Montemerlo S.R.L., our Argentine legal counsel, Gianni, Origoni, Grippo & Partners, our Italian legal counsel and by Davis Polk & Wardwell, New York, New York, our United States legal counsel. Legal matters will be passed upon for the solicitation agents by Sidley Austin Brown & Wood LLP, New York, New York, United States legal counsel to the solicitation agents. As to all matters of Argentine law and Italian law, Davis Polk & Wardwell may rely on the opinion of Marval, O Farrell & Mairal, Estudio Alegria, Buey Fern ndez, Fissore y Montemerlo S.R.L., our Argentine counsel, and, as to all matters of Italian law Gianni, Origoni, Grippo & Partners, our Italian legal counsel, respectively. As to all matters of United States law and Italian law, Marval, O Farrell & Mairal and Estudio Alegria, Buey Fern ndez, Fissore y Montemerlo S.R.L. may rely on the opinion of Davis Polk & Wardwell and Gianni, Origoni, Grippo & Partners, our New York and Italian legal counsel, respectively. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/TPC_tutor_legal_matters.txt b/parsed_sections/legal_matters/2004/TPC_tutor_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..316161244ea2f0e0b43a21c5084d5f4522191d03 --- /dev/null +++ b/parsed_sections/legal_matters/2004/TPC_tutor_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon by Goodwin Procter LLP, Boston, Massachusetts. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/UTI_universal_legal_matters.txt b/parsed_sections/legal_matters/2004/UTI_universal_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..2c585e5e1c828d1bfcf6ee58387b30c2d5ea924b --- /dev/null +++ b/parsed_sections/legal_matters/2004/UTI_universal_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Bryan Cave LLP, Phoenix, Arizona. The underwriters have been represented by Cravath, Swaine Moore LLP, New York, New York. \ No newline at end of file diff --git a/parsed_sections/legal_matters/2004/WLK_westlake_legal_matters.txt b/parsed_sections/legal_matters/2004/WLK_westlake_legal_matters.txt new file mode 100644 index 0000000000000000000000000000000000000000..67692582c98bb9d7a7aead54c3a32e56bb83969a --- /dev/null +++ b/parsed_sections/legal_matters/2004/WLK_westlake_legal_matters.txt @@ -0,0 +1 @@ +LEGAL MATTERS Certain legal matters in connection with the offering will be passed on for us by Baker Botts L.L.P., Houston, Texas and for the underwriters by Latham Watkins LLP, New York, New York. \ No newline at end of file